FEDERAL ENTERPRISES CO LTD v. THE OFFICIAL RECEIVER

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HEADNOTE

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                Upon the first appeal arising under section 265(5B) of the Companies Ordinance held : -

IN THE COURT OF APPEAL

(On Appeal from Companies Winding-up No. 65 of 1984)

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BETWEEN

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JUDGMENT

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Hunter, J. : This is the judgment of the Court.

1. Until 1984 the general rule for the distribution of assets in both bankruptcy and liquidation was that ordinary creditors ranked pari passu. This was changed in that year by the enactment of two nearly identical sections, namely section 265(5B) of the Companies Ordinance (Cap. 32) and section 38(5B) of the Bankruptcy Ordinance (Cap. 6). The section with which we are concerned (this section) is section 265(5B) which provides : -

              " Where in any winding up assets

where expenses in relation to which a creditor has indemnified a liquidator have been recovered, the Court may, on the application of the Official Receiver or the liquidator or any such creditor, make such order as it deems just with respect to the distribution of those assets and the amount of those expenses so recovered with a view to giving those creditors an advantage over others in consideration of the risk run by them in so doing".

We have added the figures (i) and (ii) to identify the first and second limbs of this section.

2. This appeal turns upon the true construction of this section and is the first time it has come before the Hong Kong Court. The section has no equivalent in England, where its sporting implications have apparently not found favour. Its origins can be traced to the bankruptcy provisions in force in one or more States in Australia before 1900, which provisions were later extended to liquidations. In Australia now, section 450 of the Companies Act 1981 is substantially identical to section 265(5B): but section 109(10) of the Bankruptcy Act 1966 differs in that the two limbs are reduced to one. We are indebted to the diligence of counsel in putting before us a number of Australian decisions upon the construction of these provisions and of their predecessors, and readily acknowledge the assistance we have derived from them.

3. The material facts are as follow. Kiu May Construction Co. Ltd. was wound up on 11th June 1984 and the respondent was appointed liquidator. Its ordinary creditors total $13,369,845. Its assets consist of :-

(i) such as it is, falls to be distributed pari passu. The issue is whether the same applies to (ii), or whether it is "just" that a particular group of creditors should receive preferential treatment.

4. One of the companies' book debts was a sum of $1.989 m. allegedly owing by Great Eagle. At a meeting of the Committee of Inspection held on 13th March 1985 it was agreed to expend up to $10,000 on obtaining counsel's opinion and/or upon his settling of a statement of claim against Great Eagle. The creditors attending this meeting, both members of the Committee of Inspection and others, agreed to cover this cost.

5. For this total fee counsel gave his opinion, which was favourable, and settled a statement of claim. In its light, on 17th May 1985 the Committee sanctioned the institution of proceedings against Great Eagle. Six creditors present were prepared to contribute H K $150,000 pro rata their respective claims towards the legal costs of these proposed proceedings upon condition that the net proceeds were distributed : -

                (a) to repay all contributions;

                (b) to pay preferential creditors;

                (c) pro rata amongst the contributing creditors.

The respondent pointed out that distribution (c) would depend upon an application to the Court under this section. Thereafter the respondent informed all creditors of this position and invited further contributions. The upshot was that creditors with claim totalling just over $9 m. contributed $286,072 towards the cost of these proposed proceedings upon the basis that the net proceeds would be distributed as in (a) and (b) above and in the expectation of an application being made to the Court by the respondent under this section.

6. On 4th June the respondent applied to the Court for an order pursuant to this section in the following terms, namely :

"That all creditors who or before the 10th June 1985 had paid their respective contributions to the Official Receiver for the purpose of funding the proposed proceedings against Great Eagle be entitled pro rata the amount of their respective contributions to the net amount (if any) recovered from Great Eagle after the repayment of their respective contributions and payment of all preferential claims in this liquidation".

In his report to the Court the respondent argued that such order could be made at that time as it would "enable the protection and preservation of assets which would probably otherwise prove irrecoverable". Upon reading the documents and without further argument Jones J. on 5th June made an order in the terms requested.

7. Great Eagle was due to issue a prospectus for a rights issue on 10th June. Sensing that this would inhibit further prevarication by that Company, the respondent renewed his demand for payment on 7th June. Great Eagle made a small offer. The respondent coupled his rejection of this, with a warning that he was in a position to institute proceedings immediately and that subject to sanction he was prepared to accept $1.95 m. in full and final settlement. Great Eagle capitulated and paid that sum the following morning.

8. On 13th June the Committee of Inspection sanctioned this settlement, but were divided as to the distribution of the proceeds. It was arranged for the respondent to apply to the Court for further directions, and for the appellant to advance the argument of the contributing creditors for a preferential distribution to them pursuant to the order of 5th June. After argument, Jones J. on 12th June rejected the contributing creditors' claim for preference under this section. From that decision the appellants on behalf of themselves and the contributing creditors now appeal.

