IGAI COMPANY LTD (IN CREDITORS’VOLUNTARY LIQUIDATION) v. GET NICE (UNION) FINANCE COMPANY LTD

HCMP 2739/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2739 OF 2013

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D E C I S I O N

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1.  On 23 October 2008 the Company passed a resolution to put itself into creditors’ voluntary winding up and form W3 was filed at the Companies Registry stating that Alan Tang and Peter Wong had been appointed liquidators of the Company. On 17 October 2013 the liquidators issued an originating summons seeking, amongst other things, a declaration that a payment of $1,050,000 made on 8 July 2008 by the company to the respondent constituted an unfair preference contrary to sections 266 and 266B(1)(b) of the Companies Ordinance, Cap. 32, and is void.

2.  The payment came to be made in the following circumstances. On 5 May 2008 the major shareholder of the company, Leung Ling, signed an agreement with the Respondent, which is a licensed money lender, pursuant to which he borrowed $2,500,000, which Mr. Leung was required to repay on or before 8 August 2008.  Mr. Leung was the majority shareholder and a director of the Company.  The Company had one other shareholder and director, Mr. Leung’s Wife, Madam Ma.  On 8 May 2008 the board of directors of the company passed a resolution approving a guarantee by the Company of Mr Leung’s obligations under the loan agreement.  A guarantee and indemnity was signed on 8 May 2008. The guarantee provided that the company guaranteed unconditionally the full and punctual payment of all sums payable by Mr Leung.  Clause (d) provided that:

(i) a written confirmation from your company stating the amount of money due to you by the borrower shall be conclusive evidence of the indebtedness at such rate of the borrower to you and accordingly conclusive evidence between you and me/us that my/our liability has accrued in respect of the amount stated.

…

(iii) Any payment due to be made by me/us to you upon demand shall be made immediately on receipt of notice of such demand. Any such notice shall be sufficiently given if posted to my/our addresses last known to you and shall be deemed to have arrived in the due course of post.

3.  Unbeknown to the liquidators at the time the originating summons was issued Mr Leung and the Respondent had also signed on 8 May 2008 a memorandum which recorded, amongst other things, that "securities" in the form of three cheques had been provided, which were post dated on 8 June, 8 July and 8 August 2008 respectively.  The cheque post dated 8 July 2008 was for $1,050,000.  That cheque was presented on 8 July to HSBC, on whom it was drawn, and honoured.  It is this transaction that the liquidators contend gives rise to an unfair prejudice.

4.  Sections 266(1) and 266B(1) of the Companies Ordinance provide respectively:

“266. Fraudulent preference

(1) Any conveyance, mortgage, delivery of goods, payment, execution or other act relatingto propertymade or done byoragainstacompany within 6 months beforethe commencementofitswinding upwhich, haditbeenmade ordone byoragainstanindividualwithin6 monthsbefore thepresentationofabankruptcypetition onwhichheis adjudged bankrupt,wouldbedeemed inhisbankruptcy a fraudulent preference,shallinthe event of the company beingwoundupbedeemedafraudulent preferenceofits creditorsand beinvalidaccordingly:

Provided that, inrelation to things made ordone before thecommencement*oftheCompanies (Amendment) Ordinance 1984(6of 1984), this subsection shall have effect with thesubstitution,for references to6 months,of referencesto3 months.

266B.    Fraudulentpreferencedeemedtobeanunfairpreference

(1) On and after the day section 36 of the Bankruptcy (Amendment) Ordinance 1996 (76 of 1996) (the  amending Ordinance) comes into operation, where the winding up of a company commences on or after that date-

(a) a reference in section 266 or 266A of this Ordinance to a fraudulent preference shall be deemed to be a reference to an unfair preference as provided for in section 50; and

(b) a reference in section 266 of this Ordinance to a period of 6 months shall  be deemed to be a reference to a period of-

(i) 6 months; or

(ii) 2 years in the case of a person who is an associate as provided for in section 51B,

of the Bankruptcy Ordinance (Cap. 6) (the principal Ordinance).”

