Hong Kong court considers grounds for striking out claims of dishonest assistance, knowing receipt and fraudulent trading

The Court of First Instance recently rejected an attempt by Bank of China (Hong Kong) Limited (BOCHK) to strike out various claims brought against it by the liquidators of China Medical Technologies (China Medical). The liquidators' claims related to BOCHK's handling of funds deposited with it by China Medical's former officers, which were allegedly obtained by fraud.

Background

Between 2007 and 2008, four officers of China Medical caused the company to enter into several transactions to acquire medical technologies of little or no value from another company named Supreme Well Investments Limited (Supreme Well) and its subsidiaries. It subsequently transpired the Supreme Well group of companies were secretly controlled by the CFO of China Medical, but this connection was not disclosed at the time. China Medical went into liquidation in 2012.

Since both China Medical and Supreme Well used their respective BOCHK accounts for these transactions, and both were served by the same bank managers who oversaw the passage of funds, the liquidators alleged that BOCHK was aware of the fraud at the time, and brought claims of knowing receipt, fraudulent trading, dishonest assistance and unjust enrichment against the bank.

BOCHK in turn applied to strike out the liquidators' claims and have the action dismissed.

Decision

The Court applied the well-established principles on striking-out and paid particular regard to matters that were specific to the liquidators' different causes of action in reaching its decision.

Knowing receipt

BOCHK submitted the liquidators did not have any claim against the bank for knowing receipt because it was merely acting as the agent of Supreme Well: no funds were received by the bank for its own use and benefit.

However, the liquidators argued that, because the cashier orders used in the transactions were deposited by the former CFO of China Medical acting on behalf of Supreme Well into the latter's BOCHK account, this gave rise to a debtor-creditor relationship between BOCHK and Supreme Well, with BOCHK becoming the legal and beneficial owner of those funds.

The Court held that the issues raised by both sides involved difficult and unsettled questions of law concerning BOCHK's receipt of assets. This made it inappropriate to strike out the liquidators' claim for knowing receipt against BOCHK.

Fraudulent trading

BOCHK sought to strike out the liquidators' claim of fraudulent trading brought under section 275 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (Section 275). This provision attaches liability to persons who are knowingly parties to the carrying on of the business with intent to defraud creditors of a wound-up company.

According to BOCHK, the transactions entered into between China Medical and the Supreme Well companies were used as a means of misappropriating funds, and did not amount to the "carrying on of business" by China Medical. As such, the liquidators failed to meet the pre-requisite for a fraudulent trading claim under Section 275.

The Court held that the fraudulent nature of the transactions did not alter the fact that they were entered into as part of China Medical's business. It also agreed with the liquidators' submission that BOCHK's "absurd" interpretation of Section 275 would exclude businesses which are predominantly fraudulent from being the subject matter of a fraudulent trading claim.

Application of the Limitation Ordinance (Cap. 347)

The Court stressed that an order striking out a statement of claim based on a limitation defence may only be sustained if that defence is "manifestly and immediately destructive of the plaintiff's claim".

On this point, BOCHK argued the liquidators' claims for knowing receipt, unjust enrichment and dishonest assistance should all be struck out given over eight years had elapsed between the accrual of the pleaded causes of action in late 2009 and date on which the liquidators issued the writ on 27 July 2018, beyond the prima facie six-year limitation period applicable.

Even though this timeline was not disputed, the liquidators claimed (among other things) that they were entitled to rely on section 26(1) of the Limitation Ordinance (Section 26(1)), which would allow them to continue with the action.

In this case, the limitation period for the fraudulent trading claim was not at issue.

Section 26(1)

Section 26(1) is in these terms:

"Subject to subsection (4), where in the case of any action for which a period of limitation is prescribed by this Ordinance, either—

(a) the action is based upon the fraud of the defendant;

(b) any fact relevant to the plaintiff’s right of action has been deliberately concealed from him by the defendant; or

(c) the action is for relief from the consequences of a mistake, the period of limitation shall not begin to run until the plaintiff has discovered the fraud, concealment or mistake (as the case may be) or could with reasonable diligence have discovered it."

The Court accepted that it was at least arguable that Section 26(1) applied to extend the limitation period for the two knowledge-based claims, i.e. the knowing receipt and dishonest assistance claims.

This is because time only started to run when the liquidators became aware of or were able to discover BOCHK's alleged involvement in the fraud, not when the fraudulent scheme perpetuated by China Medical's former officers first came to light. Such realisation, as the liquidators argued, could not have occurred before February 2014, and therefore the claims for knowing receipt and dishonest assistance were brought within time.

As regards the knowing receipt claim, the Court considered a recent Hong Kong authority for the proposition that there was a serious question to be tried on whether the meaning of "fraud" in Section 26 included situations where a defendant had acted with "some knowledge of the impropriety of the conduct involved” or unconscionably. Given 'knowledge' is one of the essential elements to prove knowing receipt and the liquidators have pleaded extensively on BOCHK's knowledge of the misappropriation of funds by China Medical's former officers, the Court took the view that it is at least arguable that Section 26 would indeed extend the limitation period for the liquidators' knowing receipt claim.

It was additionally held that whether or not the fraud could be discovered with reasonable diligence is a highly fact-sensitive question, requiring extensive examination of the facts and documents of each case.

The claim for unjust enrichment

While the Court refused to strike out the liquidators' claims for fraudulent trading, knowing receipt and dishonest assistance, the Court accepted that Section 26(1) could not apply to extend the limitation period for the unjust enrichment claim, since fraud is not an essential element to establish this claims.

On the other hand, not only was fraud not an essential element of the liquidators' unjust enrichment claim, the liquidators did not plead unconscionable conduct on BOCHK's part or that it knew of the impropriety of the former officers' misconduct. The Court agreed with BOCHK that the unjust enrichment claim was time-barred and should be struck out.

Comments

Knowing receipt, fraudulent trading, dishonest assistance and unjust enrichment are typical claims that liquidators can bring against a company's (former) officers and other third parties. This decision offers practical guidance on the thresholds and requirements for the Court to find that these are reasonable causes of action. In particular, litigants, whether they are bringing or defending such claims, should take note of the following points:

• It is not open for banks to claim on every occasion that they merely handled funds that were wrongfully deposited as agents of the depositor; each case should be determined according to its facts;
• Section 275 explicitly captures transactions of a fraudulent nature that were entered into by a company;
• It is important to determine correctly the applicable limitation period when strategizing claims arising from a company's liquidation. While companies cannot claim they are under a "disability" that prohibits them from defending its own interests under the current legislation, the Court will not ignore how early or late companies can realistically find out about frauds perpetrated.

The limitation period of the fraudulent trading claim was not at issue in this particular case, but the discussions on Section 26(1) would likely apply, given that "fraud" is an essential element in a fraudulent trading claim.