Chinacast Education Corporation and Others v. Chan Tze Ngon and Others
Read the full judgment text of HCA 1062/2012 on BabelCite. This High Court CFI judgment was delivered on 11 November 2013.
1. This is an application by the plaintiffs against the 3 rd defendant (“Ma”) for the continuation of a Mareva injunction granted ex parte by Mr Justice Tong on 19 June 2012 (“Injunction”).
Cites 2 cases
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HCA 1062/2012 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF FIRST INSTANCE ACTION NO 1062 OF 2012 --------------------
------------------------ D E C I S I O N ------------------------ 1.This is an application by the plaintiffs against the 3rd defendant (“Ma”) for the continuation of a Mareva injunction granted ex parte by Mr Justice Tong on 19 June 2012 (“Injunction”). 2.Despite the fact that Ma has indicated from day one that he intends to apply to have the Injunction discharged (no Summons has actually been taken out for that purpose), this matter has taken an extraordinary length of time to come to court for determination. This can be quite unfair because Ma is, on his contradicted evidence, badly affected by the Injunction. The abortion of the substantive hearing to determine this application in April 2013 was caused by the late filing of evidence by the plaintiffs. This court is duty bound to point out that a party who has obtained an ex parte order must do all that is reasonable to ensure that the dispute over the same is resolved without delay so as to minimise the prejudice to the affected parties. The parties 3.The 1st plaintiff (“P1”) is a Delaware company which is the ultimate parent company of the CEC Group (“Group”). Until May 2012 it was listed on NASDAQ. 4.The business of the Group consists of the provision of post-secondary and e-learning services in the Mainland, where it operates by means of wholly foreign owned subsidiaries (“WFOEs”). The educational services are provided in two ways, namely, through a traditional university group (“TUG”) and by e-learning services (“ELG”). 5.The other 4 plaintiffs are members of the Group. 6.The 2nd plaintiff (“P2”) is a BVI company with which each of the first 4 defendants (“D1-4”) entered into a contract of service to provide services for the Group. 7.The 3rd and 4th plaintiffs (“P3” & “P4”) are WFOEs in Shanghai and were the most significant of the Mainland subsidiaries in financial terms. 8.The 5th plaintiff (“P5”) held the shares in two holding companies which respectively operated two colleges belonging to the TUG. 9.The original defendants in these proceedings are D1-4 whose relationship with the Ps was at the material time as follows:
10.Ms Fu (D5) was joined as a defendant on 27 August 2012. 11.The other defendants, D6-13, were also joined on 27 August 2012, but no cause of action is pleaded against any of them. They have been joined only for the purpose of extending the Injunction to cover assets held by them which, Ps allege, are held for one of D1-4. Background to the litigation 12.In 2011, there was conflict at board level in P1 which gave rise to a proxy contest that resulted in new directors being appointed to the board, the appointment of these directors having been opposed by D1-3 (Ma says that he had only supported D1 and D2 passively in the proxy contest). It is alleged by Ps that in the early part of 2012, D1-4 acted together in attempting to obstruct the audit of the two main operating entities of the Group, P3 & P4 (it is right to point out that this was not pressed at the hearing because there was no evidence that Ma played a part in the alleged obstruction). This led to D1 being removed from his positions with P3 & P4 on 26 March 2012. At the same time D2 resigned. Ma was removed from all positions within the Group on 11 April 2012. On 29 March D4’s positions within the Group were terminated. 13.The new management then sought to assert control over all of the Group entities but found that important financial records and other documents held at the offices of P3 and P4 in Shanghai had been removed or destroyed. On 30 March 2012, D1 tried to prevent the new management from entering the premises occupied by P3 & P4 by changing the locks; he had earlier demanded that Mr Feng (the new CEO of the Group) and his team should leave. Personnel in the Shanghai finance office continued to destroy documents and on 16 April some 10 to 15 persons not employed by P1 entered the premises and forcibly took away the hard drives of computers. The chops and other important documentation required to allow for the running of the business had also been taken on the instructions of D1. 