5.  Sections 50(1) to (4) and 51(1)(c) and (2) of the Bankruptcy Ordinance, Cap. 6, provide:

“Section: 50 Unfair preferences

(1) Subject to this section and sections 51 and 51A, where a debtor is adjudged bankrupt and he has at a relevant time (defined in section 51) given an unfair preference to any person, the trustee may apply to the court for an order under this section.

(2) The court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if that debtor had not given that unfair preference.

(3) For the purposes of this section and sections 51 and 51A, a debtor gives an unfair preference to a person if-

(a) that person is one of the debtor's creditors or a surety or guarantor for any of his debts or other liabilities; and

(b) the debtor does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the debtor's bankruptcy, will be better than the position he would have been in if that thing had not been done.

(4) The court shall not make an order under this section in respect of an unfair preference given to any person 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 subsection (3)(b).

Section: 51 “Relevant time” under sections 49 and 50

(1) Subject to subsections (2) and (3), the time at which a debtor enters into a transaction at an undervalue or gives an unfair preference is a relevant time if the transaction is entered into or the unfair preference given-

....

(c) in any other case of an unfair preference which is not a transaction at an undervalue, at a time in the period of 6 months ending with that day.

(2) Where a debtor enters into a transaction at an undervalue or gives an unfair preference at a time mentioned in subsection (1)(a), (b) or (c) (not being, in the case of a transaction at an undervalue, a time less than 2 years before the end of the period mentioned in subsection (1)(a)), that time is not a relevant time for the purposes of sections 49 and 50 unless the debtor-

(a) is insolvent at that time; or

(b) becomes insolvent in consequence of the transaction or preference,

but the requirements of this subsection are presumed to be satisfied, unless the contrary is shown, in relation to any transaction at an undervalue which is entered into by a debtor with a person who is an associate of his (otherwise than by reason only of being his employee).”

6.  As is apparent from these sections what the liquidators have to establish is that at the “relevant time” the Company did anything or allowed anything to be done that had the effect of putting the Respondent in a better position than it would have been if the thing done had not been done.  There is no dispute that the relevant time is 6 months prior to the date the Company went into liquidation.  That period is 24 April 2008 to 23 October 2008.  There is a dispute as to whether the relevant event occurred on 8 May, when the guarantee was signed and the cheques provide, or 8 July 2008 when the cheque was presented and honoured.  Both dates are 6 months prior to the commencement of the winding up.  This dispute is material because section 51(2) requires the liquidators to establish that at the time the unfair prejudice took place the Company was insolvent and this task is easier the closer the relevant date is to 23 October 2008.

7.  The liquidators express suspicions in their evidence about the propriety of the Company agreeing to guarantee a personal loan to one of its directors, but the present application does not seek to set aside that transaction and, although I can understand the liquidators’ concerns, it does not seem to me that the evidence adduced before me justifies determining the present application other than on the basis that as between the Company and the Respondent the guarantee was lawful and enforceable and, indeed, Ms. Abigail Wong who appeared for the liquidators did not suggest otherwise.  Ms. Wong did, however, argue that the Respondent was not entitled to present the cheque on 8 July 2008 because it had not complied with the clauses of the guarantee quoted in paragraph 2 of this decision.  These provisions do not state that a demand has to be made before the guarantee becomes enforceable or that the Respondent has to demonstrate that Mr. Leung has failed to pay in accordance with the terms of the loan agreement.  They are provisions addressed to the obligations of the Company to pay if the Respondent seeks payment under the guarantee.  They are not apposite if the Respondent did not require the Company to do anything, in practice give it a cheque, because it already had a post‑dated cheque.  Self-evidently the Respondent would have to make a demand for payment from the Company unless it had some form of security from the Company to enforce against.  Conversely, if it did have such security such a demand was unnecessary.  However, that does not of itself dispose of the question of whether or not the Respondent was entitled to present the cheque on 8 July 2008.

8.  This was not a matter raised by Mr. Tang in his evidence in support of the application.  He simply says in paragraph 11 of his first affirmation that the Company had not received any demand before the cheque was presented, which is not in dispute.  This is a different, however, to the issue of whether or not the Respondent had to make a demand for payment from Mr. Leung before it was entitled to enforce the guarantee. Neither party filed any evidence relevant to that issue.  The evidence proceeds on the basis that the live issue is whether or not at the material time the Company was insolvent.

