RE CHEUNG HING CHIK also known as CHARLES H.C. CHEUNG, the Debtor

CACV 577/2020

[2021] HKCA 981

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 577 OF 2020

(ON APPEAL FROM HCB NO 1901 OF 2020)

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J U D G M E N T

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Hon Kwan VP:

1.  I agree with the judgment of Yuen JA.

Hon Yuen JA:

2.  This is the appeal of Charles Cheung Hing-chik (“the bankrupt”) from the Judgment of Au-Yeung J (“the judge”) given on 28 September 2020 (“the Judgment”) dismissing his application filed on 14 August 2020 for rescission of a Bankruptcy Order made on 3 August 2020.  

Background

3.1.  The petitioner is a company called Ling Sing Ltd from whose bank account the bankrupt, a certified public accountant, stole or misappropriated a sum of USD749,000. 

3.2.  On 27 February 2020, the petitioner served a statutory demand for the said sum, which was not satisfied or set aside. 

3.3.  On 7 May 2020, a petition for bankruptcy was duly presented.  At the call-over on 8 July 2020¹, the bankrupt did not dispute the debt. 

4.1.  On 3 August 2020, the petition was heard by the judge.  The bankrupt, then acting in person, orally asserted that he was able to repay the debt (which he alleged has been reduced by repayment to USD710,000²) as:

(a)    he could sell his 50% interest in Charles HC Cheung & CPA Ltd (“the CPA Company”) for an estimated sum of $6 million; and

(b)    he might receive some other funds.

4.2.  The judge noted that there was no proof of the alleged ability to pay.  Even though the statutory demand had been served 5 months before the hearing of the petition, the bankrupt “has not even started negotiating the sale of his interest in the partnership [the CPA Company]”³.  The allegation that he might receive some other funds was also rejected⁴. Accordingly, a bankruptcy order was made on 3 August 2020 (“the BO”) from which there has been no appeal. 

5.  The Official Receiver was appointed trustee in bankruptcy.  Her office reported to the court that the amount recovered from the bankrupt’s estate was $1,474.92, but that the two proofs of debt (from the petitioner and another company called Star Sight Holdings Ltd) came up to USD1,099,000⁵.

Application for rescission     

6.1.  On 14 August 2020, the bankrupt’s solicitors filed a summons for an order⁶ that the BO “be re-opened and annulled or set aside”.  The marginal note of the summons referred only to “inherent jurisdiction” and did not specify any provision in the Bankruptcy Ordinance (“the Ordinance”) pursuant to which the application was made.

6.2.  The summons was supported by two affirmations of the bankrupt filed on 13 August 2020 and 4 September 2020 respectively.  The petitioner opposed the application.

7.1.  The summons was heard by the judge on 7 September 2020.  The bankrupt was represented by counsel⁷. Although counsel’s skeleton submissions stated that “the [BO] should be re-opened and annulled/set aside”⁸, he clarified at the hearing that the application was for rescission and not annulment⁹.

7.2.  An application for annulment is governed by s.33 of the Ordinance¹⁰ which provides:

“The court may annul a bankruptcy order if it at any time appears to the court that –

(a) on any grounds existing at the time the order was made, the order ought not to have been made; or

(b) to the extent required by the rules, the provable debts and the expenses of the bankruptcy have all, since the making of the order, been either paid or secured to the satisfaction of the court”.

7.3.  An application for rescission is governed by s.98(1) of the Ordinance¹¹ which provides:  

“The court ... may review, rescind or vary any order made by it ... under its bankruptcy jurisdiction”.

7.4.  The difference between annulment and rescission was explained by the English Court of Appeal in Yang v Official Receiver¹².  Essentially, annulment treats the bankruptcy as never having been made, whereas rescission only terminates the bankruptcy.  The example given in that case was if there is a term in a contract which comes into effect on bankruptcy: it would be triggered when a BO is made even though later rescinded, whereas the same term would not be triggered if the BO is made but later annulled.  

8.1.  Returning to the hearing before the judge, the bankrupt’s counsel submitted that

“the [BO] should be re-opened and annulled/set aside pursuant to the Court’s inherent jurisdiction and BO section 98(1), on the basis that the bankruptcy Petition should and would have been dismissed under BO section 6D(3) on the strength of the Offer”¹³.

That submission is not easy to understand, because annulment would be pursuant to s.33, not s.98, and it is not clear what is meant by the application to “set aside” the BO. 

8.2.  Section 6D(3) provides:

“(3) The court may dismiss the petition if it is satisfied that the debtor is able to pay all his debts or is satisfied –

(a) that the debtor has made an offer to secure or compound for a debt in respect of which the petition is presented;

(b) that the acceptance of that offer would have required the dismissal of the petition; and

(c) that the offer has been unreasonably refused,

and, in determining for the purposes of this subsection whether the debtor is able to pay all his debts, the court shall take into account his contingent and prospective liabilities”.

