LERIC INTERNATIONAL LTD (In Liquidation) v. EASYRICH INTERNATIONAL HOLDINGS LTD AND ANOTHER

HCCW 450/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 450 OF 2006

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D E C I S I O N

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The applications

1.  There are before me are two summonses.  The earlier summons was taken out by the liquidators of the company concerned, Leric International Limited (“the Company”) on 8 October 2007 and amended on 29 January 2008.  In this summons, the liquidators seek the following orders:

(1)  a declaration that the provisional sale and purchase agreement dated 4 September 2006 (“the Provisional Sale and Purchase Agreement”) under which the Company purported to sell the property at Flat B, 13 Floor, Block 2, Dragon View, No. 83 Chung Hau Street, Kowloon (“the Property”) to Easyrich International Holdings Limited (“Easyrich”) or to Easyrich as agent of Yee Fu Investment Finance Limited (“Yee Fu”) is void under section 182 of the Companies Ordinance, Cap 32;

(2)  a declaration that the assignment dated 19 September 2006 (“the Assignment”) and registered in the Land Registry under which the Company purported to assign all its interest of and in the Property to Easyrich or to Easyrich as agent of Yee Fu is void under section 182;

(3)  a declaration that the second mortgage dated 28 April 2006 (“the 2^nd Mortgage”) and registered in the Land Registry by which the Company charged its interest in the Property to Yee Fu is void as the 2^nd Mortgage constituted an unfair preference under sections 266 and 266B of Cap. 32;

(4)  an order that Easyrich and/or Yee Fu shall within 14 days of the order to be made deliver up vacant possession of the Property to the Company;

(5)  a declaration that the payment of $668,300 to Yee Fu on or about 19 September 2006 in purported redemption of the 2^nd Mortgage out of the proceeds of sale in relation to the Provisional Sale and Purchase Agreement and the Assignment is void under section 182; and

(6)  an order that Yee Fu do pay to the liquidators of the Company $668,300 within 14 days from the date of the order to be made.

2.  The other summons was issued by Easyrich on 31 October 2007 under section 182.  It seeks an order against the Company declaring that the Provisional Sale and Purchase Agreement and the Assignment are valid.

The background

3.  The relevant background matters may be stated as follows.

4.  The Company was incorporated in Hong Kong in 1994.  Its principal activity was the trading of garments.  There were two directors at the time of its liquidation, Lam Ka Fai and Madam Lam Man Ling.  The liquidators have not been able to locate them and they have not taken part in the present applications.

5.  The Property is a residential property and was purchased by the Company in 1998 at $3,243,000.  By a mortgage dated 27 June 2005 (“the 1^st Mortgage”), the Company charged the Property to Pacific Finance (Hong Kong) Limited.  By a mortgage assignment dated 1 June 2006, Pacific Finance (Hong Kong) Limited assigned all its interest under the 1^st Mortgage to Dah Sing Bank Limited.

6.  According to the latest audited financial statements of the Company dated 16 November 2004, it had accumulated losses of over $7.3 million as at 31 March 2004.

7.  From the books available, the liquidators are not aware there had been any substantial increase in the income of Company since 31 March 2004.

8.  On 23 March 2006, judgment in DCCJ No. 495 of 2006 was entered by consent against the Company and Lam Ka Fai in favour of the plaintiff, Show Win Industries Limited (“Show Win”).  The defendants were adjudged to pay Show Win $500,000 and agreed costs of $15,000.  The nature of the claim was for goods sold and delivered.  The Company only made part payment to Show Win of $50,000.  Show Win served a statutory demand on the Company on 19 July 2006 and on 21 August 2006 presented a petition to wind up the Company.  The winding-up order was made on 25 October 2006 in the absence of the Company.

9.  There were other civil suits against the Company and Lam Ka Fai in late 2005 and in 2006.

10.  Yee Fu was a licensed money lender in 2006.  It had ceased to operate as a money lender when its licence expired in August 2007.

11.  Easyrich shared the same registered office as Yee Fu.  The sole shareholder of Easyrich and one of the two directors, Chan Chi Wai, had the same residential address as a majority shareholder and a director of Yee Fu.  The other director of Easyrich is the company secretary, a director and a minority shareholder of Yee Fu.

12.  It was admitted by Chan Chi Wai that Easyrich was used as a vehicle by Yee Fu to purchase the Property.

13.  On 28 April 2006, the Company applied to Yee Fu for a loan and a loan agreement was entered into the same day.  The principal lent was $800,000, the interest rate was 3% per month, the drawdown date was 28 April 2006, and the last day of repayment was 27 April 2007.  The Company was to repay by 12 monthly instalments.  The handling charges were $8,000.  The two directors of the Company were sureties.  The 2^nd Mortgage was entered into at the same time, by which the Company further charged the Property to Yee Fu as security for the loan facilities granted.

