Cyberworks Audio Video Technology Ltd (in Compulsory Liquidation) v. Mei Ah (HK) Co Ltd
Read the full judgment text of HCA 677/2006 on BabelCite. This High Court CFI judgment was delivered on 16 April 2020 before Coleman J.
Company law – directors' duties – de facto and shadow directors – fraudulent and dishonest breach of fiduciary duty – creditors' interests duty – insolvency – limitation – equitable compensation – inter-company set-off – transfer of assets at undervalue – winding up – Philips Royalty Agreements – under-reporting of production and royalties – Related Party Transactions at below cost – MAHK Agreement – Silver Kent Agreement – Statement of Affairs – Proof of Debt – whether Tong and MAEGL were de facto or shadow directors of Cyberworks Audio Video Technology Limited (In Compulsory Liquidation) – the Company was incorporated in November 1997 to take Philips licences to manufacture CDs, VCDs, CD-ROMs and DVDs; ceased business in February 2002 and was wound up in January 2003 on Philips' petition for unpaid royalties – Tong was managing director of MAEGL and a de jure director of the Company until 28 July 2000, thereafter allegedly remaining a de facto and/or shadow director – MAEGL was a holding company listed on the Hong Kong Stock Exchange – whether the Company was insolvent or nearing insolvency by Q4 of 1999 or as at 31 March 2000 – whether the duty to consider creditors' interests had been triggered by at the latest 31 March 2000 – whether Tong and MAEGL breached their duties by failing to place the Company into liquidation, by deliberate under-reporting of production to Philips (initially reporting only 5.4% of actual production and paying 3.8% of royalties properly due, totalling approximately US$5,968,107 in additional unpaid royalties), by causing Related Party Transactions at below cost, and by procuring transfers of the Company's plant and machinery to related companies by inter-company set-offs – whether such breaches were fraudulent and dishonest – whether Tong and MAEGL dishonestly assisted the de jure directors' breaches or committed equitable fraud – whether the claim is time-barred under sections 20 and 26 of the Limitation Ordinance (Cap 347) – whether the Silver Kent Debt of HK$4,675,587.37 recorded in the Company's audited financial statements for the year ended 31 March 2002 was settled by the alleged Arrangement between MAHK, Silver Kent and the Company – whether Silver Kent's counterclaim of HK$673,184.69 succeeded – held: Tong was a de facto director and MAEGL was a shadow director of the Company at material times; the Company was insolvent or near insolvent by at the latest 31 March 2000 with a deficiency in net assets of HK$20,611,064 and there was no realistic prospect of trading out; the creditors' interests duty was triggered; the breaches of duty were fraudulent and dishonest; section 20(1)(a) LO precluded the limitation defence; the Arrangement was not established; the Silver Kent Debt claim and the Counterclaim both dismissed – damages awarded HK$29,694,615 against Tong and HK$20,251,901 against MAEGL – interest and costs reserved.
Legal issues: De facto / shadow directorship of Tong and MAEGL · Extent of duties owed, including creditors' interests duty · Insolvency of the Company · Breach of directors' duties by Tong and MAEGL · Fraud and dishonesty of the breaches · Dishonest assistance or equitable fraud · Time bar under Limitation Ordinance · Relief and quantum · Silver Kent Debt claim · Counterclaim by Silver Kent
Outcome: Claims under the MAHK Agreement (HCA 677/2006) and the Silver Kent Agreement (HCA 678/2006) dismissed. Claim against Tong and MAEGL for fraudulent and dishonest breach of directors' duties allowed, with damages awarded against Tong in the sum of HK$29,694,615 and against MAEGL in the sum of HK$20,251,901. Silver Kent Debt claim dismissed. Silver Kent's Counterclaim dismissed.
Cited by 24 cases · Cites 10 cases
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HCA 677/2006 [2020] HKCFI 398 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO. 677 OF 2006 ________________________
AND HCA 678/2006 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO. 678 OF 2006 ________________________
AND HCA 2780/2006 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO. 2780 OF 2006 ________________________
AND HCA 658/2011 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO. 658 OF 2011 ________________________
_____________________ J U D G M E N T _____________________ A. Introduction 1.In these four consolidated actions, three of the writs were issued in 2006 and one in 2011. But the events giving rise to the claims occurred as long ago as 1998 to 2002. The long and winding path to this trial nearly involved a further lengthy detour caused by the general adjournment of proceedings (the GAP, as it is called) as a response to the Covid-19 problem. Fortunately, with the cooperation of the parties, their legal representatives and Court staff (to all of whom I express my gratitude), directions were given at a telephone hearing – see [2020] HKCFI 347 – and the trial was able to go ahead, so as to be substantially completed within the originally fixed trial period. 2.The proceedings concern the operation of a company called Cyberworks Audio Video Technology Limited (“Company”), which prior to its winding up was engaged in the manufacture and replication of audio-visual products and was an optical disc manufacturer, with the benefit of various licensing and royalty agreements (together “Royalty Agreements”) made between it and Koninkijke Philips Electronics NV (“Philips”). 3.The Company was wound up on 15 January 2003 on insolvency grounds, on the petition brought by Philips based upon unpaid royalties owed to it by the Company. By Deed dated 10 September 2010, the current plaintiff, Remedy Asia Limited (“Remedy”) took an assignment of all “rights in, title to and interests in all causes of action” belonging to the Company. 4.The proceedings were brought originally by way of four separate actions. The various defendants (together “Defendants”) are:
5.The four actions were consolidated, and the claims taken to trial are to be found in the consolidated statement of claim (“CSOC”). However, on certain aspects of the analysis it may be important as to which claims were commenced when, and in which actions. They are:
6.There is also a counterclaim by Silver Kent in the sum of $673,184.69, allegedly due from the Company broadly by reason of the overpayment of the Silver Kent Debt after 31 March 2002 (“Counterclaim”). 7.In the written opening submissions from Remedy, it was accepted that the parties’ forensic accounting experts agreed that the consideration for the MAHK Agreement and the Silver Kent Agreement had been settled by inter-company set-offs. Hence, Remedy said it would not be “pressing” its claims under those two agreements. In consequence, in their written opening submissions, the Defendants stated that the trial would no longer concern MAHK, as the only claim against it had been withdrawn. The Court was invited to enter judgment in favour of MAHK with costs, and also to enter judgment in favour of Silver Kent on the Silver Kent Agreement claim, also with costs. The precise orders to be made can conveniently be left to the conclusion of this Judgment. But it is worth pointing out at once that the circumstances surrounding the MAHK Agreement and the Silver Kent Agreement remained relevant on Remedy’s other claims. 8.All references in this Judgment to dollar sums are to sums denominated in Hong Kong Dollars, unless the context otherwise makes clear. 9.Remedy was represented at trial by Charles Manzoni SC, leading Norman Nip and Martin Lau. The Defendants were represented at trial by Rimsky Yuen SC, leading Jonathan Chang and Peter Dong. B. The Parties, Witnesses and Others in the Narrative 10.The Company was incorporated on 28 November 1997, in its former name of Mei Ah Audio Video Technology Limited. The change to the new name occurred on 4 August 2000. It ceased business on 18 February 2002. 11.The Company’s de jure directors were: Tong (from 8 December 1997 to 28 July 2000); Li Kuo Hsing (“Li”) (from 8 December 1997 to 31 March 1999); Chan Kwok Sun, Dennis (“Dennis Chan”) (from 1 April 1999 to 28 July 2000); Li Kuo Lam (from 1 April 1999 to 28 July 2000); Ho Po Nin, Benny (“Ho”) (appointed 28 July 2000); and Cheng Wing Ming, Michael (appointed 28 July 2000). It can be seen that the Board of Directors of the Company was, at least ostensibly, wholly changed on 28 July 2000 by the resignation of all three directors and the appointment of two new directors. However, at all material times, at least half of the board of the Company consisted of directors and/or management of MAEGL. 12.As to the Company’s shareholders, MAEGL indirectly held 100% of the shares in the Company to 30 March 1998. Thereafter MAEGL indirectly held approximately 35% of the shares in the Company from 31 March 1998 to a date sometime before 31 March 2000, and approximately 45% between that date and until 15 January 2003 (the date of winding up). 13.The other 65% and 55% respectively was held by a company called Sino Regal Holdings Limited (“Sino Regal”). The circumstances as to the introduction of Sino Regal into the picture, and the change in its shareholding in the Company, may be something to be explored through the evidence. Sino Regal’s shareholders were Dennis Chan (30%) and Law Kwok Leung, Steve (“Law”) (70%). Both Dennis Chan and Law were until September 2000 part of the senior management of the MAEGL group, and from January 2001 onwards directors of M21 Technology Limited (“M21”). 14.M21 is a company listed on GEM on 30 January 2001. 29.25% of the shares in M21 were held indirectly by MAEGL from around 31 March 2001 until 7 May 2004, making MAEGL the second-largest beneficial shareholder during that period. Tong was managing director of M21 at all material times. 15.The financial controllers of MAEGL, namely Ken Lam and Wilson Lai, were the internal accounting staff for the Company and the contact persons for audits of the Company. The Company’s accounts were consolidated into the group accounts of the MAEGL group. The Company’s financial statements were audited first by PricewaterhouseCoopers (“PwC”) for the financial period from date of incorporation until 31 March 1998 and for the financial years to 31 March 1999 and 31 March 2000, and then by Albert Lam & Co (“ALC”) for the financial years ended and 31 March 2001 and 31 March 2002. Albert Cheung was the partner in charge at PwC and Albert Lam was the partner in charge at the eponymous ALC. 16.Tong is an accountant by training. He was at all material times, and remains, the managing director, executive director and authorised representative of MAEGL, and was until May 2003 also the company secretary of MAEGL. MAEGL’s Annual Report 1999-2000 describes Tong as being responsible for the group’s overall general and financial administration and involved in the group’s corporate strategy and development. 17.Tong was a de jure director of the Company from 8 December 1997 to 28 July 2000, when he resigned from that position. It is in issue in these proceedings as to whether Tong remained as a de facto and/or shadow director of the Company after 28 July 2000. Tong was also the director of Silver Kent until 30 July 2003. 18.MAEGL is a company listed on the Hong Kong Stock Exchange. It is the holding or parent company of a group of companies. Its founder and chairman is Li. At the material times from 2000 to 2002, the board of MAEGL comprised:
19.MAHK is a wholly owned subsidiary of MAEGL, and according to MAEGL’s Annual Report 2002, MAHK had as its principal activity the distribution of audio-visual products in Hong Kong. There is some evidence that MAHK also provided some treasury functions for the MAEGL group. 20.Silver Kent was incorporated on 15 March 2000 with an authorised share capital of $10,000. At the time of incorporation, 2 ordinary shares of one dollar each were issued at par to the subscribers, but on 18 March 2000, Silver Kent issued and allotted 98 ordinary shares of one dollar each at par making up the total issued capital of the company to $100. It was at all material times beneficially owned as to 45% by MAEGL and 55% by Sino Regal. Tong was the director of Silver Kent from 18 March 2000 to 30 June 2003. Cheng was the director from at least 30 June 2003 onwards. 21.Remedy called two factual witnesses: (1) Wong Teck Meng (“Wong”), who also adopted the witness statement of Stephen Briscoe (“Briscoe”); and (2) Joost Johannes Joseph Bekkers (“Bekkers”). 22.Neither of Remedy’s witnesses had any contemporaneous involvement in the events giving rise to these proceedings. Wong is an insolvency practitioner who worked closely with Briscoe, one of the appointed Joint and Several Liquidators of the Company. Bekkers is an IP Licensing manager at Philips Intellectual Property & Standards. Bekkers gave evidence from Moscow, via video-conferencing facilities. 23.The Defendants called four factual witnesses: (1) Tong; (2) Law; (3) Ho; and (4) Cheng. 24.Law was described in MAEGL’s Annual Report 1999-2000 as being part of the senior management, and division head of the group’s Infotainment Technology Division, supervising several projects. Ho was described in MAEGL’s Annual Report 1999-2000 as being part of the senior management, an executive director of MAHK, and responsible for formulating the group’s sales and marketing strategies. He was appointed director of the Company on 28 July 2000. Cheng is not named as being part of the senior management of MAEGL, and in his oral evidence he accepted that he was not so named because he was not part of the senior management of the group. He was appointed director of the Company on 28 July 2000. Until that point, he had been the production manager of the Company, in which role he also continued. 25.The parties’ called a single joint expert, Simon Sham, as to the valuation of the plant and machinery the subject of the MAHK Agreement and the Silver Kent Agreement. However, no reference was made to this evidence at trial as it simply confirmed (albeit contrary to previous suggestions) that the transfer under those agreements was not made at an undervalue. 26.The parties also each called a forensic accounting expert. Remedy relied on the expert report of Colum Bancroft, and the Defendants relied on the expert report of Frank Yuen Tsz Chun. The experts also produced a joint report. 27.In addition to the questions as to whether the consideration under the MAHK Agreement and the Silver Kent Agreement have been settled by inter-company set-offs, the forensic accounting evidence broadly covers the issues as to: (1) whether the transactions entered into by the Company with related parties (“Related Party Transactions”) were transactions at below cost; (2) the impact of the MAHK Agreement and the Silver Kent Agreement on the Company’s financial position following those transactions; and (3) the solvency of the Company, namely whether it was insolvent or nearing insolvency by or in Q4 of 1999, or as at 28 March 2000, 31 March 2000 and 1 April 2000. 28.Some comments might be made about the witnesses. An important point to recognise is that the events the subject matter of investigation at this trial occurred at least 18 years ago. Hence, it is not surprising if the factual witnesses who were contemporaneously involved in those matters might on occasion have given evidence which is internally inconsistent, or where they might simply fail to recall events after so much time. Therefore, I specifically accept Mr Yuen’s invitation to be slow to draw adverse inferences against the Defendants’ witnesses, even if those factual witnesses could have “done better in the witness box”, as he put it. 29.As already indicated, the factual witnesses called by Remedy were hampered by the lack of contemporaneous involvement in the matters becoming the subject matter of the claims. However, to an extent that identifies that they have no personal interest in the outcome of the litigation. Where their evidence was by reference to documents now available, their analysis or commentary on those documents may be of limited assistance beyond the assistance which comes naturally from the parties and the Court being able to consider and analyse those documents for themselves. But some evidence went beyond the documents, and I accept that both witnesses attempted to give evidence fairly, and they were credible. 30.As to the Defendants’ witnesses, I accept Mr Manzoni’s submission that Tong was at times prone to making up evidence that suited his case, and that his evidence should be viewed with some scepticism. It is noteworthy that a significant plank of the defence as pleaded, and as contained in Tong’s own witness statement, namely that the under-reporting was a mistake of which Tong had no knowledge, was completely abandoned during Tong’s oral evidence. Some credit can be given to Tong for finally acknowledging the true situation, but little credit attaches to the stance taken up to that point. That would only increase the scepticism about the reliability of his other evidence. Wherever possible, it needs to be tested and weighed against other evidence. 31.As to Law, there did appear to be a difference between areas of his evidence which were better prepared than other areas which were not so well prepared. Of itself, that might not matter. But one important area related to his own involvement in a company, Sino Regal, which supposedly was his own investment, where little recollection was displayed. Even allowing for his medical conditions, doubt was cast on the reliability of his evidence overall, necessitating careful consideration of that evidence against all of the other materials. 32.Ho’s and Cheng’s witness statements were not impressive. Whilst both Ho and Cheng were called as witnesses to combat the assertion that Tong remained a de facto or shadow director (and/or that MAEGL became a de facto or shadow director) of the Company after they were appointed as its de jure directors, the witness statements covered little ground except directed to some specific sub-paragraphs of the CSOC. Little context was given, and no broader ground was covered. Worse still, substantial portions of the witness statements were materially identical, often verbatim down to the punctuation. This did little to engender confidence that the statements were the product of their own independent thought-process and instructions, and raises significant questions about credibility and reliability. 33.In any event, Ho did not strike me as a reliable witness. He seemed often to be evasive, and some specific areas of his evidence were inherently implausibly true. His evidence in Court was not always consistent with the answers that he gave to the Liquidators during their investigations, even though he adopted those answers as part of his evidence for this trial. He left the impression of seeking generally to protect Tong. 34.However, as Mr Manzoni accepts, Cheng came across as a generally honest witness. It may be fair to adopt Mr Manzoni’s description of him as “a slightly naive junior employee, who was toeing the line” albeit whose evidence was “more forthcoming and in some respects was refreshing”. I think this was also the impression left by what he told the Liquidators during the course of their investigations, the answers to which he adopted as part of his evidence for this trial. I accept that Cheng was a reluctant director of the Company, and was persuaded to take on the role by being told that he did not need to do anything other than he was already doing as production manager. But, he seems to have tried to take the role seriously to some extent, although he found that problematic, and he was at times probably kept in the dark. 35.I take into account that of the Defendants’ witnesses, only Tong has an interest which may be affected by the outcome of this trial. 36.As to the expert witnesses, I accept that both Mr Bancroft and Mr Frank Yuen have suitable expertise. Their reports do not differ significantly on the various forensic calculations performed or the opinions based on them. That is, no doubt, partly why the cross-examination of the experts was relatively concise. There was one difference in their respective approaches to one of the questions set by the expert evidence directions, but I am not prepared to proceed on the basis other than that it was an honest difference in interpretation of the question. The main differences between their reports essentially related to the different potential factual scenarios. But both of them properly acknowledged that factual questions are ultimately questions for the Court to decide. C. Agreed Issues 37.Some of the issues previously set out in the Agreed List of Issues have fallen away during the trial. For example, it does not seem to be significantly in dispute that at least a substantial majority, and sometimes all, of the customers of the Company were related parties. It seems to me that the following issues (re-framed and re-ordered by me, and with my labelling of them) now remain for determination:
38.A further question previously raised as to whether Tong and MAEGL were at the material times trustees of the assets of the Company which were in their possession or control (“Trusteeship Question”) has not really been addressed and I do not propose to canvas it any more. 39.Some of these issues or questions are fairly readily answered on the evidence. Other issues are more complicated. D. Limit of Pleaded Claims 40.Mr Yuen submitted that the factual matrix asserted relied upon by Remedy was broadly the same for each of the causes of action said to underpin the claims against Tong and MAEGL. They all rely on allegations of fraud or dishonesty, so that it is difficult to see how Remedy could succeed on the alternative causes of action of dishonest assistance or equitable fraud if it could not establish its case of fraudulent or dishonest breach of director’s duty. There is force in that submission. 41.Mr Yuen also complained of what he described as Remedy’s attempts to change (or more precisely expand) its case during the trial – and even again in closing submissions – by making unpleaded allegations against the Defendants and their witnesses. Mr Yuen said that the unpleaded allegations include that:
