RE CHINA BOZZA DEVELOPMENT HOLDINGS LTD

HCMP 172/2021

[2021] HKCFI 1235

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 172 OF 2021

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D E C I S I O N

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Introduction

1.  China Bozza Development Holdings Limited (“Company”) is incorporated in the Cayman Islands and listed on the GEM Board of the Stock Exchange of Hong Kong Limited (“SEHK”). According to the affirmation evidence that has been filed in support of this application the Company is an investment holding company and its business operations are mainly conducted in the Mainland through companies incorporated in the Mainland and held indirectly by the Company through intermediate holding companies incorporated in the British Virgin Islands (“BVI”).  The Company and its subsidiaries, are principally engaged in forestry management, provision of services in relation to container houses and moneylending.  The group’s major assets are the rights of use in respect of forests in the Mainland which are held by a number of mainland companies held by the BVI intermediate subsidiaries.

2.  On 15 May 2020 a petition was presented in Hong Kong for the Company to be wound up on the grounds of insolvency.

3.  On 30 November 2020 a director of the Company presented a petition in the Cayman Islands for the winding up of the Company. On 1 December 2020 the Company applied for the appointment of         soft-touch provisional liquidators to facilitate a restructuring of the debt of the Company.  On 3 December 2020 the Cayman Court appointed Lai Wing Lun and Osman Mohammed Arab of RSM Corporate Advisory (Hong Kong) Limited as soft-touch provisional liquidators along with Martin Nicholas John Trott, who is based in the Cayman Islands (“JPLs”).  On 5 February 2021 an application was made supported by a letter of request from the Cayman Court for recognition and assistance of the JPLs in Hong Kong.

4.  These kind of applications have become increasingly frequent and commonly they have been dealt with on the papers.  I declined to do so in the present case and directed that there be a hearing, which took place on 1 March 2021.  I did so for a number of reasons.  Until recently applications for recognition of soft-touch provisional liquidators appointed in a company’s place of incorporation took place in respect of listed companies, which were not subject to winding up petitions in Hong Kong. The applications occurred in cases in which a company was using a technique commonly called the Z-Obee [1]technique to restructure debt.  I had become aware that with increasing frequency such applications are being made after a petition had been presented in Hong Kong. At the time this application first came on before me I heard during the same week two winding up petitions involving companies, which had recently been placed in soft-touch provisional liquidation in the jurisdiction of incorporation: Lamtex Holdings Limited [2] and Ping An Securities Group (Holdings) Limited [3].  Lamtex, Ping An and the present case all involved the same firm of insolvency practitioners: RSM.  In short I was concerned that the Z-Obee technique, (which had been developed in order to address the problems faced by a company attempting to restructure its debt caused by the absence in Hong Kong of any statutory mechanism, which provides for restructuring under the supervision of independent professionals and also the court and the impact of the Court of Appeal’s decision in Legend International Resorts Ltd [4]) is being abused to obtain a de facto moratorium of enforcement action by creditors in Hong Kong.

5.  At the hearing on 1 March 2021 I informed the JPLs that the papers told me little about the circumstances in which the application in the Cayman Islands came to be made.  Although I had some of the papers put before the Cayman court they suggested that at the time the application had been made the Company did not have any restructuring plan, which it wished to implement out of provisional liquidation, rather it was seeking to appoint soft-touch provisional liquidators, who would then make efforts to formulate such a plan.  This was done without any creditor input or regard to the proceedings in the Hong Kong SAR, the jurisdiction in which the Company is listed and in which, along with the Mainland, most of its creditors appear to be based.  I adjourned the application in order that I could be provided with comprehensive evidence as to the circumstances in which the Company came to make the application in the Cayman Islands and RSM nominated.  The JPLs asked for a month to prepare the necessary evidence and I fixed the next hearing for 15 April 2021. I, therefore, proceed on the basis that the Company and JPLs put before me all the advice sought and obtained by the Board of the Company concerning the Company’s obligations to creditors (the Company clearly being cash flow insolvent) and options open to the Board if they thought there was any justification for trying to prevent liquidation.

