Kam Kwan Enterprise (Holdings) Ltd v. Chow Pui Shan and Others

HCA 1116/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1116 OF 2013

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BETWEEN

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J U D G M E N T

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Introduction

1.Before the court are summonses by the defendants to strike out the statement of claim under Order 18 rule 19(1) (a) of the Rules of the High Court (“Striking Out Summonses”). The plaintiff has taken out a summons for amendment (“Amendment Summons”), and the defendants (collectively “Ds”) have no objection to the plaintiff’s amendments in the event they do not succeed with their Striking Out Summonses.

2.Counsel Mr Raymond Lau appeared for the 1^st defendant and Counsel Mr Roland Lau appeared for the 2^nd to the 4^th defendants.  Counsel Mr Raymond Tsui appeared for the plaintiff.

3.The plaintiff’s claim in the main action is essentially against the defendants over the sale of a godown at Unit A2, Ground Floor and 2 Carparking Spaces in an industrial building in Tsuen Wan, New Territories (“Property”), and, in particular, the alleged breach of fiduciary duty and trust on the part of  the 1^st defendant in relation to the sale of the Property.

Dramatis Personae

4.The plaintiff (“P”), a limited company incorporated in Hong Kong is wholly owned by Guangzhou Iron & Steel Enterprise Holdings Limited 廣州鋼鐵企業集團有限公司, which in turns directly and indirectly owns or partly owns a number of companies in Hong Kong and other countries (“Group Companies”).

5.A Mr Peng Yong (“Peng”) was the General Manager and a director of P.  Madam Yang Juan (“Yang”) was the General Manager of P’s Finance Department.

6.P was/is a majority shareholder, holding 9,999,999 of the 10m issued shares of another limited company incorporated in Hong Kong called Contrive Company (Hong Kong) Limited (“Contrive”).  The remaining 1 issued share of Contrive was held by Kam Kwan Nonferrous Metals Limited (“Kam Kwan”). 

7.Contrive was in turn the majority shareholder, holding 2.8m out of 4m issued shares, namely 70% of another limited company incorporated in Hong Kong called Hopely Copper Aluminium Company Limited (“Hopely”). The remaining 30% of Hopely was held by other shareholders.  Hopely was deregistered and dissolved on 22 June 2012.

8.Contrive, Kam Kwan, and Hopely are/were all considered by P as part of the Group Companies.  

9.The 1^st defendant (“D1”) was employed by P in about 1988 as a clerk to the Finance Department and in about 2002, she was promoted to be the Deputy General Manager of P’s Financial Department, assisting Yang. 

10.The 2^nd defendant (“Billion”) was/is a limited company in Hong Kong.

11.On about 21 July 2010, the 3^rd  defendant (“D3”) and the 4^th defendant (“D4”) acquired their shareholding in the Billion, each holding one of Billion’s two issued shares, and they were the only directors.  D3 is the daughter of D1.

12.D4 ceased to be a director on 7 August 2012 and was replaced by a Mr Ip Sui Sang, the husband of D1 (“Ip”).  D1 and Ip are thus the parents of D3.

13.Mr Ku Chi Wai (“Ku”) operated a garage business at the same building next to the Property.

Background

14.Hopely purchased the Property on about 15 May 1995 at a price of HK$4.1m.  The Property was registered in the sole name of Hopely until the Property was sold. 

15.It was P’s case that D1 was given the duty to handle the sale of some of the landed properties of the Group Companies and that P had reposed complete trust and confidence in D1, who had on occasions signed provisional sale and purchase agreements for and on behalf of the Group Companies.  D1’s case, on the other hand, was that she had always been under the supervision of Yang and/or Peng and that she did not have any authority to decide or accept the terms and conditions of the sale and purchase of P’s landed properties, such decisions being made by Peng and/or Yang.

16.According to P, in mid 2010, Ku had enquired on occasions whether P was minded to sell the Property and that D1 was aware of such enquiries.  D1 denied any knowledge of this.

