Herbert Smith Freehills successfully strike out a HK$3 billion fraudulent trading claim commenced against an IPO sponsor in breach of mandatory procedural rules

Last week, the Hong Kong Court struck out a fraudulent trading claim brought by the liquidators (the "Liquidators") of China Metal Recycling (Holdings) Limited ("China Metal") against one of its sponsors (the "Sponsor") on the ground that it was brought as a High Court Writ action (the "Action"), in breach of the mandatory statutory requirement that it should be brought by a Summons in the relevant winding-up proceedings. The fraudulent trading claim was claimed for several billions of Hong Kong dollars, representing up to the full amount of debts and liabilities of China Metal on its winding up. Herbert Smith Freehills ("HSF") acted for the Sponsor in this successful application.

Background

This Action arose from the collapse of China Metal, a company that was listed on the main board of the Hong Kong Stock Exchange (the "HKEx") in 2009 ("IPO"). China Metal was the first company that was wound up upon a petition presented by the Securities and Futures Commission in the winding-up proceedings HCCW 210/2013 (the "Winding-Up Proceedings"), on public interest grounds - that a large-scale fraud had been perpetrated by, inter alios, China Metal's former chairman and CEO, Mr Chun Chi Wai Jacky on, amongst others, the HKEx and China Metal's investors.

The Sponsor acted as, inter alia, one of the joint sponsors in China Metal's IPO. The Liquidators allege that the Sponsor participated in the fraudulent breach of fiduciary duties of Mr Chun in respect of China Metal's IPO by dishonestly performing its role as sponsor. Three causes of action were advanced against the Sponsor: dishonest assistance, knowing receipt and fraudulent trading under section 275 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) ("CWUMPO") (the "s275 Fraudulent Trading Claim").

Statutory requirements for commencement of the s275 Fraudulent Trading Claim

Rule 58 of the Companies (Winding-Up) Rules (Cap. 32H) (the "Rules") expressly provides that an application under, inter alios, section 275 of the CWUMPO, shall be made by a summons returnable in the first instance in chambers. That Rule was designed to cover actions by or against delinquent directors, officers and promoters. On 10 December 2019, the Hong Kong Court held in China Medical Technologies, Inc v Wu Xiaodong [2020] 1 HKLRD 342 (the "China Medical Decision") that the procedure laid down by Rule 58 is a mandatory one.

It was recorded in the China Medical Decision that Mr Cosimo Borrelli ("Mr Borrelli"), one of the joint and several liquidators of China Metal who was also one of the joint and several liquidators of China Medical Technologies, Inc, was alive to the requirements of Rule 58. The solicitors for the Liquidators in this Action also acted for Mr Borrelli as joint and several liquidators in the China Medical Decision.

Commencement of the s275 Fraudulent Trading Claim in this Action

On 25 July 2019, China Metal and the Liquidators commenced this Action by issuing a Writ of Summons that included the s275 Fraudulent Trading Claim. On 23 June 2020, nearly 6 months after the handing down of the China Medical Decision, the Writ of Summons (as amended and re-filed) with a full Statement of Claim (both containing the s275 Fraudulent Trading Claim) was served.

On 12 May 2021, the Liquidators issued a Summons in the parallel Winding-Up Proceedings against the Sponsor seeking substantially identical relief under the s275 Fraudulent Trading Claim (the "s275 Fraudulent Trading Summons"). It was the Sponsor's position that the s275 Fraudulent Trading Summons was time-barred and the Sponsor applied to strike out the s275 Fraudulent Trading Claim in the Action.