42.There can be no dispute as to the principles governing pleadings. Pleadings are not mere formalities. They should define the scope of the evidence at trial, not the other way round. Pleadings also impose a necessary discipline and are fundamental to enabling every procedural facet of the adversarial system to operate fairly. The whole meaning of the system is to narrow the parties to definite issues, and thereby to diminish expense and delay, especially as regards the amount of testimony required on either side at the hearing. The relief which may be granted to a party must be founded on the pleadings. 43.It is trite that allegations of fraud must be pleaded distinctly and with the utmost particularity, including when claims arise from a corporate liquidation. Where dishonesty is usually a matter of inference from primary facts, the defendant is entitled to know the primary facts which will be relied upon at trial to justify the inference. It is not open to the Court to infer dishonesty from facts which have not been pleaded, or from facts which have been pleaded but are consistent with honesty. There must be some fact which tilts the balance and justifies an inference of dishonesty, and this fact must be both pleaded and proved. 44.Of course, it is also correct that pleadings are to provide the assertions of the material primary facts, and matters of evidence and law and submission should not be pleaded. There is also an aversion by most Courts against voluminous or prolix pleadings. By reference to any particular pleading, and avoiding ‘playing games’ or being overly technical, the Court should look to see whether the pleading fairly identifies such of the material and primary facts with the degree of specificity necessary to define the issues as enables the other party to understand the case he must meet and to be able to prepare for it. 45.But there can be no dispute, and there was no dispute in this case, that a party is bound by its pleading and the relief substantially as claimed. 46.Looking at the CSOC, the following points can be made:
47.Having considered again the content and structure of the CSOC, I do not think Mr Yuen’s complaints about what he says were unpleaded matters can be sustained. Looking at them in turn:
48.I do not think there was any difficulty for the Defendants to understand, to plead to, to prepare for, and to engage at trial with the claims brought. 49.Nevertheless, as during cross-examination when Mr Yuen flagged a particular point where Mr Manzoni’s line of questions appeared to go past the pleaded case, I have remained conscious of the limits of the case as pleaded. The particular point related to the suggestion put to Law that the introduction of Sino Regal was “really just a fiction and the reality is that it’s really Mei Ah and Tong that controlled the total level of the group, including Sino Regal”. I agreed with Mr Yuen that whilst Mr Manzoni was entitled to cross-examine around the allegation that MAEGL was able to and did exercise some influence over Sino Regal and its owners for various reasons, he was not on the pleading able to go further than the suggestion that there was the exercise of influence. In other words, he was not able to suggest not just influence but control because, for example, MAEGL and/or Tong were the real owners of Sino Regal. 50.I shall, therefore, focus on the pleaded claims, and the evidence and submissions properly relevant to those claims. 51.But, in any event, it is useful first to consider the relevant applicable legal principles. E. Applicable Legal Principles
52.By virtue of section 2 of the former Companies Ordinance Cap 32, a “director” was defined to include “any person occupying the position of director by whatever name called”. Further, the concepts of “de facto directors” and “shadow directors” are well-established. In the same section 2, a “shadow director” was defined to mean “a person in accordance with whose directions or instructions the directors or a majority of the directors of the company are accustomed to act”. 53.Hence, directors may be of three kinds: (1) de jure directors, being directors who have been validly appointed to the office of director; (2) de facto directors, being persons who assume to act as directors without having been appointed validly or at all; and (3) shadow directors, being persons in accordance with whose directions or instructions the directors of the company, or a majority of them, are accustomed to act. 54.These classes or types of directorship are recognised because the law requires that persons who act as directors and who thereby exercise the powers and discharge the functions of a director, whether validly appointed or not, must accept the responsibilities which are attached to the office. 55.In Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 at 183, Millet J usefully gave descriptions of de facto and shadow directors, and the differences between them. Those “influential” descriptions have been considered and slightly revised in numerous subsequent cases, including Re Gemma Ltd (in liq) [2008] BCC 308; HMRC v Holland [2010] 1 WLR 2793; Re Mumtaz Properties Ltd [2011] EWCA 610; McKillen v Mislad (Cyprus) Investments Ltd (Coroin Limited) [2012] EWHC 521 (Ch); Smithton v Naggar [2014] 1 BCLC 602; and Elsworth Ethanol Co Ltd Hartley [2015] 1 BCLC 221 – many of which were considered and applied by DHCJ Handsworth in Karla Otto Ltd v Bulent Eren Bayram [2017] 2 HKLRD 124. 56.My own summary of the principles is as follows:
57.A “mother company” or holding company can in appropriate factual circumstances be held to be a shadow director of a subsidiary, where it made the major policy decisions, exercised close control over the subsidiary’s management and financial affairs, and where the directors of the subsidiary were accustomed to act in accordance with the mother company’s directions or instructions: see, for example, Standard Chartered Bank v Antico (1995) 38 NSWLR 290 at 374. 58.But, the general rule is that an employer who is also a shareholder and who nominates a director owes no duty to the company unless the employer interferes with the affairs of the company: see Kuwait Asia Bank v National Mutual Life Nominees Ltd [1991] AC 187 at 223C. No fiction or artificiality is involved in regarding the directors of a subsidiary as employees of the parent company acting in the course of their employment, if that is what they were doing. But that does not mean that in carrying out their duties as directors of the subsidiary they were acting on the directions or instructions of the parent company, as contemplated by the statutory definition: see Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30, at 91. 59.As was also pointed out in the Hydrodam case at 185c-d, it is commonplace that some decisions regarding a subsidiary’s business made by its directors would nevertheless require the sanction or approval of the parent company, acting in that instance as the shareholder. Provided that the decision is made by the directors of the subsidiary, exercising their own independent discretion and judgment, and that the parent company only approves or authorises the decision, there is nothing which exposes the parent company to liability for the decision or which constituted a shadow director of the subsidiary. 60.It does not automatically follow that merely because a holding company may be treated as the shadow director of its subsidiary, the directors of the holding company will also be treated as shadow directors of that subsidiary. It will be necessary for the Court to consider whether the directors of the holding company simply acted as a board of that company in giving instructions to the subsidiary, or whether the directors of the holding company gave individual or personal instructions to the board of the subsidiary. In the former situation, the holding company directors ought not to be treated as shadow directors of the subsidiary, but in the latter situation the directors giving individual instructions might be treated as shadow directors of the subsidiary.
61.A de facto director owes similar duties to the company as does a de jure director. A shadow director will also owe fiduciary duties to the company, at least to the extent that he gives directions or instructions to the true directors (though not necessarily to the full extent of the range of the company’s activities). 62.It is trite that directors owe fiduciary duties to the company of which they are directors. The distinguishing obligation of any fiduciary is the obligation of loyalty, comprising at a minimum the duty to act in good faith, the duty not to place himself in a position where his duty and interest may conflict, and the duty not to act for his own benefit or the benefit of a third person without the informed consent of his principal. 63.It is also trite that directors are required to conduct themselves with standards of a reasonably diligent person having both (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b) the general knowledge, skill and experience that the particular director has. Directors are, therefore, required on a continuous basis to obtain and maintain sufficient knowledge and understanding of the company’s business so as to enable them to discharge their duties as directors. 64.In the case of Australian Securities and Investments Commission v Healey [2011] FCA 717, at §§20-22, commenting that the basic concepts and financial literacy required by directors to be in a position properly to question any apparent errors in the financial statements are not complicated, and in a way with which I respectfully agree, Middleton J put the matter as follows:
65.As to the question as to whether and the extent to which directors of an individual company are allowed or permitted to sacrifice the interests of that company in order to advance the interests of a wider group of which the company is a part, reference can be made to the decision of G Lam J in Re Wing Fai Construction Co Ltd (in Compulsory Liquidation) (unreported, HCA CWC 35/2002, 24 November 2017) at §235, where he stated (references to authorities omitted):
66.At the point in time when a company is insolvent or nears insolvency or is in doubtful solvency, or if a contemplated payment or course of action would jeopardise its solvency, the interests of the creditors ‘intrude’ on the directors’ duties, and will require the directors to take into account those interests. This may be termed the “creditors’ interests duty”. This arises because creditors become prospectively entitled through a liquidation to displace the power of the shareholders and the directors so as to deal with the company’s assets. The underlying principle is that directors are not free to take action which create a real, as opposed to remote, risk to the creditors’ prospects of being paid, without first having considered their interests rather than just those of the company and its shareholders. However, that does not give rise to any duty on the part of the directors owed directly to the creditors. Rather, the directors will owe a duty to the company to take care to protect the interests of creditors: see Geraghty, Sinclair & Snowden ‘Company Directors: Law and Liability’ at §6.122. 67.Exactly when the risk to creditors’ interests becomes real for these purposes will ultimately have to be judged on a case-by-case basis. There have been different verbal formulations (“verge of insolvency”, “dubious solvency”, “parlous financial state of affairs”, etc), but they generally fit the different factual circumstances in which they were expressed: see, for example, Re HLC Environmental Projects Ltd (in liq) [2014] BCC 337 at §§88-89. 68.In the case of BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112, at §§213-220, the English Court of Appeal considered possible answers to the question of when the creditors’ interests duty is triggered. First, it was recognised that the duty is engaged at least at the point when the company is actually insolvent, either on a cash-flow or balance sheet basis (and in most of the cases the focus is on balance sheet solvency or insolvency). But the court found more difficult the question as to where the trigger might lie, short of actual insolvency. It noted that the qualified way in which judges have expressed the trigger reflects that the directors of a company may often not know, nor be expected to know, that the company is actually insolvent until sometime after it has occurred. But it is for that reason, among others, that a test falling short of established insolvency is justified. In its conclusion, the court considered that the relevant formulation which accurately encapsulates the trigger is that the duty arises when the directors know or should know that the company is or is likely to become insolvent. In that context, “likely” means probable, not some lower test. 69.The HLC Environmental case at §§91-92 also reminds that the duty imposed on directors to act bona fide in the interests of the company is a subjective one. The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the best interests of the company. Still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether a director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. But, where it is clear that the act or omission under challenge resulted in substantial detriment to the company (or, where relevant, to its creditors), the director will have a more difficult task in persuading the court that he honestly believed it to be in the company’s (or creditors’) interests. Where a company is insolvent, or even doubtfully solvent, the interests of the company are in reality the interests of existing creditors alone. 70.The subjective test applies, however, only where there is evidence of actual consideration of the best interests of the company. If there is no such evidence, the proper test is objective, namely whether an intelligent and honest man in the position of a director of the company concerned could, in the circumstances, have reasonably believed that the transaction was for the benefit of the company (or, where relevant, to its creditors). It may therefore follow that where a very material interest, such as that of a large creditor in a company of doubtful solvency, is unreasonably overlooked and not taken into account the objective test must equally be applied. Unreasonably overlooking something is to do so without objective justification, and failing to take into account a material factor is something which goes to the validity of the directors’ decision-making process. In doing so, the court does not substitute its own hindsight judgment on the relevant facts in place of the decision made by the directors at the time, but makes an objective judgment taking into account all the relevant facts known or which ought to have been known at the time, because the directors did not themselves make such a judgment in the first place. 71.But it is important to identify at what point commercial considerations other than the fact of actual or near balance sheet insolvency come into play. On the authorities, I accept that once the directors of a company know or ought to know that the company is or is likely to become insolvent, the creditors’ interests duty is triggered. But, it is then necessary to consider whether there has been any breach of the duty. It may be that the creditors’ interests were best served by a continuation of trading, for example where negotiations for a refinancing or debt restructuring continued. But the directors’ view of matters such as that go only to whether or not the duty was breached, not to whether it was triggered. 72.That is because the existence of the duty and potential breach of it are two separate matters. The duty arises on a given set of facts, namely that the directors of a company know or ought to know that the company is or is likely to become insolvent. The duty, once it arises, cannot be ignored. But it might be addressed in a way which identifies that the duty has not been breached. Those ways might include looking at the bigger commercial picture and the commercial realities.
73.There is no definition of “insolvency” in the Hong Kong companies legislation. There is, of course, the reference to an inability to pay debts in the context of sections 177 and 178 of the former Companies Ordinance. Under section 177, a company may be wound up by the court if (amongst other things) the company is unable to pay its debts. The definition of “inability to pay debts” is in section 178, but it proceeds on a deeming basis. 74.Reference can also be made to section 168H(2) of the former Companies Ordinance, relating to the duty of the court to disqualify unfit directors of insolvent companies, which identifies that a company becomes insolvent if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up. That identifies a balance sheet approach to questions of solvency. 75.Analogous reference can be made to section 123(2) of the Insolvency Act 1986 (UK), which deems a company to be unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. That is also a balance sheet approach to questions of solvency. 76.Mr Yuen referred me to the Antico case as to an approach to the question of “ability to pay debts as and when they become due”, which is perhaps more of a cash flow or commercial solvency test. The analysis arose in the context of the statutory provision under consideration in that case, relating to the liability of a director in circumstances where a company incurs a debt at a time when it is reasonable to expect that the company will not be to pay all its debts as and when they become due. The Court held at 329B that this is a question of fact, to be decided as a matter of commercial reality, in the light of all the circumstances. It is necessary to consider the company’s financial condition in its entirety, including its activities, assets, liabilities, cash, money which it could procure by sale or on the security of its assets, and its ability to obtain financial assistance by way of loan or subscription for share capital. 77.Mr Yuen emphasised the passage at 329D where the Court stated that the question is one of ability to pay, not fact of payment. So long as there were not reasonable grounds to expect that the company would not be able to pay its debts as and when they became due, it would not matter that there were reasonable grounds to expect that the company would not in fact pay its debts, because for example it saw it as being to its own advantage to delay payment. The case also appears to support at 331C-E the proposition that it is necessary to focus attention upon what it is reasonable to expect in a given set of circumstances, such a consideration necessarily being made by someone operating in a practical business environment. It is appropriate to look at matters of substantial commercial reality, rather than on the basis of forms or technicalities. 78.However, I am not sure these passages are directly helpful for present purposes, and they risk confusing or conflating two different things, namely (a) whether a company is or is likely to become insolvent, such that the creditors’ interests duty is triggered, and (b) whether that duty, if triggered, has been breached. I have already set out above what I see as the approach to those two separate questions.
79.According to Lewin on Trusts (19th Ed) at §40-014, the general requirements for dishonest assistance liability are as follows: (1) there is a trust; (2) there is a breach of trust by the trustee of that trust; (3) the defendant induces or assists that breach of trust; and (4) the defendant does so dishonestly. 80.The breach of trust by the trustee of the relevant trust need not itself be dishonest. What must be dishonest is the assistance. In other words, all that is required is that there is a breach of fiduciary duty, and that the assistance rendered was dishonest. 81.Whether someone acted dishonestly is to be evaluated objectively based on the person’s subjective knowledge: see for example Royal Brunei Airlines v Philip Tan Kok Ming [1995] 2 AC 378 at 389B-F. It means simply not acting as an honest person would in the circumstances. Carelessness is not dishonesty, so that for the most part dishonesty is to be equated with conscious impropriety. But the standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. So, if a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour. 82.Mr Yuen drew my intention to the UK Supreme Court case of Ivey v Genting Casinos (UK) Ltd [2018] AC 391 at §74, where the proper approach to the assessment of dishonesty was canvassed. First, the fact-finding tribunal must ascertain (subjectively) the actual state of the individual’s knowledge or belief as to the facts. The reasonableness of his belief is a matter of evidence (often in practice determinative) going to whether he held the belief, but it is not an additional requirement that his belief must be reasonable; the question is whether it is genuinely held. Secondly, once his actual state of mind as to knowledge or belief as to facts is established, the question whether his conduct was honest or dishonest is to be determined by the fact-finder applying the objective standards of ordinary decent people. 83.In the context of dishonest assistance for breach of trust or fiduciary duty, ‘blind-eye’ knowledge is equated with actual knowledge for the purposes of the first stage of the test laid down in the Royal Brunei case. The imputation of ‘blind-eye’ knowledge requires two conditions to be satisfied. The first is the existence of a suspicion that certain facts may exist, and the second is a conscious decision to refrain from taking any step to confirm their existence. The existence of the suspicion is to be judged subjectively by reference to the beliefs of the relevant person, and the decision to avoid obtaining confirmation must be deliberate: see, for example Group Seven v Nasir [2019] 3 WLR 1011 at §59.
