RANDOLPH SHANE MENTON v. CSA ABSOLUTE RETURN FUND LTD

HCCW 712/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 712 OF 2004

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D E C I S I O N

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1.  This was the adjourned hearing of a petition to wind up CSA Absolute Return Fund Limited (“the Company”).  On 21 June 2004, Messrs Jan Blaauw and John Toohey (“the Provisional Liquidators) were appointed as provisional liquidators of the Company by an order of Suffiad J, an order which I continued on 2 July 2004.

2.  The Company is not incorporated in Hong Kong.  However, the court does have jurisdiction to wind it up on the just and equitable ground, notwithstanding that it is an unregistered company, under section 327(3)(c) of the Companies Ordinance.

3.  The petitioner in this matter, Mr Menton, is an investor in a fund which was operated by the Company.  It appears from the petition that the Company carried on business as a public mutual fund, or an open-ended investment company, which opened for subscriptions in February 2002, at which time the petitioner was one of the first investors in the Company, investing US$200,000 for 200 A shares in the Company.  The petitioner says that he made a further investment in December 2003, acquiring a smaller number of shares for the same amount of money, based on what was then said to be the asset value of the Company.

4.  The Company’s investment manager is CSA Management Limited and its investment adviser is Charles Schmitt & Associates Limited, the directors of which include Mr Charles Schmitt.  Charles Schmitt & Associates Limited is the subject of a restriction notice issued by the Securities and Futures Commission on 15 June 2004, and Mr Schmitt is personally subject to an injunction granted against him on 16 June 2004.  I shall refer in due course to some of the salient terms of that injunction.

5.  There are serious allegations of fraud made against Mr Schmitt and in the light of those allegations and the apparent absence of control over the company’s affairs, the petitioner sought the winding up of the company and the appointment of provisional liquidators to it in order to protect the interests of all those who might be interested in its assets.

6.  Since their appointment, the Provisional Liquidators have sought to locate assets in which the Company might have an interest and, in the course of doing so, have identified sums of some US$75 million in bank accounts of the Company which they have now taken into their possession.  Further assets in other bank accounts and securities accounts have been identified by the Provisional Liquidators as being accounts to which assets belonging to the Company appear to have been transferred or remitted.

7.  These further bank and securities accounts are the subject of the Mareva injunction which I have mentioned.  The circumstances in which the Mareva injunction came to be granted are, briefly, these:  the Securities and Futures Commission, apprehending that there were serious problems as to the status of funds and investments managed by Mr Schmitt, took out proceedings by way of originating summons in order to obtain an injunction restraining Mr Schmitt personally, or through his agents or other entities, from disposing of or otherwise dealing in assets or the proceeds of assets of investors in funds and accounts advised or managed by him or Charles Schmitt & Associates Limited, which are ultimately proven to have been misappropriated by him or by others on his instructions.

8.  Subsequent to the obtaining of this Mareva injunction, the Securities and Futures Commission applied for and obtained the appointment of Mr John Lees as the administrator of Mr Schmitt.  This appointment was made on 6 July 2004. 

9.  The activities of Mr Schmitt in the investment field are not limited to the activities of the Company.  It would appear that there are a number of other funds in respect of which Mr Schmitt was adviser and in respect of which moneys were received which the SFC is concerned to protect in the interests of the investors who placed such funds with, or through, Mr Schmitt.

10.  I am informed by Mr Harris, who appears for the Provisional Liquidators today, that although there are other funds and other entities that may have an interest in the assets that have been identified and which are the subject of the Mareva injunction to which I have referred, in the Provisional Liquidators’ estimation, some 95 per cent of the moneys and assets which have been located relate to the Company, that is to say, CSA Absolute Return Fund Limited, whereas the balance of some 5 per cent or thereabouts appears to be attributable to other investment vehicles or entities with which Mr Schmitt was involved.

11.  This breakdown is not accepted, I think, by Mr Barlow, appearing on the instructions of Mr Lees, but this is a matter which I need not decide or go into in any great detail today, other than to note the fact that this is an aspect of the matter that needs to be considered in due course.

12.  It seems that, initially, the Provisional Liquidators thought that it was undesirable to push ahead with immediate liquidation of the Company.  At that stage, their concern appears to have been that a liquidation might result in jeopardy to some of the Company’s assets in that it was thought that there might be assets of the Company which might diminish in value in the event that a winding-up order were made.  However, Mr Harris has told me today that, at this stage, following their investigations, the Provisional Liquidators do not believe that this is the position in relation to any of the assets which they have identified.

