CHINA FORESTRY HOLDINGS CO LTD (IN OFFICIAL LIQUIDATION) v. TOP WISDOM OVERSEAS HOLDINGS LTD AND ANOTHER

HCA 1089/2016

[2025] HKCFI 2893

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1089 OF 2016

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J U D G M E N T

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A.  Introduction

1.  In these proceedings, the Plaintiff (“China Forestry” or “P”) claims against its former Chief Executive Officer (“CEO”), Mr Li Han Chun (“Li” or “D2”) and his wholly-owned company, Top Wisdom Overseas Holdings Limited (“Top Wisdom” or “D1”) (collectively “Ds”), for proprietary claim over illicit gains (obtained through Top Wisdom as his alter ego or alternatively as an accessory) and/or equitable compensation on the basis that Li perpetrated a fraud on China Forestry in breach of Li’s fiduciary duties.

2.  Despite having taken active steps to defend these proceedings in the past, including mounting (unsuccessful) stay and striking-out applications, filing defence and exchanging witness statement, Li and Top Wisdom ceased to be legally represented since October 2023 and did not take further steps thereafter. In accordance with earlier court orders, China Forestry had served documents including the trial bundles and P’s written submission (“P’s Skel”) on Ds’ email addresses, but Ds failed to respond and did not attend the trial of these proceedings scheduled to commence on 8 October 2024 before this Court.

3.  China Forestry’s case and the relevant evidence in support are set out inter alia in the following key documents (“Key Documents”):

(1)  Amended Statement of Claim dated 2 August 2023 (“ASOC”);

(2)  Reply dated 4 February 2022;

(3)  Witness Statement of Mr Cosimo Borrelli (“Mr Borrelli”) dated 24 April 2023 (“Borrelli WS”);

(4)  Witness Statement of Ms Deng Huiqiong (Starry) (“Ms Deng”) dated 6 March 2023 (“Deng WS”);

(5)  Expert Report of Mr Wang Hongjie (“Mr Wang”) dated 27 April 2023 (“Wang Report”); and

(6)  P’s Skel dated 24 September 2024 (together with Chronology of Events and Dramatis Personae).

4.  At the trial on 8 October 2024, Mr Borrelli, Ms Deng and Mr Wang testified on behalf of China Forestry, adopting their statements or report (as the case may be). Specifically:

(1)  Mr Borrelli is one of the joint and several liquidators of China Forestry (“Liquidators”). His statement maps out the evidence on the False Accounting Scheme and the 2010 Guizhou and Yunnan Sham Transactions (as defined below), Li’s involvement, the loss and damage suffered by China Forestry, the tracing analysis carried out, and China Forestry’s efforts to recover loss.

(2)  Ms Deng is a PRC-qualified attorney and partner at ZY Partners specialising in investigative matters arising from insolvency or distressed situations. Ms Deng was engaged to make enquiries on behalf of the Liquidators on (i) the authenticity of bank statements and bank-in slips; (ii) the existence of China Forestry group’s purported principal logging contractor, Dehong Hongda Xingfa (“Dehong Hongda”); and (iii) the authenticity of certain plantation rights certificates and harvest permits. Ms Deng and her team carried out extensive work to verify these matters with branches of banks, local regulatory bureaux of the China Banking and Insurance Regulatory Commission (“CBIRC”), local administration for industry and commerce (“AIC”), local taxation bureau as well as local forestry bureaux. Ms Deng’s evidence corroborates the Liquidators’ findings that the False Accounting Scheme (as defined below) was perpetrated on China Forestry.

(3)  Mr Wang is China Forestry’s expert on Mainland forestry law and practice. He has provided an independent expert report opining that the 46 plantation rights certificates and the various harvesting permits examined by him were all forged. His expert evidence on forestry documents corroborates the investigations carried out by the Liquidators and Ms Deng. Importantly, his evidence is unchallenged because, despite being granted leave to file expert report on forestry law and practice, Ds never file their expert report and, pursuant to the Order of Master D To dated 13 July 2023, Ds are debarred from relying on expert evidence at trial.

5.  Further, Mr Manzoni SC, leading Counsel for China Forestry, made oral submissions in support of China Forestry’s claims at trial.

6.  On the other hand, Ds have filed the following:

(1)  Defence dated 7 December 2021 (“Defence”); and

(2)  Witness Statement of Li dated 25 April 2023 (“Li WS”).

7.  As Ds did not attend trial and Li did not testify in support, it should not be open to Ds to rely on Li WS. Having said that, as fairly accepted by Mr Manzoni SC, in the absence of Ds, China Forestry has “an obligation of fair presentation which is less extensive than the duty of full and frank disclosure on a without notice application” (see CMOC Sales & Marketing Limited v Person Unknown [2018] EWHC 2230 (Comm) at [14] per HHJ Waksmann QC, cited with approval by Ng J in Moulin Global Eyecare Holdings Limited v Olivia Lee Sin Mei[2019] HKCFI 1715 at [3]). Therefore, China Forestry has nevertheless identified and addressed the key points in the Defence and Li WS, both in P’s Skel and oral submissions by Mr Manzoni SC.

8.  The bases and evidence in support of China Forestry’s claims have been set out in the Key Documents at length. Having considered the same and other relevant evidence, this Court ultimately finds in favour of China Forestry. In this Judgment, this Court will set out the key findings and reasons in support. For the avoidance of doubt, the mere fact that any specific point or argument is not mentioned or addressed herein does not mean that it is not otherwise considered or taken into account.

B.  Salient background

9.  The salient background has been set out in P’s Skel (particularly its executive summary), the Chronology of Events, and Borrelli WS. They are based on contemporaneous documents which are not in any serious dispute.

10.  China Forestry was the Cayman Islands incorporated holding company of the China Forestry group of companies (“Group”). It was listed on the Hong Kong Stock Exchange (“HKEx”) since 3 December 2009. The Group charts and directorship information are at Schedule 1 to Borrelli WS.

11.  On 26 January 2011, following discovery of serious irregularities in the audit exercise of China Forestry, trading of China Forestry’s shares was suspended on the HKEx. On 12 February 2015, a winding-up petition was presented against China Forestry. Pursuant to the order of the Cayman Court of 18 June 2015, China Forestry was ordered to be wound up and liquidators (including inter alia Mr Borrelli) were appointed. Eventually, China Forestry was delisted from the HKEx on 24 February 2017, and it was also ordered to be wound up by the Hong Kong Court on 20 December 2017. On 16 January 2018, Mr Borrelli and his colleague Ms Jocelyn Chi were appointed as joint and several liquidators of China Forestry in Hong Kong. The present proceedings were commenced by China Forestry in 2016 after it was wound up by the Cayman Court in 2015.

12.  Li was the CEO and a director of China Forestry. On 14 February 2011, he was removed as CEO of China Forestry and all his duties and powers in all subsidiaries of China Forestry were removed. The organisational reporting chart of China Forestry prior to January 2011 is at Schedule 3 to Borrelli WS. Further, an overview of (a) key China Forestry personnel (including Li) and other relevant parties and (b) where applicable, their role in the alleged fraudulent activities, can be found at Schedule 4 to Borrelli WS.

13.  Through Top Wisdom, Li beneficially owned 6.34% of China Forestry’s shares (“Shares”). Top Wisdom was set up for the sole purpose of holding the Shares for Li.

14.  In a nutshell, P claims that Li perpetuated a fraudulent scheme to inflate the Group’s assets and revenue via fictitious plantation rights and business, and Li reaped illicit benefits for his personal gain through his wholly-owned company, Top Wisdom. These illicit gains comprise the proceeds of the sale of the Shares held by Top Wisdom, both pre and post-initial public offering (“IPO”) (in the sum of HK$11,624,930 and HK$398,650,000 respectively) and the dividends received by Top Wisdom in the sum of HK$12,424,093. In addition, China Forestry suffered other losses as a result of Li’s breach of fiduciary duties.

15.  According to P, the fraud began to unravel since January 2011:

(1)  On 25 January 2011, China Forestry’s then auditor KPMG formally reported to the board of directors of China Forestry (“Board”) various irregularities in the audit of China Forestry’s financial statements for the year ended 31 December 2010 (“FY2010”) which raised serious questions about the Group’s accounting records. This led to the suspension of trading of China Forestry’s shares on the HKEx and the removal of Li as the CEO of China Forestry.

(2)  On 2 February 2011, the Securities and Futures Commission (“SFC”) obtained an ex parte interim injunction order in HCMP 176/2011 (“Injunction Order”) freezing assets held by Top Wisdom in a UBS bank account (“Frozen Funds”), which represented the approximate proceeds of the January Share Sale (as defined below). To complete the picture, the SFC has brought separate proceedings against Li and Top Wisdom before the Market Misconduct Tribunal (“MMT”). The MMT has issued a report following the MMT proceedings (“MMT Report”). As explained below, China Forestry rightly accepts that it cannot rely on the findings or conclusions in the MMT Report, as opposed to the position or evidence advanced by the parties therein.

(3)  On 29 April 2011, KPMG issued an audit report disclaiming any opinion on China Forestry’s consolidated financial statements for FY2010 (“2010 Consolidated Financial Statements”).

16.  The alleged fraudulent scheme goes to the heart of the Group’s purported business operation.

(1)  China Forestry purported to be engaged in a substantial forestry business. Its principal operating subsidiary, Kunming Ultra Big Forestry Resource Development Co., Limited (“KUB”), recorded in its accounts ownership rights over extensive standing timber plantations in Yunnan and Sichuan. These plantation rights comprised the vast majority of the non-current assets recorded in the Group’s financial statements for the financial years ended 31 December 2008 and 31 December 2009 respectively (“FY2008” and “FY2009”, respectively), and the interim results for six months ended 30 June 2010. They were evidenced by 46 “plantation rights certificates” purportedly issued by 13 county forestry bureaux.

(2)  KUB purportedly harvested logs from those plantations pursuant to “harvest permits” purportedly issued by those county forestry bureaux. The harvesting was purportedly conducted by Dehong Hongda, the Group’s sole logging contractor in Yunnan. KUB then purportedly sold those logs to customers in Yunnan and Sichuan, thereby generating the entirety of the Group’s turnover.

(3)  It is China Forestry’s case that KUB’s purported plantation assets were in fact fictitious. The plantation rights certificates and harvest permits were forgeries. The bank statements for KUB’s principal operating account at Huaxia Bank (华夏银行), which purportedly recorded (amongst others) KUB’s receipts from customers and payments to Dehong Hongda, were forged. China Forestry contends that all of these falsities constitute strong evidence that Dehong Hongda and KUB’s purported customers did not exist.

17.  Relevantly, P’s case is that Li took active part as a perpetrator (and indeed the mastermind) of such scheme, which resulted in material overstatement of the Group’s financial position. In short:

(1)  In breach of his fiduciary duties, Li orchestrated a scheme to forge documents, engage in numerous false transactions and false accounting (“False Accounting Scheme”) across five key areas of the business, namely: (1) the Group’s principal operating bank account; (2) plantation assets; (3) harvesting; (4) customers/sales; and (5) logging expenses paid to Dehong Hongda. The False Accounting Scheme was entered into for the purposes of obscuring China Forestry’s true financial performance, thereby inflating its share price.

(2)  The False Accounting Scheme resulted in (i) material overstatement of the Group’s assets, revenues and profitability; and (ii) material misstatement of the Group’s expenses in the following financial statements of the Group (together, “Relevant Consolidated Financial Statements”):

(a)  the consolidated financial statements for FY2008 (“2008 Consolidated Financial Statements”) and the six months ended 30 June 2009 (“2009 Interim Consolidated Financial Statements”) published in China Forestry’s prospectus for initial public offering (“IPO”);

(b)  the consolidated financial statements for FY2009 (“2009 Consolidated Financial Statements”) published in the Group’s 2009 Annual Report; and

(c)  the consolidated financial statements for the six months ended 30 June 2010 published in the Group’s 2010 Interim Report (“2010 Interim Consolidated Financial Statements”).

(3)  The misstatements in the 2008 Consolidated Financial Statements and the 2009 Interim Consolidated Financial Statements:

(a)  enabled China Forestry to list on the HKEx on false pretences; and

(b)  artificially inflated the price at which the Shares were to be offered on the HKEx upon China Forestry’s listing.

(4)  Subsequent to the listing of China Forestry on 3 December 2009, the misstatements in the Relevant Consolidated Financial Statements (individually and collectively) had the effect of:

(a)  continuing to mislead investors in the Hong Kong stock market as to the true financial performance and position of China Forestry; and

(b)  further artificially inflating the price of P’s shares traded on HKEx.

18.  Worse still, as alleged by China Forestry, Li reaped huge personal benefits from that artificially inflated share price (which was the result of Li’s breach of fiduciary duties):

(1)  approximately four months prior to the IPO, Li caused Top Wisdom to dispose of 130,434 Shares for US$1,499,991 (equivalent to approximately HK$11,624,930) (“Pre-IPO Sale Proceeds”) pursuant to a share purchase agreement dated 25 June 2009 (“Pre-IPO Disposal”).

(2)  On 12 January 2011, Li caused Top Wisdom to enter into a placing agreement with Standard Chartered Securities (Hong Kong) Limited. Pursuant to the placing agreement, Li caused Top Wisdom to dispose of 119,000,000 Shares (“January Share Sale”), resulting in Top Wisdom’s receipt of total proceeds of HK$398,650,000 (“Post-IPO Sale Proceeds”).

(3)  Top Wisdom also received dividends from China Forestry in the amount of RMB10,019,430 (equivalent to about HK$12,424,093) in June 2010 (“Top Wisdom Dividend” and, together with Pre-IPO Proceeds and Post-IPO Proceeds, “Illicit Gains”).

(4)  After China Forestry raised funds through its IPO and subsequent bond offerings in Hong Kong, Li, assisted by persons acting under his direction, caused China Forestry’s subsidiaries to enter into various sham transactions in 2010 for purported acquisitions of plantation assets in Guizhou and Yunnan provinces (“2010 Guizhou and Yunnan Sham Transactions”). The 2010 Guizhou and Yunnan Sham Transactions were entered into for the purposes of defalcating funds ultimately sourced from China Forestry.

C.  Summary of China Forestry’s claims and Ds’ Defence

C1.  China Forestry’s claims

19.  Against the above background, China Forestry commenced these proceedings against Ds. Its claims may be briefly summarised as follows:

(1)  Li breached his fiduciary duties to China Forestry by perpetrating the False Accounting Scheme.

(2)  China Forestry has a proprietary claim over the Illicit Gains obtained by Ds as a result of Li’s breach of fiduciary duties, and Ds hold them on a constructive trust for China Forestry.

(3)  Top Wisdom is liable for Li’s breach of fiduciary duties as Li’s corporate alter ego; further or alternatively, Top Wisdom is liable as an accessory for dishonest assistance and knowing receipt.

(4)  Further or in the alternative, Ds are liable to pay equitable compensation in respect of any shortfall in tracing these Illicit Gains (in the sum of HK$422,699,023).

(5)  China Forestry claims against Li for equitable compensation in respect of further loss suffered by China Forestry as a result of his breach of fiduciary duties: (1) funds paid out pursuant to certain sham transactions; (2) dividends paid out to entities other than Top Wisdom; and (3) costs and expenses incurred to unravel the false accounting scheme. The loss totals HK$747,662,201.

C2.  Ds’ case

20.  The Defence does not plead a positive case and generally adopts an approach of denial or non-admission. The thrust of the Defence is to disavow any participation and distance Ds from the alleged fraud, on the basis that Li was allegedly not involved in the daily business or local operations handled by the staff of the Mainland subsidiaries. Pausing here, such line of defence is, to say the least, highly dubious given inter alia (i) the substantial scale of fraud permeating the entire business of the Group, (ii) the role assumed by Li as CEO, (iii) Li’s supervision of other staff of the Group including his cousin, Ms Wu Xiaofen (“Ms Wu”), being the Chief Financial Officer (“CFO”) for Mainland China and head of the finance department; (iv) Li’s involvement in the 2010 Guizhou and Yunnan Sham Transactions and (v) suspicious timing of Top Wisdom’s disposal of the Shares before the unravelling of the fraud.

21.  For present purposes, it suffices to say that the key points of the Defence are in line with such theme of alleged non-participation on the part of Li. Accordingly, consistent with such theme, the Defence alleges that:

(1)  Li had limited involvement in the Group’s local operations and business ever since he joined the Group and his responsibilities were limited to China Forestry’s IPO and other capital-raising projects;

(2)  The local operations were handled by the staff at the Mainland subsidiaries and Li merely rubber stamped documents presented to him;

(3)  Ds do not admit the existence of the False Accounting Scheme;

(4)  Ds deny that Li had falsified accounting records or was involved in the False Accounting Scheme;

(5)  Ds also do not admit that the Relevant Consolidated Financial Statements were misstated;

(6)  Ds claim that Li had no actual knowledge of any material falsity of China Forestry’s financial statements until KPMG raised such issue directly with him on 14 January 2011.

22.  Further, China Forestry has fairly brought this Court’s attention to the arguments raised by Ds in their previous application to strike-out certain parts of the Statement of Claim (“Strike-Out Application”). Ds argued that, as a matter of law, absent any legitimate claim of proprietary interest over the Shares, there is no basis for China Forestry to mount a proprietary claim over the sale proceeds of the Shares, and China Forestry is thus not entitled to claim a constructive trust. The Strike-Out Application was rejected by Ng J in his Judgment handed down on 21 September 2021 in [2021] HKCFI 2761 (“Strike-Out Judgment”) in reliance on FHR European Ventures LLP v Cedar Capital Partners LLC [2015] AC 250 and Tang Ying Loi v Tang Ying Ip [2015] 1 HKLRD 712. In discharge of its duty to present the case fairly, China Forestry has once again addressed the arguments raised by Ds in the Strike-Out Application.

D.  Key issues and other preliminary matters

D1.  Key issues

23.  China Forestry submits that the following key issues require adjudication by the Court:

(1)  Did Li breach his fiduciary duties to China Forestry by perpetrating the False Accounting Scheme?

(2)  What were the illicit gains obtained as a result of Li’s breach of fiduciary duties?

(3)  Do Li and Top Wisdom hold the illicit gains, or any assets into which those sums may be traced, on a constructive trust for China Forestry?

(4)  Further to the issue of constructive trust, what was the loss and damage suffered by China Forestry as a result of Li’s breach of fiduciary duties?