84.There are three elements to a claim based on the doctrine of equitable fraud: see Lo Wo v Cheung Chan Ka [2000] 2 HKLRD 370 at 381D-H. The three elements are: (1) there must be serious disadvantage on the exploitee’s part; (2) the terms of bargain must be oppressive; and (3) the exploiter’s conduct must be morally culpable.
85.Relevant to this case are considerations of sections 20 and 26 of the LO. Section 20(1) provides that:
86.The section applies in relation to company directors as well is true trustees: see Vivendi SA v Richards [2013] BCC 771 at §§185-188. In consequence, a claim against a director will become statute-barred after six years unless section 20(1) is in point. For section 20(1)(a) to be applicable to a claim against a director, the director must have been implicated in dishonest conduct. Such a director will be acting dishonestly if he “acts in a way which he does not believe is in [the] … interests [of the beneficiaries]”. 87.For section 20(1)(a) to apply, a fraudulent breach of fiduciary duties needs to be established. For a breach of trust to be fraudulent, it is not enough to show that it was deliberate. There must also be an absence of honesty or good faith. This can include being reckless as to the consequences of the action complained of: see, for example, First Subsea Ltd v Balltec Ltd [2017] EWCA Civ 186 at §§63-65. Of course, it is also trite that fraud must be distinctly alleged and proved. Therefore, an allegation that the trustee knew or ought to have known something is not an unequivocal allegation of knowledge sufficient to support a finding of dishonesty and is consistent with a claim in negligence. 88.By reference to the Vivendi case at §188, Mr Manzoni argued that where a director has been guilty of dishonest conduct, section 20(1)(a) may preclude the normal six-year limitation period from operating, not only as regards the director himself, but also in relation to anyone who dishonestly assisted him in his breach of duty. 89.However, Mr Yuen submitted that section 20(1)(a) requires a “breach of trust” by a “trustee”. Relying on Paragon Finance plc v DB Thakerar [1999] 1 All ER 400 at 408j-409j and Peconic Industrial Development v Lau Kwok Fai (2009) HKCFAR 139 at §18, Mr Yuen said that it is now well established that a person who has dishonestly assisted another in breach of trust is not a true trustee and does not, therefore, fall within section 20(1)(a). I agree. Hence, unless the person who provides dishonest assistance is himself independently a trustee for the purposes of the section, the applicable limitation period for the dishonest assistance claim is six years. 90.Section 26(1) of the LO materially provides that:
91.However, the fact that a plaintiff did not know or could not, even with reasonable diligence, have discovered the essential facts for pleading a cause of action is not on its own sufficient to postpone the commencement of the limitation period. Postponement of the period requires the additional element of fraud, deliberate concealment or mistake. The period of postponement is only up to the time when the plaintiff has discovered, or could with reasonable diligence have discovered, the fraud, deliberate concealment or mistake: see Hotung Investment (China) Ltd v Ernst & Young (a firm) [2012] 5 HKLRD 421 at §§29-30. 92.An action is “based on fraud” for the purposes of section 26(1)(a) only when fraud is an essential element of the claim. 93.For the purposes of section 26(1)(b), “concealment” means a deliberate concealment of relevant facts, and the six-year period starts to run when the concealment is discovered. But, the burden is on the plaintiff to establish that there has been a relevant concealment, and that he could not have discovered the concealed facts without exceptional measures which he could not reasonably have been expected to take. What must be concealed is something essential to complete the cause of action; it is not enough that evidence that might improve the claim is concealed, provided that the claim can be properly pleaded without it: see Lee Tsan Sum v Wong Pui Hon David [2010] 4 HKLRD 219 at §39. However, it is important to remember that what must have been concealed from the plaintiff is only the relevant fact, not that there was a right of action. Also, it is not essential to show that the defendant must have known the fact was relevant to the right of action. 94.It is also settled that the test for “reasonable diligence” is that of how a person carrying on a business of the relevant kind would act if he had adequate but not unlimited staff and resources, and was motivated by a reasonable but not excessive sense of urgency. The burden of showing that the claimant could not with reasonable diligence have discovered the fraud or concealment before the time limit rests on the claimant. The Court applies an objective standard, taking into account the personal characteristics of the claimant when considering what diligence he could reasonably be expected to have shown and the loss which the claimant actually suffered. The question to be answered dispassionately is what a reasonable person possessing the personal characteristics of the claimant would do and have discovered having regard to all the relevant circumstances: see Angela Yang v AXA Wealth Management (HK) Ltd (unreported, HCA 2016/2014, 30 November 2017, Chow J) at §§51-54.
95.I accept that it is important to remember that where a party’s case rests on inferences from primary facts, it is not enough for the circumstances to give rise to conflicting inferences of equal degrees of probability. In cases where direct proof is not available, it is enough if the circumstances appearing in evidence give rise to a reasonable and definite inference, but that means they must do more than give rise to conflicting inferences of equal degrees of probability such that the choice between them is merely a matter of conjecture. 96.But, if circumstances are proved in which it is reasonable to find a balance of probabilities in favour of the conclusion sought, in a civil case decided on the balance of probabilities it does not matter that the conclusion falls short of certainty, and that conclusion is not to be regarded as a mere conjecture or surmise. F. The Alleged Scheme and Claims – Overview 97.Though there is a need to consider some of the accounting material and technicalities, Mr Manzoni described the overall concept of the case as relatively simple. He said it involved a scheme by which the Company took a licence from Philips to manufacture CDs, VCDs, CD-ROMs and DVDs (together “CDs”) under licence. However, there was then a deliberate and dishonest decision to under-report to Philips the extent of the manufacturing. That under-reporting allowed sales to other Group companies at below cost. That created a position in which the Company was insolvent. Effectively, all of the profits to be made from manufacturing the CDs were diverted from the Company to other group companies, leaving or allowing them to sell on at a profit. There was also the transfer of hard assets, paid for by set-off accounting entries. The Company was then left bereft of cash and assets, so that the creditors “had to sing for their money at the time the balloon went up, as it inevitably would” (as Mr Manzoni put it, mixing his metaphors but conveying the essence). 98.I have already made the point by reference to the pleaded case that there is no defined “scheme” under which it was always intended that the Company should be left bereft of cash and assets to the detriment of creditors. The word “scheme” is used in a rather more loose sense, encompassing a series of actions which occurred over time, and which ended up leaving the Company in the factual position that it was bereft of cash and assets. 99.Whilst there may have been other features which contributed to insolvency, most of them were merely “noise”, and the focus can be on the under-reporting. That, said Mr Manzoni, was part of a deliberate and dishonest scheme, which inevitably would be found out. But that inevitable point was delayed as long as possible before the plug was pulled, and the Company was left with nothing to satisfy the claims of Philips. 100.Remedy’s case on the claim against Tong and MAEGL is as follows. Tong was a de jure director of the Company from shortly after the date of incorporation until 28 July 2000, but remained a de facto and/or shadow director thereafter. MAEGL was at all material times a de facto and/or shadow director of the Company. As such, Tong and MAEGL owed duties as directors. The Company was insolvent, or nearing insolvency, by Q4 of 1999, or in any event as at 31 March 2000. But, in breach of directors’ duties, Tong and MAEGL: (a) caused the Company to carry out the Related Party Transactions at an undervalue, that is at below cost; (b) sold the Company’s plant and machinery under the MAHK Agreement and the Silver Kent Agreement without receiving tangible payments from MAHK and Silver Kent; and (c) diverted the Company’s sales operations to Silver Kent at no consideration. Alternatively, it is said that Tong and MAEGL dishonestly assisted in such breaches of duty committed by the de jure directors, or committed equitable fraud against the Company. Remedy denies that any limitation defence is available to Tong and MAEGL. 101.Remedy’s case on the claim against Silver Kent for the Silver Kent Debt is as follows. During the course of their investigations, the Liquidators discovered the existence of the Silver Kent Debt. Amongst the “current assets” totalling $5,957,315 recorded as “amount due from fellow subsidiaries” in the Company’s AFS for the year ended 31 March 2002, the auditor ALC has advised that $4,675,587.37 was due from Silver Kent. Whilst Silver Kent has admitted that, at least at one stage, it owed the Company the Silver Kent Debt, it has claimed all balances were settled after 31 March 2002 (and in fact overpaid). This claim is based on an alleged arrangement (“Arrangement”) between MAHK, Silver Kent and the Company whereby (a) MAHK would place orders for products with Silver Kent, which would in turn play similar orders with the Company; (b) so that MAHK would owe money to Silver Kent for the products, whilst Silver Kent would owe money to the Company; and (c) given the relationship between the companies, MAHK would pay the Company directly for the products, thereby settling MAHK’s indebtedness to Silver Kent and in turn Silver Kent’s indebtedness to the Company. However, whilst not disputing that a total of $5,292,000 was received by the Company from MAHK, Remedy denies the existence of the Arrangement on the basis that it is unsupported by contemporaneous documents, is instead contradicted by contemporaneous documents, and is contrary to commercial sense. G. Defendants’ Case – Overview 102.Mr Yuen submitted that, in contrast to Remedy’s changing stances, the case of Tong and MAEGL has been throughout consistent with commercial sense and commercial reality. 103.Tong and MAEGL say that the Company was set up effectively as a factory for managing CDs, VCDs et cetera, and that Philips offered to sign licence agreements even before the Company was incorporated. In the initial period, far from under-reporting, the Company had on at least one occasion overpaid Philips. Hence, the allegation that the Company set out to defraud Philips right from the start must fail. 104.However, the market soon became highly competitive and under the influence of what Tong believed to be “market practice”, under-reporting began. It is now admitted that this should not have happened, but it was a matter of wrong judgment. It should not be blown out of proportion, should not be linked with the sales of plant and machinery to MAHK and Silver Kent, and should be viewed properly in the overall context of the case. 105.The sale of plant and machinery was propelled by legitimate commercial reason and improved the Company’s financial strength. The attempt by Remedy to link that sale with the under-reporting is unjustified, and based on evidence which is at most hearsay and untested assertions. The payment for the transfer of plant and machinery by intra-company set off is a fact of life in the commercial world and not intrinsically a device to defraud creditors such as a gift or undervalued sale. Back-dating is, likewise, not uncommon and in this case was done as a result of advice by auditors. The Company acted throughout with the assistance or advice of professional auditors, who provided unqualified opinions or “clean accounts” without raising concerns with the Company regarding its solvency. 106.Looking at Philips’ attitude, which was less than hostile, and where settlement offers or schemes were offered and counter offered, the Company and its Board of Directors cannot be blamed from a commercial angle for harbouring the belief that the matter could be sorted out in an amicable manner. Bekkers, the witness from Philips, himself explained that Philips did not favour strict contractual enforcement. Viewed thus, and even leaving aside the fact that the conduct complained of did not in law amount to defrauding creditors, there was not any “scheme” to defraud anyone whether as alleged by Remedy or at all. 107.Tong’s involvement in the affairs of the Company after his resignation as a de jure director can be explained by the historical background of the matters as well as his different role in MAEGL. MAEGL was itself a listed company with a separate Board of Directors (including INEDs). There is no proper evidence to suggest any wrongful conduct on its part. 108.This case is not concerned with any claim by Philips. Rather, the case concerns a claim by liquidators against parties who they allege to be de facto or shadow directors, who are accused of acting fraudulently or dishonestly. Those are serious allegations and on the evidence should be rejected. H. The Facts
109.The following recitation of facts is based upon matters which were either not in dispute, cannot seriously be in dispute, or my findings in relation to matters which were in dispute. In making factual findings, I have of course adopted the usual approach. In particular, recognising the significant passage of time since the events which gave rise to this matter, and so the potential for memories to have faded, I have considered the contemporaneous documentation whilst at the same time recognising that that documentation is clearly not complete. In addition to my assessment of the witnesses, in part by reference to their demeanour (which is not always a useful guide to truthfulness), I have considered the totality of the evidence and the inherent likelihoods or probabilities. 110.I have adopted the approach that, where one cannot say that all relevant facts are known, it may not be appropriate to proceed on the basis of eliminating the impossible and deciding that the remaining explanation, however improbable, must be the truth. I have applied the approach to drawing inferences from primary facts which I have canvassed above. I am also specifically mindful that inferences of fraud or serious misconduct should only been drawn where there is sufficient and compelling evidence to overcome the inherent improbability that such conduct had occurred. 111.For convenience purposes, I shall group the facts under various headings, but I do not lose sight of the overlap between the various factual aspects, and the possible impact of those factual points across different aspects of the case. I do not intend to rehearse all the evidence that was led at trial, though I have tried to bear it all in mind.
