Moulin Global Eyecare Holdings Ltd (in Liquidation) and Others v. Kpmg (A Firm)
Read the full judgment text of HCA 118/2007 on BabelCite. This High Court CFI judgment was delivered on 8 June 2010.
1. This was an application by the Plaintiffs in these proceedings seeking further discovery from the Defendants, pursuant to RHC Order 24 rules 3, 7 and 11. The proceedings concern claims by the Plaintiffs, all of whom are companies in liquidation, for damages from the Defendants, KPMG, their former auditors, in respect of losses the Plaintiffs claim to have suffered as a result of the Defendants’ negligence. A broad outline of the Plaintiff’s case, as appears from their Amended Statement of Cla
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HCA 118/2007 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO. 118 OF 2007 ____________ BETWEEN
____________ Before: Hon Barma J in Chambers Date of Hearing: 25 February 2010 Date of Judgment: 8 June 2010 ______________ J U D G M E N T ______________ 1.This was an application by the Plaintiffs in these proceedings seeking further discovery from the Defendants, pursuant to RHC Order 24 rules 3, 7 and 11. The proceedings concern claims by the Plaintiffs, all of whom are companies in liquidation, for damages from the Defendants, KPMG, their former auditors, in respect of losses the Plaintiffs claim to have suffered as a result of the Defendants’ negligence. A broad outline of the Plaintiff’s case, as appears from their Amended Statement of Claim is set out in my earlier judgment of 10 February 2010, dealing with applications by the Defendants for further and better particulars and for discovery. 2.The Plaintiffs’ application for discovery was made by summons dated 21 December 2009. By their summons, the Plaintiffs sought discovery of eight categories of documents, to be provided by the preparation of a further list of documents and verified on affidavit. The documents sought were:-
3.The application was adjourned in order to enable the parties to attempt to resolve (or at least to narrow) their differences in respect of the Defendants’ discovery. They have had some success in doing so, in that of the eight categories of documents of which further discovery is sought, it has proven necessary to seek a ruling in respect of the first three only. So far as the other categories of documents are concerned it was agreed that the application in relation to categories 4, 5 and 8 should be adjourned sine die, with liberty to restore if it became necessary for them to be argued, and that no order should be made in relation to categories 6 and 7. 4.The Plaintiffs’ evidence consists of two affidavits of Mr Roderick Sutton, one of the liquidators of each of the Plaintiffs. The Defendants’ evidence is contained in affidavits made by Mr William Crowe, a partner in the Defendants’ Risk Management Group, who has been closely involved in the defence of these proceedings, and Mr Grant Jamieson, the partner in charge of the Defendants’ forensic practice. 5.Mr Sutton complains that the Defendants have taken a limited approach to discovery, in that while the discovery provided by them appears to be extensive (in terms of the quantity of documentation disclosed), closer examination of what has been disclosed reveals inadequacies in the disclosure they have made. He suggests that when looked at more closely, the Defendants’ discovery consists largely of their formal working files (which have been provided in full, in hard copy) and some electronic copies of audit working papers, and that there is little disclosed documentation in the nature of correspondence (whether internal or external), draft documentation (whether of working papers or audit opinions), or documentation relating to the Defendants’ resignation as the Moulin Group’s auditors in 2002. Mr Sutton draws particular attention to what he says is the small number of e-mails disclosed, and to the fact that a draft qualified audit opinion for the 1998 audit, which makes reference to concerns about the availability of suitable audit evidence in relation to substantial payments apparently received close to the year end from the entities which are referred to in the pleadings as the North American Debtors (in respect of transactions that the Plaintiff alleges were entirely fictitious) was not disclosed in either hard copy or electronic form, and was not referred to as a document which had previously been in the Defendants’ possession. 6.In response, Mr Crowe has described the process by which the Defendants preserved their documents (both hard copy and electronic) relating to their involvement with the Moulin Group, and the approach that the Defendants and their legal advisers adopted in dealing with discovery for the purposes of these proceedings. He also explained the manner in which the Defendants kept records of work done in the course of audits carried out by them. 7.So far as record keeping generally is concerned, Mr Crowe said that the procedures by which the audit opinion was reached in any particular case would be evidenced by the documents retained in the audit working paper files and correspondence files in respect of the engagement in question. The documents retained on such files were intended to record the planning, performance, supervision and review of the audit, and to record the audit evidence obtained as a result of carrying out audit procedures on which the audit opinion was based. Although such working papers would be created in either hard copy or electronic form, the practice of the Defendants was to generate and retain hard copies of all documents that were considered necessary to record the matters mentioned above. Other documents created during the course of the audit, which did not need to be retained for the purposes of such a record would not be placed on the working paper file or kept in the correspondence file, although some such documents might have been retained, either in hard copy or electronic form, elsewhere. 