13.  The Provisional Liquidators do, however, consider that the position in relation to the company and those who have interests in it, namely its creditors and shareholders, is a matter of some considerable complexity.  It is a matter on which they have, I understand, obtained advice, both locally and in other jurisdictions, including the BVI, and from counsel in London, relating to the position of the shareholders in the funds and other persons who may stand in the position of creditors in the funds.

14.  The distinction between these two classes appears, broadly, to be as follows.  First, there appear to have been a number of persons who have provided money for investment into the Company, who were never, in fact, allocated shares in the Company despite having paid for them.  The Provisional Liquidators’ position at this stage is that such persons stand in the position of creditors of the Company.  On the other hand, there are others who, having paid subscription moneys for shares, were in fact allocated with shares.  Persons or entities in this position are regarded, at the moment, as shareholders of the Company.

15.  However, in relation to such shareholders, the position is complicated by the fact that it is considered that there is a risk that certain of the shareholders may not have had shares validly issued to them in accordance with the constitution of the Company, in which case they may turn out, at the end of the day, to be creditors rather than shareholders.  Even in the case of those to whom shares have been issued in accordance with the constitution of the Company, it is possible that they may, nonetheless, be entitled to rescind their agreements to subscribe for shares in the Company on the basis of misrepresentation or fraud on the part of those concerned in the management of the Company.  If they are entitled to do so and if they exercise their rights of rescission, it may be that they will thereupon cease to be shareholders and will thereby convert themselves into creditors of the Company. 

16.  The complexities, I think, go also to the question of whether or not the Company is solvent.  At this stage, on the basis that the only substantial creditors of the company are those who have paid moneys to the Company with a view to acquiring shares but who have not been allocated shares in it, the Company would appear to be solvent, in that its assets that have been recovered or identified would appear to exceed the amount of the claims of persons in that position.  However, the position may change if a sufficiently large number of persons who are currently in the position of shareholders turn out not to be shareholders but creditors, whether because of deficiencies in the manner in which their shares were issued to them, or because they are in a position to, and choose to, rescind their subscription agreements by which they became shareholders.

17.  Faced with these problems, the Provisional Liquidators consider that there may be scope for exploring the possibility of whether or not the various classes of persons interested in the assets of the Company may be able to reach some form of agreement or compromise that could be embodied in a scheme of arrangement that would compromise their competing claims so as to simplify the distribution process and also, perhaps, the process of proof of entitlement to payment out of the assets of the Company, whether in the capacity of a shareholder or a creditor.

18.  With this possibility in mind, the Provisional Liquidators took out a summons on 28 October 2004, seeking, among other things, to be given the power to consider the merits and feasibility of schemes of arrangement to be entered into between the Company and its shareholders and its creditors respectively, and to introduce such schemes if this is thought to be in the best interests of the shareholders and creditors. 

19.  With a view to pursuing this approach, it was also sought to extend the powers of the Provisional Liquidators to enable them to invite shareholders and creditors to form an informal committee, which the Provisional Liquidators at first suggested should consist of up to five persons, to represent the interests of shareholders and creditors and to provide their views on the merits or otherwise of such schemes.  Other directions were also sought with a view to advancing the possibility of schemes being put forward.

20.  That summons came before me on 11 November 2004.  However, prior to the hearing of the summons, correspondence was received by the Provisional Liquidators and the court from a number of persons, either investors or their representatives, expressing concerns as to the proposals which they had apparently heard about and complaining about a lack of information as to the reasons and justification for the directions that were sought.

21.  In the event, the Provisional Liquidators indicated that in the light of the views that had been expressed, they did not propose to pursue any of the expansions of their powers sought with the exception of that referred to in subparagraph (b) of their summons, by which they would be given the power to form an informal committee of creditors and/or shareholders of up to five persons, in order to enable the Provisional Liquidators to consult with the shareholders and creditors and obtain their views on various matters pertinent to the future course of these winding-up proceedings.

22.  However, in the light of the fact that the petition was fixed for hearing today, some four days later, the Provisional Liquidators were agreeable to the adjournment of their application so that it could be dealt with today, when any creditors or shareholders who wished to attend and be heard to express their views on that proposal might do so.

23.  At today’s hearing, Mr Bartlett appeared for the petitioner and sought the adjournment of the petition for a period of two months in order to enable the Provisional Liquidators to inform the creditors as to the various possible ways forward in relation to these proceedings, and also to consult the creditors as to their views as to what course they felt was best in their interests.

