CHINA FORESTRY HOLDINGS CO LTD (IN OFFICIAL LIQUIDATION)AND OTHERS v. KPMG (a firm)

HCCL 9/2019

[2021] HKCFI 1519

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 9 OF 2019

____________________

BETWEEN

____________________

________________

DECISION

________________

1.  This is KPMG’s Summons filed on 30 March 2021 (“Summons”) by which it seeks leave to apply for two classes of amendments to the Re-Amended Substituted Defence and Counterclaim (“RADCC”).

2.  The first relates to Section L of that pleading.  KPMG seeks to abandon its reliance on statutory relief under Hong Kong law and any equivalent relief available under Cayman Islands law. 

3.  The second relates to Section H.1.  KPMG seeks leave to plead that the indemnity contained in China Forestry’s Articles of Association[1] (“Indemnity”) covered the 2009 Audit claims against it (“Audit Claims”), in addition to the notes issuance claims (“Notes Claims”) in respect of which reliance on the Indemnity has been pleaded (“Indemnity Amendment”).

4.  Only the Indemnity Amendment is opposed.

5.  The extreme lateness of this application is demonstrated by the fact that the written Opening Submissions of the parties are due to be lodged with the court by tomorrow.  There can be no doubt that they will be very substantial documents supported by many bundles of authorities.  A 50-day trial of this action is due to start 1 month later on 28 June 2021.  The length of this trial is commensurate with its complexity and importance.  The claims against KPMG are in excess of US$117 million, plus interest.

6.  Thus far, this case has been carefully managed by the court with comprehensive directions, including a deadline for interlocutory applications, which was extended twice from 30 November 2020[2] to, ultimately, 17 December 2020.  A late application of the present type tends to undermine the efforts of the court in managing the case. 

Applicable principles

7.  In respect of the applicable principles, I have been referred to the much cited authorities of Hsu Ming Chi v Lam Shu Chit, unrep, HCCL 8/2013, 22 October 2014, at §§13-18, per Ng J and Tao Soh Ngun v HSBC International Trustee Ltd[2018] HKCFI 2543, at §5 per Wilson Chan J.

8.  In view of the lateness of this application, I shall bear in mind in particular the dicta of Mrs Justice Carr DBE in Quah Su-Ling v Goldman Sachs International [2015] EWHC 759 (Comm) at §38(b), (e) and (g) :

“where a very late application to amend is made the correct approach is not that the amendment ought, in general, to be allowed so that the real dispute between the parties can be adjudicated upon. Rather, a heavy burden lies on a party seeking a very late amendment to show the strength of the new case and why justice to him, his opponent and other court users requires him to be able to pursue it. …;

gone are the days when it was sufficient for the amending party to argue that no prejudice had been suffered, save as to costs.  In the modern era it is more readily recognised that the payment of costs may not be adequate compensation;

a much stricter view is taken nowadays of non-compliance with the Civil Procedure Rules and directions of the Court.  The achievement of justice means something different now.  Parties can no longer expect indulgence if they fail to comply with their procedural obligation because those obligations not only serve the purpose of ensuring that they conduct the litigation proportionately in order to ensure their own costs are kept within proportionate bounds but also the wider public interest of ensuring that other litigants can obtain justice efficiently and proportionately, and that the courts enable them to do so.”

9.  With respect, I fully agree with the dicta. See also Chun Wo Building Construction Ltd v Metta Resources Ltd, unrep, HCCT 29/2013, 22 March 2016, at §6. 

10.  Finally, I have been invited by the Plaintiffs to bear in mind that it is the pleadings that will “dictate the course of proceedings both before and at trial”.  Where witnesses are involved, “it will be the pleaded issues that define the scope of the evidence, not the other way round”.  It will “not be acceptable for unpleaded issues to be raised out of the evidence which is to be or has been adduced”: Kwok Chin Wing v 21 Holdings Ltd (2013) 16 HKCFAR 663 at §21.

Explanation for the delay

11.  This application has generated highly contentious evidence over, inter alia, KPMG’s explanation for the lateness of this application.  It is neither appropriate nor necessary to resolve the highly contentious evidence on paper.  In my view, the court is entitled to make an objective assessment of the evidence, especially where such evidence is uncontroversial or incontrovertible, and come to a view whether the delay has been satisfactorily explained. 

12.  Despite the submissions made on behalf of KPMG, I reject any suggestion that the Indemnity Amendment is somehow technical in nature because the existing plea (RADCC, §§197-199) is sufficiently wide to cover the claim of indemnity over the 2009 Audit.  Any reading of the plea will dispel such contention. 

13.  In my view, an objective assessment of the evidence relied upon by KPMG leaves little doubt that the issue whether the Indemnity would cover the 2009 Audit was considered by KPMG (a well-resourced multinational enterprise) with their legal advisors and not adopted as part of its defence after such consideration.  The following evidence of KPMG is telling :

(1) 4^th Affivadit of Ms Wong, §18

“KPMG pleads reliance on the Indemnity at paragraphs 197 to 199 of the Defence. These paragraphs have not been amended since the Defence was filed on 1 June 2020. At that time, KPMG considered the Indemnity may well not be a viable defence to the 2009 Audit claim and accordingly intended to rely on the Indemnity principally in relation to the notes issue engagement and otherwise to rely on the Court’s discretion under section 903 of the Companies Ordinance.”

(2) 6^th Affidavit of Ms Wong, §16

“Put shortly, and without waiver of privilege in any advice received by KPMG, at the time the Defence was filed on 1 June 2020, KPMG and its legal team recognised that the existence of the Indemnity was not consistent with Hong Kong practice and proceeded on the basis that the way in which any liability of Hong Kong auditors in the position of KPMG could be mitigated in respect of audit engagements would be through section 903 of the Companies Ordinance and/or the inherent jurisdiction of the Court to grant relief as a matter of Cayman Islands law (Defence, §209-211).”

