Herbert Smith Freehills secures further victory in Hong Kong's Court of Appeal for bank in defending liquidator claim for fraud

Last week, the Hong Kong Court of Appeal refused to grant liquidators (the "Liquidators") of Galleria (Hong Kong) Limited ("Galleria"), a Hong Kong company, leave to appeal to the Court of Final Appeal in relation to their action against one of Galleria's former lenders (the "Bank") for knowing receipt, dishonest assistance and fraudulent trading.

The Court of Appeal's decision marks yet another victory for the Bank in defending this piece of insolvency litigation, which commenced in 2016.

Herbert Smith Freehills act for the Bank. We successfully defended the Bank after a 15-day trial in the High Court in 2019 (see blog post here), and in the ensuing appeal to the Court of Appeal in 2021 (link to the Court of Appeal's Judgment).

The Court of Appeal's decision on leave is a reminder of the difficulties in appealing against findings of facts (especially concurrent ones), and illustrates the Court's scrutiny of attempts by intended appellants to dress up challenges to findings of fact as challenges to questions of law.

Background

Galleria was part of a multi-national furniture business. In its heyday in the early 2000s, it obtained import and export facilities from leading commercial banks in Hong Kong and the US, including the Bank.

In 2009, it transpired that Galleria's directors (the "Fus", a husband-and-wife duo) had perpetrated an ongoing fraudulent scheme involving the fabrication of bills of lading submitted to lenders (including the Bank) and of its books and records. Galleria was wound up and the Liquidators were appointed.

As part of the Liquidators' investigations, it came to their knowledge that, in 2006, the Bank had sent a small sample of bills of lading to the International Maritime Bureau ("IMB") for checking and received replies to the effect that they were "false" or "not in order". The Bank's case was that it had no doubt about the authenticity of those bills of lading, but it just wanted to understand Galleria trade flow better (at that time there was some delay in repayment of some trade facilities).

In 2016, the Liquidators commenced (in their own names as in the name of Galleria) an action against the Bank for knowing receipt, dishonest assistance and fraudulent trading.

The Liquidators alleged that the Bank’s officers must have known, from the IMB's replies, about the Fu's fraud, but nevertheless the Bank continued to finance their carrying on of Galleria's business for a fraudulent purpose. Alternatively, the Liquidators said the Bank's officers turned a blind-eye to Fus' fraud. The Liquidators therefore claimed that the Bank should be liable as an accessory to the Fu's fraud.

The Liquidators claimed that the Bank should be liable for all of Galleria's liabilities, this being the statutory remedy that can be awarded against a party to fraudulent trading. Further, the Liquidators claimed that the Bank's receipt of Galleria's loan repayments over the years constituted knowing receipt, and the Bank was not entitled to those repayments.

Judgment at first instance

In the Court of First Instance, the trial judge dismissed the Liquidator's action in its entirety after trial. The trial judge found that the Bank's officers did not have actual knowledge of the Fus' fraud. On the subject of blind-eye knowledge, the trial judge found that:

1. To constitute blind-eye knowledge, the accused party must have had a suspicion that there was something wrong, and refrained from asking questions not because of honest blunder but solely because of a desire to avoid further knowledge of the suspicious matter.
2. By adopting the holistic view of the evidence, the contemporaneous documents showed that the Bank's officers had no knowledge or serious suspicion of fraud.

(Please click here for our previous blog post on the first instance judgment)

Issues in dispute on appeal

The Liquidators appealed to the Court of Appeal, advancing the following major grounds:

1. The trial judge was wrong to find that "a person is dishonest if and only if he is conscious of all the elements of an act which together, by ordinary standards, would render the act dishonest". It sufficed if the known facts would communicate to a reasonable person a general understanding that there was a fraud, breach of trust or breach of fiduciary duty.
2. The trial judge conflated knowledge and dishonesty when applying the two-stage test for dishonesty in Royal Brunei Airlines v Tan [1995] 2 AC 378, which requires the court first to ascertain the defendant’s knowledge, beliefs and suspicions, and then to decide whether the defendant’s conduct was objectively dishonest in light of that state of mind.

