Lee Leung Nang Stewart and Others v. Li Chung Shing Tong (Holdings) Ltd

HCMP 1516/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1516 OF 2010

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BETWEEN

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Before: Hon Harris J in Court

Dates of Hearing: 9 March 2011, 18 April 2011

Date of Judgment: 5 September 2011

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J U D G M E N T

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Introduction

1.This is an application by an originating summons issued on 12 August 2010 by three minority shareholders (“the Plaintiffs”) of the Defendant, Li Chung Shing Tong (Holdings) Limited (“the Company”) under section 168BC of the Companies Ordinance (Cap 32) (“Ordinance"), which I granted leave to amend on 18 April 2011.  The Plaintiffs seek principally the following relief:

(i)   Leave to bring proceedings on behalf of the Company against its director and subsequent supervisor, Lee Karen (“Karen”), Wong Ping Ching Derek (“Wong”), PCHT Herbal Sciences Limited (“PCHT”), Wishland Limited (“Wishland”), whom I shall collectively refer to as the “putative defendants” and/or such other persons against whom the said proceedings ought to be brought under section 168BC(1) of the Ordinance;

(ii)   An order that an “independent professional accountant” be appointed for and on behalf of the Company to investigate and report to the Court on the facts or circumstances that gave rise to the prospective proceedings proposed to be brought against the putative defendants, and that all reasonable costs and expenses incurred by the independent professional accountant for the investigation be borne by the Company in accordance with section 168BG of the Ordinance; and

(iii)   Costs of these proceedings be indemnified and paid by the Company.

2.The application is opposed by the Company.

Background to the application

3.The Company was incorporated in Hong Kong on 8 January 1988 by the 1^st and 2^nd Plaintiff’s father, the late Mr Lee Chu Ho (“the Father”), and is engaged in the business of manufacturing, marketing and the sale of a traditional Chinese medicinal product called Po Chai Pills (保濟丸), which was founded over 100 years ago by the 1^st and 2^nd Plaintiff’s grandfather.

4.The Father and his first wife had 12 children. The 1^st and 2^nd Plaintiffs are two of their sons. After the Father’s first wife passed away in 1981, he married Karen in 1983 and had two sons with her. The Father passed away on 29 May 1998.

5.The 3^rd Plaintiff is the Father’s grandson.

6.According to the 1^st Plaintiff, at all material times (until around January 2010 when she completed the transfer of a substantial part of her interest to Sum Kwong Yip Derek (“Mr Sum”) and Lau Wing Hung Johnny (“Mr Lau”) via their corporate vehicles), Karen had been the majority shareholder of the Company. Additionally, she was a director of the Company for many years until her purported resignation in 19 October 2001, after which she continued to participate in the management of the Company and supervise the operations of the Company. She was re-appointed to the board of directors on 30 April 2008.

7.Prior to 2001, the Company had always, and for many years, manufactured Po Chai Pills in its traditional form (“the Traditional Pills”) at its plant in Hong Kong. However, in 2001, a new product, namely, Po Chai Pills in capsule form (“the Capsules”), was launched for sale. The impetus for this was, according to the affirmation of Karen, to “keep the Company in pace with the developments in the Chinese medical business”. The manufacturing of the Capsules involved the milling of the ingredients to a finer powder than the Traditional Pills.  The Company’s Hong Kong plant did not have the equipment capable of doing this, so the Company had to subcontract the milling of the ingredients, which were provided by the Company, and manufacturing of the Capsules to a third party.

8.In 2006 the Company employed Wong and appointed him managing director.  Wong is a registered pharmacist, who had worked for many years for Watsons.  The Company says that its Board had decided that in the light of the increasing regulation of the Chinese medicine industry in Hong Kong it was necessary to find a suitably qualified and experienced person to run the Company.  Wong introduced the Company to a Thomas Zheng, who they understood was a friend of Wong and the General Manager of Chinese Medicine Chain International Limited (“CMC”), who represented that CMC was part of the Sanjiu Enterprise Group (“999 Group”).  Wong proposed that the Company place orders with a related company, Wing Po International Trading Ltd (“Wing Po”), for whom Mr. Zheng was the contact person.  The Company understood that Wing Po was also part of the 999 Group.

