HALLMARK CARDS INCORPORATED v. YUN CHOY LTD (In Compulsory Liquidation) AND ANOTHER

HCMP 1330/2009

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1330 OF 2009

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BETWEEN

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J U D G M E N T

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1.  This is the judgment on an issue in interpleader proceedings. The dispute is on the entitlement to some proceeds for goods sold by Yun Choy Limited (“Yun Choy”) which is the plaintiff in issue and is now in liquidation.

2.  The contestants are the liquidators of Yun Choy on the one hand and the bank on the other.  The bank says that it has purchased the invoices for the goods sold by Yun Choy.  The argument is on the force and effect of a factoring agreement.  The liquidators say that the bank has not obtained the ownership of the invoices by virtue of the agreement.  The bank disagrees.

The factoring agreement (“the RPA”)

3.  The factoring agreement is called Receivables Purchase Agreement (“RPA”).  It was made between the bank and Yun Choy and dated 18 July 2008.  Yun Choy was wound up on 21 January 2009 and the liquidators were appointed on 2 July 2009.  Yun Choy had sold some goods to Hallmark Cards Incorporated (“Hallmark”) before it was wound up.  The total value of the invoices for these goods less discount is at US$425,433.45.  But Hallmark claims that it had made prepayments of US$129,666.40 to Yun Choy and the net sum payable on the invoices is US$295,767.05.  Hallmark was allowed to deduct its assessed costs of the interpleader proceedings and the net sum payable is US$288,506.10 which has been paid into court pursuant to an order of court.

4.  The relevant terms and conditions of the RPA are:

“31. Definitions

‘Available Funds’ means the Outstanding Approved Debts (calculated in Hong Kong dollars at the Exchange Rate at the time of calculation) multiplied by the Prepayment Percentage but less the Funds in Use;

‘Concentration Percentage’ means the percentage specified as such in the Receivables Purchase Agreement, being the maximum percentage of all Outstanding Debts against which the Bank may allow Prepayments to be made in or towards payment of the Purchase Price of the Debts due from the same Customer;

‘Customer’ means a person which incurs any obligation to make payment to the Seller under a Contract of Sale and is accepted by the Bank as a Customer for the purposes of this Agreement;

‘Customer Limit’ means the maximum amount of Outstanding Debts of a Customer in respect of which Prepayments may be made by the Bank;

‘Debt’ means a debt (including any tax or duty payable) and any other obligation incurred by a Customer under a Contract of Sale together with its Related Rights;

‘Discounting Charge’ means the charge calculated on the Funds in Use at the relevant rate specified in the Receivables Purchase Agreement;

‘FIU Limit’ means the limit specified as such in the Receivables Purchase Agreement representing the aggregate maximum amount of Funds in Use permissible at any time under this Agreement;

‘Funds in Use’ means the total Prepayments made by the Bank to the Seller in respect of Debts less the total amount of clear funds received by the Bank towards the discharge of Debts, plus Discounting Charges, Service Charges and all other sums payable by the Seller to the Bank.

…

3. Purchase of Debts

3.1 The Seller sells and the Bank purchases all Debts existing on the Commencement Date or arising after the Commencement Date during the term of this Agreement and subject to the terms of this Agreement.

3.2 The Seller hereby assigns the Debts existing on the Commencement Date to the Bank. The ownership of such existing Debts shall vest in the Bank forthwith on the Commencement Date.

3.3 The Seller hereby assigns all future Debts arising during the time of this Agreement to the Bank. The ownership of such future Debts will vest in the Bank automatically as soon as they come into existence without the need for any other act of transfer.

3.4 If the ownership of any Debt shall for any reason fail to vest in the Bank, the Seller shall hold such Debt on trust for the Bank.

3.5 The Bank may at its sole discretion, within 14 Business Days after the Seller’s notification of a Debt to the Bank under condition 4.1, reject and re-assign that notified Debt to the Seller, and in such event the Bank shall be relieved of all its obligations in respect of such Debt and may recover from the Seller any amount paid by the Bank in respect of such Debt.

4. Notification of Debts

4.1 The Seller shall, on the Commencement Date, notify the Bank of the particulars of the Debts then in existence. The particulars of any Debt arising after the Commencement Date shall be notified by the Seller to the Bank as soon as practicable after the Debts come into existence. Each notification of the Debts referred to in this condition 4.1 will constitute specific assignment of each Debt mentioned in such notification and shall be in addition to the general assignment of all Debts effected by condition 3.

4.2 The Seller shall provide the Bank with copies of the invoice and all other documents, instruments and information relating to each Debt as the Bank requires.

…

4.4 Unless the Bank otherwise agrees, each invoice for a Debt shall be endorsed with the notice of assignment in the form prescribed by the Bank. The Bank may also require the Seller to give any other written notice of assignment relating to a Debt to the relevant Customer.

5. Purchase Price of Debts

5.1 The Purchase Price of the Debts is to be the amount received by the Bank in clear funds towards the discharge of the Debts.

…

5.3 The Bank will credit the Purchase Price to the Factoring Account on the Business Day following the Bank’s receipt of clear funds towards the discharge of the Debts. …

5.4 The following sums shall be deducted from the amount payable by the Bank in respect of the Purchase Price:

(a) the discounts, set-offs or other allowances taken or claimed by the Customers;

(b) the Discounting Charges and Service Charges;

(c) all Prepayments made in respect of the Outstanding Debts; and

(d) all other sums due from the Seller to the Bank.

