RE KCL CAPITAL LTD

HCCW 224/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO 224 OF 2010

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D E C I S I O N

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1.  I have before me an application by the Liquidator of KCL Capital Limited (“Company”) for an order that:

“1. Payment of the Liquidator’s costs and disbursements incurred between the period from 10 June 2010 to 26 September 2012 in relation to:

(a) work carried out in realizing and preserving assets of the Company which are allegedly subject to a floating charge;

(b) work carried out in dealing with competing secured and proprietary claims asserted against the assets of the Company; and

(c) other work carried out in his capacity as Liquidator of the Company.

be paid out of the assets of the Company; and. . . ”

2.  The summons is opposed by Yen Ning Ling (“Madam Yen”), who is the holder of fixed and floating charges over the Company’s assets and mortgages by way of legal charge over landed property registered in the name of the Company.  In addition, it is opposed in certain respects by the Liquidators of Descartes Investment Management Limited (“DIM”) and Descartes Finance Limited (“DFL”), both of which are in compulsory liquidation.  DIM and DFL assert an equitable interest in the assets covered by Madam Yen’s security and say that it arose prior to security being granted and takes priority to it.

3.  The background to the application is fairly complex.  The background is conveniently summarised in the submissions filed by Mr Russell Coleman SC and Douglas Lam on behalf of Madam Yen and as I do not understand the summary to be disputed I adopt it:

“4. Thebackgroundmaybesummarisedbrieflyasfollows:

(1) The Company isincorporatedin theBVI,and itssole shareholder was Mr Edgar Chuan ("Mr Chuan") who, together with Ms Yeh Fang Ching ("Ms Yeh"), were its sole directors.

(2) Mr Chuan was an asset manager registered with the SFC, and carried on investment management business through the Descartes group of companies, which included inter alia Descartes Investment Management Limited ("DIM") and Descartes Finance Limited ("DFL"). Ms Yeh was the financial controller of DIM.

(3) Madam Yen became acquainted with Mr Chuan through mutual friends when she visited Hong Kong from time to time in 2006. Eventually, she was persuaded to invest US$3 million dollars into what was referred to as the "Athena Fund" managed by DIM in two tranches remitted into DFL's account in December 2006 and September 2007.

(4) She also opened a securities account with DIM for subscription and trading in shares of China Railway Construction Corporation (CRCC) on the Hong Kong Stock Exchange (Stock Code 1186), and on 7 March 2008, she remitted some HK$43.5 million into DIM's account (approximately US$5.6 million) for that purpose.

(5) Subscription and trades in CRCC shares were purportedly carried out between March and June 2008 by DIM, and all of the shares were eventually sold with proceeds of some HK$44 million standing to Madam Yen's credit in the securities account.

(6) From February 2008 onwards, Madam Yen made repeated requests to DIM for the redemption of her units in the Athena Fund.

(7) On June 2008, a meeting was held between Madam Yen, Mr Chuan and Ms Yeh to discuss the redemption of the Athena Fund and the outstanding balance in the DIM securities account, both of which totalled, according to Mr Chuan, US$9,922,062.21 (approximately, HK$77.4 million) (the "Indebtedness"). At the meeting, Madam Yen demanded immediate repayment of the Indebtedness, failing which she would commence legal proceedings.

(8) Mr Chuan, however, indicated that Descartes was not in a position to make the repayment of the Indebtedness, and implored her not to commence legal proceedings for the time being. In return, he agreed to and did execute a Chinese agreement ("Chinese Security Agreement") (English translation), whereby he agreed inter alia to:

(a) Execute a personal guarantee for the Indebtedness (the "Guarantee");

(b) Executeasecondmortgage(the"Second Mortgage") of5 landedpropertiesinHong Kongownedbyhim throughtheCompany(the "LandedProperties");

(c) Apersonalundertakingtodelivervacantpossessionof the Landed Properties (the"Undertaking"); and

(d) ADebenture providing forachargeoverallofthe fixed andfloatingassetsoftheCompanyas securityto Madam Yen(the"Debenture").

