Re King's Dyeing & Weaving Factory Limited (in Liquidation)
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1. King's Dyeing & Weaving Factory Limited (Kings) was incorporated as a private company on the 12th January 1965. The company was formed for the purpose of manufacturing textiles and was a family company run by the Wong family. Wong Che-keung the principal shareholder and director was the last survivor of the three brothers who formed the company and was in effective control until shortly before the company was compulsorily wound up on the grounds of insolvency on the 26th August 1986.
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HCCW000217C/1986 No. 217 of 1986 IN THE HIGH COURT OF JUSTICE HONG KONG COMPANIES WINDING UP ---------- IN THE MATTER OF THE COMPANIES ORDINANCE (CAP. 32) and IN THE MATTER OF KING'S DYEING & WEAVING FACTORY LIMITED (IN LIQUIDATION) ---------- Coram: Hon. Jones J. in Chambers Dates of hearing: 30th November, 1st-4th, 7th-10th December, 1987. Date of delivery of judgment: 5th January, 1988 ------------------ JUDGMENT ------------------- Background 1. King's Dyeing & Weaving Factory Limited (Kings) was incorporated as a private company on the 12th January 1965. The company was formed for the purpose of manufacturing textiles and was a family company run by the Wong family. Wong Che-keung the principal shareholder and director was the last survivor of the three brothers who formed the company and was in effective control until shortly before the company was compulsorily wound up on the grounds of insolvency on the 26th August 1986. 2. During the course of its business, Kings executed three debentures creating fixed charges over the plant, machinery and accessories, the first in favour of the Hang Lung Bank Limited on the 2nd May 1972 and the other two in favour of the Nanyang Commercial Bank Limited (Nanyang) on the 19th February 1975 and the 24th September 1975. By a deed of transfer dated the 6th June 1986, the debenture of the 2nd May 1972 was assigned to the Nanyang Bank. 3. The youngest son of Mr Wong Che-keung, Mr Roger Wong who had been working in the United States as an electronics engineer, returned to Hong Kong in the middle of 1984 and joined Kings in 1985 becoming acting General Manager in about April 1986. He was aware that Kings was in financial difficulty in about September 1985. 4. By January 1986, it became clear that Kings' main banker, Nanyang, was unwilling to advance further moneys unless Kings underwent a restructuring of its debts. As a result Mr Chapman of Johnson, Stokes & Master, a specialist in insolvency work, was retained on behalf of Kings. He advised that a moratorium was required followed by additional financing in order to save the company. In fact the only way whereby Kings could be saved was to keep the business going as a going concern for it had a profitable core business. A report produced by the accountants Ernst & Whinney dated the 2nd July 1986 revealed that the liabilities of Kings amounted to an amount in excess of $172.5m. with current assets of about $87.6m. leaving a deficit of between $80m. to $90m. However this sum was based upon a sum of $50m. for accounts receivable which in the event were never recovered. The anticipated deficiency for unsecured creditors would result in the unsecured creditors receiving less than ¢1 in the dollar. Approaches were also made to other banks in Hong Kong for funds, but they were all unsuccessful whilst a later approach by Mr Roger Wong to the American California Bank in July 1986 had the same result. 5. Nanyang agreed to an informal moratorium for a period of six months until the end of October 1986 on certain conditions but ultimately the efforts to achieve a formal agreement were unsuccessful as Nanyang required the support of 100% of all the creditors which proved impossible to obtain. 6. Eventually, a trade creditor presented a petition on the 23rd July 1986 to wind-up the company on the grounds of insolvency. The Official Receiver was appointed to be the provisional liquidator with effect from the same date. Mr E. Johnstone and Mr N.P. Etches, partners of Peat, Marwick, Mitchell & Co. were appointed on the 30th July 1986 to be special managers. As I have said a compulsory winding up order on the grounds of insolvency was made on the 26th August 1986. A regulating order was made on the 15th September 1986 on which date the special managers were appointed to be joint liquidators. 