Insolvency Update Powers and Works of Liquidators · 9 David Kennedy v Kelly Cheng (FACV 30/2008) 3) The court controls the use to which such evidence can be put. 4) Where the abrogation

Presentation for the Society of Chinese Accountants and Auditors

Insolvency Update – Powers and Works of Liquidators

23 November 2009

Ludwig Ng, Partner

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The functions of the liquidator:-

“These are twofold: (i) to collect the assets

of the company, settle its liabilities and distribute its surplus funds amongst its creditors; and (ii) to investigate the causes of the company’s failure and the conduct of those concerned in its dealings and affairs”

per Lord Millett NPJ in Joint & Several Liquidators of Kong Wah Holdings Ltd v. Grande Holdings Ltd (2006) 9 HKCFAR 766, at p.780D-F

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The functions of the liquidator:-

The investigation/reporting of wrongdoing is not merely incidental to collection and distribution of assets.

It’s an independent duty.

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David Kennedy v Kelly Cheng (FACV 30/2008)

Can private examination transcripts obtained under s.221 of the Companies Ordinance be released to Police without leave of Court?

David Kennedy v Kelly Cheng FACV 30/2008 (Judgment 20th October 2009)

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DK is the liquidator of Wing Fai Construction Company Limited

DK conducted s.221 examination on Kelly Cheng and Robert Yip

DK made reports to the Police, without seeking Court’s leave, enclosing transcripts of the examination. In the reports, he said he believed that Cheng and Yip had (i) misappropriated monies from Wing Fai’s bank accounts; (ii) manipulated documents; (iii) committed perjury; and (iv) withheld, concealed and/or destroyed documents.

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Cheng and Yip sued DK for contempt of court.

High Court

Kwan J: no contempt, no leave required, if there is any ambiguity in the interpretation of the relevant provisions in CO and Winding Up Rules, the benefits should be given to DK (because the standard of proof for contempt is a criminal one).

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Court of Appeal

s.221 of CO and rule 62 of WUR mean that leave must be obtained from Court before transcript of s.221 examination could be used. DK was aware of the provisions as evidence showed that he had considered but finally decided not to apply for leave. Hence, he was guilty of contempt.

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In CFA, it was argued for Cheng and Yip that:-

1) Section 221 compels answers relating to companies, abrogating the rule against self-incrimination.

2) The Companies Court always maintains a discretion as to the use which can be made of compulsorily obtained evidence. Simply because a liquidation’s purposes includes investigating the causes of the company’s failure or

whether any crime has been committed does not mean that there should be unfettered reporting of all the evidence obtained under compulsion.

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3) The court controls the use to which such evidence can be put.

4) Where the abrogation of a fundamental right is implied in a statute, the court should assume that counterbalancing protection will be put in place.

5) The only proper safeguard for persons giving evidence under compulsion pursuant to s.221 is that the court controls the transcripts of such evidence and that liquidators hold the transcripts to the court’s order, so that

the court can perform the judicial function of deciding whether a liquidator should be directed to refer a matter to the Secretary for Justice.

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6) The absence of any statutory protection is a compelling reason for a need for intervention by the court. Rule 62 is in clear terms in providing

that documents on the court file, which includes the transcripts held by the liquidators, cannot be inspected by any other person.

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7) The evidence shows that Mr Kennedy knew of the contents of rule 62, was prepared to make a

report under s.277 and was aware of the established Hong Kong practice that rule 62 was for the protection of the examinee. Notwithstanding this, he provided the transcripts to the police without leave by way of a tit-for-tat reaction to defamation proceedings brought against him by Ms Cheng. This was a collateral

purpose as distinct from the proper purpose of the liquidation.

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CFA decision:

Although the right against self-incrimination is taken away, the transcript could only be used by Police in a ‘derivative manner’.

‘Derivative use’ means that in a criminal

prosecution, if one is instituted, the prosecution could not directly use evidence in the transcript against the examinee. Those evidence could only be used as leads for further investigation.

Hence, there was no breach of human right.

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The evidence can be used in a direct manner in civil proceedings.

Rule 62 (which requires leave for inspection of transcript) is not for protection of the examinee but of the liquidation.

No contempt can be held against DK.

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Akai Hldgs Ltd (in Liq.) vs Ernst & Young (FACV 28/2008)

“Rule 62 of the WUR is NOT for protection of the examinee but of the liquidation.”