(5)  Is China Forestry entitled to claim equitable compensation for the loss and damage? If so, the amount of equitable compensation to which China Forestry is entitled.

24.  In my view, the first issue may be broken down into two components, namely (i) whether the False Accounting Scheme existed and, if so, (ii) whether Li perpetuated or participated in the same. Further, there should be relatively little dispute on the illicit gains obtained by Ds and the loss and damage suffered by China Forestry under the second and fourth issues. Rather, the key questions hinge on whether China Forestry may claim constructive trust and equitable compensation under the third and fifth issues.

25.  Before considering these issues, this Court would first address a few preliminary matters.

D2.  Top Wisdom’s locus standi

26.  One of the preliminary matters raised in P’s Skel concerns the question as to Top Wisdom’s locus standi, given that Top Wisdom is now a dissolved company under BVI law. The relevant circumstances have been set out in P’s Skel and should not be in dispute.

27.  On 29 May 2023, China Forestry and the SFC were informed for the first time by Ds’ former solicitors, Messrs King & Wood Mallesons (“KWM”), that (i) Top Wisdom had been struck off the BVI Companies Registry from November 2019 and (ii) following an amendment to the BVI Business Companies Act 2004 (“BCA”), Top Wisdom would be automatically dissolved after 30 June 2023. In this regard, as pointed out in Appendix 1 to P’s Skel, a number of amendments were made to the BCA on 1 January 2023, one of which was to the effect that if a BVI company had been struck off as at 1 January 2023 and no application to restore it was made within 6 months, it would be “deemed dissolved”.

28.  Acting sensibly, both China Forestry and the SFC immediately agreed to a withdrawal from the Frozen Funds for the purposes of restoring Top Wisdom. However, despite China Forestry’s attempts to engage with Ds through KWM (who were granted leave on 31 August 2023 to cease to act for Ds) and subsequently Messrs. Chiu & Partners (who purported to represent Ds but never formally filed a Notice to Act until stating on 9 October 2023 that they had ceased to act for Ds), Ds failed to take action to restore Top Wisdom.

29.  Therefore, as things now stand, Top Wisdom has the status of a dissolved company under BVI law. Accordingly, a question arises as to whether China Forestry can continue this action against Top Wisdom. It is China Forestry’s stance that Top Wisdom can act and defend these proceedings, which were commenced before its dissolution.

30.  In fact, the matter was already addressed at the Case Management Conference held on 21 December 2023. On that occasion, Master Ho was satisfied that China Forestry could properly continue this action against Top Wisdom, and he granted leave for China Forestry to set the case down for trial.

31.  With a view to assisting the Court, China Forestry has made detailed legal submissions on Top Wisdom’s standing as set out in Appendix 1 to P’s Skel. Having considered the same, I agree with the submissions of China Forestry as summarised below:

(1)  It is a settled principle of conflict of laws that the law of the place of incorporation is the relevant law for the determination of whether a company exists or not: Dicey, Morris & Collins, The Conflict of Laws (16^th Ed, 2022), [30-010] – [30-013]. Hence, the locus standi of Top Wisdom should be governed by BVI law.

(2)  The lex fori (i.e. Hong Kong law in this case) will generally recognise legal personality which is accepted under the entity’s law of incorporation, even if that legal personality is not recognised within the lex fori’s own system of laws: see Bumper Development Corp v Commissioner of Police of the Metropolis [1991] 1 WLR 1362 at 1373E-G; Maritime Investment Holdings Inc v Underwriting Members Syndicate 1183 at Lloyds [2015] EWHC 2190 (Comm) at [7]; Hin Sang Hong Co Ltd v Kingdom Overseas Ltd [2016] 2 HKLRD 1321.

(3)  Consequently, this Court has to assess whether Top Wisdom still exists under BVI law, and then to decide whether Hong Kong’s own procedural requirements are satisfied such that Top Wisdom is entitled to defend the Hong Kong proceedings. For such purpose, the determination has to be made having regard to what Top Wisdom can or cannot do in substance pursuant to BVI law, and not simply on the basis that Top Wisdom is described by BVI law as having been “dissolved”. As I see it, the rationale is to look at the substance rather than the form or the label alone.

(4)  BVI law is clear that Top Wisdom can continue to defend these proceedings despite having been “dissolved” in the BVI. P has adduced expert evidence from Shane Patrick Donovan, a partner of Mourant Ozannes and an experienced BVI legal practitioner. He has referred to the relevant BVI statutory provisions which make clear that a dissolved company can continue to defend proceedings commenced prior to its dissolution. Indeed, one may venture to say such statutory provisions make commercial sense as they seek to minimise the disruption to lawsuits, particularly existing legal proceedings commenced prior to the dissolution of a company under BVI law. Specifically:

(a)  Section 215(2) of the BCA provides:

“(2) Notwithstanding subsection (1), where a company has been struck off the Register and dissolved, the company, or a director, member, liquidator or receiver thereof, may -

(a) make application for restoration of the company to the register in accordance with sections 217 or 218;

(b) continue to defend proceedings that were commenced against the company prior to the date of the striking-off;

(c) continue to carry on legal proceedings that were instituted on behalf of the company prior to the date of striking-off.”

(b)  Section 215(3)(b) of the BCA further provides:

“(3) The fact that a company is struck off the register and dissolved does not -

(b) prevent any creditor from making a claim against the company and pursuing the claim through to judgment or execution.”

(5)  The fundamental point is that the corporate status of Top Wisdom under BVI law is entirely different to that of a dissolved Hong Kong company. Top Wisdom retains a capacity to act, and to defend these proceedings. As P put it, Top Wisdom remains “alive” notwithstanding the label of dissolution.

(6)  It follows that Top Wisdom continues to exist under BVI law at least for the purpose of these proceedings, as a company that has capacity to continue to defend proceedings must “exist” at least for the purposes of those proceedings. On that footing, it would also appear that the procedural requirements of Hong Kong law have been satisfied.

(7)  In any event, I accept that restoration is neither practicable nor necessary and that China Forestry will suffer prejudice if these proceedings are stayed through no fault of its own (as contended in Sections C and D of Appendix 1 to P’s Skel).

(8)  In the premises, China Forestry should be allowed to pursue this action to judgment against Top Wisdom, and there is no question of such judgment being futile.

32.  Accordingly, there should be no dispute that China Forestry can continue the present proceedings (and may obtain enforceable judgment) against Top Wisdom.

D3.  Adverse inference

33.  As Ds did not attend trial and Li has not come forward to testify, no viva voce evidence has been adduced on behalf of Ds at trial in support of the Defence. Further, P has not had an opportunity to cross-examine Li.

34.  There are authorities in support of drawing adverse inferences from the absence or silence of a witness. Relevantly, such inferences may be drawn from the absence of a witness who might be expected to have material evidence to give on an issue in an action, provided there have been some evidence adduced by the opposing party on the matter or a case to answer on that issue, and there is no satisfactory reason for the absence of the witness: see Wisniewski v Central Manchester Health Authority [1998] PIQR 324 at 340; Pacific Electric Wire & Cable Company Limited v Texan Management Limited (unreported, HCCL 16/2009, 17 September 2013) at [106]; see also Jones v Dunkel (1959) 101 CLR 298 at 312 (approved in Polaroid Far East v Bel Trade Co Ltd [1990] 2 HKLR 447 at 454). P has also fairly drawn this Court’s attention to the recent dicta by Lord Leggatt JSC in Royal Mail Group Ltd v Efobi [2021] UKSC 33 at [41]:

.  “[T]here is a risk of making overly legal and technical what really is or ought to be just a matter of ordinary rationality. So far as possible, tribunals should be free to draw, or to decline to draw, inferences from the facts of the case before them using their common sense without the need to consult law books when doing so... Relevant considerations will naturally include such matters as whether the witness was available to give evidence, what relevant evidence it is reasonable to expect that the witness would have been able to give, what other relevant evidence there was bearing on the point(s) on which the witness could potentially have given relevant evidence, and the significance of those points in the context of the case as a whole.”

35.  In the present case, Li plainly could and is expected to give material evidence in this trial. Indeed, the thrust of the Defence is that Li did not participate in the False Accounting Scheme and surely Li is a key witness to give material evidence on behalf of Ds. As a matter of fact, Li is the only witness put forth by Ds when exchanging witness statements.

36.  Further, Ds’ absence at trial may be contrasted with the period before October 2023, when Ds had taken active steps to vigorously defend the present proceedings. This tends to suggest that Ds could readily attend trial and defend these proceedings if they wished to, and would undermine any reason or excuse which may be put forth to explain their absence. In any event, Ds have not given any explanation (let alone a credible one) for their absence.

37.  The fact is that, pursuant to earlier court orders, P has served documents including the trial bundles and P’s Skel on Ds’ email addresses. As there is nothing to suggest that Ds are unaware of the present proceedings including the trial dates, the Court will proceed on the basis that Ds are fully aware of the trial but have chosen not to attend trial or call upon Li to testify.

38.  In the premises, I agree with P’s submissions that the Court should more readily draw all available inferences in favour of China Forestry.

D4.  MMT proceedings and report

39.  On 2 August 2024, the MMT issued a report (“MMT Report”) declaring its findings on, inter alia, whether Li and Top Wisdom have engaged in market misconduct.

40.  China Forestry has fairly alerted to this Court the issue of admissibility of the MMT Report.

41.  As accepted by China Forestry, it is a well-established rule that a judgment and factual finding of another court or tribunal in earlier proceedings is inadmissible in subsequent proceedings: Hollington v F Hewthorn & Co Ltd [1943] KB 587. Such rule has been applied in Hong Kong to exclude evidence of findings of statutory tribunal: Hong Kong Cable Television Ltd v Television Broadcasts Ltd and Galaxy Satellite Broadcasting Limited (unreported, HCA 1171/2005 and HCA 1256/2005 – heard together, 19 December 2005).

42.  As noted in P’s Skel, the admissibility of the MMT Report has been considered by the Court in determining the Stay Application made by Ds in these proceedings. As held by Yeung J (reported in [2020] 2 HKLRD 387), since the present proceedings is not an action for market misconduct within the meaning of section 281 of the Securities and Futures Ordinance (Cap. 571) (“SFO”), the exception for using a determination by the MMT as proof of market misconduct does not apply. It follows that, in accordance with the rule in Hollington, the factual findings and conclusions of the MMT Report are inadmissible in the trial of these proceedings.

43.  Having said that, I agree with the submissions of China Forestry that the MMT Report can be used in these proceedings for the limited purpose of showing the factual evidence presented to the MMT. This is because the use for such limited purpose would not offend the principle or rationale of the rule, which is to ensure a fair trial so that the judge can make his own decision on the evidence and submissions presented to him, without being influenced by the opinion of an earlier adjudicator, and such concern does not arise in relation to the evidence referred to in an earlier judgment: Capital Century Textile Co Ltd v Li Dianxiao[2018] HKCFI 729 at [23] – [29].

44.  As stated in P’s Skel, China Forestry has limited its references to the MMT Report to only the factual evidence referred to therein, and to the extent it is relevant. In any case, irrespective of the MMT Report, there are ample evidence in support of China Forestry’s case.

D5.  Fiduciary duty owed by Li

45.  There should be little controversy that, as the CEO and director of China Forestry, Li owed fiduciary duty to China Forestry.

46.  China Forestry has pleaded inter alia the following specific fiduciary duties owed by Li (at Schedule 3 to the ASOC):

(1)  a duty to act bona fide in good faith, honestly and in the best interests of China Forestry;

(2)  a duty not to act for any collateral or improper purpose in the discharge of his duties;

(3)  a duty to use the assets of China Forestry in a manner which he honestly believed to be in the best interests of China Forestry;

(4)  a duty not to act in the affairs of China Forestry in circumstances where there existed an actual or potential conflict of interest; and

(5)  a duty not to make profit by reason of his fiduciary position or of opportunity or knowledge resulting from it, in circumstances where there is an actual or potential conflict of interest.

47.  Ds admit in the Defence at [17] that Li owed the above duties to China Forestry.

48.  Whilst China Forestry has also pleaded that Li owed to China Forestry a duty to act with reasonable care, skill and diligence, Ds have pleaded that such duty does not form part of the fiduciary duties owed by Li. I tend to agree with Ds although it is not strictly necessary to address this because such duty is of little relevance given that China Forestry’s case against Li is really one of fraud, as opposed to negligence or failure to exercise reasonable care. On behalf of China Forestry, Mr Manzoni SC accepted in his oral submissions that it need not rely on such duty in this case anyway.

49.  As to the law on directors’ duties, it is well established. There is no need to go into details here, particularly given that China Forestry’s case against Li is one of fraud. Suffice it to say that China Forestry has referred to Re Barings plc and others (No. 5) [1999] 1 BCLC 433 at 489a-c and the Cayman decision in Peter and Ekstorm v Weavering Macro Fixed Income Fund Limited (In Liquidation) [2015] (1) CLR 45 at [55] (bearing in mind that China Forestry is a Cayman company). In addition, Appendix 2 to P’s Skel further summarises the principles on different aspects of the fiduciary duties pleaded by China Forestry, including in particular the following:

(1)  Those that are entrusted with the interests of others are expected to put the interests of the principal before their own.

(2)  Fiduciaries, by the very nature of their position, exercise power on behalf of another and pledge to act in the best interests of the other (citing Libertarian Investments Ltd v Hall (2013) 16 HKCFAR 681 at 705).

50.  Plainly, there could be no dispute that a director would be in breach of his or her fiduciary duties if he or she (1) participated in falsifying a company’s accounting records and financial statements; and/or (2) caused the company to enter into sham transactions in order to dissipate the company’s assets. Hence, if Li did perpetuate the False Accounting Scheme, he must be in breach of his fiduciary duties. Moreover, if Li did act in breach, there could be little question as to the illicit gains obtained by Ds or the loss and damage suffered by China Forestry – rather the question is whether China Forestry can assert a proprietary claim and/or recover equitable compensation. It follows that the real contentious issues are as follows:

(1)  Did the False Accounting Scheme exist?

(2)  If so, did Li breach his fiduciary duties to China Forestry by perpetrating or participating in the False Accounting Scheme?

(3)  Do Ds (including Top Wisdom as alter ego or accessory) hold the Illicit Gains, or any assets into which those sums may be traced, on a constructive trust for China Forestry?

(4)  Is China Forestry entitled to claim equitable compensation for the loss and damage suffered by China Forestry (and if so the amount)?

E.  False Accounting Scheme

51.  As mentioned above, the Court would first examine the question as to whether the False Accounting Scheme existed, before addressing in more details the role and responsibility of Li in such scheme (if it existed).

52.  As mentioned in Section B above, China Forestry claims that the False Accounting Scheme straddled across five key areas of the business, namely: (1) the Group’s principal operating bank account; (2) plantation assets; (3) harvesting; (4) customers/sales; and (5) logging expenses paid to Dehong Hongda. Such scheme resulted in misstatements in China Forestry’s financial statements and massive inflation of its assets, business and profits. In addition, on the back of such inflated figures, China Forestry raised funds through its IPO and subsequent bond offerings in Hong Kong, part of which were further dissipated away through the 2010 Yunnan and Guizhou Sham Transactions. Logically these claims could be dealt with under 4 categories (which is also the approach taken in P’s Skel), namely:

(1)  falsification of plantation rights certificates and harvest permits – these being the first category concerning purported ownership of plantation assets and purported right to undertake business of harvesting timbers on these plantation assets;

(2)  falsification of customers and principal logging contractor – these being the second category concerning purported undertaking of harvesting business based on the aforesaid ownership and right;

(3)  falsification of bank statements and accounting records – these being the third category concerning purported bank / accounting records recording false payments and receipts of the foregoing non-existent business activities; and

(4)  defalcations through the 2010 Yunnan and Guizhou Sham Transactions – these being the fourth category concerning sham transactions which divested part of the funds raised by China Forestry on the back of the falsified accounts.

E1  Falsification of plantation rights certificates and harvest permits

53.  It is not in dispute that, as at 31 December 2009, the Group, through KUB, recorded holding significant plantation assets in Yunnan and Sichuan pursuant to 46 plantation rights certificates (the particulars thereof are set out in Schedule 11 to Borrelli WS) comprising:

(1)  approximately 93% of those rights (2,390,000 mu) located in Yunnan province and held pursuant to 18 certificates;

(2)  approximately 7% of the remaining rights (186,700 mu) located in Sichuan province and held pursuant to 28 certificates.

54.  These plantation assets represent the vast majority of the Group’s non-current assets, namely (i) 96% for FY2008, (ii) 97% for FY2009 and (iii) 95% for the financial period ended 30 June 2010, i.e. first half of 2010 (“1H2010”). It goes without saying that the falsification of such assets (if proven) would have a material impact on the Group’s financial position.

55.  Further, even assuming that a company did own plantation assets, it could only legally exploit those assets if it obtained permits from the relevant county forestry bureaux authorising the harvesting of timber. On the evidence, KUB recorded harvesting 626,490 m3 of timber pursuant to 4,200 harvest permits (the particulars thereof are set out in Schedule 12 to Borrelli WS). Logically, if most of the plantation assets purportedly owned by KUB were falsified, the harvesting activities on these non-existent plantation assets could not have been real. It follows that the harvest permits could not be genuine either. In any event, I agree with China Forestry’s submissions that there is overwhelming evidence, and I find accordingly, that both the plantation rights certificates and harvest permits purportedly held by China Forestry are falsified.

56.  First and foremost, there is direct evidence of inquiries made with relevant Mainland authorities confirming the falsity of both the plantation right certificates and harvest permits. As stated in Deng WS, Ms Deng have made inquiries with the relevant county forestry bureaux as follows:

(1)  Each of the county forestry bureaux in Yunnan which purportedly issued the 18 Yunnan plantation rights certificates confirmed that they did not issue those certificates. These certificates represented 86% of KUB’s purported forestry assets as at 31 December 2009.

(2)  The relevant forestry bureaux in Sichuan which purportedly issued 22 of the 28 Sichuan plantation rights certificates confirmed that they did not issue those certificates.

(3)  Six county forestry bureaux were provided with samples of the purported harvest permits and confirmed that those purported permits were false and/or were not issued by the bureaux.

57.  By way of further observations:

(1)  Such confirmation by relevant Mainland authorities constitutes cogent evidence of falsity. There is no sound basis or reason to question the credibility of Ms Deng (who is a PRC-qualified attorney) or the confirmation from authorities (who are supposed to be independent and impartial).

