RE S. MEGGA TELECOMMUNICATIONS LTD.

HCMP 5551/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 5551 OF 2001

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JUDGMENT

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1. This is a petition under s.166(2) of the Companies Ordinance for the Court's sanction of a scheme of arrangement for S. Megga Telecommunications Ltd. ("the Company"). The application has been brought by the Company for whom receivers have been appointed by debenture-holders, and has been opposed by Mr Chan Shu -pun, a former employee who is a preferential creditor. Although there is no representative order, it can be seen from the voting at the Court-directed meeting that Mr Chan has the support of a large number of former employees.

2. Section 166 CO provides, where relevant:-

"(1) Where a compromise or arrangement is proposed between a company and its creditors or any class of them ... the court may, on the application in a summary way of the company ... order a meeting of the creditors or class of creditors ... to be summoned in such manner as the court directs.

(2) If a majority in number representing three-fourths in value of the creditors or class of creditors ... present and voting ... at the meeting, agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the court, be binding on all the creditors or class of creditors ... and also on the company ....

(3) An order made under subsection (2) shall have no effect until an office copy of the order has been delivered to the Registrar for registration ...".

The Company

3. The Company was the principal operating subsidiary of a group of

companies which was concerned with the business of manufacturing telecommunications equipment. The holding company Wireless Internetworks Ltd ("WIN") is listed on the Hong Kong Stock Exchange.

4. The group's trading and financial position began to deteriorate in 1997. In July 2000, the group completed a "self-rescue" restructuring arrangement with its bank and financial creditors. It issued certain Notes which were secured by a Guarantee and Debenture dated 21 July 2000.

Debenture

5. The Debenture given by, amongst others, the Company, contained fixed and floating charges over various assets in favour of Standard Chartered Bank in its capacity as Security Trustee for the Noteholders.

Petition for winding-up

6. Less than 12 months later however, in February 2001, a trade creditor GPI International Limited presented a petition for the winding-up of the Company.

Appointment of receivers

7. One day after the petition was presented, the Security Trustee appointed Mr Nicholas Etches and Mr Paul Brough receivers of the assets of the Company charged under the Debenture.

Scheme of Arrangement

8. The petition was opposed by the Company acting through the Receivers and by the Security Trustee. The Company put forward a Scheme of Arrangement which, if passed by the necessary majority and sanctioned by the Court under s.166 CO, would effect a compromise of the Company's unsecured debts and the dismissal of the petition. The petition was stayed pending consideration of the Scheme.

9. Briefly, the principal features of the Scheme, as far as the unsecured creditors in general were concerned, were that the Company's unsecured debts would be compromised and discharged in full, and some of the Company's assets charged under the Debenture would be "hived-across" to another subsidiary of WIN, in consideration for cash in the sum of HK$2m. and the allotment of 100m. shares (with a nominal value of $1m.) in WIN ("the Scheme Cash"). The Scheme Cash had been charged to the Security Trustee under the Debenture but would be released to the Company. The Security Trustee would further waive its rights to receive a distribution in respect of certain inter-company debts in the sum of approximately HK$805.7m.

10. Upon the Scheme becoming effective, the Scheme Cash (after deduction of costs and expenses of about HK$450,000) would be distributed to each of the unsecured creditors on a pari passu basis in proportion to their respective outstanding debts.

Scheme proceedings

11. The proceedings commenced in October 2001. On 30 November 2001, directions were obtained for the convening of a meeting of creditors under s.166(1).

Creditors' Meeting

12. On 11 January 2002, a creditors' meeting was held. According to the scrutineers' report, 127 creditors with unsecured claims totalling more than HK$863m. attended and voted. Of these, 69 creditors (54.33% of those present) with claims of HK$851,976,580.59 (or 98.65% in value) voted in favour of the Scheme, and 58 creditors (45.67% of those present) with claims of HK$11,629,291.16 (or 1.35% in value) voted against.

Opposition by former employees

13. Amongst the 58 creditors present who voted against the Scheme were 50 former employees.

14. The Company had a total of 67 former employees whose claims against the Company amounted to about $5m., of which about $1.2m. were preferential debts within the meaning of s.265 CO. (The preferential part of the employees' claims are referred to in this Judgment as "the Preferential Debts" and the former employees, to the extent of those Debts, are referred to as "the Preferential Creditors").

