KELSO ENTERPRISES LTD v. LIU YIU KEUNG STEPHEN AND ANOTHER

cacv 303/2006

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 303 of 2006

(on appeal from HCMP NO. 3302 of 2004)

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REASONS FOR JUDGMENT

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Hon Rogers VP:

1.  This was an appeal by the applicant from an order of Barma J given on 21 July 2006 whereby the judge refused the application made on behalf of the applicant that the dissolution of Universal Products (Hong Kong) Ltd (“the company”) should be deferred.  There was a further application that the current liquidators should be removed and that new liquidators should be appointed.  The judge refused both orders, although he indicated that had he ordered the deferment of the dissolution he would have arranged for the current liquidators to be changed since it was not desirable to have the major creditor at loggerheads with the liquidators.  At the conclusion of the hearing of this appeal, this court allowed the appeal by the applicant in respect of the deferment of the dissolution and the liquidators maintained their stand that they were prepared to resign.  We now give our reasons in writing.

Background

2.  The company was a fruit and vegetable wholesaler.  Its business appears to have centred around the importation of fruit, and possibly vegetables, and the selling of the same in the Mainland.  The applicant is an Ecuadorian company and supplied large quantities of bananas to the company which were then sold in the Mainland.  It appears that some time prior to September 1998, and possibly going back as far as 1996 or before, the company was in financial difficulties.  At some stage the applicant had discussions with the management of the company as to a possible restructuring.  On 26 September 1998 the applicant presented a petition for winding up the company but on the same day the company’s directors passed a resolution in accordance with section 228A of the Companies Ordinance, Cap. 32 (“the Ordinance”) commencing the special procedure for voluntary winding up.

3.  The company’s debts were substantial.  They totalled more than HK120 million dollars.  The applicant was owed US$7,538,959.19.  That was equivalent to approximately HK$59 million.  The liquidators succeeded in recovering in some of HK$9,382,332.09 but that has all been dispersed in payments.  Approximately two thirds of that sum has been spent on liquidation costs: $4,337,592.06 has been spent on the fees to Ernst & Young, the existing liquidators’ firm, and some $1.8 million has been spent on legal fees to 2 firms of solicitors.

4.  Quite understandably, the applicant is by no means satisfied with this outcome.  Not only has there been negligible recovery but there has been little or no real explanation as to how the company’s financial position has deteriorated to that extent.

5.  On 28 September 2004 a final meeting of creditors was held at which the liquidators’ accounts and final accounts were adopted.  This was followed on 5 October 2004 when the liquidators filed their final accounts with the Companies Registry, as was required under section 239(3) of the Ordinance.  Under the provisions of section 239(4) the dissolution of the company would have taken effect three months later.  However, that subsection provides that the court may, on the application of either the liquidator or any other person who appears to the court to be interested, make an order deferring the date on which the dissolution of the company is to take effect for such time as the court thinks fit.

6.  It was under those provisions that the applicant first commenced making applications for deferment of the dissolution.  As a result of investigations that took place after orders had been made, commencing with the first order made on 29 December 2004, further matters were revealed.  It appears that in 1996 the two directors of the company namely Mr Benny Wong and Miss Ng Sui Wah, who were both founders and seemingly the only shareholders, whether directly or indirectly held, of the company, sought advice as to the setting up of offshore trusts, supposedly for tax planning purposes.  It appears that at that stage it was considered necessary that debts owed by at least one of the directors, if not both, to the company should be cleared.  The suggestion was apparently made by the then auditors that dividends should be declared but the difficulty arose that the company was not in a position to pay any dividend by reason of losses which had been made.  The accounts showed a trading loss in 1995 of $10,073,567.  At the end of 1996 the company had an accumulated loss of HK$4.3 million.

7.  Seemingly at the suggestion of the former auditors, that loss was then turned into a HK$13.7 million profit by means of “merging” the 1996 results of the company with that of another company Fresh Produce Ltd which was a BVI company.  There was, apparently, no payment of a cash dividend but the declared dividend was used to set off liabilities owed by the directors, or at least one of them, to the company.  Apparently, this was all accomplished by book entries.  Such matters clearly call for thorough investigation, to say the least.  Coupled with that, it can be added that there are relevant documents that seemingly existed which are no longer available.

The Decision below

8.  The matter came before Barma J on 11 and 12 May 2006.  He commenced his consideration as to whether the dissolution should be deferred with a reference to what were termed observations made by the Court of Appeal in Re Pinto Silver Mining Company (1877) 8 Ch. D. 273 which were said to have been made in a slightly different context but were apposite.  The judge quoted from passages in 2 of the judgments in the court of appeal to the effect that the petitioner could not bring the winding up petition so long after the dissolution particularly as he had known of and assented to the dissolution and its ramifications 3 years earlier.

9.  Apparently relying on what had been extracted from that case, the judge said in paragraph 25 of this judgment:

“In these circumstances, it seems to me that if Kelso wish to have the dissolution of UPL deferred, it is incumbent on Kelso to provide some explanation for its inactivity in the final 18 months or so of the liquidation, its failure to provide the funding requested of it from time to time, and its failure to speak out at the final meeting of the creditors and make its views known.”

