RE FIVEOCEANS SUPPLY SERVICES LTD

HCCW1379/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO.1379 OF 2001

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D E C I S I O N

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Introduction

1. FiveOceans Supply Services Limited ("FiveOceans") was a general trading company which engaged in the business of supplying airlines with articles for passengers' use, such as blankets, non-slip trays, napkins and other items. The incident of 11 September 2001 struck a heavy blow on the airline industry. And in the case of the ultimate owner of FiveOceans, Swiss Air, it was fatal. It went into liquidation on 1 October 2001. FiveOceans had since been experienced difficulty in meeting its financial obligations to a number of creditors, in particular its bank, Citibank. On 20 December 2001, Citibank presented a winding-up petition against FiveOceans. In the event, FiveOceans was wound up by the court on 29 April 2002. Joint and several liquidators were then appointed on 19 July 2002.

2. By three summonses all dated 11 October 2002 taken out pursuant to section 182 of the Companies Ordinance, Cap.32, the applicants seek validation of the following payments made by FiveOceans to each of them respectively between the dates of the petition and the winding-up order :

(1) in the case of Joseph Wong & Co (HK) Limited ("JWC"), a payment of US$180,748.11 on 31 December 2001;

(2) in the case of Superspeed Transportation Limited ("STL"), a payment of HK$378,909.99 on 2 January 2002; and

(3) in the case of Gate Gourment International AG ("GGI"), a payment of US$41,134.23 on 31 December 2001.

All the applications are opposed by the liquidators. At this juncture, it is, I believe, convenient to first summarise the applicable law before turning to the applications.

The Law

3. Section 182 of the Companies Ordinance provides :

"In a winding up by the court, any disposition of the property of the company...made after the commencement of the winding up, shall, unless the court otherwise orders, be void."

4. The principles governing the exercise of the court's jurisdiction under section 182 considered by the English Court of Appeal in Re Gray's Inn Construction Co. Ltd [1980] 1 All ER 814 had been summarised by Fox LJ in Denny v. John Hudson & Co. [1992] BCLC 901 at pp.904d-905c thus :

(1) The discretion vested in the court by the provision is entirely at large, subject to the general principles which apply to any kind of discretion, and subject also to limitation that the discretion must be exercised in the context of the liquidation provisions of the statute.

(2) The basic principle of law governing the liquidation of insolvent estates, whether in bankruptcy or under the companies' legislation, is that the assets of the insolvent at the time of the commencement of the liquidation will be distributed pari passu among the insolvent's unsecured creditors as at the date of the bankruptcy.

(3) There are occasions, however, when it may be beneficial not only for the company but also for the unsecured creditors, that the company should be able to dispose of some of its property during the period after the petition has been presented, but before the winding-up order has been made. Thus, it may sometimes be beneficial to the company and its creditors that the company should be able to continue the business in its ordinary course.

(4) In considering whether to make a validation order, the court must always do its best to ensure that the interests of the unsecured creditors will not be prejudiced.

(5) The desirability of the company being enabled to carry on its business was often speculative. In each case the court must carry out a balancing exercise.

(6) The court should not validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will receive a dividend, in the absence of special circumstances making such a course desirable in the interests of the creditors generally. If, for example, it were in the interests of the creditors generally that the company's business should be carried on, and this could only be achieved by paying for goods already supplied to the company when the petition is presented (but not yet paid for) the court might exercise its discretion to validate payments for those goods.

(7) A disposition carried out in good faith in the ordinary course of business at a time when the parties were unaware that a petition had been presented would usually be validated by the court unless there is ground for thinking that the transaction may involve an attempt to prefer the disponee in which case the transaction would not be validated.

(8) Despite the strength of the principle of securing pari passu distribution, the principle has no application to post-liquidation creditors; for example, the sale of an asset at full market value after the presentation of the petition. That is because such a transaction involves no dissipation of the company's assets for it does not reduce the value of its assets.

With these propositions in mind, I now turn to the applications.

Common rationale for the payments

5. In support of the applications and to justify the payments, Mr Brian Leung Yat Ming, formerly managing director of FiveOceans, had this to say in his first affirmation filed on 12 October 2002 :

"7. At that time [i.e., when Citibank presented the winding-up petition on 20 December 2001] I, and my fellow board members, were confident that FiveOceans could trade out of its difficulties if an accommodation could be reached with Citibank. FiveOceans had banked with Citibank since it began trading and we hoped that Citibank could be persuaded to support the company so that insolvency could be avoided. I should note that for the period up to the end of 2001 FiveOceans had been profitable, and the business model was a good one.

