By James Rowland  King & Wood Mallesons Dispute Resolution Group

I.    Background

The Claimants were three Singaporean companies which had been set up to hold shares in a number of sino-foreign joint ventures established under JV contracts governed by PRC law (the “JVs”). The fourth claimant was the parent company of the first three claimants, and had entered into a Services Agreement with the general manager of the JVs (the “Services Agreement”). He was in turn the chairman and legal representative of each of the JVs and of each of their Chinese shareholders. The Service Agreement was governed for the most part by PRC law, although it contained a non-competition clause governed by English law.

The Defendants were the BVI shareholders in a number of Chinese enterprises (the “Non-JVs”) which had been gradually assimilated into the JVs’ manufacturing supply-chain. After many years both the JVs and Non-JVs were operating as an integrated manufacturing and sales business.

II.    The Claims

Eventually, a dispute arose between the Claimants and the JVs’ Chinese shareholders and general manager. The issue was whether the Non-JVs were entitled to exist and who ultimately owned the BVI companies that were the shareholders in the Non-JVs. And were those BVI companies (and their owners) really entitled to receive the profits generated by the Non-JVs? Or since the Non-JVs had been gradually integrated with the JVs, should part of their profits belong to the JVs’ Singaporean shareholders? The dispute was referred to arbitration (several parallel arbitrations) in Stockholm under the JV contracts and the Services Agreement.

As the Defendants were not parties to the JV contracts or to the Services Agreement, and could not be sued in the arbitrations, the Claimants brought claims against them in the courts in the BVI alleging: that the Defendants had dishonestly assisted the Non-JVs to usurp business opportunities belonging in equity to the JVs; that they had knowingly received from the Non-JVs profits belonging in equity to the JVs, and conspiracy to defraud.

The Claimants described the nature of their claims as follows: “The claim against the Defendants results from the fact that the Defendants, together with the Non JVs have knowingly assisted in and/or knowingly received monies resulting from breaches of agreements the benefit of which is vested in the Claimants. Further and/or alternatively the Defendants have wrongfully and with intent to injure the Claimants and/or to cause loss to the Claimants by unlawful means, conspired and/or combined together with the Respondents to the proceedings before the Arbitration Institute of the Stockholm Chamber of Commerce including the general manager of the JVs and/or others including his wife and daughter to defraud the Claimants and to conceal the fraud and the proceeds of the fraud from the Claimants.[1]

Before the Claimants could proceed with their claims for dishonest assistance, knowing receipt and conspiracy to defraud against the Defendants in the BVI, “breaches of the agreements the benefit of which is vested in the Claimants” had to first be established against the Chinese shareholders and general manager of the JVs in the Stockholm arbitrations. Therefore, as soon as the Claimants had their claims issued in the BVI, they asked the BVI court for the actions to be stayed pending the outcome of the arbitrations.

III.    The Claimants’ Application for Asset Freezing, Disclosure and Receivership Orders

In the interim, the Claimants wanted the Defendants’ assets to be frozen and for receivers to be appointed over them. In addition, they wanted the Defendants to be under an obligation to disclose information about the status and whereabouts of their assets while the freezing and receivership orders were in place (thereby revealing the identity of all of the Non-JVs, including those newly established during the course of the proceedings, if any).

BVI courts have the discretion to grant an interim injunction (such as asset freezing and disclosure orders) and to appoint a receiver "in all cases when it appears to the Court or Judge to be just or convenient”[2] although the court considers multiple factors when exercising this discretion.

For an asset freezing order, the Claimants had to show:[3]

(a)   a serious issue of law to be tried between the Claimants and the Defendants;

(b) that on the legal issue to be tried, Claimants had a good arguable case on the merits;

(c) a real risk that judgment would go unsatisfied by reason of the disposal by the Defendants of their assets, unless they were restrained from disposing of them by court order; and

(d) that in all the circumstances it would be just or convenient to grant the order (including whether damages would be an adequate remedy if injunctive relieve was not granted).

In addition, for the disclosure order, the Claimants needed to show that the assets in question were the subject of a proprietary claim.[4]

Since a receivership order is more costly, more intrusive and less reversible than an asset freezing order or disclosure order, the Claimants also had to show good prima-facie title to the property that was the subject of the application (ie. title to the asstes of the BVI companies, including their shareholdings in the Non-JVs and the profits which the Non-JVs were presumed to have distributed to them as dividends). The Claimants also had to show that the property would be at risk of dissipation if left in the possession of the Defendants until the trial.