9.The Company placed orders in late 2007 for the milling with Wing Po.  In early 2008 the Company began to place orders with CMC.  The Company claims that it was in fact the victim of a fraud perpetrated by Mr Zheng, who had without the knowledge or approval of management, subcontracted the powder milling to another factory in Guangdong called Guangdong Shijiang Bio-technology Limited (“Shijian”), which was not part of the 999 Group, appears not to have been registered with the appropriate authorities in Guangdong and where the Capsules were subsequently contaminated. 

10.The contamination of the Capsules was revealed when, on 12 January 2010, the Company’s Singapore distributor received an oral notification from the Health Sciences Authority of Singapore (“the HSA”) that some of the Capsules were suspected to have been contaminated by the cancer-causing drug “phenolphthalein” (which had been banned in 2001) and the anti-obesity drug “sibutramine” (whose side effects include increased blood pressure and heart rate, psychosis and possibly convulsion) (collectively “the Western drugs”).

11.This led the Department of Health of Hong Kong (“the DoH”) to make an announcement on 24 March 2010, directing that the Traditional Pills and Capsules, which had been commonly used by a wide spectrum of the population in Hong Kong, including vulnerable groups like children and the elderly, had to be recalled as a precautionary measure due to the serious side effects of the Western drugs (“the Announcement”).

12.The Company subsequently recalled the Traditional Pills and Capsules. An internal investigation was then carried out to ascertain the cause of the incident and the source of the contamination, and to identify steps to avoid a repeat of the incident. The Investigation Report on the Incident of Contamination Po Chai Pills Capsules, dated 1 April 2010 (“the Investigation Report”)found that all the contaminated Capsules were produced from the powder supplied by Shijian without the knowledge or approval of the Company. Additionally, the Investigation Report provided 19 recommendations on measures to improve the Company’s quality control system, which the Company duly implemented.

13.Mr Wong resigned on 12 January 2010 for personal reasons, but remained involved in the operation management of the Company until mid-February 2010. 

The proposed action

14.The Plaintiffs now seek leave to bring a statutory derivative action on behalf of the Company against the putative defendants, pursuant to section 168BC of the Ordinance. In their proposed statement of claim, the Plaintiffs allege that Karen acted in breach of her duties as director, consultant and/or supervisor to the Company by, in summary:

(i)   Failing to carry out due diligence on the third party manufacturer;

(ii)   Failing to exercise reasonable care to ensure the safety and quality of the Capsule, as evidenced by the failure to put in place adequate supervisory or quality control measures in respect of the manufacturing and sourcing of the Capsule;

(iii)   Deliberately concealing the contamination incident from the relevant authorities, including the Department of Health;

(iv)   Making false and dishonest representations to the public; and

(v)   Failing to take adequate steps to mitigate the loss suffered by the Company after the drug safety scandal had gone public.

15.The Plaintiffs allege that as a result of Karen’s breach of duties, the Company has suffered significant loss and damage.

The legal principles

16.This application is brought under Part IVAA (sections 168BA-BK) of the Ordinance, which came into force on 15 July 2005 and was introduced to enable shareholders either to institute proceedings, or intervene in proceedings which have already commenced, on behalf of companies of which they are members provided they have satisfied certain criteria. Section 168BC(1) states:

“(1) A member of a specified corporation or of a related company of a specified corporation may, with the leave of the court granted under subsection (3)—

(a) bring proceedings before the court on behalf of the specified corporation; or

(b) intervene in any proceedings before the court to which the specified corporation is a party for the purposes of continuing, discontinuing or defending those proceedings on behalf of the specified corporation.”

17.Part IVAA was recently amended by the Companies (Amendment) Ordinance 2010, which liberalised the locus requirement by extending the right to bring leave applications to members of a “specified corporation or of a related company of a specified corporation”. This effectively expands the scope of statutory derivative actions to cover “multiple derivative actions”, placing the statutory framework in line with common law developments: see Waddington Ltd v Chan Chun Hoo Thomas and Ors (2008) 11 HKCFAR 370.

18.Section 168BC(3) sets out three requirements that must be satisfied for leave to be granted to bring a statutory derivative action:

“(3) The court may, on the application of a member of a specified corporation or on the application of a member of a related company of a specified corporation, grant leave for the purpose of subsection (1) if the court is satisfied that—

(a) it appears to be prima facie in the interest of the specified corporation that leave be granted to the Plaintiff;

(b) if the Plaintiff is applying for leave to bring proceedings under subsection (1)(a), there is a serious question to be tried and the specified corporation has not itself brought the proceedings;

(c) if the Plaintiff is applying for leave to intervene in proceedings under subsection (1)(b), the specified corporation has not diligently continued, discontinued or defended those proceedings; and

(d) except where leave is granted by the court under section 168BD(4), the member has served a written notice on the specified corporation in accordance with section 168BD.”

