Introduction

In our previous newsletter titled “When is it appropriate for the Court to grant a compensation order against the director?” (June 2020 Issue), we discussed the Court of First Instance’s decision in SFC v Wong Wai Kwong David & Others [2020] HKCFI 727 (the “CFI Decision”), in which Coleman J made disqualification orders against three former directors (“Former Directors”) of EganaGoldpfeil (Holdings) Ltd (“EHL”, a company formerly listed on the Main Board of the Stock Exchange of Hong Kong) but not compensation order under section 214(2)(e) of the Securities and Futures Ordinance (Cap. 571)  (the “SFO”).

As the case concerned a large-scale misapplication of funds of EHL and its subsidiaries (the “EHL Group”), the Securities and Futures Commission (the “SFC”) appealed against the CFI Decision. Recently, the Court of Appeal (“CA”) allowed the appeal ([2021] HKCA 897). This article will discuss the factors considered by the CA in setting aside the CFI Decision of refusing to make any compensation order.

Background and the undisputed facts

The background of this series of cases has been sufficiently and adequately set out in our previous newsletter which will not be repeated. In summary, for the present purpose of this appeal:

1. On 15 June 2007, EHL entered into a three-year loan agreement with a syndicate of banks for a HK$1 billion term loan facility (the “Syndicated Loan”). HK$622 million of the Syndicated Loan (together with HK$137.8 million from EHL Group, making a total of HK$759.8 million) was subsequently transferred from EHL’s account through various subsidiaries in the EHL Group and paid to three “debtors”, namely, Uni-Star Corporation, Goloda Enterprises Ltd and Elite Choice Group Ltd, under three purported “deeds of debt” and a purported “memorandum of agreement”.
   
2. The HK$759.8 million received by the three “debtors” was transferred to Peninsula International Ltd, which then used the money to effect a buy-back of a controlling stake in EHL from ‍another company called Compagnie Financiere Richemont SA.
   
3. The judge commented the series of transactions (the “Transactions”) as a composite scheme or a “big picture” involving EHL Group as conduits of the funds that lacked commercial rationale or genuine commercial reason:
   1. they took place within an extremely short span of time from June to July 2007;
   2. the three “debtors” were not truly independent parties nor genuine trading entities. They were directly or indirectly acting under the instructions of one of the Former Directors;
   3. the “deeds of debt” were highly questionable; they were produced in a standardised format on a one-page paper, and only required the debtors to use “best endeavours” to repay;
   4. in respect of the “memorandum of agreement”, no legal advisor was engaged for EHL Group; and
   5. the proceeds of the Syndicated Loan was suddenly used to effect such shares buy-back, as opposed to the purpose of Syndicated Loan as stated in previous EHL’s announcement made with the Hong Kong Stock Exchange.
      
4. On 29 July 2009, EHL was wound up by the Court and on 9 September 2011, the liquidators were appointed (the “Liquidators”).
   
5. Each of the Former Directors has been found to have acted (i) in breach of their respective duties to EHL for their being involved in the Transaction; as well as (ii) in defalcation, misfeasance or other misconduct (under section 214(1)(b) of the SFO), in failing to make relevant disclosures to members of EHL (under section 214(1)(c) of the SFO), and in a manner unfairly prejudicial to the members of EHL (under section 214(1)(d) of the SFO).

Section 214(2) provides for the orders and remedies that may be granted if the Court is satisfied that one or more of the matters complained of in section 214(1) of the SFO are established. Hence, the SFC therefore sought, inter alia, (a) disqualification orders against the Former Directors pursuant to section 214(2)(d) of the SFO; and (b) a compensation order for the payment of HK$622 million (being part of the Syndicated Loan paid to the three “debtors” under the Transactions) pursuant to section 214(2)(b) of the SFO.

Court of First Instance’s ruling

In the CFI Decision, disqualification orders were granted but the requested compensation order was refused.

In short, Coleman J declined to make a compensation order mainly because he was of the view, amongst others, that:

1. it should remain with the Liquidators to assess the efficacy as to whether it would be beneficial to bring proceedings in the name of EHL against any party. In other words, if the Liquidators could still bring proceedings to prove the compensation and damages claimed and its entitlement, it was not necessary nor appropriate for the Court to exercise its power to grant an compensation order in a proceedings brought by the SFC, which involve inevitably involve resolving “damages” and “compensation”;
2. the amount of compensation / loss in this case was not readily ascertainable; and
3. on the premises that the Liquidators could have brought, or could still bring, actions against the Former Directors, there was the most appropriate avenue to address all the issues relating to time bar, remoteness, causation and mitigation which are not straight-forward issues. These issues had not been properly and sufficiently addressed in this proceedings brought by the SFC.