7. After his appointment as provisional liquidator, the Official Receiver considered that it was in the best interests of the creditors of Kings to carry on the business with a view to its sale as a going concern. During the course of the negotiations for a sale the special managers ascertained that Kings had executed a debenture in favour of Kazan Properties and Investments Limited (Kazan) on the 17th June 1986 that purported to create certain fixed charges and a floating charge over the assets. It is common ground that the existence of this debenture was not disclosed in the report of Ernst & Whinney dated the 2nd July 1986 and was not registered under section 80 of the Companies Ordinance until the 17th July 1986. Under these circumstances, it is not surprising that the liquidators wished to challenge the validity of the debenture. 8. However, in order that steps could be taken to sell the business of Kings as a going concern, an agreement was reached between the Official Receiver and Kazan on the 2nd September 1986 whereby Kings be sold free from the rights of the debenture holder provided that the Official Receiver retained the sum of $11m. out of the proceeds of sale to be held by him for three months and to be released to Kazan if no proceedings were commenced within this period either on behalf of Kings or Kazan in which the validity of the debenture was to be challenged. The business was sold as a going concern on the 4th September 1986 for $33m. The moneys held by the Official Receiver have been retained in an interest bearing account. 9. The liquidators issued the present summons under sections 266 and 267 of the Companies Ordinance on the 14th November 1986 for a declaration that the debenture constituted a fraudulent preference and is void under section 266 and under section 267, that the floating charge is invalid as it was created within 12 months of the commencement of the winding-up and it cannot be proved that the company was solvent immediately after the creation of the charge. In addition declarations are sought with regard to moneys paid by Kings to Kazan which were alleged to have constituted a fraudulent preference and for a declaration that dispositions made of the property of Kings are void under section 182 of the Companies Ordinance and for orders for the repayment of those sums together with the release of the sum of $11m. with interest held by the Official Receiver. By an amendment to the summons made on the 25th May 1987 a further declaration is sought claiming a sum by way of interest paid by Kings to Kazan for a period of six months before the presentation of the petition on the grounds that it constitutes a fraudulent preference. 10. Mr. Swaine who appeared on behalf of Kazan has conceded that the liquidators are entitled to an order under section 267 but has strongly resisted the other declarations that have been sought. Kazan 11. Kazan was incorporated in about 1981 at the instigation of Mr Wong Che-keung for the purpose of providing finance for Kings by means of a discounted. cheque facility. The shares of Kazan were held as to 999 by a Panamanian company called Hyperion and one share by Wong Che-keung. The directors of Kazan were Mr Wong Che-keung, his two daughters Carol Wong Yin-hing and Wong yue-mui and David Arzoony. It is significant that Mr Wong Che-keung resigned as a director of Kazan on the 17th June 1986. On the same date two companies Ephra Limited and Anclar Limited were appointed as directors. The shareholders and directors of Ephra and Anclar were the principals of K.K. Young 5 Co., the auditors of Kings. Hyperion 12. Hyperion was formed in April 1977 when the directors were Wong Che-keung, Wong Tai-ho and Wong Yin-hing. Wong Chek-keung resigned as a director of Hyperion on the 9th June 1986. The shares in Kazan held by Hyperion were converted into bearer shares in 1981 which Mr Roger Wong believes were held by his mother. It is not in dispute that Kazan was beneficially owned by Mrs Wong Che-keung and was a Wong family company closely associated with Kings. Evidence 13. Two witnesses were called on behalf of the liquidators, Mr Etches and Mr O'Driscoll, both accountants, and three for Kazan, Mr Roger Wong, Mr Ho, an accountant, and Mr Chapman. Evidence of Mr Etches 14. Mr Etches gave evidence that in his view the Kazan debenture should have been disclosed in the Ernst & Whinney report in order to give a full and fair picture of the financial situation of Kings at the time of the proposals for a reconstruction. 