14.After obtaining new chops and taking control of the Shanghai companies the new management ascertained, it says, that D1-4 had acted in breach of duty by misappropriating assets of the Group and by diverting corporate opportunities from the Group for their own benefit. These wrongful acts have been pleaded under different headings in the Statement of Claim (“SOC”), which include those summarized below. In short, a fraud of considerable scale had been committed against Ps by people who were in control of them. These companies have been stripped of a massive amount of cash as well as assets of considerable value. Much of their business has also been taken away. P1 has lost its listing status as a result of the wrongdoings and Ps are now impecunious. Diversion of resources & business opportunities 15.Two companies controlled by D4 are operating from two floors adjacent to those where the offices of the Shanghai subsidiaries of P1 are located. These two companies are ZJX and Harmony Education. ZJX has taken on projects that should rightfully have gone to the Group and/or has extracted service fees from the Group. Harmony Education has been passed off by D4 as being affiliated with P1 and has attracted business away from it, thus exploiting its goodwill. Harmony Education is setting up a university park in Anhui province and there is reason to believe that the Group’s funds have been used for such purpose. Unauthorized borrowings 16.D4 had arranged for P3 and P4 to take out loans at high rates of interest from entities associated with him. There was no need for the loans since the Group’s revenues exceeded the amounts needed to operate the business. Pledging of time deposits 17.P3 and P4 had deposits of RMB100m each with Huaxia Bank. These sums were pledged as security for loans granted to 3 companies, the identities of which have not been disclosed by the bank. The bank has confirmed that these sums have been transferred away. Cash balances of P3 & P4 dissipated 18.At the end of June 2011, the cash balances of P3 and P4 were respectively RMB494.9m and RMB180.1m. Between July 2011 and April 2012 these cash balances were depleted by transfers out of the various bank accounts so that P3 and P4 were left with cash balances of only RMB13,788 and RMB124,022 respectively. Thus, over a ten month period the cash balance of P3 was practically eliminated and that of P4 was drastically reduced. Other misappropriations of funds 19.A number of misappropriations are pleaded in paras 81-85 of the SOC. 20.Of particular significance is the transfer of US$64.5m from P1’s account in the USA with Signature Bank to CCT HK. These monies have disappeared from the Group. However, documents subsequently uncovered by the new management show that US$30m was paid to a company called Thriving Eagle and that there were numerous other unexplained and highly suspicious transactions. 21.Between June 2011 and April 2012 transfers of RMB35.6m were made by P3 to D5. An allotment of 3.7m shares in P1 to two BVI companies connected with D5 was procured in circumstances whereby no payment was made. Colleges wrongfully transferred 22.The shareholdings of P5 in the two colleges, namely, HIUBC and Lijiang College have been transferred out of the Group. These shares were transferred in March 2012 to D4 (as to 70%) and one Mr Shi (30%). Subsequently they were transferred to other persons. At the time of the transfers from P5 the Legal Representative of P5 was D2 and the Supervisor of P5 was D3. The case against Ma 23.This application only concerns Ma. Ps’ case is that Ma had acted together with D1, D2, D4 and D5 in the massive fraud committed against them. However, there is a special feature with the case against Ma. It has been acknowledged by Mr Grossman SC, who appeared with Mr Wong for Ps, that there is no direct evidence of any wrongful act committed by Ma, whether by himself or with any of the other Ds. This feature is the kernel of the arguments in this application. Mr Grossman argued that given the scale of the fraud it is impossible for the same to have succeeded without the connivance of Ma given his position in the Group. 24.On the other hand, Mr Cooney SC, who appeared for Ma, submitted that Ps’ case against Ma is speculative and little more than sweeping him up with the other Ds on the slander basis of his position in the Group. Ma maintains that he had discharged his duties to the Group properly and was not aware of any wrong being committed against Ps. The Issues 25.With the helpful submissions from both sides, the determination of this application will turn upon, firstly, whether there is sufficient evidence to give rise to an inference that Ma did connive with other Ds in the wrongdoings (the good arguable case issue). Secondly, whether the balance of convenience is in favour of continuing with the Injunction. Good arguable case 26.I start with the appropriate test. I have been referred by Mr Grossman to Gee on Commercial Injunctions, 5th edn, §12.024 (citing Mustill J’s dicta in Nenemia Maritime Corp v TraveSchiffahrtsgesellschaft GmbH) – a good arguable case is “one which is more than barely capable of serious argument, but not necessarily one which the Judge considers would have better than 50 per cent chance of success.” 27.I have also been referred to the case of Helm Hong Kong Ltd v Au Tat Kei, Decky, unrep, HCA 1517/2006, 13 December 2006 at para 6:
