QIYANG LTD AND OTHERS v. MEI LI NEW ENERGY LTD AND OTHERS

HCA 420/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 420 OF 2011

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J U D G M E N T

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INTRODUCTION

1.  By a decision dated 26 May 2016 (“the Decision”), To J found that Messrs CL Chow & Macksion Chan (“CLCMC”) did not have authority to represent D1 (“Mei Li”) in this action following the bankruptcy of D2 (“Chung”).

2.  To J ordered Mei Li to pay costs of P3 (“Listco”) of 2 Summonses, ie a Leave to Appeal Summons taken out in its name and the Authority Summons taken out by Listco, both on indemnity basis.  He also ordered CLCMC to show cause as to why a wasted costs order should not be made against the firm personally.  The costs as between Mei Li and the Trustees were reserved pending resolution of the wasted costs application.

3.  This is a hearing for CLCMC to show cause.

BACKGROUND

4.  In 2012, Mei Li made an application for summary judgment against Listco in the present action, which was heard by To J.  Whilst judgment was pending, a bankruptcy order was made by me against Chung on 27 February 2013.  On 5 March 2013, To J dismissed Mei Li’s application for summary judgment. 

5.  On 19 March 2013, D S Cheung & Co (“DSC”), solicitors, took out the Leave to Appeal Summons in respect of To J’s judgment.  As early as 9 April 2013, Listco had challenged DSC’s authority. DSC did not reply but CLCMC filed a Notice of Change of Solicitors for Mei Li.

6.  On 7 May 2013, Listco issued the Authority Summons seeking to set aside the Leave to Appeal Summons and the Notice of Change of Solicitors for want of authority of CLCMC.

7.  Three years later, by the Decision, To J held that Chung was the beneficial owner of the shares in Mei Li and Rare Earth.  Rare Earth’s interest in Mei Li was vested in the Trustees upon Chung’s bankruptcy.  Rare Earth, being a legal owner of the shares in Mei Li, voted for the appointment of Huang, niece of Chung, as director of Mei Li after Chung’s bankruptcy, without the authority of the Trustees.  The appointment was invalid and so were the subsequent resolutions passed by Mei Li to appoint CLCMC.  To J found that CLCMC had no authority to act for Mei Li, such that the Leave to Appeal Summons and the Notice of Change of Solicitors were set aside. 

8.  Listco and the Trustees asked for CLCMC to bear the wasted costs of the 2 Summonses. To J was of the view that CLCMC was on the face responsible and asked CLCMC to show cause.

9.  Listco’s case is simple.  CLCMC has been warned all the way since 7 April 2013 by Listco that they lacked authority, that Mei Li belonged beneficially to Chung (as evidenced by, amongst others, his own IVA proposal) and that if CLCMC were to proceed, they would have to bear indemnity costs. Accordingly, CLCMC should be liable for wasted costs.  Listco relies only on the statutory authority of the court.

10.  The Trustees support Listco’s application but also relies on inherent jurisdiction of the court.  By a lengthy letter dated 28 May 2015, the Trustees set out why they considered Chung to be beneficial owner of Mei Li and how Chung used Rare Earth, Mei Li and Huang as devices or puppets to hinder administration of his estate.  The Trustees clearly told CLCMC to cease acting or else they would be held liable.

11.  The Trustees also assert that CLCMC knew very well that the shares in Rare Earth and Mei Li have been vested in the Trustees, yet CLCMC preferred the interest of Chung and Huang above that of Mei Li.  There was serious conflict of interest when CLCMC acted for Mei Li without the prior consent of the Trustees.  As shareholders of Rare Earth, the Trustees have good causes of action (including breach of fiduciary duties, negligence, professional negligence, unlawful interference and conspiracy) against both Huang and CLCMC for costs already incurred by Mei Li and an indemnity of any adverse costs order against Mei Li arising from the 2 Summonses.CLCMC knew exactly what was going on as they have previously acted for Chung and then acted for Huang in the summons taken out by the Trustees to take over the beneficial interest of Chung in Mei Li and Rare Earth (“the Take-Over Summons”). If CLCMC does not bear costs personally, it will be ultimately unfair on Chung’s creditors.

EXPLANATIONS OF CLCMC AS TO ITS CONDUCT

12.  In summary, CLCMC’s explanations can be classified as:

(a) Advancing arguments upon the advice of counsel;

(b) Lack of bases for the Trustees’ serious allegations; and

(c) No liability for the additional costs incurred as a result of last minute adjournment sought by the Trustees.

13.  CLCMC submits that the statutory jurisdiction requires proof of improper and unreasonable conduct on their part, which is lacking in the present case. 

LEGAL PRINCIPLES FOR MAKING WASTED COSTS ORDER

14.  Where a solicitor is held to have acted without authority, the court has power to order him to personally bear costs thrown away under 2 types of jurisdiction:

(a) Inherent jurisdiction, under which the solicitor is required to bear costs because of his breach of warranty of authority; the liability is strict.

(b) Statutory jurisdiction under section 52A of the High Court Ordinance (Cap 4), and Order 62, rules 8 and 8A of the Rules of the High Court (Cap 4A).  This is fault-based.  The court has to find that the solicitor acted “improperly or unreasonably”.

15.  Order 62 rule 8 provides:

“(1) The Court may make a wasted costs order against a legal representative, only if-

(a) the legal representative, whether personally or through his employee or agent, has caused a party to incur wasted costs as defined in section 52A(6) of the Ordinance; and

(b) it is just in all the circumstances to order the legal representative to compensate the party for the whole or part of those costs.

(2) A wasted costs order may-

(a) disallow the costs as between the legal representative and his client; and

(b) direct the legal representative to-

(i) repay to his client costs which the client has been ordered to pay to other parties to the proceedings; or

(ii) indemnify other parties against costs incurred by them.

(3) The Court shall give the legal representative a reasonable opportunity to attend a hearing to give reasons why it should not make the order.”

16.  Rule 8A provides that the court may make a wasted costs order on its own motion or upon application and deal with it after the conclusion of the proceedings to which the order relates.  It is usually made by the judge who heard the substantive proceedings but, in the present case, To J has retired by the time CLCMC’s showing cause is heard.

17.  “Wasted costs” are defined in section 52A(6) of the High Court Ordinance (Cap 4) as:

“any costs incurred by a party as a result of—

(a) an improper or unreasonable act or omission; or

(b) any undue delay or other misconduct or default,

on the part of any legal representative, whether personally or through an employee or agent of the legal representative.” (underline added)

18.  The court has to consider 3 questions before making a wasted costs order: Ma So So v Chin Yuk Lun & anor (2004) 7 HKCFAR 300, Li CJ, at §6:

(a) Responsibility, ie whether the solicitor was responsible for (i) acting improperly or without reasonable cause or (ii) for undue delay or any other misconduct or default in any proceedings;

(b) Causation, ie whether the causal link between the solicitor’s conduct and the extent of costs incurred or wasted is established; and

(c) Discretion, ie whether the court should make the order.

19.  Even where the Court is satisfied as to the answers to questions (a) and (b), the court is not bound to make an order, but where it declines to do so, it must give sustainable reasons: Ma So So, §14.

20.  The jurisdiction is summary in nature.  It has to be exercised with care and only in clear cases where the need for an order is reasonably obvious: Ma So So, §§8-10.  For example, an order should only be made if the conduct complained of amounts to “a serious dereliction of duty”: Ho Lee Man v Wong Wai Kai (No 2) [1993] 1 HKC 193 at 196D-G (Litton JA, as he then was).

21.  Error of judgment, failure to apply any judgment at all to a case which renders a weak case hopeless or even negligence is not sufficient: Dolphin Advertising Ltd v Tronken Enterprises Ltd [2010] 1 HKC 137, §§9-10 &14, Harris J.  This is different from the English position where gross negligence is sufficient: Ridehalgh v Horsefield [1994] Ch 205, at 227D, Bingham MR.

22.  There is a distinction between solicitors presenting a hopeless case and lending assistance to proceedings which are an abuse of process of the court.  It is not entirely easy to distinguish the two by definition, but in practice it is not hard to say which is which. If there is doubt the solicitor is entitled to the benefit of it.  See Ridehalgh 234D-F.

23.  In particular, Sir Thomas Bingham MR in Ridehalgh v Horsefield [1994] Ch 205 explained “improper” and “unreasonable” as follows:

(a) “Improper” conduct means conduct which would ordinarily be held to justify disbarment, striking off, suspension from practice or other serious professional penalty. It covers any significant breach of a substantial duty imposed by a relevant code of professional conduct, as well as conduct which would be regarded as improper according to the consensus of professional (including judicial) opinion, whether or not such conduct violates the letter of a professional code: 232D‑E.

(b) “Unreasonable” means conduct which is vexatious, designed to harass the other side rather than advance the resolution of the case and it makes no difference that the conduct is the product of excessive zeal or improper motive, the test being whether the conduct permits of a reasonable explanation: 232E-G.

24.  The rationale for this high threshold is that solicitors should be allowed to do his best for his client without fear of being visited with a wasted costs order.  Accordingly, section 52A(5) HCO requires the court to, “in addition to all other relevant circumstances, take into account the interest that there be fearless advocacy under the adversarial system of justice.”  See also Ho Lee Man at 196A-C.

25.  The solicitor concerned should be informed of the allegations made against him: the conduct complained of, how such conduct caused costs to be incurred or wasted and all other circumstances relied on: Ma So So,§21.

26.  The burden is on the applicant to satisfy the court that a wasted court order should be made. Where the court calls upon the solicitor to show cause, this only shifts the evidential burden: Ma So So, §23.

27.  In exercising the wasted costs jurisdiction, the court must be astute not to treat the adverse findings against the losing party as adverse findings against the solicitors.  Those findings bind the parties but not the solicitor whose account the court has not heard.  As DHCJ To (as he then was) explained in Pine Enterprises Ltd v Cyber Strategy Ltd & ors, HCA 1221/2006, 27 March 2009:

“15. …While the judge may take notice of what happened in the proceedings before him, he has no idea of what transpired between the solicitor and his client outside the courtroom. Thus, when acting on his own finding of fact in the earlier proceedings before him, the judge must be careful not to assume adverse finding against the client as if it were adverse finding against his solicitor or to draw adverse inference from such finding against the solicitor unless it is in all the circumstances reasonable to do so. Even if the court comes to the view that the proceedings were an abuse of the process of the court, it cannot jump to the conclusion that the solicitor knowingly assisted in abusing the legal process. Fairness requires that the solicitor should be given the chance to be heard by filing affidavits or giving oral testimony, if the solicitor so desires. (underline added)

16. Furthermore, when relying on finding of fact in the earlier proceedings, the judge must be wary and not to allow himself to be carried away by the benefit of hindsight”.

28.  Although solicitors cannot automatically shelter behind counsel, if the circumstances warrant it, they may be justified in relying upon counsel’s advice: Hong Kong Civil Procedure 2017,Vol 1, p 1203.

29.  Ms Cheung, supported by Mr Chong, relies on the proposition that a solicitor, under an implied warranty of authority, who turns out not to have the authority, has to bear costs.  The solicitor’s bona fides is irrelevant:  Grand Field Group Holdings Ltd v Tsang Wai Lun Wayland & ors[2010] 5 HKC 441 at §12, Poon J (as he then was), applying Yonge v Toynbee [1910] 1 KB 215.

“When a solicitor purports to act for a client in an action, he impliedly warrants that he has the authority to represent the client. If it later transpires that in fact he did not have such authority, he has acted in breach of the implied warranty. The court would normally order him to personally pay the costs needlessly incurred by the opposing party. It matters not whether the solicitor has acted bona fide and in reasonable reliance of the instructions; or that he has been deceived into believing that he had the authority to act for the client; or that quite innocently he did not know that there was no authority or the authority once existed and ceased to exist.”

30.  Grand Field was followed in Kim Lung Transportation Co & ors v Ip Man Fai & anor, HCA 271/2012, 6 June 2012, Deputy Judge Pow SC. However, the learned Deputy Judge held that in order for the principle to apply, it is necessary that the other party has relied on the authority.  Since there was an application to strike-out the action on the grounds of want of authority, it follows that there could not have been reliance by the defendants on the warranty and so the solicitors were not liable for cost. 

31.  Harris J took a different view.  An applicant for strike out for want of authority is necessarily indicating that he does not accept that the solicitor has authority.  The solicitor who is not properly instructed will be prima facie liable to pay the costs incurred by the successful applicant.  Otherwise in most cases this would render the principle that the solicitor is liable for costs inapplicable:Hong Kong Chiu Chow Po Hing Buddhism Association Ltd, HCMP 506/2013, 29 August 2013 at §27.

32.  I share the view of Harris J, for otherwise, a party who is quick to dispute a solicitor’s authority by issuing strike-out proceedings will be in a worse off situation than one who relied on the authority thereby letting costs build up in the meantime.

33.  However, the English position is that Yonge v Toynbee was still regarded as good law.  In Zoya Ltd v Sheikh Nasir Ahmed (No.2) [2016] 4 WLR 174 §§35-40, William Trower QC sitting as a Deputy High Court Judge maintains that a claim for breach of warranty is contractual in nature and there must be both reliance and casual link between the breach of warranty and the loss claimed.  No warranty of authority arose in circumstances where the litigation was about the very authority alleged to exist.  The learned Deputy Judge stated, obiter, that a person in the position of the sole director of the company in that case was highly susceptible to the modern third party costs order as if he were the true litigant.  It would be more appropriate to make such a person liable than make the solicitor strictly liable for breach of warranty of authority.

34.  That said, I do not think Grand Field or the Buddhism Association case assist Listco or the Trustees.  Those 2 cases are not premised on the statutory jurisdiction of the court and Ms Cheung has expressly disavowed reliance on the court’s inherent jurisdiction. 

35.  Mr Chong purports to rely on inherent jurisdiction which is a strict liability (Babury Ltd v London Industrial plc & anor (1989) 139 NLJ 1596).  He submits that CLCMC should have left the claimed legal owner and beneficial owner to fight between themselves instead of wasting funds of Mei Li.  He also points out that CLCMC had expressly (not just impliedly) warranted authority. Warning letters have been issued all along the way to CLCMC.

36.  The fight between legal and beneficial owners is a matter relevant to Trustees’ but not Listco’s costs.  I do not think implied or express authority is ever a point of distinction in the authorities.  Warning letters do not take the Trustee’s case further.  Warning letters were also issued in Zoya.

