Chen v He

[2013] NZHC 2033

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

CIV-2012-404-5671 [2013] NZHC 2033

IN THE MATTER             of SS 165 and 167 of the Companies Act

1993

BETWEEN  ZHIXIONG CHEN Plaintiff Respondent

AND  YAO WEI HE

Applicant Defendant director

NZ PRODUCTS INTERNATION LIMITED

First Respondent company

YOUNGZHOU CHEN Second Respondent director

Hearing:                   25 July 2013

Appearances:           Mr N Campbell QC for Plaintiff Respondent

Mr T Banbrook for Applicant Defendant
Mr Cogswell for Y Chen - second respondent

Judgment:                12 July 2013

JUDGMENT OF ASSOCIATE JUDGE J P DOOGE

This judgment was delivered by me on

12.08.13  at 5 pm, pursuant to

Rule 11.5  of the High Court Rules.

Registrar/Deputy Registrar

Date……………

Counsel:

Mr N Campbell QC, Auckland
Mr T Banbrook, Auckland

Mr P Cogswell, Auckland

CHEN v HE [2013] NZHC 2033 [12 July 2013]

Background

[1]      By way of introduction to the background, it is necessary to note that while affidavits have been filed on both sides concerning the application which Mr He (“the  defendant”)  has  brought  for  leave  to  commence  a  derivative  action,  the evidence is only part of a wider dispute between the parties.  The proceedings were commenced by Mr Chen (“the plaintiff”) to recover an amount of $300,000 which he said the defendant owed to him and in regard to which the defendant had signed an acknowledgement of debt.

[2]      The  evidence  before  the  Court  on  the  present  application  includes  the summary judgment application evidence which the plaintiff put before the Court in support of his application for summary judgment in regard to the $300,000 debt. The defendant has filed an extensive affidavit which deals with the $300,000 but ties that issue into the wider issues that are raised by his application for leave to bring a derivative action pursuant to s 165 of the Companies Act 1993.   A response was made in due course to the application in the form of affidavits which the plaintiff and his  son,  Mr  Chen  junior,  filed  which  were  affirmed/sworn  in  June  of  2013. However, those affidavits do not respond to the considerable detail which the defendant has included in his affidavit.   The plaintiff was content for the present application to be determined without a detailed reply to the various allegations which the defendant has made in his affidavits.

[3]      There is no dispute that over a period from June to August 2010, the plaintiff advanced by instalments a sum of $300,000 to the defendant.  It is also accepted that on 16 August 2010 the defendant signed an acknowledgement of debt.  Beyond that point, nearly everything is in dispute.  The plaintiff says that the loan was meant to be repaid by 16 February 2011 but it has not been.  It is also common ground that a business was established called NZ Products International Limited (NZPIL) in June of 2010 as a result of discussions between the plaintiff and the defendant.   This company was set up to export milk formula to China.  Broadly speaking the plaintiff and the defendant’s families owned 50 percent each of the company.  The plaintiff was not a shareholder or a director, but his son was.

[4]      The following matters of background also seem not to be disputed.  NZPIL was set up for the purpose of exporting dairy products with the end purchasers being based in Hong Kong or China.  The defendant had operated his own business in that field.  The nature of that business was that the defendant, with the assistance of other persons who are paid a commission, would buy the products from retail stores and then freight them overseas.   The prices that could be obtained in Hong Kong or China were sufficient to make a profit even paying retail for the products in New Zealand.

[5]      The defendant’s position is that the $300,000 was not advanced to him as a simple loan which he had to repay The defendant says the money was provided to them on trust with the terms of that trust requiring him to introduce the funds into NZPIL,  essentially as  working  capital.    .    He  said  that  there  were other terms attaching to the advance.    The broad outlines of that arrangement, he says, were that he would only be required to repay the money if the plaintiff found that his participation in the business, which was going to be carried on by virtue of the corporate  vehicle  of  NZPIL,  was  not  to  the  satisfaction  of  the  plaintiff.    The defendant has deposed that the business in fact was profitable.

