RE KEEN LLOYD RESOURCES LTD

HCCW 1134/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 1134 OF 2002

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D E C I S I O N

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1. This is an application taken out by the Bank of China (Hong Kong) Limited ("BOC") under section 186 of the Companies Ordinance, Cap. 32 in the liquidation of Keen Lloyd Resources Limited ("the Company"). The Company was wound up on 23 July 2003 on a creditor's petition presented by BOC and liquidators were appointed on 13 November 2003. BOC seeks leave to commence proceedings under Order 88 of the Rules of the High Court against the Company in relation to 3 properties set out in the schedule to the summon, all secured under various legal charges charged by the Company to BOC (as successor of all the undertakings of Sin Hua Bank Limited, Shenzhen branch and Hong Kong branch) and to enforce the order to be obtained by BOC under the intended proceedings. I shall refer to BOC and its predecessor as "the bank".

2. It is provided in section 186 that when a winding-up order has been made, no action or proceedings shall be proceeded with or commenced against the company except by leave of the court, and subject to such terms as the court may impose.

The background

3. The background may be stated as follows.

4. The Company had been a customer of the bank since 1986 and had borrowed substantial sums from the bank under various banking facilities granted to the Company and other companies within the Keen Lloyd Group ("the Group"). Most of the indebtedness of the Group was borrowed from the bank before the Asian financial crisis towards the end of 1997. A substantial number of properties had been charged to the bank to secure the indebtedness.

5. Since about March 2000, the Group had been unable to make repayments to the bank and was in default of the charges. On 14 April 2000, a Memorandum of Agreement ("the MOA") was entered into between inter alia the Company and the bank, by which the Company agreed to sell the properties charged to the bank to reduce the indebtedness. Pursuant to the MOA, 10 properties were sold during June to November 2000.

6. On 15 February 2001, the bank appointed receivers over all 57 properties under legal charges in favour of the bank. 46 of these properties are owned by the Company, the remaining 11 properties are owned by subsidiaries of the Company.

7. In March 2001, the Company and a related company brought HCA No. 1319 of 2001 against the bank and the receivers, claiming that the bank had wrongfully alleged that the Company had repudiated the MOA and seeking a declaration that the MOA was valid and subsisting, that recovery actions brought by the bank against the Company should be stayed, and a declaration that the appointment of the receivers was invalid.

8. In April 2001, the Company obtained an interlocutory injunction in the High Court Action. The bank was restrained from proceeding with the recovery actions and to enforce the charges over the 57 properties; the receivers were restrained from acting as receivers of the 57 properties, pending the determination of the High Court Action. That injunction was discharged on 1 November 2003 by a consent summons, after the Company was wound up.

9. The winding-up order constituted a fresh event of default under the charges.

10. On 25 August 2003, the bank filed with the Official Receiver as the provisional liquidator a proof of debt in this liquidation, with an analysis of claim, for the amounts of HK$781,393,504.04 and US$68,283,290.40, with particulars of security in respect of 46 properties with an estimated value of HK$518,300,000.00.

11. According to the evidence filed by the bank in support of this application, a more up-to-date position of the total indebtedness of the Group, not just of the Company, as at 31 March 2004, amounted to HK$1,832,330,488.60 and taking into account the forced sale value of all the securities held, the net amount outstanding exceeded HK$1,046,340,490.61.

12. The bank seeks leave to commence a mortgage action as the chargee in respect of 3 properties. I shall refer to them as "the Altadena Property", "the Parkview Property" and the "Dynasty Property". In respect of each property, the bank would like to bring proceedings against the Company and the tenant of the property, to recover vacant possession. The bank has never consented to the occupation of these properties by any of the occupants. None of the tenancy agreements in respect of the properties were registered with the Land Registry.

