Galleria (Hong Kong) Ltd vs DBS Bank Ltd (Hong Kong Branch) [2021] HKCA 611    

The HK Court of Appeal ("Court of Appeal") decided on an action brought by a liquidator against a bank on three fraud related causes of action in relation to banking facilities granted to a borrower. The Court discussed the mental elements required on the part of the wrongdoer, eventually finding that the bank's actions did not amount to fraudulent conduct.

Facts

Galleria (HK) Ltd ("GHK"), was financed by borrowings from DBS Bank Ltd, Hong Kong Branch ("Bank") and other banks. Over the course of 2004 – 2009, GHK's directors used falsified bills of lading ("B/Ls") to continually obtain loan facilities and other lines of credit from the Bank and other banks. In 2006, the Bank inquired on the validity of some B/Ls with the International Maritime Bureau of the International Chamber of Commerce ("ICC-IMB") as part of a routine check, and was notified that some of the B/Ls were false. After investigating internally, the Bank found that there were plausible reasons for the inaccurate information in the B/Ls and subsequently decided to increase its credit facilities to GHK.

However, during the period of the Subprime Crisis, the Bank reduced its lending to GHK, whilst other banks increased their funding. GHK's fraudulent activities were discovered by the other banks in 2009, who petitioned to wind up GHK and other related companies. GHK's liquidators claimed against the Bank for three fraud related causes of action: (a) knowing receipt; (b) dishonest assistance; and (c) fraudulent trading, allegedly causing a loss of about US $185.5million.

Issue

Given that it was the same factual case for each of the three causes of action, the question was whether the Bank's officers knew, suspected or turned a blind eye to GHK's fraud.

The HK Court of First Instance ("Court of First Instance") Decision

Legal Principles

Each of the three causes of actions required proof of a dishonest mental element on the part of the wrongdoer. Summarily, the court highlighted the following legal principles applicable to the case:

a) whether a person is honest or dishonest given what he knows is to be objectively assessed, even if the question of a person's state of mind is a subjective one;

b) carelessness or negligence are not in themselves dishonesty;

c) The knowledge of innocent minds in different people in the company cannot be aggregated to create a "notional super-mind" that is deemed to be dishonest; and

d) blind-eye knowledge requires a person's suspicion of facts, and the making of a conscious decision to refrain from taking steps to confirm the existence of such facts.

Importantly, the Court of First Instance reiterated the high threshold for such fraud related claims, requiring proof based on cogent and "compelling evidence".  In this light, the Court of First Instance extensively examined the various email correspondences and reports in detail ("Contemporaneous Documents"), as well as the Bank officers' actions during the period of GHK's fraudulent activity.

Application to the Facts

The Court of First Instance ultimately rejected all three causes of action and found that the Bank officers had not acted dishonestly in continuing to lend to GHK.

Prior to 2006, GHK and the Bank have had a successful banking relationship for three years. After receiving the ICC-IMB report questioning the B/L's authenticity, the Bank's internal checks revealed that it was not unusual for some B/Ls to not be in order. Given the Bank officers' level of experience in fraud cases at that time, particularly in relation to ICC-IMB checks, there was inadequate reason for them to suspect that GHK was carrying on a fraudulent business, and to this end, "fraud" was only mentioned in two of the bank documents.

The Court of First Instance ultimately found that the Bank officers did not have knowledge of the fraud, had no motive to act dishonestly and did not seriously suspect any foul play. It was simply untenable that all of the Bank officers involved, with neither personal motive, collective interest nor discussion, had simultaneously turned a blind eye and continued lending to a fraudster. The Bank officers' decision to stop the internal investigations of the B/Ls was in fact "inconsistent with a mind suspecting a serious fraud against the Bank".

The Court of Appeal Decision

GHK's liquidators challenged the decision on the broad basis that the Court of First Instance had:

a) misapplied the law in relation to the mental element of the three causes of action; and

b) made incorrect factual findings and drew inaccurate inferences from such findings regarding the knowledge and dishonesty of the Bank officers.

However, the Court of Appeal ultimately affirmed the Court of First Instance's decision and agreed that the evidence did not suggest that the officers were dishonest or fraudulent in their conduct in relation to GHK. The Court of Appeal found that that the Court of First Instance had carefully considered the Contemporaneous Documents and oral testimonies in light of all relevant circumstances and did not overlook any pertinent evidence in its analysis of the case. Furthermore the Court of First Instance did not treat the inherent improbability that a Bank would act dishonestly or the lack of motive on the part of the Bank officers as decisive, nor did it incorrectly apply the law.

GHK's liquidators highlighted that the Court of First Instance failed to account for the 'countervailing evidence' and focused on a single relevant decision maker of a senior credit officer ("Senior Credit Officer") from whose the Bank's dishonesty could be attributed. It was argued that the Senior Credit Officer had motive to act dishonestly by continuing to lend to GHK to avoid the collapse of GHK and to enable the Bank to exit the lending relationship in a controlled manner.  However, the Court of Appeal found the 'countervailing evidence' was "entirely speculative", insufficient to overturn the Court of First Instance's findings and failed to suggest that the Bank had colluded with GHK. Firstly, the Senior Credit Officer was not the sole or most senior decision maker and there was no reason as to why solely his knowledge should be attributed to the Bank. The decision to discontinue investigations was also made collectively by various Bank officers and not the Senior Credit Officer alone. That such further investigations could have been easily made but were not done so further suggested a lack of suspicion on the part of the Bank officers. Finally, the Bank officers' decision to reduce the facilities provided by the Bank was made in relation to the Subprime Crisis, coupled with "over-financing" concerns that arose even before the first ICC-IMB report.

Thus, the Court of First Instance was entitled to conclude that the Bank officers did not know, suspect or turn a blind eye to GHK's fraud, and there was no justification in overturning its findings of fact nor its inferences from such facts. It was also clear that DBS was a victim of GHK's fraud and there was no dishonesty on the part of the Bank.

In arriving at its decision, the Court of Appeal also referred to the following additional principles applicable to the case:

a) Purpose of Contemporary Documents and oral testimony: The Court of Appeal highlighted that the Contemporaneous Documents "spoke for themselves" and were the "most important evidence" in determining whether the Bank officers were dishonest or had knowledge of GHK's fraud. Factual findings and inferences should be drawn from documentary evidence and known or probable facts. In contrast, oral testimony should primarily be used to gauge the credibility, personality, motivations and working practices of the witness.

b) Incompetence is not equivalent to dishonesty: The Court of Appeal reiterated that the standard of dishonesty is higher than that of negligence, and further added that an "inability and even incompetence to see what others may reasonably or readily see is not a manifestation of dishonesty."

c) Subsequent conduct may be used as evidence of dishonesty: in determining the mental state of a wrongdoer, a court is not prohibited from looking at a wrongdoer's subsequent conduct in determining whether he has acted dishonestly, and that doing so accords with common sense. Hence, it was acceptable for the Court of First Instance to have regard to the relationship between the Bank officers and GHK after the 2006 ICC-IMB report. In doing so, it found their conduct consistent with a 'perfectly normal and genuine relationship between a bank and a large corporate borrower'.

Conclusion

This case is a timely reminder to banks in relation to the management of a fraudulent account.  It is important for bankers to understand the potential legal liabilities and risks which may arise in the course of handling a fraudulent account.  Bankers should also be mindful of both contemporaneous external as well as internal correspondences, which play a vital role in the outcome of a case and can either improve or compromise their position in contentious matters.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.