8. It was not until mid January 2002 that I, and my fellow board members, realised that the company's position was irredeemable, and that it should be allowed to go into bankruptcy. As a result, on 21 January 2002, the directors resolved that the company should be voluntarily wound up as it could not continue its business, pursuant to section 228A of the Companies Ordinance.

9. Accordingly, prior to mid January 2002, my priorities were twofold:

(A) to focus on keeping the profitable parts of the business going, in order to maintain the company's cashflow; and

(B) to protect the business insofar as was possible.

10. In keeping with those priorities, I continued to make payment to a number of FiveOceans's creditors...

11. ...

12. The purpose of this affirmation is to explain to the court why I authorised these payments to be made, and why making those payments was in the best interests of both FiveOceans and its creditors as a whole."

6. Ms Chan, counsel for the liquidators, submitted that Mr Leung and the board would not honestly believe that FiveOceans could trade out of its difficulties; and that there is no evidence to suggest that FiveOceans's financial situation had deteriorated between 20 December 2001 and 21 January 2002 so as to warrant a change of view on its future prospects. On the evidence before me, there is nothing to suggest that the belief held by Mr Leung and the board was not bona fide. Indeed, it is not unreasonable for Mr Leung and the board to use their best endeavours to salvage the company at the time when the petition was presented. In the circumstances, I take note of Ms Chan's submission but accept Mr Leung's evidence in this regard.

7. Having said that, it does not necessarily follow that each individual payment must be validated. I still need to consider if there are special circumstances justifying the payment. The evidence relating to the individual payments is set out below. I first deal with the payment of US$180,748.11 to JWC on 31 December 2001.

Payment to JWC

8. JWC supplied FiveOceans with paper and plastic products like napkins and airline service trays. The terms which applied to the transactions between JWC and FiveOceans were set out in a sales and purchase contract dated 1 December 2000 ("the Contract"). Pursuant to the Contract, if FiveOceans failed to pay any amount due, JWC was entitled to cancel the contract or suspend any further deliveries to FiveOceans. The Contract further contained a provision commonly known as the Romalpa clause :

"7.2 Notwithstanding shipment and the passing of risk in the Goods, or any other provision of these Conditions, the property in the Goods shall not pass to the Buyer until the Seller has received in cash or cleared funds payment in full of the price of the Goods and all other goods agreed to be sold by the Seller to the Buyer for which payment is then due." ("Clause 7.2")

9. According to Mr Leung, FiveOceans sold the products supplied by JWC to its customers for a profit. For paper products, the profit margin was about 6 to 7%. With a much higher profit margin of 40%, the trays business was very profitable. As at 31 December 2002, FiveOceans held stock of about HK$2 million supplied by JWC but not paid for. It was anticipated that the stock could be resold for a profit of about HK$1 million. Mr Leung had not adduced any documentary evidence to support the value of the stock or his estimate of the profit. He merely referred to a statement prepared by Jetlogistics AG, the warehouse where the stock was stored, sent to him by the liquidators on or about 14 August 2002 (page 14 of exhibit "LYMB-1"). According to the information contained in this statement, various items were sold by Jetlogistics for Euro 265,176.24 and the relevant invoices were dated between 7 January and 24 April 2002. (Presumably, the sales took place either shortly before or at the same time as the dates of the invoices.) Mr Leung said that Jetlogistics exercised a lien over the stock and the said sum of Euro 265,176.24 was applied to deduct its claim of Euro 196,171.24. Jetlogistics then remitted the balance of Euro 69,005 to FiveOceans, which would be applied to the fund for paying all creditors. Mr Leung went on to say that if FiveOceans did not pay JWC the sum of US$180,748.11, representing the outstanding balance of unpaid stock as at the date of petition, JWC could have repossessed the stock pursuant to Clause 7.2 and thus prevented FiveOceans to supply the same to its customers for a profit. That would have severely damaged FiveOceans's business and its relationship with its customers and would have forced FiveOceans to incur legal costs in order to deal with the problem.

