The Cross-Undertaking in Damages in the Court of Appeal

An interlocutory injunction would usually carry with it a cross-undertaking in damages, for the Applicant to be liable for any damages suffered by the Respondent or third parties resulting from the wrongly granted injunction order.

Usually, the question of whether the cross-undertaking should even be enforced would not arise given that merits of the underlying Action supporting the injunction would be determined following Trial.

The Court of Appeal’s judgment in Shih-Hua Investment Co Ltd v Zhang Aidong And Others [2023] HKCA 1304 on 23 November 2023 was a special case where the underlying Petition supporting the injunction order did not proceed and Everglory Energy Ltd (the “Company”) had been wound up on other grounds.

Even without determining the merits of the allegations in the underlying Petition, the Court was able to enforce the undertaking, with reference to the matters that transpired after the grant of the Order.

The shareholders of the Company had a bitter and complicated litigation history, with 2 separate actions brought by Shih-Hua Investment Co., Ltd (“Shih-Hua”) on almost identical allegations of misconduct against the Respondents in managing the affairs of the Company.

Shih-Hua issued a Petition in HCCW 198/2016 (the “HCCW Action”) on 20 June 2016, seeking a buy-out order or winding up relief on the just and equitable ground, and made a number of applications for interim relief.

Notwithstanding the existence of the Petition, Shih-Hua commenced a common law derivative action in HCA 2682/2016 (the “HCA Action”), raising similar complaints to those in the Petition and obtained ex parte injunctive relief, including an order to restrain the Defendants from dealing with the money of the Company.

On the application of Shih-Hua in the HCCW Action, A. Chan J made an order that two professional accountants proposed by the Major Creditors (“New Directors”) were appointed to the Board, and Mr. Zhang was restrained from exercising directors’ power (the “Reconstitution Order”).

Thereafter, on the application of the Defendants in the HCA Action (which consisted of some of the Respondents), an order for the strike out of the HCA Action (“HCA Strike Out Order”) was granted. The Court (Harris J) criticised Shih-Hua’s conduct, including in particular their actions following the Reconstitution Order and the appointment of New Directors.

The two Actions appeared to be cut abrupt when a Master ordered the winding-up of the Company on insolvency grounds, based on the petition of a major creditor of the Company.

Shih-Hua’s appeal of the HCA Strike Out Order was dismissed by the Court of Appeal.

On 19 November 2020, the Respondents and two Interveners, issued an application by Summons to enforce Shih-Hua’s undertaking as to damages in relation to the Reconstitution Order.

On 25 February 2022, Harris J handed down his Decision ordering an inquiry as to damages to be heard before a Master (the “Decision”), which ordered the enforcement of the cross-undertaking in damages: see [2022] 1 HKLRD 1376.

The Court accepted the submissions of the Respondents and the Interveners, which drew from the observations of Shih-Hua’s conduct and the matters that occurred after the grant of the Reconstitution Order in various previous judgments in the two Actions (see §16):

• Having procured the appointment of independent directors to manage the affairs of the Company, Shih-Hua failed to put them in funds to do so and, in particular, proceed with the claims against the Respondents advanced in the Action. No explanation has ever been provided for this.
• The evidence did not support Shih-Hua’s case that there had been diversion of assets.
• Even when independent professional persons were placed in charge of the Company, they did not consider it appropriate to prosecute the claims in the Action. They stated this was for two reasons: not only because of insufficient funds, but also as they have not been able to gather relevant information regarding the claims because the books and records of the Company are incomplete and allegedly false.
• Insofar as Shih-Hua argues that the application cannot properly be advanced until the Reconstitution Order has been set-aside or discharged, this was the substantive effect of the winding up order.
• Shih-Hua had chosen not to prosecute the shareholder’s petition, as the primary relief sought by Shih-Hua was a buy-out order that could still be sought if its wished to despite the Company being wound up.

The Court commented, inter alia, that “the Reconstitution Order was wrongly granted and was sought not for the reasons advanced, but as a tactical device” (at §19). The Court then found sufficient evidence of loss (at §21).

