Zhang Heng v. Kingstone International Wealth Management Ltd and Others

HCMP 1518/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1518 OF 2016

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J U D G M E N T

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1.This is the Plaintiff’s (Zhang) application for leave pursuant to ss. 732 and 733 of the Companies Ordinance, Cap 622 to bring derivative action in the name of the 1^st Defendant (Company) against the 2^nd to 4^th Defendants (Shum, Poon and Kingstone Advisors).

2.There is a draft Statement of Claim before the court in support of this application.  It is alleged that Shum and Poon are in breach of fiduciary duties and/or breach of duty of fidelity by carrying on a business through Kingstone Advisors, and with its dishonest assistance, which conflicts with or is in competition with the business of the Company.  The relief claimed include an injunction, account of profits and damages or equitable compensation.

3.Both sides are relying upon the case of Hao Xiaoying v Green Valley Investment Ltd, unrep, HCMP 1394/2015, 10 August 2016, §8 for the applicable legal principles.  On an application for leave to commence statutory derivative action, it is incumbent upon the applicant to satisfy the court that :

(a)  On the face of the application, it appears to be in the interest of the company that leave be granted;

(b)  There is a serious question to be tried and that the company has not itself brought the proceedings;

(c)  The applicant has served a written notice on the company in accordance with s.733(3) of the Ordinance.

Issues

4.The disputes between the parties are confined to: (a) whether it is in the interest of the Company to bring the proposed action; and (b) whether a serious question to be tried has been made out.  I shall deal with the 2^nd issue first because the answer to the 1^st depends much on it.

Background

5.Zhang is a resident of Shanghai.  She has a share in a business there called Shanghai Kingstone Investment Management Co Ltd, which was established in 2009.  That company provides financial consultation services in the Mainland in the course of which it may recommend the purchase of financial products to its clients and for which it will be paid, inter alia, marketing fees by the product sellers. 

6.Shum was a broker with Taifook Lexton Wealth Management Ltd.  Zhang got to know Shum in the course of her work.  In about April 2011, Zhang expanded her business to Shenzhen.  As a result, Zhang, Shum and Li (a friend of Zhang) established Shenzhen Kingstone Investment Management Co Ltd, owning respectively 30%, 30% and 40% of its shares.  Zhang and Shum developed a close personal relationship. 

7.In 2012, Zhang and Shum agreed to set up a joint venture business in Hong Kong, which resulted in the incorporation of the Company on 28 December 2012 with a paid up share capital of HK$1M (million). According to the annual return of the Company made up to the end of 2015, prior to 26 June 2015, the shares of the Company were held by Zhang (47.5%), Shum (47.5%) and VP Ltd (a corporate vehicle of one Mr Pang) (5%).  Shum’s shares in the Company were transferred to Kingstone Financial Group Ltd (her corporate vehicle) on 26 June 2015.  That shareholding structure has remained unchanged. Shum is the sole director of the Company.

8.In March 2013, the Company obtained an insurance broker licence which entitled it to sell insurance products to its clients. 

9.Kingstone Advisors was incorporated in Hong Kong on 21 August 2014 with a paid up share capital of HK$5M.  The shares in that company were initially held by Shum (60%) and Poon (40%).  Shum’s shares were subsequently transferred to Kingstone Financial Group Ltd on 26 June 2015.  There has been no other change in the shareholding of Kingstone Advisors.

10.In August 2015, Kingstone Advisors obtained 3 licences (Licences) from the Securities and Futures Commission (SFC) to carry on Type 1, 4 and 9 regulated activities, ie, dealing in securities, advising on securities and asset management.  Shum and Poon are the responsible officers under the Licences.

11.Poon joined the Company in around February 2015 as an associate director.  According to Zhang, her relationship with Shum broke down in around July 2015.

Serious issue to be tried

Law

12.On this requirement, see Green Valley Investment Ltd, supra, at §10 :

(a)  The threshold is relatively low.  The prospects of the company’s success are to be investigated only to a limited extent, and the court should be slow to find against the applicant unless such prospects are so slim that the company cannot be said to have any expectation of success;

(b)  At the leave stage, it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law which require substantial argument and deliberation.  In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance.

13.I believe that the conjunctive (and) in the last sentence in para (b) above is an error. It should be replaced with “or”.  It stands to reason that a claim which is seriously flawed, eg, an element of the cause of action is missing, must have no real substance.  On the other hand, a viable claim contained in the draft pleading may be shown to be without real substance.

14.I have been referred by Mr Hu, appearing for the Defendants, to the following dicta of Kwan J (as she then was) in Re F & S Express Ltd [2005] 4 HKLRD 743 at §16:

“I would echo what Palmer J said in Swansson v RA Pratt Properties Pty Ltd & Another (2002) 42 ACSR 313 at p.320 para.35, that at this early stage in the development of the law on statutory derivative actions, it would be unwise to endeavour to state compendiously the considerations to which the court would have regard in determining if each of the requirements in s.168BC(3) is fulfilled, particularly as there is no effective opposition to the present application.  It would be better to confine myself strictly to the fact situation in this case when I come to consider each of the statutory requirements, as “the law will develop incrementally as different factual circumstances come before the court.”

