RE ZHAN XIANGMING

HCB 3433/2005

[2023] HKCFI 3039

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

BANKRUPTCY PROCEEDINGS NO. 3433 OF 2005

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DECISION

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INTRODUCTION

1.  This is an application made by Gracewood International Limited (“Gracewood”) pursuant to section 33(1)(a) and 33(6) of the Bankruptcy Ordinance (Cap.6, Laws of Hong Kong) (“the Ordinance”) for leave to apply for annulment of the bankruptcy order (“the Annulment Application”) made against the bankrupt on 6 July 2005 (“the Bankruptcy Order”).

BACKGROUND

2.  As far as this leave application is concerned, the relevant background is as follows.

3.  On around 27 May 2002, the bankrupt signed a personal guarantee (“the Guarantee”) in favour of Gracewood, guaranteeing, as primary obligator, the debt of USD16,626,816.86 (“the Debt”) owed by various PRC companies and/or their subsidiaries or associated companies (“the Principal Debtors”) to Gracewood.

4.  Pursuant to the Guarantee, the Debt shall be repaid in three instalments, with the last instalment due on 30 June 2002. At the end of the day, the Principal Debtors have defaulted on repayments of all three instalments.

5.  In the meantime, the petitioner (Bank of China (Hong Kong) Limited) herein presented a bankruptcy petition against the bankrupt on 6 May 2005 (“the Petition”), and pursuant to which the Bankruptcy Order was made on 6 July 2005 in the bankrupt’s absence.

6.  The bankrupt was automatically discharged 4 years later on 6 July 2009.

7.  On 12 April 2022, Gracewood commenced HCA 335/2022 (“the 2022 HK Action”) against the bankrupt and claimed for repayment of the Debt pursuant to the Guarantee.

8.  In aid of the 2022 HK Action, Gracewood applied for freezing orders against the bankrupt and his former wife in the High Court of New Zealand on 31 March 2022 so as to refrain them from dissipating their assets, and for ancillary orders requiring them to disclose full details of their assets and liabilities (“the New Zealand Proceedings”). In his Notice of Opposition filed in the New Zealand Proceedings, the bankrupt raised the defence, among other things, that upon the discharge of bankruptcy in 2009, his liability under the Guarantee had been extinguished, and that the legal effect of the discharge on any liability the bankrupt might have under the Guarantee was not affected by the terms thereof.

9.  While the bankrupt has yet to file any Defence in the 2022 HK Action, it appears that by reason of his defence raised in the New Zealand Proceedings as mentioned above, the 2022 HK Action has been ordered to be stayed by consent pending the determination of the Annulment Application herein.

10.  Both the Official Receiver and the petitioner have indicated that they shall remain neutral in this application. Their attendance at the hearing has therefore been excused.

LEGAL PRINCIPLES ON ANNULMENT APPLICATIONS

11.  Section 33(1) of the Ordinance provides that:

“(1) The Court may annul a bankruptcy order if it at any time appears to the court that –

(a) on any grounds existing at the time the order was made, the order ought not to have been made; or

(b) to the extent required by the rules, the provable debts and the expenses of the bankruptcy have all, since the making of the order, been either paid or secured to the satisfaction of the court.”

12.  The leading case in Hong Kong on the legal principles applicable to an application for annulment of a bankruptcy order is Kam Hung Cheung v Bank of China (Hong Kong) Ltd. [2009] 3 HKLRD 597. As far as the present case is concerned, the relevant parts thereof are as follows:

“22. The relevant decided cases show that, in considering whether to exercise the power under section 33(1)(a), the court should first look at whether there were any grounds on which a bankruptcy order ought not to have been made at the material time when it was made. If the court does not think that such grounds existed, it cannot invoke section 33(1)(a) to annul the bankruptcy order. If the court thinks that such grounds existed, it still has to consider whether it should exercise its discretion to annul the bankruptcy order: see Society of Lloyds v. Waters [2001] BPIR 698, 704G-H, and also Artman v. Artman [1996] BPIR 511, 513-514, and Askew v. Peter Dominic Ltd [1997] BPIR 163, 164.

23. In exercising the discretion under section 33(1), the court has to carefully consider the interests of the creditor, the debtor and the public, bearing in mind that a bankruptcy order is to be annulled only under exceptional circumstances.

