LAU SIU HUNG AND ANOTHER v. MAN KWAI FONG

HCCW 11/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO. 11 OF 2010

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J U D G M E N T

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1.  This is an application by the Liquidators under s 266 and 266B(1)(b)(ii) of the Companies Ordinance, Cap 32 (“Cap 32”) to invalidate 7 payments totalling HK$700,000 (respectively “the Payments” and “the Sum”) which were made to the respondent (“Ms Man”) by Aloha Coffee Co Ltd (in liquidation) (“the Company”) during a 6-week period from 29 April to 10 June 2009. It is contended that the Payments constituted unfair preferences and the Liquidators seek a repayment of the Sum by Ms Man.

2.  The Company was incorporated in 2001.  As its name suggested, it was in the coffee business.  On 6 January 2010, a former employee of the Company presented a winding-up petition against the Company on the ground that it was insolvent and unable to pay its debts.  It was stated in the petition that the Company was indebted to the petitioner in the sum of HK$28,072.97 together with interest thereon based on an award obtained by the latter against the former at the Labour Tribunal on 9 October 2009.  In addition, it was stated that the Company was also indebted to 7 other ex-employees in the aggregate sum of HK$196,791.80 with interest thereon based on, apparently, another award of the same date.

3.  On default of appearance by the Company, a winding-up order was made on 10 March 2010.  By virtue of s 184(2) of Cap 32, the winding-up of the Company was deemed to be commenced at the time when the winding-up petition was presented, namely, 6 January 2010.

4.  There is no dispute that at all material times Ms Man was a 51% shareholder, one of the two directors of the Company and its secretary.  According to an organisation chart provided by Ms Man, she was responsible for the administration and finance of the Company.

The statutory framework

5.  The law on unfair preference is a little cumbersome in that the relevant statutory provisions are to be found in the Bankruptcy Ordinance, Cap 6 (“Cap 6”).  Those provisions have been adopted in Cap 32 to be applied to companies.

6.  I have been referred to the authority of Re Phantom Records Ltd, unrep, HCMP 2770/03 by Mr Wong who appeared for the Liquidators.  There is a useful summary of the relevant provisions applicable to a case of unfair preference involving an ex-director of the company.  With gratitude, I respectfully adopt the summary in the that judgment of Madam Justice Kwan (as she then was) at p 21S to 24E:

“71.  In section 266B(1) of Cap. 32, it is provided that a reference in section 266 to a fraudulent preference shall be deemed to be a reference to an unfair preference as provided for in section 50 of the Bankruptcy Ordinance, Cap. 6.

72.  The relevant provisions in section 50 of Cap. 6 read as follows:

“(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).

  (5)    A debtor who has given an unfair preference to a person who, at the time the unfair preference was given, was an associate of his (otherwise than by reason only of being his employee) is presumed, unless the contrary is shown, to have been influenced in deciding to give it by such a desire as is mentioned in subsection (4).”

73.  “Relevant time” in section 50(1) is defined in section 51 and the relevant provisions are as follows:

“(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-

…

(b) in the case of an unfair preference which is not a transaction at an undervalue and is given to a person who is an associate of the debtor (otherwise than by reason only of being his employee), at a time in the period of 2 years ending with that day; and

(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) …, 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 …

  (3) For the purposes of subsection (2), a debtor is insolvent if-

(a) he is unable to pay his debts as they fall due; or

(b) the value of his assets is less than the amount of his liabilities, taking into account his contingent and prospective liabilities.”

74.  The reference to “that day” in section 51(1)(b) and (c) is the day of presentation of the bankruptcy petition on which the debtor is adjudged bankrupt.  Under section 266(1) of Cap. 32, the relevant time for a fraudulent preference is within six months before the commencement of the winding up of a company.  Section 266B(1) of Cap. 32 provides that a reference in section 266 to a period of six months shall be deemed to be a reference to a period of (i) six months; or (ii) two years in the case of a person who is an associate as provided for in section 51B, of Cap. 6.

75.  For the meaning of “associate”, one goes to section 51B and the relevant provisions are:

“(1) For the purposes of sections 49 to 51A, any question whether a person is an associate of another person shall be determined in accordance with this section.

…

(4) A person is an associate of a debtor whom he employs or by whom he is employed and for this purpose, any director or other officer of a company shall be treated as employed by that company.

