Guang Xin Enterprises Ltd v. Kwan Wong Tan & Fong (A Firm)
Read the full judgment text of CACV 292/2002 on BabelCite. This Court of Appeal judgment was delivered on 13 March 2003.
1. These appeals were from judgments and orders of Deputy High Court Judge Tong SC, dated 21 May and 18 June 2002 respectively. By the first judgment the deputy judge struck out the statement of claim in this action and dismissed the action subject to the fact that he gave the plaintiff 21 days to reformulate its claim in respect of what were referred to as the "Wantong" and "Life Circle" transactions. The plaintiff subsequently applied for an extension of time to apply for any amendment until 2
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CACV 263 & 292/2002 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF APPEAL CIVIL APPEAL NOS. 263 & 292 OF 2002 (ON APPEAL FROM HCA NO. 2788 OF 2001) ____________________
____________________ Coram: Hon Rogers VP, Le Pichon and Ma JJA in Court Date of Hearing: 25-26 February 2003 Date of Handing Down Judgment: 13 March 2003 ____________________ J U D G M E N T ____________________ Hon Rogers VP: 1.These appeals were from judgments and orders of Deputy High Court Judge Tong SC, dated 21 May and 18 June 2002 respectively. By the first judgment the deputy judge struck out the statement of claim in this action and dismissed the action subject to the fact that he gave the plaintiff 21 days to reformulate its claim in respect of what were referred to as the "Wantong" and "Life Circle" transactions. The plaintiff subsequently applied for an extension of time to apply for any amendment until 21 days from the final determination of the appeal against the first order. That application was dismissed by the deputy judge on 18 June 2002. That dismissal forms the subject matter of the second appeal. At the conclusion of the hearing of this appeal this court reserved its decision to be handed down in writing. Background 2.This action is a claim by a company in liquidation. The defendant had been the auditors in respect of the accounts for the plaintiff's final trading years. The defendant's primary case is that the statement of claim lacks essential averments that would be necessary to constitute a valid cause of action. It should be said at the outset that, in this respect, it was conceded that the plaintiff might be able to formulate a claim which would be sustainable, at any rate, on the pleadings. In relation to the cross-appeal, however, it is said that the plaintiff's claim is fundamentally bad because, in effect, it is a claim on behalf of the creditors and that a claim on behalf of the creditors should not lie against auditors. The major averments in the statement of claim 3.For the purposes of the present proceedings, it is, of course, necessary to take the allegations made in the statement of claim as being factually correct. The following facts emerge from the statement of claim. The plaintiff is a company which was placed into creditors' voluntary liquidation on 12 October 1998 by a resolution of the directors who had formed the opinion that the company could not, by reason of its liabilities, continue its business. The defendant firm was appointed the auditors of the plaintiff for the years ending 31 December 1994 to 31 December 1996. 4.The plaintiff's audited accounts for the years since its incorporation form schedules to the statement of claim. Those accounts, as well as paragraph 94 of the statement of claim, reveal that, at all times, the ultimate holding company of the plaintiff was Guangdong International Trust and Investment Corporation ("GITIC"). In January 1999, GITIC was itself declared bankrupt according to the laws of the Mainland. Nothing further is alleged about the relationship between the plaintiff and GITIC other than the fact that GITIC had provided a letter of indemnity whereby it agreed to indemnify the plaintiff against various losses. Those losses did not include the alleged losses that are the subject matter of the complaints in respect of which the plaintiff now wishes to pursue this action. There are three categories of transactions in respect of which the plaintiff now wishes to continue the action. These may be referred to as the Wantong, the Life Circle and the Standard Corporation transactions.