14.  The Company only made two instalment payments to Yee Fu under the loan agreement, by a cheque dated 27 May 2006 of $91,900 and a cheque dated 27 June 2006 of $89,800, which was only honoured on 5 August 2006.  Lam Ka Fai was contacted by Yee Fu and demands were made to the Company to repay the monthly instalments.  Lam told Chan Chi Wai he intended to repay all outstanding principal by selling the Property to Yee Fu.  After negotiation, the Company agreed to sell at $3 million.

15.  On 4 September 2006, the Provisional Sale and Purchase Agreement in Chinese prepared by solicitors was executed by the Company and Easyrich.  No sale and purchase agreement was entered into.

16.  On 19 September 2006, the Assignment was executed.

17.  The proceeds of $3 million were paid as follows.  $2,326,381.44 was paid to Dah Sing Bank Limited for redemption of the 1^st Mortgage. $668,300 was paid to Yee Fu for redemption of the 2^nd Mortgage.  $2,400 was paid to solicitors for Easyrich as costs and disbursements in the transaction.  $2,918.56 was paid to the solicitors for the Company in the transaction.

18.  Thus, other than the payment of the legal expenses in the transaction, all the proceeds were used to discharge the amount due by the Company under the 1^st and 2^nd Mortgages.

19.  The amount of $668,300 paid to Yee Fu was arrived at as follows.  As at 19 September 2006, the principal amount owed to Yee Fu was $660,000.  $8,300 was interest from 27 June 2006 to 19 September 2006.  If the terms of the loan agreement had been strictly adhered to, the interest payable for that period would be $33,660.  As a gesture of goodwill, the terms were not adhered to and $8,300 was accepted by Yee Fu in final settlement of the interest payable.

20.  Chan Chi Wai claimed he had no knowledge of the presentation of the winding-up petition when the Provisional Sale and Purchase Agreement and the Assignment were entered into.  It was only in November or December 2006 that the solicitors of Easyrich informed him they had neglected to check the status of the Company and had not conducted a winding-up search against the Company before completion of the sale and purchase.

21.  The Property was sold for $243,000 less than the price it was purchased in 1998, which was at a time when property prices had peaked.  Property prices in 2006 had fallen.  According to a quick check done by the liquidators, the market price of the Property as at 23 May 2007 was $3.12 million.  According to a valuation report obtained by Easyrich and Yee Fu, the market value of the Property with vacant possession was $3,040,000 as at 15 August 2006 and was $3,060,000 as at 19 September 2006.  The price at which the Property was sold to Easyrich was slightly below the market value.  

22.  According to Chan’s evidence, Lam Ka Fai offered to sell the Property to Yee Fu in August 2006 at $3.2 million.  Chan made enquiries with an estate agent and was told the market price was about $3 million.  He counter-offered $2.9 million to the Company and after negotiations, they arrived at $3 million as the agreed purchase price.

Was Yee Fu a secured creditor

23.  I will first deal with the question whether the 2^nd Mortgage is void as an unfair preference by virtue of sections 266 and 266B.

24.  The 2^nd Mortgage was created within 6 months of the presentation of the winding-up petition and is caught by the statutory provisions.  It was contended by the liquidators that the Company intended to put Yee Fu into the position which was better than the position it would have been in, in the event of the liquidation of the Company, if the 2^nd Mortgage had not been created, so the 2^nd Mortgage was voidable by virtue of the statutory provisions.  There is no dispute that the Company was insolvent at the time the 2^nd Mortgage was entered into.

25.  The fact that the 2^nd Mortgage had the effect of putting Yee Fu in a better position in a liquidation by transforming it from an unsecured creditor to a secured creditor is insufficient.  An intention to prefer, which is an objective test, is not the requirement under the statute.  Under section 50(4) of the Bankruptcy Ordinance, Cap. 6, which applies to unfair preference in the winding up of a company, the court shall not make any order in respect of an unfair preference unless the debtor who gave the unfair preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in section 50(3)(b), namely, the effect of putting that person into a position which, in the event of the debtor’s bankruptcy, would be better than the position he would have been in if that thing had not been done.  A desire to produce the effect in question is a subjective test (Re MC Bacon Ltd [1990] BCLC 324 at 335f to h).

26.  There is nothing in the evidence to suggest that the loan agreement and the 2^nd Mortgage were not entered into at arm’s length or that these transactions were not governed by proper commercial considerations.  Chan has asserted that withoutthe security of the 2^nd Mortgage, Yee Fu would not have granted the loan facility of $800,000 to the Company.  Fresh credit of $800,000 was provided to the Company, according to the latest affirmation of Chan.  There were two instalment payments under the loan agreement before the Company eventually defaulted.  The Company had also made part payment of $50,000 to Show Win between 23 March 2006and the service of statutory demandon 19 July 2006.  Other than the liquidators’ assertion, there is no evidence to establish there was a desire to produce the effect of putting Yee Fu in a better position in the Company’s insolvent liquidation and that such desire had influenced the decision of the Company to enter into the 2^nd Mortgage.

