YEUNG LUI MING and LAI KAR YAN as the Joint and Several Trustees of the Property of WONG YUK TUNG (A BANKRUPT) v. TANG MO LIN, IRENE AND ANOTHER

CACV 387/2019

[2021] HKCA 1056

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 387 OF 2019

(ON APPEAL FROM HCA NO. 1197 OF 2015)

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J U D G M E N T

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Hon Cheung JA (giving the Judgment of the Court) :

I. The appeal

1.1  The plaintiffs are the trustees in bankruptcy of Mr. Wong Yuk Tung (deceased) (the ‘Bankrupt’).  The Bankrupt was made bankrupt by an order dated 1 June 2009 (‘the bankruptcy order’). The bankruptcy order was discharged on 1 October 2013.  The Bankrupt was one of the directors and shareholders of the 2^nd defendant (‘Cheong Tai’) (until 28 May 2007) and Bright Success Management Company Limited (‘Bright Success’) (till 29 May and 1 June 2009).  He was also a director and majority shareholder of the following two companies :

1)  (until 4 May 2009), Perfecta Dyeing, Printing & Weaving Works Limited (振裕染印織造廠有限公司) (in liquidation) (‘Perfecta’), which was ordered to be wound up on 4 May 2009.

2)  (until 22 December 2009), Silver Yield Industries Limited (in liquidation) (‘Silver Yield’), Silver Yield was the holding company of Panyu Tanzhou Perfecta Weaving Dyeing & Printing Limited (廣州番禺潭洲振裕紡織染印有限公司) (‘Panyu Perfecta’) in the Mainland and was ordered to be wound up on 17 August 2011.

1.2  The 1^st defendant (‘Tang’) joined Cheong Tai in May 1982.  Tang and the Bankrupt were co‑shareholders and co‑directors until the transfer of the Bankrupt’s shareholdings to her and the Bankrupt’s resignation as director on 28 May 2007.  Thereafter, Tang became the sole shareholder of Cheong Tai.  She was and still is a director of Bright Success and Wintop Inc Ltd (‘Wintop’).

1.3  Thierry Kouan Kian Wong (‘Wong’) is the son of the Bankrupt.  He was a director and shareholder of Perfecta until 1 June 2009 when a bankruptcy order was issued against him.  Since his bankruptcy he was employed as a consultant in one of Tang’s companies. 

1.4  Deputy High Court Judge To acceded to the plaintiffs’ application against the defendants under section 49 of Bankruptcy Ordinance (Cap. 6) to set aside two transactions entered into by the Bankrupt.  The first transaction is a sale and purchase agreement apparently dated 23 January 2007 between the Bankrupt as vendor and Tang as purchaser (the ‘Agreement’) whereby 300,000 Class B shares (‘the Sale Shares’) in Cheong Tai was sold to Tang for a consideration of $60 million.  Under clause 2 of the Agreement, the consideration comprised of :

1)  a set-off portion in the sum of $46,027,413 being used to set-off a debt of that amount owed by Perfecta and Panyu Perfecta (collectively, the ‘Perfecta Group’) to Cheong Tai which was assumed by the Bankrupt; and

2)  a cash portion in the sum of $13,972,587 (the ‘cash portion’).

1.5  Paragraph 5 of the preamble of the Agreement stated that the Bankrupt would at no consideration procure Bright Success to transfer the legal and beneficial ownership of 38 cemetery sites in Da Peng Bay to Tang or her nominee. 

1.6  The second transaction is a deed of transfer dated 7 June 2007 (‘the Deed’) whereby the Bankrupt for nil consideration and pursuant to the Agreement procured Bright Success to transfer to Wintop which was Tang’s nominee the 38 cemetery sites at $1,805,680.20 (average price of $47,517.90 each). 

1.7  On 8 June 2007, 47 of the remaining cemetery sites were transferred to the Bankrupt, his wife, Lise Wong and Wong by two deeds of transfers at the price of $46,500 each. Those 47 cemetery sites were further transferred to Wintop at the price of $90,000 or $110,000 each.

1.8  On 28 May 2007, Cheong Tai filed Form SC7 stating that it provided financial assistance to Tang in the sum of $60 million on that date.

1.9  It is the Trustees’ case that the Agreement, the sale and transfer of the Sale Shares, the Deed and the transfer of the 38 cemetery sites to Wintop formed one composite transaction.

1.10  The Judge held that the Agreement and the Deed were entered into within a period of two years prior to presentation of the bankruptcy petition of the Bankrupt on which he was adjudged bankrupt.  The Judge held :

‘ 212. The Agreement was at an undervalue and a disposition with intent to defraud creditors. Of the stated consideration of $60 million under the Agreement, the Bankrupt only received $13,972,587 by way of cash and a set-off of $39,711,444.11 [see 2.3 below]. He was not paid his consideration for the transfer the 38 cemetery sites, which was $1,595,455.84. There was a total shortfall of $7,911,424.73. On this basis, Tang is obliged to make good the shortfall.

213.   Furthermore, the entire set-off portion of the consideration was illusory in that Perfecta’s and Panyu Perfecta’s debt acquired by the Bankrupt were worthless.  The Bankrupt exchanged his good assets in a profitable company for debts in two insolvent companies.  This is not the case where the assets exchanged turned valueless because of some subsequent events.  This is not a case where a peppercorn is good consideration for a Rolls Royce.  By virtue of his position in Perfecta, the Bankrupt knew full well that Perfecta was insolvent and was not in any position to repay the debt assumed by him.  Tang knew that as well.  As a result of the Agreement, the pool of assets available for distribution to creditors was significantly reduced.  The dispositions under the Agreement was a defraud on the Bankrupt’s creditors.  Tang, who had received the Sale Shares, is required to repay the value represented by the illusory consideration, ie the full value represented by the set-off portion of the consideration, ie $46,027,413 and the consideration not received by the Bankrupt for the transfer of the 38 cemetery sites in the sum of $1,595,455.84. The total shortfall is $47,622,868.84.  That sum is inclusive of the shortfall of $7,911,424.73 referred to in the above paragraph.

...