Applicability of the curing provisions

The Court noted that there was no argument that the s275 Fraudulent Trading Claim in this Action was brought in breach of Rule 58. In resisting the strike out application, however, the Liquidators relied on:

1. Order 2, rule 1(3) of the Rules of the High Court (Cap. 4A) (the "RHC"), which provides that the Court shall not wholly set aside any proceedings or the writ or other originating process by which they were begun on the ground that the proceedings ought to have been begun by an originating process other than the one employed;
2. RHC Order 2, rule 2(1), which provides that an application to set aside for irregularity any proceedings shall not be allowed unless it is made within a reasonable time and before the party applying has taken any fresh step after becoming aware of the irregularity; and
3. Rule 209(1) of the Rules, which provides that no proceedings under the CWUMPO or the Rules shall be invalidated by any formal defect or irregularity, unless the Court is of the opinion that substantial injustice has been caused by the defect or irregularity, and the injustice cannot be remedied by any order of the Court.

The Court disagreed that any of these rules were applicable on the ground that:

1. these rules, designed to cure irregularities, were irrelevant for the simple reason that the Liquidators had cured the defect in question by taking out the s275 Fraudulent Trading Summons (whether or not the s275 Fraudulent Trading Summons was time-barred was a separate question);
2. prima facie, the RHC do not apply to winding up proceedings by virtue of
   RHC Order 1, rule 2(2);
3. the Liquidators could not rely on Rule 209(1) to cure the defect in the s275 Fraudulent Trading Claim when they relied upon the inapplicable regime under the RHC to make the s275 Fraudulent Trading Claim. The provisions of the RHC and Rule 209(1) are different and intended to govern different regimes;
4. Rule 58 is mandatory and has the effect as if enacted by the CWUMPO. The Court held that its effect cannot be extinguished with the use of a different set of Rules. This finding is supported by the dicta in the English case of Re Osea Road Camp Site Ltd [2005] 1 WLR 760; and
5. the s275 Fraudulent Trading Claim should have proceeded in the manner prescribed by Rule 58. Had it done so, any irregularities in the application would fall to be considered under Rule 209(1).

Further, the Court referred to Leung Chi Kai v China-tech Engineering Co Ltd and Others (unrep., HCMP 209/2002, 22 April 2002), where the Court struck out an originating summons issued pursuant to s168A of the old Companies Ordinance when the correct procedure was by way of petition. The Court in that case similarly held that Order 2, rule 1(3) of RHC and Rule 209 were inapplicable and/or irrelevant.

In response to the argument that the Court should not strike out proceedings due to the use of wrong originating process or formal defect, the Court referred to paragraph 8 of Leung Chi Kai as "what the court had to say":

"If this argument is taken to the extreme, it will mean that the provisions in the [RHC] and the Companies Ordinance regarding how legal proceedings are to be commenced can be wholly ignored without consequence.  I do not consider this to be correct."

In any event, the Court confirmed that the s275 Fraudulent Trading Claim in this Action was a nullity by reason of the breach of Rule 58.

Abuse of process

Finally, the Court held that, once the s275 Fraudulent Trading Summons had been taken out, there was no reason to maintain the same s275 Fraudulent Trading Claim in the Action. The Court commented that "[d]uplicitous proceedings constitute an abuse of process and the Subject Paragraphs [concerning the s275 Fraudulent Trading Claim] are liable to be struck out".

On the basis of the above, the Court therefore struck out the s275 Fraudulent Trading Claim in the Action.

Commentary

This is the first case where the Court confirmed that a fraudulent trading claim commenced in breach of the mandatory statutory requirements under the Rules is liable to be struck out.

The Court confirmed that the provisions regarding how legal proceedings are to be commenced cannot be wholly ignored without consequence. This case serves as a reminder that procedural rules (especially those concerning commencement of proceedings) should be respected and that the consequence of any breach may potentially be significant. In particular, where the litigant is alive to the relevant procedural requirements, the Court held that it was not easy to see why there should be any complaint about the consequences for not abiding by the relevant rules.

The Court also clarified that the provisions in the RHC and the Rules are intended to govern different regimes. It is not permissible to rely on the provisions in one regime to address issues arising from a different regime.

Herbert Smith Freehills acted for the successful defendant Sponsor.