The Liquidator of ALMOND LTD t/a TAO CO (in a creditors’voluntary winding up) v. CHEONG CHAN KAO (a bankrupt) AND OTHERS

HCMP 1078/2018

[2019] HKCFI 634

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1078 OF 2018

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JUDGMENT

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Introduction

1.  On 28 February 2019, I heard the first hearing of the plaintiff’s(“P”) originating summons at 9:30 am which had been given a time estimate of 15 minutes.

2.  P, Almond Limited (“the Company”), is a company which has gone into liquidation and these proceedings are being pursued by its liquidator (“the Liquidator”).

3.  What gives rise to the present dispute are three early re-payments made by the Company in favour of three banks namely Citibank (Hong Kong) Limited (“Citibank”), Hang Seng Bank Limited (“HSB”) and DBS Bank (Hong Kong) Limited (“DBS”) (“the Three Loans”and “the Three Payments”).

4.  Such loans had been guaranteed by the 1^st defendant (“D1”) as well as the 2^nd to 4^thdefendants, who are individuals (“D2–4”).

5.  I will come back to them later.

6.  At the hearing I was informed by the Liquidator’s counsel Ms Queenie Ng, Mr Tom Ng, counsel for DBS and Ms Chloe Ma, solicitor for Citibank that for practical purposes, P and the banks had resolved their differences and was invited to make an order in terms of their consent order which I did.  There was also an earlier agreement last year between HSB and the Liquidator over the claim against it in these proceedings.

7.  The only part of the proceedings which remained ‘live’ effectively concerned D2–4, as well as D1 who was declared a bankrupt in July 2017 and who is not actively participating in these proceedings.

8.  Given the relatively modest amounts claimed and the fact that the evidence was not voluminous, I enquired how the parties wished to proceed.  I should point out that as a result of the various payments made by the banks, the amount sought from D1-4 was reduced from slightly above $3,000,000 when the proceedings were commenced to slightly below $1,000,000 now.

9.  In terms of breakdown, in its supplemental skeleton submissions the Liquidator is seeking an order against D1/2 being jointly liable for $134,274.15 and $282,169.72 respectively (for the two first payments) and $558,338.30 against D1 to D4 jointly (for the last payment).

10.  While P had filed an affirmation in support of its application,the defendants had not, although Ms Tang for D2–4 filed skeleton submissions on their behalves.

11.  I asked Ms Tang if her clients wished to file evidence and she confirmed they did not.  Given that the parties had already filed skeleton submissions I enquired if the parties were content to proceed on the basis of the evidence and skeleton submissions filed so far, in which case I would be prepared to hear the case the following day at 2:30 pm.

12.  This was agreeable and this is therefore the substantive hearing of P’s proceedings.

13.  As a housekeeping matter I should note that while a 2^nd affirmation had been filed by the Liquidator in response to the evidence filed by the banks, this was technically not filed in support of the present application and therefore no copy had been provided to D2–4.  I asked if Ms Tang had any objection if I relied for the purpose of this hearing on paragraph 44 of that affirmation.  It provided that:

“ According to the investigation, the 1^st, 2^nd, 3^rd and/or 4^th Defendants was/were guarantors of the debts owed by the Company shown as follows:-

	Creditors	Guarantors
(a)	the 5th Defendant	the 1st & 2nd Defendants
(b)	the 6th Defendant	the 1st & 2nd Defendants
(c)	the 7th Defendant	the 1st, 2nd, 3rd & 4th Defendants
(d)	Standard Chartered Bank (or SCB)	the 1st Defendant
(e)	Bank of East Asia (or BEA)	the 1st Defendant
(f)	Dah Sing Bank (or DBS)	the 1st Defendant
(g)	[Debt owed by the Company to S Creative Limited, its related company]	the 1st Defendant”

Ms Tang very fairly indicated she would have no objection.  It seems to me that it is unlikely that this is a matter which could be contentious given it refers to an objective fact and it is not one which D2–4 would be likely to be in a position to contest.

The Liquidator’s case

14.  As explained above, these proceedings concern the Three Payments:

 (1) A payment made by the Company to Citibank on 26 January 2017 in the sum of $554,274.15.  This was for a loan which was guaranteed by D1 and D2 (“the Citibank Payment”).

 (2) A payment made by the Company to HSB on 23 February 2017 in the sum of $1,222,777.48 for a loan which was guaranteed by D1 and D2 (“the HSB Payment”).

