HSIN CHONG CONSTRUCTION CO LTD (in provisional liquidation) v. BUILD KING CONSTRUCTION LTD

CACV 321 /2019

[2019] HKCA 1305

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 321 OF 2019

(ON APPEAL FROM HCCW NO 239 OF 2018)

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J U D G M E N T

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Hon Kwan VP:

1.  This is the appeal of Hsin Chong Construction Company Limited (“the Company”) against the decision of Deputy High Court Judge Le Pichon handed down on 13 June 2019 ([2019] 3 HKLRD 367). By the decision, the judge ordered inter alia that:

(1)     the exercise of Build King Construction Limited (“BK”) of the right to exclude the Company from the Hsin Chong‑Build King Joint Venture (“the JV”) under clause 17 of the Joint Venture Agreement dated 21 November 2013 (“the JVA”) on 13 December 2018 did not constitute a disposition under section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32; and

(2)     the Supplemental Agreement dated 17 December 2018 between the Company and BK shall not be avoided by section 182.

2.  The Company raised three broad grounds of appeal:

(1)     the exclusion of the Company from the JV pursuant to clause 17 of the JVA is void under section 182^[1], since “property” in section 182 should be given a broad meaning;

(2)     in any event clause 17 of the JVA was ineffective because it falls foul of one or both of the two sub-rules under the general principle that parties cannot contract out of the insolvency legislation, being the anti-deprivation principle (“the ADP”, which is aimed at attempts to withdraw an asset on liquidation or bankruptcy, thereby reducing the value of the insolvent estate to the detriment of creditors) and the pari passu principle (“the PPP”, that statutory provisions for pro rata distribution may not be excluded by a contract which gives one creditor more than its proper share)^[2]; and

(3)     the Supplemental Agreement was void under section 182 and should not be validated.

Factual background

3.  For ease of reference, I will adopt the terms and expressions used by the judge.  The relevant background matters have been summarised comprehensively in her decision:

“4. Under the JV Agreement, the Company and BK (“the parties”) established an unincorporated integrated joint venture in November 2013 to prepare and submit prequalification and, upon being prequalified, a tender for executing a major government design and construction project in Kowloon (“the Project”) with the Company taking a 65% interest and BK the remaining 35%.

5. The JV opened a number of bank accounts under the joint mandate of BK and the Company with the Bank of China Hong Kong (“BOC”).

6. The Government awarded the contract to the JV on 22 June 2016. The parties entered into Articles of Agreement with the Hong Kong Government on 30 August 2016 (“the Contract”).

7. The Company found itself in financial difficulties commencing in 2017/2018. On 17 July 2018, West Kowloon Cultural District Authority decided to determine the Company’s contract for the construction of the M+ Museum. Then on 27 August 2018, a winding up petition was issued against the Company. The petition remains adjourned to a date in August 2019.

8. On 13 December 2018, BK exercised its right under clause 17 of the JV Agreement to exclude the Company from the JV.

9. Following that exclusion, BK and the Company entered into the Supplemental Agreement whereby BK acquired the Company’s residual rights under the JV Agreement for the sum of $53.6 million.

THE JV AGREEMENT

10. The salient provisions of the JV Agreement in which the Company and BK, inter alia, provided as follows:

(a) Upon acceptance, the tender becomes jointly and severally binding on the parties. (§4)

(b) All rights and obligations of the parties shall be shared and borne by the parties in the agreed proportions of 65% to the Company and 35% to BK being their respective shares of equity interest. (§5.2)

(c) Each party shall place at the disposal of the JV such of its resources as may be required by the Executive Board and to let the JV have the benefit of all its experience, technical knowledge and skill. (§5.3)

(d) The Executive Board shall comprise two representatives from each of the parties whose decisions shall be unanimous. (§7.2)

(e) The Company shall be the Lead Company responsible for the project management and coordination in the JV. (§7.3.1)

(f) The Lead Company shall provide the following head office services at a fee which shall be paid by the JV: Procurement; Accounting; Company Secretary; IT support; Insurance affairs excluding contractor’s all risks claims; Any other services that the JV may require. (§7.3.5)

(g) Injections of working capital may be required from time to time and each party undertakes to make such capital available. (§8.5)

(h) Personnel required for the execution of the Contract shall be supplied from the employees of the parties and the party shall second to the JV such of their employees who possess the necessary degree of competence who shall remain employees of the party supplying them but shall be seconded to the JV. (§12.1)

(i) The seconding party shall settle all payments of remunerations to its seconded personnel and the JV shall reimburse the seconding party. (§12.4)

(j) Each party shall bear its own costs and disbursements of its staff. (§12.6)

(k) On the settlement of the final account, after providing for all costs, liabilities, reserves for contingencies and after repaying Working Capital, any profits remaining shall be distributed to each party as a provisional distribution. (§16.2)

(l) If the performance of the Contract shall result in a loss, each party shall bear such loss according to its share of the JV. (§16.3)

(m) Of the remaining provisions of the JV, the only provision relevant for present purposes is the default provision (§17) summarized below.

11. In outline, §17 of the JV Agreement regulates the position between the parties inter se. It confers a contractual right on the innocent party to exclude the defaulting party from the JV and carry on the JV on its own, in the absence of the defaulting party, to operate all the JV Accounts and to complete the Project. An accounting exercise is then carried out on completion of the Project to ascertain what, if any, money may be due to the defaulting party as a result of the profits made and losses incurred.

