Orient Power Holdings Ltd and Others v. Ernst & Young

HCCL 14/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 14 OF 2014

____________

____________

______________

D E C I S I O N

______________

Background

1.This is an application for specific discovery made by summons issued by the Defendant on 28 June 2016 (“Summons”). 

2.The action was brought by the liquidators and receivers of Orient Power Holdings Limited (“Orient”) and certain of its subsidiaries.  Orient was listed on the Hong Kong Stock Exchange, and was the holding company of a group of 56 companies (“Orient group”), including the 2^nd to 4^th Plaintiffs in this action.  The Plaintiffs (acting by their liquidators and receivers) claim in this action that the Defendant was negligent in its audit of the Plaintiffs’ accounts for the years ending 2000 to 2004, in failing to detect a fraud which was perpetrated on the Plaintiffs by members of the management of the Orient group, which fraud resulted in the Plaintiffs’ accounts being materially overstated.  The Plaintiffs are seeking substantial damages from the Defendant of approximately HK$500 million (excluding interest), representing misappropriated funds, interest expenses and finance costs of borrowings, dividends and a joint venture investment which the Plaintiffs claim should not have been paid or made, audit fees, and tax.  Alternatively, the Plaintiffs claim HK$913 million as an increase in net deficiency (“IND Claim”) between 10 April 2001 (when the Plaintiffs claim the Defendant should have identified and reported the fraud but for its negligence) and 3 May 2006, when receivers were appointed for the Orient group.

3.The Defendant’s application for specific discovery is directed at documents which it says are relevant to two fundamental issues in these proceedings, namely the fraud that is alleged to have been committed against the Orient group, and the IND Claim.

4.The Summons seeks discovery of 11 categories of documents, was set down for a day’s hearing on 12 January 2017, and was part heard on that day.  Since the issue of the Summons on 28 June 2016, the Plaintiffs had filed an 11^th List of Documents on 23 December 2016, whereby further documents were disclosed.  On 6 January 2017, the 4^th affidavit of Roderick John Sutton (one of the liquidators of the Plaintiffs) (“Sutton 4”) was filed, after a draft thereof had been served on the Defendant with the 11^th List on 23 December 2016. 

5.By the time when the hearing of the Summons resumed on 8 February 2017, the affidavit of Tan Hooi Leng (“Tan”) (a solicitor of the Plaintiffs) had been filed.  The liquidators had also permitted the Defendant’s solicitors to inspect 5 boxes of the Plaintiffs’ documents, and (pursuant to a summons issued by the Defendant on 6 February 2017) provided the Defendant with an index of the Plaintiffs’ 2300 boxes of documents.

6.As a result of developments since the issue of the Summons and the hearing on 12 January 2017, 8 categories of documents which are the subject matter of the application for specific discovery have been provided and/or resolved, and the application relating to 2 categories of documents (A3 and A7 a-k) has been adjourned, pending access being provided to the Defendant’s solicitors for inspection of the relevant boxes of documents. 

7.The remaining documents to which the Summons relates, and on which determination by the court is required, are categories A7 l and B1.

8.Under O 24 r 13, no order shall be made for discovery under any of the rules of O 24 unless the court is of the opinion that the order is necessary either for disposing fairly of the cause or matter, or for saving costs.

9.On the question of necessity and fair disposal, I agree that this case raises some unique features for consideration.  The claims of negligence are made against the Defendant on the basis of the investigations made by the liquidators into the affairs of the Orient group, as a result of their analyses of the documents identified from the records of the companies in the Orient group, and the view taken by the liquidators as to the falsity of the transactions between the Orient group companies and their counterparties such as subcontractors and agents.  Mr Sutton is one of the receivers and liquidators of the Plaintiffs.  He is also giving expert evidence on behalf of the Plaintiffs, as the only expert on quantum instructed by the Plaintiffs.  The Defendant has highlighted the fact that in giving his expert opinion on matters relating to the IND Claim (which forms a substantial head of damage sought by the Plaintiffs), and in analyzing the increase in the Plaintiffs’ deficiency by reference to the creditors’ claims made against the Plaintiffs, the major assets realized, and the costs of the receivership and liquidation, Mr Sutton had access to relevant information and documents in his capacity as the liquidators, but not all of such documents or information relied upon by Mr Sutton have been disclosed to the Defendant’s expert, notwithstanding requests made by the Defendant.

