Joe Zhixiong Zhou v. Saif Partners Ii L.P. and Another

HCCL 16/2016

[2018] HKCFI 898

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 16 OF 2016

(TRANSFERRED FROM HIGH COURT ACTION NO 1551 OF 2010)

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Before: Deputy High Court Judge Field in Chambers

Dates of Written Submissions by the plaintiff: 12 and 27 March 2018

Dates of Written Submissions by the 1^st and 2^nd defendants: 12 and 27 March 2018

Date of Ruling on Costs: 25 April 2018

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RULING ON COSTS

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INTRODUCTION

1.There are two consequential matters on which the Court must rule—Costs and Directions as to the taking of the account ordered by the Court.

2.The opening and reply submissions on the question of costs are all before the Court but the defendants seek more time to deal with an affirmation relating to the account with which they were served on 26 March 2018.  In these circumstances, I propose to give two rulings, one on costs which follows below and one on the necessary directions for the taking of the account which must await service on the Court of reply submissions.

3.I further direct that the defendants served their reply submissions on the account directions within 7 days of the date of this ruling. 

COSTS

4.The plaintiff (“Mr Zhou”) contends that:

(1) D2 should be ordered to pay on an indemnity basis all of the costs he incurred in bringing his carried interest claim and all of the costs he incurred in resisting D2’s counterclaims since he succeeded on his carried interest claim and D2 did not succeed on any of its counterclaims;

(2) D1 should be ordered to pay on an indemnity basis all of the costs of his carried interest claim and four–fifths of the costs he incurred in resisting the D1’s counterclaims because he succeeded on his carried interest claim and succeeded on all of D1’s five counterclaims for an account of profits, save for the claim in respect of KPCB China Fund LP’s investment in Xinrui (“the Xinrui counterclaim”).

5.In support of contentions (1) and (2), Mr Zhou submits that:

(a) the defendants abandoned their “absurdly exaggerated” counterclaims for damages late in the day after failing to obtain leave to adduce expert evidence in support thereof;

(b) having made two late applications to adduce the evidence of Xie Xuejun by video link and succeeded on the second application, the defendants then decided not to call this witness;

(c) the witness statements of the defendants’ witnesses contained to varying degrees inadmissible hearsay, legal submissions and opinion, particularly in the case of Mr Andrew Yan;

(d) the defendants filed 7 separate lists of documents in respect of their counterclaims for damages, the last being provided just over 1 month before the trial, which significantly added to the large volume of unnecessary trial documentary evidence; and

(e) in the light of Mr Zhou’s testimony that the KPCB China Fund LP’s investment in Xinrui was not profitable, D1’s success on the Xinrui counterclaim was a “Pyrrhic” victory only.

6.In regard to his contention that the defendants should pay costs on the indemnity basis, Mr Zhou submits that this was his entitlement under Article 4.3(a) of the ALPA.  In the alternative, he argues the Court should award costs on this basis as a matter of discretion, on the grounds that:

(1) the defendants pursued their massive damages counterclaims, on which a great deal of time was spent only to abandon these claims shortly before trial;

(2) the defendants’ defence to Mr Zhou’s claim was bound to fail on the true construction of the Separation Agreement and the ALPA;

(3) the only reason Mr Zhou was prevented from succeeding on his summary judgment application was the defendants’ reliance on serious allegations of misconduct that were spurious;

(4) the defendants at an inexcusably late stage (either shortly before trial or during the trial) abandoned numerous allegations,including: (a) allegations of misconduct in relation to the loansof US$300,000 and US$250,000 made personally to Zhou Yang. 

7.The defendants contend that:

(1) the Court should proceed on the basis that the trial involved two “events”, the claim on which Mr Zhou prevailed and the counterclaims where the defendants prevailed;

(2) the costs of the proceedings should be divided into two parts —the Pre-Trial Costs and the Trial Costs;

(3) since Mr Zhou was the winner on the claim, he should have all of the Pre-Trial costs pertaining to his claim;

(4) since the defendants were the winners for the most part of the counterclaims, they should get 50% of the Pre-Trial costs pertaining to the counterclaims;

(5) at least 75% of the time spent on the trial was taken up with the cross-examination of witnesses going to the defendants’ allegations of wrong-doing by Mr Zhou and in light of the Court’s findings that Mr Zhou had given untruthful evidence and the Court’s findings against Mr Zhou in respect of the US$2.5 million loan made personally to Zhou Yang, the Xinrui counterclaim and the Mobile Winks claim, Mr Zhou should pay 80% of the defendants’ costs of the Trial.

