RE ZHU KUAN (HONG KONG) CO LTD (IN LIQUIDATION)

HCCW 875/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 875 OF 2003

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D E C I S I O N

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1.  This is a summons issued on 7 July 2005 by the liquidators of Zhu Kuan (Hong Kong) Company Limited (“ZKHK”), under section 200 of the Companies Ordinance, Cap. 32.  The liquidators seek directions that they be at liberty to pay out of the assets of ZKHK the fees and expenses incurred, and the remuneration earned, regarding work undertaken by them, and by the provisional liquidators of ZKHK, in relation to the assets and affairs of Zhu Kuan Group Company Limited (“ZKG”) and Pioneer Investment Ventures Limited (“PIV”), more particularly described in the 11^th affidavit of Cosimo Borrelli sworn on 6 July 2005, on the grounds that:

(1)     such fees and expenses were properly incurred in preserving, realizing or getting in the assets of ZKHK; or

(2)     such remuneration was referable to work undertaken in relation to the winding-up, and for the benefit of, ZKHK.

2.  If it is appropriate to make the directions sought, the liquidators recognise that the directions should be qualified in 2 respects:

(1)     an exception should be made regarding any expenditure incurred solely referable to preserving, realizing or getting in specific assets of other companies in the Zhu Kuan Group (such as work undertaken in relation to the first meetings of creditors and the reporting undertaken for the Official Receiver’s office solely for ZKG), when it was not undertaken as part of the overall settlement strategy described below, as it would not be appropriate for such expenditure to be paid out of the assets of ZKHK; and

(2)     it should be further directed that ZKG should reimburse ZKHK, in the event recoveries are made for ZKG and it is in a position to repay any expenses from its own assets.

3.  In the alternative, the liquidators submit that if it is not appropriate to make the above directions, they urge the court to make a direction that ZKHK be permitted to fund the cost of work done that should be borne proportionately by ZKG and PIV by making advances to these entities on a “limited recourse loan” basis in that the loans are to be repaid in the eventandto the extent recoveries are made by ZKG and PIV.

4.  The liquidators acknowledge they have not found any reported authority directly in support of the proposed directions.

5.  The summons first came before me on 10 August 2005.  I adjourned it sine die with liberty to restore, for the liquidators to satisfy the court it is within my jurisdiction to make the directions, and suggested that the Official Receiver be informed.

6.  At the restored hearing, the Official Receiver appeared by Mr Bartlett of counsel to assist the court on matters of principle.  His position is:

(1)     a proper jurisdictional basis has not been made out by the liquidators and the directions sought would seem contrary to fundamental and established principles; and

(2)     there are significant concerns as to the consequences should such a precedent of the proposed directions be set.

7.  Before I deal with the arguments, I will relate the relevant facts.

8.  ZKG was established in Macau and ZKHK established in Hong Kong as “window companies” for the commercial activities of the Zhuhai Municipal Government (“ZMG”).

9.  ZKG is the ultimate holding company of ZKHK and at least 33 other companies and owns 100% of the share capital of ZKHK and of PIV.

10.  PIV was incorporated as a special purpose vehicle to receive a large quantity of shares in Zhu Kuan Development Company Limited (“ZKD”), which is a listed company in Hong Kong.  PIV has no assets other than the ZKD shares.  The ZKD shares were issued to PIV at the direction of ZKG as part of the consideration payable to ZKG by a subsidiary of ZKD for the acquisition of ZKG’s interests in two Zhuhai based shipping joint ventures controlled by ZMG.  The circumstances regarding this transaction and the subsequent entry into separate share charges by ZKG and PIV over ZKG’s shares in PIV and the ZKD shares are subject to proceedings in HCA No. 3502 of 2003 (“the Longway Proceedings”) between PIV, ZKG and Longway Services Group Limited (“Longway”).  PIV’s only creditor is ZKG, although Longway has asserted that it is a creditor of PIV in the Longway Proceedings.  This assertion is denied by the liquidators.

11.  By orders made on 13 August 2003, David Kennedy and Mr Borrelli were appointed provisional liquidators of ZKG and ZKHK.  By orders made on 4 October 2004, these two companies were wound up.  By orders dated 21 March 2005, Kelvin Flynn and Mr Borrelli were appointed liquidators of these companies.

12.  As for PIV, Mr Kennedy and Mr Borrelli were appointed provisional liquidators by an order made on 3 September 2003.  Whilst Mr Kennedy and Mr Borrelli were appointed provisional liquidators of PIV, all of the work undertaken has primarily been an extension of their work as provisional liquidators of ZKG.

13.  The present applications are limited to assets of and fees and disbursements incurred regarding the winding up of ZKHK, ZKG and PIV, and do not relate to the Hong Kong incorporated subsidiaries of ZKHK and ZKG which have been wound up and to which Mr Borrelli and Mr Flynn were also appointed liquidators.

