ULTRA SOLUTION HOLDINGS LIMITED v. CHAN YUI HANG

HCMP 1101/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1101 OF 2013

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D E C I S I O N

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INTRODUCTION

1. This is the hearing of the Originating Summons whereby Ultra Solution Holdings Limited, which I shall call the applicant, applies for an order that the decision of the liquidator of Leco Watch Case Manufactory Limited (“the Company”) to reject its proof of debt be varied or reversed.

2. The applicant is a company that carries on business in the manufacture and sale of watches.  Until its liquidation, the Company which was in the business of the manufacture of watch cases was a supplier of the applicant.  The Company went into creditors’ voluntary liquidation on 26 November 2012.  The respondent to the present application is the liquidator of the Company.

3. The applicant first submitted a claim to the liquidator by its solicitors on 21 December 2012.  Its claim is divided into 8 categories as follows:

(1) the value of defective watch cases which the applicant returned to the Company for repair or replacement but which the Company had failed to return – $89,499.50;

(2) plating charges paid by the applicant to the Company for plating work which was not done – $2,403;

(3) the value of sapphire glass supplied by the applicant to the Company for the manufacture of watch cases; the Company never supplied the finished products or returned the sapphire glass – $695,702.50;

(4) wasted cost of components and loss of profits arising from the applicant’s inability to satisfy its customers’ orders – (i) $286,956.63; and (ii) $238,632.65;

(5) outstanding orders due to the Company’s failure to deliver watch cases - $3,857,278.81;

(6) customers’ orders that the applicant was unable to satisfy – $6,905,031.86 and $10,603,445.74;

(7) transportation expenses incurred by the applicant for collection of goods on 30 October 2012 chargeable to the Company – $500; and

(8) cost of additional watch parts that the applicant had to purchase from third parties when the Company ceased business in November 2012 – $20,861.

4. It can be seen that the applicant’s claims fall into three groups: claims for direct losses (categories 1 and 3), claims for outstanding charges and replacement expenses (categories 2, 7 and 8) and claims for consequential losses (categories 4, 5 and 6).

5. On 10 January 2013, the liquidator responded by asking for relevant documents and asserting that consequential losses incurred after the winding up could not be set off under s 35 of the Bankruptcy Ordinance. The liquidator already expressed his belief at this stage that the applicant “will not be a creditor of the company”.

6. On 28 February 2013, the applicant lodged a proof of debt with the liquidator together with some supporting documents. Further documents were supplied by the applicant on 14 March 2013.  There was however very little by way of explanation of what the claim consisted of and how the various amounts comprised in the claim were calculated.

7. Meanwhile, the liquidator made a claim on behalf of the Company to the applicant for unpaid invoices in the amount of $3,304,525.50.

8. By a letter to the applicant dated 14 March 2013, the liquidator reiterated his view that any consequential loss incurred after winding up could not be set off and stated that he “cannot not accept this Proof of Debt unless [there is] a Court direction”.  The liquidator did not address those parts of the applicant’s claim that were not consequential losses.

9. On 23 April 2013, the applicant’s solicitors wrote to the liquidator.  The applicant admitted that it was indebted to the Company in respect of unpaid invoices in the sum of $678,843.32.  The applicant pointed out, however, that its claim against the Company, even disregarding consequential losses, exceeded $800,000.  The applicant asked the liquidator to consider its claim and acknowledge it as a creditor of the Company.

10. By a terse letter dated 2 May 2013, the liquidator stated that he would not reply to the applicant’s letters in future. 

11. Although no notice of rejection of the proof of debt has been issued as such, Mr Osmond Lam, who appears with Mr Derek Chan for the liquidator, accepts that the liquidator must be taken to have rejected the applicant’s proof and to have done so by the letter of 2 May 2013 in itself or in combination with the letter dated 14 March 2013.

