Introduction

In Securities and Futures Commission v Wong Wai Kwong David & Others [2020] HKCFI 727, the Court of First Instance, upon the petition brought by the Securities and Futures Commission (the “SFC”), made an order to disqualify three former executive directors of EganaGoldpfeil (Holdings) Ltd (“EHL”, a company formerly listed on the Main Board of the Stock Exchange of Hong Kong), namely Wong Wai Kwong David (“Wong”), Lee Ka Yu Peter (“Lee”) and Chik Ho Yin (“Chik”) (together, the “Directors”), but refused to grant compensation orders against the Directors. The Court made the disqualification orders upon its finding that each of the Directors had acted in defalcation, misfeasance or other misconduct (thus falling under section 214(1)(b) of the Securities and Futures Ordinance (Cap. 571) (the “SFO”)), and in a manner unfairly prejudicial to the members of EHL (thus falling under section 214(1)(d) of the SFO). The basis for the Court’s refusal to grant the compensation orders are set out below.

Facts

Background of EHL

As stated in EHL’s Annual Report for 2005/2006, the executive directors of EHL at the material times were (1) Hans-Joerg Seeberger (Chairman and Chief Executive); (2) Wong; (3) Lee; (4) Chik; and (5) Michael Richard Poix. It should be noted that the family of Hans-Joerg Seeberger was, as at August 2006, the controlling shareholder of EHL, holding about 37.22% of all the issued share capital of EHL through The Captive Insurance Trust and a BVI company called Peninsula International Limited (“Peninsula”). In about August 2006, a company known as Compagnie Financiere Richemont SA (“Richemont”) acquired from Peninsula (i.e. the Seeberger family) a stake in EHL for HK$430 million and then sold it back to the Seeberger family for approximately HK$760 million in July 2007 (the “Richemont Transaction”).

The Syndicated Loan

In June 2007, EHL entered into a three-year loan agreement with a syndicate of banks for a HK$1 billion term loan facility exclusively for the purpose of refinancing EHL’s existing indebtedness and financing the general working capital requirements of the EHL group (the “Syndicated Loan”).

Contrary to its stated purpose, however, HK$622 million of the Syndicated Loan was used to fund the second limb of the Richemont Transaction. In particular, EHL arranged for the said sum of HK$622 million of the Syndicated Loan to be transferred from its account to the subsidiaries mentioned below, who then transferred the same sum to Peninsula by way of the following transactions:

1. 1. Two deeds of debt in the amounts of HK$140 million and HK$89.80 million were executed by Uni-Star Corporation (“Uni-Star”) in favour of Egana.com Inc. (a subsidiary of EHL, “Egana.Com”) and Egana Investments (Pacific) Limited (a subsidiary of EHL, “Egana Investments”) respectively such that a total sum of HK$229.80 million was owed by Uni-Star to Egana.Com and Egana Investments;
      
      
   2. A deed of debt in the amount of HK$360 million was executed by Goloda Enterprises Limited (“Goloda”) in favour of Centreline Group Limited (a subsidiary of EHL, “Centreline”),such that the same sum was owed by Goloda to Centreline (all deeds of debt are referred to as the “Deeds of Debt”); and
      
      
   3. a memorandum of agreement entered into by Centreline and Elite Choice Group Limited (“Elite Choice”) concerning Centreline’s proposed acquisition from Elite Choice’s wholly-owned subsidiary, Maedler Koffer GmbH (“Maedler”), of a two-year fixed licence and right of option for renewal of a certain trademark licence and acquisition of shops operated by Maedler in Germany, pursuant to which an escrow sum of HK$170 million was paid by Centreline to Elite Choice (the “Memorandum of Agreement”).

As such, through the Deeds of Debt and the Memorandum of Agreement, the subsidiaries of EHL effectively transferred a total of HK$759.80 million to Uni-Star, Goloda and Elite Choice. Each of them then remitted the respective sum received to Peninsula, who used the funding to buy-back its stake in EHL. In other words, the HK$759.80 million used in the second limb of the Richemont Transaction were not funded by the internal resources of Peninsula or the Seeberger family, but rather by EHL without any commercial rationale or gain for EHL. The fact that there was no repayment pursuant to the Deeds of Debt and the Memorandum of Agreement confirms so. It should also be mentioned that none of Uni-Star, Goloda or Elite Choice had any actual operations or business at the material times.

Doubtful Receivables

To make matters worse, in July 2007, EHL’s trading was suspended because of the public queries raised about its finances. KPMG was appointed by EHL to conduct an independent review of EHL’s financial position, and in September 2007 it was identified that certain receivables totalling HK$2,547.55 million might not be able to be recovered (the “Doubtful Receivables”), involving, among others, the trading business of the EHL group as well as funds paid out by the EHL group pursuant to the Deeds of Debt and the Memorandum of Agreement. As a result of the Doubtful Receivables being irrecoverable, EHL became insolvent.

