The Joint and Several Liquidators of China the Joint and Several Provisional Liquidators of China Medical Technologies Inc. v. Kpmg (A Firm) and Others

HCCW 435/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO 435 OF 2012

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D E C I S I O N

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Introduction

1.I have before me 2 summonses arising from orders that I made on 24 February 2016 and 3 June 2016 for the production of documents by the Respondents (“KPMG”) to the Applicant (“Liquidators”) pursuant to s221 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32. In order to fully understand the background to these applications it is necessary to read my order of 24 February 2016 as varied by my subsequent order of 3 June 2016 and my decisions in respect of those orders, which explain comprehensively the background to the present application and the disputes that have arisen concerning the production of documents by KPMG to the Liquidators.

2.The 2 summonses sought more extensive orders than was pursued before me at the hearing.  The applications finally advanced are:

(1)   The adjourned portion of the summons of KPMG dated 26 April 2016 seeking to vary paragraph 3 of the February order to allow for redaction of the identity of certain parties referred to in a number of documents.

(2)   The Liquidators’ summons dated 1 August 2016 seeking to vary the February order to replace the order that provided that insofar as the relevant documents are in the Mainland the Liquidators be given access to them with an order that requires copies to be provided and also extending the period covered by the order by an extra year from 2009 to 2010.

3.In addition it was agreed that the Liquidators’ application that documents should be produced in Hong Kong be deferred to a further hearing on a date to be fixed. 

4.After the hearing of the application for what became the February order was made, but before my decision was delivered, KPMG approached the Ministry of Finance in Beijing (“MOF”) to discuss further with them a protocol for providing access to documents to the Liquidators.  As I explain in my February decision it had been KPMG’s case before me at the hearing in October 2015 that resulted in the February order that the MOF had issued various directives (which applied generally to auditors not just KPMG and the present case) that prohibited them giving access to the majority of documents of which production is sought without the permission of a relevant Government entity.  It was KPMG’s case at the outset that they had not been able to find a Mainland Government entity, including the MOF, that was willing to give the necessary permission.  As matters transpired when the MOF were approached after the hearing before me (and at a time when I think it reasonable to assume that KPMG recognised that they might well lose the application) they proved considerably more helpful than KPMG’s evidence filed for the October hearing suggested they would.  The MOF approved a protocol, which provided for KPMG to have the documents inspected by an independent law firm, Zhong Lun, to see if any contained state secrets or sensitive information.  I note in passing that at the October hearing KPMG’s case had focused on a concern (which as matters have transpired proved unsurprisingly illusory) that the documents might contain State secrets.  After the October hearing in discussions with the MOF, KPMG suggested that the inspection include checking for sensitive information not just State secrets.

Redaction

5.Zhong Lun did not identify any documents containing State secrets amongst the 145,000 pages of documents that they apparently screened.  Zhong Lun did, however, identify 68 pages in 41 documents that they considered contained sensitive information.  These they recorded in a log, which has been adduced in evidence.  In each case KPMG wish to produce copies redacted to exclude the name of a government body referred to in the document and in a few cases additional lines.  Mr. Li suggested that one could readily see why the Mainland authorities would regard the information to be sensitive and require redaction.  I disagree.

6.The agreement with the MOF did not define “sensitive information”.  Ms Jacqueline Wong in paragraph 31b) of her 5^th affidavit and Len Jui in paragraph 38b) of his affirmation both say that the MOF told KPMG that “KPMG Huazhen must engage external PRC counsel to review the documents[1], to ensure that no information which amounts to a state secret or is otherwise regarded as sensitive information shall be disclosed to the Liquidators”.  They do not say what they understood sensitive information to mean.  “Sensitive information” was defined in Zhong Lun’s retainer letter of 28 October 2015:

“…‘sensitive information’ shall mean information the disclosure of which might bring harm to the state interest or public interest, including: (i) non-public information involving national economy or social development; (ii) enterprise information relating to business secret, operating management, product formula, business intelligence etc; (iii) personal information involving privacy or significant economic interest; (iv) information that might affect foreign affairs, including but not limited to fiscal subsidies, tax preference, export credit, industrial policy, and industrial preferential treatment; (v) information (for instance major contract) relating to special authorities or enterprises, including but not limited to police office, national defense department, military enterprise or institution, and government.”

As I understand it KPMG suggest that this tracked similar language in arrangements agreed between the MOF and the United States’ Securities and Exchange Commission (“SEC”) for the inspection of audit documents in unrelated cases. 