28.Mr Cooney has expressed no disagreement with the above statements of law. It is fair to say that the threshold of good arguable case is not a particularly onerous one. 29.Helpfully, Mr Grossman has, for the present purpose, distilled his case against Ma into a number of wrongdoings. It was submitted that, in light of these wrongdoings, it is impossible for Ma to maintain that he did not know about or connive with the fraud practised on Ps. 30.Before I turn to those wrongdoings, I shall deal with a number of more general points. 31.Firstly, although Mr Cooney has made no admission to any fraud having been committed against Ps, on the evidence before the court that is not a matter open to doubt. 32.Secondly, it is right to say that Ps have been handicapped by the removal or destruction of their documents and records by the wrongdoers and the evidence they have managed to marshal before the court is far from complete. On the other hand, Ps’ case against Ma must be judged on the basis of the available evidence. 33.Thirdly, although Ma contracted with P2 for his service, there is no dispute that he, as a matter of fact, served as the CAO of the Group. Under clause 3.1.1 of his contract, which set out his duties, it was provided as follows:
34.Further, Ma was one of the three signatories of P1’s bank account. There is no evidence of any abuse on his part in the operation of the account. However, being one of the signatories underscores the importance of Ma’s position in the Group. 35.Fourthly, there is no controversy that one of Ma’s duties as the Group CAO was to produce quarterly consolidated group financial statements (“GFS”). These GFS were needed to meet the requirements of the US Securities and Exchange Commission. There is no dispute that in order to do so Ma would be supplied by his colleagues with various financial data, including data from various subsidiaries of P1. However, it is controversial whether Ma was required to check and confirm the data given to him and I shall return to this point below. 36.Fifthly, it is undisputed that Ma was the person responsible for dealing with the external auditor of the Group, Deloitte. The GFS were subjected to the audit of Deloitte. Ma had the responsibility to deal with issues raised by Deloitte in the course of auditing. Unauthorized borrowings 37.According to the GFS (exhibit “DF-2”) for the period ended 30 June 2011, the Group had cash, cash equivalents and term deposits of over RMB858m. That position was confirmed by a firm of forensic accountants (“FTI”) appointed in late 2011. Based on FTI’s report dated 19 December 2011, most of the cash balances were kept in the Mainland and P3 and P4 were the two subsidiaries with the most cash. 38.According to the GFS for the period ended 30 September 2011, the total amount of cash, cash equivalents and term deposits had increased to over RMB1,087m. 39.After the new management had gained control over the Group, and with significant delay which was caused by the removal of documents and company chops, it was found out that within a period of 10 months after 30 June 2011 (July 2011 to April 2012) over RMB762m had been removed from P3 and P4 representing about 80% of the total cash held by the Group as of 30 June 2011. 40.Between 2010 and 2011, over RMB780m of loans at rates of interest ranging from 1.5% to 6.5% per month were taken out by the Group’s Mainland subsidiaries, including P3 and P4. The lenders included D4 and his associates. Ps say that these high interest loans were unauthorized as the Group had ample cash reserves. The interest payment required to service such loans amounted to about RMB70-80m per annum. Plainly, this could well be a method deployed by the wrongdoers to siphon the cash from the Mainland subsidiaries. 41.It is pleaded by Ps in the further and better particulars of the SOC (“FBP”) that of the RMB762m which has gone missing (see para 39 above), RMB573m was foreclosed by banks as a result of unauthorised pledges of deposits (see below). As to the balance of RMB189m, it is believed that it was used to repay creditors who had made unauthorised lending to Ps. 42.Ps say that the unauthorised borrowings could not have taken place without Ma’s knowledge or connivance by reason of his role and responsibilities. In particular, those borrowings were not reflected in the GFS prepared by Ma and thus were hidden from the board of directors of P1. 43.I have been taken to a document which shows that there were 11 unauthorised loans taken out by P3 in December 2010 amounting to RMB16m. These loans can be traced to the bank statements of P3. However, these loans were not properly reflected in the relevant GFS, which only showed borrowings of RMB1.5m. 44.The evidence is that Ma was supplied with the bank statements of all the accounts every quarter. Further, there is uncontradicted evidence that each of the subsidiaries in the Group would submit trial balances to Ma on a monthly basis. Such documents would contain all the company’s bank transactions. 