8.Mr Crowe went on to explain the way in which the Defendants’ electronically stored information was handled. Documents were generally initially created by audit staff, mostly electronically, on the computers assigned to them. Where they were created in the Defendants’ offices, the documents would be saved to a specific sub-folder on the Defendants’ server for the client in question, known as the “working client folder”. Staff working in the field would upload documents created by them while away from the office to the same sub-folder on their return to the office. However, working drafts of documents would not be retained. 9.On 4 July 2005, Mr Sutton wrote to the Defendants to inform them that he and Mr Desmond Chiong had been appointed as provisional liquidators of the 1st Plaintiff. The letter, which was received the next day, stated that the provisional liquidators had, prior to their appointment, investigated the affairs of the 1st Plaintiff and the Moulin Group, and that there were a significant number of transactions that called for further investigation. The Defendants were asked to preserve any books and records of the 1st Plaintiff that were in their possession, and also to preserve their own documents relating to services provided to the 1st Plaintiff. Mr Crowe says that it was clear from this that litigation was in contemplation, although no indication of the particular areas of complaint had yet been provided. As a result, on 6 July 2005, the Defendants retained their solicitors (Messrs. Barlow Lyde and Gilbert) and sought their advice as to their position generally. On 22 July 2005, the provisional liquidators wrote further, asking for copies of a number of documents relating to the Defendants’ audit of the Moulin Group. 10.Mr Crowe says that the Defendants immediately took steps to secure documentation relating to the Moulin Group. This was done in accordance with advice received from their solicitors. All partners who had advised on Moulin Group related matters were contacted and requested to ensure that all existing staff who had worked on such matters preserved all documents that they had which related to the Moulin Group, whether these were old or recently created, in hard copy or electronic form, including all correspondence, e-mails and drafts. Steps were also taken to secure all electronically stored information that might be available. The original intention was to set up a secure area on the Defendants’ server (which has been referred to as the “ring fenced area”), to which all electronic information could be copied. Once documents and other information were copied to the “ring fenced area”, it would not be possible to delete or amend them. However, as a result of technical difficulties (there were concerns that there might be alterations or apparent alterations to documents copied to the “ring fenced area” as a result of their being copied to that location), it took about a year before the “ring fenced area” was available. In the meantime, in February 2006, Ms Jacqueline Wong of the Defendants’ Risk Management Group made a copy of the working client folder on the server for the Defendants’ audit group which had handled the Moulin Group audit, and stored it on the Risk Management Group’s own server. In August 2006, Mr Crowe decided that, notwithstanding that not all the technical issues had been resolved, copies of electronically stored information relating to the Defendants’ dealings with the Moulin Group should be copied to the “ring fenced area” in any event. Thus, in August 2006, all employees who had been involved with assignments relating to the Moulin Group were instructed to copy all electronically stored information in their computers to the “ring fenced area” on the server – they did so by copying such information to one of two folders in the “ring fenced area” under their names: one folder for e-mails, and the other for all electronically stored documents or information. All current partners and employees who were identified as having worked on Moulin Group related matters were also asked to confirm that they had done this. Former partners or employees were not, it seems, asked to do this, as they would have given up their assigned computers on leaving the firm, and such computers would have had their memory erased before being reissued to other members of the Defendants’ staff. According to Mr Crowe, a comparison between the documents in the working client folder on the Risk Management Group’s server with those in the “ring fenced area” shows that all documents in the former folder are in fact in the “ring fenced area” as well. 11.Mr Crowe has also stated that a number of documents which should not have been copied to the “ring fenced area” were copied to that location in error. Some such documents were privileged documents, and others were documents that concerned other clients of the Defendants. However, having been copied there, they cannot now be modified or removed. 