12. Under §17.1, the occurrence of any one of five specified events on the part of the party defaulting (“the defaulting party”), gives the other party (“the continuing party”), an option (i) to exclude the defaulting party from further participation and management of the JV and the Contract and to take over the benefits of the defaulting party in the JV (but without releasing the defaulting party from its obligations to bear its proportionate share of any loss); or (ii) to wind up the affairs of the JV.

13. §17.5 is concerned with the accounting exercise to be held upon completion or termination of the Main Contract to determine the amount of profit that the defaulting party is entitled to (if any) up to the date of its exclusion less, (i) the defaulting party’s share of losses arising whether before or after the date of exclusion and (ii) costs, expenses, losses and damages incurred by the continuing party as a result of the defaulting party’s default.

BK’S EXERCISE OF ITS §17 RIGHTS

14. By August 2018, the Company’s financial difficulties continued to worsen. As recorded in BK’s solicitors’ letter to the Company dated 17 August 2018, the Architectural Services Division (“ASD”) met with BK on 14 August 2018 and suggested (at a meeting on 14 August 2018 with BK) that BK should agree terms with the Company to transfer the Contract to BK and further intimated that, failing resolution of the situation, it could potentially terminate the Contract.

15. In the autumn of 2018, BK’s enquiry of the Company as to whether it would be open to stepping away from the JV was met with a rejection. But by 12 December 2018, the Company through Paul Lee (“Mr Lee”), one of its directors, intimated that the Company wished to sell its interest in the JV. One of BK’s executive directors, Zen Wei Peu Derek (“Mr Zen”) informed Mr Lee that BK would be interested in agreeing arrangements to remove the Company and a meeting was arranged for the following morning.

16. Having discussed the position within BK prior to the meeting, it was decided that BK should exercise its rights under §17 to exclude the Company from the JV. At the meeting, BK so informed the Company, confirming it by letter dated 13 December 2018.

THE SUPPLEMENTAL AGREEMENT

17. While the Company showed no interest in the exclusion notice, it wanted to know if the Company’s share of profit following exclusion could be agreed. After exclusion, the excluded party was no longer entitled to a share profits generated by the JV. However, it did have certain residual rights in the final account under §17 which BK wanted to acquire. With a view to a smooth transition and greater freedom in completing the Project, BK made an offer to acquire those residual rights that gave the Company part of the profits that BK hoped would be generated by the JV after the Company’s exclusion and to which the Company would otherwise not be entitled.

18. Subsequent to the exclusion of the Company from the JV, BK and the Company entered into the Supplemental Agreement on 17 December 2018 under which BK agreed to pay $53.6 million to the Company to acquire all its rights and interests in respect of the JV, the Contract or the Project (ie its residual rights under §17), such that, inter alia, the Company would have no further involvement in the JV save for its rights under the Supplemental Agreement and so released from the obligation to bear a proportionate share of any loss resulting from the Contract.  In effect, the Company’s risk of loss would be removed entirely and assumed by BK.” 

The holdings in the decision

4.  In summary, the judge held that:

(1)     BK’s exercise of the exclusion rights under the JVA did not involve any disposition of the property of the Company within section 182^[3];

(2)     clause 17 did not infringe the ADP, it had a legitimate commercial basis and did not involve any intention to evade the insolvency laws^[4]; nor did it engage the PPP^[5]; and

(3)     the Supplemental Agreement was a commercial transaction negotiated at arm’s length entered into freely by the parties and a proper price was paid for the Company’s residual rights in the JV; BK was not involved in any misapplication of the first instalment of $20 million paid to Cogent Spring Limited (“Cogent Spring”), a wholly owned sister company within the Hsin Chong Group; there is good reason to exercise the discretion under section 182 to validate the Supplemental Agreement^[6].

5.  I will deal with the three broad grounds of appeal in the order mentioned at the outset.  As acknowledged by Mr Paul Shieh, SC, who appeared for the Company on appeal^[7], the arguments concerned have been raised before the judge.

If clause 17 involved a disposition of the property of the Company within section 182

6.  The property contended by the Company to be the subject of the disposition was said to be choses in action, being its 65% interest in whatever profit was generated by the JV, and its right to participate in the JV and the Contract^[8]. The Company’s submissions may be summarised as follows:

(1)     The purpose of section 182 is to safeguard the rights of the company’s unsecured creditors.  The court should, whenever possible, and/or unless there is compelling reason and sufficient basis to do otherwise, give a wide construction of the word “property”.  The word “property” at common law is “the most comprehensive of all the terms which can be used, inasmuch as it is indicative and descriptive of every possible interest which the party can have”. (Jones v Skinner (1835) 5 LJ Ch 87 at 90^[9], cited in Re China Medical Technologies Inc (No 2) [2015] 2 HKLRD 27 at §12^[10])

(2)     Section 182 of Cap 32 provides that “any disposition of the property of the company, including things in action … made after the commencement of the winding up, shall, unless the court otherwise orders, be void”.  Even on the face of this provision, “property” is already defined to include “things in action”, such as contractual rights.  No distinction was drawn in section 182 between present and future rights. In section 2 of the Bankruptcy Ordinance, Cap 6, “property” is defined to include “things in action” and “every description of property … present or future, vested or contingent, arising out of or incident to property as above defined”.

