Chinacast Education Corporation and Others v. Chan Tze Ngon and Others

HCA 1062/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

HIGH COURT ACTION NO 1062 OF 2012

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BETWEEN

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D E C I S I O N

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The applications

1.There are 2 applications by Sena (the 2^nd defendant) under O.16 r.1 of RHC: one taken out on 24 June 2014 against Tseung and the other on 25 June 2014 against Deloitte, for leave to issue a third party notice against each of them for contribution/indemnity of the Group’s (the plaintiffs’) claim against him in this Action (“the 3^rd Party Applications”).

2.The 2^nd defendant’s application was made ex parte before Master K. Lo, who ordered that the application should be made inter partes.  Hence this hearing.[1]

3.The 3^rd Party Applications are resisted by the plaintiffs whereas the other defendants in this Action all take a neutral stance.

The factual background

4.Mr. Justice A. Chan has, in his written decision delivered on 26 September 2014 on the appeal by the 2^nd defendant in respect of the issue of security for costs against the plaintiffs, set out the outline facts of the matter. For the present purpose, it is sufficient to reiterate his summary here.  In a nutshell, the plaintiffs were members of the GEC Group.  They were operating a profitable business in the Mainland and in possession of a considerable amount of cash.  Precipitated by a dispute within the management which took place in 2011, the plaintiffs fell victim to a massive fraud involving a number of their ousted executives (the 1^st to 4^th defendants).  It is alleged that those defendants were either parties to the fraud or had assisted in its commission.  As a result of the fraud, the plaintiffs were stripped of their cash and assets.

The relevant legal basis

5.The relevant parts of Order 16 for this application are set out below:

1.  Third party notice (O. 16, r. 1)

(1) Where in any action a defendant who has given notice of intention to defend-

(a)  claims against a person not already a party to the action any contribution or indemnity; or

(b)  claims against such a person any relief or remedy relating to or connected with the original subject-matter of the action and substantially the same as some relief or remedy claimed by the plaintiff, or

(c)  requires that any question or issue relating to or connected with the original subject-matter of the action should be determined not only as between the plaintiff and the defendant but also as between either or both of them and a person not already a party to the action;

then, subject to paragraph (2), the defendant may issue a notice in Form No. 20 or 21 in Appendix A, whichever is appropriate (in this Order referred to as a third party notice), containing a statement of the nature of the claim made against him and, as the case may be, either of the nature and grounds of the claim made by him or of the question or issue required to be determined. (emphasis added)

2. Application for leave to issue third party notice (O. 16, r. 2)

(1)  Application for leave to issue a third party notice may be made ex parte but the Court may direct a summons for leave to be issued.

(2)  An application for leave to issue a third party notice must be supported by an affidavit stating-

(a)  the nature of the claim made by the plaintiff in the action;

(b)  the stage which proceedings in the action have reached;

(c)  the nature of the claim made by the applicant or particulars of the question or issue required to be determined, as the case may be, and the facts on which the proposed third party notice is based; and

(d)   the name and address of the person against whom the third party notice is to be issued. (emphasis added)

8. Claims and issues between a defendant

  and some other party (O. 16, r. 8)

(1)  Where in any action a defendant who has given notice of intention to defend-

(2)   Where a defendant makes such a claim as is mentioned in paragraph (1) and that claim could be made by him by counterclaim in the action, paragraph (1) shall not apply in relation to the claim.

6.Mr. Wong, counsel for the plaintiffs refers to the general legal principles as set out in Hong Kong Civil Procedure 2014 (Note 16/2/5):

(1)  the Court has a general discretion in all cases whether or not allow a third party notice to issue;

(2)  if a prima facie case is made out which would bring the matter within any paragraph of rule 1(1), leave will be granted to issue the notice;

(3)  the Court will not in granting leave, consider the merits of the claim but will leave these matters and objections by the plaintiff to be dealt with upon the application for directions under rule 4.

The grounds of objection

7.The plaintiffs will rely upon the follow grounds of objection:

i.  There is no useful purpose to take out the application against Tseung, the chairman of the Audit Committee, whose liability will reduce the 2^nd defendant’s liability as pleaded in the pleadings[2];

ii.  There is a lack of particulars in the notice as provided under rule 1(c );

iii.  The 2^nd defendant had not pleaded the he relied upon Civil Liability (Contribution) OrdinanceCap 377 (“the Ordinance”). See Grandregal Enterprises Ltd v Sitwell Estates Ltd [2003] 2 HKC 306 §§14-15;

iv.  The 2^nd defendant has failed to explain why the Ordinance is applicable for his claim; and

v.  The 2^nd defendant has failed to satisfy “the same damage” as provided under section 3 of the Ordinance.

