RE PATRICK COWLEY AND LUI YEE MAN, JOINT AND SEVERAL LIQUIDATORS OF THE COMPANY

HCMP 373/2020

[2020] HKCFI 922

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANOUS PROCEEDINGS NO 373 OF 2020

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REASONS FOR DECISION

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1.  On 27 April 2020 the liquidators of what, for reasons of confidentiality, I shall refer to simply as the Company, which is in voluntary liquidation, applied to the Court for a direction pursuant to s255 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32 (“Ordinance”), or the following order:

“It is appropriate for the Applicant to enter into the agreement ….and that such agreement be approved.”

2.  The agreement to which the summons refers is a funding agreement.  It is because the liquidators wish, in my view properly, for its existence and details to remain confidential that in this decision I will not describe the liquidation and the background to the application.  In any event, it is not material to the principal issues to which the application gives rise. They are:

(1)  Whether it is necessary for the liquidators to obtain the court’s approval before entering the agreement; and

(2)  If it is not necessary, in what circumstances can liquidators seek the court’s direction as to whether or not they may enter a funding agreement.

3.  The liquidators have not made this application out of a concern as to the lawfulness of the terms of the agreement.  They have been advised that it is necessary in the light of certain statements that appear in two cases concerning the need for court’s approval of a funding agreement.  The first is a decision of Peter Ng J in Osman Mohammed Arab & Anor v Chu Chi Ho Ian [1]. This concerned an application to remove a trustee in bankruptcy.  One of the grounds relied on as demonstrating the trustee’s bias against the applicants was their refusal to reveal the identity of the funder under a funding arrangement.  In addressing this ground Peter Ng J says this in [47]:

“47. As it is well-known to insolvency and bankruptcy practitioners, the sanction of the court is required for such funding agreements, even if signed, to take effect. Under section 82(3) of the Ordinance, the Trustees may apply to the court for directions in relation to any particular matter arising under the bankruptcy. It is common practice for trustees to apply for sanction under that section on an ex parte basis, sometimes simply in writing, as observed by Harris J in re Cyberworks Audio Video Technology Limited [2]in the context of corporate insolvency.”

This observation was obiter.  It has no significance to Peter Ng J’s reasoning in rejecting this complaint as demonstrating bias.  The Judge does not explain why the sanction of the court is necessary. In a recent comprehensive judgment of Marlene Ng J dealing with a proposed agreement to fund a party in matrimonial proceedings, Re A [3], her Ladyship reviews the Hong Kong authorities starting with my decision in Re Cyberworks Audio Video Technology Ltd [4].  Her Ladyship says this at [178]:

“178. The above analysis clearly shows the distinction between these cases and the Husband’s application for pre-clearance declaratory sanction for the proposed third party funding. Liquidators and trustees-in-bankruptcy who are officers of the court and who act on behalf of the creditors are in a privileged position as a result of their duty to realise the insolvency estate often in circumstances where there are no assets to fund such exercise. Their need to have approval of funding arrangements by, say, assignment of causes of action for value, are recognised and provided for by statutory rules, so even though assignment of a bare right to litigate is frowned upon as raising questions of maintenance and champerty (ie undesirable trafficking in litigation), liquidators and trustees-in-bankruptcy in exercise of their statutory duty are entitled to assign a right of action that excludes the doctrines of maintenance and champerty.”

4.  Marlene Ng J does not identify the statutory rules, which she has in mind.  It maybe that it was assumed that because there is a series of decisions in liquidation cases commencing with Re Cyberworks in which the Companies Court has approved funding agreements that it was assumed by counsel appearing before the two Judges or the Judges themselves, that the Court’s approval is necessary.  As I will demonstrate in the next section of this decision this is not accurate.  In [5]–[10] I explain in what circumstances the court’s sanction is required and in [13]–[14] I address the more general question of the circumstances in which the court’s approval of a proposed funding agreement can properly be sought.

Is the Court’s sanction of a funding agreement required?