Bokhary PJ, para 35, FACV 30/2008

This principle is illustrated in an earlier case:

AKAI HOLDINGS LTD (IN COMPULSORY LIQUIDATION) v. ERNST & YOUNG (A HONG KONG FIRM) FACV 28/2008 (Judgment 24 Feb 2009)

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Akai Hldgs Ltd (in Liq.) v Ernst & Young (FACV 28/2008)

The liquidator of Akai found that it had grossly insufficient books and records for understanding its business transactions and its reasons for failure.

Extensive s.221 examinations were conducted to reconstruct the affairs of Akai, apart from E&Y, more than 10 other people were examined. (Mainly former directors and employees of Akai and Grande Holding)

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Akai sued E&Y for negligence.

E&Y contended that the transcripts of the examinations should be disclosed pursuant to Order 24 of the Rules of High Court in the negligence claim action.

Akai resisted on the ground that leave was required under Rule 62 of the WUR and because of legal professional privilege, the Court should not give leave under Rule 62.

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High Court and Court of Appeal: the approach to modern day litigation is one of

‘cards on the table’, documents should be disclosed where they are relevant and necessary for the fair disposal of the case;

the examination was part of a general investigation mainly to enable the liquidator to reconstitute the state of knowledge that the company should possess, so as to carry out the liquidation in all its various aspects, of which litigation is just one possibility;

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Akai failed to establish that the dominant purpose of the examination is for seeking legal advice.

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CFA decision:-

in this case the only assets of the Company are claims against third parties and books and records of the Company were grossly inadequate;

investigations and legal advice are required to consider and mount such claims;

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if s.221 transcripts are to be disclosed:-

its effectiveness will be greatly hampered because liquidators will need to be careful that their questions may disclose litigation strategies to future potential defendants;

liquidators will need to exhaust all avenues of investigations before conducting s.221 examination which frustrate the legislative intention of making s.221 a quick and cost-effective investigation method

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the purpose of s.221 is not merely to reconstitute the company’s knowledge, investigating possible

causes of actions is a legitimate use of the section;

in the circumstances of this case, it is clear that the dominant purpose of the examination is to investigate causes of action and seeking legal advice, as such the contents of the examination obtained for such purpose should be covered by legal professional privilege;

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only documents and information belonging to the company obtained under the s.221 procedures may be disclosable, other information relating to potential claims against third parties is not;

the leave requirement under rule 62 is to for the protection of the liquidation, to enable the liquidator to perform his duties, NOT for third parties to advance their own interests.

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The Liq. of Wing Fai Construction Co Ltd v Yip Kwong Robert & Others (HCCW 735/2002)

Once the liquidators obtained necessary information from their s.221 examinations, they should take action promptly.

THE LIQUIDATORS OF WING FAI CONSTRUCTION CO LTD V YIP KWONG ROBERT & OTHERS (HCCW 735/2002) (Judgment: 7th October 2009)

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The defendants applied to strike out a misfeasance action brought by the liquidators against them on the ground of inordinate delay. Company wound up in 2002, a succession of

liquidators were appointed, by Dec 2004, only Nicholas Hill remained;

The 3Ds were former directors of the Company, all having resigned by the time of winding-up; the liquidator alleged they were de facto/shadow directors;

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No financial records were found, not even statement of affairs, liquidator used specialist IT consultants to retrieve data from computer hard drives and used s.221 examination to reconstruct company data;

Liquidator alleged that the Ds procured more than HK$30m to be paid to companies controlled by them for fictitious transactions;

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In August 2004, Liquidator took out misfeasance proceedings under s.276 of the CO claiming against Ds for ‘breach of fiduciary duty and/or breach of trust’;

There were a number of interlocutory applications (mainly for further and better particulars of claims) up to April 2006;

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Since April 2006, no action was taken by the liquidator to proceed with the action;

In August 2008, the Ds took out application to strike out the action on the ground of delay.

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Principles:-

An action will be struck out for delay if :-

There was inordinate and inexcusable delay;

It amounted to an abuse of process in that the plaintiff did not really intend to bring it to trial;

The Ds suffered real prejudice in that a fair trial is no longer possible (e.g. due to loss of memories, disappearance of witnesses);

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Normally the court is reluctant to strike out action if limitation period had not elapsed by the time of the striking out application (because the P could simply start the action again).

