RE SHANGHAI HUAXIN GROUP (HONGKONG) LTD (In Liquidation)

HCCW 126/2018, HCCW 239/2019 and HCCW 240/2019
(HEARD TOGETHER)

[2022] HKCFI 1060

HCCW 126/2018

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO 126 OF 2018

____________________

____________________

AND

HCCW 239/2019

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO 239 OF 2019

____________________

____________________

AND

HCCW 240/2019

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO 240 OF 2019

____________________

_____________________

(HEARD TOGETHER)

____________________

D E C I S I O N

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The Applications

1.  On 3 December 2018 I made an order directing how the proceeds of the sale of properties owned by the three associated companies the subject of the three winding up proceedings (Shanghai Huaxin Group (Hongkong) Limited (“SHX”), China Association Limited (“CAL”) and China Huaxin Petroleum Limited (“CHPL”), together, “Companies”) in which the summonses before me have been issued should be dealt with and in particular the discharge of mortgage security held by the Bank of East Asia Limited (“Waterfall Order”).  The liquidators of the Companies (“Liquidators”) now seek the Court’s sanction of the division of the net proceeds of the sale now held in a trust account (“Trust Account”) following the discharge of the security and payment of fees incurred in the liquidations.  In short the Liquidators contend that the remaining proceeds of sale should be distributed to each of the Companies in the following proportions: SHX 0%, CAL 46% and CHPL 54%.  SHX’s committee of inspection has approved the distribution.  CAL and CHPL do not have committees of inspection.

The Issues

2.  To decide this sanction application, I need to address the following two substantive issues:

(1)  Surety’s proprietary subrogation against the principal debtor: Where (i) a surety discharges the principal debtor’s debt, and (ii) the creditor holds security over the principal debtor’s assets, the surety may be subrogated to the creditor’s rights as a secured creditor in order to be indemnified.  Here CAL and CHPL as sureties paid off SHX’s loan (“Loan”) owed to the Bank of East Asia (“BEA”).  The Loan was secured by mortgages over seven properties owned by the Companies (“Properties”).  Are CAL and CHPL entitled to be subrogated to BEA’s mortgage over SHX’s property?

(2)  Surety’s proprietary subrogation against a co-surety: Where (i) a surety discharges the principal debtor’s debt, (ii) the creditor holds security over a co-surety’s assets, and (iii) in discharging the principal debtor’s debt, the surety pays more than his fair share vis-à-vis the co-surety, the surety may be subrogated to the creditor’s rights as a secured creditor in respect of the co-surety’s assets in order to achieve an equal distribution of burden between the co-sureties.  Here, when paying off the Loan, CHPL paid more than CAL.  Is CHPL entitled to be subrogated to BEA’s mortgage over CAL’s properties?

Background

3.  The pertinent facts are as follows:

(1)  CAL and CHPL are the wholly-owned subsidiaries of SHX.

(2)  Under a facility agreement dated 21 January 2016, SHX obtained the Loan from BEA, and the outstanding amount was HK$530,562,673.

(3)  The Loan was secured by mortgages over the Properties, namely:

(i)  one property owned by SHX (known as the “6^th Sale Property” in the Waterfall Order);

(ii)  one property owned by CHPL (known as the “4^th Sale Property” in the Waterfall Order);

(iii)  five properties owned by CAL (known as the “5^th Sale Property”, “7^th Sale Property”, “8^th Sale Property”, “9^th Sale Property”, and “10^th Sale Property” in the Waterfall Order).

(4)  In accordance with the Waterfall Order:

   (i)  the Loan was discharged using the proceeds of sale of CHPL’s property (namely, the 4^th Sale Property), and two properties owned by CAL (namely, the 5^th Sale Property and 10^th Sale Property);

   (ii)  the remaining proceeds of sale of the Properties have been paid into the Trust Account;

   (iii)  the costs of sale in respect of the Properties have been paid using funds in the Trust Account (“Sale Costs”);

   (iv)  as a result, as at 14 February 2022, the balance of the Trust Account was HK$71,150,279.43 but continuing to accrue interest.