10. The evidence of Mr Anthony Hon Wai Wah ("Mr Hon"), financial controller of JWC, on the value of the unpaid stock held by FiveOceans at the material time differs from that of Mr Leung. According to Mr Hon, as at 20 December 2001, the amount outstanding was US$180,748.11. In this connection, he relied on a schedule of outstanding payments (page 12 of exhibit "AHWW-1"). According to this schedule, invoices for the goods in question were dated between 13 August and 22 November 2001. (It is therefore reasonable to draw the inference that JWC supplied the goods to FiveOceans either shortly before or at the same time as the dates of the invoices.) Mr Hon said that legal advice had been taken regarding to outstanding payments. He had no doubt that if FiveOceans did not pay JWC the outstanding balance, JWC would have exercised its right under Clause 7.2 and reclaimed the unpaid goods. Mr Leung was made aware of this possibility repeatedly during November and December 2001.

11. In his affirmation filed on 29 November 2002, Mr James Wardell, one of the liquidators appointed for FiveOceans, noticed that the goods supplied by JWC to FiveOceans were shipped almost immediately to its buyers including Delta Airlines and Sage Enterprises after the invoices were issued. He had prepared a schedule (exhibit JW-2) in this regard. He said that the schedule illustrated that even if Clause 7.2 were valid, JWC would not be able to reclaim the goods from FiveOceans who had already parted possession of the same. In his second affirmation filed on 20 December 2002, Mr Hon pointed out that all the goods supplied by JWC were shipped to FiveOceans and not to its buyers. He also reiterated that had JWC not received the payment on 31 December 2001, JWC would have reclaimed the unpaid goods from whoever then holding the goods. In his second affirmation filed on 20 December 2002, Mr Leung supported Mr Hon thus :

"6. My understanding of the way the clause worked was that JWC retained title to the goods until the Company paid for them, even though the goods may have been shipped. I therefore understood that JWC could have claimed against the Company if we had possession of the goods, and possibly also against our customers if we had forwarded the goods to them. I was concerned about this because at the time the payment to JWC was made we still believed that the Company could continue trading. However, if we could not meet our supply obligations, or worse had to ask for goods supplied to be returned, this would be very damaging. The Company would lose credibility and money as a result. We would not earn the profit and the sale and could be liable for our customers for any loss suffered as a result. Furthermore, both Delta Airlines and Sage Enterprises (who we supplied with JWC products) owed the Company money at the time. If we failed to deliver the goods they ordered this would have given them an excuse not to pay us, or seek a discount."

12. In my view, there are considerable deficiencies in the evidence of the circumstances leading to the payment to JWC. First, I am unable to accept Mr Leung's bare assertion that the value of the unpaid stock held by FiveOceans as at 31 December 2001 was in the region of HK$2 million. As noted, Mr Leung is unable to adduce any documentary evidence in support. The statement prepared by Jetlogistics did not support this assertion either. It is not clear from the statement if the goods then stored in the warehouse were the same as those referred to by Mr Hon in his schedule of outstanding payments. I am only prepared to accept that the value of the outstanding stock at the material time was US$180,748.11.

13. Secondly, I am also unable to accept Mr Leung's bare assertion that FiveOceans could have earned a profit of HK$1 million by selling the unpaid stock to its customers. Again, the statement prepared by Jetlogistics does not bear out this point.

14. Thirdly, according to JWC's schedule of outstanding payments, the unpaid goods were supplied between August and November 2001. It is however not clear if those goods had been delivered to FiveOceans's customers. Paragraph 17 of Mr Leung's affirmation seems to suggest that they had not been sold or delivered. For Mr Leung said there that the stock were then stored with Jetlogistics who exercised a lien over them. If that was the case, Mr Leung has failed to explain why there was no sale or delivery to FiveOceans's customers between August and December 2001. Why were the goods simply laid idle at the warehouse? More importantly, contrary to the effect of Mr Leung's assertion, payment to JWC did not enable FiveOceans to dispose of the goods in question to make a profit. For there is simply no evidence to suggest that after the payment to JWC was made on 31 December 2001, FiveOceans then proceeded to sell the goods to its customers between then and 21 January 2002 when the board decided to wind up the company voluntarily. Instead, it would appear that the goods were then disposed of by Jetlogistics between January and April 2002. Mr Leung had not explained why that was the case.