27.  I decline to infer or find on the evidence the requisite desire was established or that the decision to grant the 2^nd Mortgage was influenced by such desire.

If a validation order should be made

28.  I turn to consider the other question, which is whether the Provisional Sale and Purchase Agreement and the Assignment should be validated or whether these transactions should be declared void under section 182.  It is not in dispute that the burden of proof is on the party seeking a validation order to displace the rebuttable presumption that the disposition of the company’s assets is inimical to the interests of the general body of creditors (Re Aw Sian Sally [1999] 2 HKC 270 at 278H to 279A).

29.  On behalf of the liquidators, Mr Tony Ko advanced a number of reasons why the court should exercise its discretion to declare these transactions void.  Firstly, he submitted the sale took place in suspicious circumstances.  He pointed to the fact that the Provisional Sale and Purchase Agreement was entered into just two weeks after the presentation of the winding-up petition, the completion of the sale took place within two weeks of the Provisional Sale and Purchase Agreement, the purchaser Easyrich was admittedly a vehicle used by Yee Fu to purchase the Property and no explanation was given by Chan Chi Wai why Yee Fu did not purchase in its own name.  Easyrich did not apply for a validation order notwithstanding it had knowledge of the winding-up petition since November or December 2006.  The summons for a validation order was taken out some ten months later, and only after the liquidators had issued their summons to declare void the transactions.

30.  I bear in mind these matters, which are not controversial.  There is on the other hand the evidence of Chan Chi Wai that he had no knowledge of the winding-up petition at the time the transactions were made.  As for the delay in seeking a validation order, I am given to understand that Easyrich was attempting to reach a compromise with the liquidators before the summons was issued.

31.  Secondly, Mr Ko submitted that the loan agreement was an extortionate credit transaction under section 264B(3) of Cap 32 in that the terms of it were to require “grossly exorbitant payments to be made ... in respect of the provision of credit”.  He initially argued that notwithstanding the loan agreement provided for an interest rate of 3% per month, Yee Fu was entitled to charge additional default interest under the 2^nd Mortgage at such rate as it “may from time to time determine”.  He pointed to an earlier affirmation made by Chan Chi Wai in which it was stated that a “handling fee” of 1 % per month was said to be chargeable.  He contended that the interest rate was effectively 48% per annum and is presumed to be extortionate under section 25(3) of the Money Lenders Ordinance, Cap. 163.

32.  Having read the latest affirmation of Chan Chi Wai and the reply submission of Mr Vincent Lam, counsel for Easyrich and Yee Fu, Mr Ko accepted today that the effective rate of interest under the loan agreement would be less than 36% per annum.  He nevertheless maintained that in the event of default, additional interest at the rate of 1 % per month would be charged.

33.  Chan had explained in a subsequent affirmation that his earlier statement was made in error in that the handling fee of $8,000 was equivalent to 1 % of the principal and was a one-off charge as provided in the loan agreement.  I see no reason why this explanation should be disregarded.  It would not be right to treat the effective rate of interest as 48%.  Even if the effective rate of interest were 48% per annum, the transaction would not be presumed extortionate under section 25(3), as this presumption would only apply where the effective rate of interest exceeds 48%.  I attach no weight to the contention that the loan agreement was extortionate.

34.  Thirdly, the sale of the Property involved a conflict of interest on the part of the two directors of the Company as both were sureties under the loan agreement.  In the event the loan remained unsatisfied, they would be personally liable to Yee Fu for the amount outstanding.  It was in the interest of these directors to see to it that the assets of the Company would be used to satisfy the amount owing to Yee Fu under the loan.

35.  I do not regard this as a material consideration.  Yee Fu was a secured creditor under the 2^nd Mortgage and would have been entitled to exercise its power of sale even if the directors of the Company did not offer to sell the Property to Yee Fu to pay the outstandingloan.  Given the extent of the liabilities of the Company to Dah Sing Bank and Yee Fu, the Property would not have been an asset available in the liquidation for the unsecured creditors.

36.  Fourthly, the sale of the Property to Easyrich, which was a vehicle of Yee Fu in this transaction, contravened the rule that a mortgagee cannot sell to himself, unless the sale is made by the court and he has obtained leave to bid; for a power of sale does not authorise the donee of the power to take the property subject to it at a price fixed by himself, even though such price be the full value (Fisher and Lightwood's Law of Mortgage, 12^th ed, paragraph 30.33).  Alternatively, even if Easyrich was to be regarded as a separate entity for this purpose, and there is no hard and fast rule that a mortgagee may not sell to a company in which he is interested, the mortgagee and the company seeking to uphold the transaction must show that the sale was in good faith and that the mortgagee took reasonable precautions to obtain the best price reasonably obtainable at the time (Tse Kwong Lam v Wong Chit Sen [1983] 1 WLR 1349 at 1355A to B).  The Property was not sold in open market.  It was submitted that no reasonable precautions were taken to obtain the best price reasonably obtainable.