112.As already indicated, the Company was incorporated on 28 November 1997. (Again, I accept that it does not follow, and I ignore any suggestion, that the very purpose of the incorporation of the Company was to allow the business to be structured so that the Company would ultimately be left as a bare shell with no assets but substantial liabilities.) But I accept the Company was incorporated specifically for the purposes of taking a licence or licences from Philips for the manufacture of CDs. Just 20 days after incorporation, on 18 December 1997, the Company and Philips entered into a CD Disc Agreement and a VCD Disc Agreement. Both agreements were signed for the Company by Tong. Both agreements related to the grant by Philips of a non-exclusive and non-transferable licence to manufacture and sell the relevant products. 113.In addition to an upfront payment, the Company was obliged to pay royalties to Philips on each licensed product manufactured and sold by the Company. The royalty rates were US$0.03 for each CD-ROM and CD audio disc with an outer diameter larger than 90 mm, and US$0.05 for each VCD. 114.However, by a side letter dated 19 May 1998 (“Side Letter”), Philips indicated that it could offer to the Company a reduction of the running royalty rate for VCDs as from 1 July 1998, to the reduced rate of US$0.03 (“Reduced Royalty Rate”). But the Side Letter made express that the Reduced Royalty Rate was conditional on the Company (as well as its parents, affiliates and subsidiaries) being “current with each and every term of the VCD Disc Agreement such to include the settlement of all royalties due thereunder”, and further conditional “upon the full compliance on 1 July 1998 with each and every term of any other licence agreement related in way (sic) to any type of CD discs or players or recorders” which the Company or connected companies had entered into or would enter into with Philips. 115.The Side Letter also made express that in the event that there was failure to comply with any term of the VCD Disc Agreement or any other licence agreement, then “it is hereby agreed and confirmed that during such period of non-compliance and until such non-compliance is fully cured, the royalty rate as specified in the current Agreement without the reduction offered herein shall apply and the reduced rate specified in this letter shall have no force or effect”. The same was made express for any other subsequent failure to comply, such that during any period of non-compliance the royalty rate should apply without the reduction, until any non-compliance had been “fully cured”. The Side Letter was also signed for and on behalf of the Company by Tong. 116.Amongst the governing terms in the CD Disc Agreement and the VCD Disc Agreement was the requirement for the Company, within 30 days after each of 31 March, 30 June, 30 September and 31 December of each year to submit to Philips a statement in writing, duly certified by the Company’s auditors, setting out with respect to the preceding quarterly period the quantities of the licence products manufactured and sold. It was also an express term that the Company should pay to Philips within 60 days after the end of each quarterly period the royalty due. Further, all payments not made on the date specified were to accrue interest at the rate of 2% per month. 117.Tong accepted in evidence, and I so find, that he carefully read and understood the terms of the Royalty Agreements and the Side Letter before he signed them on behalf of the Company. 118.Nevertheless, it is clear that the Company (a) was late in providing the relevant royalty reporting return forms and (b) in fact significantly under-reported to Philips the quantity of licenced products manufactured and sold. I accept that there was a subsequent agreement with Philips that the reported figures need not be audited quarterly, and could be audited on an annual basis, but that was the extent of the variation as to reporting. 119.It seems that the first royalty reporting, for the Q1 of 1998, was only provided on 30 June 1998. The relevant forms were signed by Tong for the Company (who was personally involved in the under-reporting right from the outset and throughout its continuation). The quantity reported to Philips, for VCDs and CDs, totalled 233,479. At the time Tong signed the forms he knew that figure was wrong. The correct figure as was later revised for the same period was 1,274,634. 120.For the period from January 1998 to December 2000, the quantity of products initially reported to Philips by the Company represented a mere 5.4% of the actual quantity which the Company admitted it had produced. This is now common ground, and is shown in the following table:
121.Further, for the same period from January 1998 to December 2000, the amount of royalties initially reported and which were paid to Philips by the Company represented a mere 3.8% of the revised amount of royalties properly payable. As a result of the Company’s admission in the Revised Royalty Report provided on 30 March 2001 (see below), the sum of US$5,968,107 (approximately HK$46,551,238) were payable by the Company to Philips. This is also now common ground, and is shown in the following table:
122.Also taking into account the royalties payable by the Company for the period from January 2001 to March 2002, the accumulated amount of royalties payable for each financial year are shown in the following table:
123.The under-reporting was deliberate, and the decision to under-report was made by Tong as director of the Company. Originally, in his first witness statement filed for these proceedings, Tong claimed not to know what the basis was for the Company’s pleaded case that the Company had deliberately and consciously understated its production level to reduce the amount of royalties payable to Philips under the Royalty Agreements. However, the contemporaneous evidence all points to the deliberate nature of the under-reporting. Indeed, when confronted with that material during cross-examination at trial, Tong was forced to concede that the decision to under-report was made deliberately, by him. He also accepted that he knew it was “wrong”. 124.First, the sheer magnitude of the under-reporting must have made it obvious that a decision had been taken deliberately to under-report. I do not accept that reporting approximately only one twentieth of the actually produced and sold figures could likely have occurred by accident or inadvertence. Nor could the person who procured that under-reporting have believed anything other than it was wrong to do so. It was not a mere error of judgment. 125.Secondly, there is a contemporaneous audit working paper relating to the audit of the period to 31 March 2000. The audit working paper was created in and subject to review over the period of June and July 2001. It relates to the audit of MAEGL, and deals with “issues to discuss”. One of the “audit issues” is entitled “Royalty fee paid to [Philips]” and reads as follows:
126.In his oral evidence, Tong accepted that his decision deliberately to under-report was on the suggestion of other staff members (though he was originally apparently reluctant to name Cheng as the person who provided him with what he called “market information”), precisely to lessen the financial cost of production. This was perceived to be necessary or appropriate so as to maintain competitiveness in the market. In his evidence, Tong accepted that the decision was his based on some market information and other information he himself obtained, and that it was a wrong decision. Those various points are fully borne out by the audit working paper, which suggests the intention and rationale was held at MAEGL and not just Company level. 127.It may be that the statements recorded in the audit working paper are not all accurate. For example, it is not clear whether Philips was in fact then suing people. Further, Tong said in evidence that legal advice had not been taken, even on a preliminary basis. Though I reject that evidence, the more important point is that the auditors were apparently told that some legal advice had been taken, and I see no reason not to accept that the working paper is a reasonably accurate record of what the auditors were told at the time. As Tong accepted during questions from the Court, and with the benefit of his own accounting background, once the auditors were made aware or learned of the failure to have complied with the contractual requirements for reporting products for royalty calculations potentially giving rise to a claim, the auditors would have wanted to understand whether any provision needed to be made, and (if not) why not making a provision might be acceptable for clean audit opinion purposes. Also, though reference is made to “additional provision”, the AFS of the Company to 31 March 2000 (the relevant accounting period under review) did not actually make any provision in this regard. 128.Philips appears to have become suspicious about the level of reporting towards the end of 1999. By letter dated 16 November 1999, Philips referred the Company to the terms of the Royalty Agreements which allowed Philips to request information from time to time so as to enable it to ascertain which products manufactured and sold would be subject to the payment of royalties. For that purpose, the Company was requested to furnish Philips with the number of CD and DVD manufacturing lines owned. 129.It took the Company six months to reply, by a letter dated 17 May 2000, informing that it had 9 manufacturing lines (though there is some suggestion in the evidence in Cheng’s interview with the Liquidators that there may in fact have been more). In his evidence, Tong could not explain the delay in reply, but it seems to me that such delay in answering a straightforward question suggests a desire to avoid providing information which was likely to reveal the under-reporting. 130.Indeed, Philips’ near immediate response was by internal letter of 22 May 2000 indicating it would like to audit the Company (amongst other licensees in Hong Kong). The internal letter was sent by Jason Kwan, then Assistant Legal Counsel (later Legal Counsel) of the System Standards & Licensing Department of Philips Hong Kong to the CFO. It identified reason “to believe that [the Company and others] severely underreported their sales figures in their royalty reports and that fraud is involved in this reporting process”. The basis for the belief that the Company had under-reported was set out as being that full capacity of the stated 9 replication lines was 10,800,000 to 16,200,000 pieces per quarter, whilst the reported amount was only 800,000 to 1,200,000 per quarter. 131.On 25 May 2000, Jason Kwan of Philips wrote to the Company pointing out that it had never provided the contractually required written statement from an external auditor confirming the accuracy of the quarterly royalty statements. It requested such a document by 10 June 2000. 132.On 7 June 2000, Jason Kwan wrote to the Company about licensing the use of DVD disc patents, it having come to the attention of Philips that the Company had been manufacturing and selling DVD products. Attendance at a meeting was invited during the week of 19 to 23 June 2000. The invitation was extended again under a similar letter dated 14 June 2000. On the same day Philips wrote to the Company, for the attention of Tong, informing of the details of the Philips licensing program for companies manufacturing and selling DVD discs. On 16 June 2000, Tong wrote back on behalf of the Company to Jason Kwan indicating that the meeting in the proposed week would not be convenient. 133.On 26 June 2000, Philips wrote to the Company, for the attention of Wilson Lai and copied to Tong, giving formal Notice of Default arising from the absence of an auditor’s statement in relation to the correctness of the royalty reports submitted, despite several previous reminders. A remedy of the default was urged within 30 days. Subsequently on 29 June 2000, Philips wrote to the Company, for the attention of Tong, informing that Philips had instructed KPMG as an independent certified external accountant to audit the Company’s books and records regarding the manufacturing, sales and other disposals of licence products as mentioned in the Royalty Agreements. 134.The 30-day period for remedying the default referenced in the Notice of Default would have expired on 25 or 26 July 2000. The default was not remedied by that date. On 28 July 2000, Tong resigned his directorship in the Company, as did the other then directors, and Ho and Cheng were appointed as directors in their place. 135.In the midst of the reporting period, after Ho and Cheng replaced Tong as the de jure directors of the Company, Cheng also signed royalty reporting forms. The first such forms are dated 31 July 2000. In his evidence, Cheng said he simply signed the forms he was asked to, the figures having been completed by the accounting department. But it is difficult to see how Cheng, as the production manager, and even on a cursory glance, would not have seen at once that the figures must have been a significant under-reporting. The sense from the evidence was that he did notice the problem (see below). 136.On 21 September 2000, Jason Kwan wrote to Tong at MAEGL to confirm the meeting to be held on 27 September 2000 between “Mei Ah, KPMG, and Philips”. 137.At around the same time, and by reference to a period ended 30 September 2000, the following was noted in an audit working paper for the client Mei Ah Mastertech Co Ltd:
138.On 26 October 2000, Jason Kwan of Philips wrote to MAEGL and the Company, for the attention of Ken Lam copied to Tong, referring to their email of 23 October 2000 (which was not in evidence), and informing them “that for royalty verification, there is no alternative to a royalty audit”. It appears that the Company or MAEGL had previously suggested that such an audit might interfere with them because the letter also stated that Philips was “not convinced that the commencement of the royalty audit at Mei Ah would be a major interference with the normal operation of your accounting department as all of the documents which KPMG requested to inspect so far should already have been prepared for general royalty reporting and accounting purposes”. Nevertheless, Philips indicated it was willing to defer the royalty audit commencement date to 8 November 2000. 139.On 6 November 2000, Philips wrote to Tong at the Company to invite him to a licensing conference relating to DVD discs, which would be held on 22 November 2000. It seems this was a follow-up on the earlier letter on this topic, and ultimately led to the DVD licensing agreements made on 12 January 2001. 140.In the meantime, by letter dated 15 November 2000 Jason Kwan wrote to the Company care of MAEGL, for the attention of Tong, referring to “our meeting of November 9, 2000”. In his evidence, Tong was unable to recall that meeting. However, I accept that Tong had attended the meeting, which is why the letter was addressed to him. The letter stated that it confirmed certain matters. Under the heading “CD Disc and Video CD Disc”, it stated (emphasis in original):
141.I find that the 9 November 2000 meeting was the first occasion on which Tong met with Jason Kwan and told him that the Company would review and correct the royalty reports previously submitted to Philips. In so far as Tong suggested in his oral evidence that he met Jason Kwan much earlier in the year to discuss this topic, and to talk about reviewing and correcting royalty reports, I reject that suggestion. On the correspondence, any earlier meetings might have been in general terms, including as regards the necessity for DVD licensing. But it was only at the 9 November 2000 meeting – notably held just one day after the postponed KPMG audit was supposed to have commenced – that review and correction of reporting was specifically discussed and offered. Clearly, the 30 November 2000 deadline was not met. 142.It is fair to point out that Philips nevertheless entered into the DVD patent licence agreements with the Company dated 12 January 2001. By those agreements, the Company took patent licenses for the manufacture and production of DVD discs. The agreements were signed by Cheng on behalf of the Company, though he wrote in his own handwriting against the reference to “Title” that he was “Production Manager” (rather than director). His explanation in oral evidence was that, as these agreements related to manufacturing of product, he had in mind his role as the production manager, and so used that title. It may be that not much turns on this, but there are no board minutes of the Company for example considering whether or not to enter into these further agreements with Philips, and if so authorising a particular person to sign on the Company’s behalf. The royalty fee for DVDs was set at US$0.003 (three tenths of a US dollar cent) on each license product sold. 143.It is also noteworthy against the chronology that there was already a significant issue that had developed between Philips and the Company as regards the correct reporting of manufacture and sale under the already existing Royalty Agreements. Of course, those agreements were necessary to provide for and regulate lawful manufacturing and sale of DVDs, even though it seems that the Company might have been previously manufacturing them without the benefit of a licence or paying any relevant fees. There is also the suggestion in the evidence that anyone who wished to manufacture DVDs was entitled to a licence, though it can be said that Philips might have chosen to cut all commercial relationships with the Company if it thought fit to do so. Overall, I think the DVD Agreements are a relatively separate matter, and I do not think much can be read into the fact that the DVD Agreements were made during the context of discussions about under-reporting under the other Royalty Agreements. 144.As it happens, the next step in the process appears to have been a meeting on 8 March 2001, a note of which was made by Jason Kwan. The meeting started between Jason Kwan and Ken Lam, but the latter “said that the 55% partner would like to meet” Jason Kwan. They therefore went to a nearby café. On the walk to the café, Ken Lam and Jason Kwan discussed the business of Mei Ah in general. The note records what happened at the café as follows (sic):
145.At this point, it may be interpolated that actually Alan Fung is not on the face of things a shareholder of any material company. But he is an employee within the MAEGL group. 146.On 12 March 2001, Philips sent a typically standard payment reminder to the Company, for the attention of Tong as “Director” and Wilson Lai as “Account Manager”. The reminder was for the submission of royalty payments of Q4 2000. No submission was ever received (other than via the corrected reporting). It can also be noted that there is no occasion on which correspondence was sent to Tong, addressed to him as a director of the Company, when he wrote back to point out that he had ceased to be a director. 147.On 16 March 2001, Jason Kwan wrote to the Company for the attention of Tong as “Managing Director”, in relation to the outstanding Q4 royalty reports and royalty payment. The letter urged settling the outstanding matters which were material breaches of the agreements, and stated:
148.On 26 March 2001, Jason Kwan of Philips wrote to the Company, on this occasion for the attention of Tong as “Managing Director”, Ken Lam as “Group Financial Controller”, Alan Fung as “Director” and Cheng as “Production Manager”. The letter made reference to previous meetings on 21 February and 8 March 2001, and stated:
149.Several matters are worthy of note in this letter. It is addressed to several people at the Company, albeit at what the Defendants now say were incorrect titles or positions, and no corrections were made. It identified that any proposal that might be considered by Philips related to (a) instalment payments and/or (b) reduction of interest. There is absolutely no suggestion that the reduction of the principal payable would be considered. All legal rights were expressly reserved. It also made clear that no discussions to resolve matters would be able to proceed without Philips’ receiving the revised royalty reports on or before 31 March 2001. 150.It seems that this letter finally prompted the provision of the Revised Royalty Report for the period January 1998 to December 2000, which is dated 30 March 2001 and was provided to Philips on that day or the following day. Against the chronology of the meetings and correspondence, it is difficult to reach any conclusion other than that the Company (and those acting for it, including Tong) had put off for as long as possible telling Philips the extent of the under-reported figures. It was only when Philips indicated that its patience had finally run out that the corrected reports were produced. This is notwithstanding that Tong and Cheng suggested in their evidence that they had started to look at the correct figures some considerable time earlier, and it must be the case that the figures were readily available to the Company. It just chose to delay providing them, just as it had deliberately under-reported the figures in the first place. 151.It is also important that because the Revised Royalty Report was provided only on 30 or 31 March 2001, and Philips had made plain that it would not enter negotiations without receiving that report, there can be no suggestion that any director of the Company could properly have had in mind before 31 March 2001 any realistic prospects for negotiations leading to a lower rate or amount of payment. But I accept that the AFS for that period were only signed off on 26 July 2001, by which time negotiations were underway. 152.A word might conveniently be said here as to Cheng’s approach to the under-reporting. When Cheng was asked to sign reports to Philips, it occurred to him that it might not be accurate. He checked against the stock held, and realised that his concern was well-founded. When he discussed the matter with Tong, first Tong did not give any answers until several months later, then Tong left him with the impression that the under-reporting was a mistake. There was no mention of any market practice, and Cheng gave evidence that Tong asked Cheng what he thought might be the cause of the under-reporting by the accounting department. It seems clear that even after Cheng became a director of the Company, Tong did not tell him of the deliberate under-reporting, and when the question was brought up with him he pretended that it was mistaken, so as to conceal it. This speaks volumes to the respective positions of Tong and Cheng.
153.As I have indicated, it was only after the provision of the revised royalty report on 30 or 31 March 2001 that there could have been any negotiation between the Company and Philips. In effect, the Company at that point having “come clean” (at least as to the extent of, if not the reason for, the under-reporting), it was possible for Philips to identify what royalties were outstanding and to begin discussions as to how to deal with those outstanding amounts, and any interest which might have accrued under the terms of the Royalty Agreements. 154.On 3 May 2001, Jason Kwan of Philips wrote to the Company, for the attention of Tong as “Managing Director” and Ken Lam as “Group Financial Controller”. The letter contained a recalculation of the overdue royalties and interest on overdue royalties in accordance with the terms of the Royalty Agreements. As at 25 April 2001, the total overdue amount exceeded US$7 million. The letter also expressed pleasure that the Company “had finally disclosed the withheld information”, but also expressed appreciation for the Company’s “sincerity in resolving the matter”. Philips looked forward to payment of the total amount on before 25 May 2001. 155.No payment was made by that date. Just before it, on 21 May 2001, Philips sent a standard payment reminder to the Company addressed to Tong as “Director” and Wilson Lai as “Account Manager”. 156.In June 2001, Tong signed various documents on behalf of the Company to be filed with the Inland Revenue Department (“IRD”), and did so against the handwritten designation of “Director” (albeit that Tong said in evidence that it was not his own handwriting). It is convenient to mention here that a similar series of documents were filed on the same basis against Tong’s signature as a “Director” in May and June 2002. 157.On 14 June 2001, Jason Kwan wrote to the Company, for the attention of Ken Lam and Alan Fung copied to Tong, referring to a meeting held on 6 June 2001. From the way the letter is addressed, I accept that Tong was not present at that meeting. The letter stated that it had been explained to Jason Kwan that the royalty liabilities had become a huge financial burden for the Company to bear “because VCD products of [the Company] have been sold at prices not including full royalties in order to compete with VCD products manufactured in the PRC”. That seems to me to be a plain admission that the products were sold below their true cost. The letter went on to suggest lump sum repayment plans over 36 months or alternatively 24 months. Both plans used the reduced rate of royalty for the VCDs, and a reduced interest rate on overdue royalties. The letter also requested a payment guarantee from the Company or its parent company or both to Philips, in the form of a bank guarantee, post-dated cheques or other appropriate instruments. 158.There is an internal email dated 16 July 2001, sent from Ken Lam to Wilson Lai, copied to the audit department of ALC. It is marked for the attention of Rebecca. Because the email is said to be of some importance, it bears quoting in full:
159.This email was not circulated to Philips. There is no other material produced which refers to a two thirds “haircut” (the “haircut” would be of two thirds if the amount to be paid is only one third). There is no material produced by Philips which in any way evidences discussion about a “haircut”, let alone any haircut of such significant proportions. All of the Philips correspondence seems to make clear that, whilst it may consider instalment payments and reduced overdue interest, no reduction on unpaid principal would be acceptable. There is no evidence of any industry-wide reductions. Indeed, when it was previously suggested to Jason Kwan at a meeting that other market players had received discount on principal, he immediately corrected that to point out that any discount would only have been on overdue interest (see above). It is beyond credibility to think that Philips might suddenly seriously have considered not just a discount on the principal but a discount of 66.7%, leaving only 33.3% to pay, and that on the lower conditional rate. 160.Insofar as it may be necessary to say so, this general position was also confirmed by Bekkers in his evidence, which I accept. 161.So, whilst I accept that the 16 July 2001 internal email may have been material on which ALC placed some reliance – properly or otherwise – in apparently approving a provision of only some $12 million in the AFS to year end 31 March 2001, I reject any suggestion that there was any real negotiation with Philips for such a two thirds “haircut”. Further, the contractually agreed royalty rate was US$0.05; the discounted rate of US$0.03 was conditional, but numerous conditions were simply never met; the suggested “haircut” was for payment of only one third of the discounted rate, that is payment of only US$0.01. These figures are stark. I reject as wholly unrealistic any possibility that Philips would ever entered into any serious negotiation for such a “haircut” or would ever have agreed to it. I also reject the suggestion that anyone acting on behalf of the Company could ever have believed it was even remotely possible. 162.Indeed, the position is only confirmed by the evidence of what happened afterwards. The next relevant communication makes absolutely no reference to any discussions as to any “haircut”. On 26 July 2001, Jason Kwan emailed Ken Lam, under the heading “installment payment proposals”, in reference to their meeting the previous week. Jason Kwan expressed that he would appreciate it if Ken Lam could forward to him his ideas on the instalment proposals before the end of the month, and that Ken Lam would understand that it would be easier for Jason Kwan to discuss with his management about the reduction of interest on overdue royalties if there is a conclusion quickly. Again, what is being discussed is only a reduction of the overdue interest. This is wholly inconsistent with the suggestion made a few days earlier that there had been discussions with Philips to pay only one third of the principal amount. On the same day Ken Lam responded that he would prepare the proposal with Alan Fung around the following weekend and get back to Jason Kwan. 163.When it came, the proposal from the Company in response to Philips’ letter dated 14 June 2001, was by the Company’s letter of 18 August 2001. There is no reference to any “haircut”. Instead, it makes two alternate proposals for repayment of the same amount of $29,279,060 over either five years or nine years. This proposal was signed by Cheng. 164.There then appears to have been a gap in the negotiations until a meeting on 21 November 2001, attended by Tong, Ken Lam and Jason Kwan. Jason Kwan’s meeting note reads as follows:
165.The Q1 and Q2 2001 overdue payments were duly made in accordance with Tong’s instructions to Ken Lam at the meeting. A written proposal was also provided the next week, in a letter dated 28 November 2001 signed by Wilson Lai as “Financial Controller”. After suggesting, it might be thought disingenuously, that the Company had always aimed at fulfilling its contractual obligations, the letter went on to say that:
166.The letter seems to suggest that shareholder support would only be provided to the Company if Philips were to agree this instalment plan, notwithstanding that shorter instalment plans had already been rejected in short shrift. This cannot have provided any comfort to Philips. 167.On 7 December 2001, Philips issued a letter rejecting the Company’s offer. The letter was sent to the Company care of Mei Ah International Holdings Limited, for the attention of Tong as “Managing Director, Mei Ah International Holdings Limited”. The letter stated (emphasis in original):
168.It seems that the Company did not wish further to discuss the matter, as no response was ever given. The Company’s shareholders did not lend any support. Instead, the Company ceased business on 18 February 2002. 169.Other than being named as the production manager addressee in the Philips letter of 26 March 2001, and his signature on the letter of 18 August 2001, there is no great sense that Cheng was in any way involved on behalf of the Company in any of the dealings with Philips relating to the under-reporting of royalties, its correction, and subsequent negotiations. Ho does not feature at all. 170.In their evidence, Ho and Cheng suggested that Tong was somehow authorised to act on behalf of the Company for negotiation purposes. But there is no contemporaneous written material to that effect, and it does not sit well with the contemporaneous written material that does exist. Philips plainly considered it was dealing with Tong as a director of the Company (as well as perhaps a director of other companies within the group). Nothing Tong did indicated that he would need to obtain authority from the directors of the Company. On the occasion at a meeting with Jason Kwan when Tong gave instructions to Ken Lam, those instructions were followed apparently without reference to any de jure director of the Company. 171.As to the idea of shareholder support, Mr Manzoni described this as “a mirage”. He pointed out the irony, in that it would be in the interests of the shareholders to support the Company throughout the operation of the scheme, because they were the beneficiaries of it by generating huge profits from the fact that the Company was selling goods to them at an undervalue, leaving them free to sell on at a significant (albeit, said Mr Manzoni, illegitimate) profit. But there is no document supporting any real consideration of obtaining shareholders’ support, and the contemporaneous accounting materials point to the opposite. None of the witnesses called by the Defendants could really identify how it was suggested the shareholders would provide their support, other than through capitalising shareholders loans which were instead paid off and so had ceased to exist by March 2001. There was no investigation of the financial ability of the shareholders to offer necessary support, and the evidence shows that Sino Regal was itself insolvent by February 2002, though little detail has been provided as to precisely when and how it became insolvent. The debts owed to related companies were settled before the debts owed to external creditors were settled. Even on the liquidation of the Company, various related companies refused to waive claims, but rather sought to claim amounts said to be outstanding to them. The word “mirage” seems apt. 172.As to the cessation of business, this was a topic discussed between the Liquidators and Cheng during his interview. In answer to the question “How did you find out that the Company was shutting down?”, Cheng answered “Patrick informed me and Keith”. On its face, that answer supports that the decision to shut down the Company was made by Tong, and not by the de jure directors. However, when this was put to Cheng during cross-examination, he effectively explained that he was talking about the negotiation of the lease, which they had asked Tong to do with the landlord. As the landlord had not given an exact date on which the Company had to move out, but allowed continued occupation to be charged on a daily basis, it felt to Tong to tell them the last day as indicated by the landlord. This, Mr Yuen suggested, showed that when asked a question by the Liquidators, Cheng was focusing on the practicalities of shutting down rather than the business decision to shut down. Nevertheless, the totality of the answers given to the liquidators and the answers given at the trial suggest to me that Tong had at least an equal role as the de jure directors in the decision to close, and went close, the business of the Company.