24.  Mr Harris, appearing for the Provisional Liquidators, supported the suggestion that there should be an adjournment of two months.  He drew my attention to the complexities as to the various positions of the different parties to these proceedings.  He also emphasised the possible desirability of a scheme of arrangement being introduced at some point.  He said, however, and I think rightly, that whatever approach was to be adopted, it was desirable to have input from and obtain the views of the various investors and creditors whose interests would be affected by any liquidation.

25.  Mr Barlow, appearing as I understand it for a contributory, Charles Schmitt & Associates Limited, albeit on the instructions of Mr Lees as the administrator of Mr Schmitt, suggested that there was a prior question that needed to be dealt with by the court.  This related to the question of the relative roles and responsibilities of Mr Lees as the court-appointed administrator of Mr Schmitt, and Messrs Blaauw and Toohey as the Provisional Liquidators of the Company. 

26.  The position does appear to be that there is, to some extent at least, an overlap in their functions in that they are both concerned with the same pool of assets although I think it is fair to say that Mr Lees’s role is slightly the wider in that his involvement will extend to assets which may not be assets to which the Company has a claim, but which may be assets to which other clients of Mr Schmitt, or other entities associated with him, have a claim. 

27.  Mr Barlow suggested that this was a matter that needed to be dealt with at as early a stage as possible and has suggested that, in the meantime, it was undesirable for additional costs and expenses to be incurred in respect of matters such as schemes of arrangement which would undoubtedly require considerable time and expense to be incurred in their drafting and putting them forward.

28.  Also before me today were a number of letters that had been sent in by various representatives of creditors.  They were, I think, generally to the effect that there was support for the proposal of an adjournment for about two months, but such support was qualified on the basis that, during the period of the adjournment, steps should be taken to enable the views of the creditors and shareholders to be obtained.  Views were also expressed as to the manner in which an informal creditors’ committee should be set up.  The concern was principally that the creditors and shareholders themselves should have some input into the composition or makeup of that committee, and that information should be provided to the creditors and shareholders (whether through that committee or through other informal meetings to be held by the Provisional Liquidators), as to the financial position of the company, and also as to the various options going forward as to how the interests of the creditors and shareholders and how their objective of obtaining as early a return of their investments or debts as possible could be achieved.

29.  At the hearing today, I allowed, exceptionally, Miss Masako Watanabe and Mr Christopher Aiello representing certain creditors and shareholders to appear and address me.  In doing so, I do not intend to set a precedent for departing from the normal practice and procedure of this court, which is that, in company winding-up petitions, the only persons who are entitled to appear and to be heard are creditors and contributories of the company and, of course, the company that is the subject of the petition itself.

30.  In circumstances such as these, where there are a number of creditors or contributories whose interests are represented by financial advisers, it remains the position that the persons with a right to attend and be heard on the petition are the contributories or creditors themselves and not their financial advisers.  If they wish to attend for the purposes of observing the proceedings, they may of course do so by whomever they choose to.  However, if they wish to address the court, the position which will in future be strictly adhered to, is that they should do so either in person or through legal representatives.  In the case of an investor or contributory or creditor which is a company or corporation, it will only be entitled to appear by a director if it has prior to the hearing obtained the necessary leave to do so from the Master, pursuant to Order 5, rule 6 of the Rules of the High Court. 

31.  However, having regard to the fact that many creditors and contributories had expressed concerns as to the information that they had received to date, and in the light of the fact that one of the objectives of today’s hearing was to enable their concerns to be ventilated and addressed, I exceptionally allowed Miss Watanabe and Mr Aiello to make representations and to state their position to me.

32.  Miss Watanabe essentially confirmed the position that is set out in the letters from the various contributories or creditors to which I have referred.  She indicated that, on clients part, there was no objection to an adjournment provided that information would be provided to the creditors and shareholders in the meantime by way of either a creditors’ and shareholders’ committee or informal meetings.  Miss Watanabe suggested that it might be appropriate or desirable to have a larger committee of some 10 persons in order to provide a better range of representation for the various creditors and contributories involved.  Miss Watanabe also took the opportunity to express concerns as to the manner in which the application by the Provisional Liquidators had been made last week, without notification to creditors and contributories who had expressed an interest in knowing what the progress of the matter was and as to the outcome of the Provisional Liquidators deliberations as to the best way forward.

33.  As to that, I should say that the Provisional Liquidators are, of course, constrained by the terms of the order by which they are appointed as to what it is that they are empowered to do.  That order sets limits on their powers.  Where they have doubts as to whether or not they are empowered to take a certain course of action, then it is entirely reasonable and proper for them to come to the court to seek authorisation to take such steps as they think are appropriate, explaining to the court why it is that those steps are being proposed and why the powers that they seek are needed to enable them to best protect the interests of the company, or to represent the interests of its creditors and contributories.