9.1.  In the present case, the grounds advanced for rescission were that the bankrupt¹⁴:

(a)  had entered into an agreement (“the Agreement”) with Lam Kwan (“Mr Lam”) for $5.6 million; and

(b)  is due to receive other loans and funds.

9.2.  Under the Agreement dated 12 August 2020¹⁵:

(1)  the bankrupt agreed to sell to Mr Lam his 50% shares in the CPA Company and his 27.7% shares in a management service company for a total of $5.6 million, of which $100,000 was to be paid as deposit within 5 working days after the BO is set aside, and the balance of $5.5 million within 3 months;

(2)  the parties agreed that the bankrupt would become a consultant of the two companies for 3 years after completion, at a salary of $50,000 per month and housing allowance of “not more than” $20,000 per month, with an option for the bankrupt to renew on the same terms for another 3 years;

(3)  “this Agreement is conditional upon and subject to the fulfillment of the condition precedent that the [bankrupt] shall have successfully obtained a Court Order to re-open and annul/set aside the [BO] within 3 months from the date hereof, failing which this Agreement shall not be effective and shall be null and void.  Each party shall then have no claim/further claim whatsoever against the other party hereon”. (Emphasis added).

The judge’s Judgment

10.  The application for rescission was rejected by the judge on the following main grounds. 

11.1.  First, the judge held that s.6D(3) had no application as it deals with the Court’s power to dismiss the petition, ie based on facts before a BO is made, but in the present case, the bankrupt was relying on facts occurring after the bankruptcy order to have it set aside¹⁶. 

11.2.  However, importantly, the judge held that even if the bankrupt’s affirmations had been adduced at the hearing of the petition, they would still not be considered sufficient to meet the requirements of s.6D(3)¹⁷.  

12.  Secondly, the judge found that there was no evidence of availability of funds from Mr Lam or the other alleged provider of loans and funds¹⁸.

13.  Thirdly, the judge found that the lump sum consideration under the Agreement itself was “barely sufficient to cover the Balance Debt¹⁹.  The bankrupt has to rely on his monthly income as consultant to meet the deficit and costs due to the petitioner. Before completion, he does not have income under the Agreement”²⁰.

14.  Fourthly, the net assets of both the CPA and management service companies had suffered a “nosedive”²¹ from 2018 to 2019, and contrary to the bankrupt’s suggestion at the hearing of the petition that his 50% interest in the CPA Company alone could be sold at $6 million, it has turned out that the total value of his shares in both companies was only $5.6 million.

15.  Fifthly, the deposit under the Agreement was only $100,000 and there was no security for the balance²².

16.  Sixthly, on the bankrupt’s own evidence, the sale of his shares in the CPA Company was at an undervalue, the consideration was insufficient to meet both proofs of debt, and would allow preference of the petitioner over the other creditor²³.

Appeal

17.  The bankrupt filed a Notice of Appeal on 27 October 2020.  The grounds of appeal may be summarized as follows:

(1)  the judge was wrong in law to hold that s.6D(3) did not apply in an application for rescission under s.98;

(2)  no reasonable hypothetical creditor would have refused the bankrupt’s offer in light of the fresh evidence;

(3)  the judge was wrong to find there was no evidence that funds were available to Mr Lam;

(4)  the judge was wrong to find that the bankrupt was unable to pay the balance of the debt owed to the petitioner, as she wrongly assumed that his only source of income would be as a consultant pursuant to the Agreement.

Discussion

18.  The judge’s refusal to rescind the BO was a decision made in the exercise of discretion.  It is well-established that an appellate court would not interfere unless there was an error in law, or a misapprehension of material facts, or the judge had failed to take relevant matters into consideration, or had taken irrelevant matters into consideration, or the decision was “plainly wrong” in the sense in which this term is understood in case law.

Ground of Appeal (1)

19.1.  The bankrupt argued that the judge was wrong in law to hold that s.6D(3) did not apply at such a rehearing as the power to review under s.98 is a “jurisdiction to rehear and to rescind or vary orders made in the exercise of its bankruptcy jurisdiction ... [which] is in a proper case, almost without limit” (Wing Lung Bank Ltd v Ho Shiu -sun and Another)²⁴.

19.2.  This is an academic argument because, as noted above, the judge also held that even if the bankrupt’s affirmations had been adduced at the hearing of the petition, they would still not be considered sufficient to meet the requirements of s.6D(3)²⁵, and for reasons set out later in this Judgment, the judge was entitled on the evidence to arrive at that conclusion.