5.  Broadly stated, the principal functions of a liquidator of an insolvent company are to obtain and realise property and rights of economic value and distribute the proceeds on a pari passu basis amongst its preferential and unsecured creditors.  The Ordinance specifies certain acts, which a liquidator is likely to be required to undertake during a liquidation that require the sanction of the court and others that do not.  The Company is in voluntary liquidation and consequently, the liquidators’ powers are derived from s251 of the Ordinance.  Section 251(1) provides:

“(1)  Subject to section 243A, a liquidator may—

(a)  exercise any of the powers specified in Part 1 of Schedule 25—

(i)  in the case of a members’ voluntary winding up—with the sanction of a special resolution of the company; and

(ii)  in the case of a creditors’ voluntary winding up—with the sanction of the court or the committee of inspection or, if there is no such committee, a meeting of the creditors;

(b)  without sanction, exercise any of the other powers by this Ordinance given to the liquidator in a winding up by the court;

(c)  exercise the power of the court under this Ordinance of settling a list of contributories, and the list of contributories shall be prima facie evidence of the liability of the persons named therein to be contributories;

(d)  exercise the power of the court of making calls;

(e)  summon general meetings of the company for the purpose of obtaining the sanction of the company by special resolution or for any other purpose he may think fit.”

6.  Part 1 of Schedule 25 specifies the powers of liquidators in both voluntary liquidations and a winding-up by the Court.  In the case of a winding-up by the Court the relevant section is s199, which provides in sub-sections (2) to (4).

“(2)  A liquidator may exercise any of the powers specified in Part 1 or 2 of Schedule 25 only with the sanction of the court or the committee of inspection.

(3)  Except as provided in subsection (4), a liquidator may exercise any of the powers specified in Part 3 of Schedule 25.

(4)  A liquidator (other than the Official Receiver) may only exercise the power specified in item 8 of Part 3 of Schedule 25—

(a)  with the sanction of the court or the committee of inspection; or

(b)  without the sanction if the liquidator has, before exercising the power, given at least 7 days’ notice of the intention to exercise the power—

(i)  (if there is a committee of inspection) to the members of the committee; or

(ii)  (if there is no committee of inspection) to the creditors.”

7.  Schedule 25 is comprehensive, but does not refer to funding agreements.  Paragraph 2 of Part 2 provides that the liquidators may (in the case of a winding-up by the Court with the sanction of the Court or the committee of inspection) “Carry on the business of the company, so far as may be necessary for its beneficial winding-up”.  Paragraphs 1 and 5 of Part 3 give liquidators in both voluntary liquidations [5] and a  winding-up by the court the following powers:

“1.  Sell the real and personal property and things in action of the company by public auction or private contract, with power to transfer the whole of the property and things in action to any person or company, or to sell them in parcels.

…

5.  Raise on the security of the assets of the company any money requisite.”

8.  Re Cyberworks concerned a funding agreement, which was structured so that the cause of action was assigned by the Company to the funder.  As I explain in [5]–[6] of my decision in Re Cyberworks a cause of action is property of the company, which the liquidators have power to sell, by assignment where applicable, to a third party.  It is not necessary for the liquidators to obtain the sanction of the court to the sale.  In my view, the fact that the consideration for the assignment is the right to receive a proportion of any recovery in anticipated litigation to enforce the right assigned does not change the nature of the transaction so as to require a liquidator to find some power other than that granted in Part 3, paragraph 1 to support his right to enter the funding agreement.  This being the case, it is not necessary for a liquidator in either a voluntary liquidation or a winding-up by the court to obtain the court’s sanction of a funding agreement, which involves the sale of a chose in action in return for a right to participate in the proceeds of successful litigation to enforce the chose in action.

9.  Not all funding agreements involve an assignment of the relevant chose in action.  In Re Company A to Re Company G [6] I approved a funding agreement between a commercial funder (ie a commercial funder, which provides funding to an insolvent company in liquidation to finance litigation and has no interest in the liquidation prior to execution of the funding agreement) and seven companies, which provided for the funder to finance the prospective litigation in return for a share of the proceeds if the litigation were to prove successful.  For the reasons explained in my decision I took the view that as the litigation could not realistically be advanced without external funding and the litigation remained under the control of the liquidators it was unobjectionable and fell within what might be called the “insolvency exception” to restrictions imposed by the law of maintenance and champerty, which I discuss in [7] to [10] of Re Cyberworks [7].  I was prepared to entertain the application, because I accepted that at the time there was no decision (which was also the case at the time of Cyberworks), which clarified how the law of maintenance and champerty applied to litigation funding in the insolvency context.  Re Company A does not as a result address the question of whether or not it was necessary for the liquidators to obtain the court’s sanction of the funding agreement.  As I have explained, the funding agreement did not involve an assignment of the chose in action and, therefore, did not involve a sale of the companies’ property.  The question is, therefore, was the court’s sanction necessary, not just desirable, in order to clarify the law?