9.  Mr. Tang in his second affirmation explains that the Company and Mr. Leung and his Wife were defendants in High Court Actions commenced by banks from 21 October 2008 and petitioned for their own bankruptcy on 3 December 2008.  It is the liquidators’ case that the Company was insolvent by early May 2008.  If this is correct it tends to follow that Mr. Leung was probably in dire financial circumstances by early July. Given the way in which the issues between the parties were framed in the evidence filed by the liquidators and the state of the evidence before me I do not think I can conclude that the Respondent was not entitled to present the cheque for payment on 8 July 2008; on the contrary on the limited evidence before me, and mindful of the fact that it is for the liquidators to prove the Company’s case, I conclude that it was.

10.  Ms. Wong identified 3 further issues on which the application turns:

(1) Did the cheques constitute security?

(2) What was the unfair prejudice and when did it occur?

(3) Was the Company insolvent at the material time?

11.  The Respondent argued that the cheques were security provided by the Company for compliance by it with its contingent obligations under the guarantee.  Ms. Wong argued that this is incorrect.  The cheques were in reality instalments repayments of the debt owed to the Respondent.  The significance of the distinction is this.  The enforcement of security does not constitute an unfair prejudice and Ms. Wong accepted that if the cheques were security the presentation of the cheque on 8 July 2008 was not an unfair preference.

12.  As the authors of Halsbury’s Laws of Hong Kong, 2^nd ed., vol 41 explain at paragraph 280.001:

“In its simplest form ‘security’ denotes something that makes the creditor more assured of being able to recover the debt (or the performance of the other obligation), as distinct from the personal claim against the debtor.[1] There is no one comprehensive definition of ‘security’. Various attempts have been made, but none is completely satisfactory.[2]. The description of security as the right given to a creditor over property or against a person over and above the personal obligation to repay the debt (or perform the other obligation)[3] is sufficient for present purposes.

The difficulty in defining ‘security’ is manifest from the many cases in recent years in which liquidators or trustees in bankruptcy on the one hand and creditors on the other have contested the nature of a particular transaction – whether it is secured or not. The point to emphasise is that, in the event of a debtor’s insolvency, a creditor, assuming the value of the security is equal to or exceeds the amount of the debt, can stand outside the insolvency and rely on his security.”

13.  The guarantee was in the broad sense described in this passage a form of security and the cheques, on the assumption that the principal liability to repay the loan was that of Mr. Leung, were an incident of the broader security represented by the guarantee. The memorandum signed at the time of execution of the guarantee refers to the three cheques as security and without more in my view this is how I think they fall to be treated.  Ms. Wong argued that in reality what appears to have been intended was that the Respondent would obtain repayment of the loan by presenting the three cheques when they fell due for presentation and as a consequence they are instalment payments not security.  There would be force in this argument if there was evidence that the 8 June cheque had been presented by the Respondent.  There is, however, no evidence that either it or the August cheque were presented.  It seems to me that in these circumstances the better view is that the cheques were provided by way of security.

14.  As I have already mentioned Ms. Wong conceded that if the cheques were security the payment made as a consequence of its presentation could not be an unfair prejudice.  In my view that concession was wrongly made.  It is correct that security given in respect of a contemporaneously created debt or future indebtedness is not an unfair prejudice[4]. It is also the case that security created prior to the period to which sections 50 and 51 apply and enforced during it does not constitute an unfair prejudice because it does not affect the statutory order of priorities of distribution of a company’s estate amongst its creditors.  The present case is different. The security was created during the 6 month period prior to commencement of the winding up.  The security was not given in respect of an advance to the Company.  All the cheques did qua the Company was to place the Respondent in a potentially better position when it came to recover any debt that might became due under the guarantee then it would otherwise be in.  They are, therefore, capable of constituting an unfair prejudice if the requirements of sections 50(3) and (4) and 51(2) are met.  I now turn to consider that issue.