5.5 If the Bank has credited to the Factoring Account the Purchase Price for an unpaid Approved Debt but such Debt subsequently becomes an Unapproved Debt for any reason (including a Dispute raised by the Customer) or the Bank subsequently discovers that such Debt should be an Unapproved Debt, the Seller shall immediately repay such Purchase Price. The Bank may debit the amount of such Purchase Price to the Factoring Account.

5.6 If a payment received by the Bank or an SCB Assignee towards discharge of a Debt is rescinded or must otherwise be returned by the Bank for an SCB Assignee for any reason, the Purchase Price credited to the Factoring Account in respect of such payment shall be repaid by the Seller to the Bank or, if the Bank so directs, the SCB Assignee. The Bank may debit the amount of such payment to the Factoring Account.

6. Credit Limits

…

6.5 The Bank may in its absolute discretion specifically refuse to accept any Debt as an Approved Debt notwithstanding any other provision in this condition 6. The Bank will inform the Seller of its refusal as soon as practicable after the Seller’s notification of such Debt to the Bank.

6.6 The Bank may at its sole discretion vary or cancel a Credit Limit. Any variation or cancellation of a Credit Limit under this condition shall not affect any Approved Debt directly arising from Goods Delivered prior to the variation or cancellation. But any Debt coming into existence after the cancellation of a Credit Limit shall be an Unapproved Debt.

…

6.8 An Approved Debt shall immediately without notice become an Unapproved Debt if:

(a) such Debt becomes the subject of a Dispute between the Seller and the relevant Customer.

7. Prepayment of Purchase Price

7.1 The Bank will, at the written request of the Seller. make Prepayments in respect of all Outstanding Approved Debts up to the Available Funds.

7.2 At the Bank’s absolute discretion, the Bank may (but is not obliged to) make Prepayments to the Seller in respect of the Outstanding Unapproved Debts up to the Prepayment Percentage of the Outstanding Unapproved Debts not overdue for more than 60 days from their relevant due date for payment.

7.3 Any Prepayments made will be debited to the Factoring Account.

7.4 The Bank shall not be obliged to make any Prepayments to the Seller if:

(a) having made such payment, the FIU Limit, the Customer Limit or the Concentration Percentage would be exceeded;

(b) a Termination Event occurs or a notice to terminate this Agreement has been given under condition 2.1; or

(c) the Bank is not satisfied with any document or information provided under condition 4.

7.5 The Bank may at any time require the Seller to repay any prepayment made:

(a) in respect of Unapproved Debts or any Approved Debt which has subsequently become an Unapproved Debt;

(b) in relation to Debts of a Customer in excess of the Customer Limit or the Concentration Percentage; or

(c) in respect of Approved Debts in excess of the Available Funds.

…

9. Collection of Debts

9.1 The Bank shall have the exclusive right (but shall not be obliged) to collect and enforce payment of any Debt in such manner as it may decide. The Seller undertakes to ensure that the Customers will pay all their Debts to the Bank or as the Bank may direct.

10. Disputes

…

10.2 If the Bank becomes aware that a Customer has raised a Dispute in relation to a Debt or a Contract of Sale, the Bank will (but is not obliged to) send the Seller a notice called a ‘dispute notice’. The Seller must resolve the dispute within the period stipulated by the Bank in such notice. The Debt will automatically become an Unapproved Debt once the Customer has raised a Dispute in relation to the Debt or the Contract of Sale to which the Debt relates.

11. Charges and Expenses

11.1 The Seller shall pay to the Bank the Discounting Charge which shall accrue on a daily basis on the Funds in Use amount at the relevant rate specified in the Receivables Purchase Agreement.

11.2 The Discounting Charge shall be debited monthly to the Factoring Account. Any debit to the Factoring Account shall be added to the Funds in Use for the purpose of calculating the Discounting Charge.

12. Appropriation of Payment and Allowance

12.1 When the Bank receives a payment in relation to a Debt of a Customer, the Bank is entitled to apply the payment in satisfaction of such Debts owed by the Customer as the Bank may at its absolute discretion decide. The Bank may apply such payment towards discharge of any Approved Debt in priority to any Unapproved Debt.

13. Insurance

13.1 The Bank or the SCB Assignee may take out and maintain insurance in relation to the Debts on such terms and with such insurers as it may select. All premiums and other sums necessary for effecting and maintaining any such insurance shall be borne by the Seller and debited to the Factoring Account.

…

19. Termination

…

19.2 Upon or at any time after a Termination Event (whether or not the Bank exercises its right to terminate this Agreement) the Bank may, with to without giving written notice to the Seller:

…

(d) require the Seller to purchase all the Outstanding Debts at a price equivalent to the outstanding Funds in Use amount plus all other sums which the Seller owes to the Bank under this Agreement or any other agreement.

