XCHRX UDL HOLDINGS LTD. v. NISHIMATSU CONSTRUCTION CO. LTD.

CACV 157/2000 & 164/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 157 OF 2000

(ON APPEAL FROM HCMP 437/1999
ON APPEAL FROM HCMP 418/2000
ON APPEAL FROM HCMP 416/2000
ON APPEAL FROM HCMP 414/2000
ON APPEAL FROM HCMP 422/2000
ON APPEAL FROM HCMP 421/2000
ON APPEAL FROM HCMP 419/2000)

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REASONS FOR DECISION

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Hon Rogers JA :

Introduction

1. These were applications for stays of execution of orders made on 18 April by Mrs Justice Le Pichon on Schemes of Arrangement. In addition, at the hearing of those applications, counsel for Nishimatsu Construction Company Limited made an application in the alternative that payment out of sums under the Schemes of Arrangement should be stayed.

The history of the proceedings

2. The matter arises in this way.

3. UDL Holdings Limited is a Bermuda company which was incorporated on 31 May 1991. The first outward signs of difficulty appear to have been in March 1998 when the United Overseas Bank issued a writ against the company for failure to pay the principal amount of a loan of $50 m. In June of that year, the United Overseas Bank obtained a charging order nisi over shares in nine of the wholly owned subsidiaries of the company. In August 1998, a winding-up petition was presented against UDL Argos Engineering & Heavy Industries Co. Ltd, which was one of the major subsidiaries of the company.

4. Apparently, in order to prevent the United Overseas Bank from gaining a preference over the assets of the company, a petition was presented in October of 1998 by the Hong Kong and Shanghai Banking Corporation Limited and consequent upon that, on 23 November 1998, the court ordered that all further proceedings in the action brought by the United Overseas Bank Limited against the company should be stayed.

5. As long ago as 22 January 1999, the company and UDL Argos filed originating summonses to apply for orders that each of them should convene court meetings to approve Schemes. The petitions against the company and UDL Argos were adjourned to allow for more time for those companies to formulate details of the Schemes. The further adjournments were objected to by various parties including Nishimatsu. The companies judge, however, granted the further adjournments.

6. There were various other winding-up petitions which were in the meantime presented against various of the company's subsidiaries and on 21 January 2000, the originating summonses to convene court meetings to approve Schemes were issued by other subsidiaries of the company.

7. On 3 February, the court made an order sanctioning the meetings. There were a total of 25 petitions to sanction the Schemes of arrangement on behalf of the holding company and 24 of the subsidiaries.

8. Those court meetings were held and the Schemes came before the companies judge on 30 and 31 March. A judgment in the matter was given on 18 April 2000 whereby the Schemes were approved.

9. On 5 May, notices of appeal were filed on behalf of seven ex-employees being preferential creditors in respect of sanctioning the Schemes of Arrangement as it related to seven of the companies.

10. On 12 May, a summons to stay the execution of the order of the companies judge was issued which was to be returnable on 26 June. On the following day, a notice of appeal was filed by Nishimatsu. Their summons for stay was issued on 20 May.

11. On 13 June, the application for stay came before the judge in chambers. That application was refused and the application was renewed before myself sitting as a single judge of the Court of Appeal on 16 June. The half hour, which was allotted to the case, was insufficient and in any event, it appeared that the matter was not ready and the hearing was adjourned until 3 July, although the court offered the parties earlier days. At the request of Nishimatsu and in the absence of opposition by any other party, the hearing was subsequently further adjourned to 10 July. On 10 July, I refused the applications and said that I would hand down my reasons in writing, which I now do.

12. For completeness, I should mention that the appeals are listed for hearing on 7 and 8 November this year. Since the hearing before Mrs Justice Le Pichon on 13 June, efforts were made by the appellants to secure earlier hearing dates for the appeals but it seems that when taking into account available dates for counsel, the court's diary could not accommodate an earlier hearing.

The application for stay

13. The grounds for this stay application are that the appellants are exercising an unrestricted right of appeal and the appeals are bona fide. It is said that unless there is a stay, the appellants' appeal will, if successful, be rendered nugatory. Two cases, in particular, were relied upon. The first, Wilson v. Church (No. 2) [1879] 12 Ch. D 454 and the other was Caine Tai Investment Co. Ltd v. Ayala International Finance Ltd and another [1983] 1 HKC 163. These two cases related to what might be termed "normal litigation". I have been informed by counsel that according to their researches, no cases have been found in relation to stay of execution in relation to Schemes of Arrangement. I will examine later in this judgment whether a Scheme of Arrangement falls within the category of ordinary cases to which a simple application of this rule applies and as to whether Schemes of Arrangement and in particular, these Schemes of Arrangement are in the nature of exceptions to the ordinary rules.

