Chingtung Futures Ltd v. Arthur Lai Cheuk Kwan and Others
Read the full judgment text of HCA 5081/1989 on BabelCite. This High Court CFI judgment was delivered on 31 December 1992.
1. The plaintiff, ChinTung Futures Ltd. is a private company in compulsory liquidation. I will call it "CTF". CTF used to be a broker on the Futures Exchange. Then came the global market crash of October 1987 which, in Hong Kong at any rate, began on "Black Monday" the 19th of that month. CTF did not survive. On April 11, 1988, a winding-up order was made against it.
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HCA005081/1989 1989, No.A5081 (Photocopying of this Headnote is not allowed) H E A D N O T E Hang Seng Index futures. Black Monday. Claim by futures brokerage house against former directors. House inadequately protected against customer default in the event of market crash. The Court said :-
IN THE HIGH COURT 1989, No.A5081 _____________
_____________ Coram: Bokhary, J. in Court Dates of hearing: 9, 12, 23-27, 30, November; 1-4, 7-8, 19 and 21-22, December 1992 Date of delivery of judgment: 31 December 1992 -------------------- J U D G M E N T -------------------- Introduction 1. The plaintiff, ChinTung Futures Ltd. is a private company in compulsory liquidation. I will call it "CTF". CTF used to be a broker on the Futures Exchange. Then came the global market crash of October 1987 which, in Hong Kong at any rate, began on "Black Monday" the 19th of that month. CTF did not survive. On April 11, 1988, a winding-up order was made against it. 2. Turning to the defendants, they are former directors of CTF. The claims against the 2nd and, 3rd defendants were settled after the case had been called on back on November 9, 1992, and just before the actual hearing got underway on November 23, 1992, after two adjournments. I am now giving judgment on the claim against the 1st defendant, Mr Arthur Lai. 3. Essentially, we are concerned with the period from early 1986 to late 1987. The account which this case is all about, Account No.C1210, was opened on May 6, 1986, and finally liquidated on November 2, 1987. 4. Mr Lai was CTF's Chairman at all material times. Also, he was a 50% beneficial owner of the ChinTung Group from the outset until July 8, 1987, when he became the 100% beneficial owner of it. 5. Account No.C1210 was opened as the result of an approach to him. He was instrumental in its opening. And he functioned as the account executive for it. 6. Trading on the account began on May 9, 1986. Throughout, such trading was exclusively in Hang Seng Index futures contracts. I will call them "HSIF contracts". 7. The day on which the account was opened, May 6, 1986, was also the day on which index futures first came on the market in Hong Kong. And they came in the form of HSIF contracts. 8. So index futures did not then - and does not really even now - have a long history in Hong Kong. Indeed, it was not until the early 1980's that the world saw them for the first time. That was in Chicago. Hong Kong was not next. But we did not lag far behind. And once we got underway, it was not long before we became second only to Chicago in the number of contracts being traded. 9. This new commodity enables investors to hedge their share positions. And whatever else may be said about speculation in index futures, speculators provide counter-parties for hedgers. 10. But it is a fact, as Griffiths, L.J. said in Merrill Lynch Futures v. York House Trading, "The Times". May 24, 1984, that: "Everybody with the slightest acquaintance with the commodity market knows that it is an unpredictable, volatile and extremely risky market in which to trade, and even experienced persons have the misfortune to lose vast sums of money". That underscores that loss alone, however great, does not indicate negligence. But it also indicates how careful you have to be. 11. Generally, trading on Account No.C1210 was done on an optimistic view of the Hang Seng Index's fortunes. And that optimism was, as we shall see, acted upon even on Black Monday itself. 12. From the opening of the account in May 1986 to the crash in October 1987, Hong Kong experienced an essentially bull market in shares. The Hang Seng Index stood at 1,787.96 points at the end of May 1986, and at 3,783.20 points immediately before the fall on Black Monday, In that market and while it lasted, the essentially bullish trading which had been done on Account No.C1210 resulted, not surprisingly, in an overall profit to the account holder. His withdrawals from the account amounted to $28,297,953.00 and exceeded his deposits into it, which amounted to $16,210,000.00. by $12,087,953.00. 13. But then, as I have said, came the October 1987 crash. On Black Monday, October 19, 1987, the Hang Seng Index closed 420.81 points down. Both the Stock Exchange and the Futures Exchange were closed over the four days which followed, Tuesday, October 20, to Friday, October 23, 1987, which would otherwise have been trading days. Then came the weekend. And when the exchanges re-opened on Monday, October 26, 1987, the Hang Seng Index closed another 1,120.70 points down. 14. There was a credit balance of $8,117,693.00 in Account No.C1210 on Black Monday. But the account was then 1,076 positions long at the time. For every point which the index moved against it, each position would suffer a loss of $50.00. Therefore, with that many long positions open, the loss on the account would be ($50.00 x 1,076) $53,800.00 per point by which the index fell. 15. With the crash, the customer defaulted on Account No.C1210. 16. The account was finally liquidated on November 2, 1987, when the last of those 1,076 positions was closed out. That, even after the $3,117,693.00 had been taken into account, left the account $83,977,986.92 in deficit. 17. Upon customer default, the loss on the account became the loss of the broker. CTF was, as its leading counsel Mr John Griffiths Q.C. puts it, "left holding the baby" in the shape of an $83.97 million loss. It says that such loss was caused by Mr Lai's breach of the duty of care which he owed it. And it seeks damages against him in that sum. He denies breach and causation, and raises other defences as well. HSIF contracts and the system under which they were traded 18. In order to follow how it is that such losses can fall also on the broker, it is necessary to look at certain features of HSIF contracts and the system under which they were traded. 19. Some of those features are well-known. Among the best known are these. 