15.  Section 50(3)(b) states that an unfair prejudice arises if the Company did anything or allowed anything to happen that had the effect of putting the Respondent in a better position than he would otherwise be in.  Ms. Wong argued that the relevant act and time at which to consider when the unfair prejudice took place and the necessary desire was formed was the date the cheques fell due not when they were provided.  This seemed initially to be made on the assumption that allowing the cheques to be presented constituted “suffering anything to be done”.  This seems to me to be wrong.  The Company had given the cheque to the Respondent on 8 May and given my finding in paragraph 9 it follows the Respondent was entitled to present it.  The presentation of the cheque did not involve “anything” being done by the Company.  It seems to me that when section 50(3)(b) refers to “suffering anything to be done” it must be read as referring to things that a bankrupt could lawfully takes steps to prevent.  It  does not seem to me that the Company could lawfully have countermanded the cheque. The presentation of the cheque by the Respondent and its payment by HSBC are not in my view events that engage section 50(3)(b) and I so find.

16.  In her reply submissions Ms. Wong put the Company’s case differently.  She argued that it could clearly be seen that the relevant account had on 7 July a closing balance of $20,228 and that during the previous week the balance had never exceeded $80,000.  On 8 July a deposit of $1,099,999 was made into the account from another account of the Company and this, Ms. Wong argued, had clearly been done in order to allow the cheque to clear.  Ms. Wong argued that this constituted the thing done by the Company which had the effect of putting the Respondent in a position which, in the event of the Company’s bankruptcy, would be better than it otherwise would be.  In my view this is correct.  That alone, however, is not sufficient to constitute an unfair preference.  Section 50(4) requires the liquidators to demonstrate that in putting the account in funds in order that the cheque could be paid the bankrupt was “influenced ….. by a desire” to put the Respondent in a better position, in the event of the Company’s bankruptcy, than it would otherwise be in.

17.  There will rarely be direct evidence of the necessary desire to prefer a particular creditor.  An inference of the necessary desire may be inferred from the facts[5]. In the present case there is no direct evidence of why $1,099,999 was transferred into the Company’s HSBC bank account on 8 July.  However, the date of the transfer and the pattern of activity in the account in July points compellingly to the conclusion that the transfer was made with the intention that the cheque would clear.  Intention to pay is different from desire to prefer one creditor over others.  Desire involves ascertaining a subjective state of mind.  Section 50(4) has its origins in section 239 of the Insolvency Act 1986.  In Re MC Bacon Ltd [6] Millett J (as he then was) considered what proof of desire involves and distinguished it from the requirement of section 44(1) of the Bankruptcy Act 1914 which had been construed by the courts as requiring the person seeking to avoid the payment to establish that is had been made with “the dominant intention to prefer” the creditor.  Rather than summarise the relevant part of Millett J’s judgment I will quote it:

“This is a completely different test. It involves at least two radical departures from the old law. It is no longer necessary to establish a dominant intention to prefer. It is sufficient that the decision was influenced by the requisite desire. That is the first change. The second is that it is no longer sufficient to establish an intention to prefer. There must be a desire to produce the effect mentioned in the subsection.

This second change is made necessary by the first, for without it it would be virtually impossible to uphold the validity of a security taken in exchange for the injection of fresh funds into a company in financial difficulties. A man is taken to intend the necessary consequences of his actions, so that an intention to grant a security to a creditor necessarily involves an intention to prefer that creditor in the event of insolvency. The need to establish that such intention was dominant was essential under the old law to prevent perfectly proper transactions from being struck down. With the abolition of that requirement intention could not remain the relevant test. Desire has been substituted. That is a very different matter. Intention is objective, desire is subjective. A man can choose the lesser of two evils without desiring either.