37.  The Trustees are only here to support Listco.  The difficulty remains, that an applicant for wasted costs bears the burden of proof and has to inform the solicitor of the “charge” he faces.  Here, CLCMC only faces one charge for wasted costs under statutory jurisdiction and no other: §§4 and 7 of To J’s order dated 26 May 2016. 

38.  Moreover, given the high threshold for a wasted costs order, “fault” of the solicitor has to be established beyond lack of authority.  In Ma Hing Yin Caroline v Crowncity Engineering Ltd & anor, HCPI 83/2005, 16 May 2006, DHCJ Muttrie held at §17 that acting without authority amounted to acting “improperly or without reasonable cause” for the purpose of the wasted costs jurisdiction. I agree with Ms Eu SC that, in the light of the authorities cited above (which the learned Deputy Judge appeared not to have the benefit of), that holding was too wide, although the wasted costs order was justified on the facts of that case.

39.  Accordingly, I rely on the principles in paragraphs 14-28 above for resolution of this matter.

ANALYSES OF CLCMC’S EXPLANATIONS

Explanation (a) – Advancing arguments upon the advice of counsel

40.  The core issue before To J which led to the costs order nisi was issue 4 (§§17, 18 & 21 of the Decision).

41.  CLCMC was only approached by Huang in April 2013, ie after Chung’s bankruptcy and there was no evidence to contradict this. CLCMC only acted for Mei Li, although at one stage Chung had also instructed CLCMC to prepare his statement of affairs.  The Trustees’ assertion that Chung was CLCMC’s long term client had no basis.

42.  CLCMC acted on the basis that according to Mei Li’s register of members, Rare Earth was the sole shareholder entitled to vote for Huang’s appointment as director.  CLCMC was appointed by the board of directors of Mei Li.  CLCMC received the supporting documents of authority from Huang, which were on their face regular.  CLCMC’s view on valid authorization was shared by one junior and 2 senior counsel.  In fact, To J accepted the documents relied upon by CLCMC to be authentic (§27 of the Decision).

43.  As a matter of company law, the company was entitled to take no notice of any trust behind its shares:  Re Universal Horizon Investment Ltd [2000] 3 HKC 627, at 630C-E (Rogers JA).  Notwithstanding Chung’s bankruptcy, Rare Earth remained the sole entity entitled to vote.  The fact that the vote was exercised without prior consultation with the beneficial owner would not render the vote invalid.  Any breach of trust was a matter between the shareholder (Rare Earth) and the beneficial owner (Chung/the Trustees).  So Huang alone had the authority (until her appointment was set aside) to act on behalf of Mei Li to appoint solicitors.  The views of the legal and beneficial owners were irrelevant.

44.  To J disagreed with this argument (§§35-43 of the Decision).  He decided that the burden of proof lay on CLCMC or Mei Li as to whether the bankruptcy order or the resolution to appoint Huang came first.  As Chung only resigned on the day of the bankruptcy order, it strongly suggested that the bankruptcy came first.  It would be fair to say that To J’s finding was based on reasonable inference as opposed to there being direct evidence. 

45.  Further, Ms Eu SC pointed out that To J distinguished the Re Universal principle from the present case in that the company had notice that the exercise of voting rights was a breach of trust.  His reasoning differed from that advanced by Listco or the Trustees.  This went to show that the point was not hopeless and far from obvious.  Anyhow, even if there was breach of trust, there was nothing to show that CLCMC knowingly assisted in that breach. 

46.  In the 3 years since the Authority Summons was issued, CLCMC did not just ignore the warning letters.  The lengthy letters from Listco and the Trustees demanding CLCMC to cease acting were met with equally lengthy replies from CLCMC to defend their authority, on the advice of counsel.  CLCMC did consider their position independently before forging on.  Any finding against Mei Li should not spill over to CLCMC.

47.  That CLCMC’s point of view (supported by counsel) was not accepted by the court did not come anywhere near a case of serious dereliction of duty, or justified struck off or suspension, or being vexatious.  It was more a case of fearless advocacy which section 52A(5) HCO preserves. The court should not be carried away by hindsight: Pine Enterprises.  To J’s decision binds Mei Li, but not CLCMC personally.

48.  It is not open to Ms Cheung to say that counsel’s view was wrong but that does not absolve CLCMC from liability for wasted costs, since CLCMC can have recourse elsewhere.  The court is here to consider if CLCMC’s own conduct justifies a wasted costs order.  I accept explanation (a).

Explanation (b) – lack of bases for the Trustees’ serious allegations

49.  The Trustees allege fraud, conspiracy and breach of fiduciary duties against CLCMC.  However, there is no evidence in support of fraud or conspiracy. As for breach of fiduciary duties, Mei Li is not before the court in this hearing. In any case, all these allegations should not be dealt with summarily. If there is doubt, CLCMC gets the benefit of it: Ridehalgh.

50.  Counsel for Mei Li took the view that they had strong merits in the appeal.  The appeal, if successful, would have caused Mei Li to recover a substantial sum of over $700 million, which would benefit Mei Li and, in turn, Chung’s estate.  There was no dispute that Chung was the beneficial owner of Mei Li and that there was nothing to bar the Trustees from regaining control of Mei Li and removing Huang as director.

51.  The Trustees themselves did not have a view on the merits of the Leave to Appeal Summons.  They could hardly say that the view taken by CLCMC was improper or unreasonable. The creditors were connected to Listco and they had motive not to support the intended appeal.

52.  I accept explanation (b).

Explanation (c) – no liability for the additional costs incurred as a result of last minute adjournment sought by the Trustees

53.  Huang had in fact waited to see if the Trustees would take steps to replace her and regain control of Mei Li.  In the meantime, the Authority Summons had been adjourned twice.  The first time was in order to seek the Trustees’ views.  The second time was just 3 days before the adjourned hearing 2 years later, for the Trustees to file affirmation evidence.  Despite enquiries of CLCMC and Listco to see if the Trustees had taken steps to regain control over Mei Li, the Trustees took another year to issue the Take-Over Summons, one day before hearing of the Authority Summons.  The Trustees again asked for an adjournment, but this was refused by To J.

54.  Such was the delay on the part of the Trustees. Hence, even if I were to find liability established against CLCMC, I would have disallowed the costs in relation to the adjournment in 2015 for lack of causation: Ma So So, §6.

CONCLUSION

55.  Having considered explanations (a) and (b), I am not satisfied that the conduct of CLCMC was improper or unreasonable within the meaning of Ridehalgh. Explanation (c) shows lack of causation between the conduct of CLCMC and the costs wasted over the 2015 adjournment.  I decline to make a wasted costs order.

56.  Ms Eu SC has conceded that upon the finding of lack of authority, CLCMC could not recover costs from Mei Li unless that finding is overturned on appeal.  It is therefore not necessary to make a “wasted costs” order to disallow costs as between CLCMC and Mei Li. 

57.  Costs should follow the event.  I make an order nisi that costs of CLCMC’s showing cause with certificates for 2 counsel should be borne by Listco.

58.  The Trustees are, strictly, not parties to this hearing as their costs have been reserved by To J.  In being here to put forth points to assist the court, the Trustees have taken a position in favour of Listco but failed. I order, nisi, there should be no order as to costs as between CLCMC/Listco and the Trustees.

59.  I thank counsel for their assistance.

HCA 420/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 420 OF 2011

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REASONS FOR DECISION

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Background

1. This is the hearing of the summons of the 3^rd Plaintiff (“Listco”) seeking to challenge the authority of Messrs CL Chow & Macksion Chan (“CLCMC”) to represent the 1^st Defendant (“Mei Li”) in this action (the “Authority Summons”).

2. The 1^st Plaintiff (“Listco”) is a company listed on the Stock Exchange of Hong Kong. 

3. The 1^st Defendant (“Mei Li”) is a company incorporated in the British Virgin Islands (“BVI”).  The 2^nd Defendant (“Chung”) was its only shareholder and sole director.

4. In January 2010, Listco and the other two plaintiffs in this action acquired certain assets from Chung, Mei Li and other vendors.  Then dispute arose in respect of that sale and purchase.  The plaintiffs commenced the present action against Mei Li, Chung and the other vendors.  On 28 September 2011, shortly after the defendants had filed their defence and counterclaim, Chung transferred his only share in Mei Li to Rare Earth Battery International Holdings Co Ltd (“Rare Earth”) for US$1, but retained his sole directorship in Mei Li.

5. The other vendors also commenced action against Chung in HCA 1283/2011 and obtained judgment against him in excess of HK$210 million.  On 20 June 2012, they presented a petition for Chung’s bankruptcy in HCB 4005/2012.  A bankruptcy order was issued against Chung on 27 February 2013.  On 28 March 2013, Beryl Yu and Sammy Choi of Messrs TK Choi & Co (the “Trustees”) were appointed joint and several trustees of the property of Chung.

6. As the bankruptcy proceedings were progressing, Chung caused Mei Li to commence a fresh action against Listco under HCA 1071/2012, the subject matter of which was identical to its counterclaim in the present action.  On 9 July 2012, Mei Li applied for summary judgment.  That application was dismissed by Deputy High Court Judge Le Pichon and the action was struck out on the ground of abuse of process of the court.  Then, on 7 August 2012, Mei Li took out a summons seeking summary judgment on its counterclaim against Listco, pursuant to Order 14 of the Rules of the High Court.  That application was heard before me on 7 February 2013.

7. On 27 February 2013, i.e. the date of issue of the bankruptcy order, Chung resigned as the sole director of Mei Li.  His niece, Huang, on behalf of Rare Earth as the sole shareholder of Mei Li, passed a resolution in writing appointing herself as the sole director of Mei Li.

8. Six days later, i.e. on 5 March 2013, I handed down my decision (the “Decision”) dismissing Mei Li’s application for summary judgment on its counterclaim. 

9. On 19 March 2013, Messrs DS Cheung & Co (“DSC”) issued a summons on behalf of Mei Li applying for leave to appeal my Decision dismissing its application for summary judgment (the “Leave to Appeal Summons”). 

10. On 9 April 2013, after ascertaining from the Official Receiver that she was unaware of the filing of the Leave to Appeal Summons and had not instructed DSC to issue the same, Listco’s former solicitors, Messrs Sidley Austin (“SA”) questioned DSC’s authority in issuing the Leave to Appeal Summons or in continuing to act for Mei Li.  DSC did not respond.

11. On 16 April 2013, CLCMC, who is Chung’s solicitors in the proceedings following his bankruptcy, filed a notice of change of solicitors for Mei Li and the 3^rd to 7^th Defendants in place of DSC.

12. On 7 May 2013, Listco issued the Authority Summons applying to set aside the Leave to Appeal Summons and notice of change of solicitors filed by CLCMC on the ground of DSC’s & CLCMC’s want of authority. 

13. In an affirmation dated 9 May 2013, Huang produced a resolution purportedly passed on 8 May 2013 ratifying the action taken by DSC in issuing the Leave to Appeal Summons and in instructing CLCMC to proceed with that application for and on behalf of Mei Li.

14. The hearing of these two summonses was then deferred, principally to enable the Trustees to make known their views, in particular, whether they would proceed with Mei Li’s intended appeal.  In the meantime, Chung left the jurisdiction to reside in the People’s Republic of China and the United States where he continued his business.

15. Three years having lapsed, these summonses are now restored for hearing.  The Trustees’ position is that neither DSC nor CLCMC has authority to act on behalf of Mei Li.  They are in support of the Authority Summons; but are unable to form a position as regards the Leave to Appeal Summons due to lack of sufficient information and co-operation from Chung and CLCMC.  The Trustees ask for an adjournment of the hearing of the Leave to Appeal Summons.  I refused that application and proceeded to hear the Authority Summons.  At the conclusion of the hearing, I allowed the application which resulted in the automatic setting aside of the Leave to Appeal Summons.  Hereunder are the reasons for my decision.

The parties’ case and issues

16. Counsel have no dispute that where a solicitor’s authority to act for a party is in question, the burden of proof rests on the solicitor asserting that authority to prove that he has been duly authorised: see Shanghai Land Holdings Limited (In Receivership) v Chau Ching Ngai[1] and Shing Hai Doing v Shing Ho Yung[2]. 

17. The factual and legal basis of the case advanced by Mei Li of CLCMC’s authority is as follows:

(1)  Chung had transferred the only issued share in Mei Li to Rare Earth on 28 September 2011, making Rare Earth the sole shareholder in Mei Li;

(2)  on 27 February 2013, the date the bankruptcy order was made, Chung resigned as the sole director of Mei Li; and Huang as the representative of Rare Earth signed a written member’s resolution appointing herself as the sole director of Mei Li with effect from the same date;

(3)  on 15 April 2013, Huang as the sole director of Mei Li signed a written board resolution, appointing CLCMC as solicitors for Mei Li in this action;

(4)  on 8 May 2013, Huang as the sole director of Mei Li signed another board written resolution, ratifying DSC’s action in issuing the Leave to Appeal Summons and resolving that CLCMC be instructed to proceed with the application; and

(5)  while admitting Chung’s beneficial ownership in Mei Li, Mei Li argues that Chung’s beneficial ownership is irrelevant because of two principles of company law.

18. Simply put, Mei Li’s case is that according to its register of members and register of directors, Rare Earth is the sole shareholder of Mei Li entitled to vote for Huang’s appointment as Mei Li’s director, and Huang was duly appointed as the sole director of Mei Li in place of Chung upon Chung’s bankruptcy.  Thus, Huang has power to ratify the action taken by DSC and to authorise CLCMC to act in the Leave to Appeal Summons.

19. Listco disputes the facts set out in paragraph 17(1) to (4) above and the authenticity of the documents relied on by Mei Li as proof of the same.  Listco argues that Chung remains as the sole registered member of Mei Li and his interest in the share in Mei Li is vested in the Trustees upon his bankruptcy by virtue of sections 12 and 58 of the Bankruptcy Ordinance. Thus Mei Li cannot act unless with the consent and direction of the Trustees and the Trustees have not consented to Mei Li taking out the Leave to Appeal Summons or retaining CLCMC.  In the alternative, Listco argues that if Chung had transferred his share in Mei Li to Rare Earth, Rare Earth holds the share in Mei Li beneficially for Chung.  Rare Earth’s interest in Mei Li comes within the meaning of “property” as defined in section 2 of the Bankruptcy Ordinance which have become vested in the Trustees by operation of sections 12 and 58 of the Bankruptcy Ordinance.  It was Chung who caused the appointment of Huang as the sole director of Mei Li and the board resolution passed by her to retain DSC and CLCMC.  As these resolutions were passed without the consent of the Trustees, they are invalidated by sections 12 and 58.