The Claimants made their application for asset freezing, disclosure and receivership orders ex-parte (ie. without notice to the Defendants) about six weeks after making an application for interim measures with notice to the respondents in the Stockholm arbitration and while the hearing of the Stockholm application was still pending. Both applications were based on almost identical evidence.

In the BVI, an example of when a receiver may be appointed ex-parte is where the court is being presented with allegations of fraud and it appears that drastic action is needed to prevent the Court’s orders from being evaded by the manipulation of offshore trusts.[5]

The Claimants’ application for interim measures in the arbitration was vigorously defended and ultimately failed. However, the Claimants succeeded on their ex-parte application in the BVI and managed to persuade a single judge of the BVI court to grant asset-freezing, disclosure and receivership orders against the Defendants.

IV.    The Defendants’ Application to Discharge the Orders

Soon after the orders were granted, the Defendants applied for them to be discharged. Unlike in the hearing of the Claimants’ application for ex-parte orders, both sides’ lawyers were present at the hearing of the Defendants’ application to discharge the orders and the discharge application was heard by a different judge from the one which had granted the orders originally.

For various reasons, partly to do with the parties’ attempts to reach an out-of-court settlement and partly to do with the court schedule in the BVI, the hearing of the Defendants’ discharge application did not take place until more than one year after the orders had been granted ex-parte. In the interim, the receivers had incurred expenses of more than US$2.5 million attempting quite fruitlessly to get in and preserve the Defendants’ assets in jurisdictions around the world.

The reasons why the Orders were ultimately discharged were numerous:

A. No good arguable case

As mentioned above, the Claimants’ had pleaded that their claims for dishonest assistance, knowing receipt and conspiracy to defraud depended on them proving breaches of the JV contracts and Services Agreement in the Stockholm arbitrations.

The judge at the discharge hearing noted that even if the Claimants established a strong case that such breaches of the JV contracts and Services Agreement had occurred, the Defendants in the BVI were never parties to those contracts. Therefore, taken alone, a finding in the arbitration that the contracts had been breached would have been insufficient to establish a good arguable case on the issues of dishonest assistance, knowing receipt and conspiracy to defraud which were to be tried in the BVI.

Dishonest assistance and knowing receipt claims are claims for ‘equitable’ relief by which the law of the BVI imposes liability on a third party to a trust in relation to a breach of trust.

To succeed on the dishonest assistance claim, the Claimants had to show that:

(a)   a person who was neither a trustee nor a beneficiary (i.e., one of the Defendants);

(b)   assisted the commission of a breach of trust, without receiving any proprietary right in the trust property itself (e.g., by acting as conduits to pass the profits of the Non-JVs into the hands of their ultimate shareholders);

(c)   dishonestly (e.g., acting other than an honest person would have, such as by deceit, fraud or even reckless risk-taking with the trust property);

To succeed on the knowing receipt claim, the Claimants had to show:

(a)   a person who was neither a trustee nor a beneficiary (i.e., one of the Defendants);

(b)   received trust property (e.g., the profits generated by the Non-JVs);

(c)   with knowledge that the trust property had been passed to it in breach of trust.

Further, for either claim, there had to be proof of a loss suffered by the beneficiaries of the trust (said to be the Claimants in this case) as a result of a breach of trust. The liability of the third parties to the trust (the Defendants in this case) would then have been to account for that loss to the Claimants, provided that the other knowing receipt or dishonest assistance elements had been proven.

Obviously, the Claimants had to show the existence of a breach of a trust relationship before either of the claims could arise.

For this ingredient, the Claimants argued that a fiduciary relationship existed between the general manager of the JVs and the Claimants because of the words in a schedule to his Services Agreement which required him to ‘observe his fiduciary obligations and not to place himself in a position where his duty and interest may conflict’ and similar words.

However the judge at the discharge hearing observed that, “This contract has two provisions relating to governing laws. Article 10 provides that save for clauses 8 and 9 which shall be governed by English law, the agreement shall be governed by PRC law. It therefore follows that the obligations in the schedule being part of article 3 fall to be covered by PRC law…I am not satisfied that the mere use of the word “fiduciary” could without more, impose a relationship of trust as is know to English law or for that matter BVI law between the general manager and the contracting parties, among them (the fourth claimant)…”

The judge agreed with the Defendants that the only acts which they were alleged to have done – holding shares in the Non-JVs and receiving dividends from them – took place in the PRC or Hong Kong, where the Defendants’ bank accounts were located. This meant that the common law principle of double-actionability applied to the claims of dishonest assistance and knowing receipt.[6] Since the Claimants had not proven that such claims would be actionable both under the law of the BVI and that of the PRC or Hong Kong, the judge held that the Claimants could not as a matter of law succeed in showing that they had a good arguable case on the merits of those claims.