14.  Although there is no specific evidence on whether Cayman Islands legal advice was obtained when the decision was made by KPMG, it was at all material times well-advised by a reputable team of lawyers, not to mention KPMG’s own international experience. 

15.  Any doubt over KPMG’s awareness of the difference between Hong Kong law and that of the Cayman Islands in that the former prohibits the limitation of liability by auditors[3] but not the latter must have dissipated when it was confirmed by the DARTS recording[4] that the court was informed of such difference by KPMG’s counsel at the hearing of the application for expert evidence on 24 September 2020. 

16.  This brings me to the evidence of the single joint expert (“SJE”) on Cayman Islands law.  KPMG relies heavily on the Final Report of Mr Lowe QC as an impetus for the Indemnity Amendment.  With respect, I have considerable misgivings about it. 

17.  Firstly, the relevant Order only permitted Cayman Islands law on 2 issues, namely, (a) Is relief akin to section 903 of the Companies Ordinance (Cap 622) available under the laws of the Cayman Islands?  (b) In what circumstances can the indemnity provisions contained in the Company’s 2007 and 2009 Articles of Association be enforced by KPMG under the laws of the Cayman Islands?

18.  Although the 2^nd issue was formulated in wide terms, there was no room to doubt that it was confined to the existing plea of reliance on the Indemnity as an implied term of the Notes Issue Engagement.  That was perfectly plain from the KPMG’s Skeleton Submissions put before the court on the expert evidence application.  In particular, section E of the Table attached to the Submissions stated KPMG’s comments against the 2^nd issue as follows:

“KPMG relies on a provision in P1’s Articles of Association that every auditor shall be indemnified out of P1’s assets and profits in respect of any act or omission in the execution of the auditor’s duty, other than in respect of fraud or dishonesty: Defence §§197-199 [A/3/158]. Expert evidence is necessary to determine the interpretation of the Articles, which is a matter of Cayman law.”

19.  Under the disguise of clarification[5], the SJE was led into expanding his report to cover an unpleaded issue, ie, whether the Indemnity might be incorporated into the 2009 Audit Engagement.  It was against the Order of this court on the scope of the evidence, and fundamentally against the principles summarised by the CFA in Kwok Chin Wing v 21 Holdings Ltd.

20.  It should be added that the correspondence exchanged between the parties in the course of agreeing the instructions to the SJE, to which the court was taken to by the Plaintiffs, suggest that KPMG was making tactical manoeuvre to try to expand the scope of the expert evidence to its advantage. 

21.  I am unable to accept that KPMG is entitled to springboard the Indemnity Amendment by acting in breach of an Order of the court.

22.  In the premises, I do not consider that the delay has been properly or satisfactorily explained.  On this ground alone, in light of the lateness of this application, I would decline this application. 

Prejudice to the Plaintiffs

23.  First of all, in my view the burden on the Plaintiffs to show prejudice (see Hsu Ming Chi, §17) is not a heavy one to discharge in light of the prevailing circumstances.  It must be accepted that in a case of this complexity and magnitude, the resources of the Plaintiffs’ team of lawyers are extremely stretched with the trial preparation in compliance with the directions of the court. 

24.  It is an unfair distraction and quite oppressive for the Plaintiffs’ team to have to deal with a new case on the Indemnity Amendment when they are due to lodge the written Opening for the trial by tomorrow.  Indeed, there are merits in the Plaintiffs’ submission that they are already prejudiced by having to divert their resources to deal with the present application whilst having to prepare for the trial. 

25.  The importance of considering and dealing with the new case is underlined by the fact that KPMG says that it is a complete answer to the Plaintiffs’ claims. 

26.  I have not lost sight of the fact that some of the arguments which may be deployed against the new case by the Plaintiffs may overlap with the arguments on the existing plea of Indemnity on the Notes Claims. 

27.  However, it is accepted by the KPMG that the Plaintiffs will be entitled to respond to the new case with argument(s) based on waiver or estoppel premised on the proposition that the parties acted on the assumption that KPMG owed an enforceable duty of care to the Plaintiffs throughout the audit.  For that purpose, the Plaintiffs will be entitled to consider the available evidence (the discovery in this case runs to nearly 200,000 documents) and the legal issues. 

28.  Further, the Plaintiffs submitted that, if the Indemnity Amendment is allowed, it will be entitled to consider evidence of, eg, accounting practice[6] and practice of the Stock Exchange which may impact upon the incorporation of the Indemnity into the 2009 Audit Engagement.  Further expert evidence may be required.  I see no reason to agree with the submission.

29.  KPMG complains that the Plaintiffs’ case on prejudice is not specific in terms of identifying relevant witness(es) or points for investigation.  I do not believe that the criticism is justified in light of the stage of development of this case and the fact that the Plaintiffs are preoccupied with the preparation for the trial.  `

30.  Putting the Plaintiffs to meeting a new case in conjunction with the trial preparation (on expert evidence alone, there are going to be 4 SJE on 4 disciplines and 2 separate experts on audit issues) is, in my view, serious prejudice.  This constitutes another reason for declining this application. 

Merits of the Indemnity Amendment

31.  Given that this court will have to adjudicate on the merits of the Indemnity on the Notes Claims, I will keep my comments here in succinct terms.  It is not readily apparent why the Indemnity was incorporated into the 2009 Audit Engagement, whether expressly or impliedly as alleged in the proposed amendments[7].

32.  In particular, the 2009 Audit Engagement Letter stated in clause 11.1 that it was subject to and governed by Hong Kong law.  It is common ground that Hong Kong law prohibits any indemnity over auditor’s liabilities.  There was also an entire agreement clause contained in clause 12.2 of the Engagement Letter which militates against the express or implied incorporation of the Indemnity.    