20. HSIF contracts involve a view of which way the Hang Seng Index will move. Not everybody will be keen on the way CTF's expert, Mr P.A. Thorpe, puts it when he says in his reports that: "In essence an HSIF contract involves the buyer and the seller betting against each other on what will be the closing value of the Hang Seng Index at the end of the agreed month". But Mr Thorpe, about whose experience I will say more in due course, knows what he is talking about. And, like it or not, the way he puts it has a refreshing way of getting the point across free of cant. 21. Continuing, contracts are offered for the current month, called the "spot" month, and for future months. Either you enter into contracts on the assumption that the index will go up, in which case you "go long". Or you enter into contracts on the assumption that the index will go down, in which case you "go short". Whether long or short, contracts are settled on the last trading day of the contract month, whichever that may be. On that day, you take the difference between the level at which the index then stands and the level at which it stood when the contract was entered into. Such difference will of course be in terms of a certain number of points. 22. As I said earlier, each point is worth $50.00. For each long contract you hold, you gain $50.00 for each point by which the index has gone up or lose $50.00 for each point by which the index has gone down. For each short contract you hold, you gain $50.00 for each point by which the index has gone down or lose $50.00 for each point by which the index has gone up. Whichever way the index moves, there is on each contract a party who gains and a party who loses correspondingly. 23. There are other less well-known but no less important features. Futures brokers must be able to rely on their customers to meet losses. Contracts begin as between brokers. But they are then novated by the Clearing House set up by the Exchange. That leaves brokers liable to the Clearing House to meet losses even if their customers default. If a customer defaults, then, subject to recovery through legal proceedings, the broker is out of pocket. So the broker has a serious risk to guard against. The loss which it might be left to carry can be substantial. Depending on the size of the loss relative to the broker's resources, such a loss may prove crippling or even fatal. It could cause the broker's liquidity ratio to fall below the level which it must maintain in order to retain its right to continue in business as a broker on the Futures Exchange. Or the loss could even render the broker insolvent in the ordinary acceptance of the term. The risk to the broker 24. That is the risk to the broker and how it arises. Guarding against the risk 25. Each side called an expert. I have already mentioned Mr Thorpe called by CTF. Mr Lai called Mr R.B.M. Nicholas. Mr Thorpe's experience includes that gained: in various senior posts in the Office of the Commissioner for Securities in the years which preceded the 1987 crash; as Chief Executive of the Futures Exchange in the aftermath of the crash; and then as an Executive Director of the newly establish Securities and Futures Commission. Mr Nicholas' experience includes that gained over a long period in responsible positions with prominent brokerage houses and as a director of the Futures Exchange. 26. Both experts dealt with what a futures broker can do to guard against customer default. In that connection. three things in particular were canvassed in depth. They are: a guarantee; knowledge of the customer; and margin. 27. In due course, I will deal with each of those things in the context of the facts of this case as I find such facts proved or admitted. At this stage, I move on to other matters, pausing only to express my thanks to both experts for their help generally, doing so now lest I forget to do so later. CTF's case 28. With that introduction, one can better follow CTF's case, to which I have adverted only in the most general terms so far. 29. Shortly stated, CTF's case against Mr Lai runs along these lines. He owed it a duty of care. And he has breached such duty. He breached it by permitting Account No.C1210 to be opened at all or without adequate safeguards. Further or alternatively, he breached it by permitting the account to be operated unsecured, inadequately margined and over-exposed. As a result, it i.e. CTF suffered damage. And the measure of such damage is the $83,977,986.92 in which the account was left in deficit upon liquidation or the extent of the deficits therein throughout 1986 and 1987. Mr Lai's case 30. All of that is denied by Mr Lai. He denies that he was in any way at fault or, if he was, than anything suffered by CTF was due to any fault of his. He says that, in any event, the course which he followed was supposedly ratified by the company, CTF, so that the case now advanced against him is barred. In so far may be necessary, he seeks an apportionment of liability between him and the other two defendants, so that any damages awarded against him would not exceed so much of the total loss to CTF as is attributable to the liability apportioned to him. He also seeks, in so far as may be necessary, two other things. One is a deduction from the award against him of what CTF has paid the Clearing House and of what the other two defendants have agreed to pay CTF under their settlements with it or at least what has been recovered so far under those settlements. The other, failing all else, is complete or partial relief under section 358 of the Companies Ordinance. Cap.32. He had pleaded an exemption clause contained in CTF's articles, but no longer relies on the same. 31. All of those matters are in issue; and they are not all that is in issue. Who was the customer? 32. Even who was CTF's customer on Account No.C1210 is in issue. I will deal with that now. 33. The account was held in the name of another company in the ChinTung Group, Chintung Investment Services Ltd, which also had Mr Lai as its Chairman. I will call it "CTIS". 34. It is now time to introduce a US$2.00 Liberian company by the name of Seletar Trading Inc. 35. How the account came to be opened is dealt with in an Affirmation made by Mr Lai on May 5, 1988, in answer to interrogatories ordered in the winding-up proceedings against CTF. This is what Mr Lai says in paragraphs 4 to 8 of that Affirmation:-
Apart from the fact that he was a general and that he wished to remain anonymous for Thai exchange control reasons, that was all that Mr Lai ever learned about that Thai military man. 36. CTF contends that the Thai general was its customer. But it advances that contention on the basis, or concession if you prefer, that, for what such right is worth, it acquired the right to look to Seletar and Mr Sukham also. For what it is worth, Mr Lai has that concession. 37. Mr Lai contends that CTIS was CTF's customer, 38. What Mr Lai says in the paragraphs which I have quoted from his Affirmation constitute admissions of fact by him. And. in my view, those admissions support CTF's contention that CTIS was a nominee for Seletar which was itself in turn a nominee for the Thai general, whose existence had been disclosed although his identity had been withheld. They do not, in my view, support Mr Lai's contention that CTIS was CTF's customer. 39. Mr Lai's Affirmation also covers how the account was operated pre-crash and what happened post-crash. The things which he says or, if you prefer, admits in regard to those matters sit comfortably with CTF's contention that the Thai general was its customer. They do not sit at all comfortably with the contention now advanced on Mr Lai's behalf that CTIS was the customer. 40. As to how the account was operated before the crash, paragraphs 9, 10 and 12 to 15 of the Affirmation are particularly noteworthy. In paragraphs 9 and 10 Mr Lai says this:-
