RE UDL HOLDINGS LTD

HCCW756/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO.756 OF 1998

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R E A S O N S

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The Petition

1. This is the adjourned hearing of the winding-up petition presented by The Hongkong and Shanghai Banking Corporation Limited ("HSBC") in respect of UDL Holdings Limited ("the Company"). The petition is based on debts owed to HSBC by United Dockyard Limited, a subsidiary of the Company. These debts were guaranteed by the Company and amount to approximately $102 million. Although HSBC holds security over assets of United Dockyard Limited, vis-à-vis the Company, it is an unsecured creditor.

2. The petition first came on for hearing on 23 November 1998. Since then there have been several adjournments. On 22 January 1999, the Company issued an originating summons pursuant to s.166 of the Companies Ordinance, Cap.32 for a court meeting of the creditors of the Company ("Scheme Creditors") to be convened for the purpose of considering a Scheme of Arrangement proposed between the Company and the Scheme Creditors. On 23 March 1999, the petitioning creditor objected to any further adjournments on the basis that contrary to the Company's assertion that a significant majority of the creditors are in principle supportive of the restructuring proposal, in fact, that is not the case. Directions were thus given for the petition to be heard on an early date. The central issue for determination is whether or not there is substantial in principle support by the Company's creditors for a scheme of arrangement, of the order of 75% by value of such creditors. At the hearing, I declined to make a winding-up order. The reasons appear below.

Parties

3. On 24 April 1999, an affidavit was filed on behalf of Nishimatsu Construction Co. Limited ("Nishimatsu"), Apple Daily Printing Limited ("Apple") and Dragages et Travaux Publics (HK) Limited ("Dragages") claiming to be creditors of the Company under parent company guarantees issued by the Company in respect of contracts entered into by its subsidiaries and seeking to appear at the hearing as supporting creditors.

4. At an earlier hearing on 23 March 1999, Nishimatsu had sought unsuccessfully to appear as a supporting creditor. The Company's position then was that the debt (alleged to be $292 million) is substantially disputed and that remains its present position. Nishimatsu's status as a creditor of UDL Kenworth Engineering Limited ("Kenworth") in respect of a liability arising under the underlying contract is an issue that has arisen in the winding-up petition relating to Kenworth and directions have been for that issue to be determined. In brief, Nishimatsu claims that Kenworth is liable to it in respect of certain sub-contract works in relation to the Chek Lap Kok Airport development. Kenworth disputes its liability and asserts a claim against Nishimatsu. Nishimatsu's primary contention appears to be that it is entitled to recover the cost of work it alleges had to be done under the sub-contract from the Airport Authority direct and on the basis of its contract with the Airport Authority, the liquidation of Kenworth and the Company would strengthen its position vis-à-vis the Airport Authority. It stands to reason that the question whether Nishimatsu is a creditor of Kenworth and thus of the Company should be dealt with at the same time and I so directed.

5. As regards Apple and Dragages, if they are allowed to appear in support of the petition, the Company must be accorded an opportunity to answer the affidavit filed in support of their claims. In view of the fact that the affidavit was only served 4 days (including a weekend) prior to the hearing, an adjournment will be unavoidable. The present petition has attracted a fair amount of publicity over the last several months. Quite why these claims have not been made earlier is not entirely clear. If the hearing of the petition were to proceed (which it did) without an adjournment, it could only be on the basis that the claims of Apple and Dragages are disregarded. In the result, Apple or Dragages did not appear.

6. United Overseas Bank Ltd. ("UOB"), a creditor in the sum of $50 million supports the petition but has not appeared. Its wishes, likes those of other creditors (including the Standard Chartered Bank) who have refused in principle support to a restructuring will nevertheless be taken into account in considering the wishes of the Company's creditors generally.

