Tam Wing Yuen and Another v. Siberian Mining Group Co Ltd and Others

HCA 2694/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2694 OF 2015

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REASONS FOR DECISION

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1.The summons before the court was taken out on 15 March 2016 by Siberian Mining Group Company Ltd (“the Company”), its wholly owned subsidiary Grandvest International Ltd (“Grandvest”) (respectively the 1^st and 2^nd defendants) together with the 5^th, 7^th, 9^th, 10^th and 11^th defendants (collectively “the SMG defendants”) to strike out the statement of claim filed by Tam Wing Yuen (“the 1^st plaintiff”) and Chow Doi Yik Caniel (“the 2^nd plaintiff”) (collectively “the plaintiffs”) suing on behalf of the plaintiffs and all other shareholders of the Company other than the 3^rd defendant Cordia Global Ltd (“Cordia”). At the conclusion of the hearing the court struck out the statement of claim as against the SMG defendants. The reasons appear below.

BACKGROUND FACTS

2.The Company is listed on the main board of The Stock Exchange of Hong Kong Limited.  The 5^th to 11^th defendants (thus including some of the SMG defendants) were the directors of the Company at all material times.

3.Cordia held 90% of the shares in Langfeld Enterprises Ltd (“Langfeld”) which in turn owned 70% of a Russian entity (“the Russian subsidiary”) that held the mining licence for Lot 1 of the Lapichevskaya coalmine (“the mine”), it being anticipated that the Russian subsidiary would later acquire Lot 1 extension (having the same geographical area as Lot 1 but for deeper depths) as well as estimated adjacent areas described as Lot 2.

4.SRK Consulting (“SRK”) carried out an independent review and evaluation of the Lapichevskaya mine project for the Company (then known as Rontex International Holdings Ltd) and on 29 October 2008 published its report.

5.On 31 October 2008, the Company and Grandvest entered into an acquisition agreement (“the agreement”) to acquire Cordia’s 90% shareholding in Langfeld (“the shares”), with Grandvest as purchaser, the Company as guarantor, Cordia as vendor and Cordia’s controlling shareholder, the 4^th defendant, as warrantor.

6.The consideration for the shares was payable by convertible notes issued by the Company.  On completion (which took place on 29 May 2009) US$253 million became payable.  It was satisfied by the issuance of the 1^st Convertible Note (“CN1”).

7.There were two contingent payments:

(1)  Upon the exercise by Cordia of its option to acquire the remaining 10% in Langfeld US$32 million became payable. The 2^nd Convertible Note (“CN2”) was issued in late 2010 to meet that obligation.

(2)  An amount in the sum of US$443.07 million calculated in accordance with clause 4.4 of the agreement became payable (pursuant to clause 4.6) upon the satisfaction of the last of the conditions therein stipulated.  It was satisfied when the 3^rd Convertible Note (“CN3”) was issued on 3 April 2013.

8.On 22 May 2015, Cordia exercised its conversion rights in the principal amount of US$30.8 million and assigned the remaining balance to Daily Loyal Ltd the 12^th defendant on 16 June 2015.

9.On 31 August 2015, the 1^st plaintiff issued a writ in HCA 1990/2015 against, inter alia, the SMG defendants seeking relief similar to that sought in the present action. However, the 1^st plaintiff only became a shareholder on 4 September 2015 when he acquired 1,440,000 shares (representing a 0.28% interest) in the Company.  The 2^nd plaintiff became a shareholder on 1 September 2015 through acquiring 100,000 shares (about 0.019%) in the Company.

10.The 1^st plaintiff discontinued HCA 1990/2015 on 11 September 2015, the Company having announced publicly on 7 September 2015 that the 1^st plaintiff was not its registered shareholder at the date of the writ.

11.The writ in this action was issued on 18 November 2015 making complaints similar to those in the discontinued action (HCA 1990/2015), seeking identical relief.

