Background

The dispute concerned shares in Yangtze River Development Ltd (YRIV), a PRC based company listed on the NASDAQ. YRIV achieved NASDAQ listing in December 2015 through a “reverse merger” process, which became popular after the global financial crisis of 2008. The process involves a private company acquiring an existing, but often defunct, U.S. public company that still carries a symbol on a U.S. stock exchange. This enables the private company quickly to begin trading in the U.S. with the gravitas of a listed company, without having to go through the rigors of an IPO.

In the case, the key parties were Fortunate Drift Limited (FDL) and Canterbury Securities, Ltd (CSL). The sole asset of FDL, a BVI company, was said to be its shares in YRIV. CSL, a Cayman Islands securities investment company, provided brokerage services to FDL pursuant to a Brokerage Contract. FDL deposited 6 million of its YRIV shares with CSL for trading purposes.

In order to obtain finance, FDL entered into a Stock Purchase Agreement (SPA) with PFS Management Limited (PFS) in which PFS bought a certain number of YRIV shares from FDL for US$10 million. The SPA contained a put option allowing PFS to sell the shares back to FDL at a prescribed price. FDL was required to secure its obligations under the put option by leaving a sufficient amount of YRIV shares with CSL.

FDL and CSL became embroiled in a dispute which resulted in FDL terminating the Brokerage Contract and demanding the return of its YRIV shares held by CSL.  CSL refused to return any shares and subsequently sold a proportion of the YRIV shares purportedly to preserve the value of the security, should PFS exercise the put option. CSL said it took this action in response to the publication of a public report by Hindenburg Research, which was going to (and did) destroy YRIV’s share price.

During the relevant period, including when FDL demanded the return of the shares, YRIV’s share price was around US$11.50. After publication of the Hindenburg Report, YRIV’s share price collapsed. By the time of trial, the shares were worthless.

FDL brought proceedings against CSL for (amongst other things) breach of contract, breach of fiduciary duty, conversion and unjust enrichment. FDL succeeded in its claims, including its claim that CSL had unlawfully retained the YRIV shares following FDL’s demand for their return.[1] Justice Kawaley held that CSL should have returned 50% of the shares, as they were not needed to secure the obligations under the put option. The judgment on liability was handed down on 17 August 2023.

Decision

On 31 January 2024, the Court delivered a ruling on the measure of contractual damages applicable in the case. The primary issues in dispute were (i) what is the ordinary measure of damages in a temporary deprivation of property case, and (ii) in what circumstances should the ordinary measure be displaced?

FDL argued that the ordinary measure of damages was the market price of the shares at the time of the breach less the contract price. Conversely, CSL argued that the ordinary measure did not apply at all to cases of temporary deprivation.[2] Alternatively, CSL argued that it was not appropriate to apply the ordinary measure in the current factual context because FDL would not have, and/or could not have, sold the shares had they been returned.

Legal Principles

The Court held as follows:

  1. In temporary deprivation of property cases in breach of contract, damages will ordinarily be measured by reference to the difference (if any) between the market value of the property when the breach of contract or duty occurs, and the market value when it is recovered.[3]
  2. The plaintiff does not need to prove that it would have sold the property if it had been lawfully returned.
  3. The ordinary rule is not universal. It may be displaced where its underpinning logic is not engaged, such as in circumstances where  the owner could not have, even if they wished, liquidated the property at the prevailing market price upon its return.
  4.  The onus is on the defendant to put the plaintiff to strict proof of its loss. However, even if the defendant does not do so, it may be clear from the evidence that the ordinary rule cannot sensibly be applied.
  5. In assessing damages where the ordinary rule is displaced, the Court must make an estimate as to what the chances are that a particular thing would have happened, and reflect those chances in the amount of damages awarded. For example, the Court may reduce the award which would otherwise have been made on a ‘pure’ market price basis, where this reflects more accurately the true market value.

Decision on the Facts

On the facts, CSL had not pleaded nor adduced evidence at trial that FDL would not or could not have sold the shares had they been returned. FDL therefore was not required to respond to the issue with positive evidence of its own.

However, evidence had been given at trial that (i) it was generally difficult to sell a large block of thinly-traded shares at one time without having a negative impact on the YRIV share price; and (ii) FDL had sought to limit the size of shares available in the market based on concerns about short-selling. In light of these considerations, the Court held that the ordinary rule should be displaced to do justice. Accordingly, the Court applied a 50% discount to the YRIV share price as at 26 October 2018 (when the relevant demand was made) to take into account the “real world value” of the shares. FDL was therefore awarded 50% of the total claimed (US$16.1 million reduced from US$32.2 million). The Court emphasised that the reduction was necessary to reflect the real market value of the shares, as opposed to reflecting that FDL had not proven actual loss (because it would not, and/or could not, have sold the shares).

Comment

  1. The case helpfully provides guidance on the measure of damages in temporary deprivation of property cases. The ordinary rule is that damages will generally be measured by reference to the difference (if any) between the market value of the property, when the breach of contract or duty occurs, and the market value when it is recovered.
  2. The ordinary rule is intended to provide parties with certainty in these types of cases. The market price at the date of wrongful retention and the date of return, in temporary deprivation cases, are rational reference points for ascertaining the quantum of any loss. In applying a sensible and principled approach, commercial actors and litigants should be able to work out more easily where they stand in these types of disputes.
  3. While the ordinary rule will be the starting point in most cases, the case illustrates that it is not a strict rule and there will be circumstances, such as this case, where the rule will be displaced. This is appropriate because there are likely to be many temporary deprivation of property scenarios where it is appropriate to reduce the damages awarded to a plaintiff – for example, where the plaintiff never intended to sell the unlawfully detained property.
  4. The decision highlights the importance of properly preparing and pleading your case from the outset. Cases of temporary deprivation of property will often turn on the counter-factual, which can be difficult for a plaintiff to make out. Had CSL put FDL to strict proof that it would not, and/or could not, have sold the YRIV shares had they been returned, it arguably may have avoided liability altogether.

[1] Whether the put option was waived is currently being litigated before the Nevada Court. If the option is held in those proceedings to have been waived, the Grand Court judgment on liability provides that all YRIV shares should have been returned by CSL on demand by FDL.
[2] This position was developed by CSL in written submissions filed after the hearing. The Court noted that during oral argument CSL had taken a different position – and had not appeared to dispute FDL’s position on the ordinary measure but instead took issue with its application on the facts of this case.
[3] In making this determination, the Court regarded as binding or highly persuasive the Privy Council decision of Solloway v McLaughlin [1938] AC 247, and declined to follow the English Court of Appeal decision of Brandeis Goldschmidt & Co Limited v Western Transport Limited [1981] QB 864.

Key Contacts

David Lee

Partner: Cayman Islands

T +1 345 814 2083
E Email David

Daniel Coelho

Senior Associate: Cayman Islands

T +1 345 814 2752
E Email Daniel

Crystal Au-Yeung

Counsel: Hong Kong

T +852 2905 5767
E Email Crystal

Ray Leung

Associate: Hong Kong

T +852 2905 5718
E Email Ray

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