RE HSIN CHONG CONSTRUCTION CO LTD

HCCW 239/2018

[2019] HKCFI 1531

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO 239 OF 2018

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DECISION

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1.  This is the adjourned hearing of the summons filed on 18 January 2019 by Build King Construction Ltd (“BK”) an interested party in the winding up proceedings against Hsin Chong Construction Company Limited (“the Company”) pursuant to section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32 (“section 182”). At the first adjourned hearing on 28 January 2019, Harris J adjourned §§1, 3 and 5 of BK’s summons for further argument which is the present hearing.

2.  §§1, 3 and 5 of BK’s summons seek orders:

 (1) confirming that BK’s exercise of the right to exclude the Company from the Hsin Chong–Build King Joint Venture (“the JV”) on 13 December 2018 under clause 17 of the Joint Venture Agreement dated 21 November 2013 did not constitute a disposition within section 182 (§1 of the summons) or alternatively validating it (§5 of the summons);

 (2) confirming that the Supplemental Agreement dated 17 December 2018 between the Company and BK (“the Supplemental Agreement”) shall not be avoided by section 182.

3.  At the conclusion of the hearing, the court reserved its decision which I now give.

BACKGROUND

4.  Under the JV Agreement, the Company and BK (“the parties”) established an unincorporated integrated joint venture in November 2013 to prepare and submit prequalification and, upon being prequalified, a tender for executing a major government design and construction project in Kowloon (“the Project”) with the Company taking a 65% interest and BK the remaining 35%.

5.  The JV opened a number of bank accounts under the joint mandate of BK and the Company with the Bank of China Hong Kong (“BOC”).

6.  The Government awarded the contract to the JV on 22 June 2016.  The parties entered into Articles of Agreement with the Hong Kong Government on 30 August 2016 (“the Contract”).

7.  The Company found itself in financial difficulties commencingin 2017/2018.  On 17 July 2018, West Kowloon Cultural District Authority decided to determine the Company’s contract for the construction of the M+ Museum.  Then on 27 August 2018, a winding up petition was issued against the Company. The petition remains adjourned to a date in August 2019.

8.  On 13 December 2018, BK exercised its right under clause 17 of the JV Agreement to exclude the Company from the JV.

9.  Following that exclusion, BK and the Company entered into the Supplemental Agreement whereby BK acquired the Company’s residual rights under the JV Agreement for the sum of $53.6 million.

THE JV AGREEMENT

10.  The salient provisions of the JV Agreement in which the Company and BK, inter alia, provided as follows:

 (a) Upon acceptance, the tender becomes jointly and severally binding on the parties.  (§4)

 (b) All rights and obligations of the parties shall be shared and borne by the parties in the agreed proportions of 65% to the Company and 35% to BK being their respective shares of equity interest.  (§5.2)

 (c) Each party shall place at the disposal of the JV such of its resources as may be required by the Executive Board and to let the JV have the benefit of all its experience, technical knowledge and skill.  (§5.3)

 (d) The Executive Board shall comprise two representatives from each of the parties whose decisions shall be unanimous. (§7.2)

 (e) The Company shall be the Lead Company responsible for the project management and coordination in the JV.  (§7.3.1)

 (f) The Lead Company shall provide the following head office services at a fee which shall be paid by the JV: Procurement; Accounting; Company Secretary; IT support; Insurance affairsexcluding contractor’s all risks claims; Any other services that the JV may require.  (§7.3.5)

 (g) Injections of working capital may be required from time to time and each party undertakes to make such capital available. (§8.5) 

 (h) Personnel required for the execution of the Contract shall be supplied from the employees of the parties and the party shall second to the JV such of their employees who possess the necessary degree of competence who shall remain employees of the party supplying them but shall be seconded to the JV.  (§12.1) 

 (i) The seconding party shall settle all payments of remunerations to its seconded personnel and the JV shall reimburse the seconding party.  (§12.4)

 (j) Each party shall bear its own costs and disbursements of its staff.  (§12.6)

 (k) On the settlement of the final account, after providing for all costs, liabilities, reserves for contingencies and after repaying Working Capital, any profits remaining shall be distributed to each party as a provisional distribution.  (§16.2)

 (l) If the performance of the Contract shall result in a loss, each party shall bear such loss according to its share of the JV. (§16.3) 

 (m) Of the remaining provisions of the JV, the only provision relevant for present purposes is the default provision (§17) summarized below.

11.  In outline, §17 of the JV Agreement regulates the position between the parties inter se.  It confers a contractual right on the innocent party to exclude the defaulting party from the JV and carry on the JV on its own, in the absence of the defaulting party, to operate all the JV Accounts and to complete the Project.  An accounting exercise is then carried out on completion of the Project to ascertain what, if any, money may be due to the defaulting party as a result of the profits made and losses incurred.

12.  Under §17.1, the occurrence of any one of five specified events on the part of the party defaulting (“the defaulting party”), gives the other party (“the continuing party”), an option (i) to exclude the defaulting party from further participation and management of the JV and the Contract and to take over the benefits of the defaulting party in the JV (but without releasing the defaulting party from its obligations to bear its proportionate share of any loss); or (ii) to wind up the affairs of the JV.