19.3 Upon termination of this Agreement for whatever reason:

(a) all Approved Debts shall automatically become Unapproved Debts;

(b) the Bank is entitled to require the Seller to purchase all the Outstanding Debts from the Bank at any time after termination of this Agreement and at a price equivalent to that payable under condition 19.2(d);

(c) the ownership of all Debts coming into existence prior to the termination of this Agreement will continue to belong to the Bank; and

(d) the respective rights and obligations of the parties under this Agreement arising from or in respect of (i) any transaction which has commenced prior to the termination of this Agreement or (ii) any Debt purchased by the Bank shall continue to apply and will remain in full force and effect notwithstanding the termination.”

The working of the RPA

5.  A senior account manager of the bank, Mr Michael Chan, has explained on affirmation how the RPA was performed.  The liquidators do not dispute the explanation.  Mr Chan referred to Clause 3 of the RPA and said that all debts in existence on the commencement date and arising thereafter were assigned by Yun Choy to the bank and ownership of all the said debts vested in the bank unless rejected and re-assigned back to Yun Choy by the bank.  The automatic assignment applied to all debts, whether or not the same had been notified to the bank.

6.  Yun Choy was obliged under Clause 4 to notify the bank of the particulars of (1) all debts in existence on the commencement date and (2) all debts arising thereafter as and when the same came into existence.  The notification was done in most cases by Yun Choy providing to the bank a copy of the invoice that it had issued to its customer.

7.  When the bank was notified of a debt, it would credit the amount of the notified debt to the debts purchased account.  Yun Choy could under Clause 7.1 request the bank for prepayment.  The bank would make prepayments in respect of all outstanding approved debts up to the available funds and as long as the FIU limit, customer limit and the concentration percentage were not exceeded after making such payment as provided in Clause 7.4.

8.  The available fund means the outstanding approved debts multiplied by the prepayment percentage but less the funds in use.  The prepayment percentage for Yun Choy was 90 per cent.

9.  The funds in use means the total prepayments made by the bank to Yun Choy in respect of debts less the total amount of clear funds received by the bank towards the discharge of the debts plus the discounting charges, service charges and all other sums payable by Yun Choy to the bank.

10.  The FIU limit represents the aggregate maximum amount of funds in use permissible at any time under the RPA.  The limit for Yun Choy was HK$30 million.

11.  A customer limit means the maximum amount of outstanding debts of a customer in respect of which prepayments may be made by the bank.

12.  The concentration percentage means the percentage specified under the RPA being the maximum percentage of all outstanding debts against which the bank may allow prepayments to be made in or towards payment of the purchase price of the debts due from the same customer. This was 100 per cent for Yun Choy.

13.  The result was that (1) when there was a positive amount outstanding under all the invoices notified by Yun Choy to the bank which were accepted by the bank as approved debts; (2) the prepayment requested by Yun Choy did not exceed 90 per cent of the total outstanding approved debts less the funds in use; and (3) after making the requested prepayment, the FIU limit, customer limit or concentration percentage would not be exceeded, the bank would then be prepared to make the prepayment to Yun Choy.

14.  The bank maintained a debts purchased account which was to record the total amount of debts owed to the bank by Yun Choy’s customers under the outstanding invoices notified to the bank by Yun Choy. That was the net amount of money potentially recoverable under the invoices.

15.  The bank also maintained a factoring account which recorded all prepayments to Yun Choy and all charges or other sums Yun Choy was liable to pay the bank.  They included the discounting and other charges that Yun Choy was liable to pay under Clause 11.  They were all recorded as debit entries. 

16.  When Yun Choy’s customers paid the bank towards discharging the debts under the notified invoices, the amount received was credited to the factoring account as the purchase price.  After taking into account the prepayments, bank charges and commissions, if there was a credit balance on the factoring account, the same was payable to Yun Choy.

17.  Mr Chan also produced some statements of the debts purchased account and factoring account showing that the bank had from time to time paid Yun Choy prepayment and debited the same to the factoring account. 

18.  There is also no dispute that all the outstanding invoices, with the exception of two of them, contain a statement as follows:

“This account has been assigned to, is owned by and payable only to Standard Chartered Bank (Hong Kong) Limited, to whom prompt notice must be given of any merchandise returned or claims of any nature. Payment made to the issuer of the invoice does not constitute valid payment. Payments must be made directly to Standard Chartered Bank (Hong Kong) Limited in full discharge of your liability.”

The liquidators’ grounds of claim

19.  Mr Wong, counsel for the liquidators, submitted three grounds of claim.  The first ground is that the transaction between the bank and Yun Choy pursuant to the RPA amounted to lending by the bank to Yun Choy and secured by a charge on Yun Choy’s book debts.  This charge is registrable under section 80(1) of the Companies Ordinance, Cap. 32.  In the absence of registration, the charge is void as against the liquidators.   The second ground is that the bank has not provided consideration for some of the debts (invoices) that constitute the total sum. The third ground is that the transaction pursuant to the RPA amounted to a general assignment of book debts by Yun Choy to the bank and such assignment is void as against the liquidators for want of registration under section 48 of the Bankruptcy Ordinance, Cap. 6.  Section 48 is applicable to winding up by virtue of section 264 of the Companies Ordinance.

