RE SURPLUS TRADER LTD

HCCW 826/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 826 OF 2004

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AND

HCCW 827/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 827 OF 2004

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BETWEEN

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D E C I S I O N

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1.  I have before me two applications, one in each of two winding-up proceedings relating to two companies, Surplus Trader Limited and Sino Trade Asia Limited, seeking orders that the legal costs incurred and to be incurred by the companies in opposing the winding-up petitions against them be paid out of their respective assets and that such payments be validated pursuant to section 182 of the Companies Ordinance.  The applications were made by summonses dated 26 April 2005, just over a week ago.  The substantive hearing of the winding-up petitions is due to take place next week, on 10 and 11 May 2005. 

2.  Briefly, the background to the applications is as follows.  On 29 July 2004, the Petitioner, Standard Chartered Bank, presented petitions against the two companies.  The petitions were based on debts allegedly due from the two companies pursuant to trade finance facilities initially granted to them in June 2003, and which were varied from time to time thereafter.  Surplus Trader is said to be indebted to the Petitioner in the amount of some US$9 million under such facilities and Sino Trade Asia is said to be indebted in the amount of some US$8.8 million.  Each of the companies has also guaranteed the indebtedness of the other so that the claim against each of them in respect of their liabilities under the facilities and their respective guarantees totals some US$17.8 million.

3.  On the same day, 29 July 2004, the Petitioner also made ex parte applications for and obtained the appointment of provisional liquidators (Messrs Middleton and Jamieson of KPMG) in respect of the two companies.  The Petitioner also brought proceedings against Mr Chan Kwok Wah, the main shareholder and a director of the companies, and his wife, making claims against them on the basis of guarantees given by them to the Petitioner in respect of the companies’ liabilities to the Petitioner.  Ex parte applications for Mareva injunctions were also made and were granted against Mr Chan and his wife.

4. The companies initially indicated that they would oppose the appointment of the provisional liquidators but, in the event, they did not contest the inter partes application and the provisional liquidators have remained in office and are now in charge of the companies’ affairs.  Since their appointment, the provisional liquidators have made three reports to the court and have also filed a number of affidavits in respect of the winding-up proceedings and various applications made in the course of those proceedings.

5. Although not resisting the appointment of the provisional liquidators, the companies did resist the petitions and considerable evidence has been filed both by the Petitioners and the companies for the hearing that is due to take place next week.

6. For the purposes of this application, the companies relied mainly on the evidence contained in Mr Chan’s eighth affirmation (one filed in each of the winding-up proceedings) in support of the applications for validation orders permitting the use of the companies’ funds to pay their legal fees.

7. In those affirmations, Mr Chan sets out some of the background and goes on to say that shortly after the appointment of the provisional liquidators, he was advised that despite their appointment, the boards of the companies nonetheless had residual power to instruct lawyers to resist the petitions and therefore to retain their present solicitors.

8. He says that on 10 September 2004, he instructed such solicitors to ask the provisional liquidators to pay the costs that had been and were to be incurred by the company in resisting the petition.  This request did not meet with the immediate approval of the liquidators.  The provisional liquidators instead raised various questions which the company does not appear to have answered at that time.  These questions related to the basis on which it was suggested that the fees of the companies’ lawyers that were incurred in resisting the petition should be paid in priority to the costs and charges of the provisional liquidations.  Subsequently, on 21 September 2004, further questions were asked as to the source of funding which had apparently been provided to the company up to that point.  No response was provided to the requests for information and no steps were taken to make any application for a validation order at that stage. 

9. Mr Chan says that he considered using his own money to fund the companies’ defences of the petitions against them but was told that he could not do so because of the Mareva injunction against him.  He then managed to raise a loan of some $620,000 from a friend which was used to fund the companies’ defence of these petitions. 

10. Mr Chan goes on to say that in early February this year, he was told that that money was running out and he therefore asked the companies’ solicitors to renew their request to the provisional liquidators for funding of the companies’ defence of the winding up proceedings.  This was done by a letter dated 8 February 2005.  On 14 February 2005, the provisional liquidators replied, stating their position.  This was again that the request was refused, principally on the ground that the assets of the companies should not, in the view of the provisional liquidators, be used to pay for such costs in priority to the expenses of the provisional liquidation unless some good reason for doing so could be shown.  Those acting for the company were again asked to provide such reasons if they wished to, but the invitation was again not taken up and no steps were taken at that stage to make an application of the nature that is now made. 