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Court (Kwan J) decision:-

there was inordinate and inexcusable delay for two years (the judge did not accept the explanation that the liquidator’s hands are too full – there were more than 10

actions going on- and there were intermittent casual discussions of settlement);

however, there were no real prejudice – the case does not

depend on witness memories;

more importantly, under s.20(1) of the Limitation Ordinance, there is no limitation period for a claim for breach of trust and fiduciary duties.

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New China Hong Kong Group Ltd (HCCL 41/2004)

However, in Re New China Hong Kong Group Limited (unrep, HCCL 41/2004, 29 Aug 08), the action against former auditors were struck out on ground of limitation period.

Members of the Companies claimed, inter alia, against E & Y and Anthony Wu for breach of common law duties in failing to report various problems to the Companies’ management/ the

Executive Committee or warn them of the same.

E & Y applied to Court to strike out the claims

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For breach of contract: 6-year time bar

For negligence: the plaintiff may not be aware of the damage until after the limitation period has expired. S.31 of Limitation Ordinance provides 2 alternative

limitation period:

6 years from the date of accrual of cause of action; or

3 years from the date of knowledge, if that period expires later

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CFI held:

The cause of action in contract and tort have accrued more than 6 years before the commencement of the respective actions against the Defendants.

Evidence showed the independent members of the boards of the Companies have knowledge of problems pertaining to what the members complained of.

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Members could not argue that the relevant facts were unknown to them so as to postpone the running of time until a moment within 3 years of the commencement of the respective actions.

(Could those members of the board be sued for negligence?)

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Ex Turpi Causa

Another case by liquidator against auditor was struck out on the ground of ex turpi causa

Stone & Rolls Limited v Moore Stephens [2009] UKHL 39 (judgment 30 July 2009)

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Stone & Rolls Ltd vs Moore Stephens [2009]

the wound-up company acting through the liquidator sued the former auditors for negligence;

the company was wholly owned and controlled by a Mr. Stojevic, who through fraudulent L/C transactions, defrauded bank creditors of a total of US$174m (stupid banks?);

the auditors applied to strike out the claim on the ground that (even if they were negligent) they had a complete defence based on the public policy principle that a person cannot bring an action based on his own illegal acts (i.e., the ex turpi causa principle );

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as Mr. S was the sole controlling mind and will of the company, his fraudulent knowledge and intent will be attributed to the company, hence the company was the one committing the fraud and it could not maintain the action because of the ex turpi causa principle.

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Court of Appeal:-

the company was itself the conduit of fraud, not the victim of fraud, it did not really suffer any loss – no recovery

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The House of Lords dismissed the action by the Company by a majority of 3:2

the majority upheld the ex turpi causa principle and held that to hold otherwise (in order to help the creditors) would require the extension of the principle in Caparo v Dickman [1990] 2 AC 605;

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The majority pointed out that the principle applied where there was one single dominant director and shareholder, or if there were other directors or shareholders who were subservient to the dominant personality, or where two or more individual directors and shareholders acting closely in concert.

“However, where innocent shareholders were ‘hijacked’ by a

fraudulent but dominant director, difficult questions arose and the court would have to look closely at the facts to see if it would be contrary to justice and common sense to allow recovery. “ Lord Walker

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the minority expressed the sentiment that to let the auditors go in this situation would significantly weaken the role of auditors as watchdog for the protection of creditors; they questioned that Caparo may be distinguishable as it was not concerned with one-man company situation;

the minority commented that whilst it is now well-established that directors owe duties to creditors when the company is insolvent, why the same could not apply to auditors who are also officers of the company?

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The Stone and Rolls case is widely publicized as a commercially funded litigation, what’s

the position regarding litigation funding in HK?

Answer: uncertain

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Commercial Funding of Liquidators’ Legal

Action

SIEGFRIED ADALBERT UNRUH v. HANS-JOERG SEEBERGER AND ANOTHER; Reported in: [2007] 2 HKLRD 414; (2007) 10 HKCFAR 31 (judgment 9 Feb 2007)

The CFA affirmed that maintenance and champerty are still torts and crimes in HK.

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Action

However, it emphasized that in assessing whether an agreement to share proceeds of litigation recovery is void for being contrary to public policy, the Court should consider whether in the particular case the champerty agreement will obstruct or promote justice.

