SECURITIES AND FUTURES COMMISSION v. QUNXING PAPER HOLDINGS COMPANY LTD AND OTHERS

HCA 2428/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2428 OF 2013

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R E A S O N S   F O R   D E C I S I O N

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1.  On 12 December 2013, the plaintiff (“SFC”) obtained a mareva injunction restraining the 1^st defendant (“Qunxing”) and its wholly owned subsidiary, the 2^nd defendant (“Best Known”), from disposing of their assets up to the value of HK$1,968,000,000. The injunction has since been varied several times. The 3^rd defendant (“Zhu YG”) and the 4^th defendant (“Zhu MQ”), the former Chairman and Vice Chairman of Qunxing respectively, were joined in April 2014.

2.  3 summonses were before me:

(1) By the summons dated 3 June 2014, Qunxing and Best Known applied for further variation of the injunction to allow them to make use of the funds in Hong Kong frozen by the injunction to defray their legal expenses incurred and to be incurred (so called “the Allowance Application”)[1].

(2) By the summonses dated 3 June 2014 and 5 June 2014, Qunxing and Best Known applied to join their banker (“ICBC”) for the purpose of an order obliging ICBC as a party to release the money from their bank accounts to their solicitors for the settlement of legal expenses pursuant to the previous orders of the court (so called “the Banker Application”)[2].

3.  At the end of the hearing, I allowed the Banker Application; but dismissed the Allowance Application.  I now give my reasons.

BACKGROUND

4.  Briefly, as a result of investigation into the affairs of Qunxing, a company listed on the Main Board of the Hong Kong Stock Exchange, the SFC commenced this action against Qunxing and Best Known.  The claim is essentially that the Qunxing has misled the public by exaggerating its turnover by gross overstatement of sales through its operational arm, Shandong Qunxing (“the Shandong Subsidiary”), before and after its offer for public subscription.

5.  Since the mareva injunction was granted, it has been varied several times upon the applications by Qunxing and Best Known.  The last variation was granted by Mr Recorder Houghton SC on 23 January 2014.  In the learned Recorder’s written decision of that date, the background of this case was set out, which I would not repeat herein.  Suffice it to say that substantial sums have been allowed to be paid out of the frozen assets to fund the ordinary business expenses of the companies.

6.  In respect of legal expenses, the injunction was varied:

(1) by the order of DHCJ Ng on 20 December 2013 allowing a lump sum of HK$500,000 for both companies;

(2) by the order of Chung J on 3 January 2014 allowing a further sum of HK$1 million for both companies; and

(3) by the order of Mr Recorder Houghton SC on 23 January 2014 allowing a further sum of HK$1 million for both companies plus HK$1.5 million per month for Qunxing and HK$150,000 per months for Best Known from 1 January 2014 to 30 April 2014.

7.  Now the companies sought the following further variations allowing payment out of the frozen assets:

(1) A further sum of HK$2.346 million for legal expenses allegedly incurred by Qunxing from 10 May 2014 to today;

(2) A further sum of HK$212,900 for legal expenses allegedly incurred by Best Known from 10 May 2014 to today;

(3) A monthly sum of HK$2.363 million towards legal expenses to be incurred by Qunxing from June 2014 to February 2015; and

(4) A monthly sum of HK$227,000 towards legal expenses to be incurred by Best Known from June 2014 to February 2015.

8.  The SFC opposed the application.  So did the Joint and Several Interim Receivers and Managers of the 2 companies (“IR”)[3].

THE PRINCIPLES

9.  The principles have been rehearsed in the written decisions of DHCJ Ng dated 20 December 2013 and Mr Recorder Houghton SC dated 23 January 2014.  I reiterate what Gee, Commercial Injunctions (5^th ed), says (at §§20.054-20.055):

“ The correct test is to consider objectively the overall justice of allowing the payment to be made including the likely consequences of permitting it on the prospects of a future judgment being left unsatisfied, and bearing in mind that the assets belong to the defendant and that the injunction is not intended to provide the claimant with security for his claim or to create an untouchable pot which will be available to satisfy an eventual judgment.