45.Mr Wong, who dealt with part of Ps’ submissions, argued that the above shows that Ma was manipulating the Group’s financial data so that important information was not disclosed. 46.Ma’s pleaded case is quite simple. He was presented with, inter alia, the accounts of P3 and P4 and those material did not reveal any loan taken out by them. Had there been such loans, concerns would have been raised by Deloitte. 47.Mr Cooney was at pains to point out that there is nothing to indicate that Ma was aware of or connived to any wrongdoings. 48.I was reminded of the evidence of Ma in respect of the scale of operation of the Group, which was described as far-flung and substantial. There were 3 universities in different provinces, an ELG business and offices in Beijing and Shanghai. Each university employed about 1,000 staff and had its own independent accounting department. The Beijing and Shanghai operations also had their own independent accounting department. Those two accounting departments employed over 40 staff. Ma said that there was no way for him to manipulate the financial data given its sheer volume. His role was to have an overview of the accounts and, more importantly, to assist Deloitte to present this overview to satisfy regulators, shareholders and directors. He could only discharge his duties by relying on information and material provided to him. 49.Mr Cooney argued with some force that if a fraud was being practised it is possible that Ma was also a victim of the fraud. He pointed out that Deloitte was unable to detect anything untoward in the course of its audits. There is no reason, Mr Cooney argued, to believe that Ma should have discovered anything wrong with the accounts he was given. 50.There is, potentially, some support for the proposition that Ma was also fooled by the fraud that was being committed. Ps have uncovered some fraudulent bank statements in the course of investigating these matters (see below). It is possible that Ma was provided with fraudulent bank statements. 51.On the other hand, Ma’s evidence concerning his role and responsibilities in the Group is unconvincing because it is, firstly, inconsistent with the terms of his service contract. 52.Secondly, there is very little said by Ma in respect of the checking and confirmation which, as a matter of common sense if nothing else, a person in his position would carry out to ensure that the information given to him was accurate. My impression of Ma’s evidence is that he sought to minimise his role and distance himself from the wrongs committed against Ps. 53.Thirdly, given his responsibility in dealing with Deloitte (there is no suggestion that Deloitte knew of or was party to any wrongdoings), the point that Deloitte was unable to discover any wrongdoing is a two edge sword. Ma was in the best position to see to it that Deloitte would not uncover anything wrong. Looking at it from a different angle, it would have been rather difficult for the fraud to evade the detection of both Ma and Deloitte. 54.Mr Grossman has made two general points to contradict the suggestion of innocence. Firstly, Ma has not suggested (certainly not in an unequivocal manner) in any of his affirmations that he was himself a victim of other people’s concealment. Indeed, I find his evidence in respect of the trial balances which Ps have managed to uncover rather unusual. These documents are inconsistent with the relevant GFS and therefore suggest that the information provided to Ma was not accurately reflected in the GFS. One would have expected that an innocent person in Ma’s position would respond to the evidence by saying that the trial balances that he was provided with were not those documents. However, Ma’s response is ambiguous (Ma’s 4th affirmation (“Ma 4th”), paras 65 and 67). Apart from repeating that he never tempered with any financial information supplied to him, he questioned the provenance of the trial balances produced by Ps. One may argue that these are matters of semantics. On the other hand, this court must form a view on the basis of the evidence before it. On such evidence, one can fairly say that Ma’s response is not consistent with that of a senior employee who was cheated by the wrongs of his colleagues. 55.Mr Grossman’s second point is that Ma had failed to cooperate with the new management in its effort to uncover the fraud. I was referred to the details pleaded in the FBP (Answer 14(7)). 56.Ma’s response to the allegation that he had refused to assist in Ps’ investigation is again rather unusual. He deposed to the fact that he was dismissed and had to leave his office immediately. He is not in possession of any document belonging to Ps. There was little he could do to help Ps (Ma 4th, paras 19 and 46). I cannot accept that such a position sits with common sense. Ma was the CAO of the Group. He must be in a very good position to assist Ps to uncover what was taken from them and to try to trace their properties. 