20. The Trustees support Listco’s application in the Authority Summons.  In addition, the Trustees argue that section 43(5) extends the definition of “property” to include the power exercisable by the bankrupt to require Huang to cause CLCMC to cease to act for Mei Li.  As Huang ignored the Trustees’ direction to cause CLCMC to cease acting for Mei Li, she was in breach of duty owed to the Trustees. The Trustees seek to invoke the court’s inherent jurisdiction to debar CLCMC from continuing to act for Mei Li.

21. Mei Li accepts that Chung was the indirect beneficial owner of the share in Mei Li.  It does not dispute the well established principle that a registered shareholder who is not also the beneficial owner of the share must vote at the instruction of the beneficial owner or the trustee in bankruptcy in the event of his bankruptcy.  There is also no argument that sections 12 and 58 do not have the effect of vesting a bankrupt’s equitable interest in shares in the trustee in bankruptcy.  Mei Li’s case is run solely on the basis that by reason of two well established company law principles Chung’s beneficial ownership of Mei Li is irrelevant or that sections 12 and 58 are rendered inapplicable to equitable interest in shares held by the bankrupt.  The first of the two company law principles relied on by Mei Li is that a company does not take notice of the beneficial interest behind the share register.  The second principle is that the management powers of a company are vested in the board of directors and where there is an effective board, the shareholders cannot in general meeting usurp the powers of the board. 

22. The issues raised by the Authority Summons are:

(1)  whether Chung had transferred his share in Mei Li to Rare Earth;

(2)  if yes, whether Rare Earth and Mei Li are beneficially owned by Chung;

(3)  if yes, whether Huang and Mei Li had knowledge of Chung’s bankruptcy and beneficial interest in Rare Earth and Mei Li;

(4)  whether the two company law principles has the effect of rendering sections 12 and 58 of the Bankruptcy Ordinance inapplicable to the interest, legal or equitable, in shares held by the bankrupt; and

(5)  whether the court has inherent jurisdiction to debar solicitors from acting for their client and, if it has, whether that jurisdiction should be exercised in the present case.

The transfer of the share in Mei Li to Rare Earth

23. Listco disputes the transfer of Chung’s share in Mei Li to Rare Earth on 28 September 2011. Its argument is rested on the Disclosure of Interest Form filed by Chung with the Stock Exchange of Hong Kong dated 13 April 2012.  In his then capacity as a substantial shareholder of Listco, Chung declared in relation to a relevant event that Mei Li was 100% owned and controlled by him.  However, as pointed out by Mr Dawes, counsel for Mei Li, the date of the relevant event was 24 August 2011, which preceded the date of the alleged transfer by almost eight months.  Though the form was filed well after the alleged transfer, Chung’s declaration must relate to the status quo as at the date of the relevant event.  I am therefore unable to draw any inference that the transfer of the share in Mei Li did not taken place on 28 September 2011 as alleged by Mei Li.

24. Ms Wong, counsel for Listco, then argues that had there been an arms-length transfer of the Mei Li share that passed the legal and beneficial ownership of the share to Rare Earth on 28 September 2011, disclosure should have been made by Rare Earth or Huang.  From the very poor quality of the photocopy of the form produced by Listco, it cannot be ascertained what was the relevant event.  Presumably it was a transfer of some of Chung’s shares in Listco rather than his ownership of Mei Li.  Even if change of ownership in Mei Li was a disclosable event, the change took place after the relevant date. Ms Wong’s argument might be advanced had Listco produced a later form showing that Chung still claimed to be the 100% beneficial owner of Mei Li.  But Listco had not.

25. Ms Wong argues in the alternative that had there been a transfer on 28 September 2011 that passed his interest in Mei Li to another company controlled by Chung just legal but not beneficial ownership of Mei Li, Chung would have had to disclose in the form the intervention of Rare Earth.  This is because all levels of intermediaries between the registered shareholder of the listed shares and the ultimate beneficial owner are required to be disclosed.  The argument also fails for the same reasons given above.

26. Ms Wong disputes the authenticity of the register of members and register of directors of Mei Li.  She refers to the difference between the copies of these registers produced by Che on behalf of Listco and that produced by Huang on behalf of Mei Li.  The copy of the register of members produced by Che was updated to 18 August 2008 showing Chung as the sole member.  The one produced by Huang was updated to 28 September 2011 showing the transfer of the share to Rare Earth on that date.  The register of directors produced by Che was updated to 31 March 2006 showing Chung as the sole director.  The one produced by Huang was updated to 27 February 2013 showing her appointment in place of Chung on that date.  They are different not just in content, but also in form, layout and format, suggesting that they are altogether different documents and not that one is a later updated version of the other.  There is a serious question as to authenticity of these registers.  Which ones are genuine?  The ones produced by Huang were certified by Mei Li’s registered agent.  Ms Wong reminds me that that agent is Chung’s accountant who is of suspicious character and had been examined by the Trustees in Chung’s bankruptcy proceedings.  On the other hand, Che did not disclose in his affirmation the source of the ones he produced.  If only I had credible evidence of the authenticity of Che’s documents, it would have been very easy to dismiss the ones produced by Huang as forgeries.  On the state of the evidence, all the differences between these copies could only lead to an unresolved mystery.

27. Mr Dawes objects to argument about the authenticity of the copies produced by Huang at this late stage on the ground that the dispute has not been properly raised.  Three years lapsed without this issue having been raised at all and Mei Li is deprived of the chance of producing any further evidence or explanation on this issue.  I agree with Mr Dawes that the challenge as to authenticity at this stage is too late and unacceptable.  I have to accept the copies produced by Huang which were certified by Mei Li’s register agent as authentic. 

28. In the circumstances, I find there was a transfer of Chung’s share in Mei Li to Rare Earth on 28 September 2011.

Whether Rare Earth and Mei Li are beneficially owned by Chung

29. Mei Li accepts that Chung is the indirect beneficial owner of the share in Mei Li.  But Listco argues that Rare Earth is also beneficially owned or controlled by Chung. This is an important springing board in Listco’s and the Trustees’ argument in the Authority Summons.  Mei Li’s stance as regards Chung’s beneficial interest in Rare Earth is not entirely clear.  Before dealing with this issue, I shall first examine Chung’s habitual use of corporate nominees or his niece, Huang, as trustee for the purpose of holding his property.  The evidence is incontrovertible and not disputed.  It would set the background for considering Listco’s argument.

30. Chung was the legal owner of the one share in Mei Li until 28 September 2011 when he transferred it to Rare Earth for US$1.  On the same day, Chung acquired all the issued shares in Great China Supreme Asset Management Co Ltd (“Great China”), another BVI company, and appointed himself as its sole director.  He then transferred to Great China all the shares in Winston Global Energy Ltd (“Winston Global”), another BVI company also solely owned by him holding a luxurious residential property in Tai Po which was used as his residence.  On 27 February 2012, Chung caused Huang to be appointed as the sole director of Winston Global in his place.  On 11 April 2012, he transferred all his shares in Great China to Huang who executed a declaration of trust and power of attorney in his favour in respect of the shares in Great China which was since registered in her name.  Huang declared that she held those shares in trust for Chung absolutely and undertook to exercise her voting powers and other rights in such manner as Chung should from time to time direct and to irrevocably appoint Chung as her attorney in all respects to sign any documents which might in Chung’s opinion be necessary or desirable and which as holder of such shares Huang had power to sign.

31. The above transfers took place shortly before 20 June 2012 when a bankruptcy petition was presented against Chung in respect of the judgment debt under HCA 1283/2011.  From the above circumstances, it would not be difficult to draw as the only reasonable inference that the above transfers were steps taken by Chung to insulate his substantial assets, including Mei Li, from the effect of a bankruptcy order which may be made against him, while retaining the beneficial interest in those assets and controlling them through Huang.

32. What precisely is the relationship between Chung and Rare Earth is unknown, but Huang’s and Chung’s one share in Mei Li provided the nexus.  First, a transfer of the only share in such a substantial company as Mei Li for US$1 could not have passed and did not pass the beneficial ownership in that share.  Rare Earth could only have been holding that one share in Mei Li on trust for Chung. Indeed, it is admitted by Mr Dawes that Chung is the beneficial owner of the share in Mei Li, though the basis of that admission remains unclear.  The evidence of Chung’s beneficial interest in Mei Li is overwhelming.  On 18 December 2012, Chung signed a Proposal for a Voluntary Arrangement in which he put the 100% shareholding in Mei Li with an asset value of HK$760 million as one of his assets.  In that proposal, Huang’s name was put under the “Trustee/Investment holding Co” column and Rare Earth’s name appeared under the “Asset Holding Company” column.  This suggests that Chung has control over Rare Earth through Huang.  Absent any explanation for this control and Chung’s beneficial shareholding of Mei Li through Rare Earth, there must be some special relationship between Chung and Rare Earth, including possibly that Rare Earth is also beneficially owned and controlled by Chung.  Who, but its beneficial owner, would have trusted Rare Earth for HK$760 million?  Second, viewing these facts together against Chung’s habitual use of corporate nominees, his use of Huang as his trustee to hold his very valuable assets and the terms of that trusteeship, his admitted beneficial ownership of Mei Li, and the fact that Huang had authority to act for Rare Earth, at least to the extent of representing Rare Earth in the company meeting of Mei Li, the only irresistible inference is that Rare Earth is also beneficially owned by Chung under similar arrangement as Great China and Winston Global are held by Huang beneficially for him. 

33. In conclusion, I find that Rare Earth and Mei Li are beneficially owned and controlled by Chung.  On 28 September 2011, he transferred his one share in Mei Li to Rare Earth at nominal value and retained its beneficial interest.  He then caused Rare Earth to bring about the appointment of Huang as the sole director of Mei Li to retain his de facto control over Mei Li.  The sum total of these transfers is that Chung put two layers of intermediaries (Rare Earth and Huang) between him and his assets to insulate his assets from his imminent bankruptcy but maintains control over them through Huang.  Rare Earth and Mei Li must be taken to have knowledge of Chung’s bankruptcy and his beneficial interest in the two companies through this common ownership and control.

34. With the above finding of fact, the parties’ dispute boils down to a question of law, which is whether the two company law principles relied on by Mr Dawes have the effect of rendering sections 12 and 58 of the Bankruptcy Ordinance inapplicable to interest in shares, legal or equitable, held by a bankrupt.  In addition, there is the separate question raised by the Trustees about the court’s inherent jurisdiction to debar solicitors from acting.

The first company law principle: the company does not take notice of beneficial interest in its shares

35. The argument of Listco and the Trustees is that by the operation of sections 12 and 58 of the Bankruptcy Ordinance, Chung’s beneficial interest in Rare Earth and Mei Li became vested in the Trustees; and Rare Earth and Huang may not exercise the power exercisable by Mei Li’s shareholder without the Trustees’ consent.  Ms Wong refers to the word “property” which is defined in section 2 of the Bankruptcy Ordinance in an all embracing manner to include “money, goods, things in action, land and every description of property, whether real or personal and whether situate in Hong Kong or elsewhere, also obligations, easements and every description of estate, interest and profit, present or future, vested or contingent, arising out of or incident to property as above defined.”  Apart from this already very comprehensive definition, references in the Bankruptcy Ordinance to property in relation to a bankrupt is extended by section 43(4) to include “references to any power exercisable by him over or in respect of property …; and a power exercisable over or in respect of property is deemed to vest in the person entitled to exercise it at the time of the transaction or event by virtue of which it is exercisable by that person (whether or not it becomes so exercisable at that time)”.  This definition is wide enough to catch the bankrupt’s equitable interest in shares of a company and the power exercisable by him as beneficial owner of shares held by his nominee shareholder.  This power includes, in the instant case, the power to direct Rare Earth how to vote at the meetings of Mei Li, to appoint or remove its director and to direct Mei Li to cause CLCMC to act or to cease to act for Mei Li.  By the operation of sections 12 and 58, on the making a bankruptcy order, all properties and powers of the bankrupt become vested in the Official Receiver, or the provisional trustee and then the trustee in bankruptcy as appropriate.  Indeed, it is trite principle that the legal owner of share shall vote as directed by the beneficial owner; and a bankrupt may only vote in respect of his shares as directed by his trustee in bankruptcy.  Accordingly, Ms Wong submits that Chung may not exercise his power of directing Rare Earth to procure the appointment of Huang as the sole director of Mei Li and to procure Huang to retain and authorise DSC and, later, CLCMC to proceed with the Leave to Appeal Summons without first obtaining the consent or direction of the Trustees.

36. Mr Dawes has no dispute about these trite legal principles, but argues that Listco’s and the Trustees’ arguments are ill-founded as being contrary to two fundamental principles of company law. The first one is that it is only the registered owner of the shares who has authority to attend and vote in meetings, and that the beneficial ownership of the shares is irrelevant.  He relies on two authorities: Re Universal Horizon Investment Ltd[3] and Morgan v Gray[4].  I shall first refer to Morgan v Gray as the principles referred to in that case are not in dispute and it would be more convenient to introduce those principles first. 

37. Mr Dawes relies on the following dicta in Morgan v Gray[5]:

“The position is very different where the company is still in operation and the bankrupt remains the registered proprietor on the company’s register of the shares which he formerly owned beneficially as well as legally. It seems to me that, unless there is some provision in the company’s articles or in the Companies Act which empowers me to say that the bankrupt is no longer a member of the company, and is, therefore, unable to vote, expressly, I must come to the conclusion that the bankrupt still remains a member as long as he is on the register; notwithstanding that by taking appropriate steps under the appropriate provisions the trustee in bankruptcy may be able to secure registration of himself as the proprietor of the shares. Unless and until that is done, and as long as the bankrupt remains on the register of the company, he remains a member in respect of those shares and is entitled, as it seems to me, to exercise the votes which are attributable to that status, notwithstanding that he has no longer any beneficial interest in the shares and that the company is entitled to pay any dividends to his trustee in bankruptcy.”