12. It is unsatisfactory that, contrary to rule 94 of the Companies (Winding-up) Rules, no ground has been stated by the liquidator for rejecting the applicant’s proof, apart from the assertion that consequential losses incurred after the commencement of winding up cannot be set off.  This stated reason, which was abandoned by Mr Lam at the hearing, relates anyhow only to consequential losses.  So far as the applicant’s claims for direct losses and charges and expenses are concerned, one cannot discern from the correspondence whether the liquidator accepted them but considered that they were entirely extinguished by set-off with the Company’s claims, or rejected them and if so on what grounds.  It is in my view not good enough for the liquidator simply to say that the burden of proof lies on the person claiming to be a creditor.  The liquidator himself has a function to perform in adjudicating on a proof of debt, the nature of which has been described as quasi-judicial. 

13. What then happened is that the applicant took out the present application and filed evidence in support of its application narrating the correspondence and exhibiting the letters and the voluminous supporting documents for its claims such as schedules, invoices, purchase orders, and delivery notes, with little explanation by the deponent.  This has made the court’s tasks difficult as the documents are hardly self-explanatory. The result of all this is that when Mr Lam in his argument raised specific issues concerning the supporting documents of the applicant, there was often no direct evidence to address them.  In these unsatisfactory circumstances, I have had to rely on inferences and inherent commercial probabilities in my interpretation of the documentation to arrive at a conclusion on the balance of probabilities.

APPLICANT’S CLAIMS

14. At the hearing of the Originating Summons, Mr Kerby Lau who appears for the applicant applies for the part of the Originating Summons relating to the claims for consequential losses to be adjourned.  He says that if the applicant succeeds on the claims for direct losses and claims for outstanding charges and expenses, it will qualify as a creditor.  It will then be entitled to information about the financial position of the Company and be able to ascertain whether there is such prospect of a substantial dividend as to make it worthwhile for the applicant to invest more resources into proving and substantiating its claims for consequential losses.

15. I do not think this is a valid reason at all for adjourning any part of the application.  I shall therefore deal with the entirety of the Originating Summons.

16. The proper approach of the court on an application to reverse or vary a liquidator’s decision rejecting a proof of debt is not in dispute.  The parties are content for me to adopt the established principles set out in Active Base Ltd v Sutton (unreported, HCCW 470/2005, 4 June 2008, per Kwan J (as she then was)) at paras 50 to 53:

“50. In determining whether to admit or reject a proof of debt, it has been said that a liquidator acts in a quasi-judicial capacity (Tanning Research Laboratories Inc. v O’Brien (1990) 169 CLR 332 at 388 to 389). An appeal against the liquidator’s adjudication under rule 95 of the Companies (Winding-up) Rules is a hearing de novo. In such a proceeding, a liquidator who defends his decision to reject a proof is no longer acting in a quasi-judicial capacity but is cast in the role of an adversary, defending the assets available for distribution against a liability which, according to the view he formed when acting quasi-judicially, is not legally enforceable. He is a party litigant though he is required to act fairly in conducting the litigation (Tanning Research Laboratories, supra. at 341).

51. In hearing the appeal, the court is bound to decide the rights of the claimant in the light of all the evidence before it, and not merely to express a view whether the liquidators were right or wrong in rejecting the proof of debt on the evidence then available before them. The onus of proof is on the claimant to show on a balance of probabilities that a real debt is due to him (Alan C.W. Tang, joint and several tee in bankruptcy of the estate of Lo Siu Fai Louis v. John J. Toohey, joint and several liquidator of Global March Ltd. [2005] 4 HKC 51, paras. 11 and 12).

52. Insofar as the claim of Active Base is resisted on the ground that the liability to which the proof relates is not enforceable against Moulin under the general law and are grounds of defence available to the company, the liquidators stand in the same position vis-à-vis Active Base as does Moulin (Tanning Research Laboratories, supra. at 342).

