G.M.I. Technology Inc v. East China Digital Technology Ltd and Another

HCMP 2036/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2036 OF 2016

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DECISION

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Introduction

1.This is the hearing of the appeal of the plaintiff (“GMI”) against the decision of the 2^nd defendant (“Wu”) as the chairman of the creditors’ meeting of the 1^st defendant (“East China”) held on 22 July 2016, pursuant to section 255 of the Companies (Winding-Up and Miscellaneous Provisions) Ordinance and rule 128 of the Companies (Winding-Up) Rules.  The relief sought by GMI includes:

(a)   a declaration that Wu’s decision made at the said creditors’ meeting reducing the amount of GMI’s proof of debt from US$6,666,519.09 to HK$1.00 for the purpose of voting is void and invalid;

(b)   a declaration that GMI was entitled to vote at the said creditors’ meeting and is entitled to vote at all future creditors’ meetings of East China in respect of the full amount of its proof of debt, ie US$6,666,519.09;

(c)   an order that the resolution passed at the said creditors’ meeting to nominate Mr Pang Wai Kui of Messrs WK Pang & Co, CPA (“Mr Pang”) as liquidator of East China be set aside; and

(d)   an order that the East China and Wu do reconvene a creditors’ meeting of East China on such time and date as the court considers appropriate.

2.GMI’s case is that it is entitled to vote at the creditors’ meeting upon its debts of about US$6.7 million which are supported by invoices, packing lists, purchase orders and audit confirmations.  Wu’s case is that the debts are contingent in nature and by law GMI is not entitled to voteon such debts.  The debts were not generated through arms-length transactions but by way of inter-entities transactions within the same joint venture.  Repayment of those debts are conditional upon East China receiving payment from another joint venture entity, Shenzhen East Faith Storage Co Ltd (“East Faith”).  East Faith had not paid and it is unclear whether it will pay.  Hence, Wu considered the debts are not yet owed to GMI.

3.Notwithstanding East China’s previous indication of its intention to contest the appeal and the filing of a lengthy affirmation of Mr Pang setting out his own views over a number of legal and factual issues of this case, at the call over hearing, Mr Tang, counsel for East China, informed Recorder Houghton SC that East China would take a neutral stance.  East China was also excused from attending this substantive hearing.

4.The issue in this case is whether the debts relied on by GMI are contingent in nature.

The applicable legal principles

5.Counsel have no dispute about the legal principles applicable to this appeal.  They are well settled and straight forward and are summarized as follows.

6.Rule 125 of the Company (Winding-Up) Rules provides that a creditor shall not vote in respect of any unliquidated or contingent debt.  A “contingent debt” refers to a case where there is doubt as to whether or not there is any debt at all.  It means a debt the amount of which cannot be estimated until the happening of some future event.  In McPherson’s Law of Company Liquidation, the learned authors wrote:

“ A contingent creditor has been described as one towards whom, under an existing obligation, the company would or might become subject to a present liability on the happening of some future event or at some future date, and in Ex parte Ruffle, Mellish LJ stated that a debt was contingent where there was a doubt whether there would be a debt at all.”

The above principle was adopted by Harris J in Re Joint Silver Ltd[1], in which he held that a contingent creditor was not allowed to vote in a creditor’s meeting.  See also: Re Drummelow ex parte Ruffle[2], and Re Rickett ex parte Insecticide Activated Products Ltd v Official Receiver[3].

7.A “contingent debt” is to be distinguished from an “unliquidated debt” which includes all cases of damages to be ascertained by court and any debt where the creditor fairly admits that he cannot state the amount. 

8.A “liquidated debt” is a pre-ascertained liability under the agreement of the parties.  Its amount must either be ascertained or capable of being ascertained as a mere matter of arithmetic. Nevertheless, in order for a sum to qualify as a liquidated sum, it needs only be ascertained, as opposed to being indisputable.  See: HM Revenue & Customs v Maxwell[4] which was cited with approval in Re Grande Holdings Ltd[5].