15.I agree with Mr Hu that the granting of leave to commence a derivative action is a fact sensitive exercise.  In deciding whether a serious issue to be tried is made out, I believe that the court has to maintain flexibility in the scrutiny of the case before it in order to: (a) to justice to all sides and (b) to avoid misuse of the statutory procedure.  In short, there can be no hard and fast rules, and the court must do what is justified in the case before it. 

The rival contentions

16.Zhang’s allegations revolve around 2 issues: (a) whether the Company’s business opportunities have been diverted to Kingstone Advisors after the latter had successfully obtained the Licenses; and (b) Kingstone Advisors’ involvement with a Fund called Alphasmart China Strategic Fund SP (Fund). 

17.Zhang says that in about early 2015 she was told by Shum that another company would be used to apply for the Licences, and that she was given to understand that the shares in this company would be held on behalf of the Company. 

18.In response, the Defendants say that the Company’s business is limited to insurance products and has never included securities.  It is common ground that the provision of services involving securities would require the Licenses.  Hence, there has been no diversion of Company’s business to Kingstone Advisors, nor any breach of duty by Shum or Poon whether in obtaining the Licenses or acting as financial consultant to the Fund.  It therefore follows that Kingstone Advisors has not dishonestly or knowingly assisted Shum or Poon as alleged.

19.Further, Poon was a shareholder and director of Kingstone Advisors prior to joining the Company, and the Company (through Shum) was aware of his relationship with Kingstone Advisors.  Therefore, there has been no breach of duty on Poon’s part.

Analysis

20.The key to the evaluation exercise in question is to look a little closer at Zhang’s allegations concerning the scope of the business which she had agreed with Shum as forming the subject matter of their joint venture. 

21.I have to say that the affirmation evidence of Zhang is quite vague.  As pointed out by Mr Hu, it is not clear from Zhang’s evidence what was actually agreed between the 2 friends, as opposed to Zhang discussing her business plan with her friend.  Although Zhang might be unfamiliar with the licencing requirements in Hong Kong, her evidence shows that she was alive to the need to acquire “various licences”.  Experienced businessmen, like Zhang and Shum, would have discussed what was needed to obtain such licences (see below).  Save for a blanket allegation that she “fully entrusted the process of application of the necessary licences to Shum”, nothing is to be found in Zhang’s evidence. 

22.The undisputed evidence of the Defendants is that the Company has never been in a position to meet the minimum requirements set by the SFC for the grant of the Licences. 

23.The relevant requirements were and are as follows :

(a)  The Company has to appoint not less than two responsible officers to directly supervise the conduct of each regulated activity.  Prior to hiring Poon, the Company was unable to meet this requirement;

(b)  The Company must maintain at all times paid up share capital and liquid capital not less than the specified amounts.  For Type 1, 4 and 9 activities, the Company must have a paid up share capital of HK$5M and minimum liquid capital of HK$3M.  In practice, it is prudent to maintain a further 20% on top of the required liquid capital so as to comply with s.6(3)(d) of the Securities and Futures (Financial Resources) Rules, Cap 571N.  The Company has never been in a position to meet these requirements.

24.In contrast, the minimum net asset value and paid up share capital required for an incorporated insurance broker was HK$100,000.  The undisputed documents show that the Company’s business has all along been confined to insurance and related products.

25.There has never been any discussion of increasing the Company’s capital to meet the requirements for obtaining the Licences, nor the hiring of staff qualified to act as a responsible officer. The contemporaneous document (exhibit “SSM-4”) shows that Zhang and Shum had contributed less than HK$0.5M each in setting up the Company. 

26.These undisputed evidence is quite compelling, in the face of which the court must look a little further than suggested in para 10 of Green Valley Investment Ltd.  It should be noted that in that case the question of serious issue to be tried was not in doubt (see paras 12 and 13 of the judgment).

27.I should mention that Zhang’s reply evidence that “Shum has all along asked me to prepare sufficient capital for the purposes of applying the SFO Licences” is nebulous and does not answer the fragility in her case. 

28.Ms Lau, appearing for Zhang with Mr Man, has identified 3 contemporaneous documents as supportive of Zhang’s case.  The first 2 documents are basically identical, the 1^st is a division of work chart in draft dated 8 January 2013 and the 2^nd was an updated chart enclosed in an email dated 21 May 2013.  These documents suggest that there was a plan for the Company to provide consultation services which would have required a Type 4 licence.  These documents appear to have been produced by Zhang or her Mainland staff, although they were sent to Shum. Whilst it can be said that they lend some support to Zhang’s case, they are by no means unequivocal.