(9) Pursuant to the Chinese Security Agreement, Mr Chuan duly executed each of the above‑mentioned documents.

(10) Although some repayment was subsequently made by Descartes and/or Mr Chuan in repayment of the outstanding balance in the DIM securities account, by November 2008, some HK$18.4 million remained outstanding in the DIM securities account alone. When DIM failed to respond to Madam Yen's continued demands, on 9 January 2009, Madam Yen commenced HCA 136/2009 against DIM and obtained a Mareva injunction for the outstanding balance in the DIM securities account.

(11) The Mareva injunction was hotly contested by DIM, with Mr Chuan and Ms Yeh both filing detailed Affidavit evidence. One of the principal grounds advanced by DIM was that the injunction should not be continued since Madam Yen was adequately protected by the security which had already been provided under inter alia the Second Mortgage and the Debenture (together, the "Security Documents").

(12) As can be seen from the Burrell J Judgment, the court disagreed on the basis that property prices in Hong Kong was falling, and DBS Bank had first charges over the Landed Properties. On 6 March 2009, the court ordered that the Mareva injunction be continued until trial or further order. It is important to note that all parties as well as the court proceeded on the basis that the Security Documents provided a valid and enforceable (albeit insufficient) security in respect of the Indebtedness.

(13) Shortly before April 2009, Madam Yen's solicitors, Messrs T C Foo & Co ("TCF") discovered evidence of fraud on the part of inter alia Mr Chuan and DIM in respect of the Athena Fund, and on 1 April 2009, Madam Yen commenced HCA 1001/2009 and obtained a Mareva injunction against inter alia DIM, DFL and Mr Chuan for the sum of US$3,000,000, being the amount invested by Madam Yen in the Athena Fund.

(14) On 24 April 2009, Madam Yen obtained default judgment against Mr Chuan and Ms Yeh in HCA 1001/2009 for the sum of US$3 million.

(15) On 27 April 2009, upon the SFC's application pursuant to section 213 of the Securities and Futures Ordinance (Cap 571) in HCMP 769/2009, the court froze the assets of inter alia DIM, DFL and the Company, and appointed administrators in respect of DIM and DFL.

(16) DIM and DFL were subsequently wound up by the court on 25 May 2009 and 23 December 2009 respectively.

(17) In the latter half of 2009, DBS Bank (Singapore branch) enforced its first legal charge over the Landed Properties, sold them and used the sale proceeds to discharge KCL's indebtedness to the bank. The net surplus of the proceeds amounted to HK$41,149,148.09.

(18) However, due to claims made by the Liquidators of DIM and DFL to the net surplus, rather than paying the surplus to Madam Yen as the second mortgagee, DBS Bank commenced HCMP 7/2010 and obtained an ex parte order allowing it to pay the surplus into court on 6 January 2010.

(19) On 20 May 2010, the SFC presented a winding up Petition against the Company and on 10 June 2010, Mr Arboit was appointed Provisional Liquidator of the Company. On 11 August 2010, the Company was ordered to be wound up by the court and Mr Arboit became the Liquidator.

(20) On 14 April 2011, the Liquidator proposed to consider Madam Yen's claims as a secured creditor under inter alia the Security Documents. To save time and costs, Madam Yen agreed to the proposal on 29 April 2011, but expressly without prejudice to her right to enforce her security in court.

(21) By a letter dated 31 May 2011, the Liquidator informed Madam Yen by way of a purported assessment and "Notice of Adjudication of Proof of Debt" that the Liquidator did not accept the enforceability of inter alia the Security Documents. On 26 August 2011, Madam Yen commenced HCA 1449/2011 against the Company to enforce her security.

(22) On 18 November 2011, upon the application of DIM and DFL, the court gave leave to DIM and DFL to be joined in HCA 1449/2011 as 2^nd and 3^rd defendants respectively for the purpose of challenging the Madam Yen's security claim and to adjudicate their claim of an equitable interest in the Landed Properties.