9.A creditor is not expected to state the amount of the debt with absolute certainty.  He is just required to provide an affidavit that at least a certain sum is due to him.  Such a statement should be taken by the court as sufficient evidence of the debt and the creditor should be admitted as a creditor for the sum named.  See: Re Drummelow[6].

10.The general approach that the chairman of a creditors’ meeting should adopt when assessing a proof for voting purpose under rule 125 is to ask himself whether, on balance, the claim against the insolvent company is established.  This involves a relatively broad and macroscopic assessment: Re Days International Ltd[7].

11.In such assessment, the benefit of doubt should be resolved in favour of the creditor submitting the proof.  Rule 128 provides that if the chairman is in doubt whether a proof should be admitted or rejected, he shall “mark it as objected to and allow the creditor to vote subject to the vote being declared invalid in the event of the objection being sustained”.  In other words, if it is plain or obvious that a claim is good, the chairman must admit it.  If it is plain or obvious that it is bad, he must reject it.  If there is a question, a doubt, he shall admit it but mark it as objected to: Emery v UCB Corporate Services Ltd[8], quoting Re A Debtor (No 222 of 1990)[9].

12.Rule 128 also provides that the power of the chairman of a creditors’ meeting to admit or reject a proof of debt for the purpose of voting shall be subject to appeal to the court.  In hearing an appeal from the chairman’s assessment, the court is not determining whether the chairman’s decision was reasonable, but is carrying out its own independent assessment of the value at which the debt should be admitted upon the same broad and macroscopic approach: Re Days International Ltd.  It is undesirable that excessive time be spent on scrutinizing a proof: Re Grande Holdings Ltd.  The correct approach is to keep the factual inquiry to a minimum and decide no more than necessary as there is an interest of timeous and efficient resolution: Adlon Limited v Eileen Sale (as Liquidator of Kingstons Investment Limited) & Derek Taylor[10].  The same benefit of doubt principle should also apply.  In other words, unless the court is sure that the claim is unliquidated or unascertained, the claim should be admitted for voting purpose.  In HM Revenue & Customs v Maxwell[11], the court held that a prima facie case of debt due and owing would be sufficient.

13.A cross-claim from a company under liquidation against the creditor cannot be used to diminish the creditor’s claim when assessing for voting purpose: Emery v UCB Corporate Services Ltd and Adlon Limited v Eileen Sale (as Liquidator of Kingstons Investment Limited) & Derek Taylor.

14.Prima facie, where it is found that the chairman had wrongly refused to allow a creditor to vote for his full entitlement either because the chairman had rejected the proof or because he had only admitted it in part, the court would usually order a new meeting on the basis of the principle of creditor democracy: Re Power Builders (Surrey) Ltd[12], with a direction as to whether the appellant creditor’s claim should be admitted at a certain value (or it is higher than a value which is big enough to defeat other votes), see: HM Revenue & Customs v Maxwell.  The court also has discretion to directly substitute the liquidator proposed by the appellant creditor, subject to the proposed liquidator’s filing of a new consent to act: Adlon Limited v Eileen Sale (as Liquidator of Kingstons Investment Limited) & Derek Taylor.

The background

15.GMI is a company listed in Taiwan which at the material times was interested in entering into the business of distributing hard disk drives in the People’s Republic of China (the “PRC”).  Sky Faith International Enterprise Limited (“Sky Faith”) was the original distributor of Toshiba hard disk drives and wished to utilize GMI’s listing status to raise funds to expand its business.  The two parties entered into a joint venture agreement orally but some of its terms are evidenced in writing in the form of a memorandum dated 5 March 2015.  Under the agreement, Sky Faith would transfer its distributorship to GMI and its staff to弘憶永達電子(深圳)有限公司  (“GMI(SZ)”), a subsidiary of GMI in Shenzhen in the PRC to provide marketing and after sale service for the disk drives.  In return, Sky Faith would be entitled to a 30% share of overall profits from the business derived from the joint venture for three years from 2015 to 2017.  The memorandum stipulates that GMI would provide credit terms to Sky Faith and Sky Faith would provide at least 50% of credit security to GMI.  Later, to facilitate import of the disk drives into the PRC, East China and East Faith were used respectively as Sky Faith’s corporate vehicles for exporting the disk drives from Hong Kong and importing them into the PRC.