Grounds of appeal

14. The grounds which were argued, on the stay application, both on the part of the preferential creditors and on behalf of Nishimatsu, centred upon whether there should have been separate meetings of preferential, secured and other creditors of the companies and whether the creditors who were subsidiaries of the holding company and were waiving their debts should also have been made the subject of separate creditors meetings. In respect of Nishimatsu, the additional point taken is that they were excluded from the meetings of creditors on the basis that their claim had been valued at $0 and it is said that had they participated and been allowed a proper quota of votes at the creditors meetings, the Schemes of Arrangement would have totally failed.

15. The documents show that in 1998, the UDL Group's total assets were approximately $1,510 billion whereas the total liabilities had increased to $2,294 million. In the Explanatory Statement of the Schemes of Arrangement, there are included appendices which demonstrate that the liquidation value of the various companies within the UDL Group are very much less than the net book values. In respect of only 3 of the 25 companies is it estimated that the assets on liquidation would exceed 5% of the total liabilities of that company. In respect of UDL Contracting Limited, the estimated value on liquidation would be approximately 5.5%. In respect of Faith On International Ltd, the estimated recovery would be 10.3% and in respect of Keen Yield Investment Ltd, the estimated recovery would be approximately 20.5%.

16. The basis of the Schemes were set out on pages 10, 11 and 12 of the judgment below which, for convenience, I repeat here :-

"THE SCHEME

In broad terms, each of the Schemes (which are identical) proposed as follows :

* The unencumbered assets of each of the companies whose creditors vote (by the required majority) in favour of the relevant Scheme of Arrangement and in respect of which the sanction of the court is obtained be pooled to form a fund for the payment of all 'external claims' of those companies other than debts covered by security held by secured creditors.

* 'External claims' are claims of creditors other than the Company and any of the Subsidiaries whose Schemes of Arrangement are sanctioned by the Court. Accordingly, the pool of unencumbered assets will not be applied to satisfy the claims of the Company and any Participating Subsidiary.

* The preferential creditors of those companies be paid the full amount of their preferential claims.

* The balance of the claims of the preferential creditors fall to be treated in line with the general unsecured creditors for any balance of their claims.

* Unsecured creditors of those companies receive dividends comprising a mixture of cash and new shares in the Company.

* Pending completion of realizations and distributions, there be a moratorium on enforcement by creditors of claims against those companies whose Schemes of Arrangement have been sanctioned by the court although pending arbitrations would be permitted to continue for the purpose of quantifying creditors' claims and establishing entitlement to dividends under the Schemes.

* Secured creditors of companies whose Schemes of Arrangement are sanctioned will be required to realize their securities within two years from the date when the relevant Scheme of Arrangement becomes effective and will be entitled to claim any shortfall after realization pari passu with general unsecured creditors (i.e. they will receive dividends in the form of cash and new shares in respect of any shortfall).

* If a secured creditor has not realized his security within the two year period, then his security will be valued and the difference between that valuation and the amount of his claim will be treated as the amount of his shortfall and entitle him to dividends as above. A secured creditor may, however, if he wishes, give notice to the Scheme Administrator that he requires his security to be valued earlier than the expiry of the two year period and in that case the matter will proceed in exactly the same way as if the valuation had taken place after the two years had elapsed.

* These terms will be in full discharge of creditors' claims against those companies whose Schemes of Arrangement are sanctioned by the Court.

If all the Schemes are sanctioned, the estimated recovery for the unsecured creditors is estimated at $0.1141 plus 0.17 new shares per dollar of scheme debt."

17. The estimated recovery under the Schemes might now be somewhat higher because according to the latest information, the tax liability which was taken into consideration earlier may now have been considerably reduced.

Merits of the appeal

18. On an application for stay, insofar as the merits are considered, in my view, the court must be cautious in expressing views so as not to prejudice the appeal.

