SULANSER CO. LTD. (in liquidation) AND ANOTHER v. CHINA ALLIED HOLDINGS LTD. AND OTHERS

HCA 8001/95

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 8001 OF 1995

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J U D G M E N T

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1. The 1st Plaintiff company ("Sulanser") is in liquidation and the 2nd Plaintiff is the liquidator of Sulanser. The Plaintiffs in this action are suing to set aside the assignment of a property of Sulanser on 10 January 1995 to the 1st Defendant ("China Allied") at the purported consideration of $5 million.

2. The property of Sulanser comprised of three units at Rooms 802-4, 8/F, Hua Qin International Building, 340 Queen's Road Central ("the Property"). The petition for winding up was presented by one Jiangxi Provincial Metals & Minerals Import & Export Corporation ("Jiangxi Provincial") on 19 May 1995, and the order for winding up was made on 21 June 1995.

3. The Plaintiffs' case comprised of three causes of action, namely :

(1) fraudulent disposition under s.60 of the Conveyancing & Property Ordinance, Cap. 219 ("CPO");

(2) fraudulent preference under s.266 of the Companies Ordinance, Cap. 32 ("CO"); and

(3) constructive trust.

The Defendants' case

4. The 2nd Defendant, Philip Fei, and 3rd Defendant, Miss Yu Kwong Sen, were at all material times the shareholders and directors of China Allied in the transfer of the said Property to it. It is the Defendants' case that the transfer of the Property to China Allied was due to a debt, due and owing to the principal of China Allied, one Tianjin International Economic Technology Co-operation Engineering and Construction Company ("Tianjin International").

5. By a loan contract made between Sulanser and the People's Construction Bank in Tianjin dated 19 February 1993, the bank agreed to lend Sulanser the sum of RMB 12 million. It was stated that it was an Agency Loan in the sense that the bank was acting as an agent for the guarantor, Tianjin International, which in fact was supported by the Tianjin Provincial Government who was the original lender of the money.

6. Sulanser was actually borrowing the money for one Hong Tai Trading Development Company Limited ("Hong Tai") in the Mainland. On 24 February 1993, a sum of RMB 12 million was paid and advanced by the People's Construction Bank to Hong Tai at the direction and request of Sulanser. According to the loan agreements with Hong Tai and the 1st and 2nd Supplemental Agreements dated 24 February and 18 May 1993, Hong Tai would have to pay a substantial sum of interest within three months. However, Hong Tai could not repay any money and Sulanser was later pressed by Tianjin International to repay the loan.

7. After the first reminder by Tianjin International to Sulanser demanding repayment dated 1 March 1994 and the second reminder dated 5 July 1994, there was a meeting between Sulanser and Tianjin International on 11 August 1994. It was agreed that the total amount of debt due and owing should be RMB 14.22 million. Sulanser also there and then agreed to make a proposal within a few days of the schedule of repayment. But in any event, it would repay RMB 200,000 before 15 August 1994.

8. No repayment has been made and Tianjin International sent its third reminder on 20 September 1994 demanding repayment. There was a final reminder on 7 December 1994.

9. By a letter dated 20 December 1994, Sulanser suggested to Tianjin International that the debt should be repaid partially by transferring the Property at the price of HK$7 million, leaving the balance of HK$7.22 million to be repaid within one month. Eventually by 23 December 1994, the parties agreed as follows :

(1) the Property be transferred to a holding company of Tianjin International in Hong Kong, i.e. China Allied at $5 million by way of partial repayment of the debts;

(2) Tianjin International would lease the Property back to Sulanser at a monthly rent of not less than $20,000; and

(3) a repayment proposal for the balance of $9.22 million to be submitted to Tianjin International before February 1995.

10. On 15 November 1994, the 1st Defendant was incorporated in Hong Kong, and on 19 December 1994 Mr Philip Fei and Miss Yu became the shareholders and directors thereof.

11. The Provisional Sale and Purchase Agreement between China Allied and Sulanser in respect of the Property was dated 28 December 1995 and the Formal Sale and Purchase Agreement between them was dated 4 January 1995. Eventually, the Property was assigned to China Allied on 10 January 1995 at $5 million as aforesaid.

12. By a letter dated 8 July 1995, Tianjin International directed China Allied to sell the Property at $6 million. Eventually, China Allied entered into a formal sale and purchase agreement with one View Fame Industries Limited on 15 July 1995 whereby China Allied agreed to sell the Property at $5.43 million with completion date fixed for 15 September 1995. The completion was restrained by an injunction obtained by the Plaintiffs in the action herein in August 1995 by reasons of the fact as appearing herein below.