7. Apart from the Company, the petition is opposed by the following creditors of the Company : (1) Wonderland Development Ltd. which holds a guarantee by the Company in respect of a debt of $30 million owed to it by UDL E&M (BVI); (2) the Kwangtung Provincial Bank which holds a guarantee for approximately $45 million owed to it by S.K. Luk Construction Company Limited and Universal Dockyard Limited; (3) Overseas Chinese Banking Corporation ("OCBC") which holds a guarantee in respect of debts totalling over $232 million owed to it by the Company's subsidiaries, UDL Dredging (Singapore), UDL Investment and UDL Marine Pte. and finally, (4) G.E. Capital Finance Ltd. which holds a guarantee in respect of debts of over $74 million owed to it by Econo Plant Hire Limited and Graceful East Limited. Wonderland had been granted leave at the earlier hearing to appear. The Kwangtung Provincial Bank, OCBC and G.E. Capital Finance were granted leave to appear at the hearing. Each of the opposing creditors holds some security in respect of the underlying debt provided by the relevant subsidiaries of the Company. In the case of OCBC, the securities held have already been realized, leaving outstanding claims of $115 million. Taking this realization into account, the opposing creditors hold debts to the value of approximately $264 million.

The evidence

8. The evidence in relation to in principle support for a restructuring appears from the 5th Affirmation of Mr Leung Yat Tung, affirmed on 22 March 1999. As appears from Exhibit YTL 22 which includes a summary table showing the response rate of major and minor creditors of the Company, the Company's creditors holding 75.15% in value of the Company's indebtedness have given in principle support.

9. At the hearing, leave was granted to file the 7th Affirmation of Mr Leung. It exhibits further tables to summarize the level of support on a number of different bases compiled from raw data that had previously been exhibited but which has been reorganised. No new material has been introduced which affects the level of support. Such new material as has been introduced is limited to the security provided at subsidiary level although it is the Company's view that it has only one class of creditors and that they are all unsecured.

10. The tables which appear at Schedule A to D of YTL 1 of Mr Leung's 7th Affirmation are structured so as to differentiate between direct and indirect creditors of the Company. Direct creditors are those who have made loans or extended credit to the Company itself and they have been further sub-divided into three categories - financial creditors, internal creditors and trade creditors. Indirect creditors consist of financial creditors who hold guarantees issued by the Company in respect of the debts of its subsidiaries. In summary, these schedules show as follows :

a) Schedule A shows that 78.07% of creditors (ignoring the value of securities provided to them by the Company's subsidiaries) are in principle supportive of the proposed scheme of arrangement in the form circulated to them on 5 January 1999. The increase from 75.15% as at 22 March 1999 is due to the fact that after the date of the 5th Affirmation, in principle support was received from the Kwangtung Provincial Bank whose debt amounts to approximately 3% of the Company's overall indebtedness.

b) Schedule B shows that after taking the value of the securities into account (whether by based on actual realisations or on estimates), some 78.15% of the Company's creditors are supportive of the proposed scheme of arrangement.

c) Schedule C shows that even if Schedule B were adjusted so as to exclude inter-company creditors, some 72.48% of the Company's creditors support the proposed scheme of arrangement in principle.

d) Schedule D shows that if regard is had only to creditors who have expressed their view on the proposals (excluding inter-company creditors), some 81.75% of the creditors who have expressed a view on the proposals are in principle supportive of them.

11. The proposed restructuring extends to the Company's major subsidiaries, i.e. UDL Argos Engineering & Heavy Industries Company Limited ("Argos"), UDL Civil Contractors Limited, UDL Ship Management Limited, UDL Marine Operation Limited, UDL Contracting Limited, Universal Dockyard Limited and Econo Plant Hire Company Limited. These enjoy in principle support from their creditors of 83.31%, 94.65%, 98.78%, 97.70%, 99.70%, 77.05% and 99.43% respectively. In the case of Argos, the percentage is challenged and the petition to wind-up Argos originally due to come on after this petition had to be adjourned because of insufficient time.