 (3) A payment made by the Company to DBS on 16 March 2017 in the sum of $1,579,325.30, which had been a loan which was guaranteed by D1 to D4 (“the DBS Payment”).

15.  The evidence as set out in Mr Yiu Cho Yan’s 1^st affidavit, in so far as is relevant, is as follows:

 (1) The Company had been incorporated on 25 September 2006.

 (2) By special resolution of the members the Company was wound up on 3 April 2007.

 (3) D1 has since the date of incorporation been a director and a shareholder of the Company.

 (4) D3 had been a director from the date of incorporation until about July 2009 and then again from 30 December 2015 to 29 December 2016 (ie about three months before it was resolved by the members to be wound up).  In addition, D3 had been a shareholder from the date of incorporation of the Company till 12 August 2009.

 (5) D2 had been the creative director of the Company whereas D4 had been its assistant general manager.  Both have been shareholders since 2015 or 2016.  Neither was a director of the Company.

 (6) D1 as mentioned above was declared bankrupt on 11 July 2017.

16.  The Citibank Payment arose in this way.  On 26 October 2015 Citibank lent $810,000 to the Company to be repaid by 36 monthly instalments of $25,000 odd.  The only security for the loan were the guarantees aforementioned.  By 26 January 2017 some $517,000 odd were outstanding.  However, on 26 January 2017 the Company repaid the whole amount early and by doing so incurred a prepayment fee and bank charges which exceeded $36,000.  This of course had the effect of releasing D1 and D2 as guarantors.

17.  In so far as the HSB Payment is concerned, it arose in this way.  HSB lent $1,530,000 to the Company on 7 March 2016 to be repaid by 36 monthly installments of $48,000 odd.  This loan was guaranteed by D1 and D2.  By 23 February 2017, $1,222,777.48 was outstanding yet the Company made early and full repayment.  This was less than two months before the Company was put in liquidation.

18.  In so far as the DBS Payment is concerned, this arose because the Company borrowed $2,000,000 on 8 April 2016 which was agreed to be repaid in 36 instalments of $62,689.  This loan was personally guaranteed by D1–4.  By 16 March 2017, some $1.6 million was outstanding and the Company decided to repay it early and fully.  This was less than one month before the Company was put into liquidation.

19.  Naturally, the Liquidator wrote to D1 to ask why in the financial circumstances the Company found itself in, there were these Three Payments.  

20.  D1 alleged that Citibank, HSB and DBS had been giving “pressure to the company to settle the loan facilities” (see his email of 22 November 2017).  D1 alleged this had been done via the telephone.  D1 apparently was not able to recall the dates of the calls and whether there was further actions or steps taken.  In so far as HSB was concerned their position as stated in their 15 February 2018 letter was that “according to our records, the repayment of [the HSB Payment] was initiated by the Company …”.

21.  After enquiries were made by the Liquidator with the banks, Citibank stated that no demand had in fact been made by it.

22.  Similar enquiries were made of DBS but no substantive answers were given by it.

23.  The Liquidator, who is a qualified accountant has prepared an insolvency analysis which shows that the Company had been insolvent at least by September 2016; and by February 2017 the net asset deficiency exceeded $8 million with assets (even assuming all receivables are collectable) being approximately half the amount of the liability.

Applicable legal principles

24.  The applicable law is different for the Three Payments.  Whereas for the first payment to Citibank, the old provisions would apply as the alleged unfair preference was made before 13 February 2017 (see section 30(1) – (4) of Schedule 26 to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“the Companies Ordinance”)., for the payments to HSB and DBS, the new section 266B(1) would apply.

25.  For the purposes of the present case, this has an impact on the meaning of ‘associates’ and presumptions but not otherwise.

26.  In terms of general principles, these have been conveniently and succinctly set out by Kwan J (as Kwan JA then was) in Re Phantom Records Ltd HCMP 2770/2003 (unreported, 7 December 2006) at paragraphs 82 – 88:  

“ 82. To make out a case of unfair preference the Official Receiver would need to establish the following matters:

(1) Records was insolvent as at 13 January 1999, when it made the payment by cheque to the 1^st respondent;

(2) the payment by cheque to the 1^st respondent had the effect of putting him into a position, which, in the event of Records’insolvent liquidation, would be better than the position he would have been in if the payment had not been made; and

(3) Records, acting by its directors who were the respondents, was influenced in deciding to make the payment by a desire to produce the effect in (2).