THE PRESENT ACTION

12.Simply stated, the plaintiffs’ case is that the conditions triggering the obligation to issue CN3 were never met: hence the Company’s obligation to issue CN3.  They seek:

(1)  declarations that

(a)  the HASS report was not one within the meaning of clauses 4.4 and 4.6.2 of the agreement;

(b)  the issuance of CN3 was invalid, void and of no effect;

(c)  the partial allotment of shares under CN3 was also invalid, void and of no effect; and

(2)  injunctions restraining conversion of CN3 into shares.

THE STRIKE OUT SUMMONS

13.The SMG defendants seek an order to strike out the action and submitted that as the plaintiffs have no claim independent from that of the Company and derive nothing personally from the declarations sought, in substance, the action is nothing but a derivative action and not a personal action.

14.To the extent that the action is a derivative action, Mr Kwok who appeared for the SMG defendants challenged the plaintiffs’ locus to bring the present action on the basis that under Cayman Islands law leave to bring a derivative action is a substantive and not merely a procedural requirement.  It is common ground that no leave has been obtained from the Cayman Islands courts to commence a derivative action.

15.Further, and in any event, the plaintiffs have failed to establish a prima faciecase that the company would be likely to succeed if it brought the action itself and that the action falls within an applicable exception to the rule in Foss v Harbottle which must be shown for a common law derivative action.

16.I propose to deal first with the application on the basis that the action is a common law derivative action before considering the question of Cayman leave.

WHETHER PRIMA FACIE CASE ESTABLISHED

(A) Whether Company would be entitled to relief

17.The two conditions stipulated in clause 4.4 of the agreement for the issuance of CN3 are:

(1)  the Russian subsidiary obtaining the mining licence for Lot 2; and

(2)  the issuance of a technical report by a technical expert acceptable to “the Purchaser” (meaning the Company/‌Grandvest) and Cordia “confirming the probable and proved coal reserves of Lot 2 ... being not less than 12,000,000 tonnes (“Certified Reserve”).

18.That the Russian subsidiary obtained the mining licence for Lot 2 on 1 November 2010 is common ground.  It is the second of the conditions that is contentious.

19.On 27 March 2013, HASS Natural Resources Limited (“HASS”) prepared a technical report on Lot 2.  HASS was the technical expert acceptable to Grandvest and Cordia.  At the time of the HASS report, Mr Tso was a member of AusIMM and he had shown a letter from the Exchange stating its acceptance of Mr Tso as a joint‑signatory of the technical report.  Mr Tso had cited his past job references and reports issued for other Hong Kong listed companies that could be cross‑referenced by internet searches.  

20.On 6 June 2016, Mr Tso was expelled from AusIMM as he had been unable or unwilling to provide definitive proof of his qualifications.  But at the relevant time in 2013, there was no reason to doubt his qualifications or credentials and no one had any inkling of his deception.

21.While the plaintiffs have raised numerous points directed at undermining the HASS report and to show that the conditions stipulated in clause 4.4 of the agreement had not been met, I need only focus on the principal ones.

(i)  Reserve estimates: resource or reserve?

22.The HASS report states (at p 108):

“Exploration to date at coal deposit has been successful in the delineation of 14.91 million tonnes of coal (measured plus indicated) in situ resources, and an additional 121.75 million tonnes of inferred resources. The classifications are based on the author’s experience and guidance from internationally accepted standards.

...

We have categorised 14.91 Mt of this coal as a Proved/Probable Reserves at this time. Further amendment to the licence limits and furtherexplorationinthefutureislikelytoresultintheupgradingof Resources to additional Reserves.” (emphasis added)

23.Mr Fung who appeared for the plaintiffs invited attention to the fact that the SRK report attached to the agreement as schedule 7 was expressly incorporated as part of the terms of the agreement.  The phrases “coal resource” and “coal reserve” are defined in Appendix 6 of the SRK report and he submitted that reading those definitions it is clear that “resource includes reserve and not the other way round”.

