RE MF GLOBAL HONG KONG LTD

HCCW 356/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING UP) PROCEEDINGS NO 356 OF 2011

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JUDGMENT

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Introduction

1.  The MF Global Group was, until it became insolvent in late October 2011, a substantial international financial derivatives and commodities brokerage firm based in New York. Amongst its subsidiaries was MF Global Hong Kong Limited (MF HK) which by an order made by me in November 2011 was put into provisional liquidation in Hong Kong on the application of the company itself. MF HK provided execution and clearing services for exchange traded futures and options and over-the-counter derivative products, and for non-derivative foreign exchange products and equities in the cash market (which for ease of reference I shall refer to generically as “securities”). Many of the counterparties to transactions entered into by MF HK on behalf of its clients were also part of the MF Global Group and MF HK's directors recognised that as a result of the Group's collapse it was not possible for the company to continue to carry on business.  MF HK was wound up on 11 January 2012.

2.  MF HK’s business consisted of regulated activities for which it was required to be licensed by the Securities and Futures Commission.  In order to meet the applicable regulatory requirements MF HK set up segregated bank accounts in which it deposited clients’ money (Client Money).  The sums in the segregated accounts represent an estate of assets and liabilities which is readily identifiable and which MF HK holds on trust for its clients (Qualifying Clients). In this decision I shall refer to these assets as the “Trust Estate” and MF HK’s own assets and liabilities as the “General Estate”.

3.  The liquidation is well advanced.  I have to date made 4 orders permitting the Liquidators to make interim payments to clients of Client Money on a pari passu basis.  Each of the orders provided that the costs and expenses of the Provisional Liquidators or the Liquidators, depending on when the order was made, in administering, collecting in and dealing with the Client Money, including the costs of the applications and the costs and expenses associated with effecting the interim payment be paid out of the Client Money prior to the final distribution, be borne on a pari passu basis by the clients.  I delivered reasons for so ordering on 15 December 2011, 15 May 2012 and 6 March 2014. 

4.  MF HK now seeks the following orders:

“1.   The entire amount of the costs and expenses of the Liquidators in administering, collecting in and dealing with the monies held by the Company on behalf of its clients in segregated accounts established under the Securities and Futures (Client Money) Rules (Cap 571I) (“the Trust Costs” and the “Client Money” respectively), be borne on a pari passu basis by clients of the Company with a proprietary interest in the Client Money (the “Qualifying Clients”), and the Trust Costs be paid out of the Client Money pool prior to any final distribution to the Qualifying Clients.

2.   To the extent that a Qualifying Client suffers a shortfall in recovering the entire amount of that part of the Client Money as relates to him (as determined by the Liquidators in accordance with paragraph 2 of the Order dated 6 March 2014) due to the pari passu deduction of the Trust Costs pursuant to paragraph 1 above, the Qualifying Client will:

(a)   Have an unsecured claim for that shortfall which is admissible to proof against the Company; or alternatively

(b)   Not have a claim in respect of that shortfall against the Company.

3.   To the extent that a Qualifying Client suffers a shortfall in recovering the entire amount of that part of the Client Money as relates to him (as determined by the Liquidators in accordance with paragraph 2 of the Order dated 6 March 2014) due to a deficiency of assets in the Client Money pool, the Qualifying Client will:

(a)   Have an unsecured claim for that shortfall which is admissible to proof against the Company; or alternatively

(b)   Not have a claim in respect of that shortfall against the Company.

….

5.   Costs of this application be borne equally by the Qualifying Clients (and as between those Qualifying Clients on a pari passu basis) and the general estate of the Company as costs and expenses incurred in the winding up of the Company.”

5.  Two other companies, both in liquidation, which were part of the MF Global Group have appeared before me on this application: MF Global Holdings Limited (MF Holdings) and MF Global UK Limited (MF UK).  MF  Holdings has no objection to orders 1 and 4.  MF UK, which is a Qualifying Client, agrees with MF HK, although it has advanced an additional reason for concluding that any shortfall due to the deduction of Trust Costs or a deficiency in the Trust Estate should be provable against the General Estate of MF HK. 