173.The MAHK Agreement is dated 28 March 2000, but it is not disputed that the agreement was actually signed after that date, and indeed after the end of the relevant accounting period. Also, although the payment terms provided for in the MAHK Agreement identify “Full payment upon signing of the Agreement”, that was not accurate in that (a) no cash payment was transferred; and (b) the accounting entries for an accounting set-off could not have been done before the end of the financial period to 31 March 2000, and must have been done at a later date as an after period adjustment. 174.What happened was apparent from an audit working paper for the period to year end 31 March 2000. The document status and maintenance record for that audit working paper identified that it was created not before 21 June 2000. By reference to “amounts due to related companies”, various late adjustments were made. The paper suggests that the starting position was that the amount due to MAHK was $17,965,216 – though this appears in part to be made up of reversing the director’s loan of $8 million, which reversal was apparently only affected on 30 March 2000, just one day before the end of the accounting period. 175.There are then three “late adjustments”: (1) a late adjustment on bulk discount in the sum of $10,133,483; (2) a late adjustment on interest in the sum of $2,801,671; and (3) a late adjustment on “sale of FA” in the sum of $29,638,816. The first two late adjustments take the total amount due to MAHK to an adjusted figure of $30,900,370. Against that amount is set-off the late adjusted sale figure of $29,638,816, being the stated consideration in the MAHK Agreement. It is for that reason that the forensic accounting experts agree that the consideration was settled by accounting set-off. 176.But there is force in Mr Manzoni’s submission that the late adjustments were rather “dubious”, to use his word. The charge of interest, even by way of late adjustment, is accepted to be probably justifiable, not least by reference to another part of the same audit paper which specifically identifies the auditors had advised the client to charge interest on the advanced to the Company at prime +1.5% per annum. But the late reversal of the amount due to director right at the end of the accounting period, and the sudden grant of a bulk discount, granted after the end of the relevant accounting period, do raise real questions. When added to the other amounts due, the late adjustment on bulk discount effectively permitted the set-off of the consideration under the MAHK Agreement, which would not otherwise have been possible. No commercial explanation has been offered as to why that discount was suddenly granted at that time. But, ignoring why the discount was suddenly granted, the effect of it was to reduce the Company’s assets by over $10 million, at a time when the forensic accounting experts agree that the Company was insolvent (see below). 177.There is an agreement which purports to evidence the leasing back from MAHK of the machinery sold by the Company to MAHK (“Leasing Agreement”). The Leasing Agreement bears the date 31 March 2000. There is no dispute that the Leasing Agreement was not made on the date it bears, though there is a dispute as to when it was made. The earliest possible date on which it was made is 4 August 2000, as the agreement is made by the Company in the name which it only took by the change effected on 4 August 2000. It is signed by Tong for MAHK and by Cheng for the Company (who signed against an authorised signatory chop also in the Company’s new name). Of course, as it purports to lease back the machinery previously sold, it must post-date the sale. 178.In oral evidence, Cheng accepted that he signed the Leasing Agreement for and on behalf of the Company simply because he was told he had to sign it. Even though Cheng was a director of the Company at the time that he signed it, his evidence identified that he paid no heed to its content for the purposes of deciding (in his role as director) whether it was an appropriate document or agreement for the Company to enter into. 179.The Silver Kent Agreement is dated 1 April 2000. It is common ground that it was also not made on that date, but rather later. There remained a dispute as to how much later it was signed. (In his oral evidence, Tong originally claimed he had indeed signed it on 1 April 2000, then changed his evidence to say he now recalled it was signed later to record the terms of an oral agreement previously made). The agreement was signed by Tong for Silver Kent and by Cheng for the Company. But, again, it seems clear that the Silver Kent Agreement could not have been signed before at least 4 August 2000, because it is made in the name of the Company which only became its name on that date. In fact, there is significant evidence pointing to the likelihood that the Silver Kent Agreement was made only after the end of the financial year dated 31 March 2001, that is more than a year after the date it bears. 180.There is an accounting voucher for the transfer of the machinery from the Company to Silver Kent dated 1 April 2000, though it has the initials of the Company referring to the name changed only on 4 August 2000. The voucher journal number is J04001, but the original of the document identifies that that number is written over the top of something else which has been covered with a white-out product. There is also an accounting journal voucher recording a sale of fixed assets to Silver Kent, again purporting to be dated 1 April 2000. There is also some white-out on that document, both as to the relevant accounting figures and to the identity of the company to which the sale was made. The original of the document allows one to read that the name of Silver Kent has been written over the name MA (China). 181.That evidence is consistent with an email dated 4 May 2001 from Ken Lam to Wilson Lai, copied to Tong, which states:
182.The machinery referred to is the machinery the subject matter of the Silver Kent Agreement. This identifies the original idea, even as late as May 2001, was for the transfer of the machinery from the Company to Mei Ah (China). So it must have been even later than that the decision was made instead to transfer it to Silver Kent. 183.Also by reference to an internal management report of the Company, one can see that it was necessary to write back depreciation as a result of the sale of machinery, decided after the event. Tong’s explanation in oral evidence that the monthly recognition of a depreciation amount arose only because there was no record made in relation to the sale of the material, and the depreciation had to be reversed (written back) when the record of the sale was made does not ring true. I reject the idea that the Silver Kent Agreement merely documented an oral agreement which had been made on 1 April 2000. 184.The Silver Kent Agreement also contains a payment term stating “Full Payment upon signing of the Agreement”, which was again not accurate for the reasons already explained. 185.I do not accept that these various documents, and the accounting treatment accorded to them by way of after the event alterations and adjustments, were simply the way that some matters are treated in some companies. The Company was not some small family run business. It was part of, or an associated company of, a listed group of companies, with properly trained accounting staff, and with a director (also a director of the listed company) who is himself a trained accountant.
186.The AFS of the Company for the period to 31 March 1998 – signed by Tong – showed an operating loss for the period of $1,516,515, with a balance sheet showing net assets of $21,632,571. That takes into account the share capital increase in the period to the issued and paid-up total of $10 million. 187.The AFS of the Company for the period to 31 March 1999 – signed by Tong – showed a profit before taxation of $3,883,807 and net assets of $18,690,572. The Company’s customers who were related companies, including MAHK, constituted 88.98% of the turnover. Amongst the “current liabilities” were “amounts due to related companies” in the sum of $18,038,889, and “amount due to a director” in the sum of $8 million. The director in question was apparently Li. 188.The AFS of the Company for the period to 31 March 2000 – signed by Ho and by Cheng as “Chairman” – showed a loss for the year of $402,411 and net assets of $11,964,881. Of the turnover of $96,127,974, $83,785,267 or 87.16% was in sales to related companies. There can be no doubt that the “costs of sales” identified generating that turnover did not include the proper amount of royalties payable to Philips under the Royalty Agreements. It is thus obvious from the figures already canvassed, and even from the mere fact of the extent of under-reporting, that had the true cost of sale been identified, a far greater loss for the year would have eventuated. It can also properly be inferred that the products were sold by the Company at below cost. I do not think the fact that the auditors signed off on the accounts without qualifying their opinion changes the analysis; the fact is that the goods were sold at below cost. 189.MAHK sourced 78% of its purchases from the Company for the same period, which it then sold on with a gross profit margin of 35%. The AFS for MAHK for the year ended 31 March 2000 identified that MAHK made a profit for the year of $36.3 million on a turnover of $144 million. 190.Amongst the “current liabilities” in the AFS for the Company was an “amount due to shareholders” in the sum of $32,323,095. In the subsequent consideration of the Insolvency Question, it may be relevant to remember that that sum was not described as a “long-term liability”, and that a standard definition of a “current liability” is one that is payable within 12 months, although the relevant note to the accounts stated that “[t]he amounts are unsecured, interest-free and have no fixed terms of repayment” except for some proportion which bears interest at prevailing market rates. The amount due to a director (Li) for the previous period had reduced to nil. 191.The AFS for the period to 31 March 2000 also showed disposal of certain fixed assets. Primarily, that related to assets supposedly sold by the Company to MAHK under the MAHK Agreement. 192.The AFS of the Company for the year ended 31 March 2001 – signed by Ho, and by Cheng as “Chairman – showed a loss of approximately $18.3 million on turnover of $104 million, and a net asset deficiency of $6,334,897. This is a clear insolvency on at least the balance sheet basis (of course, even ignoring the fact of the significant under-reporting of royalties due to Philips). The previous year’s “current liabilities” which included the “amounts due to shareholders” in the sum of $32,323,095 was reduced as at 31 March 2001 to nil. Any idea that the shareholders might have consented to change those loans to equity had wholly evaporated by that date, and it gives some credence to both (a) that the figure was properly identified as a current liability rather than a long-term liability (because it was wholly paid off within the 12 months between accounting periods) and (b) that the shareholders never in fact intended to support the Company by either waiving the loans or changing the loans to equity. 193.In the accompanying schedule of detailed income statement (for management information only) one of the “other operating expenses” is an amount for “licensing charges” in the sum of $12,047,110. It seems the bulk of that figure comprised a provision against outstanding royalties owed to Philips as a result of the under-reporting. It also seems that the provision was set at roughly one third of the amount then outstanding (although, strictly, Philips was owed about $42 million at the time). 194.All of the product manufactured by the Company in the financial period was sold to Silver Kent. All of the product which Silver Kent purchased was purchased from the Company; it had no other source. Those facts are evident from the AFS of the Company and Silver Kent respectively. There is an interesting mismatch in the figures, where the AFS of the Company records turnover of $104,211,001 whereas the sales to a fellow subsidiaries/related company is in the figure of $104,352,785. Though that figure is slightly higher than the turnover figure it matches the “cost of goods sold” figure stated in the AFS for Silver Kent for the same period. 195.That document also records Silver Kent’s profit before taxation for the period as being $14,546,796, and the sum of $12,217,121 net of taxation. The AFS for Silver Kent record its administrative expenses as totalling $6,086,964, but of that figure $6,066,864 was a figure for “depreciation”. The balance was for small sums for audit fee, business registration fee, and legal and professional fees. There is no administrative expense for staff, for marketing or anything of the like. It is also clear that in the relevant financial period Silver Kent did not even have or operate its own bank account. 196.The AFS for the Company for the year to 31 March 2002 identify a loss from ordinary activities before taxation of $20,867,533 on turnover of just over $70.5 million. Again, Silver Kent was the Company’s only customer. The accumulated losses carried forward are above $37.2 million, which when netted off against the share capital gave net losses on the balance sheet of $27,202,430. The notes to the accounts again identify one operating cost as licensing charges of approximately $12.3 million, the bulk of which was a similar provision against royalties as have been made the previous year (even though the amount then outstanding was at least $45 million and probably far higher). 197.On those various facts alone, it is difficult to see the commercial justification for interposing Silver Kent between the Company and the purchasers down the line (particularly, but not limited to, other related or associated companies), unless it was simply to ‘shift’ costs and profits. As already stated, for the accounting period to 31 March 2001, the Company made a loss of $18.3 million (as reported, and even ignoring for present purposes the suppressed royalty amounts) and there was a net cash outflow of over $24.5 million. On the other hand, over the same period Silver Kent reported making a profit of $14.5 million. Silver Kent sold on around 72% of the product it purchased from the Company to other companies within the Group, meaning approximately $10.47 million of its profit was earned directly from buying product from the Company and selling it to another company within the Group. Unfortunately, it is not clear from the evidence what further profits the Group then made in its on-sales. 198.But, even the creation of the sales to Silver Kent appears to have been an after-thought, put into place after the end of the accounting period. Indeed, the suggestion put forward on behalf of the Defendants that Silver Kent had a legitimate business as a “distribution agent” can be rejected. The AFS for Silver Kent for the year to 31 March 2001 identifies that for its turnover of $121,566,545 the costs of goods sold was $104,352,785. But the underlying vouchers dated 31 March 2001 identify that the vast bulk of that sum was made up of two transfers created after the event, through two amounts of $99,423,691.11 and $4,089,348.39, together totalling $103,513,039.50. There is also a transfer voucher dated 31 March 2001 which talks about a current account reallocation as at that date of $90,013,268.32, being transfer from the Company’s current account with MA (China) to its current account with Silver Kent. 199.On the basis that those vouchers are dated 31 March 2001, Tong had to accept that Silver Kent’s total turnover was transferred to it on the last day of the financial year. But even that assumes, which I am not prepared to do, that the vouchers were properly dated. It seems at least more likely than not that the vouchers were even ante-dated to the last day of the financial period. 200.Not only did Silver Kent have no contemporaneous apparatus of staff for conducting the relevant business, it never took any physical delivery of goods it supposedly purchased from the Company. In so far as it “distributed” product at all, it largely did so internally to the group, enabling other group companies to make further profit from on-sales. 201.Indeed, Law accepted in evidence that the sales and assets were transferred to Silver Kent to create an “edifice of business”. Whilst he suggested that this was for the purposes of the intended flotation of M21, it at least proves the falsity in the idea that there was a genuine ongoing business during the relevant financial period. There was not. 202.As it happens, that also affects the assertion made by Law in his evidence in the context of the Silver Kent Debt claim, which was based on an assertion of the Arrangement said to have existed during the financial year beginning 1 April 2000. Clearly, the existence of these end of or after the end of period accounting entries gives the lie to some prior existing off-setting arrangement between the Company, Silver Kent and MAHK.