The Company and JPLs’ evidence

6.  The evidence that was adduced demonstrated that the Board did not seek legal or other professional advice on the consequences and implications of the Company’s dire financial position or the statutory demand after it received the statutory demand or the Petition issued against it.  What appears to have happened can be explained briefly. Professor Phillip Fei, who became Chairman of the Board in July 2019, explains in his affirmation that from 12 February 2020 the Company began to issue occasional circulars to creditors informing them of its financial position and giving the impression that it had commenced some form of debt restructuring.  Details of the restructuring were not provided.  There is no evidence that the Board had anything one could sensibly describe as a plan to restructure the Company’s debt or business.  I am told nothing about the Company’s business, how it came to be unprofitable, why any investor might be interested in injecting funds into the Company or how the Board thought that the Company’s business might be rehabilitated.

7.  Apparently in June 2020 discussions with an investor, Chen Jianwei, resulted in an agreement being signed pursuant to which the Company could borrow up to HK$83,500,000 to be used to refinance the Company’s debt.  However, it would appear that Mr Chen only provided HK$3,300,000 and the hope that his loan would facilitate repayment of the creditors, nearly all of whom appear to be individual lenders to the Company resident in the Mainland, proved in vain.

8.  In 2020 the Company began with no success to look for investors to improve its financial position.  In November 2020 Professor Fei became acquainted with Perry Ng. Apparently Mr Ng shared with Professor Fei his experience in another listed company in Hong Kong, which was also facing financial difficulties at the time and was attempting to restructure its debts through a scheme of arrangement with the help of soft-touch provisional liquidator, who happened to be RSM, who were assisted by Michael Li & Co and Conyers, Dill and Pearman, who the Company subsequently instructed in the present matter.

9.  Professor Fei subsequently met with RSM, who explained to him soft-touch provisional liquidation. This left Professor Fei believing, and I quote from [16] of his affirmation, “…. that the Company will be better placed to negotiate with its creditors and may have a higher chance of restructuring its debt with the help of soft-touch Joint provisional liquidators.  More particularly, the majority of the creditors of the company are retail bond creditors who have lost confidence in the management after the Company failed to honour the previous settlement proposal.” At the meeting with RSM, RSM produced a presentation explaining something about the firm and the services that it could provide.  I will quote what the presentation says about the Company’s current position as RSM understood it and how the Company might proceed:

“We understand that you intends to carry out debt restructuring and formulate, promote and implement a restructuring plan. However, as the Petitioner has filed a winding-up petition in the High Court of Hong Kong, the board of directors of your company needs to consider the potential outcome which the company appears before the winding-up hearing on 2 December 2020 and provisional liquidator be appointed by the High Court of Hong Kong.

According to the public information, the Petitioner has not yet applied for the appointment of a provisional liquidator. At the same time, as mentioned earlier, under the existing judicial system of Hong Kong, even if the appointment power lies with the Hong Kong court, it is still difficult for the company to request the Hong Kong court to appoint a provisional liquidator for restructuring purposes. In Hong Kong, the appointment of a provisional liquidator means that the powers of the company’s existing board of directors and management will immediately cease, and its role will become to cooperate with the provisional liquidator in taking over, investigating and reorganising the company according to the power granted by the court when the provisional liquidator considers appropriate. Then, the provisional liquidator needs time to understand the company the management’s restructuring plan. Therefore, the debt restructuring plan that your company originally intended to promote will therefore face great delay and uncertainty.

However, there is an alternative plan for China Bozza. Since China Bozza is a company incorporated in the Cayman Islands, you can seek to appoint an independent professional institution jointly accepted by the company, investors and creditors as a restructuring consultant or the aforementioned provisional liquidator (with power for restructuring purposes only) in the Cayman Islands courts. On the basis of low intervention (Soft-touch Basis), the provisional liquidators could work with the company’s board of directors and management to design and promote a debt restructuring plan that balances the best interests of all stakeholders.