19.In the present case, the Plaintiffs seek leave to bring proceedings on behalf of the Company against Karen, a former director of the Company. It is therefore incumbent upon the Plaintiffs to satisfy the Court that it appears to be prima facie in the interest of the Company that leave be granted; that there is a serious question to be tried and that the Company has not itself brought the proceedings; and that the Plaintiffs have served a written notice on the Company in accordance with section 168BD.

20.Section 168BD requires that written notice stating the intention of the Plaintiff to apply for leave under section 168BC and the reasons for such an application be served on the company at least two weeks prior to the making of such an application.  The requirement is satisfied in the present case.  This, therefore, leaves the “interest of the company” and “serious question to be tried” requirements to be dealt with, which I now turn to.

(a) Prima facie in the interest of the specified corporation

21.It is now well-established in Hong Kong that the threshold for the “interest of the company” criterion is low. In deciding whether it is prima facie in the interest of the company for leave to be granted, the court should have regard to the fact that “there should not be a trial within a trial and the court should not be forced to enter into the merits of claims where there are serious disputes”: see Re Lucky Money Ltd & Others, unreported, HCMP 505/2006, 18 July 2006, per Kwan J at para 41; see also Re MyWay Ltd [2008] 3 HKLRD 614, per Barma J at para 31.

22.In Re F & S Express Ltd [2005] 4 HKLRD 743, Kwan J (as she then was) considered Palmer J’s judgment in the Australian decision of Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 and said, at paras 17-18:

“17. As Palmer J had commented in Swansson v RA Pratt Properties Pty Ltd & Another (2002) 42 ACSR 313 at p 324 para 55, there is a significant distinction between a requirement that the proposed action is in the interests of the company and a requirement that the proposed action may be, or appears to be, or is likely to be in the interests of the company. In jurisdictions with legislative requirements of the latter kind, the courts have taken the view that the best interests of a company need be considered only in a prima facie way.

18. In Bellman & Others v Western Approaches Ltd (1981) 130 DLR (3d) 193 at p 201, the British Columbia Court of Appeal drew a similar distinction between the two kinds of requirements and held that where the court has to be satisfied the proposed action would appear to be in the interests of the company, what is sufficient at the stage of granting leave is that ‘an arguable case be shown to subsist’”.

23.In the subsequent decision of Re Grand Field Group Holdings Ltd [2009] 3 HKC 81, Kwan J, at para 21, reiterated her view that the court need only be concerned with the presence of an “arguable case” when determining whether the proceedings are prima facie in the interest of the company:

“21. For the first requirement , it is only necessary to establish it appears to be prima facie in the interest of the Company to sue. It is not necessary or appropriate to establish this to a particularly high standard and the court should not attempt to resolve the underlying dispute. It would suffice if an arguable case is disclosed and, on the face of it, it would be in the interest of the Company to bring proceedings”.

24.I agree that satisfying the “interest” criterion only requires the Plaintiff to surmount a relatively low threshold by showing that the proposed action is prima facie in the interest of the company. In contrast to the Australian legislation, which requires that pursuit of a particular legal action will serve the “best interests” of the company in the sense that it will enhance the welfare of the company and its stakeholders (see Carpenter v Pioneer Park Pty Ltd (in liquidation) (2004) 211 ALR 457 at 464).  Section 165BC(3)(a) of the Ordinance explicitly uses the expression “prima facie” thus introducing a significantly lower threshold. It will therefore suffice, for the purposes of this leave application, that I am satisfied that, on the face of the matter, the Plaintiff’s proposed action is in the interests of the company.

25.I have, however, greater difficulty in equating, as Kwan J’s judgments in Re F & S Express (see paragraph 18) and Re Grand Field Group Holdings (paragraph 21) may be read as doing, satisfying the criterion to be found in section 168BC(3)(b), namely, that “there is a serious question to be tried”, with establishing that it is in the “interest of the company” that proceedings are commenced.  Kwan J refers in paragraph 18 of Re F & S Express to the Canadian case of Re Bellman and Western Approaches Ltd (1981) 130 DLR (3d) 193, where the British Columbia Court of Appeal seemed to say, at 201, that the question of whether the bringing of derivative proceedings “appeared to be … in the company’s interest” was essentially a determination of whether “an arguable case [could] be shown to subsist”. This approach comes close to eliding, in my view incorrectly, the 2 requirements in section 168BC(3)(a) and (b).