16.In August 2014, Sky Faith transferred its sales staff to GMI(SZ).  On 21 January 2015, GMI and GMI(SZ) on the one part and Ng Ka Wai (“Vincent”) on behalf of Sky Faith and his brother, Wu, on the other part entered into two quadripartite agreements under which they provided their real properties as securities for the debt owed by East China to GMI.  It was until then that the parties executed the memorandum.  Between July 2014 and February 2016, GMI supplied East China with disk drives which East China caused to be stored in the warehouse of East Faith in the PRC.  East Faith was responsible for selling the disk drives to end consumers and collecting payment from them. 

17.The joint venture went well until June 2015 when East China failed to pay in full the disk drives supplied between 24 June 2015 and February 2016.  Vincent’s property was realized for settlement of part of the outstanding debt.

18.On 22 July 2016, East China passed a special resolution to cause itself to be wound up voluntarily under section 228(1)(c) of the Companies Ordinance by reason of its liabilities.  On the same day, Wu, as its sole director, presided the creditors’ meeting in which GMI’s representative also attended.  Despite GMI had submitted its proxy and claim form of US$6,666,519.09 in advance, Wu refused to admit the claim in full but assigned a notional value of only HK$1 to GMI for voting purpose in the creditors’ meeting.  Notwithstanding GMI’s protest, the meeting carried on and a resolution was passed appointing Mr Pang as liquidator of East China.

19.The aggregate of all other creditors’ claim was HK$9,357,825. GMI’s representative made it clear that it proposed Mr Mat Ng and Mr John Robert Lees of JLA Asia Limited be appointed as joint and several liquidators.  Thus, as long as GMI’s claim had been admitted at any amount above that, Mr Pang’s appointment would not have been approved.

The joint venture agreement and the pay when paid term

20.The debts are not disputed.  East China’s case is that they arose out of a non-arms-length transaction such that it only made commercial sense if they were contingent debts.  Mr Tang submits that this non–arms-length nature can only be explained if the sales which gave rise to the debts are viewed in the context of the joint venture.  The ordinary mode of operation would have been for GMI to export the disk drives to GMI(SZ) which would then sell them to end consumers.  However, this would create audit difficulties and import and export complications for GMI.  To overcome these problems, Sky Faith and GMI entered into an arrangement under which GMI exported the disk drives to a Hong Kong dummy, which is East China, which in turn exported them to a PRC entity, which is East Faith for storage and delivery to end customers and collect sale proceeds.  East China, being a dummy, was a mere conduit and employed no staff.  Its function, Mr Tang argues, was to facilitate the export process and its obligation was to pay GMI if and when payments are received from East Faith.  GMI’s sales to East China were internal transactions within the joint venture and were non–arms-length in nature.  The debts were contingent and payable as and when East China was paid.

21.Mr Tang also relies on the affirmation of Bruce Lee, who was the ex-Product Manager of GMI responsible for negotiating the joint venture agreement.  He tries to add weight to Bruce Lee’s evidence by emphasising the fact that Bruce Lee had now left the employment of GMI and is an independent witness.  In his affirmation, Bruce Lee said that for this type of business, profits were not made through a difference between the purchase price from the supplier and the selling price to the end consumers.  He said that often sales to consumers result in loss. Profits for distributors are derived from rebates and other subsidies which offset such loss and generate profit.  Bruce Lee asserted that the profit centre of the joint venture was GMI which was the recipient of the rebates and subsidies.  All other entities, ie GMI(SZ), East China and East Faith were “cost centres”.  Hence, the relationship between GMI group and Sky Faith group rested on overall accounting. 