37.  The fourth matter is a factor to be taken into account.  But I do not think this should be necessarily fatal to the application for a validation order.  On the available evidence, the price at which the Property was sold was close to the market price, albeit slightly lower.  The Company had offered to sell to Yee Fu at $3.2 million and Chan Chi Wai had made enquiries with an estate agent before he made a counter-offer at $2.9 million and the price of $3 million was reached after negotiation.  I decline to find in these circumstances that no reasonable precautions were taken to obtain the best price reasonably obtainable.  It is entirely speculative if the Property could have been sold for more than $3 million at the time.  What is certain is that if the Property had been sold by a forced sale, the process would have taken much longer and the Company would be liable to pay a greater amount of interest to the secured creditors under the 1^st and 2^nd Mortgages, not to mention other miscellaneous expenses in connection with a public sale or a sale by private treaty, such as the costs of a public auction or the commission of estate agent.  The sale was advantageous to the Company in that there were savings in the amounts of redemption moneys that the Company was required to pay and the liabilities of the Company were reduced.  Further, Yee Fu made an additional concession to the Company in that it was not required to pay interest at the full rate of $33,660 but only $8,300.

38.  I have a discretion at large under section 182, subject to the general principles which apply to any kind of discretion and subject also to the limitation that the discretion must be exercised in the context of the liquidation provisions of the statute (Denney v. John Hudson & Co Ltd [1992] BCLC 901 at 904d to e).  It does not appear to me that the interest of unsecured creditors had been prejudiced in the particular circumstances, nor had the principle of pari passu distribution been affected, bearing in mind that other than paying the legal expenses incurred, all the proceeds of sale were used to pay off the two secured creditors.  I ask myself the two questions posed by the court in Re Tramway Building & Construction Co Ltd [1988] 1 Ch 293 at 303D:

(1)  if a prior order under section 182 had been sought, would it have been granted; and

(2)  whether the sale of the Property to Easyrich had the result of reducing the assets available in the winding up for the unsecured creditors.

39.  As I have stated earlier, the Property would not have been an asset available in the liquidation for the unsecured creditors.  There were advantages to the Company in selling the Property to Easyrich at $3 million in September 2006 and I would have made a validation order to authorise the sale if such an application were made before the completion of the sale.  The answer to the second question is no, for the reasons which appear earlier.

40.  I consider it appropriate to exercise my discretion to validate the Provisional Sale and Purchase Agreement and the Assignment.

41.  Mr Ko submitted on the basis of Re Tramway Building & Construction Co Ltd that if a validation order were not made, insofar as the money paid by Easyrich to the Company under the sale was used to discharge the Company’s secured indebtedness under the 1^st and 2^nd Mortgages, Easyrich would be entitled in equity by subrogation to keep alive the discharged security in order to secure the repayment of such moneys from the Company.  If he was advancing that as a reason for refusing to make a validation order, I do not agree with it.  That scenario was only considered by the court in Re Tramway in the event that a validation order was not made.  If the discharged security were kept alive, the Company would be exposed to the liability for further interest.  I am told by Mr Lam that further interest in the intervening 28-month period from September 2006 at the rate of 6.5% per annum, being the rate of interest charged by Dah Sing Bank, would be in the region of $352,834.

42.  Lastly, Mr Ko took the point that Easyrich and Yee Fu did not seek a validation order in respect of the payment of $668,300 to discharge the 2^nd Mortgage.  This omission in the summons has not caused any prejudice to the liquidators.  I would also grant a validation order in respect of the payment aforesaid.

43.  Mr Lam seeks an order that costs are to be paid to Easyrich and Yee Fu on both summonses on the basis that they have successfully obtained a validation order and resisted the liquidators’ application.

44.  Mr Ko seeks an order that costs shall be awarded to the liquidators on both summonses prior to the filing of the valuation report by Easyrich on 28 November 2007, as it was only then it became apparent that the Property was sold at a price close to the market value.  As for the costs after November 2007, he asked for no order as to costs on the basis that the burden is on Easyrich and Yee Fu to satisfy the court that a validation order should be made and the matter could not have been dealt with by consent as suggested by Mr Lam.

45.  I am persuaded that Mr Ko’s position on costs is fairly taken.  I make an order on costs in each of the summonses as he has submitted, with the additional provision that the costs incurred by the liquidators in these applications are treated as a liquidation expense and are to be paid out of the assets of the Company.