The Plaintiffs' allegations

13. Jiangxi Provincial obtained an Arbitration Award in the Mainland on 23 August 1993. On 5 December 1994, judgment was obtained in Hong Kong by Jiangxi Provincial in HCMP No. 887 to enforce the Arbitration Award.

14. The Plaintiffs therefore allege that the transfer of the Property to China Allied coincided closely with the enforcement of the judgment as a result of the Arbitration Award in December 1994, and invited the Court to draw the inference that the transaction was made with the intention of preferring China Allied to other creditors. Further, the Plaintiffs also allege that the transaction was made without any or any adequate consideration in the sense that the consideration of $5 million, if it was true, was in any event an undervalue of the Property.

The law

15. The Plaintiffs' case depends on whether the transaction was a fraudulent preference under s.266 of CO or whether it was made with an intent to defraud creditors without any valuable consideration or good faith under s.60 of CPO. The question of constructive trust is also dependent on the aforesaid allegation of fraudulent preference and disposition.

16. The concept of fraudulent preference has been fully explained in the case of In re Cutts [1956] 1 WLR 728 (CA) per Lord Evershed M.R., Jenkins and Hodson L.JJ. It was held in that case that :

"(1) that the onus was on the person alleging a fraudulent preference to prove to the satisfaction of the court that the payment impugned was made by the bankrupt with the intention of preferring the payee over his other creditors; (2) that it was competent to the court to draw the inference of an intention to prefer from all the facts of the case; (3) that the intention to prefer, which must be proved, must be the principal or dominant intention; there might, however, be a valid distinction between an intention to prefer and the motive for that intention; (4) (Jenkins L.J. dissenting) that on the facts the bankrupt voluntarily made the payment with the intention of giving the society preference over the other creditors, and it was therefore a fraudulent preference within section 44(1)."

Lord Evershed, M.R. explained the concept of fraudulent preference at pp. 733-734 as follows :

" (3) The words used in the section are 'with a view of.' I have used the word 'intention' as synonymous with the word 'view'; and other words-e.g., 'object'-have also been used as synonyms in the cases. But whether the word used be 'intention' or some other word, since it is notorious that human beings are by no means always single-minded, the intention to prefer, which must be proved, is the principal or dominant intention. There may also be a valid distinction for present purposes between an intention to prefer and the reason for forming and executing that intention.

It is at this point that the greatest difficulty, as it seems to me, arises, the difficulty being as often as not one of definition of the words used. If a debtor, knowing himself to be insolvent and knowing, also, that bankruptcy is imminent, deliberately elects to pay his oldest friend or his closest relative and to leave his other creditors unpaid or with little chance of being paid, it would appear to me to be irrelevant that he made the selection because of the love he bore for his friend or relative or because of his hopes for general but unspecified favours from them in the future. I am therefore not prepared to accept Mr. Raeburn's submission that a deliberate choice in the present case by the debtor of the building society for payment, because the society was the most important of his clients could not for that reason constitute a fraudulent preference. For if a debtor deliberately selects for payment A in preference to all his other creditors, it cannot, to my mind, matter, in the absence of other relevant circumstances, whether A is the debtor's oldest friend, closest relative or best client. On the other hand, where a debtor, owing money in all directions, has also robbed his employer's till, he may, knowing himself to be insolvent, elect to reimburse the till in order that, when the crash comes, the damaging fact of his robbery may not be discovered. Or a debtor may elect to make a particular payment under pressure of some threat, or to obtain for himself some immediate and material benefit or to fulfil some particular obligation. In these cases the reason for the payment affects, essentially, the intention in making it. In the instances given the intention, that is the real or dominant intention, will no longer be to 'prefer' (that is to pay, as it were, out of turn) but will be to avoid the detection of a criminal act; to relieve the threat; to get the benefit and postpone the evil day; or to satisfy the particular obligation. Though the question of pressure in some form or another has, in the reported cases, often been the crux of the matter, it is plain that an inference of intention to prefer may be displaced in many other way than by showing that the debtor acted under pressure. Examples are indeed legion. But in the present case the examples that I have given provide the closest analogies to the suggestions on the society's side; and the real question before us is whether, upon the evidence and the findings of the county court judge, the true inference is intention to prefer or whether an inference of some other kind similar to those in the examples given is, at the least, not equally legitimate."

17. With the aforesaid observation and explanation in mind, I shall endeavour to analyse the facts of the case in order to determine whether the principal or dominant intention of the assignment of the Property to China Allied was to prefer China Allied over other creditors of Sulanser.