The first ground

20.  Section 80 provides:

“(1) Subject to the provisions of this Part of this Ordinance, every charge created after the fixed date by a company and being a charge to which this section applies shall, so far as any security of the company’s property or undertaking is conferred thereby, be void against the liquidator and any creditor of the company, unless the particulars of the charge (which must include those specified in subsection (1A) and be in the specified form), together with the instrument, if any, by which the charge is created or evidenced, are delivered to or received by the Registrar for registration in manner required by this Ordinance within 5 weeks after the date of its creation, but without prejudice to any contract or obligation for payment of the money thereby secured, and when a charge becomes void under this section the money secured thereby shall immediately become payable.”

21.  Mr Wong, submitted that despite the RPA having expressed the transaction as a sale and purchase of the debts due from Yun Choy’s customers, it was not an out-and-out sale of book debt.  It was, despite its good drafting, in substance an assignment by way of security creating a fixed charge over the book debts.  He said the RPA masked the true nature of the transaction between the bank and Yun Choy.  He referred to In re George Inglefield Ltd. [1933] Ch 1 at 17 per Lord Hanworth citing Helby v Matthews [1895] AC 471 at 475  per Lord Herschell:

“My Lords, it is said that the substance of the transaction evidenced by the agreement must be looked at, and not its mere words. I quite agree. But the substance must, of course, be ascertained by a consideration of the rights and obligations of the parties to be derived from a consideration of the whole agreement.”

22.  He then drew three differences between a sale and a charge by reference to the judgment of Romer J in George Inglefield at page 27:

“It appears to me that the matter admits of a very short answer, if one bears in mind the essential differences that exist between a transaction of sale and a transaction of mortgage or charge. In a transaction of sale the vendor is not entitled to get back the subject-matter of the sale by returning to the purchaser the money that has passed between them. In the case of a mortgage or charge, the mortgagor is entitled, until he has been foreclosed, to get back the subject-matter of the mortgage or charge by returning to the mortgagee the money that has passed between them. The second essential difference is that if the mortgagee realizes the subject-matter of the mortgage for a sum more than sufficient to repay him, with interest and the costs, the money that has passed between him and the mortgagor he has to account to the mortgagor for the surplus. If the purchaser sells the subject-matter of the purchase, and realizes a profit, of course he has not got to account to the vendor for the profit. Thirdly, if the mortgagee realizes the mortgage property for a sum that is insufficient to repay him the money that he has paid to the mortgagor, together with the interest and costs, then the mortgagee is entitled to recover from the mortgagor the balance of the money, either because there is a covenant by the mortgagor to repay the money advanced by the mortgagee, or because of the existence of the simple contract debt which is created by the mere fact of the advance having been made. If the purchaser were to resell the purchased property at a price which was insufficient to recoup him the money that he paid to the vendor, of course he would not be entitled to recover the balance from the vendor.”

23.  Mr Wong further submitted that the commercial purpose of selling book debts is to eliminate the risk of having to write off bad debts in exchange for an earlier though smaller payment.  Such sale passes the title of the debts as well as the risk of non-payment.  However, Clause 3.5 of the RPA gave the bank the sole discretion to reject and re-assign the debt. The risk of non-payment of a debt by a customer thus remained with Yun Choy and did not pass to the bank.  Hence, the RPA was not a true sale.

24.  Furthermore, under Clause 7.2, the bank had no obligation to make prepayment for unapproved debts.  Clause 5.5 also provided that if an approved debt should later become an unapproved debt for any reason, Yun Choy had to repay the bank of prepayment in respect of this debt.  Under Clause 6.5, the bank could also refuse to accept any debt as an approved debt. An approved debt would also become an unapproved debt under Clause 6.8(a) if it should become the subject of a dispute between Yun Choy and the customer of the debt.   In that event Yun Choy had to repay the prepayment. 

25.  Under Clause 5.6, if the payment by a customer to the bank of a debt should be rescinded or the bank had to repay the debt, then the purchase price of the debt that the bank had credited to Yun Choy’s factoring account pursuant to Clause 5.3 had to be repaid by Yun Choy to the bank.  Under Clause 7.5, any prepayment that was made for debts of a customer when the debts exceeded the customer limit or the concentration percentage or for approved debts that exceeded the available funds had to be repaid by Yun Choy as well.  Under Clause 9.1, Yun Choy also had obligation to ensure the payments by the customers of the debts to the bank.

26.  The discounting charge under Clause 11.1 also accrued on the amount of funds in use at the specifying rate on a daily basis. Such charge was in fact interest on an outstanding loan.   Under Clause 19.2(d), the bank could, upon or after a termination event, require Yun Choy to purchase all the outstanding debts and the sum of the funds in use.  That is essentially the repayment of the outstanding loan.  Under Clause 13.1, Yun Choy was also responsible for paying the premium of insurance in relation to the debts.  Mr Wong submitted that all these protections to the bank destroyed the transaction under the RPA as an out-and-out sale.  This is also the first incident of security referred to by Romer J. 

27.  Secondly, Mr Wong submitted that Yun Choy had an equity of redemption of the debts.  The reason being that if the payments by Yun Choy’s customers of debts to the bank should exceed the sums debited in the factoring account, the credit balance would be payable to Yun Choy.  Hence, the bank had to account to Yun Choy and Yun Choy could recover the full value of its book debts.  This is the second incident of security referred to by Romer, LJ. 