7.The only evidence that has been placed before the court, which provides any information about the proposed redactions, is the log itself.  This does not explain why the proposed redactions contain “sensitive information”.  I will give the first item on the log by way of example:

No.	Date of document	Author	Receipt(s)	Email subject	Pages of blackout	Nature of information redacted	Extent of blackout
1	2008-05-29T00:46:36.3 57+0800	Jin, Grace (Beijing/A11)	Zirlen, Bruce (HK/PTR) CC: Lin, Michelle (BJ/A11); Seah, Meng Teow (Beijing/A11); Zhu, Diane (Beijing/A11)	CMED draft AR memo	1	Name of government body	Name

8.What seems to have happened is that Zhong Lun went through the documents and treated as sensitive any reference to a government body.  Why references to all government bodies should be treated as “sensitive” is nowhere explained.  There is no evidence before me which suggests that KPMG has made any effort to clarify with the MOF whether it has any concerns about the limited number of documents that they wish to provide in redacted form.  I am not satisfied on the evidence filed by KPMG that the information that they wish to redact falls within the definition of “sensitive information” in the retainer letter.

9.I will explain how these documents are to be dealt with after considering the Liquidators’ application. 

Liquidators’ Application

10.The Liquidators’ justification for seeking a modification of the February order to require production of copies is this. The Liquidators accept that the February order, although not in the terms they had sought, represented a sensible balance between obtaining access for the Liquidators and KPMG’s concerns about the regulatory restrictions they believed themselves to be under.  However, since the hearing in October 2015 it has become apparent that the concerns expressed by KPMG were exaggerated.  Further, KPMG has not complied properly with the 2 orders.  KPMG simply ignored the initial deadlines imposed on them and have similarly disregarded paragraph 1.3 of the June order.  It is inconvenient and costly for the Liquidators to go to Beijing to inspect the documents rather than be provided with copies.  It is also inefficient because they are forced to work from notes of what staff thought were relevant parts of documents at the time they inspected the documents rather than use analytical software and storage capabilities to deal with the very large number of documents, a significant number of which they say are helpful in advancing their investigations.  In addition the Liquidators say that the electronic data with which they have been provided is in a form that is difficult to analyse effectively.  In the circumstances, say the Liquidators, the court should make an order requiring production of copies unless the MOF or other relevant entity takes steps to prevent KPMG so doing and that the order should provide a mechanism to cater for that possibility.

11.Mr Li opposed a variation to the existing order on 2 grounds:

(1)   The February order did not give general liberty to apply and it is now too late to seek a variation to it.

(2)   It seeks to reopen a decided issue.

12.I do not think there is any substance to either of these points.  It is correct that the February order does not grant general liberty to apply.  It does not seem to me that this bars the Liquidators returning to court with a new application if the circumstances can be demonstrated to have materially altered.  Similarly, the fact that I originally decided that it was appropriate to order inspection rather than production of copies does not in my view bar the Liquidators returning to court with a new application if they can demonstrate the circumstances have changed materially. It is also an unattractive argument for KPMG to advance as they have filed in support of their own application a considerable amount of evidence, much of which as matters transpired was unnecessary, including new expert evidence, which sought to reopen issues concerning the regulations under which KPMG operate in the Mainland and the approach of the MOF to supervision of auditors.

13.It seems to me that there is justification for the Liquidators returning to court.  It is quite clear that the evidence put before the court for the October hearing exaggerated the difficulties KPMG faced.  It is apparent from my February decision that I felt that KPMG had not been candid with the court.  The way in which matters developed after the hearing and, in particular, the MOF’s accommodating approach to this matter only serve to confirm the views I expressed in my decision.  For example, the thrust of KPMG’s case was that the documents might contain State secrets and this was clearly intended to influence the court and encourage a sympathetic response to KPMG’s attempts to avoid a production order.  It is now clear that this was not the case and the reason why the evidence as to what the State secrets might be was vague was because there was nothing of substance to the point; a fact that it is difficult not to conclude was known to those members of KPMG with knowledge of the contents of the documents.

14.I recognise that in recent years the regulatory environment in the Mainland has developed in such a way as to impose restrictions on the freedom of auditors to allow audit work papers out of the Mainland.  I also recognised the logistical problems of dealing with such a large quantity of documents. However, given their accommodating approach since October 2015 there is reason to doubt whether the MOF would object to copies of the vast majority of the documents being produced to the Liquidators on condition that they are not taken out of the Mainland and they will, if so directed by the MOF, be returned to KPMG or such other entity as the MOF directs.