Discussion

8.Mr. Yeung acting for the 2^nd defendant submits that at this leave stage, the Court will only consider the plaintiffs’ complaint on delay as decided in So Kai Hau v YSK2 Engineering Co Ltd [2010]5 HKLRD 278 by Master M. Ng ( as she then was) and a prima facie case that the 2^nd defendant can establish against the third parties.  As to the particulars or the merits of his case, that will be for the stage of directions to be given under the third party proceedings.  However, he agrees that even at this stage if it can be shown that the third party proceedings are bound to fail, such as that raised by the plaintiffs that it does not serve any useful purposes, the Court should take that into consideration in exercising its discretion in this leave application.

9.Upon my query as to why the issue of the personal liability of Mr. Tseung, the chairman of the Audit Committee should be investigated in the trial, Mr. Yeung submits that in paragraph 54 of the Amended Defence and Counterclaim [175], the 2^nd defendant had pleaded that even if the 3^rd and the 4^th plaintiffs had entered into the unauthorized loans, which was denied, the plaintiffs had failed to mitigate their loss or damage by failing to ensure that the Audit Committee discharged its statutory duty to supervise and/or maintain an effective system of internal control of financial reporting and he set out the various reports which showed that no authorized loans were entered into.

10.I have been referred to various paragraphs in the pleadings concerning this common issue between the main action and the third party proceedings. In the third party notice [10], the 2^nd defendant said that the plaintiffs claimed against him for damages arising from the inaccuracies of the financial statements of the 1^st plaintiff and he was responsible as the Chief Financial Officer of the 1^st plaintiff and he wanted to hold Mr. Tseung as the chairman of the Audit Committee liable if he were held liable.  So he said at paragraph 32 of his 8^th affidavit [316]: “If I had been negligent in the review of those financial statements, it must follow that members of AC should similarly be negligent in the discharge of their duties.”  On the same basis, he held Deloitte liable as the third party as well.

11.However, upon analysis of the pleadings, it appears clear that the plaintiffs did not, in their pleaded case, complain the compilation of the financial statements or reports, but rather the misconduct of the 2^nd defendant in his conspiracy with other defendants in dissipating the plaintiffs’ assets and cash.  At trial, the court should not be concerned with how the financial statements or reports were compiled by Deloitte or the Audit Committee.  The real issues of dispute will be the facts whether the 2^nd defendant had conspired with other defendants to defraud the plaintiffs as pleaded in the pleadings.

12.Mr. Wong comments that the 2^nd defendant has failed to explain what perceived advantage would accrue to him by joining Tseung.  The requirements under O.16, r.2 is a mandatory provision, which must be complied with before the Court considers the application for third party proceedings.  The requirements are necessary for the Court to consider exercising its discretion as to whether leave should be given to the 2^nd defendant to issue the notice.  Absent such information, the application is a non-starter.  This will support the plaintiffs’ argument that the 2^nd defendant has taken out this application as delaying tactics, more so when the application is taken out belatedly, immediately before leave is given to the plaintiffs to set down for trial.

13.It is therefore difficult for this Court to understand the bases upon which the 2^nd defendant makes this application against Tseung and Deloitte from the affidavit evidence. The 2^nd defendant’s solicitor has, in his written submissions, attempted to state the reasons in support of this application.  I shall now quote the relevant parts as follows:

“Defence of Sena to the Group’s claim

8. It is denied by Sena in his Defence and Counterclaim (“Sena’s Def”) that he was a party of the fraud perpetrated by others against the Group or was involved with or rendered any assistance in the commission of any the Unlawful Acts.

9. Insofar as the alleged breach of his contractual duties, it is Sena’s case that he has always performed his contractual duties consistent with the terms of his service agreement including

(a) working with Deloitte and AC on the statutory filings with US authorities (para 22);

(b) liaising with Deloitte on behalf of CEC in relation to the statutory filings, “preparing the narrative portion of 2011 Form 10K so that once Deloitte completed the financial portion, the full annual report could be submitted at the earliest possible time” (para 25.7); and

(c) if Sena had failed to discharge his duties in maintaining an effective system of internal control of accounting practices, the Group failed to mitigate their loss by ensuring that AC (of which Tseung was the Chairman) would discharge its statutory duty to supervise Sena (para 54).