17.In any event, in about mid July 2010, P decided to sell the Property.  P said D1 was entrusted with the task of the same, but this was again denied by D1.

18.According to D1, on about 15 July 2010, Peng instructed her to liaise with the bank to do a valuation of the Property and a verbal valuation was given by the bank to P on 16 July 2010.

19.On about 20 August 2010, Peng signed a provisional agreement on behalf of P to sell the Property to Billion for HK$3.6m.

20.Less than 6 months thereafter, on about 12 January 2011, Billion signed a provisional agreement, by which  the Property was sold to Ku for HK$8.3m.  Billion thus made a profit of HK$4.7m.

21.It was P’s case that D1 had acted in breach of her fiduciary duty. 

22.Further, according to P, D1 had by a confirmation letter 確認書dated 14 August 2012 (“Confirmation Letter”), admitted that she had misled P’s Board of Directors into selling the Property at HK$3.6m which was lower that the market price to Billion, and that D1 had also admitted that she arranged for Billion to purchase the Property and that she had abused the trust of P and authorities conferred on her by P.

23.P said she was induced by duress/pressure exerted by P to sign the Confirmation Letter which was prepared by P, including a threat of report to the ICAC.

24.P issued the writ together with the statement of claim (“SOC”) on 21 June 2013.  The main cause of action of P against D1 was for breach of fiduciary duty with D2 to D4 being her accessories.  As to D2-D4, P’s claim against them is for “dishonest assistance” and “knowing receipt”.

25.D1’s defence was filed on 5 September 2013, and the defence of the other defendants filed on 9 September 2013.  P’s replies to the defences were later filed in October 2013.  The Striking Out Summonses were then taken out by Ds on 6 January 2014.

Legal Principles on Striking Out under Order 18 rule 19(1)(a)

26.There was no real dispute on the general principles on striking out under rule 19(1) (a).  Mr Raymond Lau referred this court to CY Foundation Group Ltd v Best Max Holding Ltd, unreported HCA 787 of 2011, where Recorder Lisa Wong SC approved the commentaries in the Hong Kong Civil Procedure 2013:-

“(1) First, this being an application under rule 19(1) (a) only, no evidence is admissible under rule 19(2). The Court will simply assume the facts as pleaded in the statement of claim to be proved and determine, on that basis, whether he pleading discloses a reasonable cause of action.

(2) Second, the question for the Court is whether the allegations as pleaded in the statement of claim disclose some cause of action or raises some question that ought to be tried. It is not concerned with an assessment of the strength or weakness of the case. The mere fact that the case is weak, and not likely to succeed, is no ground for striking it out. The Court would only strike out when it is impossible, and not just improbable, for the case to succeed.

(3) Third, where a pleading is defective only for want of particulars to which the other side is entitled, particulars (and not an order to strike out the pleading) should have been sought under Order 18, rule 12. The Court can properly refuse to strike out even a pleading seriously lacking in particularity if the defect is not the result of a blatant disregard of Court orders and can be remedied.

(4) Fourth, where a statement of claim does not disclose the cause of action relied upon but there is reason to believe that the case can be improved by amendment, the Court may give an opportunity to amend, even though the formulation of the amendment is not before the Court[1].”

Ds’ Grounds for the Striking Out Summonses

27.D1’s  ground for striking out was that the SOC disclosed no reasonable cause of action for two reasons :

(i) P’s claim against D1 was against the basic company principles of separate legal personality of a company;

(ii) P’s claims fell foul of the “rule against reflective loss” (“Rule”).

28.D2-D4 challenged the locus standi of P in bringing its claims against D1.  As P’s claims against them arose out of the breach of D1’s fiduciary duties, if P could not establish locus for its claims against D1, its claims against D2-D4 ought to be similarly struck out.  They again relied on the Rule.