24.Mr Fung focused on the phrase “in situ resources” in the first of the two passages from §10 of the HASS report set out above used in relation to the delineation of the 14.91 Mt of coal, noting that HASS was there expressly referring to ‘resources’ and not ‘reserves’.  He then referred to the sentence “[t]he Reserves quoted include the quoted Resources” at p 63 of the HASS report, suggesting that it reinforced his argument that HASS was confusing ‘reserves’ and ‘resources’.  It was submitted that given HASS’ confusion over those terms, the HASS report was not a technical report that satisfied the condition in clause 4.4 of the agreement and so could not have triggered the Company’s obligation to issue CN3.

25.The point taken is palpably bad. The HASS report estimated proved and probable reserves to be 14.91 Mt. The estimates are tabulated in §7.7 of the HASS report headed “Coal Reserve Estimation”.  Table 4 reads:

“ Table 4: Reserve Estimate of the Mine on Lot 2 only, 2013

Area	Seam	Resources (Mt)			Reserves (Mt)
		Measured	Indicated	Inferred	Proved	Probable
Lot 2	Kemerovsky	1.57	3.65	36.53	1.57	3.65
	Volkovsky	2.24	5.22	60.88	2.24	5.22
	Vladimirovsky	0.67	1.56	23.34	0.67	1.56
	TOTAL	4.48	10.43	121.75 [sic]	4.48	10.43"

26.It is apparent from Table 4 of §7.7 that the total of “Proved” and “Probable” Reserves of Lot 2 as stated came to 14.91 Mt.  It will be seen that the figures appearing under Reserves are grouped under two sub‑headings, namely, “Proved” and “Probable” while those appearing under Resources are grouped under three sub‑headings, namely, “Measured”, “Indicated” and “Inferred”.  What is clear is that the figures set out under “Proved” and those set out under “Probable” respectively correspond exactly to those stated under the sub‑headings “Measured” and “Indicated” under Resources.  While the terminology used is different, they must be referring to the same subject matter. The only difference between Resources and Reserves is the existence in the former of an additional sub-category under the sub‑heading “Inferred”.

27.That reading is confirmed in §7.3 of the HASS report (at p 61) which deals with coal resource classifications.  It explains how the Russian (GKZ) classification system corresponds to international mineral reporting codes such as those developed by the Institute of Mining, Minerals and Metallurgy (IMMM) and the Code for Reporting of Mineral Resources and Ore Reserves in Australia (the JORC Code).  Measured Resources and Proved Reserves correspond to Russian A + B categories, Indicated Resources and Probable Reserves may correspond to Russian C1 or C2 categories and Inferred Resources may correspond to Russian C2 category or Mineral Resources of P1 category.

28.As regards the sentence at p 63 of the HASS report mentioned in §24 above, suffice it to say that it originated with the SRK 2008 report: see SRK’s Executive Summary, p ii and §5.6 of SRK’s 2008 report at p 24.

29.I do not accept that HASS confused reserves and resources in its evaluation of those estimates.  I consider that point sought to be made regarding “in situ resources” to be hopeless when regard is had to the discussion in the HASS report of GKZ terminology described in §7.4.  Under GKZ terminology Balanced Reserves (in situ resources) are converted into “Industrial Reserves” by deduction of expected mining losses and “[a]ctually, the Industrial Reserves are a part of Balanced Reserves that is economically minable”.

30.For completeness, I would mention that there appears to be an arithmetical error in Table 4 inasmuch as the aggregate of the Inferred Resources amounts to 120.75 Mt and not 121.75 Mt as stated.  However that error is immaterial for present purposes and does not affect the fact that the HASS report does satisfy the condition stipulated in clause 4.4 of the agreement.

(ii)  Alleged lack of requisite borehole drilling information

31.As earlier noted, the mining licence was obtained in November 2010.  It is also common ground that despite some overlap, the geographical area of Lot 2 granted under the licence is very different from and far more extensive than what was thought would be Lot 2 at the time of the SRK report.  That is apparent from a comparison of the plan attached to the SRK report with the plan attached to the 2010 licence both of which can be found in exhibit “HSJ‒19”.  ‌To avoid any misunderstanding, the estimated area should be differentiated from the area granted under the mining licence in 2010 and hereafter, where necessary, they will be referred to as “the estimated Lot 2” and “the actual Lot 2” respectively.