20.  However, I have set out below my thoughts on the proposition of law contained in the first sentence of §17 of the Judgment:

“In my view, section 6D(3) has no application as it deals with the Court’s power to dismiss the petition, ie based on facts before any bankruptcy order being made. In the present case, the Bankrupt is relying on facts occurring after the bankruptcy order to have it set aside”.

Insofar as that brief first sentence is understood to mean that the court cannot, at a s.98 application, take into account the matters set out in s.6D(3), that would appear, with respect to the judge, to be an unjustified restriction on the court’s wide jurisdiction under s.98.

21.1.  In Cheung Wah v The China State Bank Ltd²⁶, a petition was presented by a mortgagee bank against Cheung.  She made an offer of instalments to repay the mortgage debt (but not the high legal costs demanded by the bank, which were untaxed and which were not included in the statutory demand or petition).  The bank refused her offer.  The judge who heard the petition made a BO.  At a subsequent s.98 application, Ribeiro J (as he then was) held that it was unreasonable of the bank to have refused that offer.  Applying s.6D(3), he made a rescission order under s.98. 

21.2.  That is an example of s.6D(3) being applied in a s.98 application, where the relevant fact (the offer) occurred “pre-BO”.  However, there is no reason why it cannot be applied in an application where the relevant fact occurred “post-BO”.  

22.1.  It is well-established that the bankruptcy jurisdiction is unique in empowering the court under s.98 to review any order made by it.  As this statutory power does not contain express limitations, it empowers the court to review even a BO, and to decide whether, on such review, it should be rescinded or varied. 

22.2.  The English equivalent of s.98 (s.375 IA) was examined in Papanicola v Humphreys²⁷ where (after an examination of a number of authorities) Laddie J held:

“[25] It seems to me that a number of propositions can be formulated in relation to s.375. ...

(1) The section gives the court a wide discretion to review vary or rescind any order made in the exercise of the bankruptcy jurisdiction.

(2) The onus is on the applicant to demonstrate the existence of circumstances which justify exercise of the discretion in his favour.

(3) Those circumstances must be exceptional.

(4) The circumstances relied on must involve a material difference to what was before the court which made the original order. In other words there must be something new to justify the overturning of the original order.

(5) There is no limit to the factors which may be taken into account. They can include, for example, changes which have occurred since the making of the original order and significant facts which, although in existence at the time of the original order, were not brought to the court’s attention at that time.

(6) Where the new circumstances relied on consist of or include new evidence which could have been made available at the original hearing, that, and any explanation the applicant gives for the failure to produce it then or any lack of such explanation, are factors which can be taken into account in the exercise of the discretion.

[26] The second and fourth of these propositions merit some expansion. Inherent in s.375 is the concept that something has changed so that it is appropriate for the court to reconsider its own earlier order. If there is no change in circumstances, the only way to challenge the order is by appeal. The court is not to review its order simply on the basis that the applicant wants to present essentially the same facts and the same arguments but more forcefully or attractively. ...”.

(Emphasis added).

22.3.  In other words, the test is whether an applicant for rescission has shown exceptional circumstances, involving a material difference to what was before the court earlier, to justify the overturning of the BO.  The jurisdiction is so wide that the applicant can rely on facts occurring whether before or after the BO (although if the facts had occurred pre-BO, he would have to explain why he had not drawn them to the attention of the judge earlier). 

23.1.  The words “may dismiss the petition” in s.6D(3) do not mean that the subsection can never apply to the court’s consideration of an offer to compound made “post-BO”.  It would be noted that s.6D(1) also states that “the court shall not make a bankruptcy order on a creditor’s petition unless it is satisfied that the debt ... has been neither paid nor secured nor compounded for, etc”. The language of this subsection is also premised on a “pre-BO” situation. However s.6D(1) has been applied when the court considered “post-BO” facts in an application to rescind. 

23.2.  For example, in Yang v Official Receiver, the local authority assessed Yang’s house for council tax on the basis of multiple occupation.  When Yang did not pay the tax, the local authority obtained a liability order.  The local authority then instituted bankruptcy proceedings on the ground of the liability order, and a BO was made against her.  After the BO, however, the liability order was set aside on the ground that there was no multiple occupation. 

23.3.  On Yang’s application for annulment or rescission of the BO, the court examined the effect of a liability order in determining whether there was a debt at the time of the BO.  It held that the debt only ceased to exist when the liability order was set aside.  Accordingly there was a debt in existence at the time of the BO, and so the BO should not be annulled.  However, in light of the setting aside of the liability order (a “post-BO” fact), the court exercised its jurisdiction under the English equivalent of s.98 to rescind the BO.