15. Fourthly, paragraph 6 of Mr Leung's second affirmation seemed to suggest that some of the goods had been sold and delivered to Delta Airlines and Sage Enterprises. (See paragraph 10 above.) But he has failed to condescend on particulars as to when the sales took place and the amount of profits generated from these transactions, if any.

16. These lacunas have rendered the evidence on the circumstances pertaining to the payment to JWC highly unsatisfactory. In the circumstances, I reject the assertion that the payment to JWC was to enable FiveOceans to earn profits which it otherwise would not have done. I accordingly reject the assertion that the payment was made in the interests of the creditors generally.

17. Referring to paragraph 6 of Mr Leung's second affirmation, Mr Stock, counsel for all the applicants, submitted that delays to delivery of goods to Delta Airlines and Sage Enterprises could have resulted in non-payment of debts owing by them to FiveOceans. But as noted, it is not clear if the delivery to Delta Airline or Sage Enterprises had actually taken place. And Mr Leung had failed to condescend on the necessary particulars. Accordingly, I am unable to accept this submission.

18. Both Mr Leung and Mr Hon placed much reliance on Clause 7.2. For present purposes, I am prepared to accept the submission of Mr Stock that pursuant to that clause, JWC was entitled to reclaim possession of the unpaid goods from FiveOceans and its customers. But in light of my rejecting the primary contention that payment to JWC was to enable FiveOceans to earn profits that it otherwise would not have done, no significant mileage can be gained from Clause 7.2.

19. Two further grounds were advanced to justify the payment to JWC. First, it was the evidence of both Mr Leung and Mr Hon that an order of "Delta Trays" for US$24,403 was due to be delivered in January 2002 pursuant to a certain purchase order. If JWC had not received payment on 31 December 2001, JWC would have refused to deliver the goods. Mr Leung further said that FiveOceans could make a profit of US$9,762 upon resale to its customers. FiveOceans was having tremendous financial difficulties at the time. Was it likely to be for the benefit of the creditors generally to reduce the company's cash assets by paying over US$180,000 to JWC in return for supply of goods from JWC which could only generate, upon resale, a mere profit of less than US$10,000? I think not.

20. The second ground can be found in paragraph 12 of Mr Hon's first affirmation. He said that at the time of the payment, JWC held on behalf of FiveOceans approximately 1,800 to 2,000 cartons of napkins for supply to Swiss Air and Sabena with a value of US$44,000 and about 151,000 pieces of Delta Trays with a value of US$48,000. JWC would have refused to deliver those goods to FiveOceans had it not received the payment on 31 December 2001. But for goods to be supplied to Swiss Air and Sabena, there is little point for FiveOceans to ask for delivery because Swiss Air had already gone into liquidation by then. For the "Delta Trays", the payment of over US$180,000 to JWC at that critical moment overweight any possible profits that could be generated from the resale of those goods. It is therefore not likely to be in the interests of the general creditors.

21. For the above reasons, I am not satisfied that there are special circumstances which justify the full payment to JWC at the expense of other creditors. I will therefore refuse the application for validation by JWC.

22. I next consider the payment to STL.

Payment to STL

23. STL acted as freight forwarder and customs clearing agent for FiveOceans in the supply of its goods to Europe and USA. At the end of November 2001, FiveOceans owed STL HK$378,909.99. STL had been chasing for repayment but to no avail. On 10 December 2001, STL issued a demand letter to FiveOceans and threatened to exercise a lien over the company's shipments if payment was not received. Mr Leung was concerned. In paragraph 24 of his first affirmation, he put forward the following reasons :

"(A) Firstly, we had a shipment of 3 to 4 containers in transit with STL bound for Los Angeles. Since 11 September 2001 Unites States Customs had been a lot stricter than before. Until September 2001 goods could wait with Customs for up to a week before Customs started making enquiries and the goods risked confiscation. After September 2001, if goods were not immediately and smoothly cleared, Customs would suspect that there was a problem and require the goods to be returned to the place of origin.

