EXTRAMONEY LTD AND ANOTHER v. CHAN, LAI, PANG AND CO (a firm)

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JUDGMENT

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Clough, J.A.:

1. This is the judgment of the court.

2. The first plaintiff, Extramoney Limited ("Extramoney"), and the second plaintiff, Carrian Holdings Limited ("CHL") appeal against the order made by Barnett J. on the 4th December 1989 under section 357 of the Companies Ordinance (Cap. 32) requiring the plaintiffs to give the defendant, Chan, Lai, Pang & Co. (a firm of certified public accounts) security for the defendant's costs in this action in the sum of $1.5 million by way of bank guarantee.

3. The plaintiffs are members of the Carrian group of companies. It is common ground on the pleadings that at all material times Extramoney was a sub-subsidiary of CHL through CHL's wholly - owned subsidiaries Carrian Finance Limited and Carrian Realty Limited. CHL is in liquidation, having been made the subject of a compulsory winding up order on a creditor's petition on the 7th November 1983. The joint liquidators of CHL are Mr. T.B. Stevenson and two other partners in a leading firm of certified public accountants.

4. Both plaintiffs are hopelessly insolvent. Extramoney, which is not in liquidation, would certainly not be able to pay any costs which might be awarded against it in favour of the defendant in the action. It is also abundantly clear that if the defendant were to obtain an order for costs against CHL and such costs were required to rank pari passu with CHL's other debts, at the date of the winding up order, then the liquidators would be unable to pay any appreciable amount of those costs.

5. The plaintiffs claim against the defendant in the action arises in connection with the alleged breach by the defendant of its alleged duty to both the plaintiffs in connection with the audit of the 1980 accounts of Extramoney in the course of which it is alleged to have wrongfully passed Extramoney's 1980 profit and loss account which overstated that company's profit by $101,688,640.10. As a consequence of this overstatement it is alleged that Extramoney incurred losses by reason of its liability to pay the Inland Revenue $17,617,556 by way of tax and surcharge. Having discharged this liability as the parent company of Extramoney in reliance upon the defendant's audit report, CHL also claims against the defendant in respect of the same loss.

6. A preliminary point was raised by the court at the hearing of the appeal, namely, whether the plaintiffs were entitled (as they claimed) to bring this appeal without the leave of Barnett J. or of this court, or whether such leave was required under section 14(2)(e) of the Supreme Court Ordinance (Cap. 4) because the learned judge's order was one ".... relating only to costs which are by law left to the discretion of the court or tribunal." This point was raised because it went to the jurisdiction of the court to entertain the appeal: c.f. white v. Brunton [1984] Q.B. 570 (C.A.) at p.573H-574.

7. The matter was only lightly argued, but it seems to us to be clear that this appeal does not require leave under section 14(2),(e). Our understanding is that this is the view that has hitherto been applied in practice in this court without any jurisdictional point being raised.

8. It may be said that in a wide sense the judge's order relates only to costs, because the question of security relates only to costs. Howver, in our opinion, in its application to an order relating only to costs, section 14(2)(e) does not extend to a situation like the present or that arising under Order 23, where the court is not concerned with making any order in the exercise of its discretion relating to the incidence or basis of costs of the parties to proceedings but is primarily concerned with exercising its discretion as to whether to require the giving of security to a party in respect of costs which it might not be awarded at the conclusion of the proceedings.

9. Whilst the court is concerned to quantify the security by making a notional assessment of the likely costs that might be awarded to the applicant if successful in the action, the primary concern of the court is with the factors relevant to the question of the giving or refusing of the security. The order of the court reflects the decision of the court on that question.

10. We are fortified in our opinion on this point by the approach of the English Court of Appeal in Thompson v. Fraser [1986]1 W.L.R. 17 (C.A.) where it was held that an order under Order 62 rule 8 that a solicitor pay a party's costs personably was not an order "relating only to costs" within section 18(1)(f) of the Supreme Court Act 1981 since it related primarily to the conduct of the solicitor and did not relate only or primarily to costs.

11. We add that the jurisdictional question which arose in this case does not arise in England because under Order 59 rule 1A (6) (o) an order for or relating to security for the costs of an action is to be treated as interlocutory and section 18 (1) (h) of the Supreme Court Act 1981 provides for the requirement of the leave of the court or the Court of Appeal as a prerequisite of an appeal against any interlocutory order (with exceptions hot here relevant).

12. Reverting to the substance of the present appeal, the writ was issued on the 21st December 1987 and the statement of claim was filed on the 29th December 1988. The defence was filed on the 8th March 1989. It was not until the 5th June 1989 that the defendant issued its summons for security under section 357. No evidence in support of the summons was adduced until the 20th July 1989 when the affirmation of Mr. Thomas Lai, one of the partners in the defendant firm, was affirmed and filed. In the meantime there had been protracted correspondence between the solicitors for the parties which unhappily failed to achieve the desired compromise on the question of security for the defendant's costs.