Therefore, the principle is that a defendant can use its own money which is frozen under a Mareva injunction to fund the defence provided that it is apparent that there are no other funds or source of payment which should as a matter of objective fairness be used to pay for the defence rather than the frozen funds. This may require the defendant to adduce ‘credible evidence’ about his other assets before the court can be satisfied that it is just that he should be able to use the particular frozen assets.

Because a real risk of dissipation has already been established by the evidence, judges are entitled to have a “very healthy scepticism” about assertions made by the party against whom the Mareva injunction has been granted, and this should be borne in mind in deciding whether further evidence should be required. If in addition the defendant has been less than frank in his dealings with the court or the claimant over legal or living expenses, this would tend to reinforce the case for putting in place a regime requiring the defendant to adduce evidence showing a complete picture each time he requires further funds, thus enabling the court to police the payments.”

Hong Kong Civil Procedure 2014 Vol.1 at §29/1/79 reads:

“……In considering whether the defendant has other assets available to meet expenses, the court is not limited to the funds to which the defendant has a strict legal right if there are reasonable grounds for believing that the defendant can obtain money elsewhere, including in appropriate cases, by lifting the corporate veil to take into account the resources of the defendant’s parent company.

……

……Where the defendant has hidden away substantial assets overseas, it would be unjust to permit the defendant to use the assets subject to a Mareva injunction to pay expenses……The court must seek to balance the risk of deliberate dissipation of frozen assets by the defendant against abuse of the freezing order to pressurize the defendant illegitimately……”

DISCUSSION

10.  In line with the above principles, the SFC asked me to have a healthy skepticism about the assertions and evidence in support of the companies’ present application.  I did no less than that.

11.  Qunxing and Best Known described the present application as one of continuation or extension of the order last made by Mr Recorder Houghton SC.  I would hence start with the decision of the learned Recorder.

12.  Mr Wong SC (appearing with Mr Dawes) for the SFC has succinctly summarized in his submissions the significant parts of that decision which explained why the learned Recorder last allowed the variation in those terms.  In this respect, the learned Recorder referred to the fact that there were substantial assets available in the Shandong Subsidiary which, as mentioned, was the wholly owned operation arm of Qunxing.  Through the Shandong Subsidiary, Qunxing is interested in the majority of the group’s cash in the sum of RMB 655 million and undistributed profits in the sum of RMB1.3 billion.

13.  Mr Li for the companies somehow suggested that the Recorder rejected the SFC’s argument by reference to such substantial assets of the Shandong Subsidiary.  That in my view was inaccurate reading of the decision.  What the Recorder did was indeed taking the substantial assets of the Shandong Subsidiary in account together with the business practice of Qunxing as well as the practical consideration in respect of sourcing the necessary funds from the Shandong Subsidiary to the companies in Hong Kong.  The consideration of these factors prevailing at the time led the Recorder to conclude that the overall justice lied in favour of granting the variation (see §§37 to 40 of the decision).

14.  It is important to note the concluding observation of the learned Recorder.  He acknowledged that whilst it was feasible to transfer the funds from the Shandong Subsidiary to the companies here, it would have had to take at least a couple of months before the money could in fact be made available to the companies.  Therefore the substantial assets of Shandong Subsidiary could have little bearing on a short term application.  However, had he been asked to consider a longer period time, the position in regard to Shandong Subsidiary would have weighed more heavily in his deliberation.

15.  By the present application, the companies were suggesting that the amounts so far allowed up to the end of April 2014 had been spent and the account was in deficit.  They asked for variation to cover a long term, namely from May 2014 up to 2/2015.

16.  In support, the companies argued that the development since the order of the Recorder left them with no alternative but resort to the frozen assets to defray their legal expenses.  Yet such development was exactly what the SFC and the IR asked me to examine with scepticism. And it was not difficult to see why.

17.  In view of the learned Recorder’s observations mentioned above, Qunxing and Best Known would have reasonably been expected to seek from the Shandong Subsidiary further funding of legal expenses in this action in the long run, albeit having to take months as observed by Mr Recorder Houghton SC.  There was no suggestion or evidence of such attempt at all since January 2014.

