A China Hustle? The Cayman Islands Court Says, “No” – Claritas Successfully Rebuts Allegations of Fraud in Establishing Claims for Breach of Contract and Fiduciary Duty

On 17 August 2023, The Honorable Mr Justice Kawaley handed down judgment in the matter of Fortunate Drift Limited v Canterbury Securities, Ltd (FSD 227 of 2018) following a two-week trial in the Grand Court in June 2023. Katie Pearson of Claritas successfully acted for the Plaintiff, Fortunate Drift Limited (“FDL”), instructing Stephen Atherton KC of Twenty Essex, who was assisted by Rupert Coe and Mark Baldock, both of Three Stone Chambers. The 76-page judgment is available here.

FDL is a BVI company, whose principals are based in Hong Kong and mainland China.  The Defendant, Canterbury Securities, Ltd (“CSL”), is a Cayman-registered company doing business in the Cayman Islands.  CSL is a “registered person” under the Securities Investment Business Act (2020 Revision). FDL deposited shares in a NASDAQ-listed company, “Listco”, with CSL in August 2018.

In order to help FDL obtain finance, CSL introduced FDL to PFS, Ltd (“PFS”) as a potential purchaser of Listco shares. Following the introduction, FDL and PFS, with the assistance of CSL, signed a Stock Purchase Agreement (the “SPA”), whereby PFS purchased 1,144,584 shares in Listco from FDL for US$10,000,000.  The SPA was governed by Nevada law.

The SPA contained a put option allowing PFS to put the purchased shares back to FDL.  FDL agreed to leave sufficient shares in its account with CSL to cover its obligations under the Put Option, if it was exercised by PFS.

In the events that unfolded between the conclusion of the SPA in August 2018 and December 2018:

  • FDL discovered that the owner of PFS was Erin Winczura, who was also “the face of CSL” (Judgment, paragraph [11]). Previously, CSL “gave the impression it was a neutral actor in the transaction and made it impossible for FDL to identify any connection between CSL and the ‘third party’ purchaser before it was committed to consummating the transaction” (Judgment, paragraph [61](d)).
  • FDL suspected that PFS had waived the Put Option by selling the purchased shares, and therefore sought the return of the Listco shares deposited in its account with CSL. Whether or not the Put Option was waived is the subject of separate proceedings before the Nevada courts.
  • On 6 and 7 December 2018, CSL sold a portion of FDL’s Listco shares for US $19,959,397.18, supposedly to protect PFS’ position should the Put Option be exercised. CSL claimed that the need to sell was precipitated by the publication of an article by the notorious US-based short seller Hindenburg Research, which alleged that Listco was a fraudulent scheme to siphon money away from U.S. public markets.  At the time, Hindenburg Research itself held a short position in Listco.

FDL issued proceedings against CSL seeking relief for:

  • Breach of fiduciary duty in failing to disclose the connection between CSL and PFS arising out of Ms Winczura’s interests in both companies.
  • Breach of duty and/or conversion of FDL’s shares because it sold shares on 6 and 7 December 2018 without FDL’s authority.

CSL defended the claim on a number of bases, the most prominent of which was that FDL was not entitled to relief because it was party to Listco’s alleged “fraudulent scheme to inflate the price of its publicly traded shares artificially” (Judgment, paragraph [106]). CSL had suggested in the course of the trial that the context of this case was similar to that explored in documentary “The China Hustle”, which “exposed the way in which some Chinese companies listed on the US Stock Market fraudulently exploited the greed of Western investors hoping to make easy profits through investing in China” (Judgment, paragraph [3]).

In the event, Kawaley J found as follows:

  • CSL did owe FDL fiduciary duties “which obliged it to disclose that PFS was a closely connected entity and act in good faith to FDL with a view to mitigating any relevant conflicts of interests” (Judgment, paragraph [61]). That was a finding of particular note, given the reticence of the law to impose fiduciary duties on experienced commercial actors who are parties to a commercial relationship.
  • CSL breached those duties by “failing to disclose and failing to effectively mitigate the very significant conflicts of interest when it decided to liquidate the Collateral Shares in early December 2018” (Judgment, paragraph [63]).
  • CSL breached its contractual duties to FDL in failing to return the portion of FDL’s Listco shares which would not have been needed to cover the Put Option (which the Judge concluded was at least 45% of the shares which FDL had deposited with CSL) (see Judgment, paragraphs [64]-[76]).
  • CSL breached its contractual duties to FDL in selling the shares on 6 and 7 December 2018 because it did so contrary to the instructions on which CSL held the shares (Judgment, paragraphs [77]-[96]).
  • Subject to hearing CSL’s counsel if justice required it, FDL’s alternative claim for conversion of its shares in Listco succeeded (Judgment, paragraph [97]-[101]).

In finding for FDL, Kawaley J rejected CSL’s allegations of fraud, holding that the “pivotal allegation that FDL was engaged in the fraudulent scheme has not been proven” (paragraph [129]).

The upshot of the Judgment is that FDL was successful so far as CSL’s liability to it was concerned. The question of what specific relief it is appropriate to grant will be determined at a further hearing.