28.  Mr Wong further submitted that if the payments of debts by the customers to the bank should be less than the funds in use or the loan, the bank was entitled to recover the balance from Yun Choy.  That is the third incident of security referred to by Romer J. 

29.  Mr Wong also referred to Clause 5.1 and submitted that there was no fixed price for the purchase of a debt and the prepayment was merely a loan.  He further submitted that the transaction in the RPA only created a fixed charge as the notice of assignment of debt given to the customer merely restricted Yun Choy from disposing of the debt as charged and gave the bank a proprietary interest in the debt (see Agnew v CIR [2001] 2 AC 710 and In re Spectrum Plus Ltd [2005] 2 AC 680).

30.  Hence, Mr Wong submitted that despite the RPA being expressed as a purchase agreement, it was in substance a revolving credit facility granted by the bank to Yun Choy and secured by a fixed charge over Yun Choy’s book debts.  In support of this point Mr Wong also referred to the original proof of debt filed by the bank with the liquidators which referred to the RPA as a security.  This proof of debt has however been replaced and substituted by a new one which does not refer to the RPA as security.

31.  A senior account manager of the bank, Mr Eric Lee, said on affirmation that the reference to the RPA as a security in the original proof of debt was an inadvertent error.  I do not think the inclusion of the RPA as a security in the original proof is relevant to the task of interpretation of the RPA as the original proof is merely subsequent conduct of the bank which does not throw light on the meaning of the RPA. 

32.  Finally, Mr Wong referred to the contra preferentem rule and submitted that it should be applied against the bank if the court should be of the view that the nature and/or effect of the RPA is unclear.  I do not think this rule of construction needs to be referred to as the drafting of the RPA embodies no ambiguity that this rule may assist to resolve.

33.  Mr Wong on the basis of the above submissions summed up that the RPA was a fixed charge on Yun Choy’s book debts which was registrable under section 80(1) of the Companies Ordinance. Since it was not registered, it was void as against the liquidators. 

Second ground

34.  The second ground is advanced by the liquidators in the event that the first ground should fail.  Under this ground, Mr Wong submitted that the bank had given no consideration to the debts in nine invoices.  Yun Choy had notified the bank of six of these invoices but had not requested for any prepayment.  It had also notified the bank one invoice but its request for prepayment was not acceded to by the bank.  There were two invoices that Yun Choy had not even notified the bank. 

35.  Mr Wong does not accept that the RPA is a deed and hence submitted that consideration was required for the purchase of debts. He then submitted that the RPA was not a whole turnover agreement but a facultative agreement where the purchase by the bank of any debt was at the bank’s option and there would be no purchase if the bank did not exercise the option.  He referred to Clause 3.5 which gave the bank the sole discretion, after being notified by Yun Choy of a debt, to reject and re-assign the debt to Yun Choy.   Hence, he submitted that the RPA only gave the bank an option to purchase debts from Yun Choy. 

36.  Since there was no prepayment for the nine invoices, there was no consideration for the purchase of these invoices and the bank had not purchased them.  The total sum of these invoices is at US$139,977.25.  After deducting the prepayment by Hallmark as calculated and claimed by the liquidators, the net sum receivable from these invoices as suggested by the liquidators is US$104,505.08.  Mr Wong submitted that the liquidators should be entitled to this sum under the second ground.

The third ground

37.  This ground is also advanced in the event that the first ground should fail.  The invoices covered by this ground overlapped with those in the second ground save for one invoice which amounts to US$2,264.23 as calculated by the liquidators.  Mr Wong relied on section 48 of the Bankruptcy Ordinance and section 264 of the Companies Ordinance.  He submitted that section 264 incorporates section 48 into the winding up of companies.  Section 48 of the Bankruptcy Ordinance provides:

“(1) Where a person engaged in any trade or business makes an assignment to any other person of his existing or future book debts or any class thereof and is subsequently adjudicated bankrupt, the assignment shall be void against the trustee as regards any book debts which have not been paid before the date of the bankruptcy order, unless the assignment has been registered with the Registrar (of the High Court) in a register to be kept by him for that purpose. Provided that nothing in this section shall have effect so as to render void any assignment of book debts due at the date of the assignment from specified debtors, or of debts growing due under specified contracts, or any assignment of book debts included in a transfer of a business made bona fide and for value, or in any assignment of assets for the benefit of creditors generally.

(2) For the purposes of this section, “assignment” includes assignment by way of security and other charges on book debts.”

38.  Section 264 of the Companies Ordinance provides:

“264. In the winding up of an insolvent company the same rule shall prevail and be observed with regard to the respective rights of secured and unsecured creditors and to debts provable and to the valuation of annuities and future and contingent liabilities as are in force for the time being under the law of bankruptcy with respect to the estates of persons adjudged bankrupt, and all persons who in any such case would be entitled to prove for and receive dividends out of the assets of the company may come in under the winding up, and make such claims against the company as they respectively are entitled to by virtue of this section.”

39.  Mr Wong submitted that section 48 falls within the ambit of section 264 as section 48(1) concerns the respective rights of secured and unsecured creditors.  Section 48(2) also provides that “assignment” includes assignment by way of security and other charges on book debts as that had been effected by the RPA.  Furthermore, section 48(1) also concerns debts provable.  If the assignment of book debt by the RPA is void against the liquidators, then the bank could not rely on the assignment to collect the debts which were not due at the date of the assignment. 