15. A detailed analysis of the accounts of Kings and Kazan made by Mr Etches revealed that at the 16th June 1986 Kings owed Kazan approximately $12.4m. of which $1.2m. was secured by a guarantee of Mr Wong Che-keung and that between the 17th June 1986 and the 24th July 1986 Kings received $9.530m. from Kazan. and during the same period Kings paid Kazan $11.267m. The sum of $1.2m. had been loaned several years previously and had never been repaid whilst the balance related to two tranches of debts in respect of advances believed to have been made by Kazan to Kings after the 1st April 1986 which came to a total of abut $5.55m. and advances made by Kazan to Kings before the 31st March 1986 which amounted to about $5.65m. The moneys were loaned by Kazan to Kings by means of cheques in favour of Kings and on the same day or shortly thereafter a postdated cheque in the same amount would be drawn by Kings in favour of Kazan as security. Mr Etches was of the opinion that the cheques were exchanged and cleared through the bank, but when there was in fact no net transfer of funds. In some cases payments made by Kings were in excess of receipts from Kazan but whenever a final payment was made by Kings to Kazan, an equal amount was received from Kazan on the same or the next day. He said that the transactions did not serve any purpose apart from round-tripping the money and that there could be no possible commercial explanation for the transactions other than to create an illusion that the Kazan debenture was primarily in respect of new advances rather than past advances. Prior to the 1st April 1986, Mr Etches said that a similar pattern had been adopted of cheques being replaced by postdated cheques which were cashed through the bank account with equivalent sums of cash being received from Kazan on substantially the same day. Mr Etches concluded that this was an attempt to show that new money was being advanced and that the repayments were repayments of old debts but in character, they would amount to an exchange of cheques which were both cleared through the bank on the same day or one or two days apart. Evidence of Mr O'Driscoll 16. Mr O'Driscoll, the accountant of Ernst & Whinney who was responsible for the report on the financial situation of Kings said that the report was made under tune constraints and that he did not have the opportunity to do a detailed review of the books and records which he would have done under normal circumstances. He dealt mainly with Mr Roger Wong and said that at the time of the preparation of the report he was aware of the debenture in favour of Kazan which he knew represented the Wong family interests. In reply to a question as to why the Kazan debenture was not referred to in the report, Mr O'Driscoll said :
17. Under general circumstances, Mr O'Driscoll said that it would be the lead banker who would provide critical funds but as the lead bank was not sympathetic to Kings, it was therefore necessary for the family company to provide these funds. The reason advanced for non-disclosure was that the reason for such advances might he misunderstood by creditors at the creditors' meeting to be called, and it was therefore agreed with Mr Wong that in view of any misunderstanding that might arise which could be prejudicial to the hopes of achieving a restructure, the debenture would not be disclosed. Mr O'Driscoll believed that the funds to be advanced would be in the region of $1m. - $2m. and that Kazan was a new vehicle set up for the purpose of making these critical funds available. Mr O'Driscoll was aware that the debenture would be used in the subsequent restructuring of Kings and would be released to creditors who supported the restructuring or otherwise he shared with them. He said that it was not the intention to conceal the debenture from the creditors once the restructuring had been considered and that such a non-disclosure was only of a temporary nature. However, he conceded that if he had been aware of the facts as he now knows them and had to make the decision again, he would have revealed the debenture in the report. Evidence of Mr Chapman 18. Mr Chapman Was instructed on behalf of Kings in April 1986 and advised that in order to avoid liquidation, the company should he kept going as a going concern and that additional funding would have to be obtained for that purpose. He conducted negotiations with Nanyang in conjunction with Mr Wong Che-keung and Mr Roger Wong and a draft debenture in anticipation of execution by Nanyang was prepared. The draft debenture to secure all amounts becoming due from time to time was described as an all moneys debenture. The conditions for the proposed restructuring of Kings were set out in a number of telexes between the solicitors for Nanyang and for Kings which can be found in Bundle D at Tab 5. The scheme was to be run by the major creditors, who with the exception of the landlord of the factory premises, Winland, another Wong company were financial institutions and would result in support being given to Kings by the granting of new security which would extend not only to the new finance which would be provided, but also to cover their existing indebtedness. Although the debenture would be given to Nanyang as the debenture holder, the bank could also take the benefit of the debenture including the other financial institutions and Winland. Security would therefore be shared between those institutions on terms to be agreed under a separate document whilst the figure for additional finance was to be in the region of about $20m. Both the long term and short term finance were anticipated to be given by Nanyang. 