12.So far as the discovery process is concerned, Mr Crowe said that audit working paper files were disclosed in their entirety for the financial years ending on 31 March 1998 to 31 March 2001. Disclosure was also made of the complete hard copy audit correspondence files for those periods. For prior periods, a review was made, with the assistance of the Defendants’ solicitors, of the hard copy documents in the audit working paper and correspondence files, and documents that were regarded as being relevant to the issues raised in the pleadings were disclosed. For electronically stored documents, such documents were also reviewed, and any such documents from any source that contained material relevant to the issues raised in the pleadings were also disclosed. 13.The Plaintiffs, however, are not satisfied with the discovery that has been provided. They suggest that the documents that have been disclosed consist largely of what was on the audit working paper files, and a limited number of electronic documents. They say that the amount of electronically stored information that has been disclosed is surprisingly small, that draft or earlier versions of documentation that may exist appear not to have been disclosed, that at least one draft qualified opinion (in relation to the 1998 audit) was not disclosed or otherwise referred to, and that they consider that the Defendants have taken a limited approach to discovery by working with close reference to the pleadings, rather than approaching the issues in what the Plaintiffs suggest is a more appropriate, broader, sense. The Plaintiffs have also expressed concerns as to whether the steps taken by the Defendants to ensure that relevant documentation was secured were sufficient and were effective. 14.In the course of the argument at the hearing, it became clear that perhaps the major issue that divided the parties was the question of what the appropriate test of relevance for purposes of discovery should be. Mr Jat, for the Plaintiffs, suggested that all documentation relating to the Moulin Group, or at least to audits of the Moulin Group should be regarded as relevant. He contended that it would be wrong to regard the Plaintiffs’ claims as being limited to particular aspects of the Defendants’ audit of the Moulin Group. He said that the Plaintiffs’ case, as explained by Mr Sutton in his affidavits, went to the whole of the audit process, at every stage, and that therefore, for all practical intents and purposes, every document created by the Defendants in the course of their audits was potentially relevant, and should be disclosed as part of their discovery. On the other hand, Mr Lam, for the Defendants, maintained that it was necessary to ascertain the issues from the pleadings, even if in broad terms, and to confine discovery to documents which were relevant to those issues. He disagreed with the suggestion that virtually every aspect of the audit was in issue for the purposes of these proceedings. He said, moreover, that discovery should only be ordered if there was a fair probability of the discovery sought producing material that would be of reasonable evidential significance. 15.Both parties accepted the approach of Colman J in O Company v M Company [1996] 2 Lloyds LR 347 as the correct approach to adopt. In that case, which concerned a cargo claim for losses arising as a result of an explosion and fire (the cause of which was not known) on board a ship which caused damage to cargo on board the vessel. In that case, Colman J said (at page 350):
16.Colman J went on to consider the level of likelihood that a document would provide such information that should be required as the threshold for requiring further discovery to be provided, concluding (at page 351) that:
17.In my view, to suggest, as the Plaintiffs do, that just about every document generated by the Defendants in the course of their audits of the Moulin Group is potentially relevant to these proceedings, is to cast the net of discovery too wide. The shape of the Plaintiffs’ case is quite apparent from the Amended Statement of Claim – it is based on the existence of a scheme on the part of the Plaintiffs’ former management to inflate the Moulin Group’s turnover and sales and thus its revenue and profits, resulting in it suffering the losses (mainly dividend and interest payments that should or would not otherwise have been made) that are alleged. The nature of the scheme is set out in paragraphs 53 to 79 of the Amended Statement of Claim (which I have summarised in paragraphs 11 to 27 of my earlier judgment). It is apparent from those sections of the Amended Statement of Claim that the thrust of the allegations relates to the alleged overstatement of revenue and profits by the recording of fictitious sales to the North American debtors, and the use of a variety of devices (the circular trade finance transactions, supposed advances to third parties, and the supposed assets of Leadkeen held through Ma Wu Bei) to disguise the fact that such supposed sales were fictitious. 