On the basis of the above dicta, Mr Dawes argues that only the registered shareholder has authority to vote or to act in respect of affairs of the company and the trustees in bankruptcy as beneficial owners of its shares had no say whatsoever unless they take steps to constitute themselves the registered shareholder. He therefore argues that the validity of a bankrupt’s vote depends on company law principles and his bankruptcy is irrelevant. As Rare Earth had duly passed a resolution appointing Huang as Mei Li’s sole director and in that capacity Huang had duly passed two board resolutions giving DSC and CLCMC authority so to act, CLCMC had authority to act for Mei Li.  He further submits that the position must be a fortiori when the bankrupt, as in the present case, is only a beneficial owner of the shares.

38. With respect, Mr Dawes is quoting the above dicta selectively and out of context.  In Morgan v Gray, the bankrupt shareholder was authorized by his trustee in bankruptcy to vote, but the defendant rejected his vote.  The factual circumstance in that case is the reverse of the one in the present case.  It was under that factual circumstance that Danckwerts J said that a bankrupt who was the legal and beneficial owner of shares in a company is still entitled to vote as long as his name remains on the share register.  Danckwerts J did not go that far as say that a bankrupt shareholder has an unqualified right to vote without having first secured the consent or direction of his trustee in bankruptcy.  There is no doubt that the right to vote is a membership right exercisable only by members of the company.  But it is interesting to note the following observations of Danckwerts J in the second paragraph of the judgment preceding the passage quoted by Mr Dawes[6]:

“It is curious that apparently it has never been decided whether, in spite of bankruptcy, a member of a company who remains a registered proprietor of shares on the company’s register can continue to vote. It is no doubt the case that, if he can vote, he must exercise those votes in accordance with the direction of the persons beneficially entitled to the shares, which in the present case would, of course, be his trustee in bankruptcy, because the beneficial interest in his shares at any rate would have vested in the trustee in bankruptcy.”

First, it is trite principle that the registered shareholder, if he is not also the beneficial owner of the shares, must vote in accordance with the direction of the persons beneficially entitled to the shares.  If he is a bankrupt, he must vote in accordance with the direction of his trustee in bankruptcy.  Second, the observation of Danckwerts J reflects the universal acceptance by companies and company law practitioners of this trite principle as applied in the case of bankruptcy, that is, a bankrupt shareholder may not vote unless as directed by his trustee in bankruptcy.  Thus, a member’s right to vote is one thing which is governed by company law principle, his authority to vote or the validity of his vote in the event of his bankruptcy is another governed by general trust principle and bankruptcy law. 

39. With those principles in the background I now turn to Re Universal Horizon Investment Ltd quoted by Mr Dawes as authority for the proposition that a company does not take notice of the interests behind the share register.  In that case, the plaintiff company (UHHL) which was the majority shareholder of its subsidiary company (UHIL) requested a general meeting to pass a resolution to remove the defendant as a director of the subsidiary (UHIL).  The dispute in that case was between the majority and minority shareholders which did not involve the exercise of the power to vote by a nominee or bankrupt shareholder.  A side issue which arose was whether the majority shareholding of the plaintiff company (UHHL) was held on trust for beneficiaries other than the defendant.  It was in that context that Rogers JA held, obiter, that a company does not take notice of the interests behind the share register.  He said:

“ I would, however, mention that the beneficial ownership of the 9,000 sharesis not a matter which seemingly, on the face of it, concerns Mr Shi, Mr Mao or Mr Yip [the defendants]. If there were other parties who had any beneficial interest in those shares or any interest, direct or indirect, through a family trust, it would seem that they were the members of the late Mr Tong’s family and not the directors. In any event, it seems to me that as far as company law is concerned, the company and therefore the courts do not look behind the shareholding of a company to see who are beneficially interested in the shares. Under s 102 of the Companies Ordinance Cap 32, the register of members is prima facie evidence of any matters which are inserted therein. Since, as had been shown in the exhibit, UHHL is registered as the shareholder of the 9,000 shares in UHIL, this court should proceed upon the basis that UHHL is the shareholder and, on the basis that Madam You is entitled to give instructions on behalf of Holdings, the matter should proceed accordingly.”

(Emphasis by Mr Dawes underlined.)

Mr Dawes relies on the underlined dictum as authority for his proposition that the bankruptcy provisions are rendered inapplicable by the company law principle.

40. That principle is derived from section 102 of the repealed Companies Ordinance (i.e. section 634 of the current Companies Ordinance which is equivalent to section 117 of the Companies Act 1948).  Our former section 101 prohibited notice of any trust, expressed, implied or constructive from being entered on the register of members.  The former section 102 provided that the register is proof of any matters that were by the Ordinance directed or authorized to be inserted in it.  Thus, the combined effect of the former sections 101 and 102 was to preclude a company from entering notice of trusts or equitable interests in shares in its register of members and to take notice of such interest.  The purpose of these sections and the principle derived from them is to protect a company from liability towards owners of equitable interests in its shares and to protect third parties dealing with the company on the basis of the particulars entered in the register: see Societe Generale de Paris v Walker[7].  This is a well established company law principle which makes a lot of practical sense.  If a listed company has to verify whether its registered members’ shares are held on trust for other beneficial owners, it would be impossible for the company to conduct its proceedings. Thus, the company only need to satisfy itself that only persons whose names are in the register of members may vote, without having to look behind their shareholdings to see who are beneficially interested in their shares.  Consequently, a company is not liable to the beneficial owners of its shares for registering improper dispositions of shares by the registered shareholder, or for paying over dividends to the registered shareholder, or for not verifying whether an authorised return of capital is properly applied by the registered shareholder in satisfying equitable claims of the beneficial owner. The classic case is Simpson v Molson’s Bank[8] in which the House of Lords held that the company which knew that the registered members were the executors of the will of a deceased member and had a copy of the will, was not liable to the beneficiaries to whom the shares had been bequeathed for registering a transfer of the shares by the executors to another person.  However, this principle only protects the company in its dealings with its members and third parties in their dealing with the company on the strength of resolutions which appear to have been properly passed by its members.  All the examples I quoted are to that effect.  

41. As this principle is developed to protect the company and third parties dealing with the company, it must necessarily follow that the company cannot abuse this principle to protect itself from its own wrongful acts or fraud.  If a company actively participates in a breach of trust by a trustee of its shares, it will be liable to the beneficiaries in the same way as any other person.  Likewise, it must also follow that a third party cannot invoke this protection if it has knowledge of or participates in the wrongful acts or fraud of the company. 

42. By the operation of sections 12 and 58, the bankrupt’s property is vested in the trustee in bankruptcy. While retaining his legal title in the share, the bankrupt member becomes a trustee of the share and of the power to vote for his trustee in bankruptcy.  He may not vote unless at the direction or with the consent of his trustee in bankruptcy.  If a bankrupt shareholder votes without the consent of his trustee in bankruptcy, he commits a fraud or breach of trust against the trustee in bankruptcy and his vote shall be invalid.  If to the knowledge of the company, a shareholder has been adjudged bankrupt, the company may not take his vote into account, unless the shareholder has been authorised by his trustee in bankruptcy to vote and votes as directed. If, with knowledge of the bankruptcy, the company takes such an unauthorized vote into account or gives effect to such an unauthorized resolution, it participates in the bankrupt’s breach of trust or fraud against the trustee in bankruptcy.  It cannot rely on the protection afforded by the company law principle.  The vote or resolution passed is invalid and liable to be set aside.  The company principle does not give authority to the member if the company has knowledge of his lack of authority to vote.  Thus, the law is not as simple as Mr Dawes puts it that the company law principle entitles the bankrupt to vote regardless whether he had the consent of his trustee in bankruptcy.  The right to vote is one thing, the validity of the vote as exercised by the person entitled to vote is another.  With respect, Mr Dawes is trying to sweep that distinction under the carpet of company law principles when quoting Re Universal Horizon Investment Ltd.

43. Having regard to the authorities, I consider the principle that a company does not take notice of beneficial interest in its shares only protects the company in the proper conduct of its proceedings, including those in relation to voting and passing of resolutions.  The company need not look behind the register.  It is entitled to take into account the vote by a person whose name has been entered in the register of members.  On the other hand, the legislature has enacted a set of detailed rules under the Bankruptcy Ordinance applicable specifically to a bankrupt’s property for the protection of unsecured creditors of the bankrupt.  Sections 12 and 58 vest the bankrupt’s property, including his equitable interest in shares and the powers attached to such interest, in the trustee in bankruptcy.  The principle that a bankrupt shareholder may only vote as directed by his trustee in bankruptcy is thus developed.  If a bankrupt shareholder votes without the consent of his trustee in bankruptcy, he commits a fraud against his trustee in bankruptcy.  His vote is invalid and resolution passed on the basis of that vote is also invalid.  The company law principle does not automatically validate the vote by a bankrupt shareholder who has not been authorized by his trustee in bankruptcy to vote.  If the company has knowledge of the bankrupt shareholder’s lack of authority to vote and gives effect to that vote, it participates in the bankrupt’s fraud against the trustee in bankruptcy.  It may not rely on the protection given by the company law principle.  The vote is invalid.  Properly understood, that company law principle and sections 12 and 58 of the Bankruptcy Ordinance have different scopes of operation.  The company law principle and the bankruptcy provisions blend in nicely as a coherent body of rules.  How the company law principle and the bankruptcy provisions interact with one another depends on whether the company has knowledge of the shareholder’s bankruptcy.  There is no question of the company law principle rendering the bankruptcy provisions inapplicable to interest in shares held by the bankrupt or the bankruptcy provision excluding the company law principle.  

Application of the law to the facts of the present case

44. It is admitted that Rare Earth holds the one share in Mei Li as trustee for Chung.  On 27 February 2013, two events occurred. The bankruptcy order was made against Chung which has the effect of vesting Chung’s property, including his beneficial ownership of that one share in Mei Li, in the Official Receiver.  The other event is that Mei Li passed a resolution appointing Huang as its sole director.  That resolution was procured by Rare Earth as the sole shareholder of Mei Li.  If the bankruptcy order was passed before the resolution, then Rare Earth was required to seek authority from the Official Receiver before it may procure the passing of the resolution.  If the resolution was passed before the issue of the bankruptcy order, the question about authority from the Official Receiver does not arise. The question is which of these events came first.  Under Order 42 rule 3 of the Rules of the High Court, an order of the court takes effect from the day of its date.  Vesting of Chung’s beneficial interest in the share in Mei Li took effect on that day.  As the burden of proving authority rests on the solicitor whose authority to act is challenged, CLCMC or Mei Li, for that matter, bears the burden of proving that the resolution was passed before the bankruptcy order was made.  But there is a total lack of evidence, whether from CLCMC or Mei Li.  On the other hand, Chung chose not to resign from his sole directorship in Mei Li until the date when the bankruptcy order was made.  This strongly suggests that it was upon the making of the bankruptcy order that Chung resigned and saw the need for appointing Huang in his place.  By reason of sections 12 and 58, the power to control Mei Li including the power to appoint its sole director was vested in the Official Receiver.  There is no dispute that the consent of the Official Receiver had not been obtained before Rare Earth passed the resolution.

45. Whether Mei Li may rely on the company law principle depends on whether it has knowledge of Rare Earth’s lack of authority to vote, in other words, whether it has knowledge of Chung’s bankruptcy.  As discussed above, by reason of Chung’s common beneficial ownership and control over Rare Earth and Mei Li, these companies must have knowledge of Chung’s bankruptcy and the surrounding circumstances and cannot rely on the protection given by the company law principle.

46. While the finding of Rare Earth’s and Mei Li’s knowledge of Chung’s bankruptcy is sufficient, the facts of this case are so damaging to Mei Li that they cry out for a finding of fraud.  As already observed above, as the litigation in this action progressed, Chung started to insulate Mei Li from his personal liability by divesting his legal ownership in the one share in Mei Li to Rare Earth, but keeping his sole directorship so as to maintain de facto control over this asset rich company.  On the date of the making of the bankruptcy order against him, he resigned from his position as the sole director of Mei Li and caused Rare Earth to pass a resolution in its capacity as the sole shareholder of Mei Li to appoint Huang as the sole director of Mei Li.  It is also my finding that Huang is Chung’s nominee, trustee and puppet.  Thus it is manifestly clear that what Chung did was to put up a façade that he had neither legal nor equitable interest in Mei Li so as to take Mei Li out of his estate in order to defraud his creditors.  By reason of common beneficial ownership and control of Rare Earth and Mei Li, all these facts were known to Rare Earth and Mei Li.  By giving effect to the resolutions, these companies are parties to the fraud. They cannot rely on the company law principles to protect them from their own fraud.  The resolution appointing Huang as Mei Li’s sole director is invalid and so are the two resolutions to ratify DSC’s Leave to Appeal Summons and to authorize CLCMC to continue to act for Mei Li.

The second company law principle: shareholders may not usurp the management power of the company

47. The second company law principle relied on by Mr Dawes is that the management powers of a company, including the power to commence legal proceedings are vested in the board of directors.  Where there is an effective board, the shareholders cannot in general meeting usurp the powers of the board.  He quotes Miracle Chance Ltd v Ho Yuk Wah David[9] and Chan Shu Chun v Right Margin Ltd[10].  This is a trite principle.  Mr Dawes relies on the board resolution signed by Huang on 15 April 2013 as evidence of the properly constituted board.  But in my view, it is inapplicable here.  There is no question of the Trustees trying to usurp the powers of the board.  The question is whether Huang had authority to exercise the powers of board on behalf of Chung in view of his bankruptcy.  In those two authorities quoted by Mr Dawes, there were effective boards.  Whether the resolutions are valid depends on whether Huang was validly appointed as a director of Mei Li.  For reasons as already explained above, Mei Li’s resolution purportedly passed by Rare Earth appointing Huang as director is invalid.  Thus, the two board resolutions purportedly passed by Huang to adopt DSC’s actions in taking out the Leave to Appeal Summons and to appoint CLCMC to continue with the application are also invalid.

The court’s inherent jurisdiction in regulating the conduct of lawyers appearing before it

48. The Trustees support Listco’s application in the Authority Summons.  Mr Chong, counsel for the Trustees, adopts the argument of Listco.  In addition, he invites the court to exercise its inherent jurisdiction to control its own processes including regulating the conduct of lawyers who appear before it and to exercise that jurisdiction to debar CLCMC from acting for Mei Li.  Mr Chong’s argument is premised on the extended meaning of “property in relation to a bankrupt” under section 43(4) of the Bankruptcy Ordinance and Mei Li’s or Huang’s breach of trust in relation to the property of the bankrupt.