57.Mr Grossman’s criticisms are not sterile forensic points. The court must assess the evidence with common sense. 58.Coming back to the unauthorised borrowings, the sheer volume of such borrowings, the duration of their existence and the amount of money required to service the interest payment tend to suggest that it is very difficult for such unlawful acts to have escaped Ma. I should add that given the fact that P3 and P4 were in possession of a huge amount of cash or cash equivalents, a reasonable CAO would have paid special attention to the finance of these companies. 59.Importantly, the evidence shows (see below) that this is not the only complaint of Ps which gives rise to an inference that Ma was a party to the fraud. Mr Grossman has made a powerful point that this court must consider the culminative effect of the evidence. Pledging of time deposits 60.Ps’ case is that between December 2009 and November 2011, numerous pledges were made with the cash deposits of P3 and P4. These pledges were made for the benefit parties who were unrelated to the Group. These deposits have now been lost. Ps allege, inter alia, that Ma had permitted these pledges to be made, failed to investigate them and failed to record them in the GFS. 61.Ma accepts that these pledges were highly irregular. However, he maintains that they were not disclosed in the financial material supplied to him and therefore he had no knowledge of the same. 62.I have already dealt with the general arguments of both sides when I considered the unauthorised borrowings. 63.I am not convinced about Ma’s explanations. Just looking at the unauthorised borrowings and the pledges, there is a strong inference that there were too many irregularities to have escaped an honest CAO. Dissipation of cash balances (i) The RMB762m claim 64.The details of this claim have been covered in paras 37 to 39 above. 65.In addition to his claim that he had relied upon the financial information given to him, Ma’s case is that he did not operate or have control over the bank accounts. 66.Like the first two complaints, I find Ma’s explanation unconvincing. (ii) The other misappropriation of funds claim 67.Between January 2008 and December 2011, US$64.5m was transferred from P1’s account with Signature Bank in the US to ChinaCast Technology (HK) (“CCTHK”) Ltd. Ma says that this is a wholly owned subsidiary of P2. However, the 2 shares of CCTHK were owned by D1 and P1 (I do not regard this as a point against Ma). The funds have since been transferred out of the Group and cannot be traced. 68.Ma says that those funds were used to pay the expenses of offshore entities belonging to the Group, capital injection into Mainland subsidiaries of P2 and the cost of acquisition of colleges by Mainland subsidiaries. 69.Ma explained that in December 2009, as a result of a fund raising exercise Ps were in possession of about US$44m. That fund was later used in the acquisition of colleges in the Mainland. According to a public announcement of P1, the acquisition of one such colleges, which was completed in August 2010, required about US$66.2m. 70.I have been taken by Mr Wong to the evidence of false bank statements (Mr Woodrum’s 1st affidavit, para 16). It appears that Deloitte was provided with bank statements with stated balances which differed dramatically with the truth. I am not sure how this piece of evidence supports this complaint of Ps. In any case, it is a point which cuts both sides as I have alluded to in para 50 above. 71.In light of Ma’s evidence, I would disregard this complaint in my consideration of whether a good arguable case has been made out. Transfer of colleges 72.The core of Ps’ TUG business was made up of 3 universities in Wuhan, Lijiang and Chongqing, respectively HIUBC, Lijiang College and FTBC. The shares in HIUBC were held by P5. In March 2012, those shares were transferred to D4 and an employee of HIUBC who is said to be closely associated with D4 by the name of Shi (“Shi”). On 5 April 2012, those shares were onward transferred to 3 other individuals and out of the Group’s control. 73.In respect of Lijiang College, P5 was also its shareholder. P5’s shares in that college were transferred to D4 and Shi in March 2012. Those shares were transferred to 2 other individuals on 9 April 2012. Again, the Group has lost control over the college. 74.P1 held its interest in FTBC through P4 and one Chongqing Chaosheng Education and Investment Co Ltd. Those interest were also transferred to D4 and Shi on a date unknown to Ps. However, the record shows that FTBC has also been transferred out of the Group and is now owned by 23 individuals none of whom is known to Ps save for one Mr Shi Qin Yan who is understood to be the son of Shi. 75.Understandably, in this complaint Ps rely heavily upon the fact that Ma was the supervisor of P5 (that is not a relevant consideration in respect of FTBC). 