In re FINBO ENGINEERING CO. LTD.

1997, No.CWU 496

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP

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J U D G M E N T

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1. This is a petition to wind up Finbo Engineering Company Limited ("Finbo") on the ground that it is unable to pay its debts and that it is just and equitable that it should be wound up. A statutory demand was served pursuant to section 178(1) which remains unsatisfied.

2. The Petitioner AMEC Electrical and Mechanical Engineers Limited ("AMEC") is a mechanical and electrical subcontractor. Finbo was its sub-subcontractor on a project at the Hong Kong University of Science and Technology. It is common ground that on 6 August 1996, AMEC made a payment of wages to the employees of Finbo under section 43C of the Employment Ordinance, Cap.57. The sum so paid became a debt due by Finbo to the superior subcontractor by reason of section 43F.

3. Finbo opposes the petition on the ground that the debt is substantially in dispute because it is entitled to a set-off. The claim to a set-off arises under the sub-subcontract relating to the project. In November 1997, Finbo issued a writ against AMEC. Under paragraph 8 of its Statement of Claim filed on 6 January 1998, it claims the balance of interim payment applications in respect of works done by Finbo up to and including 1 August 1997 as well as the total value of authorised variations, totalling $2.787 million. On that basis, even allowing for the amount paid by AMEC on behalf of Finbo, Finbo is still entitled to $1.5 million for completed subcontract work and variations. This claim is disputed by AMEC who has counterclaimed for over $15 million in respect of the sub-subcontract.

The issues

4. The issues are whether :

(1) there is either -

a) a legal set-off or, alternatively,

b) an equitable set-off

to AMEC's claim;

(2) in any event, whether in the exercise of its discretion, the court ought to make a winding-up order in view of Finbo's cross-claim.

5. As to the difference between legal set-off and equitable set-off, a pithy statement of that difference is to be found in Axel Johnson Petroleum AB v. M.G. Mineral Group AG [1992] 1 WLR 270 where Leggatt LJ observed (at 274H) :

"The state of the law is unsatisfactory that allows a set-off at law of debts which are liquidated, even if unconnected, and in equity of debts which are connected, even if unliquidated, but not a set-off of debts which are both unliquidated and unconnected."

Legal set-off

6. Finbo's claim under paragraph 8 of the Statement of Claim is plainly a liquidated claim. The fact that damages are also claimed under paragraph 14 does not alter this fact. Counsel for AMEC submitted that legal set-off does not apply for two reasons : first, for historical reasons, legal set-off does not apply in Hong Kong; second, mutuality is lacking.

7. Legal set-off arose in England under two statutes enacted in 1729 and 1735 ("the Statutes of Set-off"). The Statutes of Set-off were repealed in England in 1879 by Section 2 of the Civil Procedure Acts Repeal Act and the Statute Law Revision and Civil Procedure Act 1883 in so far as they applied to the Supreme Court of Judicature. As appears from Hanak v. Green [1958] 2 QB 9 at 22, this has been interpreted as preserving the right of set-off originally conferred by the Statutes of Set-off. Mr Carolan's submission is that as the Statutes of Set-off were not in the Schedule to the Application of English Law Ordinance, Cap.88, they form no part of the law of Hong Kong.

8. This submission by counsel for AMEC was raised for the first time at the hearing itself, it not being part of his written skeleton submissions. It would appear that the point that legal set-off does not apply in Hong Kong has not been considered by the Hong Kong courts before. Although counsel for Finbo endeavoured to deal with the point at the hearing despite being taken by surprise, it was plainly not a satisfactory way of addressing an issue that is of considerable difficulty. Accordingly, after the hearing, I directed that further written submissions be made by counsel for Finbo by 9 March with a right to counsel for AMEC to reply by 12 March. I now have the benefit of lengthy written submissions from both sides.

9. I am indebted to counsel for Finbo for his exhaustive historical research on the reception of English law and practice regarding set-off and counterclaim in Hong Kong. As appears below, the position is not that legal set-off has never formed part of the law of Hong Kong : the critical question is whether this right has been abolished.