22.Bruce Lee’s evidence is contradicted by Lewis Lo’s.  Lewis Lo is the President of GMI whom Bruce Lee reported to.  He is fully aware of the negotiation between Bruce Lee and Vincent on behalf Sky Faith.  According to Lewis Lo, Bruce Lee was mainly concerned with functions, roles and obligations of the different business entities involved.  He said that the questions of how the disk drives were to be imported and exported and delivered to end consumers, how sales and marketing were to be conducted and how payments from end consumers were to be collected had not been discussed in detail between Bruce Lee and Vincent because Sky Faith had an established operation and logistics structure in the PRC, ie East Faith.  In fact, Bruce Lee had left his post by the end of 2014, five months before execution of the memorandum.  According to Lewis Lo, the parties intended to maintain the way things had been done through East Faith in the PRC and the relationship between GMI and Sky Faith and East China was merely a seller-buyer relationship.

23.Mr Tang argues that against the background of the joint venture inherent probabilities lie heavily against a deal between the parties whereby GMI is entitled to enforce the debts booked vis-à-vis East China at will.  He submits that the use of East China as a conduit to facilitate import and export of the disk drives makes more sense.  Such arrangement ensured that GMI was not given an unfair commercial advantage by having the ability to blindly demand its debt vis-à-vis East China without taking into account the terms of the joint venture agreement and the settlement of accounts based on overall accounting. 

24.The other side of the coin is that such arrangement would put GMI at serious financial risk.  The disk drives shipped to East China were no longer in GMI’s control after the shipment.  This arrangement would mean East China or East Faith could hold onto the disk drives indefinitely without paying for them and would suffer no loss at all if they were not sold or paid by the end consumers.  GMI had no control over the process of sale and collection of payment.  Sky Faith, on the other hand, could enjoy profit if the business was smooth.  The numerous emails and correspondence issued by the staff of East China which I shall later refer to shows that it is also demonstrably untrue that East China was a dummy employing no staff.  Given the fact that Sky Faith, East China and East Faith were all independent entities not under GMI’s control and given the volume and costs of these sales, no sensible businessmen would have agreed to enter into such a pay when paid term.  Such a term defies commercial and common sense, even in the context of the joint venture.

25.As for “overall accounting”, it is a vague term.  It is not clear from the evidence the precise terms of the joint venture agreement.  There is no doubt that the parties agreed to share in the profits at the ratio of 3:7 as between Sky Faith and GMI.  But “overall accounting” even in that context does not embrace the notion of pay when paid only and nothing else.  The parties could trade between themselves and then work out the profit at the end of the joint venture or a financial year or at such time as is convenient or as mutually agreed. 

26.One thing which is clear is that clauses 8 and 9 of the memorandum exclude the notion of pay when paid.  Clause 8 states unequivocally that “GMI will offer credit limit and term to Sky Faith to handle TSVP business”.  In addition, clause 9 states that “Sky Faith will provide the at least 50% of credit security guarantee to GMI”.  These are terms which are to be used in a seller–buyer relationship.  Pursuant to this clause, Vincent and East China entered into two quadripartite agreements pledging their properties in the PRC to GMI as security for East China’s debts.  If there were the pay when paid arrangement, there would have been no need to write these terms into the memorandum and to enter into the quadripartite agreements.  More telling is that Vincent’s property was in fact sold to pay off some of the debts.  He explained that it was for comity reason that he allowed his property to be sold.  But I think his connivance is inconsistent with the pay when paid term.

27.Mr Tang tries to draw support from Bruce Lee’s affirmation in which he explained that the purpose of the security was to ensure Sky Faith and its affiliates will faithfully and honestly perform its logistics and treasury functions.  Hence, Mr Tang submits that the security is not intended to deal with the risk of irrecoverability of account receivables, but the risk of Sky Faith, East China and East Faith not complying with their duties in performing their logistic and treasury functions.  This assertion is not supported by the terms of the memorandum.  It is difficult to understand why there is this divergence between the evidence of Bruce Lee and Lewis Lo.  In my view, this pay when paid arrangement does not make commercial sense.  Apart from the fact that Bruce Lee’s affirmation has been contradicted by Lewis Lo’s, his assertion just cannot stand when it is tested against clause 8.  It is manifestly obvious that the security was the usual security for the credit facility or goods sold and delivered.