13.  §17.5 is concerned with the accounting exercise to be held upon completion or termination of the Main Contract to determine the amount of profit that the defaulting party is entitled to (if any) up to the date of its exclusion less, (i) the defaulting party’s share of losses arising whether before or after the date of exclusion and (ii) costs, expenses, losses and damages incurred by the continuing party as a result of the defaulting party’s default.

BK’S EXERCISE OF ITS §17 RIGHTS

14.  By August 2018, the Company’s financial difficulties continued to worsen.  As recorded in BK’s solicitors’ letter to the Companydated 17 August 2018, the Architectural Services Division (“ASD”) met with BK on 14 August 2018 and suggested (at a meeting on 14 August 2018 with BK) that BK should agree terms with the Company to transfer the Contract to BK and further intimated that, failing resolution of the situation, it could potentially terminate the Contract.

15.  In the autumn of 2018, BK’s enquiry of the Company as to whether it would be open to stepping away from the JV was met with a rejection. But by 12 December 2018, the Company through Paul Lee (“Mr Lee”), one of its directors, intimated that the Company wished to sellits interest in the JV.  One of BK’s executive directors, Zen Wei Peu Derek (“Mr Zen”) informed Mr Lee that BK would be interested in agreeing arrangements to remove the Company and a meeting was arranged for the following morning.

16.  Having discussed the position within BK prior to the meeting, it was decided that BK should exercise its rights under §17 to exclude the Company from the JV.  At the meeting, BK so informed the Company, confirming it by letter dated 13 December 2018.

THE SUPPLEMENTAL AGREEMENT

17.  While the Company showed no interest in the exclusion notice, it wanted to know if the Company’s share of profit following exclusion could be agreed. After exclusion, the excluded party was no longer entitledto a share profits generated by the JV.  However, it did have certain residual rights in the final account under §17 which BK wanted to acquire.  With a view to a smooth transition and greater freedom in completing the Project,BK made an offer to acquire those residual rights that gave the Company part of the profits that BK hoped would be generated by the JV after the Company’s exclusion and to which the Company would otherwise not be entitled.

18.  Subsequent to the exclusion of the Company from the JV, BKand the Company entered into the Supplemental Agreement on 17 December 2018 under which BK agreed to pay $53.6 million to the Company to acquire all its rights and interests in respect of the JV, the Contract or the Project (ie its residual rights under §17), such that, inter alia, the Company would have no further involvement in the JV save for its rights under the Supplemental Agreement and so released from the obligation to bear a proportionate share of any loss resulting from the Contract.  In effect, the Company’s risk of loss would be removed entirely and assumed by BK. 

THE ISSUES ARISING

(A) §17

 (1) Whether the exercise of §17 rights is a disposition within section 182

19.  The general principle is that parties cannot contract out of the insolvency legislation.  Section 182 is the anti-avoidance provision for corporate insolvency.  It provides as follows:

“ In a winding up by the court, any disposition of the property of the company, including things in action … made after the commencement of the winding up, shall, unless the court otherwise orders, be void.”

20.  Whether §17 breaches the anti-deprivation rule [1] rendering it void is one of the issues that arises.  That issue is addressed next in §§39 – 76 below.

21.  The provisional liquidators (“the PLs”) take the view that the exercise of §17 rights amounts to a “disposition” within section 182 and is void.  In Re AGI Logistics (Hong Kong) Ltd [2016] 5 HKLRD 737 the Court of Appeal held (at §10) that the meaning of “disposition” is broad and that it “encompasses any dealing in the tangible or intangible assets of a company and any other act that reduces or extinguishes a company’s rights in an asset and transfers value in it to another person”.

22.  Mr Manzoni SC appearing for BK submitted that the exercise of §17 rights cannot amount to a “disposition”.  He submitted thatto amount to a disposition there needs to be a disponor and a disponee.  Here,there was no act by the Company or its agent.  There was no dealing with any asset that belonged to the Company.

23.  BK submitted that section 182 is designed to avoid dispositions of a company’s property but it is not designed to prevent third parties who are not the company’s agents from exercising their contractual rights. The §17 rights were exercised by BK as it was contractually entitled to do which has had the effect of reducing a future entitlement of the Company in the JV but that did not involve any act on the part of the Company or its agent.

24.  I accept that the present case did not involve any act on the part of the Company or its agent.  While most dispositions would involve there being a disponor and a disponee, it does not follow that the exercise cannot amount to a disposition given its broad meaning.  Although BK submitted that such a requirement is evident from the AGI Logistics case, none of the passages referred to so state.

25.  In determining the question whether there was any “dealing” in an asset of the Company or any other act reducing or distinguishing its rights in that asset, the “asset” or “rights” in question must first be identified.

26.  Mr Dawes SC who appeared for the PLs submitted that prior to the exclusion, the Company had a 65% interest in whatever profit was generated by the JV.  It was said that that was a chose in action belonging to the Company which was stripped away from the Company as a result of the exercise of the §17 rights and thus a disposition of the Company’s property.