13. On the 24th July 1989 the defendant's summons was adjourned by the master to a judge in chambers. By the time the summons came to be heard by Barnett J. on the 4th December 1989 a substantial volume of evidence, much of it consisting of forensic argument rather than fact, had been filed. By the end of the hearing there was no issue on quantum. The parties had agreed that if security was to be provided it should be in the sum of $1.5 million. The substance of the defendant's evidence by Mr. Lai was that the plaintiffs were both hopelessly insolvent and that the liquidators of CHL who claimed to hold substantial assets had not given any details about the amount of those assets, about the amounts of the creditor's claims or about the proceedings brought by and against the liquidators.

14. The liquidators relied on the evidence of Mr. Stevenson who acknowledged that there were potential creditors' claims which, if admitted to proof, would swamp the assets held by the liquidators of CHL, but he emphasised that any judgment for costs against the liquidators of CHL would be a liquidator's expense and have priority over creditors' proofs of debt. As to the reluctance of the liquidators to make detailed disclosure to the defendant, Mr. Stevenson invoked the normal practice of liquidators not to disclose the amount of the liquidation assets or creditors' proofs to persons not involved in the liquidation.

15. However he went on to depose that the "....assets in the CHL liquidation are the equivalent of several times the value of the Plaintiffs' claim herein (HK $17.5 million) and many times greater that (sic) the value of the Defendants' request for security (HK $2.1 million)."

16. As regards a prospective order for costs in favour of the defendant against Extramoney, Mr. Stevenson deposed:

17. Mr. Stevenson was at pains to emphasise, to allay anxiety expressed in Mr. Lai's evidence concerning the ear marking of assets of CHL or distribution to creditors, that any order in the action for costs against the liquidators would take priority over creditors' proofs and over the liquidators' fees. He concluded his evidence with the following undertaking:

18. The defendant was not satisfied that Mr. Stevenson's evidence and undertaking established that they did not required the protection of an order for security for costs. In a second affirmation Mr. Lai complained inter alia that the defendant's position would be precarious if, before the conclusion of the action, the liquidators were to pay (1) the professional fees and disbursements of the liquidation (which could be paid from time to time) (2) the costs of other litigants in proceedings involving the liquidators and (3) claimants and creditors. In particular Mr. Lai complained of lack of information of the costs of litigation in which the liquidators were involved and of the risk of other litigants achieving priority over the defendant by obtaining orders for security for costs.

19. The liquidators relied on the evidence of their solicitor Mr. C.J. Passmore which included information about other pending proceedings in which they were involved. Two actions were mentioned. CHL by the liquidators was one of two plaintiffs in an action against a firm of solicitors who had previously acted for the Carrian Group. No order for security for costs had been made against the liquidators in that action, the defendants having been satisfied with appropriate undertakings given by Mr. Stevenson. In another action brought. by China Underwriters Limited (in liquidation) against Bumiputra Malaysia Finance Limited (now called BBMB Finance (Hong Kong) Limited) the service of a third party notice on CHL was imminent. Mr. Passmore also confirmed that the Creditors' Committee (by which we take it that he meant the committee of inspection of CHL) had approved the giving of the undertaking which Mr. Stevenson had offered on behalf of CHL in CHL'S solicitors letter dated the 4th July 1989. None of this evidence satisfied the defendant, as the further evidence of Mr. Lai indicated.

20. The judge gave an extempore judgment in which he rehearsed his understanding of the arguments of counsel and then concluded first that, on the evidence before him, CHL had not rebutted the presumption of insolvency which arose by reason of its being in liquidation. His reasoning for this conclusion was as follows:

21. The judge then indicated that, having regard to the principles laid down in Sir Lindsay Parkinson & Co. Ltd. v. Triplan Ltd. [1973] 1 Q.B. 609 (C.A.), he considered CHL should give security. As regards the undertakings proposed by the liquidators he said:

22. Having concluded that CHL must give security the judge could see no reason why Extramoney should not also give security. He went on to comment on what he termed "the Murjani decision". While no objection can be taken to such a reference in an oral extempore judgment, we venture to suggest that it would be helpful to this court and to law reporters and practitioners if the proper citation is added when the judgment is subsequently reduced to writing.

23. Section 357 of the companies ordinance provide as follows:

24. An applicant for security for costs under that provision must therefore establish, before the court's discretion becomes exercisable, that there is reason to believe that the company in question will be unable to pay the costs of the applicant defendant if successful in his defence. However it is well settled that where a company is in liquidation it is presumed to be insolvent and will therefore be unable to pay the relevant costs. In the present case CHL was required to rebut that presumption.