18.Thus, following the approach laid down in O Company v M Company, clearly all documents which relate to the North American debtors, the circular trade finance transactions, the advances to third parties and the Leadkeen/Ma Wu Bei payments, and the Defendants examination of these matters in the course of their audits, will be of potentially significant evidential materiality. Beyond this, if there should be documents that suggest that there were other ways, not as yet pleaded, in which the fictitious sales were disguised, these too would be of sufficient evidential materiality to justify the making of an order for discovery. But beyond this, where documents generated by the Defendants in the course of their audits do not touch on such matters, it is not immediately apparent why they are relevant, or would be of sufficient potential materiality to call for their disclosure. While it is correct to say that the Plaintiffs’ complaints against the Defendants extend to each stage of the auditing process – from planning, to the obtaining of adequate audit evidence, to the failure to detect what are alleged to have been material irregularities in the Plaintiffs account, and the failure to report or to qualify the Plaintiffs’ accounts appropriately, it is equally important to note that the complaints at each of these stages relate to alleged shortcomings that had to do with the broad scheme that has been identified – thus, for example, the section on failure to obtain sufficient audit evidence sets out a case that highlights the respects in which insufficient evidence is said to have been obtained in relation to the North American debtors, the circular trade finance facilities, the advances to third parties and the Leadkeen/Ma Wu Bei payments. 19.In O Company v M Company the cause of the explosion and fire on board the vessel that caused the loss of and damage to the cargo which was the subject matter of the claim was unknown. Nonetheless, Colman J approached the question of discovery by considering whether or not the documents sought were likely to produce something of evidential significance, focussing on documents that might throw light on conditions in areas of the vessel that were in proximity to, or in some way connected with, the location in which the explosion and fire occurred. Similarly, it would be appropriate here to focus on documents that are reasonably closely related to the central areas of complaint, as it would be such documents that might be expected to yield material that may be of significance for the claim. 20.The Defendants have said in their evidence, and Mr Lam has reiterated, that their approach has been to look at the question of relevance by reference to the pleaded issues, without seeking to confine relevance by too close reference to the details of the pleading. I do not see that this approach is mistaken, and I am therefore of the view that the approach advocated by Mr Lam is to be preferred to that put forward on behalf of the Plaintiffs. 21.With this in mind, I turn to consider the specific categories of documents that remain in issue on this application. 22.Category 1: This request calls for the production of all audit working papers, whether hard copy or electronic, including all drafts in respect of the audits of the Plaintiffs and the consolidated Moulin Group audit for the years from 1998 to 2002. 23.Hard copies of the audit working paper files and audit correspondence files have already been disclosed. According to the Defendants, all other documents in their possession have been reviewed for relevance, and appropriate disclosure made. A small number of additional files, which the Defendants say are of peripheral relevance have been identified and will be disclosed. The Defendants have indicated that they will conduct a further review of the documentation in their possession by reference to the broad pleaded issues, particularly in the light of the amendments introduced in the Amended Statement of Claim, and disclose any further documents that may be relevant. They have also agreed (without conceding relevance) to disclose all drafts of working papers. 24.So far as disclosure of documents not on the audit working paper and audit correspondence files are concerned, it seems to me that the offer made by the Defendants to conduct a further review of the documents in their possession is sufficient. There is no reason to suppose that they have misconceived the appropriate test of relevance – on the contrary, for the reasons which I have explained above, it seems to be that they have understood it correctly. Insofar as there are audit working papers or correspondence which do not relate to the Plaintiffs’ pleaded case, understood in the broad sense explained by Colman J in O Company v M Company these are not documents which would be likely to be of sufficient evidential materiality to be regarded as relevant for discovery purposes. 