The Claimants were also ultimately unsuccessful in satisfying the judge at the discharge hearing that they had a good arguable case on their conspiracy to defraud claim. Firstly, their allegation against the Defendants was that they had been set up by the general manager of the JVs to hold shares in the Non-JVs and receive funds from them as part of an overall fraud. However, the judge held that, having regard to their legal nature, they could not have participated in the conspiracy, since they had not existed before their own incorporation. The judge also noted that the acts could not categorically be said to have been committed in the BVI, so the question of double actionability also arose as an obstacle to the conspiracy claim which the Claimants did not address in their ex-parte application.

In concluding, the judge found that the Claimants “had not overcome the first hurdle” of establishing a good arguable case that the general manager of the JVs was in a fiduciary relationship with the Claimants and had breached that relationship. Therefore, the Claimants had not satisfied the legal threshold justifying any of the interim orders which they had obtained at the ex-parte hearing.

B. Non-Disclosures and lack of frankness

In the BVI, litigants also have a duty to the court on an ex-parte application to act in the utmost good faith and disclose to the court all matters to be taken into account by the court in deciding whether or not to grant relief without notice. In a famous English case, Donaldson LJ held that: “the rule requiring full disclosure seems to me to be one of the most fundamental importance, particularly in the context of the Draconian remedy of the Mareva[7] injunction. It is in effect together with the Anton Pillar[8] order, one of the law’s two ‘nuclear’ weapons. If access to such a weapon was obtained without the frankest disclosure, I have no doubt at all that it should be revoked.[9]

An ex-parte applicant in the BVI also has a duty to identify to the court any defences which, although not yet taken, would have been available to the Defendant if the application had been made with notice and the Defendant had had an opportunity to present its case.

The important non-disclosures which the discharging judge identified in the Claimant’s ex-parte application were as follows:

(a) The Claimants relied on a rumour as part of their case for interim relief. The rumour was that a fundamental change to the distribution system of the JVs was about to take place, and that four Non-JVs would be set up as regional sales centres to replace one of the JVs’ as the entity responsible for sales and distribution. The rumour was said in the BVI court to be “recent” but almost identical evidence which the Claimants had given in support of their application for interim measures in the arbitrations in Stockholm six weeks earlier had not claimed that the rumor was at that time recent. This suggested that the word “recent” had only been added to influence the BVI court of the need to grant interim relief on an urgent basis.

(b) The Claimants relied on a conversation which they allege took place during a cigarette break in a board meeting of the JVs, in which the general manager of the JVs allegedly boasted that the Claimants could not prove he was the man behind the BVI companies and that it was impossible to find out who was behind them. Again, there was an almost identical affidavit submitted by the Claimants in support of an earlier application for interim measures in the Stockholm arbitrations, but there had been no reference to the alleged cigarette-break conversation in it. In both of the above instances, the judge in the BVI court concluded that slight differences between the evidence which had been submitted in the arbitrations and in the BVI court should have been brought to the attention of the judge at the ex-parte hearing, because this was relevant to the weight that should have been given to the evidence as a whole.

(c) The Claimants had not produced a copy of a JV Agreement which would have highlighted provisions on which the respondents in the arbitrations would have relied in defence of the claims of breach of contract brought against them.

(d) The Claimants had not drawn the court’s attention to the relevant provisions in the Services Agreement. In particular, they had not alluded to the fact that the agreement expired two years earlier. Nor did the Claimants reveal that they had not themselves performed their obligation of paying the salary due under the Services Agreement, if as they argued, the agreement had then been extended by conduct.

(e) The Claimants told the court as part of their case on the alleged fraud that, in a forensic report, Deloitte had uncovered a large number of inaccuracies in the PRC records of newly set-up Non-JVs. However upon a detailed review, the Deloitte report exhibited to the Claimants ex-parte application did not refer to any such inaccuracies.

(f) The Claimants failed to produce audited accounts of the JVs which detailed extensive related-party transactions between the JVs and the Non-JVs and disclosed the fact that the Non-JVs were ultimately controlled by the JVs’ Chinese shareholder. The judge found that these audit reports (copies of which the Claimants had received annually) directly contradicted the Claimants’ allegations of fraud and should have been presented to the court at the ex-parte application.