10.  Paragraph 1 of Part 2 of Schedule 25 provides that a liquidator may “Bring or defend any action or other legal proceedings in the name and on behalf of the company”.  Paragraph 9 of Part 3 of Schedule 25 provides that a liquidator may “Do all things as may be necessary for winding-up the affairs of the company and distributing its assets”.  Clearly, pursuing litigation to recover monies or other property owed to a company is covered by Paragraph 1 of Part 2 and the taking of steps necessary to facilitate the litigation comes within paragraph 9 of Part 3.  Funding litigation in my view comes within Paragraph 9.  At its most simple it would cover providing costs on account to solicitors.  The funds could be obtained from the sale of property of the company, which is permitted by Paragraph 1 of Part 3 or by borrowing against the property of the company, which is permitted by Paragraph 5 of Part 3.  As I have already explained, it can also be done by entering a funding agreement, which involves assignment of the chose in action in exchange for a share of the proceeds of the litigation as was done in      Re Cyberworks[8]. It seems to me that there is no reason not read Paragraph 9 of Part 3 as extending to a liquidator entering into a funding agreement, which does not involve an assignment of a chose in action.  In my view it does.

11.  It was argued before me by Mr Woods that there were other analysis, which reached the same conclusion.  The first was that conducting litigation to recover money owed to a company comes within Paragraph 2 of Part 2, namely, carrying on the business of the company so far as may be necessary for the company’s beneficial winding-up. Although a company in the course of conducting its business may find itself having to commence legal proceedings to enforce its rights, in my view, this is not the kind of activity that the phrase “carry on business” is directed to and extending Paragraph 2 of Part 2 to pursuing litigation and matters incidental to the litigation, is to give the expression a strained interpretation as demonstrated by Paragraph 1 of Part 2 (which expressly deals with legal proceedings) and the wide wording of Paragraph 9 of Part 3.  In any event given my conclusion in [10] it is not necessary to stretch the meaning of Paragraph 2 of Part 2 to reach the conclusion that Parts 2 and 3 of Schedule 25 give a liquidator the power to enter on behalf of a company in liquidation a funding agreement.

12.  Another alternative was advanced, namely, that the agreement contains a provision to assign the proceeds of the litigation when received and that this would act as an equitable charge and thus the agreement comes within Paragraph 5 of Part 3, which gives a liquidator the power to “Raise on the security of the assets of the company any money requisite”.  I think this argument strains both the meaning of Paragraph 5 and the terms of the agreement.  I do not think the agreement can be fairly read as a security document.  The assignment of the proceeds is very much ancillary to the principal purpose of the agreement and would not, as I read the agreement, raise security at the time of the agreement’s execution or during most of the period of its implication.  I think it is difficult, and unnecessary, to find in Paragraph 5 a power, which enables a liquidator to enter a funding agreement, the substance of which is simply a right to share in the proceeds of the litigation in return for providing funding.

13.  Section 251(1)(b) of the Ordinance provides that a liquidator of company in voluntary liquidation may without sanction, exercise any of the powers to be found in Parts 2 and 3 of Schedule 25. Consequently the liquidators of the Company do not require the court’s sanction to cause the Company to enter into a funding agreement, which I have found comes within the exercise of the powers granted by Paragraph 9 of Schedule 25.

14.  Section 199(2) and (3) of the Ordinance permits a liquidator of a company in a winding-up by the court to exercise the following powers:

“(2)  A liquidator may exercise any of the powers specified in Part 1 or 2 of Schedule 25 only with the sanction of the court or the committee of inspection.

(3)  Except as provided in subsection (4), a liquidator may exercise any of the powers specified in Part 3 of Schedule 25.”