49. Mr Chong reminds the court of its inherent jurisdiction to control its own processes.  He refers to the judgment of the High Court of New Zealand in H v S[11]in which the courtextended that jurisdiction to regulating the conduct of lawyers who appear before it.  The facts in H v S are not relevant.  In the exercise of that jurisdiction, the court removed counsel who was also a witness in that action from acting for one of the parties. Asher J said:

“(21) The High Court has an inherent jurisdiction to control its own processes, except as limited by statute, and that jurisdiction extends to regulating the conduct of lawyers who appear before it. As was stated by Richardson J in Black v Taylor as part of that jurisdiction the Court is able to determine which persons should be permitted to appear before it as advocates.⁴ He observed:⁵

‘In determining what categories of person may appear [the Court] does so in accordance with established usage and with what is required in the public interests for the efficient and effective administration of justice.’

(22) Within that jurisdiction the Court has the power to debar counsel or solicitors from acting where that is necessary for justice to be done or to be seen to be done. This includes the power to direct a lawyer not to appear, when the fair and efficient operation of the Court process could be impeded because of the knowledge of past or present actions of that lawyer.⁶ In exercising that jurisdiction the Court must preserve confidence in the sound function and fairness of the Court process. Disputes must be resolved by the Courts in a plainly fair, open and even-handed way.

(23) That jurisdiction is not to be exercised lightly. A litigant should not be deprived of his or her choice of counsel without good cause. The right of a litigant to choose counsel is a basic right which the Court will only exercise in a clear case, where it is satisfied that the actual or apparent fairness of the Court process requires it.

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⁴Black v Taylor [1993] 3 NZLR 403 (CA)

⁵  Black v Taylor, above n 4, at 408, citing Halsbury’s Laws of England (4th ed, reissue, 1998) vol 3(1) Barristers at [396]

⁶  Black v Taylor, above n 4, at 409; Accent Management Ltd v Commissioner of Inland Revenue [2013] NZCA 155; [2013] 3 NZLR 374 at [31]; Beggs v Attorney-General [2006] 2 NZLR 129 (HC) at [20]”

50. I am in agreement with H v S and the authorities cited therein. I am also of the opinion that the court must have inherent jurisdiction to control its own processes and regulate the conduct of lawyers who appear before it.  But it appears to me that this inherent jurisdiction is only exercisable against lawyers who are duly authorised to appear before the court and whose conduct in the matter is called into question.  This jurisdiction is to be exercised sparingly and not lightly or casually whenever it is convenient.  If a lawyer is duly authorised to appear before the court, all the considerations mentioned in the above quoted paragraphs become relevant; and in an appropriate case, the court may exercise that inherent jurisdiction. If a lawyer is not authorised to appear due to want of authority, then the proper course to take is to remove him on that ground on the basis of established legal principles of substantive law rather than to rely on the exercise by the court of this inherent jurisdiction. 

51. In this case, my primary finding is that CLCMC has no authority to act.  This is therefore not a proper case to exercise that inherent jurisdiction.  This does not mean CLCMC’s conduct was unreproachable.

Conclusion

52. For the above reasons, I find that Mei Li’s resolution dated 27 February 2013 passed by Rare Earth appointing Huang as Mei Li’s sole director is invalid.  As such, the board resolutions passed by Huang ratifying the issue of the Leave to Appeal Summons by DSC and appointing CLCMC to act for Mei Li in the intended appeal are also invalid.  Accordingly, the 3^rd Plaintiff’s Authority Summons is allowed; 1^st Defendant’s Leave to Appeal Summons and the Notice of Change of Solicitors filed by CLCMC are set aside.

53. There is no reason why the usual rule of costs to follow the event should not apply.  Applying the usual rule, the 1^st Defendant should pay the costs of the 3^rd Plaintiff and the Trustees.  However, as I have found, the 1^st Defendant was hijacked into this litigation by Chung through Rare Earth and Huang; and the only share in the 1^st Defendant is vested in the Trustees.  Thus, a costs order against the 1^st Defendant would effectively be a costs order against the estate of the bankrupt.  If the bankrupt’s estate is insufficient to meet all the debts of the bankrupt, the creditors will suffer prejudice.  On the other hand, CLCMC is on the face responsible for the costs incurred.  The 3^rd Plaintiff and the Trustees have asked for a wasted costs order. 

54. However, there is no reason why as between the 3^rd Plaintiff and the 1^st Defendant, the usual rule should not apply.  Accordingly, I make a costs order as between the 3^rd Plaintiff and the 1^st Defendant that the 1^st Defendant shall pay the costs of the Authority Summons and Leave to Appeal Summons and the costs of the hearing including the costs of the hearing on 13 May 2013 with certificate for two counsel and all costs reserved.  For cases involving want of authority, it is also the usual rule that such costs should be taxed on indemnity basis.  Hence, such costs shall be taxed on indemnity basis.  The costs of the Trustees shall be reserved until after hearing the application of wasted costs against CLCMC.

HCA 420/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 420 OF 2011

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D E C I S I O N

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Background

1.  I have before me three summonses: (1) the 1^st defendant’s summons dated 7 August 2012 seeking an order that final judgment be entered against the 3^rd plaintiff pursuant to Order 14 of the Rules of the High Court; (2) the 3^rd plaintiff’s summons dated 25 January 2013 seeking leave to file and serve the 4^th Affirmation of Jaime Che (“Che”); and (3) the 3^rd plaintiff’s summons dated 28 January 2013 seeking leave to file and serve an Amended Reply and Defence to Counterclaim.  Ms Chan SC, counsel for the 1^st defendant, agreed that the 4^th Affirmation of Che and the draft Amended Reply and Defence to Counterclaim be admitted for the purpose of fairly disposing of the 1^st defendant’s summons, while reserving the defendants’ rights.  The 3^rd plaintiff’s two summonses are adjourned.

2.  The background leading to this litigation and the 1^st defendant’s summons is as follows.  The 3^rd plaintiff is a company listed on the Hong Kong Stock Exchange.  It holds all the issued shares in the 1^st plaintiff, which was formed for the purpose of acquiring Union Grace Holdings Limited (“Union Grace”) and its wholly owned subsidiary, Thunder Sky (HK) Ltd, from Winston Chung (“Chung”), his wholly owned company (the 1^st defendant), and five other vendor companies owned or controlled by Miao Zhenguo (“Miao”).  Union Grace was in the business of manufacturing and sale of lithium‑based battery products and related battery business.  The acquisition process commenced in around January 2010.  The parties entered into an acquisition agreement dated 18 January 2010 (“Acquisition Agreement”).  Under the Acquisition Agreement, the vendor’s shares in Union Grace were transferred to     the 1^st plaintiff as purchaser.  The total consideration consisted of 783,517,010 shares in the 3^rd plaintiff (“consideration shares”), convertible bonds issued by the 3^rd plaintiff in the amount of $1,493,296,5 and cash  of $100,000,000.  The 3^rd plaintiff was the purchaser’s guarantor, while Chung and Miao were the vendors’ guarantors.  The acquisition was completed on 25 May 2010 when Union Grace became a wholly owned subsidiary of the 1^st plaintiff.  Thunder Sky (HK) Ltd, which has since changed its name, is now the 2^nd plaintiff and the main operating arm of the business acquired.

3.  For the purpose of implementing the Acquisition Agreement, the above mentioned parties or some of them together with other companies, mostly under the control of Chung, entered into eight other related agreements:

(1)      Supplemental Acquisition Agreement dated 30 April 2010;

(2)      Master Supply Agreement dated 18 January 2010;

(3)      Confirmation Letter Agreement dated 25 November 2010;

(4)      Patent Licence Deed dated 18 January 2010;

(5)      Supplemental Patent Licence Deed dated 12 February 2010;

(6)      IP Licence Deed dated 19 May 2010;

(7)      Guarantee dated 26 March 2010; and

(8)      Service Agreement dated 2 June 2010.

4.  In accordance with the Terms And Conditions Of The Bond (“Terms and Conditions”), the 3^rd plaintiff had the right to redeem the whole or part of the convertible bond by issuing an irrevocable redemption notice to the holder of the bond.  There was a partial redemption of the convertible bond issued to the 1^st defendant, which resulted in a re‑issue of a convertible bond certificate to the 1^st defendant in the amount of $760,751,606 under certificate number 18 dated 10 February 2011.

5.  Subsequently, dispute arose between the plaintiffs and the defendants over the performance of the Acquisition Agreement and related agreements.  On 8 March 2011, the 3^rd plaintiff issued another redemption notice to redeem the bond under certificate number 18, but did not deliver a cheque in the redemption amount to the 1^st defendant in accordance with the Terms and Conditions. Then, four days later, the plaintiffs commenced the present proceedings.  A statement of claim was filed on 14 June 2011.  The defendants filed their defence and counterclaim dated 23 August 2011.

6.  In another action, HCA 1283 of 2011, Che, Miao and others obtained judgment against Chung in an amount in excess of $210 million. On 20 June 2012, they presented a bankruptcy petition, HCB 4005 of 2012, against Chung, which is now awaiting judgment.

7.  At the same time as the bankruptcy petition was proceeding, the 1^st defendant commenced a new action, HCA 1071 of 2012, against the 3^rd plaintiff, the subject matter of which was identical to its counterclaim in the present action.  On 9 July 2012, the 1^st defendant applied for summary judgment under that new action.  That application was dismissed by Deputy High Court Judge Le Pichon and the new action was struck out on the grounds of an abuse of process of the court.  On 7 August 2012, the 1^st defendant took out the present summons seeking judgment against the 3^rd plaintiff on its counterclaim.

General principles applicable to an application under Order 14 rule 5

8.  It was stated in the marginal note in the 1^st defendant’s summons that the application was made under Order 14 rule 1.  As submitted by Mr Scott SC, leading counsel for the 3^rd plaintiff, the application should have been made pursuant to Order 14 rule 5 as it was made by the 1^st defendant as counterclaimant and not as plaintiff.  I agree.  The two rules are not without distinction.  The hurdle which a counterclaimant has to overcome to obtain summary judgment against a defendant under Order 14 rule 5 is higher than that which a plaintiff has to discharge in obtaining judgment against a defendant under Order 14 rule 1. As was pointed out by the learned authors in Hong Kong Civil Procedure 2013, Vol 1 at paragraph 14/5/1, this rule should not be resorted to except in a clear case for the following reason:

“In most cases in which the defendant might desire to apply for summary judgment on the counterclaim, the plaintiff will have already served his statement of claim; and unless the claim or claims made by the plaintiff can be shown to be unsustainable or not bona fide or wholly unconnected with the defendant’s counterclaim, the defendant may not be able to depose to his belief that there is no defence to his counterclaim or part thereof in respect of which he seeks to apply for summary judgment.”

The making of a counterclaim presupposes that the plaintiff has a valid claim which constitutes a valid built‑in defence to a counterclaim.  Hence, the counterclaimant has to show that the plaintiff’s claim is unsustainable or not bona fide or wholly unconnected with the defendant’s counterclaim.  Failure to take timely action to strike out the plaintiff’s claim may be treated as indication that the plaintiff has a valid defence to the counterclaim.  But this procedural advantage should not be over emphasised.  Ultimately, it is the justice of the case which matters.

9.  The test in an Order 14 application is as simple as whether the defendant’s assertions are believable.  That question has to be answered not by taking those assertions in isolation but by taking them in the context of so much of the background as is either undisputed or beyond reasonable dispute: Re Safe Rich Industries Ltd CACV 81/1994, unreported, per Bokhary JA, as he then was.

10.  Summary judgment under Order 14 is not intended to be a mini trial on affidavits.  Where there are complicated factual issues in dispute, Order 14 is clearly not the correct procedure: Paul Y Management Ltd v Eternal Unity Development Ltd [2008] HKEC 1359 at paragraph 19 and Hong Kong Civil Procedure 2013, Vol 1at paragraph 14/4/9.

11.  Where a defendant can show he has a bona fide cause of complaint against the plaintiff, as grounds of defence and counterclaim, arising from the same subject matter, he should be given unconditional leave to defend: Shenzhen Baoming Ceramics Co Ltd v Companion‑China Ltd [2000] 2 HKLRD 288 at 293‑294.

12.  The authorities show that there are four different classes or groups of orders which the court would make where a defendant to a counterclaim, ie the original plaintiff, raises a set‑off or counterclaim as a defence (which for avoidance of confusion is hereunder referred to as “counter‑counterclaim”): Hong Kong Civil Procedure 2013, Vol 1 at paragraph 14/4/14.  These are:

(1)  where the plaintiff can show an arguable set‑off, equitable or otherwise, he is entitled to leave to defend to the extent of the set‑off;

(2)  where the plaintiff sets up a bona fide counter‑counterclaim to the defendant’s counterclaim arising out of the same subject matter as the action and connected with the grounds of the counter‑counterclaim, the order should not be for judgment on the counterclaim, subject to a stay pending trial of the counter‑counterclaim, but should be for unconditional leave to defend the defendant’s counterclaim, even if the plaintiff admits the whole or part of that counterclaim;

(3)  where there is no defence to the counterclaim but a plausible counter‑counterclaim of not less than the counterclaim is set up, judgment should be for the defendant on the counterclaim with costs stayed until trial of the counter‑counterclaim; and

(4)  where the counter‑counterclaim arises out of a separate and distinct transaction or is wholly foreign to the counterclaim, judgment should be for the defendant with costs without a stay.

The court has no discretion in cases falling under class 1 but to grant leave to defend.  But, because of the lack of clarity between classes 2, 3 and 4, the court has freedom to respond to the perceived justice of the individual case.

The 1^st defendant’s counterclaim and grounds for summary judgment

13.  The 1^st defendant’s case on the counterclaim is that upon issuing the redemption notice, the 3^rd plaintiff was obliged under the Terms and Conditions to deliver a cheque for $760,751,606 to the 1^st defendant, but it failed to do so.  The issuance of the redemption notice was admitted by the 3^rd plaintiff.  The 3^rd plaintiff has not put forward any defence to the counterclaim other than a general allegation that it was entitled to set off the damages suffered by the 1^st to 3^rd plaintiffs.