14.  The liquidators have given a detailed account of the work conducted for ZKHK, ZKG and PIV and this may be summarized as follows:

(1)     pursuing legal proceedings under section 221 of Cap. 32, legal proceedings in the PRC and other work to recover the books and records;

(2)     investigating the affairs of these companies, establishing the entitlement of these companies to their assets, and pursuing compensation due to them as a result of the seizure and/or dissipation of these assets, primarily by ZMG and its officers;

(3)     completing procedures required to gain control and to investigate the affairs of these companies’ assets and subsidiaries in Hong Kong and the PRC and to ascertain creditors’ entitlement to any realizations from these assets and subsidiaries;

(4)     pursuing legal proceedings in respect of the land in Zhuhai owned by both ZKG and ZKHK and seized by ZMG;

(5)     bringing the financial and other affairs of ZKHK and ZKG and the conduct of ZMG to the attention of relevant authorities in Hong Kong, Macau, Guangdong and Beijing;

(6)     commencing legal proceedings in the PRC, Hong Kong and the British Virgin Islands and obtaining control of and over the identified assets of these companies and their subsidiaries; and

(7)     working with key officers of ZMG with a view to establishing a settlement or restructuring of the affairs of ZKHK and ZKG which may be able to provide a better return to creditors than would be the case if the winding up of the two companies were finalised.

15.  The liquidators have also undertaken work to identify the creditors of the three companies.  The creditors comprise primarily banks and financial institutions.  ZMG had used ZKHK to procure funds from financiers which ZKHK then loaned to ZKG on an unsecured basis for transactions and investments.  The total claims of creditors against ZKHK and ZKG are about HK$8 billion.  ZKHK is owed HK$644 million odd by ZKG, which is 8% of the total debts of ZKG; ZKHK is the second largest creditor of ZKG.  Creditors who are owed HK$3.3 billion are creditors of both ZKHK and ZKG, because of guarantees given by ZKG.

16.  The three companies and subsidiaries conducted business with little distinction between the different legal personalities of each company within the Group.  Much of the work performed by the provisional liquidators and subsequently the liquidators are conducted for the benefit of the creditors of these companies as a collective group, rather than as three separate bodies.

17.  The provisional liquidators and liquidators have attempted to apportion their costs and disbursements between the three companies, as fairly and evenly as possible.  The lawyers engaged by the provisional liquidators and liquidators have done the same exercise.  According to the letter of the liquidators to the committee of inspection dated 5 July 2005, total fees and disbursements including legal fees incurred up to that date were HK$43.4 million odd and were apportioned as follows: HK$25.3 million to ZKG, HK$15 million to ZKHK and HK$3 million to PIV.

18.  Nearly all of the realizations to date have been of the assets of ZKHK and its subsidiaries, totalling HK$83 million.  ZKG and PIV have realizable assets totalling approximately HK$3.23 million and HK$175 million respectively, but these assets are either not readily realizable or are subject to legal proceedings in the PRC, Macau and Hong Kong.  It is unlikely there would be any realizations of PIV’s assets until the Longway Proceedings have concluded.

19.  The liquidators have sought the views of the committee of inspections of ZKHK and ZKG on the present application, and received confirmation from the two members that they have no objection.  The liquidators have also written to all known creditors of the three companies in July 2005 outlining the application, it would appear that no objection has been received from any creditor.  On 15 August 2005, the liquidators held a creditors’ meeting of ZKHK and ZKG and the creditors were informed of the application, no objection was raised by any creditor then or since.

20.  The liquidators say that if the present application is not successful, the creditors of ZKHK would obtain a windfall for the substantial work done on behalf of ZKG and PIV, but for which they have received real and direct benefit and for which they will continue to obtain benefits.  It would also be unfair to the creditors of ZKG, because the nature of the work undertaken to date on behalf of the three companies has laid the foundation for the settlement discussions with ZMG, which if successful, would be of real, direct and immediate benefit to the creditors of ZKHK.

21.  The liquidators have adopted a strategy in relation to the Group as a whole that sought to bring ZMG back to the negotiating table.  They discovered areas in which ZMG was vulnerable to claims by one or more companies in the Group.  These claims against ZMG represent the most significant asset of ZKHK and other companies in the Group.  The best prospect of maximising recovery for the benefit of all creditors of each of the companies in the Group lay in realizing the various claims against and associated with ZMG.  Both ZKHK and ZKG have similar if not identical claims against ZMG.  Thus, expenses were incurred in trying to maximise the value of a group-wide settlement of claims against ZMG, for the benefit of the three companies.  Steps taken in the Longway Proceedings are part of the wider strategy to bring pressure to bear on ZMG.  This litigation also gave the provisional liquidators opportunity to seek discovery from Longway and production orders under section 221 from a number of professional advisers to entities associated with ZMG and from ZKD.  The liquidators have conducted a thorough review of their work done.  Virtually all of the work undertaken is part of the overall settlement strategy.