10.In the usual case when parties’ experts prepare and file their reports, they are given access to the same set of documents, and given equal treatment in their capacity of expert witnesses who are independent of the parties to the litigation.  The fair disposal of the issues in dispute for determination at trial and the fair presentation of expert evidence for the assistance of the court require access to be given to each expert in respect of documents which are relevant to their independent expert opinion.  I agree that it is not for Mr Sutton, acting in the dual role of liquidator and expert, to dismiss Mr Ellison’s request for documents which are necessary for Mr Ellison’s analysis of the issues on which expert evidence is required, simply on the ground that Mr Sutton himself does not consider these documents to be relevant to Mr Ellison’s consideration of the issues addressed in Mr Sutton’s expert report.

11.Relevance is to be determined by the pleadings and the issues which are in dispute between the parties to be decided at trial.  Necessity will be considered, bearing in mind these issues in dispute, the scope of the discovery sought, the interests of proportionality, cost-effectiveness, procedural economy, ensurance of fairness between the parties, and the just resolution of the disputes in the action.

A7 l: documentation recording the receipt of funds from customers

12.According to paragraph 34 of the Re-Amended Statement of Claim (“SOC”) in these proceedings:

“The Plaintiffs’ financial statements were materially misstated, and did not give a true and fair view of the consolidated financial affairs of OP (ie Orient) and the OP Group, as a result of a series of repetitive and related transactions through which a fraud was perpetrated on (the 1^st Plaintiff) and the OP Group”.

13.The Plaintiffs claim that the falsification of the Orient group’s accounts were undertaken at the direction of its chairman (“Poon”) and vice-chairman (“Wu”), and was implemented at their direction, and at the direction of the financial controller of the Orient group, and staff acting under her direction.  In particular, the SOC pleads in paragraph 36 that:

“36.1  From the years 2000 to 2004, the audited financial statements of subsidiaries within the OP Group reported sales of raw materials to purported third parties, and accounts receivables at year end from these purported third parties.

36.2  The third parties were purportedly acting as “subcontractors” to companies in the OP Group, providing manufacturing services to OP Group companies (and in particular, OPE and OPCS) for a fee.

36.3  The subcontractors in fact had no operations and were controlled by Poon and Wu.

36.4  The subcontractors were controlled and used by Poon and Wu to manipulate the OP Group’s profits, by either creating false sales of raw materials, or improperly capitalizing expenses as accounts receivable.”

14.According to the SOC (paragraph 36.5), the Orient group’s accounts were falsified by (1) dealings with 2 specified companies (“Pacific Crown” and “Dong Kuen”) which purported to act as buying agents or subcontractors of the Orient group (but which were in fact controlled by the management of the Orient group); (2) false sales of raw materials to a company known as Ever Earth Limited (“Ever Earth”); and (3) false dealings with further counterparties, including Pacific Crown, Dong Kuen, Ever Earth, other specified Hong Kong and PRC subcontractors (“Subcontractors”), and a company known as Wuxi Multimedia Ltd (“Wuxi”).

15.The Plaintiffs plead, in paragraph 52 of the SOC, that the audited accounts of the 1st Plaintiff and the Orient group for the years ended 31 December 2000 to 31 December 2004 did not give a true and fair view of the financial affairs of Orient and the Orient group, had not been properly prepared and did not comply with the applicable disclosure provisions of the Listing Rules.  According to the SOC, the accounts receivable balances recorded in the audited financial statements as owing by the Subcontractors and other false counterparties such as Pacific Crown, Ever Earth and Wuxi were entirely false, and should have been written off.  The Plaintiffs further claim (in paragraph 58 of the SOC) that sales of raw materials to purported purchasers such as Pacific Crown, Ever Earth and Wuxi were entirely false, and should not have been recorded in the financial statements of the relevant Orient group company, or in the consolidated accounts of the Orient group.

16.It is the liquidators’ position (as evident from Mr Sutton’s witness statement and from Sutton 3 made on 12 August 2016) that in relation to the Subcontractors and Ever Earth, fictitious documents such as invoices, subcontracting agreements and sale and purchase agreements had been created.

17.In the Summons, the Defendant seeks specific discovery of all documentation which “evidences the existence, or the business or financial position” of any of the Subcontractors, or of Ever Earth, including (under A7 l) “documentation recording the receipt of funds from customers through the financing of trade receivables ...  in respect of the bank accounts” of the 3rd Plaintiff, the 4th Plaintiff and another 3 companies within the Orient group, for the period between 1 January 2000 and 31 December 2004.

18.The Defendant has highlighted that the discovery made by the liquidators on behalf of the Plaintiffs have been given in a piecemeal and incomplete fashion, and that such discovery has produced documents which show that certain points pleaded by the Plaintiffs are plainly incorrect, demonstrating discrepancies between the Plaintiffs’ pleaded case, and the documents produced on piecemeal discovery.