Berkley Applegate orders

6.  For the reasons explained in my earlier decisions I will make an order in the terms of paragraph 1, namely, a Berkley Applegate order.  What requires consideration is the right of Qualifying Clients to prove for any shortfall in their recovery in the liquidation of MF HK.

Deficiency in the Trust Estate and its impact

7.  As I have mentioned the liquidation of MF HK is well advanced. The Liquidators have not yet formally called for proofs of debt. They anticipate, however, that MF HK is solvent and that there will be a surplus of assets of approximately $53.4 million. The Liquidators are now able to estimate fairly accurately the likely total costs of dealing with the General Estate (General Costs) and also the costs incurred in dealing with the Trust Estate (Trust Costs), which are likely to be in the order of $40 million.  Understandably it has not always possible to draw a precise dividing line between work carried out in connection with the General Estate and the Trust Estate.  The liquidators approach has been to allocate “grey area” costs to the General Estate and have otherwise allocated the entirety of the costs of administering the Trust Estate to the Trust Estate. There is no dispute between the Liquidators of MF HK, MF Holdings and MF UK that the Liquidators MF HK’s approach to allocating costs has been consistent with the Berkley Applegate principles and is also fair on the facts of this particular liquidation.

8.  It will be readily appreciated that as a result of the payment of the Trust Costs there is a shortfall in the amount available to Qualifying Clients.  The second order the Liquidators seek would allow a Qualifying Client to prove for his portion of the shortfall.  The third order addresses a possible shortfall, which is estimated to be approximately $0.67 million, arising from a deficiency in the Client Money Pool itself and would give Qualifying Clients in this circumstance a right to prove for any resulting shortfall.

9.  The admissibility of proofs of either of these shortfall claims, together with the relevant post liquidation interest, would have a significant impact upon any potential distribution to MF HK's sole shareholder, MF Holdings; although MF Holdings is also a creditor and a Qualifying Client.  Conversely MF UK, which is Qualifying Client for present purposes, will benefit.  It is for these reasons that the Liquidators of the 3 companies come to take the positions that they do and enable competing arguments to be advanced before me.

The Parties Positions

10.  Reduced to its essentials MF HK’s argument is as follows.  MF HK held the Trust Estate as trustee for the Qualifying Clients.  MF HK’s duties necessarily included returning the assets comprising the Trust Estate when lawfully required to do so.  As one would expect MF HK also entered into agreements with Qualifying Clients recording the terms upon which assets were to be held.  This included a client agreement, which was revised on 1 September 2011, and which has been referred to accordingly before me as the “RCA”.  MF HK says that on the proper construction of the RCA it also contains a requirement that the Trust Estate be distributed to the Qualifying Clients when MF HK was lawfully requested to do so.  Necessarily, says MF HK, these obligations have been breached and it is the loss caused by those breaches that it suggests Qualifying Clients should be able to prove for in its liquidation.

11.  MF Holdings accepts that contractual and fiduciary relationships may exist between the same parties. However, it argues, where the parties have entered into an agreement to define their relationship that agreement will regulate, exclusively, their rights and obligations including any obligations one of them may have as a fiduciary.  Accordingly, in the present case it is the RCA that one looks at to identify whether or not obligations have been breached by MF HK and give rise to a claim which can be proved in its liquidation. MF Holdings submits that on a careful analysis of the RCA it becomes apparent that the risk of liquidation of MF HK resulting from the liquidation of the MF Global Group as a whole was born by the Qualifying Clients.  Further MF Holdings suggests that upon the proper application of the principles upon which Berkley Applegate orders were devised the orders sought are not appropriate. MF Holdings points out that nearly all the Trust Assets have been realised. The shortfall, which gives rise to the third order sought, is minimal. The majority of the shortfall is attributable to the Trust Costs. The Trust Costs do not represent a sum wrongfully withheld by MF HK. They represent deductions on account of the Liquidators’ costs and expenses which were incurred in their capacity as trustees.  The Qualifying Clients did not object to these deductions.  For present purposes they must be assumed to have agreed to them.