(23) On 21 February 2012, DIM and DFL filed their defence and counterclaim in HCA 1449/2011 and the action is presently in the stage of discovery.

5. In the course of the winding up, the Liquidator has up to 26 September 2012 incurred (according to him) costs and disbursements totalling HK$5,647,828.22, as follows:

(1) Time costs of himself and his staff of HK$2,147,488.90;

(2) Disbursements ofHK$518,953.54; and

(3) Legal costs incurred by Deacons of HK$2,981,385.78.”

4.  The reason the application is contested is that there are currently no free assets of the Company to meet the Liquidator’s costs and expenses and the Liquidators seek an order that the costs are paid out of the assets covered by the security.  The position of Madam Yen and DIM and DFL is as follows.  Madam Yen argues that if her security is valid the Liquidators cannot have recourse to the assets covered by it to pay any costs they now seek payment of other, perhaps, than a small proportion that I address later, and that this application cannot, therefore, be determined until the validity of her security is determined.  I understand that DIM and DFL are neutral in this regard, but contend that if the court were to decide that payment of the costs claimed should at this stage be paid out of the assets covered by the security the Liquidator is not entitled to all the costs and expenses claimed.

5.  The Liquidator accepts that I cannot determine on this application whether or not the second mortgage and the debenture created, as is asserted in the High Court Action, a valid second legal charges over the landed property and valid legal first fixed or floating charge over the assets of the Company specified in the debenture.  What Mr Hudson, on behalf of the Liquidator, argued is that the court can, however, take a view on whether or not the Liquidator has undertaken the work for which he claims payment in dealing with the alleged security and DIM and DFL’s claims and that if it does that such fees and associated expenses, including Deacons own fees, are payable on the principles explained in In re Berkeley Applegate (Investment Consultants) Ltd [1989] 1 Ch 32 and which has been applied in Hong Kong: see my judgment in Re MF Global HK Ltd (No 2) [2012] 3 HKLRD 56 at para 5 and the authorities referred to in that paragraph.  I disagree.

6.  The principles explained and applied in Berkeley Applegate and subsequent similar cases concern the recovery by Liquidators of their fees and expenses out of assets held by a company over which equitable interests are asserted by others.  Whilst that may be the position in respect of DIM and DFL’s claims, it is not the position in respect of Madam Yen.  Madam Yen asserts that the second legal charge and debenture created valid legal charges.  It seems to me that she clearly has an arguable case that they are valid and enforceable against the Company.  The House of Lord’s decision in Buchler and Another v Talbot and Others [2004] 2 AC 298 establishes that recourse cannot be had to assets charged to creditors as security for payment of the expenses of a liquidation with one very limited exception.  This principle, and the reasons for it, are explained in the judgments of Lord Hoffman and Lord Millett.  Rather than summarise the relevant parts of the judgment it is convenient to quote from them:

Lord Hoffman at paragraphs 28 to 31:

“28. The winding up of a company is a form of collective execution by all its creditors against all its available assets. The resolution or order for winding up divests the company of the beneficial interest in its assets. They become a fund which the company thereafter holds in trust to discharge its liabilities: Ayerst v C & K (Construction) Ltd [1976] AC 167. It is a special kind of trust because neither the creditors nor anyone else have a proprietary beneficial interest in the fund. The creditors have only a right to have the assets administered by the Liquidator in accordance with the provisions of the Insolvency Act 1986: see In re Calgary and Edmonton Land Co Ltd [1975] 1 WLR 355, 359. But the trust applies only to the company’s property. It does not affect he proprietary interests of others.

29. When a floating charge crystallises, it becomes a fixed charge attaching to all the assets of the company which fall within its terms. Thereafter the assets subject to the floating charge form a separate fund in which the debenture holder has a proprietary interest. For the purposes of paying off the secured debt, it is his fund. The company has only an equity of redemption; the right to retransfer of the assets when the debt secured by the floating charge has been paid off. It is this equity of redemption which forms part of the fund held on trust for the company’s creditors which arises upon a winding up.