11. In early April this year, the companies were apparently advised that it was necessary to instruct counsel for the hearing of the petition that is due to take place next week.  They then requested their solicitors for an estimate of the costs and to make one more request to the provisional liquidators for release of funds.  Although this appears to have been something of which the companies were advised in early April, it was not until 23 April 2005 that their solicitors wrote to those acting for the provisional liquidators.  No immediate reply was received, apparently because the solicitor handling the matter for the provisional liquidators was unfortunately indisposed for a day or two at that time.  The companies thereupon issued these applications. 

12. The principal concern of the companies is that, without funding from assets in the hands of the provisional liquidators, they will be unable to fund their defences to the petitions and that the costs that they have already incurred so far will be wasted. 

13. As far as the amount of costs involved is concerned, the amount incurred to date consists of some $620,000 which has already been paid out of the loan obtained from Mr Chan’s friend, with a further HK$200,000 of costs which have been incurred but which remain unpaid.  The estimate is that a further $500,000 odd will be needed to mount the defence of the petitions at the hearing next week. 

14. The provisional liquidators filed an affidavit (Mr Middleton’s fifth affidavit) yesterday stating that the provisional liquidators’ position in respect of these applications was neutral.  They did, however, take the opportunity to provide the court with information as to the financial position of the companies at this point in time.

15. Although the provisional liquidators are neutral in relation to the applications, the applications are opposed by the Petitioner, which appears through Mr Harris today.

16. I propose to start with the approach which the court should take to an application such as this.  It is, I think, correct, as Mr Wou who appeared for the companies submitted, that a company faced with a winding-up petition is entitled to resist the petition and that its board retains a residual power to instruct lawyers for this and related purposes notwithstanding the appointment of provisional liquidators to the company.  This is clear, I think, from Union Accident Insurance Company Limited [1972] 1 All ER 1105.  Mr Harris did not dispute this proposition. 

17. As I understood him, Mr Wou initially submitted that in the normal case where no provisional liquidators had been appointed, a company was entitled to use its own assets to defend itself against a winding-up petition and did not need to apply for a validation order in respect of such expenditure.  With respect, I do not think that this is correct.  In the usual case, on the presentation of a petition and its advertisement, a company will find that its bank accounts are frozen.  To the extent that it has available to it cash or other assets out of which it can pay its legal fees, it will no doubt be able to do so in the sense that it will be possible to make payment in respect of such fees.  However, any payment so made will, unless validated pursuant to section 182 of the Companies Ordinance, be void in the event of a winding-up order being made.  In that event, any payments made by the company to its lawyers between the presentation of the petition and the making of the winding-up order would be recoverable from its lawyers.  I think, in the end, that Mr Wou accepted that this was the case.

18.  The question is, therefore, in what circumstances should the court grant a validation order which has the effect of enabling the company to use its assets to defend itself against a winding-up petition.  Mr Wou submitted on the basis of Re Crossmore Electrical and Civil Engineering Limited [1989] BCLC 137 and Re Wah Ying Cheong Co. Ltd (unreported, CFI, HCCW 225 of 1996, 14 March 2003) that the cost of defending itself against a petition was part of a company’s ordinary business expenses and so should generally be validated.  With respect, I do not think that this is quite correct either.  The question of whether or not a company is entitled to pay its ordinary business expenses pending the hearing of a winding-up petition is a matter that has been considered in a number of authorities, to which I will come in due course.

19.  However, I should point out first that in Crossmore the position was that there was a minority shareholder’s petition under the English equivalent of section 168A of the Companies Ordinance.  The petitioner in that case was also the controlling shareholder of a company which had presented a creditor’s petition against the company.        

20.  In the context of the shareholder’s petition, an application was apparently made for validation order which would have had the effect of permitting the company to carry on business by paying its ordinary business expenses.  This application was not opposed and Mr Justice Hoffman (as he then was) made an order saying that he was satisfied, apart from the fact that the application was not opposed, that the financial position of the company was such as to justify the making of the order in that case. 

21.  A question then arose as to whether the costs of defending the creditor’s petition could be regarded as part of the ordinary business expenses of the company.  It was in this context that Mr Justice Hoffman said that it was.  However, it is important, I think, not to lose sight of the fact that in that case, the company was both solvent and trading and carrying on business. 

22.  In Wah Ying Cheong the dispute was also a shareholder’s dispute and it appears clear from the judgment of Madam Justice Kwan in that case that the company was solvent and that the bulk of the legal fees in respect of which a validation order was sought and made related to matters other than the defence of the petition.  It is therefore not particularly surprising that a validation order was granted, extending to the payment of legal fees. 