19. As I have indicated, the first point taken is said to be a point of jurisdiction. It is argued that the court had no jurisdiction to approve the Schemes. It is said that the creditor companies within the UDL Group who had agreed to forgo all their debts amongst themselves should either not have voted at all or should have been the subject of separate creditors meetings. Reliance was placed upon a general proposition derived from Lord Esher MR's judgment in Sovereign Life Assurance Co. v. Dodd [1892] 2 QB 573. It is said, for example, relying on an unreported decision of Mrs. Justice Arden in In re the Hawk Insurance Co. Ltd, 21 December 1999 that these companies should be treated as being in a separate class.

20. The judge below examined the law relating to classes of creditors very carefully. Based on the principle articulated, for example, by Bowen LJ in the Sovereign Life Assurance case and applied in the decision of Nazareth J (as he then was) in In re Industrial Equity (Pacific) Ltd [1991] 2 HKLR 614 which was followed by Jonathan Parker J in In re BTR (plc) [1999] 2 BCLC 675, the judge came to the conclusion that what should be considered was the question of rights: the question of interests could be considered by the court as a matter of discretion on the hearing of the petitions. I see no grounds for disturbing that.

21. The judge saw even less grounds for excluding the non-scheme subsidiaries of the company.

22. The next category of creditors which it is said should have had a separate meeting were the secured creditors. In any re-construction, the cooperation of the secured creditors is naturally essential. In almost any re-construction should the secured creditors not be willing to cooperate, any arrangement would be almost bound to fail. In this case, the secured creditors are given the option of relying on their security or having it valued. In any event, if they do not rely on their security within a period of two years, the security is liable to be valued.

23. In relation to the preferential creditors, it is said that they too should have had separate meetings. True it is that a preferential creditor is, as is obvious, entitled to be paid first to the limit of his preference but, in this case, the preferential creditors' rights of preference are specifically preserved.

24. The question of separate creditors meetings was extensively discussed not only on the hearing of the petition but at the hearings when the court meetings were ordered. Although the question of separate creditors meetings and the failure to hold creditors meetings has been said to be a question of jurisdiction of the court to sanction Schemes of Arrangement under section 166 of the Companies Ordinance and its corresponding sections under the 1929 legislation, whether the creditors fall into separate classes which require separate meetings is a matter of judgment which, in my view, depends upon their rights.

25. In the present case, I am not persuaded that the judge was wrong. In the words of Bowen LJ in Sovereign Life Assurance v. Dodd at page 583 :-

"It seems plain that we must give such a meaning to the term 'class' as will prevent the section being so worked as to result in confiscation and injustice, and that it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest."

26. As at present advised, I do not consider that there has been transgression of this concept.

27. Looking at the Schemes as a whole, it seems to me that the secured creditors, for example, are more likely, if any body, to suffer a confiscation or injustice whereas the general body of creditors stands to gain considerably from the Schemes going ahead. The seven employees who make these applications, apart from the preferential rights of their claims, and Nishimatsu, if and insofar as their claim is established, would fall within the category of general creditors. On what has been argued so far they, at least, have come nowhere near establishing that their rights would be prejudiced by the Schemes going ahead.

The matter of discretion

28. It was said that the subsidiary companies should not have been allowed to vote at the meetings. It was indicated that they were so bound up with the fate of the parent companies that they could not exercise independent judgment. The judge dealt with this at page 34 of her judgment. She said that the directors of the subsidiary companies themselves owed a duty to those companies and she was not prepared to assume that they were acting in breach of fiduciary duties. Although Templeman J in In re Hellenic Trust Ltd [1976] 1 WLR 123 at 126 may have taken a different view in respect of subsidiary companies in the case which he was considering, each case must, in my view, be considered on its own and the question of assumptions and deductions on the facts of a particular case are not questions of law, they are questions of fact.

29. On behalf of Nishimatsu, a point was taken as to whether it should have been permitted to take part in the creditors meetings. This point was considered fully in the judgment and at present, I am not persuaded that the judge was wrong. Nishimatsu's claims against the company amount to more than $343 million in aggregate. They arise out of a contract with the Airport Authority in respect of which subsidiary companies of the holding company were nominated sub-contractors.