33.  The only particular provided in the proposed amendment which had anything to do with the Articles of China Forestry referred to clause 1.1 of the Engagement Letter.  The reliance on clause 1.1 is misplaced because it dealt with China Forestry’s obligations to prepare proper financial statements.

34.  At the hearing, KPMG placed emphasis on the proposition that the incorporation of the Indemnity was a collateral agreement.  The reference to collateral agreement was made in a half-hearted manner.  It was only referred to in one of the particulars (para 198.7) to support the allegation of express or implied incorporation of the Indemnity :

“In the circumstances, under the law of the Cayman Islands or, alternatively, under Hong Kong law, the Indemnity was an express term of each of the 2009 Audit and the notes issue engagement by way of incorporation into the 2009 Audit engagement letter and notes issue engagement letter and/or as a contract collateral thereto entered into between the 1^st Plaintiff and the Defendant on or around the time of the Defendant’s acceptance of its respective appointments.”

35.  I am unable to see any additional force in the collateral agreement point.  It was not adequately explained why the issue of collateral agreement may turn upon Cayman Islands law when the 2009 Audit Engagement was governed by Hong Kong law. 

36.  I am unable to see strength in the Indemnity Amendment which may justify this late application (see para 8 above).

Disposition

37.  For these reasons, I dismiss the Summons, save that the unopposed amendment is allowed.  The costs of and occasioned by the Summons, including the costs thrown away by the unopposed amendment, together with the costs of and occasioned by 2 Summonses for additional evidence filed on 14 and 25 May 2012, be to the Plaintiffs.  I certify that the attendance by both Mr Karas and Ms Au at the hearing was justified.

38.  I decline the Plaintiffs’ application that the costs be paid on indemnity basis.  Whilst the lateness of the Summons and the pressure which it had placed on the Plaintiffs are regrettable, I have to bring into the balance the importance of the application to KPMG as well as the size of the claims against it. 

Mr Jason Karas and Ms Astina Au, instructed by Lipman Karas, for the 1^st – 4^th Plaintiffs

Mr Douglas Lam SC, Mr Jason Yu and Mr Cyrus Chua, instructed by Kirkland & Ellis, for the Defendant

HCCL 9/2019

[2020] HKCFI 2614

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 9 OF 2019

___________________

___________________

________________

D E C I S I O N

________________

1.  There are 2 applications before the court: (1) KPMG’s Summons filed on 4 June 2020 (amended on 7 September 2020) for, inter alia, a further and better list of documents described in the Amended Schedule (“Discovery Summons”); and (2) KPMG’s Summons dated 20 August 2020 requiring the Plaintiffs to identify the documents amongst their own discovery which they dispute authenticity (“Authenticity Summons”).

2.  The discovery sought concerns 3 classes of documents :

(1)  Notes, transcripts or recordings of interviews conducted by the Joint Official Liquidators of the 1^st Plaintiff (“Liquidators”) in connection with their investigations into the business and affairs of the 1^st Plaintiff’s group of companies (“Group”) with specified directors, officers or members of management of the Group (no less than 36 persons) (“Key individuals”);

(2)  Written communications between the Liquidators and the Key Individuals in connection with the Liquidators’ investigations into the Group’s business and affairs;

(3)  Reports provided by the Liquidators to the Group’s creditors, to the extent they refer to the Group’s business and affairs.

3.  The “business and affairs” of the Group are defined as follows :

(1)  The “true state of the Group’s business and financial position, and any suspected fraud, wrongdoing or negligence of the Key Individuals” from “1 January 2009 to 18 June 2015”;

(2)  Any “actual or potential choses in action” that may be available to the Liquidators to pursue or get-in which “concern some or all of the losses which the Plaintiffs seek to recover from” KPMG;

(3)  “[R]easons for and events leading to the 1^st Plaintiff’s insolvency”.

Respective case

4.  The following is a high-level summary.  KPMG audited the 1^st Plaintiff’s consolidated financial statements for the years ended 31 December 2009 (“2009 Audit”) and 2010 (“2010 Audit”).

5.  The Plaintiffs allege that the Group was the victim of an extensive fraud perpetrated by Mr Li Han Chun (“Li”), the Group CEO.  It is alleged that KPMG negligently failed to detect any of the alleged irregularities in 5 areas in respect of the 2009 Audit.

6.  It is KPMG’s case that it did identify irregularities in the key areas of alleged fraud and performed extended audit procedures in response.

7.  The Plaintiffs allege that if KPMG had carried out additional audit procedures or reached a different judgment, KPMG would have concluded that Li and the Group’s management had forged the documents supplied to KPMG and given fraudulent explanations to KPMG, and KPMG would have reported this to the 1^st Plaintiff’s board of directors (“Board”) and/or audit committee (“Audit Committee”), which would have taken steps that would have prevented the Group from suffering the claimed losses.

8.  The Plaintiffs allege that if KPMG had reported the irregularities to the Audit Committee in March 2010, the Board would immediately have taken steps to safeguard the Group’s assets and to dismiss Li and persons acting under his direction.

9.  Further, the Plaintiffs would have immediately taken action to prevent certain payments made pursuant to sham transactions defined as the KUB[1] Prepayments, 2010 Guizhou Sham Transactions and 2010 Yunnan Sham Transactions.  The 1^st Plaintiff would not have paid a final dividend of RMB 157,911,060 in June 2010 (“2010 Dividends”), and it would not have issued US$300 million Senior Notes on 22 November 2010 and would therefore have avoided wasted expenses.

10.  KPMG has denied the chain of causation.  In addition, KPMG has pleaded defences of contributory negligence, failure to mitigate loss, reflective loss and limitation, and advanced a Counterclaim of circuity of action based on the fraudulent misrepresentations of management. 

Issues on Discovery Summons

11.  In opposing the application, the Plaintiffs say that the documents sought are irrelevant and, insofar as they are relevant, they are covered by legal professional privilege.  The Plaintiffs also say that it is now practically impossible to establish the true state of the Group’s business and financial position over the period of time in question.