Legal Principles on the Rule

29.The principles on the Rule originated in Prudential Assurance Co Ltd v Newman Industries Ltd & Others (No 2) [1982] Ch 2014[2] and were authoritatively discussed by the House of Lords in Johnson v Gore Wood & Co [2002] 2 AC 1.  As summarised by Lord Bingham after considering the cases :

“These authorities support the following propositions (1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder’s shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made good if the company’s assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss. … (2) Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding. … (3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by a breach of duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other…[3]

30.Lord Bingham went to add that:-

“These principles do not resolve the crucial decision which a court must make on a strike-out application, whether on the facts pleaded a shareholder’s claim is sustainable in principle, nor the decision which the trial court must make, whether on the facts proved the shareholder’s claim should be upheld. On the one hand the court must respect the principle of company autonomy, ensure that the company’s creditors are not prejudiced by the action of individual shareholders and ensure that a party does not recover compensation for a loss which another party has suffered. On the other, the court must be astute to ensure that the party who has in fact suffered loss is not arbitrarily denied fair compensation. The problem can be resolved only by close scrutiny of the pleadings at the strike-out stage and all the proven facts at the trial stage: the object is to ascertain whether the loss claimed appears to be or is one which would be made good if the company had enforced its full rights against the party responsible, and whether … the loss is “merely a reflection of the loss suffered by the company”. In some cases the answer will be clear, as where the shareholder claims the loss of dividend or a diminution in the value of the shareholding attributable solely to depletion of the company’s assets, or a loss unrelated to the business of the company. In other cases, inevitably, a finer judgment will be called for. At the strike-out stage any reasonable doubt must be resolved in favour of the claimant.” [4]

31.Further Lord Miller had this to say:

“…The problem was that the only conduct relied upon as constituting a breach of that duty was the misappropriation of assets belonging to the old companies, so that the only loss suffered by the plaintiff consisted of the diminution in the value of his shareholding which reflected the depletion of the assets of the old companies. The old companies had their own cause of action to recover their loss, and the plaintiff’s own loss would be fully remedied by the restitution to the companies of the value of the misappropriated assts … If [the plaintiff] were allowed to recover for the diminution in [the shares’] value, and the companies for the depletion of their assets, there would be double recovery. Moreover, if the action were allowed to proceed and the plaintiff were to recover for the lost value of his shares, the defendant’s ability to meet any judgment which the old companies or their liquidators might obtain against him would be impaired to the prejudice of their creditors. The plaintiff would have obtained by a judgment of the court the very same extraction of value from the old companies at the expense of their creditors as the defendant was alleged to have obtained by fraud[5].”

32.The above principles have been applied in a number of subsequent cases including Day v Cook [2002] 1 BCLC 1 and also in Hong Kong in Re Landune International Ltd [2005] 1 HKLRD 39. In that case, the plaintiff was a former director of both C, a company and S, its subsidiary.  The plaintiff petitioned to wind up C on basis of outstanding payments.  Subsequently C and S commenced an action and cross-claimed against parties including the plaintiff for, among other things, fraud.  C acknowledged the debt to the plaintiff but applied to strike-out the plaintiff’s petition on the basis of the unlitigated cross-claim.  C’s application was dismissed by Kwan J, as she then was, on the ground, that among other things, that the cross-claim would be defeated by the Rule, in that any loss suffered by C would merely be reflective of loss suffered by S.  C appealed arguing that (a) the damages claimed were C’s own loss, not a reflective loss, as the primary victim of a fraud; and (b) the fact that C held shares in S should not prejudice its right to recover money as victim of the fraud.