25. In our judgment the judge demonstrably misdirected himself in law when considering whether CHL had rebutted the presumption in the present case. In the first passage of his judgment cited above he clearly attributed the "serious trouble" in which CHL found itself to "the prospective creditors, one of whom is a prospective creditor for something.... in excess of HK$1 billion." It was for this reason that the judge regarded Mr. Stevenson as ".... saying that although he has the money now, before this action is concluded, he may not."

26. In the same passage the judge mentioned that he had already referred to the prospective creditors of CHL. In the earlier part of this judgment he had done so in the following terms when summarising Mr. Kaplan's arguments on behalf of the defendant:

27. We are accordingly constrained to conclude that, when considering the evidence relied upon by the liquidators to rebut the presumption, the judge overlooked the important principle that expenses incurred in winding up a company are payable, not provable and that any costs awarded to the defendant against the liquidators in this action would have to be paid in full in priority to the costs of the liquidation, including the liquidator's own costs of the action, and that execution for them will not be restrained: see Buckley, 14th edition, volume 1 at p.568 citing Madrid Bank v. Pelly (1869) L.R. 7 Eq. 442; Re Dominion of Canada Plumbugo Co. (1884) 27 Ch D.33 (C.A.) and Re Pacific Coast Syndicate, Limited [1913]2 Ch 26, all cases relied upon by Mr. Barlow for the liquidators on appeal: see also section 265(4) of the Companies Ordinance and rule 179 of the Companies (Winding-up) Rules.

28. Mr. Barlow assured us that he cited Re Pacific Coast Syndicate, Limited to the judge. We think it unfortunate that the judge did not refer to that case in his judgment. If he had done so we venture to think that he would not have misdirected himself. In the event his finding on the question whether the liquidators had rebutted the presumption of insolvency for the purposes of section 357 was fatally flawed.

29. Considering the evidence on the footing that the liquidators were not entitled to pay any proving creditor or their: own costs of litigation in priority to any costs for which they might be held liable to the defendant in this action, we conclude that on any realistic footing the liquidators hold ample assets to meet the defendants prospective costs which had been agreed at $1.5 million.

30. On the evidence before the judge there were two other actions to take into account by reason of the liquidator's involvement, or, in the case of the third party proceedings, likely involvement. At the hearing of the appeal Mr. Barlow drew attention to a judgment of Jones J. concerning the winding up of CHL which was handed down on the 2nd February 1990. It appears from that judgment, and from what Mr. Barlow informed the court on instructions, that the liquidators have so far recovered a very substantial sum in the liquidation and that they now contemplate bringing a third action (in addition to the present action and the other two actions mentioned in Mr. Passmore's affidavit) to recover two properties. Mr. Barlow informed this court that there was a possibility of further litigation by the liquidators but they had no present intention of starting any fresh action. When considering the evidence before the judge we have therefore leaned in favour of the defendant by ignoring the actual amount now known to have been recovered by the liquidators for CHL but accepting that CHL is or will soon be involved in three actions ("the additional actions") in addition to the present action, and will be vulnerable to an adverse order for costs in all the additional actions.

31. Mr. Stevenson's evidence was deliberately general and not fully informative regarding the amount of the assets held by the liquidators. However he had deposed that the assets in question were "several times the value" of the plaintiffs' claim in the action, which he put at $17.5 million. We understand this to mean that the assets amount to a value of at least $51.5 million (i.e. $17.5 million x 3). Bearing in mind that CHL would only be liable for the taxed costs of other parties, that one of the liquidators' additional actions was another negligence claim, that the other was for the recovery of two properties and that the Mr. Barlow informed us that the third party proceedings involved five parties, we consider that it is reasonable to assume that the liquidators are unlikely to incur or to have to pay costs to any particular party in excess of $2.0 million. Assuming that all the additional actions are concluded before the present action, that the liquidators are unsuccessful in all of them and have to meet a double bill of costs, the total liability would be about $12 million (i.e. $4 million x 3). Even if there were subsequent appeals and adverse orders for costs it seems most unlikely that the additional actions, on the gloomiest forecast, could generate a liability of more than $20 million for the liquidators.

32. That leaves a balance of $30.5 million to cover the defendant's prospective costs of $1.5 million and any liquidation disbursements in the mean time. It seems to us that it would be unrealistic to regard the defendant as being in need of protection as to costs in such circumstances bearing in mind that CHL is not trading. In terms of section 357 the liquidators' evidence had rebutted the presumption of insolvency to the extent required and there was no reason to believe that CHL would be unable to pay the costs of the defendant if successful in the action. We were unable to envisage even a small risk to the defendant of the kind identified in the English Court of Appeal in the recent case of Thune v. Roll cited by Mr. Kaplan (reported in the Times newspaper of the 2nd March 1990). We venture to think that the judge would have come to the same conclusion if he had ignored the proving creditors.