10. The Statutes of Set-off which were 18th Century English Statutes became part of the law of Hong Kong as a result of section 3 of Ordinance No.15 of 1844 ("SCO 1844") which established the Supreme Court of Judicature at Hong Kong. Section 3 reads as follows :

"And be it further enacted and ordained, That the Law of England shall be in full Force in the said Colony of Hong Kong, except where the same shall be inapplicable to the local Circumstances of the said Colony, or its Inhabitants : ... Provided also, that in all Matters relating to the Practice and Proceedings of the said Supreme Court, and not hereinafter provided for by this Ordinance, the Practice of the English Courts shall be in Force, until otherwise ordered by any Rule of the said Court ... "

Local circumstances would not have made the statutes inapplicable or subject to modification.

11. Subsequent amendments to SCO 1844 made by Ordinance No.6 of 1845, Ordinance No.2 of 1846, Ordinance No.3 of 1873 and Law Revision Ordinance (No.27 of 1937), Schedule, Item 17(1) ("SCO 1937") did not affect the application of the Statutes of Set-off in Hong Kong. That much is now common ground between the parties.

12. But the parties differ as to the effect of the Application of English Law Ordinance (No.2 of 1966) ("AELO") which later became Cap.88. The AELO provided ―

(1) for the common law and the rules of equity to be enforced in Hong Kong so far as applicable and subject to any necessary modifications (section 3);

(2) for certain English Acts as listed in the Schedule to the Ordinance to apply to Hong Kong subject to such modifications as local circumstances warranted (section 4); and

(3) that subject to the provisions of the Ordinance, the practice of the Supreme Court of Judicature of England for the time being in force shall be in force in the court (section 7).

Neither the Statutes of Set-off nor the 1879 and 1883 Acts have ever been listed in the Schedule to the AELO.

13. What therefore is common ground is that for a period of over a 120 years, (i.e. from 1844 to 1966) legal set-off was part of the law of Hong Kong. Mr Carolan submits that a consequence of the AELO was that it abolished legal set-off in Hong Kong. Mr Reyes disagrees. He submits that there was no need for the AELO to make the Statutes of Set-off applicable to Hong Kong to preserve legal set-off because by 1966 the English practice of allowing a pleading of legal set-off as a defence in an action had been firmly established as part of Hong Kong practice and procedure through the various Supreme Court Ordinances enacted between 1844 and 1937, and further that the original rationale for the Statutes of Set-off had gone with the institution of counterclaim by the Judicature Acts. Moreover, section 7 of the AELO preserved English practice and procedure in Hong Kong subject to any contrary provisions in SCO 1837 as then current.

14. Whether legal set-off remains available in Hong Kong, notwithstanding the AELO, is a question of considerable complexity. Did the AELO have the drastic effect of abolishing legal set-off which had been part of Hong Kong law for well over a century? There are no Hong Kong decisions on point nor is it a question that would ever arise under English Law. It would appear that one may have to look for guidance elsewhere. In this context, a most useful discussion may be found in the erudite monograph on the subject, Derham on Set-off, 2nd Ed., 1996 at 132 - 137. The jurisprudence of Australian jurisdictions such as New South Wales and Queensland may be of relevance here. This is because in both of those jurisdictions, the Statutes of Set-off which had originally been incorporated into their respective laws were subsequently repealed by the Imperial Acts Application Act 1969 for New South Wales and by the Imperial Acts Application Act 1984 for Queensland neither of which has a saving provision similar to that contained in the 1879 and 1883 Acts.

15. In Stehar Knitting Mills Pty. Limited v. Southern Textile Converters Pty. Limited [1980] 2 NSWLR 514 the Court of Appeal of New South Wales whilst holding that the operation of the Imperial Acts Application Act 1969 caused the abolition of set-off at law in that State, (as to which see Sydmar Pty Ltd v. Statewise Developments Pty Ltd (1987) 73 ALR 289 at 292), accepted the argument that the Statutes of Set-off were wholly procedural rather than substantive in character so that there was no reason why the Supreme Court Rules made pursuant to legislation which contained a rule-making power with respect to matters of practice and procedure could not be the source of a similar right. It is to be noted that this decision is the subject of a powerful critique by Derham based on the proposition that Judicature Acts and the Rules of the Supreme Court made pursuant to those Acts did not alter the rights of the parties and did not confer any new rights of set-off. See also Meagher, Dunmow & Lehane on Equity Doctrines and Remedies, 3rd Ed. at para. 3714.