27.  The PLs further submitted that the Company’s right to participate in the management of the JV and the Contract as a contracting party is an important chose.  The ability to accrue the necessary points to be able to bid in future Government contracts was said to be invaluable to the Company.  Thus the exclusion operated to destroy what was said to be an invaluable chose in action.

28.  However, it seems to me wholly artificial to view a share of future profits that has yet to be generated as an existing “asset” of the Company when the Company, being insolvent, was in no position to perform its own contractual obligations.  Logically, the Company’s ability to perform must be a precondition of its entitlement to share in those future profits.

29.  It was further submitted that the PLs are in a position to discharge the Company’s obligations under the JV Agreement and that but for the exclusion, the Company (acting through the PLs) would have been able to discharge its obligations.  But the performance of the Company’s obligations goes beyond attending board meetings or (where necessary) appointing agents to act on their behalf which, admittedly, the PLs are in a position to do.  But that is as far as it goes.

30.  When one turns to consider the discharge of obligations under the JV Agreement, is it realistic to think that the PLs would be able to discharge the Company’s obligations and responsibilities as the lead party in the JV?  What resources (in terms of experience, technical knowledge and skill) would the PLs be able to place at the Board’s disposal (§5.3)? How are the PLs able to provide the head office services (itemised in §7.3.5 of the JV Agreement) when the Company has vacated its head office and is insolvent?  What employees of the PLs (or their agent(s)) with the necessary degree of competence could be supplied as personnel required for the execution of the Contract and how are the PLs proposing to pay the seconded personnel (§12)?

31.  Those questions need only to be posed to reveal the hollowness of the PLs’ claim that they (whether by themselves or through agents) are able to discharge the Company’s obligations.  If, as is my view,the PLs are unable to do so, the exercise of the exclusion rights could not be regarded as destroying or dealing with any “asset” of the Company or “rights” which cannot be accrued because of the Company’s insolvency.

32.  For those reasons, I do not consider that the exercise of exclusion rights under the JV Agreement by BK involved any disposition of the property of the Company.

33.  If (contrary to my view) the exercise of exclusion rights did involve a disposition within section 182 (and assuming that §17 does not otherwise breach the anti-deprivation principle), it will be necessary to consider how far contracting parties may validly agree to one party terminating further performance on the bankruptcy of another.

34.  That issue was considered in Lomas v JFB Firth Rixson Inc [2012] 2 All ER (Comm) 1076. Longmore LJ (at §88)cited with approval the following passage from the judgment of Briggs J[2] in the court below: 

“ Where the asset of the insolvent company is a chose in action representing the quid pro quo for something already done, sold or delivered before the onset of insolvency, then the court will beslow to permit the insertion, even ab initio, of a flaw in that assettriggered by the insolvency process. By contrast, where the right in question consists of the quid pro quo (in whole or in part) for services yet to be rendered or something still to be supplied by the insolvent company in an ongoing contract, then the court willreadily permit the insertion, ab initio, of such a flaw, there being nothing contrary to insolvency law in permitting a party either to terminate or adjust what would otherwise be an ongoing relationship with the insolvent company, at the point when it goes into an insolvency process.”

35.  In Belmont Park, Lord Mance (at §175) rejected the existence of any general rule[3] to the effect that any provision for termination on bankruptcy, which would deprive the trustee or liquidator of the opportunity of continuing the contract and so deprive the bankrupt estate of future potential advantage, would infringe the principle (see §§175 – 179).  In so doing, he expressly endorsed Longmore LJ’s summary (set out in §88 of Lomas) of the distinction made by Briggs J in the passage cited above.

36.  The application of the anti-deprivation principle to contracts has to be considered on a case-specific basis and the factors Briggs J suggested are relevant as one means of distinguishing between a commercial rearrangement of rights to reflect the economic consequences of insolvency and an attempt to pre-empt the distribution of assets in a bankrupt estate: see per Longmore LJ at §91d of Lomas.

37.  Applying the distinction drawn by Briggs J to the present case, it is the latter of the two situations (for services yet to be rendered or something still to be supplied by the insolvent company) that is applicable and not the former.

38.  It follows that, in my view, dispositions made pursuant to §17 are valid.

 (2) Whether §17 offends the anti-deprivation principle

39.  The leading English authority is the decision of the Supreme Court in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd & Anor [2012] 1 AC 383.  Lord Collins conducted an exhaustive review of the general principle that parties cannot contract out of the insolvency legislation and its two sub-rules, namely (i) the anti‑deprivation rule (which dates from the 18^th century) and (ii) the pari passu rule that it is contrary to public policy to contract out of pro rata distribution on insolvency (now embodied by statute).

40.  However, it should be borne in mind that while there is some overlap, the two sub-rules are aimed at different mischiefs.  As Lord Collins explained (at §1):

“ The anti-deprivation rule is aimed at attempts to withdraw an asset on bankruptcy or liquidation or administration, thereby reducing the value of the insolvent estate to the detriment of creditors. The pari passu rule reflects the principle that statutory provisions for pro rata distribution may not be excluded by a contract which gives one creditor more than its proper share.”