215.     ...... The only remedy available to the Trustee is an order for damages to make good the shortfall in consideration for the Sale Shares.  Accordingly, I make an order that Tang shall pay damages to the estate of the Bankrupt in the total amount of $47,622,868.84.  This amount is based on my finding that the set-off portion of the consideration, whatever the amount set-off, was illusory and that part of the consideration paid by the Bankrupt which has not been taken into account in the Agreement was the loss in value of his 80% shareholding in Bright Success.  The 1^st defendant shall pay interest on the above amount from the date of the writ until judgment at the rate of prime rate plus one percent and thereafter at judgment rate until full payment.’

1.11  The defendants now appeal.

II.  The foundation of the plaintiff’s claim

2.1  The Judge succinctly summarised the foundation of the plaintiff’s claim :

‘ 84. The insolvency of Silver Yield, Perfecta and Panyu Perfecta is the underlying basis of the Trustees’ case that the transaction was a disposition with intent to defraud creditors and at an undervalue in the sense that as a result of the transaction the Bankrupt exchanged his good assets for bad assets and Cheong Tai exchange its bad assets for good assets. The good assets were the Sale Shares. The bad assets were Perfecta’s and Panyu Perfecta’s debts owed to Cheong Tai and Cheong Wah respectively, which stood no chance of ever being repaid.’

2.2  The Judge elaborated on the insolvency of Silver Yield and Perfecta :

‘ 85. According to the audited financial statements for the years ending 31 March 2006, 2007 and 2008, Silver Yield was balance sheet insolvent. Its loss had been accumulating since 2006. Its balance sheets recorded a deficit of $158.1 million, $160.5 million and $167.2 million in those three years, respectively. In the audited financial statement for the year ended 31 March 2007 (just two months before the date when the Agreement was signed), the auditors opined that there was fundamental uncertainty as to its going concern.

86. In paragraph 5 of the Affidavit of Gordon Chan, the Bankrupt’s solicitor, filed under HCB 1592/2009, Gordon Chan deposed on behalf of the Bankrupt that the Bankrupt became bankrupt due to pledging his own credit to secure financing for Silver Yield which in turn supported Perfecta.  Due to losses at Perfecta it was unable to repay Silver Yield which also became insolvent.  A winding‑up petition was presented against Silver Yield on 15 June 2009 and the company was ordered to be wound up on 17 August 2011.  While the affidavit was about the financial condition of the Bankrupt and Silver Yield prior to June 2009, their dire financial condition would not have developed overnight, but must have been a gradual process which started much earlier.  It probable started in the year 2005/2006 when its financial statement showed a deficit of $158.l million.  Silver Yield was insolvent at the time of the Agreement and the Deed in 2007.

87. Perfecta’s audited financial statement for the three years ended 31 March 2006, 2007 and 2008 showed net assets of $204 million, $175.5 million and $90 million, respectively.  However, it included trade amounts due from Silver Yield in the amount of $427 million, $399.8 million and $408 million in those three years respectively.  According to Wong, the sum was lent to Silver Yield “to do business”.  As Silver Yield was insolvent, the debts were bad debts.  Excluding the said bad debts, Perfecta would have recorded total net liability of $223 million, $224.3 million and $318 million respectively for those three years.  Perfecta is therefore balance sheet insolvent.’

2.3  The Judge held that the Bankrupt had not had the full value under the Agreement of the set‑off portion of $46,027,413 :

‘ 179. On the defendants’ case, the set-off portion consisted of three components, namely (1) various loans from Cheong Tai to Perfecta Group (which includes Perfecta and Panyu Perfecta) in the total sum of $23.3 million; (2) Perfecta’s trading debts totalling $5,123,718.10; and (3) two loans owed by Panyu Perfecta to Cheong Wah (a subsidiary of Cheong Tai) in the total sum of RMB 17 million. In the analysis above, the defendants have only succeeded in proving this three indebtedness in the amounts of $18,300,000, $16,747,856 and $4,463,588.11, making a total of $39,511,444.10. In total, the Bankrupt did not receive the full value of the set‑off portion of the consideration to the extent of $6,515,968.89.

180.  But, in respect of the value which the Bankrupt received, it is unsecured debt owed to him by Perfecta Group.  Perfecta Group was a failing group at the time of the Agreement.  The Bankrupt and Tang must have knowledge of the financial condition of Perfecta Group.  Perfecta was ordered to be wound up on 4 May 2009 following the presentation of a petition for its winding up and a petition for the Bankrupt’s bankruptcy on 6 February 2009. Silver Yield, the holding company of Panyu Perfecta was ordered to be wound up on 17 August 2011 following the presentation of a winding-up petition on 15 June 2009.  The effect of the Agreement was that the Bankrupt exchanged his shareholding in a profitable company with the debts of Perfecta Group which was in a net current liabilities position.  It was in fact insolvent and would be unable to repay the debts assumed by the Bankrupt.  The debts of Perfecta Group assumed by the Bankrupt is worthless.  This part of the consideration is illusory.  For this reason, the Bankrupt has not received the entire value of the set‑off portion of the consideration, not just short of $6,515,968.89 as calculated above.’

2.4  In respect of the 38 cemetery sites the Judge held :

‘ 181. The Trustees argue that the Bankrupt suffered a loss in the value of his 80% shareholding in Bright Success by reason of the transfer of the 38 cemetery sites to Wintop pursuant to paragraph 5 of the preamble to the Agreement. The 38 cemetery sites had a market value of $90,000 or $110,000 each. For easy quantification, I assess their total value at $3,800,000. They were transferred to Wintop for $1,805,680.20. Bright Success therefore suffered a loss in the value of its equity equivalent to the difference between the market value and the amount it received, ie $1,994,319.80. Hence, the value of the Bankrupt’s 80% interest in Bright Success was diminished by $1,595,455.84. The Trustees claim this loss as value not received by the Bankrupt under the Agreement.’

II.   Grounds of appeal

3.1  Two grounds of appeal are relied upon by the defendants.

3.2  The first ground relates to $16,747,856 which is part of the set-off portion (the ‘Panyu Perfecta Debts’).  Mr. Pow SC (together with Mr. Tang) for the defendants argued that the Judge erred in finding that the Panyu Perfecta Debts were illusory and worthless.

3.3  The second ground relates to the balance of the set‑off portion (the ‘Perfecta Debts’) in the sum of HK$22,963,588.11.  Mr. Pow also argued that the Judge erred in finding the Perfecta Debts were illusory and worthless.