Applicable principles

12.  The principles on discovery applications are trite.  They were summarised in Li Tak Yee v Sociéte Générale, unrep, HCA 2478/2009, 16 April 2013, §§24-54.  I do not propose to repeat them here.

13.  In relation to legal professional privilege (“LPP”), the following is a useful summary :

(1)  Legal advice privilege attaches to communications between a client and his lawyer, where the lawyer is acting in the course of his professional relationship and within the scope of the lawyer’s professional duties, under conditions of confidentiality, and for the purpose of enabling the client to seek, or the lawyer to give, legal advice or assistance in a relevant context: Passmore on Privilege, 4^th edn (2020), at [2-003];

(2)  Litigation privilege attaches to confidential communications between a client or his lawyer and a third party for the dominant purpose of use in litigation that, at the time the communication is made, is either proceeding or pending, or reasonably anticipated or in contemplation, and to which the client is or reasonably anticipates becoming a party, for the purpose of either (i) enabling legal advice to be sought or given or (ii) seeking or obtaining evidence or information to be used in or in connection with the litigation concerned: Passmore, at [3-006].

Lateness of these applications

14.  This is a late application in light of (a) the complexity of this case; (b) the stage at which these proceedings have reached (the first round of witness statements was exchanged on 24 August 2020 and the parties are to exchange supplemental statements no later than 30 October 2020); and (c) the fact that a 50-day trial for this case will begin on 28 June 2021.  Regrettably, there remain unresolved interlocutory applications.  In addition to the 2 Applications before the court, there are 2 outstanding applications for adducing expert evidence.

15.  The lateness of the present applications requires the court to consider its potential effect on trial preparation on which the parties should be focused, and to scrutinise the Applications with the Underlying Objectives in mind: see O 1A, r 1 and Li Tak Yee, §§29-34.

Relevance and necessity of the documents sought

16.  For the present purposes, the pleadings are to be considered broadly and relevance is determined by reference to the wide Peruvian Guano test: Li Tak Yee, §§26 and 28.

17.  KPMG says that the Liquidators’ investigations (and the documents sought) are relevant to 2 main pleaded issues:

(1)  What was the extent of the alleged fraud and who was implicated in the fraud or otherwise responsible for the losses claimed?

(2)  What was the true state of the business and financial position of the Group from 2009 and onwards?

True state of business

18.  Dealing firstly with the 2^nd issue, I have not been able to find from KPMG’s 112-page Substituted Defence and Counterclaim (“D/CC”) any positive case pleaded in respect of the “true state of business”.

19.  Of the arguments advanced by KPMG, the strongest one on relevance was rested on one of the losses claimed by the Plaintiffs, namely, the 2010 Dividends of RMB 157.9 million.  It was said that that the court can only assess the likelihood of whether the 2010 Dividends would have been paid in any event (ie, even if KPMG had disclaimed the 2009 Audit opinion or reported additional matters to the Board) if there is evidence as to the true financial position of the Group in 2009.  The decision whether to issue a dividend necessarily required the Board and its shareholders to reach a conclusion as to whether the Group was solvent or insolvent and whether it had sufficient distributable reserves from which a dividend could be paid.

20.  The Plaintiffs’ pleaded case on the 2010 Dividends is quite simple.  It is averred that the Dividends were paid in reliance on the misstated Financial Statements for 2009 and KPMG’s unqualified audit opinion in respect thereof.  Had KPMG reported findings of fraud or indicia of fraud requiring further investigation, the Dividends would not have been paid (see Substituted Statement of Claim (“SOC”), §§144-145).

21.  Apart from putting the Plaintiffs to proof, KPMG’s case is that the Plaintiffs in fact had substantial business (albeit not properly documented), was holding substantial cash and further dividend of RMB 63.5 million was paid in February 2012 by the 1^st Plaintiff after they had reported irregularities to the Audit Committee in respect of the 2010 Audit (see D/CC, §§177.6, 188-189).

22.  I have not overlooked section D1 of the D/CC, §§34-40.  The section contained much submission which can only serve to obfuscate.  Stripped of the submissions, the section contained little more than the findings of the Independent Board Committee (“IBC”) to the effect that the Group had a substantial cash business and a large cash balance. 

23.  In the Substituted Reply and Defence to Counterclaim (“R/D”), §111, it was pleaded that apart from the special dividend of RMB 63.5 million[2] paid in March 2012 no other dividend was declared and paid by the 1^st Plaintiff.

24.  The Plaintiffs had made it abundantly clear in their submissions that it is not part of their case that the Group had no business (such a case was repeated attributed to the Plaintiffs by KPMG).  Indeed, one would have thought that any suggestion that the Group had no business would not sit well with the fact the 1^st Plaintiff had paid out substantial dividend in 2010. 

25.  I agree with KPMG’s submission that the Plaintiffs’ case on loss is counterfactual.  The court will likely have to rely on inferences in the adjudication of such case.  However, in my view, the relevance of “true state of business” is at best marginal in light of the pleaded cases summarised above. 

26.  This brings me to the Plaintiffs’ case that it is now practically impossible to establish the true state of the Group’s business and financial position over the period of time in question.  The Plaintiffs rely upon the fact that KPMG and their successor, Crowe Horwath, were unable to establish the true state of the Group’s business.  KPMG disclaimed the 2010 consolidated financial statements.  Crowe Horwath disclaimed the 2011 and 2012 consolidated financial statements (2012 being the last set of audited accounts prior to the appointment of Liquidators in 2015 to the 1^st Plaintiff).

