RE GUANGDONG INTERNATIONAL TRUST & INVESTMENT CORPORATION HONG KONG (HOLDINGS) LTD (In Creditors’ Voluntary Liquidation)

HCMP 2638/2017

[2018] HKCFI 2498

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2638 OF 2017

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D E C I S I O N

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The Application

1.  In this application the issue before the court concerns the application of conventional liquidation principles to a novel set of facts:  If a company in liquidation in Hong Kong has only foreign assets, the liquidator may comply with foreign distribution procedures and distribute the assets pari passu.  Guangdong International Trust & Investment Corporation Hong Kong (Holdings) Limited (“Company”) is in liquidation in Hong Kong, with assets in Hong Kong and the Mainland.[1] Under Mainland regulatory rules, the Mainland assets may be distributed only in RMB and only to creditors holding Mainland bank accounts.  But some creditors do not have a Mainland bank account.  Are the liquidators unable to distribute the Mainland assets? 

2.  Under section 255 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“CWUMPO”), the liquidators of the Company (“Liquidators”) [2] seek a direction that they be permitted to:

(1)  distribute the Company’s cash balances held in a Mainland bank account (“Mainland Account”) to creditors of the Company who have Mainland bank accounts and are willing to accept RMB dividends, on a pari passu basis;

(2)  distribute the Company’s assets in Hong Kong to all creditors of the Company (other than those who have received the proposed RMB dividends) on a pari passu basis; and

(3)  rely on the notices of assignment (and similar documents) received by the Liquidators for the purposes of determining each creditor’s eligibility to receive dividends.

3.  The liquidators’ position is that the order sought is consistent with Hong Kong’s liquidation law and practice, including the principle of pari passu distribution.  A draft Order was appended to Mr Ho’s skeleton argument.

Background

4.  The Company’s liquidation may be summarised as follows:

(1)  The Company is a wholly-owned subsidiary of Guangdong International Trust & Investment Corporation, the Company was incorporated in Hong Kong on 6 June 1989 and went into creditors’ voluntary liquidation on 12 October 1998.

(2)  Since the commencement of liquidation, realisations of approximately HK$1,144.3 million have been made.

(3)  As at December 2014, dividends paid to preferential and unsecured creditors amounted to approximately HK$998.7 million.

(4)  In or about September 2005, dividends in RMB were paid within the Mainland using funds from the Mainland Account held with the Bank of China Guangzhou Yue Xiu Sub-branch (“BOC”).

(5)  The remaining assets of the Company consist of:

(a)  HK$18 million cash at bank in Hong Kong; and

(b)  RMB38.9 million cash in the Mainland Account (“RMB Asset”), equivalent to HK$43.8 million at the exchange rate of RMB1:HK$1.127 (being the rate available from The Hong Kong Association of Banks as at 2 October 2018).

5.  The Mainland Account has been operated as follows:

(1)  The Mainland Account was opened in March 1999 to facilitate recoveries in RMB.  Due to non-compliance with Mainland regulatory requirements, the Mainland Account has been frozen since September 2007.

(2)  Before the Mainland Account was frozen:

(a)  realisations amounting to about RMB30 million were deposited into the Mainland Account and then remitted to Hong Kong (with the approval of the State Administration of Foreign Exchange (“SAFE”));

(b)  funds from the Mainland Account were used to pay some dividends in RMB to creditors within the Mainland on a pari passu basis.

6.  While the Liquidators will be able to operate the Mainland Account again (subject to certain conditions explained below), SAFE would not permit the RMB Asset to be converted into Hong Kong Dollars and remitted to Hong Kong for the following reasons:

(1)  The RMB Asset represents the proceeds of recovery of advances made by the Company to Dongguan Donghua (Dongsheng) Power Company Limited (“Dongguan Company”) which is a Mainland entity (“Advances”).

(2)  From Mainland’s regulatory perspective, the Advances were improper because the Advances were in breach of Mainland regulations, there were irregularities in the registration of the Advances as foreign debts, and the Advances documentation was incomplete.

7.  After extensive negotiation with BOC, the Liquidators have obtained BOC’s approval to operate the Mainland Account subject to the following conditions to comply with the Mainland regulatory requirements:

(1)  the RMB Asset must be withdrawn in its entirety, such that the Mainland Account balance is zero thereafter (and the Mainland Account closed);

(2)  the RMB Asset is remitted to specified bank accounts within the Mainland held by identified creditors;

(3)  the Hong Kong court permits the Liquidators to deal with the RMB Asset as proposed;

(4)  with the Hong Kong court’s permission, the Liquidators issue an allocation report setting out the list of eligible creditors, their respective dividend entitlements, and their Mainland bank account details.