76.Ma’s evidence is that the transfers to D4 and Shi were likely to have been carried out in accordance with the advice of Mainland lawyers. Under Mainland regulations, there was a restriction over foreign ownership of education institutes. To overcome the same, Ps were advised to adopt a Variable Interest Entity structure (“VIE”) for holding the interest in the colleges. I was taken to various contemporaneous documents. For the present purpose, I am satisfied that it is likely that the transfers to D4 and Shi were made to put the VIE into effect. 77.As regards the second transfer, which is a gravamen of this complaint, I bear in mind that they were made shortly before Ma was dismissed from his position on 11 April 2012. I am not satisfied that there is sufficient evidence to indicate any wrongdoing on Ma’s part and I shall also ignore this complaint from my consideration. Conclusion on good arguable case 78.Despite my rejection of two of the complaints, there is sufficient evidence to meet the threshold. 79.For completeness, I should mention that Mr Cooney has, quite fairly, not pressed the arguments concerning hearsay evidence and non-disclosure. It is therefore not necessary to deal with them. Balance of convenience 80.The main considerations here are (a) the Injunction, perhaps expectedly, is affecting Ma badly and (b) whether damages are adequate compensation if it subsequently turned out that the Injunction ought not to have been granted. 81.There is uncontradicted evidence that Ma’s life is in limbo since the Injunction was made. In particular, he has not been able to find a suitable employment. One can well understand that Ma will have to disclose these matters to his prospective employer and that would seriously damage his prospects of getting suitable work. On the other hand, there is force in Mr Grossman’s argument that the difficulty is not caused by the Injunction but by the action against him. 82.Further, Ma has not been able to start a business which he has conceived because his assets are frozen. This is quite important in light of Ma’s inability to get a suitable job. In this regard, Mr Grossman accepts that Ma may seek Ps’ consent for a variation of the Injunction to allow him to start a business. 83.I take the view that it will be very difficult to assess the compensation which should be paid to Ma in the event that the court held that the Injunction should not have been granted. 84.Moreover, the evidence is that Ps are impecunious. This litigation is being funded by P1’s shareholders. 85.Taking these matters into consideration, I take the view that the Injunction should be continued but with a variation to allow Ma to withdraw HK$2m so as to enable him to start the business he has in mind. The evidence is that Ma’s share of the start-up capital would be RMB$1.5m. 86.I have considered whether the ordinary living expenses of HK$20,000 per week should be adjusted in light of the variation. I have decided against doing so because it normally takes some time before a business can return a profit. I have also decided against imposing an obligation on the part of Ma to make disclosure on the finance of the new business. Should there be a material change of circumstances in the future, Ps have the liberty to come back to the court. However, I believe that the ordinary and proper business expenses allowance of HK$20,000 per week should cease when the HK$2m have been released. 87.In addition, Ps must fortify their undertaking as to damages within 14 days from today with either a payment into court or a bank guarantee of HK$3m. This was the lower of the two sums suggested by Mr Cooney. 88.Further, I am dissatisfied with the progress of this action. It is essential for a plaintiff who has obtained a Mareva injunction to prosecute his action without any delay. Ps must also undertake to prosecute this action with all due expedition. 89.I grant the parties liberty to apply. Conclusions 90.The Injunction to be varied as indicated above should continue until the conclusion of trial or further order. The solicitors for Ps and Ma should endeavour to agree the terms of the Injunction. Any disagreement should be set out succinctly in a joint letter to the court for resolution. 91.I make an order nisi that the costs of this application be Ps’ costs in the cause with a certificate for two counsel. 92.Last but not least, I am grateful for the assistance of counsel in these matters.
Mr Clive Grossman, SC and Mr Jonathan Wong, instructed by Fried Frank Harris Shriver & Jacobson, for the plaintiffs Mr Nicholas Cooney, SC instructed by Lee & Chow, for the 3rd defendant | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cases cited in this judgment
Further hearings and rulings under HCA 1062/2012