Moving on to paragraphs 12 to 15, one finds Mr Lai saying this:-
41. As to what happened in the aftermath of the crash. it is paragraph 11 of the Affirmation which is particularly noteworthy. In it Mr Lai says:-
42. In advancing the contention that CTIS was CTF's customer, Mr Daniel Fung, Q.C. for Mr Lai relies heavily on the account opening documents. 43. Looking at the forms used, including the Customer's Agreement form, one sees that CTIS's name has been inserted as that of the customer. The word "house" has been inserted in the box for account executive. And the expression "house minimum" has been inserted in the box for margin rate. 44. But none of that is irreconcilable with CTF's contention. 45. If CTIS was a nominee, then the appearance of its name is to be expected. 46. As far as the account executive is concerned, it is common ground that Mr Lai fulfilled that role. But it is just as understandable that he would do so for a valued customer in the ordinary sense as it is that he would do so for another group company. 47. And as far as margin rate is concerned, there is the document with which Mr Griffiths confronted Mr Lai in the course of cross-examination on the meaning of the expression "house minimum". The document is the very first memorandum within the ChinTung Group dealing with the house minimum margin requirement in respect of HSIF contracts. Such contracts, it will be remembered, first came on to the market on May 6, 1986, the day on which the account was opened. The memorandum is dated May 12, 1986. By it, the house minimum margin requirement per HSIF contracts was fixed at $10,000.00. That was the minimum margin per HSIF contract fixed by the Futures Exchange, acting pursuant to its powers under rule 441 of its Rules, in May 1986. The rule 441 minimum, I might as well mention now, went up to $12,000.00 on January 12, 1987, and to $15,000.00 on August 15, 1987. 48. Still on margin rate, and quite apart from the aspect of the matter which I have just dealt with, the fact that less than the rule 441 minimum was charged on any given account is of little or no help in deciding whether that account was that of a customer in the ordinary sense or of a group company. That is because CTF did accord some ordinary customers a lower margin rate than the rule 441 minimum. 49. There is, I should mention, a resolution passed by CTIS's board on May 6, 1986, the day on which Account No.C1210 was opened, which resolution reads:-
50. I treat that resolution as neutral on the issue as to who was CTF's customer. A resolution thus worded could come about either in the scenario contended for by CTF or in the one contended for by Mr Lai. 51. Nothing in the evidence given by Mr Lai or called on his behalf, certainly nothing in such evidence which I find reliable, really advances his contention that CTIS was CTF's customer. Indeed, some of the answers given under cross-examination by Mr Lai actually provide support for CTF's contention that the Thai general was its customer. 52. But even ignoring any such support, I am satisfied that the contract between broker and customer here was between CTF and the Thai general. That is how it was formed by Mr Lai for CTF and Mr Sukham for the Thai general. The way in which it was structured, with CTIS as a nominee for Seletar, which was in turn a nominee for the disclosed but unidentified Thai general, was also the work of Mr Lai for CTF and Mr Sukham for the Thai general. The evidence is all that way. And so is the common sense and commercial reality of the matter. 53. CTF's customer was, I hold, the anonymous Thai general, who hid behind a Liberian company and was represented by the shadowy Mr Sukdam. But, as I have indicated, Mr Lai has the benefit, for what it is worth, of the concession, equally for what it is worth, that CTF acquired the right to look to Seletar and Mr Sukham also. The hazards of trading in HSIF contracts 54. I am about to revert to a guarantee, knowledge of the customer and margin as means of guarding against the hazards of trading in HSIF contracts. 55. Before doing so, however, it is necessary to say a little more in regard to such hazards. We have already seen how Griffiths L.J. put it in Merrill Lynch Futures v. York House Trading (supra). 56. Coming closer to home, one can begin by looking at CTF's standard form Commodity Account Information Letter. It contains an acknowledgement for the customer to sign. The acknowledgement is in these terms:-
57. Next, let us look at CTF's standard form Customer's Agreement. It contains a Risk Disclosure Statement as required by rule 431 of the Futures Exchange's Rules. Below the statement, one finds a sentence which reads "I/We have read and understand the above statement thoroughly" followed by a space for the customer's signature. The statement itself reads:-
58. Both of those standard forms were among those used in the present case. Neither Mr Lai nor anyone else has sought to disavow anything said in the acknowledgement or the Risk Disclosure Statement. A guarantee 59. Obviously, a properly drawn and executed guarantee from a guarantor who is good for the money would protect the broker in the event of customer default. There was no guarantee in respect of Account No.C1210. 60. Mr Nicholas, the expert called on Mr Lai's behalf, was pressed in cross-examination on the question of a quarantee. Thus pressed, what Mr Nicholas accepted was to this effect. Elders, the brokerage house with which he was associated, would probably have required a guarantee before permitting the heavy trading which took place on the account. But is right to note that Mr Nicholas emphasised that Elders were at the conservative end of the scale in these matters. 61. On the question of a guarantee - and generally - Mr Lai stressed there was great competition among brokers for customers. He said that this customer would have taken his business elsewhere if required to come up with a guarantee. That, in all the circumstances, seems likely to me. In the events which have happened, I have no doubt that Mr Lai wishes that this customer had gone elsewhere. But that is a different matter from what I now have to consider. Knowledge of the customer 62. I turn now to knowledge of the customer. In assessing the danger of a customer defaulting and its chances of, in the last resort, recovering against him through legal proceedings, a broker needs to know a good deal about that customer. 