8.  The Liquidators have obtained Mainland legal advice confirming that the above procedures are the only available avenue to access the RMB Asset to pay the Company’s creditors. 

9.  In light of the distribution conditions attached to the RMB Asset, the Liquidators have sought to obtain the creditors’ views.  The creditors’ position can be divided into the following four main categories:

(1)  creditors with Mainland bank accounts and willing to accept RMB dividends (about 20%);

(2)  creditors willing to accept RMB dividends, but unsure if a Mainland bank account could be successfully opened or a third party’s Mainland bank account could be used (about 30%);

(3)  creditors unwilling to accept RMB dividends (including being unwilling to open a Mainland bank account) (about 29%);

(4)  creditors failing to respond to the Liquidators (about 21%).

10.  The final factual background concerns some creditors’ assignment of their right to receive dividends:

(1)  A Form 72 (set out in the appendix to the Companies (Winding-up) Rules (Cap 32H) (“CWUR”)) permits an original creditor to direct the Liquidators to pay dividends to another person (such as an assignee).  Certain of the assignees have further assigned their rights to receive dividends to further assignees by way of Form 72 or other transfer documents such as assignment or novation agreements or “modified” Form 72.

(2)  Some of the Forms 72 received are in the standard form as appears in CWUR and are thus expressed to be revocable by the original creditors.  The standard Form 72 stipulates: “[i]t is understood that this authority is to remain in force until revoked by me/us in writing”.  No written revocation has been received. 

(3)  Regardless of the precise transfer document used, the Liquidators believe that the creditors intended in all cases to divest themselves permanently of their right to receive dividends.

The Principles of Insolvency Distribution relevant to this Application

11.  Three principles of insolvency law are relevant to this application, namely:

(1)  the principle of collectivity;

(2)  the principle that liquidation does not create new substantive rights or destroy the existing ones; and

(3)  the principle of pari passu distribution.

12.  The principle of collectivity underlying an insolvency process was succinctly summarised by Morgan J in JSC Bank of Moscow v Kekhman:[3]

“A bankruptcy is normally regarded as being in the interests of the creditors as a whole which is, of course, why creditors often themselves petition for the bankruptcy of an insolvent debtor. Bankruptcy can bring various benefits to creditors. One benefit is the orderly realisation of the debtor’s assets and an equal distribution to creditors. The alternative is a free-for-all which will favour some creditors at the expense of other creditors. Thus, if one regards the creditors as a whole, an orderly equal realisation is better than a free-for-all. Normally, the court prefers to avoid a free-for-all of this kind. In Singularis Holdings Ltd v PricewaterhouseCoopers [2014] UKPC 36, at [12], the judgment of the Privy Council explained that the main purpose of a winding up order in England was usually to avoid this kind of free-for-all.”

13.  It is a well-established principle that insolvency proceedings are essentially administrative in nature because they do not create or destroy rights or obligations.  Lord Hoffmann has explained this on a number of occasions:

“[A] winding up order does not affect the legal rights of the creditors or the company. It only puts into effect a process of collective execution against the assets of the company, for the benefit of all creditors.” [4]

“The purpose of bankruptcy proceedings … is not to determine or establish the existence of rights, but to provide a mechanism of collective execution against the property of the debtor by creditors whose rights are admitted or established. That mechanism may vary in its details. For example, in personal bankruptcy in England, the assets of the bankrupt are vested in a trustee for realisation and distribution to creditors. So the mechanism operates by divesting the bankrupt of his property. In corporate insolvency, on the other hand, the insolvent company continues to be owner of its property but holds it in trust for the creditors in accordance with the provisions of the Insolvency Act 1986... In the case of personal bankruptcy, the bankrupt may afterwards be discharged from liability for his pre-bankruptcy debts. In the case of corporate insolvency, there is no provision for discharge. The company remains liable but when all its assets have been distributed, there is nothing more against which the liability can be enforced... At that point, the company is usually dissolved.

But these are matters of detail. The important point is that bankruptcy, whether personal or corporate, is a collective proceeding to enforce rights and not to establish them. Of course, … it may incidentally be necessary in the course of bankruptcy proceedings to establish rights which are challenged: proofs of debt may be rejected; or there may be a dispute over whether or not a particular item of property belonged to the debtor and is available for distribution. There are procedures by which these questions may be tried summarily within the bankruptcy proceedings or directed to be determined by ordinary action. But these again are incidental procedural matters and not central to the purpose of the proceedings.” [5]

14.  Because liquidation does not create new rights or obligations, the liquidator has to deal with the company’s assets as he finds them, subject to the restrictions attached to the assets.  For instance, liquidation does not overcome the inherent unassignability of some property.  Thus a liquidator may not assign a chose in action that, by its express terms, is not assignable to a third party (see Owners of Strata Plan 5290 v CGS & Co[6]).