[6]      There does not seem to be any suggestion that the plaintiff had been involved in the milk powder export business previously, whereas the defendant had been.  The defendant says he had an existing businesses and that he, in effect, transferred that business into NZPIL and received nothing for it.  He said he was prepared to do that because of the corresponding advantages he would get from having the plaintiff, who seems to be a person of substance, introducing capital into NZPIL.  The defendant said that such stock as he had in his own personal business was transferred across to NZPIL for it to use in the course of its business.  NZPIL then began actively buying and  had,  according  to  the  defendant,  by  September  2010  spent  approximately

$413,000 which had been partly funded by funds introduced by the plaintiff and partly  by  way  of  sales.    The  defendant  claims  that  the  $300,000  which  was introduced to the company from the plaintiff via him, the defendant, was recorded in the accounts of NZPIL as a shareholder advance by him and his son.

[7]      The defendant says that some time after September 2010 it was decided that the business be altered by extending it into products other than New Zealand diary and that a Hong Kong company should be established as the vehicle for sales into China.  In fact a company called HKDIL was set up with the defendant receiving 30 percent of the shares.  Once HKDIL was operative, the defendant says that NZPIL no longer sold direct to end users in Hong Kong and China but supplied its product to HKDIL which then undertook that role.

[8]      Eventually in  February 2012 when the defendant was in Hong Kong he visited a HKDIL warehouse which he observed to contain New Zealand dairy products that he saw were not those which had been sourced from NZPIL.   He claims that he was told that the stock belonged to the plaintiff.  The defendant said:

I realised then that Mr Chen had unbeknown to me been doing the same business as NZPIL and HKDIL, storing the New Zealand dairy products that he exported to HK from NZ at two of HKDIL’s three warehouses.

[9]      At around about the same time the defendant also says he claims to have discovered that while he was in Hong Kong the plaintiff and his family had siphoned off most of the funds from NZPIL.   The defendant says he arranged to transfer

$80,000 out of NZPIL to his own personal account.  He decided to lock up all of the HKDIL warehouses.   At this point the relationship between the plaintiff and the defendant appears to have broken down.  The Chens wished to have HKDIL wound up and have the profits distributed. The defendant says that he released HKDIL’s property to it a few weeks after he had locked the warehouses.

[10]     The defendant says that at some point the plaintiff had incorporated a new Hong Kong company “New Zealand Milk Powder Limited”.  It does not mention what the significance of that was but I infer that it is the contention of the defendant that that company is carrying on in Hong Kong the same business that HKDIL had carried on previously.

Leave to bring derivative proceeding

[11]     The key assertions that the defendant makes are that he considers that the Chens had planned as early as February 2011 to cut him out of the business, they by that time having:

Learned the ropes of the business from me and after having through HKDIL obtained all my trade secrets particularly my suppliers contacts for the products here in New Zealand and my Hong Kong and China customers contacts.

[12]     He  also  deposes  that  in  February  2011  the  plaintiff  incorporated  a  new company in New Zealand, DNZIL.  He concludes this part of the evidence by saying that:

112.     I  am  now  aware  that  the  Chen’s  had  through  DNZIL  been undertaking   this same business as NZPIL exporting the same products to HK  to Mr  Chen’s  controlled  HK  company,  New  Zealand  Milk  Powder Limited unbeknown to me and using HKDIL’s warehouses, in breach of their contractual arrangements with me and in breach of their of their duties to NZPIL.

[13]     He says that the plaintiffs’ setting up of HKDIL in February 2011 was a ploy by the plaintiff to gain access to information about the defendant’s Hong Kong and China business contacts.   He says that there is evidence that the Chens’ company DNZIL has  exported the same products from  New Zealand to Hong Kong and distributed the products through HKDIL’s distribution channels.  He also says there is evidence that another son of the plaintiff has been buying up the same products in New Zealand.

Section 165 Companies Act

[14]   The key parts of the section which governs the bringing of derivative proceedings is subsection (2):

(2)       Without  limiting  subsection  (1)  of  this  section,  in  determining whether to grant leave under that subsection, the Court shall have regard to—

(a)       The likelihood of the proceedings succeeding:

(b)The costs of the proceedings in relation to the relief likely to be obtained:

(c)       Any action already taken by the company or related company

to obtain relief:

(d)The interests of the company or related company in the proceedings being commenced, continued, defended, or discontinued, as the case may be.