63. In the present case, the broker did not even know the customer's name. As to his identity, all that it knew was that he was a Thai general. 64. Mr Lai, with some support from Mr Nicholas, suggested that after trading on the account had gone on for some time the broker could afford to become more confident of the customer. Perhaps so. But "more" is a relative term. 65. It seems to me that the broker here started off with no basis on which any reasonable broker could be confident of the customer. The customer made money. So perhaps the broker could become more confident of the customer's acumen or that of his agent. But the extent to which it could was very limited. Overall, the customer had made money by being generally bullish in what, on the whole, had been a bull market. As Mr Thorpe said : "You are right till you are wrong". The customer was right for a time. And then he was wrong. 66. Nor did the broker ever have any reason to be confident that the customer could or would pay a huge sum into the account if a huge loss occurred and such payment become necessary. We have already seen that the total withdrawn from the account exceeded the total deposited into it by $12.08 million. 67. It is true that the customer deposited over a million dollars into the account before he made any withdrawal from it. And it is also true that it was not until almost 5 months after the account had been opened that the total withdrawn first exceeded the total deposited. But those facts, even if taken at face value, told the broker little or nothing of what would happen if a crash were to create a huge loss necessitating a huge payment into the account. 68. Moreover, those facts cannot even safely be taken entirely at face value. For there are also these facts. Although trading on the account began on May 9, 1986, no deposit into the account was made until June 27, 1986, when $350,000.00 was paid into the account to clear off a deficit of $55,008.18 and leave a credit balance of $294,991.82. Until then the account had been in deficit the whole time; and trading had taken place without any deposit having been made. 69. It is true that from and including August 17, 1987, to and including October 13, 1987, a total of $11,900,000.00 had been deposited into the account. But that loses its shine when it is noticed that over that period, withdrawals from the account came to a total of precisely the same sum of $11,900,000.00. In light of those withdrawals, those deposits gave no reliable indication that "new money", as Mr Thorpe put it, would be brought in if things went badly wrong, giving rise to a huge loss, and such money was needed in a huge sum if the broker were not to be left to carry that loss. Margin 70. Turning to margin, one sees that rule 441 of the Futures Exchange's Rules opens with this prohibition:-
And the rule then goes on to provide that:-
71. As I have already mentioned, the rule 441 minimum margin requirement per HSIF contract was: set at $10,000.00 in May 1986; increased to $12,000.00 on January 12, 1987; and further increased to $15,000.00 on August 15, 1987. 72. In recognition of reality, the Guidelines issued by the Futures Exchange allowed certain lee-way in regard to margin where "day trades", "maintenance" and "straddle" were concerned. 73. I propose to borrow from Mr Thorpe's report in order to produce succinct explanations of those matters. 74. As to day trades, the report says that the Guidelines recognised that they "could be undertaken without initial margin where the customer had an established account provided margin was in place to cover any open HSIF contracts remaining at the end of the day". 75. Then as to maintenance margin, the report says that the Guidelines provided that "in respect of existing open HSIF contracts" margin had only to be "maintained" at "70% of initial margin" but, however, that "members could not open new HSIF contracts for a customer unless the member held customer funds in excess of the initial margin requirements for that customer's existing open HSIF contracts." 76. And as to straddle margin, the report illustrates the position by pointing to an actual example. The example appears in the revised schedule prepared by Ernst & Young on the trading on Account No.C1210 from the time when it was opened on May 6, 1986, to the time when it was finally liquidated on November 2, 1987. That document, which everyone has referred to as the "Ernst & Young Schedule". shows, as Mr Thorpe's report points out, this. On August 20, 1986, the account held 300 short August, 100 short September and 100 long October HSIF contracts. Following the Futures Exchange's Guidelines then in effect, Ernst & Young have offset the September shorts and the October longs. And that reduced the margin requirement by $1.6 million from $5 million to $3.4 million. 77. Having mentioned the effect of the Guidelines on those specific aspects of margin, I should at this stage refer to a general point which is made on margin in the Guidelines. 78. The very first thing said in the Guidelines is this:-
79. And the one page Circular dated July 31, 1986, under cover of which the Guidelines were sent to brokers contains this advice:-
80. Let us remind ourselves once again of the minimum margin rates per HSIF contract which the Futures Exchange had set pursuant to rule 441. The rate first set was $10,000.00. That was back in May 1986. The rate was raised to $12,000.00 on January 12, 1987. And then it was raised further to $15,000.00 on August 15, 1987. 81. What were the rates set or purportedly set by the broker in respect of Account No.C1210? They were no more than the rates at which margin was due from brokers to the Clearing House. So they were : $3,000.00 starting in May 1986; $5,000.00 from August 14, 1986; $7,000.00 from January 12, 1987; and $8,000.00 from August 15, 1987. 82. Knowing as we do that the loss per contract would be $50.00 per point by which the index moved against the holder, such protection as those rates gave against adverse index movement is easily calculated. 83. $10,000.00 protected up to 200 points; $12,000.00 did so up to 240 points; and $15,000.00 did so up to 300 points. So much for the rule 441 minimum rates. 84. Now let us consider the Account No.C1210 rates. $3,000.00 protected up to 60 points; $5,000.00 did so up to 100 points; $7,000.00 protected up to 140 points; and $8,000.00 protected up to 160 points. Size of CTF and Account No.C1210 85. Before going on, in order that things may be seen in their proper perspective, it is of some importance to look at certain statistics. 