IV.     Panyu Perfecta Debts

1)  The defendants’ arguments

4.1  Mr. Pow argued that the Judge had wholly failed to identify relevant evidence, analyse them and make findings as to whether Panyu Perfecta was insolvent and unable to pay its debts as of the actual date of the Agreement, i.e. 28 May 2007.  His finding ignored the objective uncontradicted evidence adduced by the plaintiffs itself at trial, namely the audited financial statement (‘AFS’) of Panyu Perfecta, which clearly shows that Panyu Perfecta was solvent and capable of repaying its debts as at 28 May 2007.

4.2  Mr. Pow developed his arguments by reference to Schedule 1 of the Amended Notice of Appeal which discussed the AFS of Panyu Perfecta for the year ended 31 December 2017 (‘Panyu Perfecta AFS’).  From this schedule Mr. Pow referred to nine items which show that Panyu Perfecta was in a healthy state :

(1)  Its registered capital had been increased from US$61,800,000 to US$76,800,000 and that the new injection of capital was completed by 2 June 2007.  Furthermore, after merging with Panyu Tanzhou Fengyu Garment Manufacturing Company Limited the registered capital became US$77,360,588;

(2)  The total assets as at the beginning and the end of 2007 were approximately RMB 1.77 billion and RMB 1.55 billion respectively;

(3)  The total liabilities as at the beginning and the end of 2007 decreased from approximately RMB 861 million and RMB 627 million respectively;

(4)  The total owner’s equity as at the beginning and the end of 2007 was approximately RMB 911 million and RMB 923 million respectively;

(5)  Panyu Perfecta had fixed assets to the approximate value of RMB 966 million with an additional land use right valued at approximately RMB 105 million;

(6)  During that financial year, the ‘current liabilities’ saw a substantial reduction of about RMB 201 million from approximately RMB 750 million (at the beginning of the year) to RMB 554 million (at year end).  Similarly, there was a substantial reduction of ‘long term liabilities’ of RMB 42 million from approximately RMB 110 million to RMB 68 million.  This was the clearest indication of Panyu Perfecta’s ability to pay its debts when due;

(7)  The ‘undistributed profit at the end of the year’ was approximately RMB 67 million;

(8)  During that financial year, there was cash inflow of approximately RMB 529 million and the company made repayments of RMB 539 million. This also indicated that Panyu Perfecta was able to repay its debts; and

(9)  During that financial year, Panyu Perfecta’s monetary funds in hand increased from approximately RMB 6 million to RMB 7.3 million.

4.3  Mr. Pow further argued that it was never the plaintiffs’ pleaded case that Panyu Perfecta was insolvent at the date of the Agreement.  The plaintiffs’ pleaded case on insolvency pertained merely to Perfecta (by reason of the purported insolvency of Silver Yield).  They did not plead that Panyu Perfecta was insolvent or unable to pay its debts as at the material date of 28 May 2007.

2)  Discussion   

4.4  I will deal first with the argument on lack of findings by the Judge.  The parties clearly knew the issue concerns Panyu Perfecta’s solvency because Panyu Perfecta and Perfecta are part of the Perfecta Group. Panyu Perfecta in turn is a subsidiary of Silver Yield.  The defendants did not raise any objection on pleadings before the Judge.  As apparent from the judgment, the focus of the defendants’ arguments (not by Mr. Pow who only appeared in the appeal) below was on the solvency of Silver Yield and Panyu Perfecta and extensive submissions were made on the financial statements of these two companies.  But the solvency of Panyu Perfecta was also canvassed.

4.5  First, the Panyu Perfecta AFS was considered.  The Judge stated that :

‘ 99. Perfecta Group [which consisted of Perfecta and Panyu Perfecta] was laden with debts. It owed Cheong Tai and Cheong Wah $46 million. It owed Lise Wong $40 million since 2002. The Bankrupt had been pouring money into the companies to keep them afloat which led to his own bankruptcy. The cash portion of the consideration under the Agreement and the proceeds of sale of the 38 cemetery sites were paid to Perfecta. In the face of these facts, any suggestion based on the financial statements of Panyu Perfecta that the three companies were extremely financially healthy must be viewed with grave suspect. This is particularly so as the defendants have not denied the Trustees’ case of Perfecta’s insolvency and has not pleaded any positive case to the contrary. The defendants only pleaded that they have no personal knowledge as to Perfecta’s insolvency and thought it was ‘profitable’.’ (emphasis added)

4.6  The Judge further rejected Wong’s evidence who claimed that Perfecta was in a healthy financial state and it only suffered loss as a result of the fire in Panyu Perfecta.  The Judge held :

‘ 102. In the face of the evidence I mentioned above, I am not the least impressed with Wong’s evidence. Wong painted a very rosy picture of Perfecta’s business. Turnover and profits increased. Banks and people in the industry were willing to lend because Perfecta was expanding and had a promising future. On the other hand, the incontrovertible evidence is that before the fire Perfecta was already suffering from cash flow problem caused by Panyu Perfecta’s or Silver Yield’s inability to repay their debt to Perfecta. Perfecta owed Lise Wong $40 million. Perfecta Group owed Cheong Tai and Cheong Wah $46 million. Perfecta probably also owed the Bankrupt $13.9 million under the cash portion of the consideration and the proceeds of sale of the 38 cemetery sites which were paid to Perfecta instead of the Bankrupt. All these took place before the fire.’

4.7  The Judge also held at [105] that the debts owed by Panyu Perfecta to Cheong Wah was a bad debt which stands little chance of being repaid.  All this shows that the Judge had indeed considered the solvency or the lack of it of Panyu Perfecta.

4.8  The relevant test for solvency is discussed in Re  GW  Electronics  Co Ltd, CACV 24/2017, 2 April 2020.  This Court per Yuen JA held :

‘ 29.2. Insolvency may be tested by either the cash flow test (also called the commercial insolvency test) or the balance sheet test. The cash flow test is normally used and there is no reason why it should not be used in the present case. As Wilson LJ held in Paulin v Paulin :

“It is well established that the inquiry into whether on the relevant date the bankrupt was able to pay his debts is an inquiry not into whether his liabilities exceeded his assets [‘balance sheet insolvency’] but into whether he could meet his liabilities when they were due [‘commercial insolvency’]”.’

