Re Parnip Investment Ltd.

CACV000083/1991

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Coram: Hon. Fuad, V-P, Penlington and Nazareth, JJ.A.

Date of Hearing: 25 October 1991

Date of Handing Down Judgment: 29 November 1991

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JUDGMENT

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Nazareth, J.A. (giving the judgment of the Court):

1. On 20th May 1991 Jones J. dismissed the appellant company's application for a validation order under section 182 of the Companies Ordinance (Cap. 32) to sanction from its funds payment of certain legal costs. The appellant now appeals to this Court against that order.

2. The facts can be quite shortly stated in the following way. The appellant company was incorporated in November 1988 under the Companies Ordinance by the three persons who are now the shareholders primarily to trade in salted duck eggs to be procured from Vietnam. The nominal capital of $1 million divided into 100,000 shares of $10 was fully paid up. The shareholders are Mr. Tsoi Chak-shing who holds 40,000 shares and Mr. Lau Pong-ting and Mr. Lam Fat each of whom hold 30,000 shares. Each of the three is also a director and each apparently brought connections and  expertise to the company. Tsoi had experience and connections in trading with Vietnam through the U-Harbour Co Ltd ("U-Harbour") which he controlled or beneficially owned. Lam was in the restaurant business; and Lau and his father had long been in the business of importing and selling eggs in Hong Kong.

3. The company's business did not prosper. The three shareholders had to make loans to it which remain unpaid, and it has now ceased trading. In resolving the accounts the shareholders fell out, Tsoi on the one side and Lau and Lam on the other. The former says this happened when he  claimed a 5% commission that had been originally orally agreed. For their part the latter two contend that Tsoi and U-Harbour first, overcharged the company for eggs from Vietnam in respect of 13 transactions; second, improperly charged an addition of US1 cent per egg; and third, underpaid the company for sales of goods sent to Vietnam. Mr. Tsoi denies these allegations and claims that U-Harbour has not been paid and that he has been wrongly excluded from membership of the company.

4. On 20th July 1990 the company's solicitors commenced correspondence with Tsoi's solicitors in pursuit of the three claims. On 17th August 1990 U-Harbour commenced action in A5642 of 1990 by writ with an indorsement of claim against the company claiming damages of over $1 million. A Statement of Claim was filed on 17th October 1990 which revealed U-Harbour's claim as primarily relating to a 5% agency fee or commission which Tsoi claims was orally agreed on 1st December 1988.

5. On 30th August 1990 Tsoi issued the winding up petition (No. 254 of 1990) in the context of which the appellant's application for a validating order has been made. The petition claims that it was the mutual intention and agreement of the three shareholders that the company would be run as a quasi-partnership and all three allowed to take an active part in its affairs; that because of heavy losses between December 1988 and March 1990, in excess of $997,178.50, the shareholders had to make substantial loans to the company; that about mid-March they agreed that the company should cease trading and be wound up; that its debts are in excess of $2.179 million (including some $440,000 owed to Tsoi) against assets of $1.102 million held on deposit; that it was therefore insolvent; that further and in the alternative Lau and Lam had excluded Tsoi from taking part in the affairs of the company and denied him information relating to the state of affairs and remaining assets.

6. Tsoi's allegations are denied by the company which wishes to contest the action, to lodge a counterclaim in respect of the three claims mentioned, and also to oppose the petition. It is in relation to the legal costs of these steps that the application to Jones J. was made. Having referred to the action and petition, Jones J. in his concise judgment went on to deal with the application in the following way:

"      Mr. Chan, counsel for the company, agrees that the assets amount to $1.1m. and that the application today, if granted, will reduce the assets of the company to about $400,000, and that if any further application is made, the company will become insolvent in any event, whether or not the claims made in the petition are justified. I asked Mr. Chan if he had any authority to support the application, but he said be had none. With regard to the proceedings against the company in the High Court, Mr. Shum for the petitioner drew my attention to s.181 of the Companies Ordinance which provides that after the presentation of a winding up petition and before a winding up order has been made, the company, or any creditor, or contributory, may apply for a stay of the proceedings. No application has been made, but I am satisfied that this course should have been adopted instead of running up a large sum by way of costs. Once a winding up petition has been presented, the assets of the company should be preserved as far as possible, for the benefit of the general body of creditors and the shareholders. A validating order for a disposition under s.182 should therefore only be made where it will be for the benefit of the creditors or for some other good reason. The practical result of granting the present application will inevitably lead, as I have said, to the insolvency of the company on the assumption that it is not already insolvent. The payment sought to be made cant in no way be described as being for the benefit of the creditors or the contributories. Indeed, I do not consider that in the normal course of events, s.182 is intended for this purpose, for applications for a validating order should normailly be made in connection with the ordinary business of the company or if good cause can be shown. As a result, I am quite satisfied, in the exercise of my discretion, that the summons should be dismissed with costs."