In order to achieve the above objectives and gradually realise your company’s debt restructuring in a planned way, we recommend that your company implement a restructuring plan in stages.  The main task of the first stage is to apply to the Cayman Islands for the appointment of provisional liquidators limited to the purpose of restructuring.  The following is the preliminary idea and timetable of our proposed debt restructuring plan.”

10.  This description of the options open to the Company was incorrect.  It was not necessary to appoint soft-touch provisional liquidators in the Cayman Island in order to restructure the Company’s debt.  The Board could have appointed RSM to advise it on restructuring in Hong Kong and attempted to persuade creditors and the Court in Hong Kong to adjourn the Petition in order to allow the Company the opportunity to progress a restructuring.

Directors’ Duties to Creditors

11.  It is unclear what in practice either the Company or RSM had in mind.  Restructuring is a term used to describe the process of altering existing debt obligations and business activities of a company with a view to improving its medium to long term financial and business viability.  It is not a thing in itself; a kind of medication for the ills of a distressed company.

12.  If one views restructuring of an insolvent listed company simply as a commercial transaction consisting of selling the Company at a price attractive to investors interested in acquiring a listed vehicle for their own business, it is likely influence to whose interests one gives weight and the different parties will all have different interests.  An investor’s imperative is to buy at the lowest price, which necessarily means paying creditors as little as possible.  The owners of the Company, and I think it might reasonably be assumed the Board they have appointed and in cases such as the present who choose the provisional liquidators, are interested in avoiding liquidation as it would result in them loosing their entire investment.  For the owners anything is better than liquidation, which literally.  For the professionals involved it is an opportunity to earn fees underwritten by an investor.  If these considerations are what motivates the decisions of the parties to which I have referred and creditors are not involved in the restructuring process that creditors’ interests are largely unheard, and not as they should be driving the process.

13.  What a company should be advised once it appears likely that it is insolvent is that the interests of the creditors become paramount.  In West Mercia Safetywear v Dodd [5] Dillon LJ approves the statement of Street CJ in Kinsela v Russell Kinsela Pty Ltd:

“In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorise or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholders’ assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration.”

14.  Various other authorities include dictum to the effect that once a company becomes insolvent the directors’ fiduciary duties are owed to the general body of creditors not to the shareholders.  A recent example is the decision of Coleman J in Cyberworks Audio Video Technology Limited v Remedy Asia Ltd and others [6].  In [66]–[68] Coleman J explains:

“66. At the point in time when a company is insolvent or nears insolvency or is in doubtful solvency, or if a contemplated payment or course of action would jeopardise its solvency, the interests of the creditors ‘intrude’ on the directors’ duties, and will require the directors to take into account those interests. This may be termed the ‘creditors’ interests duty’. This arises because creditors become prospectively entitled through a liquidation to displace the power of the shareholders and the directors so as to deal with the company’s assets. The underlying principle is that directors are not free to take action which create a real, as opposed to remote, risk to the creditors’ prospects of being paid, without first having considered their interests rather than just those of the company and its shareholders. However, that does not give rise to any duty on the part of the directors owed directly to the creditors. Rather, the directors will owe a duty to the company to take care to protect the interests of creditors: see Geraghty, Sinclair & Snowden ‘Company Directors: Law and Liability’ at §6.122.

67. Exactly when the risk to creditors’ interests becomes real for these purposes will ultimately have to be judged on a case-by-case basis. There have been different verbal formulations (‘verge of insolvency’, ‘dubious solvency’, ‘parlous financial state of affairs’, etc), but they generally fit the different factual circumstances in which they were expressed: see, for example, Re HLC Environmental Projects Ltd (in liq) [2014] BCC 337 at §§88-89.