33.The Court of Appeal dismissed C’s appeal in Landune International Ltd v Cheung Chung Leung CACV 225 of 2005, [2006] 1 HKLRD 39, and held that, among other things, the Rule debarred a shareholder from suing to recover a loss which was merely a reflection of the loss suffered by the company of which he was a shareholder. As observed by Yuen JA, it did not matter whether the shareholder (of the company which suffered the direct loss and damage) had its own independent causes of action, as the question remained whether the loss could be recovered if the subject company enforced its rights against the defendant.[6]

34.Mr Raymond Lau further referred to Waddington Ltd and Chan Chun Hoo (2008) 11 HKCFAR 371.  The plaintiff in this case was a minority shareholder of the holding company C, which owned a subsidiary S1, which in turn, wholly owned other subsidiaries including S2 and S3.  The plaintiff alleged that the 1^st defendant, the chairman and executive director of C and a director of all the subsidiaries, had concluded three transactions, one on behalf of S2 and two on behalf of S3, in breach of his fiduciary duties.  The plaintiff sought to bring common law derivative action in this respect.

35.The action was first commenced by the plaintiff suing on behalf of itself and all other shareholders of C except the 1^st and the 2^nd defendants.  The 1^st and the 2^nd defendants took out a striking out application.

36.At First Instance[7], Barma J, as he then was, found that the claims advanced in the derivative action brought by the plaintiff on behalf of C were merely reflective of the alleged losses of C’s sub-subsidiaries, and therefore precluded by the Rule.  He further held that a minority shareholder in a holding company may as a matter of law be allowed to bring proceedings, by a “multiple derivative action” on the wholly-owned sub-subsidiary which had the cause of action, in circumstances where the alleged wrongdoer was effectively in control at every level of the corporate chain.  He applied the threshold test laid down in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, and held that a derivative action by the plaintiff brought on behalf of S2 and S3 would in principle be available.

37.The matter eventually went all the way to the Court of Final Appeal but what was held by Barma J above was agreed by Ribeiro PJ and Lord Millett NPJ.

38.As seen from Waddington, and as submitted by Mr Raymond Lau, the Rule would equally apply to a sub-subsidiary.  As said by Lord Millet PNJ :-

“Any depletion of a subsidiary’s assets causes indirect loss to its parent company and its shareholders. In either case the loss is merely reflective loss mirroring the loss directly sustained by the subsidiary and as such it is not recoverable by the parent company or its shareholders for the reasons stated in Johnson v Gore Wood (supra). But this is a matter of legal policy. It is not because the law does not recognise the loss as a real loss; it is because if creditors are not to be prejudiced the loss must be recouped by the subsidiary and not recovered by its shareholders. It is impossible to understand how a person who has sustained a real albeit reflective loss which is legally recoverable only by a subsidiary can be said to have no legitimate or sufficient interest to bring proceedings on behalf of the subsidiary[8].”

39.Further, the Rule applies to all companies, even if they are in receivership, in liquidation, or have been dissolved[9].

40.Mr Raymond Lau had also referred to Gardner v Parker [2004] EWCA Civ 781where the defendant owned 85% of the issued shares of a company BDC, the remaining 15% being held by trusts created for the benefit of the plaintiff and his family.  BDC’s two largest assets were 9% of the issued share capital of a company S Ltd and a debt owed to BDC by S Ltd. The defendant, the sole director of both BDC and S Ltd procured the transfer by S Ltd of an asset it owned to another company in which he had interest, and BDC went into liquidation subsequently.  The liquidator assigned to the plaintiff all BDC’s rights of action in respect of shares, properties and other assets etc, and the plaintiff brought proceedings against the defendant claiming damages for breach of fiduciary duty alleging, among other things,  that the transfer by S Ltd of the asset had been at a substantial undervalue.  The judge found that the Rule defeated the plaintiff’s claim, and the plaintiff appealed.

41.It was held by the Court of Appeal in England that the Rule was not concerned with barring causes of action as such but with barring recovery of certain types of loss and therefore whether the cause of action lay in common law or equity and whether the remedy lay in damages or restitution made no difference as to its applicability.  Since the foundation of the Rule was the need to avoid double recovery, there was a powerful case for saying that it should be applied in a case where, in its absence, both the beneficiary and the company would be able to recover effectively the same damages from the defaulting trustee/director, and accordingly the fact that a claim was brought for breach of fiduciary duty did not prevent the claim being barred by the application of the Rule[10].