32.The plaintiffs referred to §§13 and 18 of the 2^nd affirmation of Hong Sang Joon a director of the company dated 31 August 2016 (“Hong 2”) where it is stated that sufficient borehole drilling data is necessary for a proper assessment of coal reserves, that in 2008 (the date of the SRK report) SRK noted the lack of such data  and SRK recommended a closer examination of the data for the estimated Lot 2 which, at that date, was an estimated area as no licence had yet been granted by the Russian government. In fact, as is common ground, the actual Lot 2 under the mining licence occupied a different geographical area: its shape and configuration bear little or no resemblance to the estimated Lot 2.

33.For reasons not apparent, that particular paragraph concerning the estimated Lot 2 in the SRK report came to be replicated (at p 37) in the HASS report in §4.2 under the heading “Exploration History” when it would not appear to be apposite given the different geographical area involved. A map of the actual Lot 2 (derived from Appendix 3 to the 2010 mining licence) is at p 29 of the HASS report.

34.As explained in the Executive Summary, work undertaken by HASS for producing its technical report involved reviewing information provided, site visits etc, analysis of the provided data and any additional data and writing the report.

35.According to Hong 2, §§14 and 16, borehole data for the 2010 Lot 2 for reserve estimation purposes only became available after the 2010 auction and the award of the mining licence.  Before the auction the Russian government had conducted certain borehole drilling works and analysis of the estimated coal in the licence area.  Based on expert evaluation, by the time of the 2010 auction, the Russian government had indicated in the auction document that the “amount of reserves of A + B + C1 categories is about 17 Mt” and registered in the state balance in subgroup “a” for Petrovsky area.

36.It should be mentioned that in view of complaint letters SEHK received in about 2014, many of which were from one Charles Zhi (“Mr Zhi”) concerning the mine acquisition and issuance of CN3 similar to those made in the present case, one of the resumption conditions required the Company to conduct an investigation into those complaints including the question whether the issuance of CN3 was valid: see p 6  of the Company’s resumption announcement dated 22 April 2015.

37.As a result, an investigation into the complaints was carried out.  ‌The Company’s auditors engaged another independent technical expert, Roma Oil and Mining Associates Ltd (“Roma”) to carry out a review of the HASS report.  Roma had previously conducted a due diligence report dated 15 January 2014 in relation to the actual Lot 2 for Best State Investments Ltd.

38.Insofar as the plaintiffs complain (at § 40 of the plaintiffs’ written submissions) that “the state of meagre borehole information since 2008 had remained miserably unchanged” and that HASS had been labouring on “no sufficient borehole information on Lot 2”, it would appear that there is no basis for the complaint.  Drillings were conducted in 2012 and 2013 as is apparent from the tabular summary of Roma’s confirmations in its Review Report of 29 May 2014 to be found at pp 10 - 12 of the Company’s resumption announcement dated 22 April 2015.

(iii)  Other complaints

39.I do not consider it necessary for present purposes to address other subsidiary points taken in the written submissions of the plaintiffs and which were not brought up at the hearing itself.  They add up to nothing of note.

40.As regards doubts concerning the expert’s qualifications arising from his recent expulsion from membership of AusIMM, it is far from clear that the estimated coal reserves stated are actually wrong or false.

41.In fact, apart from confirmation from the Roma Review Report dated 29 May 2014, it should be mentioned that in August 2015, GKZ (the Russian State Committee of Reserves) approved the coal reserves of Lot 2 (in respect of open pit mining) to be approximately 14.3 Mt and more recently, on 11 August 2016, a new technical report obtained by the Company from a reputable technical expert estimated the probable coal reserves of Lot 2 at 14.47 Mt.

42.For all those reasons, I do not consider the plaintiffs have shown a prima facie case that the Company would be entitled to the relief claimed to set aside CN3.