12.  MF UK support MF HK’s application.  It agrees with MF HK’s arguments, but suggests that there is an alternative route to reaching the same conclusion, namely, that parallel to the proprietary claim against the Trust Estate there is available to it a personal claim against the General Estate arising from the contractual right to claim repayment of an equivalent sum of the funds deposited with MF HK.

The Revised Clients Agreement

13.  Clause 35.1.5 of the RCA provides that all monies, securities and other property received by MF HK from Qualifying Clients or any other person for the account of the Qualifying Client shall be held by MF HK as trustee and segregated from MF HK's own assets. The clause goes on to provide expressly that assets so held by MF HK would not form part of its assets for insolvency or winding up purposes and should be returned to Qualifying Client promptly upon the appointment of a provisional liquidator or liquidator.  Similarly clause 10.1 provides that securities purchased on behalf of a Qualifying Client should be deposited in a segregated account designated as a trust or client account.

14.  The RCA only deals obliquely with a Qualifying Client’s right to payment of monies in his account or the delivery of securities purchased on his behalf.  For example, clause 10.8 recognises MF HK’s obligation to deliver securities, but is focused on the mechanics and specifies that it does not have to deliver the precise securities purchased.  It is sufficient if it delivers securities of the same class, denomination and nominal amount and which rank parri passu with those purchased.  Of course, there is no dispute that Qualifying Clients were entitled to payment of monies or delivery of securities standing to their credit in their accounts.

15.  As one would expect the RCA contains provisions intended to protect MF HK and restrict Qualifying Clients’ rights against the company in the event of its staff making a mistake of some sort.

Clause 21.2

The Client undertakes to indemnify and keep indemnified MF HK in respect of any costs, claims, demands, damages and expenses whatsoever which may be reasonably and properly suffered or incurred by MFG HK directly or indirectly arising out of or in connection with any transaction entered into by MFG HK as agent on behalf of the Client or otherwise whatsoever or howsoever arising out of anything done or omitted to be done by MFG HK in accordance with the terms of this Agreement or pursuant to any Client’s instruction or communication. The Client also agrees to pay promptly to MF HK, on demand, all damages, costs and expenses (including legal expenses on a full indemnity basis) reasonably and properly incurred by MF HK in the enforcement of any of the provisions of this Agreement.

Clause 27.1

27.1 MFG HK shall not be responsible or liable for:

27.1.7 for taking or not taking any action in connection with or arising out of this Agreement or any Transaction to which the terms of this Agreement apply unless the Client shows that MF HK acted negligently or in bad faith.

16.  No clause other than clause 35.1.5 makes express reference to liquidation of MF HK, although clause 37 deals with amalgamation.  For example clause 27, which deals with “breakdowns, force majeure and liability” does not refer to liquidation of MF HK and regulate the parties’ rights in the event that it were to occur.  This seems to me to be relevant because it is part of MF Holding’s argument that the terms of the RCA govern the obligations of MF HK not only as a party to the various agreements it signed with Qualifying Clients but also as trustee.

MF Holdings’s arguments

17.  MF Holdings advances three reasons why it says that the orders sought in paragraph 2 and 3 of the summons should not be granted.  Only the first two apply to the shortfall in assets.  In summary they are:

(1)   There has been no breach by MF HK of the RCA, which defines its obligations as trustee as well as contractually;

(2)   The RCA excludes liability for the loss arising from MF HK going into liquidation and being unable to return the assets comprising the Trust Estate; and

(3)   Allowing the Qualifying Clients to prove in the liquidation would be inconsistent with the Berkeley Applegate principle.

Has there been a breach of the RCA?