…

(9) In this section, “company” includes any body corporate (whether incorporated in Hong Kong or elsewhere) …””

7.  Having set out the rather complicated statutory framework, it would be helpful to identify in simple terms the elements which will have to be established by the Liquidators in order to succeed in this application, namely:

(a) Ms Man was one of the Company’s creditors at the time when the Payments were made (see s 50(3)(a) of Cap 6) [1];

(b) the Payments had the effect of putting Ms Man into a position which, in the event of the Company’s insolvent liquidation, would be better than the position she would have been in had the Payments not been made (s 50(3)(b));

(c) in deciding to make the Payments, the Company was influence by a desire to put Ms Man into a better position as per (b) above (s 50(4));

(d) on the basis that Ms Man was a director (and thus an associate) of the Company at the time of the Payments, they were made within a period of two years before the commencement of the winding-up of the Company, ie, between 7 January 2008 and 6 January 2010 (s 266B(1)(b)(ii) of Cap 32 and s 51B(4) of Cap 6); and

(e) the Company was insolvent at the time of the Payments (s 51(2)(a)).

The Liquidators’ case

8.  It is contended by the Liquidators that this is a straight forward case.  It is said that the uncontested evidence is sufficient to make good this application and that no viable argument has been advanced by Ms Man to resist the same.

9.  It is right to say that there is no dispute that Ms Man was a creditor of the Company at the time of the Payments.  Although the evidence which was initially filed by the Liquidators might suggest that Ms Man was not a creditor of the Company [2], that matter was subsequently clarified in the 5^th affirmation of Lau Siu Hung at paras 4 to 7.  Given that Ms Man agrees that she was a creditor of the Company, I accept the clarification of the Liquidators.  Hence, the first of the five elements identified above is satisfied.

10.  As regards the second element (see para 7(b) above), I agree with the Liquidators that there is little scope for argument. The Payments clearly had the effect of putting Ms Man in a better position than the one she would have been in had the Payments not been made, in the event of an insolvent liquidation of the Company.  In short, where a company is in insolvent liquidation, its creditors are only entitled to distribution of its assets, if any, in accordance with established priorities.  The Payments had the effect of enabling Ms Man to obtain repayment of some of the debts owed to her by the Company without regard to those priorities.  Therefore, I accept that the second element has also been established.

11.  The third element, in conjunction with the fifth, are contentious and I shall deal with them in more detail later.  It suffices to note at this juncture that for the third element the Liquidators rely primarily upon a statutory presumption under s 50(5) and 51B(4) of Cap 6.  They contend that there is no evidence before this court to rebut the presumption.

12.  There is no dispute over the fourth element.  As stated above, the Payments (7 in total) were made during a 6-week period from 29 April to 10 June 2009 and thus within a period of two years prior to the commencement of the winding-up of the Company.  The Payments ranged from HK$30,000 to HK$200,000.

13.  For the final element, the Liquidators’ case is that in accordance with the Cash Flow Test prescribed under s 50(1)(3)(a) of Cap 6 the Company was insolvent at the time when the Payments were made. Although there appears to be an attempt in the Liquidators’ final affirmation filed on 21 November 2012 to rely upon also the Balance Sheet Test under s 50(1)(3)(b) of Cap 6, I disregard it for reason of fairness.  The said affirmation was filed, in accordance with this court’s directions, to respond to the evidence submitted on the 11^th hour by Ms Man via her affirmation filed on 16 November 2012.  The Balance Sheet Test is a fresh point and goes beyond answering the new evidence.

Ms Man’s case

14.  Ms Man is not legally represented.  In summary, Ms Man’s case is that there were three people behind the Company – herself, the other director (“Leung”) and one Mr Yip (“Yip”).  Some of her shares in the Company were held on behalf of Yip.  Over the years she had made a number of personal loans to the Company to finance its operation.  There is disagreement between the parties as to the total amount of such loans.  Ms Man says that the sum exceeded HK$1.5 million as of 27 April 2009, whereas the Liquidators contend that the debts stood at HK$516,054.09 as of 28 April 2009.

15.  Ms Man says that although the business of the Company was showing promise in 2009 and profits were expected in the second half of that year, due to the disagreement between her and Leung there was an agreement by the shareholders (probably Yip was involved in that decision) to terminate their co-operation over the operation of the Company.  There is a set of minutes of a meeting of the Board of Directors of the Company (“the Board”) on 24 April 2009 (“the Minutes”) which recorded that decision (it will be seen below that the Minutes are not agreed).  In addition, it was recorded that a final account up to 31 March 2009 would be done.  However, the intention at the time was not to wind-up the company.  Instead, it was anticipated that the shares in the Company would change hand.