41.  The distinction between the two sub-rules is by no means clear-cut.[4] Their relationship was characterized in Lomas as being “both dependent and autonomous”.

42.  It is common ground between the parties that the bona fides of the parties or commercial justification is not relevant to the application of the pari passu rule. That rule precludes a bankrupt from agreeing to distribute its property other than in accordance to that prescribed by the law: see British Eagle International Air Lines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758, 780G.

43.  Where the parties differ is whether the bona fides of the parties or commercial justification is relevant when it comes to the application of the anti-deprivation rule and is one of the principal issues for determination.

44.  The Supreme Court (in Belmont Park) held that in applying the anti-deprivation rule it is necessary to look at the substance of the agreement rather than its form and to consider whether the provision in question amounted to an illegitimate attempt to evade the relevant bankruptcy law or had some legitimate commercial basis and its ratio is to be found in the judgment of Lord Collins at §§102 – 109 (expressly concurred in by the majority of court): see Lomas [5] (at §85).

45.  For present purposes, the following extract from Lord Collins’ judgment is relevant:

“ 102 It would go well beyond the proper province of the judicial function to discard 200 years of authority and to attempt to re-write the case law in the light of modern statutory developments. The anti-deprivation rule is too well-established to be discarded despite the detailed provisions set out in modern insolvency legislation, all of which must be taken to have been enacted against the background of the rule.

103 As has been seen, commercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the anti-deprivation rule. Despite statutory inroads, party autonomy is at the heart of English commercial law. Plainly there are limits to party autonomy …. But … it is desirable that, so far as possible, the courts give effect to contractual terms which parties have agreed. And there is a particularly strong case for autonomy in cases of complex financial instruments ….

104 No doubt that is why, except in the case of a blatant attempt to deprive a party of property in the event of liquidation …, the modern tendency has been to uphold commercially justifiable contractual provisions which have been said to offend the anti-deprivation rule …. The policy behind the anti-deprivation rule is clear, that the parties cannot, on bankruptcy, deprive the bankrupt of property which would otherwise be available for creditors. It is possible to give that policy a common sense application which prevents its application to bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy.

105 Except in the case of well-established categories such as leases and licences, it is the substance rather than the form which should be determinant.  Nor does the fact that the provision for divestment has been in the documentation from the beginning give the answer, nor that the rights in property in question terminate on bankruptcy, as opposed to being divested.  Nor can the answer be found in categorising or characterising the property as ‘property subject to divestment on bankruptcy’.”

46.  Lomas (at §§86 – 87) considered those passages in Lord Collins’ judgment as an authoritative statement of the anti-deprivation principle:in each case the “touchstone” is “to consider each transaction on its merits to see whether the shift in interests complained of could be justified as a genuine and justifiable commercial response to the consequences of insolvency”.

47.  The shifts in interest upon the exercise of §17 rights of exclusion in the present case so far as concerns the defaulting party is thus: the defaulting party is excluded from participating in the profits of the JV accruing after the date of exclusion while having to continue to bear the defaulting party’s share of losses whether incurred before or after the date of exclusion as well as all costs, expenses, losses and damages incurred by the continuing party as a result of the default.

48.  As a preliminary observation, it is worth noting that of the five events of default that could trigger a §17.1 exclusion, four of them concern non-insolvency events, in fact, breaches of contract.  That factor, of itself, would suggest an absence of any deliberate intention to evade insolvency law: see Belmont Park at §109.

49.  The PLs submitted that Belmont Park has changed the law in this regard by taking into consideration the commercial justification or the intention of the parties to the transaction.  It was said that in the Hong Kong Court of Appeal’s decision in Peregrine Investments Holdings Ltd & Another v Asian Infrastructure Fund Management Co Ltd LDC & Others [2004] 1 HKLRD 598 and also the cases prior to Belmont Park in English jurisprudence, the focus was on the effect of the deprivation provision and not the intention behind it, citing British Eagle and Money Markets International Stockbrokers Ltd (in liquidation) v London Stock Exchange Ltd [2001] 4 All ER 223 (“the MMI case”) in support (describing the former approach as ‘the old approach’).

50.  Mr Dawes submitted that the rationale for focusing on effect rather than intention must be because the paramount consideration interests of the unsecured creditors and questioned the need to draw a distinction [6] between the anti-deprivation and the pari passu rules. Belmont Park was said to shift more emphasis on party autonomy, which is a policy consideration.

51.  The suggestion that Belmont Park introduced a new approach or has somehow changed the law is not supported by any fair reading of Lord Collins’ judgment.  As is apparent from §102 of Lord Collins’ judgment [7], the anti-deprivation has existed for nearly 200 years.  Lord Collins agreed [8] with Lord Neuberger MR (echoing the latter’s earlier statement [9] in the MMI case) that it was not easy to identify the precise nature or limits of the anti-deprivation rule.  For greater clarification, Lord Collins carried out the exercise of tracing the history of the anti-deprivation rule, analysing its development and distilling the principles derived from judicial decisions spanning almost two centuries.  To describe his judgment as effecting a change in the rule is a total mischaracterisation.