15.  It is necessary for the liquidator of a company in compulsory liquidation to obtain the sanction of the committee of inspection or, absent a functioning committee of inspection, the sanction of the court. However, once sanction has been obtained ss(3) allows the liquidator to exercise the powers to be found in Part 3 of Schedule 25 without obtaining sanction of either the committee of inspection or the court.  As I have found that Paragraph 9 of Part 3 gives a liquidator the power to cause a company to enter a funding agreement it follows that the court’s sanction of a funding agreement is not required in the case of a winding-up by the court.

Seeking the court’s directions

16.  In the present case the funding agreement contained a condition precedent in the following terms: “the Hong Kong court duly sanctioning the entry by the Company and the Claimant into this Agreement in the term sought under the Draft Court Application in accordance with Hong Kong law and such sanction continuing in full force and effect or holding that no sanction is required”.  It was the principal position of the liquidators that sanction was not required, but that the decisions of Peter Ng J, and more recently Marlene Ng J, introduced uncertainty and that it is necessary both for the purposes of satisfying the condition precedent and more generally clarifying the uncertainty that exists in the market about whether or not court sanction is required.  I agree, although the way in which the direction sought in the originating summons was framed was not in my view appropriate; a subject that I return to in [19]–[23].  It was not the liquidators’ position that they had any concerns about any particular provision in the funding agreement or the lawfulness generally of the arrangement encapsulated in it.  The liquidators’ position was, therefore, different to that in the liquidations, which gave rise to the applications and decisions in cases such as Re Cyberworks and Re Company A to Re Company G, which took place at a time when the absence of any decisions about the application of the law of maintenance and champerty to funding of insolvent liquidations gave rise to concerns, legitimate in my view, that justified directions being sought from the court concerning the lawfulness of the proposed arrangements.  Although it is not necessary for me to do so it will be useful if I take this opportunity to say something about the circumstances in which a liquidator can properly seek the direction of the court in respect of a proposed funding agreement.

17.  Section 255(1) and (2) of the Ordinance provide in the case of voluntary liquidations a right to seek the court’s directions in relation to a liquidation:

“(1)  The liquidator or any contributory or creditor may apply to the court to determine any question arising in the winding up of a company, or to exercise, as respects the enforcing of calls, or any other matter, all or any of the powers which the court might exercise if the company were being wound up by the court.

(2)  The court, if satisfied that the determination of the question or the required exercise of power will be just and beneficial, may accede wholly or partially to the application on such terms and conditions as it thinks fit, or may make such other order on the application as it thinks just.”

18.  In the case of a winding-up by the court the relevant provisions are worded differently.  Section 200(3) and (4) provide:

“(3) The liquidator may apply to the court in manner prescribed for directions in relation to any particular matter arising under the winding up.

(4)  Subject to the provisions of this Ordinance, the liquidator shall use his own discretion in the administration of the assets and the distribution thereof among the creditors.”

19.  Although the Ordinance gives a liquidator the right to seek directions from the court, this does not mean that the liquidator can ask the court to approve any decision he is contemplating because the liquidator is uncertain about its appropriateness.  Schedule 25 sets out those powers that a liquidator may exercise.  The extent to which they require prior sanction by a committee of inspection or the court varies depending on whether the liquidation is compulsory or voluntary, but at least in the case of Part 3, a liquidator in both types of winding-up may exercise the extensive powers without having to obtain prior approval [9]. This demonstrates (as does ss200(4)) that the liquidator is to conduct a liquidation exercising their own professional expertise and judgment.  It is clear from the authorities that, for example, a liquidator cannot properly seek a direction, which involves asking the court to approve what is largely a matter of commercial judgment.  The principal reason for this is that judges are generally not well placed to make judgments about what is in somebody else’s best commercial interests.  As Street CJ observes in Re Mineral Securities Asia Ltd (in liq) [10]:

“When the court is required to pronounce upon the commercial prudence of a transaction it enters upon a slippery and uncertain field. Apart from the lawyers, disclaimer of expert qualifications in matters of business prudence, the very process of litigation and the necessary limitations upon the scope of admissible evidence, restrict the available material to far less than is necessary for the making of a commercial decision.”