16.  According to Ms Man, the eventual winding-up of the Company was caused by Leung’s refusal to inject further funds into the Company.  Morever, some of the Company’s debts were collected and kept by Leung; some of the Company’s business was diverted to Leung’s own company; and some of the Company’s properties were taken away by Leung.  It appears that the dispute between Ms Man and Leung became quite bitter and the police was involved.  It is apparent from the material adduced by Ms Man that she disagrees with the proposition that the Company was insolvent at the time of the Payments.

17.  Finally, Ms Man contends that the Payments were sanctioned by the Board as recorded in the Minutes.

18.  It would be appropriate to deal with the fifth element first because the solvency of the Company at the time of the Payments would have impacted upon the intention of the Company, acting by its directors.

19.  To resolve the issue of solvency, I need to turn to the law.

Law – the Cash Flow Test

20.  It appears that there are not many authorities from Hong Kong in which the Cash Flow Test (“the Test”) was discussed.  There is a helpful commentary on the Test in Principles of Corporate Insolvency Law by Goode, 4^th ed, at paras 4-15 to 4-21.  I have also been referred by Mr Wong to The Law of Insolvency by Fletcher, 4^th ed, at paras 20-026 to 20-027.

21.  One must start from the root statutory provision from which the Test is derived – “[a company] is insolvent if [it] is unable to pay [its] debts as they fall due”.  Quite rightly, it was pointed out by Mr Goode that this formulation is deceptive in its simplicity.  There are a number of questions arising from that formulation.  Examples that were given included: what is the meaning of “debts” and to what extent, if at all, should one consider the debts which will become payable in the future?  There is a body of Australian authorities and, to a lesser extent, English authorities which shed light on these issues.

22.  I am quite happy to accept that the essential question is whether the company’s financial position is such that it can continue in business and still pay its way.  It accords with commonsense that one must look, with a commercial approach, at the company’s financial position as a whole.  Implicit in that proposition is that the court should focus on the relevant constituents of the financial picture to determine whether the Test is satisfied.  In this regard, I respectfully agree with what was said by Emmett J in Quick v Stoland Pty Ltd (1998) 29 A.C.S.R. 130 (Federal Court of Australia), which was quoted in Principles of Corporate Insolvency Law, para 4-16:

“In answering these questions, the court looks at the company's financial position taken as a whole. In Quick v Stoland Pty Lt,⁸⁰ Emmett J., discussing the comparable concept of insolvency under s.95A of the Australian Corporations Law (now the Corporations Act 2001 (Cth)), put the matter in the following way:

“In order to determine whether the company was solvent at a given time, it would be relevant to consider the following matters:

– All of the company's debts as at that time in order to determine when those debts were due and payable.

– All of the assets of the company as at that time in order to determine the extent to which those assets were liquid or were realisable within a timeframe that would allow each of the debts to be paid as and when it became payable.

– The company's business as at that time in order to determine its expected net cash flow from the business by deducting from projected future sales the cash expenses which would be necessary to generate those sales.

– Arrangements between the company and prospective lenders, such as its bankers and shareholders, in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a time later than the debts.””

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⁸⁰ (1998) 29 A.C.S.R. 130 at 138 (Federal Court of Australia).

23.  Further, by reason of the use of the phrase “as they fall due” in s 51(3)(a) of Cap 6 and in adopting a commercial approach, the court must take into account an element of futurity in the determination of insolvency.  In other words, not only the company’s existing debts would be considered.  Debts which will fall due in the near future and the likely availability of funds to meet those debts would have to be taken into account as well.

24.  With these principles in mind, I proceed to consider the contentious issues.

Analysis

25.  Before the start of the hearing, I raised with Mr Wong the necessity of cross-examination on the evidence.  I was persuaded that such an exercise was unnecessary.  With respect, Mr Wong is right in his submission that there is ample evidence which is either uncontroversial or incontrovertible showing that the Company was in financial difficulties, particularly with its cash flow, no later than March 2009.