4.9  I also agree with Mr. Joffe (together with Ms. Fong and Mr. Ng) for the plaintiffs who had demonstrated by reference to the Panyu Perfecta ASF that Panyu Perfecta was clearly insolvent and the debt it owed to Cheong Wah was bad debt :

(1)  Most of its assets were not readily realizable.  The balance of account receivables (‘A/R’) as at 31 December 2007 was RMB 130 million, of which RMB 126 million was due from Silver Yield, which was both cash flow and balance sheet insolvent (net current liabilities stood at HK$412 million and net liabilities at HK$160 million).  At best, only around RMB 4 million would be realizable.

(2)  For ‘Prepayments’ of around RMB 10.93 million, RMB 10.19 million had been due for over three years, suggesting that they were unlikely to be realizable. Similarly, for ‘Other receivables’, only about RMB 8.67 million was likely to be readily realizable.  Of inventories of around RMB 312 million, only RMB 156 million (RMB 149 million + RMB 7 million) represented finished goods.  The average cost of export operations was thus RMB 486 million (RMB 548 million +  RMB  424 million/ 2), resulting in an inventory turnover of 3.12 times (RMB 486 million/ RMB 156 million), meaning it would take around 117 days (365/ 3.12) to sell the finished goods, which were hence not readily realizable.  Fixed assets of RMB 966 million included mostly land and buildings, plant and machinery, and intangible assets land use right of RMB 105 million as at 31 December 2007, all of which were unlikely to be readily realizable.

(3)  Only RMB 20.71 million of Panyu’s assets was realisable.  This was made up of funds of RMB 7.3 million, A/R of RMB 4 million, Prepayments of RMB 0.74 million (RMB 10.93 million ‑ RMB 10.19 million)and RMB 8.67 million of other receivables.  As a result, Panyu was cash flow insolvent when it had a current liability of RMB 554 million, even assuming the debts to Silver Yield (i.e. RMB 70 million) could be set off against some of the Silver Yield receivables. 

(4)  The defendants relied on increase of registered capital. But it is doubtful whether Silver Yield actually paid up.  In Silver Yield’s AFS for the years ending 31 March 2006, 2007 and 2008, there was no change in the costs of investment of shares in Panyu Perfecta, contrary to what Note 16 of Panyu Perfecta AFS suggested.  If there had been any increase in paid up share capital, the cost of investment of shares should have increased.  Further as shown in the same Note, the issued capital was not fully paid.  The 2^nd paragraph of the Panyu Perfecta AFS merely stated that the increased capital should be paid on or before 2 June 2007.  Further, the total owners’ equity of Panyu Perfecta was RMB 911 million as at 1 January 2007 and RMB 993 million as at 31 December 2007.  Without the questionable increase of issued capital of US$15 million, there was, in fact, a decrease in owners’ equity throughout the year (i.e. RMB 911 million >RMB 993 million – US$15 million (around RMB 96 million)).

(5)  Paragraph 5(3) of the Panyu Perfecta AFS stated that there was negative cash flow during the year.  There was a negative cash flow of RMB 1.65 million. This is made up of the following : net cash flow from operating activities RMB 123.63 million less net cash outflow from 1) investing activities RMB 88.54 million and 2) financing activities RMB 36.74 million.  It borrowed RMB 529 million during the year and paid out RMB 539 million as repayment of loans and RMB 27 million as interest (i.e. a total of RMB 566 million cash outflows).  It relied heavily on short term borrowings to repay loans (which could not be paid in full, and the cash flow gain under trading activities was used to repay loans), resulting in a negative cash flow of RMB 36.74 million under financing activities.  The fact that Panyu Perfecta had to refinance by short term borrowings shows that it was suffering from cash flow problems which again supports the conclusion that Panyu Perfecta was cash flow insolvent. While there was an item of positive inflow of cash of RMB 1.32 million, this was only attained due to the foreign exchange gain of RMB 2.97 million outside Panyu Perfecta’s control.

4.10  Mr. Pow in his reply was not able to refute these submissions.  In respect of the cash flow he merely referred to the net cash flows from operating activities of RMB 123,628,810.34 and the cash at hand at the beginning and end of 2007 of the respective sums of RMB 6 million odd and RMB 7.3 million without addressing the issue of negative cash flow of RMB 1.65 million.  In respect of the inventory, he argued that it could have been disposed of by means of substantial discount without any evidence of the market condition or how receptive the market may take up such ‘fire‑sale’ goods.  On the issue of short term loans Mr. Pow submitted that these loans were not due for a while without answering the contention that the heavy reliance on short term loans demonstrated that Panyu Perfecta was suffering from cash flow problems.

4.11  Mr. Pow emphasised the net equity of Panyu Perfecta of RMB 911 million.  In fact, this point was addressed by the Judge :

‘ 97. Next, Mr Smith SC [counsel for the defendants below] argues that there was some understatement in the financial statements of Silver Yield for the year ended 31 March 2007,which if adjusted would show that the financial position of Silver Yield and Perfecta was extremely healthy. He was referring to the item described as “interest in a subsidiary” in the balance sheet. “Note 8” of the same financial statement shows that “interest in a subsidiary” includes the unlisted shares of Panyu Perfecta, recorded at cost with a value of $163,950,000. However,according to the audited financial statements of Panyu Perfecta for the year ended 31 December 2007, the total net equity of Panyu Perfecta was stated to be RMB 911 odd million. Thus, Mr Smith SC submits that if this value had been recorded in the financial statements of Silver Yield, the net equity of Silver Yield, even if the amount due to Perfecta is retained, would be in excess of $580 million; or almost $1 billion if the amounts due to Perfecta are written off.

98. Mr Maurellet SC argues that the ‘erroneous’ records in the accounts cannot be taken seriously given that neither of the defendants’ witnesses had any primary knowledge of those matters and not having called those who prepared those accounts.  In my view, the auditor’s comment in the financial statement for the year ended 31 March 2007 thatthere was fundamental uncertainty as to the company as a going concern is fatal to Mr Smith SC’s submission.  In making such a damaging statement as an auditor, the auditor must have exercised due diligence and verified the accounts.  He must have cautiously considered the value of this subsidiary which was probably the most valuable asset of Silver Yield and the very reason for its own existence.  Furthermore, if the auditor was wrong about it, the Bankrupt and Wong would have jumped up, protested and caused the auditor to put it right.’