27.  As an example, Note 2 to the 1^st Plaintiff’s 2010 consolidated financial statements, which was referred to in KPMG’s disclaimer of opinion, stated as follows : 

“Following Mr. Li’s admissions to the Board, the Independent Committee was able to locate the Cash Records but has not been able to locate the related supporting documents of Kunming Ultra Big for year ended 31 December 2010 or the Cash Records or related supporting documents relating to before 2010.”

…

… As a consequence, the Board has reason to believe that the financial statements in previous years might not reflect the true and fair view of the company’s financial performance and position.  Due to loss of some books and records, and lack of cooperation from Mr Li, Ms Wu and Mr Zhang the Board believes that it is almost impossible, and not practical to verify the financial information as reported in the consolidated financial statements of the Group for the current and past years.”

[emphasis added]

28.  It should be highlighted that the Liquidators had taken extensive steps to recover documents from numerous third parties.  Altogether, there are some 1.5 million documents in the Liquidators’ possession; about 1.25 million documents had been disclosed in these proceedings after agreement was reached by the parties on the scope of discovery.  However, the Liquidators are not in any better position than KPMG to say what the “true state of business” was. 

29.  The suggestion by KPMG that the discovery sought is “likely to provide significant general observations about the Group which will be informative and assist the Court in its assessment of this case” is both unconvincing and tends to lend weight to the Plaintiffs’ complaint that this is a fishing exercise. 

30.  I am not satisfied that the discovery sought will materially improve the picture provided by the existing material such as the financial statements and the IBC investigations for which it was assisted by 2 international firms of accountants (see D/CC, §§37-40).

31.  Moreover, the breadth of the discovery sought lends weight to the Plaintiffs’ complaint that the scope of the Application is too board and oppressive.  Given the stage of these proceedings, the parties should be focusing their time and energy on narrowing the disputes and preparing for the trial. 

32.  For these reasons, I disagree with KPMG on the relevance or necessity of the documents pertaining to the “true state of business”. 

Fraud

33.  In respect of the extent of the fraud and the perpetrators (see para 17(1) above), the Plaintiffs had made specific allegations in relation to 5 key areas of fraudulent activity within the Group’s business in 2009, which KPMG ought to have identified and reported to the Audit Committee.  The Plaintiffs claim loss in respect of specific payments made in 2010 and 2011, which they say would have been prevented had KPMG identified the aspects of fraudulent activity in the Group’s business.

34.  The Plaintiffs allege that Li was assisted by, inter alia, 7 identified individuals (“7 Individuals”) in his wrongdoings[3].

35.  KPMG’s case on the fraud is quite opaque.  The closest to a plea on the extent of the fraud and the people involved is to be found in paras 168.2 and 168.4 of the D/CC :

“168.2. If the Plaintiffs prove the fraud, it will be shown to be a sophisticated and wide-ranging fraud involving the collusion of numerous members of the 1^st Plaintiff’s Board, Audit Committee, management and 420 employees, as well as various third party banks and government officials. To the extent the Court finds that every reasonably competent auditor would have raised additional questions or sought additional evidence, those requests would have been met with further falsified information and documentation and additional staged site visits orchestrated by the dishonest members of management and those charged with governance and the fraud would have remained undetected in any event.

…

168.4.  Even if the Plaintiffs prove the alleged fraud and that every reasonably competent auditor would have detected and reported it, it is denied that the Audit Committee would have avoided the losses claimed by taking the steps pleaded in paragraph 135.  The alleged fraud could only have been carried out with the collusion or gross incompetence and apathy of the 1^st Plaintiff’s Board, executive management and Audit Committee.  Those persons would not have acted to prevent the alleged losses regardless of the matters reported.”

36.  These paragraphs did not contain any proper plea of material facts.  Instead, they contain generalised assertion (“will be shown”) of widespread fraud involving numerous unnamed individuals.

37.  In Schedule A to the D/CC, an “Overview of the 2009 Audit” was set out, the generalised allegation of widespread fraud was repeated in para 2 :

“The audit work pleaded in this Schedule demonstrates that, if the Plaintiffs are successful in establishing the alleged fraud, it was a wide ranging and elaborate fraud involving collaboration with numerous third parties, voluminous falsified documentation and dishonesty among those at the highest levels of the Plaintiff companies. Further audit procedures would not have uncovered such a fraud, because such procedures would have been met with additional false documents and explanations.”

38.  Paragraph 2 was pleaded to in para 3.1 of Schedule 1 of the R/D as follows :

“Regarding the first sentence, the Plaintiffs admit only that the fraud was wide ranging and involved voluminous falsified documentation and dishonesty among those at the highest levels of management. Further, KPMG’s case that no fraud is admitted, alternatively if there was a fraud it was wide ranging and elaborate, is not coherent.”

39.  I bear in mind that serious allegations are made against professionals in this action, which may affect their livelihood.  Further, it might have been the case that KPMG was hoodwinked by the fraudsters in the course of the 2009 Audit.

40.  On the other hand, there is no issue that there was a wide ranging fraud involving people in the top management.  By its very nature, it is quite unlikely for the parties to be able to get to the bottom of a sophisticated and wide ranging fraud. 

41.  Importantly, the trial of this action will not be about the fraud, although it is an important backdrop against which the court will have to inquire into the adequacy or otherwise of the 2009 Audit. 

42.  Without properly defined parameters in the pleadings or the Discovery Summons (the relevant part of the definition (see para 3(1) above) is hopelessly wide and no attempt had been made to narrow it down), it would not be right to allow discovery at this late stage of the proceedings (with the filing of the witness statements, the parties’ factual case had been laid out) with the hope that something useful may be turned up. 

43.  This brings me to the probative value of the materials sought. It must be borne in mind, first and foremost, that the Liquidators had shared with KPMG the documents available to them.  There is equality in analysing and making use of those documents.