8.Replying to the submissions made on behalf of Mr Zhou, the defendants submit:

(1) there is no justification for distinguishing costs between D1 and D2 since D2 is the general partner of D1 and the partnership is not a separate legal entity, and all the Counterclaims were made by both D1 and D2;

(2) the defendants’ success on the Xinrui claim should not be regarded as a pyrrhic victory just because Mr Zhou, who was found to be an untruthful witness in respect to his dealings with Zhou Yang on the Xinrui transaction, testified that the transaction was unprofitable;

(3) the defendants having succeeded at least in part on their accountof profits counterclaim, it would be wrong in principle to award Mr Zhou any of his costs in resisting the counterclaim;

(4) but for the issue of contractual interpretation, the defendants would have succeeded on their misconduct allegations in respect of the US$2.5 million loan and the Mobile Winks claim;

(5) Mr Zhou has no entitlement to indemnity costs under Article 4.3 of the ALPA given that (i) Article 4.3 provides cover “only to the extent that (i) such Covered Person has not committed any act constituting Cause and has acted in a manner reasonably believed to be in or not opposed to the best interest of the Partnership, the General Partner, the Fund General Partner or the Fund …”; and (ii) the Court found that Mr Zhou solicited Zhou Yang to act in breach of the My Show Covenant contrary to Article 3.2(a)(ii) of the ALPA in connection with the Xinrui transaction;

(6) the Court ought not to award costs on the indemnity basis in the exercise of its discretion since the defendants’ case on the meaning and effect of the Separation Agreement and the ALPA was reasonably arguable; it is clear from the Court’s findings that the defendants’ allegations of misconduct were not spurious; the withdrawal of the defendants’ damages counterclaim was based on a responsible professional judgment in light of the refusal of the Court to allow expert evidence to be given in support of it; the Defendants at no stage withdrew the factual allegations underlying their case of breach of fiduciary duty.

THE RELEVANT APPLICABLE RULES OF COURT

Order 62, rule 3 :

9.

(2) If the Court in the exercise of its discretion sees fit to make any order as to the costs of or incidental to any proceedings (other than interlocutory proceedings), the Court shall, subject to this Order, order the costs to follow the event, except when it appears to the Court that in the circumstances of the case some other order should be made as to the whole or any part of the costs.

(2A)   If the Court in the exercise of its discretion sees fit to make any order as to the costs of or incidental to any interlocutory proceedings, it may, subject to this Order, order the costs to follow the event or make such other order as it sees fit.

Order 62, rule 5 :

10.

“ (1)   The Court in exercising its discretion as to costs shall, to such extent, if any, as may be appropriate in the circumstances, take into account—

(aa)   the underlying objectives set out in Order 1A, rule 1;

(a)   …;

(b)   …;

(c)   …;

(d)   …;

(e)   the conduct of all the parties;

(f)   whether a party has succeeded on part of his case, even if he has not been wholly successful; …

(g)   ….

(2)   For the purpose of paragraph (1)(e), the conduct of the parties includes—

(a)   whether it was reasonable for a party to raise, pursue or contest a particular allegation or issue;

(b)   the manner in which a party has pursued or defended his case or a particular allegation or issue;

(c)   whether a claimant who has succeeded in his claim, in whole or in part, exaggerated his claim; and

(d)   conduct before, as well as during, the proceedings.”

The application in Hong Kong of the Elgindata (No 2) principles

11.The well-known principles enunciated by Nourse LJ in Elgindata (No 2) [1992] 1 WLR 1207 at 1214A–C are:

“ (i) Costs are in the discretion of the court. (ii) They should follow the event, except when it appears to the court that in the circumstances of the case some other order should be made. (iii) The general rule does not cease to apply simply because the successful party raises issues or makes allegations on which he fails, but where that has caused a significant increase in the length or cost of the proceedings he may be deprived of the whole or a part of his costs. (iv) Where the successful party raises issues or makes allegations improperly or unreasonably, the court may not only deprive him of his costs but may order him to pay the whole or a part of the unsuccessful party’s costs.”