(B)  Whether action falls within an exception to the rule in Foss v Harbottle

43.This question can be dealt with briefly.

44.The plaintiffs appear to rely on the ultra vires exception contending that the issuance of CN3 was invalid or void.  That the directors had power to issue convertible notes for the Company appears to be accepted.  It is to be noted that there is no complaint about the issuance of CN1 and CN2.  In my view, absent fraud and/or wrongdoer control on the part of the directors responsible for the misfeasance, none of the exceptions to the rule would apply.

45.In so far as it is asserted that the conversion shares were allotted below the nominal or par value of the Company’s shares, it would not appear to have been the case as the conversion shares were allotted at $48 per share when the nominal / par value was $0.20 per share.

Consequential causes of action

46.The consequential causes of action said to arise are premised on the plaintiffs’ case that the Company’s obligation to issue CN3 never arose.  As no prima facie case has been shown that CN3 should never have been issued, those causes of action do not arise for consideration.

Conclusion

47.For the reasons set out above, I am of the view that the plaintiffs have not met the requirements stated in Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370 to bring a common law derivative action. On that basis, the action must be struck out as against the SMG defendants and dismissed.

48.If, as the SMG defendants contend, leave from the Cayman Island courts is a substantive rather than a procedural requirement going to locus, it would merely constitute an additional reason for striking out the claim.

49.Accordingly, in determining the present application, it is unnecessary to consider the correctness of the plaintiffs’ contention that the decision in Wong Ming Bun v Wang Ming Fan [2014] 1 HKLRD 1108 is distinguishable on the basis section 184C(6) of the BVI Companies Act 2004 rendered leave from the BVI courts a condition precedent to the right to commence a derivative action itself.  That is a matter for decision on another occasion.

THE PLAINTIFFS’ CLAIMS FOR DECLARATIONS

50.The plaintiffs fall back position is that the actions are personal actions and that they have the necessary standing to sue for declarations.

51.Mr Fung, relying on the judgment of Aikens LJ in Rolls‑Royce plc v Unite the Union [2010] 1 WLR 318 (at §120) submitted that all that was required was a dispute between parties over the existence of a legal right and that the claimant for the declaratory relief will be affected by the determination on the disputed issue.

52.As I understand the argument, the plaintiffs contend that as CN3 was issued for no value, the conversion shares would also be issued for no consideration.  Therefore the issuance of conversion shares would have the effect of diluting the plaintiffs’ shareholdings. It was said that the injury in present case was not about loss to the Company but dilution of the relative shareholding of the plaintiffs for no consideration paid to the Company.

53.The plaintiffs’ argument is difficult to follow given the facts of the present case: they did not become shareholders until September 2015.  CN3 was issued on 3 April 2013, approximately 2½ years before they acquired nominal shareholdings (respectively 0.28% and 0.019%) in the Company. Any dilution would have taken place well before they decided to invest in the Company.  I do not accept that they suffered any loss or injury as a result of acquiring their respective nominal shareholdings.

54.Feetum v Levy [2006] Ch 585 which Mr Fung relied on does not assist the plaintiffs.  That case concerned the circumstances the scope of declaratory relief. In that case, D3, a developer of computer software entered into an exclusive license agreement with D4 a limited liability partnership (LLP) that had been formed by its designated members being the 5 claimants in the action.  The LLP had issued a counter indemnity to D3 secured by a debenture that contained a power to appoint joint administrative receivers.  Receivers appointed by D3 requested the claimants as designated members of the LLP to comply with their requests.  The claimants sought a declaration that the appointment of the receivers was invalid.

55.On appeal by D3, it was held (at §80 – 81) that the claimants were not prosecuting a cause of action vested in the LLP. That holding shows the importance of first identifying whether what is being prosecuted is in substance a derivative action. If it is a derivative action, the plaintiffs will not be entitled to declaratory relief. 