86. By the summer of 1987, CTF was among the five biggest brokers in Hong Kong in terms of trading volume in HSIF contracts. It rubbed shoulders with the likes of James Capel, Jardine Fleming, Sun Hung Kai and Wardley Thompson - to list those houses in alphabetical order. 87. During the life of Account No.C1210, CTF had an average of 12.17% of the HSIF contracts market. For large portions of the period between January and November 1987, its share exceeded that average. That has to do with CTF in relation to the market as a whole. And it is impressive in its way. But, despite that, CTF as a company is not all that large. 88. Its last audited balance sheet is as at March 31, 1987. And there one sees: net current assets of $7,293,887.00; fixed assets of $11,510.00; $700,000.00 as the value of the seat on the Futures Exchange; a total of $8,005,397.00 for those three items; a long term loan of $4,000,000.00 from the holding company; the deduction of that $4,000,000.00 from that total of $8,005,937.00; and finally after such deduction a result of $4,005,397.00. Mr Lai did emphasize that the loan was a long term one from a parent company. That is certainly so. But his evidence as to CTF's finances having strengthened considerably between that balance sheet date and the eve of the October 1987 crash is vague and unconvincing. His evidence of the financial strength of the group as a whole is not much better, even assuming it to be to the point. Anyway, in the end, CTF could not save itself. Nor did the group save it. 89. Now let us look at Account No.C1210 in relation to CTF. It was not CTF's biggest account. There were others who had bigger ones with CTF. They included Talbot Investments controlled by the Wangs of the Chinachem Group, and Morgan Stanley of international reknown. Both were short at the time of the October 1987 crash, when the Thai general was long. And now they sit on CTF's committee of inspection. 90. Nevertheless, Account No.C1210 was a very large one. On average, it represented 11.45% of CTF's business in HSIF contracts. And almost all of CTF's business was in such contract. 91. Finally, let us look at Account No.C1210 in relation to the market as a whole. On 11 days between May 6, 1986, and November 2, 1987, the account represented more than 10% of the market. On certain days, of which August 8, 1986, is an example, the account's share of the market exceeded 13%. Activity of Account No.C1210 92. On the statistics which we have just looked at, you would not be surprised to hear that the account was a very active one. And that is borne out by the fact that trading on the account took place on 256 out of the 367 trading days which came within its life time. Negative opening balance in Account No.C1210 93. On 49 out of those 256 days the account had a negative opening balance. And on 25 of those 49 days, the account would have been in deficit even if all open positions on it had been closed out immediately. Open positions in Account No.C1210 94. Trading on the account was, as I have said, essentially bullish. The open positions which I am about to mention were all long ones. More than 500 such positions were often open on the account during its life time. For example, the maximum was: 600 in November 1986; 1,198 in April 1987; 861 in May 1987; 975 in July 1987; and 1,076 at the close on Black Monday itself. Potential for loss on open positions 95. The potential for loss on any given number of open positions upon any given adverse index points movement can be calculated by multiplying $50.00 by the number of positions and then multiplying the product of that calculation by the number of adverse points. 96. So for example, the loss on 1,000.00 open long positions would be ($50.00 x 1,000 x 100) $5 million for every 100 points by which the index fell. And that means a loss of:
97. At the close on October 26, 1987, the first trading day after Black Monday, the Hang Seng Index was 1,541.51 points down from the close on the Friday immediately preceding Black Monday. By early morning on Black Monday, before the huge drop of that day had taken place, the number of open long positions on Account No.C1210 had reached 1,076. The effect of such a drop upon such positions would be ($50.00 x 1,076 x 1,541.51) $82,933,238.00. I give that by way of illustration. Earning commission 98. Having said all of that, let us not lose sight of this on the other side of the coin. Brokers are in business to earn commission. The duties of directors of a brokerage house include a duty to further that object. And they have to do so even at some risk to the house. For not all risks are unacceptable. 99. Moving from the general to the particular, competition for customers, or at least those whose trading was on a scale which yielded very substantial commission, was very keen between futures brokers throughout the period with which we are concerned. So much so that Mr Nicholas said, in effect, that prudent brokers were rather thin on the ground at the time. 100. Naturally, attracting and retaining customers, especially very substantial ones, is of great importance to any broker at any time. And, moving once again from the general to the particular, the importance to CTF of that was heightened by the fact that, in order to obtain a seat near the trading floor, it had committed itself to a certain minimum level of turnover, so that it would be liable to pay certain charges in any month in which it failed to achieve that level. Matter for the customer 101. Another matter to be borne in mind is this. A broker is not his customer's keeper. There are of course risks which have to be disclosed to potential customers before they embark upon futures trading. But if they enter the market after having been so warned, then the broker, if itself reasonably safe, is normally there to execute its customers' orders rather than to question their wisdom. 102. Take the 300 long positions which the customer here acquired on Black Monday to bring the number of long positions open on Account No.C1210 up to as many as 1,076. 103. The report submitted to the Governor on May 27. 1988, by the Securities Review Committee chaired by Mr Ian Hay Davison, which report Mr Lai put in evidence under a hearsay notice, opens thus:-
