Re K C K Garment Factory Ltd

HCCW 300/2014

[2019] HKCFI 585

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING‑UP PROCEEDINGS NO 300 OF 2014

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D E C I S I O N

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1.On 20 January 2017, the liquidators (“Liquidators”) of K C K Garment Factory Ltd, (“the Company”) issued a summons under sections 266, 266A, 266B, and section 276 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) seeking declarations that—

“1. … a payment in the sum of HK$10,246,575 made on 3 October 2014 by the Company to the 1^st Respondent constituted an unfair preference pursuant to sections 266 and/or 266B(1) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap. 32 (the ‘CWUMPO’) and is null and void;

2. … a payment in the sum of HK$241,667 made on 10 October 2014 by the Company to the 1^st Respondent constituted an unfair preference pursuant to sections 266 and/or 266B(1) of the CWUMPO and is null and void;

3. … under section 276(1) of the CWUMPO that the 2^nd, 3^rd and 4^th Respondents as directors of the Company at the material time were guilty of misfeasance and/or breach of duties and/or breach of trust in relation to the Company and be liable to contribute such sum to the assets of the Company by way of compensation as the Court thinks just;

4. An Order that the 1^st, 2^nd, 3^rd and 4^th Respondents do jointly and severally make payment to the Provisional Liquidators and/or contribute to the assets of the Company at such sums received by the 1^st Respondent as stated in paragraphs 1 and 2 above or at such sums as the Court thinks just;

…”

2.A petition to wind up the Company was presented by the Company on 17 October 2014 and a successful application was made by it to appoint provisional liquidators, who are now the Liquidators, on the same day.  The Company was wound up on 31 October 2016. 

3.The 1^st respondent, Hong Kong Construction Financing Limited, is a licensed money-lender. In August 2014, it was approached indirectly for a bridging loan of HK$20 million.  The 1^st respondent was provided with documents demonstrating the financial position of the Company, including a letter from Chong Hing Bank Ltd dated 6 August 2014 offering a finance facility of HK$160 million subject to satisfaction of various conditions.  In addition, the Company offered joint and several personal guarantees by Eric Woo the 2^nd respondent, who was a director of the Company and held an indirect beneficial interest of 33% in it, and Benson Lo, who was Eric Woo’s friend. 

4.The 1^st respondent granted two loans, each of HK$10 million for one month repayable on 3 October 2014.  Towards the end of September 2014, the Company requested an extension.  The 1^st respondent agreed to extend the time for repayment of the principal under the 2^nd loan if the Company repaid the principal of the 1^st loan and the interest that had accrued on both loans; the Company agreed.  On 3 October 2014, the amount of the principal and interest under the 1^st loan was repaid.  On 9 October 2014, the parties entered into a supplemental agreement in respect of the 2^nd loan, providing that interest was to be repaid on 10 October 2014, and the principal was to be deferred for one month with interest. On 10 October 2014, the Company paid the amount of HK$241,667.00.

5.It is not contended by the Liquidators that the original agreement is not a genuine commercial transaction.  What they argue is that the repayments were not made to satisfy a genuine commercial need of the Company in late September or early October 2014, but to reduce the liabilities of Eric Woo, in particular under his guarantees and also that of his friend Benson Lo. 

6.It is not disputed by the 1^st respondent that the Company was insolvent during the material period and that the payments to it and to Eric Woo had the effect of preferring him.  Eric Woo did not take part in the proceedings against him.  The 1^st respondent defends the application against it on the basis that in order to succeed in the claim, the Liquidators have to show that the payments were made with an independent desire to prefer the 1^st respondent, and this they have not, and cannot do. 

7.I shall start by considering the applicable legal principles.  The relevant statutory provisions provide:

“Cap. 32 Companies (Winding Up and Miscellaneous Provisions) Ordinance

266. Unfair preferences voidable in certain circumstances

…

(2) If the company has at a relevant time (within the meaning of section 266B) given an unfair preference to a person, the liquidator may apply to the court for an order under subsection (3).

(3) Subject to section 266C, on an application under subsection (2), the court may make an order that it thinks fit for restoring the position to what it would have been if the company had not given that unfair preference.

(4) The court must not make an order under subsection (3) unless the company was influenced, in deciding to give that unfair preference, by a desire to produce in relation to that person the effect mentioned in section 266A(1)(b).

…”

Cap. 6 Bankruptcy Ordinance

50.  Unfair preferences

(1)  Subject to this section and sections 51 and 51A, where a debtor is adjudged bankrupt and he has at a relevant time (defined in section 51) given an unfair preference to any person, the trustee may apply to the court for an order under this section.

…

(3)  For the purposes of this section and sections 51 and 51A, a debtor gives an unfair preference to a person if—

(a)  that person is one of the debtor’s creditors or a surety or guarantor for any of his debts or other liabilities; and

(b)  the debtor does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the debtor’s bankruptcy, will be better than the position he would have been in if that thing had not been done.

(4)  The court shall not make an order under this section in respect of an unfair preference given to any person unless the debtor who gave the unfair preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in subsection (3)(b).