It is not, however, sufficient to establish a desire to make the payment or grant the security which it is sought to avoid. There must have been a desire to produce the effect mentioned in the subsection, that is to say, to improve the creditor’s position in the event of an insolvent liquidation. A man is not to be taken as desiring all the necessary consequences of his actions. Some consequences may be of advantage to him and be desired by him; others may not affect him and be matters of indifference to him; while still others may be positively disadvantageous to him and not be desired by him, but be regarded by him as the unavoidable price of obtaining the desired advantages. It will still be possible to provide assistance to a company in financial difficulties provided that the company is actuated only by proper commercial considerations. Under the new regime a transaction will not be set aside as a voidable preference unless the company positively wished to improve the creditor's position in the event of its own insolvent liquidation.

There is, of course, no need for there to be direct evidence of the requisite desire. Its existence may be inferred from the circumstances of the case just as the dominant intention could be inferred under the old taw. But the mere presence of the requisite desire will not be sufficient by itself. It must have influenced the decision to enter into the transaction. It was submitted on behalf of the bank that it must have been the factor which “tipped the scales”. I disagree. That is not what subsec. (5) says; it requires only that the desire should have influenced the decision. That requirement is satisfied if it was one of the factors which operated on the minds of those who made the decision. It need not have been the only factor or even the decisive one. In my judgment, it is not necessary to prove that, if the requisite desire had not been present, the company would not have entered into the transaction. That would be too high a test.

It was also submitted that the relevant time was the time when the debenture was created. That cannot be right. The relevant time was the time when the decision to grant it was made. In the present case that is not known with certainty. It was probably some time between 15 April and 20 May, although as early as 3 April Mr Glover and Mr Creal had resigned themselves to its inevitability. But it does not matter. If the requisite desire was operating at all, it was operating throughout.”

18.  As Millett J explains the requisite desire is to produce the effect mentioned in sub-section (3)(b).  It is sufficient that the decision was influenced by that desire.  It does not have to be the sole motivating factor in the debtor’s decision.  The relevant time at which to assess the presence of the requisite desire is the time when the decision to do the thing it is suggested constitutes the unfair preference was taken.

19.  What the liquidators need to demonstrate is that it can be inferred from the facts that I am satisfied have been proved, that the decision to transfer funds to HSBC, which I think it can reasonably be inferred was taken shortly before the transfer, was at least partly influenced by the desire to ensure the Respondent was paid more than he would otherwise be paid in the event that cheque was dishonoured and subsequently the Company went into bankruptcy.  It is quite possible that Mr. Leung may have been influenced by such a desire.  It is also possible that he was more concerned about the Respondent chasing him for the money and that he did not give any thought to what the consequences would be for the Respondent if the Company went into liquidation.  Although the Court can assess the surrounding circumstances and the objective effects of a transaction to see if it can infer the requisite desire without any direct evidence of the decision maker’s motivation the surrounding circumstances will have to be compelling in order to justify the Court drawing the necessary inference.  In the present case all that has been proved is the fact of the transfer and the balance in the account during July.  It does not seem to me that I can fairly draw the inference from such sparse facts that Mr. Leung was motivated by a desire to achieve the effect specified in section 50(3)(b).  To hold otherwise in my view would be to turn what is a subjective test into an objective one.  The subjective test will commonly be difficult to satisfy particularly if the presumption in section 50(5) does not, as in the present case, apply and this needs to be borne in mind when considering whether an application under section 266 is viable.

20.  I, therefore, find that insofar as the relevant act is the transfer on 8 July 2008 the liquidator has failed to establish that it constitutes an unfair preference.

21.  Ms. Wong did, in the alternative, argue that the issue of the cheques itself could constitute an act which came within section 50(3)(b).  This argument was advanced in case the court took the view that the relevant decision by the Company was the one to issue the cheques.  The argument was not advanced in case I reached the conclusion that (a)  the transfer into the HSCB account was capable of satisfying section 50(1)(b) but, (b) that the decision to make the transfer was not influenced by the requisite desire.  However, in the light of my finding that the transfer on 8 July did not constitute an unfair prejudice it becomes necessary to consider whether the creation of the security represented by the cheques constituted an unfair preference.  In my view it did not.