68. In the case of BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112, at §§213-220, the English Court of Appeal considered possible answers to the question of when the creditors’ interests duty is triggered.  First, it was recognised that the duty is engaged at least at the point when the company is actually insolvent, either on a cash-flow or balance sheet basis (and in most of the cases the focus is on balance sheet solvency or insolvency).  But the court found more difficult the question as to where the trigger might lie, short of actual insolvency.  It noted that the qualified way in which judges have expressed the trigger reflects that the directors of a company may often not know, nor be expected to know, that the company is actually insolvent until sometime after it has occurred.  But it is for that reason, among others, that a test falling short of established insolvency is justified.  In its conclusion, the court considered that the relevant formulation which accurately encapsulates the trigger is that the duty arises when the directors know or should know that the company is or is likely to become insolvent.  In that context, ‘likely’ means probable, not some lower test.”

15.  In the context of a group of companies it will also be relevant for directors to understand that the duty to consider the interests of creditors, requires the directors to consider the interests of the creditors of each company in a group separately.  As Godfrey Lam J explains in [235] in Re Wing Fai Construction Co Ltd [7]:

“As a matter of principle, it is not a sufficient justification for the directors involved in such payments to say that they looked to the benefit of the group as a whole. Each company, albeit within a group, is a separate legal person with separate interests and separate and probably different creditors. It is the duty of the directors of a company “to consult its interests and its interests alone” in deciding how to exercise their powers as directors of that company; they are not entitled to sacrifice the interests of that company in order to promote the interests of other group companies, even if they are also directors of them: Walker v Wimborne (1976) 137 CLR 1 at 6–7; Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 Ch 62, 74D–E; Linter Group Ltd v Goldberg (1992) 7 ACSR 580, 620.”

16.  These principles and how they apply is something of which directors should be informed by lawyers and informed insolvency practitioners when they are asked to advise a board of a company, which it seems likely is insolvent.  Consistent with this one would expect creditors to have a central role in the development of any plan to restructure a company’s debt.  Historically this has been the case in Hong Kong when dealing with listed companies.  I touch briefly on the history of the use of provisional liquidation as a vehicle to facilitate restructuring in [31] of my decision in China Huiyuan [8].  I think it will be useful if I say more about this in this decision in order to give greater context to the present issues and my reasoning.

Soft-touch provisional liquidation in Hong Kong

17.  As a consequence of the Asian Financial Crisis, which began to effect Hong Kong from about the second half of 1997 a number of listed companies began to experience financial difficulties. Commonly local banks such as HSBC and Standard Chartered were their major creditors.  The banks required a number of these companies to appoint independent financial advisers (“IFA”), which the banks approved, to assist them address their financial difficulties.  The advisers were specialist insolvency practitioners.  In a number of cases a stage was reached at which the IFAs and the banks took the view that control of the companies needed to be taken out of the hands of management, who they had concluded were not capable of finding means to maximise value for the benefit of creditors.  At the time it was easier than is currently the case to sell a listed company to a purchaser primarily interested in acquiring a listed vehicle.  If this was thought to be the best method of maximising value it required the involvement of personnel capable of managing the process.  This was achieved by a creditor issuing a petition and applying for appointment of provisional liquidators, normally the IFAs, with the agreement of other actively involved creditors, who, particularly in the case of banking creditors, were informed and involved in the formulation of the terms of the restructuring.  As far as I am aware the first case in which this happened was Seapower Resources International Limited [9], which followed from a series of cases concerning members of the HIH [10]insurance group, in which Hartmann J had accepted in the face of opposition from the Official Receiver, that the companies could be restructured out of provisional liquidation.  In the case of Seapower the provisional liquidators’ powers were extended to allow them to introduce a scheme of arrangement 4 months after their appointment.  This technique continued to be used [11] until the decision of the Court of Appeal in Re Legend International Resorts Limited [12] brought it to halt.  The Court of Appeal took a differing view to Hartmann J and the judges who had heard the reported cases referred to in footnote 11, and held that section 193 of what is now the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32, did not allow provisional liquidators to be appointed, and I simplify, principally for the purpose of restructuring.