40.  However, Mr Wong accepts that the specific notification of debts or invoices to the bank amounted to specific assignments rather than general assignments and thus not caught by section 48.  He nevertheless submitted that there were six debts or invoices that were notified to the bank on 23 September 2008 when the bank had terminated the RPA on 22 September 2008. He said the notifications of these debts were ineffective as specific assignments.  There were also two invoices which had not been notified to the bank and there was no specific assignment of them.  Their total value less the prepayment by Hallmark as calculated and claimed by the liquidators is US$102,240.85.  The liquidators should be entitled to this sum on the third ground.

The bank’s reply on the first ground

41.  Mr Man, counsel for the bank, submitted on the proper approach to be adopted.  He said I should consider the terms of the RPA in order to decide whether it is a sale or charge.  He referred me to Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 where Dillon LJ said at 161f to 162d:

“In my judgment there is no one clear touchstone by which it can necessarily and inevitably be said that a document which is not a sham and which is expressed as an agreement for sale must necessarily, as a matter of law, amount to no more than the creation of a mortgage or charge on the property expressed to be sold. It is necessary therefore to look at the provisions in the master agreement as a whole to decide whether in substance it amounts to an agreement for the sale of goods or only to a mortgage or charge on goods and their proceeds. In doing that I would in a case such as the present apply the law as stated by Lord Herschell in McEntire v Crossley Bros Ltd [1895] AC 457 at 462-463 [1895-9] All ER Rep 829 at 831 where he said:

‘... I quite concede that the agreement must be regarded as a whole - its substance must be looked at. The parties cannot, by the insertion of any mere words, defeat the effect of the transaction as appearing from the whole of the agreement into which they have entered. If the words in one part of it point in one direction and the words in another part in another direction, you must look at the agreement as a whole and see what its substantial effect is. But there is no such thing, as seems to have been argued here, as looking at the substance, apart from looking at the language which the parties have used. It is only by a study of the whole of the language that a substance can be ascertained.’

In the same case Lord Watson said ([1895] AC 457 at 467, [1895-9] All ER Rep 829 at 833-834):

‘As is usual in cases of this kind, we have heard a great deal in the course of the appellants’ argument of the necessity of attending to the substance of the agreement which we have to construe.  My Lords, that is a canon of construction which is applicable to all agreements; but it must always be borne in mind that the substance of the agreement must ultimately be found in the language of the contract itself.  The duty of a Court is to examine every part of the agreement, every stipulation which it contains, and to consider their mutual bearing upon each other; but it is entirely beyond the function of a Court to discard the plain meaning of any term in the agreement unless there can be found within its four corners other language and other stipulations which necessarily deprive such term of its primary significance.’”

42.  Staughton LJ also said in the same case at 186c to d:

“There are in my opinion two routes by which this principle can be overcome. The first, which I will call the external route, is to show the written document does not represent the agreement of the parties. It may, if one wishes, then be called a sham, a cloak or a device. The second is the internal route, when one looks only at the written agreement, in order to ascertain from its terms whether it amounts to a transaction of the legal nature which the parties ascribe to it.”

43.  Both Mr Man and Mr Wong agree that there is no question of the RPA being a sham and that I should adopt the internal route.  I am also referred to Orion Finance Ltd v Crown Financial Management Ltd [1996] 2 BCLC 78 at 85e where Millett LJ said:

“The legal classification of a transaction is not, therefore, approached by the court in vacuo. The question is not what the transaction is but whether it is in truth what it purports to be. Unless the documents taken as a whole compel a different conclusion, the transaction which they embody should be categorized in conformity with the intention which the parties have expressed in them.”

44.  Mr Man also asked me not to be guided by the economic effect rather than the terms of the RPA.  He referred to another statement of Staughton LJ in Welsh Development at page 185h to i:

“One can start from the position that statute law in this country, when it enacts rules to be applied to particular transactions, is in general referring to the legal nature of a transaction and not to its economic effect.”

45.  Mr Man submitted that the RPA did not create a charge.  He referred to Beale, Bridge, Gullifer & Lomnicka: The Law of Personal Property Security (2007) at para 2.30.

“2.30 If the agreement states that an absolute interest is transferred, it is open to the court to look at the rights and obligations created by the agreement in order to decide if this is truly the case. In the reported cases, the courts have consistently upheld the absolute nature of the transfer, despite features that might be thought to indicate that the transfer was by way of security. One such feature is that the purpose price paid for the receivables is discounted to reflect early payment: this could be seen as a provision for interest, but the courts have repeatedly distinguished a discount charge from payment of interest, on the grounds that it is fixed and paid once and for all whereas interest accrues from day to day. Another is that the seller of the receivables usually guarantees that they will be paid by the debtors: often providing bills of exchange to cover this guarantee liability. This might look as though it demonstrates the third of Romer LJ’s incidents of security: that where the security realizes less than the secured obligation, that obligation still remains. Again, the courts have denied this, and have pointed out that the nature of receivables is that the buyer has no or little knowledge of the chances that the debts will be paid, and therefore will want, as far as possible, to make sure that he gets what he bargained for. Thus it is common for sales of receivables to be with recourse. Such provisions are not seen as indicative of security, despite the fact that a sale with recourse is economically indistinguishable from a secured loan. The buyer may also take bills of exchange or payment from the seller by way of direct debit or standing order, allowing the seller to collect and retain the proceeds of the debts ‘sold’. Not only does this support the recourse provisions, it also has the de facto effect that the buyer of the receivables not only does not collect them, but receives ‘payment’ of the receivables as a constant stream of income rather than as and when they are paid by the debtors. However, the courts have made it clear that payment by this method is not inconsistent with the sale of receivables: the parties are free to choose the most convenient method of payment. Further, once the receivables have generated enough to cover the purchase price and the discount charge, the seller (I think should be buyer) may allow the buyer (I think should be seller) to keep any further money received from the debtors: this is expressed to be a further instalment of the purchase price. While this could be seen as an obligation to account for the surplus, and thus fall within the second of Romer LJ’s incidents of security, the courts have treated this feature as entirely consistent with a sale. It is very clear that, when considering outright assignments of receivables, the courts have consistently looked for the legal rather than the economic substance of the transaction and have upheld freedom of contract.”