(2)  Whilst Ms Deng only obtained confirmation of falsity on 22 of the 28 Sichuan certificates, it is not strictly necessary to obtain confirmation that all certificates were falsified. Such inference may well be drawn on the footing that all Yunnan certificates and the bulk of Sichuan certificates were forged (not to mention other evidence in support) – it is thus inherently probable (or indeed rather likely) that the rest of the certificates were also forged.

(3)  Even if only the bulk of Sichuan certificates was forged, it already represented a very substantial percentage, given that the Sichuan certificates only account for 7% of all plantation assets. The outstanding 6 (out of 28) certificates represent roughly 1.5% (6/28 x 7%) of all plantation assets which is relatively insubstantial.

(4)  Importantly, the real question is whether Li acted in breach of fiduciary duties and obtained the Illicit Gains as a result. It does not really matter even if only the bulk (as opposed to all) of the plantation assets were falsified, as that would still very much be a breach of fiduciary duties, as a result of which the Illicit Gains were obtained. The overall analysis remains intact all the same.

(5)  Similarly, it is not strictly necessary for China Forestry to obtain confirmation that all harvest permits were false. To start with, as the bulk (if not all) of the plantation assets were falsified, it goes without saying that the harvest permits cannot be real. In any event, such inference is reinforced by the confirmation of falsity of the samples of harvest permits by the 6 county forestry bureaux.

58.  Second, China Forestry has tendered expert evidence from Mr Wang on the authenticity of the plantation rights certificates and harvest permits purportedly held by China Forestry. As mentioned above, such expert evidence is not challenged since Ds elect not to adduce expert evidence and are debarred from doing so. In short, Mr Wang concludes that the purported plantation rights certificates and harvest permits are all falsified because:

(1)  The purported plantation rights certificates do not conform with the uniform national style format. For some plantation rights certificates (those purportedly issued in Luxi County and Jinhekou (金河口) District), the authority allegedly issuing the certificates did not exist at the time of the purported issuance. Mr Wang, with assistance of government sources, has also verified various purported certificates as forged.

(2)  The purported harvest permits likewise exhibit various features of forgery. The purported harvest permits appear to have been mass produced and contain identical harvesting areas and locations, which Mr Wang noted were highly unlikely to be the case in reality. The formats of the purported harvest permits do not conform with that specified for a genuine harvest permit (for example in terms of document orientation and the type of official chops used). Many of the purported harvest permits do not contain the various required particulars necessary for identifying the forestry land to be harvested. Various harvest permits of Lianghe (located in Yunnan province) were purportedly issued in Sichuan, a different province.

59.  Having considered the Wang Report, I agree that it fleshes out China Forestry’s case and should be accepted, not only because Ds have not adduced any expert evidence to contradict it, but also because the opinion and conclusions in the Wang Report are substantiated by Mr Wang’s meticulous examination of the purported plantation rights certificates and harvest permits, based on his decades of work experience on Mainland forestry law and practice.

60.  Third, I agree with China Forestry’s submissions that the investigation conducted by the Group’s advisors in respect of the audit issues identified by KPMG during its audit for FY2010 also exposed the falsity of certain harvest permits. In particular:

(1)  The Luxi County Forestry Bureau confirmed that genuine harvest permits would be machine printed. However, the harvest permits provided to KPMG for the audits of the Group’s consolidated financial statements were handwritten.

(2)  An official from the Shuangjiang County Forestry Bureau confirmed with Jun He Law Offices that the bureau did not issue any harvest permits to KUB from 2008 to 2010.

(3)  An official from the Jinkouhe (金口河) County Forestry Bureau also confirmed that the chop reading “Jinhekou” (金河口) (being a misspelling) appearing on KUB’s harvest permits was not the bureau’s chop. Indeed, one would have considered it rather unlikely for a genuine official chop to contain such misspelling.

61.  Fourth, as submitted by China Forestry, the purported plantation rights certificates and harvest permits exhibit peculiar features which are highly suspicious and indicative of forgery. Without being exhaustive:

(1)  The purported plantation rights certificates (which record large areas of forestry assets) lack important details such as location of the relevant plantations or the accompanying map. As explained by Mr Manzoni SC by reference to an example, many of these certificates merely record location at a village without further particulars and coordinates, which cast doubt on their authenticity.

(2)  Five of KUB’s plantation rights certificate purportedly bore the forestry bureau chop of the Jinhekou (金河口) county, which did not exist. This was a misspelling of Jinkouhe (金口河) county. As mentioned, it is highly improbable that a genuine official chop would have such a mistake.

(3)  In nearly all the permits within each batch, the handwriting and completed details are identical, the county forestry bureau chops are all in the same position, and many of them bear the same serial number. These factors tend to suggest that the harvest permits were created in batches en masse, with each batch comprising dozens of or even hundreds of permits purportedly issued by the same county forestry bureau on the same date. This is unlikely to be genuine or authentic.

(4)  All the purported permits contain blank fields for the corresponding plantation rights certificate number and “sub-compartment”, which is required for identifying the trees permitted to be harvested. The non-completion of such fields casts doubt on the authenticity of the permits.

62.  Fifth, the Liquidators’ fund flow analysis shows that KUB paid no funds for the purported acquisition of forestry rights in Yunnan.

63.  As submitted in P’s Skel, KUB recorded that it acquired its Yunnan plantation assets in March and July 2008 pursuant to 18 purchase agreements. The payments which made up the “consideration price” appeared in the false bank statements of KUB’s operating account with Huaxia Bank (华夏银行) (“Huaxia Operating Account”) but not in KUB’s authentic bank statements for 2008 and 2009.

64.  If there were no genuine payments for acquiring the Yunnan plantation assets, KUB could not have obtained genuine right or ownership over them.

65.  Sixth, in further support of the foregoing, KUB in fact did not pay the forest maintenance fees recorded in its financial statements.

66.  It is not in dispute that forest maintenance fees were required to be paid before obtaining harvest permits. Indeed, probably as an attempt to conceal the fraud, the forest maintenance fees purportedly paid by KUB were recorded in the false bank statements of the Huaxia Operating Account. However, there should be no question that such maintenance fees were not in fact paid, as they are not recorded in the authentic bank statements. This is further borne out by the inquiries made by Ms Deng with the Shuangjiang, Luxi and Lianghe County Forestry Bureaux who confirmed that KUB had not paid such fees in 2009.

67.  As there were no genuine payments of forest maintenance fees by KUB, this necessarily casts doubts on China Forestry’s purported ownership of plantation assets and corroborates the Liquidators’ findings that KUB in fact did not hold the plantation assets at the relevant times.

68.  Seventh, notwithstanding the aforesaid evidence, Ds have not put forth any positive case and merely resort to non-admission of the falsity of the plantation rights certificates and harvest permits. Worse still, Ds chose to be absent at trial and did not call upon Li to testify. Applying the principles examined above, the Court should draw adverse inference against Ds on the question of authenticity of such certificates and permits in any case.

69.  Fundamentally, without genuine plantation rights certificates and harvest permits, the Group simply cannot undertake the business of harvesting timbers. It follows that, if such certificates and permits are forged, there could hardly be any (or any substantial) harvesting business and activities. This would in turn cast grave doubt on the authenticity of the Group’s customers, principal logging contractor, and bank / accounting records. Reversely, if the latter could also be proven to be false on independent grounds, it would fortify the conclusion that the certificates and permits were false in the first place.

E2  Falsification of customers and principal logging contractor

70.  On record, all revenue recorded by China Forestry for FY2008 (RMB544.95 million), FY2009 (RMB793.69 million) and 1H2020 (RMB494.26 million) originated from the sale of harvested timber from KUB’s plantations to 17 purported customers. It goes without saying that the authenticity of these 17 purported customers would have an important bearing on the authenticity of China Forestry’s reported revenue. Moreover, all timbers sold by China Forestry were supposed to be harvested by Dehong Hongda, the sole logging contractor purportedly engaged by KUB. It follows that the authenticity of Dehong Hongda would also have a material impact on the authenticity of the purported harvesting business of China Forestry.

71.  Having considered the relevant evidence and the submissions by China Forestry, I find that there were no genuine harvesting business and sales of timbers by the Group, since the records of KUB’s purported (i) customers and (ii) principal logging contractor (Dehong Hongda) were plainly forged.

72.  First of all, I accept China Forestry’s submissions and find that KUB’s 17 purported customers in 2009 did not in fact exist. Among others:

(1)  KPMG, Ernst & Young (China) Advisory Limited (“Ernst & Young”), Fangda Partners (the law firm engaged by the SFC to conduct an investigation) and the Liquidators all conducted separate corporate searches on the purported customers with predominantly negative results or results inconsistent with the customer information provided by China Forestry’s management to KPMG at the relevant times.

(2)  The Liquidators located on the Group’s finance department’s computer 209 editable bank-in slips recording payments from these purported customers, evidencing attempts by the Group to falsify payment records (which could be edited to suit its need). Most tellingly, all the final (fake) bank-in slips recorded payments to customers’ bank accounts with bank codes starting with “3017710”; however, this bank code signifies a non-existent branch of the Bank of Communications in Lhasa, Tibet. It is highly implausible that all 17 customers banked with the same bank branch in a different (and indeed remote) province. This constitutes a strong indicia of fraud.

(3)  Payments to purported customers were recorded in the false bank statements of the Huaxia Operating Account but not the authentic bank statements.

73.  Second, as submitted by China Forestry, there is compelling proof that Dehong Hongda, the sole logging contractor purportedly engaged by KUB to harvest KUB’s plantation assets in 2008 and 2009, did not exist either:

(1)  In late March/early April 2009, KPMG’s agent Sinotrust conducted a search on Dehong Hongda but was unable to locate the latter’s records. The Liquidators’ subsequent searches in 2020 have similarly been unable to locate any entity by that name.

(2)  Ms Deng made enquiries with the Dehong AIC which confirmed that Dehong Hongda could not be found in its records.

(3)  The purported payments to Dehong Hongda are recorded in the false bank statements of the Huaxia Operating Account but not the genuine bank statements.

(4)  Ms Deng confirmed with Agricultural Bank of China that Dehong Hongda’s bank account as shown on the bank slips did not exist.

E3  Falsification of bank statements and accounting records

74.  Perhaps the most alarming part of the False Accounting Scheme is the sheer extent to which the perpetrators had gone through, not only to forge plantation rights certificates and harvest permits, but also to falsify bank statements and accounting records to deceive regulators, accountants (such as KPMG) or professional advisors and make the fraud even harder to detect.

75.  By way of overview, the investigations by the Liquidators reveal that the False Accounting Scheme is the result of a systemic plan and concerted efforts to fabricate documents and perpetuate fraud on an all-encompassing scale. Specifically, the Liquidators uncovered extensive hard copy documents and forensic images of electronic storage media (including the image of a computer) used by the Group’s finance department at its Beijing head office as follows:

(1)  Ernst & Young was the forensic accountant firm engaged by the Audit Committee of China Forestry to conduct an independent investigation following KPMG’s identification of audit issues in January 2011. It provided to the Liquidators copies of forensic images taken from 16 desktop and laptop computers from the Group’s Beijing office.

(2)  Among the images taken include images of a computer referred to as “Finance PC1, 财务公用 [common PC]” (“Finance PC1”), which was identified in Ernst & Young’s investigation report as the common PC used by the Finance Department. Finance PC1 contained important evidence showing that the Group’s accounting records had been falsified.

(3)  Most shockingly, it contains blatant evidence of document falsification, including editable Microsoft Word versions of bank-in slips recording payments from KUB’s customers, editable Microsoft Word versions of bank statements, and instruction manuals as to how documents should be created. As Mr Manzoni SC vividly put it, the instruction manuals function like a “fraud playbook”, giving staff clear instructions how to create documents (such as bank receipts and invoice with seal) to perpetrate the fraud.

76.  Premised on such overview, China Forestry has invited the Court to examine falsification of specific categories of documents.

77.  First, in relation to falsification of bank-in slips, the Liquidators identified from Finance PC1 the following evidence:

(1)  A manual titled “昆明自制凭证及工作简单操作说明” [Simplified instructions for the self-creation of Kunming documentation and work operations] which contained detailed instructions on falsification of bank-in slips, invoices and transfer requests. According to the metadata, the document was created by Ms Chen Qiubo, a member of the Beijing finance department.

(2)  A manual titled “高彦青工作条目” [Gao Yanqing work items] which sets out the “division of responsibilities” for creating invoices and accounting records. Ms Gao Yanqing also worked at the Beijing finance department.

(3)  The Liquidators identified on Finance PC1 bank-in slips that were created pursuant to the work manuals.

(4)  Both Ms Chen and Ms Gao worked under the supervision of the Mainland China CFO, Ms Wu. On Li’s own evidence, Ms Wu is his cousin and was recruited by him to join Beijing Zhaolin (the predecessor of China Forestry).

78.  The above is not only telling evidence of fraud, but also strong indicia of participation of Li (through Ms Wu and the staff supervised by her). Importantly, the electronic version of the “work-in-progress” editable bank-in slips found on Finance PC1 could be substantially matched with the “final” fabricated bank-in slips, as shown in Schedule 9 of Borrelli WS. This means the work manuals were used in practice to fabricate bank-in slips.

79.  Second, in relation to the creation of a “local book”, Ernst & Young discovered that there were two sets of KUB ledgers for 2008 to 2010:

(1)  a false set of ledgers maintained at China Forestry’s head office in Beijing for the purposes of preparing the (misstated) published consolidated financial statements (for which local staff were unaware of); and

(2)  another set of “local” ledgers obtained from KUB’s local accounting staff which could not be reconciled with the published consolidated financial statements.

80.  The existence of two sets of ledgers is yet another clear indicia of fraud. It evidences a conscious attempt to fabricate a false set of ledgers to create the false picture that China Forestry had substantial harvesting business and revenues.

81.  The reality is that the “local” ledgers (which record much less assets and revenues) are the genuine set of ledgers as they are consistent with KUB’s authentic bank statements. Indeed, as acknowledged by Li (in his witness statement in the MMT proceedings at [153]), if the local ledgers are the genuine set of ledgers, China Forestry would never have conducted any logging activities, and the sales volume in 2009 and 2010 were almost non-existent.

82.  Third, there was falsification of the Group’s operating account bank statements.

83.  By way of background, on 19 May 2008, KUB (the Group’s main operating subsidiary) opened the Huaxia Operating Account with the account number 4835200001801100002661. Yet, there is compelling proof that the bank statements for the Huaxia Operating Account and related accounting records provided by China Forestry to KPMG for audit were falsified:

(1)  Some of these bank statements incorrectly bore an incorrect account number of 4835200001801100002611 (i.e. the second last digit is incorrect, as it should be “6”). The staff at the Huaxia Bank confirmed to Ms Deng that this account did not exist.

(2)  The People’s Bank of China (“PBOC”) and the CBIRC, being primary regulatory bodies for financial institutions in Mainland China, have confirmed the sets of authentic and falsified bank statements, as authentic and falsified, respectively. With respect, such confirmation from the Mainland regulatory bodies should suffice and there is no reason to doubt or question the same.

(3)  Editable versions of the purported bank statements for the Huaxia Operating Account in Microsoft Word format were located by the Liquidators from Finance PC1. These purported bank statements either match or closely match the chopped (fabricated) Huaxia Operating Account bank statements which PBOC and CBIRC confirmed to be forged.

84.  The existence of such false bank statements evidences a blatant attempt to falsify accounts and conceal the same by resorting to false bank statements. Significantly, the Huaxia Operating Account was used to receive payments from customers and pay for operating expenses and plantation assets. If the bank statements were false, the implication is that the corresponding payments and expenses are fictitious. A comparison with the false set of ledgers indicate that receipts and payments recorded in the falsified Huaxia Operating Account bank statements mainly comprise of:

(1)  gross receipts from KUB’s customers totalling RMB1.477 billion;

(2)  payments in respect of KUB’s purported acquisition of Yunnan plantation assets totalling RMB949.7 million;

(3)  payments of forest maintenance fees, which were required to be paid to county forestry bureau as a condition of applying for harvest permits, totalling RMB54.9 million; and

(4)  payments to the Group’s sole logging contractor in Yunnan, Dehong Hongda, totalling RMB268.6 million.

85.  Since the bank statements are false, the above receipts and payments could not be real, and must be fictitious. This is confirmed by the authentic Huaxia Operating Account statements which only record gross receipts of RMB140.3 million and gross payments of RMB140.2 million during the same period. A comparison with the “local” ledgers reveal that such authentic receipts and payments mainly comprise of:

(1)  receipts of RMB138.9 million being internal transfers from KUB’s USD account held with Huaxia Bank; and

(2)  payments of RMB122.4 million for purported acquisitions of forestry land.

86.  Fourth, the falsified statements were actively deployed to deceive regulators and advisors. Specifically, the falsified Huaxia Operating Account bank statements were provided to KPMG for the audits to conceal the fact that China Forestry had no substantial assets and business when they were in truth fictitious (including inter alia (1) receipts from KUB’s purported customers; (2) forest maintenance fees; (3) payments in respect of KUB’s purported acquisition of Yunnan plantation assets; and (4) payments to Dehong Hongda).

E4  Defalcations: 2010 Yunnan and Guizhou Sham Transactions

87.  Having considered the relevant evidence and China Forestry’s submissions, I am satisfied that these were in fact sham transactions entered into for dissipating China Forestry’s funds.

88.  First, in relation to the 2010 Yunnan Sham Transaction, it is not in dispute that, on 25 January 2010, KUB entered into an agreement to acquire rights over 300,000 mu of forests in Honghe prefecture in Yunnan from Beijing Jialan Huaxin Investment Holdings Co., Ltd. (“Beijing Jialan”). On 27 January 2010, KUB paid RMB60 million to Beijing Jialan. Li was involved as he signed the purchase agreement and approved the payment. Yet, there is ample evidence to suggest that this was a sham transaction to misappropriate funds of KUB (and in turn China Forestry):

(1)  KUB did not receive any actual plantation assets despite having paid RMB60 million. The only three plantation rights certificates purportedly received by KUB were all falsified (as explained in Borrelli WS at [238] – [241]). This suggests that the transaction was just an excuse to procure KUB to make substantial payments.

(2)  The RMB60 million payment was simply written off in the same year (2010) as it was made without recognition of any plantation assets in the 2010 Consolidated Financial Statements. This tends to suggest that it is nothing but an excuse to misappropriate funds at the outset.