12. I now turn to consider the issues which arise in deciding how the court's discretion should be exercised.

Whether lengthy adjournments are appropriate

13. Counsel for HSBC referred to the judgment of Godfrey JA in Re Esquire (Electronics) Ltd. [1996] 3 HKC 309 at 312F-313A :

"..... An unpaid creditor is entitled ex debito justitiae to an order; .... Even where a petitioning creditor consents to an adjournment or stay, the court is reluctant to grant anything but a short adjournment, usually to enable the petitioner to consider some proposal put forward by the company. Only in an exceptional case will a long adjournment be granted; and never one for an indefinite period. Long adjournments are inherently undesirable. A winding-up order, if made, dates back to the date of presentation of the petition. Adjournments made the process of liquidation more complex. Dispositions made between the presentation of the petition and the making of the winding-up order have to be examined to see if they are justifiable; and delay increases the number of these transactions and makes their examination more difficult. The winding-up procedure is not ordinary litigation. The special considerations which apply to creditor's winding-up petitions require that they should be heard promptly. In normal cases where the debt is admitted a period of four weeks from the date of the first hearing ought to suffice to enable the petitioning creditor, if still unpaid, to decide whether to press for a winding-up order or whether to rely on other arrangements put forward by the company. Usually this period should also suffice to enable the company to decide whether or not to promote some such other arrangement."

The petition in the present case was first heard over five months ago. It was submitted that applying the principles stated in Re Esquire, no further adjournments should be entertained.

14. I do not read the judgment of Godfrey JA as laying down any inflexible rule to the effect that no adjournments beyond a period of four weeks from the day of the first hearing should be allowed. Rather, the short period of adjournment alluded to is to enable the company to decide if some other arrangement should be put forward. If it does and the alternative arrangement has the support of the creditors or a substantial majority of them, it must follow that such adjournments as may be necessary should be granted until the creditors are able to decide whether or not to accept the alternative arrangement by voting at any court convened meeting. Otherwise the short adjournment would not serve any useful purpose given the procedure involved in a section 166 application. There is certainly nothing in Re Esquire (supra) to suggest that where there is a clear majority of creditors in support of a restructuring proposal and opposed to a winding-up, adjournments may not be granted to enable the scheme to be formulated and put to the creditors.

15. In my judgment, there is no intrinsic objection to granting adjournments assuming a restructuring is being proposed and that proposal enjoys sufficient in principle support, such that there are reasonable prospects for it to be accepted by the requisite majority.

Whether consent obtained was based on misleading information

16. On 5 January 1999, the Company wrote to its creditors in the following terms :

" We refer to our letter to you of 13th October 1998 proposing a restructuring of the UDL group (to be effected by a scheme of arrangement) as an alternative to liquidation. Lenders with 77.15% of [the Company's] debts demonstrate their support of the scheme as opposed to liquidation. The Lenders' strong preference was apparently one factor taken into account by the Court on 13th November 1998 and adjourning the winding-up petition by HSBC to 11th January 1999 (next Monday). We understand that HSBC's action was taken on behalf of all Lenders to protect the Lenders' rights in relation to the charging order action taken by UOB.

....

Our Restructuring Accountant, Ernst & Young, have reviewed the Proposed Scheme and their comments are set out in the attached letter dated 5th January 1999 ...."

17. According to HSBC, that letter was misleading in that (1) the alleged support of 77.15% in value of the Company's debt included a significant portion of support that was conditional; (2) the alleged support did not take into account the full extent of the debt because not all creditors had been accounted for; (3) the Ernst & Young report of 5 January 1999 sent with the proposed scheme was itself misleading; and (4) the letter misrepresented HSBC's reasons for presenting the petition.

Conditional support

19. Did the failure to inform the creditors that a significant portion of the support given in October was conditional vitiate the consent given by the creditors in response to the letter of 5 January 1999? It is to be noted that whilst the in principle support given in October was conditional, it was nonetheless a vote in favour of rather than in opposition to any restructuring proposal. In that sense, the letter of 5 January could not be said to be false. Moreover the table summarising the responses to the October letter presented to the court contained four separate columns headed "Agree", "Conditional Agree", "Disagree" and "No Reply". The responses were thus clearly categorised. The only 'wrinkle', it seems, related to Nippon Credit. It sent two replies : the reply to the Company's subsidiary Well Raise was negative but the reply to the Company was positive though conditional. The response was classified as "Conditional Agree". In the circumstances I do not consider the 'wrinkle' to be significant.