83. The respondents have disputed the matters in (1) and (3). They do not appear to have challenged (2).

84. In respect of (1), the Official Receiver would have to establish insolvency within the meaning of either section 51(3)‌(a) or (b).

85. As for the matter in (2), whether an act has the effect provided for in section 50(3)(b) would appear to involve a purely objective test (Trustees of the Property of Hau Po Man Stanley (in bankruptcy) v. Hau Po Fun Ivy [2005] 2 HKC 227 at 233B). It is clear that the payment by cheque to the 1^st respondent had the effect of putting him in a better position he would have been in if the payment had not been made, in the event of an insolvent liquidation of Records. I hold the matter in (2) established.

86. In relation to (3), two elements are required to be established:a desire to produce the effect of improving the creditor’s position in an insolvent liquidation, and such desire had influenced the decision to enter into the transaction.

87. A desire of improving the creditor’s position in an insolvent liquidation is a subjective state of mind. Desire is different from intention. Whereas intention is objective in that a person is taken to intend the necessary consequences of his actions, a person is not to be taken as desiring all the necessary consequences of his actions and one can choose the lesser of two evils without desiring either (Re MC Bacon Ltd.[1990] BCLC 324 at 335f to 336a; Re Hau Po Man Stanley, supra. at 233C).There is often no direct evidence of the requisite desire and the existence of this state of mind may be inferred from all the relevant circumstances, even ‘contrary to the denials of those whose state of mind is inquired into to determine what state of mind is attributed to the company making the decision’ (Re Fairway Magazines Ltd. [1993] BCLC 643 at 649f).

88. As for influence, this requirement is satisfied if it was one of the factors which operated on the minds of those made the decision.  It need not have been the only factor or even the decisive one.  It is not necessary to prove that if the requisite desire had not been present, the company would not have entered into the transaction (Re MC Bacon Ltd., supra. at 336c to d).”

Analysis

27.  The defendants have not filed any evidence.  The Court therefore has to rely on P’s evidence only and draw such inferences as may be appropriate.

28.  There is no explanation from D2-4 as to why for example, they would have agreed to guarantee the Company’s loans if they were just ordinary employees or shareholders and what their precise relationship with D1 or between each other is.

29.  There is also no evidence as to the state of their knowledge as to why the Company at the precipice of being wound up elected to make the Three Payments and not others.

30.  The defendants did not dispute that the Company was insolvent at the material times.  This is consistent with the fact the members put the Company into liquidation weeks after the payments, as well as the liquidation analysis prepared by the Liquidator.

31.  One can discern from the skeleton submissions filed by D2–4 that their basis of opposition is two-fold:

 (1) D2–4 have not “received any of the monies” and therefore there is “no legal basis for P to seek relief for payment” against the defendants.

 (2) D2–4 are not “associates” of the Company for the purpose of the Ordinance.

32.  I can deal with the first point shortly.

33.  Notwithstanding the helpful submissions of Ms Tang, I was satisfied that when a company pays a debt which is guaranteed by a third party under certain circumstances (see below), that third party may be asked to account for the benefit he obtained.

34.  Section 266A of the Companies Ordinance provides:

“ (1) A company gives an unfair preference to a person if—

(a) that person is—

(i) one of the company’s creditors; or

(ii) a surety or guarantor for any of the company’s debts or other liabilities; …”

35.  Section 50(3) of the Bankruptcy Ordinance provides:

“ (3) For the purposes of this section and sections 51 and 51A, a debtor gives an unfair preference to a person if—

(a)   that person is one of the debtor’s creditors or a surety or guarantor for any of his debts or other liabilities; …”

36.  The relevant principles have also been summarised in Transaction Avoidance in Insolvencies (3^rd ed) at paragraphs 5.44, 5.45 and 5.129:

“ 5.44 Where the debtor pays a creditor whose debt has been guaranteed by a third party, the debtor’s motivation may be to relieve the guarantor of liability. In this case, there will be a preference of the surety or guarantor, even if there was no desire to improve the position of the creditor, provided that the transaction had the effect of preferring the guarantor or surety and the other requirements of section 239 are met. If, however, the payment was also influenced by a desire to benefit the creditor, there will of course be a preference of the creditor.”

“ 5.45 The sections enable relief to be granted against either the creditor or the surety (see para 5.129), although obviously the amount recovered from the creditor and surety collectively cannot exceed the amount of the preference. Generally, it is arguable that recovery should be ordered in the first instance against the guarantor.”