Court of Appeal’s ruling

This appeal made by the SFC is concerned solely with the judge’s exercise of his discretion in refusing to make a compensation order. The CA allowed the appeal for the following major reasons.

(1)   Impediment in bringing separate proceedings

It was submitted by one of the Former Directors’ legal representatives that “there was no impediment to prevent the Liquidators bringing proceedings in EHL’s name against any alleged wrongdoers, in order to recover damages.” The judge was in error as it had not indicated whether it had accepted such contention of “no impediment”, and most important of all, he had failed to assess whether there was any impediment for the Liquidators to bring separate proceedings against the Former Directors.

As a matter of fact, it is simply unlikely to view it as viable for EHL to bring proceedings afresh: (a) EHL was wound up in July 2009, which was ten years earlier; (b) there are time bar concerns: the matters complained of took place in June and July 2007 and even one of the Former Directors’ legal representatives also admitted that if proceedings were to be brought by EHL, time bar was obviously an issue; and (c) no proceedings had been brought by the Liquidators against any of the Former Directors up to date due to lack of funds. Cash has further tightened as ten years have accrued in liquidation, which made commencing fresh actions against the Former Directors practically unviable.

(2)   Readily ascertainable compensation amount

The amount of compensation sought by the SFC was HK$622 million. This amount was part of the Syndicated Loan paid to EHL and then misapplied through the wrongful activities of the Former Directors to the three “debtors”. Whilst the legal submissions of the Former Directors’ legal representatives was that there was “some doubt” or “possible discrepancy” as to the amount of EHL’s loss, CA rejected all these untenable and rather speculative arguments and maintained that the amount of the loss was readily ascertainable. The CA appears to have taken the simplest, most direct and pragmatic approach, in the sense that the loss was the funds funnelled out from EHL, which was the sum the Company lost (when the sum was received by the three “debtors”) because of the wrongful acts of the Former Directors. It is really unnecessary to make things too complicated.

(3)   Causal connection satisfied

Regarding the argument that causation, foreseeability, mitigation, contributory negligence, limitation could be raised as defences in a civil action to be brought by EHL when it is fairly clear that no separate proceedings would be brought, the CA had no difficulty in categorising such as “a red herring” and see “no reason” for the Court to be concerned with such potential defences (when it was more likely than not that these defence could be raised in reality).

In any event, the required degree of causal connection has been satisfied. In the context of a possible compensation order, it may be necessary to consider the issue of breach of fiduciary duty and causation, and there are broadly three categories:

1. 1. 1. breaches leading directly to damage to or loss of the trust property;  
      2. breaches involving an element of infidelity or disloyalty which engage the conscience of the fiduciary (i.e. there does not involve loss or damage to the trust property); and
      3. breaches involving a lack of appropriate skill or care (i.e. there does not involve any lost to the trust property, nor infidelity or disloyalty).

The CA categorised that the breach of duties of the Former Directors fell under the 2^nd category. And most importantly, that causation is established on a “but for” basis without constraint of the common law causation rules on remoteness and foreseeability. After all, it was incumbent on the Former Directors to show that the loss or damages would have occurred in any event, i.e. without any breach on their part. With the facts of this case, they clearly failed to establish such and hence the required degree of causal connection has been established.

Conclusion

At the outset, the CA had made clear that this case is an appeal against the exercise of the judge’s discretion. The function of the appeal court is one of review: “It will not disturb the judge’s exercise of discretion unless he had misdirected himself with regard to the principles or the evidence or had misunderstood the law or evidence in accordance with which his discretion had to be exercised, or had wrongly taken into account irrelevant matters or failed to take into account relevant matters, or that his exercise or discretion was plainly wrong. It is only if and after the appeal court has reached the conclusion that the judge’s exercise of discretion must be set aside for one or more of these reasons that it would exercise an original discretion of its own.” This is clearly a high threshold to meet.

Nonetheless, the CA in this case demonstrates no hesitation in overruling the CFI’s Decision and to order delinquent directors to repay the victim company, this is especially the case if (a) the company is in liquidation and any such payment would benefit the creditors of the liquidated company; and (b) the company itself has not and is unable to pursue any proceedings to recover any damages or compensation. This CA judgment simply clears off any of our doubts and demonstrates once again the Court is prepared to do justice when the circumstances call for it.