22.  With the benefit of substantial information, realizations from Hong Kong subsidiaries, and having committed to primarily successful litigation in Hong Kong, the PRC, Macau and the BVI, the liquidators re-commenced settlement negotiations with ZMG in the second half of 2004, which resulted in a memorandum of understanding signed on 25 January 2006.

23.  The liquidators will reimburse ZKHK for any payments made regarding fees, expenses and remuneration earned for the work undertaken by the provisional liquidators in respect of the assets and affairs of ZKG and PIV, upon the completion of the restructuring contemplated under the memorandum of understanding, or the recovery of assets pursuant to the litigation mentioned earlier.

24.  I am reasonably satisfied that the grounds on which directions are sought are made out, namely, that

(1)     a substantial part of the fees and expenses apportioned to ZKG and PIV was properly incurred in preserving, realizing or getting in the assets of ZKHK; and

(2)     such remuneration was referable to work undertaken in relation to the winding up, and for the benefit of, ZKHK.

25.  I now turn to the jurisdiction upon which directions are sought.

26.  It was initially submitted by Mr Carolan for the liquidators that jurisdiction is founded on rule 179 of the Companies (Winding-up) Rules, according to which the assets of the company are first to be applied in “payment of the fees and expenses properly incurred in preserving, realizing or getting in the assets …”.  In his reply submission, Mr Carolan has accepted the Official Receiver’s position that this provision does not, of and in itself, provide jurisdiction for the directions sought.  I think that must be right.  I agree with Mr Bartlett that this provision does not authorise or extend to the ordering of priorities in one liquidation for work conducted in another.

27.  Nor do I think that the other provision mentioned by Mr Carolan, namely section 265(5B) of Cap 32 (which allows for a creditor to be reimbursed in priority over others where he has indemnified the liquidator for the costs of recovering, protecting or preserving assets) is of assistance in conferring jurisdiction on the court.

28.  Here in Hong Kong, we simply do not have legislation in other countries as, for instance, in New Zealand, where a pooling order may be made, so where two or more related companies are in liquidation, the liquidations in respect of each are to proceed as if they were one company, to the extent the court so orders and subject to such terms and conditions as the court may impose.

29.  That leaves only inherent jurisdiction.  I must be satisfied that the inherent jurisdiction sought to be invoked is not inconsistent with or contrary to established principles.

30.  The liquidators meet with a difficulty here.  And that is the principle that each company in a group of companies is a separate legal entity possessed of separate legal rights and liabilities (Gore-Browne on Companies, 45^th ed., para 7[9A], citing Adams v Cape Industries plc [1990] Ch 433 at 532).  The Scottish decision of Taylor (Liquidator of Neil Middleton and Co Ltd), Petitioner (1976) SLT 82 is founded on this fundamental principle of distinct corporate identity.  A liquidator’s office is separate for each company and the funds of a liquidation are the separate funds of each company.  I have considered this decision in the context of an apparently solvent company in Re Boldwin Construction Co Ltd, HCCW No. 340 of 2002, 20 August 2003, at paras 17 to 25 and 28.  The relevant part of the decision in Taylor at 84 of the report reads as follows:

“The general principle which then has to be observed is that a limited company is a distinct legal person.  It may have close relations with other legal persons, but its separate identity remains.  In my opinion, this principle continues to apply in a company’s liquidation, and it implies that the liquidator’s office is held separately from any other such office, that the funds of a liquidation are the separate funds of the separate company in liquidation, and that the liquidator’s intromissions can only be with these separate funds.  In my opinion, it would be inconsistent with principle that there should be intromissions with the funds of one liquidation to provide remuneration for the liquidator acting in another liquidation”.

31.  Taylor has been cited with approval in various textbook authorities, for the proposition that it is not competent to charge the expense of one liquidation against the assets ingathered in another liquidation, even when the first liquidation was undertaken with a view to securing a benefit for the creditors in the second liquidation (Palmer’s Corporate Insolvency, 1996 ed, para 1.318.2; Corporate Insolvency: Law and Practice, by Milman & Durrant, 3^rd ed, para 2-53). See also Loose on Liquidators, 4^th ed, page 189.

32.  The principle established in Taylor seems to me to be a sound one.  Nor am I persuaded by Mr Carolan there is an adequate basis for distinguishing Taylor so that the principle established could be circumvented in some way.  Mr Carolan submitted that what was held to be impermissible in Taylor could be got around if two conditions are satisfied, firstly, there is creditors’ consent and secondly, it is done with the approval of the court.

33.  As to the second condition, I find this to be somewhat circular, as here I am concerned with the question whether the court does have power to give approval.