26.I accept that in most cases if a “serious question to be tried” has been demonstrated it will follow that it is prima facie in the interests of the company that proceedings are pursued and the converse, of course, will also be true.  In this context the “serious question to be tried” criterion can be viewed as a bench mark indicating whether or not it is likely to be in the interests of the company that proceedings are pursued and, in my view, this is how Kwan J’s judgments in both Re Grand Field Group Holdings and Re F & S Express are to be read.

27.There will, however, be cases in which a serious question to be tried is established, but it may not be in the interest of the company that proceedings are commenced.  One can imagine, for example, cases in which it is established that the company has a claim against a person with which it regularly does business, however, the board has taken the view that proceedings would damage the business relationship with the other party and that the maintenance of the relationship is more valuable to the company than any likely recovery in the contemplated proceedings. 

28.In cases in which the board of the company has made a bona fide commercial decision that it is not in the interests of the company that proceedings are commenced generally the court will be slow to override that decision.  In Re Bellman, supra, the court was of the view that provided the directors of the company felt, in their honest and impartial opinion, that it was not in the company’s interests to bring an action that decision would operate as a bar to a member’s derivative action. Nemetz CJBC, speaking for the Court, had this to say at 203: 

“How is a Court to exercise its discretion in coming to a determination that it is satisfied that ‘it appears to be in the interests of the corporation’ to allow the derivative action to be brought? The discretion is a wide one. However, despite its breadth, nowhere does Parliament say, nor, in my opinion, was it intended, that the logic of the common law in cases of this kind be disregarded. One must first look to the decision of the directors who, having been given reasonable notice by a complainant in good faith, decide not to assert a corporate right of action”.

29.As Nemetz CJBC recognised there is a danger in giving determinative, or close to determinative, weight to the views of the board as there will be cases in which the complaint relates to their own conduct and in such circumstances the impartiality of their decision is inevitably raised.  In my view the position in Hong Kong can be summarised as follows.  In cases in which a prospective claim is not against the directors the board’s view of what is in the commercial best interests of the company should generally be given considerable weight.  In cases in which the prospective claim is against a director, the board’s view is of less significance; although each case will turn on its individual facts.

30.In previous cases, other factors that have come under consideration have included, inter alia, whether the proposed defendant to the action has the financial capability to pay: Carpenter v Pioneer Park Pty Ltd (in liquidation), supra, at 465; see also Swansson v RA Pratt Properties, supra, at paras 57-60; whether the company is already embroiled in proceedings and the member is merely seeking to intervene in such proceedings pursuant to section 168BC(1)(b): Re MyWay Ltd [2008] 3 HKLRD 614 at para 33; see also Vrij v Boyle [1995] 3 NZLR 763 at 767; and whether the relief sought by the Plaintiff would put an end to the business of the company which is currently trading profitably and is in a sound financial state: Goozee v Graphic World Group Holdings Pty Ltd (2002) 42 ACSR 534 at 549.  As Kwan J observed in paragraph 16 of her judgment in Re F & S Express, ibid, we are still at the early stages in the development of the law on statutory derivative actions in Hong Kong and it would be unwise to state compendiously the considerations to which the court will have regard. The above cases can, however, provide useful illustrations of the factors, which may be relevant.

(b) Serious question to be tried

31.As I have already explained, in addition to satisfying the “interest” criterion, section 168BC(3) also requires the court to be satisfied that there is a “serious question to be tried” and that the company itself has not brought the proceedings.  In most cases one would expect that this is the criterion that should be examined first as if it cannot be satisfied it will normally necessarily follow that it is not in the interest of the company to commence proceedings.

32.Like the first requirement, the “serious question to be tried” criterion is “likewise of a relatively low threshold”: Re Grand Field Group Holdings Ltd, supra, at para 21. In Re F & S Express, supra, Kwan J, citing Palmer J in the Swansson case, supra, at para 25, put the test in this way:

“21. To ascertain if there is a serious question to be tried, the court ‘will not normally enter into the merits of the proposed derivative action to any great degree’, and the Plaintiff has ‘the same relatively low threshold to surmount as in the case of an application for an interlocutory injunction’”.