4.12  Mr. Pow argued that the audited financial statements were relied upon by the plaintiffs and admitted as evidence of truth by way of hearsay notice issued by the plaintiffs.  In my view there is a difference between the admissibility of documents and the weight to be attached to them.  In respect of the latter, section 49 of the Evidence Ordinance (Cap. 8) has identified the considerations relevant to the weighting of hearsay evidence.  The plaintiffs in this case were, of course, relying on the audited financial statements in support of their case on the insolvency of Panyu Perfecta, Perfecta and Silver Yield but the specific issue that the Judge was dealing with in [97] and [98] of his judgment was the defendants’ argument on the ‘erroneous’ records.  The Silver Yield financial statements on their face did not reveal any error.  The Judge was clearly entitled to hold that he attached no weight to this argument in the absence of testimony from the auditors. 

4.13  In my view the defendants’ submission in respect of Panyu Perfecta is really a challenge to the findings of fact by the Judge.  There is clearly evidence which supports its insolvency and the defendants have failed to demonstrate that the Judge’s finding on this issue is plainly wrong which is the threshold requirement for this Court to interfere with the Judge’s decision.

V.  Perfecta Debts

1)  The defendants’ submission

5.1  In relation to the Perfecta Debts, Mr. Pow submitted that the Judge’s finding that the Perfecta Debts were worthless was based on his view that Silver Yield and Perfecta were insolvent and were unable to pay their debts as at 28 May 2007.  This in turn was based on erroneous understanding or interpretation of the financial information contained in the audited financial statements of Silver Yield and Perfecta.  In particular :

(1)  The Judge misunderstood and misapplied a statement made by the auditors in Silver Yield’s AFS (ended 31 March 2007) under the heading ‘Fundamental uncertainty relating to the Company’s going concern’ [1) the auditor’s comment issue];

(2)  The Judge misunderstood and misinterpreted the financial data contained in Silver Yield’s AFS for the years of 2006, 2007 and 2008.  He also failed to read them in conjunction with the objective and uncontradicted Panyu Perfecta AFS. If he had done so, he should have appreciated that the ‘interest in a subsidiary’, i.e. in Panyu Perfecta, was only stated ‘at costs’ in Silver Yield’s financial statements at HK$163,950,000.  In fact, the value of Panyu Perfecta was RMB 911 million as of 31 December 2007.  If the proper value of Panyu Perfecta was adopted in his analysis, the Judge could not have concluded Silver Yield to be ‘balance sheet insolvent’ as of 28 May 2007 [2) Silver Yield’s interest in Panyu Perfecta issue];

(3)  The Judge also failed to appreciate numerous other financial data in the AFS of Silver Yield that contradicted his finding that ‘the debts owed by Silver Yield to Perfecta were unlikely to be recovered as at 28 May 2007’.  His finding was thus flawed [3) Silver Yield insolvency issue];

(4)  Flowing from his errors about Silver Yield’s financial condition and ability to repay Perfecta, the Judge then purported to ‘write off’ this debt from the current assets of Perfecta in Perfecta’s AFS (ended 31 March 2007).  He then concluded, wrongly, that Perfecta was therefore ‘balance sheet insolvent’ as of 28 May 2007.  In so doing, he misunderstood and misinterpreted various financial data in the AFS of Perfecta for the years 2006, 2007 and 2008 [4) Perfecta insolvency issue];

(5)  The Judge appears to have placed undue weight on the defendants’ ‘failure to put up a positive case’, and accordingly viewed the defendants’ contentions in relation to the healthy financial positions of Panyu Perfecta, Perfecta, and Silver Yield as of 28 May 2007 ‘with grave suspect’.  This was wrong because the defendants were entitled to put the plaintiffs to proof and the defendants’ contentions were well-supported by objective evidence discernible from the financial statements of these three companies all adduced by the plaintiffs [5) Burden of proof issue]; 

(6)  Finally, compounding from his misunderstanding and misinterpretation of the financial evidence, the Judge wrongly rejected the evidence of Wong when he explained that the financial downfall of the Perfecta Group happened after 28 May 2007.  It actually began with a fire which broke out at the factory of Panyu Perfecta on 10 September 2007.  Wong’s evidence was, in fact, corroborated by the various financial statements [6) Wong’s evidence issue].

5.2  Mr. Pow elaborated on these six issues in Schedule 2 of the Amended Notice of Appeal and in his reply submission.  The Judge had, in fact, covered many of these issues in his judgment.  Again unless the plaintiffs can demonstrate the Judge’s findings on these issues are plainly wrong, there is no room for this Court to intervene.

2)  Discussion

5.3  Before I address Mr. Pow’s submissions it is of note thatthe Judge had specifically considered the following matters relied upon by the defendants that Perfecta and Silver Yield were solvent :

(1)  The increase in turnover of Perfecta.  The Judge held that turnover is not an indicator of profitability or solvency.

(2)  The increase in profits of Perfecta.  The Judge held that profitability is not an indicator of solvency.  A company may be insolvent, due to, for example, its inability to recover the debts due from its insolvent debtor.

(3)  The positive figure for Perfecta’s net assets.  The Judge held that it is not sufficient to look merely at figures but also to the nature of the assets.  The major asset of Perfecta was the debt due from Silver Yield which is insolvent.

(4)  Perfecta and Silver Yield must be considered as a whole.  If the debt from one is to be written off, there would be an equivalent of writing off of debt due to the other.  The Judge held that this argument defied logic and the reality is that the money represented by the debt was not there.  Taking into account the $40 million loan from Lise Wong to Perfecta, the consolidated figures of the two companies would still record a total liability of HK$24.9 million. Further, Perfecta was also cash flow insolvent and had frequently borrowed from Tang and Cheong Tai.  Other evidence in support of the insolvency include, first, Gordon Chan’s statement that the $13.9 million cash consideration was used to save Perfecta; second, the Bankrupt instructed Cheong Tai to pay the purchase price for the 47 cemetery sites to Perfecta instead of to Wong and himself; third, Lise Wong’s loan of $40 million advanced since 2002 had never been repaid and fourth, Chong Hing Bank petitioned in 2009 for Bankrupt’s bankruptcy because of his failure to indemnify Perfecta’s indebtedness to the Bank of $19 million.  The financial condition must have developed earlier.