12.These principles, which pre-dated the Civil Justice Reforms in England and Wales, were adopted in Hong Kong before Hong Kong’s own Civil Justice Reforms were implemented.  In Wong Kam Tong v The IO of Yuen Long Tin Shing Court [2012] 2 HKLRD 1128 at para 13, Cheung JA (with whom the other members of the Court agreed) said that following the amendment to the Hong Kong Rules of Court in the wake of Hong Kong’s Civil Justice Reforms, “while the ‘follow the event principle’ will still play a significant role in Hong Kong, it will nonetheless only be a starting point from which the Court can depart, the rationale being that a mechanistic adoption of the ‘follow the event principle’ may result in parties incurring unnecessary costs in civil litigation.”

13.More recently, in Kam Leung Sui Kwan, Personal Representativeof the Estate of Kam Kwan Sing, the Deceased v Kam Kwan Lai & ors, unreported, 3 February 2016, FACV 4/2015, the Court of Final Appeal has said:

“ As this Court has previously said, too inflexible an application of the rule that costs generally follow the event is to be avoided but the discretion to depart from the rule should be exercised with due circumspection since too ready a departure from the general rule encourages unnecessary argument. Nevertheless, the principles for depriving a successful party of part of his costs set out in Re Elgindata (No.2) are well-established and continue to apply in this jurisdiction notwithstanding the amendments to the rules of procedure under the Civil Justice Reform.”

DISCUSSION AND ANALYSIS

The costs pertaining to Mr Zhou’s claim for carried interest

14.In my opinion, Mr Zhou should have all of his costs pertaining to his claim for carried interest.  The defendants’ defence based on the contention that he was guilty of misconduct amounting to “Cause” so that, pursuant to Article 7.1(c) proviso (iv) his applicable percentage became equal to 0.05 multiplied by what would otherwise be his applicable percentage, was legally misconceived.  It follows in my view that the fact that much time at the trial was taken up in cross-examining Mr Zhou on the defendants’ allegations of misconduct, including allegations that to some extent overlapped with the defendants’ breach of fiduciary allegations, is no reason why Mr Zhou should not be entitled to the costs of his claim without any deduction.

15.I do not, however, accept the submission made on Mr Zhou’s behalf that the costs of his claim should be assessed on the indemnity basis.  Dealing first with the claim under Article 4.3 of the ALPA, I agree with the defendants’ contention that the Court’s finding that Mr Zhou solicited Zhou Yang to act in breach of the My Show Covenant contrary to Article 3.2(a)(ii) of the ALPA in connection with the Xinrui transaction means that he is not entitled to any indemnity under that provision.

16.As to Mr Zhou’s claim for indemnity costs in the Court’s discretion, indemnity costs are awarded where a party is responsible for something “outside the norm”, see Excelsior Commercial & Industrial Holdings Ltd v Salisbury Hamer Aspden and Johnson [2002] All ER (D) 39 (Jun).  Examples of conduct outside the norm include baseless allegations of fraud, bringing a claim that totally lacks merit, and misleading the court.  In my opinion, the conduct of the Defendants in defending Mr Zhou’s claim in the manner they did was not “out of the norm” such as to require the Court to mark its disapproval thereof by awarding indemnity costs.  I reject the suggestion that the defendants knowingly manufactured a set of false, spurious allegations of misconduct against Mr Zhou.  Although the witness statements of the defendants’ witnesses contained inadmissible material, those witnesses gave truthful evidence.  I am also of the view that the defendants’ abandonment of their damages counterclaim and their misconduct allegations in respect of the loans for US$300,000 and US$250,000 late in the day is not conduct justifying indemnity costs.  I say this because I can see no proper basis for concluding that their counterclaim was anything other than a genuine claim and I am satisfied that it was abandoned in the light of the Court’s refusal to permit expert evidence to be given in support of it.  As for the decision not to press the misconduct allegations made in respect of the loans, this was responsibly taken by Mr Pow SC and the allegations in question were not improperly made.

The costs pertaining to the defendants’ counterclaims

17.In light of the defendants’ abandonment of their damages counterclaim, Mr Zhou is entitled to his costs from both defendants in defending that counterclaim down to the point it was abandoned.