30. The position of Nishimatsu was considered in a judgment of 10 May 1999 in respect of an application to adjourn the winding-up petition. That judgment is reported at [1999] 2 HKLRD 817 at 820. It appears that at that stage the matter was being put forward on the basis that a winding-up of Kenworth, one of the two companies directly involved with Nishimatsu, would strengthen the Nishimatsu's position as against the Airport Authority to be able to claim against the Airport Authority directly.

31. Nishimatsu's claim is now the subject of arbitration proceedings and on the evidence, it appears to be fully disputed. As the judge below observed, there is no question of any mala fides in respect of such dispute. Although Mr Griffiths SC, on behalf of Nishimatsu, claimed, contrary to the stand taken in the court below, that Nishimatsu could present a winding-up petition on the basis of being a contingent creditor, in my view, the alleged debt is disputed, the dispute is on substantial grounds and Nishimatsu is not in a position to present a winding-up petition. In my view, again, as things stand at present, there would not appear to be grounds for disturbing the judge's judgment in this respect.

32. On behalf of the preferential creditors, a point was taken that the preferential creditors should have a separate meeting as a matter of discretion because in the normal course of events an ex gratia payment of some $36,000 each under the Protection of Wages on Insolvency Ordinance might be obtained after a winding-up order. It appears that the Commissioner is not prepared to make ex gratia payments to former employees unless there is a winding-up order. As is pointed out in the judgment, section 16(1)(b) of the Ordinance provides that the trigger for the exercise of the discretion is the presentation of the winding-up petition. In my view, if the Commissioner is failing to exercise his discretion correctly, the matter should be taken to the Board. Even if section 20 of that Ordinance prohibits judicial review, the matter can be taken to the ombudsman. As far as the present case is concerned, the statutory rights of preference have been preserved in the Schemes. The question of whether the Schemes should be approved because the former employees could gain ex gratia payment from extrinsic sources is clearly not a matter which should persuade a court to refuse to sanction a scheme approved by the creditors generally. This is all the more so where those responsible for making the ex gratia payments are seemingly exercising their statutory discretion on a wrong basis.

33. Mr Chan, on behalf of the employees, also submitted that the employees could have grouped together to force the Schemes to be drafted so as to give them extra rights and benefits over and above that which they have as preferential creditors. That is not, obviously, a matter of right, it is a matter of interest. It is not something which arises out of their debts being partially preferential. Whilst, it is a matter which the court might take into account in the exercise of its discretion that, it seems to me, has been done. However, I find it difficult to see how there could be justification for permitting a small number of creditors to insist on holding up a scheme unless they receive some advantage over and above that enjoyed by other creditors whose rights in this respect are identical.

The advantage of having a liquidation

34. A point was made that if there were liquidations, the powers of the liquidator to investigate the affairs of the company would be very different from the powers of the Administrator under the Schemes. At one stage, it was suggested that there was evidence to suggest misfeasance or impropriety on the part of the directors. Counsel for Nishimatsu was in the unenviable position of having to withdraw any imputation against the directors when he was unable to point to any evidence to support it. He fell back on a submission that the drop in value of the Group assets coupled with the rise of disabilities in 1998 showed the need for investigation. That would not appear to be so. There has been no attempt to hide the downturn in the Group's financial position and the judge accepted the reasons.

35. The point was made that the Administrator under the Schemes came from the same firm which conducted the audits of the company. Despite that, I see no grounds for suggesting impropriety in this respect or potential misfeasance and it appears to be a new point taken on this application.

36. Looking at the Schemes as a whole, it seems to me that they are undoubtedly in the interest of the creditors. The amount recoverable on a liquidation, according to the documents, would be almost negligible but the amounts which the creditors stand to gain, if the Schemes go ahead, would appear to be many times that amount.

37. I would agree with the judge's summary of the matter when she said, on the application for stay, that the chances of success on the appeal were not high at all.

38. As regards the application for a stay pending the appeal, I am wholly unconvinced that any irreparable damage would be done to any of the parties should the stay not be granted. In respect of the preferential creditors, none of the arguments that were put forward appear to me to have any weight in this regard. As I have indicated, the preferential rights of the preferential creditors have been preserved and there is no question but that they will be paid their preferential rights first. As regards the balance of their claims, they are likely to gain far more as a result of the Schemes than they would if there were a winding-up. If their appeal succeeds, the Schemes will probably fail. If that were to happen, then almost inevitably there would be a collapse of the whole UDL Group with consequential winding-up orders and whatever benefits they may obtain under the Protection of Wages on Insolvency Ordinance will be maintained. As regards Nishimatsu, again, I fail to see how their rights will in any way be prejudiced if the matter is left over to the appeal.

