Frozen Assets, Third Party Rights and Disclosure
The SFC and CPSL Litigation
On 29 June 2018 the Court of Appeal (Cheung, Yuen and Kwan JJA) handed down its Judgment in the latest round of litigation between the SFC and employees of China Pacific Securities Limited and their relatives.
The allegations arise out of an SFC inspection in 2012 which found very substantial ($156m) discrepancies in client securities accounts, the focus of the allegations fall primarily on a former account executive (Wah) who, the SFC alleges, falsely recorded that she and three of her relatives had deposited physical shares with CPSL, then gave orders to sell those (non-existent) shares. CPSL duly sold the shares in its account through the central clearing and settlement system of the Stock Exchange. What CPSL actually sold were shares belonging to its other clients, but the proceeds of sale were paid to Wah and her relatives.
In February 2013 the Securities and Futures Commission (SFC) commenced legal proceedings and applied for and was granted a Mareva injunction against Wah, restraining her from disposing of her assets up to the value of $156,471.705 – the sum that CPSL had replaced in the accounts of those clients whose shares had been sold. One of the accounts restrained was a securities account that she held with CPSL.
CPSL had neither commenced any proceedings against its former employee nor had it applied to be joined as a party to the SFC action.
The Mareva was varied by consent to permit her to withdraw funds to pay for her legal representation. The consent order did not specify the account(s) from where the funds could be withdrawn and so in 2017 the defendant sought to liquidate her CPSL account and to withdraw the proceeds from it. CPSL refused to permit her to do so and so she issued a summons against CPSL to compel it to:
(i) Desist from obstructing her and the SFC from carrying out the consent order.
(ii) Sell all her shares held in its account and hold the net proceeds.
(iii) Place the net proceeds into a bank account to be managed by her solicitors.
The hearing took place before DHCJ Francis and saw representations made by the defendant, the SFC and CPSL. Although CPSL was not at that point party to any proceedings involving the SFC or Wah both Wah and CPSL appear to have agreed at the hearing that it be joined. The Judge considered and applied the ruling in Hong Kong Life Insurance Ltd v Fung Siu Cheung Michael and others HCA1164/2012 (HKLI)– where Chu J considered how the Court show approach the release of funds the subject of an injunction to fund a defendant’s legal costs – and then went on to consider what the proper position was for CPSL, not being at all material times a party to any action.
The HKLI case establishes that where the Mareva injunction involves a proprietary claim by the plaintiff, the court in exercising its discretion would consider:
(a) whether the defendant had demonstrated with full and frank evidence that there were no other available assets that can be used to pay his legal expenses, and
(b) if so, then the court should then balance the potential injustice to the parties respectively, taking all relevant circumstances into account, in particular the strength of the parties’ respective cases
Where the plaintiff is not asserting a proprietary claim to the assets in question, the court should consider whether the defendant has shown by sufficient evidence that:
(a) he does not have other assets available to meet the legal expenses,
(b) the purpose of the application is not to dissipate the asset so as to frustrate later execution of any judgment.
The Judge at first instance rejected the defendant’s case on the summons outright. He held:
(i) That she had not shown that she had no other assets available to meet legal expenses and had failed to disclose the means by which she had acquired the securities in her CPSL account.
(ii) That CPSL had a potential claim against its former employee and the value of that claim – given CPSL’s compensation of its other clients – was larger than the value of Wah’s account.
Wah appealed and argued that:
(i) As CPSL was not a party to any action it had no locus in the proceedings and the Judge had had no jurisdiction to determine the dispute.
(ii) Even if CPSL could intervene in the consent order the Judge applied the wrong test and adopted the wrong burden of proof.
(iii) Even if the correct test had been applied the Judge erred both in finding that CPSL had a proprietary claim and in rejecting Wah’s evidence and that it was not open to the Judge to prioritise which assets the defendant should dispose of first.
The Court of Appeal held:
1. The Consent Order was not a ‘private agreement’ between the defendant and the SFC with CPSL merely being a third party.
2. A consent order could not override the interests of a third party in the defendant’s assets.
3. That interest was established by showing an arguable case that the defendant had incurred a liability to CPSL through her actions.
4. CPSL was entitled to intervene in the application to liquidate assets as an entity whose interests would be adversely affected if the application were to be granted.
5. The test for the granting of a variation of a Mareva injunction was no different simply because the opponent to the variation was an intervener in proceedings as opposed to the party who had sought the injunction in the first place.
6. Where CPSL could show it had suffered loss (as it could) it could seek protection of its position through the Mareva.
7. Since the purpose of a Mareva is to protect assets the Judge was entitled to consider whether the variation sought complied with that purpose. Unless there was clear evidence that the balance of the defendant’s securities account would be adversely affected (such as clear evidence of a falling market) the Judge was plainly entitled to consider that liquid assets in bank accounts should be used first, instead of liquidating a securities account.
8. The Judge was entitled to take into account (among other failings) the fact that the defendant had not disclosed the sources of income from which she was able to purchase the securities.
• The test in HKLI v Michael remains good law.
• As far as defendants who are subject to a Mareva injunction are concerned this case shows, again, the critical importance of full disclosure to the Court when applying to vary to release frozen funds. The English Court of Appeal has long held that in the context of ordinary civil litigation a party who is subject to a freezing order made to protect a proprietary claim cannot draw on the contested funds unless he shows that he has no other available assets on which he can draw. In SOCA v Azam  EWHC Civ 970 the Court of Appeal considered what the position was where there were doubts about the defendant’s disclosure. It held “if the evidence leaves the court in doubt, but with specific grounds for suspicion that the applicant has not disclosed all that he could and should about his assets, then it may resolve that doubt against the applicant”. Those seeking to argue that they are being forced, by the claimant/intervenor’s position to prove that they have no funds outside those covered by the injunction may however find assistance in the judgment of Mitting J in The Queen on the Application of the Director of the Assets Recovery Agency v Gale  EWHC 1320.
• As far as third parties are concerned this case shows that it is not necessary to have commenced proceedings against a defendant in order to protect a third party’s position but, frankly, it is highly desirable that the third party should do so. CPSL were here in a fortunate position both in that it had to be notified as account manager of the defendant’s intention to liquidate her assets and that through subrogation it had assumed the rights of its compensated clients. Other third parties with a competing interest in funds covered by a Mareva may not have been as lucky. It plainly assisted CPSL that it had decided, in the intervening period between the first instance decision and the appeal to being proceedings of its own but had CPSL issued proceedings against the defendant shortly after it became aware of the detail of the SFC’s claim it would have been able to demonstrate its own proper locus and the strength of its case, thus obviating the need to scramble late in the day to protect its claim over assets.