16. As noted above, the Statutes of Set-off which had been applicable in Queensland were repealed in 1984. Whilst in New South Wales, the relevant Supreme Court Rules only came into being after the Statutes of Set-off had been repealed, that was not the case in Queensland where the relevant rules had been in existence since 1900. Because the legislation which repealed the Statutes in New South Wales was enacted in 1969 and therefore before the Supreme Court Rules were made in 1970, the view has been expressed that the Stehar Knitting Mills reasoning (i.e. the Rules being the 'source' of legal set-off) can have no application in Queensland so as to save legal set-off : see Derham, "Recent Issues in Relation to Set-Off" (1994) 68 ALJ 331 at 334.

17. Whilst the Hong Kong position appears to be more akin to that of Queensland rather than New South Wales, the question whether the repeal of the Statutes of Set-off in Queensland in 1984 brought about the abolition of the legal right of set-off is 'a serious question' : see per Cooper J in Walker v. Department of Social Security (1995) 129 ALR 198 at 217, ll. 3 - 4. That question remains an open one in Queensland. Not only do I agree with the sentiment expressed by Cooper J, it is wholly inappropriate to determine such an important question (viz. whether legal set-off was abolished by the AELO) in the context of an application to stay or dismiss winding-up proceedings.

18. For present purposes, suffice to say that this question admits of no easy answer. So at a minimum, Finbo must at least have an arguable defence based on legal set-off, the existence of such right raising 'a serious question'.

19. The objection based on the absence of mutuality appears to be premised upon some requirement that the claims must be of a similar nature and that because in the present case, there was a debt owing by Finbo to AMEC but a mere 'claim' to liquidated damages by Finbo against AMEC, it is insufficient. The objection of counsel for AMEC appears to be that an undisputed debt may not be set off against a disputed debt and in that sense there is no mutuality. That, however, does not appear to be the meaning of 'mutuality' for the purposes of legal set-off.

"Mutuality in fact refers to two characteristics, that the demands must be between the same parties, and that they must be held in the same capacity, or right, or interest. It is concerned with the status of the parties and their relationship to each other. It is not concerned with the nature of the claims themselves. ... The requirement of same parties is intended to ensure that A's right to sue B may not be set off against A's indebtedness to C, or that a joint demand may not be set off against a separate demand. The same capacity or right means that each of the parties, who is liable to the other, must be beneficially interested in a cross-claim against that other. In other words, 'there must be identity between the persons beneficially interested in the claim and the person against whom the cross-claim existed'."

See Derham on Set-Off, (supra) at 319-320.

20. B. Hargreaves Limited v. Action 2000 Limited [1993] BCLC 1111 offers little assistance to AMEC. It involved a surveyor's valuation of construction costs with deductions for defective work which were mere estimates and not, as in Finbo's claim, an ascertained amount. For that reason, the claims in Hargreaves were not readily ascertainable. In my judgment, the objection based on mutuality is misconceived.

21. Counsel for AMEC raised a further objection. This was that if legal set-off applies in Hong Kong, Finbo is not entitled to set-off. It was contended that it is contrary to principle and public policy to allow set-off as it would mean that a superior contractor will never be able to recover what he has had to pay to the employees of the sub-contractor by reason of the statutory provisions until the claims under the construction contract have been resolved and that it would be wrong in principle to defer statutory liability until the resolution of the cross-claims. But such policy considerations do not ineluctably flow from section 43 of Cap.57. Nothing in the legislation compels the court to reach the conclusion suggested.

22. In my judgment, Finbo plainly has an arguable defence based on legal set-off to render the debt inarguably substantially disputed on bone fide grounds. Pysogea v. Rightfairs Development Ltd. [1991] 1 HKC 341 which is heavily relied on by AMEC is distinguishable because that decision rested solely on equitable set-off. In that case, the learned judge did not address the question (because it was not argued) that legal set-off applied.

Equitable set-off

23. AMEC relies on Pysogea as the answer to any claim to equitable set-off. That case also concerned a petition founded on a debt due to the petitioner by reason of section 43 of the Employment Ordinance. The petitioner also sued for damages and other relief for breaches of the subcontract. The respondent alleged wrongful termination of the subcontract and counterclaimed for $1.8 million. The respondent then moved to strike out the petition on the ground that the debt claimed by the petitioner was bona fide disputed on substantial grounds. Jones J dismissed the motion, holding that the subcontract between the petitioner and the respondent was a separate transaction from the liability incurred to the respondent's employees under the Employment Ordinance. Further, he held that the demand for payment by the petitioner arose under Cap.57 and was not closely connected with the building contract to enable the respondent to put forward a claim for set-off and that the issue was independent from the building contract and did not go to the root of the petitioner's claim.