5.It is alleged, in paragraphs 29, 30(a), 31 to 33 of the statement of claim, that letters of credit were opened by the plaintiff in favour of "suppliers", purportedly for the supply of steel pipes and other goods which would be on sold to Wantong Steel Pipe Co. Ltd. It is not clear whether there was more than 1 supplier, but all the transactions in 1994 were said to have been with Kwong Wah. What is said is that no goods were purchased and, instead, these were fictitious transactions whereby money was obtained by the supplier from the banks on the basis of forged documents. The supplier would, at some stage, repay the plaintiff the monies that had been received from the relevant bank and that fact confirmed that there were no genuine sales. The transactions were entered into the plaintiff's accounts as part of the gross invoiced sales, which, evidently, they were not. It is pleaded that the sums in respect of the letters of credit transactions should not have been included in the turnover figure. It is alleged that there was a close connection between Kwong Wah and the plaintiff in that two of the directors of that company had been in the plaintiff's employ and, indeed, one of those directors, who is said to have been the chief signatory of the applications for the letters of credit on behalf of the plaintiff, was the accounts manager of the plaintiff until 1998. Furthermore, one of the vice-chairmen of Wantong had, at one stage, been a director of the plaintiff and the other had been a manager of the plaintiff until 1995.
6.In respect of the Life Circle transactions, it is alleged in paragraphs 34 to 36 of the statement of claim that letters of credit were opened in favour of two suppliers, Kam Kiu International Limited ("Kam Kiu") and Southern Plywood Industry Sdn Bhd, for the supply of Malaysian plywood. Again, it is said that no goods were obtained and there was no onward sale of any goods to Life Circle. The monies which were received from the banks by both Southern Plywood and Kam Kiu were repaid by Kam Kiu. Unlike the Wantong transactions, in this case the transactions appeared in the plaintiff's accounts as interest and commission which were said to have been received; they were not treated in the accounts as sales, as such. It is said that the documents which purported to evidence the sale transactions were signed by two directors of the plaintiffs, a Mr Ye Qing Lin and Huang Qing Zhou and three of the plaintiff's managers namely, Geng Guang Li, Wong Yin and Chung Fuk Cheung. 7.The transactions in relation to Wantong and Life Circle were alleged to have been continued in the periods to which the 1995 and 1996 accounts related. The Standard Corporation transaction 8.The allegation in respect of Standard Corporation is that in the years 1996, 1997 and 1998 the plaintiff made new advances in respect of what were termed "major projects" in relation to "Standard Corporation". In paragraph 172 of the statement of claim it is said that the 1996 accounts included $41.7 million in respect of a new investment in Standard Corporation and then in paragraph 173(b), it is said:
9.It might be mentioned at this stage that the written submissions on behalf of the plaintiff go further than the allegations in the statement of claim. They refer to the fact that Standard Corporation, being a subsidiary of the plaintiff, would not have purchased a building from Kam Kiu had the matters referred to in paragraph 173(b) been revealed.
10.The statement of claim sets out both the statutory duties of the auditors as well as the common law duties of care, which arise as a result of the relationship between an auditor and the client. It also sets out some of the statements of standard accounting practice, which governed the manner in which audits should have been conducted and accounts prepared. For present purposes, nothing arises out of this. Furthermore, no question arises, on this application, on the allegation that the defendant was in breach of duties, both under contract and the common law, because of the manner in which the accounts were presented in relation, at least, to the Wantong and Life Circle transactions. It should be noted that the complaint is that instead of drawing the various irregularities to attention in the auditors' reports and in the accounts, the defendant reported that the financial statements gave a true and fair view in all material respects of the plaintiff's affairs.