(3)     The judge was wrong in law and in fact to hold that it is wholly artificial to view “a share of future profits that has yet to be generated” as an existing asset of the Company, in that the Company, being insolvent, was in no position to perform its own contractual obligations so the exercise of the exclusion rights under clause 17 could not be regarded as destroying or dealing with any “asset” or “right” of the Company which cannot be accrued because of its insolvency^[11]. She had confused the existence of an asset with the ascertainment of the value and extent of the asset.  The finding that the provisional liquidators would not be able to discharge the Company’s obligations as the lead party in the JV^[12] was made without evidential basis.  The judge had failed to have any or any sufficient regard to the evidence that the JV would have been able to complete the Project without any further financial injection from the Company.

(4)     In any event, the exercise of exclusion rights had resulted in the removal or diminution of existing rights or property of the Company, in that profits earned before the exclusion would be diminished by any future losses that the Company has to bear. Further, the Company was deprived of the chance to earn the necessary points under the prequalification system operated by the Government for contractors bidding for design and build contracts. 

7.  I agree with the judge in holding that the exercise of exclusion rights under clause 17 of the JVA did not involve a disposition within section 182 of Cap 32.  Her reasoning cannot be faulted.

8.  On the meaning of “property”, Ms Linda Chan, SC for BK^[13] referred the court to In re Campbell (A Bankrupt) [1997] Ch 14 at 18C to G in support of her submission that a mere expectation to be paid money upon completion of the Contract is not a “property” within section 182, as such right, being completely indeterminate, is not a contingent interest in property, but a mere “possibility of achieving an interest in something which presently does not exist but may exist in the future”.  It was held by Knox J in Re Campbell that such right falls outside the ambit of “property” under section 436(1) of the Insolvency Act 1986^[14].  Ms Chan also drew an analogy with Revenue and Customs Commissioners v Football League Ltd [2012] Bus LR 1539, which held that as the right of the football club to payment was subject to a condition precedent that it completed all its fixture obligations for the relevant season and it was unable to do so, the defaulting club was not deprived of an asset because there was no debt due to it (at §§136 to 137, 143 to 146).

9.  The authorities cited by Ms Chan are apt.  I do not agree with Mr Shieh that the statements in those cases were taken out of context by Ms Chan.

10.  Re Campbell was concerned with the problem whether the prospect of an award from the Criminal Injuries Compensation Board was “property” that would vest in a trustee in bankruptcy when the award was made after the bankruptcy order.  The prospect of payment did not arise out of the performance of a contractual obligation, as Mr Shieh was keen to differentiate from the present situation.  But the context is nonetheless of relevance.  In construing whether the prospect of such an award would come within the definition of “property” in section 436(1) of the Insolvency Act 1986 so as to form part of the bankrupt’s estate, Knox J was unable to accept that “property” in this context “is intended to describe anything other than an existing item” and did not accept that “it is susceptible of referring to something which has no present existence but may possibly come into existence on some uncertain event in the future” (at 18D).  The right to receive a legacy on a contingent event is a contingent or future interest within the definition of property, as “there is existing property in respect of which there is a contingent interest”.  This is distinguishable from the owner of a lottery ticket or one who has filled in a coupon on football pools, as “there is no underlying existing property which, or the proceeds of sale of which, are susceptible to the existence of a proprietary interest, even a future one” (at 18E to G).

11.  In construing “property” for the purpose of section 182 to ascertain if it should form part of a company’s assets in a winding up by the court, I am inclined to think that an analogy may properly be drawn with the statutory construction in Re Campbell.  I do not think “property” for present purpose is “susceptible of referring to something which has no present existence but may possibly come into existence on some uncertain event in the future”.  In respect of the prospect of payment arising from future performance of the Contract, “there is no underlying existing property” which is susceptible to the existence of a proprietary interest, there is merely “the possibility of achieving an interest in something which presently does not exist but may exist in the future”.  There is no legal entitlement to receive a share of any future profits unless the Company was in a position to perform and had performed its own contractual obligations. This is akin to the situation in Revenue and Customs Commissioners v Football League Ltd, in which the entitlement to payment was subject to the condition precedent which the insolvent club was unable to fulfil.  I reject Mr Shieh’s contention that the judge had confused the existence of an asset with the ascertainment of the value and extent of the asset.

12.  As for the Company’s right to participate in the JV and the Contract and the opportunity to earn the points under the prequalification system operated by the Government, I agree with the judge it is hollow to speak of such rights (which are personal to the Company and cannot be assigned without the prior consent of BK^[15]) when the Company was unable to discharge its own obligations.  Whether the Company could earn any points was subject to review by the Architectural Services Department^[16], so the Company had merely an expectancy of achieving this.

13.  I turn to consider whether the judge was correct to find on the totality of the evidence that the Company was in no position to perform its own contractual obligations.

14.  There can be no dispute that the Company was insolvent at the material time.  It had failed to pay salaries of its employees seconded to the Project and contributions to the Mandatory Provident Fund of its employees.  It had failed to pay its suppliers and sub-contractors.  Trading in the shares of its parent company has been suspended since March 2017.  A creditor’s petition for winding up was presented against the Company in August 2018.  Other creditors brought legal proceedings to enforce their claims.  Receivers were appointed in respect of the share charge of the Company in December 2018.