(abstract principle not always sure how to apply)

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Action

There was no decided case on whether a commercial funding agreement for a liquidator to bring action is contrary to public policy on the ground of being a champerty.

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Action

Winnie Lo, a solicitor was convicted of maintenance in relation to a personal injury claim and sentenced to 15 months in July 2009.

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Action

The Courts in the Akai case were aware of the existence of the funding agreement but no objection was taken to it and no discovery was sought.

Akai v Ho Wing On HCCL 37/2005 (Judgment of Stone J on 9th February 2009)

AKAI v. THANAKHARN KASIKORN THAI CHAMKAT CACV 177/2008 (judgment of Le Pichon JA in CA on 2nd April 2008)

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Security for Costs against Wound-up Companies

The judgment of Le Pichon JA is about security for costs. However, the liquidator seems to have made a mistake there which he corrected in Akai v E&Y FACV 10/2009 (judgment on 30th October 2009)

E&Y applied for security for costs against Akai;

High Court refused, CA granted, Akai appealed to CFA;

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Two grounds for application:-

O.23 of the Rules of High Court – resident outside

HK

s.357, Companies Ordinance:-

Court may order security for costs against a company if there is reason to believe that the company will be unable to pay the costs of a successful defendant

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CFA decision:- O.23 does not apply as Akai, though incorporated

in Bermuda, is centrally managed in HK whether before or after its winding-up;

S.357 does not apply as ‘company’ as defined therein means only HK incorporated company.

Hence, Akai does not need to provide security for costs for a 6 months trial even it is well-known that the litigation was funded by a commercial funder.

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Removal of Liquidators – When would a

liquidator be removed by the Court?

Beatrice Tsang v Maxly Yeung HCCW 49-52/2006 (decision 7th January 2009), CACV 21-24/2009 (decision 29th October 2009)

The Tsangs and Yeungs were 50/50 shareholders of a group of companies;

Disputes and distrusts arose and the companies were wound-up under s.177(1)(f) of the Companies Ordinance;

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Beatrice Tsang v Maxly Yeung (CACV 21-24/2009

PLs had been appointed shortly after presentation of petitions and prior to the winding-up order;

The Tsangs were dis-satisfied with the performance of the PLs before the winding-up order and shortly afterwards; they alleged that the PLs were biased in favour of the Yeungs and negligent/incompetent in their handing of the winding-up in particular in relation to PRC aspects;

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Principles:-

section 196(1) of the CO provides that “A

provisional liquidator or liquidator appointed under section 193 or 194 may resign or, on cause shown, be removed by the court.”

‘on cause shown’ does not equate to ‘as the court thinks fit’

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it should not be easy to remove a liquidator simply because his conduct had fallen short of the ideal in one or a few respects, since it would often be the case that in any liquidation which had proceeded for some time, that something could be identified as things which could have been done better or more effectively,

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it was undesirable for liquidators to be too readily removed, since that would generally have undesirable consequences for the liquidation, in terms of cost and delay, and also in terms of causing liquidators and provisional liquidators generally to be more concerned to protect their own position than to pursue what they conceived to be the interests of the company;

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however, the court could remove a liquidator if the applicants can show either:-

a perception of bias based on objective and reasonable ground; or

a justifiable loss of confidence

AND that it was in the interest of the winding-up that the liquidator be removed (i.e., their removal would not cause disproportionate expense and delay)

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High Court and CA decision:-

many of the complaints against the PLs are either unjustified or insufficient to support a removal application;

however, the PLs in (i) allowing the companies to channel all receipts and payments through the personal accounts of Yeung Senior and (ii) operate the business through a company controlled by the Yeungs and charging 5% turnover as commission WITHOUT FIRST CONSULTING the Tsangs gave rise to justified perception of bias and loss of confidence, EVEN THOUGH there was no evidence of actual loss being caused to the companies;

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their removal would not cause disproportionate expense and delay;

liquidator removed and have to pay costs of the application and appeal personally.

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Recent Cases on Setting Aside Pre-Winding Up Transactions

Re Sweetmart Garment Works Limited (In Liquidation) HCCW 755/2005 [2008] HKCU 173

The Company went into compulsory liquidation on a creditor’s petition.

A little over a month prior to the presentation of the petition, the Company granted a mortgage over a yacht in favour of HSG Nordbank AG, a non-associate of the Company.