Features of the Doubtful Receivables

Some extraordinary features of the Doubtful Receivables are:

1. 1. the debtors had good repayment history but suddenly all of them simultaneously had difficulties in repayment;
   2. there were various “ round-robin” transactions, whereby the full amount of the funds were, after several layers of transfers via third parties, remitted back to the EHL group on the same day;
   3. the debtors could not be located at their business addresses;
   4. the debtors and the group companies of the EHL group (except for one) happened to all maintain bank accounts at the same branch of Wing Hang Bank;
   5. there was no record evidencing actual physical delivery of goods concerned in the dubious transactions;
   6. no legal advice was sought and no due diligence was performed on the counterparties to the dubious transactions, notwithstanding the large sums placed with them; and
   7. there were no board minutes or documents detailing the commercial reasons and rationale behind the transactions. 

The cheque payments, board approval and transaction documents with respect to the Doubtful Receivables were signed and approved by the Directors. Further, seven out of the eight debtors of the Doubtful Receivables were controlled by Wong or his nominees. Of note is that the Directors admitted committing various misconduct found on their part.

Principles in relation to the granting of a compensation order

The SFC commenced proceedings against the Directors under section 214(1) of the SFO for, inter alia, conducting the business or affairs of EHL in a manner involving defalcation, fraud, misfeasance or other misconduct towards EHL, its members or part of its members. Under section 214(2)(e) of the SFO, the Court may “make any other order it considers appropriate”, whether for regulating the conduct of the business or affairs of the corporation in future, or for the purchase of the shares of any members, or otherwise. Although it does not expressly provide for the granting of a compensation order, the Court’s power to grant such an order is established in Re Styland Holdings Ltd (No 2) [2012] 2 HKLRD 325.

The overarching principle is that the Court ought not to make a compensation order where the amount of compensation to be paid is not readily ascertainable. The Court further distinguished the cases of (1) misappropriation of group funds, where the loss is readily ascertainable, from  (2) losses arising out of the impeached transactions entered into without proper authorisation, where the loss is not easily ascertainable. It was held that where there is a need to ascertain the damages that a listed company has suffered by reason of its director’s breaches of duty, it would be preferable for this to be done by making use of the power to order the listed company to bring proceedings under section 214(2)(b) of the SFO.

Previous case laws also provide that ascertainableness of the compensation sum is one of the determining factors as to the Court’s exercise of discretion to grant compensation orders. For instance, in Securities and Futures Commission v Tong Shek Lun and Others [2020] HKCFI 435, a compensation order was granted where the amount had been agreed by the SFC and the defendant directors.

Decision on the compensation orders

In the present case, the SFC submitted that there is no difficulty in ascertaining the compensation sum because in the funding exercise of Peninsula’s buy-back from Richemont, the same HK$622 million was funnelled through a series of intra-group transfers until the eventual transfer out of the EHL group. However, the Court took the view that the enquiry involves the issues of foreseeability, mitigation, contributory negligence, remoteness, causation and time bar, which are not necessarily entirely straightforward, and more importantly, have not been sufficiently dealt with by the parties.

Coleman J remarked that, “where the person or persons actually suffering the loss could have brought, or could still bring, an action of the more typical sort in which such forms of compensation are claimed and entitlement proved”, it might not be the best case to make a compensation order. This is because actions under section 214 of the SFO are brought for public benefit, and so where the company or the liquidator(s) already have the standing and incentive to bring a proper action to redress the wrong done by the directors or officers, it is not necessary for the SFC to intervene to achieve justice. The matter instead rests in the hands of the company or the liquidator(s). Thus, Coleman J declined to make the compensation orders, since it should be EHL’s liquidators (who have been engaged by EHL) who should bring proceedings against the Directors to recover damages, if they deem this course of action to be in EHL’s interests.

Takeaway

Whilst the SFC may, for the purpose of applying for compensation order, take out an application under section 214(2)(b) of the SFO to seek a court order that the listed company shall bring in its name to such proceedings as the Court considers appropriate against the defaulting directors, this judgment serves to remind listed companies or liquidator(s) (as the case may be) to consider initiating legal action against its defaulting directors when damage is suffered by the listed company as a result of the directors’ misconduct, even though the amount of such damages cannot be easily ascertained. In particular, the Court considered that in exercising the SFC’s public or regulatory functions by reference to section 214(1) of the SFO, proceedings brought by the SFC may not always be the appropriate proceedings within which to resolve matters relating to “damages” or “compensation”.