(5)  In paying off the Loan (HK$530,562,673), CHPL paid more than CAL:

   (i)  out of the proceeds of sale of the 4^th Sale Property owned by CHPL, HK$295,365,604 was paid to BEA;

   (ii)  out of the proceeds of sale of the 5^th Sale Property and 10^th Sale Property owned by CAL, HK$235,197,069 was paid to BEA.

4.  Having reached a consensus as to the distribution of the balance in the Trust Account, the Liquidators seek the Court’s sanction of the proposed distribution as follows:

(1)  The responsibility for the Sale Costs should be in proportion to the treatment of the proceeds of sale:

(i)  To the extent the proceeds were used to pay off the Loan, SHX would bear the relevant portion of the Sale Costs.

(ii)  The remaining Sale Costs would be borne pro rata by each of the Companies in proportion to their respective equity value in the Properties.

(2)  As SHX is the principal debtor under the Loan, and CAL and CHPL are co-sureties:

    (i)  SHX would indemnify CAL and CHPL;

    (ii)  CHPL would seek contribution from CAL so that their respective burden for the Loan would be equalised.

(3)  Applying the above rationale to the balance in the Trust Account, the Companies’ respective entitlement would be thus:

    (i)  SHX: 0%;

    (ii)  CAL: 46%;

    (iii)  CHPL: 54%.

5.  As I have mentioned earlier the committee of inspection of SHX have approved the proposed distribution.  Both CAL and CHPL have no committee of inspection.

Legal Principles

6.  Section 199(2) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“Ordinance”) provides:

“A liquidator may exercise any of the powers specified in Part 1 or 2 of Schedule 25 only with the sanction of the court or the committee of inspection.”

7.  Paragraph 2 of Schedule 25 of Part 1 of the Ordinance refers to this power:

“Make a compromise or arrangement with—

(a) creditors or persons claiming to be creditors; or

(b) persons having or alleging themselves to have any claim (present or future, certain or contingent, ascertained or sounding only in damages) against the company, or for which the company may be rendered liable.”

8.  In determining whether to grant the sanction sought, the Court applies the following well established principles:

(1)  The Court must consider whether the proposed settlement is in the commercial best interests of the company, reflected prima facie by the commercial judgment of the liquidator.

(2)  In deciding whether or not to sanction a proposed compromise, the Court gives weight to the interests of those who have a real interest in the assets of the company in liquidation.

(3)  The Court should ordinarily respect the commercial judgment of the liquidator and grant sanction, unless the course of action proposed by the liquidator is regarded by the Court as so unreasonable or untenable that no reasonable liquidator would take it.

See Re Shun Kai Finance Co Ltd[1]; and Re Pacific Harbor Asia Fund I Ltd[2].

9.  Under section 15 of the Law Amendment and Reform (Consolidation) Ordinance (Cap. 23) (“LARCO”), a surety who pays a debt is entitled to have assigned to him any judgment or security held by the creditor, and to the creditor’s remedies and upon a proper indemnity to use the creditor’s name in any action or other proceedings in order to obtain an indemnity from the principal debtor.  In other words, “payment by a surety of a debt would procure for him the benefit of the securities held for the debt together with their priority”[3].  “[E]ven if the securities were given after the contract of guarantee was made, and even if they are deemed to be satisfied by the payment of the debt …, the surety is entitled to the benefit of them”[4].