203.As indicated above, the Company changed its name with effect from 4 August 2000. That date is very shortly after Ho and Cheng were appointed directors on 28 July 2000. In that context, Mr Manzoni suggests the change of name might take on some importance, although Mr Yuen says the attempt is to ‘make a mountain out of a mole hill’. 204.Mr Manzoni first referred to the change of name in the context of challenging the credibility and reliability of Ho’s evidence. This point was said to be an example of Ho’s evidence being implausible, because he attempted to say that all discussions and the agreement relating to the change of name were conducted between him and the shareholders in the period from 28 July 2000 to 4 August 2000. Ho suggested that there was a meeting between shareholders and the directors (though there are no minutes of any such meeting), albeit his evidence fluctuated on the point in a way which tended to show uncertainty as to even the identity of the shareholders. 205.In response, Mr Yuen pointed out that Briscoe said in his witness statement that the change of name was effected by a shareholders’ resolution passed on 26 July 2000. But that seems to me to make Ho’s evidence even more problematic, and less reliable. He had purported to have a clear recollection of specific discussions between the shareholders and the directors, which began only after his appointment as director. If Briscoe is right, the resolution had in fact been passed by the shareholders two days before Ho was appointed as a director. Ho was not, and did not even claim to be, party to discussions about a change of name before his appointment. 206.The whole point of the challenge in cross-examination of Ho was to suggest that he was not even engaged in the type of activity relating to the change of name of the Company despite the fact that he was supposedly a director at the time. It was in response to that challenge that Ho stated his version of events. That that version must be incorrect, on the apparent chronology of the earlier resolution, tends to show that Ho was simply trying to show real activity as a director, when he rather had little if anything to do with it. I do not think the ‘escape card’ is to be found in Mr Yuen’s suggestion that Ho was really talking about implementation of the change of name, and had otherwise made a mistake. 207.Hence, the point seems to me to go to two different aspects of the case. First, it casts real doubt on the reliability of Ho’s evidence. Secondly, it tends to show that Ho was not involved in director’s tasks (though he sought to suggest he was). This also chimes with Cheng’s evidence, to the effect that he was told of the change of name, which he thought was funny, and went along with it as a kind of fait accompli. I. The Questions for Determination
208.On this topic, it is necessary to distinguish between Tong and MAEGL. Merely because there may be a finding that one is either a de facto or shadow director does not automatically lead to any finding that so is the other. This is clear from the correct legal approach. 209.For Tong, the starting point is of course that he was originally a de jure director. On the facts, Tong was a de jure director of the Company at the inception of the under-reporting and for a substantial period of the under-reporting, as well as at the times of the dates on the MAHK Agreement and the Silver Kent Agreement (though I have found that both agreements were in fact made after Tong ceased to be a de jure director). Tong was also a director during a substantial part of the period over which the Related Party Transactions took place. 210.Mr Manzoni submitted that Tong’s resignation was academic, because he remained the actual person in control of the Company and the two incoming directors, Ho and Cheng, were simply his lieutenants. 211.Reliance was placed on Tong’s position as managing director of MAEGL, which is an investment holding company where the group’s main operations are carried out through its subsidiaries and associated companies, such as the Company. On his own admission, Tong was the person in charge of the “group’s general overall and financial administration”, so can properly be described (as Mr Manzoni described him) as at the top of the hierarchy of the MAEGL Group. 212.On the other hand, whilst Ho was part of the senior management of MAEGL, he had no formal position prior to his appointment as director of the Company, and there was still no change of remuneration upon that appointment. As he himself said, his role within the Company was to set sales policy, which had previously been a role taken up by a non-director, Keith Cheung. Nor was it made clear what sales or marketing strategies were really formulated at any time by Ho, or what strategies were even necessary in the context of the Company’s manufacturing as part of a group of companies, members of which formed the bulk of its own customers. 213.As to Cheng, he was previously the production manager, and was talked into becoming a director of the Company on the assurance that in reality he would simply continue in the same role. He did not receive any pay increment, nor any business card identifying him as a director. Before appointment, he had no idea as to the duties of a director. It seems to me to be significant that those who purportedly appointed him took no steps to ensure that Cheng was suitably qualified or that he became aware of what duties he would bear as a director. By contrast, they led him to believe that nothing much was required other than what he was already doing. His own efforts to find out what duties he might have taken on did not produce much useful information. 214.From the history and positions of those appointed, and the way in which they were appointed, the inference is that those effecting the appointment were perfectly content with de jure directors who were unlikely to know what duties attached to the job, and perhaps unlikely to trouble to find out or otherwise to ‘make waves’. This seems particularly so in the context of a complete change of the board of directors at that time, where the new directors could not even rely on some continuity from the composition of the previous board. There was even limited or confused understanding by Ho and Cheng as to the identity of the Company’s shareholders, and no impression that either felt that they were there to represent the interests of one of the shareholders by representation on the board, or how they might do so. 215.Whilst it may be correct that it is unsurprising that Ho and Cheng might be expected to report to Tong, given Tong’s status as the Executive Director of MAEGL, the fact is that they do not appear to have reported to anyone else. There is no suggestion that either Ho or Cheng ever reported matters to Sino Regal. 216.Mr Yuen suggested that Remedy’s case on de facto and shadow directorship was illogical, self-contradictory and contrary to commercial sense. He emphasised that in addition to considering whether what was done by the person was something which could only be discharged by a director, de facto directorship required the person to act on an equal footing with the other directors, and shadow directorship required a puppet master and puppet(s). 217.Mr Yuen then referred to the fact that it was Remedy’s own submissions that Tong kept from Cheng the fact of under-reporting, and the deliberate decision to do so, even after Cheng became a de jure director, and even after Cheng raised questions showing his concern as to whether the reporting figures were correct. On Remedy’s own submissions that Tong concealed from, and deceived, Cheng, Mr Yuen asked for the application of common sense and posed the question: “If Ho and Cheng were mere puppets, why would Tong need to hide those things from them?”. Put another way, the submission was that the very fact that Tong is said to have hidden things from the de jure directors must mean that he was neither a de facto or shadow director, as there was no equality of footing and no puppet string-pulling. 218.But Mr Manzoni’s answer to the submission was as follows. In order to be a de facto director, a person does not need to conscript his co-directors into his dishonest scheme. Those are two completely different questions. Whilst being a de facto director connotes being at least equal to the de jure directors, it does not stop the de facto director sitting above them. I agree. As to the position of shadow directorship, it may be that, if the puppet director is simply going to do what the puppet master instructs, matters of honesty or dishonesty may be irrelevant. Here, Mr Manzoni relied on the fact that Cheng had raised some query and was essentially fobbed off. That, he said, itself is a demonstration of the control Tong had over the Company and its de jure directors. I agree. 219.The evidence as a whole identifies that Ho and Cheng did not really have control over the Company, at least not on their own. Though it is perhaps not quite as big a point as Mr Manzoni would have it, there is something relating to the evidence surrounding the change of name. But it is also unclear why Cheng came to be designated “Chairman”, when he was the more junior of the two new directors, albeit the one rather more on site for the Company’s manufacturing business. There were apparently remarkably few discussions between Ho and Cheng of the sort which directors carry out; the informal discussion surrounding matters of production and the like, which may have taken place, do not strike me as being equivalent to directors’ meetings. There is no single board minute of any meeting, and I find that there were no such meetings. I reject Ho’s and Cheng’s evidence in so far as each of them at times suggested that there were some, albeit very few, meetings. 220.There is no email or other form of written communication, or record of any meeting, between Ho and Cheng. There was little evidence of any involvement by Ho and Cheng in the financial affairs of the Company. Whilst it is correct that Cheng was an authorised signatory on the Company’s bank account, he was already an authorised signatory before appointment as director, and because he was the production manager. His signing powers were limited to a relatively small dollar amount. Even if Tong was or continued to be the other signatory because he held a wider financial remit within the Group, that does not of itself explain the lack of involvement of the de jure directors. 221.The evidence as to what Ho and Cheng considered in the light of the Company’s significant losses during, and at the end of, the year ended 31 March 2001 was unimpressive and inconsistent. The reality seems to be that Ho and Cheng signed the financial statements of the Company with little attempt properly to understand them or to react to what they showed. They relied on Tong, or the accounting staff who acted on his directions and instructions. I do not think they merely consulted Tong about directorial decisions, as Mr Yuen suggested. The sense is that Tong retained full financial control over the Company after his resignation as a de jure director. The more junior accounting staff, in particular Ken Lam and Wilson Lai, plainly acted on Tong’s instructions even in respect of matters relating to the Company, when they might have been expected to look to the de jure directors of the Company but did not. 222.Tong continued to take an active role in the Company, the activity in question being frequently that commensurate with being a board member. He continued to sign various documents as “director”, and in relation to the documents provided to the IRD there was no reason for him to sign them at all unless acting as a director. Outsiders continued to consider Tong had control over the Company. They included the auditors (even if they also dealt with Ken Lam and Wilson Lai, as might be expected) and those at Philips, the latter of whom frequently addressed him as a “director” of the Company without any pushback or correction from Tong. I take Mr Yuen’s point that there is some self-contradiction in the suggestion made by Remedy that Tong resigned as a director to avoid responsibility, because it would then make no sense for him deliberately to hold himself out as a director of the Company when conducting negotiation with Philips. But the point only goes so far, and not that far. 223.Focusing on what Tong did, rather than what he called himself or was called by others, the dealings between the Company and Philips, being the essence of the commercial activity of the Company, were throughout conducted at board management or directorial level by Tong. Tong’s fingerprints remained all over those dealings, long after his resignation as de jure director. The continuation of the under-reporting was at Tong’s decision. His reason for the deliberate under-reporting was kept from at least Cheng, and there is nothing to suggest that Ho took any interest in the level of reporting at all. 224.I do not accept that the negotiations conducted with Philips by Tong were somehow authorised by Ho and Cheng. There is no convincing evidence of any such grant of authority, or the extent of authority or remit granted to Tong by them. There is no evidence that Ho or Cheng took any steps to acquaint themselves with what might be a reasonable stance in the negotiations, or what might be reasonable prospects at the end of those negotiations. I accept that some involvement from Tong might have been appropriate in circumstances where other group companies might have been providing financial assistance in the form of guarantees and the like, but the correspondence identifies that seeking such assistance was really conditional only on first obtaining an acceptable agreement with Philips for payment by instalments over a lengthy period. The level of those payments to be made by the Company and the period over which the payments will be made were plainly matters being decided by Tong alone. 225.There is no evidence that Ho or Cheng were given any explanation or materials to assess the provision made in the accounts relating to unpaid royalties. Indeed, Cheng and Ho do not seem to have had any dealings of any substance with the auditors. There is no evidence that they were informed of any potential “haircut”. With one or two exceptions, the evidence shows that they were not even shown the content of the letters relating to the negotiations, or told about any of the meetings at which negotiation or discussion with Philips took place. 226.There is no real evidence that anyone other than Tong decided that the Company would cease business, or when it would cease business. I do not accept that this decision was merely in relation to the practicalities of the cessation of business. The decision to cease the Company’s business arose in the context of the activities of the MAEGL group as a whole. There is no suggestion in the evidence that Ho and Cheng had the necessary materials to consider that decision in context, or that they even attempted to do so. 227.In conclusion, applying the legal principles I have identified, I find that Tong was a de jure director of the Company from shortly after its incorporation until 28 July 2000, and thereafter became and remained a de facto director at all material times. On that basis, I do not think I need to make any findings as to whether or not Tong was a shadow director. But there is some sense that his fellow directors, the de jure directors Ho and Cheng, would essentially do whatever they were asked to do by him without much question, and that they were accustomed to acting in accordance with instructions given by Tong. This may be relevant when considering the position of MAEGL. 228.As to MAEGL, I agree with Mr Yuen that the allegations made against it merit special attention, not least because if a parent company were to be held as a shadow director of its subsidiary, that might have significant ramifications in the commercial world. 229.Mr Manzoni makes the following points in relation to MAEGL. First, he relies on Tong as being an agent of MAEGL. Secondly, he relies on the influence which MAEGL exercised over the Company through its accounting department. Thirdly, he relies on the exercise of influence through the other shareholder, Sino Regal. 230.As to the first point, the activities of Tong have been canvassed above and need not be rehearsed. But I agree with Mr Yuen that it would be wrong to attribute liability to MAEGL merely by virtue of the fact that senior management of that company were appointed as directors of the Company (or that one of them acted as a de facto director of the Company). The first and second points are, it seems to me, to some degree connected. 231.As to the second point, I agree with Mr Manzoni that there is a common theme in the Defendants’ witness evidence that they were merely “following” the accounting department. Each of Tong, Ho and Cheng effectively fell back on the accounting department as having been the people that made the relevant calculations and explanations, which they were simply asked to sign and did sign. Mr Manzoni submits that this shows how MAEGL was able to implement the fraudulent scheme through its accounting department. 232.But Mr Yuen is correct that this is not the way the case was really pleaded by Remedy, even though there is reference to the internal accounting staff of Ken Lam and Wilson Lai as the contact persons for audits of the Company. That seems to me to be rather different from an allegation that MAEGL specifically used its accounting department to give instructions to the Company’s de jure directors (as might suggest shadow directorship), or to do things which only a director could do in a manner at least equal with other directors (as might suggest de facto directorship). 233.Mr Yuen also made the submission that it is not clear what is actually meant by the contention that the “accounting department” was the means of the exercise of influence. Whilst that may appear to refer to the group of people who looked after the accounts of the group, such as Ken Lam or Wilson Lai, and might extend to Tong, again that is not how the case was originally presented in the pleadings or in the witness statements. On that basis, the contention now put forward was not addressed in the evidence, and there may be various entirely innocuous reasons why accountants were involved. I agree, as it seems to me that accounting staff would almost necessarily be involved in many aspects of the business of companies within a group, and unless sufficient clarity is identified as to the actual allegation being made it is unlikely that such obvious activity could properly be taken as somehow constituting directorial actions. 234.Of course, Mr Manzoni places reliance on the audit working paper dated 11 August 2000 (see above), which suggests MAEGL – that is, holding company level – involvement in the decision as to what to do about under-reported royalties, including a possible legal strategy and transferring assets away from the Company. I have already found that, notwithstanding that this is a hearsay document, there is no real reason to doubt that PwC staff were in fact told what is recorded as having been told to them by MAEGL management (even if it was not Tong, as he asserted). 235.Mr Yuen submitted that it is inherently unlikely that the auditors would have approved such an express scheme to avoid liability by the transfer of assets proposed by the Company and/or MAEGL. That may be so, but it may be that focus on the legality or proprietary of what was told to the auditors was not the focus of the auditors at the time. The audit focus would likely have been on whether or not an appropriate provision needed to be made in the circumstances. I do not regard the notation made by the auditors of what they were told as somehow “approving” the transfer of assets. In any event, on the materials I do not think it would be safe to assume that the audit work was of a high quality, so that any particular reliance could be placed upon the auditors’ then approach. Those materials include the evidence which Albert Cheung of PwC gave in answer to the questions on the section 221 enquiry – on which Mr Yuen places some reliance – where he was reluctant to concede that there might been asset “stripping”, and was firm that the idea to transfer assets so as to avoid liability to Philips was not that of PwC. 236.Mr Yuen may be on firmer ground when he submitted that there is little or no evidence which has been produced as to what directions or instructions MAEGL had given to the board of the Company at the material times, so that there is no evidence to contradict both Ho’s and Cheng’s denials that any such directions had been given. That, submitted Mr Yuen, is fatal to Remedy’s claim in this regard. 237.Mr Yuen also asked the Court not to lose sight of the point that MAEGL is a listed company, with a separate Board of Directors including the INEDs. As Mr Yuen said, there is no allegation that the INEDs were not properly performing their duties, and the way in which Remedy now frames its complaints effectively ignores the INEDs altogether, or suggest they simply turned a blind eye to whatever the wrongful conduct was of which Remedy now makes complaint. 238.In response, Mr Manzoni submitted that Remedy does not need to say that MAEGL was acting through its Board of Directors in becoming a de facto or shadow director of the Company. He said that it could do that through its management, its executive directorship, namely Tong. Whether MAEGL was acting as a de facto director of the Company is a question of fact. It does not necessarily need to have been a policy approved or otherwise by the board of MAEGL. As Mr Manzoni put it, the holding company is not going to make a board decision that it should act as a de facto director of a subsidiary or associated company. What would happen (he said) is that the executive management or directorship of the holding company would, as a matter of fact, act in that capacity. 239.As to the third point relating to influence through Sino Regal, there is evidence of some influence, but it is perhaps weakened if the proper limit to the pleaded case is borne in mind. The pleading as it stands pre-supposes that Sino Regal was genuinely a separate company, actually owned by Law and Dennis Chan, albeit a company and shareholders over whom it is said MAEGL was able to and did exert influence. 240.On the facts, there is an oddity in the absence of any real Sino Regal representation on the board of the Company, notwithstanding that Sino Regal was the majority shareholder of the Company and MAEGL was only a minority shareholder. The composition of the board before 28 July 2000 had no representation by a director appointed by Sino Regal – except for Dennis Chan in the period 1 April 1999 until 28 July 2000. The others were all from MAEGL’s side. 241.As for Dennis Chan’s position, there was conflicting evidence as to the reason for his appointment, and no convincing explanation as to his subsequent resignation. I do not accept that Cheng was appointed because Dennis Chan wanted him to be appointed, even though that might be what Cheng was told by Tong. The fact that Law, the other shareholder of Sino Regal, could not explain Cheng’s appointment gave the lie to that. Ho and Cheng were both MAEGL employees. Even Law as the other shareholder of Sino Regal was himself an employee of MAEGL who described himself as part of the IT department, a back-office style of role. 242.Even if one assumes Dennis Chan genuinely represented Sino Regal, the majority shareholder of the Company was not represented at board level for most of the time, and in particular when it was making losses and was insolvent, notwithstanding the suggestion made that the shareholders were willing to support the Company. There is force in Mr Manzoni’s submission that it is unlikely that the majority shareholder, acting independently and without influence from MAEGL, would allow such a situation and would not insist on board representation when the Company was in the difficult financial position it reached. The confusion over the role of Alan Fung, another employee of MAEGL, but who was apparently held out as a director of Sino Regal to Philips by or with the assistance of Ken Lam, is also indicative of MAEGL influence. 243.There is also enormous uncertainty, or a strange gap in the evidence, relating to the circumstances by which Sino Regal came to be a shareholder of the Company in the first place, and how its shareholding subsequently came to be reduced from 65% to 55%. The commercial justifications for any involvement of Sino Regal, or for the reduction in its shareholding, were never made clear. The inference is that Sino Regal became a shareholder under the influence of MAEGL to do so, and for some reason reduced its shareholding on the same basis and under the same influence. 244.However, the fact that MAEGL may have been able to influence Sino Regal does not necessarily translate into acting as a de facto or shadow director. For such a finding, it would be necessary to identify specific acts of influence amounting to directorial actions. To put it another way, that one shareholder is able to influence the other shareholder does not necessarily mean that it acted in a role which triggered directors’ duties. Being or acting as a shareholder or director are two different things, and a person will not be regarded as acting as a director unless he does things in that capacity, and that it is something which could only be done in that capacity. 245.Of course, I have in mind that the real benefit of directing the Company in its under-reporting, in its engaging in the Related Party Transactions, in its continuing to trade when insolvent, in its delaying as long as possible any Philips enforcement actions, and the like, all enured to the benefit of the group of companies of which the ultimate holding company was MAEGL. So it might be asked how MAEGL could obtain that benefit without being responsible for the cost of so doing, though the answer to that question must not be permitted to fudge the correct legal and factual analysis. 246.Mr Yuen submitted that it would be a ‘quantum leap’ to hold MAEGL liable merely on the basis of the allegation that Tong or other de jure directors had acted in breach of their fiduciary duties, or even if they preferred the interests of the group of companies under MAEGL as a whole. The question remains whether MAEGL acted in such a way as to create it either a de facto or shadow director, and it is important not to put the cart before the horse. Further, that Ho and Cheng discussed matters with Tong and Li is wholly understandable, given that MAEGL was a substantial shareholder in the Company, and given the Company’s role in manufacturing product for the group. 247.Taking the various points together, it seems to me that the ‘crunch’ question would remain as to how the parent company, as a company and as distinct from any individual person, would have acted as a de facto or shadow director. In this case, other than the allegations which relate to partial ownership or overlapping directorships and management or influence over a fellow shareholder, the only really substantive allegation pointing specifically to MAEGL being a de facto or shadow director of the Company is based upon the alleged agency of Tong. 248.But even that point seems to be fraught with some difficulty because it tends to suggest that Tong’s actions might have created either himself or alternatively MAEGL as a de facto or shadow director, but not both of Tong and MAEGL. It might be said that if Tong was acting as an agent, then his acts would be taken to be those of the principal. If his acts were his own, then he was not a mere agent of a principal. There is also the artificiality in this case that arises from the fact that the only person who can really be described as the physical embodiment of MAEGL is Tong himself (ignoring references generally to the “accounting department”, as I have ruled is necessary). If, as I have found, Tong was a de facto director, it would be artificial to think that the actions he took in that capacity could somehow make MAEGL a de facto director. Nor would it make sense to think that MAEGL became a shadow director by Tong acting as the puppet master of Tong as the puppet. 249.But it is logically possible for Tong to have become a de facto director of the Company, and for his exercise of control over the other (de jure) directors to be attributed to MAEGL to render it a shadow director. Stepping back, the big picture shows the operation of the Company in a way which was inevitably contrary to its own best interests and specifically so as to benefit other companies within the MAEGL group. Whilst that activity began when Tong was a de jure director, it was continued – and it was able to be continued – after his resignation by his continuing to act as a de facto director, and by the appointment of malleable and subservient de jure directors to the Company, over whom MAEGL (through Tong) was able to exercise the necessary control from the shadows. 250.I therefore conclude on all the evidence that MAEGL was not a de facto director, but was a shadow director of the Company from at least 28 July 2000.