20. So far as concerns the consent given in response to the letter of 5 January, it would only be vitiated if it can be shown that it would not have been forthcoming had the creditors been told that a substantial part of the 77.15% support given in October 1998 was conditional, or, put differently, the result of the creditors' October response as portrayed in the January letter was a factor which materially affected the creditors' response to the letter of 5 January.

21. In this regard, it is important to bear in mind what was sent to the creditors : apart from the letter of 5 January, they were sent (as Appendix 7 to the proposed scheme,) an opinion letter of 18 November 1998 being Ernst & Young's group liquidation analysis. The November letter made plain that Ernst & Young had been retained as restructuring advisers to the Company since early 1998. In May 1998, based on the unaudited management accounts as at 31 January 1998, Ernst & Young estimated that the liquidation recovery for unsecured creditors of the group would be in the range of less than $0.04 to less than $0.10 in a dollar. In view of the deteriorating market in the interim, Ernst & Young believed that the liquidation recoveries by November 1998 would be substantially lower than that based on the January 1998 numbers. They opined that liquidation recovery, after costs, would "be practically nothing". In their January letter, Ernst & Young stated that :

"The liquidation recoveries (after liquidation costs) for unsecured creditors from liquidations of [the Company] itself and the other UDL group companies would be practically zero."

They also opined that :

" Given the liquidation is so unattractive for unsecured creditors both in [the Company] itself and in the different subsidiaries, we believe that the unsecured creditors should pursue any viable restructuring plan rather [than] liquidation. ....

In conclusion, we would repeat that, given the unattractiveness of liquidation, the unsecured creditors should have nothing to lose by supporting the Proposed Scheme."

22. The overwhelming majority of creditors to whom the restructuring package was sent were "financial creditors". Common sense alone would suggest that such creditors would be guided by the financial information conveyed to them rather than by any "herd" instinct. That it is so appears to be borne out by the evidence filed by the opposing creditors : this shows that the decisive factor was the advice of Ernst & Young. Having regard to this evidence, I am unable to conclude that the creditors' consent was other than "informed". Moreover, the letters from Hang Seng and Natexis Banque when fairly read do not support the "herd" instinct submission. After perusing the list of creditors, I am inclined to agree with counsel for the opposing creditors that a little more credit should be given to the recipients of the information which are commercially mature business entities.

Incomplete list of creditors

23. It was submitted that the tables produced by the Company showing in principle support are unreliable because the list of creditors used in compiling those tables is incomplete. HSBC sought to rely on the fact that Nishimatsu, Apple and Dragages who claim to be creditors do not feature in the list. As noted above, Nishimatsu's claim as a creditor is disputed. And as regards Apple and Dragages, for reasons set out earlier, their claims cannot be taken into account for the purposes of this hearing since the Company has not had the opportunity of responding to them. There is therefore no evidence that any creditor has been omitted, intentionally or otherwise.

24. Counsel for HSBC submitted that it is for the Company to satisfy the Court that a full list of creditors has been presented. I have to say that I have some difficulty with that submission. It is unclear what is being suggested. How is the Company to go about satisfying the Court that a full list has been presented? Surely all it can do at this stage is to put forward the names of those the Company believes to be creditors. After all the rationale of advertising a court meeting if one were to be convened is to give notice to creditors so that any creditor who has been overlooked would be able to take appropriate steps. It would be another matter if it can be shown that the Company has knowingly omitted creditors from the list, but there is no evidence of bad faith on the part of the Company. Indeed the Company recognises that possible creditors under performance guarantees have not been included in the list of creditors. Claims of contingent and/or disputed creditors are different in nature from the claims of creditors whose debts have crystallised and are undisputed. For one thing, the amount or value to be assigned can be a matter of some difficulty. This potential liability is under consideration and the draft of the scheme documentation suggests that it is intended to take such contingent and/or disputed debts into account.

25. On the evidence, there is no basis for concluding that the list of creditors is inaccurate or incomplete such that the level of support assessed on the basis of that list can be said to be unreliable.

