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Over a three-year period, Applicant made 48 payments to Beneficiaries, most of which were made under letters of credit, but it never received any goods. For example, two Group companies that received payouts from Applicant for purchase of goods, Famous Capital and King Capital (Beneficiaries), never traded goods and never carried any business operation, despite purporting to do so. Applicant had obtained letters of credit from four different banks. Beneficiaries received payments from issuers on these LCs after presenting false bills of lading. After payment, Applicant reimbursed the issuers. Consequently, issuers did not suffer losses from the transactions. Applicant later received payments-in from Beneficiaries appearing to re-pay the majority of the payments-out; however, there was a shortfall of HKD 36,151,301.87.

Subsequently, Applicant was sold by Parent Company, at which time Group made payments to settle all of Applicant’s outstanding bank debt. Applicant was later liquidated, and the Liquidator (Liquidator) sued three former company directors (Directors) for misfeasance, claiming that the use of Applicant’s funds for goods that were never received amounted to breach of duty, dishonesty, and misfeasance. The Court of First Instance, Lam, J., dismissed the case.

Liquidator alleged the HK 36 million shortfall was essentially a gift which was dispersed to other companies of the Group, at the expense of Applicant. The Judge found that Directors actions were a breach of duty, but that Applicant had not suffered loss as a result. The Judge stated that the LC transactions “were plainly illegal and, indeed, criminal, in the sense that they were a fraud on the issuing banks”. However, in assessing loss and damages, the Judge ruled that Directors were only liable for paying the loss that was caused by the breach of duty. The Judge found that the funds obtained by the illegal transactions were channeled to entities in the Group, and that the Group’s post-sale discharge of Applicant’s debts was a direct result of the transactions. Ultimately, Applicant received a net benefit of over HKD 59 million, which far outweighed the HKD 36 million alleged shortfall.

Directors argued that the LC transactions were not a breach of duty, because the LCs were a “method of obtaining financing on favourable terms”. Directors claimed that since the Group always intended to indemnify Applicant’s debts, the illegal transactions funded operations that served the best interest of Applicant, without the intention of permanent financial loss. The Judge ruled that, even if it were true that the LCs served a rational company interest, the deceit of the transactions and the forging of documents exposed Applicant to criminal liability, and potentially jeopardized Applicant’s ability to acquire government construction contracts. The Judge concluded that approving the transactions amounted to a misuse of fiduciary powers regardless of intent.

The Judge noted that it did not matter that the funds which were channeled from the LC transactions to the Group could not be traced to the exact funds which later repaid Applicant’s debts. The important detail was that, although Directors approved a depletion of funds which added to Applicant’s bank debt, the same entities that received the funds later paid Applicant’s bank debts at a net surplus. Therefore, Directors breach of duty in approving the LCs did not result in an unrecovered actionable loss.

[EHM]

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