(3)  Beijing Jialan was incorporated only less than 2 months before the transaction and appeared to have no plantation assets and incur no income or expenses at the time. It seems to be an artificially created entity for a sham transaction.

(4)  Li had close relationships with Beijing Jialan and its senior management which Li did not disclose to the Board. Such close relationship is borne out by Li being employed by another company owned by Beijing Jialan and its senior management after Li’s removal from China Forestry.

89.  Second, in relation to the 2010 Guizhou Sham Transactions, it is not in dispute that, between March to November 2010, KUB and China Forestry’s two other subsidiaries, Chengdu Fine Fit Forestry Resource Development Co., Limited (“Chengdu Fine Fit”) and Guizhou Wosen Forestry Development Company Limited (“Guizhou Wosen”), entered into seven agreements with Guizhou Jinping Changsheng Xinglv Forest Farm Co., Ltd (“Guizhou Jinping”) and Guizhou Changsheng Green Resource Development Co., Ltd. (“Guizhou Changsheng”) to acquire 768,636 mu of forests in Guizhou. RMB413,928,518 in total was paid to Guizhou Jinping and Guizhou Changsheng pursuant to these agreements. Li was involved as he signed a supplemental letter of intent on behalf of Chengdu Fine Fit and four agreements on behalf of KUB, Chengdu Fine Fit and Guizhou Wosen. He also gave approval for all payments. Yet, as submitted by China Forestry, there is ample evidence to suggest that they were nothing but sham transactions:

(1)  The Group recognised substantial prepayment assets, plantation assets and lease prepayment assets from these agreements in the 2010 Consolidated Financial Statements. Yet, all of these amounts were subsequently written off in the consolidated financial statements for the subsequent financial year ended 31 December 2011. This tends to suggest that it is nothing but an excuse to misappropriate funds at the outset.

(2)  Most of these agreements do not contain adequate information to identify the purported plantation rights being transferred.

(3)  Guizhou Jinping and Guizhou Changsheng either provided falsified plantation rights certificates or certificates that were subsequently revoked by the local forestry bureau.

(4)  Guizhou Wosen’s director and general manager, Mr Zhou Xiaolin (“Mr Zhou”), also controlled Guizhou Changsheng and Guizhou Jinping, the counterparties to the sham transactions. The fact that the same personnel was in control of both parties suggests that the transaction is not genuine or at arms’ length.

(5)  Mr Zhou also caused Guizhou Jinping and Guizhou Changsheng to pass on a total of RMB 60 million to Li’s associates. As recorded in a judgment made by the Nanming District of Guiyang City, Guizhou, Li asked Mr Zhou to transfer part of the funds to Beijing Jialan, an associate also related to Li and involved in the 2010 Yunnan Sham Transaction.

90.  Third, as part of the tracing exercise, a total amount of RMB 473,928,518 was paid out from China Forestry’s funds, whilst the amount recovered is only RMB50 million, leaving a net balance of RMB 423,827, 518.

(1)  KUB paid RMB60 million in relation to the 2010 Yunnan Sham Transactions. Subsequently, KUB recovered RMB20 million from Beijing, leaving a shortfall of RMB40 million.

(2)  KUB, Chengdu Fine Fit and Guizhou Wosen paid RMB413,928,518 to Guizhou Jinping and Guizhou Changsheng in relation to the 2010 Guizhou Sham Transactions. Following Li’s removal from the Board, the Group and the Liquidators attempted to recover the defalcated funds from Guizhou Changsheng, Guizhou Jinping and Mr Zhou but in vain (save for RMB30 million recovered and returned by the Public Security Bureau to the Group).

(3)  The Liquidators have identified that the net amount of payments in the sum of RMB423,928,518 made pursuant to the 2010 Yunnan and Guizhou Sham Transactions could be traced back to China Forestry’s own funds, namely the proceeds from pre-IPO investments and IPO of China Forestry.

E5.  Ramifications of False Accounting Scheme

91.  All in all, the falsification of China Forestry’s plantation assets, harvesting activities and sales caused China Forestry’s assets, revenue and profits in its financial statements to be massively overstated, creating an illusion that it was a profitable business with substantial assets.

92.  This, in turn, inflated the share price of China Forestry and enabled Ds to obtain the Illicit Gains.

93.  On top of the Illicit Gains, the False Accounting Scheme enabled China Forestry to raise substantial funds from the IPO and subsequent bond issuance. Such funds were then transferred to China Forestry’s Mainland subsidiaries, part of which were in turn dissipated to entities associated with Li through the 2010 Yunnan and Guizhou Sham Transactions.

94.  In the premises, this Court finds that the False Accounting Scheme existed which enabled (i) the Illicit Gains to be obtained and (ii) defalcations to take place by the 2010 Yunnan and Guizhou Sham Transactions. The next question is Li’s involvement and responsibility and, specifically, whether he perpetrated or participated in the False Accounting Scheme.

F.  Li’s Involvement and Responsibility, and his perpetuation of the False Accounting Scheme

95.  Li was at all material times the former (i) CEO of the Group, (ii) executive director of China Forestry and (iii) substantial shareholder (through Top Wisdom) in China Forestry. Importantly, Li was also appointed as director and general manager of China Forestry’s subsidiaries including in particular (i) KUB (since the date of its establishment on 7 March 2008 until 16 March 2011), (ii) Chengdu Fine Fit (since the date of its establishment on 21 March 2008 until 16 March 2011), and (iii) Guizhou Wosen (since the date of its establishment on 27 August 2010 until 6 April 2011). At all material times, KUB was China Forestry’s principal operating subsidiary, while KUB Chengdu Fine Fit and Guizhou Wozen were the Group’s subsidiaries which purported to acquire plantation assets in the 2010 Guizhou Sham Transactions. In view of Li’s key position and responsibility, any suggestion that Li was ignorant of the False Accounting Scheme and had no involvement whatsoever despite its pervasiveness should, with due respect, be subject to proper scrutiny.

96.  In this regard, Section B of Schedule 4 to the Borrelli WS has provided an overview of the responsibility of Li and his role in the fraudulent activities as alleged by China Forestry. Further, Section F of P’s Skel sets out the submission on behalf of China Forestry as to Li’s involvement in the fraudulent scheme. These will be examined further below. It suffices to say that, having considered the same and other relevant evidence, this Court is ultimately satisfied on a balance of probabilities that Li perpetrated the False Accounting Scheme. Li was a key player (and indeed the instigator and mastermind) of the fraud, as a result of which he obtained the Illicit Gains, and enriched himself through the 2010 Yunnan and Guizhou Sham Transactions.

F1.  Preliminary matter

97.  Before going into the key reasons in support of the Court’s findings regarding Li’s involvement and responsibility, there is a preliminary matter which this Court would like to address. Throughout its evidence and submissions, China Forestry has referred to various statements made to the SFC by China Forestry’s ex-employees and former auditors in support. Whilst China Forestry has not called upon them to make witness statements and testify in these proceedings, it nevertheless seeks to rely on them apparently as hearsay evidence. China Forestry submits that the Court should give substantial weight to the evidence of these interviewees because, by virtue of Section 184 of the SFO, they were at the risk of committing a criminal offence if they provided false or materially misleading answers during the SFC’s interviews. In addition, China Forestry relies on the statements made by the relevant witnesses in the MMT proceedings, as referred to in the MMT Report.

98.  In my view, whilst it is obviously preferable for China Forestry to cause its ex-employees and former auditors to come forward to testify in these proceedings as witnesses, this is not the only way China Forestry could rely on their evidence. There is, in principle, no inherent bar to China Forestry relying on their statements during the SFC’s interviews and the MMT proceedings, subject of course to the weight to be attached to such hearsay evidence.

99.  On the question of weight to be attached to such evidence, I agree with China Forestry’s submissions that, given the risk of committing a criminal offence, the interviewees had little incentive to give answers or statements pointing to Li’s involvement in the False Accounting Scheme, if that was not in fact the truth. Whilst the same rationale may not apply to evidence given in the MMT proceedings, it remains open to the Court to attach appropriate weight to such evidence, particularly bearing in mind that there is no evidence to point to any specific reason or incentive on the part of China Forestry’s ex-employees and former auditors to make false allegations against Li. In the circumstances, material weight could be attached to such evidence, with the caveat that such evidence should be considered in conjunction with other relevant evidence as a whole.

100.  Having addressed such preliminary matter, I would move on to consider Li’s alleged perpetration of the False Accounting Scheme by examining various aspects of Li’s role and responsibility vis-à-vis the same.

F2.  Falsification of accounting records and control of audit process

101.  It is China Forestry’s case that (i) the Group’s accounting records were falsified at the direction of Li; (ii) Li’s position as CEO allowed him to rely on his subordinates to do the “dirty work” of falsifying accounting records, (iii) Li also personally falsified the Group’s accounting records, and (iv) Li tried to hide such falsities from KPMG on more than one occasion. I agree with China Forestry that there is strong evidence in support of its case.

102.  First of all, there is direct evidence of Li’s personal participation in the falsification of some of the Group’s accounting documents.

(1)  During Deloitte’s review of employees’ data as part of its forensic investigation, it identified 26 editable electronic bank statements. From metadata, Li was identified to be the creator of (i) 12 editable bank statements of Beijing Zhaolin, China Forestry’s predecessor; and (2) two editable bank statements of KUB Beijing office’s China Merchant Bank account. This is a direct proof of Li’s participation in the fraud.

(2)  According to the investigation by the Independent Board Committee, Li provided falsified Huaxia Operating Account bank statements to KPMG. At Li’s instructions, his cousin Ms Wu (CFO for Mainland China and head of the finance department) and Mr Zhang Hongyu (Chief Resources Officer) (“Mr Zhang”), together with the staff at the finance and resources department, created a separate set of accounting records for KUB. Most surreptitiously, Li, Ms Wu, Mr Zhang and others had deleted a large amount of data in an attempt to destroy evidence. All these constitute strong evidence of Li’s involvement in the fraud.

103.  Second, Li’s previous statements concerning the accounting records are unconvincing and/or inconsistent. Among others:

(1)  Mr Michael Cheung (former financial controller of China Forestry) stated in his interview with the SFC dated 9 February 2011 that when he discussed the audit issues raised by KPMG with Li, Li said he would not “exclude the possibility” that “some people at the lower level” would “prepare some statements or whatever in order to palm the auditor off”. If Li were innocent and had no involvement in the accounting fraud, one would have expected Li (as CEO) to be extremely concerned with the issues and would be vigilant in uncovering what actually happened, rather than making a cryptic statement to underplay the severity of the irregularities and attribute them to staff “at the lower level”. It supports an inference that Li was aware that the irregularities originated from senior management (including Li himself).

(2)  Li gave inconsistent statements as to his knowledge of the “local ledgers”. In Li WS at [169], he claims that he first learnt of the “local ledgers” in 2014, almost three years after China Forestry’s collapse. Yet, on the other hand, in Li WS at [170], he claims that he was told by Mr Shi Chuansheng, his subordinate with responsibility for KUB, that the reason why the ledgers did not match with the financial statements was that many transactions were conducted in cash and not properly recorded. As such, even during the times when Li was the CEO of China Forestry, he must already be aware of potential issues with the ledgers. The suggestion that Li did nothing to address the same and remained ignorant of the “local ledgers” until 2014 is hardly credible.

(3)  According to the evidence of Mr Raymond Tong (former Hong Kong CFO of China Forestry) (“Mr Tong”) as recorded in the MMT Report, after KPMG raised the issue that all customers’ bank accounts bear a prefix indicating a non-existent bank branch in Tibet, he asked Li about this on 17 January 2011 when they both attended a conference in Shanghai. In response, Li said: “We’ve gone down there and asked the local customers there and also asked the Co-ops in the countryside. The Co-ops in the countryside said to me, “What number do you want? I can give you whatever numeral prefix”.” This suggests that, by January 2011 (if not earlier), Li was already aware of the fictitious nature of such prefix.

104.  Third, as submitted by China Forestry, Li closely controlled the process of communicating with KPMG in China Forestry’s audits:

(1)  Ms June Yu (audit partner of KPMG responsible for China Forestry’s IPO audit) confirmed in her SFC interview on 12 July 2016 that Li was the person that KPMG’s audit team had the most contact with for their IPO audit. According to her, Li was personally well informed of China Forestry’s financial position.

(2)  Ms Janette Yu (audit partner of KPMG responsible for China Forestry’s 2009 audit) confirmed in her SFC interview on 16 May 2012 that she primarily had contact with Li regarding the audit. She further confirmed in the MMT proceedings her understanding that Li was responsible for the management of the Group’s daily operations and acted as the contact point for the audits.

(3)  Mr Jackie Lee (manager of KPMG) stated in his SFC interview on 2 December 2011 that Li “called the shots” and made the arrangements for KPMG’s site visits to customers, banks, tax bureaux and forestry bureaux.

(4)  Ms Naomi Lau (assistant manager at KPMG) stated in her SFC interview on 14 February 2011 that before KPMG would approach an external party, for instance in relation to bank confirmations, KPMG would contact Li who would arrange the visits for KPMG.

105.  Fourth, when suspicions were raised by KPMG, Li took active part to downplay such concerns. He also personally arranged site visits and even provided false information to cover up the False Accounting Scheme:

(1)  According to KPMG’s meeting minutes dated 3 December 2010, when KPMG raised certain audit concerns with China Forestry’s management, Li agreed to arrange site visits and bank confirmations.

(2)  On 14 January 2011, KPMG discussed with Li again on the audit irregularities identified. During a meeting with Li on that day, Mr Wen Guoping and Mr Tong, when KPMG raised questions on the irregularities with the customers’ bank account numbers, Li explained that “[China Forestry] has built up the relationship with some of its customers since 1999. The operation of rural credit union (农村信用社) did not comply with the standard”. Li repeated this explanation at a subsequent meeting on that day with KPMG (which only Li and KPMG attended). Later, Mr Li Han Chun changed his story and claimed that the reason was “to minimise VAT payment”. These explanations were false because, as examined above, China Forestry’s customers are fictitious and non-existent.

(3)  Li personally accompanied KPMG on a site visit to Huaxia Bank in Kunming after KPMG noticed the Huaxia Operating Account bank statements bore a different account number. During the site visit, the banking staff purportedly attributed the inconsistency of the account numbers on bank statements to a “printing error”. This explanation was false, as the relevant bank statements were in fact forged. There is force in China Forestry’s submissions that Li found it necessary as CEO to personally accompany the auditors to such meeting, which is suggestive of an attempt to conceal the fraud from KPMG by colluding with relevant banking staff (who were plainly lying) in providing false information to explain away the falsified bank statements.

(4)  According to the answers of Mr Xiao Feng (a former non-executive director of China Forestry) in his interview with the SFC on 15 February 2011, after KPMG formally raised the audit issues, Li repeated to the Board again that the (non-existent) customers used rural credit union for their banking. As to cash balances, Li maintained that the cash balance was real and that “KPMG had got it wrong”. It was not until contradictory record became available did Li start to tell other stories.

(5)  All these suggest that Li was privy to the fraud. With a view to covering up the fraud, Li took active part to appease KPMG and proffered false excuses to try to explain the suspicions away.

106.  All in all, there are compelling proof of Li’s participation in the False Accounting Scheme. As contended by China Forestry, this is consistent with Li being the perpetrator of the False Accounting Scheme, as an instigator of a fraudulent scheme would have taken control of dealing with the auditors himself or herself in order to manage the information provided to the auditors.

F3.  Li’s involvement in China Forestry’s operations and financial affairs

107.  It is significant that the False Accounting Scheme was perpetrated on a substantial scale which permeates the entire business of the Group. As mentioned above, the fictitious plantation assets represent the vast majority of the Group’s non-current assets, namely (i) 96% for FY2008, (ii) 97% for FY2009 and (iii) 95% for 1H2010. A senior officer intimately involved in China Forestry’s operations and financial affairs (such as Li) could hardly claim to be ignorant and innocent in such pervasive fraudulent scheme.

108.  First, as mentioned earlier, Li was a director and CEO of China Forestry between 21 December 2007 and 14 February 2011, and he also assumed directorships in China Forestry’s key subsidiaries including KUB, Chengdu Fine Fit and Guizhou Wosen. Whilst Li may claim to be ignorant if the fraud relates only to a minor part of the business, it is an entirely different picture here as the fraud went to the root if not the entirety of the Group’s purported harvesting business. I accept China Forestry’s submissions that, given Li’s position in China Forestry and the key subsidiaries, it defies belief that he was not aware of the Group’s financial matters including the fraud.

109.  Second, the above is reinforced by the statements or answers from various former employees of China Forestry confirming Li’s responsibility for the Group’s daily operations and financial affairs (including audits):

(1)  Mr Raymond Tong stated in his SFC interview on 8 February 2011 that Li was “very clear about the operation of the company” and that “everyone is supposed to report to him”. He further confirmed in his SFC interview on 29 October 2013 that “not many issues would be reported to Li Kwok Cheong [i.e. former Chairman of China Forestry] probably, because... most of the reports were made to the CEO [i.e. Li]”.

(2)  Professor Wong Tak Jun (a former director of China Forestry) stated in his SFC interview on 23 March 2011 that Li was the person who was “really involved in hands-on (operation of the company)” and “virtually the only (person) in the whole board who’s clearest about the main operation of the company”. On the other hand, Mr. Wong considered that Mr Li Kwok Cheong (the former chairman) had general knowledge of the direction of China Forestry given his significant shareholding, but was not really clear about operational matters.

(3)  Mr Li Zhi Tong (a former director of China Forestry) stated in his SFC interview on 23 July 2014 that Li “had the final say for everything”. He also stated that Li was responsible for purchase of forestry land including arrangement for payment.

(4)  Mr Liu Can (a former director of China Forestry) stated in his SFC interview on 28 August 2014 that Li oversaw the overall operation of the Group including acquisition of forestry land. After Li left China Forestry, most of the key staff of the subsidiaries were replaced because of their connections to Li.

(5)  According to the evidence of Mr Xiao Feng (a former non-executive director of China Forestry) as recorded in the MMT Report, Li accompanied him on a due diligence trip to Sichuan, and he said Li introduced the KPMG staff to the local management and a couple of the local officials from local authorities, and he made a lot of introduction to how they conducted business activities such as logging, harvesting and how promising this business could be in the future and all that.

110.  Third, even on Ds’ own evidence (i.e. Li WS), Li was intimately involved in China Forestry’s business operations and financial affairs:

(1)  Li recruited senior staff including his cousin Ms Wu (CFO of the Group’s Mainland China operations), Mr Zhang (Chief Resources Officer) and Ms Ma Xinxiu (responsible for administration) who directly reported to him. Li also made appointments of the vice-general managers of KUB and Chengdu Fine Fit.