30. Putting aside any fixed charges, the position is therefore that if a company is in both administrative receivership and liquidation, its former assets are comprised in two quite separate funds. Those which were subject to the floating charge (“the debenture holder’s fund”) belong beneficially to the debenture holder. The company has only an equity of redemption. Those which were not subject to the floating charge (“the company’s fund”) are held in trust for unsecured creditors. In the usual case in which the whole of the company’s assets and undertaking are subject to the floating charge, the company’s fund will consist only of the equity of redemption in the debenture holder’s fund.

31. In principle, each fund bears its own costs.  The expenses of the administrative receivership are borne by the debenture holder’s fund.  The expenses of winding up are borne by the company’s fund.  The debenture holder has no interest in the winding up and the unsecured creditors have no interest in the administrative receivership.  So there is no reason why either group should contribute to the expenses of the other.  Occasionally (for example, if no receiver has been appointed) a Liquidator will realise an asset forming part of the debenture holder’s fund.  As the debenture holder is entitled to the proceeds, it is right that he should pay the cost of realisation: see In re Regent’s Canal Ironworks Co; Ex p Grissell (1875) 3 Ch D 411.  But the debenture holder has no liability for the general costs of the winding up.”

Lord Millett at paragraphs 51, 54, 57‑58, 62‑63:

“51. Bankruptcy and companies liquidation are concerned with the realisation and distribution of the insolvent's free assets among the unsecured creditors. They are not concerned with assets which have been charged to creditors as security, whether by way of fixed or floating charge. Secured creditors can resort to their security for the discharge of their debts outside the bankruptcy or winding up. Assets subject to a charge belong to the charge holder to the extent of the amounts secured by them; only the equity of redemption remains the property of the chargor and falls within the scope of the chargor's bankruptcy or winding up. As James LJ observed in In re Regent's Canal Ironworks Co (1877) 3 Ch D 411, 427 charge holders are creditors ‘to whom the [charged] property [belongs]. . . with a specific right to the property for the purpose of paying their debts’. Such a creditor is a person who ‘is to be considered as entirely outside the company, who is merely seeking to enforce a claim, not against the company, but to his own property’ per James LJ in In re David Lloyd & Co (1877) 6 Ch D 339 at 344.

. . .

54. It would clearly have been inappropriate to allow unsecured but preferential debts to be paid out of assets charged by way of fixed charge in priority to the claims of the holder of the charge. This would have been an unwarranted interference with the property rights of the charge holder. By making it very difficult for businesses to raise money on the security of their assets it would also have been contrary to the interests of both lenders and borrowers. But the development of the floating charge, which enabled a company to grant a charge over the whole or substantially the whole of its undertaking, and which was still of recent origin in 1883, changed the picture. The existence of a floating charge deprived the preferential creditors of much of the benefit which the 1883 and 1888 Acts were intended to give them. It enabled the charge holder to withdraw all or most of the assets of an insolvent company from the scope of the winding up and leave the Liquidator with little more than an empty shell and nothing with which to pay preferential debts. Accordingly the Preferential Payments in Bankruptcy Amendment Act 1897 made the preferential debts payable if and so far as necessary out of the proceeds of a floating charge in priority to the debt secured by the charge.

. . .

57. It is necessary to appreciate what section 2 of the 1897 Act and its successors did and, even more importantly, what they did not do. They applied in the winding up of a company where the assets available for payment of general creditors were insufficient to meet the preferential debts in full. So the assets available for payment of general creditors in a winding up remained the primary source of payment of the preferential debts. Such assets do not include charged assets, which are not available for payment of the general body of creditors until the claims of the charge holder have been satisfied. They are what remains of the company's free assets after the expenses of the winding up have been paid or provided for. The greater such expenses the less that is left for the general creditors and consequently the less that is available for the preferential creditors. So far as there were insufficient assets after the expenses of the winding up had been paid or provided for to enable the preferential debts to be paid in full, section 2 of the 1897 Act and its successors made them payable out of the assets subject to the floating charge.