(3)Leave to bring proceedings or intervene in proceedings may be granted under subsection (1) of this section, only if the Court is satisfied that either—

(a)       The company or related company does not intend to bring, diligently continue or defend, or discontinue the proceedings, as the case may be; or

(b)It is in the interests of the company or related company that the conduct of the proceedings should not be left to the directors or to the determination of the shareholders as a whole.

Authorities concerning when leave will be granted

[15]     The test to when considering whether to grant leave to bring a derivative action is that of a prudent business person in the conduct of his or her own affairs when deciding whether to bring the claim.

[16]      In the Needham v Ebt Worldwide Ltd case, this test was referred to:[1]

[1] Needham v EBT Worldwide Ltd (2006) 3 NZCCLR 57 (HC) (emphasis added).

[22]      An authority often referred to concerning such applications is the case of Vrij v Boyle [1995] 3 NZLR 763. In that case, Fisher J considered s

165’s predecessor under the Companies Act 1955. With reference to the likelihood  of  the  proceedings  succeeding  the  Judge  adopted  the  test suggested in Smith v Croft [1986] 1 WLR 580 and said:

It is not for me to conduct an interim trial on the merits. The appropriate test is that which would be exercised by a prudent business person in the conduct of his or her own affairs when deciding whether to bring a claim. Such a decision requires one to consider such matters as the amount at stake, the apparent strength of the claim, likely costs and the prospect of executing any judgment.

[23]     On one view the test adopted by Fisher J encompasses not only consideration of the likelihood of the proceedings succeeding but also other relevant considerations such as the costs in relation to the relief likely to be obtained and the overall interests of the company. As such the test is also applicable to other aspects of s 165(2) and to the exercise of the overall discretion.

[17]     In  the  Vrij  case,  a  shareholder  in  the  claimant  company  set  up  another business  operating  in  the  same  field  as  the  company.[2]      The  substance  of  the plaintiff’s complaint was that the other shareholder was effectively diverting away from the original business custom and other benefits which ought to have remained with the claimant.   The applicant sought leave to bring a derivative action in the name of the company against the allegedly offending shareholder.   Fisher J after

referring to the allegations said:

There is affidavit evidence, which, if accepted, might be thought to take (the company’s) claim some distance.  I certainly make no attempt of course to comment on the ultimate merits.  There is, however, sufficient to warrant the grant of leave ...

[2] Vrij v Boyle [1995] 3 NZLR 763 (HC).

[18]     The Judge gave leave to the plaintiff to institute a derivative claim by the fourth defendant against the shareholder in the following terms:

This to be founded upon breach of fiduciary duty and, if that plaintiff so elects, breach of a  contract of employment  or some  other akin contract governing the relationship between [the shareholder] and the company.

[19]     The claim in the present case alleges that the director owed fiduciary duties to the company.  It is asserted that Mr Chen as a de facto director had taken advantage of his position to start a competing business.

Fiduciary obligation

[20]     A similar breach of duty to that claimed in this case was the basis for an application under the Companies Act 1955 in Holden v Architectural Finishes Ltd.[3]

McGechan J in that case noted the following essential elements of the cause of action:

It is as well to keep principle in mind. The fiduciary obligation is designed to protect the company against exploitation. There will be no protection if a director can acquire truly confidential information, or learn of unique opportunity, resign, and exploit. On the other hand, prohibitions must not be taken too far. More general knowledge and skills acquired in the course of office, even if quite specialised, and use of information or opportunities learned but in any event globally available, are not to be suppressed.  To do so would injure commerce, and with that the public interest. The dividing line at times is an exercise in judgment.

[3] Holden v Architectural Finishes Ltd (1996) 7 NZCLC 260,976 (HC).

[21]     Further light is thrown on the nature of the cause of action relied on in the present case by the remarks of Barker J in CBA Finance Ltd v Hawkins.[4]

[4] CBA Finance Ltd v Hawkins (1984) 1 BCR 599 (HC).

