The Court of Final Appeal (“CFA”) has recently been asked to consider whether the Hong Kong Courts have the ability to order a plaintiff to pay security for costs where the plaintiff is a foreign incorporated company which has established a place of business in Hong Kong.

Having declined the request for security for costs, on 30 October 2009 the CFA handed down the reasons for its decision: Akai Holdings Limited (in compulsory liquidation) (Akai) v Ernst & Young (a Hong Kong firm) (EYHK), FACV No 10 of 2009 (Akai case).

This article examines the CFA’s decision and discusses an anomaly which currently remains in Hong Kong law; namely that security for costs cannot be obtained against a company which, whilst incorporated outside of Hong Kong, has its central management and control in Hong Kong and is believed will be unable to pay an order for costs made against it.

Background

Akai was incorporated in Bermuda, had a place of business in Hong Kong and, as such, was registered under Part XI of the Companies Ordinance (CO) which provides for the registration of companies incorporated outside of Hong Kong.

In 2000, Akai was placed into liquidation both in Bermuda and Hong Kong. As part of the liquidators’ remit to realise assets to distribute to Akai’s creditors, they brought proceedings against EYHK, who had been the auditors of Akai for several years, claiming damages in the vicinity of US$1 billion for alleged negligence and breach of duty by EYHK in auditing Akai’s accounts.

The dimensions of the Akai case were large: the claim was filed in May 2004 and took a number of years to progress through the pre trial stages. The hearing which was set down for September 2009 was estimated to last six months. In reflection of the magnitude of the case, EYHK applied for security for costs of approximately HK$200 million.

Relevant Law

In Hong Kong, an application for security for costs can either be brought under:

  1. 1.Section 357 of the CO (Section 357) which provides that in respect of a limited company the Court can, where credible evidence shows reason to believe the plaintiff will be unable to pay the costs of the defendant if successful in its defence, order the plaintiff to pay security for costs; or
  2. 2.Order 23, Rule 1(1)(a) of the High Court Rules (Order 23) which provides that the Court can, if it is just to do so, order security for costs to be paid by a plaintiff who is ordinarily resident out of Hong Kong.

Section 2(1) of the CO defines a “company” as any “company formed and registered under” the CO. Narrowly construed, this definition does not include companies incorporated outside of Hong Kong, even though such companies may have a place of business in Hong Kong and be registered under Part XI of the CO, as Akai was. In addition, companies like Akai may not fall within the ambit of Order 23, since having established a place of business in Hong Kong, they may be found to be ordinarily resident in that jurisdiction.

Accordingly, there is a jurisdictional gap that exists in the current law: how should companies be treated that are incorporated outside Hong Kong, but having a place of business and their central management and control in Hong Kong, if it can been shown that there is credible evidence that they may be unable to pay any costs award made against them? It was this gap that the CFA was asked to address in the Akai case.

Court of First Instance

In the Court of First Instance, EYHK brought its application for security for costs under Order 23 on the basis that Akai was ordinarily resident out of Hong Kong. It was accepted that, as a matter of Hong Kong law, the test for residence of a limited company is determined by reference to the location of its central management and control.

On behalf of Akai it was argued that, given the factual circumstances surrounding the company, both pre and post liquidation (i.e. that its director, James Ting, had been located in Hong Kong and that the company’s books and records were maintained in Hong Kong), Akai was ordinarily resident in Hong Kong and, therefore, an order for security for costs could not be made against it under Order 23. In response, EYHK argued that the current management and control of Akai was located overseas. Akai was a company that was in the course of an ancillary winding up in Hong Kong under the auspices of the lead winding up jurisdiction, Bermuda, and thus represented a company that must be regarded as being ‘ordinarily resident’ in Bermuda.

In his judgment, the Honourable Mr Justice Stone confirmed the following:

  1. Oder 23 should be used in the present tense, namely that the plaintiff is (as opposed to was) ordinarily resident out of the jurisdiction;
  2. te Court is bound by the strict terms of Order 23 and has no inherent jurisdiction to order security for costs; and
  3. the “domicile” of a company was entirely different from the residence of a company.

Dismissing EYHK’s application for security for costs, Mr Justice Stone concluded that Akai was ordinarily resident in Hong Kong for the purpose of the High Court Rules and that, accordingly, Akai did not fall within the ambit of Order 23. In reaching his decision, Mr Justice Stone took into account that prior to Akai being placed into liquidation, the central control and management was undoubtedly in Hong Kong. Indeed, “Hong Kong was the epicentre of Mr Ting’s [Akai’s director’s] corporate empire, of which Akai, which was then listed on the Main Board of the Hong Kong Stock Exchange, was one of its leading lights”.