24. Furthermore, the person applying to annul a bankruptcy order bears the burden of proving that when the order was made there were grounds on which the order ought not to have been made: see OBE Insurance (Hong Kong) Ltd v. Chan Wai Man William, HCB 187/2000.” (emphasis added)

THE ISSUES

13.  The bankrupt has filed various affirmations in opposition to the Annulment Application. It appears therefrom that the bankrupt’s main contentions made therein are that the Annulment Application should be dismissed because:

(1)  There has been inordinate and inexcusable delay in the making of the Annulment Application on the part of Gracewood which has caused him serious prejudice and difficulties in gathering and putting forward all evidence to oppose the application;

(2)  As opposed to what Gracewood asserted[1], the Bankruptcy Court had jurisdiction to make the Bankruptcy Order against him because he has carried on business in Hong Kong in the period of 3 years prior to the date on which the Petition was presented to the Court;

(3)  He had maintained various places of residence in Hong Kong from 1996 through to the filing of the Petition on 6 May 2005.

14.  Be that as it may, it is accepted by the bankrupt that, for the purpose of this leave application, the Court may proceed on the assumption that there are reasonable arguments as to whether the Bankruptcy Order ought not to have been made at the material time when it was made. This Court therefore does not have to deal with the jurisdiction issues under sub-paragraphs (2) and (3) above.

15.  On the other hand, it is noted from Mr Ng’s submission that, as far as this leave application is concerned, the stance taken by the bankrupt is that:

(1)  The threshold test as to merits on a leave application under section 33(6) of the Ordinance should not be “serious issue to be tried” as suggested by Gracewood’s counsel, but “reasonably arguable case which enjoys realistic prospect of success”;

(2)  Gracewood’s claim made in the 2022 HK Action is time-barred and doomed to fail. As such, Gracewood does not have any pecuniary or financial interest in the bankruptcy status of the bankrupt. Hence, the present application should be dismissed because Gracewood is not an “interested person”;

(3)  Furthermore, it is not reasonably arguable that the Court should exercise its discretion in annulling the Bankruptcy Order in any event because of the inordinate and inexcusable delay on the part of Gracewood in taking out the Annulment Application which has caused irreparable prejudice to the bankrupt.

16.  In light of the above, the issues which this Court has to deal with when considering whether leave should be granted to Gracewood are confined to the followings:

(1)  What is the test applicable to an application for leave to apply for annulment of a bankruptcy order made under section 33(6) of the Ordinance?

(2)  Does Gracewood pass the legal threshold in its argument that it is an “interested party” under section 33(6) of the Ordinance?

(3)  Does Gracewood pass the legal threshold in its argument that the Court should exercise its discretion in annulling the Bankruptcy Order in the event it is held that it ought not to have been made?

DISCUSSION

The relevant test for leave

17.  While section 33(6) of the Ordinance stipulates that leave is required to be obtained by an “interested person” who intends to apply for annulment of a bankruptcy order, the statutory provision does not go on to specify the threshold which the applicant has to meet. Counsel from both sides have also been unable to locate any case authority on the point.

18.  Mr John Scott SC (together with Mr Richard Yip and Mr Enoch Fong) suggested that reference may be made to the leave requirement of statutory derivative actions, and the same threshold of “serious question to be tried” should be adopted for the purpose of the present application. It was further submitted that the threshold should not be set too high for annulment cases which frequently involve heavily contested facts as to whether the bankruptcy order ought not to have been made.

19.  On the other hand, Mr Ng submitted that the Court should draw analogy with an application for leave to appeal against interlocutory orders in which leave would not be granted unless the Court is satisfied that there is reasonable prospect of success in the intended appeal.

20.  On my part, I agree that the threshold under section 33(6) of the Ordinance should be “reasonable prospect of success” for the following reasons.

21.  First, I do not agree, as submitted by Gracewood, that a lower threshold should be adopted merely because annulment cases would frequently involve heavily contested facts.

22.  Second, section 33(6) of the Ordinance was added pursuant to the recommendation of the Law Reform Commission in its 1995 Report on Bankruptcy (“the LRC Report”). At that time, section 33(1) of the Ordinance provided that:

“Where in the opinion of the court a debtor ought not to have been adjudged bankrupt, or where it is proved to the satisfaction of the court that the debts of the bankrupt are paid in full, the court may, on the application of any person interested, by order annul the adjudication.”