10.  It follows that Sena has established a prima facie case that both Deloitte and Tseung should at least be equally liable to the Group for the alleged loss and damage suffered by them arising from the fraud for their breach of contractual duties as independent auditor of the Group and breach of his statutory duties as Chairman of AC.”

14.It must be pointed out here that in the affidavit of the 2^nd defendant, there is a confusion as to the real issues to be tried at the trial as mentioned above.

15.In the written submissions, the relevant parts of the pleadings have not been identified for verification.  This is not helpful for the Court, especially for interlocutory applications hearing where the Court is not given sufficient time to prepare for the matter as the trial judge preparing for the trial.  This is the reason why we have to spend quite a lot of time on the references to the pleadings today.

16.However, the plaintiffs object to the application, saying that even if there were inaccuracies in the financial statements which the audit committee ought to have revealed, there is no casual relationship between the deficiency in the audit committee’s performance of its function and the losses currently suffered by the plaintiffs as the accuracy of the financial statements affected the share price, which can be affected by other factors too.[3]  The same comments also apply to the application to join Deloitte.[4] To this proposition, the 2^nd defendant has made no response.

17.In the plaintiffs’ counsel’s written submissions at §9, the plaintiffs said “the Plaintiffs in their Reply have not mounted a case that they are not responsible for any proven default or omission on the part of the Audit Committee.  See Reply and Defence to Counterclaim §100 [1/228].”

18.The plaintiffs therefore argue that the present application is not necessary.  It will only cause more costs and further delay in the progress of this Action.

19.On the issue of lack of particulars in the third party notice, the plaintiffs submit that the notice is defective in that it has not disclosed the bases upon which indemnity or contribution is claimed, rendering it impossible for the plaintiffs to challenge the validity of the claims or the Court to make the decision.  The Court should be able to hear arguments on this issue and make the decisions accordingly as in Lee Tak Yan & Ors v The Prudential Enterprises Ltd & Ors, HCA 4225 of 2001, 27 May 2003 §§40-59 and 64-69.  If the 2^nd defendant relies upon the Contribution Ordinance, Cap.377, he had not pleaded specifically in his pleadings.  Even if the notice is to be treated as a writ, it has to disclose the nature of the claims against the defendants, which the notice has failed to do.  See Ting Siu Wing v Chan Kwok Bun [2012] 5 HKC 87 §8.

20.It appears that it is unnecessary to discuss the pleading of foreign law in the notice as argued by Mr. Wong, counsel for the plaintiffs as he agrees that if the application is made under section 3 of the Contribution Ordinance, the damage has to be the same as the plaintiffs claimed against the 2^nd defendant, the legal basis of which must be the same as well.

21.The plaintiffs have accused the 2^nd defendant’s application being a delaying tactics[5], which the 2^nd defendant disagrees.

22.There comes the consideration of proportionality of the damage claimed by the plaintiffs against the 2^nd defendant and the claim of contribution or indemnity under the notice.  It can be seen at once that the claim under this notice is only a very small part of the claims in this Action against the defendants, including the 2^nd defendant.  To allow the 2^nd defendant’s application will inevitably cause delay in this Action for over one year.  One has to bear in mind that if Tseung and Deloitte were joined as third parties, they have to take part in the main action, which will take the major part of the trial and will undoubtedly expose huge amount of costs for the third parties.  Mr. Wong will be quite right to point out that if the third party proceedings were to proceed, the issue of multi-jurisdictions will come into the proceedings, which will prolong the trial or even muddle the real issues of dispute between the plaintiffs and the 2^nd defendant.  As to delay, the 2^nd defendant has already warned that there will be other defendants taking out similar applications as well.  This will envisage a further delay in the progress of this Action.  The exercise of the Court’s discretion has to keep in line with the objectives of the CJR, saving costs and time for the parties and the Court.  The disadvantage of allowing these applications appear outweigh the advantage.

23.The 2^nd defendant has no answer to the above comments.  In the end, the 2^nd defendant’s application has to be dismissed.

24.On the costs of this application, including the costs reserved and today’s hearing, they should be given to the plaintiffs who have succeeded (with counsel’s certificate) and they are to be assessed under O.62, r.9A RHC at $180,000 to be paid by the 2^nd defendant to the plaintiffs within 14 days from the date hereof.

Mr. Jonathan Wong, instructed by Fried, Frank, Harris, Shriver & Jacobson for the plaintiffs

Mr. Leslie Yeung Kwok Leung, of C.L. Chow & Macksion Chan, for the 2^nd defendant