53. It is otherwise if a liquidator supports his rejection of a proof of debt in reliance on a ground which allows him, and him alone, to go behind a judgment, an account stated, a covenant or an estoppel on which the company’s liability is founded (In re Van Laun; Ex parte Chatterton [1907] 2 K.B. 23 at 31; In re Exchange Securities Ltd. [1988] Ch. 46 at 59 to 60). In these instances, the liquidator is armed with grounds for rejecting a proof of debt additional to any grounds available to the company under the general law. As stated by the majority of the High Court of Australia in Tanning Research Laboratories, supra. at 339:

‘The principles which determine enforceability of the liability to which a proof of debt relates are, in the main, the same as the principles which would be applied in an action brought directly against the company to enforce that liability. … But this general rule is qualified.  As the parties whose interests are affected by admission of a proof of debt are the general body of creditors and the contributories rather than the company in liquidation, there are some liabilities which would be enforceable against the company but which a liquidator is not bound to admit to proof of debt lest the interests of creditors and contributories may be unjustly affected.  A liquidator may properly reject a proof of debt if the liability, though enforceable against the company, is not a true liability of the company but is founded merely on some act or omission on the part of the company which unjustly prejudices the interests of the creditors or contributories in the assets available for distribution.’ ”

17. I shall deal with the eight categories of the applicant’s claims separately below.

CLAIM FOR DIRECT LOSSES (CATEGORIES 1 AND 3)

Category 1

18. The applicant’s case is that it ordered watch cases to be manufactured by the Company.  When the Company delivered the products to the applicant, some of them were found to be defective.  The applicant returned these defective cases to the Company for repairs, but the Company failed to return them to the applicant (it is not clear whether or not the Company did repair them).  The Company is therefore indebted to the applicant for the price of the watch cases not returned.

19. The applicant’s case is supported by the following evidence:

(1) The applicant has adduced copies of the purchase orders it placed with Leco International Watch Case Limited (not with the Company whose name is Leco Watch Case Manufactory Limited).  Mr Wong Wan Shan, a director of the applicant, has stated on affirmation that the arrangement the applicant had with the Company had always been that the purchase order was issued to Leco International while the payments for invoices were made to the Company.  On this basis it seems to me that these documents evidence the agreement for the Company to make certain watch cases for the applicant.

(2) The delivery of the manufactured products by the Company to the applicant is not evidenced by any document, but there are “returned goods slips” issued by Ultimos Manufacturing Pte Ltd addressed to the Company in respect of goods returned to the Company.

(3)   There are also replacement delivery notes evidencing that the Company delivered some replacement products to Ultimos Manufacturing Pte Ltd.  Where there is a shortfall of the replacement products delivered by the Company compared to the amount of defective goods returned to the Company, the applicant contends there is a corresponding liability on the part of the Company.

20. Broadly speaking, the applicant’s case is supported by the documentary evidence.  The relevant order numbers, model numbers and return slip numbers are consistent in the paper trail.  In fact, Mr Osmond Lam does not actually dispute this claim in principle, and takes issue only with the applicant’s calculation of the quantum of its claim.

21. There are two points here.  First, in the applicant’s calculation, apart from the price of watch cases, the applicant also claims a small amount which it alleges it paid to the Company for etching on the watch cases.  This is evidenced by the words, for example, “蝕底 $0.40 x 489 PCS” or “蝕底字 $0.40 x 621 PCS” in the relevant purchase orders. The liquidator contends that the meaning of these words is unclear and that they are not sufficient to establish liability.  It seems to me from the documentation, however, that the Company did undertake etching work as part of the arrangement with the applicant.  Having examined the purchase orders in the context of all the documentation, I am satisfied it is more likely than not that the orders placed by the applicant included orders for etching work to be done by the Company for the separate specified amount per unit.  It is inherently likely that this remuneration for etching was paid to the Company together with the price for the watch cases.  I think therefore that this amount was rightly included in the applicant’s claim.

22. The second point raised by the liquidator is this.  Each of the relevant purchase orders placed by the applicant with the Company contained the words “spare 1%” (in Chinese).  Mr Lam contends that this means the Company would provide an additional 1% of the ordered amount of products as spare goods to replace any defective items in the batch.  This is, he says, illustrated by a particular purchase order for 303 watch cases, in respect of which the Company delivered three watch cases, specified to be “spare”, free of charge.  He says the spare goods were therefore for the Company’s protection, as a buffer against defective goods.  He argues that the applicant is only entitled to compensation if and only to the extent that the number of defective watch cases in a batch exceeded the number of spare cases. On this basis, and by reference to a schedule attached to his skeleton argument showing the revised amounts due in respect of each purchase order, he said that the amount of this category should be reduced from $89,499.50 to $47,685.52.