44.  Amongst the discovery sought, the materials which are most relevant to the issue of fraud must be the interview records of the Key Individuals.  These interviews could only have taken place no less than 4 or 5 years after the events.  According to the Liquidators’ evidence, none of the 7 Individuals had been interviewed by them[4]. It would be wishful thinking to believe that any of the interviewees had confessed to taking part in the fraud upon interview 4 or 5 years later. 

45.  The most which one may expect would be allegations made by interviewee(s) against one or more people in the management.  At the highest, it would be hearsay evidence which requires careful scrutiny before it can be relied upon, if at all, because the interviewee might have a motive to lie, eg, to exculpate himself/herself and lay the blame on someone else.

46.  The meeting notes of Mr Su Xiaoming[5], which had been disclosed by the Liquidators, serve to illustrate the point.  Mr Su was recorded to have said that Li had falsified the accounts on behalf of Li Kwok Cheong, the Group’s Chairman, who was “trying to get money from the Group and … run off”.  However, it was recorded also that Mr Su had suffered considerable loss from his investment in China Forestry, his relationship with the Chairman Li went soured over monetary dispute and he was looking to bring action to recover his loss (including against KPMG).  Self-evidently, such evidence has to be treated with considerably caution by the court.

47.  It will not be right for any part of the trial to be turned into an inquiry of the fraud based on a collection of hearsay evidence of questionable probative value. 

48.  It is incumbent for the court, having in mind the Underlying Objectives, to take a balanced view of the value of the materials sought to KPMG and to the court, and how discovery of such material at this stage may impact on the trial. 

49.  For these reasons, I am unable to agree with KPMG that the fraud materials are relevant or necessity.

50.  For completeness, no submission was made by KPMG in respect of the documents which may fall within the definition as stated in paras 3(2) and (3) above.  Para 3(3) is irrelevant.  In respect of para 3(2), KPMG had pleaded no positive case under its allegation of failure to mitigate loss[6] (it is therefore not a proper plea: see Hong Kong Civil Procedure 2021, vol 1, [18/8/23]), and is likewise irrelevant.  It may be added that the Liquidators’ documents were available to KPMG, and the latter is free to bring third party proceedings if it sees fit.

51.  In respect of the class of documents referred to in para 2(2) above, the sheer breadth of it is oppressive and should be rejected. 

52.  As regards the Liquidators’ Reports (see para 2(3) above), apart from the lack of relevance or necessity of “business and affairs” discussed above, I am unable to see why it is relevant or necessary to know, as Mr Yu (who appeared for KPMG) submitted, the view of the Liquidators on those matters.  The court will be required to examine the facts of this case and to adjudicate on the allegations made against KPMG. 

LPP

53.  In light of the above discussions on relevance and necessity, the analysis on LPP can be succinctly stated.

54.  The Plaintiffs claim that the documents covered by para 2(1) above, insofar as they may be relevant and save for a limited number of possible exceptions (which had been disclosed), are covered by litigation privilege because the relevant interviews were conducted for the dominant purpose of investigating, instigating and pursuing court proceedings. 

55.  The Plaintiffs rely on Akai v Ernst & Young (2009) 12 HKCFAR 649, in which the Court of Final Appeal held that interviews conducted by liquidators were covered by litigation privilege.  It was submitted that this case is analogous to Akai.  Akai’s liquidators were suing the company’s former auditors EY.  EY sought disclosure of transcripts and notes of interviews and examinations conducted by the liquidators. 

56.  The test for litigation privilege may be seen from the dicta of Lord Hoffmann (§117) as follows :

“The case in my opinion depends upon the answers to two simple questions. First, did the liquidators conduct the examinations for the sole or dominant purpose of obtaining advice from their solicitors as to bringing or conducting legal proceedings? Secondly, were such proceedings reasonably anticipated at the time? These questions are an application to the facts of this case of the general principles of legal professional privilege stated by the House of Lords in Waugh v British Railways Board [1980] AC 521.”

57.  The focus of KPMG’s criticisms concerned the evidence advanced by Mr Borrelli in support of the privilege claim.  In assessing the evidence, it is important to note that the 1^st Plaintiff was hopelessly insolvent with few assets to be realised aside from legal claims against third parties.  Therefore, a key focus of the Liquidators’ work was to investigate available claims[7].  KPMG’s reliance on the possible sale of the listing status of the 1^st Plaintiff as part of the focus of the Liquidators is misplaced, because the 1^st Plaintiff’s listing was cancelled in February 2017 and the earliest of the interviews over which privilege is claimed took place in August 2017.

58.  Further, all the allegedly privileged interviews took place after the writ was issued against KPMG. 

59.  Viewed in light of these facts, the evidence set out in paras 64 to 70 of Borrelli 5^th is, in my view, sufficient to answer the 2 questions identified by Lord Hoffmann in the affirmative.

60.  In respect of the documents identified in para 2(3) above, the Plaintiffs claim that they are largely relevant, and where they may be relevant, they are subject to LPP because they (a) contain legal advice received by the Liquidators or the 1st Plaintiff, (b) report on work undertaken by the Liquidators and their legal advisers in relation to legal claims, or (c) make observations about the merits of such claims.

61.  KPMG says that reasons (b) and (c) are not sufficient reasons for either of the 2 types of LPP :

(1)  Legal advice privilege does not attach to communications between a client and a third party save where it records legal advice: see §13(1) above;

(2)  Litigation privilege attaches to documents created for the dominant purpose of litigation.  The Plaintiffs have not made any claim as to the purpose of the Liquidators’ Reports.  It is plain that the dominant purpose of such reports was to keep the creditors informed of the progress of the liquidation, rather than to obtain legal advice or use in litigation.

62.  KPMG accepts reason (a), ie, a document is protected by legal advice privilege if it reveals the substance of legal advice.  However, it is contended the Plaintiffs should be ordered to disclose the Liquidators’ Reports, with liberty only to redact portions of the reports that reveal the substance of legal advice.