20.  This echoes the oft quoted observation of Lindley LJ in a different, but analogous, context in Re English Scottish & Australian Chartered Bank [11]that creditors acting on sufficient information and with sufficient time to consider a decision are much better judges of what is to their own commercial interest than a court can be.

21.  The extent to which it is the intention of modern common law insolvency regimes that liquidators are so far as possible left to conduct liquidations without close supervision by the court is demonstrated by the court’s approach to attempts to interfere with a liquidator’s decision.  The court will not do so unless it can be demonstrated that the liquidator has not acted in good faith, made an error of law or principle or the decision is perverse in the sense of falling outside the range of decisions a liquidator having proper regard to the relevant principles might make [12].  A liquidator’s decision is broad and intentionally so.  It follows from this that a decision which comes within this broad discretion, particularly if the decision is commercial in character, not only does not require the approval of the court, but also generally will not be amenable to a direction approving it.

22.  A direction must require something other than a general endorsement of a proposed cause of action.  Normally, it will require the formulation of a precise issue.  The issue will commonly be legal and of significance.  Even if the issue is not purely a question of law it must call for the exercise of some legal judgment [13]. If it does not, then it will be a matter which a liquidator is able to decide himself and a court will be in no better position to express a view.  In Re The Bell Group Ltd (in liq) [14] Hasluck J (citing Re Newtronics Pty Ltd; Ex parte Steward)[15] explains that it is role of the court to grant or deny approval to a liquidator’s proposal.  I would put it slightly differently.  The role of the court is to determine the issue raised by the direction that is sought.  Hasluck J goes on:

“57.  The principles applicable to an application under s 477(2B) were reviewed by Gordon J in Re Newtronics Pty Ltd; Ex parte Stewart [16]. The role of the court is to grant or deny approval to the liquidator’s proposal. Its role is not to develop some alternative proposal which might seem preferable. Further, the task of the court is not to reconsider all of the issues which have been weighed up by the liquidator but simply to review the liquidator’s proposal, paying due regard to his or her commercial judgment and knowledge of all of the circumstances of the liquidation, satisfying itself that there is no error of law or ground for suspecting bad faith or impropriety, and weighing up whether there is any good reason to intervene in terms of the expeditious and beneficial administration of the winding up.

58.  It was said further in that case that the court’s approval is not an endorsement of the proposed agreement but is merely a permission of the liquidator to exercise his or own commercial judgment in the matter.  It follows from these precepts that, in my view, as indicated by the reasoning in Brown v DML Resources Pty (in liq) (No 7) [17], it is not necessary for notice of the present ex parte application to be given to the defendant banks or other actual or prospective creditors, with a view to affording them an opportunity to be heard, because the directions and orders applied for do not purport to determine the matters in issue.  The effect of the directions procedure is to protect the liquidator against any possible allegations of breach of duty: McPherson: The Law of Company Liquidation (4^th ed) at 352 to 355.”

23.  I agree that it is not for the court to develop alternative proposals if unhappy with what is proposed by the liquidator, but depending on the issue it may be appropriate for the court to suggest changes to a proposed cause of action, which would change what the court might take the view is problematic into something acceptable.  In so far as the final sentence of the passage I have quoted tends to suggest that the court can be asked to review generally a proposed cause of action, I would, with respect, differ.  As I have explained in the previous paragraph, in my view what is necessary is the formulation of an issue or issues, which require a legal judgment.  This does not mean that by identifying within a broad issue a legal component a liquidator can legitimately ask the court to determine the broad issue if for the most part it has no legal component.  For example, in the present case the direction as originally framed asked the court whether it was appropriate for the Company to enter the 47-page funding agreement and to approve the agreement.  Even if within that broad issue it was possible to identify a legal issue, it was not an appropriate way to formulate the relief.  What was required was the identification of, for example, a provision within the agreement about which the liquidators had some concerns and wanted the court’s view as to whether it was, for example, lawful.  As it transpired the issue that required determination was whether or not it was necessary to obtain the court’s sanction before causing the Company to enter the funding agreement. That clearly was a legal issue and suitable for consideration by the court.

24.  I would anticipate that formulating directions in the manner I have described will help focus minds on what the real issues of concern are, which will be helpful to liquidators and assist the court in helping them resolve those concerns.