15.  Mr Shieh’s submission is that notwithstanding the insolvency of the Company, there is evidence to support a finding that the JV was financially self-sustaining as at the date of its exclusion in December 2018 and the JV would have been able to complete the Project without further financial injection by the Company.  The Company had paid $9.1 million to the JV being its share of the initial working capital of $14 million, which was repaid to the parties at the very early stage of the Project in October 2016. There is no evidence that further injection of capital by the Company was needed.  Mr Shieh referred to the ongoing interim payments received by the JV under the Project, and the financial reserves of the JV in the sum of $207 million as in January 2019.  He submitted that the estimated net profit of the JV would be self-generated in the progress of the Project, pointing to the cash flow projection of the Project Manager’s report prepared in September 2018, which gave a forecast of more than $100 million in the JV accounts from December 2018 to the completion of the Project in March 2021.  He contended that the Company had the necessary manpower to complete the Project, as BK had taken over the Company’s employees to continue with the Project after its exclusion.  And there was no assertion in the affirmations filed on behalf of BK that the Company or the provisional liquidators would be incapable of completing the JVA.

16.  The above points were drawn mainly from the 1^st affirmation of one of the former directors, Lee Kok Foo James.  They were answered in the affirmations filed by BK.  As explained in the 1^st affirmation of Cheung Siu Lun, the contract price was originally $2,480 million.  At the time of the Company’s exclusion, works of approximately $620 million had been carried out.  With an estimated date of completion of 15 months from the Company’s exclusion, the JV’s expenditure would be in the order of $100 million a month.  It was crucial for the JV to ensure that it retained adequate cash to meet this level of expenditure and to manage its affairs in a way which generated a positive cash flow.  As the Company was unable to pay its employees and suppliers, BK had agreed to the JV advancing funds to the Company to pay its employees and assured the JV’s supply chain that it would pay if suppliers should fail to get paid.  Other events have occurred which rendered it difficult to predict what (if any) the actual profit will be on the Project^[17].

17.  It seems to me Mr Shieh’s submission is unrealistic. If the JV was indeed financially self-sustaining, the Architectural Services Department would not have expressed serious concerns at its meeting with BK in August 2018 about the “very severe and detrimental” potential impact on the Contract in view of the Company’s financial difficulties and suggested to BK to take proactive action to prevent the Contract from being jeopardised and agree terms with the Company to transfer the Contract to BK^[18].

18.  It is immaterial that no allegation was made in the affirmations of BK that the Company was incapable of completing the JVA.  On the totality of the evidence, the judge is clearly entitled to come to the view that the Company, being insolvent, was in no position to perform its own contractual obligations.

19.  The Company further complained that when the judge made the finding that the provisional liquidators appointed on 18 January 2019 would not be able to discharge the Company’s obligations under the JVA, she posed a number of queries concerning the obligations of the Company as the lead party in the JV^[19] but those queries were not raised in the evidence and the skeleton arguments by BK.  Hence, the Company was deprived of the opportunity of adducing evidence to address those queries of the judge and her finding was made without evidential basis.

20.  There is no substance in the above contention.  As noted by the judge^[20], the queries regarding the ability of the provisional liquidators to discharge the Company’s obligations under the JVA were made in response to the submission to the contrary made on behalf of the Company.  This is borne out by those parts of the transcript both sides referred us to^[21].  In any event, I agree with Ms Chan that the queries raised by the judge are unanswerable.

21.  As the Company was unable to perform its obligations under the JVA, there is no basis to assert that the Company has been deprived of a right to share in the future profits of the JV or to participate in the Contract. And as a disposition of any such right cannot have any impact on the creditors of the Company, section 182 is not engaged.

22.  As for the contention that the exclusion had resulted in the removal or diminution of existing rights or property of the Company, this is also without merit.  Any diminution of the profits earned before the exclusion is not caused by future losses that the Company has to bear, but by its inability to partake in the future profits earned by the JV as it was unable to perform its obligations under the JVA. 

23.  The judge had an alternative basis for upholding the validity of the exercise of clause 17 to exclude the Company from the JV, if, contrary to her holding, the exercise of exclusion rights did involve a disposition within section 182, and, assuming that clause 17 does not otherwise infringe the ADP^[22]. It is not strictly necessary to consider this, as I am in agreement with her primary holding.  I will deal with this succinctly as both parties have made submissions on this.

24.  The judge’s reasoning is based on the following dicta of Briggs J in Lomas & Ors v JFB Firth Rixson Inc & Ors [2011] 2 BCLC 120 at §108 (which have been approved by the Longmore LJ on appeal ([2012] 2 All ER (Comm) 1076 at §88 and in Belmont Park at §§130 to 131 per Lord Walker of Gestingthorpe JSC and at §§175 to 177 per Lord Mance JSC):

“Where the asset of the insolvent company is a chose in action representing the quid pro quo for something already done, sold or delivered before the onset of insolvency, then the court will be slow to permit the insertion, even ab initio, of a flaw in that asset triggered by the insolvency process. By contrast, where the right in question consists of the quid pro quo (in whole or in part) for services yet to be rendered or something still to be supplied by the insolvent company in an ongoing contract, then the court will readily permit the insertion, ab initio, of such a flaw, there being nothing contrary to insolvency law in permitting a party either to terminate or adjust what would otherwise be an ongoing relationship with the insolvent company, at the point when it goes into an insolvency process.”