23.  In paragraphs 7.13 and 7.14 of the LRC Report, it was stated that:

“7.13 Under the Bankruptcy Ordinance, section 33(1), an application for annulment may be made on the application of any person interested but the meaning of ‘person interested’ is not defined. The Insolvency Act dispensed with the requirement that the applicant should have an interest and is silent as to who should make the application. Under the present law an interested person includes the trustee in bankruptcy and the personal representatives of the bankrupt but does not include a person having an interest based on family sentiment or similar feelings alone.

7.14 In most cases an application for annulment would be made either by the trustee or by the bankrupt but there could be circumstances where an application could be made by another party. We recommend therefore that the discretion as to who should be allowed to make an application should lie with the court.”

24.  Section 33(6) was as a result enacted, in which the leave requirement was introduced.

25.  As submitted by Gracewood, this requirement was added for the purpose of filtering out applications which are unmeritorious. This purpose will be defeated if the threshold is set at too low a standard. It is meaningless (and will be a waste of time and costs) to let an application proceed if it does not even have reasonable prospect of success.

26.  Third, I accept Mr Ng’s submissions that in an annulment application, the applicant would be challenging the court’s prior decision in the making of a bankruptcy order. In such circumstances, a higher threshold than merely “serious question to be tried” should be adopted.

27.  Hence, leave to apply for annulment should only be granted if the Court is satisfied that the application for annulment has prospects that are more than “fanciful” without having to be “probable” (SMSE v KL [2009] 4 HKLRD 129 at [17]).

Whether Gracewood is an “interested party”

28.  It was submitted by Mr Ng for the bankrupt that Gracewood has no reasonable prospect of establishing that it has any pecuniary or financial interest in the bankruptcy status of the bankrupt. This is because, it was said, Gracewood’s claim under the Guarantee is time-barred. He submitted that this is so despite the fact that:

(1)  Clause 8 of the Guarantee provides that: “擔保人同意有關向擔保人追索負債的時間限制應由該公司 [i.e. Gracewood]向擔保人提出還款要求之日開始計算”; and

(2)  Gracewood only served a written notice on the bankrupt on 9 March 2022 demanding him to pay the Debt despite the fact that the Debt was due to be paid by the Principal Debtors by 30 June 2002.

29.  It was alleged that there is an implied term in the Guarantee that if Gracewood intends to claim against the bankrupt under the Guarantee, Gracewood must issue the demand within a reasonable period of the principal debtor’s default in settling the Debt, otherwise Clause 8 of the Guarantee would have the drastic and absurd effect of defeating the limitation period set by the laws, and allowing an indefinite time for Gracewood to pursue the claim against the bankrupt.

30.  Furthermore, it was submitted that it must be implied that a contractual discretion must be exercised in good faith for the purpose for which the power was conferred, and not arbitrarily, capriciously or in bad faith.

31.  However, it was said, since no demand for payment had been issued by Gracewood for around 20 years, there can be no proper explanation as to Gracewood’s failure to issue the said demand within a reasonable period.

32.  Accordingly, the bankrupt alleged that Gracewood had breached the aforesaid implied terms by reason of its failure to demand for repayment of the Debt within a reasonable time from the alleged default of the Principal Debtors, and that, pursuant to the “prevention principle”, Gracewood is precluded to take advantage of its own wrong, whatever the Guarantee may provide. Hence, the condition precedent for the accrual of the cause of action (i.e. demand for repayment) is deemed to be satisfied within a reasonable period upon the default of the principal debtors and the limitation period for Gracewood’s claim against the bankrupt would have begun to run. Therefore, the 6-year limitation period would have long lapsed before Gracewood issued the writ against the bankrupt in the 2022 HK Action on 12 April 2022. Further or alternatively, Gracewood should not be permitted to take advantage of the postponement of the accrual of limitation period in Clause 8 of the Guarantee and claim against the bankrupt for breach of the Guarantee 20 years after the default of the principal debtors.