11.The material plea that the plaintiff now relies upon in respect of the Wantong and Life Circle transactions is contained in paragraph 107 of the statement of claim. The part specifically relied upon reads:
It is alleged that at the date of the liquidation the balance outstanding as a result of these transactions was $551 million and that at least $264.5 million of this loss would have been avoided. In relation to Standard Corporation, as already noted, it is alleged that the plaintiff would not have made any investments that would have involved Mr Lam or Kam Kiu. 12.For completeness, it should be mentioned that the statement of claim as originally drafted had included other claims in respect of which the judge had used the term "trading loss claims". Those amounted to allegations that if the true state of the plaintiff's finances had been revealed, the plaintiff would have ceased trading and therefore not made losses in subsequent years. That plea was held by the deputy judge to be a bad plea on the basis of established authority. There was no appeal against that holding, except in relation to the Standard Corporation transaction, and, therefore, no more need be said about that, save that it took up a considerable amount of the statement of claim. The decision below in respect of the Wantong and Life Circle claims 13.The deputy judge below considered the claim in respect of the Wantong and Life Circle transactions under the heading of the "sales loss claims". He considered that such a claim against auditors would be based on their failure to uncover misfeasance by the management in misapplying assets of the company. He termed this a "defalcation claim". At paragraph 91 of the judgment, he considered that the fictitious transactions of the trading loss claims should be treated as defalcation claims. In paragraph 99 of the judgment, the deputy judge expressed the view that the plaintiff would have a viable claim if it were to plead (a) credible facts which go to show that the "sales" were a fraud on the plaintiff and (b) that the board of directors was misled and (c) that the plaintiff by its directors or shareholders relied on the negligent audit in failing to stop the fraud which led to losses. 14.On this appeal Mr ter Haar QC, on behalf of the plaintiff, took issue, first of all, with the suggestion that the plaintiff's claim is dependent upon an allegation of fraud on the plaintiff. Whilst he readily admits that, on the basis of the allegations at present in the statement of claim, there are grounds for alleging that fraud had been committed on the banks by the submission of bogus sales documents, he avers that it is sufficient to found a cause of action that there should have been irregularities to which the auditors should have drawn attention by their audit report. In respect of the argument that the matter of causation had not been adequately pleaded, Mr ter Haar again averred that the pleading was sufficient. He pointed out that the allegations in the statement of claim in relation to the Wantong and Life Circle transactions follow closely the Precedent Form 9P/3 in Jackson and Powell, Professional Liability Precedents October 2000. It is said that in the light of that, the allegations are complete and, although further and better particulars may be provided, the pleading, as a pleading, is sufficient. Ingredients of claims against auditors 15.In order to consider whether the statement of claim is sufficient, as it stands at present, it would be convenient to highlight what would be necessary in a pleading for a claim for damages to be made against an auditor. In my view the essential headings can be summarised as follows:
The pleading in the present case 16.The essence of the pleading in relation to the present case has already been summarised. The statutory, contractual and common law duties of care have been fully pleaded and no issue has been taken in respect thereof. It has also been pleaded that those duties were owed to the plaintiff. Some minor distraction was raised in the present proceedings by a suggestion that the auditors' duties were duties owed to the shareholders as opposed to the company. Reliance was made, in particular, on passages in the speeches in Caparo Industries Plc v. Dickman [1990] 2 A.C. 605. They go to show the underlying philosophy behind the requirement for audited accounts and the reasons why it is the shareholders in general meeting, rather than the directors, who appoint the auditors. That, however, does not detract from the fact that the auditors' contractual duty is owed to the company which appoints them and the common law duty of care and the statutory duties are owed to the company. 17.The Caparo case was concerned with a claim by a company which had taken over the company in respect of which the relevant defendants had been the auditors. The claim was, therefore, a claim in tort and not a claim in contract. Furthermore it was not a claim by a shareholder but was treated as a claim by an outsider. The case was not concerned with whether the company, which had had its accounts audited, had a claim against the auditors but was concerned with whether an outsider would have a claim against the auditors. The question of liability of the auditors was tried as a preliminary issue. The House of Lords held that no duty of care was owed to a potential investor in the company, since, in this respect, it was a non-shareholder. It is evident from passages in the speeches of Lord Bridge and Lord Oliver that it was understood that the company itself might have had a claim. At page 626D-E Lord Bridge made reference to shareholders losses being recouped in an action by the company and not by the shareholders. At page 630 F-G Lord Oliver said:
18.Since this action is concerned with an action by the company and not an action by the shareholders, it is unnecessary to consider the duties owed to shareholders. It is sufficient to say that the duties are owed to the plaintiff. In relation to the breach of duty, again, there is no live dispute, for the present purposes, as to the sufficiency of the allegation of breach of duty. The real question comes as to whether there is a sufficient causal link between the breach of duty and any loss alleged by the plaintiff to have been consequent upon that breach of duty. 19.At times during the hearing, questions were raised as to whether the damage had been sufficiently identified in the pleading, but in my view it must be taken to have been so identified in respect of the Wantong and Life Circle transactions to the extent that the losses have been pleaded. For a successful claim to be made these losses would have to be pleaded as unrecovered losses but that, in the context, would be a minor addition, which, in the course of argument, was, for practical purposes, taken as read. 20.Mr ter Haar relies on two further sets of averments that he says should be taken as being incorporated in the pleadings. The first was contained in a letter of 19 April 2002 that was sent in response to a letter from the defendant's solicitors shortly prior to the hearing in the court below. The material part of that letter reads:
21.In addition, on the final day of the hearing in the court below, there was submitted to the court an additional paragraph to be inserted as paragraph 104A. For present purposes the material parts of that read:
would have, in effect, prevented the plaintiff from carrying out the transactions which caused the loss. 22.It is pertinent to emphasise, in this respect, that it is not alleged that the plaintiff did not know the matters which it is alleged the defendant's audit should have revealed. In this way, if not others, the pleading still materially differs from the precedent in Jackson and Powell to which reference has already been made. There are, perhaps, good reasons in this case for the plaintiff not wanting to put its case on that basis. Knowledge of Mr Huang, and possibly Mr Ye, if not some of the managers, may well be attributed to the plaintiff. In this context it may be observed that very little is pleaded as to the internal workings of the plaintiff and as to the various responsibilities of the different parties. The argument on behalf of the plaintiff was put on the basis, that even if such knowledge might be attributed to the plaintiff, either as a matter of fact or as a matter of law, it was still open to the plaintiff to aver that, should the majority of directors, either of the plaintiff or of its ultimate parent, GITIC, have become aware of the transactions, they would have taken steps to stop any continuation. The argument was that public revelation might have been enough to have prompted the relevant directors into action even if they had prior knowledge of the "irregularities". 23.It seems to me that a pleading along those lines might be viable save for one matter. It would it seems to me be necessary for the pleading to contain particulars as to precisely who would have taken what steps had the matters, which were alleged to have been deficient in the auditors' report and accounts, been revealed. In this respect the precedent in Jackson and Powell is relevant. The precedent to which Mr ter Haar made particular reference related to a situation where the managing director of a company had committed a fraud on the company and the sample pleading contained the averment that the company was ignorant of the facts. In those circumstances it is easily understandable that a logical connection may be made between the company, which was previously unaware that a fraud was being committed against it, becoming aware of the fraud and taking steps to recover in respect of it and to prevent repetition. 24.On the other hand a company that knew irregularities were taking place, seems to me to be in a different position. In such circumstances it is by no means clear that, even if the auditors were to draw attention to the irregularities, the company would take any steps to prevent the continuation of those irregularities, because the company had known about them and would, without more, be presumed to have approved of its own conduct. In my view, the logical conclusion that a company would take immediate steps in respect of a hitherto unknown fraud does not apply in a situation where a company itself knows that it is committing "irregularities" and the matter happens to be spelt out in the accounts. This is particularly so in the case of a private company, because the accounts are not generally published. Since the matter has now reached the stage where the plaintiff will have to amend its pleading in order to save it, there is no doubt in my mind that those particulars should be provided as part of any amendment, if indeed this is the plaintiff's case. 25.In relation to the lack of knowledge on the part of the directors of GITIC, I consider that there is at present a deficiency in the pleading as to what control it is alleged was and would have been exercised by those persons in respect of the plaintiff. It is to be noted that the audited accounts revealed GITIC to have been the ultimate holding company, whereas sub-paragraph 2 of the proposed paragraph 104A refers to GITIC being a shareholder of the plaintiff. 26.To conclude, the deputy judge was right to strike out the statement of claim as it stood as far as the Wantong and Life Circle claims were concerned. I should also add that, particularly in cases of professional negligence, particular care needs to be given to the pleading of causation. As is put at paragraph 75-05 of Bullen & Leake & Jacob's Precedents of Pleadings (14th ed.) Vol. 2, "Causation of loss often involves more complex issues in a professional negligence case than in an ordinary negligence claim, making it generally necessary to set out the material parts relied upon as correcting the negligence to the damage suffered."