7. The appellant's first ground in its Notice of Appeal lists some ten matters to which it is said the learned Judge failed to give any or sufficient consideration. Some of these clearly must have been considered by him; many are trivial, and at least one was not argued before him. The second ground is that in exercising his discretion the learned Judge erred in coming to the conclusion -

8. The extensive grounds in the Notice of Appeal together with some additional grounds consented to by Mr. Edward Chan, Q.C. for Tsoi, were pursued by Mr. William Waung for the appellants only to the extent addressed in this judgment.

9. It is convenient to begin with the first limb of the second ground of the appellant's Notice, i.e. that in the exercise of his discretion the learned Judge erred in coming to the conclusion that the result of granting the application will inevitably lead to the insolvency of the company in the absence of evidence. This can very shortly be disposed of. It is clear from the evidence that some $700,000 has already been expended in legal costs. If the appellants were successful and the additional costs were, sanctioned, that would exhaust the remaining assets of the company. It is clear that before either the petition or the action is determined, indeed before either hearing is commenced, the company's funds will be exhausted. Accordingly Mr. Waung's contention that the appellant's counterclaim is likely to amount to some $4-5 million does not assist him, for the evidence, such as it is, points clearly to all available funds being exhausted before the hearing of either proceedings. It follows therefore that the Judge did not err in his conclusion.

10. The second limb of the second ground is that the trial Judge erred in coming to the conclusion that the payment can in no way be described as being for the benefit of the creditors and contributories when the counterclaim in the action was brought for the purpose of collecting the assets of the company, for the benefit of the creditors and contributories. In the sense found by the trial Judge, rightly in our view, that the funds would be exhausted prior to determination of either proceedings which would then have to be abandoned, the trial Judge was correct that the payment would not produce any benefit either to the creditors and contributories or the company.

11. We turn then to the appellants' main ground of appeal. Mr. Waung submits that the practice of the courts on validation order applications is to allow payment pending the petition if payment is made honestly and in the course of business [Palmer's Company Law, 24th Ed. Vol. I pp. 1452-3, para 88-74; see also Practice Direction No. 1 of 1990, (1990) BCC 292]. That is not disputed by Mr. Chan. The cogent reason for the practice was succinctly set out by Lord Cairns in In re Wiltshire Iron Co. ex parte Pearson (1868) 3 Cn App 443 at p. 447 where he pointed to the importance of petitions not ipso facto being allowed to paralyse the business of a company that was actually trading - in contrast to one in extremis - without any counterbalance of advantage and to the great injury of those interested in the assets of the company.

12. In the present case the company has clearly ceased trading and indeed been disposing of assets required to operate the business, so that it is not necessary to permit it to continue to trade in order to preserve its assets. Nonetheless it seems to us that even if the company is not trading it must be in the ordinary course of its business for the company to preserve and bring in its assets whether by way of defending legal claims or proceeding by way of counterclaim, so that the disposition should be sanctioned unless there is some good reason for the court's discretion to be exercised otherwise than in accordance with the practice adverted to. We shall return to the matter of the court's discretion.

13. Mr. Waung relies also upon the principles formulated by Slade J. in In re Burton and Deakin Ltd [1977] 1 WLR 390 at 397 G-H where he said:

"If on an application under section 227 [the English equivalent of section 182] relating to a solvent company, (a) evidence is placed before the court showing that the directors consider that a particular disposition, falling within their powers under the company's constitution, is necessary or expedient in the interests of the company, and (b) the reasons given for this opinion are reasons which the court considers that an intelligent and honest man could reasonably hold, it will in the exercise of its discretion normally sanction the disposition, notwithstanding the opposition of a contributory, unless the contributory adduces compelling evidence proving that the disposition is in fact likely to injure the company ...

While I nave attempted to formulate these statements of principle so as to explain the basis upon which I decide this particular case, I should nevertheless make it clear that, they are intended merely as broad guidelines. No limits are placed by the sections court's discretion to grant or to refuse an application under section 227, and such a discretion will of course be exercised in every instance having regard to the particular circumstances of the particular case."

14. As has already been said, the company must be regarded as insolvent, and the principles therefore do not appear to us to apply. In addition it is difficult to see now an intelligent and honest man could have reason for regarding the disposition as necessary or expedient in the interests of the company, given that it should be obvious that the funds necessary would run out prior to conclusion of the proceedings. Furthermore the evidence is compelling that the funds will run out and the company accordingly will be injured by the loss of its remaining funds without any counterbalancing benefit. Finally Slade J. himself did not suggest that the principles or broad guidelines formulated by him limit the court's discretion to refuse the application. That discretion was referred to as an absolute discretion by Wynn-Parry J.in In re T.W. Construction Ltd [1954] 1 WLR 540 at 543, adopting the expression used by Vaughan Williams J. in re reptoire Opera Company (1895) 2 Manson 314, 316 and by Vaisey J. in re Steane's (Bournemouth) Ld [1950] 1 All ER 21.