18.  There is no dispute that a contractual and fiduciary relationship can exist at the same time and commonly the fiduciary relationship arises because the parties have entered into an agreement[1]. Securities agreements which result in monies and securities in segregated trust accounts are an obvious illustration.  MF Holdings argues that MF HK’s obligations in respect of the property it held on trust for the Qualifying Clients is defined by the RCA and defined exclusively by its terms in the sense that no additional obligations are imposed by the general law of trusts.  MF Holdings says that this is apparent from various statements of principle to be found in the authorities.  In Hospital Products Ltd, ibid, Sir Anthony Mason explains at paragraph 70 that “The fiduciary relationship, if it is to exist at all, must accommodate itself to the terms of the contract so that it is consistent with, and conforms to, them. The fiduciary relationship cannot be superimposed upon the contract in such a way as to alter the operation which the contract was intended to have according to its true construction.” Similarly, in Henderson v Merrett Syndicates Ltd[2] Lord Browne-Wilkinson says “The existence of a contract does not exclude the co‑existence of concurrent fiduciary duties (indeed, the contract may well be their source); but the contract can and does modify the extent and nature of the general duty that would otherwise arise.”  Jacobson J in ASIC v Citigroup Global Markets Australia Pty Ltd (No 4)^[3] is to similar effect “280  It may be that a fiduciary cannot exclude liability for fraud or deliberate dereliction of duty but beyond that there appears to be no restriction in the law to prevent a fiduciary from contracting out of, or modifying, his or her fiduciary duties, particularly where no prior fiduciary relationship existed and the contract defines the rights and duties of the parties: [citation omitted]. 281  The effect of the Australian and English authorities referred to above is that where a fiduciary relationship is said to be founded upon a contract, the ordinary rules of construction of contracts apply. Thus, whether a party is subject to fiduciary obligations, and the scope of any fiduciary duties, is to be determined by construing the contract as a whole in the light of the surrounding circumstances known to the parties and the purpose and object of the transaction:[citation omitted]. The same approach applies to exclusion clauses: [citation omitted”

19.  It follows, says MF Holdings that in the first instance one must look to the RCA to ascertain whether or not there has been a breach of duty that has caused loss in the form of the shortfall, for which MF HK contends Qualifying Clients should be allowed to prove in the liquidation.  MF Holdings says not for a number of reasons.

20.  The first is that the Qualifying Clients have consented to the deductions from the Trust Estate in the form of payments of the Liquidators’ costs and expenses.  It is correct as a statement of fact that none of the Qualifying Clients objected to the making of Berkley Applegate orders.  However, it seems to me to be entirely artificial to suggest that this constituted an authorised transfer of Qualifying Clients’ money to a third party.  By the time any of the orders were made MF HK was already in breach of duty by virtue of failing to return money and securities.  The orders were a means of ensuring that those entrusted with sorting out the problems caused by MF HK’s inability to honour its obligations under the RCA were paid.  By the end of the liquidation Qualifying Clients will have been paid a significant proportion of the Trust Estate.  There will, however, be a shortfall.  As a result prima facie MF HK will be in breach of the RCA.

Does the RCA exclude liability for breach of duty?

21.  MF Holdings argues that if the Court were to conclude, as I do, that there has been a breach of duty that has caused the loss, such loss is irrecoverable by virtue of the limitation clauses I have referred to earlier.  It says that it is permissible for a trustee to reduce by agreement the scope of what would otherwise be his liabilities as demonstrated by Armitage v Nurse [4] in which Millett LJ, as he then was, said this:

“[Can] a trustee exemption clause validly exclude liability for gross negligence? It is a bold submission that a clause taken from one standard precedent book and to the same effect as a clause found in another, included in a settlement drawn by Chancery counsel and approved by counsel acting for an infant settler and by the court on her behalf, should be so repugnant to the trusts or contrary to public policy that it is liable to be set aside at her suit. But the submission has been made and we must consider it. In my judgment it is without foundation. There can be no question of the clause being repugnant to the trust. In Wilkins v Hogg (1861) 31 L.J.Ch. 41, 42 Lord Westbury LC challenged counsel to cite a case where an indemnity clause protecting the trustee from his ordinary duty had been held so repugnant as to be rejected. Counsel was unable to do so. No such case has occurred in England or Scotland since.”