15. As at the date of the meeting (11 January 2002), no part of the Preferential Debts had been paid by the Company, nor were there sufficient assets or funds for the Preferential Debts to be paid in full. According to an affidavit of the Company's solicitor Mr Mark Fairbairn filed on 7 March 2002 (after the meeting), the net sum available to be distributed amongst the preferential creditors under s.79 CO (which will be referred to below) was about $447,000 only, or one-third of the Preferential Debts.

16. Nevertheless, the Company convened only one meeting, grouping the Preferential Creditors together with other unsecured creditors, and the Scheme was passed.

17. There is no serious dispute that if there had been a separate meeting of the Preferential Creditors as a class, the Scheme would not have been passed at that meeting. In that case, it was likely that the petition for the Company's winding-up would have proceeded.

Application for Court's sanction

18. The application for the Court's sanction of the Scheme came on for hearing originally in March 2002. Mr Chan Chi-hung, counsel for Mr Chan Shu-pun the Opposing Creditor, advanced the following written submissions:-

(a) the Preferential Creditors had different rights from other unsecured creditors, and therefore should have had a separate meeting. As no separate meeting had been held, there was no approval by the requisite majority at the meetings required under s.166(1), and the Court had no jurisdiction to proceed to consider sanction under s.166(2);

(b) accordingly, the petition should be proceeded with; upon winding-up, the Preferential Debts would have priority over the Noteholders' claims to assets charged under the floating charge [s.265(3B)], and contrary to the Receivers' assertion, the Company did have assets which, but for the floating charge, would have been sufficient to discharge the Preferential Debts;

(c) on winding-up, the floating charge would be invalid as it had been created less than 12 months before presentation of the petition (s.267), unless it could be proved by the Noteholders that the Company was solvent immediately after the charge was created. That was unlikely in view of the financial circumstances of the Company;

(d) even if the Court did have jurisdiction, it should as a matter of discretion refuse to sanction the Scheme under s.166(2).

19. The submissions in relation to what was comprised in the floating charge necessitated an adjournment of the hearing to 22 October 2002.

Post-meeting events

20. Shortly before the resumed hearing however, on 18 October 2002, Mr Brough filed his 6th affidavit stating that by reason of certain recent collections, the Receivers now anticipated paying all the Preferential Debts in full within a matter of weeks.

21. Mr Chan Chi-hung indicated that his client would be prepared to abandon his opposition to the application upon full payment of his Preferential Debt, and suggested that an adjournment for that purpose might be appropriate, but Mr John Scott SC for the Company continued with the application (correctly in my view) on the basis that if the Court had no jurisdiction under s.166(2) to hear it, the presence or absence of opposition would make no difference.

Were the Preferential Creditors a separate class of creditors?

22. I now turn to the main issue, i.e. whether the Company should have convened a separate meeting for the Preferential Creditors as a separate class of creditors.

UDL

23. In UDL Holdings Ltd and others [2002] 1 HKC 172, Lord Millett NPJ (giving the judgment of the Court of Final Appeal) drew attention to the significance of the decision - that has to be made by the company - whether to group its creditors into one, or more than one, class for the purposes of a scheme of arrangement under s.166 (at p178).

24. Lord Millett held that the grouping depended upon the similarity or dissimilarity of the creditors' rights against the company and the way in which those rights were affected by the scheme, and not upon the similarity or dissimilarity of their private interests arising from matters extraneous to such rights (at p184).

25. In UDL, the opponents of the scheme were also former employees who had been grouped with other unsecured creditors in one meeting. However (unlike the present application), the scheme provided that their preferential debts were to be paid in full in preference to the claims of ordinary unsecured creditors, and the evidence was that there were more than sufficient funds to do so. The employees nevertheless argued that they were still entitled to a separate meeting because in relation to the balance of their claims (which were not preferential debts), more time would be taken for distributions under the scheme than for payments that the employees could get on winding-up by reason of ex gratia payments out of the Protection of Wages on Insolvency Fund. The Court of Final Appeal held that those interests in relation to the balance of their claims were private interests, not deriving from any legal right against the Company, and private interests did not entitle them to demand a separate meeting to veto the scheme (at p186 B-C).

Preferential Creditors' rights against the Company

26. In the present case, Mr Scott SC contended first, that the Preferential Creditors did not have dissimilar rights to other unsecured creditors, because priority to payment of the Preferential Debts was given by statute and were statutory rights against receivers and liquidators, not rights against the Company.