27.As regards the Standard Corporation claim, the matter is somewhat different. The plaintiff has sought, in argument, to put the matter on the basis that Standard Corporation, which was a subsidiary of the plaintiff, would not have entered into a contract to purchase a building from Kam Kiu in 1996 had it been aware of the true nature of the transactions with which Mr Lau and Kam Kiu were involved. I have to say, however, that the manner in which the matter is at present pleaded is wholly unacceptable. Even putting together what facts might be gleaned from paragraph 101(b) and what remains of paragraphs 172 and 173, I find there is no comprehensible allegation of a specific transaction which was entered into as a result of a specified defect in the auditors' report or accounts by reason of which the plaintiff suffered loss, which would otherwise have been avoided. In short the pleading is by no means clear enough to disclose a cause of action. 28.Whether or not the plaintiff is in a position to plead a cause of action based on the Standard Corporation transaction is by no means certain. The allegation, as far as can be gleaned from the statement of claim and the skeleton arguments, involved Standard Corporation, as a subsidiary of the plaintiff, purchasing a building from Kam Kiu. If that impression be wrong, the error highlights the defects in the present pleading. But why it should be that the purchase of a building, in itself, caused loss is by no means clear. The fact that a building in Hong Kong contracted to be purchased on 6 December 1996 may be worth far less now, according to present day values, than it was then is no indication that a loss has been suffered that could be attributed to anything other than a fall in market value. In any event, it seems to me that, if a claim on this basis is to be made, the facts giving rise to the claim must be pleaded in a concise, precise and comprehensible manner. It would not be acceptable to have to wade through scattered paragraphs in the hope of gleaning facts from which some cause of action might be arrived at. Still less is it acceptable to have to ferret out some basis for a claim from many years' audited accounts. 29.I am of the view that this part of the statement of claim should be struck out. The remoteness-policy argument 30.Under the subheading 'Remoteness', the deputy judge came to the conclusion, in relation to what he categorised as the trading loss claims, that the auditor's liability would be limited "to the value of the shares held by the shareholders at the time of the negligent audit" see paragraph 75. He did so on the basis of the proposition that, because it was the plaintiff's case that it was hopelessly insolvent in 1994, any recovery in this action would be for the benefit of the creditors and not for either the shareholders or the plaintiff itself. 31.Whereas this argument was put forward on the basis of policy, the deputy judge dealt with it as a question of remoteness. When the deputy judge came to what he referred to as the sales loss claims, in other words the Wantong and Life Circle claims, he appears to have considered the argument inapplicable. As part of the appeal, the plaintiff contends that the argument is totally inapplicable. By a respondent's notice the defendant contend that the matter is one of policy and is equally applicable to the sales loss claims as well as the trading loss claims. 32.Mr Pollock QC, on behalf of the defendant, did not shrink from the fact that this is a new point that has never been the subject of a decision in a relevant court before. The argument is founded, in part, upon observations made by Lord Hoffmann towards the end of a speech which he made to the Chancery Bar Association in London in June 1999. The theme of Lord Hoffmann's speech was that courts have frequently used expressions such as "It is a matter of common sense ..." to justify a conclusion without giving adequate consideration to the underlying principle. At page 22 of the printed version of the speech, Lord Hoffmann gave an example of a company in insolvent liquidation suing its auditors for negligence in auditing its statutory accounts. In that case, the claim against the auditors had been made on the basis that because of a failure to reveal fraud, the company had continued trading and had thereby increased the losses. The claim was made in respect of the increase in the losses which had occurred after the faulty audit of the accounts. The matter had been disposed of as a matter of causation. On page 23 of the speech Lord Hoffmann suggested that the matter could have been covered by the scope of the duty owed by the auditors. It was pointed out that any recovery would have been solely for the benefit of the creditors and hence the claim was, in effect, a claim for their benefit. Since no duty was owed to the creditors, the policy should be that recovery should not be allowed. 