22.  This I accept.  However, the clauses relied on by MF Holdings, namely, clauses 21.2 and 27.1.7 do not, as I have already observed, expressly refer to liquidation of MF HK.  Clause 21.2 provides that “Neither MFG HK nor any of its directors …….. shall have any liability whatsoever (whether in negligence or otherwise) for any loss, expense or damage suffered by the Client as a result of :  any condition or circumstances which are beyond the reasonable control or anticipation of MFG HK ….”. This is very broad wording.  Does it exclude a claim by Qualifying Clients arising from MF HK’S failure to return monies and securities?  In my view it does not.  It seems to me that this clause addresses loss caused by events beyond MF HK’s control that prevent it complying with obligations in respect of the trading of securities on behalf of Qualifying Clients as illustrated by the remainder of the clause which states “ including but not limited to any delays in the transmission of orders due to disruption, breakdown, failure or malfunction of transmission of communication facilities, failure of electronic or mechanical equipment, telephone or other interconnection problems, prevailing fast market conditions, governmental agency or exchange actions, theft, or war (whether declared or not), severe weather, earthquakes and strikes”..It does not seem to me that the fact that the clause’s introductory language refers to “any condition or circumstance” alters that clear import of the clause read in the context of the agreement as a whole, with its express provision that Qualifying Clients’ money and securities are to be held on trust, namely, that the exclusions cover loss howsoever arising caused during the normal course of MF HK’s business and not a failure as fundamentally inconsistent with the substance of the RCA as failing to return money and securities held on trust by MF HK. 

23.  Similarly in my view clause 27.1.7 does not extend to a failure to return to Qualifying Clients trust assets.  It is directed to a failure to take action in the course of operating the account which causes loss, such as not executing orders, unless it can be shown that it arose from negligence.  In my view the terms of the RCA do not exclude the Qualifying Clients’ right to claim for any loss caused by MF HK’S failure to return the assets comprising the Trust Estate to them when requested.

24.  This is sufficient to dispose of MF Holdings’s objection to paragraph 3 of the summons, which is limited to the small shortfall in respect of the assets.  MF Holdings advances a third objection in respect of the shortfall arising from the deduction of the Liquidators’ costs and expenses.

Would allowing the Qualifying Clients to prove in the liquidation be inconsistent with the Berkeley Applegate principle?

25.  The third objection goes to the rationale for the Berkley Applegate principle.  MF Holdings argues that the contentious orders would undermine the underlying Berkeley Applegate principle that persons who are beneficially interested in property should be required to bear the costs of administering that property. 

26.  It may be, argues MF Holdings, that a Berkeley Applegate order, at least one made under insolvency legislation, itself is inherently ‘temporary’ in nature, ie simply a ‘liquidator’s direction’ [5] providing comfort to the liquidator, and that the real issue as to what the trust estate and general estate respectively are to bear is to be litigated later: as was the case Berkeley Applegate (No. 3) [6] and Re Cresvale Far East Nominees Ltd.[7]  However, it says that does not mean there is anything ‘temporary’ about the underlying reasoning.  The reasoning in Berkeley Applegate relies on general equitable principles and is not dependent on considerations from the law of insolvency:

“The authorities establish, in my judgment, a general principle that where a person seeks to enforce a claim to an equitable interest in property, the court has a discretion to require as a condition of giving effect to that equitable interest that an allowance be made for costs incurred and for skill and labour expended in connection with the administration of the property.” [8]

This is also reflected, says MF Holdings, in how the Court gives effect to Liquidators/trustee’s entitlement:

“The allowance which the Court gives in the exercise of this jurisdiction does not result in the creation of a personal claim against the beneficiary of the trust property. The jurisdiction operates by way of subjecting his beneficial interest to an obligation to pay the remuneration and costs allowed by the court. This is clear from the way in which the jurisdiction was expressed in the passages quoted above from Berkeley Applegate itself and Sports Betting Media. … It follows that the exercise of the discretion results in the creation of a proprietary interest in priority to that of the beneficiary whose equitable interest is to be enforced. If the trust property were insufficient, there could be no suggestion of the beneficiary being personally liable to pay any shortfall. Nor can the beneficiary be entitled to delivery of the property, leaving the fiduciary to enforce a personal claim against him for the remuneration and costs allowed to him by the court.” [9]