18.  On the contrary, unannounced to the SFC or the public, an application in the Mainland for the liquidation/restructuring of the Shandong Subsidiary had been made so that it became under receivership on 24 February 2014, just a month after the order of Mr Recorder Houghton SC.  Further, after the SFC’s letter dated 18 March 2014 to Qunxing to inquire into the situation, Zhu YG and Zhu MQ resigned from Qunxing on 21 March 2014.

19.  The SFC then applied ex parte (on notice) for interim receivership and managership of the companies in Hong Kong.  This was granted by To J on 28 March 2014; and continued inter partes by Anthony Chan J on 4 April 2014.  On the same day, Anthony Chan J also dismissed the companies’ application to discharge the injunction.

20.  According to the Mainland legal advice obtained by the SFC, the receivership of the Shandong Subsidiary connotes either insolvency or a predominant likelihood of inability to pay its debts.  The immediate question was, and still is, how the Shandong Subsidiary turned itself from possessing RMB655 million cash and RMB 1.3 billion of undistributed profits into a situation warranting receivership in just a month.  Mr Ng for the IR raised the same question; and expected explanation by the companies in order to come clean of suspected hiding away or dissipating of the assets of the Shandong Subsidiary.

21.  Mr Li referred to his clients’ evidence that the employees were concerned about the group’s future; and made complaint to the Mainland authorities, which led to the receivership.  I found that difficult to understand, in view of the fact that up the time of the order of Mr Recorder Houghton SC, the Shandong Subsidiary still had substantial assets and the injunction was never extended to those assets.

22.  One must also note that this was not a case of application for liquidation or restructuring by the employees or creditors of the Shandong Subsidiary.  According to the documents, it was the Shandong Subsidiary which applied for voluntary liquidation and hence the receivership/ restructuring.

23.  In the circumstances, the companies are effectively relying on the development which was their own making as the basis for their present application.  For this, and against the above background, Qunxing and Best Known had much to explain in discharge of their evidential burden as the applying parties.

24.  Qunxing and Best Known relied on the evidence of their current Chairman and director, Guo Guang Quan (“Quo”), in support of the present application; but he was actually unable to explain the state of affairs surrounding the Shandong Subsidiary.  Until their resignation in March 2014, Zhu YG was the Chairman of Qunxing and the Shandong Subsidiary, while his son, Zhu MQ, was the Vice Chairman of Qunxing and director or the Shandong Subsidiary.  They were in control of the group at the material time; yet were completely silent in respect of what happened.

25.  Quo deposed to the effect that the new directors had made enquiries with the receiver of the Shandong Subsidiary but to no avail.  But there was no evidence that attempt had actually been made to seek the receiver’s consent for allowing the Shandong Subsidiary to fund the legal expenses of its parent company in the present action.  Mr Li did not argue otherwise; but questioned the meaning of such attempt in view of the stance of the receiver there.

26.  Mr Li argued that so long as the current directors of the companies had done all they could, the companies without other financial means should not be prevented from using its own assets to fund its legal expenses for the defence of this action.

27.  I could not agree in the circumstances of this case.  As mentioned, Qunxing and Best Known could only expect their evidence to be subject to healthy scepticism every time when they sought variation of the injunction to allow them to use the frozen assets.  This was not to facilitate abuse or illegitimate pressure on them but to ensure that injunction would remain as meaningful as when it was granted.  If the companies could not provide actual and satisfactory explanation for what has happened to the substantial assets of the Shandong Subsidiary and what appeared to be a self-generated state of inability to source funds from the Shandong Subsidiary to Hong Kong, they could only expect the court to hold that against them in balancing where the overall justice lied.

28.  Mr Wong and Mr Ng also asked me to assess the situation of Qunxing and Best Known in the light of the substantial amounts already allowed out of the frozen assets to be spent by the companies on legal expenses up to the end of April.  In particular, Mr Wong submitted that whilst it was suggested that the balance of the companies with their solicitors was “in the red”, it was an assertion without details.