23. There are in my view several problems with this argument, however.  First, the liquidator’s suggested purpose of the spare goods is not based on any evidence.  Mr Lau retorts that since the 1% spare goods were stipulated by the applicant in its purchase orders, it is likely that the spare goods were needed by the applicant to cater for its own needs during the further manufacturing process.  The Company was therefore obliged to ensure that the entire batch of products including the spare goods were of merchantable quality and fit for purpose.

24. Secondly, if the liquidator’s suggestion about the purpose of the spare goods is correct, one would have thought the applicant would only return to the Company for repairs or replacement the defective goods in excess of the buffer provided by the spare goods.  It is therefore likely that what the applicant returned to the Company were defective watch cases that were not made good by the spare goods, and which the Company had an obligation to repair or replace.  Any shortfall in providing such repaired or replaced cases is a shortfall that is not “neutralised” by any spare goods and therefore attracts liability.

25. Thirdly, the rejection and return of the defective cases were evidenced by the return slips which were apparently accepted by the Company. There is no evidence to suggest that the Company took the position then that it did not have to replace or repair all the defective goods returned.  There is little room now for the Company to contend that it did not accept the rejection of all the goods and did not accept liability arising from such rejection.

26. For these reasons I also reject the liquidator’s second argument in respect of this claim.

Category 3

27. The applicant makes this claim on the basis that it had delivered certain quantities of sapphire glass to the Company for the manufacture of watches ordered by the applicant but the Company failed to produce and deliver the watches or return the sapphire glass.  The applicant therefore claims the price of the sapphire glass from the Company.

28. The applicant’s case is supported by the following evidence:

(1) The applicant has adduced the invoice issued by the third party seller of the sapphire glass to the applicant itself, evidencing the purchase by the applicant of the sapphire glass for the price specified in the invoices.

(2) There are delivery notes in evidence showing the sapphire glass was delivered by the seller to the applicant.  It is reasonably to be inferred that the applicant had paid for the glass.

(3) The applicant has adduced copies of slips showing delivery of sapphire glass to the Company.  These delivery slips were created on the letterhead of Ultimos Manufacturing Pte Ltd.  However, the remarks column there set out certain numbers which are the numbers of the purchase orders placed by the applicant with the Company (as referred to in the next sub-paragraph).  Furthermore, there is a sentence on all of these delivery slips (except one) stating: “代 Ultra Solution Holdings Limited 退貨” (meaning “returning goods for Ultra Solution Holdings Limited”). Furthermore, the number of pieces of each type of sapphire glass stated on these delivery slips in aggregate match the number of pieces of such sapphire glass purchased by the applicant from the third party seller.

(4) There are also in evidence copies of purchase orders for watch cases placed by the applicant with Leco International, receiving them as agent for the Company.  These purchase orders specified that the sapphire glass required was to be supplied by the applicant itself.

29. Given the documentation, it seems to me likely that the sapphire glass was purchased by the applicant, and delivered by Ultimos Manufacturing Pte Ltd on behalf of the applicant to the Company for the manufacture of watch cases pursuant to purchase orders placed by the applicant with the Company.

30. On behalf of the liquidator, Mr Lam submits that the sentence on the delivery slips that reads “代 Ultra Solution Holdings Limited 退貨” (meaning “returning goods for Ultra Solution Holdings Limited”) is inconsistent with this interpretation.  In particular, he points out that, on the applicant’s case, there was nothing being “returned”.  This is a valid point as far as it goes, but it seems to me that looking at the documentation as a whole including the consistent cross-referencing numbers referable to the purchase orders placed by the applicant with the Company, the applicant’s case is to be preferred on a balance of probabilities.  In my view, the sentence in question, which appears to have been stamped on to the delivery slips, is only partly correct in that the delivery was being done “for Ultra Solution Holdings Limited” ie for the applicant, but is more probably than not a mistake when it refers to “returning goods”.