52.  In fact, the first full judicial analysis of the principles is to be found in the MMI case (cited by the PLs).  At §§117 – 118, 10 rather limited propositions extracted from the cases are set out.  For present purposes, (2), (5) and (6) [10] are relevant.  Those propositions show that intention is relevant.  Even when one has to look at the effect, it is the overall position or picture that needs to be considered: it does not actually exclude the question of intention.

53.  I now turn to Peregrine which concerned the liquidation of P1, the holding company.  P1 through a wholly-owned subsidiary, P2, held a 4% interest in an infrastructure fund (“the Fund”).  P1 and P2 were partiesto the agreement entered into between the various holders of the Fund (“the Fund Shareholders Agreement”).  For the purposes of managing the Fund,a management company, D1, was established.  P1 paid for 31.5% of the shares in D1 held by P2 on its behalf.  Six months later, P1, P2 and the other shareholders of D1 entered into a Managers Shareholders’ Agreement (“MSA”).  Clause 14 of the MSA provided a scheme for the transfer of shares in D1 to the other shareholders at par value in certain events, including a winding up petition being presented to wind up a shareholder (the defaulting shareholder) and/or any affiliate which is a party to the Fund Shareholders Agreement.  

54.  The provisional liquidators in that case challenged the transfer as being contrary to the anti-deprivation principle.  The defendantscontended that the principle was not applicable because (a) it only applies to instances where the owner of the property in question has made a contract in respect of his own goods; and (b) the MSA was a bona fide and fair agreement among the shareholders of D1.

55.  The defences were rejected as missing the point. As Rogers VP explained, the principle looks to whether a person can insist on retaining an unfair advantage to himself at the expense of creditors in a bankruptcy.  It is the dealing with property of the insolvent and the diminishing of the value therein that is important: §§32 – 33.

56.  It will be seen from the facts of that case that P2 was an asset of P1 and its value was based upon the value of its shareholding in D1 and the Fund.  It is clear that the other shareholders benefited from receiving P2’s shares at par (being at a serious undervalue) and had done so as a result of their reliance on and putting into operation the clause 14 provisions thus preventing the true value of P2 being realised and distributed under the insolvency provisions.  In those circumstances, Rogers VP considered the fact that those shareholders may have had good commercial reasons towant to enter into a contract with the clause 14 provisions immaterial, citing British Eagle: §29.

57.  The Court of Appeal agreed with the trial judge that clause 14 of the MSA which allowed the other shareholders to derive a benefit from a contract in fraud of insolvency laws, diminishing the value of assets available to creditors on P1’s insolvency was contrary to public policy and void. 

58.  While bona fides was mentioned by Woo VP (§100) he was addressing the bona fides of the parties because what they were trying to do was to punish or to recompense themselves which was not legitimate and not the commercial justification or bona fides of the provision.  In other words, he was not dealing with the same bona fides as in Belmont Park.  He then proceeded to conclude (at §101) that the bona fides of the parties to clause 14 is not at all relevant to the application of the anti-deprivation principle.

59.  The Peregrine case concerned the application of the anti‑deprivation principle.  British Eagle concerned the application of the pari passu principle which is the other sub-rule of the general principle that parties cannot contract out of the insolvency legislation.  The observation that good intentions or commercial reasons for having clause 14 were immaterial was plainly correct.  Peregrine was a “blatant attempt”[11] at diminishing the value of assets in the insolvent’s estate available for creditors.  British Eagle was a case where good intentions/commercial reasons also did not matter.  I do not read that passage as a statement of general application that intention never matters in the application of the anti-deprivation principle.

60.  In British Eagle, the clearing house arrangements provided for a different distribution of the insolvent’s property from that prescribed by law.  It was in that context that Lord Cross held (at 780H) it to be “irrelevant” that the parties to the clearing house arrangements had good business reasons for entering into them and did not direct their minds to the question how the arrangements might be affected by the insolvency of one or more of the parties.  Lord Cross was not addressing the anti-deprivation principle when he made those comments but the contracting out of the statutory scheme for distribution.

61.  I do not accept Mr Dawes’ submission that since British Eagle and the MMI case, the focus is on the effect of the transaction, ignoring the commercial soundness or intention of the parties [12].  I do not consider the Peregrine case to be authority for the proposition put forward by the PLs that the bona fides of the parties or commercial justification is not relevant to the application or otherwise of the anti-deprivation rule.  The anti-deprivation principle applicable in Hong Kong does not come from a different source and is derived from English law. 