The facts

18. In this respect, I shall first of all consider whether the advancement of the loan, together with all the aforesaid agreements thereof, were bogus as alleged by the Plaintiffs before considering whether the repayment by way of the transfer of the Property was made with the principal or dominant intention of preferring China Allied. Thereafter I shall also consider whether the Property was transferred at an undervalue.

(1) The Loan

19. The Defence called five witnesses besides its surveyor. DW2 Wang Jing Wei was the legal representative and General Manager of Tianjin International. DW3 Chen Zhi Feng ("Chen") worked for the Tianjin City and Rural Construction Committee ("the Committee"), and he was the Deputy Chairman thereof since 1992. He was responsible for overseeing the operation of Tianjin International. Chen was also the succeeding majority shareholder and director of China Allied after the 2nd Defendant, Philip Fei (DW4) in 1996, Chen has made a declaration of trust in favour of Tianjin International. DW5 Xu Ying Sheng was the General Manager of Hong Tai in 1993 when the aforesaid loan was advanced to Hong Tai and he was the one who signed the loan agreement with Sulanser.

20. DW6 Miss Yu was, and still is, one of the two shareholders and directors of China Allied. She is the daughter of Mr and Mrs Yu (also known as Madam Chen), the two shareholders and directors of Sulanser.

21. After I heard the evidence from the defence witnesses, I came to the view that the loan was not a bogus arrangement between Sulanser and Tianjin International and between Sulanser and Hong Tai. It is true that this enormous amount of loan was totally unsecured and the way it was arranged was apparently in a careless manner. However, Sulanser had been borrowing money from Tianjin International without any security before and had repaid its debts with interests. Madam Chen was in fact a Deputy General Manager of Tianjin International at the time of the loan. She had been a close colleague and friend of Mr Wang (DW2) for sometime. I find this kind of loan arrangement in the Mainland is quite prevalent between people of close relationship where transaction is based on kwang si (relationship) rather than security.

22. It was true that Tianjin International did not know the purpose of Sulanser's borrowing. Sulanser did not know the purpose of Hong Tai's borrowing either. It was suggested that Sulanser, through Mr and/or Mrs Yu, knew the purpose of Hong Tai's borrowing. There was no evidence to that effect. The evidence through Mr Xu was that most of the money was used to make a film which was eventually censored by the government and the same could not be released. It is common general knowledge that the return on the making of a movie could not be as soon as three months as stipulated in the loan agreement between Sulanser and Hong Tai. However, the evidence of Miss Yu, the daughter of Mr and Mrs Yu, was that Mr Yu was in the dark as to the purpose of Hong Tai's borrowing. He was motivated by the quick and large return by way of interests within three months. He considered that he was cheated.

23. From the evidence of all these witnesses, I cannot come to a conclusion that all these arrangements were just bogus, otherwise all the documents presented to the court were forged documents in order to make up a case of indebtedness to support the consideration for the transfer of the Property. I do not consider that that was the case here.

(2) The Value

24. Accordingly, the interest in the Property disposed of was made for valuable consideration. One, however, would have to consider whether it was made in good faith to China Allied, being agent of Tianjin International, not having, at the time of the disposition, notice of the intent to defraud creditors.

25. I shall dispose of the question of whether the Property was assigned at an undervalue here first.

26. The Plaintiffs' surveyor, Ms Lau of M/s Francis Lau & Co., testified that their valuation for the Property on 10 January 1995 was $7.3 million and 5 July 1995 at $6.6 million. The valuation of the Defendants' surveyor, Mr Peter Cheung, was, on the other hand, assessed at $5.5 million and $5.4 million respectively. However, admittedly Ms Lau said her assessment was based on selling the Property in three separate units within a reasonable time (say one month) to a willing buyer in the market, i.e. without taking into account bulk sale and forced sale as Mr Cheung's valuation. Thus all in all although $5 million might well be a bit below the market value of $5.5 million as assessed by Mr Cheung (which I would prefer), taking into account a forced sale, the stated consideration cannot be said to be at an undervalue since Sulanser would not have much bargaining power as against its creditor, Tianjin International.

(3) Was there any intention to prefer China Allied for Tianjin International to other creditors

27. Here I consider that this intent to defraud creditors on the part of Sulanser under s.60 of CPO is equivalent to the intention to prefer the same fraudulently under s.266 of CO, though notice of such an intention to defraud on the part of China Allied is not required under s.266.