14.  Ms Chan SC, leading counsel for the 1^st defendant, submits that such a general allegation does not amount to an arguable defence to the counterclaim because: (1) the 3^rd plaintiff does not have any claim against the 1^st defendant and there could be no set‑off for claims made by the 1^st and 2^nd plaintiffs against the 2^nd to 7^th defendants; (2) any possible claim by the 3^rd plaintiff would be for reflective loss of the 1^st and 2^nd plaintiffs and is unsustainable; (3) the redemption notice is of the nature of a promissory note such that set‑off is excluded under well‑settled legal principles; and (4) set‑off is also excluded by the Terms and Conditions which is binding on the 3^rd plaintiff.  The 3^rd plaintiff disputes each of these grounds.

Whether set‑off is only available between the same parties in a litigation

15.  It is well settled that a legal set‑off requires both the claim and counterclaim be for liquidated sums which can be ascertained as at the date of the pleading: Axel Johnson Petroleum AB v MG Mineral Group AG [1992] 1 WLR 270 at 272F‑274C, per Leggatt LJ.  As the 3^rd plaintiff’s claims are for damages, it must be relying on equitable set off.  The thrust of Ms Chan SC’s argument is that equitable set‑off requires the cross‑claims to be between the same parties: Muscat v Smith [2003] 1 WLR 2853 (CA) at paragraph 42‑45 and Edlington Properties Ltd v JH Fenner & Co Ltd [2006] 1 WLR 1583 (CA) 520.  She further submits that throughout the Amended Statement of Claim, there was no claim by the 3^rd plaintiff against the 1^st defendant; all claims were directed at breaches of the Acquisition Agreement or related agreements by the 2^nd to 7^th defendants; and the only breaches pleaded against the 1^st defendant were breaches of clause 6.2 of the Acquisition Agreement for which no remedy was pleaded against the 1^st defendant and breaches of clause 8.3 which was about breach of undertaking to the 1^st plaintiff.

16.  On the law, Mr Scott SC argued that it is more than arguable that both Muscat v Smith and Edlington Properties Ltd, which were landlord and tenant cases involving an assignment of certain rights, have limited bearing in the present case.  Having read the judgment in Muscat v Smith in some detail, I am unable to agree with Mr Scott SC.  It is clear from paragraph 36 of his judgment that the case was decided on the general law of equitable set‑off. Buxton LJ said:

“36. The point is therefore a short one. It will, however, be necessary to preface it by some account of the general law of equitable set‑off in order to address the argument presented to us; and then to turn to the effect on this case of the assignment.”

Then he continued in paragraphs 42 to 45:

“42. Mr Smith [the tenant] therefore has to assert his set‑off by appealing to general principle, reaching well outside the law of landlord and tenant. There is no case supporting, or coming anywhere near to supporting, a general principle making set‑off available where the defendant has a claim against someone other than the plaintiff; and such a rule would be contrary to elementary principles of the law of contract; contrary to the essential nature of set‑off; and contrary to assumptions made in cases of high authority, including many that bind this court.

43. First, the law of contract. The breaches of which Mr Smith complained, and which he wished to set off in this action, were committed by Mr Walker [the former landlord], not by Mr Muscat [the present landlord]. For that reason, it is necessarily and properly accepted in Mr Smith’s pleadings and in his argument that he could not bring an action for damages against Mr Muscat. That is because there is no privity of contract between Mr Smith and Mr Muscat in respect of those breaches. To permit Mr Smith’s claim none the less to be effective against Mr Muscat by way of set‑off would undermine that basic rule.

44. Second, the set‑off with which we are concerned is and is only one that operates as an incident of litigation. Such a set‑off is merely a sub‑species of counterclaim: see the analysis of Slade LJ in the National Westminster Bank case [1993] 1 WLR 72, 76E‑G. It is a special and privileged type of cross‑claim because it operates in the litigation to extinguish the claim and prevent its original establishment, rather than to provide a sum to be balanced off against the claim once established: see the account given by Lord Denning MR in the Federal Commerce case [1978] QB 927‑974. That distinction is of course of crucial importance to Mr Smith in defending the possession action in the present case. But a counterclaim plainly cannot be asserted against someone other than the claimant: so by the same token neither can the sub‑species that is set‑off be so asserted.

45. Third, authority. The dearth of specific statements supporting the proposition that a cross‑claim must be a claim against the original claimant is attributable to the fact that that proposition has always been taken for granted. All of the recent cases discussing whether the cross‑claim was sufficiently closely connected with the claim to be set off against it in the same litigation presuppose that the claims, whatever they are, lie between the same parties. That stands out from, for instance, the various discussions cited in the judgment of Forbes J in British Anzani (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] QB 137, 154D‑H. Counsel for Mr Smith sought to suggest that a wider rule could be found in the dictum of Lord Denning MR in the Federal Commerce case [1978] QB 927, 974:

“We have no longer to ask ourselves: what would the courts of common law or the courts of equity have done before the Judicature Act 1873?  We have to ask ourselves: what should we do now so as to ensure fair dealing between the parties?”

But that observation went only to a more liberal attitude to the question of whether a cross‑claim sufficiently impeached the claim to create a set‑off: the issue discussed in the passage with which this dictum culminates, and to which reference has already been made in paragraph 44 above.  It certainly cannot be relied on to convert the rule of set‑off into some more general equitable doctrine, and much less into a form of palm‑tree justice.”

17.  Next, Mr Scott SC argues that the present case is on all fours with a line of authorities on transaction set‑off including Dole Dried Fruit and Nut Co v Trustin Kerwood Ltd [1990] 2 Ll Rep 309, Bim Kemi v Blackburn [2001] 2 Ll Rep 93, Townearn Industrial Ltd v Globe Holdings Ltd [2003] 1 HKC 186and Benford Ltd v Lopecan SL [2004] 2 QB 618.  If by that submission he is suggesting that a transaction set-off is available to a defendant who has a counterclaim against someone other than the plaintiff in the same litigation, with respect, that is inconsistent with the line of authorities he quoted.  For example, in the Dole Dried Fruit case, the defendant had a counterclaim against the plaintiff in the same litigation in a claim which arose out of the same transaction.  I think what was decided in the Dole Dried Fruit case was the degree of closeness required between the counterclaim and the claim as to permit a set-off.

18.  The dicta of Buxton LJ in Muscat v Smith are very strong dicta to the effect that equitable set‑off is only available to the same parties in a litigation who have a claim against one another and not available to a defendant who has a claim against someone other than the plaintiff.  As the dicta show, the principle in Muscat v Smith is supported by authorities and well established general legal principles.  It is therefore a principle of general application and not as Mr Scott SC suggests as being limited to landlord and tenant cases. 

19.  Next, I consider Mr Scott SC’s argument insofar as he purports to advocate for an extension of the principle in Muscat v Smith.  He quotes extensively from the judgment of Morrison J in Benford Ltd v Lopecan.  In Benford Ltd v Lopecan SL, the claimant sold and delivered trucks to the defendant which were ordered by the defendant in its capacity as distributor under the umbrella of the distribution agreement.  The claimants sued for price of goods sold.  The defendant asserted that the claimants had breached the distributorship agreement by appointing other companies to distribute its products in territories covered by its distribution agreement with the defendant and by reason of such breach the defendant was unable to sell the trucks ordered and counterclaimed for damages.  Two of the issues before the court were (1) whether the defendant had any real prospect of defending the claim for the price of the goods sold; and  (2) whether there should be a stay of execution of any judgment on the claim pending determination of the counterclaim.  Morrison J held that it was very arguable that the defendant had a defence to the claim for the price of goods sold; hence it was not necessary to determine the second issue; but if the court had ordered delivery up of the trucks or payment of the price it would have granted a stay.  That judgment contained an analysis of the Dole Dried Fruit case and Bim Kemi v Blackburn and a useful summary of the difference between what is termed “independent set‑off” and “transaction set‑off”.  It would be adequate to refer to the part of the judgment quoted by Mr Scott SC.  Morrison J said in paragraphs 10 to 17:

“10. The real argument between the parties hinges on the question whether the counterclaims which are being brought in this case and the defences which are being advanced constitute what the courts now call a transaction set‑off, on the one hand, or an independent set‑off, on the other. The two have quite different effects. A transaction set‑off operates as a defence (see the case of Glencore Grain v Agros Trading)whereas an independent set‑off involves, so to speak, striking a balance of account, where the two claims are looked at independently. The transaction set‑off, as I say, operates as a defence as such and extinguishes the claim.

11. What is the nature of the set‑off alleged in this case? It can be seen from the pleadings that part of the set‑off is intimately connected with the claim.The purpose of the distribution agreement was to enable the defendants to sell the goods which they were procuring, ordering and buying from the claimants. They were to have exclusive access to a market for the Claimants’ goods. The distribution agreement, as was correctly submitted by counsel for the claimants, did not constitute a contract of sale in itself, it transferred rights to the parties, including, in particular, the right of the defendants to sell the goods which he had bought from the claimants in the designated agreed territories.

…

13. Is that a transaction set‑off? It seems to me that it is, or, to put it more neutrally, it is strongly arguable that it is. I start with the text book which has helpfully been provided to me, called “The Law of Set Off” by Rory Derham, the third edition. At p 83 of the book it is made plain by the learned author that, so far as the Courts are concerned, the approach in a set‑off situation is not to ask the question, “Would it be just or fair to deprive the defendant of a potential set‑off?” These are not questions which determine whether there is a transaction set‑off situation or not. It was put much more elegantly by the late Mr Justice Hobhouse, where he said in the case of Leon Corporation v Atlantic Lines & Navigation Co Inc (“The Leon”) [1985] 2 Lloyd’s Rep 470 at p 474):

 “Equitable principles derive from a sense  of what justice and fairness demand.  This does not mean that equitable set‑off has been reduced to an exercise of discretion.  Since the merging of equity and law equitable set‑off gives rise to a legal defence.  This defence does not vary according to  the length of the Lord Chancellor’s or arbitrator’s foot.  The defence has to be granted or refused by an application of legal principle.”

14. The legal principle involved is set out clearly, in my judgment, in the case of Glencore Grain v Agros Trading, a decision of the Court of Appeal, reported at [1999] 2 All ER 288, where the Court analyses and helpfully summarises the effect of the seminal decision given by Lord Justice Hoffmann, who I think was responsible for coining the phrase “transaction set‑off and independent set‑off” in the case of Aectra Refining and Marketing Inc v Exmar NV [1995] 1 All ER 641. As always, in these cases it is not so much the definition of the principle which is difficult, it is the application of the principle to the facts in question. There must be, as it seems to me, a close commercial relationship between the claim on the one hand and the defence and counterclaim on the other.

15. In Dole Dried Fruit and Nut Co v Trustin Kerwood Ltd [1990] 2 Ll Rep 309, the Court examined a case which was not that dissimilar to the present one. It was a distributorship agreement. The defendants’ case was that they were appointed by the plaintiffs as sole and exclusive agents for the importation and distribution in England of the plaintiff’s prunes and raisins. They acquired those products, and the defendants claimed damages for repudiation of the distribution agreement. Three weeks later the plaintiffs commenced separate proceedings in which they claimed $735,000 as the price of goods sold and delivered under a series of sale contracts. The defendants did not dispute the plaintiff’s claim but they said that they were entitled to set‑off their counterclaim for unliquidated damages. In the Court of Appeal Lord Justice Lloyd said this:

“The whole purpose and intent of the agency agreement was that the parties should enter into contracts for the purchase and sale of the plaintiffs’ goods.”

I interpose, so here.

 “The sale contracts were thus concluded in fulfilment of agency agreement.”

So here.

  “In those circumstances the claim and the counterclaim are sufficiently closely connected to make it unjust to allow the plaintiffs to claim the price of goods sold and delivered without taking account of the defendants’ counterclaim  for damages for breach of the agency agreement.  If that is right, then the defendants are entitled to rely on their counterclaim as a set‑off.  It follows that they have an arguable defence for the purposes of [Order 14].  Accordingly I would dismiss the plaintiffs’ appeal.”

…

16. But the Court of Appeal reconsidered the matter in Bim Kemi v Blackburn [2001] 2 Ll Rep 93, where the Court held, firstly, that the degree of closeness required for an equitable or transaction set‑off was that of an “inseparable connection”, but it was not necessary that the cross‑claim should arise out of the same contract. All that was required was that it should flow from the dealings and transactions which gave rise to the subject of the claim; secondly, and I take this from the headnote:

 “The principle that the cross‑claim should be one flowing out of and inseparably connected with the dealings and transactions which also gave rise to the claim was apt to cover a situation where there were claims and cross‑claims for damages in respect of different but closely connected contracts arising out of a long‑standing trading relationship which was terminated; that fact would not per se so establish the requisite ‘inseparable connection’ but in an appropriate case it might well be manifestly unjust to allow one claim to be enforced without taking account of the other …”

In his judgment, Lord Justice Potter, at para 36, said:

 “Like the Judge, I consider that Mr Turner’s submissions for Blackburn are correct.  In so holding, again like the Judge, I regard it as appropriate to apply the test propounded by Lord Brandon in the Bank of Boston case unconstrained by the former concept, difficult to define and apply, of ‘impeachment of title’, which has since been replaced, or at least redefined, in terms of a cross‑claim which ‘flows  out of and is inseparably connected with the dealings and transactions giving rise to the subject in the claim’. While the circumstances of every case call for individual consideration, it seems to be that the Dole Fruit case provides a useful parallel with the situation in this case.  There, the Court was satisfied there was a sufficiently close connection in the case of a claim for the price of goods sold and delivered pursuant to a contract made under the ‘umbrella’ of a distributorship agreement which had been repudiated.”

And he then went on to say that, in the present case, the connection was less close, but nonetheless the test of a close and inseparable connection was satisfied. That does, I think, infer that the case of Dole is not to be regarded as an oddity but, rather, has been given the stamp of approval by the Court when considering the question of set‑off.