42.It is further clear from Pico North Asia Holdings Limited and Cheung Yuk Ting and Another, HCA 1371/2009, 8 February 2011 that the Rule is not limited to claims for damages.  Fok J, as he then was, had also said that the defendants in that action could owe different fiduciary duties to the plaintiff, by reason of the alleged relationship of trust and confidence arising from their business dealings to those owed by them and this did not affect the application of the Rule.

43.With the above principles in mind, I turn to the present applications.

Discussion

44.There was no real dispute between the parties on the general principles set out in Johnson v Gore Wood in relation to the Rule.  The main dispute before this court is whether the Rule applies in the circumstances of this case. 

45.In the present action, P is suing in its own capacity as employer of D1.  P has not brought a derivative action suing on behalf itself and/or other shareholders in Contrive and/or in Hopely.  Neither Contrive nor Hopely has been named as a plaintiff, or as a defendant. So far as this court was aware, no leave had been sought or obtained by P to commence a derivative action under section 733, Part 14, Division 4, the Companies Ordinance, Cap 622.  P’s case was that it was not suing in the capacity as one of the ultimate shareholders/owners of Hopely[11].

46.Mr Tsui submitted that the questions to be asked in the present applications were:

a. to whom the fiduciary duty is owed? 

b. did D1 owe any fiduciary duty to Hopely?

c. who suffered the loss?

d. in what capacity did the plaintiff claim that loss?

47.Mr Tsui further submitted that the fiduciary duty was owed by D1 to P, and not to Hopely, as D1 was not employed by Hopely, and save that D1 was required by P in the course of her employment with P to handle the financial matters of Hopely, D1 had no other relation with Hopely.  It was P who suffered loss in its capacity as D1’s employer.  Thus, it was Mr Tsui’s submission that P’s claims, as further set out in the proposed amended SOC, would not offend against the Rule.

48.Mr Tsui had relied on a New Zealand case Christensen v Scott [1996] 1 NZLR 273.  In that case, the Court of Appeal in Wellington referring to the case of Prudential Assurance Co Ltd and while accepting that what was said by the English Court of Appeal that a member had no right to sue directly in respect of a breach of duty owed to the company was correct, went on to say that this would not necessarily  exclude a claim brought by a party, also a member, to whom a separate duty was owed and who suffered a personal loss as a result of a breach of that duty.

49.Mr Tsui had submitted that Lord Hutton in Johnson v Gore Wood had quoted what was said above in Christensen v Scott and it was Mr Tsui’s submission that there was at least scope of argument as to whether the approach in Christensen v Scott would be preferable.

50.Lord Hutton had said in Johnson v Gore Wood was as follows:

“... In my opinion the resolution of the conflict between Prudential Assurance and Christensen v Scott narrows down to the issue whether, as held in the former case, the shareholder is debarred from bringing to trial an action claiming loss where such loss is merely reflective of loss suffered by the company, or whether the shareholder is entitled to proceed to trial on such a claim, it being a matter for the trial judge, if the plaintiff establishes his claim, to ensure that there is no double recovery and that creditors and other shareholders of the company to not suffer loss, which was the course which Pumfrey J held should be followed.