34.  Up to this point, the Provisional Liquidators have attempted to communicate with the creditors and contributories by means of circular letters which they have sent out from time to time.  It is fair to say that the circular letters do not always contain a full description of all the matters that the Provisional Liquidators have deliberated upon, but that is not to say that they need necessarily do so.  In circumstances such as these where the issues involved can be complex, it is not, to my mind, surprising that the Provisional Liquidators should not think it appropriate to disclose all the various pieces of advice which they might have received, or the entirety of their thought processes, until they have come to a settled view as to what may be the legal position and the appropriate way forward.

35.  Mr Harris informed me today that that position has now been reached, or is very close to being reached, and the Provisional Liquidators have come to the view that the method of communication adopted up to now is probably no longer appropriate and that, in future, it would be more convenient and more effective to communicate with the creditors by means of the informal committee which they were proposing should be set up, if they were given power to do so.

36.  Mr Aiello, appearing on behalf of Genesis Capital Management, initially pressed, I think, for an immediate winding-up order to be made.  Mr Aiello’s position was slightly complicated by the fact that although Genesis Capital Management, or two funds which it operates, had, he said, some US$8 million of their money misappropriated by Mr Schmitt, it is, at this stage, unclear whether all of that money went into the Company with which these proceedings are concerned.

37.  On the Provisional Liquidators’ part, their investigations suggest that a relatively small proportion of the funds that may have been misappropriated from the entities with which Mr Aiello is concerned found their way into the Company itself, whereas the bulk of such funds may have found their way into other entities or investment vehicles operated by Mr Schmitt which have proved (or at least are strongly suspected) to be bogus or fraudulent investment vehicles.

38.  If that is the case, then it may be that the bulk of the claims that Mr Aiello’s investment entities have relate to assets which may form part of the assets of the group of companies in which Mr Lees, as administrator of Mr Schmitt, has, unquestionably, the only interest or only right to administer, as opposed to aspects of the Company that is in provisional liquidation.

39.  It seems to me that, at the end of the day, even if I were to treat the position of Mr Aiello as being that the entirety of the US$8 million which has been misappropriated from the funds with which he is associated has found its way into the Company, his views, with respect, would, at the end of the day, not be sufficient to outweigh the views that have been received from others with interests in the provisional liquidation.

40.  I have in mind, in particular, that although they have lodged no notice of intention to appear at the hearing of the petition, there is correspondence from a number of other investors or shareholders, or persons and firms representing them, which indicates that a substantial number of investors tend to support at least a limited adjournment of these proceedings to enable consultation to take place as to what may be the best way forward in the best interests of the various parties involved.

41.  Finally, Miss McKenna, who appears for the Official Receiver, indicated that the Official Receiver’s main concern was as to the appropriateness of schemes of arrangement being advanced outside the liquidation; that is to say, during the stage when the company is still in provisional liquidation rather than after a winding-up order is made.  I think, in fairness, that Mr Harris accepts that this is an issue that needs to be addressed and clarified before any substantial expenditure is incurred in formulating and putting forward schemes of arrangement for consideration by the creditors and shareholders, and for this court’s consideration and sanction, if appropriate.

42.  Nonetheless, I think Mr Harris’s position was that, although it was accepted that matters such as the detailed drafting of a scheme or schemes which would be likely to involve substantial expenditure of time and money could, and should, wait until after such matters had been clarified, it was still nonetheless desirable for an informal creditors’ committee to be formed to enable the Provisional Liquidators to ascertain the views of the creditors on the various courses and options that might be open. 

43.  Thus, for example, if the creditors, having been consulted, were strongly of the view that the more appropriate course would be for the Company to be put into liquidation and that no question of a scheme of arrangement should be explored until after the Company were in liquidation, the position would undoubtedly be that, in those circumstances, the Provisional Liquidators would feel that it was more appropriate for the Company to be put into liquidation, leaving the question of any possible scheme of arrangement to sort out complexities as to the respective rights and interests of various parties to the company’s assets to be dealt with in the course of the liquidation.

44.  With the exception of Mr Barlow, and perhaps Mr Aiello, the position seems to be that all other parties who have appeared or expressed views on the matter were of the view that, while an adjournment would be appropriate in the circumstances of the case, it was desirable that the adjournment should not be one in which nothing was done, and that some work should be done in the liquidation with a view to ascertaining the opinions of the various groups of persons who have an interest in it, so that the parties and the court might be better informed as to the respective views of the various interested parties on the merits of the different options that might exist.