31. Although the delivery slips were issued by Ultimos Manufacturing Pte Ltd, given the cross-references to the applicant’s purchase orders, I think that it has been established on the balance of probabilities that the delivery was made on behalf of the applicant.  It is clear that it was the applicant who purchased the sapphire glass from the third parties and it was the applicant who placed the orders for watches with the Company accepting the responsibility to supply sapphire glass to the Company for those watches.  Furthermore, there is no suggestion by the liquidator that the Company has received any claim from Ultimos Manufacturing Pte Ltd that duplicates or overlaps with the applicant’s claim.  In these circumstances, I think that the liquidator’s objection to Category 3 fails and that the applicant has a valid claim against the Company.

CLAIM FOR CHARGES AND EXPENSES (CATEGORIES 2, 7 AND 8)

Categories 2 and 7

32. Mr Lam confirmed in his skeleton argument that the liquidator does not dispute category 2 (plating charges) and category 7 (delivery charges).

Category 8

33. The applicant’s case is that as a result of the winding up of and the cessation of business by the Company in late November 2012, the applicant had to incur additional expenses in December 2012 in buying additional parts for the manufacture of watch cases by, presumably, some other contractors that had replaced the Company.  The documents adduced in support include (i) the purchase orders placed with the Company prior to late November 2012 showing that certain parts would be provided by the purchaser to the Company for the manufacture of watch cases, and (ii) the purchase orders placed by the applicant with various third parties for additional parts in December 2012.  The two groups of documents (i) and (ii) can be cross-referenced using the production order numbers which appear on both.

34. In his skeleton argument for the liquidator, Mr Lam stated this claim was not disputed.  At the hearing, however, he raised two points.  First, some of the purchase orders placed with the Company were unsigned and, secondly, some of the purchase orders placed with the Company were placed by Ultimos Manufacturing Pte Ltd, not the applicant.  I reject the first objection.  It seems to me probable from the documentation including the subsequent purchases of replacement parts that the purchase orders were in fact placed and accepted, that parts were provided to the Company and that the transaction would have been completed but for the collapse of the Company in late November 2012.

35. There is however force in the second objection. There is nothing to show that the applicant lost the parts delivered to the Company in respect of purchase orders placed by Ultimos Manufacturing Pte Ltd. The fact that the applicant paid for the replacement parts after the collapse of the Company is not sufficient to make the Company liable to the applicant.  There must therefore be deducted from the applicant’s claim under this head the amounts referable to the replacement parts relating to the purchase orders placed by Ultimos Manufacturing Pte Ltd with the Company.  These amounts which are not apparent from the documents will have to be worked out by the parties.

CLAIM FOR CONSEQUENTIAL LOSSES (CATEGORIES 4, 5 AND 6)

36. These claims, albeit by far the larger claims of the applicant, can be shortly dealt with, because it seems to me, and I do not think Mr Lau seriously disputes, that the evidence adduced in support of these claims is deficient and wholly inadequate.

37. Category 4 consists in part of claims for the cost of other components which had been ordered and paid for by the applicant but which, it is alleged, had been wasted as a result of the Company’s failure to produce the watch cases ordered.  No document has been adduced to support this claim.  Another component of Category 4 is the loss of profits from the sale of the finished watches.  The schedule prepared by the applicant simply sets out its sale price of the completed watches in question.  There is nothing to show what the profits were, if any. 

38. Category 5 relates to purchase orders placed with the Company which had not been fulfilled.  The sum claimed of $3,857,278.81 is actually the total value of the contracts based on the sale price of the watch cases by the Company to the applicant.  I see no basis for any claim for this amount.  Nor is there any evidence in support of a claim for any lost profits which the applicant would have earned had the Company fulfilled the purchase orders and which the applicant had lost as a result of the Company’s failure to fulfil the orders.