23.  Where the company in question is insolvent, however, it seems to me that the position will be different.  In that case, the relevant principles are those summarised by Lord Justice Fox in Denny v John Hudson & Co [1992] BCLC 901 at pp.904-905.  In my view, these principles apply whether the application for a validation order is made before the making of a winding-up order or after one has been made. 

24.  In general, it will not be possible for the court considering whether or not to grant a validation before the petition has been heard to form anything other than a very provisional view, if that, as to the merits of the petition or the opposition to it.  In exceptional cases where it can be shown either that the company has a very strong prospect of resisting the making of a winding-up order or that a winding-up order is virtually certain to be made, this is a matter which can be taken into account.  But it seems to me that such cases are likely to be relatively rare and that this is not such a case.  Mr Wou did not seek to persuade me that it was, and having had the opportunity to look at the evidence filed by both sides in respect of the petition hearing next week, I am satisfied that this is not a case in which it could be said that the companies’ prospects of resisting the making of a winding-up order are so strong that this in itself should provide a basis on which a validation order should be granted. 

25.  Thus the court has to ask itself whether the making of the validation order is likely to be in the interests of the companies’ creditors as a whole.  There may be cases where the amount of the assets available for expenditure are so large and the impact of a validation order so small so far as the creditors are concerned, that it would be appropriate to grant the validation order.  One such case was, I think, my decision in AIM Investments (Holdings) Ltd (unreported, CFI, HCCW 64 of 2004, 2 February 2004) in which I granted a variation of a Mareva injunction to enable a company to fund its defence of the Mareva injunction and associated winding-up proceedings and granted a validation order in respect of such payments.  In that case, I said that it might be appropriate in a case where limited funds were required, taking into account the funds of the company as a whole, to grant a validation order to enable the company to defend itself against winding-up proceedings. 

26.  In this case, the companies suggest that they are, in fact, solvent.  This suggestion appears to be made largely on the basis of the statements of affairs in respect of them, made on the basis of information provided by Mr  Chan in about August 2004.  It was on this basis that Mr Wou submitted that Surplus Trader had (or should have) cash of some $115,000 plus some $483,000 by way of an inter-company debt that was owed to it by Sino Trade Asia and therefore had overall assets of HK$599,000.  So far as Sino Trade Asia is concerned, it was said to have net assets of some HK$3 million of which some HK$338,000 was in the form of cash.  The balance consisted of the net amount of receivables that were said to be due from a Singapore company by the name of Elliott Gordon Singapore Limited and a Korean company known as Bumwoo Isp Company Limited.  In addition, it was said that there should be an additional HK$400,000 cash realised from the sale of electronic chips which were in the possession of the company and in respect of which the provisional liquidators had obtained permission to sell in February this year.

27.  The position disclosed by the provisional liquidators is very different.  They have produced a statement of the receipts and payments accounts of the two companies since their appointment.  This account indicates that Sino Trade Asia has currently a cash balance of some HK$81,000 and that Surplus Trader has no cash balance at all. 

28.  The provisional liquidators have also indicated in Mr Middleton’s fifth affidavit, and in reports filed with the court previously, that the companies appear to have no ongoing business dealings.  They say that there have been no contacts from suppliers, buyers or trade partners in the nine months since their appointment, with one exception in relation to a transaction involving the sale of machinery to a buyer in the Republic of Ireland in respect of which some funds have been collected. 

29.  I propose to deal first with the position of Surplus Trader.  It seems to me that there is no basis on which to doubt what Mr Middleton says as to the company’s financial position.  The only cash that it could have had, according to the statement of affairs, was $115,000.  It appears, however, that this represents a credit balance on an account with Standard Chartered Bank, the Petitioner, and that (as Mr Middleton has pointed out) such funds are not available to the company since Standard Chartered Bank has refused to make such funds available to the provisional liquidators on the basis that it is entitled to retain them to offset the indebtedness of the company to it. 

30.  As far as the account receivable is concerned, this is a balance due from Sino Trade Asia, so that the recoverability of this amount will depend on that company’s financial position.  Whatever may be the position as to its recoverability, it is quite clear that it does not represent cash in hand.  It seems to me, therefore, that as far as Surplus Trader is concerned, there are no assets available that can be made available for the use of the company in defending itself against the petition proceedings even if it would have been appropriate to do so.  There is therefore, in my view, no point in making the order sought and I decline to do so.  In any event, it seems to me that, for the reasons which I will explain in the context of the application in relation to Sino Trade Asia, it would not have been appropriate for me to exercise my discretion to do so in this case.