58. But section 2 and its successors did not authorise any of the costs and expenses of the winding up to be paid out of the assets subject to the floating charge, nor was there any reason for them to do so. Of course, if there were insufficient free assets to meet the expenses of the winding up in full, there would be nothing left to meet the preferential debts, and the whole of those debts would fall to be paid out of the assets comprised in the floating charge. There would also be nothing with which to pay the balance of the expenses of the winding up. Like the debts due to the ordinary unsecured creditors these would remain unpaid. But so they would before 1897: James LJ had already drawn attention to the fact that those who render services to an insolvent company or person frequently find that they have to go without payment, a result which did not strike him as unjust: see the Regent's Canal case 3 Ch D 411, 426. If this was a hardship, it was not one which the 1897 Act was intended to remedy. Its purpose was to provide a secondary fund for the payment of the preferential debts, not to relieve Liquidators by making new provision for the payment of the costs of a winding up at the expense of the holder of a floating charge.

. . .

62. In considering the incidence of the costs and expenses of the winding up it must be borne in mind that there are two distinct funds: (i) the proceeds of the free assets which belong to the company and are administered by the Liquidator in a winding up and (ii) the proceeds of the assets comprised in a floating charge which belong to the charge holder to the extent of the security and are administered by the receiver. In principle, and save to the extent, if any, that statute may make provision to the contrary, the costs of administering each fund are borne by the fund in question. In principle, therefore, the expenses of a winding up are borne by the assets comprised in the winding up, that is to say the company's free assets, and the expenses of a receivership are borne by the assets comprised in the floating charge.

63. The costs of realising a particular property, however, must be distinguished from the general expenses of the winding up or receivership.  The costs of realisation are deductible from the proceeds of the property realised, whether it is realised by the Liquidator or the receiver, for it is only the net proceeds of the property which are comprised in the winding up or receivership as the case may be.  Costs incurred in preserving an asset are treated in the same manner.  The costs of preserving or realising assets comprised in a floating charge, if incurred by the Liquidator, may therefore be recouped by him out of the charged assets in priority to the claims of the charge holder: see the Regent's Canal case 3 Ch D 411 at 427.”

7.  What is clear from these judgments is that if a particular asset is covered by a fixed or floating charges, except to the limited extent referred to in paragraph 63, recourse cannot be had to that asset or the proceeds of its sale to pay any part of the Liquidator’s fees and expenses because those assets do not form part of the company’s assets.  Mr Hudson submitted that this principle applies if the security is clear, but if there is doubt about it, as in the present case, the fees and expenses of a Liquidator incurred in resolving the doubts are recoverable out of the charged assets even if a court subsequently finds that the security is valid and, therefore, the charged asset is not the property of the company.  For this reason Mr Hudson argued the court can now order that the Liquidator’s costs and expenses are paid out of the sums realised from the sale of the properties and shares notwithstanding that the High Court Action has not been determined and it is possible that the second legal charge and the debenture will be held to be valid.  The result of this would be that if it is determined that the proceeds of the sale of the landed property are the property of Madam Yen, in other words if the Liquidator’s rejection of the security and defence of the High Court Action is found to be misconceived, the costs incurred in this regard by the Liquidator should be paid by Madam Yen.  I asked Mr Hudson if he was aware of any decision in which a court had accepted this argument.  He said that he was not.

8.  In paragraph 86 of his judgment in Buchler Lord Millett said this about a similar situation:

“86. After the 1986 Act, however, the decision acquired greater significance. Its history since has been one in which judges, bound by the decision, have wrestled with the problem of avoiding the absurdities to which it could lead. In In re MC Bacon Ltd [1991] Ch 127 a Liquidator claimed that the costs of an unsuccessful attempt to set a floating charge aside should be paid out of the assets subject to the charge in priority to the claims of the charge holder. But for the decision in Barleycorn the claim could not have got off the ground. A more absurd and unjust outcome could hardly be imagined. The court was able to avoid it only by finding a way to disallow the costs of the action as recoverable expenses of the liquidation.”