(5)  Silver Yield’s interest in Panyu Perfecta if properly recorded, would show RMB 911 million.  Its net equity would be in excess of $580 million if the amount due to Perfecta is retained and almost $1 billion if the amount due to Perfecta is written off.  The Judge rejected this by referring to the auditor’s comment.

(6)  The three companies were extremely financially healthy.  The Judge rejected this by referring to the fact that the Perfecta Group was laden with debts and the proceeds of sale of the 38 cemetery sites were paid to Perfecta.

(7)  Perfecta was healthy enough to declare a dividend of almost $50 million.  The Judge held that the dividends were probably set‑off against existing loans or ploughed back to Perfecta by loan.

(8)  Wong’s evidence suggested that Perfecta’s business was expanding and funds were needed to cope with its expansion and not because of cash flow problem.  The problem was caused by the fire.  The Judge held the company had cash flow problem even before the fire.

1)  The Auditor’s comment issue

5.4  Mr. Pow submitted that contrary to the Judge’s understanding of the auditor’s opinion, the auditor did not opine that there was fundamental uncertainty as to whether Silver Yield could survive as a going concern.  In fact, the auditor merely remarked that ‘the financial statements have been prepared on a going concern basis where the validity of which depends upon the continuing financial support of the related company as disclosed in Note 2 to the financial statements’.  The auditor did not suggest that there was appreciable risk that the related company would withdraw such continuing financial support.  The auditor then stated that the financial statements do not include any adjustments to reduce the value of assets to their recoverable amount; to provide for any further liabilities which might arise; or to reclassify non-current assets and liabilities as current assets and liabilities.  The auditor again did not suggest any appreciable risk Silver Yield might not survive as a going concern.

5.5  The auditor then stated that ‘the fundamental uncertainty has been adequately disclosed in the financial statements and our opinion is not qualified in this respect’. What the auditor did to qualify its opinion was in relation to Silver Yield’s failure to prepare consolidated financial statements including the books and accounts of its subsidiary.  Instead, Silver Yield merely recorded its interest in the subsidiary at costs.

5.6  Mr. Pow further submitted that nearly identical statements were made by the auditor in the AFS of Silver Yield for the year ending 31 March 2006 under an identical heading ‘Fundamental Uncertainty Relating To The Company’s Going Concern’.  The incontrovertible fact was that Silver Yield survived as a going concern for another year between 1 April 2006 and 31 March 2007. During this same year its turnover increased by 48%; its profit before tax was more than doubled; and the amount due to Perfecta was reduced by approximately HK$26.8 million.

5.7  Flowing from this misunderstanding of the auditor’s opinion, the Judge erred in relying on it as supportive of his eventual finding that Silver Yield (and accordingly, Perfecta) was insolvent.

5.8  In my view the financial state of Silver Yield as disclosed in its AFS speaks volumes about how healthy this company was.  This must be the context in which the auditor’s comment is to be judged.

5.9  As at 31 March 2007, Silver Yield suffered loss.  It owed Perfecta HK$399.8 million.  Its cash and cash equivalent also stood at around HK$1 million.  It was clearly cash flow insolvent (with net current liabilities) and balance sheet insolvent (with net liabilities).

5.10  There were net current and net liabilities in 2006 as well.  As Mr. Joffe submitted the fact that there were identical statements in the AFS of Silver Yield for the year ending 31 March 2006 is irrelevant. Silver Yield could have been insolvent in 2006 already with net current and net liabilities.  If Silver Yield were not insolvent, there would be no reason for the auditors to opine that there was fundamental uncertainty as to the going concern of Silver Yield, especially when the continuing financial support of the related company (i.e. Panyu Perfecta, which was already insolvent) was required.

5.11  Mr. Pow further submitted that in the AFS of Silver Yield for both years ending 31 March 2006 and 2007, the auditor (at Note 19 in each set of the AFS) remarked, under the heading ‘FINANCIAL RISK MANAGEMENT - Financial Risk - Liquidity Risk’ that ‘[Silver Yield] manages its funds conservatively by maintaining a comfortable level of cash and cash equivalents in order to meet continuous operational need.  Various banking facilities and credit lines have also been arranged with different banks in order to fund any emergency liquidity requirements’. Mr. Pow submitted that in the circumstances, there was no evidential basis to support the Judge’s finding that the debts owed by Silver Yield to Perfecta were ‘unlikely to be recoverable’ at the time of the Agreement.

5.12  In my view and I agree with Mr. Joffe that reading the auditor’s report in its proper context, Note 19 was not made by the auditor but rather it was based on the information provided by Silver Yield.

2)  Silver Yield’s interest in Panyu Perfecta issue

5.13  I have already referred to the Judge’s view in [97] of his judgment on this issue. There really is no room for this Court’s intervention on this issue.  The argument by Mr. Pow that the Judge erred in holding Silver Yield is balance sheet insolvent if Silver Yield’s stake in Panyu Perfecta is properly taken into account must be rejected.  Further as submitted by Mr Joffe, since Panyu Perfecta was insolvent, it is incorrect to treat its total net equity as the value of its shares owned by Silver Yield.  Shares of an insolvent company are worthless : Re Estate of Haque Shaquil, [2012] 1 HKLRD 689 at [33].

5.14  Mr. Pow also submitted that it is clear from the auditor’s report of Silver Yield for the year ending 31 March 2007 that they did not have books and accounts of Panyu Perfecta and had only limited information about Panyu Perfecta. The auditor stated that accordingly the ‘interest in the subsidiary’ was recorded at cost.

5.15  But as Mr. Joffe had submitted the defendants had misinterpreted the auditors’ qualification.  Instead of stating that they did not have any books and accounts of Panyu Perfecta, the auditors stated that they had not obtained all the information and explanations (not having none), and were unable to determine whether proper books of account had been kept.  Based on the auditors’ cautious approach, the Judge was entitled to infer and conclude that the auditors must have cautiously considered the value of Panyu Perfecta.

