On March 14, 2018, the Honourable Justice Penny of the Ontario Superior Court (Commercial List Division) released a decision granting a US$2.6-billion judgment to the SFC Litigation Trust for fraud and breach of fiduciary duty in its action against Allen Chan, the former CEO of Sino-Forest Corporation. The decision is the largest judgment of its kind in Canadian history. The case is remarkable in other respects, as well.

The Sino-Forest Fraud

Sino-Forest was a publicly traded company listed on the Toronto Stock Exchange with a market capitalization of approximately $6 billion at its peak. Its principal businesses included the ownership and management of forest plantations, the buying and selling of standing timber, wood logs and wood products, and the complementary manufacturing of downstream wood products.

Sino-Forest seemed like a remarkable success story. Between the 2003 and 2010 financial year-ends, Sino-Forest’s revenue grew from $265.7 million to $1.9 billion (an approximately 625% increase) and its assets from grew from $418 million to $5.7 billion (an approximately 1,270% increase). Between August 2004 and October 2010, Sino-Forest used its apparent success to raise approximately $3 billion through debt and equity financing.

In June 2011, a short seller called Muddy Waters Research published a report describing Sino-Forest as a “multi-billion dollar Ponzi scheme ... accompanied by substantial theft.” Among other things, the report alleged that Sino-Forest did not hold the full amount of timber assets it reported, that it overstated its revenue, and that it had engaged in undisclosed related-party transactions.

The same day that the Muddy Waters report was released, Sino-Forest’s Board appointed an Independent Committee to investigate the allegations in the report. In turn, the Independent Committee retained professional firms to assist with the investigation. After eight months of investigation, the Independent Committee released its final report in January 2012, disclosing that the issues it examined, including timber asset verification and related party transactions and relationships, “proved very difficult to definitively resolve.”

Also following the Muddy Waters report, the Ontario Securities Commission (OSC) commenced an investigation into Sino-Forest. In August 2011, the OSC issued an order alleging including that Chan, the CEO of the company, and other certain directors and officers “appear to be engaging or participating in acts, practices or a course of conduct related to its securities which it and/or they know or reasonably ought to know perpetuate a fraud.” Among other things, the order cease-traded Sino-Forest’s securities and required Chan and other members of management to resign. The OSC delivered a Statement of Allegations in May 2012, alleging that Chan and other members of management “engaged in a complex fraudulent scheme to inflate the assets and revenue of Sino-Forest”.

In March 2012, Sino-Forest filed for protection under the Companies’ Creditors Arrangement Act, which led to approving a plan of arrangement by the court. The plan, among other things, transferred Sino-Forest’s litigation rights to a litigation trust to pursue for the benefit of Sino-Forest’s creditors.

In March 2014, the SFC Litigation Trust commenced an action in the Ontario Superior Court against Chan for orchestrating the fraud in breach of the fiduciary duties he owed the company.

In August 2014, the SFC Litigation Trust obtained a worldwide Mareva order from the Ontario Superior Court freezing all of Chan’s assets. Chan appealed the Mareva order to the Ontario Divisional Court, arguing that the Litigation Trust failed to establish that Chan had assets in Ontario. In a split decision released in March 2017, the Divisional Court dismissed Chan’s appeal, holding that the Mareva order was justified by the Court’s in personam jurisdiction over the defendant—not whether the defendant has assets in the jurisdiction.

Chan obtained leave to appeal the Divisional Court’s decision to the Ontario Court of Appeal. However, Chan abandoned the Mareva appeal shortly after Justice Penny’s trial decision was released.

The Trial Against Chan

The trial was held over 46 days in March, April, and May 2017, with closing argument taking place in July 2017. Several aspects of the trial process and judgment are notable.

The proceeding was conducted as a “paperless” trial. The affidavits, transcripts, documents, and written submissions were filed in an online database that could be readily accessed by the parties during the trial. Display monitors throughout the courtroom were linked to a computer controlled by the party conducting the examination or making submissions. The affidavits, transcripts, and written submissions were hyperlinked to the documents and cases cited as references.

In July 2016, Chan, who resides in Hong Kong, brought a motion asking that Justice Penny appoint a commissioner to sit in Hong Kong to take his evidence, and the evidence of witnesses Chan intended to call who lived in Hong Kong and mainland China.

Justice Penny held that Chan was a party and was compellable in Ontario by virtue of having attorned to the jurisdiction. However, Chan’s non-party witnesses were not compellable. Due to the importance of the assessment of the credibility of Chan’s witnesses, Justice Penny held that he (being the trial judge) should take the commission evidence of those witnesses in Hong Kong.

As a result, three weeks of the trial were held in Hong Kong with Justice Penny sitting as the commissioner.

The Decision Against Chan

Justice Penny’s decision was released on March 14, 2018, finding that Chan was liable for US$2.6 billion in damages for fraud and breach of fiduciary duty, and punitive damages of C$5 million.

The decision largely turned on the credibility (or the lack thereof) of Chan and his witnesses. Among other things, Justice Penny wrote in his decision that:

  • [he] found the evidence of Mr. Chan, and his other fact witnesses, to be contrived;
  • [Mr. Chan’s witnesses’] evidence changed in response to new evidence or when confronted with inconsistencies or other problems with their account of events;
  • [Mr. Chan’s witnesses’] explanations were frequently implausible on their face, lacking any ring of truth, and/or unsupported by any contemporaneous documentary evidence; and
  • Mr. Chan’s evidence, in particular, was frequently impeached by prior inconsistent testimony under oath on discovery or in affidavits sworn in earlier proceedings in this case.

In the decision, Justice Penny found that Chan secretly controlled many of Sino-Forest’s counterparties (i.e., its suppliers and customers) through a complex network of relationships with third parties. The third parties acted as Chan’s “nominees”, holding positions as directors, officers, and shareholders on his behalf.

Justice Penny further found that Sino-Forest’s primary business model under which it claimed to buy and sell forestry plantations within China was a fraud and that “Sino-Forest lacked the requisite documentation to find the standing timber assets, much less prove that it had any ownership interest in them.” Justice Penny also found that Chan defrauded Sino-Forest by causing it to fund deposits and advance payments to entities that Chan secretly controlled.

Both parties presented expert evidence on the losses suffered by Sino-Forest. Justice Penny ultimately accepted the evidence of Litigation Trust’s expert Peter Steger in arriving at the US$2.6-billion damages figure, being the funds that would have been available to Sino-Forest to invest in legitimate business operations but for Chan’s fraud and breaches of fiduciary duty, considering certain amounts already recovered by the beneficiaries of the trust.

In July 2017, the OSC released a decision against Chan and other members of Sino-Forest’s management finding they perpetrated a fraud. Although the OSC’s sanctions decision has not been released, jail time is not an available penalty. The Royal Canadian Mounted Police have initiated no proceedings arising out of the Sino-Forest fraud.

The SFC Litigation Trust continues to pursue outstanding claims against others, including professionals, for the Sino-Forest fraud. The recent judgment against Chan will assist in the prosecution of those claims.