25.  The judge considered the factors suggested by Briggs J as one means of distinguishing between a commercial re-arrangement of rights to reflect the economic consequences of insolvency and an impermissible attempt to pre-empt the distribution of assets in a bankrupt estate.  Applying that distinction, she held that the right in the present situation consists of the quid pro quo for services yet to be rendered by the Company and there is nothing objectionable about the contractual provision to terminate further performance on the insolvency of the Company.

26.  Mr Shieh argued that the judge was wrong to regard the distinction of Briggs J as a self-standing rule so as to provide an alternative basis for upholding the validity of clause 17.  He submitted that Briggs J’s distinction had formed part of the analysis of whether a contractual provision infringes the ADP, and this was borne out by the discussion of Lord Mance in Belmont Park at §175.

27.  This seems to me to be a somewhat sterile debate.  Mr Shieh did not challenge the correctness of the distinction of Briggs J.  As for his contention that the present case does not fall within the latter of the two situations being services not yet rendered as held by the judge, I do not agree with him.  As I have held, there is no merit in the contention that the exclusion had resulted in the removal or diminution of existing rights. In any event, the judge did consider the distinction again when she came to analyse whether clause 17 would infringe the ADP^[23].

28.  For all the reasons given above, the first broad ground of appeal must fail.

If clause 17 infringed the anti-deprivation principle

29.  As noted in Hudson’s Building and Engineering Contracts (13^th ed) at §11-093, almost all of the standard form building contracts contain express provisions providing for determination of the contract in the event of insolvency and further set out the consequences.  The authors expressed surprise that the validity of a termination clause conditioned on liquidation or administration remains an open question.

30.  The judge took the decision of the Supreme Court in Belmont Park as the leading authority and adopted the approach as stated by Lord Collins in §§102 to 105, as the ADP applicable in Hong Kong does not come from a different source and is derived from English law.  In summary, it is necessary to look at the substance of the agreement rather than its form, and to consider whether the provision in question amounted to an illegitimate attempt to evade the relevant insolvency law or had some legitimate commercial basis.  In each case, the “touchstone” is “to consider each transaction on its merits to see whether the shift in interests complained of could be justified as a genuine and justifiable commercial response to the consequences of insolvency” (Lomas & Ors v JFB Firth Rixson Inc & Ors, per Longmore LJ at §86)^[24].

31.  It is pertinent to note that in Belmont Park, after reviewing the authorities over the last two hundred years, Lord Collins stated at §75:

“The overall effect of the authorities is that, where the anti‑deprivation rule has applied, it has been an almost invariably expressed element that the party seeking to take advantage of the deprivation was intending to evade the bankruptcy rules; but that where it has not been applied, the good faith or the commercial sense of the transaction has been a substantial factor. By contrast, in the leading pari passu principle case, British Eagle [1975] 1 WLR 758, it was held by the majority that it did not matter that the clearing transaction was a sensible commercial arrangement not intended to circumvent the pari passu principle.”

32.  It is important to bear in mind the above difference in approach regarding good faith or the commercial sense of the transaction in applying the ADP and the PPP.  The judge followed Belmont Park and took into consideration the commercial justification or the intention of the parties to the transaction in applying the ADP.  Even when one has to look at the effect of the provision on the unsecured creditors, it does not exclude the question of intention^[25].

33.  Adopting the approach as mentioned, the judge held that clause 17 of the JVA did not infringe the ADP.  Her reasoning may be summarised as follows:

(1)     Of the five events of default that could trigger the exercise of the rights of exclusion in clause 17, four of them concern non‑insolvency events, in fact, breaches of contract.  That factor, of itself, would suggest an absence of any deliberate intention to evade insolvency law^[26].

(2)     The initial draft of the JVA actually emanated from the Company.  It was not created specifically for this particular JV and hence it is likely to have been a form of contract used by the Company from time to time. BK has also produced evidence of three instances involving similar clauses^[27].

(3)     The shifts in interest upon the exercise of the clause 17 rights of exclusion are thus: the defaulting party is excluded from participating in the profits of the JV accruing after the date of exclusion while having to continue to bear the defaulting party’s share of losses whether incurred before or after the date of exclusion as well as all costs, expenses, losses and damages incurred by the continuing party as a result of the default^[28]. The judge found commercial justification for the above shifts in interest as mentioned below.

(4)     There are reasons for having a provision that the defaulting party continues to bear its share of the loss on the Project.  In large construction projects, claims for latent defects tend to emerge upon completion of the project.  If such defects had arisen at a time when the Company was in charge of the Project as the lead party, it would only be fair that it should be made to bear its share of those losses.^[29]

(5)     There is also the fact that the default completely changed the risk profile of the Project so far as concerned the continuing party.  The provision is negotiated to protect the continuing party (be it the Company or BK) and gives legitimate protection to the innocent party who, when it agreed to the JV, did not do so on the basis of having to assume 100% of the risk^[30].