63.  Despite the fact that the Liquidators were reporting on the legal claims and making observations on their merits, I am inclined to agree with KPMG’s contention on the dominant purpose of the Reports. 

64.  However, as stated in para 52 above, I fail to see the relevance or necessity of these Reports and I would not accede to the Application even with the legal advice redacted.   

65.  For these reasons, I only agree with the Plaintiffs’ claim to privilege in relation to the documents required under para 2(1).

Authenticity Summons

66.  There is merit on the Plaintiffs’ submission that by this application KPMG seeks to impose a reverse O 27, r 4 burden on them.  Under that rule, if “a party on whom a list of documents is served” wishes to dispute the authenticity of a document disclosed in that list, he must do so within 21 days of inspection or dispute the authenticity in his pleadings.  Otherwise, the party receiving the list will be deemed to admit authenticity “unless the Court otherwise orders”.

67.  The burden of identifying from the 1.25 million of disclosed documents those which are not authentic is self-evidently oppressive.  In any case, I fail to see why that can be possible in a case of widespread fraud. Nor why the exercise is required in light of the pleadings in this case. 

68.  The Plaintiffs had identified in their pleadings the false documents they rely upon.  Further, in his 6^th affidavit, Mr Borrelli had set out in Schedule 1 the falsified primary documents in the 5 areas of fraudulent activity with references to how they can be located in the discovery.  In addition, Schedule 2 set out the ancillary documents which are likely to have been falsified as a matter of inference. 

69.  Mr Karas had confirmed that the documents identified in Schedules 1 and 2 are consistent with and taken into account Mr Borrelli’s witness statement.  I believe that the assurance is sufficient to answer KPMG’s concern that the Plaintiffs might shift their case in the course of the trial by making new allegation of false document.

Disposition

70.  For these reasons, both the Discovery Summons and the Authenticity Summons are dismissed with a costs order nisi that the costs be to the Plaintiffs. 

71.  As Mr Karas had agreed in the course of the hearing, the Plaintiffs should file and serve a supplement affidavit confirming that the table of summary contained in para 67 of Borrelli 6^th had set out all the interviews or meetings which the Liquidators had with the Key Individuals. That should be done within 7 days from the date of this Decision.

72.  Last but not least, I am grateful for the assistance provided by Mr Yu and Mr Karas.

HCCL 9/2019

[2020] HKCFI 2615

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 9 OF 2019

___________________

___________________

_________________________________

R E A S O N S   F O R   D E C I S I O N

_________________________________

1.  There were 2 applications to adduce expert evidence at the trial. The parties had respectively taken out their Summons on 11 September 2020. There was urgency in dealing with the applications in light of the fact that the 50-day trial of this action was due to commence on 28 June 2021. Any further delay in putting in train the expert evidence might put the trial at risk. Accordingly, the applications were determined at the end of the hearing. There were my reasons for the determination.

2.  There is another Decision in this action which is to be handed down at the same time as this Reasons for Decision.  A summary of the background of this case can be found in that Decision (“Discovery Decision”). 

3.  There were potentially 5 areas of expert evidence, namely, (1) Audit; (2) Mainland Forestry Law and Practice; (3) Mainland Commercial Law and Practice; (4) Forensic Accounting; and (5) Cayman Islands Law.  There was substantial agreement between the parties on the expert evidence. 

4.  The need for such evidence in the fields of (1) to (3) was agreed.  Such agreement met with the court’s approval. 

5.  The Plaintiffs were in favour of appointing a Single Joint Expert (“SJE”) for all areas.  That was not agreeable by KPMG in respect of (1), (2) and (4). 

6.  The Plaintiffs disagreed with the introduction of expert evidence for (4) and (5), and maintained that SJEs should be appointed if ordered by the court.

7.  Much of the issues for the expert(s) in the 5 fields were agreed.  The issues were helpfully set out in a table attached to KPMG’s skeleton arguments (“Table”) with appropriate mark-ups to illustrate what was not agreed.  At the hearing, further agreement was reached by the parties on the issues.

Applicable principles

8.  The court was referred to the recent authority of Shenzhen Futaihong v BYD [2019] 2 HKC 175, at §§4-5, in which can be found the principles that guided the court in determining if expert evidence should be admitted and the directions for the same. 

9.  Paragraphs 8 and 9 of Shenzhen Futaihong were also important.  The Court of Appeal highlighted the duty of the court to manage this aspect of the case in accordance with the Underlying Objectives contained in O 1A, r 1.  Such dicta resonated with the observation by the court in Galleria v DBS[2018] HKCFI 773, §17, that the court should be more assiduous in controlling the admission of expert evidence.

10.  In Peace Mark v Chau Cham Wong Patrick [2017] HKCFI 1934, §§35-49, the court had set out the reasons for preferring SJE over separate experts (“SEs”).  In particular, the instruction of SJE served to avoid partiality and thus enhanced the quality of assistance to the court and to narrow down the issues (§§44-45). 

11.  In Chang Pui Yin v Bank of Singapore [2017] HKCFI 605, at §11, the court referred to the trend to rely on SJE with the confidence that he/she would be able to give all the necessary assistance required in order to address the concerns of both parties.

12.  O 38, r 4A(5) contained a non-exhaustive list of factors which the court might take into account in deciding whether to appoint SJE.  This court was also referred to the commentaries at Hong Kong Civil Procedure 2020, vol 1, [38/4A/2]. 

Mainland Commercial Law and Practice

13.  There was controversy over the need for evidence regarding reflective loss (C2 of the Table).  At the hearing, Mr Karas, who appeared for the Plaintiffs, quite fairly recognised that the law on the viability of this defence was not settled (see Topping Chance v CCIF CPA[2020] HKCA 478, §§35-42).  It would therefore not be right to exclude expert evidence on this issue. 

Forensic accounting

14.  At the hearing, Mr Karas agreed to the need to have expert evidence on the alleged loss represented by the “KUB Prepayments” and “2010 Guizhou and Yunnan Sham Transactions”. 