15.  As can be seen from the passages above, the principle of pari passu distribution of the company’s assets is central to the English insolvency regime.  In a Hong Kong voluntary liquidation, this principle is enshrined in section 250 of CWUMPO.  However, the operation of the pari passu principle merits some elaboration.

16.  The pari passu principle is a central but not an inflexible principle of our type of insolvency regime.  It is replete with de jure and de facto exceptions.  As Vinodh Coomaraswamy JC (as he then was) has observed:

“I therefore do not consider it correct today – if it ever was – to describe the pari passu principle as the fundamental or default policy of insolvency distribution underlying our statutory insolvency scheme. Indeed, it can be said with justification that a principal purpose of any mature insolvency scheme is precisely to delineate departures from the pari passu principle on policy grounds.” [7]

See also Look Chan Ho, Cross-Border Insolvency: Principles and Practice,[8] Ch 6 (in particular pp 291–305) explaining why the pari passu principle is not an inflexible principle of insolvency law.

17.  The pari passu principle does not apply to assets that are not available for the insolvent debtor’s unfettered use, such as flawed assets.  A typical flawed asset arrangement is where the customer and the bank agree that the former’s cash deposit is “flawed” in the sense that it will become repayable only if the bank’s loan to a third party is repaid.  This means that if the customer goes into liquidation, the liquidator’s right to the deposited monies will be no better than the customer’s right was, and the liquidator will be prevented from distributing the cash held in the account unless the relevant condition has been met:

“These provisions fetter the depositor’s use of the deposit while the principal debt remains unpaid. In his hands the deposit — his chose in action — is a flawed asset. If he becomes insolvent, the asset forms part of the involvent [sic] estate, but it remains a flawed asset subject to the same contractual restrictions as before.” [9]

18.  Creditors who are eligible for pari passu distribution may decide not to participate in the distribution, just as creditors could validly subordinate their claims in a liquidation.  The validity of subordination agreements is a well-established judge-made exception to the pari passu principle (see Re Lehman Bros International (Europe) (No 4)[10]at [37]–[38] and [56]; Re SSSL Realisations (2002) Ltd [11]at [66]).

19.  The court may also depart from the pari passu principle in some circumstances.  In Re Agrokor,[12] the court referred to Re Bank of Credit and Commerce International SA (No 3)[13] as an illustration that “[t]he principle of pari passu can be overridden in appropriate cases even under English law”. 

20.  The pari passu principle is concerned with substantive pro rata division of assets among creditors, and is unconcerned with the precise procedural mechanisms to achieve the substantive result.  For example, in order to achieve pari passu distribution, the creditors’ debts (including any currency conversion) must be valued on the same date (see Wight v Eckhardt Marine[14] at [28], and Re Lehman Brothers Finance Asia[15] at [39]).  Provided valuation is done on the same date, that date could be the date of the winding-up or another date because the precise date is a mere procedural matter. 

21.  The decision in Re Bank of Credit and Commerce International SA (No 10)[16]serves to illustrate that such matters as the precise date of valuation of debts and the currency of dividend payments are mere procedural matters which do not detract from the substantive operation of the pari passu principle.  In Re BCCI (No 10), the English court permitted assets to be remitted to Luxembourg because the English liquidation was ancillary to the principal liquidation in Luxembourg and the distribution by the Luxembourg liquidators would adhere to the pari passu principle (albeit with different Luxembourg rules applying as to certain issues, for example currency conversion).  For present purposes, the pertinent passages are:

“The English liquidators’ report to the court dated 2 February 1996 raised eight separate matters in respect of which funds might need to be retained and in respect of which directions from the court were thought to be needed. They were (1) set-off; (2) currency conversion; (3) claims admission procedures; (4) claims under examination; (5) claim valuation date...

Some of these matters present no present problem. The Luxembourg liquidators have indicated that they propose to admit all claims in US dollars at 3 January 1992 exchange rates and to pay all dividends in US dollars. No provision need now be made in respect of currency conversion difficulties.