10.  The relevant common law principles are explained in the following two decisions:

(1)  Liberty Mutual Insurance Company (UK) Ltd v HSBC Bank plc[5]:

“[Subrogation] is a remedy, rather than a cause of action, founded in equity and natural justice not in contract, designed to prevent unjust enrichment…

A surety who pays off the debt owed by the principal debtor is subrogated to any securities given by the debtor as security for the debt…

[A] surety will be entitled to every remedy, which the creditor has against the principal debtor; to enforce every security and all means of payment; to stand in the place of the creditor; not even through the medium of contract, but even by means of securities, entered into without the knowledge of the surety; having a right to have those securities transferred to him; though there was no stipulation for that; and to avail himself of all those securities against the debtor.  This right of the surety also stands, not upon contract, but upon a principle of natural justice …”

(2)  Bank of China (Hong Kong) Ltd v Yip Fung[6]:

“[T]he equity of the surety, subject to the paramount right of the creditor to be paid, is to have the creditor’s powers applied to produce an equitable result as between all persons liable. The aim is to ensure that the person primarily liable should bear the whole burden in relief of others, or if there is a deficiency that it should fall equally upon those with secondary liability. These rights of a surety do not depend upon any contract involving the principal debtor or the sureties. Such rights depend upon equitable principles of readjusting the unequal placing of burdens upon persons or properties all equally liable at all.

The surety who has discharged the principal debtor’s obligation can be indemnified to the extent of any amount he has paid in reduction of the guaranteed debt.”

11.  In Menelaou v Bank of Cyprus UK Ltd[7], Lord Carnwath referred to the following as “[a] simple modern statement of the principle of subrogation”:

“What is the basis of the doctrine of subrogation? It is simply that, where A’s money is used to pay off the claim of B, who is a secured creditor, A is entitled to be regarded in equity as having had an assignment to him of B’s rights as a secured creditor”. [8]

I agree with the Liquidators that under section 15 of LARCO, a surety has a right of subrogation against a co-surety to equalise their respective burden.  The reasons are explained by Robb J in Barber v De Prima[9] which concerns s3 of the Law Reform (Miscellaneous Provisions) Act 1965 (NSW), being in pari materia with section 15 of LARCO:

“Section 3 of the Act provides:

(1) A person who, being surety for the debt or duty of another, or being liable with another for a debt or duty, pays that debt, or performs that duty, is entitled:

(a) to have assigned to that person, or to a trustee for that person, every judgment, specialty or other security held by the creditor in respect of that debt or duty, whether or not that judgment, specialty or other security is taken at law to have been satisfied by the payment of the debt or the performance of the duty, and

(b) to stand in the place of the creditor and to use all the remedies, and, if necessary, and on a proper indemnity, to use the name of the creditor in any proceedings to obtain from the principal debtor or any co-surety, co-contractor or co-debtor (as the case requires) indemnity for the advances made and loss sustained by the person who paid the debt or performed the duty.

(2) The payment of the debt or the performance of the duty by a surety is not a defence to any such proceedings referred to in subsection (1).

(3) A co-surety, co-contractor or co-debtor is not entitled under this section to recover from another co-surety, co-contractor or co-debtor more than the proportion to which, as between those parties themselves, that person is justly liable…

On the proper interpretation of the wording of s 3 of the Act, the right of a surety (or other person described in the section) to stand in the place of the creditor in sub-s (1)(b) should not be treated only as an adjunct of the right to enforce judgements, specialties or other securities that are assigned by the creditor to the surety in accordance with the entitlement created by sub-s (1)(a). The use of the word ‘and’ between the two paragraphs of sub-s (1) should be treated as giving the surety an additional right, and not merely a subsidiary right to the right of assignment. If the creditor assigns to a surety a judgment, specialty or other security in accordance with sub-s (1)(a), the fact that the surety is an assignee (after that assignment has been perfected in accordance with any applicable legal provisions) should be sufficient to enable the surety to enforce the judgment, specialty or other security, without the need for a provision such as the one in sub-s (1)(b). That provision would be superfluous if it does not have an independent operation.

Further, the two paragraphs operate in somewhat different circumstances.  The first gives the surety a right to the assignment, and after the assignment the surety can enforce the judgment, specialty or other security independently by exercising all of the rights that were available to the creditor.  The second gives of the surety the right to stand in the place of the creditor to use all the remedies of the creditor in any proceedings.  That will be a course that may provide satisfaction to the surety where the creditor’s rights against the principal debtor or co-sureties are of a nature where they must be enforced by curial proceedings, or by order of some other tribunal.”

