In the case of Re New China Hong Kong Group Limited (unreported, HCCL 41/2004, 29 Aug 2009), the Court of First Instance confirmed that the time limit for bringing an action in negligence runs 3 years from the date of knowledge of the independent directors (instead of that of the liquidators), if that period expires later than 6 years from the date on which the cause of action accrues.

Background

The 1^st Plaintiff (“NCHKGp”), 2^nd Plaintiff (“NCHKCap”) and the 3^rd Plaintiff (“NCHKFin”) were amongst a group of some 36 companies in the New China Group which went into liquidation in 1999.  The 1^st Defendant (“E & Y”) was a well-known accounting firm, and was appointed as the auditors for the Plaintiffs for the whole period from their incorporation to their respective liquidation.  In addition, E & Y also occupied the position as the financial adviser on the Executive Committee of NCHKGp from February 1993.  The 2^nd Defendant (“Wu”) was an audit partner of E & Y.  He was a director of NCHKGp from November 1992 to February 2003, and thereafter represented E & Y as the financial adviser on the Executive Committee.

The Plaintiffs alleged that NCHKFin had conducted business in a manner which was imprudent, reckless and/or improper.  In particular, NCHKFin had made substantial advances to 7 debtors who did not own substantial assets.  No attempt was made on the part of NCHKFin to procure sufficient security to secure the advances.  In most cases, the only security held by NCHKFin was the securities purchased with the advances. 

The essence of the Plaintiffs claims against E & Y and Wu was that for the years in 1994 and 1995,  both E & Y, acting in their dual capacity as the financial adviser on the Executive Committee and the auditors for the Plaintiffs,  and Wu failed to :-

1)        report the problems to the companies’ management or the Executive Committee;

2)        warn the companies’ management or the Executive Committee of the problems; and

3)    warn, report or make disclosure of the imprudent, reckless or improper manner in the Annual General Meetings.

As a result of the negligence of E & Y and Wu, the Plaintiffs suffered loss which consists of (i) the loss of the opportunity to realize the securities of the respective debtors; and (ii) the loss representing the value of the additional advances to the debtors, which could and would have avoided.

Actions were bought against E & Y and Wu on 30 July 2004 and 24 January 2005 respectively to claim, among other things, damages for breach of common law duties as well as breaches of their fiduciary duties as auditors, financial adviser, and director of the Plaintiff.  Subsequently, E & Y and Wu applied to the Court for an order that the actions be struck out on the grounds that the claims pleaded were time-barred.

The Applicable Legal Principles

A)   Periods of Limitation

For most actions, the limitation period is six years from the accrual of the cause of action as prescribed by section 4 of the Limitation Ordinance (Cap. 347). Any action begun after the expiration of limitation period is time-barred. 

One of the exceptions to this rule is where damages is claimed in the tort of negligence and such damages could not have been discovered by the Plaintiff at the date of the accrual.  In such cases, the Plaintiff may bring an action against the Defendant either within (1) six years from the date on which the cause of action accrued; or (2) three years from the earliest date on which the Plaintiff had both (a) the knowledge required for bringing an action for damages in respect of the relevant damages; and (b) a right to bring such an action, whichever is later.

Another exception is where any fact which the Plaintiff has to prove in order to establish a prima facie case is deliberately concealed from him by the Defendant.  If so, the time limit does not start to run until the fraud has been discovered or could with reasonable diligence be discovered.  Important to note is that if the Plaintiff is already aware of the facts relevant to his right of action, there cannot be a “concealment”.

B)   Accrual of Cause of Action

A cause of action in negligence accrues when the damage which results from the tortuous conduct is real, as distinct from minimal or negligible, and actual.  The concept of “damage” encompasses any detriment, liability or loss capable of assessment in monetary terms.  Therefore, the ordinary six years limitation period runs from the moment that the Plaintiff suffers real and actual damage. 

C) Knowledge

The law does not require the Plaintiff to have detailed knowledge of all the acts and omissions of the Defendant as constituting negligence.  What matters is the Plaintiff’s knowledge of what constitutes “the essence of the complaint of negligence”.  As soon as the Plaintiff knows enough to make it reasonable for him to begin to investigate whether or not he has a case against the Defendant, the “essence” of the act or omission is gained.  Knowledge that any acts or omission did or did not, as a matter of law, involve negligence is irrelevant.

On point to note is that a person’s knowledge includes knowledge which he might reasonably have been expected to acquire from facts ascertainable by him, with assistance of expert advice where reasonable to do so.  Generally, a company is also fixed with the knowledge acquired by an employee, officer or agent who acts for the company within the scope of his employment.   However, different consideration applies when the employee or officer concerned is acting in fraud of his employer and the knowledge he possess is relevant to the fraud.  In such cases, the company will not be fixed with the knowledge acquired by the employee or officer concerned (i.e. the Fraud Exception).  (N.B. The Fraud Exception shall not be construed any wider to include wrongdoings falling short of fraud against the company.

Findings

Recoverability of the Debts

The Plaintiff argued that the loss representing the value of the additional advances to the debtors was merely contingent and depended upon the recoverability of the indebtedness.  The indebtedness only became unrecoverable when NCHKFin went into liquidation on 25 January 1999.  Hence, the cause of action in negligence did not accrue before that date.

On the basis of the facts that the debtors’ repayment covenants were worthless, the Court found that the loss was suffered at one when the advances were entered into and the Plaintiff had suffered real detriment in having missed the opportunity to realize the debtors’ securities by 31 March 1995 in respect of the 1994 account and by 31 March 1996 in respect of the 1995 account.  In this respect, the contention that the nature of the loss was merely contingent and not actual is bound to fail.

On examination of the evidence available in the present case, the Court was of the view that the independent directors of the Plaintiffs had knowledge of the “the essence of the complaint of negligence”.  Moreover, this is not a case where the Fraud Exception will apply as neither of the independent directors have been accused of having conducted themselves fraudulently, dishonestly or have otherwise committed breaches of duties against the respective companies.  Therefore, upon the appointment of the liquidators in early 1999, they would be fixed with the knowledge, actual or imputed, acquired by the Plaintiffs.

For the reasons stated, it is not open for the Plaintiffs to argue that the relevant facts were unknown to them so as to postpone the running of time until a moment within 3 years of the commencement of the respective actions.

Moreover, as the Plaintiffs had knowledge of the “essence of the complaint of negligence”, the Plaintiff also failed to set up an arguable case that there has been concealment of facts relevant to their right of action.

Breach of Fiduciary Duty

The Plaintiffs argued that E & Y and Wu failed to exercise reasonable care and skill when performing their audit work and in relation to the view expressed in the audit reports.  It is the Plaintiffs’ case that every further advance amounted to a fresh breach of duty.

However, the Court was of the view that such breach of fiduciary duty had occurred at the time when E & Y signed the accounts and gave their unqualified opinion in respect of each of the Plaintiffs, that is, 6 May 1995 in the case of NCHKGp, 28 April 1995 in the case of NCHKCap, and 18 April 1995 in the case of NCHKFin.  In any event, such breach would have occurred by the latest when the reports were laid before the AGM of NCHKGp on 27 October 1995 (i.e. the cause of action had accrued more than 6 years before the commencement of the actions against E & Y and Wu).

Therefore, the Plaintiffs claims for breach of common law duties and breaches of their fiduciary duties were time-barred.