33.Put in that way, the argument has some attraction. Nevertheless, the shifting way this proposition, which was said to be based on policy, was put on behalf of the defendant in the course of argument, alone demonstrated that the effect of any such policy had not been fully considered. It was certainly not clear enough to constitute a ground for striking out the statement of claim. It should be pointed out that, in the present case, the claim is not simply a claim in tort, it is a claim in contract. It is, furthermore, not a claim on behalf of the shareholders. It is a claim by the company and, in particular, a contractual claim. 34.A company is a separate legal entity from its shareholders. If it has a contractual claim it is entitled, at least, to nominal damages for any breach. As was pointed out in argument on behalf of the plaintiff, it is difficult to discern a policy reason which would exclude recovery for loss occasioned by a breach of contract. In the course of argument, the difficulties which would arise by reason of having to discern whether a claim by the company would be disallowed on the basis of insolvency would depend upon the clarity of the situation which gave rise to the insolvency. 35.The notion that policy considerations should deny relief in respect of particular claims that would otherwise be viable is something that would need careful and detailed consideration before so far-reaching a proposition could be upheld. The application of a policy which would be limited solely to claims against auditors is something which would need rational deliberation. It may well be that policy considerations might lead to the conclusion that in cases involving corporate misfeasance where a number of different parties were responsible for the particular misfeasance, for example, directors, auditors, legal advisors or whoever, liability should be apportioned in the first instance and recovery should only be possible to the extent of that party's proportional liability. Such policy considerations have led to a change in the law in other jurisdictions, such as New South Wales, but it would be for the legislature to introduce such a change in the law. 36.I am therefore of the view that the sales loss claims cannot be struck out on this ground alone. Appeal against decision of 18 June 2002 37.In the further decision of 12 July 2002, the deputy judge said at paragraph 3:
The deputy judge then went on to hold that he was powerless to rectify the situation because he considered that the action had already been dismissed. Whereas this appeal is not against the order of 12 July, it should be pointed out that the court has a considerable degree of flexibility in procedural matters, both as to the exercise of the powers to extend time after expiry of time and otherwise. If a court considers the justice of a situation requires the exercise of that flexibility it should not be put off simply because a formal application has been made in what might be technically regarded as the wrong form or because some further order should have been sought in a summons. 38.Be that as it may, in upholding the decision of the deputy judge below that the statement of claim in its present form does not disclose a valid cause of action, the reasoning of the deputy judge has not been followed in its entirety, in particular that in relation to defalcation. Therefore the circumstances under which the deputy judge exercised his discretion are not the relevant circumstances which this court has now held should apply. There is, furthermore, considerable force in the argument on behalf of the plaintiff that to force the plaintiff to produce amendments based upon the judgment of 21 May 2002 was to compel the plaintiff to plead the case in a way which it did not wish to do; and in a way which it might not have been able to do and, in my judgment, was not therefore necessary. Furthermore, there is a possibility that the Standard Corporation claim might be revived. Conclusion 39.I would therefore dismiss the appeal against the first judgment and order (CACV 263/2002). In view of the possible viability of the plaintiff's claim, I would allow the second appeal by the plaintiff (CACV 292/2002) and substitute an order that the plaintiff should have 21 days from the handing down of this judgment in which to make an application to amend the statement of claim. Since in CACV 263 of 2002 the plaintiff has failed to secure the reversal of the order of the judge below but has, nevertheless, succeeded in the arguments relating to defalcation and remoteness, there should be no order as to costs in respect of that appeal. The plaintiff should be entitled to the costs of the appeal in CACV 292 of 2002. I would therefore make an order for costs accordingly. I would not alter the orders as to costs below. Hon Le Pichon JA: 40.I agree. Hon Ma JA: 41.I agree. Hon Rogers VP: 42.There will therefore be orders as per paragraph 39 above.
Representation: Mr Roger ter Haar QC and Mr Godfrey Lam, instructed by Messrs Deacons, for the Plaintiff/Appellant Mr Gordon Pollock QC, Mr Charles Sussex SC and Mr Jonathan Harris, instructed by Messrs Linklaters, for the Defendant/Respondent |
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