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Proving dishonesty and “blind-eye knowledge” in fraud-related causes of action against bank creditor

2019-08-01

Introduction

In Re Galleria (Hong Kong) Limited [2019] HKCFI 1877, the Court of First Instance discussed the mental elements required to be proven in the claims for knowing receipt, dishonest assistance, and fraudulent trading against a creditor of a company in liquidation. 

Background

Galleria Group, comprising Galleria Inc (USA) and Galleria (HK) Ltd (“GHK”) (in liquidation), had a business history of more than 20 years. The business of GHK was financed by borrowings from multiple banks, including but not limited to one of its largest creditors DBS Bank Ltd (Hong Kong Branch) (“DBSHK”).  From 2004 to 2009, GHK’s directors fabricated and submitted fraudulent bills of lading to lenders and DBSHK.  In around March 2016, DBSHK inquired the authenticity of B/L with International Maritime Bureau of the International Chamber of Commerce and was informed that some of the bills of lading were false while some appeared to be genuine in various IMB Reports (“IMB Reports”).  After receiving the IMB Reports, DBSHK did conduct an internal investigation but eventually decided to increase its lending to GHK. In November 2017, DBSHK also sent two bills of lading to ICC-IMB for checking but no adverse results have been shown.  

Since January 2008 and in the context of the Subprime Crisis, DBSHK considered a reduction in financing to GHK, and did thereafter manage to considerably reduce its lending to GHK from US$34.9 million in March 2006 to approximately US$7.7 million in February 2010 whereas other lenders had substantially increased their lending in the meantime. 

The liquidators of GHK (“Liquidators”) therefore commenced proceedings against DBSHK on the grounds of (a) knowing receipt, (b) dishonest assistance, and (c) fraudulent trading (“3 Causes of Action”).  The main reasons are that DBSHK must have known of, or deliberately turned a blind-eye to GHK’s fraud, but failed to inform other lenders and therefore causing them a loss of about US$185.5 million, the calculation of which is based on the proofs of debt received by the Liquidators. DBSHK contended that it was a victim of GHK’s fraud, instead of being an accessory to it.

The law

Each of the Three Causes of Action requires the proof of mental elements on the part of the wrongdoer. The Court found that this action is a case of dishonesty which requires proof based on cogent or “compelling evidence”. The applicable principles of dishonesty are:-

1.          Although the question of a person’s state of mind, which concerns what the person actually knows, is subjective, the Court shall objectively assess whether the person is honest or dishonest given what he knows.

2.          Carelessness or negligence are not in themselves manifestations of dishonesty.

3.          When assessing the credibility of a witness, the Court normally attaches much weight to undisputed contemporaneous documents, inherent probabilities, motive or the lack of it, logic and common sense.

4.          One cannot aggregate the knowledge of innocent minds in different people to create some “notional super-mind” of the company.

 

The applicable principles of “blind-eye knowledge” are:-

1.          Knowledge of a fact may be imputed to a person if he suspects certain facts may exist but turns a blind eye to it, namely deliberately or consciously (not negligently) abstaining from enquiry so as to avoid certain knowledge of what he already suspects to be the case.

2.          According to Group Seven Ltd v Notable Services LLP [2019] EWCA Civ 614, the suspicion must be firmly grounded and targeted on specific facts.

Ruling

Dishonesty

After taking a holistic view of the evidence, including the email correspondences and the testimony obtained in cross-examination, the Court rejected the Liquidators’ case on knowledge of fraud or dishonesty on the part of DBSHK.  It is of the view that DBSHK has not seen the IMB Reports as fraud risk since it was told by the Trade Services of DBSHK that the findings that some bills of lading are false or not in order are not unusual.  DBSHK was also told that GHK account was operating normally. It achieved 26% sale growth in 2005 and did make some repayments.  DBSHK did not want to raise a false alarm of fraud.  Although DBSHK reduced its lending to GHK after IMB Report, the Court considered it was against the backdrop of the Subprime Crisis that the facilities granted to GHK were restructured.

The Court also indicated that the wide circulation of the IMB Reports is a fundamental weakness in the Liquidators’ case. It is inconceivable that one will think of turning a blind-eye to a fraud which many of his colleagues know and all colleagues were at the same time turning a blind-eye to it.

Because of the aforesaid reasons, the Court further found that DBSHK was a victim of GHK’s fraud since the bills of lading in question were pledged to DBSHK.

Subject of the fraud

Based on the finding that DBSHK was a victim of GHK’s fraud, the Court found it difficult to see (a) how knowledge of a number of fraudulent transactions practised on DBSHK can be equated with knowledge that GHK’s business was being carried on with intent to defraud creditors or for a fraudulent purpose; and (b) how knowledge that one is being defrauded can translated into being a party to such fraud.

In particular, the proposition that DBSHK dishonestly induced or assisted in a breach or fraud on itself defies all common sense.  It was also contrary to common sense that DBSHK as a victim shall pay twice over the money it was cheated by GHK if the Court found DBSHK liable for knowing receipt.

According to Criterion Properties v Stratford UK Properties [2004] 1 WLR 1846 and Akai Holdings Ltd v Kasikorn Bank [2010] 3 HKC 153, a claim in knowing receipt must fail if the defendant’s receipt is pursuant to a valid and binding contract.  The fact that the loan facilities agreements between DBSHK and GHK remain valid and therefore GHK was still contractually bound to repay DBSHK leads to a conclusion that a claim of knowing receipt could not be established.

Quantum of compensation

The Court found that the Liquidators’ calculations on quantum are flawed since it was calculated based on the proof of debts that have been received but have not been adjudicated upon.  

Conclusion

This is the first Hong Kong case following the ruling in Group Seven Ltd v Notable Services LLP that one of the pre-conditions of imputing knowledge of fact to a person turning a blind eye to a fact is that the suspicion of that person must be firmly grounded. This case also illustrates the importance of common sense when assessing whether there is any knowledge of fraud or dishonesty on the part of the wrongdoer and serves as a reminder to the liquidators not to base its calculation of damages on the proof of debts that have not yet been adjudicated in the causes of action of knowing receipt, dishonest assistance, and fraudulent trading.  

 

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: insolvency@onc.hk                                   T: (852) 2810 1212
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www.onc.hk                                             F: (852) 2804 6311

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2019


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