9.  In the light of the House of Lords decision in Buchler it does not seem to me that the Liquidator’s argument is sustainable.  Neither does it seem to me that the result, namely that they will not be able to recover their fees and expenses unless Madam Yen’s action is unsuccessful, is, as Mr Hudson suggested, unfair.  At the time the Company was put into liquidation Madam Yen’s claim was known.  Mr Hudson accepted that Madam Yen’s claim has been consistent and transparent.  To the extent that Madam Yen’s claim necessitates establishing that a mistake has been made in the drafting of the second legal charge and the debenture, the Liquidator does not assert a positive case to the contrary.  He simply point out that the second legal charge and debenture state that they secure loans made to the Company when in fact, and this is common ground, no such loans were made.  Madam Yen contends that it was quite clear at the time that the security was intended to cover sums advanced by her to Mr Chuan and companies controlled by him.  If the Liquidator, or his legal advisers, had been alive to the Buchler principle at the outset and he was concerned that there were no free assets out of which his fees and expenses could be paid, he could, if so advised, have sought directions from the court at that stage as to whether they could be paid out of the allegedly secured assets.  If the application had been unsuccessful, as it follows from what I have said above in my view it would have been, the Liquidator could have sought funding from a party with an interest in the outcome of the dispute and if it had not been forthcoming taken a view as to whether he could properly continue in his office.

10.  It may be that Madam Yen’s claim will fail.  If DIM and DFL’s claims are also unsuccessful there will be considerable free assets out of which the Liquidator’s fees and expenses are payable.  If DIM and DFL are successful the Berkeley Applegate principles will be engaged and the Liquidator will be able to seek payment pursuant to them.  This being the case the correct course is to adjourn the summons.  Before making a final order in this regard it is necessary to address the submission that the exception to the Buchler principle referred to above applies.

11.  The Liquidator has exhibited a schedule setting out a description of the categories of work carried out by the Liquidator, his staff and Deacons during the liquidation.  Section A4 covers work done to recover monies and other assets belonging to the Company held in Singapore by DBS Bank Limited.  Madam Yen accepts that a portion of these costs might relate to preservation and, or realisation of assets covered by the security and thus be recoverable by the Liquidator.  However, Mr Coleman points out that the descriptions in section A4 appear to describe work done primarily by Deacons and extends to matters which go beyond preserving or realising the assets.  This I accept.  Mr Coleman submitted that given the terms of the debenture it must be assumed for present purposes that the assets are Madam Yen’s property and that the Liquidator should have consulted with her before incurring costs, which he intended to recover out of her assets, particularly as the sums involved were relatively small (HK$1,139,103.00) and Madam Yen might have taken the view that it was sensible to leave the assets where they were until her action had been resolved rather than incur substantial costs (the Liquidator seeks HK$310,387.30).  I agree.

12.  In respect of section A4 it seems to me that the court does not have information directed specifically to demonstrating what fees and expenses have been incurred in preserving and realising the assets.  Section A4 is too general and seems to go beyond this.  It needs to be borne in mind in this regard that the scope of what falls within this exception is narrow: see In re Regent’s Canal Ironwork Co (1875) 3 Ch D 411, 427 per James LJ 420‑421. It is open to the Liquidator to make a further application specifically tailored to these criteria if he wishes, but I do not think that the court has the necessary information before it at present to make an appropriate order in respect of these sums.

13.  In the circumstances it seems to me that the correct course is to adjourn the summons with liberty to apply.  The Liquidator can restore it in part if he wishes to seek an order in respect of the preservation and realisation of the assets in Singapore.  The remainder of the application probably needs to await the outcome of Madam Yen’s action.

14.  So far as costs are concerned, I make the following costs order nisi.  The costs of the hearing before me on 27 February 2012 be paid by the Liquidator to Madam Yen.  So far as the costs of DIM and DFL is concerned as their position is largely neutral at present I think the appropriate course is to reserve those costs until Madam Yen’s action, to which they are a party, is determined.  If any party wishes to challenge this costs order they should notify the court in writing within 7 clear days of handing down of this judgment.