3)  Silver Yield insolvency issue

5.16  Mr. Pow referred to the ability of Silver Yield to repay part of the debts in 2007 it owed to Perfecta.  The debt was HK$426 million in 2006 and was reduced by $27 million to HK$399 million in 2007.  In my view, this paltry payment of $27 million can hardly demonstrate Silver Yield’s ability to repay its huge debt of HK$426 million or to refute the Judge’s finding that the debts owing to Perfecta by Silver Yield is ‘unlikely to be recoverable’.

4)  Perfecta insolvency issue

5.17  Mr. Pow complained that as a result of the wrong holding by the Judge that Silver Yield was insolvent, Perfecta was treated as being balance sheet insolvent and cash insolvent when its AFS showed the contrary position :

(a)  Perfecta’s AFS for years ending 31 March 2006 and 2007 showed that the turnover of Perfecta increased from HK$562.8 million to HK$716.8 million, representing a year‑on‑year increase of approximately 27%.

(b)  Similarly, its net profit increased from HK$19.3 million in 2006 to HK$20.7 million in 2007, representing a year‑on‑year increase of approximately 7.3%.

(c)  Its gross profit for 2006 was approximately 19%, whereas the gross profit in 2007 was approximately 15%.

(d)  Its cash balance in hand for 2006 and 2007 was HK$61.4 million and HK$77 million respectively.  There was an increase of nearly HK$16 million indicating a healthy cash flow situation.

(e)  At the same time, ‘trade amount due from Silver Yield’ was reduced by over HK$27 million.

(f)  Overall ‘current liabilities’ decreased by over HK$25 million in 2007 when the corresponding ‘cash in hand’ increased by HK$15.6 million.  Comparing the current liabilities towards banks, there was a significant drop of over HK$49 million in 2007.  These were clear signs of a healthy cash flow situation up to 31 March 2007.  Quite apart from wrongly concluding that Perfecta was ‘balance sheet insolvent’, the Judge erroneously ignored the fact that Perfecta was clearly ‘cash flow solvent’. The Judge’s finding at [93] that Perfecta was cash flow insolvent because it owed Cheong Tai HK$46 million was against the weight of incontrovertible evidence decipherable from the financial statements.

(g)  The retained profits of Perfecta for 2006 was HK$121.8 million and HK$92.9 million for 2007 (even after the declaration of dividends as below).  The profit for the year ending 31 March 2006 was HK$19.3 million which was increased to HK$20.7 million for the year ending 31 March 2007.  The Judge at [89] wrongly rejected these as evidence of solvency.  He simply proceeded on the erroneous basis that Silver Yield was unable to meet its debts towards Perfecta as of 28 May 2007.

(h)  Perfecta’s AFS ending 31 March 2007 showed an interim dividend of HK$600 per share totalling HK$49.6 million was declared and paid.  In this regard, the Judge erroneously dismissed the significance of this by speculating at [100] that ‘[t]he dividends were probably set‑off against existing loans or ploughed back to Perfecta by way of loan’, when there was no evidence in support of such speculation.  To the contrary, the AFS of Perfecta ending 31 March 2007 did not disclose any shareholders’ or directors’ loans, thus directly contradicting the Judge’s speculation that the dividends may have been ‘ploughed back to Perfecta by way of loan’.

(i)  As disclosed at Note 12 of Perfecta’s AFS ending 31 March 2007, personal guarantee from all the directors was released in July 2006 by the banks, clearly demonstrating the banks’ confidence in the financial condition of Perfecta.

5.18  In my view, Perfecta’s AFS does not support Mr. Pow’s case that Perfecta was solvent.  As Mr. Joffe had demonstrated, Perfecta’s 2007 AFS clearly show that it was both cash flow and balance sheet insolvent.  Of trade amounts of HK$399.9  million due from related companies, HK$399.8 million were due from Silver Yield which was insolvent and should be treated as bad debt.  Deducting HK$399.8 million from HK$540.6 million would result in current assets of HK$140.8 million and total assets of HK$203  million (i.e. HK$140.8    million + HK$62.2 million).  This is to be contrasted with its current liabilities of HK$335.8   million and total liabilities of  HK$427.4  million  (i.e.    HK$335.8    million  + HK$91.6 million).  Further, HK$52 million of cash at bank and on hand out of HK$77 million was pledged with the banks and therefore not readily realizable.

5.19  Mr. Pow’s submission on the increase in turnover or net profits or other figures is irrelevant because only the cash flow test and balance sheet test should be adopted.  A company can make profits but at the same time be insolvent.  The fact that the directors of Perfecta were released from guarantees in July 2006 and there was a declaration of dividends is also irrelevant.  In Note 11 of Perfecta’s AFS for the year ended 31 March 2008, there were personal guarantees from directors during the financial year (i.e. during the period when the Agreement was entered into on 28 May 2007). Further, a company can declare dividends even though it is cash flow insolvent as dividends can be accrued and paid subsequently.  Declaration of dividends by no means proves that a company is financially healthy.

5.20  In his reply submission, Mr. Pow stressed that Panyu Perfecta, Silver Yield and Perfecta all had positive cash flow to sustain their operation.  As of 31 March 2007 Perfecta had $77 million cash and it could easily pay off the $23.3 million debt due to Cheong Tai.  He submitted that every company is in debt at any one time.  In my view this does not assist the defendants.  The fact is that Perfecta had large liabilities.  Further, its cash deposited with the banks was pledged to obtain loans and facilities.  The repayment to Cheong Tai would have a direct impact on Perfecta’s cash flow situation and as Mr. Joffe submitted it may constitute fraudulent preference.  As the larger picture revealed, the financial conditions of these companies were all linked up.  If Panyu Perfecta was insolvent, then Silver Yield’s interest in Panyu Perfecta was worthless.  In turn, if Silver Yield was insolvent, this will have a chain like effect on Perfecta as well.  Mr. Pow has not been able to demonstrate that the Judge’s finding on these issues is plainly wrong.

5.21  Mr. Pow also complained that the Judge at [86] misinterpreted the evidence of Gordon Chan in concluding Silver Yield and Perfecta were insolvent at the time of the Agreement.  He submitted that the passage from the affidavit of Gordon Chan does not specify a definite timeframe at which Perfecta was said to be unable to repay Silver Yield leading to the latter’s insolvency in 2009.  The Judge simply inferred that dire financial condition would have started much earlier and ignored the evidence of financial health of Perfecta and Silver Yield.