17. Therefore, applying the principles to the facts of this case, it seems to me to be very arguable that the defendants have a defence to the claim for the price of goods sold and delivered because the sale contract was under the umbrella of the distribution agreement and the claims and cross‑claims are closely connected in a commercial sense. It is true that the evidence as to the amount of damages which are to be claimed in the counterclaim have not yet been fully quantified or properly formulated, and it is fair to point out that the evidence in relation to the damages claim is thin, but this is the Commercial Court and it, the Court, is familiar with the damage which may be caused to a distributor by the wrongful repudiation of his distributorship agreement as is alleged, whether in removing Cordoba or the way the Claimants are alleged to have repudiated the Distributorship Agreement. It is not speculative to suggest that the amount of the cross‑claim could be substantial, and could well exceed the amount of the claim.” (emphasis supplied).

20.  In summary, a transaction set‑off operates as a defence and extinguishes the claim.  To qualify as a transaction set‑off, there must be a close commercial relationship between the claim on the one hand and the defence and counterclaim on the other.  The degree of closeness required for a transaction set‑off is an inseparable connection, but it was not necessary that the cross‑claim should arise out of the same contract.  All that is required is that it should flow from the dealings and transactions which gave rise to the subject matter of the claim.  This is a looser test and is apt to cover a situation where there were claims and cross‑claims for damages in respect of different but closely connected contracts arising out of a long-standing trading relationship which was terminated. 

21.  It is not entirely clear whether, in a case such as the present one involving a number of co-plaintiffs and co-defendants in the same litigation, the principle in Muscat v Smith applies narrowly to a co-plaintiff vis-à-vis a corresponding co-defendant only or broadly to the co-plaintiffs as one party and the co-defendants as another party as Mr Scott SC contends. 

22.  Ms Chan SC criticises such liberal extension of a general equitable doctrine as much less than a form of palm‑tree justice.  I do not think so.  Putting aside for the time being counsel’s disagreement that set-off as a defence is only available between the same plaintiff and the same defendant, the basis of that defence is that the claim and counterclaim are closely connected.  As was held by the Court of Appeal in Bim Kemi v Blackburn, all that was required was that the counterclaim flows from the dealings and transactions which gave rise to the subject matter of the claim.  Not only that it need not arise from the same contract, the Court of Appeal even extended it to cover a situation where there were claims and cross-claims for damages in respectof differentbut closely connected contracts arising out of long a standing relationship which was terminated.

23.  The principle in Muscat v Smith is premised on a very simple scenario where A owed an obligation to B, and C owed an obligation to A.  Under such a scenario, A cannot set off an obligation he owed to B by an obligation owed to him by C.  This is full of common sense and is consistent with established legal principles.  The situation should be no different where the co-parties within one group are so related to one another as to form one party because all benefits under the transactions accruing to one group go to their common funds and all their liabilities are also to be discharged from that common fund.  Thus, where B and C in fact form one conglomerate and the underlying transactions from which the obligations arise are so interconnected as to form one transaction, there is no reason why set-off is not available among the three parties.  The same applies where A consists of a number of co-parties.  

24.  It may well be that set-off between co-plaintiffs as one party and co-defendants as the opponent party is already covered by the principle in Muscat v Smith.  Perhaps, just as the dearth of specific statements supporting the proposition that a cross‑claim must be a claim against the original claimant is attributable to the fact that that proposition has always been taken for granted, the lack of specific statements supporting Mr Scott SC’s proposition may well be attributable to the fact that this wider application of the principle has also been taken for granted and never challenged.  Furthermore, commercial transactions are ever growing in complexity to meet with the needs of the modern society.  In a situation where a number of co-plaintiffs and co-defendants are involved  in the same transaction or closely related transactions and where the    co-plaintiffs are so related to one another as to form one party while the co-defendants are also so related as to form the opponent party, there is no reason why the principle in Muscat v Smith should not be extended to meet what justice and fairness in the modern commercial reality demand.  Such an extension of the legal principle, if in fact it is an extension, demonstrates that the law is living and developing to meet with the growing needs of commercial reality.  It is far from being palm-tree justice.  Either way, in an appropriate factual situation, Mr Scott SC’s proposition may present a plausible defence which deserves to be fully argued and explored at trial.

Whether the claim and counterclaim are inseparably connected

25.  If the defence of set-off is available to the 3^rd plaintiff, it has to prove an inseparable connection between its claim and the 1^st defendant’s counterclaim.  On the fact, the eight related agreements were entered into for the purpose of implementing or giving effect to the Acquisition Agreement.  It is very arguable that all the transactions involving the Acquisition Agreement and the eight related agreements constituted one series of related transactions and an integral whole of the acquisition with the plaintiffs as the buyers party and the defendants the vendors party.

26.  The 3^rd plaintiff is the holding company of the 1^st and 2^nd plaintiffs. It provided the consideration for the purchase of the shares in Union Grace by the 1^st plaintiff.  It brought about the conclusion of the eight other related agreements between the plaintiffs and the defendants, including the 1^st defendant.  As the operative arm of the plaintiffs’ group, the 2^nd plaintiff entered into some of the eight related agreements with the defendants.  The plaintiffs can therefore be treated as one entity or the buyers party as a whole.  They are also the plaintiffs in this litigation. 

27.  On the other hand, the 1^st defendant, Chung as the 2^nd defendant and the other five companies owned by Miao were the vendors under the Acquisition Agreement. Chung together with the 1^st, 3^rd to 7^th defendants, of which he was the owner, are parties to the related agreements.  In addition, Chung was also the defendants’ guarantor.  They are also the defendants in this litigation.  Thus, all of them can be treated as one entity or the vendors party as a whole.

28.  The plaintiffs purchased no factories or other tangible assets from the defendants.  The only assets they acquired were intangible assets such as supply rights, distribution rights, customer goodwill, exclusive patent and intellectual property usage rights.  The Acquisition Agreement would be meaningless unless it was entered into together with the eight related agreements and vice versa.  The 3^rd plaintiff would be providing the consideration shares, the convertible bonds and cash for nothing if no acquisition was to take place or if the related agreements, particularly the Master Supply Agreement, were not entered into or were breached.  Similarly, the Master Supply Agreement would be meaningless if the plaintiffs had not acquired the intangible assets and intellectual property rights.  In effect, the transactions under the Acquisition Agreement and the eight related agreements constituted one integral whole or one series of related transactions with the plaintiffs together constituting one contracting entity and the defendants and vendors together constituting the other contracting entity. 

29.  The 1^st defendant’s claim for redemption money under the Terms and Conditions and the 3^rd plaintiff’s claim for set‑off in respect of breaches of the related agreements were inseparably connected to each other and flowed from the dealings and transactions between the plaintiffs’ group and the defendants’ group.  It simply defies common sense to allow the 1^st defendant to claim part of the consideration under the Acquisition Agreement, ie the redemption money in respect of the bonds redeemed or to be redeemed, without taking into account the 3^rd plaintiff’s counterclaim for damages for breach of the Acquisition Agreement under which the convertible bonds were issued to the 1^st defendant.

30.  The present case is on all-fours with the Dole Dried Fruit case and Bim Kemi v Blackburn.  The issue of the convertible bond and the Terms and Conditions were part and parcel of the Acquisition Agreement and the related agreements.  The connection between the related agreement and the Acquisition Agreement in the present case is no different from, if not stronger than, that between the sales of goods agreements under the umbrella of the distribution agreement in Dole Dried Fruit case and Bim Kemi v Blackburn.  In my view, it is very arguable that the 3^rd plaintiff’s claim for breaches of the various agreements is inseparable from the 1^st defendant’s claim for the redemption money under the redemption notice, the Terms and Condition and the Acquisition Agreement; and the 3^rd plaintiff is entitled to claim set‑off as a defence against the 1^st defendant’s counterclaim.

The damage suffered by the 3^rd plaintiff

31.  It is Ms Chan SC’s contention that no claim was pleaded by the 3^rd plaintiff against the 1^st defendant and no damage was suffered by the 3^rd plaintiff because there was no dispute that all intellectual property rights relating to the electric battery products belonged to the 2^nd plaintiff and all the business and manufacturing operations were carried out by the 2^nd defendant.  Mr Scott SC argues that is incorrect as a matter of pleading.  He refers to a number of paragraphs in the Amended Statement of Claim, such as paragraphs 48, 54, 63, 71 and the prayers.  I do not find it necessary to quote any of those paragraphs here; suffice it is to say, I have read those paragraphs and I agree with Ms Chan SC.  The only breaches pleaded by the 3^rd plaintiff against the 1^st defendant were breaches of clause 6.2 of the Acquisition Agreement for which no remedy was pleaded against the 1^st defendant, and breaches of clause 8.3 which was about breach of undertaking to the 1^st plaintiff.  The 3^rd plaintiff, being the party which paid the consideration for the acquisition on behalf of the 1^st and 2^nd plaintiff, suffered no damage as the result of any breach by the 1^st defendant.  All damage was suffered by the 2^nd plaintiff which is the holder of the intellectual property rights etc and the operating arm of the plaintiffs’ group. 

32.  Next, Mr Scott SC refers to the expert report by the plaintiff’s expert, FTI, in which FTI opined that the 3^rd plaintiff suffered impairment in the value of the 3^rd plaintiff’s intangible assets.  In reply, Ms Chan SC argues that according the FTI report, the losses were estimated either on the basis of impairment in the value of the shareholding in Union Grace or on the basis of loss of profit arising from breaches of the Master Supply Agreement entered into by the 2^nd plaintiff.  Hence, the only party which may have suffered any loss, whether in terms of loss of business opportunities, loss of profits or loss of goodwill is the 2^nd plaintiff and the loss allegedly suffered by the 3^rd plaintiff was reflective loss.  Specifically, Ms Chan SC referred to paragraph 1.3.3 of the FTI report in which the expert referred to the loss as reflected by the changes in the market value of the 3^rd plaintiff’s shares when the breaches came to light.  Mr Scott SC objects to this line of argument being raised as it had never been pleaded by any of the defendants and it is impermissible for the 1^st defendant to even raise an issue not found in its pleadings but introduced by way of legal submission.  Nonetheless, he was prepared to deal with that argument.  He relies on paragraph 1.3.3 of the FTI report.

33.  In paragraph 1.2.8, the expert carefully distinguished between the 3^rd plaintiff from the other co‑plaintiffs. He identified the 3^rd plaintiff as “Sinopoly” and all the other plaintiffs collectively or singly as “the plaintiffs”.  Thus, on the face, wherever FTI referred to Sinopoly’s loss, it meant loss suffered by the 3^rd plaintiff.  FTI concluded his assessment in paragraphs 1.3.2 to 1.3.5 as follows:

“1.3.2 First, I have considered the impairment in the value of Sinopoly’s intangible assets set out in the financial statement. This impairment, which has been agreed by Sinopoly’s auditors, reflects the reduction in the value of the intellectual property acquired under the Agreements and which was included in Sinopoly’s accounts at that time at fair value. It is the Plaintiffs’ case that the diminution of value of its intangible assets was a direct consequence of the Defendants’ alleged breaches.

1.3.3 Second, I have considered changes in Sinopoly’s market value around the time when the alleged breaches came to light. Specifically, I have considered the change in value between 21 February 2011, when Sinopoly’s shares were suspended from the Hong Kong stock exchange, and 4 April 2011, when trading in its shares resumed.

1.3.4 Both of these methods are what are known as “top down” analyses of the Plaintiffs’ losses. In other words, they infer the value of the Plaintiffs’ losses from observed changes in the value of the company and its assets. Implicitly, it is assumed that all of any observed decrease in value is to the account of the Defendants.

1.3.5 In a third analysis, I have considered the Plaintiffs’ potential losses using a “bottom up” approach that seeks to calculate the value of the Defendants’ alleged breach of the MSA [the Master Supply Agreement]. This is one breach out of several that the Plaintiffs may wish to take into account in Suit 420 [this action] and may therefore be expected to understate their total losses.”

(Emphasis added)

34.  FTI used three different methods in assessing that loss.  It assessed the loss as reflected, firstly, in the 3^rd plaintiff’s financial statements; secondly, in the market value of its shares before and after the breaches came to light; and, thirdly, part of the plaintiffs’ loss by assessing the value of the defendants’ breach of the Master Supply Agreement.  It is clear from paragraph 1.3.2 that in assessing the loss suffered by the     3^rd plaintiff, FTI assessed the impairment in value of the various intangible property rights acquired under the Acquisition Agreement and related agreements.  Though the 3^rd plaintiff’s auditors might have included the value of those intangible assets in the books of the 3^rd plaintiff, what the auditors did could not change the fact that the intangible assets were acquired by the 2^nd plaintiff, and any loss in that value was loss suffered by the 2^nd plaintiff and not the 3^rd plaintiff.

35.  In paragraph 1.3.3, FTI said that it used the market value of the 3^rd plaintiff’s own shares as a basis of assessment.  Though FTI was not using the market value of the shares of the 1^st and 2^nd plaintiffs in the assessment, such value must reflect the impairment in value of the intangible assets and the loss as result of breaches of the Master Supply Agreement suffered by the 2^nd plaintiff.  The same applies to the loss assessed under paragraph 1.3.4.  In substance, the loss was not suffered by the 3^rd plaintiff.

36.  Thus, although on the pleading, the 3^rd plaintiff has pleaded loss against the 1^st defendant, on the evidence, the loss allegedly suffered by the 3^rd plaintiff was reflective loss suffered by the 1^st and 2^nd plaintiffs.  It was not possible to argue that any loss was suffered by the 3^rd plaintiff. 

Whether the redemption notice constituted a promissory note

37.  The 1^st defendant’s purpose of launching this line of argument is to exclude the availability of set‑off as a defence from the 3^rd plaintiff.  It is well settled law that in an action on a promissory note, a defendant will not, save in exceptional circumstances or upon strong grounds, be allowed to set up a set‑off or counterclaim for damages and the plaintiff will be entitled to judgment for the amount claimed without a stay of execution.      This principle applies irrespective of whether the counterclaim is connected with or arises out of or is independent of the contract in respect of which the promissory note was given and whether or not the action is between the immediate parties to the bill: Hong Kong Civil Procedure 2013, Vol 1, paragraph 14/4/15; Fielding & Platt Ltd v Selim Najjar [1969] 1 WLR 357 at 361; Yuen Chak Construction Co Ltd v Tak Son Contractors Ltd [1997] 3 HKC 294 at 298G‑I; Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH [1977] 1 WLR 713 at 721.

38.  Section 89(1) of the Bills of Exchange Ordinance defined a promissory note as follows:

“A promissory note is an unconditional promise in writing made by one person to another signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money to, or to the order of, a specified person or to bearer.”