10.  The judge took the view that the applicant had not done a number of things that it should have done.  He appears to have taken a strong view in relation to Kelso’s reticence to fund the liquidators in particular in relation to a proposed action against the former auditors of the company.  The judge took the view adversely against the applicant that it had not funded an application to examine the former directors of the company under section 221 of the Ordinance.  He concluded in paragraph 30 his judgment:

“In these circumstances, it does not seem to me that Kelso has made out any proper basis for the court to exercise its discretion in its favour in relation to the further deferral of UPL’s dissolution.  I am satisfied that Kelso was well aware of the steps being taken in the liquidation, and in the light of its close involvement in the liquidation, its failure to provide funding when called upon to do so, and its failure to provide any good explanation for its inactivity until shortly before UPL was due to be dissolved, I do not think that it would be right to accede to the application for a further deferral of UPL’s dissolution.”

This appeal

11.  On this appeal Mr Sussex SC, who appeared on behalf of the applicant, argued that by attempting to extract a parallel with the In re Pinto case the judge had put the “bar too high”.  He argued that in view of the fact that it was the applicant’s position that it was willing to fund the further conduct of the liquidation and that there would be no detriment to any party, in particular the creditors would not be adversely affected at all, the judge had erred in the exercise of his discretion.  Counsel acknowledged that there was little or no authority as to how the court’s discretion should be exercised on a question of deferring the dissolution of a company under section 239(4).

12.  Mr Bleach SC, who appeared on behalf of the liquidators, did not seek to argue that there should no deferment of the dissolution.

13.  In my view the correct approach to the question of whether a dissolution should be deferred under section 239(4) must start with the question of what it is hoped, and what is likely, to be achieved by deferring the dissolution.  Hence the reasons put forward by the applicant must be considered first.  In this regard, of course, the interests of the creditors would be very important.  The court must also have regard to the public interest.  That public interest includes the proper and effective administration of the liquidation.  That, in turn, includes the need that there be investigations into possible past misconduct by those running and responsible for the running of the company.  The court must then consider whether there is likely to be any detriment to any party by deferring the dissolution.

14.  As indicated above, there are clear reasons, which are now apparent, to consider that there should be a full and detailed examination into the conduct by the directors and shareholders and former auditors of the company.  There may well be legitimate cause for complaint which the liquidators should take up.  Examination under section 221 thus becomes very important.  That must be the starting point.

15.  The judge dismissed the question of the directors of the company having permitted the company to trade whilst insolvent on the basis that it is unlikely that the applicant would have funded any claim.  Questions involved in such actions by directors in knowingly trading whilst the company is insolvent could extend to more serious consequences than a mere civil claim.  It is clearly in the public interest that any such conduct be thoroughly investigated and, if appropriate, those responsible brought to book.

16.  As regards any possible detriment, whether to third parties or other creditors, I see none save that if there have been misdeeds, those responsible might have to account for them.  In this regard, a highly important matter, which was referred to by the judge but does not appear to have weighed in this regard, was the fact that the applicant was prepared to fund the further conduct of the liquidation.  Importantly, therefore, the creditors and any others involved are unlikely to be prejudiced in any way.  It could be added that the fact that the applicant is willing to chance its existing funds despite having lost a considerable amount of money already, is a litmus test of the fact that the major creditor considers that there are stones that need to be turned.

17.  I agree with the submission that in applying what was considered the approach in the In re Pinto case the judge has put the bar too high.  That approach might be appropriate if third party rights were likely to be adversely affected.  The In re Pinto case however, was a very different case from the present.  It was a case where a winding up petition was presented in respect of a company that had been dissolved 3 years earlier.  The dissolution of the company had been accomplished by the transfer of substantial assets in what could be termed a reconstruction using a new company.  Mines and other assets had been transferred to a new company, which had undertaken to pay the mortgage debts of the original company.  That had happened some 3 years previously.  In the intervening time no doubt a great deal had happened.  The new company had no doubt worked the mines and traded.  It was in that context that the submission was made and accepted by the court that the petitioner, who had known and assented to the dissolution and everything that was done in accordance with it, could not then seek to petition for winding up, effectively trying to undo the dissolution and set aside the transfer of the assets.  Clearly not only would third party rights have been affected, but to seek to undo such substantial transactions so long after the relevant events would have created very substantial problems.  Coupled with that, of course, because what was sought was the commencement of a winding up, the costs of the winding up would have come out of the assets of the company.  In the present circumstances questions of delay cannot be an absolute bar as it was in the In re Pinto case.

18.  Furthermore, in my view, particularly in the light of the history and the way the matters have emerged, it is not fair to the applicant to hold against it that it had not funded the liquidators at least to the extent that seems to have been held against the applicant in this regard.  This is quite apart from the fact that in making comments as to the willingness to fund the liquidators, the judge appears to have considered that the applicant had, since 2001, only funded the liquidators to the extent of US$10,000 and that appears to be substantially less than was actually the case; there are other factors.  Creditors have to be wary about how they fund liquidators.  Whilst my strongly held view that the policy underlying section 265B(5B) of the Ordinance is to encourage creditors to fund litigation by the liquidator for the benefit of the general body of creditors has now been accepted at the highest level, it is clear that, despite that policy, creditors stand at risk as to costs in any litigation even though they may not be in control of that litigation themselves.

19.  As regards the potential litigation against the former auditors that the judge referred to in paragraph 19 of the judgment, I would simply say that litigation against former auditors is no open and shut affair.

20.  It remains to be said that in making the order that has been made there is no guarantee that the applicant will be able to secure recovery whether for itself or the other creditors.  It is by no means certain that it may be possible to show any particular wrongdoing to the required standard of proof or that any penalties may be imposed on any parties responsible.  Nevertheless the circumstances would seem to me clear that, even on the basis of the public interest alone, there are matters that require proper investigation.

Hon Suffiad J:

21.  I agree.