29.The 3^rd document is a record of a very short “wechat” exchange between Zhang and Shum where the former enquired about what licence was held by the Company.  I do not believe that this piece of  evidence materially improves the quality of Zhang’s case. 

30.In the premises, it was very ambitious for counsel to have submitted that “the documentary evidence … is overwhelming”. 

31.To the contrary, as Mr Hu has pointed out, the contemporaneous documents generated when the relationship between the parties had fallen apart contain no complaint about the Licences even though Zhang was fully aware that Kingstone Advisors was holding the same.  Zhang’s complaints were mainly directed at a trademark issue.

32.Further, those documents show that the valuation of the Company put forward by Zhang for a buy-out to resolve the disagreement with Shum took no account of the Licences.  This is inexplicable if the shares in Kingstone Advisors were held on behalf of the Company as she alleges. 

33.In the premises, I found that Zhang’s evidence is vague.  Her allegations do not sit well with common/business sense or the undisputed facts, and are contrary to the weight of the contemporaneous documents. 

34.Finally, Ms Lau relied on O’Donnell v Shanahan [2009] 2 BCLC 666, §§55-72 and submitted that it is no answer to a claim for breach of fiduciary duty that the business opportunity fell outside the employer’s existing scope of business.  On the other hand, Mr Hu, relying on Company Directors: Duties, Liabilities, and Remedies, 2^nd edn, §§15.46 and 15.51-15.55, submitted that there is no breach of fiduciary duties in this case when there is no reasonable likelihood of a conflict given the different scope of business between the Company and Kingstone Advisors.

35.In my view, this is not in truth a case of a fiduciary stealing the opportunity of his employer.  The issue is the scope of the Company’s business as agreed between Zhang and Shum.  For the reasons stated above, I do not believe that Zhang has made out a serious issue to be tried.  I have reminded myself of a useful commentary on “a serious question to be tried” in Hong Kong Civil Procedure 2017, vol 1, rubric 29/1/10.

36.For completeness, firstly, I see no merit in the claim against Poon, who joined the Company well after the establishment of Kingstone Advisors.  It is not suggested that Poon knew about the agreement between Zhang and Shum. 

37.Secondly, I see little substance in the complaint in connection with the Fund.  The documents show that the dealings in connection with the Fund were above board.  In contrast with the nebulous nature of Zhang’s evidence, there is clear evidence by Shum that Kingstone Advisors’ role with the Fund was limited to giving financial/market advice.  In fact, the Fund was sold indirectly by the Company via insurance products.  This is supported by exhibit “SSM-16”. 

Interest of the Company

38.In light of the above conclusion, I shall deal with this issue briefly.  The threshold to be satisfied is low.  If a serious issue to be tried is demonstrated, in most cases it would follow that it is prima facie in the interest of the company to bring proceedings to recover its loss and damage.  However, the court will have regard to the practical benefit to the company in bringing such proceedings.  The benefit to the company is normally a matter of looking at the economics.  See Green Valley Investment Ltd at §11.

39.Had I found that there is a serious issue to be tried, I would, although not without reluctance, have been satisfied that it is in the interest of the Company to bring derivative action against the Defendants.  The reluctance arises from, firstly, the costs of the litigation. Mr Hu’s suggestion that they are likely to be in the region of HK$1.5M is not unreasonable.  The Company appears to have limited resources.  Thus, it may ill afford such litigation.  On the other hand, the financial position of the Company has not been entirely made clear to the court by Shum, who is in control of it. 

40.Secondly, there is force in Mr Hu’s submission that the intended action is likely to harm the Company.  That is to be expected for a company which provides services.  Further, Shum and Poon represent the entire management of the Company.  There is uncertainty whether they will or can continue to work for the Company in the face of an action against them by the same, and what will happen to the Company without them.

Ancillary issues

41.Had I granted leave, I would have acceded to Mr Hu’s request, relying on Re F & S Express Ltd, supra, §§28-30, to defer the decision on whether Zhang’s costs in bringing the derivative action should be indemnified by the Company in light of: (a) the uncertainty over the Company’s financial ability and (b) the weakness of the action.

42.As regards Mr Hu’s argument that Zhang should provide security for the Company’s costs in the derivative action as a condition for leave (see Re Gen2 Partners Inc, unrep, HCMP 1255/2011, 15 June 2012, §§63-4), it is unnecessary to deal with it.  It is not a straightforward matter and, like the situation in Re Gen2 Partners Inc, I do not believe that the issues have been fully ventilated.  An application for security for costs can be brought for that purpose. 

Conclusion

43.By reason of the aforesaid, this application is dismissed with a costs order nisi against Zhang, to be taxed if not agreed. 

44.Last but not least, I am grateful to counsel for their assistance. 

Ms Queenie Lau and Mr James Man, instructed by Anthony Siu & Co, for the Plaintiff

The 1^st Defendant was not represented and did not appear

Mr Derek Hu, instructed by Cheng, Yeung & Co, for the 2^nd to 4^th Defendants