(6)     It was clearly sensible and in the interests of the parties to provide for the contingency that has occurred, namely, the insolvency of one of the parties.  Both are seasoned players in the construction industry: they have similar bargaining strengths and access to legal advice.  This was a commercial bargain entered into freely by the parties.  It is not the function of the court to rewrite a commercial bargain^[31].

34.  Mr Shieh argued that the judge erred in law in ruling that commercial justification or the intention of the parties to the JVA can be taken into account in determining the ADP.  He contended that the ADP should focus on the effect of the provision on the unsecured creditors to be protected, rather than the intention of the parties or the bona fide or otherwise of the provision itself, which the creditors have no control of or involvement in.  Other than the decision of the Court of Appeal in Peregrine Investments Holdings Ltd & Anr v Asian Infrastructure Fund Management Co Ltd LDC & Ors [2004] 1 HKLRD 598, which I will discuss below, Mr Shieh has not cited any authority in support of his proposition.

35.  As pointed out by Ms Chan, his contention is against a long line of authorities reviewed by Lord Collins in Belmont Park at §§69 to 79, including the following: Higinbotham v Holme (1819) 19 Ves Jun 88 at 92; In re Stephenson; Ex p Brown [1897] 1 QB 638 at 640; Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279 at 290 to 291; Bombay Official Assignee v Shroff (1932) 48 TLR 443 (Privy Council) at 446; In re Apex Supply Co Ltd [1942] Ch 108 at 114. And as noted by the judge^[32], in the first full judicial analysis of the principles in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, Neuberger J formulated ten “rather limited propositions” from the cases at §118, and the propositions in (v) and (vi) show that the intention of the parties is relevant.

36.  In Belmont Park, Lord Collins concluded that “commercial sense and absence of intention to evade insolvency laws have been highly relevant factors in the application of the anti-deprivation rule” (at §103) and that except in the case of a blatant attempt to deprive a party of property in the event of liquidation, “the modern tendency has been to uphold commercially justifiable contractual provisions which have been said to offend the anti-deprivation rule” (at §104).  Mr Shieh did not seek to explain in what way these conclusions are wrong and should not be followed in Hong Kong.

37.  Instead, he relied on certain statements of the Court of Appeal in Peregrine and submitted that as a matter of precedent, the Court of Appeal in Hong Kong had focused on the effect of the deprivation provision and not the intention behind it.  He also criticised the judge for making a “contrived distinction” between the bona fides of the parties and the bona fides of the provision in seeking to explain that Woo VP in Peregrine was only addressing the bona fides of the parties, not the commercial justification or the bona fides of the provision as discussed in Belmont Park^[33].

38.  Rogers VP said in §29 of that case that “it matters not that there might have been good commercial reasons” for the contractual arrangements under consideration. Woo VP said in §101 that he is “firmly of the view that the bona fides of the parties to [the contractual provision] or its operation was fair and equal amongst all shareholders … is not at all relevant to the application or otherwise of the anti-deprivation principle”. I accept that the distinction drawn by the judge between the bona fides of the parties and the bona fides of the provision may be somewhat strained, as that part of the judgment of Woo VP which began from §93 was headed “The bona fides and fairness of the contractual provision”.

39.  The above remarks of Rogers VP and Woo VP must be understood in the light that the court was concerned with a case where there was a “blatant attempt” at diminishing the value of assets in the insolvent’s estate available for creditors, so the observations that good intentions or commercial reasons for having the contractual provision were immaterial in those circumstances were plainly correct^[34].

40.  It is pertinent to bear in mind that the above statements of the judges were influenced by what Lord Cross said in British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758 at 780G to H^[35] that the parties to the “clearing house” arrangements had good business reasons for entering into them and did not direct their minds how the arrangements might be affected by the insolvency of a party were irrelevant.  As Lord Collins had stated in Belmont Park at §75 quoted earlier, British Eagle was concerned with the application of the PPP, and this must be distinguished from the situation in applying the ADP.  Neither Rogers VP nor Woo VP had noted this material distinction.  At §78, Lord Collins mentioned “there is an impressive body of opinion from some of the most distinguished judges that, in the case of the anti-deprivation rule, a deliberate intention to evade the insolvency laws is required” and “that conclusion is not affected by the decision in British Eagle”, as the PPP is clear and parties cannot contract out of it.

41.  The remarks of Rogers VP and Woo VP are not germane to the ratio of the case as explained above.  Peregrine was correctly decided on the facts and there is no obstacle to the courts in Hong Kong in following the approach in Belmont Park in applying the ADP.

42.  Mr Shieh took issue with the judge in her discussion of the distinction between a flawed asset ab initio and a subsequently flawed asset^[36]. As pointed out by Ms Chan, the judge was dealing with the distinguishing features in Peregrine.  I do not consider the distinction of much use in the present discussion concerning the application of the ADP, and it is not necessary to pray in aid the distinction in view of a host of other factors considered by the judge that I have mentioned earlier.  It is unnecessary to deal with Mr Shieh’s arguments on the distinction, save to observe that Lord Collins had not actually rejected the distinction in Belmont Park at §89, as submitted by Mr Shieh, see also Lord Collins at §§88 and 105 and Lord Mance at §163.