The ‘claim valuation date’ problem arises from the circumstance that the Luxembourg liquidation commenced on 3 January 1992 but the English liquidation did not commence until 14 January 1992. Interest bearing claims would, therefore, accrue some 10 days’ additional interest if proved in a [sic] English liquidation than would be able to be claimed in a Luxembourg liquidation. In their report of 20 February 1996, the English liquidators have expressed the view that ‘it would not be unfair for any creditor to receive a dividend based on claims calculated as at 3 January 1992’ and that they ‘do not consider it appropriate for any provision to be made for the different claim valuation date that would apply were the liquidation of BCCI SA a purely English liquidation’. I agree.” [17]

22.  As regards the assignment of the right to receive dividends and the use of Form 72, the position is as follows:

(1)  Rule 142(7) of CWUR provides: “If a person to whom dividends are payable desires that they shall be paid to some other person he may lodge with the liquidator a document in the Form 72 which shall be a sufficient authority for payment of the dividend to the person therein named.”

(2)  Form 72 may be used to authorise an assignee to receive dividends (eg Bank of Credit and Commerce Hong Kong v Asian Winner[18]). But, consistent with rule 142(7), the authorised person under Form 72 need not be an assignee and may simply be the creditor’s representative or agent.

(3)  Consistent with general principles of agency law, a principal may terminate his agent’s authority.  Hence the reference in Form 72 to the revocation of authority. 

(4)  However, where the right to receive dividends has been assigned, the concept of revocation of the assignee’s authority is irrelevant because the right to receive dividend already belongs to the assignee.  In the context of an assignment, Form 72 and other forms of transfer documents received by the Liquidators play the role of an “express notice in writing” under section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Cap 23), thereby effecting a legal assignment of the chose in action and vesting the right to receive dividends in the assignee.

The Order sought is consistent with all of the above liquidation principles

23.  In distributing the RMB Asset as proposed in the Order, the Liquidators will remain in charge of the whole distribution process. The principle of collectivity will be maintained throughout.

24.  The RMB Asset is a chose in action governed by Mainland law and its use is thus properly subject to restrictions under Mainland law:

“In determining the situs of a chose in action (such as the balance of a bank account), the general rule is that they are situate in the country where they are properly recoverable or can be enforced. The lex situs in turn, will apply when determining entitlement to the chose in action, and how such entitlement is to be dealt with.” (Footnotes omitted.)[19]

“The contractual right to receive payment of a debt is an item of property, that is to say, a chose in action. It can be transferred by the creditor to a third party, but the validity of the transfer necessarily depends upon the lex situs, because the courts of the country where the debt is have jurisdiction over the title to it.” [20]

25.  The distribution mechanism in relation to the RMB Asset respects the inherent limitations on the Company’s ability to use the RMB Asset, which I have described in [6]–[7].  The Order thus respects the principle that liquidation does not create new rights or obligations for the Company or its creditors. 

26.  The Order sought is consistent with the pari passu principle.  The distribution of the RMB Asset is capable of two alternative analyses, neither of which constitutes a breach of the pari passu principle:

(1)  Every creditor who has a Mainland bank account is entitled to pari passu distribution from the RMB Asset.  The criterion of having a Mainland bank account ought to be regarded as merely a procedural requirement which does not detract from the substance of pro rata division of the RMB Asset among all eligible creditors.

(2)  Alternatively, it is well-established that the pari passu principle applies only to assets that are available for pari passu distribution:

“[T]he rule embodied in all insolvency legislation [is] that the general unsecured creditors should share pari passu in the available assets of the insolvent estate.” [21]

As a matter of Hong Kong conflict of laws, Hong Kong insolvency law (including section 250 of CWUMPO) would not override the Mainland limitations attached to the RMB Asset which is a chose in action governed by Mainland law. Indeed the Hong Kong analysis would be exactly the same when faced with a foreign liquidator’s request to access assets in Hong Kong relying on foreign insolvency law.  In Bank of Credit and Commerce International (Overseas) v Bank of Credit and Commerce International (Overseas), Macau Branch,[22] the Macau liquidator applied to withdraw BCCI’s deposit in Hong Kong so that the deposit could be distributed in accordance with Macanese insolvency law.  The Court of Appeal refused the application and reasoned as follows:

“The Macau liquidator claims to have a prior claim to the funds in court because although the deposits were made in the name of the bank, they were made by those responsible for the management of the Macau ‘branch’ out of assets held by the ‘branch’; and that therefore the deposits should be treated as ‘assets’ which, in accordance with the undertakings given by the bank to the Governor of Macau, cannot (by virtue of Article 113 of the Decree to which I have referred) be made available to the bank until all obligations contracted by the bank in Macau have been met.