33.In other words, in ascertaining whether or not there is a “serious question to be tried”, the prospects of the Plaintiff’s success are to be investigated only to a limited extent, and the court should be slow to find against the Plaintiff unless his prospects are so slim that he cannot be said to have any expectation of success. I am reminded, in this regard, of Megarry VC’s oft-cited explanation in Mothercare Limited v Robson Books Limited [1979] FSR 466, in which he said, at 474:

“… the prospects of the plaintiff’s success are to be investigated to a limited extent, but they are not to be weighed against his prospects of failure. All that has to be seen is whether the plaintiff has prospects of success which, in substance and reality, exist. Odds against success no longer defeat the plaintiff, unless they are so long that the plaintiff can have no expectation of success, but only a hope. If his prospects of success are so small that they lack substance and reality, then the plaintiff fails; for he can point to no question to be tried which can be called ‘serious’, and no prospect of success which can be called ‘real’.”

34.I agree with this approach, and accordingly adopt it.

Discussion

35.I now turn to consider whether, in the present case, it is prima facie in the interests of the Company to take out the proposed action, and whether there is a serious question to be tried. Mr Coleman SC, for the Company submitted that it is not prima facie in the interest of the Company for leave to be granted for the following reasons:

(i)   The contamination incident was only a one-off incident and will not happen again in the future; and

(ii)   The costs of the proposed action would plainly outweigh any benefit gained from relief for the Company’s loss in the contamination incident, taking into account the commercial realities of the situation.

One-off incident

36.In respect of the “one-off incident” point, Mr Coleman submits that shortly after the release of the Investigation Report, the Company took immediate remedial action, namely, informing the Chinese Medical Division of the DoH to withdraw its application for registration of the Capsules, and informing the DoH that production and sale of the Capsules had ceased. In addition, the Company duly implemented the 19 measures recommended by the Investigation Report so as to improve and tighten the quality control system and to avoid similar incidents from happening in the future. Such conduct by the Company was, in Mr Coleman’s submission, enough to satisfy the DoH such that on 11 May 2010, the DoH announced that it had permitted the Company to resume production and sale of the Traditional Pills. Moreover, since the contamination incident, on each occasion that the DoH have sent representatives to the Company’s manufacturing premises to audit its drug safety and quality control system, the DoH have been satisfied with the standard of the Company in terms of its professional competence and regulatory compliance.

37.Lastly, Mr Coleman draws my attention to the fact that Mr Wong, the person in charge of the production of the Capsules and outsourcing matters, has already resigned and left the Company. For these reasons, Mr Coleman argues that there is no risk of the same incident occurring in the future, rendering the proposed action and investigation wholly unnecessary.

38.In response, Mr Johnny Mok SC, for the Plaintiffs, submits that the fact that the Company may have taken steps to ensure that the contamination incident is not repeated in the future is nowhere to the point. The fact, he says, that a drug safety scandal has occurred is a serious matter which has caused the Company considerable injury, both financially and in terms of its reputation. Whether or not the incident was “one-off”, Mr Mok submits, “there is no reason why the wrongdoings should be condoned, let alone totally absolved, by the very persons (the directors and Karen) who themselves are implicated”. Mr Mok further contends that the circumstances surrounding the resignation of Mr Wong on 12 January 2010 raise suspicions and, “at worst, smack of a cover-up operation to prevent a proper and though investigation” against Mr Wong, Karen, and other persons involved in the Company’s management who might be responsible for the incident.

39.I agree with Mr Mok that the fact that the contamination incident in the present case may or may not have been a “one-off” incident is no answer to the fact that wrongdoing was perpetrated against the Company and that Company should not in any way be hindered from pursuing a claim against those involved by reason of this. Accordingly, I do not think that this can be a reason to support the contention that it is prima facie not in the Company’s interest to pursue to proposed action.

Benefits outweighed by costs of proposed action

40.So far as the argument that the costs of the proposed action would outweigh any benefit to be gained is concerned, Mr Coleman submits firstly that the loss of sales caused by the contamination incident is insignificant given that the sale of the Capsules had in any event always been sluggish and accounted for less than 0.8% of the Company’s total sales. Additionally, due to the remedial actions taken by the Company in the immediate aftermath of the contamination incident, the sales of the Traditional Pills were only suspended for a brief period from 24 March 2010 to 11 May 2010, thereby minimising any loss or damage to the Company.