My Lords, whilst in a case such as Christensen v Scott there may be merit in permitting an individual shareholder to sue, the decision in Prudential Assurance has stood in England for almost 20 years and, whilst the decision has sometimes been distinguished on inadequate grounds, it has been regarded as establishing a clear principle which the Court of Appeal has followed in other cases.  I further consider that the principle has the advantage that, rather than leaving the protection of creditors and other shareholders of the company to be given by the trial judge in the complexities of a trial to determine the validity of the claim made by the plaintiff against the defendant, where conflicts of interest may arise between directors and some shareholders, or between the liquidator and some shareholders, the principle ensures at the outset of proceedings that where the loss suffered by the plaintiff is sustained because of loss to the coffers of the company, there will be no double recover at the expense of the defendant nor los to creditors of the company and other shareholders.  Therefore, whilst I think that this House should uphold the Prudential Assurance principle, I also consider that it is important to emphasis that the principle does not apply where the loss suffered by the shareholder is separate and distinct from the loss suffered by the company[12].”

51.Thus, Lord Hutton was clearly of the view that the principle in Prudential Assurance should be upheld and in his view that the principle should not apply where the loss suffered by the shareholder was separate and distinct from the loss suffered by the company. 

52.Mr Raymond Lau had submitted that what was said in Christensen v Scott and by Lord Hutton above in Johnson v Gore Wood was against the weight of the authorities. In any event, so far as the present case is concerned, I do not consider that any of the loss and damage said to have been suffered by P in the present case, can be said to be in any way separate and distinct from the losses suffered by Hopely.  This is because on P’s own case, and as set out in its answers to D1’s request for further and better particulars in this respect, P had stated clearly that the loss and damage suffered by P was in its capacity as the majority shareholder of Hopely and were the profits that could have been made by Hopely if the Property had been sold at the market price.[13]

53.Further, while it is arguable that D1 owed P fiduciary duties as pleaded, that by itself does not mean that Hopely does not have any cause of action against D1 on the assumed facts.

54.As pointed out by Mr Raymond Lau, on the assumed facts pleaded in the SOC, Hopely has causes of action against the defendants including conspiracy by unlawful means by way of misrepresentation. 

55.Also, 30% of Hopely was held by other shareholders apart from Contrive, and Mr Lau submitted that it would be plainly wrong that P should recover the loss of Hopely to the exclusion of other shareholders or creditors.

56.Having considered the above, in my view, whatever causes of action P has against D1, its loss and damage are reflective of the loss suffered by Contrive or Hopely.  I am also of the view that the defects in the SOC are not curable by P’s present proposed amendments of the SOC. 

57.Although, prima facie, on the facts pleaded, a derivative action may be available on behalf of Hopely, P had not asked the court to give it a further opportunity to seek leave to reformulate or to reconstitute its pleadings/claims.

58.In the light of the above, I accept both Mr Laus’ submissions that P’s claims in this action offend against the Rule and should accordingly be struck out as disclosing no reasonable cause of action, and P’s action should be dismissed.

Orders

59.My order is thus :-

(i) P’s  statement of claim against the defendants be struck out;

(ii) P’s present action against the defendants be dismissed;

(iii) P’s summons of 12 February 2014 be dismissed.

60.As for costs, D1 has sought costs on indemnity basis.  At this stage, I am only prepared to order P to pay the defendants’ costs of all the summonses on party and party basis.  This is an order nisi, which shall be made final after 21 days.

Mr Raymond Tsui and Mr Freddy FK Tsang, instructed by Tang Tso & Lau, for the plaintiff

Mr Raymond Lau, instructed by Foo Leung & Yeung, for the 1^st defendant

Mr Roland Lau and Miss Soo Kyung Baek, instructed by Ambrose Ng & Co, for the 2^nd, 3^rd and 4^th defendants

[1] See para 2

[2] See para 19, Landune International Ltd and Cheung Chung Leung CACV 225 of 2005

[3] At 35E

[4] At 36E

[5] 64A-D

[6] At 44H-46C

[7] HCA 3291/2003, 29 April 2005, at para 36

[8] At para 74

[9] Minority Shareholders, Joffe QC et al: Law Practice and Procedure, 4^th Edition 4-115

[10] See Holding (1), on pg 555

[11] See para 27, P skeleton submissions

[12] At pg 55C-H

[13] Answer to request 1(a), B:49