RE TIFFIT SECURITIES (HONG KONG) LTD

HCCW 86/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO. 86 OF 2007

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REASONS FOR DECISION

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1.  By this application, the Liquidators of Tiffit Securities (Hong Kong) Limited (“the Liquidators” and “the Company” respectively) seek directions essentially as to the manner in which dividends in the liquidation to be paid to clients of the Company with claims against it (or shares to be returned to such clients) should be apportioned between the individual clients and the Investor Compensation Company (“the ICC”), which manages the Investor Compensation Fund (“the Fund”) under the Securities and Futures Ordinance (Cap. 571), where the client concerned made a claim on the Fund on the failure of the Company.  Their position was that the Subrogation Percentage, which would determine the relative entitlements to such dividends as between the Investor Compensation Company Limited (“the ICC”) and the client concerned, should be calculated by reference to the loss sustained by the client using the closing prices of the shares in question on 18 July 2006, the date on which the Securities and Futures Commission (“the SFC”) served a restriction notice on the Company by which the Company was prevented from carrying on business.

2.  At the hearing, I made an order substantially in terms of the summons, and indicated that I would give my reasons at a later date.  This I now do.

3.  The background to this matter is that the Liquidators were initially appointed as Administrators of the Company on the application of the SFC pursuant to section 213(2) of the Securities and Futures Ordinance, shortly after the service of the restriction notice.  Following the winding up of the Company on 2 May 2007, they were appointed its liquidators on 9 October 2007, having previously been appointed as its provisional liquidators.  Prior to the winding up of the Company, in their capacity as Administrators, they had sought directions as to how they should approach claims by clients of the Company who had deposited shares or cash with the Company, in circumstances where there was a shortfall of shares and cash on hand, compared with the quantities of shares and amounts of cash that should have been held by the Company on behalf of such clients.  By an order dated 20 November 2006 (“the November Order”) I gave certain directions as to this.  By a further order dated 18 January 2007(“the January Order”), Kwan J gave further directions for this purpose.

4.  Following the winding up of the Company, Kwan J directed that the claim notices filed by the clients with the ICC, which had been dealt with by the Liquidators in accordance with the November and January Orders, should be treated as proofs of debt for the purposes of the liquidation.

5.  Under the Securities and Futures (Investor Compensation – Claims) Rules (Cap. 571T) (“the Rules”), which govern the operation of the ICC and the Fund, the ICC may, if it is satisfied that a client has suffered loss in respect of securities or cash deposited by him with his stockbrokers, make a payment to the client in respect of such loss, limited to a maximum payment of HK$150,000.  For the purpose of calculating the loss in respect of which such compensation may be paid, Rule 7(3)(a) requires such loss to be assessed by reference to the value of the shares as at the date on which the stockbroker in question defaulted on its obligations to its client.  For present purposes, that is the date of the restriction notice which the SFC served on the Company, namely 18 July 2006.

6.  Where the ICC pays compensation to a client, it is given a right of subrogation in respect of any claims that the client may have against the stockbroker concerned by section 87(1)(a) of the Ordinance.  However, under that section, the right of subrogation is limited in that it entitles the ICC to share in any recoveries by the investor from the stockbroker concerned in the same proportion as the amount of compensation paid bears to the loss that the client has suffered.  Thus, where a client has suffered a loss of, say, HK$100,000, he will generally be paid in full as the loss will be less than the maximum amount of compensation that can be paid.  In such a case, the ICC will have a right of subrogation for the full amount of the compensation paid.  However, where the loss exceeds the maximum amount of compensation payable, the client will only receive HK$150,000 from the Fund.  Thus, where a client suffers a loss of, say, HK$200,000, he will receive at most HK$150,000 from the Fund.  In this situation, the ICC will be entitled to share in any recovery made by the client from the stockbroker concerned in the proportion of 150,000:200,000, or 3:4.  Expressed in percentage terms, this means that the ICC will be entitled to receive 75% of any recovery, with the client receiving 25% of such recovery.  The percentage of the recovery to which the ICC is entitled in any particular case is the Subrogation Percentage which is the subject of this application.

7.  Where the stockbroker concerned is solvent, this is unlikely to present any problems, since the client will simply recover his loss in full, out of which the ICC will recover the amount of compensation paid to the client.

8.  The complication that has arisen here is the result of the fact that, under Rule 82(1)(b) of the Companies (Winding-Up) Rules, the amount of the clients’ claims against the Company in its liquidation must be ascertained as at the date of the commencement of the liquidation, 2 May 2007.  This is some 9½ months after the date of default by reference to which such claims were valued for the purposes of the clients’ claims lodged with the ICC.  Apart from the unlikely scenario where the market price of any missing securities was the same on both of these dates, the amount of the loss for which the client’s proof should be admitted will be different from that on the basis of which compensation was paid.  For example, if the price of the shares in the example I gave above had increased between those dates, the amount of the loss that would have been suffered would also increase.  Conversely, if the price of such shares had fallen, the loss would be smaller.  The question would therefore arise as to which loss figure should be used to calculate the Subrogation Percentage.