62.  As will become apparent, the fact that the MSA and clause 14 were commercially justifiable was not a material factor on the facts of Peregrine because the P1’s rights in the shares in D1 stemmed from the articles of association when the shares were allotted. D1’s articles specifically provide for a transfer of shares on the bankruptcy of the member and so did not bestow an interest that would be terminated on insolvency.  The MSA (and clause 14) only came into existence subsequently, some six months later, providing for alienation at an undervalue upon the happening of a bankruptcy.  It was thus not a flawed asset ab initio [13]. Rather, it was a subsequent flaw and,as Lord Collins explained [14], an interest which a person has, cannot be qualified after the acquisition of that interest by determining or controlling it in the event of bankruptcy in such a way that creditors, who otherwise might have benefited, would be disappointed or delayed.

63.  That distinction was recognised in Peregrine. The articles of association of D1 did not contain provisions similar to those contained in clause 14 of the MSA.  The D1 articles specifically provided for the transfer of shares on the bankruptcy of the member and did not bestow an interest that would be terminated on insolvency.  What the D1 shareholders have done by clause 14 of the MSA was to provide for alienation at an undervalue upon the happening of the bankruptcy.  In other words, it was not a flaw ab initio but a subsequent flaw inserted into an asset after it was acquired: see §§30 – 31 of Peregrine.

64.  The observation in §29 of Peregrine that “it matters not that there might have been good commercial reasons” for the MSA/clause 14 is therefore correct.  However, it would be wrong to apply it as a statement of general principle that the intention of the parties is never material to the application of the anti-deprivation principle. 

65.  For the reasons stated above, in deciding whether §17 offendsthe anti-deprivation principle, the approach to be adopted in the present case is that set out in Belmont Park and Lomas: see §§42 – 43 above.

66.  BK submitted that §17 is directed at adjusting the ongoing relationship between the parties in the event of an insolvency.  In other words, it was an instance of “a commercial rearrangement of rights to reflect the economic consequences of insolvency” [15].

67.  The initial draft of the JV Agreement actually emanated from the Company.  It was not created specifically for this particular JV and hence itis likely to have been a form of contract used by the Company from time to time. BK has also produced evidence of three instances involving similar clauses.  Whether it could be said to be a form of contract in common usage matters not.

68.  The PLs’ main criticism was directed at the provision that notwithstanding exclusion, it remains the Company’s responsibility to bearits share of post-exclusion losses until the completion or termination of the Project.  It was submitted that the effect of the provisions was draconian, unfair and commercially unjustifiable.

69.  BK proffered several reasons for having a provision that the defaulting party continues to bear its share of the loss on the Project.  In large construction projects, claims for latent defects tend to emerge upon completion of the project.  If such defects had arisen at a time when the Company was in charge of the Project as the lead party, it would only be fair that it should be made to bear its share of those losses.

70.  There is also the fact that the default completely changed the risk profile of the Project so far as concerned the continuing party.  The provision is negotiated to protect the continuing party (be it the Company or BK) and gives legitimate protection to the innocent party who, when it agreed to the JV, did not do so on the basis of having to assume 100% of the risk.

71.  The PLs then sought to isolate and single out §17.5(b) as offending the pari passu rule.  I agree with Mr Manzoni that §17 is not about a creditor being entitled in an insolvency to a greater share of the assets than other creditors.  It should be borne in mind that §17 was part of the original bargain and not a flaw subsequently inserted.  It is therefore distinguishable from Peregrine for that reason.  Rather, it was part and parcel of a commercial rearrangement of the parties’ rights to address the economic consequences of insolvency of one of them.  While potentially itcould engage the anti-deprivation rule, it does not engage the pari passu rule.  

72.  The amount claimed under §17.5(b) is not at the discretion or whim of BK: not only has any such loss to result from the default, it hasto be calculated by an independent party appointed by the executive board. That fact supports the view that it was part and parcel of the contractual protection for the continuing party negotiated at the outset of the JV.

73.  It was clearly sensible and in the interest of the parties to provide for the contingency that has in fact occurred, namely, the insolvency of one of the parties.  Both parties are seasoned players in the construction industry: they have similar bargaining strengths and access to legal advice. I have no doubt that this was a commercial bargain entered into freely by the parties.  It is not the function of the court to rewrite a commercial bargain.  In the present case, it is difficult to discern any scheme or plan to evade insolvency laws.

74.  The question how far contracting parties may validly agree to one party terminating further performance on the bankruptcy of another has already been considered: see §§33 – 38 above.

75.  Whether or not the provision in §17.5 amounts to a penalty is a separate question and will be considered below.

76.  In conclusion, in my view, §17 does not offend the anti-deprivation rule.

 (3) Whether §17 amounts to a penalty

77.  The penalty objection also relates to §§17.1(i) and 17.5 and their combined effect.  The PLs maintain that they serve no legitimate commercial purpose and only serve to punish the defaulting party.  Those aspects have already been touched upon in the context of the anti-deprivation rule.

78.  BK cited the following passage from the decision of the Supreme Court in Cavendish Square Holding BV v Makdessi [2016] AC 1172 at §32 as the appropriate test:

“ The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance.”