41.In contrast, Mr Coleman submits that the investigation that the Plaintiffs seek is likely to cost the Company at least hundreds of thousands of dollars, if not more. The Company is not, according to Mr Coleman, in a financially sound position to pay this, particularly given that it already owes substantial debts to Karen, Mr Sum and Mr Lau after the three individuals advanced loans to the Company to pay costs incurred in the recalls as well as to fund the Company’s operations after the incident.

42.On 14 July 2011 (after the hearing) I was sent by the Defendant’s solicitors the audited financial statement for the year ending 31 March 2011.  The income statement shows a loss for the year of $4,541,168, which is an increase from the loss for the year ending 31 March 2011 of $2,620,848.  The balance sheet shows an increase for the year ending 31 March 2011 in the Company’s net liabilities from $8,192,919 to $12,734,087. Unsurprisingly in these circumstances note 20 to the financial statement contains a note that the financial statements have been prepared on a going concern basis on the strength of the majority shareholder’s undertaking to provide such financial assistance as is necessary to maintain the Company as a going concern.  During his address Mr. Coleman made the point (although without the benefit, of course, of up to date accounts) that the impact on the financial state of the Company of proceedings must be relevant in determining whether or not it is in its interest for the proceedings to be pursued.  I do not accept that this is necessarily correct.  It seems to me that the court can make an order allowing an applicant to bring proceeding on behalf of a company if he is prepared to bear in the first instance the costs.  If the proceedings prove successful he may then be granted an indemnity.  This being so it follows that the ability of the Company to bear the costs of the proceedings is not directly relevant to whether or not it is in its interests for leave to be granted. It is relevant to the terms on which leave is granted.

43.Further, Mr Coleman argues that an analysis of the commercial realities of the situation counsel in favour of the costs of pursuing a derivative action outweighing any benefits to be gained by the Company. From the Company’s perspective, Mr Coleman says, its sales and reputation have already recovered from the contamination incident. Any further resources expended on litigation against potential wrongdoers would therefore be detrimental to the Company’s financial position, not to mention that the Company’s reputation would be further tarnished through widespread media coverage if the incident is further litigated. Mr Coleman also emphasises that even if the Company does bring derivative proceedings, it is unclear whether it will be able to recover anything from Mr Wong if it is successful, nor is it clear if Mr Zheng (who allegedly defrauded the Company) would be in a position to pay damages in a successful misrepresentation suit against him.

44.I see the force of Mr Coleman’s submissions. As I have discussed earlier, commercial considerations and the Company’s Board’s assessment of them are relevant in the determination of whether it is prima facie in the company’s interest to commence an action. In this case, those commercial considerations include the substantial litigation expenses in respect of bringing an action, the risk of further damage to the Company’s reputation, and the potential uncertainty concerning putative defendants’ ability to satisfy any judgment obtained against them. These considerations must be borne in mind when considering whether it is prima facie in the Company’s interests for proceedings to be brought.

45.However, having given due weight to these factors I am unable to agree with Mr Coleman. It seems to me that notwithstanding the commercial considerations in favour of avoiding unnecessary litigation expenses and further damage to the Company’s reputation, the fact remains that the case as advanced by the Plaintiffs clearly discloses serious questions to be tried.  As I have already explained in my view the court should not assume that because a serious question to be tried has been established it is in the Company’s interest to pursue litigation, however, the stronger the case, the stronger must be the presumption that it is prima facie in the interest of the company to pursue the action.  In the present case in my view there is strong case that one or other of the putative defendants has breached a duty to the Company.

46.What seems clear at this stage is that the Capsules were contaminated by the Western drugs, and that such contamination took place in the Guangdong factory that contracted to mill powder. This is evidenced by the DoH’s press release on 29 March 2010, as well as the Investigation Report dated 1 April 2010.

47.The fact of the contamination and the outsourcing points to misfeasance of some nature. This is particularly so, bearing in mind that the Company is a manufacturer of a proprietary Chinese medicine (i.e. the Po Chai Pills), and as such, must comply with various regulations and guidelines, with the responsibility for ensuring compliance falling to the directors. Mr Mok pointed out that section 16 of the Chinese Medicines Regulation (Cap 549F) was an example of express duties that the Company was obliged to uphold, including ensuring that

“adequate steps have been taken to prevent contamination of any ingredient or packing material used, any intermediate product generated or any proprietary Chinese medicine manufactured in the course of manufacture”.