15. Mr. Waung submits that whether validation should have been ordered for each set of costs should be separately considered in relation to each of the three legal steps the company wishes to take first in relation to the defence of the winding up petition, he submits not only should the validation order be made as being in the ordinary course of business, but also because denial would deprive the company of its ability to defend itself and thereby pre-empt the question of whether or not the defence was a good one, which would be the effect referred to by Hoffmann J. in Re Crossmore Electrical and Civil Engineering Ltd (1989) 5 BCC 37 at 39D-E. As to the latter it must be said that it is really the limited amount of the company's funds that deprives it of the ability to defend itself.

16. It is also of interest that in that same case Hoffmann J. stated that:

"The company is a nominal party to the section 459 petition, but in substance the dispute is between the two shareholders. It is a general principle of company law that the company's money should not be expended on disputes between the shareholders; see Pickering v. Stephenson (1872) LR 14 Eq 322. Consequently, it seems to me clear that such expenditure on defending the section 459 petition would not be in the ordinary course of business and the order should be subject to a proviso which states that expressly...."

17. The latter observations of Hoffmann J. seem to be in point in the present matter, for the clear indications are that the dispute concerns not so much the company as Tsoi on the one hand and Lau and Fat on the other.

18. Mr. Waung goes on to submit that what is sought by the petition amounts in fact to an injunction against the company restraining it from dealing with its assets on the ground that that would be a breach of the director's fiduciary duty; and that this ought not to be allowed upon the authority of Re a Company No. 005685 of 1988 (1989) 5 BCC 79. In that case Hoffmann J. was asked for sanction in the common formula that the company may pay debts in the ordinary course of business. It was agreed that the company was fully solvent. The motion was under the Insolvency Act 1986 to validate payments into and out of the company's bank account. The petitioners desired that the common formula, that the company may pay debts in the ordinary course of business, should be stated expressly not to include any costs of defending the petition. Hoffmann J. said this:

"The argument is thus about whether it would be a breach of fiduciary duty on the part of the directors of the company to spend the company's money in this way. The jurisdiction under section 127 is designed for the protection of creditors - and I suppose also to some extent contributories - in the event of there being an insolvent liquidation, so that the relation-back doctrine would apply to disposition of the company's assets. It does not seem to me right that that jurisdiction should be used in a case where there is no question about the company being able in the end to pay all its lawful debts and therefore no such protection is required. What I am being asked to do is to use the section 127 jurisdiction in order to give the petitioners what would amount to an interlocutory injunction restraining the company's board from dealing with its assets in a certain way on the ground that that would be a breach of their fiduciary duty. If an application for such an injunction were made, the basis upon which the court would go into the matter would be rather different from the way in which it has been put to me now."

In the present case, the boot is very much on the other foot. There is no question, if the disposition is sanctioned, but that the company will not be able to pay at least the independent creditor. No more need be said.

19. We return then to the question of the learned Judge's exercise of discretion, in particular whether there was good reason to warrant his departure from the usual whereby payments made honestly and in the ordinary course of business would be sanctioned. The following matters are relevant, that is to say, the inevitability of insolvency if the payments in question are sanctioned, the high probability if not certainty of the company's funds running out well before the proceedings are concluded, the consideration that the action and counterclaim will receive from the liquidator with the possibility that both may be permitted, and with the possibly greater likelihood of being completed with less costly legal fees, the fact that trading has ceased, and the existence of at least one independent creditor who is likely to be deprived of payment altogether if the disposition is sanctioned. All these seem to us to constitute compelling reason for departing from the usual practice and refusing the sanction sought. It follows that no reason has been shown why the discretion of the learned Judge was exercised in any way less than satisfactory.

20. We would add that had some error of principle been demonstrated on the part of the Judge and it had become necessary for this Court to exercise its own discretion, we would have had no hesitation in coming to the same conclusion.In taking that view we have not overlooked Mr. Waung's claim of the lack of bona fides on the part of the petitioner and his submission that the petition was launched to pre-empt and stifle the appellant's counterclaim. Evidence to support such a claim is singularly lacking. Likewise we have not overlooked Mr. Waung's submission that the absence of any record or written demand by Tsai of the 5% agency commission tends to cast doubt upon his claim. We do not think the evidence enables us to accept that submission to any sufficient degree to offset the factors and considerations adumbrated. Furthermore we recognise that it would be quite wrong to enable a party to pre-empt and stifle a claim simply by launching a winding-up petition. We are far from satisfied that there is evidence of that in this case. If there were, the unquestioned discretion that the court has would have enabled the matter to have been appropriately dealt with.

21. For the reasons given the appeal is dismissed.

22. We indicated at the end of the hearing that we would hand down our judgment and deal with the matter of costs by order nisi. We accordingly make an order nisi that the petitioner is to have the costs of the appeal.

Representation:

William Waung (M/S Lau, Wong & Chan) for Appellant

Edward Chan, Q.C. and Erik Shum (M/S W.K. Lo & Wong) for Respondent