79.  The question therefore is whether §17 imposes a detriment on the Company out of all proportion to any legitimate interest of BK in the enforcement of the primary obligation.  It was submitted that given the risks to which the innocent party is exposed and the adverse impact on the JV as a result (such as the risk of termination of the Main Contract [16] by ASD, the risk of contractors or suppliers refusing to supply or charging increased prices, the negative impact on BK’s own reputation as regards future tendering work for the government), it was not unreasonable to protect BK’s interest to require the defaulting party to maintain its risk of loss.  As earlier noted, the risk profile for a single JV partner to carry out the Project on its own as a result of the default is significantly different from the shared risk with the possibility of an increased risk of loss.  Additional protection was therefore not unreasonable.

80.  In so far as it was said to have a deterrent effect, if it deters theCompany from committing the relevant breaches, there is nothing inherently penal in the provision.  It would in fact benefit the JV if it is conducive to the parties achieving the commercial objectives in completing the Project.

81.  The PLs submitted that the effect of §17 is that when one looksat the primary and secondary obligation analysis, the primary obligation isto maintain solvency and the secondary obligation would be the obligation to bear post-exclusion losses.  That, it was said, was disproportionate to protecting the legitimate commercial interest of the counterparty.

82.  §17 lists five situations that are events of default.  The first is insolvency but the remaining four concern breaches of contract on the part of the defaulting party.  If the submission that the primary obligation is to maintain solvency were correct, following it through, it would mean that there would be right to damages arising because of the insolvency which would be a somewhat curious state of affairs.  The mere fact that the partywho is insolvent is identified as a defaulting party does not make it a default in the sense of a breach of contract or breach of a primary obligation.  For that reason, I do not accept that the provision imposed an obligation to maintain solvency.

83.  As earlier noted, when considering anti-deprivation principle,the parties are sophisticated and seasoned participants in the construction industry.  It hardly needs stating that the court would be slow to interfere with the commercial bargain of the parties.

84.  Accordingly, I am not persuaded that §17 is a penalty provision.

(B) The Supplemental Agreement

85.  The parties reached an oral agreement as to the terms of the Supplemental Agreement on 13 December 2018: BK agreed to acquire the Company’s residual rights in the JV for an aggregate amount of $53.6 million, payable to the Company by instalments.  The consideration was calculated on the basis that the Company would be paid 25% of the projected profits of the JV, less 10% to reflect the fact that the Company would be receiving the money earlier than they would have done under the final account provisions of §17.

86.  As recorded in BK’s solicitors’ letter of 4 March 2019, the calculation was based on the Project Manager Report to the JV Board (“the PM Report”), reflecting the position for the period 14 September 2018 to 28 November 2018 [17] :

	Calculation
Profit before Exclusion	Amount of profit earned by the JV as of 31 October 2018: HK$43.51 million. 65% × HK$43.51 million = HK$28.3 million
Profit after Exclusion	Projected gross profit: HK155.43 million Projected amount of profit earned by the JV after exclusion: HK$155.43 million − HK$43.51 million = HK$111.92 million. (25% × HK$111.92 million) × 90%  = HK$25.2 million
Aggregate Amount = HK$28.3 million + HK$ 25.2 million = HK$53.5 million NB: An additional HK$0.1 million was included in the Aggregate Amount

87.  On 14 December 2018, the Company requested that payment be made to Cogent Spring Limited, a wholly owned sister company within the Group as the Company’s bank accounts were frozen because of the petition and outstanding MPF contributions and employees’ wages could not be paid. 

88.  The Supplemental Agreement signed by the parties on 17 December 2018 provided for payment to the Company by two instalments of $20 million [18] and $33.6 million respectively.  Payment was to be made into the “designated account” requested by the Company which was Cogent Spring’s bank account.

89.  The PLs’ case is that the consideration was inadequate but no evidence was adduced to show in what respects it was inadequate.  Under the JV Agreement, the Company will not be paid its share of profitsearned up to the date of its exclusion until completion of the Project and the final accounting which could be some two years away.  It had no entitlement to share in any post-exclusion profits. There is also the risk of having to bear its share of the loss should the Project suffer a loss at the end of the day.

90.  Under the Supplemental Agreement, its receipt of its pre‑exclusion profit share would be accelerated; it would also receive 25% of projected profits (less 10%)[19]; and at the same time, the risk of having to bear post-exclusion losses was entirely removed.  Those are considerable upsides from the perspective of the Company (and its unsecured creditors).

91.  On the available evidence, there is nothing to suggest that the price was unfair or at an undervalue or simply a figure plucked out of the air.  On the contrary, the basis of the valuations is explained.  There is noreason not to believe that the price was negotiated at arm’s length.  On the basisthat a proper price was being paid for the Company’s residual rights in the JV, it would be a transaction that, prima facie, the court would validate.

92.  Had the payment been made directly to the Company, there would be no question of the court not validating the transaction.  The only matter that has given rise to some hesitation is the fact that, at the very least, BK had an inkling that part of the proceeds would be applied by the Company in settling outstanding MPF contributions and employees’ wages that would contravene section 182 (absent any prior validation order [20]) and that BK could be said to be facilitating a possible contravention by making payment to Cogent Spring instead of the Company directly.