9. The first question which arises is whether the Court has jurisdiction under this section to make an order before, or only after assets "have been recovered" or "have been protected or preserved". In making his ex parte order of 5th June, the Judge seems to have been persuaded by the respondent's argument that he could act then. Again on 12th July he felt able to take a "broad view" of the section and reached the same conclusion.

10. For a number of reasons we cannot agree. First, we share the view taken in Australia, and apparently first expressed by Walker J. in Re Lance, Ex pte Official Assignee (1900) 21 NSW R29 and in Re A. Shadler Ltd. (1904) 5SR (NSW) 33, that as the section created an exception to the general rule of pari passu distribution, the Court had to construe it strictly and could only act in circumstances which fell fairly within its precise terms.

11. Secondly, the consistent use of the past tense in the section is in our view decisive and deliberate. The Court is only empowered to consider what is just after the material recovery and with the wisdom of hindsight. It can then see exactly what steps have had to be taken, and measure precisely the risk or risks in fact run by the material creditors. The facts of this case illustrate the difficulties and dangers of making an assessment in advance.

12. Thirdly, a clear distinction is drawn in the section between the first and second limbs, between recovery on the one hand and protection and preservation on the other. The first seems to contemplate litigation initiated by a liquidator; the second contemplates perhaps more defensive action. In our view this $1.95 m. could only constitute assets ''recovered".

13. We are therefore constrained to conclude that the Order of 4th June was made without jurisdiction.

14. The next question is whether the subscribing creditors here can be said to have provided "an indemnity" within the meaning of this section, having regard particularly to the fact that the phrase "payment of moneys" appears only in the second and not in the first limb. It is not inappropriate here to notice the bankruptcy origins of this section, and that section 109(10) of the Australian Bankruptcy Act 1966 has one limb which refers only to "an indemnity". The two limbs in this section may well reflect the differences between the respective liabilities for costs of trustees in bankruptcy and liquidators. The trustee in bankruptcy is in general personally liable for a successful defendant's costs, and accordingly needs an indemnity against both that risk and his own costs: Williams on Bankruptcy, 19th edition, p. 403. A liquidator may be personally liable in an application brought in his name, Re Wilson Lovatt (1977) 1 All E. R. 274: but if he sues in the name of the Company he risks no personal liability and a defendant's sole remedy is to seek security for his costs: Buckley on the Companies Act, 14th edition; Vol. I, p. 600.

15. The proposed proceedings against Great Eagle would have been brought in the name of the company. The respondent therefore needed protection for his own costs and the means in hand to provide security (if necessary) for the defendant's costs. This factor coupled with the respondent's natural desire to have the security of cash deposits, as opposed to a paper indemnity, explained the manner in which the contributions were requested and made in this case. Both parties joined in submitting that these contributions were not only "payments of money". They amounted in all to a fortified indemnity of the respondent up to the total sum contributed, which sum was regarded by the respondent as sufficient for the institution of proceedings. We agree. "If necessary": said Vaughan Williams J. in Re London Metallurgical Co. (1895) 1 Ch. 758, 768, "creditors in liquidation, as in bankruptcy, must provide an indemnity fund". That is precisely what these creditors did.

16. It follows that on 12th July the learned Judge had jurisdiction to make an order under this section, and the last question is whether he was right in the exercise of his discretion to refuse one. Helpful general guidance as to the exercise of this jurisdiction can be found in the judgment of Jefferies J. in Re Farrow (1957) QSR 452, 458 where he says :

"Each case must stand on its own footing, and a Judge must arrive at the best conclusion he can after weighing all the circumstances, the amount of risk run, the amount recovered, the proportion between the debts of indemnifying creditors and the non-indemnifying creditors and all other matters".

Of these factors the section requires the Court to have particular regard to the seriousness of the "risk run".

17. We agree here with the Judge's dismissal of this as minimal. We think there is considerable force in the respondent's argument that on the terms upon which the indemnity fund was created here, the creditors were accepting a future risk which never materialised because no proceedings were ever commenced. But we are prepared to deal with the matter, as did the Judge, on the more favourable basis that the indemnifying creditors in fact impliedly accepted the obligation of the original group for counsel's fees the only cost in fact incurred. This obligation has of course been discharged by the respondent out of the moneys recovered, and he has also returned all contributions with interest. In such circumstances we conclude that justice does not require the contributing creditors to be preferred over the remaining creditors in the distribution of this $1.95 m.

18. This appeal is therefore dismissed. Having regard to the difficulties attendant upon the exercise of this jurisdiction, we would be minded to extend the parties' agreement on costs in the Court below to this Court, and make an order nisi that the costs of both parties on a common fund basis be paid out of the funds in this liquidation.