18.  It will be appreciated that in the circumstances I have described there was little risk of proper regard not being given to the interests of the general body of unsecured creditors.  The cases that have currently been coming before this court are increasingly very different.  The present case illustrates one reason why this is so.  The Company does not appear to have any banking debt in Hong Kong.  The creditors are nearly all what are described as purchasers of “bonds”.  This suggests, particularly in the context of a listed company, that the creditors are holders of a series of publicly tradeable bonds.  They are not.  Their debts arise from individual loans at remarkably low interest rates made by members of the public.  Commonly the loans are made because the “bond” (whose holder will normally be from the Mainland) give the purchaser residency rights in Hong Kong, or for reasons touched on in my recent decision in China Greenfresh Group Co Ltd [13], provide a mechanism to evade Mainland exchange controls.  Lamtex [14] and Ping An [15] are recent examples.  In many cases the procuring of such loans seems to be little more than a scam as the companies are already distressed and the risk of default is significant.  Unsurprisingly the creditors have little understanding of their rights or the methods available for securing the maximum return on the loans that they have made.

The Present Case

19.  As I have already explained, in the present case the Board neither sought nor were offered proper legal advice.  It is suggested in the evidence filed for this application that the reason soft-touch provisional liquidation was sought was because the Board believed that creditors might be more trusting of attempts to restructure debt if independent professionals were appointed.  This is not, however, mentioned in the minute of the Board meeting at which the Board resolved that the Company commence proceedings in the Cayman Islands with a view to appointing soft-touch provisional liquidators.  I note in passing the first of the resolutions passed by the Board is in the following terms:

“It is in the interest and commercial benefit of the company and its shareholders as a whole to implement a debt restructuring and to present the petition and make the application to the Grand Court to facilitate such debt restructuring.”

This was drafted by this Company’s Hong Kong solicitors Michael Li & Co.  As I have demonstrated in [12]–[14] this evidences a failure to understand to whose interests, namely the creditors, the Board need to have regard.

20.  Creating confidence amongst creditors also does not feature as a consideration in any of the documents RSM have produced contemporary to the application or in the evidence submitted to the Cayman Court.  We probably find the primary driver behind appointing RSM and applying for soft-touch provisional liquidation explained in [30] of Professor Fei’s 2^nd affirmation filed in the proceedings in the Cayman Islands:

“In addition, I understand they have an established network of investors who might be interested in becoming ‘White Knights’ of the Company after carrying out a suitable due diligence process. In the event that it is not feasible to rescue the Company, appointing Provisional Liquidators at this juncture would ensure that the assets of the Company will be properly preserved, which is in the interests of the creditors, public shareholders and all other stakeholders of the Company.”

It is also apparent that no consideration appears to have been given by the Company or its advisers to whether or not it might be in the interests of its creditors for the Company to be wound up.

21.  I think it a fairly compelling inference that RSM were selling their ability to find an investor and work with it to avoid a liquidation and retain some shareholder value.  The creditors were a group to be bought off; not the group whose financial interests took priority to other considerations.  I note that the wording used by the drafter from Conyers Dill & Pearman also suggests a lack of familiarity with the principles I have explained in [12]–[14].

Conclusion

22.  This case illustrates that the way soft-touch provisional liquidation commenced in the place of incorporation of listed companies has been used recently has strayed materially from the way it was originally used in Hong Kong.  The indifference shown in the present case by both the insolvency practitioners and legal advisers to the relevant guiding principles is troubling particularly as Lamtex and Ping An involve the same professionals and a body of creditors who are ripe for exploitation and whose rights need protection.  That does not mean that a restructuring involving a sale of the Company to an investor is not in the best interests of creditors, but it does mean that the court needs to supervise closely the use of the Z-Obee technique to avoid it being misused by professionals more concerned with generating fees than the interests of creditors.