22.  Section 50(3)(b) requires the act or omission (“anything or suffers anything”) will, not may, have the effect of putting the creditor in a better position in the event of the debtor’s bankruptcy than he would otherwise be in.  This was recognised by Morrit J in Re Ledingham-Smith [7] in which he said this:

“The phrase ‘will be better’ in relation to the events of the individual’s bankruptcy used in section 340(3)(b) envisages a bankruptcy after the doing of the thing in question. It also predicates that the position will be better, not may be.”

23.  The cheques were all post dated. There was no certainty that the cheques would be honoured at the time when they could be presented.  There may not have been sufficient funds in the account or by that time a petition to wind up the Company might have been presented in which case the bank, on the assumption it knew of the petition and followed normal practice, would not have paid even if there had been sufficient funds in the account unless an order was granted pursuant to section 182 of the Companies Ordinance.  Accordingly, section 50(3)(b) is not satisfied.  It also seems to me that the evidence does not establish that the requisite desire to produce the effect required by section 50(3)(b) was present.

24.  In the light of my earlier decisions it is not necessary for me to consider whether at the relevant times the Company was insolvent and I will deal briefly with this issue.

25.  The evidence in relation to insolvency is quite limited.  The Respondent has adduced the Company’s audited financial statement for the year ending 31 December 2007.  The financial statement was audited by PwC and the audit report is dated 20 August 2008.  It shows that in 2007 the Company made an after tax profit of $10,716,718 and that it had assets totalling $130,683,414 and non-current and current liabilities of $111,837,663.  It was, therefore, solvent.  The auditor’s report is unqualified.  There is no suggestion that PwC has become aware of any matter post year end that required them to add any qualifications concerning the financial affairs of the Company at the time they signed the audit report.

26.  By October 2008 the Company had gone from a fairly healthy condition into insolvency and according to its statement of affairs its liabilities exceeded its assets by in excess of $30,000,000. There is little explanation about how this happened other than that during 2008 the World was in the throes of an economic crisis and this affected the garment industry to which the Company was a supplier.  Mr. Tang explains in his first affirmation that by the end of May the total balance in the Company’s accounts was a total of just $635,359 and that 8 of the Company’s 14 accounts were overdrawn. By the end of June the balance was a negative figure of $2,451,345.

27.  The Respondent argued that the relevant accounting standards require an auditor to note in his report any matters of significance that occur after the end of a financial year that come to his attention during the audit.  Mr. Kim argued that the fact that PwC’s report makes no reference to any material adverse change in the Company’s financial state indicates that the Company was probably solvent in August when the report was signed.  What we do not know is when the audit was actually carried out and what recent financial information they had to hand.  It may be PwC saw little beyond books and accounts for the first quarter of 2008.  However, I accept that the absence of any notes or qualifications tends to suggest that in the earlier part of 2008 the Company had not yet encountered very serious financial problems.

28.  Mr. Kim also emphasised that it must have been possible for the liquidators to adduce more evidence of the Company’s ability to pay its debts when they fell due in May and July than a summary of its bank balances.  They could, he suggested, have adduced evidence of demands for payment and creditors being paid late if this were the case. The absence of such evidence suggested that the Company’s financial problems became severe after the dates we are concerned with.  I think there is some force in this point certainly in respect of 8 May.  In my view the evidence adduced by the liquidators falls short of proving on the balance of probability that the Company was insolvent either on a cash flow or balance sheet basis on 8 May.  However, it seems to be probable that it was insolvent by 8 July by which time it is clear from the bank account records that its cash position had declined rapidly and it probably could not repay all its banks.

29.  I, therefore, dismiss the originating summons and order that the Company pays the Respondent’s costs.

30.  There is one outstanding matter that needs to be addressed.  On 3 July I heard an application for security for costs, which I declined primarily on the grounds that it was brought too late. The Respondent applied at the outset of the hearing of the originating summons for leave to appeal and for the adjournment of the originating summons.  I indicated that I was minded to decline the applications largely for the reason that since I had read the papers and the costs of the hearing had already been incurred they seemed pointless.  I formally dismiss those applications, but I think in the circumstances it is appropriate to make no order as to costs in respect of them which I do.  It is unfortunate that the Respondent did not make the application at the commencement of the proceedings when it would have been much more likely to succeed.