26.  To her credit, Ms Man frankly explained to this court that due to the growth of the Company’s business (average monthly turnover exceeding HK$900,000 in April to June 2009), the delayed receipt of payment from its customer (about 60% of its receivables were due in 30 to 60 days) and the lack of any capital injection since incorporation in 2001 (remaining at all material times at HK$400,000), the Company was in serious liquidity difficulty.  It required up to HK$400,000 per month to maintain its operation.  However, Ms Man said that the Company had substantial receivables to the tune of HK$1.2 million.

27.  Ms Man’s explanation fits with the documentary evidence in terms of the liquidity problem.  Paragraph 1 of the Minutes referred to the Company’s lack of funding and the fact that it was relying over the years upon borrowings from friends, bank and shareholders.  Paragraph 2 referred to the need to raise funds for the operation of the Company.  There is a notice with a copy of a cheque both dated 27 April 2009 which evidenced an injection of HK$120,000 by Ms Man to meet the urgent need of the Company [Hearing Bundles, p 31-2].  Further, there are 14 notices all dated 7 May 2009 which recorded the payment by Ms Man herself of salaries to the Company’s staff totalling HK$144,822.45 [p 290-304 of the bundle of documents (“Bundle M”) which was exhibited to Ms Man’s affirmation filed on 16 November 2012].

28.  Another indication of the financial difficulties which the Company was in can be found in Bundle M, p 3.  Pages 1 to 11 of Bundle M constituted a set of submissions or explanations by Ms Man.  On page 3, in paras iv (ii)(a) and (b), it was stated that Ms Man had to make payments in the sums of HK$70,000 and HK$20,000 on behalf of the Company on respectively 24 May and 21 June 2006.

29.  As pointed out by Mr Wong, after February 2009, the Company’s bank account was regularly overdrawn.  There is no evidence that the Company had any credit facility apart from an overdraft limit of HK$120,000.  I accept Mr Wong’s submission that some of the overdrawing was caused by or partly attributable to some of the Payments [3].

30.  It is plain from the evidence that the Company’s financial problem was not resolved.  Clearly, it did not have an inexhaustible source for borrowing. Eventually, it ceased doing business on 6 July 2009.  However, on 9 June 2009, its bank account was frozen at the instigation of Leung.  Ms Man contends that it was a wrongful act by Leung.

31.  For completeness, I should mention the situation concerning one of the Company’s biggest trade creditors, Tan Heong San Enterprise Ltd (“THS”).  The uncontroverted evidence is that there was a cheque drawn by the Company in favour of THS dated 15 May 2009.  It was not paid because there were insufficient funds.  There can be no suggestion that THS was tolerating the non-payment in light of a notice from THS to the Company dated 3 June 2009 by which the Company was pressed for the settlement of its trade debts [HB/585].

32.  Given the concession of Ms Man that the Company had a serious liquidity problem and the evidence highlighted above, the only issue I need to resolve concerns the Company’s receivables.  Do they change the financial picture?  I think not.

33.  Ms Man contends that the Company had more than HK$1.16 million of receivables as of 30 June 2009.  Out of those receivables, about HK$800,000 were under 30 days credit terms; about HK$328,000 were subject to cash on delivery terms; and the remainder was under 45-60 days credit terms [Bundle M, p 7].  Ms Man says that some of these receivables had been collected and wrongfully kept by Leung.  The Liquidators dispute the viability of these receivables and the allegation against Leung.

34.  First of all, the Liquidators question the COD (cash on delivery) receivables.  By definition, they should have been paid long time ago when the goods were delivered by the Company to its customers.  In any case, efforts were made them to chase up on such receivables and none of the customers agreed that they owed any money to the Company.

35.  As regards the other receivables, two points should be made.  Firstly, it was suggested in a letter from Ms Man to the Liquidators dated 1 June 2012 that 90% of the receivables should have been received by July 2009 [HB/112].  However, efforts by the Liquidators to recover the assets of the Company have so far resulted in the collection of only about HK485,000 [HB/775].  There is no suggestion that the Liquidators could have done better in the exercise.

36.  Secondly, I do not accept Ms Man’s allegation that some of the Company’s receivables had been siphoned off by Leung.  That matter was investigated by the Liquidators and Leung disputed the allegation. More importantly, Leung had produced evidence to the Liquidators to demonstrate that he had in fact assisted in the collection of the Company’s receivables after June 2009 which were then paid into the Company’s account [HB/616-750].

37.  In the premises, I believe that the total amount of collectable receivables of the Company was considerably smaller than the amount claimed by Ms Man.  Further, I cannot see how these receivables changes the picture concerning the dire financial circumstances of Company.