Nevertheless, there were people in Hong Kong who remained bullish over the weekend which preceded Black Monday and at the opening of the markets here on that day. Their thinking seems to have run along these lines. What had happened in New York on the Friday was due to poor United States trade figures. Here in Hong Kong the fundamentals were still good. And the rumours of a takeover of Hong Kong Land was an added source of buoyancy. So there were bargain-hunting opportunities here. 104. CTF itself may on may not have thought along those lines. The customer under Account No.C1210 seems to have done so. There is no evidence that CTF had assumed any duty to give the customer investment or speculation advice. And even if it had, this case does not concern any such duty. So with one proviso, it was not for CTF to question the customer's wisdom. The protection which brokerage houses need 105. But the proviso is a crucial one. For it is this. CTF had to consider the danger of the customer sustaining a loss on which he would default, leaving the same to fall upon it. 106. All futures brokers need reasonable protection against customer default. They need such protection commensurate with the hazards of futures trading. 107. I need not repeat what I have already said in regard to the hazards of trading in HSIF contracts. 108. Nor need I repeat what I have already said in regard to a guarantee, knowledge of the customer and margin as means of guarding against those hazards. Guardians 109. For its own safety, each futures brokerage house needs to have in place reasonable safeguards against customer default. In each such house, the ultimate responsibility for the house's safety rests upon its directors. They are its guardians. And they must take reasonable steps to see that such safeguards are in place. That would be a duty of theirs. "Safeguards duty" 110. It would be convenient to call it the "safeguards duty". Mr Lai's duty 111. Clearly, Mr Lai owed CTF the safeguards duty in respect of Account No.C1210. For as director and account executive, and in all the circumstances, he was not only a guardian of CTF but its paramount guardian in respect of that account. Breach 112. Was he in breach of that duty? 113. Let us look yet again at a guarantee, knowledge of the customer and margin. 114. While I wish to avoid repeating myself, I will repeat this, since it was so long ago that I said it. CTF's customer was the Thai general. But Mr Lai has the benefit, for what it is worth, of the concession, equally for what it is worth, that CTF acquired the right to look to Seletar and Mr Sukham also. 115. CTF had no guarantee in respect of customer default on Account No.C1210. 116. It had no knowledge of the Thai general, Seletar, Mr Sukham or anybody else on the basis of which it could afford to be reasonably confident that default would not occur if the market crashed, or that legal proceedings would be fruitful in the event of default. 117. As far as margin is concerned, CTF had set margin rates for Account No.C1210 which were considerably lower than the minimum rule 441 rates. When the rule 441 minimum protected up to 200 points, the rate for the account protected up to only 60 and later 100 points. When that minimum protected up to 240 points, the rate for the account protected up to only 140 points. And when that minimum protected up to 300 points, the rate for the account protected up to only 160 points. 118. All of that is against the background of what emerges from the Risk Disclosure Statement, the Guidelines and the Circular in regard to margin, which I have dealt with and need not repeat. 119. Even after all that, the account was on many occasions under-margined even on the basis of the reduced rates set for it. 120. The customer was one whom Mr Lai, as he admitted, accepted after some hesitation. He accepted him because his trading was likely to generate very substantial commission, so he was accepted on the basis that he would trade heavily : without a guarantee, without any meaningful knowledge of him and at heavily discounted margin rates. Mr Lai gave some rather vague evidence of a deposit of certain shares as security. Neither the manner nor the matter of such evidence impressed me in the least; and I rejected it. 121. From the outset, the safeguards duty was flouted by Mr Lai. The account was opened practically without any safeguard. It should not have been. Even if opening the account can be justified, it was permitted to remain open although it had become badly under-margined by April 1987, even on the basis of the rates set by CTF, discounted as they were. It certainly should have at least been closed by then. But it was not. And even if that failure is ignored, the situation which was permitted on the eve - and indeed at the brink - of the October 1987 crash left CTF so exposed that Mr Lai's conduct must, in my view, be considered very rash indeed. 122. I do not say that lightly. There is no need to repeat what I have said as to CTF's size relative to the size of this account. Nor is there any need to repeat what I have said as to the potential for loss on open positions. 123. What might be added is this. On March 26, 1973, the Hang Seng Index fell by 188.7 points, losing 13.3% of its value in a single day. A 13.3% drop in October 1987 would have been one in the region of 500 points. 124. On 776 long positions, being what were held on this account at the close on the Friday before Black Monday, the loss which a 500 point drop would have caused is ($50.00 x 776 x 500) $19, 400,000.00. That would have exceeded the credit balance of $8,117,693.00 then standing in the account by $11,282,307.00. 125. And on 1,076 long positions, being the extent to which this account had become long by. Black Monday itself, the loss which a 500 point drop would have caused is ($50.00 x 1,076 x 500) $26,900,000.00. That would have exceeded the then credit balance of $8,117,693.00 by $18,782,307.00. 126. In my judgment, Mr Lai was in breach of the safeguards duty which he owed CTF in respect of Account No.C1210. Damage resulting 127. I turn now to the question of the damage resulting from that breach. 128. Here, CTF's argument may be summarised thus. The loss of $83,977,986.92 represented by the deficit which was left in the account when the last of the long positions in it were closed out on November 2, 1987, which loss fell upon it by reason of the customer's default, is the damage resulting from Mr Lai's breach of the safeguards duty which he owed it. That is so because, in a market as volatile as the futures market, the extent of such a loss was foreseeable. And even if the extent of such loss was not foreseeable, the whole loss is nevertheless recoverable since the whole of the loss was of a kind which was foreseeable, which is all that the law requires for full recovery. Whenever I say "foreseeable", I mean of course "reasonably foreseeable". 129. Mr Lai's argument, on the other hand, may be summarised thus. The extent of the loss was not foreseeable. And, the loss being purely economic, a defendant is only liable to the extent to which it was foreseeable. Also, the October 1987 crash and the four day market closure following Black Monday broke the chain of causation. 130. Those are of course mere summaries of arguments which had been developed before me by Mr Griffiths and Mr Fung with their usual ability. 131. On the evidence before me, I find as a fact that the extent of the loss here was foreseeable. The market was an inherently volatile one. There was simply no basis on which any guardian of a brokerage house could safely assume that the market would never experience a significantly greater fall than it had experienced in the past. And, in any event, the percentage of its value which the Hang Seng Index shed on March 26, 1973, exceeded the percentage of its value which it shed on Black Monday. The danger of even greater drops following drops of that kind before the market bottomed out was also within past experience. In 1973, the Hang Seng Index shed 33% of its value in a week. 33% of the value of the 3,783.20 points at which the index stood immediately before the fall on Black Monday comes to 1,248.45 points. 132. In response to questions which I asked to clarify his answers, Mr Lai's own expert, Mr Nicholas, confirmed that his evidence on the point came to this, which I set out verbatim:-
