LEUNG TUNG HOI AND ANOTHER v. LAI YIP DYEING FACTORY LTD AND OTHERS

CACV 54/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 54 OF 2015

(ON APPEAL FROM HCMP 2054 OF 2012)

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REASONS FOR JUDGMENT
AND DECISION ON COSTS

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Hon Barma JA (giving the Reasons for Judgment and Decision on Costs of the Court):

1.  This was an appeal by the 1^st and 2^nd applicants, Leung Tung Hoi and Lee Cheuk Kwon, against the judgment of Harris J dated 6 February 2015, by which the judge dismissed their application for leave pursuant to section 168BC of the Companies Ordinance (Cap 32) to commence a derivative action on behalf of the 1^st respondent, Lai Yip Dyeing Factory Limited (“the Company”), against the 2^nd to 5^th respondents. At the conclusion of the appeal, we allowed the appeal, and having heard the parties on costs, reserved our decision on costs to be handed down together with the reasons for our judgment. These are our reasons for allowing the appeal, and our decision on costs. The delay in handing down these reasons is regretted.

2.  The background to these proceedings can be summarised as follows:

(1) The Company carries on business dyeing and processing yarn that it acquires from suppliers.  Initially it did so in Hong Kong, but since the 1990s it has done so on the Mainland, in Panyu, through a joint venture company.

(2) The applicants were directors of the Company from its incorporation in 1986 until April and May 2011, when they were removed as directors.  They were also members of the board of the joint venture company until their removal, also in April and May 2011.

(3) The 2^nd respondent has been a director of the Company since 2006, and the 5^th respondent, his cousin, is alleged to be the ultimate owner of the 3^rd and 4^th respondents, which between them own all of the ordinary shares in the Company.  The Company also has non-voting shares, some 89% of which are owned by the applicants, with about 11% being owned by the 3^rd respondent.  The non-voting shares give the applicants an economic interest in the Company, but no influence over its operation or management qua shareholders.

(4) The applicants contend that the Company built up large stocks of yarn over a period of years, but that an audit of such stocks carried out in July 2011 revealed that substantial amounts of such stocks had gone missing (according to the audit report, some 6,300 odd metric tons of yarn had disappeared without explanation).

(5) The applicants contend that the 2^nd respondent is responsible for the missing yarn, their case being that he misappropriated it and disposed of it at an undervalue.  They further contend that the 5^th respondent conspired with the 2^nd respondent to do this, and that the 3^rd, 4^th and 5^th respondents dishonestly assisted in what amounted to a fraudulent breach of fiduciary duty by the 2^nd respondent, by failing to take any steps to stop his misconduct.  On this basis, they seek to claim, derivatively on behalf of the Company, for the losses that they say have been caused to it.  Allegations were also made to the effect that the 2^nd respondent had caused monies which should have been paid to the Company in respect of disposals from its stocks of yarn to be paid into his personal accounts, based on a statement provided by a third party who claimed to have been involved in transactions involving the Company’s stocks of yarn.

(6) The 2^nd to 5^th respondents’ position was to deny the allegations, and to contend that any missing yarn was lost due to wastage in the processing of the yarn.  They alleged that it was well-known that some loss was inevitable when yarn was being processed, and that the Chinese customs authorities had accepted varying levels of wastage from time to time (first 2.5%, then 4.5% and eventually 7%), when assessing whether or not the stocks actually held were in accordance with the quantities declared to the authorities so as to determine whether taxes and duties were payable on amounts of yarn which could not be accounted for.  It was suggested that allowing for wastage at 7%, the whole of the allegedly missing amount could be substantially accounted for.  Reliance was also placed on the fact that the 2^nd respondent, having at one stage been arrested, had had the case against him dismissed.  The 2^nd to 5^th respondents also contended that there was no basis on which the 3^rd and 4^th respondents, as mere shareholders, could have any liability to the Company.

3.  The judge observed that the principal questions for his consideration were whether it was prima facie in the interests of the Company for the proposed action to be brought, and whether there was a serious question to be tried.  He also noted that the threshold to be surmounted in relation to both of these questions was not a high one, and that it was not the court’s function in such an application to do more than decide whether or not there was an arguable case, pointing out that it was not for the court to carry out a mini trial on the basis of the affidavit evidence.

4.  The judge then considered the question of whether or not there was a serious question to be tried.  He dealt briefly with the claim against the 3^rd and 4^th respondents, who were shareholders of the Company, pointing out that it was difficult to see what relevant duty they might be under in their capacity as shareholders.  While accepting that a claim might potentially be framed as a claim for relief against unfairly prejudicial conduct, he observed that no such claim was being advanced, and so did not need to be considered.  He accordingly concluded that the proposed action did not disclose any claim against the 3^rd and 4^th respondents which raised any serious question to be tried, and dismissed the application as against them.

5.  So far as the 2^nd and 5^th respondents were concerned, the judge considered the claim against them in respect of the missing stocks of yarn and their response to it, and, having evaluated in some detail the merits of that claim, expressed the view that while on the face of the proposed statement of claim there might appear to be an arguable claim against the 2^nd respondent, when the evidence which was before him was taken into account, the claim was one which had no prospect of success.  It was therefore not one which it could be in the Company’s interests to bring.  In coming to this conclusion, the judge expressed some doubt as to the accuracy of calculations by the Company’s auditors as to the extent of the discrepancy between the stock as recorded (and registered with Mainland customs authorities) and as actually existing in the Company’s warehouse, and also expressed the view that much of that discrepancy must have been accounted for by wastage, and that much of such wastage must have occurred before the 2^nd respondent had assumed office as a director of the Company.