…”

8.What is required to be proved to succeed with such a claim was explained by Millet J (as he then was) in Re MC Bacon Ltd:[1]

“ This is a completely different test. It involves at least two radical departures from the old law. It is no longer necessary to establish a dominant intention to prefer. It is sufficient that the decision was influenced by the requisite desire. That is the first change. The second is that it is no longer sufficient to establish an intention to prefer. There must be a desire to produce the effect mentioned in the subsection.

This second change is made necessary by the first, for without it it would be virtually impossible to uphold the validity of a security taken in exchange for the injection of fresh funds into a company in financial difficulties. A man is taken to intend the necessary consequences of his actions, so that an intention to grant a security to a creditor necessarily involves an intention to prefer that creditor in the event of insolvency. The need to establish that such intention was dominant was essential under the old law to prevent perfectly proper transactions from being struck down. With the abolition of that requirement intention could not remain the relevant test. Desire has been substituted. That is a very different matter. Intention is objective, desire is subjective. A man can choose the lesser of two evils without desiring either.

It is not, however, sufficient to establish a desire to make the payment or grant the security which it is sought to avoid. There must have been a desire to produce the effect mentioned in the subsection, that is to say, to improve the creditor's position in the event of an insolvent liquidation. A man is not to be taken as desiring all the necessary consequences of his actions. Some consequences may be of advantage to him and be desired by him; others may not affect him and be matters of indifference to him; while still others may be positively disadvantageous to him and not be desired by him, but be regarded by him as the unavoidable price of obtaining the desired advantages. It will still be possible to provide assistance to a company in financial difficulties provided that the company is actuated only by proper commercial considerations. Under the new regime a transaction will not be set aside as a voidable preference unless the company positively wished to improve the creditor’s position in the event of its own insolvent liquidation.”

9.It follows that if a transaction is entered with proper commercial considerations or is a result of pressure exerted on a Company, the requisite desire will generally be lacking: Re Leric International Ltd [2]  and Re Hau Po Fun & anor.[3]

10.There is a dispute between the Liquidators and the 1^st respondent as to whether the evidence has demonstrated that the payments were made for a proper commercial purpose, and/or in combination with pressure exerted by the 1^st respondent through its solicitors demanding that they be repaid by the Company.  In my view, the absence of Eric Woo, and the vague evidence, for example the lack of contemporaneous correspondence concerning demands for repayment, make it difficult to assess precisely what was motivating Eric Woo and the Company in making the repayments I referred to above.  This is a subject to which I shall return. 

11.The principal legal issue that requires consideration is the consequences of the payments reducing both the Company’s liabilities to the 1^st respondent and also the guarantor’s contingent liabilities to the 1^st respondent.  Ms Cheung argues that if the Company intended to prefer the guarantor, it follows that in order to produce this result, it must have desired the concomitant result, namely, to reduce the liabilities to the 1^st respondent, which was a necessary step in reducing liabilities under the guarantee.  This argument relies heavily on the decision of Jonathan Parker J in Re Agriplant Services Ltd.[4]  The facts of that case were similar with a payment resulting in a reduction of the liability of a director under a guarantee to the payee.  The factual position was summarised by the Judge at 608h–i as follows:

“ At this point I must return to s 239 of the Act. It is indisputable, and it not disputed, that the payment to CAF had the effect of improving the position of both CAF as a creditor and Mr Sagar as a contingent creditor under his guarantee in the event of an insolvent liquidation of the company. It follows that for the purposes of ss 239 and 241 the payment constituted a preference given to CAF and to Mr Sagar.”

The Judge went on at 610 to say this:

“ In his closing speech Mr Vickers put CAF's case thus, and I summarise his submissions. (1) Section 239 is concerned with preferences, not with transactions, in the sense that orders may be made only against a person or persons to whom a preference has been given. This may or may not include all the parties to a particular transaction.

(2) The legislation contemplates that where more than one person has been preferred by a particular transaction, an order may be made against some of those persons but not against others; vis-à-vis those others therefore the transaction will stand.

…

I agree with Mr Vicker’s propositions (1) and (2), and I further agree that (as I observed earlier) before an order can be made against CAF the court must be satisfied that in making the payment the company, that is to say in practice Mr Sagar, was influenced by a desire to improve the position of CAF on an insolvent liquidation of the company. But at that point I part with Mr Vickers. The evidence in the instant case establishes, and I find, that in making the payment to CAF, the company, that is to say Mr Sagar, was influenced by a desire to improve the position both of himself and of CAF on an insolvent liquidation of the company. At the time the payment was made, Mr Sagar was well aware that an insolvent liquidation of the company was inevitable and that it was only days away. In procuring the company to make the payment his desire was to reduce the amount of the current arrears under the leasing agreements, which would have the effect of reducing his own liability for the current arrears under his guarantee and also with a view to paving the way for a takeover of some or all of the agreements by LVE, thereby providing Mr Sagar with some measure of protection against the accrual of further liability in the future under his guarantee, either for future payments by way of rent or for any shortfall on the repossession and sale of equipment subject to the leasing agreements. Given the inevitability and the imminence of an insolvent liquidation of the company, it was only by improving the position of CAF on an insolvent liquidation of the company that Mr Sagar’s own position under his guarantee could itself be improved. Mr Sagar wanted (desired) to reduce the company’s debt to CAF; that is to say, to produce in relation to CAF the effect described in s 239(4)(b) for just that reason.”