29.  In my view, Qunxing and Best Known have failed to discharge their burden in significant respects in the present application. Overall justice did not lie in favour of granting the variation in the circumstances.

QUANTUM

30.  Millions out of the frozen assets have so far been allowed for Qunxing and Best Known respectively towards their legal expenses in this action.  This case has just reached the stage of close of pleadings. The companies now sought substantially more; and produced their solicitors’ skeleton bill of costs in support.

31.  Mr Wong criticised the number of fee earners involved and highlighted items which had engaged or would engage excessive number of hours of work.  He also questioned what appeared to be internal inconsistency between items.  Some of them, in my view, were glaring.  He submitted that the quantum projected was patently excessive and utterly unjustifiable.  In the event that variation was allowed, he submitted that the amount allowed should in no way exceed the limit set by Mr Recorder Houghton in January.

32.  Likewise, Mr Ng for the IR asked me to be sceptical about the quantum projected.  He also observed that whilst the skeleton bill presented the alleged legal expenses incurred and to be incurred for the defence of this action, the correspondence with those acting for Qunxing and Best Known suggested that some of the expenses were spent on dealing with the inquiry and investigation by the SFC in exercise of its statutory power. Mr Ng questioned whether such expenses fell within the ambit of the orders of the court in granting the variations, which were for legal expenses for the conduct of defence in this action.

33.  Mr Li explained that the substantial legal expenses had to be incurred in order to “catch up” with the years of investigation conducted by the SFC.  Neither the SFC nor the IR sought to understate the complexity of the case.  Nevertheless, whilst the SFC might have spent years on investigating into the affairs of Qunxing (and the Shandong Subsidiary) previously unknown to it, it sounds odd that Qunxing and Best Known were unable to answer the SFC’s contentions without having to spend like amount of effort on “catching up” with the SFC’s investigation.

34.  I see merits in the arguments advanced by the SFC and the IR in respect of quantum.  But in view of the above conclusion, I need go no further on this.

THE BANKER APPLICATION

35.  As to the Banker Application, that the companies sought to achieve their purpose by way of all 3 summonses was unnecessary and confusing[4]. In any event, ICBC by letter dated 5 June 2014 confirmed no objection to that and would not attend the hearing.

ORDER

36.  I therefore made the following order:

(1) The Allowance Application is dismissed; Qunxing and Best Known shall pay the costs of the SFC and the IR in any event[5]. Costs shall be taxed, if not agreed; and in the case of the SFC, with certificate for 2 counsel.

(2) ICBC is joined as a respondent to the Banker Application; and as such, ICBC shall comply with paragraphs 3 and 4 of the Order made by Anthony Chan J dated April 2014 (as per copies of that Order and (as referred to therein) the Order of Mr Recorder Houghton SC dated 23 January 2014 to be attached to the order made herein).  No order as to costs of this application.

[1] §1 of the summons.  §2 of the summons effectively asked the court to make an order confirming the order of Mr Recorder Houghton SC dated 23 January 2014 for the purpose of the Banker Application (below), which was unnecessary.

[2] §1 of the summons dated 3 June 2014; §§1-2 of the summons dated 5 June 2014 (§2 of this summons was actually identical to §2 of the other summons dated 3 June 2014 referred to above.

[3] The IR first requested to adjourn the matter, whilst both the SFC and the defendants were prepared to proceed.  The IR eventually withdrew the request.

[4] See footnotes 1 and 2 above.

[5] At the hearing, the IR expressed concern about their exposure to costs liability as a result of the application initiated by the former directors of Qunxing and Best Known; and suggested that the former directors should be made personally liable for such costs.  I refrained from doing so.  Pursuant to the order of To J appointing the IR, the former directors of the companies were specifically allowed to conduct the defence in the present action on behalf of the companies.  It will be for the IR at the appropriate stage to consider whether and, if yes, what recourse they have against the former directors for personal liability for such costs.  The request of the IR also could not be entertained without first making the former directors parties in their personal capacities.