Final appeal serves up sushi
In the past decade or so sushi has become increasingly popular – both in Hong Kong and globally.
The concept of the sushi restaurant chain proved a winner in 2004 for the founders of the first Itamae Sushi chain restaurant in Hong Kong. This led to opening of further Itamae Sushi restaurants, ultimately spawning a decade of rivalry between the founders as to ownership of the chain.
Recently, the Court of Final Appeal granted permission to appeal so that the dispute can finally be resolved.(1) Among other things, the case highlights the importance of clear contractual drafting and obtaining written confirmations of oral representations.
Facts
Ricky Cheng, Jason and Daisy Poon (siblings) and Shigemitsu Katsuaki were shareholders in the Ajisen group of companies, which has operated a chain of Japanese ramen noodle restaurants in Hong Kong since 1996.
The Ajisen shareholders later decided to expand into the sushi restaurant business. Smart Wave Limited was incorporated in 2004 as the corporate vehicle to manage and operate the first Itamae Sushi restaurant in Tsimshatsui, Kowloon. Cheng and the Poons were the three major shareholders of Smart Wave and Cheng was the sole director.(2)
Between December 2004 and September 2006, six further Itamae Sushi restaurants were established, operated by six different companies, of which Cheng was the sole director and shareholder. This resulted in disputes between Cheng and the other Ajisen shareholders about their interests in the other Itamae restaurants. As a compromise, Cheng and the Poons(3) entered into a shareholders' agreement to govern their rights as shareholders in Hero Elegant Ltd. Hero Elegant and its subsidiaries were established to manage and operate the Itamae sushi restaurants under the Hero Elegant agreement.
However, notwithstanding the Hero Elegant agreement, Cheng:
- continued to manage and operate the Itamae restaurants through the other companies without transferring the shares in those companies pursuant to the Hero Elegant Agreement; and
- later established further Japanese sushi restaurants named and marked ITACHO SUSHI (in contrast to the ITAMAE SUSHI mark).
Accordingly, Jason Poon, on behalf of himself and other shareholders of Smart Wave, commenced a derivative action against Cheng for damages and an account of profits for breach of fiduciary duty.(4)
Litigation history
Court of First Instance
The Court of First Instance dismissed Smart Wave's claim regarding the other Itamae restaurants.(5) This was on the basis of findings that Smart Wave operated only one of the restaurants in the chain, and that its shareholders had never intended Smart Wave to have the exclusive right to carry on the sushi restaurant business using the Itamae name and mark. Rather, it was agreed from the outset by the Ajisen shareholders that the chain of Itamae restaurants would be established using different corporate vehicles, all using the Itamae name and mark.
However, the court allowed Smart Wave's claim regarding the Itacho restaurants and awarded damages to be assessed up to 2010 (when Smart Wave ceased operation). As a director of Smart Wave, Cheng was held to have breached his fiduciary duty to act in the best interests of Smart Wave by operating a competing sushi restaurant business under a different but similar name to Itamae.
Court of Appeal
The Court of Appeal found that Cheng was in breach of his fiduciary duties towards Smart Wave in connection with the other Itamae and Itacho restaurants.(6) Smart Wave's appeal in respect of the other Itamae restaurants was therefore allowed.
Significant to the Court of Appeal's finding was the fact that, unlike the understanding held by Cheng and the Poons, there was no evidence to suggest that the other shareholders of Smart Wave understood that Smart Wave had no exclusive right to operate other Itamae restaurants.
Therefore, as Cheng was the sole director of Smart Wave, he was under a fiduciary duty to act in its best interests. It was against the interests of Smart Wave for him to operate a competing sushi business where the business opportunity was diverted from Smart Wave to himself.
The Court of Appeal also agreed that Smart Wave was entitled to elect an account of profits from Cheng. It ruled that all profits obtained by Cheng by reason of his fiduciary position were to be held by him as a trustee of Smart Wave, and that he was liable to account for them.(7) However, the calculations were limited to when Smart Wave ceased business (ie, in 2010), because subsequently, Cheng was no longer in a position of conflict.
Court of Final Appeal
Permission to appeal was refused by the Court of Appeal on the basis that the questions formulated were not reasonably arguable, concerned well-established principles of fiduciary duty and shareholder consent and were otherwise fact specific.(8) Cheng therefore sought permission to appeal from the Court of Final Appeal,(9) submitting six questions concerning:
- the scope of the 'no conflict' rule of a director's fiduciary duties;
- the application of the Duomatic principle of informal shareholder consent;(10) and
- the position taken by a nominal representative in a derivative action (ie, Jason Poon) compared with his personal capacity.