251.The question as to the extent of duties owed is essentially a legal question, which has been answered above by reference to the authorities. 252.Once it is accepted, as I do accept and as is common ground between the expert forensic accountants, that the Company was actually insolvent or (at best) nearing insolvency throughout the material period from and after Q4 1999, the creditors’ interests duty was triggered. What that duty entailed has also been canvassed above. Whether or not the duty was breached will be considered below.
253.Questions of insolvency can be considered by reference to a cash flow test (sometimes called the commercial insolvency test), or the balance sheet test. It is the commercial insolvency test which normally looks at an ability to pay debts as they fall due, whereas the balance sheet test compares assets against liabilities, to identify the extent or deficiency in net assets. In this case, focus has been on both, though with greater emphasis on the balance sheet. 254.Net assets are calculated by subtracting a company’s total liabilities from its total assets. The surplus/(deficiency) of the Company’s net assets based on its audited accounts for each of the respective financial years is shown in the following table:
255.An analysis (by Briscoe) of the Company’s net assets after taking into account the difference between the amounts of licensing fees shown in the audited accounts as being paid to Philips and the actual amount of royalties which the Company admitted to Philips it had under-reported is shown in the table below.
256.That analysis points to the Company having become balance sheet insolvent during the financial year ended 31 March 2000. If it is assumed that the under-reported royalties accrued evenly during that year, the analysis suggests that the Company became balance sheet insolvent sometime in Q3 of 1999, and by Q4 of 1999. 257.The question of insolvency, and the date upon which the Company might have become insolvent was one of the questions addressed by the forensic accounting experts. Following the exchange of the expert forensic accounting evidence, in the form of the individual reports and the subsequent joint report, this issue has become rather less controversial. 258.On their analysis, the joint opinion of Mr Bancroft and Mr Frank Yuen is as follows:
259.The references to Scenarios A, B, and C are to differing scenarios, the applicable one of which will turn on factual findings, as follows. Scenario A calculates the royalties due to Philips based on the royalty rates stipulated in the Royalty Agreements. These are also the rates adopted in the Philips Proof of Debt. Scenario B calculates the royalties due to Philips based on a reduced royalty rate for the VCDs being the subject of the agreement in the Side Letter, and royalty rates for the CDs and DVDs as stipulated in the Royalty Agreements. Scenario C calculates the royalties due to Philips at one third of the royalties calculated that the Reduced Royalty rates. This is the “haircut” scenario. 260.For the sake of completeness, I would point out that Scenario C has also been broken down into three potential situations. Situation 1 assumes the sales to related companies had the same gross profit margin as the sales to third party customers. Situation 2 assumes the sales to related companies had a higher gross profit margin than the sales to third party customers. Situation 3 assumes sales to related companies had a lower gross profit margin than the sales to third party customers. However, as I have already rejected any factual basis for adopting Scenario C, it can be ignored on any of the three potential situations. 261.Having excluded Scenario C, it does not really matter whether Scenario A or Scenario B is applied (save as to identifying the extent of the insolvency). This is because the experts agree that the Company was insolvent on either Scenario A or Scenario B as from Q3/Q4 of 1999 and throughout the remainder of the material period. However, insofar as the extent of insolvency might matter, Scenario B is not the applicable scenario. This is because the Reduced Royalty Rate was expressly conditional, and the necessary conditions were obviously not fulfilled. Scenario A is the applicable scenario, and it is the only scenario in which the true extent of the royalties is recognised. 262.Mr Manzoni, I think correctly, also drew my attention to the overall financial picture of the Company over the material period. By 2000, the Company had a turnover of approximately $100 million, was making huge losses, and was massively insolvent if regard is had to its true liabilities. In the approximate five-year period from the date of its incorporation to 31 March 2002, the Company reduced its balance sheet value from $10 million of paid-up capital to a negative value of approximately $70 million. 263.Therefore, even if it were relevant, I agree that the prospects that the Company could trade out of that situation were minimal. Indeed, the last suggestion which the Company made to Philips for payment of the outstanding royalties arising from the significant under-reporting involved instalments offered over a period of 10 years (and it is not clear that even that proposal took into account the need for the Company in the meantime to pay the royalties on properly recorded levels of production and sale). 264.But I do not think the prospects of trading out of insolvency are relevant at this stage of the analysis. The question of insolvency is a binary question; either a company is insolvent or it is not. What the directors might do in the face of the fact of insolvency might be relevant to whether or not they have acted in breach of the duties they owe as directors, including the creditors’ interests duty triggered by the fact of insolvency. 265.The same is true in relation to the possibility of negotiating a reduction in the necessary payments to Philips. I shall, therefore, consider those matters in the context of the allegations of breach of duties.
266.On the basis of the now admitted deliberate under-reporting of production levels and royalties payable, leading to the sales at below cost and to the misrepresentation in its financial statements of the Company’s true financial position, Tong was plainly in breach of his duties owed as a director. So was MAEGL from when it became a shadow director. Insofar as Mr Yuen suggests that there is no pleading that the under-reporting was by itself a breach of duty, he of course himself recognises that it can be relied upon in support of allegations that there was a breach in the sale of products to related companies at below cost and in the alleged scheme to transfer away the Company’s assets. 267.I reject the idea that the under-reporting was satisfactorily commercially explained, so that it might be regarded as having not been done with the intention of acting against the Company’s interests. It was contrary to the interests of the Company to expose itself to an enormous claim from Philips, and at the same time to sell products at below cost. I reject the idea that the under-reporting might somehow have been justified by the fact that the Company operated in a market suffering from rampant issues of piracy. 268.In so far as it is necessary, I find as a fact that the Company was not entitled to the lower conditional Reduced Royalty Rate, as it was in breach of the conditions throughout the period from the inception of the arrangement identified in the Side Letter. That means that the relevant royalty rate is the original rate of US$0.05 (such that the applicable scenario when considering questions of insolvency – see above – is Scenario A). 269.It is agreed between the experts that the Related Party Transactions were at below cost for the period from 28 November 1997 (date of incorporation) to 31 March 1998, and for the year ended 31 March 2000, albeit not at below cost for the year ended 31 March 1999 (because the Company actually made a profit in that year). In that context, I do not think it necessary to resolve slight differences between the expert accountants as to whether or not certain costs such as depreciation and salaries should or should not be included in the calculations. 270.It was, therefore, also a breach in effect to divert profits from the Company to other parts of the MAEGL group via the Related Party Transactions, carried out at an undervalue. 271.Further, from at least early 2000 until the Company was wound up, Tong and or MAEGL procured the Company to transfer away the Company’s business and assets to related companies without regard to the Company’s ability to discharge its debts owed to creditors. I reject the idea that the purpose of the transfers was to improve the financial position of the Company. It may be correct that one financial indicator showed some improvement, as the experts agree, but that was only one indicator. 272.Mr Frank Yuen’s analysis on this point was of limited value, as he read the relevant question (I accept honestly) as rather more narrow than it was. The analysis looked only at the snapshot of the position as at 1 April 2000, and his conclusion that the impact was insignificant is limited to that snapshot. It also presupposed that the transactions actually took place on the dates put on the MAHK Agreement and the Silver Kent Agreement. But those dates are not correct, as the documents were ante-dated by many months, and probably more than a year. Mr Frank Yuen accepted that the figures he relied upon would have changed in the intervening period. 273.I prefer on this point the evidence of Mr Bancroft, who read the question in its wider form looking at the impact following the sale of plant and machinery and its leaseback by reference to the various matters identified in the question. To perform his analysis, he reversed to the extent possible the accounting entries identified in respect of the transactions pursuant to the MAHK Agreement and the Silver Kent Agreement respectively. He then considered the impact on relevant balance sheet and income and expense items for the subsequent years after the sales leaseback transactions. His conclusion, which I accept, was that if the sale and leaseback transactions had not been conducted, the net current liabilities, and the current ratio, and the operating results of the Company would all have deteriorated. 274.Mr Bancroft also carried out a liquidation analysis by comparing the financial position of the Company as at 28 March 2000 with the position as at 31 March 2001. That analysis indicated that the assets receivable by the Company’s other third-party creditors and Philips would have been reduced by $6,403,150 and $8,715,780 respectively should the financial position of the Company as at 31 March 2001 be considered, compared with the corresponding reductions as at 1 April 2000 of $804,706 and $1,433,736 respectively as set out in Mr Frank Yuen’s report under Scenario A. just before his oral evidence, Mr Bancroft produced another attachment which out the liquidating analysis of the Company with and without the sale of plant and machinery to MAHK and Silver Kent under Scenario A. That attachment identified the percentage recovery to diminish from 86% to 68%. 275.Overall, I do not think the evidence supports any suggestion that the transfer of the Company’s assets to related companies was ever decided upon with any improvement in mind as to the Company’s ability to discharge its debts owed to creditors, and to Philips in particular. There is nothing to support such a positive intention. In fact, as the audit records identify, the intention was to transfer away assets as a strategy to avoid the consequences of claims by Philips. It seems to me that the timing of the transfer of assets is relevant to motive, and so to the key question (as Mr Yuen described it) of whether a sale of the CD liners and machineries to a related or associated company was bona fide in the best interest of the Company and potentially the creditors. Against the financial picture of the Company at the time, and the apparent idea behind the transfer of assets, as well as the significant ante-dating of the transactions, I do not think the transactions were put forward bona fide with the best interests of the Company and its creditors in mind. 276.I also accept Mr Bancroft’s view as to the negative impact that the transactions had on the assets receivable by third-party creditors and Philips. 277.So, I find the Company’s sales to its related companies and/or the transfer away of fixed assets were made without regard (at least, without the correct regard) to the Company’s ability to discharge its debts owed to creditors at a time when the Company was insolvent or nearing insolvency. 278.As to the possibility of any negotiated settlement with Philips, I have already found that there was no realistic possibility of reaching a settlement with any reduction of the principal amount. Nor was there any realistic possibility of reaching a settlement on payment by instalments over anything longer than a four-year period. It might be, as Tong said, that there were continuous negotiations, but the extent of any positive progress was slight and the prospects of an actual settlement were low at the time negotiation ceased with the parties significantly far apart, and when the gap (if anything) was widening. 279.I have already found also that there were no realistic prospect of trading out of the situation of insolvency. Indeed, I do not think there was any intention to do so. It is also striking that the shareholder support was never forthcoming, and instead the loans to shareholders were paid off. No attempt was made to obtain any binding commitment from the shareholders to support the Company, and at least one of the shareholders faced significant financial difficulty in providing support in any event. I accept the inferences that no commitments were really considered at the time, and it was a breach not to have put the company into liquidation within a very short time of its becoming insolvent. 280.I reject Mr Yuen’s submission that any duty to consider the creditors’ interest did not arise until only around December 2001. In my view, it arose at the latest by March 2000. However one formulates the creditors’ interests duty, I do not think the directors in this case – being Tong as de facto director, MAEGL as shadow director and, indeed, Ho and Cheng as de jure directors – acted in compliance with the duty they owed to the Company, encompassing the interests of the Company’s creditors as a whole as well as those of the shareholders.
281.The deliberate under-reporting so as to suppress – that is, to reduce by nearly 95% – the royalties payable to Philips was dishonest. Stepping back, Philips was clearly concerned as to manufacture and sale of products without the relevant licence, and therefore without appropriate compensation for the use of its intellectual property rights. The whole purpose of the Royalty Agreements was to permit lawful use of those intellectual property rights. Just as manufacture and sale without any attempt to pay appropriate royalties would be ordinarily understood as dishonest – the word “pirating” is often used to connote that dishonesty – so manufacture and sale with only partial payment of royalties would obviously also be ordinarily understood as dishonest in relation to that part of the production and sale which was not reported and for which royalties were not paid. 282.Applying the test for an assessment of dishonesty set out above, Tong (and through him MAEGL) acted dishonestly. Mr Yuen submitted that the question in relation to dishonesty should be based on whether there were good commercial reasons for the decisions taken by the board of the Company. He said that if there were such good commercial reasons, no finding of dishonesty should be made. I reject that submission as being far too broad. In one sense, it was a commercially good decision and made for a good commercial reason not to report properly the royalties which would otherwise be payable to Philips, as it permitted selling at a lower price. But it would be ludicrous to suggest that that would somehow make it necessarily an honest decision. I also reject the submission made by Mr Yuen that it is not objectively dishonest or fraudulent for a director to under-report in an effort to maintain the competitiveness of the Company and then explore, to the best of his abilities, means to repay true liabilities owed by the Company through negotiations with the creditor. 283.Even if the intention behind the under-reporting was to allow the supply of goods at below cost to maintain the competitiveness of the Company in a difficult market – though that ignores the interposition of Silver Kent, which I am not prepared to do – and Tong also believed that a significant number of players in the market were doing the same thing, he must have known, and on any objective standard any ordinary decent person would know, that that was dishonest. 284.Again, even assuming Tong believed that the outstanding royalties payable to Philips were negotiable – and I have rejected the possibility that he believed that there was any room for negotiation over the principal amount owed – to continue to under-report and, therefore, to sell at below cost and to mis-state the financial position of the Company was also dishonest by any objective standard. Indeed, I have found that the correct reporting and the ensuing negotiations were deliberately delayed as long as possible, so as to maximise the time during which the Company could continue to operate in a manner which Tong (and through him MAEGL) knew, and any ordinary decent person would know, was dishonest. 285.Insofar as it is necessary to do so, I reject the idea that the transfer of assets under the MAHK Agreement and the Silver Kent Agreement was made to obtain better banking facilities for the Company. Though a larger loan was later obtained, I do not think the link was made in evidence that that was the purpose of the transfer of assets, nor even that the transfer was what facilitated the larger loan. 286.Dishonesty in breach of the duties owed has been established.