5.22  Again, this is a challenge on the findings of fact by the Judge and the defendants have failed to show that the findings were plainly wrong.  The Judge’s holding that the ‘relevant time’ referred to by Gordon Chan was the time of the Agreement is further supported by the following holding :

‘ 94. In paragraph 16 of the Affidavit of Gordon Chan made on behalf of the Bankrupt due to his ill health, it was stated that the sum of $13.9 million cash consideration received under the Agreement was used to “save” Perfecta. These may be taken as the words of the Bankrupt, the very person who ran Perfecta to the ground. These words reflect that at the time of the Agreement Perfecta was in dire financial hardship and need to be saved. There is also no dispute that the Bankrupt instructed Cheong Tai to pay the purchase price for the 47 cemetery sites to Perfecta instead of to Wong and himself. That is another piece of evidence of Perfecta’s insolvency.’

5.23  There were other points made by Mr. Pow concerning Silver Yield and Perfecta’s solvency, which include the loan of $40 million from the Bankrupt’s wife Lise Wong to Perfecta and other matters.  I do not consider that these matters are of such significance that they would be able to upset the Judge’s findings on the issue of insolvency.

5)  Burden of proof issue

5.24  This point can be dealt with shortly.  It is clear that the Judge’s decision is not based simply on the burden of proof but rather on the whole of the evidence.

6)  Wong’s evidence issue

5.25  Again, the Judge’s rejection of Wong’s evidence is clearly within his province as a trial judge who had the benefit of hearing and seeing the witness before him and the task of weighing the evidence of the witnesses in the light of the other evidence, including the AFS of the three companies which show that these companies were insolvent at the time the Agreement was entered into which was before the fire relied upon by Wong.  This point does not assist the defendants.

5.26  Accordingly the defendants’ appeal must be dismissed.

3)  Respondent’s Notice

(1)     The issues

5.27  The plaintiffs issued a Respondent’s Notice dealing with the following matters :

(i)  It argued that the Judge should not treat the set off portion of the consideration to include debts in the sum of RMB 17 million made up of RMB 8 million and RMB 9 million owing to Cheong Wah by Panyu Perfecta [(i) The Cheong Wah debt issue].

(ii)  It argued that the Judge should not treat the HK$23.3 million loan owed by Perfecta to Cheong Tai to include HK$6 million advanced by Grow Up Trading [(ii) The Grow‑up Trading issue].

(iii)  It denied that the Judge did not make any findings on Panyu Perfecta’s insolvency.  Further, if this was the case, it relied on the submissions that I have dealt with to affirm the Judge’s finding that the set off portion of the consideration is illusory [(iii) The Panyu Perfecta insolvency issue].

(2)     Discussion

5.28  From the outset it has to be pointed out that no issue was taken by the defendants that issues (i) and (ii) are in the nature of a cross‑appeal.  The plaintiffs’ reliance on Bokhary PJ’s comment in Common Luck Investment Ltd v Director of Legal Aid [2002] 3 HKLRD 81 is misplaced.  Bokhary PJ held :

‘ 31. Where, as happens under a respondent's notice under sub‑para.(a) and (c) [of Order 59, rule 6(1) of the Rules of the High Court], the Court of Appeal is asked to change the trial court’s order, the situation is in reality that of a cross-appeal. But where, as happens under a respondent’s notice under sub‑para.(b), the Court of Appeal is only being asked to affirm the trial court’s order, albeit on additional or alternative grounds, the situation is not that of a cross‑appeal. In VCS v Magmasters [1984] 1 WLR 1208 at p.1209F Sir John (later Lord) Donaldson MR noted that “a respondent’s notice covers three quite different situations” and that the situation under sub‑para.(b) merely adds “further arguments to an existing appeal” while the situation under sub‑para.(a) and the situation under sub‑para.(c) is each “in reality a cross‑appeal”.’

5.29  What Mr. Pow submitted is that issues i) and ii) involve challenges to findings of fact by the Judge and the ‘plainly wrong’ threshold applies to the challenges. I agree with Mr. Pow.

(i)  The Cheong Wah debt issue

5.30  Mr. Joffe submitted that the Judge was wrong when he treated Recital 4 of the Agreement as a mistake.  Under Recital 4 the set off portion should only include debts owed by the Perfecta Group to Cheong Tai.  The Judge’s view is contradicted by the terms of the letter dated 8 July 2014 from the defendants’ own solicitor which described the RMB 9 million to be a sum from Perfecta by way of set off in Cheong Wah’s account and not a loan from Cheong Wah to Panyu Perfecta.  The solicitor was not called to give evidence to explain the mistake and adverse inference should be drawn.

5.31  Mr. Joffe also referred to other errors (such as the issue of exchange rates, clean break and others) made by the Judge on this issue.  In my view, the plaintiffs have failed to cross the threshold in seeking to overturn the findings of fact by the Judge who had discussed the RMB 17 million debt in [150]‑[162] of the judgment below.  It cannot be said that the Judge is plainly wrong on this issue.

(ii)     The Grow-up Trading issue

5.32  Mr. Joffe submitted that the HK$6 million should not be included under the set‑off portion.  He referred to the unsatisfactory nature of Tang’s explanation but still the Judge accepted that HK$6 million was a loan owed to Cheong Tai by Perfecta.

5.33  In my view it is within the province of the Judge to hold that :

‘ 134. Included in the indebtedness was a loan in the sum of $6 million actually advanced by Grow Up Trading Ltd, which was an unrelated company. Tang’s explanation was rather convoluted. In gist, her evidence is that Grow Up Trading was a company owned by her brother and she caused her brother to make the payment on behalf of Cheong Tai. I accept it was a loan owed to Cheong Tai by Perfecta.’

5.34  It has not been demonstrated that the Judge is plainly wrong on this issue.

(iii)    The Panyu Perfecta insolvency issue

5.35  I have already dealt with this issue earlier.

VI.     Conclusion

6.  The defendants’ appeal is dismissed.  The plaintiff’s Respondent’s Notice save for the Panyu Perfecta insolvency issue is dismissed.

VII.   Costs

7.  There will be an order nisi that the plaintiffs are to have the costs of the appeal.  The defendants are to have one third of the costs relating to the arguments on the Respondent’s Notice.  There will be certificate for two counsel for both the plaintiffs and the defendants.