43.  I reject Mr Shieh’s contention that even if it is permissible to consider the bona fides and commercial justification, there was insufficient justification in this situation.  I agree with the judge’s reasoning as summarised earlier. She had applied the ADP in a commercially sensitive manner and taken into account the policy of party autonomy and the upholding of commercial bargains.  I would uphold her ruling that the ADP was not infringed in this instance.

If clause 17 infringed the pari passu principle

44.  The PPP was said to be infringed by clause 17.5(b), which is concerned with the accounting exercise to be held on completion or termination of the Contract to calculate the amount of profit up to the date of exclusion that the defaulting party is entitled to, less “all costs, expenses, losses and damages incurred by the Continuing Party directly or indirectly as a result of the default of the Defaulting Party”.

45.  Mr Shieh submitted that this provision infringed the PPP because the effect of this is that any claim by BK for loss and damage against the Company, which would otherwise have to be proved in liquidation and rank pari passu with other creditors, would be set off in the accounting exercise conducted thereunder, thereby giving the continuing party preferential treatment and rendering its recovery rate more than other unsecured creditors.

46.  The judge held that clause 17 was part of the original bargain and not a flaw subsequently inserted.  It was part and parcel of the contractual protection for the continuing party negotiated at the outset of the JV.  While potentially it could engage the ADP, the PPP was not engaged. The amount claimed under clause 17.5(b) is not at the discretion or whim of BK, not only has any such loss to result from the default, it has to be calculated by an independent party appointed by the executive board^[37].

47.  Mr Shieh submitted that insofar as the judge relied on the fact that the provision was part and parcel of the contractual protection negotiated at the outset of the JV, there is no authority to support why this should be considered relevant in the context of applying the PPP.  He also made the point that bona fides or commercial justification is irrelevant to the operation of the PPP, citing British Eagle.

48.  It seems to me that the judge’s holding has the support of this passage in Goode on Principles of Corporate Insolvency Law (5^th ed) at §7-03 pp 259 to 260 cited by Ms Chan^[38]:

“In considering the potential costs of the common law pari passu rule, it is important to emphasise that it has a narrow ambit: since it is concerned with arrangements that would provide unsecured creditors with more than their “proper share”, it is concerned only with arrangements that govern the treatment of what would otherwise be an asset available for distribution to creditors.  It therefore remains open to parties to agree that an interest being granted to a debtor is limited or conditional in some way, and such limitations and conditions fall to be respected by the liquidator in accordance with the general principle that he must take the company’s assets as he finds them, even where the condition or limitation has been inserted with a view to protecting the position of one or more creditors.  Such an arrangement does not remove an asset from creditors – it simply qualifies the nature of the asset – and as such, the pari passu rule has no role to play. As explained above, the anti-deprivation rule may apply to such arrangements, but only where it is the fact of insolvency proceedings having being opened that limits or conditions the debtor’s interest: non-insolvency related limitations or conditions on the debtor’s interest fall outside the scope of both rules.”

49.  Revenue and Customs Commissioners v Football League Ltd was cited by the author as an illustration in support of the proposition that it does not offend the PPP where a debtor’s interest under a contract is expressed to be limited or conditional by reference to the debtor’s entry into insolvency proceedings.

50.  What is the asset here that would otherwise be available for distribution to creditors? The parties have agreed under clause 17.5 that the interest being granted to the defaulting party is to be limited or conditioned in some way, and such limitation and condition fall to be respected by the liquidator, as he must take the company’s assets as he finds them, subject to all limitations and conditions.  Here, the contractual arrangement qualifies the nature of an asset upon the exercise of the exclusion right on insolvency.  As the defaulting party, the Company is to be paid its proportionate share of the profits earned and received by the JV calculated up to the exclusion date upon the completion or termination of the Contract, an event which has not yet occurred, less the claims of the continuing party mentioned in clause 17.5(b), as well as its share of any losses arising from the Contract whether before or after the date of exclusion in clause 17.5(a). Clause 17.5 does not remove from the creditors an asset otherwise available for distribution.  Nor is there property capable of being distributed under clause 17.5 as at the commencement of liquidation.  The PPP has no role to play.

51.  Ms Chan further submitted it is wrong in law for the Company to contend that clause 17.5 infringed the PPP in that its effect is to allow a set-off between BK and the Company and that “this is precisely the vice against which the PPP is directed”. Section 35 of the Bankruptcy Ordinance, Cap 6, which applies to a company in liquidation by virtue of section 264 of Cap 32, provides that there shall be a set-off of the “mutual debts or other mutual dealings” existing as at the commencement of winding up between the company in liquidation and any other person claiming to prove a debt. In re First Bangkok City Finance Ltd [1993] 2 HKLR 408 was cited as an example where set-off was applied under the statutory provisions.

52.  Mr Shieh submitted that to ascertain if there are “mutual debts or other mutual dealings” for the statutory set-off to apply, one should be looking at clause 16 of the JVA, which governs final accounts in the situation where there is no default and both parties have performed their obligations under the JVA.  The effect of clause 16 is that the distribution of profits will be made from the JV account, after deducting costs, liabilities, and reserves for contingencies.  It is not the case of one party paying another.  He also submitted that the deduction mechanism provided in clause 17.5 would cover the share of losses arising after the date of exclusion, and this cannot be part of the mutual dealings.