[22]     Barker J discussed the case of Canadian Aero Service Ltd v O’Malley,[5] where the Supreme Court of Canada said at [46]:

What is before this Court is not a situation where various opportunities were offered to a company which was open to all of them, but rather a case where it had devoted itself to originating and bringing to fruition a particular business deal which was ultimately captured by former senior officers who had been in charge of the matter for the company.  Since Canaero had been invited to make a proposal on the Guyana project, there is no basis for contending that it could not, in any event, have obtained the contract or that there was any unwillingness to deal with it.

[5] Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3rd) 371.

[23]     Barker J considered – in my view, correctly so, that Canadian Aero Service did not support the expansion of the fiducial duty to encompass “global opportunities”.

Other matters relevant to exercise of the discretion under s 165

[24]     One of the factors which has relevance to the grant or refusal of leave, and the subsidiary consideration of whether the litigation would be in the interests of the company, is the likelihood of success of any proceedings that might be taken, pursuant to leave being granted under s 165.   Those considerations in turn are affected by the overall approach that the intended claimant and its legal advisers appear to be taking to the proposed proceedings.  In connection with that, I note the submission that Mr Campbell made concerning the adequacy of the draft pleadings that have been filed.  He characterised these as lacking in precision and being prolix.

[25]     I agree that there is substance to this assessment.   It is helpful to recall to mind the remarks which Eichelbaum J made concerning pleadings:[6]

The object of obtaining crisp admissions or denials and thus defining the points at issue is entirely defeated by a lengthy diffuse narrative which is likely to elicit only a generalised response.

[6] Thomson v Westpac Banking Corp (No 2) (1986) 2 PRNZ 505 (HC).

[26]     Those remarks are applicable in the context of the present case.

[27]     A separate element which is often referred to in cases where leave is sought under s 165 is the question of whether there is a prospect that a liquidator will be appointed to the company.  If that is to happen, then rather than leaving the potential proceedings in the hands of one of the warring shareholders, it may be preferable for any determination concerning the potential claim to be made by the liquidator.  Such a course would have the advantage of the decision being made by someone who is able to bring objectivity to bear and who, thus, is more likely to pursue the interests of the company without distraction.

[28]     In  the present  case,  the  company is  not  trading.    Apart  from  the  s  165 application, it is also proposed that the company should bring a claim against the Chen interests in the sum of $1.7 million representing alleged overpayments which have been made to them.   There is no reason why that claim, too, could not be considered by a liquidator and if it was thought to have merit, to be pursued by the liquidator rather than one of the shareholders.

[29]     In  either  case,  it  would  seem  inevitable  that  if  the  company  is  to  be committed to litigation, then the person who will have to fund the litigation in the first place will be Mr He.  That is because the company has been left without any significant financial resources which would enable it to carry on litigation in regard to either of the two claims which have been raised by Mr He.

[30]     It is correct that a derivative action is not ruled out for the reason only that the aggrieved party has  available to him/her the option of bringing winding up proceedings against the company.  In Techflow New Zealand Ltd v Techflow Pty Ltd, Elias J (as she then was) considered the relationship between a derivative action and

liquidation:[7]

[7] Techflow New Zealand Ltd v Techflow Pty Ltd (1996) 7 NZCLC 261,138 (HC).

I do not necessarily agree that the derivative action should not be available in cases where the complain [sic] is no longer trading, but in such cases it is necessary to consider whether it is the most appropriate procedure for redress, and whether the results sought to be obtained on behalf of the company are more appropriately addressed in the course of winding up.

(emphasis added).

[31]      Counsel for Mr He sought to distinguish Techflow from the present case and submitted that if the availability of liquidation was a tenable ground of opposition to an application for leave to bring a derivative action, s 165 would be made redundant. However, Techflow is not a bar to the granting of leave to bring a derivative action where the company has  ceased trading.   The important point to be taken from Techflow is the necessity to consider the most appropriate procedure for redress given the actual circumstances of the company.  That assessment needs to be based upon the prudent business person test discussed above.  The Court may consider on the  facts  before  it  that  the  most  appropriate  procedure  is  to  grant  leave  for  a derivative action.  Nor does the availability of liquidation make s 165 redundant, as there are a wide range of circumstances in which a party might seek leave to bring a derivative action.  The company ceasing to trade is just one of these circumstances.