287.In the circumstances of the above findings, it may not be necessary to deal with the matters relating to the alternate case on dishonest assistance. But I shall do so for the sake of completeness. 288.Mr Yuen submitted that the case in dishonest assistance is fundamentally flawed. First, he said that there was no proper pleading of any breach of fiduciary duty against Ho or Cheng, because although there was an allegation that Tong and MAEGL were aware that the various transactions involved or comprised breaches of duty and trust on the part of themselves and the de jure directors of the Company, no particulars were offered as to what fiduciary duties Ho and Cheng had supposedly breached. He also said that the allegation of breach of duties made against Ho and Cheng in Remedy’s closing submissions are of a different nature to the allegations pleaded against Tong and MAEGL. So, said Mr Yuen, the dishonest assistance claim should fail in limine. 289.However, I disagree. It seems to me that the claim in dishonest assistance is sufficiently pleaded in the CSOC. It is the essence of the claim that the Company acted in various inappropriate ways, and insofar as it did so by the de jure directors, they necessarily were in breach of their duties owed as directors. Insofar as they were assisted by others, those others’ actions and their quality can be assessed. 290.Mr Yuen also submitted that the claim was unmeritorious in any event. First, a third party should not be held liable unless he is an active participant in the breach of trust, and mere knowledge of the fiduciary’s breaches without any conduct over and above such knowledge is not sufficient either. Therefore, he said, allegations that Tong and MAEGL were “aware” of the relevant facts or that there was a “failure to prevent” the relevant breaches of duties are bad pleas. 291.However, on my findings, there was activity by Tong (and through him MAEGL) over and above merely being aware of the failures on the part of the de jure directors. I have found that those failures were in effect directed by Tong or engaged in by Ho and Cheng with Tong’s strong influence over them and the conduct of the Company as a whole. 292.I have already found that Tong’s and MAEGL’s actions were dishonest. So, were it necessary to do so, I would find the alternative case on dishonest assistance established.
293.On my findings as to (a) de facto and shadow directorship, (b) extent of duty, (c) breach of duty, and (d) dishonesty, no limitation defence is available to Remedy’s primary claims. This is the result of the operation of section 20 of the LO. 294.It is only necessary to consider the potential effect of section 26 of the LO in the context of the alternative case on dishonest assistance. On this aspect, there seems to me to be considerable force in Mr Yuen’s submission that Remedy has not articulated what “relevant facts” were concealed by virtue of the inability of the Liquidators to make enquiries into the lost records previously held by Silver Kent. As Mr Yuen said, the submissions made on behalf of Remedy during the trial tended to demonstrate that it was capable of formulating the cause of action based upon the alleged “scheme” by reference to documents in relation to Philips and the audited statements of the Company at the material time. There is no allegation against the Defendants that those documents were the subject of any deliberate concealment. 295.Further, whilst acknowledging the particular position of the Liquidators in the context of a winding up, and making appropriate allowances for lack of resources, there does appear to me to have been significant delay in the process of investigation, even in the conduct of section 221 examinations. Were it necessary to do so, I would hold that Remedy cannot rely on “concealment” for the purposes of section 26 of the LO in respect of the alternative claim.
296.By the CSOC, Remedy seeks various declaratory relief, principally as regards the de facto or shadow directorships of Tong and MAEGL. Though I have made appropriate findings, I do not think formal declarations need be made. Remedy also claims that Tong and MAEGL are liable to it for equitable compensation for loss and damage suffered by the Company as a result of their fraudulent breaches of fiduciary duty and/or trust and/or for equitable fraud. It is pleaded that the entirety of the loss – said to have arisen from each breach cumulatively – is demonstrated by the difference between (a) the true value of the assets of the Company at the relevant date immediately prior to which the breaches were carried into action and (b) the true value of the assets of the Company upon winding up on 15 January 2003. 297.That latter value is pleaded to be either a deficiency of $107,011,915, as estimated by the Company’s Liquidators, alternatively $50,540,168 as contained in the Statement of Affairs (“SOA”) signed by Ho on behalf of the Company on 29 July 2003. In Remedy’s closing submissions, the figures are slightly varied. The liability to the Company is said to flow from the fact that since the Company was insolvent by Q3 of 1999, had Tong and MAEGL been acting in the Company’s best interests, they should have put the Company into liquidation. Therefore, it is said, Tong and MAEGL are liable to the Company in terms of its shortfall in assets, based either on the sum of $106,764,198 (by reference to Philips’ Proof of Debt, rounding so as to ignore a few cents), or alternatively $50,305,679 (by reference to the SOA). 298.In the Defendants’ written closing submissions, Mr Yuen suggested that Remedy’s pleadings and submissions did not deal properly with questions of remedy and quantum. But, pending sight of Remedy’s closing submissions, Mr Yuen offered certain key points of argument. One of them was that it was difficult to see what loss the Company had suffered from carrying on with its business operations when it was insolvent. Emphasising that the complaint was not that Tong and MAEGL breached their fiduciary duty by causing the Company to become insolvent, but rather that they failed to put the Company into liquidation when it became insolvent, it was submitted that the loss was, at best, the loss of the creditors. But I agree with Mr Manzoni response that that submission has no merit at all. 299.I also agree with Mr Manzoni’s analysis as to the calculation of appropriate relief. The analysis identifies that once the Company became insolvent, directors acting in its best interests would have put the Company into liquidation. Therefore, the directors in breach of their duties would be liable to the Company in terms of its shortfall in assets, subject to subtracting from the extent of the shortfall the amount of the insolvency as at the material date. In other words, the liability is as to the increased amount of insolvency over the period from the material date I find when the Company ought to have been placed into liquidation until the date when it was in fact wound up. 300.The material date for Tong is 31 March 2000, which is when I consider the Company should have been placed into liquidation had there been no breach of the fiduciary duties owed by the directors in post at that time. The material date for MAEGL is 28 July 2000, when it became a shadow director, or perhaps a few days later on say 31 July 2000 (and an immediate breach arose because Tong’s knowledge was at once attributable to MAEGL in this context). 301.As to the shortfall, I do not think it is correct to rely on the Philips Proof of Debt, in the full sum of $106,764,198 (which is the suggested Hong Kong dollar amount of the United States dollar amount put forward in the proof). If one looks at the calculation of that sum, almost a quarter of it is attributed to interest (though I note it is said to be calculated by reference to the contractually agreed rate in the Royalty Agreements). Further, a considerable amount of the total arises in addition to amounts which were already outstanding as at the end of Q1 of 2000. 302.On the other hand, I accept that there are also questions about the accuracy of the SOA of the Company submitted by Ho. Indeed, concerns about its accuracy, and the failure on the part of Ho to have provided further information in response to enquiries made by the Liquidators, form part of the argument put forward by Remedy in support of its case on limitation. Nevertheless, looking at the evidence as a whole, it seems to me that the deficiency figure in the SOA is the better figure to adopt for present purposes relating to relief. Though it may not be comparing like with like, I have also performed a calculation of the elements comprising the Philips Proof of Debt arising after the end of Q1 of 2000 (and ignoring interest) and that figure (approximately $47 million) and the deficiency figure in the SOA (approximately $50 million) are, in context, reasonably close. 303.So I take the relevant loss to be the difference between (a) the deficiency in net assets of the Company as at 31 March 2000 (for Tong) and 31 July 2000 (for MAEGL) and (b) the deficiency identified in the SOA. 304.Mr Frank Yuen identified, when taking the under-reported royalties into consideration, the deficiency in net assets of the Company as at 31 March 2000 (on Scenario A) was $20,611,064. Therefore, the relevant shortfall figure as at that date is $29,694,615. 305.Identifying the relevant shortfall figure at 28 or 31 July 2000 is less straightforward. But it is possible to adopt a straight line calculation by reference to the asset deficiency as at 31 March 2000 ($20,611,064) and that at 31 March 2001 ($48,939,206 – see above) and assume a monthly increase in the deficit of $2,360,678, and so $9,442,714 over the four months from 31 March to 31 July 2000. Hence, the deficiency in net assets as at 31 July 2000 would have been $30,053,778, and the relevant shortfall figure as at that date is $20,251,901. 306.I award damages in the sum of $29,694,615 as against Tong, and in the sum of $20,251,901 as against MAEGL. 307.In those circumstances, there is no need to consider the possibility of any account.
308.Because the claim for the Silver Kent Debt was commenced by writ in 2006, no limitation question arises. 309.The starting point is that as at 31 March 2002, the amount due from Silver Kent to the Company was $4,675,587.37. This was admitted by both Law and Ho in cross-examination. The issue is whether the amount was paid to the Company subsequent to 31 March 2002. 310.The Defendants’ case is based on payments said to have been made by MAHK to the Company after 31 March 2002, but for debts incurred by Silver Kent prior to that date. As already identified above, it is said that this was pursuant to the alleged Arrangement whereby (a) MAHK would place orders with Silver Kent; (b) Silver Kent with them place matching orders with the Company; and (c) MAHK would pay the Company on behalf of Silver Kent directly, and so settling MAHK’s indebtedness to Silver Kent as well as Silver Kent’s indebtedness to the Company. 311.Mr Manzoni submitted that the Arrangement could not have existed for various reasons. First, he described as “curious” that payments were said to be made by the Company after 31 March 2002 when it ceased doing business as at 18 February 2002. Secondly, he pointed to the lack of commercial justification for the imposition of Silver Kent in the middle, when the Company could readily have traded with MAHK directly. He also pointed to the lack of commerciality in MAHK paying the Company directly, therefore depriving Silver Kent of the ability to receive its own profits. 312.Mr Yuen, however, pointed to the evidence that payments were indeed made by MAHK to the Company after 31 March 2002. No attempt was made at trial to challenge the authenticity of the documents concerned. He further referred to Remedy’s own pleading where the receipt of the sum of $5,292,000 by the Company from MAHK has been admitted. As the claim is a debt claim, Mr Yuen submitted that the fact that the payments continued to be made after the Company ceased trading is not relevant. He also submitted that Remedy is ‘blowing hot and cold’, at times seeking to rely on the Company’s accounts when it suits, but disputing the veracity or reliability of the accounts in pursuit of the Silver Kent Claim. 313.Looking at the Arrangement, I have already held that I do not think it could have been in place from 1 April 2000, as was asserted by Law. The whole ‘distribution’ arrangement to interpose Silver Kent between the Company and MAHK was an afterthought and an ex post facto construct. Indeed, of the various related parties identified as having current accounts with the Company as at 30 September 2000, Silver Kent was not named either as a debtor or a creditor of the Company at that date. That strongly suggests that at least by that date Silver Kent had not had any financial dealings with the Company. That fact is also consistent with the various statements issued by MAHK for the corresponding period, which indicate that purchases made by MAHK did not involve Silver Kent, as Silver Kent is simply not referenced. 314.Insofar as Silver Kent’s defence to the Silver Kent Claim depends on the existence of the Arrangement, at least on the basis that it was in place from 1 April 2000 as pleaded and as stated by Law in his evidence, it must fail. 315.But it remains the apparent fact that monies were received from MAHK after 31 March 2002. The documents evidencing those payments also suggest that they were made (often in round numbers) by cheques paid to the Company, with some reference to the settlement of invoices in July, August and September 2001. Whilst Mr Manzoni submitted that there is no record to show that, after ceasing business, the Company agreed to accept payments from MAHK in settlement of the Silver Kent Debt, the fact is that those payments were made and accepted (even though there is a disparity in the fact that MAHK is said to have paid to the Company a sum in excess of the amount due from Silver Kent to the Company as at 31 March 2002). No other reason has been shown why else those monies might have been received, although that might be the result of incomplete documentation available to the Liquidators from the various relevant sources, and the significant passage of time. Indeed, once as it is accepted that the Arrangement was not in place, and that for at least a significant part of the overall trading period Silver Kent was not contemporaneously involved, it is no great surprise that payments were made and subsequently continued to be made by MAHK. 316.In the end, there is clearly some uncertainty around the whole situation factually. But, though I have rejected the basis of the pleaded defence if it turns on the existence of the Arrangement, it seems to me that the real thrust of the defence is that the Company has been paid on a number of the invoices it raised relating to product manufactured and sold (whether to Silver Kent, or more directly to other companies). That the money came from MAHK rather than from Silver Kent merely gives rise to the possibility of necessary accounting between those two entities. In the circumstances, I do not accept that Remedy has proved its entitlement on the Silver Kent Claim.
317.As to the counterclaim, Mr Manzoni’s simple proposition was that no claim could be brought by Silver Kent against Remedy, because as a matter of law an assignee (here, Remedy) is not liable for the assignor’s (here, the Company’s) debt: see Honour Finance Co Ltd v Chan Yan Pak [1988] HKC 864 at 866D-E and Legend Investments Ltd v Ho Yuk Wah David (No. 1) [2010] 2 HKLRD 424 at §§17-18. 318.Mr Yuen submitted that this is not a case where a defendant has counterclaimed against an assignee only after the assignor had commence proceedings. In this case, Silver Kent initiated the counterclaim long before there was any indication that Remedy might replace the Company as the plaintiff. In any event, the Deed of Assignment dated 10 September 2010 not only assigned the Company’s causes of action but also “the right to defend the Proceedings or any counterclaim or set-off”. So, said Mr Yuen, when the Master made the order to substitute Remedy as plaintiff in place of the Company, the clear intention of the Court and all involved must have been that Remedy would carry on not only the Company’s claims but also the defence of the pre-existing counterclaim by Silver Kent. There would, he said, in any event be an equitable set-off to reduce or extinguish the claim. 319.On the matter of principle, I agree. It seems to me that the Deed of Assignment, and the subsequent substitution of Remedy as plaintiff, was intended to put Remedy in the position formerly occupied by the Company both in respect of the claims and the counterclaim. Whilst Remedy took an assignment of “the right to defend” the counterclaim, which on one reading might seem to have created an option, essentially Remedy was taking the rights to the debt subject to the right of set-off reflected in the making of the counterclaim, pre-existing the date of the assignment. I agree that the Silver Kent Claim and the Counterclaim are in effect two sides of the same coin. 320.As to the evidence, as well as the accepted payments made from MAHK in the total of $5,292,000 (see above), there are documents showing direct payments by Silver Kent to the Company totalling $157,500 in April and December 2002, and some further payments of debts owed by or attributable to the Company. Subject to giving credit for transfer of fixed assets in various deposit balances from the Company as shown by transfer vouchers dated 30 April 2002, and the balance sheet of the Company as at 30 November and 31 December 2002, in the sum of $118,815.09, that would give a net sum due from the Company to Silver Kent of $673,184.69. 321.However, in light of the significant lack of clarity surrounding the various inter-company accounting issues, and where Mr Yuen accepts that the claim on the Silver Kent Debt and the Counterclaim are two sides of the same coin, I do not think it would be correct to allow the Counterclaim. To put it another way, I am not satisfied that Silver Kent has on the balance of probabilities established its entitlement, and I therefore dismiss the Counterclaim. J. Result 322.The claims under the MAHK Agreement and the Silver Kent Agreement originally made in HCA 677/2006 and HCA 678/2006 are dismissed. 323.The claim against Tong and MAEGL, for fraudulent and dishonest breach of duties (as de jure, de facto and/or shadow directors) owed to the Company is allowed and damages are awarded in the sum of $29,694,615 as against Tong, and in the sum of $20,251,901 as against MAEGL. 324.The Silver Kent Debt claim is dismissed. 325.The Counterclaim is also dismissed. K. Interest and Costs 326.I reserve any questions relating to interest on the damages awarded to the hearing on which I shall consider all questions of costs. 327.I reserve all questions of costs, including any costs issues outstanding prior to the trial, to a further hearing to be fixed for three hours in consultation and accordance with the diaries of one Counsel for Remedy and one Counsel for the Defendants respectively. 328.At least 10 working days in advance of the hearing, the parties should exchange and file with the Court their written submissions on interest and costs.
Mr Charles Manzoni, SC, Mr Norman Nip and Mr Martin Lau, instructed by Gall, for the plaintiff Mr Rimsky Yuen, SC, Mr Jonathan Chang and Mr Peter Dong, instructed by Chan, Lau & Wai, for the 1st to 3rd defendants | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cases cited in this judgment
Other judgments that cite this case
Further hearings and rulings under HCA 677/2006