53.  I do not accept his submissions.  The provision for final account in clause 16 is not applicable to the situation where there is default, which is governed by clause 17.  It is expressly provided in clauses 16.2 and 16.3 that the provisions therein are “if applicable, as modified by the provisions of Clause 17” and “if applicable, as set out by the provisions of Clause 17”.  As for his contention that post-exclusion items would not form part of the mutual dealings, this is not correct in law.  Dixon J in Hiley v Peoples Prudential Assurance Co Ltd (1938) 60 CLR 468 at 496 and 497 had explained as follows^[39]:

“In the first place the general rule does not require that at the moment when the winding up commences there shall be two enforceable debts, a debt provable in the liquidation and a debt enforceable by the liquidator against the creditor claiming to prove. It is enough that at the commencement of the winding up mutual dealings exist which involve rights and obligations whether absolute or contingent of such a nature that afterwards in the events that happen they mature or develop into pecuniary demands capable of set off. If the end contemplated by the transaction is a claim sounding in money so that, in the phrase employed in the cases, it is commensurable with the cross‑demand, no more is required than that at the commencement of the winding up liabilities shall have been contracted by the company and the other party respectively from which cross money claims accrue during the course of the winding up.”

54.  I agree with Ms Chan that the statutory provisions of set-off would apply in this instance.

55.  For all the reasons given above, I am not persuaded there was any infringement of the PPP.

If the Supplemental Agreement should be validated under section 182

56.  The judge held that the agreed consideration of $53.6 million under the Supplemental Agreement was a proper price to be paid for the Company’s residual rights in the JV^[40]. There is no challenge of this on appeal^[41]. The Company only challenged the judge’s exercise of discretion to validate the Supplemental Agreement under section 182^[42].

57.  Mr Shieh’s main arguments are along these lines:

(1)     Clause 5(d) of the Supplemental Agreement directed BK to pay the consideration not to the Company but to a wholly owned sister company Cogent Spring, which is a separate entity.  BK knew or was at least put on notice that it is problematic for it to pay the consideration to Cogent Spring instead.  As the judge has found, BK had “an inkling that part of the proceeds would be applied by the Company in settling outstanding MPF contributions and employees’ wages that would contravene section 182 (absent any prior validation order) and that BK could be said to be facilitating a possible contravention by making payment to Cogent Spring instead of the Company directly”^[43].

(2)     Cogent Spring was specified under the Supplemental Agreement to receive the payments from BK so as to circumvent the legal effect of the winding-up proceedings. BK had raised concern earlier about the Company’s request to pay the first instalment of $20 million to Cogent Spring and was informed subsequently this was because the Company’s accounts had all been frozen.  Hence, BK had actual or at least constructive notice of the impropriety to use the bank account of Cogent Spring to circumvent the legal restrictions on disposing of the Company’s property.

(3)     After BK paid $20 million to Cogent Spring, a substantial part of it was dissipated by Cogent Spring in paying the directors and staff of the Company in preference to other unsecured creditors and is now beyond the reach of the Company.  The payment of $20 million by BK to Cogent Spring is itself a disposition of the Company’s property which should be invalidated.

58.  I do not think there are any valid grounds to interfere with the judge’s exercise of discretion to validate the Supplemental Agreement.

59.  By clause 5(e) of the Supplemental Agreement, the Company confirmed that BK’s payment to Cogent Spring in clause 5(d) “will be understood as and/or equivalent to the effect that [BK] has discharged its liability in connection with or arising from [the Supplemental Agreement].” Cogent Spring was designated as the Company’s agent to receive the consideration from BK on the Company’s behalf.

60.  The judge has fully considered the circumstances in which $20 million was paid to Cogent Spring. Insofar as part of the proceeds had been applied in contravention of section 182 and so prejudiced the unsecured creditors, it would have been because of the subsequent misapplication of the proceeds by the Company and/or its directors and not BK. BK was not in a position to control or direct the Company’s application of the proceeds^[44]. The judge could discern no ulterior purpose or agenda in BK making payment into the designated account^[45].

61.  There is no evidence that BK had actual or constructive notice of any acts of impropriety of the payments out from the account of Cogent Spring caused to be made by the Company.  When BK raised concern about the request of the Company to pay $20 million to Cogent Spring, this was before BK was informed by the Company that the reason for the request was because the Company’s accounts were frozen and hence it was not possible for the Company to apply the funds to pay its employees^[46].

62.  This ground of appeal is without merit and must be rejected. It is unnecessary to deal with Ms Chan’s further submission that this ground of appeal is academic as BK has accepted the Company’s repudiation of the Supplemental Agreement on 9 September 2019 and has terminated the same.

Conclusion and costs

63.  For all the above reasons, I would dismiss the Company’s appeal.  As there is no dispute that costs should follow the event, I would order the Company to pay the costs of BK of this appeal, with a certificate for two counsel.

Hon Cheung JA:

64.  I agree with the judgment of Kwan VP.

Hon Yuen JA:

65.  I agree with the judgment of Kwan VP.

Mr Paul Shieh SC and Mr John Hui, instructed by Wilkinson & Grist, for the Company (Appellant)

Ms Linda Chan SC and Mr John Leung, instructed by Hogan Lovells, for Build King Construction Limited (Respondent)

The Official Receiver, attendance excused