12.With respect to the Judge, this seems to me to be wrong.  As Millet J explains, intending a result and desiring it are different.  The Company could desire to reduce Eric Woo’s liabilities under the guarantees, and in order to achieve this desired result, intentionally reduce its liabilities to the 1^st respondent.  It does not follow that the Company desired to reduce its liabilities to the 1^st respondent.  It may well be that if not for the guarantees, it would not have reduced its liabilities to the 1^st respondent because it did not have a desire to do so.  Reducing its liabilities to the 1^st respondent was simply an intentional consequence of its desire to reduce liabilities to the guarantors.  This is explained by professor Roy Goode in Goode on Principles of Corporate Insolvency Law:[5]

“In making a payment, the company may be influenced by a desire to improve the creditor’s position, the surety or both the creditor and the surety. The question of whether there is the requisite desire must be asked in respect of each person to whom a preference has been given. A desire to prefer the creditor does not of itself indicate an intent to prefer the surety; conversely, the company may intend to prefer the surety without being in any way influenced by a desire to assist the creditor. The typical case is where a company’s account has been guaranteed by the directors, who at a time when the company is insolvent arrange for it to repay the bank, not out of any desire to improve the bank’s position but to obtain a release from their own liability to the bank. This is a preference of the sureties because the repayment operates not merely to affect the relations between the bank and the sureties but to avoid a situation in which the sureties, having paid the bank under their guarantee, are left to prove in the winding-up in competition with other creditors for their indemnity entitlement.…”

It is also a distinction identified by Mr Justice Anthony Chan in Re Kam Toys & Novelty Manufacturing Ltd [6]which was upheld on appeal.[7]

13.Ms Cheung accepted in closing that if this is the view I took of the law, it would be difficult for the Liquidators to establish the necessary independent desire to benefit the 1^st respondent.  It seems to me that this is correct and that there is insufficient evidence from which I could properly draw the inference, because that is what it would be, that the Company desired to prefer the 1^st respondent.  I would, however, go further. 

14.It does not seem to me that the Liquidators have proved sufficient facts from which I can draw the inference that the Company intended to prefer Eric Woo.  What stands in the way is the undisputed fact that Eric Woo tried to get the 1^st respondent to extend both loans. This is inconsistent with an intention, let alone a desire, to prefer the 1^st respondent or the guarantors.  The Liquidators have not explained how this is to be reconciled with the desire to prefer. There is no evidence that this was some sort of cunning ploy.  The totality of the evidence, including the request to extend the loans, is consistent with a genuine, albeit confused and perhaps misconceived, attempt to keep the Company going for a little longer.  It is here worth pointing out that these Liquidators were appointed provisional liquidators expressly to restructure the Company and its associated Companies, which indicates that it was not Eric Woo’s intention to liquidate the Company’s business, and is a reason why he may have wanted to raise additional finance. 

15.In conclusion, I find that the Liquidators have failed to demonstrate the necessary components of unfair prejudice payments to the 1^st and 2^nd respondents, in particular the failure to demonstrate the necessary desire.  It follows that I will dismiss the summons.

(Submissions on costs)

16.I will make an order that the applicants pay the respondents’ costs of the proceedings, with a certificate for one counsel.

(Further submissions)

17.I also have before me another summons of the same date seeking similar declarations against Apparel Partner Ltd, which was beneficially owned by Eric Woo and his Father, the 3^rd respondent, in respect of payments made to it. 

18.Apparel Partner Ltd is an associate of the Company and therefore the presumption in subsection (5) of section 50 of the Bankruptcy Ordinance (Cap 6), namely that the necessary desire required to satisfy subsection 4, is presumed.  As I have already indicated, it is clear that the Company was insolvent during the relevant period and the payments were made during the relevant period.  Given the fact that the presumption applies and, as in the case of the 1^st summons, Eric Woo and the 3^rd and 4^th respondents who are directors of the Company have not contested the summons, it follows that the case in the application against them is proved. 

19.I will, therefore, make the declarations in [1] to [4] of the summons, and order that interest is payable and the respondents pay the applicants’ costs of the summons.

Ms Janine Cheung (15 and 17 January 2019), instructed by ONC Lawyers, and Mr Eric Woo (21 January 2019), of ONC Lawyers, for the Joint and Several Provisional Liquidators

Mr Bernard Mak (15–17 January 2019) and Ms Jacquelyn Ng, instructed by Tung, Ng, Tse & Lam, for Hong Kong Construction Financing Limited

S W Tai & Co, for Apparel Partner Limited, the 2^nd respondent (bankrupt), and the 4^th respondent, absent

Stephen Liu and David Yen, the Joint and Several Trustees of the Property of the 3^rd respondent (bankrupt), were not represented and did not appear