33. It follows that in the case of CHL the discretion of the court to order security for costs under section 357 never became exercisable. If there should be a material change of circumstances it would be open to the defendant to make a further application for security: see Gordano Building Contractors Ltd. v. Burgess [1988]1 W.L.R. 980 (C.A.) per Mann L.J. at p.894. Mr. Stevenson, has voluntarily undertaken to the court, as an officer of the court, that he will inform the court and the defendant if the liquidation assets should fall "to a level whereby there may be reason to believe that the Plaintiffs may be unable to pay the Defendants' costs....". It seemed to us that this was a very proper undertaking for a liquidator to give but that it would be wrong to regard it as indicating that under the existing circumstances the defendant is in need of protection under section 357 and is in some way being put to unjustified inconvenience if required to make a fresh application for security in the event of a material change of circumstances.

34. As to Extramoney, there can be no doubt that there is reason to believe that it will be unable to pay the defendant's costs in the action if the defendant is successful. The discretion of the court under section 357 must therefore arise in the case of Extramoney, but, as Lord Denning observed in the Sir Lindsay Parkinson Case at p.626 C-D, the important word in section 357 is "may". The judge is not bound to order security in every case where it is apparent that a company will be unable to pay the costs of a successful defendant.

35. In the present case the nature of the claim made by the plaintiffs is such that it seems to be inconceivable that CHL might succeed against the defendant in circumstances where Extramoney failed and were alone made to pay the defendants' costs. CHL's claim overlaps that of Extramoney. It follows that if Extramoney's claim fails, CHL's claim will also fail and both plaintiffs will be ordered to pay the defendant's costs. But CHL is good for those costs and the defendant can only be entitled to one set of costs if successful in the action. In such circumstances the defendant is fortuitously protected from the insolvency of Extramoney by the assets of its parent company CHL.

36. Furthermore the liquidators, with the sanction of the CHL committee of inspection have offered to give an undertaking to "indemnify" the defendant in respect of the relevant costs. Mr. Stevenson has added to that undertaking (which the defendant refused) his personal undertaking in similar terms. Mr. Stevenson is a partner in a firm of certified public accountants of considerable standing and can be taken to be a man not only of integrity but also of substance.

37. Mr. Kaplan contended that CHL's undertaking might be impugned by creditors of CHL. We agree, but it seems to us to be most unlikely that such an undertaking given with the sanction of the committee of inspection in proceedings intended to recover assets for the creditors of CHL would be challenged at all, let alone effectively challenged, because CHL will in any event be ordered to pay the defendant's costs of the action if Extramoney's claim fails, as in that event CHL's claim will also fail. Mr. Kaplan suggested that it was arguable that CHL's undertaking might only make the defendant one of CHL's creditors and thus be of no value. We cannot accept that argument which seems to ignore the principle that costs and expenses incurred by a liquidator in the winding up of a company on behalf of the creditors ought to be paid in full and are not provable: see Buckley, 14th edition, vol. 1, at p.567, citing Re London and Colonial Company, ex parte Clark (1869) L.R. 7 Eq. 550.

38. In the unusual circumstances of` this case, for which there is no reported precedent, it seems to us that the undertakings really provide an effective supplement to the present reasonable certainty that the defendant will recover its costs from CHL in any event if the defendant succeeds in the action. We can therefore see no basis for exercising the courts discretion by ordering Extramoney to give security for the defendant's prospective costs.

39. Accordingly we allow the appeal. On the basis that the liquidators maintain CHL's and Mr. Stevenson's respective undertakings we consider it would be proper in all the circumstances that they should be included in the recitals to our order. We will make an order nisi awarding the costs of the appeal to the liquidators and Extramoney. As regards the costs of the application below we consider that although the liquidators gave no indication in the correspondence (prior to the filing of Mr. Lai's first affirmation on the 20th July 1989) regarding the actual amount of the assets in hand in the liquidation, their solicitor's letter dated the 4th July 1989 contained sufficient material to require a more constructive approach from the defendant than its solicitor's letter dated the 12th July 1989.

40. In their letter dated the 4th July the liquidators informed the defendant that they held substantial cash deposits. Their proposals included an offer to set aside a sufficient sum to meet the defendant's prospective costs in the action if the defendant should succeed. This offer was brushed aside in the defendant's solicitor's letter dated the 12th July because it did not contain any fresh suggestion as to how the defendant's costs could be secured. In our opinion had the defendant and those advising the defendant appreciated that the relevant costs were payable and not provable (the correspondence and evidence shows they did not) and followed up the liquidators' offer to set aside an appropriate sum, the probability is that the application could have been avoided. Certainly by the time the evidence on behalf of the liquidators had been filed it should have been apparent to the defendant that they did not require the protection of an order under section 357. We will therefore make an order nisi awarding the costs below to the liquidators and Extramoney.