(B) If the goods were delayed then FiveOceans would be late in delivering to its customers. This risked the customers either rejecting the goods and refusing to pay, or using the late delivery to demand a discount. It was also possible that a claim would be brought against FiveOceans if the delay had caused the customer its own logistical problems. I note that of the containers in transit, two were 40' containers containing blankets which were to be delivered to Delta. Blankets were one of the most profitable products that FiveOceans would supply, as the purchase price of each blanket would be approximately US$2, but we would on sell each blanket for US$3. On two 40' containers FiveOceans would expect to make at least HK$500,000.00 profit (after deduction of transportation and insurance costs). The other container was a 45' container of plastic trays. On that cargo, FiveOceans would make at least a profit of HK$200,000.00.

(C) FiveOceans was shipping on average 2 to 4 containers a month using STL. If we did not pay STL, STL would refuse to handle our future shipments. For the reasons already set out at (A) above, a change in Customs clearing agent had to be avoided as any change would make US Customs suspicious and put smooth clearance in jeopardy.

(D) If STL exercised a lien, it would eventually sell the goods. This would result in FiveOceans losing even more money."

He therefore took the view that it was in the best interest of the company that STL be paid. It would enable continued smooth delivery of goods to the company's customers in the USA. And FiveOceans could earn the profits on those sales. Mr Leung believed that the payment was for the benefit of all the company's creditors.

24. In her affirmation filed on 12 October 2002, Ms Chan Po Yee, executive director of STL, gave the breakdown of the outstanding balance of HK$378,909.99. She said that she had advised Mr Leung and his assistants on a number of occasions in November and December 2001 that STL would halt shipments and exercise a lien if payment was not received shortly. STL was not aware of the winding-up petition until it received a letter from the liquidators on 25 January 2002.

25. The above was not seriously challenged by Mr Wardell. However, he said in his affirmation filed on 29 November 2002 that it was only a speculation on the part of Mr Leung that cooperation with STL was required to enable proper shipment of the goods. He noted that the shipments were despatched on the same date as the invoice. Accordingly, it would be difficult to see how STL would be able to insist on payment of the invoice before effecting the shipment. In his second affirmation, Mr Leung dealt with this objection. He said despite shipment having been despatched, STL could still stop the goods in transit.

26. Mr Stock submitted that STL acted as a customs clearing agent for the FiveOceans abroad, and would therefore have exercised control over the goods upon arrival at their destination. But for the payment to STL on 2 January 2002, STL would have attempted to hold goods and would have had an opportunity to do so upon their arrival. In light of the sensitive climate at US customs since 11 September 2001, delays upon arrival would have been particularly disruptive to FiveOceans. I agree. I am satisfied Mr Leung's concerns were legitimate and that the payment to STL in the circumstances was bona fide in the course of business and would likely to be for the benefit of FiveOceans's creditors generally. I will therefore allow STL's application.

27. I now come to the payment to GGI.

Payment to GGI

28. FiveOceans's sale and customer care services were handled by the company's office in Switzerland, and the company had two employees working there. For reasons related to the Swiss law, the employees had employment contracts with GGI, a Swiss company related to FiveOceans. The payment of US$41,134.23 to GGI on 31 December 2001 was reimbursement for the salaries of the employees for the period between October and December 2001. If is Mr Leung's evidence that if the payment had not been made, there was a risk that the employees would not stay with the company. This would leave the company with no sales team, and create difficulties with the collection of the company's receivables. One of the employees was Mr Th. Schmid. The contract of employment between Mr Schmid and GGI dated 23 November 2000 was exhibited as LYMB-2 to Mr Leung's second affirmation. Under the employment contract, Mr Schmid was to be fully seconded to FiveOceans. According to Mr Leung, a similar arrangement was made with the other employee, Marielle Beyer, although there was no written contract.

29. The liquidators did not seriously dispute these points. Ms Chan however submitted that there is no evidence to suggest that if the payment were not made, the employees would stop working for FiveOceans. In my view, it is reasonable to draw such an inference. Any reasonable man would think twice if he should continue to work for his employer if the latter did not pay wages punctually. In the circumstances, I hold that the payment to GGI was justified and a validation order should be granted.

Conclusion

30. For the above reasons, I will dismiss JWC's application and allow the application of STL and GGI. I will make an order nisi that the liquidators shall have the costs of JWC's application against JWC, to be taxed if not agreed; and that in respect of the application of STL and GGI, their costs will be paid out of FiveOceans's assets and that such costs be given priority after the taxed costs of the petition and after the liquidators' remuneration.