18.D1 succeeded on its alternative account of profits claim for breach of fiduciary in respect of the Xinrui counterclaim.  It did so because it established that Mr Zhou owed the duties of a fiduciary as a Limited Partner under the ALPA (a contention hotly resisted by Mr Zhou) and by proving that Mr Zhou, acting in his own interest rather than in the interest of D1 and his Fund II co-partners, colluded with Zhou Yang to establish Xinrui as an enterprise separate from My Show and the WOFE whilst Mr Zhou was still an active partner under the ALPA.

19.I reject the submission that D1’s success on this claim should be regarded as a “Pyrrhic” victory.  The extent to which any profit was made on the Xinrui investment will be determined upon the taking of the account that the Court has ordered.

20.The defendants’ claim for breach of fiduciary duty in respect of the US$2.5 million loan failed on the facts—the Court found that Mr Zhou honestly believed that the US$2.5 million would be used to meet the WOFE’sworking capital requirements and that Zhou Yang could be trusted to use the money for those purposes, given in particular his (Zhou Yang’s) incipient right to acquire a 70% majority interest in My Show if that company’s earnings for 2006 were stated to be at least US$3 million in its accounts for that year. 

21.The defendants’ account of profit claim in respect of Mobile Winks failed for lack of proof that Mr Zhou or Keytone Ventures or KPCB ever invested in Mobile Winks.  However, it is implicit in the Court’s finding that Mr Zhou solicited Zhou Yang to breach the My Show covenant and misused confidential information in his dealings with Zhou Yang concerning Mobile Winks, that in so acting Mr Zhou was wrongfully putting his own interest ahead of the interest of D1.

22.The defendants account of profit claim in respect of My Show Ad failed fairly and squarely on the facts, the Court finding that Zhou Yang did not incorporate that company with the intention that it should be a secret competitor to the WOFE and that Mr Zhou was entitled to trust Zhou Yang to ensure that My Show Ad was run as part of the business of the WOFE.

23.The defendants also had a pleaded case that Mr Zhou acted in breach of fiduciary duty and contrary to Article 3.2(d) of the ALPA in makingvarious public statements that disparaged the Partnership, the General Partner and Fund II.  However, this case was not substantively pursued at trial and in any event lacked any foundation for a claim for an account of profits.

24.The above five account of profit claims were all predicated on Mr Zhou being subject to a fiduciary duty not to put his own interest ahead D1’s interest, but otherwise they were distinct, separable claims each depending on proof of the facts upon which each was based.

25.It goes without saying that the Court should take into account in favour of the defendants that they won on the important issue whether Mr Zhou was subject to the duties of a fiduciary and that D1 succeeded on the Xinrui counterclaim which occupied a considerable amount of time at trial.

26.I also think that the Court should take into account to a significant extent in favour of Mr Zhou the failure of the defendants to succeed on the claims made in respect of the US$2.5 million loan and the My Show Ad because these claims occupied a middling amount of time and were lost fair and square on the facts.  In like manner, the Court should in addition take into account the failure of the claim based on disparagement but to a much lesser extent since almost no time at the trial was taken up on this claim.

27.As to the Mobile Winks claim, I do not think that any allowance in favour of Mr Zhou should be made based on the defendants’ failure to succeed on this claim.  I say this because the defendants established that Mr Zhou acted in breach of fiduciary duty, albeit that they were unable to show that he profited from the breach.

28.Taking into account the considerations articulated above, I conclude that the defendants should have 65% of the costs of their account of profits counterclaim.

29.I am also of the view that no distinction should be drawn between the defendants when making the appropriate costs order.  The counterclaims and the defences to the carried interest claim were all advancedjointly by one set of legal representatives without any distinction being made between the defendants.

CONCLUSION

30.For the reasons given above I order that:

(1) The defendants must pay the costs of Mr Zhou’s claim for carried interest and the costs of their abandoned damages counterclaim, these costs to be assessed on the standard basis unless otherwise agreed.

(2) Mr Zhou must pay 65% of the defendants’ account of profit counterclaims, these costs to be assessed on the standard basis unless otherwise agreed.

Mr Barrie Barlow SC, leading Mr Chan Pat Lun, instructed byReed Smith Richards Butler, for the plaintiff

Mr Jason Pow SC, leading Mr Alexander Tang, instructed by Peter Yuen & Associates, for the 1^st and 2^nd defendants