13. The Altadena Property was mortgaged to the bank under 3 legal charges dated 1 May 1997, 5 March 1998 and 5 March 1998. A tenancy agreement was purportedly entered into between the Company and Winko Motor Industries Limited ("Winko") on 27 June 2002, on the basis of a loan agreement by which the rental received by the Company was to be used to set off indebtedness of HK$12.6 million due to Winko. Winko is a subsidiary of the Company. The tenancy was for 7 years from 1 July 2002. The Altadena Property is occupied by the former director of the Company, Chin Kam Chiu ("Mr Chin") and his family. Management fees have been outstanding since January 2004. The current market value of the Altadena Property is HK$65 million.

14. The Parkview Property was mortgaged to the bank under 2 legal charges both dated 9 January 1998. A tenancy agreement was purportedly entered into with Akan Group Limited ("Akan") on 18 April 2002, again under a similar loan agreement by which rental received from Akan would be used to set off the Company's debt to Akan. The duration of the tenancy was 3 years from 20 April 2002. The person who signed the tenancy agreement on behalf of Akan was the same person who signed a proof of debt on behalf of Winko. The current market value of the Parkview Property is HK$18.8 million.

15. The Dynasty Property was mortgaged to the bank under 3 legal charges all dated 5 March 1998. A tenancy agreement was purportedly entered into with Open Share Investments Limited ("Open Share") on 13 September 2002, under a similar loan agreement by which the rental received by the Company was to be used to set off the debt to Open Share. The duration of the tenancy was 5 years from 16 September 2002. The current market value of the Dynasty Property is HK$31.7 million.

16. Winko, Akan and Open Share have refused to vacate the properties. They are all companies incorporated in the British Virgin Islands.

17. The bank has not received any rent from Winko, Akan or Open Share. Not only that, the outstanding management fees, rates and government rent, which had not been paid by the Company, have to be paid by the bank. From April 2002 to March 2004, the bank has paid over HK$500,000.00 for these outgoings. Further outgoings would be at least HK$40,000.00 a month. The total current market value of the 3 properties is about HK$115.5 million.

18. The only sensible thing to do is to recover vacant possession and dispose of the properties by letting or selling.

19. I should also mention that on 21 April 2004, after the issue of this summons on 16 February 2004, the receiver of the properties has issued a writ of summons against each of Winko, Akan and Open Share, seeking a declaration that the purported tenancy agreement entered into by each of them is null and void, an order for vacant possession, and mesne profits. An application has been made to serve these writs on the BVI companies out of the jurisdiction but leave has not been granted as yet.

The legal approach

20. In an application for leave to proceed under section 186, the key question is "what is the appropriate method for determining the proposed claims - is it separate proceedings or is it the winding-up process" and for determining this question, it is not necessary for the court to undertake any investigation into the merits of the allegations in the proposed claim (Re Bank of Credit and Commerce International SA (No. 4) [1994] 1 BCLC 419 at 426 d to i). The court will exercise its discretion according to what is right and fair in the circumstances (Re Aro Company Limited [1980] Ch.196). If the proposed action involves substantial issues of facts that are in dispute and matters of law of complexity which could only be properly decided by way of proceedings, leave would be granted (Re King's Dyeing and Weaving Factory Limited (No. 2) [1986] HKC 621 at 623G).

21. It is well established that leave will readily be granted to secured creditors to enforce a mortgage or security on the company's property, unless the liquidator offers to give all that the mortgagee can obtain by his proceedings or an order in the winding up has already given him that relief (Pennington's Corporate Insolvency Law, 1997 ed., page 329; Principles of Corporate Insolvency Law, by Roy Goode, 2nd ed., page 168; Halsbury's Laws of Hong Kong, Vol. 6, para. [95.1337]). In this situation, the court "proceeds on the principle of paying the utmost respect to the legal or equitable rights of the persons whose interests are not being administered in the proceedings before it" (In re Henry Pound, Son & Hutchins (1899) 42 Ch. D. 402 at 422, per Fry LJ). The principle was fully expounded by James LJ in In re David Lloyd & Co (1877) 6 Ch. D. 339 at 344 to 345 in these terms:

"These sections in the Companies Act, and the corresponding legislation with regard to bankrupts, enabling the Court to interfere with actions, were intended, not for the purpose of harassing, or impeding, or injuring third persons, but for the purpose of preserving the limited assets of the company or bankrupt in the best way for distribution among all the persons who have claims upon them. There being only a small fund or a limited fund to be divided among a great number of persons, it would be monstrous that one or more of them should be harassing the company with actions and incurring costs which would increase the claims against the company and diminish the assets which ought to be divided among all the creditors. But that has really nothing to do with the case of a man who for the present purpose is to be considered as entirely outside the company, who is merely seeking to enforce a claim, not against the company, but to his own property. The position of a mortgagee under such circumstances is, to my mind, exactly similar to that of a man who said, 'You the company have got property which you have taken from me; you are in possession of my property by way of trespass, and I want to get it back again' ... The mortgagee says, 'There is some property upon which I have a certain specific charge, and I want to realise that charge. I have nothing to do with distribution of your property among your creditors. This is my property.' Why a mortgagee should be prevented from doing that I cannot understand."

The opposition of the liquidators

22. The liquidators contend that notwithstanding the well established principle of granting leave to a secured creditor to enforce his security, that principle has no application in this instance. The reasons are as follows.

23. The liquidators say that the background to this matter is not straightforward. Various creditors of the Company and Mr Chin have alleged that the bank is not owed nearly as much as claimed. Mr Chin has also alleged that the properties held as security are worth far more than the value ascribed to them by the bank.

24. Mr Chin and various senior officers of the bank were convicted of conspiracy to defraud on 22 April 2004 in HCCC No. 158 of 2003. The conspiracy relates to HK$222 million being credit facilities secured dishonestly by the accused from the bank in that up to 25 letters of credit were opened, negotiated and paid out by the bank when there was no underlying transaction of sale and purchase. Although the conviction relates to 25 letters of credit only, the ICAC has provided to the liquidators a list of 617 letters of credit involving HK$9.5 billion used by the Group to obtain finance from the bank from January 1996 to March 2000.

25. Mr Manzoni has made these submissions for the liquidators:

(1) There is an issue whether the bank is entitled to debit against the account of the Company amounts which it knew were fraudulently drawn; as it was alleged by the accused in the criminal trial that the bank had suffered no loss because the security of the properties adequately covered the money that had been lent, the money sought to be recovered by the bank under the charges could be part of the fraudulently lent money.

(2) It is possible that the fraud may extend to letters of credit other than those prosecuted by the ICAC; to the extent that the fraud relates to 617 letters of credit and/or HK$9.5 billion and/or any part of the debt currently claimed by the bank, the bank is not entitled to deduct that amount from its accounts.

(3) Hence, the bank is not entitled to seek possession of the properties purporting to secure the indebtedness which is not, in fact, a proper indebtedness.

(4) A further issue arises is the extent to which the mortgages were fraudulently entered into, as in the evidence in the criminal trial, fraudulent letters of credit were secured by mortgages, so it is possible that the charges in question were part of the fraudulent scheme and not binding on the Company.

26. Mr Manzoni says the liquidators will not stand in the way of the bank in obtaining possession, as soon as the liquidators can be satisfied that money is owed to the bank and that the bank is entitled to enforce the charges. The way forward, as suggested by Mr Manzoni, is for the bank to provide yet more information to the liquidators including:

(1) a running account to identify the true status of the account or accounts, the way in which the accounts have moved over time, identifying what amounts were drawn, when and in respect of what, what amounts have been credited and when;

(2) all board resolutions and minutes authorising the Company to execute charges in favour of the bank; and

(3) a complete breakdown of the accounts of the Company showing, among other things, the amounts recovered by the bank through the sale of the mortgaged properties and the rentals received.

27. Whilst it looks like there may be significant issues on the validity of the charges and whether the Company is indebted to the bank at all, once the bank can demonstrate to the satisfaction of the liquidators these are not issues at all by providing the information as suggested by Mr Manzoni, the liquidators will not object to the recovering of possession by the bank. He has submitted that this should be resolved in the liquidation process with cooperation, so as to avoid incurring legal costs unnecessarily.