133. As far as the market closure is concerned, Mr Nicholas very properly included in his report a statement that even if the Stock Exchange had opened its doors on the day following Black Monday, the Futures Exchange might not have done so as the Guarantee Corporation was insolvent at the time, its capitalization having been far too small and having already been exhausted. Having regard to the low capitalization of the Guarantee Corporation, its failure was foreseeable. It was also foreseeable that, in that event, an alternative guarantee arrangement would be necessary before the Futures Exchange could re-open its doors. It took some time to make such arrangements, so that they were not in place until the weekend before the re-opening of both Exchanges on Monday, October 26, 1987, All of that was foreseeable too. The defence of novus actus interveniens, as it is called, fails in all the circumstances. 134. Subject to anything which may avail Mr Lai by way of ratification, apportionment, deduction or section 358 relief, to each of which I will come in turn, CTF is, in my judgment, entitled to damages against Mr Lai in the sum of $83,977,986.00, rounding it down to the nearest dollar. 135. I have come to that conclusion on the facts without having to resolve the rival arguments of law as to what has to be foreseen before liability can exist. Nevertheless, in deference to counsel's arguments, and also because my views formed with the benefit of those arguments may be of some assistance in the disposal of other cases, I will say this much. 136. At the end of his discussion on duty and remoteness, which he describes as a "kaleidoscopic branch of the law", the learned author of "MrGregor on Damages", 15th ed. (1988), from which book counsel on both sides have found it convenient to quote, cites as salutary the observations of Denning L.J. in Roe v. Minister of Health [1954] 2QB 66 at p.85. There that master of the law, common sense and the art of working the two in tandem said this:-
137. Cases like the present one are seldom if ever easy. But that approach removes unnecessary complications in deciding them. 138. Where a director fails to take reasonable care to protect a brokerage house from default by a customer in index futures, he puts the house at risk in the event of a severe market movement against the customer. If such a movement occurs, and it causes such default and therefore loss to the house, then the extent of the house's loss will depend on the extent of the adverse movement. Viewing the house's loss as the consequence, the adverse movement as the risk, and the director's failure as the negligence, the first question becomes this one. Is the consequence fairly to be regarded as within the risk created by the negligence? And in answering that question you take into account all the risk factors which were known at the time, such as: the volatility of the market; its unpredictability; the difficulties which you may experience in closing out positions in a crash, especially if you have a large number of them to close out; and so on. 139. In the present case, on the whole of the evidence, I have no doubt that the question is to be answered "yes" in CTF's favour and against Mr Lai. At the time, all the risk factors I have just mentioned specifically existed. So did others, including the low capitalization of the Guarantee Corporation. 140. The matter could be left like that. But, judging by the arguments addressed to me on the concepts of kind and intent in this case, it seems to me that it would both further explain my conclusion in this case and assist in the disposal of similar cases if I were to go on to say this. 141. Where market crashes are concerned, any rigid line of demarcation drawn between kind and extent would be unreal. A crash of doomsday dimensions would no doubt be of a kind beyond foreseeability in law. But disastrous crashes have a long history. And a crash of that kind is not unforeseeable merely because it sets a new record in the extent of points lost in a day or over a longer period. Moreover, in the futures market inability to close out long positions quickly in a crash has always been a recognized kind of danger. And the consequences of such inability are not necessarily taken out of the foreseeable disaster range and into the unforeseeable doomsday range merely because their extent has, or might have, been increased by an additional element of difficulty such as market closure. 142. That is another way of looking at it. And looked at in that way also, the loss in respect of which CTF seeks redress is foreseeable on the view which I take of the facts of the present case. Ratification 143. Mr Fung contends that Mr Lai's conduct can be, and has been, ratified by the company, CTF. Mr Griffiths contends that CTF has not attempted to ratify Mr Lai's conduct and that, in any event, such conduct cannot be ratified. 144. In my judgment, Mr Griffiths is right on both points. 145. There has been no resolution ratifying or attempting to ratify Mr Lai's conduct. Of course, ratification need not be by way of a resolution passed in general meeting and may be by way of assent in some less formal manner. And Mr Lai did use to have the entire voting power of CTF at his command. But there is no evidence that he used or attempted to use such power to ratify his conduct whether formally or informally. The fact that he might have done so if he had thought about it is another matter. There is no evidence that he ever thought about it before a winding-up order had been made against CTF putting it beyond his control. 146. No ratification whether formal or informal had been attempted. And that is enough to put an end to the matter. 147. Nevertheless, I think that I should deal with whether any such attempt would have succeeded if one had been made. And I say at once that in my view no such attempt would have succeeded. For I do not consider Mr Lai's conduct as being capable of ratification. 148. On my view of the facts, such conduct jeopardised the very existence of the company. That is the sort of case this is. As to such cases, in Nicholson v. Permakraft (NJ) Ltd [1985] 1 NZLR 242 at p.250. Cooke J, in the Court of Appeal in New Zealand, referred to the dicta of Cumming-Bruce and Templeman, LJJ in the Court of Appeal in England in Re Horsley & Weight Ltd [1982] Ch.442 at p.454-456, and then said:-