19.In Sutton 3 which was made on 12 August 2016, the liquidators claim that the Plaintiffs’ discovery of a total of 850 boxes of documents was undertaken in 2 trenches, between June and November 2014.  On completion of their discovery in November 2014, the plaintiffs served their 1st List of documents on 23 June 2014, the 2^nd List on 24 July 2014, the 3^rd List on 21 August 2014, the 4^th List on 22 September 2014, the 5^th List on 19 November 2014 and the 6^th List on 28 November 2014.  Additional documents were identified and disclosed in the course of the preparation of Mr Sutton’s witness statement and his expert report, resulting in the service of the Plaintiffs’ 7^th List on 31 March 2015 and the 8^th List on 31 July 2015. 

20.When the Defendant first claimed in December 2015 that the Plaintiffs’ discovery was deficient, and requested disclosure of further documents, the Plaintiffs’ 9^th List and 10^th List were served on 22 February 2016 and 12 August 2016 respectively.  As the Defendant highlighted, its requests for discovery have all led to disclosure by the liquidators of further relevant documents, despite their previous assertions that all relevant documents had been disclosed.  According to the Defendant, this demonstrates that the liquidators’ review of documents and their identification and production of relevant documents are inadequate and incomplete.

21.Sutton 3 was made at the same time as the service of the 10^th List on 12 August 2016, by which the Plaintiffs disclosed for the first time bank statements and banking records of the Subcontractors, correspondence between the liquidators and the banks relating to the Hong Kong Subcontractors and Ever Earth, correspondence between the liquidators and the former auditors of the Hong Kong Subcontractors, and accounting records relating to the Hong Kong Subcontractors and Ever Earth.  On behalf of the Defendant, it was highlighted that these documents which show the existence and operations of the Subcontractors and Ever Earth had not been disclosed in any of the Plaintiffs’ earlier lists filed pursuant to their review of the 850 boxes of documents. The Defendant claims that documents which show the existence and normal trading operations of the Subcontractors and Ever Earth are relevant to the Plaintiffs’ assertion that the relevant transactions between the Subcontractors and Ever Earth and the Orient companies are false.

22.What remains disputed by the liquidators are the documents recording the receipt of funds from customers (of the Plaintiffs and the Orient group companies) through the financing of trade receivables in respect of the bank accounts maintained by the relevant Plaintiffs and the Orient companies.

23.Although the liquidators maintain, as part of the claims made by the Plaintiffs in these proceedings, that there were fictitious transactions and documents created by the management of the Orient group, they have clarified in Sutton 4 (filed on 6 January 2017) that what they claim is that documents created by the Orient group which purport to evidence transactions between the Orient group companies and the Subcontractors are false, but they do not claim that the bank statements of the Orient group companies are false, or forged.  What are alleged to be fictitious are the transactions between the Orient group companies on the one part, and the Subcontractors and Ever Earth on the other part.  The sales of raw materials to Ever Earth as recorded by the relevant Orient group company are claimed to be false, and the role allegedly played by the Subcontractors in the Orient group’s manufacturing process is claimed to be false.  The liquidators accept that the sale by the Orient group companies to third parties of finished and manufactured products are genuine, and that the payments made by these third parties for the goods sold, through trade finance or otherwise, are not disputed.

24.This was made clear in paragraph 67 of Sutton 4:

“In particular, it is not OP’s case that:

67.1  sales of finished goods by the OP Group to third party customers (such as Thompson) are false;

67.2  the sales of finished products to third party customers were not settled/paid for; or

67.3  the banking documents, all the OP Group’s records, relating to settlements/payments by third party customers are false.” (Emphases added)

25.On the basis of the liquidators’ stance as expressed in paragraphs 64 and 67 - 69 of Sutton 4, the Defendants’ request for documents which record the receipt of funds from customers is not a matter which is disputed, or in issue for the trial of the action.  The documents sought under A7 l, regarding the receipt of funds for the purchases, are not disputed and so are not relevant to any matter in question in this cause or matter.  Even if remotely relevant in the Peruvian Guano sense, I am not satisfied that discovery of the documents is necessary for the fair disposal of the action, or for saving costs, for an order to be made under O 24 r 13.  By now, elaborate discovery has already been made, with the trial set to commence in September 2017, and it will be oppressive to order the disclosure of this category of documents bearing in mind the overriding principles of proportionality, cost-effectiveness, procedural economy, expeditious disposal of cases and ensurance of fairness between the parties.