“ 5.129 Where the preference entails the payment of a creditor, in order that a guarantor will not be called upon by that creditor to pay sums under the guarantee, the statutory provisions are structured in such a manner that recovery may be made against either the creditor or the guarantor. Recovery may be made against the creditor, whether or not the debtor intended to benefit the creditor,as under section 241(1)(d) recovery may be made against a person,such as the creditor, who has received a benefit as a result of the preference.If an order is made against the creditor, however, it may well be that the court will think it fit to revive the guarantee in order to prevent unfairness being caused to the creditor.”

37.  On the facts before the Court, it is unnecessary to have resort to presumptions which of course would be necessary if there was no or insufficient evidence one way or the other.  In situations where there was sufficient evidence, rather than no evidence at all, presumptions are unlikely to be of any moment.

38.  The Company was seriously insolvent by early 2017, there is no evidence of banks chasing for the repayment of the relevant loans (which is perhaps related to the fact there were personal guarantees by others) and the payments were to be made by instalments.  Of the two banks which responded to the Liquidator’s queries, both shared the position that they did not chase the Company but rather it paid voluntarily early on its own volition.

39.  All three re-payments involved paying early and in full when there is no evidence of aggressive chasing by any one of the banks.  It is not the case of just one payment to one bank but rather a pattern of behavior.

40.  Given the Company’s financial situation and the timing of the Three Payments, there is no doubt that this would be caught by the unfair preference provisions as at the relevant time when the payments were made,the Company was insolvent.  There is no question that the defendants have been put in a better position by reason of the Three Payments.  But for the payments the banks would have called them on their guarantees.

41.  The only real question is therefore whether on the evidence P has shown on a balance of probabilities that (1) the Company had the desire to produce the effect of improving the defendants position in an insolvent liquidation and (2) that such desire had influenced the decision to make the payment.

42.  While the relevant desire is a subjective state of mind, it may be inferred from all the relevant circumstances.  That mind would be the mind of D1 being the Company’s sole director.

43.  I am satisfied on the evidence that P has proved the relevant desire on the balance of probabilities:

 (1) None of the defendants have filed any evidence, not even to refute Mr Yiu’s suggestion that the payments were influenced by a desire to prefer.

 (2) The pattern and timing of the payments: shortly one after another, early re-payments were made for loans repayable by many instalments, and which were guaranteed by D1 and D2–4, when the Company was insolvent and about to put itself in liquidation,  when there is no evidence of the banks chasing and there being no other explanation.

 (3) The fact that the defendants were connected to the Company in the ways referred to above.  Irrespective of whether they are “associates” within the meaning of the Ordinance they are sufficiently close to the Company, its management and affairs such that they were willing to enter into personal guarantees to guarantee the Company’s debts, and such that the Company’s business became their business.  This is not a case of arm’s length dealings.  I am not for a moment saying that in every case where a third party guarantees a company’s debts one would infer that there is some close connection between them so that one would tend to infer that a payment putting them in a better position would necessarily be influenced by a desire to prefer them.  This would depend on the type and size of the company as well as the attributes of that third party.  It is essentially a fact specific enquiry.  On the present facts and in the absence of any evidence or explanation by the defendants it can be inferred that the defendants were ‘insiders’ connected to D1 and that the Company through D1 wanted to benefit them by selectively paying for the debts which were guaranteed by them rather than other creditors.

 (4) I am alive to the fact that it could be argued by D2-4 that D1 orchestrated the payments to benefit himself rather than D2–4 but by doing so he incidentally helped them.  There is no evidence for that hypothesis and it would not sit well with the fact D1 was himself bankrupted only some months after the last payment was made.  D1 was made a bankrupt in July 2017, and therefore the bankruptcy petition would have been presented some time before that.  This is consistent with the evidence (see above) that the Company did not discharge other debts which were guaranteed by D1 only.  The inference is that D1 must have realized the writing was on the wall in so far as his own financial position was concerned, and all that could be done was to help D2–4 who had agreed to help the Company in its time of need.  A conscious decision was thus made to use the Company’s remaining funds to first discharge such debts as were guaranteed by D2–4.

44.  For these reasons, I find that P has made out his case based on unfair preferences against all the defendants.  I will therefore hear the parties as to the terms of the order and costs.

45.  It remains for me to thank the parties for their able assistance.