(2)  Li was the main contact person of the Group and the “person in charge” of the IPO project. In particular, he liaised with the local staff to assist the due diligence carried out by the professional parties, and IPO sponsors and their legal team would contact him for due diligence or interview requests with respect to local forestry bureaux and China Forestry’s forestry assets, customers, suppliers or banks. He also personally attended site visits with professional parties.

(3)  Ms Wu and Mr Zhang (both handpicked by Li) were also heavily involved in liaising with IPO professional parties and would report directly to Li on the information and documents provided to the professional parties.

(4)  KPMG would communicate with Ms Wu or Li himself before conducting interviews with third parties or site visits, whilst the involvement of Mr Li Kwok Cheong (as Chairman) was limited.

(5)  Li would monitor the overall financial situation of the Group by taking note of the capital investment made by China Forestry to its subsidiaries and the purchase price paid by the Group and/or its subsidiaries for the acquisition of forestry assets. He often visited the offices of KUB and Chengdu Fine Fit, and represented the Group in exploring new business opportunities.

(6)  Li was responsible for setting up KUB’s account with Huaxia Bank in Kunming, Yunnan, and that as a result, he became acquainted with the bank branch chief, Mr Jin Bin, who was later recruited by Li as a vice-general manager of KUB. This militates against Li’s assertion that he had no knowledge of KUB’s real bank balance at Huaxia Bank.

111.  The above points to the intimate role and involvement of Li in the business operations of the Group. As such, if the bulk (if not entirety) of the business operations of the Group are fictitious, it defies belief to suggest that Li was not involved and had no knowledge at all.

F4.  Li’s involvement in forest acquisition and related fraudulent activities

112.  Li was heavily involved in the Group’s acquisition of the fictitious and non-existent plantation assets. As Li was the main person responsible for approving such acquisitions and the payments for the same, it defies common sense to suggest that Li had no knowledge whatsoever that the plantation assets did not in fact exist.

113.  First, the process of acquiring plantation assets was controlled by Li, Mr Zhang and Ms Wu.

(1)  As stated in Li WS at [96(e)] and [97], Li’s attention had mainly been on plantation assets and he would approve the release of funds for local subsidiaries’ acquisition of plantation assets.

(2)  As accepted in the Defence at [31], Li would sign or execute purchase agreements and documents (such as payment vouchers) for acquisition of plantation assets.

(3)  KPMG’s work papers record that all forests acquisitions were entered into by Li and his team, and the acquisition of forestry lands required approval by Head of Resources Management Department [i.e. Mr Zhang] and General Manager [i.e. Li]. This is consistent with KUB’s internal policy that all decisions in relation to forestry acquisitions should be decided by a working meeting convened by KUB’s general manager (i.e. Li).

(4)  KPMG’s audit walkthrough of the forestry assets acquisition process also shows that Li approved the requests for payments in respect of the acquisitions of plantation assets and visited the plantations considered for potential acquisition.

114.  Second, there is evidence pertaining to Li’s involvement in fraudulent activities relating to China Forestry’s purported plantation assets:

(1)  On 23 April 2010, Li sent Mr Tong a falsified letter purportedly issued by Funing County Office of the Leading Team of Intensified Reform of Collective Forest Ownership System (富宁县深化集体林权制度改革领导小组办公室), which stated that KUB’s plantation rights certificates issued in Funing County “were in the process of being altered”. Mr Tong then forwarded this document to KPMG.

(2)  Ms Naomi Lau stated in her SFC interview on 27 February 2012 that when KPMG communicated to Li that KPMG could not verify customer information, Li responded that “regarding these customers, at the back there’re really some customers existing. You go to visit the genuine customers”. Given that the customers were non-existent, Li’s response suggests that he was giving a false explanation to explain away KPMG’s concerns.

115.  For the avoidance of doubt, China Forestry has also relied on the assertions made by Mr Li Kwok Cheong (former Chairman) during his interview with the SFC that Li made reference to bogus harvesting permits and fictitious purchase of timber logs. In my view, given the potential role of Mr Li Kwok Cheong, there is at least a possibility that he might be seeking to shift the blame to other staff. As such, it does not appear prudent or reliable to attach significant weight to the evidence from Mr Li Kwok Cheong himself.

116.  All in all, given Li’s responsibility in plantation assets acquisition and the involvement of Mr Zhang and Ms Wu who directly reported to him, it is inherently improbable that the plantation rights certificates and harvest permits would have been fabricated en masse without his instructions. Indeed, given Li’s intimate involvement (including visits to plantations considered for potential acquisition), it is inherently improbable that he did not know that the plantation assets did not exist. Simply put, the non-existent plantations could not conceivably escape the notice of Li (and a fortiori Mr Zhang and Ms Xu who reported directly to him). All these suggest that Li was privy to the fraud.

F5.  Li’s involvement in the 2010 Yunnan and Guizhou Sham Transactions

117.  As examined above (and also accepted in Li WS at [171] – [172]), Li signed most of the agreements for the 2010 Yunnan and Guizhou Sham Transactions and approved all the payments. Li’s indisputable involvement in these transactions which are plainly sham transactions casts further doubts on the credibility of Li and reinforces China Forestry’s case that Li was the perpetrator of the False Accounting Scheme.

118.  First, as submitted by China Forestry, in view of Li’s control over the plantation assets acquisition process, Ds’ assertion that Li believed that the 2010 Yunnan and Guizhou Sham Transactions were genuine is not credible.

119.  Second, Li wrongly failed to disclose his relationships with the counterparties of these transactions to the Board. Among others:

(1)  As to the 2010 Guizhou Sham Transactions, Li was involved in setting up Guizhou Wosen and introduced Mr Zhou to Mr Li Kwok Cheong. As examined in Section E4 above, Mr Zhou was a director of Guizhou Wosen but also controlled Guizhou Jinping and Guizhou Changsheng, the counterparties to the 2010 Guizhou Sham Transactions (which was never disclosed).

(2)  As to the 2010 Yunnan Sham Transaction, by virtue of his connection to Beijing Jialan (which was not disclosed) as examined in Section E4 above, Li was connected to the purported seller of the transactions.

120.  Third, as examined in Section E4 above, it was recorded in a judgment made by the Nanming District of Guiyang City, Guizhou that Li asked Mr Zhou to transfer a total of RMB60 million from Guizhou Changsheng’s account to Li’s associate, including Beijing Jialan, an entity which was also involved in the 2010 Yunnan Sham Transaction.

121.  The above not only constituted a clear and egregious conflict of interest in breach of Li’s fiduciary duties, but also reinforces that Li was the perpetrator of the False Accounting Scheme as he stood to benefit from the defalcations of China Forestry’s funds (raised on the back of such scheme) through these sham transactions.

F6.  Ds’ evidence

122.  As mentioned at the outset, since Ds have not attended trial and called upon Li to testify, it is not strictly open to Ds to rely on the evidence in the Li WS. Nevertheless, in discharge of its duty to present the case fairly, China Forestry has also dealt with Ds’ case and evidence in response (some of which has been canvassed above).

123.  As noted in Section C2 above, Ds’ main defence is one of general denial or non-admission. As to Ds’ non-admission of the existence of the False Accounting Scheme, it has little mileage given the overwhelming evidence on such fraudulent scheme as analysed in Section E above.

124.  As regards Ds’ allegation that Li never had actual knowledge of any material falsity of China Forestry’s financial statements throughout his time at China Forestry, nor was he suspicious or made aware of any suspicions of any substantial falsity until 14 January 2011 when KPMG directly raised such issue with him (Defence at [2.4]), or that he was sidelined by Mr Li Kwok Cheong (Li WS at [55] –[59]), it could hardly succeed bearing in mind the evidence examined above as to:

(1)  Li’s key role and responsibility in the operations and financial affairs of the Group;

(2)  Li’s (personal) involvement in the falsification of accounting documents;

(3)  Li’s taking active steps and giving false explanations to KPMG after suspicions were raised; and

(4)  Li’s involvement in the defalcations of China Forestry’s funds through the 2010 Yunnan and Guizhou Sham Transactions.

125.  Moreover, given the massive scale of the fraud, it is inherently improbable that the False Accounting Scheme was undertaken by junior accounting staff alone. They would hardly falsify accounting records and government documents without instructions or involvement from senior management, particularly as they would not benefit substantially through such fraudulent scheme. In contrast, Li, as a substantial shareholder of China Forestry (through Top Wisdom), would stand to benefit from the fraud – and as a matter of fact Li did obtain the Illicit Gains and enriched himself in the sham transactions as a result of the such fraud.

126.  Further, Li is the only witness on behalf of Ds and yet Ds chose not to attend trial or call upon Li to testify. Faced with the overwhelming evidence presented by China Forestry, Ds have provided no satisfactory explanation for the failure to call upon Li to testify in these proceedings, and I am satisfied that adverse inference should be drawn against Li on the issues of both the existence of the False Accounting Scheme as well as Li’s perpetuation of the same.

F7.  Findings against Ds

127.  For all these reasons, I find on a balance of probabilities that Li perpetrated the False Accounting Scheme and took part in the defalcations of China Forestry’s funds through the 2010 Yunnan and Guizhou Sham Transactions. Indeed, Li was the instigator and mastermind behind the False Accounting Scheme. Not only did he personally fabricate accounting records, he also directed other staff to engage in the False Accounting Scheme, and knowingly signed various agreements and approved the payments for the sham transactions. In doing so, Li acted in breach of his fiduciary duties owed to China Forestry.

128.  For the avoidance of doubt, I agree with China Forestry’s submissions that it is not necessary for it to show that Li was the only perpetrator behind the False Accounting Scheme (and the Court has made no finding to such effect). As rightly submitted by China Forestry, the fact that there may have been others assisting Li (or indeed other instigator(s), if any) in such fraud does not otherwise diminish the leading role played by Li and the fact that he acted in breach of fiduciary duties owed to China Forestry.

G.  Illicit Gains

129.  As mentioned in Section B above, the False Accounting Scheme resulted in (i) material overstatement of the Group’s assets, revenues and profitability; and (ii) material misstatement of the Group’s expenses in the Relevant Consolidated Financial Statements (i.e. the 2008 and 2009 Consolidated Financial Statements and the 2010 Interim Consolidated Financial Statements).

130.  A detailed analysis of the impact of the False Accounting Scheme on the Relevant Consolidated Financial Statements has been included in Appendix 3 to P’s Skel. For present purposes, it is not necessary to go into the same in details, and it suffices to say that the core impact is as follows:

(1)  The non-existent plantation assets in Yunnan and Sichuan resulted in a massive overstatement of the Group’s reported assets.

(2)  Various payments relating to the forestry assets, such as forest maintenance fees and payments to logging contractor, did not in fact occur. This resulted in material misstatement of the Group’s operating expenses.

(3)  The purported sales to KUB’s customers were unreal and KUB did not receive payments from these purported customers. The fictitious sales resulted in material overstatement of the Group’s reported revenues and profits.

131.  Importantly, the overall result of the False Accounting Scheme is that it overstated the Group’s reported assets, revenues and profits, which would have the effect of painting a much rosier picture of the Group’s financial position and business performance than it was, thereby artificially inflating the price at which the Shares were to be offered on the HKEx upon China Forestry’s listing, as well as the price at which the Shares were to be traded after listing.

132.  As a result of the False Accounting Scheme which was perpetrated by Li in breach of his fiduciary duties owed to China Forestry, Ds were able to obtain the Illicit Gains including the Pre-IPO and Post-IPO Sale Proceeds (by disposing of Shares at an artificially inflated price), and the Top Wisdom Dividends (which would not have been declared by China Forestry but for the misstatements in the Relevant Consolidated Financial Statements). It is China Forestry’s case that it has a proprietary claim based on constructive trust against Ds as a result (which will be considered in Section H below).

133.  For the avoidance of doubt, I agree with China Forestry’s submissions that Li’s assertion, that at the time of arrangement of the January Share Sale he was not aware that KPMG had identified audit irregularities, is no answer because China Forestry’s claim is premised on Ds obtaining the Illicit Gain as a result of Li’s breach of fiduciary duties, which is not dependent on the timing of his knowledge that his breach of fiduciary duty had been uncovered. In any case, on the evidence, KPMG raised audit issues with Mr Zhang and Ms Wu and followed up with Li on the same day on 3 December 2010, well before Li’s disposal of most of his Shares by the January Share Sale.

H.  P’s Proprietary Claim

H1.  Constructive Trust over the Illicit Gains

134.  China Forestry’s cause of action is premised on Li’s breach of his fiduciary duties in the execution of the False Accounting Scheme, as a result of which he made the Illicit Gains, benefiting from the increased share price. China Forestry contends that the relevant law is clear. In short, when an agent or fiduciary acquires a benefit he is treated as having acquired that benefit on behalf of his principal, so that the benefit is owned by the principal who has a proprietary (as well as personal) remedy against the agent or fiduciary. The rule is not compensatory, but is a disgorgement of the profit: FHR European Ventures LLP v Cedar Capital Partners LLC [2015] AC 250 at [7] & [33]; Joe Zhixiong Zhou v SAIF Partners II L.P. and Another[2020] HKCFA 44 at [14].

135.  Importantly, China Forestry asserts a proprietary claim against Ds. It relies on the decision of the UK Supreme Court in FHR for the proposition that the benefit gained is acquired on behalf of the principal and the obligations of the agent/fiduciary is to deliver it up to the benefit of the principal. Hence, China Forestry seeks an equitable proprietary interest over the Illicit Gains acquired by Ds as a result of Li’s fiduciary position, or through an opportunity resulting from that position.

136.  As mentioned in Section C2 above, in the Strike-Out Application, Ds argued that, as a matter of law, absent any legitimate claim of proprietary interest over the Shares, there is no basis for China Forestry to mount a proprietary claim over the sale proceeds of the Shares, and China Forestry is thus not entitled to claim a constructive trust. Such argument was rejected by Ng J in the Strike-Out Judgment (particularly at [26] and [28]) in reliance on FHR and Tang Ying Loi v Tang Ying Ip [2015] 1 HKLRD 712.

137.  In particular, in Tang Ying Loi, Chow J (as he then was) concluded at [100(3)] that FHR shows that a constructive trust may be imposed even though the benefit (i) did not flow from an asset which was (a) beneficially owned by the principal, or (b) intended for the principal, or (ii) was not derived from an activity of the agent which, if he chose to undertake it, he was under an equitable duty to undertake for the principal.

138.  In my view, the above should provide sufficient legal basis for China Forestry’s claim of constructive trust over the Illicit Gains, and Ds have not attended trial to argue otherwise.

139.  Nevertheless, in discharge of its duty to present the case fairly, China Forestry has addressed once again the arguments raised by Ds in the Strike-Out Application. For completeness, I would briefly address this.

140.  First, Ds’ primary argument in the Strike-Out Application (that China Forestry is not entitled to a proprietary claim because it did not assert proprietary interest over the Shares) is contrary to established legal principles. Having considered the relevant authorities including FHR, Tang Ying Loi and the Strike-Out Judgment, I see no reason to depart from the consistent views expressed therein. That should suffice as an answer to Ds’ legal argument.

141.  Second, in the Strike-Out Application, Ds argued that under Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd [2012] Ch 453, a beneficiary of a fiduciary’s duties cannot claim a proprietary interest over assets purchased by the defaulting fiduciary with funds which were not beneficially owned by the claimant or derived from opportunities beneficially owned by the claimant. Ds further argued that Sinclair was only partially overruled by FHR insofar as bribes or secret commissions were concerned.

142.  As pointed out by China Forestry, such argument was rejected by Ng J at [34] of the Strike-Out Judgment, stating that “this court does not agree that the discussion in FHR of the ‘rule’ in equity was confined to cases of bribe or secret commission”. It is in any case clear from FHR (particularly at [33] – [35] & [48]) that the Supreme Court was choosing between the respondents’ position that the general rule in equity applies to all unauthorised benefits (which is consistent with fundamental principles of law of agency), and the appellant’s position that the rule should not apply to a bribe or secret commission (which is more likely to result in uncertainty). The Supreme Court found in favour of the respondent, upheld the general rule and declined to make an exception for bribes and secret commissions. It follows that the general rule should apply to all unauthorised benefits, including the Illicit Gains obtained in breach of fiduciary duties in the present case.

143.  In other words, there is nothing in FHR to limit the application of the rule to bribes or secret commission – rather it was held that the rule is of general application, and bribes or secret commission (and by extension of logic other unauthorised benefits) are of no exception. That the rule is of general application is also buttressed by the general formulation coined by Chow J (as he then was) in Tang Ying Loi at [100(3)].

144.  Third, Ds argued in the Strike-Out Application that because the SFC may apply under the SFO for disgorgement of profits in respect of the Post-IPO Proceeds, to declare a constructive trust over the Post-IPO Proceeds would unjustly elevate China Forestry’s interest to a level above China Forestry’s shareholders.

145.  Such argument did not find favour with Ng J. As he stated at [41] of the Strike-Out Judgment, the present proceedings are only concerned with the rights and liabilities between China Forestry and Ds inter se. As such, the remedies under the SFO are irrelevant to China Forestry’s entitlement to a proprietary remedy, and whether China Forestry’s proprietary claim has priority over a third party’s competing claim is a separate question which this Court does not need to concern itself with. I agree with Ng J’s view.

146.  In any event, if either China Forestry or SFC wishes to assert priority over another’s competing claim, there is no apparent bar to such party taking out an appropriate application in relevant proceedings. In this regard, as acknowledged by China Forestry in P’s Skel at [199], the SFC has obtained an Injunction Order in HCMP 176/2011 to freeze the Frozen Funds, which largely represent the Post-IPO Proceeds, and since both China Forestry and the SFC are parties to HCMP 176/2011, neither of them will be able to enforce the Frozen Funds without the knowledge of the other and adjudication by the Court in HCMP 176/2011.

H2.  Proprietary Claim over Top Wisdom Dividends

147.  In principle, the above analysis should apply not only to the Pre-IPO Proceeds and the Post-IPO Proceeds, but also the Top Wisdom Dividends, on the basis that they represent the benefits acquired by Ds by Li as an agent or fiduciary of China Forestry, in breach of Li’s fiduciary duty owed to China Forestry, such that Li is treated as having acquired such benefits on behalf of China Forestry.