The Ernst & Young letters

26. Counsel for HSBC took issue with the letters of Ernst & Young in that Ernst & Young being the restructuring advisers were not in a position to give independent advice. Issue was also taken as to the advice contained in their letter of 5 January 1999. HSBC's position is that it is not entirely impossible that if the Company were put into liquidation, the creditors would receive a dividend. It was wrong for Ernst & Young to have ruled out that possibility. Further, Ernst & Young failed to address an alternative possibility which is that liquidation is no bar to a restructuring under section 166.

27. Ernst & Young's position in the restructuring is made very clear in their letters. They did not conceal their role in the restructuring. It would have been obvious to anyone reading the letters that Ernst & Young were not purporting to give independent advice. Ernst & Young also stated very clearly that they were unable to verify the numbers underlying the proposed scheme due to time constraints. Again, no one reading their letter could have been misled in that regard. Moreover Ernst & Young's assessment of the likely return under the proposed scheme versus liquidation has not been shown to be unfounded.

28. As will become apparent later (see under "Liquidation and schemes of arrangement"), the point that liquidation is no bar to a restructuring has no merit in the context of the present case.

29. In my judgment, the criticisms sought to be made against Ernst & Young are unwarranted.

HSBC's reasons

30. The other respect in which the letter of 5 January is said to be misleading is the reason why HSBC presented a winding-up petition. It would appear from the letter of 24 October 1998 from HSBC's solicitors that the petition was precipitated by the decision of UOB to proceed with a charging order application on 27 October 1998. Concurrent with the petition, HSBC presented a summons seeking a stay of a charging order application until the conclusion of the hearing of the petition presented on 24 October 1998.

31. Given the terms of that letter and the events prior to 5 January 1999, the Company's "understanding" of HSBC's decision cannot be said to be wholly unfounded or unreasonable. Certainly HSBC did not object to any of the adjournments until the hearing of 11 January 1999. Accordingly, the statement in the 5 January letter concerning HSBC's reasons for presenting the petition has not been shown to be misleading. In any event, assuming there to be a mis-statement, it is far from obvious that it would have been material.

Classification of creditors

32. HSBC submitted that the creditors ought to have been divided into different classes, such as financial creditors, trade creditors, inter-company creditors and contingent and prospective creditors, secured and unsecured. Even within the classes of secured creditors, they may have to be divided into separate classes as the securities held are not common to the whole "secured creditors" classes. Additionally, internal creditors, i.e. subsidiaries of the Company, in particular wholly owned subsidiaries should be treated as a separate class as they will not necessarily have the same view as other creditors since they may themselves be facing liquidation.

33. It is of course correct that the responsibility for determining what creditors are to be summoned to vote at any meeting as constituting a class rests with the Company. If there are separate classes, they must be identified and dealt with accordingly. All those matters no doubt arise for consideration in due course when the scheme has been properly formulated and settled. But at this stage, I do not consider it to be the Court's function to second-guess the formulation of the scheme or, indeed, to express a view as to whether there is more than one class of creditors. That must be a matter for the promoter of the scheme. The Company, relying on the holding in In re Industrial Equity (Pacific) Limited [1991] 2 HKLR 614 that it is the dissimilarity of rights rather than the dissimilarity of interests that is determinative of a class, is of the view that there is only one class of creditors. That may well be correct but it would be premature for me to express any view on that question now and I do not propose to do so.

Exercise of the discretion

Petitioner's right is a class right

34. Counsel for the Company submitted that the right of the petitioner to obtain a winding-up order is a class right and in deciding whether or not to make the winding-up order, the Court has regard to the views of the other creditors. As counsel for Wonderland and Kwangtung Provincial Bank pointed out, if authority for the proposition that the petitioner's right is a class right be required, it is to be found in the judgment of Buckley J in Re Crigglestone Coal Company, Limited [1906] 2 Ch. 327 at 331-332 (affirmed by the Court of Appeal) :

" But then comes another consideration, viz., that the order which the petitioner seeks is not an order for his benefit, but an order for the benefit of a class of which he is a member. The right ex debito justitiae is not his individual right, but his representative right. If a majority of the class are opposed to his view, and consider that they have a better chance of getting payment by abstaining from seizing the assets ..... the Court gives effect to such right as the majority of the class desire to exercise. This is no exception. It is a recognition of the right, but affirms that it is the right not of the individual, but of the class; that it is for the majority to seek or to decline the order as best serves the interest of their class. It is a matter upon which the majority of the unsecured creditors are entitled to prevail, but on which the debtor has no voice."

