In the case of Re New China Hong Kong Group Limited (unreported, HCCL 41/2004 and HCCL 2/2005, 29 Aug 2008), the Court of First Instance held that the cause of action against former auditor accrued from the date of the auditor’s report but not the date of discovering the negligent act by the Liquidators.

Background

The 1^st Plaintiff (“NCHKGp”) was a public listed company and the ultimate holding company of the NCHK group of companies. The 2^nd Plaintiff (“NCHKCap”) was a wholly owned subsidiary of NCHKGp and the 3^rd Plaintiff (“NCHKFin”) was a wholly owned subsidiary of NCHKCap. All the Plaintiffs went into liquidation in 1999.  The 1^st Defendant Ernst & Young (“E & Y”) was appointed as the auditor for the Plaintiffs since their incorporation and the financial adviser on the Executive Committee of NCHKGp from February 1993.  The 2^nd Defendant Wu Ting Yuk Anthony (“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, among other things, 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 without sufficient securities.  When the Plaintiffs went into liquidation, the said 7 debtors were among the top largest debtors of NCHKFin.

The Plaintiffs claimed against E & Y and Wu, inter alia, for their failure to properly conduct the audit of the Plaintiffs’ accounts in 1994 and 1995. Despite the knowledge of the matters mentioned above, E & Y had failed to report or warn the management or the Executive Committee of the Plaintiffs. Instead E & Y had given an unqualified opinion that the financial statements represented a true and fair view of the Plaintiffs’ state of affairs. As a result, the Plaintiffs had not taken timely remedial actions to minimize their loss and damages.

The Liquidators of the Plaintiffs commenced legal actions 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 Plaintiffs and a member of the Executive Committee. E & Y and Wu applied to the Court for an order to strike out the action on the grounds that the Plaintiffs’ claims were time-barred.

The Applicable Legal Principles

Limitation Periods

In most cases, the limitation period for commencing legal action is six years from the date of accrual of the cause of action (section 4 of the Limitation Ordinance).

An exception to this rule is where the damages could not have been discovered by the plaintiff at the date of the accrual, the plaintiff may bring an action against the defendant 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 (section 31(1) of the Limitation Ordinance). Where the damages are deliberately concealed from the plaintiff by the defendant, the time limit does not start to run until the fraud is discovered or could, with reasonable diligence, be discovered.

Accrual of Cause of Action

In the present case, the Plaintiffs argued that the negligence claims against E & Y did not accrue until the outstanding indebtedness of the 7 debtors were proved unrecoverable, i.e. the date of liquidation of NCHKFin (25 January 1999).  Further, even if the negligence claims accrued more than 6 years, the Plaintiffs did not have knowledge of the facts relevant to the causes of action. In the alternative, the relevant facts were deliberately concealed from the Plaintiffs by E & Y and Wu. The Plaintiffs did not discover the concealment until after the Liquidators had reviewed the documents disclosed by E & Y under Section 221 proceedings in early 2005.

However, the Court did not accept the Plaintiffs’ argument. The Court held that when a cause of action accrued (i.e. when a breach of duty occurred) must be distinguished from when the resulting damages arose. A cause of action in tort accrues when a person incurs a liability to pay damages to the plaintiff even if the quantification of the damages is not then ascertainable. The time for bringing the plaintiff’s action runs from the moment that the plaintiff suffers damages. The fact that the damages cannot be quantified, or is not known, at that moment is not relevant. Since the Plaintiffs’ claim was based on E & Y and Wu’s breach of duties arising from their failures to exercise care and skill, the breach was committed the moment when such failures occurred. E & Y breached their duties when they signed the accounts and gave their unqualified opinion in respect of the Plaintiffs or alternatively, when the auditors’ reports were laid before the AGM, the latest.

What knowledge is required and whose knowledge constitutes the relevant knowledge?

The knowledge which sets time running under section 31 of the Limitation Ordinance consists both of the plaintiff’s actual knowledge and knowledge which is imputed to him. The plaintiff’s knowledge is in relation to the damage incurred and not the defendant’s liability. 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 “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 knowledge of the essence of the act or omission is gained. It is irrelevant as to whether the plaintiff knew that the defendant’s conduct constituting negligence or that he had a good claim against the defendant.

Whether or not a company is fixed with the knowledge acquired by its employee, officer or agent depends on the requisite status and authority of the individual in question regarding the particular act or omission. An employee who acts for the company within the scope of his employment will usually bind the company. Where the company is the victim, and the employee’s activities have caused the company to suffer loss, the knowledge of the said employee is not to be imputed to the company if he is acting in fraud of his employer.

Upon closely examining the evidence, the Court took the view that it was within the knowledge (whether actual or imputed) of the board of directors and the Executive Committee of the Plaintiffs that the business of NCHKFin was being conducted in an imprudent or improper manner.  It must also be known to them that E & Y had given unqualified audit reports and that no advice had been given to making provisions for the loans to the 7 debtors. The Liquidators’ complaint as to concealment of details of E & Y’s audit work, destruction of the audit working papers; or the obstruction or opposition to the section 221 proceedings, were irrelevant and did not amount to fraud. They were not essential matters or relevant facts for the purpose of postponing the running of time under the Limitation Ordinance.

In addition, the Court also found that the Liquidators in fact had knowledge of the state of NCHKFin’s account and also the under-collateralisation of the loans soon after their appointment in 1999. The Court held that upon the appointment of the Liquidators in early 1999, the Plaintiffs would be fixed with the knowledge, actual or imputed, of all the essential facts.