48.I am persuaded, at least at this stage, that on the face of it, one or morepeople within the Company’s senior management failed to exercise due diligence to ensure the safety and quality of the manufacturing of the Capsules.  At this stage the court is concerned to avoid a trial within a trial: Re Lucky Money Ltd, supra, at para 41.What I need to be satisfied of is that there are serious questions to be tried.  It is not for the court at this stage to go into the details of what defences may or may not be available to the putative defendants and to try and make a preliminary assessment of their strengths.

49.Furthermore, I think it is noteworthy that the proposed case is primarily against Karen, not Mr Wong or Mr Tseng. To that extent, the concerns advanced by Mr Coleman that it is unclear whether the intended defendants would have the financial capability to pay damages in the event that the Company succeeds in its action, in large part fall away. 

50.I consider the case of Carpenter v Pioneer Park, supra, to which I have earlier referred to, to be instructive. That case concerned a shareholder’s application for leave to bring proceedings on behalf of the company against a third party bank. The proposed proceedings were based on the allegation that the bank had wrongfully terminated its finance facilities to the company, and without justification, had proceeded to call up indebtedness, appoint administrators and sell property in purported exercise of a power of sale under a mortgage. Barrett J, at para 21, was of the view that the proceedings were in the interests of the company given that a strong arguable case was disclosed on the facts as well as the existence of a “potential defendant with undoubted financial substance”.

51.At this stage the position is that there are grounds for thinking that there are strong claims to be pursued against one or other of the putative defendants and that it may be that one or other of them has sufficient means to satisfy any judgment.  The present Board of the Company is in a position of conflict in terms of assessing what is in the best interests of the Company and less weight should be given to their views than would be the case if this were not so.

52.In conclusion, in my view it has been demonstrated both that there are serious questions to be tried and that it is in the best interests of the Company that the proposed proceedings are pursued.

Appointment of independent professional accountant

53.In addition to its leave application to bring derivative proceedings on behalf of the Company under section 168BC, the Plaintiffs in their originating summons also apply for the appointment of an independent professional accountant to investigate and report to the Court on the facts or circumstances that gave rise to the proceedings proposed to be brought against Karen, pursuant to section 168BG.

54.Section 168BG of the Ordinance provides:

“(1) The court may, at any time, make any order and give any direction it considers appropriate in respect of any proceedings brought or intervened in by a member of a specified corporation, or of a related company of a specified corporation, under section 168BC(1), or in respect of an application for leave made under section 168BC(3), including—

(a) …

(b) …

(c) …

(d) an order appointing an independent person to investigate and report to the court on—

(i) …

(ii) the facts or circumstances that gave rise to the proceedings; or

(iii) ...

(2) Where the court makes an order under subsection (1)(d), it may make any other orders it considers appropriate for the purposes of that subsection.

(3) Where the court orders the appointment of an independent person under subsection (1)(d), the court may, at any time—

(a) order any or all of the following persons to be liable for any expenses arising out of the investigation—

(i) the specified corporation;

(ii) the parties to the proceedings or application;

(iii) the member who brought or intervened in the proceedings, or made the application; and

(b) review, vary or revoke an order made pursuant to paragraph (a).

(4) If an order made pursuant to subsection (3)(a), or the order as varied pursuant to subsection (3)(b), makes 2 or more persons liable for the relevant expenses, the court may also determine the nature and extent of the liability of each of those persons.

(5) ...”

55.Mr Mok submitted that an independent professional accountant is necessary because the Plaintiffs have good reasons to believe that relevant information which may be detrimental to the wrongdoers have been deliberately suppressed by the management of the Company. Those reasons, in summary, are that on various occasions the Plaintiff’s solicitors made enquiries with the Company’s board, only to be met with “evasive or wholly unsatisfactory responses”.

56.Mr Coleman, on the other hand, argued that appointing an independent auditor was entirely unnecessary and a waste of time and costs, given that an objective and comprehensive investigation had already been carried out by the Company in the aftermath of the contamination incident, as evidenced by the Investigation Report. That report, Mr Coleman submitted, addressed all the matters worth investigating, including identifying the source of contamination and the person likely to have caused the powder to be processed in the Guangdong factory (i.e. Mr Zheng), confirming that none of the Traditional Pills contained the Western drugs and no trace of contamination was found at the Company’s manufacturing premises, and outlining a list of remedial measures to prevent the contamination incident from happening again.