Shih-Hua appealed on 5 grounds, which can be broadly stated as follows:

• Harris J’s decision that the Reconstitution Order was wrongly granted was based on improper inferences and presumptions and not in accordance with the evidence.
• There was no new evidence to warrant Harris J’s decision that the Reconstitution Order was wrongly granted.
• There is an inconsistency between the Decision and the decision for the HCA Strike Out Order.
• An incorrect test was applied by the judge in considering whether the Respondents and Interveners had suffered loss.
• The discretion to order an inquiry was not exercised judicially with regard to all the relevant circumstances.

The Court of Appeal (consisting of G. Lam JA and Barma JA) rejected all 5 grounds. G. Lam JA gave Judgment of the Court.

Grounds 1, 2, 3 and 5 were challenges to factual findings and the exercise of discretion by Harris J. The Court of Appeal did not accept the submissions of Shih-Hua that there were any such errors in fact or errors in the exercise of discretion. The Court of Appeal was reminded that an appellate court would not interfere with a judge’s exercise of discretion except where the established, special grounds are shown, such as that the judge has misunderstood the law or the evidence or the exercise of his discretion was plainly wrong such that it was outside the generous ambit within which reasonable disagreement is possible: see §57, citing Cheung Kam Wah v Cheung Hon Wah & Ors [2005] 1 HKC 136 at §17.

Moreover, the Court of Appeal provided useful and authoritative guidance on the principles of enforcing the cross-undertaking for damages for an injunction, quoting and drawing from various threads of authorities in England and Wales and Hong Kong:

1. An order for inquiry into damages on the cross-undertaking can be made on the basis that, regardless of the ultimate merits of the action, the injunction was ‘wrongly granted’: at §34, quoting from Yukong Line Ltd v Rendsburg Investments Corp & others[2001] 2 Lloyd’s Rep 113 per Potter LJ.
2. The term ‘wrongly granted’ covers the far wider circumstances in which the injunction may be discharged and an inquiry ordered than the term ‘wrongly obtained’. In respect of those wider circumstances it is necessary to distinguish between the position where the order is attacked on the grounds that the Court lacked jurisdiction to make it and the position where the Court makes an order within its jurisdiction but which is subsequently demonstrated or conceded to have been too wide in its scope or unjustified or inappropriate on the facts: at §34, quoting from Yukong.
3. The question whether the undertaking should be enforced is a separate question from the question whether the injunction should be discharged. The order for an inquiry as to damages is discretionary, such discretion being exercised in accordance with equitable principles, taking into account all the circumstances of the case, but bearing in mind that, since the injunction should not have been obtained, prima facie the plaintiff ought to bear the loss: at §35, quoting from
4. Whether an interim order was wrongly made is judged retrospectively, with the benefit of hindsight.  There is no need to demonstrate that the court’s original decision to grant the interim order was wrong or unjust when it was made. Nor is there any need to prove fault on the part of the party that obtained the interim order: at §36.
5. At the stage of exercising its discretion whether to order an inquiry the court does not hear protracted argument on whether the suggested loss is recoverable.  The court need only be satisfied there was credible evidence that the party in question had suffered loss which was prima facie or arguably caused by the order.  Thereafter it is a matter to be resolved at an inquiry: at §54.

This case further serves as a reminder that in applying for an injunction, the Applicant’s actions both before and after the grant of the injunction will be scrutinised when the Respondent seeks to enforce the cross-undertaking in damages.

In this case, Shih-hua’s failure to provide an indemnity or undertaking as agreed contributed to the lower Court’s finding that the injunction was “wrongly granted” for the enforcement of a cross-undertaking in damages. As the Court of Appeal underscored: “The fact was that having excluded Zhang from management, Shih-Hua did not fund or provide an indemnity to the New Directors for carrying out what they independently considered to be the priorities”: at §44. This supported a finding that the Reconstitution Order was wrongly granted.

William Wong SC, Lai Chun Ho and Terri Ha acted for the 1^st and 2^nd respondents and the 1^st and 2^nd interveners.