38.  For completeness, a lot of the material produced by Ms Man is irrelevant for the purpose of this application and will not be dealt with in this Judgment.  Most notable is the material concerning her allegations of wrongdoings against Leung.

39.  Last but not least, it must be remembered that the Company was wound-up by an ex-employee for failing to pay a sum of HK$28,072.97 with interest awarded to her by the Labour Tribunal on 9 October 2009 [HB/29].  Commonsense dictates that the inability to pay a relatively small sum speaks volume on the solvency of the Company, notwithstanding the fact that it had ceased trading in July 2009.

40.  At the end of the day, there is no escape from the conclusion that the Company was at the time of the Payments insolvent.

Law – the “requisite mental elements”

41.  I now turn to the third element (see para 7(c) above) and for convenience I shall refer to it as “the requisite mental elements”.  There are only two points raised by Ms Man to try to rebut the statutory presumption, namely, (i) the Payments were authorised by the Board as stated in the Minutes and (ii) she did not at the time foresee the winding-up of the Company.  Before examining those points, I turn again to the law for guidance.  I cite again from Re Phantom Records Ltd, supra, at p 27E-U:

“86.  In relation to (3), two elements are required to be established: a desire to produce the effect of improving the creditor’s position in an insolvent liquidation, and such desire had influenced the decision to enter into the transaction.

  87.  A desire of improving the creditor’s position in an insolvent liquidation is a subjective state of mind.  Desire is different from intention.  Whereas intention is objective in that a person is taken to intend the necessary consequences of his actions, a person is not to be taken as desiring all the necessary consequences of his actions and one can choose the lesser of two evils without desiring either (Re MC Bacon Ltd. [1990] BCLC 324 at 335f to 336a; Re Hau Po Man Stanley, supra. at 233C).  There is often no direct evidence of the requisite desire and the existence of this state of mind may be inferred from all the relevant circumstances, even “contrary to the denials of those whose state of mind is inquired into to determine what state of mind is attributed to the company making the decision” (Re Fairway Magazines Ltd. [1993] BCLC 643 at 649f).

88.  As for influence, this requirement is satisfied if it was one of the factors which operated on the minds of those made the decision.  It need not have been the only factor or even the decisive one.  It is not necessary to prove that if the requisite desire had not been present, the company would not have entered into the transaction (Re MC Bacon Ltd., supra. at 336c to d).”

Analysis

42.  The Minutes in conjunction with copies of “Resolution (1)” signed by Ms Man and Yip suggest that a resolution had been passed approving the repayment of no less than HK$200,000 to Ms Man every month.  The repayment was to be financed from the proceeds of sales generated by the Company’s operation [HB/189-193].  There is controversy surrounding the Board meeting of 24 April 2009.  According to the contemporaneous documents from Leung, he protested against the legitimacy of the meeting and the resolutions purportedly passed thereat.  It was stated that the meeting was called with proper notice and Leung had refused at the time to make any decision given the absence of adequate information [HB/309-312].

43.  The relevant documents tend to support Leung’s complaints because he did not sign his copy of Resolution (1) and, more importantly, Yip was not a director of the Company and not entitled to sign a resolution of the Board.  I therefore have serious doubt as to the validity of Resolution (1).  Bearing in mind also that the prevailing financial circumstances of the Company militated against such a resolution, I am quite prepared to hold, if it is necessary, that Resolution (1) was indeed invalid.

44.  However, I do not see that the point assists Ms Man at all.  I am unable to see how it can be right for a board of director to be able to override the statutory regime on unfair preference.  Quite the contrary, the relevant statutory provisions recognise the control or influence which directors have over a company and any potential unfair preference in their favour would be subject to more stringent scrutiny under the regime.

45.  Finally, I am unimpressed by the suggestion that Ms Man did not foresee the winding-up of the Company.  This was a relatively small company.  She was one of two directors with special responsibility over the finance of the Company.  She was aware of the Company’s financial difficulties and yet in those circumstances she caused the Company to pay her HK$700,000 within a 6-week period.

46.  In these premises, I have no difficulty in holding that Ms Man has not discharged the presumption against her.

Conclusions

47.  Accordingly, I find that all five elements identified above have been established and I grant the relief sought in the Liquidators’ Summons filed on 16 July 2012, save that the repayment by Ms Man should be made within 14 days from today.  I make an order nisi that the costs of this application be to the Liquidators.