27. I do not agree with that submission. The Preferential Creditors' rights are rights to payment out of the Company's assets, the Company being subject to the Ordinance providing for their priority to payment. Those prior rights are clearly rights against the Company not enjoyed by ordinary unsecured creditors.

"Receivers' respect for s.79 CO"

28. Secondly, Mr Scott SC submitted that in any event, the Preferential Debts have been specifically provided for under the Scheme. Although the Preferential Debts were regarded as ordinary unsecured debts in the Scheme, he said paragraphs 4.2 and 4.3 of the Explanatory Memorandum gave the Preferential Creditors an additional right.

29. Paragraphs 4.2 and 4.3, which were contained in a section entitled "Issues in respect of the Debenture", stated :-

"4.1. The Debenture given by the Company ... seeks to create fixed charges over the majority of the assets of the Company and floating charges over all the remaining assets which are not subject to a fixed charge.

4.2. One of the principle duties of the Receivers is to preserve, collect in and realise all the assets of the Company which are charged under the Debenture and distribute the proceeds of sale (after the deduction of costs and expenses and where applicable the payment of preferential creditors (as defined in section 265 Companies Ordinance)) to the Security Trustee, Nevertheless, prior to any distribution, a legal distinction needs to be drawn between a fixed charge and a floating charge.

4.3. The distinction is important for two reasons:-

First, in the event that a winding-up order is made within twelve (12) months from the date of creation of the Debenture, section 267 Companies Ordinance provides that any floating charge is void if it was created at a time when the Company was insolvent and no new cash was provided in return for the floating charge. No equivalent provision applies in respect of fixed charges.
Second, under section 79 of the Companies Ordinance, the Receivers are obliged to pay only preferential creditors (as defined by section 265 of the Ordinance) out of the proceeds of all assets which have been realised and which assets were subject to the floating charge. There is no equivalent provision which applies in respect of the fixed charges".

30. Section 79 CO provides:-

"(1) Where a receiver is appointed on behalf of the holders of any debentures of a company secured by a charge which, as created, was a floating charge, ... then, if the company is not at the time in course of being wound up, the debts, which in every winding-up are under the provisions of Part V relating to preferential payments to be paid in priority to all other debts, shall ... be paid out of any assets coming to the hands of the receiver ... in priority to any claim for principal or interest in respect of the debentures.

(2) The periods of time mentioned in the said provisions of Part V shall be reckoned from the date of the appointment of the receiver ... "

(In the present case, the time difference for payments under s.79 and under s.265 is minimal as the Receivers were appointed only 1 day after the presentation of the petition for winding-up).

31. Mr Scott SC submitted that paras. 4.2 and 4.3 of the Explanatory Memorandum showed that the Receivers were aware of their duties to the Preferential Creditors under s.79 and would "respect" them.

32. That is not the same as saying, however, that the Preferential Debts would be paid in full in priority, which is the right that the Preferential Creditors have which separates them from ordinary unsecured creditors. The Receivers' own case (as shown in Mr Fairbairn's affidavit) was that as at the meeting in January 2002, there were insufficient assets to satisfy the Preferential Debts in full. Therefore, there was an outstanding balance of the Preferential Debts that would be left unpaid, but under the Scheme, all the "Scheme Debts" (defined as all unsecured debts - which would include the outstanding balance of the Preferential Debts) would be "fully and finally discharged" (para. 4.1 Scheme of Arrangement) in exchange for pro rata payment of the Scheme Cash to all creditors. In other words, although part of the Preferential Debts would be paid by the Receivers making deductions from the proceeds of sale (as per para. 4.2), the Preferential Creditors would lose their right to priority payment in respect of the outstanding balance of the Preferential Debts.

33. That this was the effect of the Scheme is clear. This was confirmed in Mr Fairbairn's affidavit (paragraph 14):-

"As part of the preferential payments to the Company's employees will be satisfied by payment of the Net Proceeds [$447,962.29], the remaining shortfall of the preferential payments owed to the Company's employees of approximately HK$772,010.26 (being the difference between the preferential payment payable to the employees (approximately HK$1,219,972.55) and the Net Proceeds) will be compromised and discharged as with all other unsecured debts in accordance with the terms of the Scheme".

34. Mr Scott SC submitted that the Preferential Creditors still had an advantage over ordinary unsecured creditors in that they could prove in the Scheme for the full amount of their claims and also receive part payment of their Preferential Debts under s.79 CO.