149. Whether negligent conduct is capable of ratification does not turn on whether the negligence was gross. That I think is clear from what Sir Raymond Evershed MR said in Re B. Johnson & Co. (Builders) Ltd [1955] 634 at p.648. And, as explained by May LJ in Multinational Gas & Petrochemical Co. v. Multinational Gas & Petrochemical Services Ltd [1983] 1 Ch. 258 at pp.280-282, the reference to gross negligence by Templeman LJ in Re Horsley & Weight Ltd (Supra) at p.456 does not really conflict with what the Master of the Rolls said in the 1955 case. 150. What matters is the nature of the exposure brought about by the negligence. 151. The principle, which suffices CTF on the facts of this case, may be stated thus. Where any director or directors so fail to take reasonable care to protect a company as to expose it to a risk of insolvency, and the company becomes insolvent as a result and therefore goes into liquidation, then, if any creditor of the company suffers loss and is driven to proving in the liquidation for redress, the company's claim against the negligent director or directors cannot be defeated, to the ultimate detriment of any creditor, by any ratification which such director or directors may be able to procure of their own negligent acts or omissions. Apportionment 152. Turning to another matter, I now deal with Mr Fung's submission in regard to apportionment. The submission runs thus. If I find that CTF is entitled to damages, then I should apportion some of the blame to the other two defendants. And I should limit the judgment against Mr Lai to such percentage of those damages as matches the percentage of blame apportioned to him, say 50%. 153. I decline to adopt any such course. If the other two directors were liable along with Mr Lai in a case such as this one, then the liability which the three of them would share would he joint and several liability. And CTF would be entitled to judgment against each of them for the full amount of the damages sustained. Execution would of course be another matter. And so of course would apportionment as between the defendants among themselves. Deductions 154. I turn now to certain deductions which Mr Fung invites me to make from any judgment against Mr Lai. 155. First, he asks me to deduct the amount paid by CTF to the Clearing House in respect of house margin on the 1,076 positions open on Black Monday, because the Clearing House would otherwise Have been able to prove in the liquidation for the same. 156. I decline to make that deduction. The broker was entitled to full payment from the customer. And full payment would have covered what had been paid to the Clearing House. 157. Next, there are the settlements between CTF and the other two defendants. Under those settlements, CTF is entitled to $3,000,000.00, a sum made up of $1,500,000.00 from each of the other two defendants. There is disagreement between CTF and Mr Lai as to how much has been paid pursuant to such settlements. And there is no evidence by which I can resolve that disagreement. So any deduction would be difficult on the facts, to say the least. 158. In any event, the settlements announced in Court on November 23, 1992, were announced as ones to be embodied in Tomlin Orders to be submitted in draft in due course. In such circumstances, the proper course is to make no deduction, leaving the amount of the judgment against Mr Lai undisturbed by any deduction, but leaving him with such comfort as he may derive from the knowledge that CTF's right to execution under its judgment against him will of course be limited by what it recovers from the other two. Section 358 relief 159. I turn now to section 358 of the Companies Ordinance, Cap.32, subsection (1) of which provides that:-
The section applies of course to directors. 160. There is no allegation, let alone evidence, of dishonesty on Mr Lai's part. I emphasise that not because anybody involved in this case is in any doubt on that score, but rather because Mr Lai may wish to have that made clear to those with less knowledge of this case. 161. On reasonableness, however, Mr Lai stumbles in his pursuit of section 358 relief. For I have found: that he failed to act reasonably; and that it is such failure which has resulted in the loss giving rise to the liability from which he seeks relief. 162. But even ignoring that difficulty in Mr Lai's way, I would not, in all the circumstances of this case, exercise in his favour any discretion which I had to relieve him from liability in whole or in part. 163. That is not to say that I do not feel a great deal of sympathy for Mr Lai, a man of very considerable ability who, lured by large profits, ran dreadful risks and unfortunately must now bear the consequences. Conclusion 164. In the result, I award CTF damages against Mr Lai in the sum of $83,977,986.00. Before hearing counsel, now or on another occasion if they prefer, on interest and costs, I would like to express my thanks to both legal teams for all their assistance throughout this case. And. trusting that Mr Fung will permit me to do so, I would like to pay particular tribute to the way in which he, having come to the case very late, rapidly mastered it, so that he was able to conduct his client's case with his usual very considerable ability.
165. CTF asks for formal judgment for damages in the sum of $83,977,986.00, I grant that. CTF also asks for payment out to its solicitors of the $1.75 million which it paid into court on November 20, 1992, pursuant to my Order made on November 18, 1992, ordering it to pay that sum into court as security for Mr Lai's cost. I also grant that. 166. Certain other matters will be adjourned for argument on a date to be fixed in consultation with counsel's diaries. Those matters are: costs; interest; the question of payment out of the money paid into court by Mr Lai on November 20, 1992, in respect of security for CTF's costs; and any other ancillary matters which may arise. 167. The Tomlin Order embodying the settlement as between CTF and the 2nd defendant has just been submitted to me in draft for my approval; and I signify my approval of the same by signing that draft.
Representation: Mr John Griffiths QC and Mr Geoffrey Ma (instructed by Messrs Lovell White Durrant) for the plaintiff, CTF. Mr Daniel Fung QC and Mr Philig Dykes (instructed by Messrs Cheng, Yeung & Co.) for the 1st defendant. Mr Arthur Lai. _ |