57.Further, Mr Coleman contends that any concerns regarding which relevant Ordinances and/or Practising Guidelines have been breached and by whom would not be addressed by the appointment of an independent auditor. This is because, according to Mr Coleman, the accountant would not be well-versed in the Chinese medicine business and as such would not be in a position to assist in ascertaining whether there have been breaches of relevant regulations. In any event, Mr Coleman says that investigations have already been carried out by relevant authorities, and the Company has already been charged and fined in respect of breaches of sections 23(1) and (2) of the Pharmacy and Poisons Ordinance (Cap 138).  I accept that there is force to these points.

58.I agree that, at this stage, it is not necessary to appoint an independent professional accountant. In Re Lucky Money Limited, supra, Kwan J, at para 6, exercised her authority under section 168BG to appoint an independent auditor to investigate and to report to the court on matters raised in the conflicting evidence. However, in Re Grand Field Group Holdings, supra, at para 49, her Ladyship made clear that the presence of conflicting evidence is not, in and of itself, a reason to appoint an independent auditor:

“49. I decline to make an order to appoint an independent auditor to investigate the financial position of the Company. If the Company wishes to engage such an auditor, it is at liberty to do so, without an order from the court. As for Mr Tsang, it seems to me that the information presently available to him is prima facie sufficient to bring proceedings. I do not see the need for investigation by an independent auditor to be appointed by the court at this stage. The appointment of an independent auditor in Re Lucky Money Limited was made on the special facts of that case, and it does not mean an appointment is called for whenever there is sharp conflict in the evidence filed”.

59.I agree with this approach. The Court, in my view, should only exercise its discretion to appoint independent accountants in exceptional circumstances where, without such an appointment, the Plaintiff would be unable to satisfactorily bring proceedings against the intended defendant. That is not to say, as Kwan J was quick to emphasise, that the Plaintiffs may not engage an auditor without an order from the Court – it is free to do so of its own accord.

Substantive Orders

60.For the foregoing reasons, I grant leave to the Plaintiffs to bring a statutory derivative action on behalf of the Company in the terms as sought in the Amended Originating Summons. I, however, refuse the application in respect of the appointment of the independent professional accountant.

Costs

61.It follows from the substantive orders that I have made that the Plaintiffs should have their costs of this application paid by the Company.

62.The Plaintiffs also ask to be indemnified for the costs of the proposed proceedings out of the assets of the Company.

63.Section 168BI(1) of the Ordinance provides:

“(1) The court may, at any time (including on granting leave under section 168BC(3)), make any order it considers appropriate about the costs incurred or to be incurred by the following persons in relation to an application for leave made under section 168BC(3) or any proceedings brought or intervened in, or to be brought or intervened in, under section 168BC(1)—

(a) the member;

(b) the specified corporation; and

(c) any other parties to the application or proceedings.

(2) An order made under subsection (1) may require the specified corporation to indemnify out of its assets against the costs incurred or to be incurred by the member in making the application or in bringing or intervening in the proceedings.

(3) The court may only make an order about costs (including the requirement as to indemnification) under this section in favour of the member if it is satisfied that the member was acting in good faith in, and had reasonable grounds for, making the application, or bringing or intervening in the proceedings.”

64.As I have already mentioned the present financial viability of the Company is dependent on the majority shareholder’s undertaking to provide such financial assistance as is necessary to maintain the Company as a going concern.  On the face of the financial statements without such financial assistance the Company would probably be insolvent.  In my view in these circumstances it would not be appropriate at this stage to make an order for the payment of the costs of the proposed proceedings to be paid out of the assets of the Company.  The Plaintiffs can renew that part of their application (paragraph 5), which I adjourn sine die, at such time as they are able to put further information before the court concerning the costs of the proposed proceedings and the financial state of the Company which in their view justifies further consideration of this issue.

Mr Johnny Mok, SC leading Mr Johnny Ma, instructed by Messrs Lo and Lo, for the 1^st to 3^rd Plaintiffs

Ms Linda Chan and Ms Zabrina Lau, instructed by Messrs Stephenson Harwood, for the Defendant (on 9 March 2011)

Mr Russell Coleman, SC leading Ms Zabrina Lau, instructed by Stephenson Harwood, for the Defendant (on 18 April 2011)