35. Be that as it may, the point is that the Preferential Creditors' rights as against the Company was to payment of their Preferential Debts in full in priority to ordinary unsecured creditors. As at the date of the meeting, there was no evidence that the amounts that they would receive by way of the s.79 payment (on the Receivers' figures) and under the Scheme would equate to the amount of their Preferential Debts.

36. If I understood him correctly, Mr Scott SC also submitted that the scheme could not have operated to extinguish the Preferential Creditors's statutory rights. With respect, that is not so. Preferential creditors can waive their rights, so long as a separate meeting had been convened for that particular class of creditors to consider the scheme. In the present case, however, if a separate meeting of Preferential Creditors had been convened in January 2002, it would have been unlikely that they would have voted in favour of the Scheme, given the actual voting that took place at the meeting. By voting against the Scheme, they would in effect have enabled the petition to proceed, and in a winding-up, they would be able to pursue with the liquidators their position as to the validity of the floating charge and their view of the value of the Company's assets under the floating charge.

37. In conclusion, it is clear in my judgment that the Preferential Creditors were a separate class of creditors from ordinary unsecured creditors, and the Company should have convened a separate meeting for them instead of grouping them together with ordinary unsecured creditors.

Effect of no separate meeting - no jurisdiction

38. The effect of the Company's failure to convene a separate meeting for the Preferential Creditors is significant. Since the Preferential Creditors' rights which are to be compromised under the Scheme are different from those of ordinary unsecured creditors, the Scheme had to be treated as a compromise with more than one class of creditors. But as far as the class of Preferential Creditors is concerned, there has simply been no meeting convened, let alone any approval by the necessary majority. Accordingly, there is nothing which falls for the Court's sanction.

39. In UDL (at p184I), Lord Millett stated the principle that "the court has no jurisdiction to sanction a scheme which does not have the approval of the requisite majority of creditors voting at meetings properly constituted" in accordance with the principles that creditors with different rights against the company should have separate meetings.

40. At p178 D-H, Lord Millett added, when he addressed the issue whether it was helpful to leave the question whether the meetings were correctly convened to the third stage (i.e. the application for the Court's sanction):-

"It might be thought singularly unhelpful to leave the question whether the meetings were correctly convened to the third stage, by which time a wrong decision by the company at the outset will have led to a considerable waste of time and money. But in my opinion the practice is a sound one. The only alternative would be to require the initial application to be made inter partes and for notice of the application together with a copy of the scheme to be given to everyone potentially affected by it, with the risk of incurring the costs of a contested hearing and possible appeals before it could be known whether the scheme was likely to attract sufficient support in any event. The present practice ensures that those advising the company take their responsibility seriously, since an error on their part will be fatal to the scheme. At the same time it leaves the question, which goes to the jurisdiction of the court to sanction the scheme, to be decided at the appropriate time, that it to say when the court is asked to sanction it. By then the outcome of the meeting or meetings will be known and the question, which will no longer be hypothetical, can be argued between the appropriate parties, that is to say the company on the one hand and those who object to the scheme on the other".

41. Since the Court's jurisdiction is conferred by statute, I simply have no discretion which I can exercise in favour of the Company, even in the light of the post-meeting evidence of the availability of sufficient assets to pay (it is said, in the near future) the Preferential Debts in full.

42. In view of the above, it is clear that the Court has no jurisdiction to sanction or reject the Scheme. It is not possible for the Court to somehow confer jurisdiction on itself by speculating that when the Preferential Debts have been paid in full, there would be no opposition to the Scheme. It is not known whether there would be any consequential changes to the Scheme. Even if there is no change, it cannot be assumed that the Scheme would be passed. Payment of the Preferential Debts in full would deplete the assets available for ordinary unsecured creditors under s.79(3) CO, and therefore the position of the ordinary unsecured creditors may be affected.

43. In the circumstances, it would not be appropriate for me to set out my views on the interesting issue whether the book debts were subject to a fixed charge or a floating charge, as this issue goes to the merits of the scheme, which should only be considered at the stage when the Court decides to sanction or reject it.

Order

44. I therefore have to dismiss this petition, with an order nisi that the Company is to bear the costs of the Opposing Creditor, the Opposing Creditor's own costs to be taxed in accordance with Legal Aid Regulations.