27.  MF Holdings says that were the costs claims to succeed, that would undermine that principle, and defeat the Court’s reasons for granting the Berkeley Applegate order in the first place.  It is clear from the reasoning within Berkeley Applegate (No. 2) that the Courts’ concern in granting such orders is not merely to confer protection on the Liquidators (against criticism and on fees), but also to see that costs are borne by the appropriate persons to bear them, bearing the interest of all stakeholders in mind.  I do not think this fairly characterises the Court’s concern.

28.  The issue arises in the context of a consideration of how a liquidator should be paid.  Berkley Applegate explains why it is appropriate that a liquidator’s costs are paid out of trust assets which he is required to identify and administer.  It does not follow in my opinion that having decided that it is equitable for those costs to be recovered from the trust assets that the resulting loss caused by the diminution of the trust assets cannot be claimed from the company.  MF HK failed to honour its obligations to return Trust Assets about the time it went into liquidation and it is that breach of duty that has led to the diminution in the Trust Assets.  It is artificial to approach the matter on the basis, as MF Holdings’s argument does, that the cause of the loss is the Court orders.

29.  MF Holdings says that where trustees act upon a ‘final’ determination of the Court in its equitable jurisdiction that the trust assets are to bear certain costs associated with those assets, there can be no question of the trustees being in breach of trust or contact.  This in my view is to misunderstand the issue. 

30.  This part of MF Holdings’s argument assumes that the Liquidators hold the Trust Assets on trust for the Qualified Clients.  It is, however, incorrect to characterise a liquidator as a trustee in the full and literal sense of the term.  A winding-up order does not affect the legal title in a company’s assets, which remains vested in the company.  As was explained by Lord Diplock in Ayerst v C & K (Construction) Limited [10]on the making of a winding-up order the company holds assets over which it has legal title on a statutory trust arising by virtue of insolvency legislation on trust for its creditors.  It is uncommon because it is rarely necessary for a liquidator to apply to have title transferred into his name and, as far as I am aware, that has not happened in respect of any part of the Trust Estate.  A liquidator’s status is more properly characterised as that of an agent of the company over whom he is appointed to carry out a statutory task and on being so appointed he assumes a fiduciary position[11].  It follows in my view that it is inapposite to approach the matter as if the liquidators have merely replaced the directors of the company and that acts they initiate are to be treated as those of the trustee of the Trust Estate.  The Berkley Applegate principle is concerned with the right of the fiduciary appointed pursuant to the statutory insolvency regime to recover his costs from the estate over which he had been appointed.  It is in my view wrong, therefore, to suggest that what the Court is being asked to do is to enforce the Qualifying Clients’ right to the Trust Assets full and free of any deduction.  The Court is being asked to confirm that the current and final shortfall can be claimed against MF HK by way of proving in its liquidation.  This is entirely different and in many liquidations allowing this would probably result in minimal additional recovery.

31.  MF Holdings’s arguments involve a mischaracterisation of the problem the Berkley Applegate principle addresses and resolves.  Berkeley Applegate recognises that it is equitable for fiduciaries tasked with collecting in and administering trust property held by the company which they supervise, to recover their costs of so doing out of the trust assets.  It is inherent in this reasoning that there is at the material time no practical nor fair alternative.  It does not follow that the beneficiaries cannot look to the trustee (in this case MF HK), which has breached its duty and caused the problem the fiduciaries have been appointed to resolve, for reimbursement of the amounts deducted from trust assets if it is worth while pursing such claims.  This was recognised by Peter Gibson J in Berkley Applegate No. 3 supra at page 805H.  In my view allowing the Qualifying Clients to prove for the shortfall caused by the deduction of the Liquidators costs and expenses is consistent with the Berkley Applegate principle.

Conclusion

32.  I will, therefore, make orders in the terms of the summons.