B1: documentation listing, explaining and evidencing the fees incurred in the receivership and liquidation of the Orient group

26.The Defendant seeks discovery of documents which explain and evidence the fees incurred in the receivership and liquidation.  These are said to relate to the Plaintiffs’ IND Claim of HK$913 million, which is the largest of the heads of claim put forward on behalf of the Plaintiffs.  In essence, the IND Claim is for the increase in the net deficiency arising on the actual liquidation of the Orient group, compared with the theoretical and hypothetical net deficiency that would have arisen had the Orient group been put into liquidation earlier, upon the Defendant’s detection of the fraud if due care had been exercised.

27.In Mr Sutton’s expert report of 31 July 2015, he calculates the net asset deficiency of the Orient group based on a hypothetical liquidation as at each of 31 December 2000, 31 December 2001, 31 December 2002, 31 December 2003 and 31 December 2004, and compares each of these figures to the claimed deficiency as at the date of appointment of the receivers on 3 May 2006.  The Plaintiffs’ claim is for the difference between the actual deficiency and the various hypothetical deficiencies.  According to the Defendant’s expert, Mr Ellison, Mr Sutton calculated the hypothetical deficiencies by estimating the assets that would have been recovered at the hypothetical liquidation dates, and deducting from those recoveries the assumed costs of the liquidation and the balances due by each company at those dates to their creditors. 

28.Mr Sutton’s report states that liquidation and legal costs were part of the calculation of the hypothetical deficiencies, and that for such purpose, he had calculated costs on the basis of an assumed percentage of asset recoveries, without reference to the costs actually incurred in the liquidation.

29.Mr Ellison explained that to give his final expert opinion, he requires information and documents concerning the actual costs of the receivership and liquidation, and the results of the liquidation of the subsidiaries in the Orient group.  In response to Mr Ellison’s request, Mr Sutton states that the actual costs of the receivership and the liquidation are irrelevant to the calculation of the hypothetical deficiencies. 

30.In view of the difference in the experts’ views, a matter for determination at trial will be whether the actual costs or the assumed hypothetical costs should be used in the calculation of the hypothetical deficiency. 

31.Since the issue of the Summons on 28 June 2016, the liquidators have confirmed, by Sutton 3 served on 12 August 2016, that HK$169.9 million had been paid as the total costs and expenses of the liquidation, which sum comprised a sum of HK$111 million as the costs incurred by the receivers in trading on the business following their appointment, and the balance of HK$59 million is administrative costs, including the legal and other fees and expenses of the receivers and liquidators.  No further breakdown or documentation has been provided. 

32.Mr Sutton’s expert report shows that only HK$26.8 million is deducted as liquidators’ fees and legal costs in his calculation of the hypothetical deficiency at 31 December 2000.  The difference between the actual costs of HK$169.9 million and the hypothetical costs of HK$26.8 million is HK$143 million, which forms a significant part of the total IND Claim of HK$913 million made against the Defendant.  According to Mr Ellison, in using the sum of HK$26.8 million for the deduction of liquidators’ fees and legal costs, Mr Sutton’s calculation of the IND Claim assumes that the liquidation and receivership costs have increased six-fold between a hypothetical liquidation in 2000 and an actual receivership or liquidation in 2006, ie from HK $26.8 million to at least HK$169.9 million, and this difference is claimed from the Defendant, despite the fact that the liquidation is in respect of the same Orient group. 

33.In view of the issues in dispute between the experts as to the calculation of the IND Claim, I agree that the fair disposal of the claims made at trial requires the disclosure to the Defendant of the documents quantifying, explaining and evidencing the costs of the receivership and liquidation, which include the costs incurred in continuing the business of the Orient companies.  In seeking the difference between the hypothetical costs and the actual costs of the liquidation, the Plaintiffs have put the actual costs in issue and will have to establish such costs as part of its quantum claim for the IND Claim.  The Defendant may argue that such trading and administrative expenses and costs would have to be incurred in any event in the hypothetical liquidation at the relevant times.

34.The Defendant has narrowed down the scope of the discovery required for the trading expenses, seeking invoices for such expenses in excess of HK$100,000.

35.At this stage, I will make an order in a more limited scope than that specified in the Summons for B1, for discovery of invoices issued for professional expenses (including receivers’, liquidators’ and legal fees), and invoices in excess of HK$100,000 for trading expenses paid, in the receivership and liquidation of the Orient group.  To the extent that privilege is claimed in respect of any information that may be contained in the invoices for legal fees, this should be clearly specified and particularised.