15.In the circumstances I consider that it is appropriate to make a new order in the following terms:

3.   Insofar as the Documents referred to in paragraph 1 of the February order or copies thereof are located in the Mainland or stored in a form which allows them, as at 24 February 2016, to be accessed only in the Mainland:

(1)   the 1^st Respondent shall within 35 clear calendar days, produce copies of the Documents to the Liquidators in the Mainland after redacting the information identified by Zhong Lun law firm as “sensitive information”;

(2)   the Liquidators shall retain, maintain and keep safe the copies of the Documents provided to the Liquidators and any further copies whether in physical or digital form taken by the Liquidators in the Mainland until further order;

(3)   the 1^st Respondent shall within 21 clear calendar days hereof cause such application as is required and alternatively permitted and alternatively possible under the Laws of the People’s Republic of China to be made for a determination as to whether or not there is any restriction under the Laws of the People’s Republic of China on copies of the aforesaid documents without redactions being provided to the Liquidators alternatively inspection of the aforesaid documents without redactions being made available for inspection by the Liquidators;

(4)   the 1^st Respondent shall in the event that it is determined that copies of the aforesaid documents without redactions may be provided to the Liquidators or inspected by them, provide copies or allow inspection as the case may be within 14 clear calendar days of the Respondents receiving notification of the relevant determination;

(5)   the 1^st Respondent shall maintain a written record of any application or applications made pursuant to sub-paragraph 3 hereof including hearings, meetings or telephone conversations;

(6)   the 1^st Respondent shall within 14 clear calendar days hereof provide to the Ministry of Finance of the People’s Republic of China a copy of this order along with a translation in simplified Chinese and a copy of this decision along with a translation in simplified Chinese;

(7)   the 1^st Respondent shall within 14 clear calendar days to notify the Ministry of Finance of the People’s Republic of China in writing of the date on which the Respondents will provide documents in accordance with sub-paragraph 1 hereof; and

(8)   there be general liberty to apply.

16.This order is structured so as to allow the MOF to take any action it considers appropriate to prohibit production of copies of documents and for KPMG to make any necessary applications to this court.

Extending Order to 2010

17.There are 2 other matters that remain to be dealt with.  The first is the Liquidators’ application in paragraph 12 of their summons of 1 August 2016 to vary the date in paragraph 1.3 of the February order from 31 December 2009 to 31 December 2010.  Mr Borrelli explains in paragraph 89 of his 34^th affidavit sworn on 1 August 2016 that during the course of inspection of the documents the Liquidators have discovered that KPMG undertook work for the Company in connection with its financial statements for the year ending 31 March 2010 and the convertible notes prospectus dated 30 November 2010.  The Liquidators say that at the time the initial summons was issued they were not aware that KPMG had carried out any work after the end of 2009.

18.In his 4^th affirmation, deposed on 9 September 2016, Isaac Yan explains in paragraphs 61 to 70 that Mr Borrelli’s assumptions about the work KPMG carried out in 2010 is incorrect.  He explains in paragraphs 63 to 70 that the only work carried out in 2010 by KPMG related to various filings that were necessary with the SEC.  Mr Yan describes the work in some detail and then says in paragraph 70 that no other work was carried out by KPMG for the Company in 2010.  However, KPMG seek time to file further evidence in relation to paragraph 12 of the Liquidators’ summons of 1 August 2016 and for their legal advisers to consider their response.  I have difficulty in understanding why this is necessary.  In my view KPMG has had sufficient time to deal with this matter and on the basis of what Mr Yan says there would appear to be little that can usefully be added.  All that KPMG has will relate to the SEC’s filings, which he has described.  This matter has dragged on for longer than is desirable.  It seems to me that in order for the Liquidators to understand the affairs of the Company it is necessary for the Liquidators to be given the opportunity at least to inspect such further documents as KPMG has which come within the original order for the year 2010.  For reasons I explained in my February 2016 decision they have little information from the Company itself.

19.Mr Li on behalf of KPMG suggested that this application is not for a variation of paragraph 1.3 of the February order as it is framed in the summons, but in the nature of a new application, although he took no point in respect of this.  It seems to me that nothing of substance turns on this issue.  I will order that paragraph 1.3 of the February order is varied to replace “31 December 2009” with “31 December 2010”.

Publication of February Decision

20.The final matter concerns the publication of my February decision, which has not been uploaded onto the Judiciary website because of concerns that the MOF might be reluctant to cooperate further if my reasons are made public at this stage.  I think it is desirable that my reasons are made public as soon as possible, because they deal with matters of some importance.  However, I will delay doing so until after the revised order for production has been implemented and it is clearer how the MOF responds to it.

Costs

21.In the light of my conclusions in my view it is appropriate that KPMG pay the costs of those paragraphs of both summonses that have been determined by this decision.  I make a costs order nisi to this effect.

Mr Charles Manzoni SC, instructed by Lipman Karas, for the applicants

Mr Lawrence Li, instructed by Smyth & Co, for the 1^st respondent