On August 5 2015 the Appeal Committee of the Court of Final Appeal granted permission to appeal two of the six questions as matters of great general or public importance.
Comment
The issues raised in the forthcoming appeal demonstrate that the scope of a director's fiduciary duties is often difficult to define. Although Cheng's opening of the other sushi restaurants appears to conflict with the interests of the shareholders of Smart Wave, the Court of Final Appeal has seen merit in granting Cheng permission to challenge this very point.
The 'no conflict' ground of appeal is illustrated in Australian case law, which has held that the duty owed by fiduciaries:
- does not attach to every aspect of the fiduciary's conduct;
- is very much fact specific; and
- "should only be applied to a state of affairs which discloses a real conflict of duty and interest and not just some theoretical or rhetorical conflict".(11)
Smart Wave's agreed modus operandi was to operate one restaurant only. The Ajisen shareholders' agreed modus operandi was to incorporate one company for each operation of sushi restaurants, which was mirrored in the Hero Elegant agreement. With this in mind, did Cheng subject himself to a real conflict of duty and interest to Smart Wave by opening the Itacho and other Itamae restaurants? If so, was Cheng permitted by the company to do so because it was done with the unanimous assent of Smart Wave's shareholders (ie, under the Duomatic principle)?
In a dense 'foodie' destination city such as Hong Kong, a sushi restaurant opened as few as two subway stations away will often not affect the business of the first sushi restaurant enough to pose a real conflict of duty and interest for someone like Cheng. While it may have distracted Cheng's attention from developing the first Itamae restaurant, at what point would a real conflict of duty and interest arise?
The 'as of right' monetary threshold to appeal a civil judgment to the Court of Final Appeal was abolished in late December 2014.(12) However, the Court of Final Appeal is continuing to exercise its discretion to grant permission for final appeals in an interesting range of civil cases.(13)
For further information on this topic please contact Rebecca Wong or Gary Yin.
(2) Smart Wave initially had nine shareholders, including Cheng and the Poons, who had always remained its three major shareholders.
(3) The parties to the Hero Elegant agreement were in fact Cheng and Fine Elite Group Ltd. Fine Elite was a corporate vehicle set up by the Poons, of which they were the only shareholders.
(4) Fine Elite also commenced proceedings against Cheng for specific performance of the Hero Elegant agreement, which the court dismissed on the basis that Fine Elite was in repudiatory breach of the Hero Elegant agreement (see Fine Elite Group Ltd v Cheng Wai Tao [2013] HKEC 804, May 24 2003 (HCA 1269 of 2008 and HCA 304 of 2011)).
(5) Supra note 4 and Poon Ka Man Jason v Cheng Wai Tao [2013] HKEC 1937, December 6 2013 (HCA 1269 of 2008 and HCA 304 of 2011). The latter judgment was to deal with a question raised by Jason Poon after the first decision on whether Smart Wave was entitled to an account of profits.
(6) Poon Ka Man Jason v Cheng Wai Tao [2015] HKEC 114, January 21 2015 (CACV 135/2013).
(7) Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134.
(8) Poon Ka Man Jason v Cheng Wai Tao [2015] HKEC 757, May 8 2015 (CACV 135/2013).
(9) Supra note 1.
(10) This is a principle, derived from Re Duomatic Ltd [1969] 2 Ch 365, that where all shareholders of a company unanimously assent to a matter that is capable of being assented to at a general meeting, then that assent is as binding as if the resolution was passed by the shareholders at a general meeting.
(11) Canberra Residential Development v Brendas (2010) 80 ACSR 270 at Paragraph 36.
(12) For further details please see "Civil appeals – one shot as of right only".
http://www.internationallawoffice.com/newsletters/detail.aspx?r=30760&redir=1
(13) At the time of writing, the Appeal Committee of the Court of Final Appeal has granted leave to appeal in four out of eight applications since the removal of the 'as of right' appeal to the Court of Final Appeal, including Tsit Wing (Hong Kong) Co Ltd v TWG Tea Company Pte Ltd, FAMV 6/2015, May 20 2015 and FAMV 6/2015, June 22 2015. For further details please see "Final appeal over tea brewing".
http://www.internationallawoffice.com/newsletters/detail.aspx?r=31825&redir=1
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