15.  However, Mr Karas proposed that, with its expertise, KPMG could agree to the fund tracing compiled by the Plaintiffs or to indicate the areas of dispute with the view to have the matters resolved by agreement or considerably narrowed down without incurring the costs of expert evidence.  To some degree, KPMG was receptive to the proposition subject to a number of conditions.     

16.  The court would certainly encourage the parties to take whatever course mutually agreeable which would be conducive to an expeditious and costs effective resolution of the issues.  On the other hand, bearing in mind that there was no time to waste, it was appropriate to grant the directions needed for the expert evidence in question.  Should the parties be able to come to agreement on the fund tracing, the directions would become redundant. 

17.  However, I disagreed with KPMG that part of Mr Borrelli’s evidence should be expunged.  I am unable to see how such evidence would constitute real unfairness to KPMG or why the expert would be unduly influenced by the same (see also paras 31 and 32 below). 

18.  As regards the need for forensic accounting evidence on the “true financial position” of the Group in 2009, the issue was argued at length in KPMG’s discovery application (see the Discovery Decision).  At best, the “true financial position” was of marginal relevance.  Further, the court agreed with the Plaintiffs that it was practically impossible to find out the “true financial position” due to, inter alia, the missing books[1]. The proposed expert evidence in this area was disallowed.

Cayman Islands Law

19.  The court agreed with the relevance of the 2 issues set out in the Table (E1 and E2).  Mr Karas complained that KPMG had produced no evidence on the availability of a defence akin to s. 903 of the Companies Ordinance, Cap 622 under Cayman Islands law to support its application.  There was merit in the criticism but the court was prepared to overlook the deficiency in light of the need to resolve the applications without delay.  In the event that it turned out to be a pointless exercise, the Plaintiffs might have an argument on costs. 

20.  I was satisfied that on the pleadings the construction of the indemnity provisions of the 1^st Plaintiff’s Articles of Association was in issue and such construction involved Cayman Islands law.  Accordingly, the Cayman Islands law evidence was approved by the court. 

SJE or SEs

21.  The Plaintiffs submitted that the appointment of SJEs would save time, enormous amount of costs and the court resources both before and at trial.  KPMG did not take issue with the saving of costs and time if SJEs were appointed[2].

22.  It was further submitted that the appointment of SJEs would serve to ensure the orderly and proportionate preparation of the trial.  I was inclined to agree given the complexity of this case, not least the number of experts involved.   

23.  Mr Yu, who appeared for KPMG, in his detailed skeleton arguments had taken every conceivable point on this issue.  Much of the arguments were focused on the Audit field.  The main argument was the need for the court to sample a range of different opinions. 

24.  Although the court was not altogether convinced that a SJE would be less capable than SEs to assist the court on the range of opinions (see Peace Mark, §46), it needed to take into consideration the likely degree of controversy, the value of the claim (US$115 million plus interest) and the importance of the issue (audit evidence would have a critical bearing on the issue of liability): see O 38, r 4A(5). 

25.  If KPMG, dissatisfied with the evidence of the SJE, applied to adduce their own evidence on the issue(s) which they did not accept, that might well put the trial in jeopardy.

26.  Further, Mr Yu had proposed directions for the SEs (including limitation on the size of the reports) which would mitigate the additional time and costs required for their evidence (as compared with SJE). 

27.  In these circumstances, and not without considerable reluctance, the court agreed with the appointment of SEs in Audit.

28.  As regards Mainland Forestry Law and Practice, KPMG seemed to suggest that the expert they had instructed was unique or rare in terms of his experience in Forestry Practice.  That was not accepted by the Plaintiffs and had given rise to concern on the Plaintiffs’ part on having a level playing field.  I was not convinced on the evidence that KPMG’s expert was not replaceable with a suitably qualified SJE. 

29.  I took the view that KPMG’s suggestion that the variation of practice of the Mainland forestry authorities required the court to sample a range of opinions was overstated.  I saw no reason why a suitably qualified SJE would not be in a position to advise the court on the variation of practice. It might just be a matter of strictness with which the rules and regulations were enforced in difference areas. 

30.  In respect of the costs already incurred by KPMG on instructing experts.  There was no evidence of the amount of such costs.  KPMG should be well aware that no expert evidence could be adduced without the approval of the court.  Pursuant to the order of M Chan J dated 16 July 2019, the issue of expert evidence would be considered at the 2^nd CMC[3]. If KPMG had decided to instruct their experts without the leave of the court, they had taken a risk with their eyes open (see Galleria, §10).

31.  Turning to Forensic Accounting, KPMG complained that the evidence of Mr Borrelli and Ms Deng were tantamount to expert evidence, and therefore constituted an unfair advantage to the Plaintiffs unless KPMG had their own expert.  I did not believe that the complaint was well-founded.  Neither Mr Borrelli nor Ms Deng was put forward as expert witness.  I was unable to see why the court would attach special weight to their evidence. 

32.  It should not be overlooked that KPMG had enormous expertise in accounting (including forensic accounting).  A SJE would be as much its expert as that of the Plaintiffs.  KPMG would be able to participate in giving instructions to the SJE and to comment on his/her draft report before finalisation, and if they saw any oversight or deficiency in the draft no doubt that would be pointed out. 

33.  Guided by the principles identified above as well as the Underlying Objectives, and taking a holistic view of the best way forward, I was in no doubt that SJEs were appropriate in all fields, with the exception of Audit. 

Expert issues

34.  The remaining disagreements were minor and resolved at the hearing. 

35.  In respect of issue D3 of the Table, it was noted by the court that the parties would endeavour to agree the quantum of the wasted notes issuance costs given that the majority of the constituents of such costs were documented.  Should they fail to do so, the specific disagreement(s) could be dealt with by the SJE.