The loan was drawn down three days later and used to repay an existing overdraft of the Company with the Bank.

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Following presentation of petition, the Bank exercised its right under the mortgage and took possession of the yacht. The vessel was sold and a sum was realized after the deduction of sale expenses.

The liquidators sought a declaration that the mortgage constituted an unfair preference in favour of the Bank.

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Held:- It is no longer necessary to establish a dominant

intention to prefer as requested (under the old law of fraudulent preference) but a desire to better the creditor’s position.

There is no need for there to be direct evidence of the requisite desire. Its existence may be inferred from the circumstances of the case.

The requisite desire must be one of the factors which operated on the minds of those who made the decision. It needed not be the only factors or even the decisive one.

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Having reviewed the contemporaneous correspondence between the Bank and the Company and the evidence of the steps being taken by other creditors of the Company, the judge found that the steps taken by the Bank were too mild and unspecific, which could not sensibly be regarded as constituting pressure on the Company in any real form.

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Other creditors

Demand letters by solicitors

Terminated formalities

Bankruptcy proceedings against directors/guarantors

The Judge held that:

In stark contrast, the steps taken by the other creditors were “more concrete, more serious, and instituted much more promptly” than those threatened

by the Bank.

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Also, given it did not appear that there could have been any real prospect of the Company trading through its difficulties, it could not be said that the mortgage was granted to preserve the ongoing commercial relationship with the Bank. As the overall indebtedness of the Company to the Bank was not thereby reduced by the mortgage, the judge found no good reason for the grant.

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Role Model for Creditors

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Re Tradepower (Holdings) Ltd (in liquidation)

CACV 101/2008 [2009] HKCU 3

A creditor obtained summary judgment against the Company, with damages to be assessed.

The directors of the Company effected a ‘deferred shares scheme’ for its most important subsidiary (TPHK)

which in effect transferred ownership of TPHK to another company (G) controlled by the directors. The purported explanation was that G had been helping TPHK to finance its property purchase.

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A petition to wind up the Company was made shortly after the deferred shares scheme.

Held:-

the CA did not accept the explanation of the directors, citing Feeman v Pope (1870) 5 Ch App 538 which states that:

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“ … if the necessary effect of [a transaction] was to defeat, hinder, or delay the creditors, that necessary effect was to be considered as evidence of an intention to do so. A jury would undoubtedly be so directed, lest they should fall into the error of speculating as to what was actually passing in the mind of the settlor, which can hardly ever be satisfactorily ascertained, instead of judging of his intention by the necessary consequences of his act, which consequences can always be estimated from the facts of the case …”

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Whilst agreeing that the test for “intent to defraud” is a subjective one, the CA is of the view that such subjective intention could be inferred from objective facts, without speculating as to what was passing in the directors’ minds. On the facts of the case, the CA found that the inference of “intent to defraud” was simply irresistible.

CA also held that in any event, it was a breach of directors’ fiduciaries to have effected the deferred shares scheme.

Note: 1. The case is under appeal to the CFA now.

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Investigating Directors’ Negligence

The Test:-

i. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as the director in relation to that company (an objective test); and

ii. the general knowledge, skill and experience that the director actually has (a subjective test).

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Re D’Jan of London Ltd [1994] 1 BCLC 561

Mr D'Jan signed an insurance proposal for his company.

The form asked:-

Have you or any director or partner ... been director of any company which went into liquidation ... ?

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The question was answered 'No'.

Mr D'Jan admits that this was wrong. He had been director of wound up companies.

The form was filled in by his insurance broker, who had been handling his personal and corporate insurance affairs for about five years. Mr D'Jan says that Mr Shenyuz (the insurance broker) had demonstrated his competence by obtaining good rates and recommending him to loss adjusters who had obtained satisfactory settlements on his claims. So he trusted Mr Shenyuz to fill in the form correctly.

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Held:-

Mr. D’Jan was negligent and liable to compensate the company.

However, the judge held he was not gross negligence and acted honestly.

He was 99% shareholder of the company and the form was signed at a time when the company was solvent.

Liability limited to his own claim against the company as creditor.

The End Thank You

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Documents

Insolvency Update Powers and Works of Liquidators · 9 David Kennedy v Kelly Cheng (FACV 30/2008) 3) The court controls the use to which such evidence can be put. 4) Where the abrogation