6.  Mr Cheung, appearing for the applicants, submitted that the judge had erred by going into the evidence in detail, in order to assess the strength or otherwise of the applicants’ proposed claim on behalf of the Company.  He submitted that all that was necessary at this stage was to consider whether or not there was a serious question to be tried, and emphasised that having regard to the existence of the auditor’s report, which identified the existence of a large discrepancy between the recorded and actual stock, the evidence of the third party to the effect that there had been sales of such stock the proceeds of which had been paid into the 2^nd respondent’s personal bank accounts, and the fact that the 2^nd and 5^th respondents’ version of events was disputed by the applicants, it was clearly the case that there was a serious question to be tried. 

7.  Mr Cheung also pointed out that the judge had adopted a relatively high wastage rate of 7%, which was also disputed by the applicants, and that even using that rate, there remained a discrepancy (albeit a smaller one) which could not be fully accounted for.

8.  So far as the claims against the other respondents were concerned, Mr Cheung submitted that the claim against the 5^th respondent was broadly similar to those against the 2^nd respondent, as it was the applicants’ case that the 2^nd and 5^th respondents had been jointly involved in the misappropriation of the Company’s yarn stocks.  As for the claims against the 3^rd and 4^th respondents, he submitted that the claim as pleaded was that they had assisted in the 2^nd and 5^th respondents’ dishonest breaches of duty by failing to take any steps to prevent them or to investigate, and by causing the applicants to be removed as directors of the Company – a claim which the judge had not dealt with.

9.  In response, Mr Hui, who represented the 2^nd to 5^th respondents, urged that as the appeal was against the exercise of the judge’s discretion, this court should not depart from it unless there had been some error of principle in the judge’s approach.  He also submitted that the appeal was an appeal against findings of fact made by the judge after he had considered all of the evidence before him, so that this court should be very slow to interfere, and should do so only if satisfied that the judge’s conclusions were plainly wrong.  In support of this latter submission, Mr Hui relied on the well-known decision of the Court of Final Appeal in Ting Kwok Keung v Tam Dick Yuen (2002) 5 HKCFAR 336 and a number of cases in this court in which the “plainly wrong” test was applied to the drawing of inferences as well as to the finding of primary facts (such as Pang Ketian Sally v Tam Yuk Hung Annie (CACV 147/2013)).

10.  The latter submission by Mr Hui is misconceived.  Ting Kwok Keung and the Court of Appeal decisions applying it all concerned appeals against findings of fact made at trial, after hearing the witnesses and considering all of the documentary evidence before the trial judge.  The approach there laid down cannot be directly applied to an application such as the present.  Indeed, it makes no sense to seek to apply it to the present situation, where the task of the judge is simply to consider whether or not there exists a serious question to be tried.  It is no part of the judge’s function (as the judge rightly recognised) in such an application to make any findings of fact at all.

11.  As for Mr Hui’s argument that the judge’s exercise of discretion should be respected, we of course accept that this court should not readily interfere with an exercise of discretion, and should do so only if some error of law is identified, or if the exercise of discretion was plainly wrong.  However, in this case, with respect, it seems to us that the judge was in error in going into the evidence in the depth that he did, and coming to conclusions as to the merits of the claim against the 2^nd (and by extension, the 5^th) respondent, when the arguments put forward by the 2^nd respondent were very much disputed by the applicants.  Thus, in relation to the difficulties which the judge had with the report by the Company’s auditors, it seems to us that the existence of such difficulties could not be resolved on the papers at this stage, and called for further investigation and evidence from the auditors, which would be forthcoming in the event of a trial, rather than treating it as inherently improbable.  Similarly, so far as the possible explanation of loss of yarn through wastage was concerned, this too was a matter that called for further investigation and evidence, particularly when the figures being suggested by the respondents were disputed by the applicants.  Additionally, the judge does not seem to have dealt with the allegations of misappropriation involving sales of yarn and payment of proceeds into the 2^nd respondent’s personal accounts.  In these circumstances, while we appreciate that the judge may have seen little benefit to the Company in having what appeared to him to be weak claims pursued on its behalf, even if one were to accept that the claims were not particularly strong (as to which we express no views), we do not think that they could be said to be so weak as to raise no serious question to be tried.

12.  As the claims against the 5^th respondent are based on his alleged participation in the misfeasance or breach of duty of the 2^nd respondent, it seems to us that the claims against him should similarly be permitted to proceed.

13.  As for the claims against the 3^rd and 4^th respondents, the judge did not deal with the claim as actually formulated in the applicants’ proposed pleading.  While we would not say that the claim for dishonest assistance is free from difficulty, we would not, at this stage be prepared to say that it does not raise any serious question to be tried.  We therefore think that it too should be allowed to proceed for the present.

14.  For the foregoing reasons, we allowed the appeal.

15.  So far as costs are concerned, although Mr Hui submitted that costs should only be awarded against the 2^nd and 5^th respondents, this was on the basis that there were no claims that could proceed against the 3^rd and 4^th respondents.  As we have allowed the appeal in its entirety, in respect of the claims against all the respondents (other than the Company), we think that the appropriate costs order would be that the 2^nd to 5^th respondents should pay the applicants’ costs of this appeal and in the court below.