33.  As recognised by the bankrupt himself, Clause 8 of the Guarantee expressly provides that the time limitation for Gracewood to sue for repayment of debt should start to run from the time when Gracewood demands for payment. In such circumstances, I am of the view that it is at least reasonably arguable that the parties had contracted to exclude the operation of the limitation period by express agreement (see Chen Jinhui v Wong Kam San & Others [2021] HKCFI 710 at [174] – [178]) and as a result such time should only start to run from 9 March 2022 (i.e. when Gracewood issued a written demand to the bankrupt), despite the various reasons which the bankrupt alleged that the Clause should not be interpreted in such a way. It is also reasonably arguable that the alleged implied term to demand within a reasonable time did not exist, because it contradicts an express term of the Guarantee: Kensland Realty Ltd v. Whale View Investment Ltd & Another (2001) 4 HKCFAR 381 at [23].

34.  Further, given Gracewood’s evidence that the bankrupt had been nowhere to be found for a long time, it is at least reasonably arguable that Gracewood did not breach the alleged implied term (even if such a term existed) by not issuing any demand for repayment under the Guarantee until March 2022.

Exercise of discretion

35.  In effect, it was the submission of the bankrupt’s counsel that it is fanciful that the Court would exercise its discretion in annulling the Bankruptcy Order.

36.  With respect, I do not agree:

(1)  There is case law which suggests that where the Court had no jurisdiction to make a bankruptcy order in the first place, the discretion can only be exercised one way by rescinding the order which it had no jurisdiction to make. The Court cannot have discretion not to rescind because the effect of not rescinding would be to affirm the order which it had no jurisdiction to make: Re Fung Chi Fong [2011] 2 HKLRD 856 at [43] and Re Wong Lei Kwan Joanne [2009] 3 HKLRD 173, at [29];

(2)  In any event, the Court should decide whether to exercise its discretion in not annulling a bankruptcy order despite the finding that it ought not to have been made in the first place by taking into account all the circumstances of the case. In the circumstances of the present case, despite the long lapse of time between the date of the Bankrupt Order and the date of this application, I am of the view that it is at least reasonably arguable that the Court would exercise its discretion to annul the Bankruptcy Order.

DISPOSITION

37.  For reasons of the aforesaid, leave is granted to Gracewood to apply for annulment of the Bankruptcy Order.

FURTHER DIRECTIONS

38.  On 22 February 2023, Ng J ordered that, in the event Gracewood’s leave application is granted, the following deponents of affirmations filed herein do attend Court (whether in person or by video-link with leave of the Court) at the substantive hearing for cross-examination:

(1)  the bankrupt;

(2)  Gang Gordon Chen;

(3)  Wong Kai Wa; and

(4)  Chue Chi Yat David.

39.  Bearing the above in mind, and having been confirmed by counsel from both sides that the Annulment Application is ready to be set down for substantive argument, I make the following directions:

(1)  No further affirmation may be filed without leave of the Court;

(2)  The Annulment Application be set down for substantive hearing (with 3 days reserved).

(3)  The date of the said substantive hearing shall be fixed in consultation with counsel’s diaries (one counsel per party only), provided that such consultation shall not lead to a delay of more than 3 months. In the event such consultation will lead to a delay of more than 3 months, the first available date of the Court shall be fixed as the hearing date of the substantive hearing;

(4)  All affirmations filed so far in the Annulment Application shall be admitted as evidence for the said application, save that the affirmations of the bankrupt, Gang Gordon Chen, Wong Kai Wa and Chue Chi Yat David shall not be so admitted unless they attend Court for cross-examination pursuant to Ng J’s order dated 22 February 2023. In the event they attend Court for cross-examination, their affirmations shall stand as their evidence-in-chief.

COSTS

40.  In normal cases, where leave is granted, the costs of the leave application would be in the cause of the substantive application.

41.  However, Mr Scott SC submitted that Gracewood should be entitled to its costs of the leave application, on the ground that the bankrupt should not have opposed this leave application.

42.  On the other hand, Mr Ng submitted that there is no reason why the usual order of “costs in the cause” should not be made. He asserted that it was reasonable for the bankrupt to insist that the leave application should be heard separately.

43.  In my view, given:

(1)  Gracewood’s serious allegation that the bankrupt had been lying in his evidence which was relied on in his opposition against the leave application;

(2)  The bankrupt shall be cross-examined at the substantive hearing;

(3)  The Court may only consider the aforesaid serious allegation upon the cross-examination of the bankrupt (and other deponents) at the substantive hearing,

The question of costs of the leave application should be decided after the substantive hearing.

44.  I therefore order that the costs of the leave application be reserved.