(g) The Claimants told the court that their claims (for dishonest assistance, knowing receipt and conspiracy to defraud) were proprietary claims[10] not merely claims for damages. However at the discharge hearing the Claimants were forced to admit that their claims were not proprietary claims. The judge at the discharge hearing observed that this particular non-disclosure wrongly influenced the judge on the ex-parte application to believe that the case was suitable for the appointment of receivers.

(h) The Claimants misrepresented the results of the company searches which they had done on the Defendants. These showed that some of the BVI companies had been struck off the register and then re-instated at about the same time that the Claimants had issued notices of arbitration in Stockholm. The Claimants led the court to believe that, while de-registered, the Defendants had been holding nothing of relevance and were re-instated purely in order to help the Chinese shareholders in the JVs avoid judgment in the arbitrations. However, the judge found this highly inaccurate since the Defendants had never been holding “nothing of relevance”, and instead had continued to hold large shareholdings in the Non-JVs, even while they were de-registered.

(i) The Claimants had failed to tell the court that their damages calculation in the arbitration included a future-loss element which projected to 2045, or that if they were successful in the arbitration, then they would obtain an order stopping the contract-breaching conduct and eliminating their claim for future losses. Nor did the Claimants inform the court that, as the JVs owned assets worth RMB 6.183 billion there was no real risk that, if successful in the arbitration, the Claimants would not be able to recover damages from their Chinese shareholders. The judge at the discharge hearing decided that the court considering the ex-parte application should have been informed of these matters since, when exercising its discretion to grant interim relief a BVI court is required to consider whether, instead of injunctions, damages would have been an adequate remedy.

(j) By omitting from their evidence certain words from an important PwC memorandum, the Claimants conveyed an impression to the court that the management of the JVs had engaged in some form of tax evasion and were refusing to provide the Claimants (through PwC, the JVs’ auditor) with information. The judge observed that whomever had drafted the Claimants’ affidavit evidence must have realized that the omission put an entirely different light on the content of the PwC report and that the omission must have been made deliberately in order to influence the court. 

Indeed, the judge found in this case that “looking at the case in the round, the failures to disclose matters to the court were grievous when viewed in totality and the orders must go.”

V.    Conclusion

In this case the Claimants realized what an incredible strategic advantage they would obtain if they were granted interim injunctions which, in essence, gave the BVI court control over their opponents’ assets until after an arbitration award was rendered. However, the impact of the injunctions was limited in the interim because the Defendants had few assets in jurisdictions where the injunctions could be enforced directly or where the authority of the BVI court-appointed receivers could be recognized without complicated cross-border litigation. The main practical effect of the injunctions in the interim was to shock the Defendants and to create prejudice against the respondents in the arbitration.

Ultimately, this effect was reversed: By the time the grant of the injunctions was re-heard before a different judge, the Defendants had had a full year to organise their evidence and to subject the many defects in the Claimant’s ex-parte application to forensic scrutiny. Although a year is a long time to suffer an interim asset freezing, disclosure and receivership order, it is not a long time in light of international arbitration schedules. In this case, the judgment on the discharge application was issued before the first evidentiary hearing in the arbitration and it was very unhelpful to the Claimants at that stage.

Although the Claimants had enjoyed an enormous strategic advantage while the injunctions were in place, and the injunctions must have impressed the arbitral tribunal, the discharge judgment eliminated the injunctions well before an award was rendered which the injunctions might have secured. In other words, their ultimate purpose was defeated. In addition, the discharge judgment described the Claimants’ lack of frankness to the BVI court as “grievous”. Although the impact of this criticism may not have done any serious harm to the Claimants prospects in the arbitration, it most certainly upset the Claimants’ strategy of pursuing numerous parallel litigations. The dispute was ultimately settled by mutual agreement.

The case demonstrates that extremely harsh interim relief is difficult to maintain against well-advised defendants.

King & Wood advised the defendants in this case as well as advising the respondents in the related arbitration and other parallel proceedings.

[1] Claimants’ Re-Amended Claim Form

[2] Section 24, West Indies Associated States Supreme Court (Virgin Islands) Ordinance, Cap 80

[3]American Cyanamid Co v Ethicon Ltd [1975] AC 396 HL

[4] Republic of Haiti v. Duvalier [1990] 1QB 202

[5] ICIC v Adham & Ors [1998] BCC 134 at 136

[6] Sibir Energy PLC v Gregory Trading ECSC Civil App. 26/2005

[7]  An asset freezing order.

[8] An injunction allowing a person to enter the premises of another to search for and take copies of specified documents.

[9] Bank Mellat v. Nikpur [1985] F.S.R. 87

[10] Claims for the recovery of property belonging to them.