39. It was said that expenses would be incurred by the Scheme Administrator which would be irrecoverable and wasted if the appeal were to succeed and the Schemes collapse. No quantification of this has been made and I am not satisfied that any large amount would be incurred other than would be incurred in the event of liquidations.

40. Mr Griffiths further argued that, in the alternative to there being a stay of execution of the judge's order, the court could order that there be no payment out under the Schemes. It appears to me, however, that Mr Chan, on behalf of the companies, is correct that the party who would be paying out under the Schemes would not be the company but would be the Scheme Administrator. The Scheme Administrator was not before the court, not surprisingly because he had not been served with papers, still less with the application. Nor was it made clear in the application for a stay of execution of the judge's order that there would be any order sought against the Administrator. In any event, it seems to me that it would be a wrong exercise of the court's power in relation to Schemes under section 166 to make an order which would vary the schemes, particularly on an application such as this. The Schemes have been approved by the creditors. The prescribed conditions have been satisfied and the Schemes are now effective. If the court, were subsequent to the creditors' approval, particularly on a stay application, to try to vary the Schemes, that seems to me to be wholly wrong. Likewise, if the court were now to grant some form of injunctive relief against the Administrator of the Schemes, that would be tantamount to varying the Schemes and, in my view, would be wrong. The Schemes have become effective and the matter should be dealt with on the full appeal or not all.

41. I have, in the foregoing part of the judgment, dealt with the matter on the basis of the argument that was put forward that the test which the court should apply is simply to see whether if the appeal is bona fide, the court should act to ensure that the appeal will not be nugatory. I have also done my own researches in the matter and I too, like counsel, have been unable to find a case in which there has been a stay pending appeal of a Scheme of Arrangement.

42. I, for my part, do not regard this as an ordinary case. Particularly in this case and no doubt, in many Schemes of Arrangement, I regard it as a matter falling within the exceptional variety. There are here Schemes involving a group of companies whose assets are still today worth on an on-going basis more than a thousand million dollars. Should the "rescue" not succeed, the companies are likely to be wound up, not only the holding company but probably all the group companies as well.

43. In those circumstances, enormous value will inevitably be lost. This is demonstrated, as I have indicated, in the Explanatory Statement of the Schemes. The court must therefore, it seems to me, bear in mind not only the rights of the appellant and the likely consequences should the appellant succeed on the appeal but also the likely consequences, if a stay is granted. It may well cause an appeal not to happen. It may well cause in effect the collapse of the Schemes with a consequential winding-up. There is not only the interests of the other creditors to be taken into account but there is the wider general public interest in the preservation of the existing value of these companies and the avoidance of a destructive winding-up.

44. Whereas in this case, I do not have to go so far to decide this application, I consider that the court should look beyond the simple rule which prevents, for example, a simple judgment debt being paid to a person or entity of little substance or to an entity outside the jurisdiction without security. The matter has already been considered by the specialist judge who has had conduct of this case for more than one year, who is fully familiar with all the facts and nuances of the case and who has made a detailed, careful and reasoned judgment. To risk upsetting Schemes which have taken months to prepare on the basis of a simple rule of thumb expressed to apply to ordinary cases such as those of simple debts would, in my view, be quite wrong.

45. For these reasons, this application was refused.

46. At the hearing, Mr Chan requested that the opposing preferential creditors' costs of this application should be taxed in accordance with the Legal Aid Regulations. I expressed my doubts as to whether that was appropriate. As I have indicated, the preferential creditors' rights have been preserved. It seems to me that if the appeals were to succeed, the preferential creditors would have lost nothing. I see very little point in this application save that it extended the litigation. To give it the epithet of being tactical would be to put a benevolent gloss on the application. In those circumstances, I had my doubts that the costs of the litigation, over and above that subsidised by the legal aid fund, should be borne out of the amount eventually recovered by the preferential creditors. However, Mr Chan assured me that those instructing him had advised the preferential creditor appellants as to what they stood to gain out of the application and the liability which they were likely to incur should the application fail. In those circumstances, with some misgivings, I am prepared to make an order that there should be a legal aid taxation, despite the fact that I consider that the preferential creditors would have been best advised not to make this application.