46.  Mr Man referred to Welsh Development again at 154d where Dillon LJ said:

“It is now well-established that factoring or block discounting amounts to a sale of book debts, rather than a charge on books debts, even though under the relevant agreement the purchaser of the debts is given recourse against the vendor in the event of default in payment of the debt by the debtor.”

47.  Regarding the liquidator’s argument that the discounting charge which accrued on the daily basis was in fact interests on the loan, Mr Man referred to Lloyds v Scottish Finance Ltd v Cyril Lord Carpets Sales Ltd and others [1992] BCLC 609 at 615i to 616a where Lord Wilberforce said:

“… it has to be appreciated that block discounting is essentially a method of providing finance. Commercially and in its economic result, it may not differ from lending money at interest: the ‘discounting charge’, which represents the finance house’s profit, is stated in term of so much per cent per annum, which percentage is no doubt based upon current interest rates. Legally, however, there is no doubt that discounting is not treated as the lending of money and that the asset discounted is not considered as the subject of a charge.”

48.  Hence Mr Man submitted that by looking at the terms of the RPA rather than the economic effect, the daily accrual of discounting charge under the RPA did not make the transaction a lending of money and the assignment of debts under the RPA a charge of book debts.

49.  Regarding the bank’s right to require Yun Choy to repay the prepayment or not to make prepayment to Yun Choy under certain circumstances so that the risk of non-payment of the invoices remained with Yun Choy, Mr Man submitted that a sale with recourse is still a sale.  He found support again from Welsh Development at 161d to f where Dillon LJ said:

“In particular it is clear from Re George Inglefield Ltd., and the Lloyds v Scottish case, (a) that there may be a sale of book debts, and not a charge, even though the purchaser has recourse against the vendor to recover the shortfall if the debtor fails to pay the debt in full and (b) that there may be a sale of book debts, even though the purchaser may have to make adjustments and payments to the vendor after the full amounts of the debts have been got in from the debtors.”

50.  Lord Wilberforce also said in Lloyds v Scottish Finance at 616f to h:

“In block discounting ‘transactions’, the purchaser is acquiring an asset (viz a book debt) which he did not create, as to the validity of which he has no knowledge, which he is not going to collect, and of any default in whose realisation he may be ignorant. He naturally requires a certain margin, or reserve, or as is sometimes said, security to ensure, so far as possible, that he will get what he has bargained for. But it is a fallacy (into which the appellants’ argument falls) to argue from this towards a conclusion that the transaction as a whole is one of security or charge. There are many contracts, of sale, or for building work, or otherwise, where some security is required by one party that the other will fulfil his promise. But this does not alter the nature of the contract itself or turn it into a contract by way of charge. In the present case, the fact that the purchasers wanted guarantees, or security, or reserves to ensure that they received the whole of what they had bought, cannot convert a transaction of purchase into one of charge.”

51.  The payment of insurance premium by Yun Choy is again not a problem for the bank as the buyer is entitled to be secured that he would obtain the value of what it has bought.

52.  Regarding the argument of equity of redemption, Mr Man submitted that Yun Choy’s entitlement to be paid the credit balance in the factoring account did not amount to an equity of redemption.  He also submitted that there is nothing wrong in a sale of debt for the purchase price to be fixed by the amount to be collected by the purchaser later.  He is supported by statements of Dillon and Staughton LJJ in Welsh Development at 161e and 189a to c. 

53.  Finally, Mr Man submitted that what could be achieved by a fixed charge can also be achieved by a sale and it is the legal nature of the RPA rather than the economic effect that matters.

Decision on first ground

54.  I think Mr Man is right.  The terms of the RPA state clearly that the arrangement is a sale.  Mr Wong’s submissions are all constructed on the economic effect of the RPA.  However, all the indicia that he relied on to say that it was an arrangement of a revolving loan secured by a fixed charge on book debts are permissible in a sale of debts arrangement.  Mr Man’s submissions are built on solid statements of the law and I accept them. I hold that the RPA is a sale transaction and not a charge. 