34.  On the first condition, creditors’ consent, I do not think that is sufficient to displace the principle of separate corporate identity.  The interest of creditors in the assets of a company in winding up is explained in this way by Professor Goode in Principles of Corporate Insolvency Law, 3^rd ed at para 3-08:

“The statutory trust upon which the company in winding up holds the assets and realisations is not of a kind which confers on the creditors beneficial co-ownership or, indeed, a proprietary interest of any kind.  Their rights are limited to invoking the protection of the court to ensure that the liquidator fulfils his statutory duties.  Their position is analogous to that of residuary legatees in an unadministered estate.  They have a right to compel performance of the executor’s duties but no interest in the assets comprising the estate until completion of the administration, during which time beneficial ownership of the assets is in suspense.  The company thus holds the assets for statutory purposes, not for persons.  Even the declaration of a dividend confers no right on the creditors to sue for the dividend; all they can do is to make an application to the court for an order requiring the liquidator to perform his duties.  These principles apply to preferential and ordinary creditors alike.”

35.  I agree with Mr Bartlett that whereas in the situation of a solvent company as in case of Boldwin, some mechanism was found by using shareholder democracy to deal with the fact that there are separate corporate identities involved, it is equally necessary in the situation of a winding up for a mechanism to be devised, whether by way of an appropriate scheme of arrangement (as considered in Taylor, Noter [1992] BCC 440) or by some other means, so as not to offend the principle of separate corporate identity.

36.  As stated in The Law of Receivers and Administrators of Companies, by Lightman and Moss, 2000 ed, para 2-047, the offices of liquidator and provisional liquidator are statutory and their powers derive solely from statute.  The liquidators must act in accordance with the relevant statutory scheme.

37.  I am not satisfied it is within the inherent jurisdiction of the court to make a direction that the liquidators of ZKHK be at liberty to pay out of the assets of ZKHK the fees and expenses incurred for the work undertaken in relation to the assets and affairs of ZKG and PIV, even though the expenditure incurred in the liquidations of the other two companies may properly be regarded as also having been incurred for the purpose of preserving, realizing or getting in the assets of ZKHK.

38.  The lack of jurisdiction is the stumbling block, so I do not get to consider if I ought to exercise my discretion in giving the direction sought.

39.  However, I should mention that I note the Official Receiver’s concern that if a direction of this kind be granted, there may be repercussions in that there may be an impact on the general principles of commerciality in assessing whether the fees and expenses of a liquidator are properly incurred, as this might have to be measured by reference to a group’s assets irrespective of the commerciality as regards the individual company’s position (see the principles in Mirror Group Newspapers plc v Maxwell [1998] BCC 324 and adopted in Re Peregrine Investment Holdings Limited [1998] 2 HKLRD 670).  The court should be vigilant in monitoring the expenditure of trust property in the administration of a company in liquidation, the Official Receiver is also concerned that such applications may be made too readily in future in a situation involving a group of companies where there is an intermingling of assets.

40.  This leaves the alternate direction sought by the liquidators, namely that ZKHK be permitted to fund that part of the cost of work done that should be borne proportionately by ZKG and PIV by making advances to these entities on a “limited recourse loan” basis, on the ground that such work is properly to be regarded as having been undertaken also for the purpose of the winding up of ZKHK.

41.  Mr Carolan submitted that ZKHK clearly has a genuine and substantial interest in the outcome of the actions taken in relation to the assets and affairs of ZKG and PIV.  ZKHK is a net creditor of ZKG and ZKG is, according to the liquidators, the sole creditor of PIV.  Mr Carolan cited Trendtex Trading Corporation v Credit Suisse [1982] AC 679 and Norglen Limited v Reed Rains Prudential Ltd [1996] 1 WLR 864 at 888B to C, in support of the proposition that it is permissible to fund the litigation and take an assignment of rights in an action.  In this instance, much of costs relate to various applications under section 221, where it is not possible to assign one company’s statutory right to another.

42.  I decline to give the direction sought on the available materials for these reasons.  Firstly, relatively little is known about the limited recourse loan.  Secondly, regard must be given to the fact that realisable assets of ZKG are estimated to be about HK$3 million odd, whereas the costs apportioned to it are in the region of HK$25.3 million.  Thirdly, it is not clear whether it is within the power of the liquidators to make such a limited recourse loan without the sanction of the court under sections 199(2)(d), (e) or (h).  Fourthly, it is not apparent the liquidators have secured unanimous creditors’ consent of ZKHK for the limited recourse loan, I do not regard the consent of members of the committee of inspection as sufficient.

43.  The liquidators would have to resort to other measures canvassed in the course of argument to provide for the payment of their fees and disbursements apportioned to ZKG and PIV.

44.  I order the Official Receiver’s costs and the costs of the liquidators in this application to be paid out of the assets of ZKHK.