25.So far as draft documents are concerned, it seems to me that draft documents which relate to areas falling outside the broad framework of the Plaintiffs’ case need not, strictly speaking, be disclosed, notwithstanding that the entire audit working paper and correspondence files have been disclosed, and that the final version of some such documents may have been disclosed. The reason for the disclosure of the entirety of these files has been explained by the Defendants as being in order to ensure the integrity of the files, and not as a concession as to the possible relevance of everything in them. In these circumstances, not all drafts of documents that are to be found in such files will necessarily be relevant to these proceedings. Even in relation to documents that have the necessary relevance, drafts of those documents which contain no material differences from the final versions would not appear, strictly speaking, to require disclosure. However, the mere fact that a document is a draft of a disclosed final version does not, ipso facto, mean that the draft need not be disclosed. If the draft differed in some material respect from the final version, or threw light on the approach adopted by the Defendants as to the matter dealt with by it, it would be likely to be of sufficient materiality as to call for disclosure. However, as the Defendants have agreed to disclose all drafts of documents the final versions of which have been disclosed, it is not necessary to make any further order in respect of draft documentation. 26.Category 2:This concerns all qualified opinions, including drafts of qualified opinions in relation to any audits conducted by the Defendants from 1991 to 2002. This request is based on the fact that the liquidators found among the Plaintiffs’ documents a copy of a draft qualified opinion in respect of the 1998 audit. The reason for the qualification proposed in the draft audit opinion related to payments of some HK$210 million received from the North American debtors shortly before the March 1998 year end. 27.The Defendants do not dispute that this document is relevant. However, they say that despite searches, they have not located it (or a copy of it) in either their hard copy or electronic documents. They accept that it should be disclosed in the appropriate part of their list as a document which was once in their possession, but is no longer in their possession, together with such explanation as they can give for it no longer being with them. They say, however, that this is the only case of such a document being missing in their papers, and that it does not provide a basis for supposing that there might be other such documents which have not been disclosed. The Plaintiffs, on the other hand, contend that the non-disclosure of this document is supportive of their view that the Defendants have not properly carried out their discovery obligations. 28.Having regard to the fact that Mr Crowe has explained on affidavit that the reason for the non-disclosure of this document earlier is because it was simply not in the possession of the Defendants, in that no copy of the document can be found in either the hard copy documentation or electronically stored information which has been preserved, and his frank acceptance that it is a relevant document which should (and would) have been disclosed had the Defendants had a copy of it, I am not inclined to conclude that the existence of a single document of this nature, important though it may prove to be to the Plaintiffs, is a sufficient basis for thinking that there has been any extensive failure in the Defendants’ attempts to preserve documents relating to their dealings with the Moulin Group, having regard to the steps that were taken to ensure that documents were secured as soon as the Defendants were put on notice of a possible claim against them. 29.In the circumstances, although the 1998 draft qualified opinion will have to be dealt with in a supplemental list of documents in due course, I do not consider it necessary to make any order in respect of this category of documents either. 30.Category 3: This request calls for the disclosure of all documents stored in the “ring fenced area”, including the working client folder, along with any documents stored as part of the process in relation to the upgrading of laptops. 31.Mr Jat suggested first that all documents that were stored in the “ring fenced area” were likely to be of some relevance, in the sense that he had contended for when putting forward his arguments as to the appropriate approach to relevance for purposes of discovery. However, in the light of the evidence of Mr Crowe, it seems that that is not the case. Mr Crowe has explained that there are some documents that were mistakenly copied to the “ring fenced area” that should not have been, either because they were privileged or because they in fact related to other clients of the Defendants. However, having been copied to the “ring fenced area” it is not possible for the documents to be deleted or modified. Mr Jat accepts that such documents should not be disclosed. It seems that there are also documents which relate to non-audit engagements for the Moulin Group which have also been copied to the “ring fenced area” – such documents would also seem to me not to be discoverable, since they would not appear to relate to the audit engagements which form the basis of the Plaintiffs’ claim. 