39.  The redemption notice reads:

“We hereby irrevocably elect to redeem the principal amount of the Convertible Bond (the “Bonds”) we issued to you dated [ ] in accordance with the Conditions (as defined in the Terms and Conditions) and the terms below and enclose a cheque payable to you of the amount so redeemed.

   (It then sets out the redemption date and amount.)”

40.  Ms Chan SC also relies on clauses 1.3 and 11 of the Terms and Conditions which provided as follows:

“1.3 The obligations of the Company arising under the Bonds constitute direct, unsubordinated and unconditional obligations of the Company and rank, and shall at all times rank equally among themselves and pari passu with all other present and future unsecured and unsubordinated obligations of the Company without any preference or priority among themselves. No application shall be made for a listing of the Bonds.”

4.1  All payments by the Company hereunder shall be made in immediately available funds free and clear of any withholdings or deductions for any present or future taxes, imposts, levies, duties or other charges.  …

11.   … Once a Redemption Notice is given, the Company shall deliver to the Bondholder at its address referred to in Condition 14 a cheque for the Redemption Amount against delivery of the Bonds … for cancellation or … for endorsement by the Company … .”  (emphasis added)

41.  She argues that the redemption notice bears all the qualities of a bill of exchange or promissory note in that it is in writing, made and signed by the 3^rd plaintiff, specifying a sum payable to the 1^st defendant and the redemption date and stating that the 3^rd plaintiff irrevocably elects to redeem the bond. She attempts to make good the unconditional nature of the promise to pay by reading the redemption notice in conjunction with clause 1.3 of the Terms and Conditions, which stated that the obligation of the 3^rd plaintiff was unconditional, and with clause 11 which stated that the 3^rd plaintiff shall deliver a cheque for the redemption amount once a redemption notice is given.

42.  On the contrary, Mr Scott SC argues that the redemption notice by itself contained no promise to pay any sum of money and it was impermissible to read it in conjunction with and/or construed it within the factual matrix of clause 11.  He further argues that clause 11 only set out the mechanism for redemption, ie by delivery of a cheque against delivery up of the bond.  To say the least, I think the parties envisaged there would be further steps to be taken before the bond would be converted into a cheque.  I agree with Mr Scott SC that it would be rewriting the parties’ contractual bargain to suggest that the redemption notice, even taken together with the bond and Terms and Conditions constitute a promissory note. I doubt if the redemption notice together with the bond and the Terms and Conditions would be accepted by the commercial community as a promissory note. At the highest, the redemption notice is evidence of a simple debt.  To put it more neutrally, it is at least strongly arguable that the redemption notice is, at the highest, evidence of a simple debt such that the defence of set‑off is available if the other requirements for set‑off are satisfied.

Whether set‑off is excluded by the terms of the Convertible Bond

43.  Next, Ms Chan SC argues that properly construed the Terms and Conditions do not permit any defence of set‑off to be raised.  She refers to Esso Petroleum Co Ltd v Milton [1997] 1 WLR 938 (CA), in which the court held that the parties’ agreement to pay by direct debit was equivalent to a requirement to pay cash and excluded the right to set‑off. Hence, she argues that the 3^rd plaintiff’s obligation to deliver a cheque upon giving the redemption notice was equivalent to payment by cash which excluded the right to set‑off.  Such argument is premised on the basis that the redemption notice, the convertible bond and the Terms and Conditions constitute a promissory note.  For same reason as explained above, there are further steps to be taken before the convertible bond would be converted into a cheque.  Not until there was actual exchange of the convertible bond for a cheque was there payment by cash.  It is therefore very arguable that before that exchange takes place, at the highest the redemption notice is evidence of a simple debt such that the defence of set‑off is available if the other requirements for set‑off are satisfied.

44.  Next, Ms Chan SC argues that the use of the phrases “unconditional obligations” in clause 1.3 and “shall be made in immediately available funds” in clause 4.1 is inconsistent with a defence  of set‑off which would delay full payment.  I agree with Mr Scott SC’s submission that in the context of clause 1.3, the term “unconditional obligations” refers to distributions in an insolvency scenario that does not even relate to whether or not amounts due under the convertible bond can be subject to set‑off in the event of fundamental breaches of the Acquisition Agreement.  I also agree with Mr Scott SC that in the context of clause 4.1, that clause must be construed ejusdem generis.  That clause deals with payments in the nature of taxes and Government levies and does not relate to or preclude the operation of set‑off.  Putting it more neutrally, it is arguable that on the true and proper construction the clauses do not exclude set-off.  

Conclusion

45.  I reach the following conclusions.

46.  The applicable legal principle is that the defence of set-off is available to a defendant (the 3^rd plaintiff in the present case) who has a counterclaim (the original claim in the present case or a counter-counterclaim as I call it) against the plaintiff (the 1^st defendant in the present case) in the same litigation if the counterclaim (the original claim in the present case) is inseparably connected with the dealings and transactions giving rise to the subject matter in the claim.  The problem is the application of the principle to the facts of the case.

47.  On the fact, it is strongly arguable that on their true construction, the Terms and Conditions do not exclude availability of set-off as a defence; and that the redemption notice is not of the nature of a promissory note such that the defence of set-off is excluded.

48.  The 3^rd plaintiff has pleaded no defence to the 1^st defendant’s claim for redemption money under the redemption notice and Terms and Conditions other than the defence of set-off by reason of its original claim against the defendants.  Though the 3^rd plaintiff pleaded breaches by the 1^st defendant and loss suffered as a result, on the evidence such loss is   of the nature of reflective loss.  Thus, the 3^rd plaintiff has no real    claim against the 1^st defendant.  Any claim it may use to set off the     1^st defendant’s counterclaim for redemption money is the claims the 1^st and 2^nd plaintiff have against the 1^st to 7^th defendants.

49.  The central issue in the 1^st defendant’s application boils  down to this.  In a case such as the present one involving a number of  co-plaintiffs and co-defendants, whether the claims of one co-plaintiff (the 1^st and 2^nd plaintiff) against a co-defendant (the 1^st to 7^th defendants) could be used to set off another co-defendant’s (the 1^st defendant’s) counterclaim against a different co-plaintiff’s (the 3^rd plaintiff’s) claim depends on whether the principle in Muscat v Smith applies narrowly to a co-plaintiff vis-à-vis a corresponding co-defendant or broadly to the co-plaintiffs as one party and the co-defendants as another.  From the authorities quoted to me, it is not entirely clear whether the principle is to be applied narrowly or broadly.  I have not been referred to any authority one way or the other.  If a case meets the inseparable connection test, it is at least arguable that the principle should be applied broadly.  The present case certainly meets that test.  Accordingly, I think the defence of set-off is a plausible defence which needs to be fully argued and explored at trial.

50.  In view of the above conclusions, I think the 3^rd plaintiff’s defence of set-off falls within the third if not the second class of cases mentioned in paragraph 14/4/14 of Hong Kong Civil Procedure 2013, Vol 1.  The usual order would be judgment for the 1^st defendant on the counterclaim with costs stayed until trial of the claim.  In the present case, because of the lack of clarity as to where this case actually stands, the court has discretion to make such order as appropriate for the perceived justice of the case.

51.  The 1^st defendant’s claim is basically for the balance of the purchase price for the shares of Union Grace sold.  It only represented a small fraction of the consideration paid by the 3^rd plaintiff under the Acquisition Agreement.  The defendants had received the bulk of their consideration.  In the light of the FTI report, it is not speculative to suggest that the plaintiffs’ claim could be very substantial and could far exceed the amount of the defendants’, including the 1^st defendant’s, counterclaim.  Though the 3^rd plaintiff has not put up any defence to the counterclaim other than a set‑off, it would be manifestly unjust in the circumstances to allow the 1^st defendant to have judgment for the redemption money without taking into account the plaintiffs’ claim for damages for the 1^st defendant’s breaches of the Acquisition Agreement and related agreements.  Taking all of the above into account, I think it would not be just to enter judgment for the 1^st defendant.

52.  Furthermore, fourteen months lapsed without the 1^st defendant taking any action to strike out the 3^rd plaintiff’s claim.  Instead, it took out a new action against the 3^rd plaintiff on the same subject matter as its counterclaim a month after Miao and others presented a bankruptcy petition against him.  The 1^st defendant’s delay in taking action suggest that the present application was made for an ulterior motive and that the 1^st defendant’s application is an abuse of the legal process.  This is another reason for not entering judgment for the 1^st defendant.

53.  In conclusion, for the perceived justice of the case, it is appropriate that my discretion should be exercised in favour of the      3^rd plaintiff.  Accordingly, I dismiss the 1^st defendant’s summons.  The effect is that the 3^rd plaintiff has unconditional leave to defend to the extent of the set‑off.  I make a costs order nisi that the costs of the application including the costs of the hearing shall be the plaintiffs’ costs in the cause with certificate for two counsel.  Such costs are to be taxed if not agreed.

Mr John Scott SC and Ms Elizabeth Cheung, instructed by Sidley Austin, for the 3^rd Plaintiff

Ms Linda Chan SC and Mr Keith Lam, instructed by DS Cheung & Co, for the 1^st Defendant

HCA 420/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 420 OF 2011 & NO 1071 OF 2012

____________

AND

HCA 1071/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1071 OF 2012

____________

____________

(Heard together)

_____________________________________

REASONS FOR JUDGMENT

_____________________________________

1. Two summonses came on for hearing on 1 August 2012.  The earlier in time is a summons in HCA 1071/2012 ("2012 Action") taken out by Sinopoly Battery Ltd (formerly known as Thunder Sky Battery Ltd) ("Sinopoly") on 4 July 2012 to strike out the statement of claim in the 2012 Action.  Mei Li New Energy Ltd ("Mei Li") is the plaintiff in the 2012 Action.  The second is a summons dated 7 July 2012 taken out by Mei Li in HCA 420/2011 (the "2011 Action") for leave to discontinue its counterclaim against Sinopoly.

2. At the conclusion of the hearing, I refused leave to discontinue the counterclaim and ordered that the 2012 Action be struck out with costs to Sinopoly.

3. Sinopoly is one of the plaintiffs in the 2011 Action.  Mei Li is the first defendant in that action. Mei Li filed a defence and counterclaim on 23 August 2011 which was amended on 13 March 2012.

4. Mei Li’s counterclaim against Sinopoly related to a convertible bond issued by Sinopoly on 10 February 2011.  It was for the sum of $760,751,606 ("the redemption amount") said to be repayable pursuant to a redemption notice dated 8 March 2011 issued by Sinopoly to Mei Li.

5. On 10 April 2012, Sinopoly and its co-plaintiffs filed a reply and defence to counterclaim.

6. On 18 June 2012, Mei Li’s solicitors sent a letter on Mei Li’s behalf requesting a cheque for the redemption amount, confirming that Mei Li was "ready, willing and able to deliver the [Convertible Bond] …upon receipt of a cheque for the redemption amount …"

7. In pertinent part, clause 11 of the convertible bond reads:

"…once a Redemption Notice is given, the Company shall deliver to the Bondholder at its address referred to in Condition 14 a cheque for the Redemption Amount against delivery of the Bonds (which the Bondholder is obliged to deliver to the Company upon such Redemption Notice being given) for cancellation …"

8. Logically, the summons for leave to discontinue the counterclaim should be considered first as its result could have a bearing on the summons to strike out.

9. Mr Warren Chan SC, leading counsel for Mei Li, submitted that a party is at liberty to discontinue an action and then to issue a fresh action. As stated in the judgment of Yuen JA in Sincere's Knitting Mills Ltd v Cheong Pui Fan [2005] 4 HKC 363 at § 25

"there is no objection in principle to a party seeking leave to discontinue an action with the intention of instituting a fresh action subsequently …"

10. While the principle is not doubted, Mei Li may not withdraw its counterclaim without the leave of the court. Whether leave should be granted involves the exercise of the court's discretion, having regard to all the circumstances.

11. The counterclaim and 2012 Action involve the same parties. The cause of action is also the same and arises from Sinopoly's failure to pay the redemption amount under the convertible bond. In substance, the same relief is sought. Further, the counterclaim has progressed further than the 2012 Action: Sinopoly’s reply and defence was filed in April. In those circumstances, absent good reason for bringing the 2012 Action, the court should be slow to exercise its discretion to grant leave to discontinue the counterclaim and, concomitantly, to allow the 2012 Action to proceed.

12. In the present case, it was not apparent to the court what defect existed in the counterclaim that could not be remedied by an appropriate amendment.  If it was because of the absence of a plea to the effect that Mei Li was "ready, willing and able" to deliver the bonds, plainly that could be remedied by way of amendment to the counterclaim.

13. Mr Chan explained that good reason existed for bringing the 2012 Action. He submitted that it could be argued that Mei Li’s cause of action was not complete without a prior written notice. As written notice was only given on 18 June 2012 which was several months after the filing of the counterclaim, it was not a defect that was curable by way of amendment. Mr Chan added that while it was not an argument that he considered to be correct, he could not rule out the possibility of it being raised in the future.

14. For my part, I simply do not see that clause 11 requires the bondholder to give prior written notice or that such written notice is essential for the bondholder to complete its cause of action.  I am not satisfied that good reason underpinned the bringing of the 2012 Action.

15. Quite apart from the matters mentioned in §11 above which weigh against Mei Li’s application, the 2012 Action, if permitted to go forward, will more likely than not engender yet more applications.  Such applications are bound to take up judicial time and resources and generate unnecessary costs. An example that readily comes to mind would be an application for the 2011 Action to be heard at the same time as the 2012 Action. From a case management perspective, such an outcome would be highly undesirable.

16. For all those reasons, I refused Mei Li’s application for leave to discontinue the counterclaim, but intimated to Mei Li that an application for leave to amend the counterclaim would be viewed favourably.  It followed from the refusal of leave to discontinue that the 2012 Action could no longer remain on foot. Accordingly, it was struck out.

Mr Anthony Chan, SC & Ms Elizabeth Cheung instructed by Sidley Austin for the 3^rd Plaintiff in HCA 420/2011 & the Defendant in HCA 1071/2012

Mr Warren Chan, SC & Mr Law Man Chung instructed by Orrick, Herrington & Sutcliffe for the 1^st Defendant in HCA 420/2011 and the Plaintiff in HCA 1071/2012