28.The evidence that the debts are not contingent debts is overwhelming.  They are supported, on the one hand, by purchase orders issued by East China to GMI and, on the other, by invoices and packing lists issued by GMI to East China.  The pay when paid term is contradicted by the fact that all the invoices issued by GMI specified a payment term of net-45 days. 

29.There are numerous emails and other contemporaneous exchanges between the staff of GMI and East China in which East China’s staff unambiguously acknowledged East China’s indebtedness to GMI.  In particular, in an email dated 2 February 2016, GMI’s accountant stated that the balance due from East China as at 31 December 2015 was US$8,020,316.13 to which East China’s accountant replied pointing out that there was a slight discrepancy between the parties’ record which stated that the amount owed was US$20.14 less.  It is also significant to note that the confirmation of balance issued by East China confirmed that as at 31 December 2015, it owed GMI US$8,020,316.13 whereas the amount due from GMI to East China was recorded as “nil”.  This confirmation of balance was affixed with East China’s seal, and a softcopy of the same was also attached to an email from the accountant of East China or Sky Faith to the accountant of GMI.  From the email history, it can be seen that this email originated from a staff of East China who was in correspondence with GMI’s auditor and another staff member of GMI after receiving the auditor’s request for confirmation of balance.  Most of the documentary evidence emanated from East China’s representatives was generated by East China, some of which even bore its company seal.  These contemporaneous documents show that the debts were treated by the parties as genuine debts arising from genuine sale and purchase transactions.

30.It is common ground that the parties had entered into a joint venture agreement.  Some of the terms of that agreement were evidenced in the memorandum.  The pay when paid term is inconsistent with the express terms of the memorandum which require GMI to offer credit limit to Sky Faith and Sky Faith to provide security for disk drives delivered.  It does not sit well with the contemporaneous documents, especially the invoices specifying payment within 45 days, the audit documents and the parties’ email exchanges.  Against the factual matrix, particularly the fact that Sky Faith, East China and East Faith were all independent entities over which GMI had no control and the volume and value of the transactions, the pay when paid term does not make business sense.  It is even absurd.

31.East China raised some cross-claims.  Apart from the fact that as a matter of law such cross-claims do not have the effect of diminishing the debts, they are based on East China’s happy assumption that the debts were contingent debts.

32.Taking a broad and macroscopic approach in assessing GMI’s proof, I am well satisfied that the debts are proven.  Wu’s decision to give a nominal value of HK$1 to these sizeable debts was manifestly wrong if not made in bad faith.  The debts should be admitted in full for voting purpose.

Conclusion

33.For the above reasons, Wu’s assessment of GMI’s proof of debt at the nominal value of HK$1 was manifestly wrong and must be set aside.  I assess the amount of GMI’s proof of debt at US$6,666,519.09.  Had Wu properly assessed GMI’s proof of debt, the debt owed to GMI would have far outweighed the aggregate of all other creditors’ claims and Mr Pang’s appointment as liquidator would not have been approved.  His appointment must also be set aside.  East China should reconvene a creditors’ meeting in accordance with the terms of the order to be made hereunder. 

34.Accordingly, I grant the plaintiff an order in terms of sub-paragraphs (a), (b) and (c) of paragraph 1 above and a further order that the 1^st and 2^nd defendants do convene a creditors’ meeting of the 1^st defendant within 14 days of the date of this decision.  The defendants are advised that this order is effectively a mandatory injunction order.  If the 2^nd defendant refuses or neglects to reconvene the meeting and afford GMI its voting right as I assessed, he will be liable for contempt of court.

35.I also make a costs order nisi that the plaintiff’s costs up to and including 28 February 2017 shall be paid by the 1^st and 2^nd defendants jointly and severally; and the costs thereafter shall be paid by the 2^nd defendant solely.

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Mr Lewis Law, instructed by Fung Wong Ng & Lam LLP Solicitors, for the plaintiff

Mr Alexander Tang, instructed by Keith Lam Lau & Chan, for the 2^nd defendant  

Attendance of the 1^st defendant was excused as granted by Mr Recorder Houghton SC