Decision on appeal

The Court of Appeal dismissed the Liquidators' appeal with costs and upheld the CFI Decision. The Court of Appeal held that:

1. Although there were authorities suggesting that it was not necessary the defendant should know all the details before it had grounds to suspect fraud (as such, a statement made by the trial judge as stated in ground 1 above may not have been accurate), in the current case, the assessment of the evidence was not affected materially. The trial judge would have arrived at the same conclusion in any event.
2. The trial judge had properly taken a holistic approach to ascertain all the relevant facts for the subjective first stage of the test for dishonesty, including the knowledge and beliefs of the Bank officers. He then applied the objective second stage of the test. Hence, the trial judge applied the two-stage test correctly.

The Court of Appeal also held that the trial judge, by taking a holistic approach, considering the relevant evidence and assessing the accumulation of knowledge chronologically, correctly made the following factual findings:

1. the Bank’s officers did not have any knowledge or serious suspicion of fraud based on the fraudulent B/Ls.
2. the Bank's Senior Credit Officer (SCO)'s decision of not taking further enquiry as regards to the IMB Reports and false B/Ls did not imply that the SCO had blind-eye knowledge or was dishonest.
3. The Bank was a victim of Galleria's fraud and in any case, there was nothing unconscionable for a victim of a fraud to receive back part of its own money. Therefore, the knowing receipt claim must fail.

It is also worth noting that, on the knowing receipt claim, the Court of Appeal affirmed the trial judge's view that a claim in knowing receipt will fail where the defendant’s receipt is pursuant to a valid and binding contract (in this case, the facility agreement between the Bank and Galleria was never set aside and remained valid and binding).

After the appeal being dismissed, the Liquidators applied for leave to appeal the Court of Appeal's judgment to the Court of Final Appeal.

Dismissal of Liquidators' application for leave to appeal at the Court of Final Appeal

The Liquidators raised the following major questions as grounds for application for leave:

1. As regards the attributing knowledge to a defendant company in the context of dishonestly assisting a breach of fiduciary duty:
   1. Was the test in Hong Kong whether the individual whose knowledge was sought to be attributed “the sole or most senior decision maker” or the “relevant decision maker in respect of the relevant transactions?
   2. How should the court approach the inter-related questions of dishonesty, knowledge and attribution when a relevant individual did not play a material role in the events which gave rise to the complaints of dishonesty, but that individual was not the sole or most senior decision-maker?
2. As regards the legal test in assessing dishonesty in a dishonest assistance claim, was it permissible for a trial judge to assess honesty as a jury question, or was the trial judge required to first assess the knowledge of the relevant individual(s) and then determine whether or not the relevant individual(s) had been objectively dishonest?
3. Would it be dishonest for a banker to continue lending to its customer when they knew that the question of whether the customer was guilty of fraud in respect of reported suspicious transactions was unresolved?
4. In a claim for knowing receipt that was founded on a breach of fiduciary duty by the director of a company in transferring the company’s assets to the defendant, did the fact that the defendant had a valid and binding contractual right to receive those assets meant that the knowing receipt claim must fail?

The Court of Appeal declined to grant leave to appeal. Importantly, the Court of Appeal found that the case turned on the factual findings made by the judge and affirmed by the Court of Appeal, specifically, the finding that the Bank officers involved were not in any sense dishonest and none of them suspected fraud or foul play.

The Court of Appeal reminded itself to exercise caution on disturbing the concurrent factual findings. It noted that the Liquidators were attempting to cloak their challenge of the judge’s findings with questions of law.

For the above reasons, given that there was no knowledge that could be attributed to the Bank, the Court of Appeal noted that question 1 (the question on the attribution of knowledge) simply did not arise. Furthermore, given that there was no dishonesty found on the Bank officers, leave to appeal for questions 2 (question about the test of dishonesty) and 3 (question on the bankers' behaviour) were also rejected.

The Court of Appeal noted that question 4 (the knowing receipt question) was an academic question that does not arise on the facts (i.e. given the findings on the Bank officers' state of mind and on the lack of unconscionability). It was therefore not appropriate to grant leave to appeal on that question.

Comments

This long-running litigation is an example of the sometimes unusual factual scenarios in which a liquidator may be able to construct a claim against a third party – very often a bank.

Such claims are typically carefully framed such that they would be difficult to strike out at the interlocutory stage, i.e. it would be difficult for the defendants to get rid of them at an early stage in litigation proceedings.

This is so especially given the nature of these claims would often be fact-specific. For example, the claims in the Galleria case were primarily defeated on the facts.

Defending such claims therefore require meticulous consideration and presentation of the contemporaneous evidence, in a manner that will in turn encourage and assist the Court to take a holistic view of such evidence.