Given its pre-liquidation position, Mr Justice Stone then turned to consider what had changed in terms of “ordinary residence” post liquidation. He did not consider that EYHK’s reliance on the fact that the Hong Kong liquidation was ancillary to the Bermudian winding up, which he viewed as a conceptual difference only, was enough. He was of the opinion that Akai’s liquidation process in Hong Kong was as much “Hong Kong-centric in terms of central management and control as was the case prior to its winding-up”. Amongst other things, Akai was in liquidation pursuant to an order of the Hong Kong Courts, had the majority of its creditors in Hong Kong, the liquidator with the day-to-day conduct of Akai’s affairs was resident in and an officer of the Hong Kong Companies Court and had assembled and held all relevant books and records in Hong Kong.

Expressing sympathy to EYHK, Mr Justice Stone advised that “this is a rare example of a first instance court stating that it has been driven to a decision which it does not find attractive, nor in the circumstances fair, and going so far as to express the hope that its view on the point at issue is held to be incorrect”. He noted that in the normal course of events, absent the objection to jurisdiction, it was evident from the circumstances of the case that the Court would have not hesitated in making an appropriate award for security for costs. His decision was a result of “the continuing anomaly of an overseas registered company with its central management and control in Hong Kong” that “falls out with the ambit of Order 23, rule 1(1)(a), and thus does not permit the order of security for costs in an application mounted under this section”.

Court of Appeal

On appeal to the Court of Appeal (CA), EYHK relied on both Section 357 and Order 23 (although the CA was not ultimately required to rule on the points of appeal raised in relation to Order 23 given its favorable decision to EYHK under Section 357).

The CA was asked to consider whether Section 357 includes a non-Hong Kong company carrying on business in Hong Kong or is restricted to companies formed and registered under the CO as defined.

Concluding that the definition of “company” does apply to non-Hong Kong companies registered under Part XI of the CO, and thereby in granting EYHK’s application for security for costs, the CA adopted a purposive approach keeping “the context [of Section 357] very much in mind”. In reaching this conclusion, the CA considered that:

  1. the purpose of section 357 is to confer the protection of security for costs on defendants who are sued by impecunious limited companies;
  2. it was being asked to construe Section 357 in the first decade of the twenty-first century where overseas companies which are ordinarily resident in Hong Kong are commonplace; and
  3. there was no rational basis for treating an overseas limited company ordinarily resident in Hong Kong differently from those companies incorporated in Hong Kong.

Court of Final Appeal

Akai appealed on the basis that the CA had erred in its construction of the scope of Section 357 and was granted leave to appeal on grounds that the appeal involved questions of great general or public importance.

The primary issue on appeal was: what was the meaning of “company” for the purpose of Section 357? The CFA overturned the decision of the CA concluding that Section 357 does not apply to foreign companies registered and with an established place of business in Hong Kong. The CFA considered that the definition of “company” in section 2(1) of the CO was clear: it means any company which was formed and registered under the CO (i.e. a company incorporated in Hong Kong). Adopting this literal and ordinary meaning, the Court would have no jurisdiction to order security for costs against Akai.

Whilst the CFA acknowledged that Section 357 must be construed in light of its purpose and in the context of the other provisions in the same Ordinance, the CFA was not satisfied that the context justified giving the definition of “company” an extended meaning as the CA had done. In its reasoning, the Court of Final Appeal noted that it was not the judiciary’s role to extend the scope of legislation to cater for changes in circumstances or recent developments. Rather, it was the judiciary’s role to interpret the legislation in the manner the legislature had intended.

Implications

As recognised by the Courts, during recent years there has been a significant increase in the number of foreign incorporated companies registering and establishing places of businesses in Hong Kong. In the event that defendants are involved in litigation with such companies, it is unfortunate that, as illustrated by the Akai case, Hong Kong law may not provide for the ability to award security for costs to these defendants.

The present system effectively presents overseas companies, which have a place of business and their central control and management in Hong Kong, with an advantage in that they may resist applications requiring them to pay security for costs. In light of the ever increasing number of foreign companies establishing places of business in Hong Kong, it may therefore be appropriate to remove this anomaly.

This article is based on a piece that first appeared in Asian-Counsel magazine.