45.  It seems to me that it is appropriate for me to adjourn the further hearing of this petition.  The questions are how long that adjournment should be, and whether, in the meantime, there is merit in the creation of an informal committee of creditors and shareholders, or whether the taking of steps to form such an informal committee, and for that committee to proceed to deliberate some of the options that are available, will prove at the end of the day to be a wasted expense.

46.  On balance, it seems to me that that will not be the case.  I say this because it seems to me that it is important for the court to be informed, in any event, as to the position that is taken by the various interested parties.  It seems to me that the formation of such a committee and the consultation between the Provisional Liquidators and the committee and, through that mechanism, with the wider body of creditors and shareholders, will enable the Provisional Liquidators to obtain a better assessment of the various views that may be expressed as to the way forward in relation to this liquidation, and to obtain a sense of the relative strength of the competing views.  Thus, for example, one of the matters that I would expect to be considered is whether the matter should go forward to a liquidation, or whether the matter should go forward by way of a scheme, such as the scheme of arrangement that the Provisional Liquidators have indicated is a possible option. 

47.  It seems to me that the court needs to be informed as to the views of the creditors and contributories as to those competing options, and that the formation of an informal committee of creditors will be a useful means by which the Provisional Liquidators will be able to obtain information as to the views of the various creditors and contributories, and to convey those views to the court prior to the next hearing of this matter.

48.  It also seems to me that, having regard to the legitimate interests of the creditors and contributories in knowing what the issues confronting the Provisional Liquidators are, and what the options available to the creditors and contributories are, that the formation of such a committee will probably do a great deal to promote that objective and will, I hope, enable the creditors and contributories to be put into a position whereby they have sufficient information to be able meaningfully to assess the options available to them.

49.  Finally, it seems to me that, whatever views are obtained as to how best to proceed, and perhaps also as to how best to resolve the differences between the interests of the various groups that I have mentioned (that is to say, the shareholders, those shareholders who may be entitled to rescind their subscription agreements and those who are, apparently, creditors of the company), information as to the views of the various parties as to how their competing interests may best be resolved may well be of assistance to whoever ultimately is charged with the consideration of and dealing with their interests.

50.  It seems to me that, for those reasons, it would be preferable to use the period during which this matter is to stand adjourned in a useful manner, and that this can best be done by giving the Provisional Liquidators the power that they seek to form an informal committee of creditors and/or shareholders with a view to consulting them as to their views as to the manner in which this matter should progress.

51.  With that in mind, I propose to adjourn the further consideration of these winding-up proceedings until 10 January 2004, eight weeks from today.  I propose also to allow the Provisional Liquidators’ application for an extension, or variation, of their powers in terms of subparagraph (b) of their summons issued on 28 October 2004.

52.  The only change that I would be minded to make is that, whereas the Provisional Liquidators have indicated in the summons that they wish to have a committee of up to five persons, Mr Harris has indicated that the Provisional Liquidators do not think there will be a problem if that number is expanded to seven.  I have considered Miss Watanabe’s suggestion that there should be a larger committee, but it seems to me that it is necessary for a balance to be struck between having as wide a representation of the interests of the creditors and shareholders as possible, and having the ability to convene meetings and to conduct the proceedings at them in a manageable and orderly fashion.  With that in mind, I will limit the number of representatives on the committee to seven rather than five.

53.  As far as the constitution of the committee is concerned, I am informed by Mr Harris that the intention is for the Provisional Liquidators to seek nominations for membership to that committee and, if more nominations are received than places are available, for the selection of representatives to the committee to be undertaken in some manner that is acceptable, or fair, to all those concerned.  It would seem that the most appropriate way in which to do this would be to allow perhaps the creditors and shareholders to have some input as to their preferred representatives or, perhaps, to allow creditors to each nominate a representative with those gaining the support of the most creditors being appointed to the committee.

54.  However, those are matters of administration which I think are best left to the Provisional Liquidators to resolve.  I will, however, grant liberty to apply in order that any difficulties or issues that need resolution by the court may be dealt with. 

55.  So far as Mr Barlow’s indication that a summons is to be issued in order to deal with the question of the overlap between the responsibilities of the administrator and the Provisional Liquidators is concerned, I think that that is a matter that should be dealt with as soon as possible.  I would, therefore, invite Mr Barlow and those instructing him to take steps to issue the necessary proceedings at the earliest opportunity.