31.  I turn then to the position in relation to Sino Trade Asia.  Here, too, it seems to me that unless grounds can be shown for doubting the information that has been provided by the provisional liquidators, I should accept their evidence as to the current financial position of the company.  On that basis, it would appear that there is only HK$81,000 available in the form of cash.  This is before any payment has been made in respect of any of the expenses that have been incurred by way of professional fees by the provisional liquidators themselves and by those instructed by them. 

32.  This amount is clearly not anywhere near enough for the purposes of the company, given that it has indicated that it needs some HK$500,000 to fund the defence of the petition in the coming week.  It seems to me on that ground alone that there is no point in making any order in respect of Sino Trade Asia since any order made would not have the effect of enabling the company to defend itself against the petition.  However, it seems to me that the matter goes further than that.

33.  Mr Wou took issue with the figures put forward by the provisional liquidators saying that a number of matters did not appear to have been taken into account.  With respect, I do not think that any of the points that were taken have any real substance.

34.  The first point that was taken was that the amount of cash initially obtained was substantially less than $338,000 that was said to be available according to the statement of affairs.  The explanation for this is to be found in Mr Middleton’s fifth affidavit.  It is essentially that the balance of the cash consisted of the company’s credit balances with Standard Chartered Bank which had been withheld by the bank and which were not, therefore, available to the company.   

35.  The other cash that has been received from other bank accounts and other sources has been wholly accounted for in the receipts and payments account.

36.  So far as the other receivables are concerned, Mr Middleton has said in his latest affidavit that although these accounts receivable appear in the statement of affairs, the provisional liquidators do not consider that they are likely to be recoverable.  Mr Wou criticised this statement, pointing out that there was no evidence as to any steps having been taken to recover such sums, or as to what had been done about these receivables.  But it seems to me that the receivables are, at best, of limited relevance for present purposes because even if they were theoretically recoverable and might produce, at some point in the future, some funds for the company, they would not produce any funds that would be available for use for the purpose for which the company wants them, that is, to pay the legal fees for next week’s hearing.  Moreover, it seems to me that it would be necessary for the company to pursue those from whom the receivables are said to be due in order to make any recovery in respect of them.  But with the funds available on hand, it would seem that there is no realistic prospect of this being achievable. 

37.  Mr Wou also referred to the funds that should have been raised as a result of the sale of the computer chips for which permission was granted by the court in February this year.  However, the position in respect of this is explained in paragraph 7 of Mr Middleton’s fifth affidavit in which he explains that following the obtaining of the order, a further check was carried out on the chips in question and they were found to be different from the description which they had been given in the documentation relating to their original supposed sale, a transaction with a company called Maxon Limited.  The evidence as it now stands suggests that the chips in question are unlikely to be saleable and that, even if they were saleable, they are unlikely to produce any significant amount of money. 

38.  Mr Wou also mentioned the existence of certain shares in a Korean company called AMIC and a claim against a Korean gentleman by the name of Mr Son.  Both of these matters are fully dealt with in the third report of the provisional liquidators and it is clear from that report that there is unlikely to be any recovery in respect of either of these matters.

39.  It therefore seems to me that the company, Sino Trade Asia, has no assets to speak of.  That being the case, it is difficult to see that it would be in the interests of the creditors to allow the small amount of funds remaining available to be used for the purpose of funding the company in its defence of the petition. 

40.  Viewed from the perspective of its financial position, the company would appear to be insolvent and the statements to that effect by the provisional liquidators in their various reports and affirmations would appear to be justified.  In the circumstances, I can see no real benefit to the unsecured creditors in allowing the use of the small amount of money that remains with the provisional liquidators to be used for the purpose of resisting the petition. 

41.  I also find it difficult to see, with respect, what commercial purpose would be served by the company being permitted to use these funds to resist the petitions.  It does not appear on the evidence available that the companies have any ongoing business.  Notwithstanding the passages in Mr Chan’s third affirmation to which Mr Wou drew my attention, it seems to me that the position as stated by the provisional liquidators is clear and is not contradicted by any more recent evidence that has been put forward by or on behalf of the companies. 

42.  Further, there is no suggestion that Mr Chan would be in a position to meet an order for the payment of costs of the companies’ resistance to the petitions if the court were minded to make a Bathampton order at the end of the petition if the resistance to the petition were to fail.

43.  In those circumstances, it seems to me that, applying the normal principles applicable to the making of a validation order, it is not appropriate in this case for the court to exercise its discretion by making the order sought.

(Submissions re costs)