24. The question is whether Jones J intended to lay down any inflexible rule that whenever a petition is based on a debt created under section 43 of the Employment Ordinance, equitable set-off has no application. It would appear not for if that had been the holding, it would have been unnecessary for the learned judge to refer, as he did, to the fact that "no fault can be attached to the petitioner for the company's failure to fulfil its obligations" (at 346C). The very reference to 'fault' must mean that it is relevant to enquire into the reasons why the company failed to fulfil its obligations and whether the petitioner was in any way to blame for that failure. Unfortunately, the facts in Pysogea do not appear from the judgment. Accordingly, the basis for the statement cited above is unclear. Nonetheless, it would appear that the reasons why the company failed to pay its employees and whether the petitioner caused and/or contributed towards that failure is a relevant factor.

25. For my part, I do not accept that there is an inflexible rule such that equitable set-off can never apply where the claim by the petitioner is based on a debt owed under the provisions of section 43 of Cap.57. Whether or not there is equitable set-off would depend on the facts. On the facts of the present case, there is prima facie evidence that AMEC caused and/or contributed to the failure on the part of Finbo to pay its employees by constricting its cash-flow. That being so, I would, with the greatest respect, differ from Jones J and on the facts of the case before me, at a minimum, Finbo has an arguable case that equitable set-off applies.

The court's discretion

26. In any event, Finbo has asserted a cross claim which equals or exceeds AMEC's claim in respect of the debt in proceedings which are pending. Although AMEC has asserted a counterclaim to that action which, if successful, would overtop Finbo's claim, this does not alter the fact that at the end of the day, Finbo's claim may indeed overtop AMEC's claim. In such a situation, the court has an unfettered discretion whether or not to dismiss the petition or make a winding-up order. See Re Pendigo Ltd. [1996] BCC 608 at 611 D-E.

27. It has been stated that in exercising the discretion, the factors that are relevant include :

" The extent of the connection (if any) between the admitted debt in a cross claim, where the proceedings in relation to the cross claim are pending or are merely contemplated, whether the company has been guilty of any delay in seeking to have the cross claim determined, the age of the admitted debt and the age of the cross claim, and the nature and extent of any dispute in relation to the cross claim."

See Boyle & Marshall, Practice and Procedure of the Companies Court, 1997 Edition at 9.179.2.

28. As noted above, the proceedings in relation to the cross claim are pending and although the writ was not issued until after the presentation of the petition, it is apparent from Finbo's letter of 27 March 1997, that they had had difficulty in employing a contract consultant for the preparation of documents for the submission of their claims. It cannot be said that they were really guilty of any delay. Moreover, the arrangement which, according to Finbo was in place between it and AMEC relating to the sub-subcontract had unusual features in that AMEC agreed to purchase the materials on behalf of Finbo subject to a handling charge of 2.5%, the reason being that Finbo was a small subcontractor with limited cashflow. Interim payment applications therefore assumed an importance for Finbo. It is alleged that AMEC was late in the delivery of many materials necessary for the execution of the works and that delay was caused as a result. There is also a complaint about the lack of access which further impeded progress of the works.

29. This court obviously cannot go into the merits of the allegations: that would be for another forum on another occasion. However, those matters are relevant to the exercise of the court's discretion and unless any of those allegations are demonstrably wrong or unfounded, I have to proceed on the assumption that those are the facts. On that assumption, if it were a question of the exercise of the court's discretion, I have little hesitation in concluding that it would not be appropriate to make any winding-up order in the present case.

Stay or dismissal

30. Finbo's counsel submitted that if he succeeded on the ground of set-off, the petition ought to be dismissed as an abuse of the process. If he were to succeed on the discretion point, then it was open to the court either to stay or dismiss the petition. Counsel for AMEC requested that any order should be made nisi in the circumstances.

31. Since I have come to the conclusion that Finbo has an arguable defence of set-off, both legal and equitable, I am minded to dismiss the petition and I make an order nisi to that effect.

32. So far as costs are concerned, they must follow the event and I also make an order nisi to that effect.