28. The Defendants submitted that by the end of 1994, Sulanser had been hard pressed by Tianjin International to repay the loan after several reminders. However, I also note the followings, namely :

1) The loan agreement between Sulanser and Hong Tai and the loan contract between Sulanser and the People's Construction Bank were such that the loan should be repaid by May 1993. It is highly relevant that no written demand for the same had been made until the first reminder in March 1994 which was referred to in the third reminder dated 20 September 1994 but the same has not been produced to Court. The first written demand produced to Court was dated 5 July 1994. That would be more than nearly a year after the debt was due. The arbitration award obtained by Jiangxi was dated 23 August 1993. Sulanser must have been aware of the arbitration proceedings leading to the award since mid 1993 and the fact that Jiangxi Provincial was trying to enforce the Arbitration Award by way of HCMP No. 887 which eventually was realised by the judgment in this jurisdiction on 5 December 1994. Thus by December 1994 Sulanser was aware that Jiangxi Provincial was trying to enforce the judgment of considerable amounts being (1) US$198,000, (2) RMB 90,000 together with interests, and (3) arbitration fee in the sum of RMB 33,070. In other words no action was taken for a year by Tianjin International. When it started to press hard for the repayment that was the time of the arbitration leading to the award.

2) The agreement and arrangement for the transfer of the Property was reached quite quickly at the end of 1994. That was the time Jiangxi Provincial was trying to enforce the award in Hong Kong. Mr Yu even raised $2.6 million himself to repay the outstanding mortgage on the Property before the transfer.

3) One of the shareholders and directors of China Allied was no other person than the very daughter of Mr and Mrs Yu, i.e. Miss Yu.

4) Miss Yu was instructed by her father Mr Yu, to apply to set aside the award in January 1995 when the Property was transferred. I consider that it cannot be a coincidence that Miss Yu was instructed by her father to set aside the judgment obtained by Jiangxi Provincial in December 1994. Her affirmation made for and on behalf of Sulanser in the position of a deputy general manager, in the application to set aside the arbitration award was made on 16 January 1995. The company appeared in person to save up legal costs. In the meantime the Property was transferred to China Allied on 10 January 1995. This application failed. I accept the submission of the Plaintiffs that Sulanser was stalling for time.

5) After the winding up petition was lodged by Jiangxi Provincial on 19 May 1995 and the winding up order made on 21 June 1995, Tianjin International instructed Philip Fei and Miss Yu on or about 8 July 1995 to sell the Property. I could accept the sale to View Fame was a genuine sale made at arm's length. I do not consider that the timing of this subsequent sale was suspicious. Although Tianjin International's letter of instruction was dated 8 July 1995 addressed to Philip Fei and the letter of View Fame's solicitors offering to buy the Property was also dated 8 July 1995, I accept Mr Yuen's submission for the Defendants that probably Miss Yu had been informed by Mr Wang of Tianjin International in Tianjin before 8 July (as she said that was what she could faintly recall) and she had instructed two Hong Kong estate agents for the purpose of sale. In so doing, she had also instructed the management office of the building to hand over the key to the prospective buyers which in turn led to the offer of View Fame who was introduced by the management office.

6) However Miss Yu insisted that Wang only paid the HK$20,000 equivalent RMB to her to repay interest on the deposit to View Fame. No further payment was made. In fact China Allied paid a further sum of $51,000 odd by way of legal fees and charges/disbursement to View Fame. I accept Mr Smith's submission for the Plaintiffs that Miss Yu was trying to hide the fact that all these monies came from her parents in the scheme of preferring Tianjin International to Jiangxi Provincial.

29. The chronology of the aforesaid events strongly indicated that the transfer of the Property was made with the principal or dominant intention to prefer Tianjin International than other creditors, in particular Jiangxi Provincial, when the latter was trying to obtain and later enforce the arbitration award. In so doing, Sulanser was disposing its only valuable asset in Hong Kong in favour of Tianjin International than other creditors. It was clearly aware of the judgment debt of Jiangxi Provincial.

30. Accordingly, I find the transfer in question was made with the intention to defraud creditors for the purpose of s.60, albeit it was made for valuable consideration but not in good faith to China Allied who, at the time of the disposition, had notice of the intent to defraud creditors under s.60 of CPO. It goes without saying that it is also a fraudulent preference under s.266 of CO. Consequently, China Allied is now holding the Property in constructive trust for the liquidator of Sulanser.

31. The Plaintiffs are therefore entitled to the relief as claimed in paragraphs 1 to 12 inclusive of the Statement of Claim. However, they are not entitled to the declaration that the Property held by the Defendants is held on trust for Jiangxi Provincial only for payment of their indebtedness as I have found that China Allied was an agent for Tianjin International who is also a genuine general creditor of Sulanser itself. In short the Property is now held on trust for all creditors of Sulanser including Tianjin International. There shall also be an order nisi for costs of the Plaintiffs against the Defendants.