56.But Jonathan Parker LJ then explained that the injury for which the claimants seek to complain was not based on the claimants’ capacity as ordinary members of the LLP but “an injury to them personally” by reason of the tax consequences to them and their obligation to comply with the receivers’ requests should the appointment be valid. The claimants as designated members were not merely directly interested in the issue as to the validity of the appointment, but were “directly affected” by it.

57.In the present case, assuming CN3 were ultra vires the Company and its issuance was incapable of being ratified by the members, applying the Feetum requirement, any claim against the wrongdoers would be a claim vested in the Company (ie a derivative claim) and would not fall within any exception to the rule in Foss v Harbottle, there being no injury to the plaintiffs personally.

58.The plaintiffs also seek a declaration that the partial conversionof shares pursuant to CN3 was invalid and an injunction restraining conversion of CN3 into shares. The plaintiffs referred to section 116(3) of the Companies Ordinance which states that a member of a company may bring proceedings to restrain the company from doing any act in contravention of subsection (1) or (2).  Those subsections prohibit a company from doing any act that it is not authorised to do by its articles or from exercising the power that has been expressly modified or excluded by its articles contrary to that modification or exclusion. In that context, reference was made to clause 8 of the memorandum of association and to articles 12(1) and 112 of the Company's articles of association.

59.But the plaintiffs' submission overlooked the provisions of section 116 (4) of the Companies Ordinance:

“Proceedings must not be brought under subsection (3) in respect of any act to be done in fulfilment of a legal obligation arising from a previous act of the company.”

Since no prima facie case has been shown to invalidate CN3, it is not open to the plaintiffs to challenge any partial conversion made pursuant to it since the obligation to issue shares arises from a previous act of the Company.

ORDER

60.It was in those circumstances that the order that the plaintiffs’ action be struck out as against the SMG defendants and dismissed was made.

61.At the conclusion of the hearing, when the court indicated that it would deal with costs by way of an order nisi, the SMG defendants intimated their intention to apply for indemnity costs on the basis that the plaintiffs had engaged in inequitable conduct.  They highlighted the following matters:

(i) the plaintiffs appear to have someulteriormotive for bringing this action given that the complaints revolve around CN3 which was issued well over three years ago and long before the plaintiffs became shareholders;

(ii) the complaints are stale;

(iii) the circumstances in which this action came about suggest that the plaintiffs deliberately became shareholders in order to commence a derivative action (having discontinued his earlier action (HCA 1990/2015) after his attention was drawn to the fact that he was not a shareholder at the date of the writ and re‑issuing it on 18 November 2015 as the present action);

(iv) there is reason to believe that the plaintiffs have some personal grievance against the Company: in addition to this action they have also, together with Mr Zhi (against whom a restrictive order was made in June 2016 with respect to fresh proceedings against the Company) pursued a winding up petition against the Company on 17 December 2015 (HCCW 392/2015);

(v) there is evidence to suggest that the first plaintiffs funded the legal expenses of Mr Hyon (Mr Zhi’s father‑in‑law) with respect to two legal proceedings (HCA 168/2015 (discontinued) and HCCW 282/2014 (struck out))  brought against the Company.

62.In relation to the restrictive order made against Mr Zhi, it should be noted that Mr Zhi has brought no fewer than 14 actions seeking to undermine the CNs issued to Cordia: see § 11 (1) of the Reasons for Judgment of G Lam J in HCMP 443/2015. Further, while the exact relationship between the plaintiffs and Mr Zhi is not known, they are all petitioners in the winding up petition (HCCW 392/2015).

63.In light of the material put forward by the SMG defendants, I consider it appropriate to make an order nisi that the plaintiffs do pay the costs of the SMG defendants on an indemnity basis.

Mr Danny Fung and Mr Leo Yu, instructed by Edward Lau, Wong and Lou, for the plaintiffs

Mr Eugene Kwok, instructed by Baker & McKenzie, for the 1^st, 2^nd, 5^th, 7^th, 9^th to 11^th defendants

The 3^rd, 4^th, 6^th, 8^th and 12^th defendants were not represented and did not appear