23.  As I explain in [7] of China Huiyuan [16] as a matter of private international law, a liquidator, including a provisional liquidator, should be recognised as having the powers to act on behalf of the company over whom they are appointed that have been bestowed on them by the courts of the place of incorporation.  It follows that notwithstanding my misgivings about how this matter has developed the JPLs should be recognised and I will so order. However, granting an order providing active assistance is a different matter. I am not currently satisfied that I should make an order granting the type of general assistance which I have on previous occasions, because of concerns that I have about the way in which the JPLs are approaching this and other cases.  I will grant general liberty to apply thus giving the JPLs the option to seek a further order if it is required and they can justify it.

24.  I would also add the following observations.  As I explain in Lamtex [17] the fact that provisional liquidators have been appointed in the place of incorporation does not mean that the Hong Kong Court will automatically adjourn a petition issued in Hong Kong.  I will not repeat the reasoning to be found in Lamtex.  I note, however, that there does appear to be a material difference in the approach of the Cayman Court and Hong Kong Court to granting adjournments at the request of a company seeking time to restructure its debt.  As I explain in [38] of Lamtex the Hong Kong Court will grant an adjournment if it is demonstrated by a company that it has a proposal to address its financial difficulties that is in the best interests of the general body of unsecured creditors, particularly if there is in principle support from sufficient of the creditors in terms of value of the unsecured debt to suggest that if a scheme of arrangement is introduced it is likely to achieve the necessary statutory majority in value (75%) to engage the court’s discretionary power to sanction the scheme.  If the skeleton argument submitted to the Cayman Court is accurate it would appear that the Cayman Court’s criteria are less onerous and that a proposal does not have to be demonstrated in order to obtain an adjournment of a petition and the giving of time for a company to attempt to restructure its debt through soft-touch provisional liquidation.  If this is correct, practitioners need to be mindful of the differences in the approach of the Cayman and Hong Kong Courts and their consequences.

25.  Practitioners should be alive to the need for evidence to be filed that provides an informed and candid description of a company’s financial position and what is envisaged to be the most likely solution to its problems.  This should not need stating, but the evidence filed in a large number of cases involving Mainland listed businesses suggests that it requires emphasising.  If the reality is, for example, that a company is (a) hopelessly insolvent, (b) there is no prospect of realising value from sale of its indirectly owned assets in the Mainland as they will be seized by Mainland creditors and (c) the only hope of achieving other than a de minimis return to off-shore creditors is the sale of the company to an investor, who may wish to acquire it to use as a listed vehicle for a different type of business; this should be explained and justified.  Simply referring to a possible “debt restructuring” and treating the expression as a kind of magical incantation, the recitation of which will conjure up an adjournment of the petition is as inadequate as it is facile.

26.  I will grant an order for recognition in the terms appended in this decision.

IT IS ORDERED THAT:-

1.  The provisional liquidation of China Bozza Development Holdings Limited (in Provisional Liquidation in the Cayman Islands) (“Company”) and the appointment of Mr. Martin Nicholas John Trott of R&H Restructuring (Cayman) Limited, Windward 1, Regatta Office Park, PO Box 897, Grand Cayman, KY1-1103, Cayman Islands; and Mr. Osman Mohammed Arab and Mr. Lai Wing Lun, both of RSM Corporate Advisory (Hong Kong) Limited, 29/F., Lee Garden Two, 28 Yun Ping Road, Causeway Bay, Hong Kong, as the Joint Provisional Liquidators for the Company for restructuring purposes (“JPLs”), pursuant to the Order of the Grand Court of the Cayman Islands dated 3 December 2020, be recognised by this Court.

2.  The JPLs do have liberty to apply.

3.  The costs of this application be paid out of the assets of the Company as an expense of the provisional liquidation.