RE LUEN CHEONG TAI CONSTRUCTION CO LTD

HCCW 190/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 190 OF 2002

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REASONS FOR JUDGMENT

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1. On 10 October 2003, I made a validation order pursuant to s. 182 of the Companies Ordinance (Cap. 32) in respect of 6 payments received by the Applicant, Adrian Engineering Limited, from the company in liquidation, Luen Cheong Tai Construction Company Limited (the "Company") between March and June 2002, after the presentation of the petition to wind up on 18 February 2002, the winding-up order having been made subsequently on 15 July 2002. I made no order as to costs as between the Applicant and the Joint Liquidators, who through counsel maintained a neutral stance in the application. I said I would give my reasons later, which I now do.

2. The Company was a construction company. It was the main contractor of a certain government project. The Applicant was its sub-contractor and was basically responsible for undertaking the whole project. According to the sub-contract between the Company and the Applicant, the Applicant was entitled to receive 98% of the contract price (subject to the usual retention money provisions and so forth). According to the unchallenged evidence adduced on behalf of the Applicant, there was a past history of default and delay in making payment of interim payments and monies due and payable by the Company to the Applicant, resulting in litigation and government intervention, details of which I need not go into. Eventually, an agreement was reached between the Company and the Applicant in May 2001 for the setting up of a special account in the name of the Company but with both the Company and the Applicant as joint signatories with the Hang Seng Bank, into which the government was notified to pay the monies in respect of the project works. Under the arrangement, the Company would pay the Applicant out of the monies so deposited into the Hang Seng account by the government an agreed percentage as interim payments, pending the taking of the final account. Pursuant to the arrangement, some payments were received by the Applicant. The unchallenged evidence from the Applicant was that without these interim payments, the Applicant would not have continued working in the project (as it would have been quite entitled to do), thereby causing the Company to abandon the project together with a substantial exposure to damages payable to the government in that event.

3. As mentioned above, the winding-up petition was presented by another creditor of the Company in February 2002. In March 2002, the payment arrangement mentioned above was changed: contract monies received from the government were paid (directly or, in respect of the first payment in question, through the Hang Seng account) into another account of the Company maintained with DBS Kwong On Bank ("DBS") under the sole control of the Company. Cheques were then drawn on the DBS account by the Company in favour of a director of the Applicant, who would in turn draw cheques in favour of his own company as payment of the interim payments due to the Applicant. The director of the Applicant specifically opened a personal account with DBS, the purpose of which, according to his affirmation, was to enable him to verify with DBS immediately that the cheques issued by the Company from the DBS account were good for payment and could be credited to his account.

4. It was in those circumstances that altogether 6 payments totalling over $13 million were received by the Applicant from the Company through its DBS account between March and June 2002, after the presentation of the winding-up petition and before the making of the winding-up order in July 2002. It should be noted that all 6 payments were in respect of sub-contract works carried out by the Applicant, and certified by the government to be payable. A substantial amount of the total payment was in respect of works done after the presentation of the winding-up petition. The payments all came from monies received by the Company from the government in respect of the works in question. Out of the monies received by the Company in respect of the works, the Company had kept over $5 million (which was far in excess of the 2% gross profit that the Company should have been made out of this government project, being the difference between the main contract price and the sub-contract price).

5. By summons dated 11 August 2003, the Applicant applied for a retrospective validation order in respect of the 6 payments in question.

6. The principles governing an application under s. 182 of the Companies Ordinance are well established. Fox LJ summarized them in 8 propositions in Denney v John Hudson & Co. [1992] BCLC 901, 904d-905b as follows:

" The principles governing the exercise of the court's jurisdiction under s. 522 [the equivalent of our s. 182] were considered by the Court of Appeal Re Gary's Inn Construction Co. Ltd [1980] 1 All ER 814 at 819-821, [1980] 1 WLR 711 at 717-719. The leading judgment was given by Buckley LJ and was concurred in by Goff LJ and Sir David Cairns. I take the following propositions to be approved by that judgment:

(1)	The discretion vested in the court by s. 522 is entirely at large, subject to the general principles which apply to any kind of discretion, and subject also to limitation that the discretion must be exercised in the context of the liquidation provisions of the statute.
(2)	The basic principle of law governing the liquidation of insolvent estates, whether in bankruptcy or under the companies' legislation, is that the assets of the insolvent at the time of the commencement of the liquidation will be distributed pari passu among the insolvent's unsecured creditors as at the date of the bankruptcy.
	...
(3)	There are occasions, however, when it may be beneficial not only for the company but also for the unsecured creditors, that the company should be able to dispose of some of its property during the period after the petition has been presented, but before the winding-up order has been made. Thus, it may sometimes be beneficial to the company and its creditors that the company should be able to continue the business in its ordinary course.
(4)	In considering whether to make a validating order, the court must always do its best to ensure that the interests of the unsecured creditors will not be prejudiced.
(5)	The desirability of the company being enabled to carry on its business was often speculative. In each case the court must carry out a balancing exercise.
(6)	The court should not validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances making such a course desirable in the interest of the creditors generally. If, for example, it were in the interests of the creditors generally that the company's business should be carried on, and this could only be achieved by paying for goods already supplied to the company when the petition in presented (but not yet paid for) the court might exercise its discretion to validate payments for those goods.
(7)	A disposition carried out in good faith in the ordinary course of business at a time when the parties were unaware that a petition had been presented would usually be validated by the court unless there is ground for thinking that the transaction may involve an attempt to prefer the disponee - in which case the transaction would not be validated.
(8)	Despite the strength of the principle of securing pari passu distribution, the principle has no application to post-liquidation creditors; for example, the sale of an asset at full market value after the presentation of the petition. That is because such a transaction involves no dissipation of the company's assets for it does not reduce the value of its assets."

7. The Applicant through its director maintained in his affirmation that it had no knowledge of the presentation of the winding-up petition until after the making of the winding-up order in July. In other words, it had no knowledge of the petition when the 6 payments were paid and received. Mr Maurellet, counsel appearing for the Joint Liquidators, who as I said maintained a neutral stance in the application, drew my attention to the change of payment arrangement shortly after the presentation of the winding-up petition that has been alluded to above, as possibly suggesting knowledge on the part of the Applicant of the presentation of the petition. In answer, the Applicant through its counsel, Mr Merry, orally explained to the Court the reasons for the change of payment arrangement, which explanations were subsequently pursuant to an undertaking given by Mr Merry on behalf of his client confirmed in a supplemental affirmation from the director of the Applicant. I do not propose to go into the details of the explanations. Suffice it to say, first, I agree that the sudden change of payment arrangement shortly after the presentation of the winding-up petition did raise a question mark over the claimed ignorance of the Applicant of the petition; secondly, the latest explanations proffered by the Applicant regarding the change of payment arrangement did not entirely remove the suspicion raised.

8. However, in my view, it is not the law that knowledge of the presentation of a winding-up petition in a retrospective validation situation is by and of itself fatal to the validation application, although the absence of knowledge of the petition at the material time is a relevant and indeed a "very powerful factor" (per Oliver J in Re J Leslie Engineers Co. Ltd [1976] 1 WLR 292, 304B/C) to be considered in relation to the exercise of the court's discretion under s. 182. (Of course, knowledge of the petition is nonetheless an important factor to be borne in mind, particularly in considering whether the payment in question was made in good faith.) In my judgment, a fortiori, a mere suspicion of knowledge on the part of the Applicant of the presentation of the petition was not by and of itself fatal to the validation application.

9. In the present case, I proceeded on the basis that there was a reasonable suspicion of knowledge on the part of the Applicant of the presentation of the petition. As I said, that was an important factor in itself to be taken into account. On that basis, I would proceed to examine the other relevant factors in the present case.

10. In my judgment, on the facts of the present case, one important factor was that on the evidence there could be no doubt that the 6 payments were made in the ordinary course of business of the Company, and were received by the Applicant in its ordinary course of business. As I mentioned above, the 6 payments were in respect of works done by the Applicant pursuant to the sub-contract in question, which had been in being well before the presentation of the winding-up petition. There was a past history of payments for certified sub-contract works prior to the presentation of the petition. There was an established arrangement for the making of such payments. Although, as I emphasized above, the payment arrangement was for some reason changed after the presentation of petition, that did not, however, alter the nature of the 6 payments; they continued to be payments in respect of certified sub-contract works that had been done by the Applicant under the government project and they were funded by corresponding payments received from the government. There was no suggestion whatsoever that there were any set-off, counterclaim, deduction, defective work and so forth that would have entitled the Company to refuse or reduce payment to the Applicant.

11. Whilst the suspicion of knowledge of the presentation of petition had to be borne in mind in considering whether the payments were made by the Company and received by the Applicant in good faith, the fact that they were payments made in the ordinary course of business of both companies was also an important consideration to be taken into account.

12. Another significant consideration here was the benefit to the Company and thus the unsecured creditors of the Company now that it is in liquidation, which had been obtained from the making of the 6 payments. As I said, the undisputed evidence was that but for these payments, the Applicant would have (quite legitimately) stopped work a long time ago. In other words, the 6 payments kept the government project afloat, and I have no doubt that the keeping of the government project afloat on the facts of the present case benefited the Company, given the mere conduit-pipe role played by the Company in the government project, and given the substantial amount of money actually retained by the Company out of the monies paid by the government in respect of the post-petition sub-contract works carried out by the Applicant. In Re J Leslie Engineers Co. Ltd, supra, at p. 304, Oliver J, in a passage cited with approval by the Court of Appeal in Denney (at p. 905g-i), said:

"Whilst obviously the absence of any actual knowledge in the recipient of a payment that a petition is in being is a factor - indeed a very powerful factor - to be considered in relation to the exercise of discretion, I do not think that, by itself, it can be conclusive and, indeed, Mr. Potts does not so contend. I think that in exercising discretion the court must keep in view the evident purpose of the section which, as Chitty J. said In re Civil Service and General Store Ltd., 58 L. T. 220, 221, is to ensure that the creditors are paid pari passu. Obviously there are circumstances where this cannot in fairness be the sole criterion in cases where, for instance, the creditor concerned has since the presentation of the petition helped to keep the company afloat, or has otherwise swollen the company's assets, salvage cases and that sort of thing."