148.  On top of that, Mr Manzoni SC stresses that, in relation to the Top Wisdom Dividends, China Forestry asserts a proprietary claim not only due to the alter ego argument (as examined in Section H3 below) but also that China Forestry has a claim to the return of what was its money. Simply put, the Top Wisdom Dividends is a straightforward payment out of China Forestry’s own money and paid in breach of fiduciary duty. On that basis, China Forestry claims to retain a continuing equitable proprietary interest in it, and such claim in respect of Top Wisdom is also proprietary in nature. China Forestry prays in aid Selangor United Rubber Estates Ltd v Cradock (No. 3) [1968] 1 WLR 1555 at 1575-1577 per Ungoed-Thomas J and Belmont Finance Corp v Williams Furniture Ltd (No.2) [1980] 1 All ER 393 at 405 per Buckley LJ, and the analysis of these authorities in Byers and others v Saudi National Bank [2024] 2 WLR 237.

149.  In Byers, the UK Supreme Court held that to sustain a claim in knowing receipt, a claimant must establish a continuing proprietary interest in the asset received. In considering the issue, the two members of the Court who gave the principal judgments each analysed the authorities referred to on dispositions of company property in breach of fiduciary duty, and concluded that such cases are best analysed as ones in which the company retains the equitable beneficial interest in the assets, this interest arising at the moment that the assets are applied in breach of that duty: see Byers per Lord Briggs JSC at [32], [49] and [61], and per Lord Burrows JSC at [177]-[188].

150.  In the present case, there can be no question that the Top Wisdom Dividends were paid by China Forestry out of the latter’s funds. As such, once such assets (being China Forestry’s funds) were applied and paid out as dividends in breach of fiduciary duty, China Forestry’s equitable beneficial interest arose at the moment of such application of funds.

H3.  Top Wisdom’s liability to account

151.  On the facts, Li held the Shares through Top Wisdom. On the face of it, it was Top Wisdom (as opposed to Li) who obtained the Illicit Gains (including the Pre-IPO Proceeds, the Post-IPO Proceeds and the Top Wisdom Dividends). The question therefore arises as to whether China Forestry can also assert a proprietary claim against Top Wisdom and, if so, on what basis.

152.  Insofar as the Top Wisdom Dividends are concerned, I have found that China Forestry could pursue a proprietary claim against Top Wisdom to the return of what was its money (see Section H2 above).

153.  Without prejudice to the foregoing, China Forestry’s primary case is that Top Wisdom is equally liable for Li’s breaches of fiduciary duty because Top Wisdom was simply Li’s corporate alter ego which he controlled and through which he acted, for the purposes of holding the Illicit Gains, and hence the Court should lift the corporate veil.

154.  As an alternative, China Forestry claims the same against Top Wisdom for accessorial liability of dishonest assistance and knowing receipt, as pleaded in paragraph 76 of the ASOC.

155.  China Forestry contends that, either way, Top Wisdom holds the Illicit Gains on constructive trust for it.

H3.1  Top Wisdom being Li’s alter ego

156.  There is ample support from authorities that, where a fiduciary controlled a company and made use of it as a vehicle through which the fiduciary enjoyed the profit which he earned in breach of his fiduciary duty, the Court may pierce the corporate veil to make such company liable for the acts of the fiduciary as its controlling shareholder: see e.g. Gencor ACP Ltd v Dalby [2000] 2 BCLC 734 at [26] (where Rimer J lifted the corporate veil on the basis that the offshore company was (i) in substance little other than the fiduciary’s offshore bank account held in a nominee name, (ii) simply a creature company used for receiving profits and (iii) the alter ego through which the fiduciary enjoyed the profit which he earned in breach of his fiduciary duty); see also Highfit Development Co Ltd v Koo Siu Ying[2018] HKCFI 105 at [14] and Pacific Electric Wire & Cable Company Limited v Texan Management Limited and others (unreported, HCCL 16/2009, 12 April 2012) at [538] & [541].

157.  In particular, I agree with China Forestry’s submissions that the following propositions can be distilled from the authorities above:

(1)  The corporate veil should be pierced where a wrongdoer controlling the company uses it as a façade or device to facilitate or cover up his own wrongdoing.

(2)  Relevant factors include: (i) whether the company is wholly owned and controlled by the wrongdoer; (ii) whether any other individuals have any beneficial interest in the company; and (iii) whether the company concerned engages in any business activities and/or has the employees required to do so.

158.  Applying the above principles, this Court is satisfied that the corporate veil of Top Wisdom should be pierced on the facts herein:

(1)  Li was the sole shareholder and director of Top Wisdom. Top Wisdom was therefore wholly owned and controlled by Li.

(2)  On Ds’ own evidence (Li WS at [6]), Top Wisdom was set up for the sole purpose of holding Li’s Shares.

(3)  There is no suggestion or evidence that Top Wisdom had other business operations and/or assets except holding the Shares. It is simply a creature company used by Li for receiving profits.

(4)  In any case, Ds admit (at [18] of Defence) the averment at [41] of ASOC that Li was the directing and controlling mind and will of Top Wisdom, such that the knowledge of Li was the knowledge of Top Wisdom insofar as any dealings in relation to China Forestry or its business, Shares or affairs were concerned.

159.  Accordingly, Top Wisdom is the alter ego of Li and should be directly liable for the acts of Li as its controlling shareholder.

H3.2  Alternatively Top Wisdom is accessorily liable

160.  In view of the above finding, it is not strictly necessary to consider China Forestry’s alternative case. Nevertheless, I will deal with it here for completeness.

161.  As submitted by China Forestry, it is trite that the core ingredients of the cause of action of dishonest assistance are as follows:

(1)  a trust or fiduciary obligation owed by the trustee / fiduciary to the plaintiff;

(2)  a breach by the trustee or fiduciary (such breach need not be dishonest);

(3)  the third party must have assisted in the breach being carried out (even if it was not inevitable that loss would have been caused); and

(4)  the third party must have acted dishonestly whilst assisting.

(See FM Capital Partners Ltd v Marino & Others [2018] EWHC 1768 at [82]; see also China Metal Recycling (Holdings) Limited (In Compulsory Liquidation) v Chun Chi Wai[2021] HKCFI 378 at [76], citing Grupo Torras SA v Al-Sabah (No 5) [1999] CLC 1469, per Mance J at 1664A-B)

162.  Whilst the formulation in China Metal Recycling contains a further requirement of “resulting in loss”, it appears that such requirement is not mandatory because a breach does not necessarily result in loss (in the strict sense). Echoing this, it is trite that once the ingredients of dishonest assistance are satisfied, the third party is liable to: (a) compensate for the losses resulting from the trustee/fiduciary’s breach of duty; and/or (b) personally account for his or her profits: FM Capital Partners at [84]. It follows that there is no requirement to show that the assistance provided would inevitably have resulted in the beneficiary suffering a loss (FM Capital Partners at [82(iv)]).

163.  On the facts, the above requirements are plainly satisfied:

(1)  As found by this Court, Li has acted in breach of his fiduciary duties.

(2)  Top Wisdom assisted in Li’s breach of fiduciary duties by disposing of the Shares (or receiving dividends) at Li’s instruction thereby securing a gain for Li.

(3)  Top Wisdom can be attributed with the knowledge of Li as its sole shareholder and director (as admitted at [18] of Defence) that these receipts were traceable to Li’s breach of fiduciary duties.

(4)  Top Wisdom’s assistance in Li’s breach of fiduciary duties was clearly dishonest according to the standards of ordinary people, in that it sold the Shares with the knowledge that the value of the Shares had been artificially inflated by the False Accounting Scheme which Li perpetrated.

164.  Accordingly, Top Wisdom is liable to account to China Forestry for the Illicit Gains it obtained by way of its dishonest assistance.

165.  As regards knowing receipt, it is trite that the core ingredients of the cause of action are as follows:

(1)  a disposal of assets in breach of fiduciary duty;

(2)  beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiff; and

(3)  knowledge on the part of the defendant that the assets he received are traceable to a breach of fiduciary duty.

(See El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685 at page 700 (Hoffmann LJ), cited in Pacific Electric Wire & Cable Company Limited v Texan Management Limited (unreported, CACV 94/2012, 17 September 2013) at [151])

166.  Based on the facts as analysed above, there should be little dispute that such ingredients of knowing receipt are also satisfied.

167.  Accordingly, Top Wisdom as the third party knowing recipient should be treated as holding the Illicit Gains upon constructive trust for the company and should restore the same: see China Metal Recycling (Holdings) Limited (In Compulsory Liquidation) v Chun Chi Wai[2021] HKCFI 378 at [86].

I.  P’s Claim for Equitable Compensation

I1.  As alternative to proprietary claim

168.  Further and in the alternative to its proprietary claim, China Forestry makes a claim for equitable compensation against each of Li and Top Wisdom in respect of the Illicit Gains.

169.  As a starting point, in circumstances where a breach of duty by a fiduciary causes loss or damage to the principal, it is widely accepted that the fiduciary is under an obligation to restore the loss: Libertarian Investments Ltd v Hall (2013) 16 HKCFAR 681 at [87].

170.  More specifically, on the premise that Ds hold the Illicit Gains, or any asset into which those sums may be traced, on a constructive trust for China Forestry, it is argued by China Forestry that, where such property cannot be traced and returned in specie, or restoration in specie is inadequate (for example, when there is a shortfall), China Forestry can elect to claim equitable compensation against Li and Top Wisdom for the shortfall, relying on Libertarian at [166] – [172] and China Metal v Chun at [86]. Initially, I have some hesitation whether China Forestry may elect to claim equitable compensation for what essentially are the benefits gained by Ds as opposed to the loss suffered by China Forestry, but I am ultimately persuaded that there is no impediment to such claim, bearing in mind the rule is not compensatory but is a disgorgement of the profit, and the proposition of China Forestry is based on the precise formulation set out in China Metal v Chun at [86].

I2.  Other loss and damage suffered by China Forestry

171.  There should be little dispute that Ds are also liable to pay equitable compensation for other loss and damage suffered by China Forestry as a result of Li’s breach of fiduciary duties. As submitted by China Forestry, causation is established on a “but for” basis without the constraints of common law causation rules on remoteness and foreseeability, and the Court is entitled to assess compensation with the full benefit of hindsight: Libertarian at [79] – [81] & [90] – [91].

172.  On the facts (having regard in particular to the computation at Appendix 4 to P’s Skel), aside from the Illicit Gains over which China Forestry claims a proprietary interest, this Court is satisfied that Li is also liable to pay equitable compensation for the following loss and damage suffered by China Forestry as a result of his breach of fiduciary duty on a “but for” basis:

(1)  defalcations of China Forestry’s funds through the 2010 Yunnan and Guizhou Sham Transactions in the total amount of HK$525,671,362 (after deducting the amount subsequently recovered);

(2)  dividends paid out by China Forestry on 22 June 2010 (on the basis of the materially misstated 2009 Consolidated Financial Statements) to entities other than Top Wisdom, in the amount of HK$183,385,621.242; and

(3)  costs of unravelling the False Accounting Scheme in the total amount of HK$38,605,218.

J.  Conclusion

173.  For all these reasons, I find in favour of China Forestry as follows:

(1)  Li breached his fiduciary duties owed to China Forestry by perpetrating the False Accounting Scheme.

(2)  As a result of Li’s breach of fiduciary duties, Li and Top Wisdom obtained the Pre-IPO Sale Proceeds, Post-IPO Sale Proceeds and Top Wisdom Dividends (i.e. the Illicit Gains).

(3)  Li and Top Wisdom hold the Illicit Gains, or any assets into which those sums may be traced, on a constructive trust for China Forestry. To the extent any sum of the Illicit Gains is not recoverable through tracing, China Forestry can elect for equitable compensation for the sums.

(4)  China Forestry is also entitled to claim equitable compensation against Li for other loss and damage set out in paragraph 171 above.

174.  Further, as costs should follow the event in general, I would order Ds to bear China Forestry’s costs of this action on a party to party basis.

175.  In this regard, as stated by Ng J at §46 of the Strike-Out Judgment, since Mr Melwani is not a counsel, it is inappropriate for the Court to give certificate for counsel for his assistance. Instead, Ng J considered it appropriate for the Court to certify that the attendance of Mr Melwani together with Mr Manzoni SC at the hearing was justified for the purpose of taxation. Accordingly, I would adopt the same approach and certify that the attendance of Mr Melwani together with Mr Manzoni SC at the trial was justified for the purpose of taxation.

176.  In the premises, I would grant an order in terms of the draft order at Appendix 5 to P’s Skel, with the modification that the reference to “a cost order nisi” at paragraph 5 thereof be replaced by a reference to “a cost order”, given that submissions on costs have already been advanced at the trial.

177.  Last but not least, it remains for me to thank Mr Manzoni SC and Mr Melwani for the helpful assistance given to the Court.

Mr Charles Manzoni SC, instructed by, and Mr Vishal Melwani (solicitor advocate), of Karas So LLP, for the Plaintiff

The 1^st and 2^nd Defendants being absent

HCA 1089/2016

[2021] HKCFI 2761

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1089 OF 2016

________________________

________________________

________________________

J U D G M E N T

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Introduction

1.  This is the hearing of paragraph 1 of the Defendants’ summons dated 9 July 2018 (“Summons”)  seeking to strike out parts of the Statement of Claim annexed thereto underlined in red[1] as disclosing no reasonable cause of action.

Background

2.  The Plaintiff was a company incorporated in the Cayman Islands in December 2007.  At all material times, it was the holding company of the China Forestry group of companies (“Group”)  which engaged in a business involving the management and development of forests, the harvest of forest resources and the sale of logs mainly in the PRC. 

3.  In December 2009, the Plaintiff’s shares were listed on the Main Board of the Hong Kong Stock Exchange (“HKSE”)  pursuant to an initial public offering (“IPO”). 

4.  The 2^nd Defendant (“Li”)  was an executive director and CEO of the Plaintiff when it was listed in 2009.  After KPMG had identified the irregularities in the 2010 Audit referred to below, he was removed from his positions as the CEO and the executive director in February 2011 and February 2012 respectively. 

5.  Li is the sole shareholder of the 1^st Defendant (“Top Wisdom”).  Li, through Top Wisdom, was a substantial shareholder of the Plaintiff, holding approximately 6.34% of the Plaintiff’s shares up to 12 January 2011. 

6.  On 12 January 2011, Li procured Top Wisdom to enter into a placing agreement with Standard Chartered Securities (Hong Kong)  Limited to dispose of an aggregate of 119 million Plaintiff’s shares for a consideration of more than HK$398 million (“January Share Sale”).

7.  On 25 January 2011, the Plaintiff’s auditor, KPMG, reported to the Board a number of irregularities in the financial year ended 31 December 2010 (“2010 Audit”).  This led to the suspension of trading of the Plaintiff’s shares on 26 January 2011.[2] 

8.  On 2 February 2011, the SFC obtained an ex parte interim injunction freezing assets held by Top Wisdom in a UBS bank account, which represented the approximate proceeds of the January Share Sale.

9.  On 18 June 2015, the Plaintiff was wound up by the Grand Court of the Cayman Islands and liquidators were appointed (“Liquidators”).[3] 

10.  On 25 April 2016, the Plaintiff commenced the present proceedings.  The Writ was served on the Defendants in June and July 2017.  The Plaintiff subsequently served its Statement of Claim on 30 April 2018.  The deadline for service of the Defence and Counterclaim was extended by consent to 9 July 2018, the day when the Defendants issued the Summons. 

The Plaintiff’s case

11.  The Plaintiff commenced the present action on the basis that Li, in breach of his fiduciary duties owed to the Plaintiff and for his own personal benefit, orchestrated a scheme (“Scheme”)  to cause the Plaintiff and/or its subsidiaries to engage in false transactions and false accounting, resulting in

(1)  the overstatement of the assets, revenues and profitability of the Group, and

(2)  the misstatements of the Group’s expenses,

in the Plaintiff’s prospectus, the 2008 consolidated financial statements, the 2009 interim financial statements, the 2009 consolidated financial statements and the 2010 interim financial statements. 

12.  The effect of the Scheme was to create the false impression that the Group was more profitable and valuable than it actually was, thereby inflating the price of the Plaintiff’s shares. 

13.  With the knowledge of the Scheme and the inflation of the price of the Plaintiff’s shares, Li carried out the following transactions for his personal benefit:

(1)  On 25 June 2009, Li caused Top Wisdom to dispose of 130,434 of the Plaintiff’s shares prior to the Plaintiff’s IPO for US$1,499,991 (“Pre-IPO Proceeds”). 

(2)  In June 2010, Top Wisdom received dividends from the Plaintiff in the sum of RMB10,019,430 (“Top Wisdom Dividend”).

(3)  On 12 January 2011, Li caused Top Wisdom to dispose of 119,000,000 of the Plaintiff’s shares for HK$398,650,000 (“Post-IPO Proceeds”). 

14.  It is the Plaintiff’s case that Li, through Top Wisdom, obtained the Pre-IPO Proceeds, Post-IPO Proceeds and Top Wisdom Dividend as a result of his fiduciary position or pursuant to an opportunity resulting from that fiduciary position.  The Plaintiff claims that the Defendants hold the Pre-IPO Proceeds, the Post-IPO Proceeds and the Top Wisdom Dividend on constructive trust for the Plaintiff. 

Deliberation

15.  The present application concerns only the alleged constructive trust over the Pre-IPO Proceeds and the Post-IPO Proceeds (“Proceeds”). 

16.  According to the Defendants, central to the present application is a distinct legal question viz whether proprietary relief by way of a constructive trust in the proceeds of a director’s sale of his own shares in the company is available to the company on the ground that fraud was committed by that director in order to enhance the apparent value of the shares. The Defendants submit that the alleged constructive trust over the Proceeds is entirely misconceived as a matter of law.

Principles on striking out

17.  The applicable legal principles are uncontroversial: the Court would only exercise the power to strike out the plaintiff’s Statement of Claim for disclosing no reasonable cause of action in a plain and obvious case, where the claim must be obviously unsustainable, the pleadings must be unarguably bad and it must be impossible, not just improbable, for the claim to succeed.