In my opinion, while these reasons would be entirely applicable to any deposits made in the name of the bank in Macau, they are not applicable to deposits made in the name of the bank outside Macau. Once such deposits, repayable in Hong Kong and subject to Hong Kong law, were made, the chose in action representing those deposits (the lex situs of which was of course Hong Kong) ceased to be an asset available to or, to put it in another way, within the grasp of the Macau liquidator. The Macau liquidator is, no doubt, entitled and indeed bound to get in all assets in Macau which he can get his hands on so as to apply them for the benefit of the creditors on whose behalf he was appointed. And he is, no doubt, entitled, if he thinks he can get away with it, to attempt to get in assets which are not in Macau but situate elsewhere. Since the lex situs of the chose in action with which this case is concerned is plainly Hong Kong, and not Macau, I am quite satisfied that these assets do not fall to be treated by this court as assets situate in Macau for the purposes of the Macanese liquidation of the bank.” (Emphasis added.) [23]

I adopted this analysis in Re Performance Investment Products Corp.[24]

27.  It follows that creditors who do not have a Mainland bank account cannot complain about the lack of pari passu distribution from the RMB Asset because, under Mainland law, the RMB asset is not available for distribution to these creditors in the first place.  In other words, on this analysis, the operation of the Hong Kong pari passu principle in respect of the RMB Asset has to be qualified accordingly.  From the perspective of creditors who do not have a Mainland bank account, the RMB Asset is akin to a flawed asset arrangement because the RMB Asset is not freely available to the Company. 

28.  As regards creditors who are eligible for distribution from the RMB Asset, but have chosen not to receive any RMB dividends, there would be no breach of the pari passu principle.  Their election to forgo RMB dividends is equivalent to a creditor having entered into a subordination agreement.  Contractual subordination is a well-established exception to the pari passu principle.

29.  Creditors who have failed to respond to the Liquidators can properly be deemed to have chosen to forgo RMB dividends.

30.  One might object that the practical effect of the Order sought is that the Company’s assets (on a pooled basis) would not be distributed pari passu to all creditors.  I agree with Mr Ho that such a criticism is misconceived.  The objection assumes that the assets can be pooled, overlooks the inherent limitations attached to the RMB Asset, and contradicts the established Hong Kong conflict of laws principles exemplified in Bank of Credit and Commerce International (Overseas) v Bank of Credit and Commerce International (Overseas), Macau Branch.[25] If the Company’s only asset is the RMB Asset, it would follow from the principle of liquidation being merely administrative that the RMB Asset would be available for pari passu distribution only to creditors who have Mainland bank accounts.  It is hard to see what principle would justify preventing the RMB Asset from being distributed just because the Company happens to have some assets in Hong Kong.

31.  In any event, this in my view is a proper case for the court to depart from the pari passu principle for the following reasons:

(1)  the pari passu principle is not inflexible and is capable of judicial departures;

(2)  the Liquidators have no other avenue to distribute the RMB Asset;

(3)  permitting the proposed distribution of the RMB Asset would facilitate closure of the long-running liquidation and would be in the best interests of the creditors as a group;

(4)  permitting the Liquidators’ proposed distributions would be consistent with:

(a)  the general principle that liquidation being an administrative process does not expand or diminish the Company’s substantive rights and obligations; and

(b)  the general principle that, ultimately, “[i]nsolvency is concerned with the distribution of the debtor’s uncharged assets among his unsecured creditors” (Re Bank of Credit and Commerce International (No 8)[26]).

32.  The Company’s assets in Hong Kong can be distributed to all creditors on a pari passu basis.  But creditors who have received dividends from the RMB Asset would be subject to the hotchpot rule.  Given the amount of the RMB Asset and the Hong Kong assets, the effect of the hotchpot rule would be that creditors who have received RMB dividends would not be eligible to receive further dividends from the Hong Kong assets.

33.  In relation to creditors who are assignees based on the Liquidators’ receipt of Form 72 and other transfer documents, the Liquidators’ duty would be to recognise these assignees’ right to receive dividends.  No issue of revocation of the assignees’ right arises.

34.  In permitting the Liquidators to make the proposed distributions, the court would be applying conventional insolvency principles and conflict of laws principles in relation to the RMB Asset which is governed by Mainland law.  Hong Kong insolvency law does not confer new property rights on the Liquidators and giving effect to the limitations attached to the RMB Asset would not breach the pari passu principle.

Order

35.  I will make an order in the terms of the draft attached to Mr Ho’s skeleton argument.