93.  BK’s position was that that was a matter internal to the Company and not for a third party purchaser who is making a payment into the Group.  BK made payment to the Company’s nominee to discharge its obligations as purchaser.  Any disposition made subsequently of the proceeds would not have been made by BK but by the Company.

94.  How should the court exercise its discretion?  In so far as the proceeds (or part thereof) have been applied in contravention of section 182 and so prejudiced the unsecured creditors, it would have been because of misapplication of the purchase monies by the Company and/or its directorsand not BK.  In any event, BK was and is not in a position to control or direct the Company’s application of the proceeds.

95.  For BK, the acquisition of the Company’s residual rights in the JV was a commercial transaction negotiated at arm’s length.  No ulterior purpose or agenda in BK making payment into the designated account can be discerned.  It is not the PLs’ case that BK breached any duty or obligation whether to the unsecured creditors or anyone else. The only reason not to validate would be to punish BK for somehow facilitating a potential breach by the Company. But how would that benefit the unsecured creditors?

96.  For a start, if the transaction is rendered void, the $53.6 million will have to be repaid to BK.  The Company will have to await the completion of the project and the final accounting before it could receive the accrued profits up to the date of its exclusion. It has no right to any share of post-exclusion profits and its exposure to the possibility of having to carry its share of the loss on the Project will continue until its termination or completion. 

97.  In those circumstances, I can see no good reason for the court not to exercise its discretion to validate the transaction.

ORDER

98.  For the reasons stated above, there is to be an order in terms of §§1, 3 and 5 of the summons dated 15 January 2019. BK should also be released from the undertaking set out in the fourth preamble to the Order dated 28 January 2019 made by Harris J.

99.  There is to be an order nisi that costs of and arising from this application be paid out of the assets of the Company to BK (to be taxed if not agreed).

APPENDIX

“17. Default

17.1     In the event that a Party (hereafter called ‘the Defaulting Party’ which expression shall include any successors, receivers or legal representative);

17.1.1    is insolvent or makes a composition or arrangement with its creditors or has a winding up order made or (except for the purposes of amalgamation or reconstruction) a resolution for voluntary winding up is passed or a provisional liquidator, receiver or manager of its business or undertaking is duly appointed or where possession is taken by or on behalf of the holders of any debentures accrued by a floating charge on any property comprised in or subject to the floating charge;

17.1.2    contrary to the provisions of Clause 21, has assigned the whole or part of its rights;

17.1.3    has failed to execute any of the counter-guarantees or counter-indemnities required by the sureties of the security required by the Contract within a period of twenty-one (21) Days after having received written notice from the Executive Board to do so:

17.1.4    has failed to provide the required Working Capital in accordance with Clause 8.7 and 8.8 within a period of twenty-eight (28) Days from the Due Date as specified in Call Notice pursuant to Clause 8.8;

17.1.5    has committed any other breach of its obligations under this Agreement which, in the case of breach capable of remedy, is not remedied within twenty-eight (28) Days of notice from the other Party requiring such remedy;

then and in any such event, the other Party (hereinafter called ‘the Continuing Party’) shall at its discretion have the following rights (without prejudice to any other rights and remedies of the Continuing Party against the Defaulting Party under this Agreement or otherwise):-

(i) to exclude the Defaulting Party from further participation in the management of the Joint Venture and the Contract and the profits arising therefrom and to take over the benefits of the Defaulting Party in the Joint Venture (but without releasing the Defaulting Party from its obligation to bear its proportionate share of any loss resulting or to result from the Contract):

(ii) to wind up the affairs of the Joint Venture in so far as it concerns the Defaulting Party.

17.2     The Continuing Party shall have the right to retain for the completion of the Works all assets of the Joint Venture and all plant, equipment and materials provided by the Defaulting Party (whether on loan, lease, hire or otherwise) at the time of exclusion until the completion and handing over of the Works.  The Continuing Party shall further have the right to operate the Joint Venture Account(s) without reference to the Defaulting Party, and the Defaulting Party, shall execute and do all deeds, documents and things necessary or expedient to facilitate the exercise of such right and the completion of the Works by the Continuing Party.

…

17.5     Upon completion or termination of the Contract, receipt of all amounts due to be paid by the Client pursuant to the terms thereof and the ascertainment of all liabilities of the Continuing Party under or arising out of or in connection with the Contract or the construction of the Works, the Continuing Party shall, subject as hereinafter provided, account to the Defaulting Party who shall be entitled to receive an amount equal to the sum provided by him towards the Working Capital together with his proportionate share (as adjusted in accordance with the terms and conditions hereof as the case may be) of any profits or other entitlements earned and received by the Joint Venture in respect of the Contract but calculated up to the date when the Defaulting Party was excluded from the Joint Venture less:-

(a) his share of any losses arising from the Contract calculated in accordance with the Proportions whether before or after the date of exclusion; and

(b) all costs, expenses, losses and damages incurred by the Continuing Party directly or indirectly as a result of the default of the Defaulting Party.

Such calculation to be determined by an independent party appointed by the Executive Board (comprising of members appointed by the Continuing Party) upon completion of the Contract.”