28. There is no evidence at this stage to substantiate the possibility of fraud mooted by the liquidators to vitiate the legal charges, the validity of which has not only not been challenged by the Company in all the civil proceedings but was affirmed and relied on by the Company by its conduct in entering into the MOA (the schedule of mortgaged properties to the MOA included the 3 properties in question), commencing HCA No. 1319 of 2001 and obtaining the interlocutory injunction in that action.

29. As submitted by Mr Yuen, SC, it is difficult to see how the fraudulent acts of the accused in the criminal proceedings can in any way reduce the amounts of the debts owed by the Company to the bank which is the victim of the conspiracy.

30. For present purpose, it is not necessary to investigate the merit or otherwise of the liquidators' hypothesis that the charges in question might be part of the fraudulent scheme or that the bank might not be entitled to recover any amount from the Company because of the involvement of its senior management in the fraudulent scheme. Assuming those matters are to be raised by the liquidators to oppose the bank's claim to recover vacant possession under the legal charges, these serious allegations of fraud should be properly decided by way of proceedings. Such issues would hardly be suitable for determination in the liquidation, as they involve substantial disputes of fact and matters of law of complexity.

31. I note also from the evidence that the bank has already supplied a lot of information to the liquidators, before and after the issue of this summons, on the legal charges and the indebtedness of the Company. The liquidators do not consider the information supplied sufficient for the purpose of their investigation. This does not seem to me a good reason for refusing leave to proceed. The liquidators can still proceed with their investigation, which may well take some time, even though leave is granted to proceed. It is not in the interest of any one that recovery of possession of the subject properties should be further delayed.

32. Besides, the validity of the tenancy agreements purportedly entered into with Winko, Akan and Open Share may well be in dispute. This dispute should be resolved by way of proceedings. Mr Yuen has submitted that the matter of the other proceedings brought by the receiver against the tenants alone should best be left to be resolved between the bank and the receiver, as the bank would not want to incur two sets of costs. Further, it is desirable that the Company should be made a party to the proceedings brought against the tenants so that all disputes may be resolved with all the proper parties in the proceedings. I agree.

33. As for the point raised in the liquidators' affirmation that the bank may not have locus to apply for possession when the receiver has already asserted possession, this has not been pursued by Mr Manzoni. This point is bad in law. The remedies of the bank as mortgagee are cumulative, the bank is not obliged to select only one remedy and pursue it exclusively. Having appointed the receiver, the bank is not thereby prevented from recovering vacant possession. Also it is clear that the bank is the proper party to commence the intended mortgage action (Hill v O'Driscoll [1998] 2 HKLRD 994.

Orders

34. For the above reasons, I grant the application in terms of the summons.

35. In respect of costs, Mr Yuen seeks an order that the costs incurred in this application be divided into two parts. There should be no order as to costs incurred in respect of issuing the summons and the preparation of the first supporting affirmation, as the bank would need to seek leave from the court to commence the proceedings. Thereafter and as the liquidators have indicated that they would oppose the application even before the first hearing of that summons before a Master, the Company should pay the bank's costs.

36. It seems to me right to divide up the costs in that way, to prevent any party to the litigation to have a try-on, on the pretext that the other side would need to come to court for relief anyway.

37. As to the costs incurred after issuing the summons, I note Mr Manzoni's submission that the liquidators are doing no more than discharging their duty towards the unsecured creditors and they are adopting a neutral stance although voicing their position. The liquidators in my view did more than taking a neutral stance. They should not be treated differently from any other litigant, having taken a position unsuccessfully. The second part of the costs should follow the event.

38. I make the following orders in respect of costs:

(1) there be no order as to costs for the issue of the summons and the preparation of the first supporting affirmation; and

(2) thereafter, the applicant's costs of the application including the costs reserved on 23 February 2004 be paid by the Company, with a certificate for counsel for the hearing on 23 February 2004 and a certificate for two counsel for the hearing today.