39. Category 6 relates to the orders placed with the applicant by its customers for finished watches.  All that there are in evidence are the purchase orders placed by the customers.  This is not sufficient to support the claim.  In any event, most of those purchase orders were issued to Ultimos Manufacturing Pte Ltd, not the applicant.

40. It is clear, therefore, that the applicant has not established its claims against the Company in these categories.

THE COMPANY’S CLAIMS

41. It is not in dispute that the burden lies on the liquidator to prove that the applicant is indebted to the Company in the amount alleged by the liquidator. 

42. The liquidator originally claimed the sum of $3,304,525.50 from the applicant based on invoices issued by the Company to the applicant, which, the liquidator alleges, were unpaid.

43. By its solicitors’ letter dated 27 February 2013, the applicant informed the liquidator of a number of problems it had identified in the Company’s claim, including in particular that a large number of invoices had been paid by the applicant by three cheques in October and November 2012.  The bank, number, and date of each cheque were supplied.

44. On 3 April 2013, the liquidator replied, accepting some of the problems identified by the applicant and asking for proof of the cheques.

45. On 23 April 2013, the applicant’s solicitors responded and provided the copy of one of the three cheques.  The applicant had not been able to locate copies of the other two.  The applicant acknowledged that the Company had a claim against it on those invoices that remained unpaid, which totalled $678,843.32, but maintained that it was not indebted to the Company in respect of the other invoices relied on by the liquidator.

46. In the third affirmation of Mr Wong Wan Kwan filed on behalf of the applicant on 27 August 2013, the applicant produced copies of the other two cheques as well as copies of internal computer records of the applicant showing which invoices were paid by the three cheques.  I am satisfied that these records are reliable documents which demonstrate that the vast majority of the invoices relied upon by the liquidator had already been paid.

47. The dispute that remains live for the purpose of the hearing is whether ten invoices dated 24 November 2012 truly showed there were amounts due from the applicant to the Company.  The invoices contain references to delivery note numbers.  The applicant however denies having received these invoices or the corresponding goods.  No delivery notes could be produced by the liquidator to prove delivery, in contrast with other invoices dated earlier in the same month in relation to which delivery notes were located.  Nor is there any evidence of the ten invoices having been sent by the Company’s staff to the applicant, such as fax records.  It is to be noted that the date of these invoices was 24 November 2012, only two days before the Company was put into liquidation.  It is possible that the invoices had been prepared but not issued because delivery was prevented by the collapse of the Company.  In these circumstances, I do not think that it has been shown that these sums are due from the applicant to the Company. 

48. I hold therefore that the applicant is indebted to the Company in the admitted amount of $678,843.32.

49. There is no dispute that by reason of the provisions of s 35 of the Bankruptcy Ordinance (Cap 6) which applies in the winding up of an insolvent company by virtue of s 264 of the Companies Ordinance (Cap 32), this amount is to be set off against the claims of the applicant.

CONCLUSION

50. The applicant has therefore established categories 1, 2, 3, 7 and 8 (in part) of its claim.  The liquidator has not shown the applicant to owe anything to the Company beyond the admitted amount of $678,843.32.  The amount of category 8 which is admissible to proof remains to be worked out.  The applicant is in any event a net creditor of the Company in the sum of over $100,000.  The liquidator’s decision to reject the applicant’s proof of debt is therefore varied accordingly.

51. In addition, the applicant seeks a number of ancillary orders such as an order that the liquidator produce a host of documents to the applicant for inspection.  I do not think any ground has been made out for these orders.  There is nothing to indicate that, after the applicant is held by the court to be a net creditor of the Company, the liquidator would nevertheless deny it the usual entitlements of creditors to information concerning the affairs of the Company.  I am therefore not prepared to grant those orders.

52. Taking into account the fact that the applicant has succeeded only in relation to its claims for direct losses and charges and expenses, I make a costs order nisi that 70% of the applicant’s costs of this application (but not the costs of the proof) are to be paid out of the assets of the Company.