18.  In Ha Francesca v Tsai Kut Kan & Ors (No 1) [1982] HKC 382 at 392F-H, Silke JA observed:

“ … striking out should only be done in plain and obvious cases, there should be no trial upon affidavit. Disputed facts are to be taken in favour of the party sought to be struck out. The claim must be obviously unsustainable, the pleadings unarguably bad and that it be impossible, not just improbable, for the case to succeed before a court will strike out. If the court does not think the matter to be clear beyond doubt or if it fails to be satisfied that there is no reasonable cause of action or that the proceedings are frivolous or vexatious, then, there should be no striking out. One must be careful not to drive a plaintiff from the judgment seat nor should the court decide difficult points of law in proceedings such as this.” (emphasis added)

Proprietary relief by way of a constructive trust

19.  Mr Manzoni SC submits and this court agrees that, in this area of law, the leading authority is undoubtedly the seminal decision of FHR European Ventures LLP v Cedar Capital Partners LLC [2015] AC 250. 

20.  In that case, the second defendant was acting for the purchasers in the negotiation for the purchase of a hotel and successfully concluded the purchase.  Unknown to the purchasers, the second defendant was contractually entitled to receive and did receive a commission from the owner of the hotel.  On discovering that the commission had been paid, the purchasers/claimants issued proceedings seeking recovery of that sum, alleging that it constituted a secret profit.  At issue was whether the claimants were entitled to a declaration that the second defendant had received the commission on constructive trust for the claimants absolutely.  The Supreme Court held that where an agent acquired a benefit which came to his notice as a result of his fiduciary position, or through an opportunity resulting from that position, the general equitable rule was that he was to be treated as having acquired the benefit on behalf of his principal, so that the benefit was owned by the principal who had a proprietary as well as personal remedy against the agent.

21.  At [7], Lord Neuberger of Abbotsbury PSC formulated the general equitable rule as follows:

“ … The agent’s duty to account for the bribe or secret commission represents a personal remedy for the principal against the agent. However, the centrally relevant point for present purposes is that, at least in some cases where an agent acquires a benefit which came to his notice as a result of his fiduciary position, or pursuant to an opportunity which results from his fiduciary position, the equitable rule (‘the rule’)  is that he is to be treated as having acquired the benefit on behalf of his principal, so that it is beneficially owned by the principal. In such cases, the principal has a proprietary remedy in addition to his personal remedy against the agent, and the principal can elect between the two remedies.” (emphasis added)

22.  The rationale of the rule can be gleaned from [30] of the judgment. 

“ 30 The respondents’ formulation of the rule, namely that it applies to all benefits received by an agent in breach of his fiduciary duty to his principal, is explained on the basis that an agent ought to account in specie to his principal for any benefit he has obtained from his agency in breach of his fiduciary duty, as the benefit should be treated as the property of the principal, as supported by many judicial dicta including those in para 19 above, and can be seen to be reflected in Jonathan Parker LJ’s observations in para 14 above. More subtly, it is justified on the basis that equity does not permit an agent to rely on his own wrong to justify retaining the benefit: in effect, he must accept that, as he received the benefit as a result of his agency, he acquired it for his principal. Support for that approach may be found in Mellish LJ’s judgment in McKay’s Case 2 Ch D 1, 6, and Bowen J’s judgment in Whaley Bridge 5 QBD 109, 113.”

23.  At [10], Lord Neuberger recited a contention by counsel for the second defendant which did not find favour with his Lordship. 

“ 10 On the one hand, Mr Collings QC contends for the appellant, Cedar, that the rule should not apply to a bribe or secret commission paid to an agent, because it is not a benefit which can properly be said to be the property of the principal. This has the support of Professor Sir Roy Goode, who has suggested that no proprietary interest arises where an agent obtains a benefit in breach of his duty unless the benefit either (i)  flows from an asset which was (a)  beneficially owned by the principal, or (b)  intended for the principal, or (ii)  was derived from an activity of the agent which, if he chose to undertake it, he was under an equitable duty to undertake for the principal. Sir Roy suggested that ‘to treat [a principal] as having a restitutionary proprietary right to money or property not derived from any asset of [the principal] results in an involuntary grant by [the agent] to [the principal] from [the agent’s] pre-existing estate’: ‘Proprietary Restitutionary Claims’ in Restitution: Past, Present and Future (1998)  ed Cornish, p 69 and see more recently (2011)  127 LQR 493. …” (emphasis added)

24.  That contention, in particularly the suggestion of Professor Sir Roy Goode, is strikingly similar to the Defendants’ 1^st Ground for striking out at section E1 of their skeleton submissions.  In section E1, the Defendants submit that (i)  Li, through Top Wisdom, acquired the relevant Plaintiff’s shares from Kingfly Capital Limited on 31 March 2008 for a consideration of US$32 million, (ii)  there is nothing in the Statement of Claim which contains a legitimate basis for the Plaintiff to assert a constructive trust over those shares, (iii)  hence, Top Wisdom held the relevant Plaintiff’s shares in its own right as full beneficial owner, and (iv)  absent any legitimate claim of proprietary interest over those shares, there is no basis for the Plaintiff to mount a proprietary claim over the sale proceeds of the shares.

25.  No authority has been cited by the Defendants in support of proposition (iv)  above which is just a bare assertion of the law by them.  However, as can be seen from [10] of the FHR judgment quoted above, it has the support of Professor Sir Roy Goode who suggested that no proprietary interest arises where an agent obtains a benefit in breach of his duty unless inter alia the benefit flows from an asset which was beneficially owned by the principal.  That suggestion was not accepted by Lord Neuberger.

26.  Specifically, proposition (iv)  is contrary to what Anderson Chow J (as he then was)  has ruled in Tang Ying Loi v Tang Ying Ip [2015] 1 HKLRD 712 at [100 (3)] at which his Lordship endorsed the view that FHR shows that a constructive trust may be imposed even though the benefit (i) does not flow from an asset which was (a) beneficially owned by the principal, or (b) intended for the principal, or (ii) was not derived from an activity of the agent which, if he chose to undertake it, he was under an equitable duty to undertake for the principal.

27.  In view of the above, this court is not persuaded that the Defendants’ submission based on proposition (iv)  renders the Plaintiff’s proprietary claim over the Proceeds plainly unsustainable and obviously bad.  The Defendants’ 1^st Ground for striking out must be rejected.

28.  On the facts, FHR was a case about secret commission, a point heavily and repeatedly emphasised by the Defendants in seeking to distinguish FHR from the present case.  However, if one examines the judgment of FHR carefully, there is no indication that Lord Neuberger intended the general equitable rule to be restricted to cases of secret commission (or bribes for that matter).  On the contrary, there are indications all over the judgment which suggest the general equitable rule applies to all kind of unauthorised benefits received by a fiduciary.

29.  At [13], his Lordship referred to a number of decided cases without any hint of disapproval:

“ 13There is a number of 19^th century cases not involving bribes or secret commissions, where an agent or other fiduciary makes an unauthorised profit by taking advantage of an opportunity which came to his attention as a result of his agency and judges have reached the conclusion that the rule applied. Examples include Carter v Palmer (1842)  8 Cl & Fin 657, where a barrister who purchased his client’s bills at a discount was held by Lord Cottenham to have acquired them for his client. The Privy Council in Bowes v City of Toronto (1858)  11 Moo PC 463 concluded that the mayor of a city who bought discounted debentures issued by the city was in the same position as an agent vis-à-vis the city, and was to be treated as holding the debentures on trust for the city. …” (emphasis added)

30.  Similarly, at [18] and [19], Lord Neuberger made the observation that many of the cases his Lordship referred to support the contention that the general rule applies to all benefits which are received by an agent in breach of his fiduciary duty:

“ 18 It is fair to say that in the majority of the cases identified in the previous five paragraphs it does not appear to have been in dispute that, if the recipient of the benefit had received it in breach of his fiduciary duty to the plaintiff, then he held it on trust for the plaintiff …

19 However, many of those cases contain observations which specifically support the contention that the rule applies to all benefits which are received by an agent in breach of his fiduciary duty. In Sugden 3 Sm & G 192, 194, Stuart V-C said that ‘it is a well-settled principle that, if a trustee make a profit of his trusteeship, it shall enure to the benefit of his cestui que trusts’. And in McKay’s Case2 Ch D 1, 5, Mellish LJ said that it was ‘quite clear that, according to the principles of a Court of Equity, all the benefit which the agent of the purchaser receives under such circumstances from the vendor must be treated as received for the benefit of the purchaser’. …” (emphasis added)

31.  Lastly, at [33], Lord Neuberger expressly approved the proposition adopted by the claimants as follows:

“ 33The position adopted by the respondents, namely that the rule applies to all unauthorised benefits which an agent receives, is consistent with the fundamental principles of the law of agency. The agent owes a duty of undivided loyalty to the principal, unless the latter has given his informed consent to some less demanding standard of duty. The principal is thus entitled to the entire benefit of the agent’s acts in the course of his agency. …” (emphasis added)

32.  The Defendants’ 2^nd Ground for striking out is set out in section E2 of their skeleton submissions at paragraph 25 ie the Plaintiff’s claim for a proprietary interest over the Proceeds is unsupported by established principles in equity.  In support of that submission, at paragraph 29, the Defendants refer to the English Court of Appeal decision in Sinclair Investments (UK)  Ltd v Versailles Trade Finance Ltd[2012] Ch 453, in particular what Lord Neuberger expressed in [88] & [89]:

“ 88 In my view, Lewison J was right to reject TPL’s proprietary claim to the proceeds of sale of the shares. It is true that the decisions in the Reid case [1994] 1 AC 324, Sugden v Crossland 3 Sm & G 192 and (at least arguably)  Pearson’s Case5 Ch D 336 go the other way. However, there is a consistent line of reasoned decisions of this court (two of which were decided within the last ten years)  stretching back into the late 19^th century, and one decision of the House of Lords 150 years ago, which appear to establish that a beneficiary of a fiduciary’s duties cannot claim a proprietary interest, but is entitled to an equitable account, in respect of any money or asset acquired by a fiduciary in breach of his duties to the beneficiary, unless the asset or money is or has been beneficially the property of the beneficiary or the trustee acquired the asset or money by taking advantage of an opportunity or right which was properly that of the beneficiary.

89 For the reasons I have given, previous decisions of this court establish that a claimant cannot claim proprietary ownership of an asset purchased by the defaulting fiduciary with funds which, although they could not have been obtained if he had not enjoyed his fiduciary status, were not beneficially owned by the claimant or derived from opportunities beneficially owned by the claimant. …” (emphasis added)

33.  At paragraphs 31, 33 and 35, the Defendants submit that (i)  Sinclair was only partially overruled by the UK Supreme Court in FHR insofar as bribes or secret commissions were concerned, (ii)  the discussion in FHR of the “rule” in equity was confined to the question of the availability of a proprietary remedy specifically over the bribe or secret commission taken by an agent when exploiting an opportunity arising from his fiduciary position, and (iii)  Sinclair remains a sound authority for the principle that a fiduciary’s gain/profit from criminal activities (except for bribe or secret commission)  is not held on trust for the principal, because such gain/profit does not arise from opportunities beneficially owned by the principal.

34.  With respect, for reasons already explained in paragraphs 28 to 31 above, this court does not agree that the discussion in FHR of the “rule” in equity was confined to cases of bribe or secret commission.  At least, it is arguable that the discussion in FHR of the “rule” was not so restrictive as the Defendants submit.  Further, if one compares the formulation of the “rule” at [7] of FHR with the formulation of the principle at [88] and [89] of Sinclair, one can see that the two formulations cannot both be right, or at least it is arguable that they cannot both be right. 

35.  Lastly, as Mr Manzoni SC points out, the Court of Appeal in Sinclair have dealt with the case as though it were concerned with bribes.  At [55] and [56], Lord Neuberger observed:

“ 55Both the judgment below and the arguments before us focused on cases where the courts have had to consider whether, where an agent or employee accepts a bribe or secret commission or the like, his principal or employer beneficially owns the bribe. As in the present case, the money in such cases was received by a fiduciary and, although its receipt derived from his fiduciary position and was a plain breach of his fiduciary duties, it was not money which was part of the assets subject to his duties, or derived from such assets.

56I am prepared to accept for present purposes that, if a claimant beneficially owns a bribe received by a fiduciary, it follows that TPL’s proprietary claim to the proceeds of sale of the shares must succeed. None the less it is worth pointing out that a fiduciary who accepts a bribe receives it directly because of his fiduciary function, e g as the principal’s agent, in order to induce him to place a contract for the principal with the bribe payer. Not only did Mr Cushnie not acquire the shares with, or as a result of, his breach of duty as director of TPL, but the profit which he made on the shares was as a shareholder in VTFL (indirectly through VGP)  not as a director of TPL. Having pointed out that distinction I can well see that, for practical as well as principled reasons, the proceeds of sale of the shares, as an unauthorised secret profit, should be treated for present purposes in the same way as a bribe.” (emphasis added)

36.  Hence, for the sake of argument, even if the “rule” laid down in FHR is only confined to cases of bribe, it is at least arguable that Sinclair can no longer be regarded as a sound authority, in light of FHR. 

37.  For the above reasons, the Defendants’ 2^nd Ground for striking out is also rejected.  This court is of the view that, on the present state of the law, the Plaintiff has at the very least an arguable proprietary claim over the Proceeds.

38.  The Defendants’ 3^rd Ground for striking out can be found in section E3 of their skeleton submissions.  At paragraphs 37 and 38, the Defendants submit that (i)  if the Plaintiff’s assertions in the Statement of Claim were to be established, Top Wisdom/Li’s disposal of the relevant Plaintiff’s shares after the IPO would constitute insider dealing for the purpose of section 270 of the Securities and Futures Ordinance, Cap 571 (“SFO”), (ii)  the SFC can apply under section 213(2)(b)  of the SFO for a restoration order against the insider dealer/fiduciary to restore the parties to the relevant transactions to the position before they were entered into, (iii)  the Market Misconduct Tribunal (“MMT”), upon the finding of insider dealing, can order disgorgement of profit pursuant to section 257(d)  of the SFO, and (iv)  other persons who have sustained pecuniary loss as a result of the insider dealing are entitled to seek compensation under section 281 of the SFO. 

39.  On the basis of the above, the Defendants submit at paragraph 41 that, in the present case, to declare a constructive trust over the Proceeds in favour of the Plaintiff would unjustly elevate its interest to a level above those purchasers of the relevant shares or other persons who have sustained pecuniary loss and are entitled to claim compensation under section 281 of the SFO.  The Defendants conclude at paragraph 42 that:

“… The injustice so occasioned is itself a cogent illustration of the obvious fallacy in P’s claim of a proprietary interest over the Post-IPO proceeds.”

40.  With respect, the Defendants’ submission at paragraph 41 of their skeleton submissions is irrelevant for the purpose of deciding whether the Plaintiff’s proprietary claim over the Post-IPO proceeds should be struck out.  The submission, taken to its highest, is a factor to be considered in determining the Plaintiff’s proprietary claim over the Post-IPO proceeds.  The Defendants’ conclusion at paragraph 42 is a non sequitur. 

41.  In this Action, this court is only concerned with the rights and liabilities between the Plaintiff and the Defendants inter se.  This court is not concerned with the yet to be established liabilities of the Defendants under the SFO or the yet to be established remedies available to the SFC, the MMT or any other persons as a result of the alleged insider dealing.  The time may or may not come when, for instance, the SFC will assert a competing claim over the Proceeds vis-a-vis the Plaintiff.  It is clearly premature at this stage to conjecture that that time will definitely come and the SFC’s competing claim must prevail over the Plaintiff’s asserted proprietary claim over the Proceeds.

42.  For these reasons, this court is not satisfied that the so-called “injustice” illustrates the obvious fallacy of the Plaintiff’s claim of a proprietary interest over the Post-IPO proceeds.  The Defendants’ 3^rd Ground for striking out must also be rejected.

43.  To conclude, this court is not satisfied that the Plaintiff’s proprietary claim over the Proceeds is so obviously unsustainable that it is impossible to succeed.

Disposition and costs order nisi

44.  Paragraph 1 of the Summons is hereby dismissed.

45.  There shall be an order nisi that costs of and occasioned by the application be to the Plaintiff, to be taxed if not agreed, and paid by the Defendants forthwith, certificate for Leading Counsel.

46.  Since Mr Melwani is not a counsel, it is inappropriate to give certificate for counsel for his assistance in this case. In accordance with the practice endorsed in China Forestry Holdings Co Ltd (in Official Liquidation)  & Ors v KPMG unrep, HCCL 9 of 2019, 27 May 2021, Anthony Chan J, this court hereby certifies that the attendance of Mr Melwani together with Mr Manzoni SC at the hearing was justified for the purpose of taxation.

Mr Charles Manzoni, SC and Mr Vishal Melwani, Solicitor Advocate, instructed by Lipman Karas, for the Plaintiff

Mr Ambrose Ho, SC, Mr Isaac Chan and Mr Francis Chung, instructed by King & Wood Mallesons, for the 1^st and 2^nd Defendants

HCA 1089/2016

[2020] HKCFI 526

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1089 OF 2016

______________

______________

____________________

DECISION

____________________

1.  This is the substantive hearing of the application under §2 of the Summons dated 9 July 2018 (the “Summons”) taken out by the 1^st and 2^nd defendants (“D1” and “D2” respectively) for an order that:

“ All further proceedings in this action be stayed until 28 days after the issuance of the written report by the Market Misconduct Tribunal (‘MMT’) in the proceedings relating to the listed securities of the Plaintiff regarding whether the persons specified in the notice to the MMT by the Securities and Futures Commission have engaged in market misconduct.”

The background facts

2.  The plaintiff (“China Forestry”) was incorporated in the Cayman Islands in December 2007.  It was the holding company of the China Forestry group (the “Group”).

3.  In December 2009, China Forestry was listed on the Hong Kong Stock Exchange pursuant to an initial public offering (the “IPO”). At that stage, D2 was its CEO, and until February 2011, one of the directors.  Through D1 which was D2’s wholly‑owned company, D2 held 6.34% of the shares of China Forestry.

4.  At all material times, Li Kwok Cheong (“KC Li”) was P’s majority shareholder and Chairman.

5.  On 12 January 2011, D2 procured D1 to enter into a placing agreement (the “D1 Post‑IPO Placing”) with Standard Chartered Securities (Hong Kong) Limited and disposed of an aggregate of 119 million shares of China Forestry for consideration of about HK$398 million (the “D1Post‑IPO Placement Proceeds”).

6.  During the course of the audit of the Group’s financial statements for the year ended 31 December 2010, China Forestry’s auditor, KPMG, identified a number of irregularities which raised serious questions about the Group’s accounting records, KPMG reported those irregularities to the board of China Forestry on 25 January 2011.