13. In short, the 6 payments kept the Applicant in its job under the government project, which in turn kept the Company afloat in relation to the government project, and swell the Company's assets. As I mentioned above, the Company kept a total in excess of $5 million of contract monies from the certified sub-contract works underlying the 6 payments, which was far in excess of the Company's 2% gross profit. Rightly or wrongly, the entire sum (of over $5 million) is now available to the unsecured creditors for distribution pari passu, in some sense at the expense of the Applicant, which in relation to the over-retained contract monies would merely rank as an unsecured creditor along the other unsecured creditors of the Company.

14. The keeping of the Company afloat in relation to the government project also benefited the unsecured creditors in a negative sense in that it minimized the exposure of the Company to damages, common law or liquidated, for early wrongful termination of the main contract. As it happened, the 6 payments enabled the Applicant to carry on working under the government project, so much so that by the time the winding-up order was made and the Applicant eventually stopped work, the government project had been completed by the Applicant to a very substantial and significant extent. That obviously benefited the unsecured creditors in general.

15. Finally, I tend to agree with Mr Merry's submission that in fact the present case fell within proposition no. 8 mentioned by Fox LJ in Denney, insofar as the payments were in respect of sub-contract works that were carried out and certified after the presentation of petition. To that extent, the Applicant could be classified as a "post-liquidation creditor".

16. Of course, the proposition would be easiest to apply if one were only concerned with an one-off post-petition disposal of asset, in which event all that one would be concerned to ensure was that the company should receive sufficient and adequate consideration from the disposal.

17. The proposition would be less easy to apply in case of payments or intended payments of money to keep a contract of the company alive after the presentation of the petition. In that case, I would have thought one would need to enquire not only whether the company would receive sufficient and adequate, or full market value, goods or services from its opposite contracting party under the contract if it was continued and kept alive by the payments after the presentation of the petition. One would also be concerned to find out whether the continuation of the contract would lead to a net profit or some other benefit to the company, because otherwise the unsecured creditors of the company would be worse off by the continuation of the contract even though the company would receive goods or services of full market value from the contract if it was continued. For ultimately the question is whether continuation of payment under the contract post-liquidation would lead to a reduction and thus dissipation of the company's assets.

18. However, the present case was less complicated. The simple reason was that the Company, on the facts, only played a conduit-pipe role in the government project. Its gross profit was 2% of the contract price, being the difference between the main contract price and the sub-contract price. So far as the main contract price was concerned, there was no evidence to suggest that the main contract price fixed by agreement with the government was anything less than the full market value of the contract works. So far as the sub-contract price was concerned, one would have thought that a 2% margin was a significant margin given the main contract price, the minimal role played by the Company in the project and the usual overheads that one would expect the Company in this type of situations to be incurring.

19. But in any event, as Mr Merry rightly pointed out, the Company did not merely earn 2% from the continuation of the sub-contract works after the presentation of the petition, it earned "illegitimately" far beyond the 2% entitlement - it kept about $4.8 million out of the government payments in respect of the sub-contract works in question, on top of its 2% entitlement. As mentioned above, there was no suggestion of any defective work in respect of the post-petition sub-contract works carried out by the Applicant.

20. For all those reasons, as I said, I tend to agree with Mr Merry's submission that this was also a case falling within proposition no. 8 mentioned by Fox LJ in Denney.

21. Finally, I should also specifically mention that on the facts of the present case, it appears extremely fair and reasonable to me that the payments, which were effectively earned by the Applicant as the sub-contractor of the whole government project single-handedly, should be made to the Applicant and should be allowed to remain in the Applicant's hands notwithstanding the presentation of the winding-up petition.

22. Apart from the above specific matters, I have also borne in mind the general circumstances of the case, and the other matters mentioned in both counsel's very helpful oral as well as written submissions. Having borne all relevant circumstances in mind, in the exercise of my discretion, I came to the conclusion that a retrospective validation order should be made, and it was accordingly made.

23. As regards costs, I have taken into account the fact that the Joint Liquidators took a neutral stance in the application, and the submissions made on their behalf by counsel were extremely fair and helpful. In the exercise of my discretion, I made no order as to costs.

24. I would like to take this opportunity to thank counsel on both sides for their helpful assistance.