32.This apart, I am not satisfied that it would be right to adopt the approach suggested by the Plaintiffs. In my view, it would be tantamount to requiring the Defendants to turn over the contents of their filing cabinets (in this context, electronic ones) for the Plaintiffs to rummage through. I do not think that this is an appropriate means of given discovery of documents relating to the matters in question in these proceedings. Just as there are likely to be hard copy documents preserved which are not discoverable by reason of their lack of relevance, so it is likely that there will be, in the “ring fenced area”, electronically stored information which is likewise not discoverable, as it does not relate to the issues arising in these proceedings, viewed in a broad sense. 33.It is relevant to note that at the time when information was copied to the ring fenced area, all that was known was that there was likely to be a claim against the Defendants for alleged negligence, and that such a claim was likely to relate to the Defendants’ role as auditors of the Plaintiffs. It was not until the Statement of Claim was served that the shape of the Plaintiffs’ case would have been known to the Defendants. That being so, when electronic documents were copied for the purpose of preservation, this would have been done for all documents still available in electronic form, not all of which will be of relevance to the claims that have now been advanced (a good example is the case of documentation relating to the Defendants’ audit of another company in the Moulin Group known as Peace City Investment Limited, which was formerly the 5th Plaintiff in these proceedings – although allegations of negligence were made in respect of the audit of this company, it was eventually concluded by the Plaintiffs that no loss had been suffered as a result thereof, and the claim has not, therefore, been pursued, and it is difficult to see any reason why documents relating to it should be relevant to the matters now in issue between the parties). There is therefore likely to be information in relation to the audits of the Plaintiffs which is not relevant to the claims that have been put forward, as I have explained in the context of the documents sought under category 1. 34.Although the Plaintiffs have also suggested that there may be doubts as to whether or not all documents were in fact properly copied, saying that it is not clear that there was verification that instructions to preserve such information were properly followed, I do not think that the steps taken by the Defendants should be regarded as insufficient. 35.In my view, it would not, as a matter of principle, be appropriate to make an order of the nature sought by the Plaintiffs where (as here) this is likely to result in disclosure of documents which do not relate to matters in question in the proceedings. Such documents are not discoverable under our rules relating to discovery, and there would appear to be no basis for requiring a party to disclose irrelevant documents along with relevant ones simply because it might prove more convenient to do so. 36.Further, I am not satisfied that this would in fact be a more convenient or cost effective course to adopt. Leaving aside the fact that the Defendants would in any event have to go through the information stored in the “ring fenced area” to weed out documents that were placed there by mistake, if everything else were simply handed over to the Plaintiffs, it would be necessary for the Plaintiffs themselves to sort through the material to identify what is relevant and what is not. The task is one that has to be performed, whether by the Defendants or the Plaintiffs. In either case, it will involve the expenditure of time and cost. If the Plaintiffs were to do the exercise, they would (as Mr Jat accepted) seek to recover the costs of doing so at the end of the day, assuming that they are successful. It is therefore unlikely that there would be any appreciable saving in costs or time spent – the only question would be which party should incur the costs in the first place, and which party should bear them at the end of the day. 37.For these reasons, I do not think that it would be right to make the order sought in respect of this category of documents either. 38.Thus, I do not propose to make any order in respect of the documents under categories 1 to 3 of the Schedule to the Plaintiffs summons. As already indicated, the Plaintiffs did not seek any order in respect of categories 6 and 7, and I shall make no order as to them either. So far as categories 4, 5 and 8 are concerned, the summons will be adjourned sine die with liberty to restore. 39.So far as costs are concerned, I think that the appropriate order would be for the costs of the hearing itself to be paid by the Plaintiffs to the Defendants in any event, as the Defendants have been successful in relation to all three of the categories that have been argued. However, so far as the balance of the costs of the application are concerned, having regard to the fact that the Defendants have agreed to take certain further steps in relation to discovery (without conceding an obligation to do so), and the Plaintiffs have as a result not pursued a number of matters, I shall order that the costs should be in the cause. Both of these orders are orders nisi, and either party may apply to very them in the usual way if they wish to do so.
Mr Jat Sew-Tong, SC, instructed by Messrs Clifford Chance, for the Plaintiffs Mr Godfrey Lam, SC, instructed by Messrs Barlow Lyde & Gilbert, for the Defendants | |||||||||||||||||||||||||||||||||||||||||||
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