24.  In other words, the words “may dismiss the petition” in s.6D(3) or “shall not make a bankruptcy order” in s.6D(1) do not impose a temporal limit on the application of these subsections.  Rather, they set out the procedure to be adopted by the court if it finds that the contents of either of those subsections are satisfied.  In Wing Lung Bank, after obtaining judgments against the debtors, the bank issued bankruptcy notices against them.  However it only sent them to the former address of the debtors.  No payment was made by the debtors and they did not appear at the hearing of the petitions.  Receiving orders were made against them.  The debtors then applied for rescission of the receiving orders.  In the court of appeal²⁸, Clough J (as he then was) delivering the judgment of the court, held that apart from applying for rescission, the debtors should also have asked for the petitions to be dismissed²⁹.    

25.1.  In conclusion, I take the view that in light of the very wide jurisdiction given in s.98, the court can consider an offer to compound in a rescission application even though it is based on “post-BO” facts.  However, a number of factors would have to be taken into account, including whether there exist other creditors who have submitted proofs of debt, the position taken by the trustee in bankruptcy, the impact of the BO on the bankrupt’s legal relationships with third parties, etc.

25.2.  In the present case however, the above is academic, because the judge had found that even if the bankrupt’s affirmations had been adduced at the hearing of the petition, they would still not be considered sufficient to meet the requirements of s.6D(3)³⁰, and it is clear from the following discussion that the judge was entitled on the evidence to arrive at that conclusion.

Grounds of Appeal (2) and (3)

26.1.  In arriving at that decision, the judge noted there was no proof of availability of funds from Mr Lam³¹.

26.2.  The judge was clearly entitled on the evidence to come to that view, and applying the principles governing the exercise of discretion, there is no ground for this appellate court to interfere with it. 

-  Importantly, there was no affirmation from Mr Lam deposing to (and no evidence supporting) his ability to come up with a sum of the magnitude of $5.5 million within 3 months of the proposed order.  Before this court, the bankrupt submitted that the judge did not ask him if Mr Lam was able to pay the sum.  However, it is clear that the onus is on the bankrupt as the applicant in a rescission application to demonstrate the existence of circumstances which justify exercise of the discretion in his favour³².

-  The fact that Mr Lam is a certified public accountant does not raise a presumption that he would be able to raise the required capital within the required time, especially since the turnover of both companies have, in the judge’s words, suffered a “nosedive”. 

-  Mr Lam has not even paid the deposit of $100,000 referred to in the Agreement, as that is contingent on the BO being “annulled/set aside”.

-  Although the bankrupt alleged that he had sold part of his interests in both companies to Mr Lam in 2019 for a total consideration of $3,617,110, there is no evidence that that sum (or any part thereof) has been paid.  Even if it has been paid, it does not follow that after that sizeable expenditure, Mr Lam would be able to come up with an even larger sum within such a short time thereafter.

-  Significantly, the financial statements of the CPA Company and the management service company, exhibited by the bankrupt, show that neither company is cash rich, such as to be able to provide funds of that magnitude to Mr Lam whether by way of a dividend or a loan. 

Ground of Appeal (4)

27.1.  In his skeleton submissions before this court³³, the bankrupt contended that the judge was wrong to hold (without asking him about his existing source of income) that after the BO, his only source of income would be as a consultant under the Agreement (and therefore if the Agreement cannot be carried into effect, the bankrupt would have no income).

27.2.  However, the judge was entitled to make that finding because in §12 of the bankrupt’s affirmation filed on 14 August 2020, he deposed that “the [BO] brought to me disastrous effect, as I will not be able to continue to practice as a certified public accountant”.  Thus, it would only be if the BO is rescinded that the Agreement would be effective, and it would only be after the Agreement is effective that he could work as a consultant for the CPA Company and obtain income.  This is clear in §11 of the same affirmation, where he deposed:

“After the sale of my shareholding in the Companies to my existing Partner, I would remain as a Consultant working in the Companies. I would then have sufficient money to repay the debt owed to the Creditor”. (Emphasis added).

27.3.  There is no evidence that the bankrupt has any other sources of income.

28.1.  Finally, I note that the Agreement contains an express time limit³⁴ to the effect that the Agreement has expired by effluxion of time when this appeal was heard.  When this court asked the bankrupt about the clause in question, he argued that it meant that Mr Lam had to pay the consideration within 3 months.  That is an incorrect construction of the clause, which stated clearly that if the BO was not annulled/set aside within 3 months from the date of the Agreement (12 August 2020), “this Agreement shall not effective and shall be null and void”. 

28.2.  There was no evidence from the bankrupt that this clause has been varied so that it remained effective when this appeal fell to be heard, and we have only assumed in favour of the bankrupt that the Agreement has remained effective.

Order

29.  For the above reasons, the appeal should be dismissed, and as the parties have agreed that costs should follow the event, the bankrupt should pay the costs of the appeal to the petitioner.  The Official Receiver has not appeared and has not asked for costs.

Hon Au JA:

30.  I agree with the judgment of Yuen JA.