Assessment of cause of action against plaintiff as director

[32]     One instance of a breach of fiduciary obligation occurs where the departing director seeks to exploit an opportunity which the company uniquely possessed, or which was available only to a limited number of other persons in the area of business endeavour which the director knew about because of his directorship.  The fact that the opportunity in this case cannot reasonably be viewed as closely held information conferring a competitive disadvantage on the company would be a contra-indication against the Court finding that a fiduciary obligation had been breached when the director took steps to set up a business in the same area of activity.   I agree with Mr Campbell that the reality of the applicant’s operation – buying dairy products off retail shelves – hardly qualifies as a type of know-how exclusive to the company or a limited range of other parties.  It is not clear either that the company can realistically claim that knowledge of the market opportunity to buy the products in question from supermarket shelves in New Zealand and sell them at a profit in China was a special advantage that the company possessed.  For these reasons I would not estimate the company’s chances of success in bringing an action against the director for breach of fiduciary obligation as being great.

The procedural point

[33]     Mr Campbell also submitted that the proposal which the defendant has made that the company would, in the event of leave being granted under s 165, be joined as a counterclaim plaintiff in the proceedings is not viable.  He submitted:

Even if the Court were minded to grant leave to Mr He to bring a derivative action, that action cannot be brought by way of a counterclaim in the present proceeding. NZPIL is not a party to this proceeding, and a non-party cannot bring  a  counterclaim:  Nippon  Credit  Australia  Ltd  v  Girvan  Corp  NZ Ltd (1991) 5 PRNZ 44.

[34]     The relevance of this point would seem to  be that when  considering an application for leave to bring a derivative action, the Court needs to consider all the circumstances including whether the proposed procedural vehicle is apt for the purpose which the applicant has in mind.  However, it needs to be kept in mind that applications of this kind are typically brought by way of an originating application with the applicant providing a draft statement of claim which he/she intends to file in the event that leave is granted.  It would be possible for the Court to grant leave in this case authorising Mr He to bring an application pursuant to s 165 without resolving  the  question  of  whether  the  correct  procedural  approach  would  be  to launch any substantive proceeding which the Court granted its consent to, in the form of a counterclaim in the present proceeding or whether a separate stand-alone proceeding is going to be required.

[35]     However, for the reasons that I have given earlier in this judgment I do not consider that leave ought to be granted so the point which Mr Campbell has raised does not need to be resolved.

Summary

[36]     The present judgment is concerned with the application for leave to bring a derivative action pursuant to s 165 of the Companies Act.  The cause of action which the company would sue on would primarily be based upon the alleged breaches of the duties which Mr Chen owed to the company as a director.  Other possible actions which have been referred to in the submissions which counsel have filed include the possibility that Mr He could bring an action against Mr Chen alleging a breach of

fiduciary obligations which Mr Chen owed to him, Mr He, arising out of the joint venture agreement which the parties allegedly entered into and consequent to which, the company was incorporated.   This judgment is not concerned with the possible causes of action arising out of breaches of the alleged joint venture.

[37]     I have concluded that  leave ought  to  be declined  on  the grounds  that  a prudent company director would not embark upon the litigation that Mr He has in mind for the following reasons.  Assuming it is proved that Mr Chen set up a parallel company structure to carry on a similar business to that which the subject company was  involved  in,  it  is  doubtful  that  his  actions  amounted  to  a  breach  of  his obligations owed as a director to the company.  It is not clear that the director has taken advantage of information that had a confidential character.  Both the potential market for the milk product marketing businesses and the way in which the company operated to obtain product for that market leave one with the impression that there was nothing particularly unique about the opportunity which Mr He had conferred upon the company.  Further, the company is no longer trading, and having regard to the situation that exists between the directors, would be a suitable candidate for winding up.   After considering the arguments of counsel and the evidence, I am firmly of the view that the appointment of a liquidator would represent the best approach to resolving the issues between the parties so far as the company is concerned and that would include making a decision as to whether the company ought to pursue Mr Chen for the alleged breaches of his duties as company director.

Orders

[38]     The application  for leave to  bring proceedings  pursuant  to  s  165  of  the Companies Act is dismissed.   The parties should confer on the question of costs relating to the application and if they are unable to agree to file memoranda not

exceeding four pages in length within 10 working days of the date of this judgment.

J.P. Doogue

Associate Judge