12.  Barber v De Prima is, therefore, authority for the proposition that section 15(2) of LARCO “entitles the surety to stand in the shoes of the creditor to enforce the creditor’s securities against co-sureties in curial proceedings”[10].

13.  Robb J goes onto explain in [48], [124] and [136] that the rights of subrogation and contribution co-exist so as to ensure an equal distribution of liability between co-sureties:

“48. The right of one surety, who is a party to a deed with a principal debtor and other sureties, to be indemnified by the principal debtor, or to receive contribution from the co-sureties upon payment of more than the first surety’s share of the debt, arises out of the fact that the surety has paid the debt (in relation to the indemnity owed by the principal debtor), or that the surety has paid more than the surety’s share of the debt (in the case of co-sureties), and is a creation of equity, and not the terms of the deed. Even where there is a common law remedy, … the right to contribution arises in order to provide restitution or to avoid unjust enrichment, when the surety pays more than the surety’s share of the debt, and in no way involves the enforcement of the deed…

124. [T]he authorities that have examined the principles governing subrogation in equity … clearly establish that the remedies of subrogation and contribution coexist, so that if for any reason a surety is unable to achieve an equal distribution of the burden between co-sureties after paying the creditor by means of the personal action for contribution, the surety is permitted to stand in the shoes of the creditor to enforce the creditor’s securities and other rights against those co-sureties…

136. [A] surety who has paid the creditor is entitled to subrogation to the creditor’s securities and other remedies against co-sureties who have not paid.”

Application of the Principles to the present case

14.  The proposed distribution of the funds in the Trust Account is consistent in my view with the above principles of subrogation for the following reasons:

(1)  First, because SHX has to indemnify both CAL and CHPL, they together have proprietary subrogation claims (amounting to HK$530,562,673) against the proceeds of sale of the 6^th Sale Property (amounting to HK$15,761,844 before deducting the Sale Costs).  Therefore, SHX’s interest in the proceeds of sale of the 6^th Sale Property would be wiped out, with CAL and CHPL sharing the proceeds on a pro rata basis.

(2)  Second, when discharging the loan, CHPL paid HK$295,365,604 and CAL paid HK$235,197,069.  As co-sureties, CHPL and CAL’s burden should be equalised.  Therefore, CHPL has a proprietary subrogation claim against the proceeds of sale of the 5^th Sale Property, 7^th Sale Property, 8^th Sale Property, 9^th Sale Property, and 10^th Sale Property, in order to equalise the burden between it and CAL as co-sureties.

(3)  Third, the apportionment of the Sale Costs is consistent with the principles that (a) SHX should indemnify both CAL and CHPL in respect of the discharge of the Loan, and (b) CHPL and CAL’s respective burden should be equalised.

(4)  The application of the above principles requires to the funds in the Trust Account to be distributed only to CHPL (54%) and CAL (46%).

15.  As the proposed distribution is consistent with the statutory and equitable principles of subrogation, sanctioning the proposed distribution of the funds in the Trust Account would in my opinion be a proper exercise of the Court’s discretion under section 199(2) of Ordinance.  CHPL and CAL mortgaged their properties to secure SHX’s Loan which is also secured over SHX’s property.  CHPL and CAL then used the proceeds of sale of their own properties to discharge SHX’s Loan.  In the process, CHPL paid more than CAL. Consequently, the principles of proprietary subrogation require that, out of the proceeds of sale of the Properties, SHX should indemnity CHPL and CAL and CAL should make a contribution to CHPL to equalise the burden between themselves as co-sureties.  The proposed distribution from the Trust Account would settle the entitlement of each of the Companies, consistent with both statute and the common law.

Order and Costs

16.  I will make an order in the terms of the summonses including as to costs.  As the legal costs are payable out of a specific trust fund (ie the Trust Account) subject to proprietary claims, the Court may properly order that the Liquidators’ costs be taxed on a trustee basis[11].