7.  On 2 February 2011, the Securities and Futures Commission (the “SFC”) commenced HCMP 176 of 2011 (“HCMP 176”) against D1 and D2.  According to the Originating Summons as subsequently amended on 4 March 2011, the SFC alleges knowledge by D1 and D2 of KPMG’s detection of irregularities in the course of the 2010 audit, so that the D1 Post‑IPO Placing constituted insider dealing, contrary to the relevant provisions of the Securities and Futures Ordinance (the “SFO”).   

8.  At the same time when the Originating Summons was taken out, SFC obtained an ex parte interim injunction (the “Injunction”) freezing assets up to HK$398,219,458.00, including the sum of HK$394 million held by D1 in a UBS bank account (representing approximately the D1 Post‑IPO Placement Proceeds).  The Injunction remains in force.  HCMP 176 has otherwise been stayed (by consent on 4 January 2018). 

9.  In June 2015, China Forestry was wound up by an order of the Grand Court of the Cayman Islands.  Liquidators were appointed (the “Liquidators”). 

10.  On 25 April 2016, the writ herein was filed.  As summarized by Mr Manzoni, leading counsel for China Forestry:

“ 11.  The writ ... sought compensation from the Defendants for breach of duty or on an accessorial basis, including in respect of the [D1 Post‑IPO Placement Proceeds][1].

...

17. ... In short, China Forestry alleges that [D2] orchestrated a pervasive and substantial false accounting scheme (the ‘False Accounting Scheme’) in breach of his fiduciary and other duties owed to China Forestry for his own personal gain and to the detriment of China Forestry. China Forestry submits in these proceedings that the Defendants hold illicit gains (the ‘Illicit Gains’) obtained from the artificial inflation of the price of China Forestry’s shares on a constructive trust for China Forestry.

18.     Other than the Illicit Gains, China Forestry also seeks equitable compensation for various losses suffered by China Forestry as a result of the False Accounting Scheme, including misappropriations by [D2], dividends paid out on the basis of the misleading accounts and various costs which would not have been incurred had [D2] not breached his fiduciary and other duties.”

11.  On 16 January 2017, the SFC commenced HCA 117 of 2017 (“HCA 117”) against inter alios China Forestry, KC Li and D2.  The SFC alleges that the defendants engaged in market misconduct in respect of the Prospectus, the 2009 financial report and 2010 interim report. 

12.  The writ in HCA 117 has never been served upon the Liquidators.  China Forestry has subsequently been removed as a party.

13.  HCA 117 was stayed by consent on 14 November 2017.

14.  On 3 May 2018, the SFC issued the Notice referred to in §2 of the Summons (the “SFC Notice”).  The SFC Notice:

(a)  recites the SFC’s view that market misconduct within the meaning of ss 277 and 270 of the SFO has or may have taken place in relation to the securities of China Forestry;

(b)  names the persons suspected to have perpetrated market misconduct (collectively the “Specified Persons”) as being:

(i)  KC Li;

(ii)  D2; and

(iii)  D1;

(c)  requires the MMT to conduct proceedings (the “MMT Proceedings”) and determine:

(i)  whether any market misconduct in the nature of false or misleading information inducing transactions, insider dealing or otherwise has taken place;

(ii)  the identity of any person who has engaged in the market misconduct found to have been perpetrated; and

(iii)  the amount of profit gained or loss avoided, if any, as a result of the market misconduct found to have been perpetrated. 

15.  Specifically in respect of the suspected market misconduct within the meaning of s 277 of the SFO:

(a)  277 of the SFO concerns disclosure of false or misleading information inducing transactions;

(b)  the relevant paragraphs of the SFC Notice read that:

“ 23. Various types of information relating to China Forestry’s business operations and financial information ( ... referred to herein as the ‘Disclosed Information’) were disclosed, circulated or disseminated to the public in the Prospectus, the 2009 Annual Results and the 2010 Interim Results.

24. [KC Li] and [D2] disclosed, circulated or disseminated, alternatively authorised or were concerned in the disclosure, circulation or dissemination of the Disclosed Information in the Prospectus, the 2009 Annual Results and the 2010 Interim Results, respectively.

...

48. The Disclosed Information was materially false or misleading in respect of:

48.1. The Group’s revenue, profit and turnover generating activities ...

48.2. The value, existence and nature of the Group’s assets ...

48.3. China Forestry’s suitability to be listed and/or the quality of the Group’s management.

...

   51.    Both [KC Li] and [D2] knew, alternatively were reckless or negligent as to whether the Disclosed Information, or any part of it, was false or misleading as to a material fact or was false or misleading through the omission of a material fact.”

16.  Specifically in respect of the suspected market misconduct within the meaning of s 270 of the SFO:

(a)  270 of the SFO concerns insider dealing;

(b)  the relevant paragraphs of the SFC Notice read that:

“ 53. KPMG’s identification of the 2010 Audit Issues and/or the fact that the Disclosed Information, or a substantial part of it, was materially false or misleading were specific information about China Forestry or the Shares, and were not generally known ...

54. [D2] knew in December 2010 that KPMG had identified some of the 2010 Audit Issues and could or would in due course reveal other false and misleading disclosures that had been made by China Forestry. He also knew that the Disclosed Information, or a substantial part of it, was materially false or misleading. [D2] knew that these two pieces of information (individually or collectively) amounted to relevant information in relation to China Forestry.

55. [D2’s] knowledge was imputable to [D1].

56. On 12 January 2011, after trading hours, [D2] procured [D1] to enter into [the D1 Post‑IPO Placing] with [Standard Chartered Securities (Hong Kong) Limited] for placing an aggregate of 119,000,000 shares at HK$3.35 per share ...

57. On 13 January 2011, [D2] procured [D1] to execute the [the D1 Post‑IPO Placing] and the settlement sum of HK$398,219,458.00 (net of fees and expenses) was paid to [D1].”

Parties’ submissions

17.  In summary, Mr Chan, counsel for the defendants, submits that the present proceedings should be stayed as requested given that (1) all factual issues in the MMT Proceedings and the present action are “essentially identical”, (2) that the Liquidators and the SFC are effectively making rival claims against the D1 Post‑IPO Placement Proceeds, (3) that the findings in the MMT report as to whether any market misconduct has taken place “should be” admissible as proof of liability in the present action under ss 281(7) and (8) of the SFO; (4) that practically it is unrealistic to expect the Liquidators to seek to further pursue the present action for the purpose of achieving a result different from that reached by the MMT; and (5) that all evidence adduced before the MMT will be admissible herein and will significantly facilitate the disposal of the present proceedings.

18.  Mr Manzoni resists the application.  His main grounds are that (1) the MMT proceedings and the present action involve different parties and cannot be determinative of the present action, (2) the MMT report will not be admissible in these proceedings; (3) the MMT Proceedings are not Court Proceedings, and (4) a stay will prejudice China Forestry.

The law on stay

19.  The Court has the discretion under s 16(3) of the High Court Ordinance and Order 1B rule 1(2)(e) to order a stay of proceedings.

20.  When deciding how the discretion is to be exercised, the basic principle is what would serve the ends of justice between the parties and as far as the administration of justice is concerned.  Whether there is identity of parties is also an important consideration.  As observed by Ma J (as he then was) in Linfield Ltd v Taoho Design Architects Ltd [2002] 2 HKC 204:

“ 14. One starts with the basic principle: what would serve the ends of justice between the parties to the litigation and as far as the administration of justice is concerned? This recurrent theme can be found in all cases involving stays on the basis of lis alibi pendens: see The Abidin Daver at 412B‑D (noting in particular the well known words of Lord Diplock, ‘It is a recipe for confusion and injustice’). I have also found helpful a statement of principle contained in the judgment of Sellers LJ in Compagnie Nouvelle France Navigation SA v Compagnie Navale Afrique du Nord (The ‘Oranie’ and The ‘Tunisie’) [1966] 1 Lloyd’s Rep 477, where at 487(1), he said:

The guiding principles are:

(1) that the stay must not cause injustice to the claimant in the arbitration, and

(2) that the applicant for a stay must satisfy the Court that the continuance of the arbitration would be oppressive or vexatious to him or an abuse of the process of the Court: in short, that it would be unjust.

I would add that where a plaintiff institutes proceedings as of right (and not in breach of an arbitration agreement or exclusive jurisdiction clause) he is not to be deprived of carrying on those proceedings unless very good reasons exist to the contrary.

...

16. ... Even if there are multiple sets of proceedings involving similar or even the same issues, if there is no identity of parties, I fail to see how it is desirable or even possible for one or more of such proceedings involving different parties to be stayed pending the resolution of any other set or sets of proceedings.  The determination of any issues in proceedings between different parties would not be binding on any other party in another set of proceedings.  I recognize immediately that this may give rise to a risk of inconsistent findings, but where findings made in earlier proceedings (even on the same issues) are not binding in later proceedings, the risk is inevitable.  However desirable it may be to have consistency, findings made in different proceedings between different parties cannot be made binding on other persons.”

21.  Linfield was applied by Deputy Judge Lisa Wong SC (as she then was) in Eastman Chemical Ltd v Heyro Chemical Co Ltd [2012] 2 HKLRD 135 at [29].

22.  Recently, the relevant considerations when deciding whether to grant a stay were summarized by Au‑Yeung J in Poon Ka Man Jason v Cheng Wai To & Ors [2018] HKCF1 771, that:

“ 36. The court has discretion, as a matter of case management, to grant a stay of proceedings generally or until a specified date or event: High Court Ordinance, Section 16(3); Order 1B, rule 1(2)(e) of the Rules of the High Court (‘RHC’).

37. Where, as here, the action was commenced as of right, the court should only grant a stay when there are ‘very good reasons’ and in ‘rare and compelling circumstances’. The stay must not cause injustice to the Plaintiff, and the Defendants must show that continuing the proceedings would be unjust to them. See: Zhang Xiuhong v Liu Wenchen & ors (HCA 2118/2012, 20 July 2017), §34, per Au‑Yeung J, citing Ng J’s judgment in AIG Europe Ltd & ors v Fast‑Link Express Ltd & ors (HCAJ 114/2014, 10 January 2017), §§9‑13. The ultimate question is what would serve the ends of justice.

38. Exercise of discretion would involve balancing between (1) possible wastage of Court’s time and resources and also parties’ time and costs (if there is no stay) on the one hand and (2) possible delay of the proceedings for a short period of time (if there is a stay) on the other hand: see The Al Dhabiyyah [1999] 4 HKC 414, at p 420A‑F.

39. The court must bear in mind that the underlying objectives of the court is to increase cost‑effectiveness of court proceedings; ensure that a case is dealt with as expeditiously as is reasonably practicable; promote reasonable proportion and procedural economy in the conduct of proceedings; and to facilitate settlement of disputes: Order lA, rule 1(a), (b), (c) and (e) of the RHC.”

23.  I will apply the above principles and considerations when considering how the discretion should be exercised.

The admissibility of the MMT report

24.  One plank of Mr Chan’s submissions[2] is that the findings in the MMT report as to whether any market misconduct has taken place “should be” admissible under ss 281(7) and (8) of the SFO as proof of liability in the present action.

25.  The relevant parts of s 281 of the SFO are:

“ (1) Subject to subsection (2), a person who has committed a relevant act in relation to market misconduct shall, whether or not he also incurs any other liability (whether under this Part or otherwise), be liable to pay compensation by way of damages to any other person for any pecuniary loss sustained by the other person as a result of the market misconduct, whether or not the loss arises from the other person having entered into a transaction or dealing at a price affected by the market misconduct.

(2) No person shall be liable to pay compensation under subsection (1) unless it is fair, just and reasonable in the circumstances of the case that he should be so liable.

...

(7) Without prejudice to section 62 of the Evidence Ordinance (Cap. 8), in an action brought under subsection (1)—

(a) the fact that there is a determination by the Tribunal pursuant to section 252(3)(a) that market misconduct has taken place;

(b) the fact that there is a determination by the Tribunal pursuant to section 252(3)(b) identifying a person (whether or not a party to the action) as having engaged in market misconduct,

shall, in so far the determination is still subsisting, be admissible in evidence for the purpose of proving, where to do so is relevant to any issue in the action—

(i)   in the case of a determination referred to in paragraph (a), that the market misconduct has taken place; or

(ii)  in the case of a determination referred to in paragraph (b), that the person has engaged in market misconduct.

(8) In an action brought under subsection (1), where the fact that there is a determination referred to in subsection (7)(a) or (b) is admissible in evidence under subsection (7)—

(a) then—

(i)   in the case of a determination referred to in subsection (7)(a), the market misconduct that is the subject of the determination shall, unless the contrary is proved, be taken to have taken place; or

(ii)  in the case of a determination referred to in subsection (7)(b), the person that is the subject of the determination shall, unless the contrary is proved, be taken to have engaged in market misconduct; and

(b)  without prejudice to the reception of any other admissible evidence as evidence of the determination or for the purpose of identifying the facts on which the determination was based, the contents of a report of the Tribunal containing the determination and published under section 262(2)(b)(i), or the contents of a copy of a report of the Tribunal containing the determination and made available under subsection (9), shall also be admissible in evidence for such purpose.”

26.  In my view, the meaning of s 281 of the SFO is clear.  S 281(1) creates a statutory cause of action enabling “any other person” who has sustained pecuniary loss to claim compensation by way of damages against a person who has committed market misconduct.  The concept of “fair, just and reasonable in the circumstances of the case”, to which that statutory cause of action is subject, is introduced in s 281(2). Ss 281(7) and (8) permits the admission of the relevant MMT report in the proof of certain issues.  But the operation of those 2 sub‑sections is confined to “an action brought under subsection (1)” of s 281.  They have no application to an action not brought under s 281(1) (eg based on tort or for breach of contract).

27.  Mr Chan submits that the legislative intent that can be gleaned from ss 281(7) and (8) is to facilitate proof of market misconduct for the purpose of seeking compensation, and that there is no reason why similar facilitation should not also be afforded to actions otherwise than those brought under s 281(1).

28.  I do not accept that submissions.  No authority has been cited in support.  Nor has any Hansard or similar documents placed before me.  I will not speculate as to why ss 281(7) and (8) have been worded as they are.  But their operation is clearly confined to “an action brought under subsection (1)”.  Had the legislature intended to expand the admission of a determination by the MMT to other or all civil proceedings, it could easily have said so — see for example s 62 of the Evidence Ordinance, which renders a conviction admissible for certain specific purposes “in any civil proceedings”.

29.  In the present case, China Forestry (or the Liquidators) is not relying on the statutory cause of action under s 281(1). I agree with Mr Manzoni’s submissions that ss 281(8) and (9) have no broader application to proceedings such as the present, which is not brought under s 281 and where no pecuniary loss as a result of market misconduct is claimed.

Discussion

30.  On the facts of the present case, applying the aforesaid legal principles, and for the following reasons, I refuse the defendants’ application for a stay:

(a)  There is no identity of parties between the MMT Proceedings and the present action.  China Forestry is not a party to those proceedings.  The results of the MMT Proceedings will not be binding on China Forestry or the Liquidators.  They have no right to test the evidence, no right to attempt to establish any case which it may want to establish, or to make any submission to the MMT;

(b)  There is a lot of force in Mr Manzoni’s submissions, which I accept, that it would be highly prejudicial to require the resolution of China Forestry’s claim against the defendants to await the outcome of a set of proceedings which is not binding on it and over which it can have no influence;

(c)  The prejudice is particularly acute when, as accepted by Mr Chan[3], the Liquidators and the SFC are effectively making rival claims against the defendants’ only substantial, namely the D1 Post‑IPO Placement Proceeds frozen by the Injunction; 

(d)  Not only are the MMT Proceedings not determinative of the present action, even the issues do not all overlap. Whilst the factual background relevant to the MMT Proceedings and the present action is primarily the same, both the issues, and hence what the parties set off to establish, are very different.  In the MMT Proceedings, the issues, as framed by the SFC Notice, are whether there was any market misconduct within the meaning of ss 277 and 270 of the SFO, whether the Specified Persons were involved, and the amount of any profit gained or loss avoided.  For the present action, the main issue is whether there has been any breach of fiduciary duties on the part of D2 using D1 as the vehicle, and whether there is consequentially any constructive trust.  The mental elements entailed are also very different;

(e)  The nature of the MMT Proceedings is also different from a High Court civil action.  MMT Proceedings are inquisitorial in nature.  It is not bound by the strict rules of evidence.  It may receive and consider any material even if the material would not be admissible in evidence in civil proceedings in a court of law[4];

 (f)  Whilst the Liquidators will no doubt consider the impact of any MMT report when available on the further conduct of this case, given that they are not parties to the MMT Proceedings, the different issues involved, and the different applicable rules of evidence, it is speculative at best at this stage to say what the Liquidators will make of the report, and far too much a straitjacket to at this stage force them to wait pending the result of those proceedings;

(g)  Another important consideration is this.  Even assuming that the MMT is going to rule that market misconduct has been committed, whether the SFC can lay claim on the frozen D1 Post‑IPO Placement Proceeds will still be dependent upon whether China Forestry can establish its proprietary claim over those same proceeds on the basis of constructive trust. Such rival claim of priority amongst the SFC and China Forestry will have to be resolved by the Court.  The matters raised in the present action will have to be considered and resolved at some stage;

(h)  Mr Chan submits that as all the evidence served upon the defendants for the purpose of the MMT Proceedings and adduced before the MMT will have to be disclosed for the purpose of this action, the related discovery exercise will be laborious and costly.  My view is that the difficulty of the exercise has been exaggerated.  When preparing the MMT Proceedings, D2 would be expected to go through all the used and unused materials served upon him by the SFC.  The discovery exercise for the purpose of this action should not be too much of an added burden;

(i)  Based on counsel’s estimate, there may still be sometime before the MMT report will become available.  Mr Chan’s estimate is summer of 2020;

(j)  In all the circumstances, my view is that it would not serve the ends of justice for the present action to be stayed.  The proprietary claim and interest of China Forestry over the frozen D1 Post‑IPO Placement Proceeds will need to be determined any way.  Little costs will be saved by staying the present action.

Disposal

31.  For the above reasons, I dismiss the defendants’ application under §2 of the Summons.

32.  I make a cost order nisi that the defendants should bear the cost of the application, to be taxed if not agreed. Any party seeking variation or summary assessment should file their submissions within 14 days from the date hereof, submissions in response within 7 days of receipt, and submissions in reply within another 7 days.