9.  It is for this reason that the Liquidators wish to obtain directions giving guidance as to the appropriate basis on which the Subrogation Percentage is to be ascertained, so that they will then be in a position to make distributions from the available assets of the Company, and divide the amount payable in respect of a particular client’s loss between the client and the ICC in the appropriate way.  The Liquidators’ position is that the Subrogation Percentage should be ascertained by reference to the loss on the basis of which compensation was paid – i.e., that ascertained on the basis of the value of the shares in question on the date of default, and not on the basis of the loss as at the date of winding up.

10.  In practical terms, the effect of this will be that where the share price for the shares in question has risen between the date of default and the date of winding up, the subrogation percentage will be higher than it would have been had the loss on the basis of which it is calculated been ascertained as at the date of the winding up.  Where the price of the shares has fallen, the converse will be true.  It should, however, be emphasised that the ICC will not under any circumstances recover more than the amount of compensation actually paid – if the application of the subrogation percentage on the basis proposed means that the ICC’s share of any recovery (in this case, dividend payment) exceeds the amount of the compensation paid (which may happen, depending on the level of the dividend payable in the liquidation and the Subrogation Percentage in the particular case), any surplus will simply be paid to the client.  This is obviously right, since the purpose of the right of subrogation conferred on the ICC is to enable it to recoup payments it has made, and not to derive a windfall gain.

11.  In my view, given that the client’s ability to claim compensation, and the ICC’s corresponding right to subrogation, arise out of the Ordinance and the Rules, it necessarily follows that the Subrogation Percentage is to be determined by reference to the losses on the basis of which compensation was paid by the ICC, as the relationship between the client and the ICC must be governed by the Ordinance and the Rules, pursuant to which compensation out of the Fund is payable.  These provide clearly that the date at which the loss is to be assessed, on which basis the compensation is to be paid, is by reference to the date of default.

12.  Whenever a client makes an application for compensation, he invokes the provisions of the Ordinance and the Rules.  His entitlement to compensation from the ICC, and the rights as between himself and the ICC should therefore be crystallised on the same basis.  I see no reason for concluding that the Subrogation Percentage might then vary from that arrived at on the basis of the loss for which compensation was paid depending on the happenstance of what ultimately proves to be the loss suffered by the client, whether in the course of proceedings brought by the client against the stockbroker concerned, or in the course of a proof filed by the client in the winding-up of such stockbroker, in either of which situations a different date for the assessment of the client’s loss may arise.

13.  Thus, as between the client and the ICC, where the client chooses to make a claim against the ICC and to seek compensation, he does so on the basis that he thereby enters into an arrangement by which he and the ICC are bound as between themselves by the provisions of the Ordinance and the Rules relating to that aspect of the matter.

14.  An alternative way of looking at it would be that, so far as the client is concerned, having received compensation, the situation is that, as between himself and the ICC, any recoveries made thereafter must be shared between himself and the ICC in the proportion that the compensation paid bore to the loss suffered.  In that context, since the compensation is paid by reference to a loss which is assessed as at the date of default, for the purpose of ascertaining that proportion, the loss to be used must be the loss on the basis of which the ICC paid compensation.  That is the loss assessed by reference to the value of the shares in question at the date of default.  Once that proportion is determined, it governs the relationship between the client and the ICC for all purposes thereafter, so that whatever the forum, or whatever the way, in which the client ultimately recovers his losses, any recovery made in respect of the losses arising out of the same relationship must be shared between the client and the ICC in the same proportion.

15.  Thus, what will happen in the winding-up of the Company is that the client will put in his proof of debt (in this case, he is treated as having done so by his claim form where he made a claim for compensation), which will be admitted by the Liquidators.  Having ascertained the value of the claim (by reference to the date of the winding-up), the appropriate dividend can be worked out.  Once the amount of the dividend is known, the Liquidators will be able to allocate it as between the investor and the ICC in accordance with the Subrogation Percentage calculated as set out above.

16.  In doing that, the Liquidators will in effect be adjudicating on the separate claims by the ICC in its capacity of subrogated creditor and by the client personally.  In doing so, they must take into account the rights of the ICC and the client inter se, and would therefore be bound to apply the Subrogation Percentage that arises as a result of the application of the Ordinance and the Rules, rather than a percentage that arises on the basis of the claim in the liquidation, which would be based on a date well after the date of default, and which would vary depending on how the price of the shares in question had moved in the meantime.

17.  I am therefore satisfied that the appropriate date to use for the purpose of determining the Subrogation Percentage is the date of default: in this case, 18 July 2006, and it is therefore appropriate that a direction should be given in accordance with paragraphs 1 and 2 of the Liquidators’ summons. The remaining direction sought is consequential on this determination, so I shall make that direction as well.  As far as the costs of the application are concerned, these are to be paid out of the assets of the Company.