Costs

36.The Summons was issued in June 2016.  Requests for the documents had been made by the Defendant in correspondence in December 2015.  Counsel for the Plaintiffs highlighted the fact that the liquidators have endeavored sensibly to cooperate and to limit the areas of dispute.  As a result, after the hearing on 12 January 2016, parties have been able to confine further arguments to 2 categories of documents.

37.On behalf of the Defendant, it was pointed out that on the face of Sutton 3 and Sutton 4, it was clear that the steps taken by the liquidators in their review of documents for discovery had been inadequate, and that the claims made by them in Sutton 3 and Sutton 4, that there were no further relevant documents for disclosure cannot reasonably be taken to be conclusive (Matthews and Malek: Disclosure (4^th edition) para 6.43).  It was further emphasized that the liquidators have on repeated occasions claimed that there were no further relevant documents for disclosure, and yet have continued to disclose relevant documents after the Defendant had pressed for the same, as evidenced by the history of the disclosures and lists of documents served, and in particular, the 11^th List in December 2016 notwithstanding the liquidators’ earlier assertions that all relevant documents had been disclosed. 

38.The Defendant also pointed out that it was clear from Sutton 4 itself that the liquidators had not reviewed documents outside the period 2000 to 2004, nor documents for companies other than the Plaintiffs.  This demonstrated that the discovery exercise conducted by and on behalf of the liquidators was obviously insufficient, since the Defendant’s audit work for the year ended 31 December 2004 was conducted through to 20 April 2005 when the 2004 audit was signed, and the damages claimed in the action include dividends which were paid in 2005, sums alleged to have been misappropriated in 2005 and alleged increase in net deficiency through to May 2006, all of which makes the Plaintiffs’ affairs during and after 2005 relevant for the purposes of discovery.

39.In relation to the Defendant’s request for discovery of documents relating to Wuxi and the Subcontractors, Sutton 4 suggested that 5 boxes of documents marked Orient Power Services Ltd and Wuxi for 2000 to 2004 had not previously been reviewed before the Plaintiffs’ 11^th List.  It was only when the affidavit of Tan was served in February 2017, that it was claimed that in fact, documents outside the period 2000 to 2004 had been reviewed, the boxes reviewed included documents relating to companies in the Orient group other than the Plaintiffs, all boxes that may contain documents relating to the allegedly false counterparties including Wuxi had been included in the review, and finally, identified the documents which had been withheld on the grounds of privilege.

40.It was also in Sutton 4 that the Plaintiffs’ case as to the falsity of the documentation regarding the Orient companies, their counterparties and the banks was clarified and explained, on the basis of which I agree that discovery of the A7 l documents is unnecessary in the light of the clarification.

41.Although the categories of documents which form the subject matter of the Summons are wide in scope, I am satisfied that there were grounds on which the Defendant sought specific discovery, in light of the discovery exercise described in Sutton 3 and Sutton 4 as to how documents had been selected for review.  Although reasonable steps had been taken by and on behalf of the liquidators in December 2016 and January 2017, which have the effect of limiting the ambit of the arguments made under the Summons, these steps could have been taken earlier, in good and sufficient time before the hearing of the Summons, so that costs can be saved.  The hearing on 12 January 2017 in particular could have been avoided or shortened, if the steps taken in December and January had been taken earlier.

42.The liquidators have emphasized that they have agreed to make the disclosures and to provide the access to documents, without concessions on the relevance or necessity of the documents. 

43.If all the categories of documents for which discovery is sought were contested and argued, I might not have ordered the wide discovery for some of the categories of documents sought.

44.In all, bearing in mind that one day on 12 January 2017, and the substantial part of the afternoon on 8 February 2017 were spent in hearing arguments on the Summons, and considering the wide scope of some of the documents sought, and the arguments made on relevance, necessity and privilege, the fair order of costs would be that the Plaintiffs should pay 70% of the costs of the Summons, including the costs of the hearing on 12 January and 8 February 2017, with certificate for 2 counsel. 

45.The court expects the parties to act reasonably and sensibly after access is given to the Defendant for inspection of the documents, such that it will not be necessary to waste further time and costs on interlocutory skirmishes which can be avoided with common sense and reasonable co-operation. In the event that the parties should have to appear in court to argue any further orders to be made on A3 and A7, the reasonableness of the parties’ conduct after 12 January 2017 will be considered, when the court determines any costs orders. 

Mr Victor Dawes SC and Mr Justin Ho, instructed by Lipman Karas, for the 1^st to 4^th plaintiffs

Ms Roxanne Ismail SC and Ms Queenie Lau, instructed by Davis Polk & Wardwell, for the defendant