Bona fide reasons

35. In one respect, the observations of Buckley J in Re Crigglestone Coal Company Limited (supra) need to be qualified. Good reason has to be shown by the majority if their wishes are to prevail. This appears from the judgment of Willmer LJ in Re P. & J. Macrae Ltd. [1961] 1 WLR 229 at 235 :

" ..... before a majority of creditors can claim to override the wishes of the minority, they must at least show some good reason for their attitude ... I have no doubt that where a majority of creditors do for good reason oppose a petition for the winding up of a company, then, prima facie, they are entitled reasonably to expect that their wishes will prevail, in the absence of proof by the petitioning creditor of special circumstances rendering a winding-up order desirable in spite of their opposition. But I am certainly not prepared to accept the view that the bare fact of the opposing creditors being in a majority is of itself sufficient, still less conclusive."

36. In K & R Wong Construction Company Limited [1998] 2 HKC 364 at 369C-G, I had expressed a similar view. In that case, no reasons had been advanced by the opposing creditors. That is not the case here. The opposing creditors have filed evidence to the effect that their decision was based on the report of Ernst & Young. They made a commercial decision : having regard to Ernst & Young's letter of 5 January considered above, they believe that it would be in their interest to support a restructuring. It is a commercial decision, weighing the prospects of receiving practically nothing as opposed to something.

37. Apart from the opposing creditors who have filed evidence, the court should also have regard to the fact that a large number of creditors have expressed in principle support for a restructuring. Is that support, ipso facto, a valid or sufficient reason? In my judgment, the answer must be in the affirmative. Creditors who support a scheme of arrangement which compromises their debts normally do so because they consider it to be in their financial interest. It would not be unreasonable to draw such an inference from the very fact of support.

Liquidation and schemes of arrangement

38. Counsel for HSBC sought to impugn the report of Ernst & Young and the decision of the opposing creditors on the basis that they failed to consider an alternative which is that the same solution (i.e. a scheme of arrangement) can also arise after liquidation since it is open to the liquidator to promote such a scheme. It is of course extremely unusual for schemes of arrangements to be promoted by liquidators. Such schemes are normally put forward with a view to 'saving' the company from liquidation and the incentive to do so would normally have evaporated upon the making of a winding-up order. Thus, once a company is in liquidation, the likelihood of a scheme being promoted by a liquidator is virtually nil unless it is funded by a third party and the liquidator's costs are underwritten.

39. On the evidence before the Court, this is not a case where there is a white knight. Plainly Mr Leung's efforts to rescue the Company have been made on the basis that the Company will not go into liquidation. There is certainly no evidence that he is willing to promote any scheme or fund the promotion of any scheme if the Company is to be wound-up. Rather, it is apparent from the proposed scheme circulated to creditors in January that the rescue rationale is the retention of the UDL Group as a going concern. The costs of the scheme and the costs of seeking assets to pay creditors of some $20 million is being funded externally by Mr Leung. Accordingly, I find that HSBC's attack to be without merit.

Conclusion

40. The evidence shows that the value of the debts of creditors who have refused to give in principle support to any restructuring have increased from 11.45% as at 22 March 1999 to 14.49% of the overall debt. Even so, that falls substantially short of what would constitute a blocking vote, viz. in excess of 25% in value of the debts.

41. I am satisfied on the evidence that a substantial majority of the creditors of the Company have expressed in principle support for the scheme and that there are at least reasonable prospects of the scheme obtaining the approval of the requisite majority. Although the Argos petition has still to be heard, even if a winding-up order were made on that petition, it would not be fatal to the scheme. Rather, it would mean that the scheme would have to be revised. In those circumstances, given the wishes of the majority of creditors who have expressed in principle support (which includes the opposing creditors who have appeared at the hearing of the petition,) and given that there are valid reasons for their so doing, it would not be a proper exercise of my discretion to make a winding up order at this stage.

42. Costs are to follow the event and I make an order nisi in favour of the Company and the opposing creditors.