The bank’s reply to the second ground

55.  Mr Man does not agree that separate consideration needs to be provided for each of the debts.  He referred to the terms of the RPA and submitted that it is clearly a deed.  He further submitted that the RPA is a whole turnover agreement and the beneficial interest in the future debts vested in the bank as and when they came into existence.   He said that it is wrong to equate the bank’s right under Clause 3.5 to reject or reassign a debt as an option to purchase a debt.  The right to re-assign presupposes an assignment having taken place, hence the RPA is not a facultative agreement but a whole turnover agreement. 

56.  He then referred to Edward Tailby v The Official Receiver (1888) 13 App Cas 523 at 533 where Lord Watson said:

“The rule of equity which applies to the assignment of future choses in action is, as I understand it, a very simple one. Choses in action do not come with the scope of the Bills of Sale Acts, and though not yet existing, may nevertheless be the subject of present assignment. As soon as they come into existence, assignees who have given valuable consideration will, if the new chose in action is in the disposal of their assignor, take precisely the same right and interest as if it had actually belonged to him, or had been within his disposition and control at the time when the assignment was made. There is but one condition which must be fulfilled in order to make the assignee’s right attach to a future chose in action, which is, that, on its coming into existence, it shall answer the description in the assignment, or, in other words, that it shall be capable of being identified as the thing, or as one of the very things assigned. When there is no uncertainty as to its identification, the beneficial interest will immediately vest in the assignee.”

57.  In the present case, there is no problem of identification as all debts are identifiable by reference to the RPA. 

58.  Mr Man also referred to Salinger on Factoring, 4th edition, at the end of paragraph 7-011 which states:

“It is now generally accepted that, for this purpose under an agreement of the whole turnover type, one payment to the client or one credit to the client’s account should be sufficient because the agreement is a single indivisible contract for the sale of the debts to which it relates.”

59.  Mr Man also referred to Snell’s Equity, 32nd edition,

“3-109. Whether or not value is required for the assignment depends on the type of chose which is being assigned and on the form of the assignment. It should be noted at the outset that the question of value arises only between the assignor and the assignee; the debtor is not permitted to refuse to pay the assignee on this ground.

Value is necessary for an equitable assignment of rights of property not yet in existence, or for the creation of a mere charge (as distinct from a complete transfer), for such assignments are based on there being a contract that the property in question shall be assigned or stand charged. Value is also required for an agreement to assign an existing chose in action at some time in the future.

But value is not required for other equitable assignments of equitable choses provided the assignor has done everything required to be done by him in order to transfer the chose in action.  Although the contrary view has been expressed, it has been established that the value is also not required for other equitable assignments of legal choses in action.  Thus an assignment of part of a debt is valid despite the absence of consideration.  Also an assignment by declaration of trust is effective since a completely constituted trust is valid without consideration.”

60.  Thus Mr Man submitted that there was no need for the bank to provide consideration for the assignment of the invoices that came into existence after the commencement date. 

Decision on the second ground

61.  I also agree with Mr Man.  His arguments are based on sound propositions of law.  I do not think the liquidators are entitled under the second ground to any part of the payment due from Hallmark.

The bank’s reply to the third ground

62.  Mr Man submitted that section 48 of the Bankruptcy Ordinance is not within the scope of section 264 of the Companies Ordinance.  He referred to Re Count D’Epineuil (1881) 20 Ch D 217 at 219 where Fry J considered section 10 of the Judicature Act, 1875, which was the forerunner of section 264.  The learned judge said:

“… the section is not intended to enlarge the assets to be administered, but only to vary the rights of the persons entitled to the estate.”

63.  Buckley on the Companies Acts, Volume 1, para 317 also  states:

“The section applied a particular rule to the administration of the assets of the company; it did not bring into the assets something which apart from the section would not be assets.”

64.  Mr Man also disagreed that the six invoices that were notified to the bank on 23 September 2008 had not been specifically assigned.  The reason being that Clause 19.3(d) provided that the parties’ rights and obligations in respect of debts purchased by the bank prior to the termination would remain in full force and effect despite termination. 

65.  For the two invoices that were not notified to the bank, Yun Choy was in breach of the RPA in not making the notification.  Since Yun Choy could not have taken advantage of its own wrong, the two invoices would be deemed to have been notified to the bank as well (see Kensland Realty Ltd v Whale View Investment Ltd & Another (2001) 4 HKCFAR 381).

Decision on the third ground

66.  Mr Man is also correct on this ground.  Fry J’s decision is correct and I hold that section 48 of the Bankruptcy Ordinance is not within the scope of section 264 of the Companies Ordinance as it is not the purpose of section 264 to enlarge the pool of assets available to the unsecured creditors.

67.  Furthermore, the bank’s rights in the RPA over the six invoices that were notified on 23 September would continue as the invoices had come into existence before the termination of the RPA.  These invoices had therefore been specifically assigned to the bank and not caught by section 48.  The same applies to the two un-notified invoices as Yun Choy should have notified the bank about them.   In the premises, I also hold against the liquidators on the third ground.

Judgment

68.  I therefore order the payment out of the US$288,506.10 together with interest accrued, if any, to the bank.  I further order Yun Choy to pay the bank US$7,260.95 to make up the sum of US$295,767.05.

69.  I also make a costs order nisi that Yun Choy do pay the costs of the proceedings to the bank.

(Discussion re costs)

70.  And I also make the same costs order for the reserved costs.