19. At this time Mr Chapman believed that Kings was operating on a day-to-day basis by virtue of internal cash low, but later realised that the matter of interim finance had become independent of the long term finance. Mr Chapman was aware that one of the major creditors of Kings was Kazan. Ultimately when Nanyang refused to agree to a restructuring unless there was 100% support from the other creditors, discussions took place between him and Mr Roger Wong that the debenture could be given to Kazan to secure interim finance on the basis that the debenture could either be released or shared in the event of full additional financing becoming available and the informal scheme proceeding. 20. After Nanyang withdrew from the proposed restructuring and after the abortive visits to seek financial assistance from other banks, the draft debenture that had been prepared for Nanyang was used for Kazan. A directors' meeting of Kings held on the 14th June 1986 passed a resolution that the debenture be given in favour of Kazan and it was executed on the 17th June 1986. 21. The final proposals for the restructuring of Kings were set out in a letter from Johnson, Stokes & Master dated the 9th July 1986 addressed to all the creditors of Kings which enclosed a letter from Kings of the same date setting out brief details of the company's current financial position, but without disclosing the debenture. 22. Mr Chapman alleged that Mr Roger Wong had not been the status of Kazan and did not with the Wong family, but merely informed him that it would not be a problem in terms of the creditors. However, he became aware that Kazan was a family company before the debenture was executed. 23. Although he believed that there would only be a slim chance of a successful restructuring, nevertheless, he thought that there was a chance having regard to the majority views of the trade creditors of Kings who were supportive and from the impression he gained that there was a lot of family goodwill in terms of the business and the creditors' involvement with the individuals behind Kings. Accordingly, he expressed the view that a further approach could then be made to the lead bank, Nanyang, despite the fact that there was not 100% support as required and that the bank in California was unlikely to inject a substantial amount of money into Kings. 24. He denied that after a discussion about pouring good money after had, he had suggested to Mr Roger Wong that a debenture could be taken out which would secure the interests of Kazan as the interim lender. According to Mr Chapman, there was a discussion to the effect that someone else other than Nanyang could act as the lead bank to provide additional finance, but the conversation was then directed to the question of interim finance and whether Kazan was able to do so. Mr Roger Wong said that Kazan could provide interim finance and inquired whether the company could take security for that purpose and whether it would be possible to delay its registration. At that juncture Mr Chapman advised Mr Wong upon the provisions of sections 266 and 267 of the Companies Ordinance but he did not recall whether any specific discussion took place as to whether the debenture should cover both old and new moneys. He attributed his failure to remember because he was working under pressure at that time. However, he disagreed with the evidence of Mr Etches that the Kazan debenture would effectively ruin the remaining chance of a restructure. He also expressed the opinion that the failure to disclose the debenture did not amount to misleading the creditors. 25. A suggestion that Mr Chapman may have blundered by overlooking the fact that the debenture was an all moneys debenture as he was working under pressure was untenable. The documents speaks for itself. Evidence of Mr Roger Wong 26. Mr Roger Wong was the only member of the Wong family who gave evidence. Medical evidence was produced to show that Mr Wong Che-keung was unfit to give evidence although he had given evidence in the section 221 proceedings earlier in 1987 whilst Mr Roger Wong's wife, Emily, who was concerned with the accounts of Kings is pregnant and expects a child on the 1st February 1988 and has been advised not to travel to Hong Kong as she is in a high risk group. None of the three directors of Kings who passed the resolution to execute the debenture in favour of Kazan gave evidence and no explanation was put forward as to why they were not called. 27. Mr Roger Wong is an intelligent man and was actively engaged in the management of the company together with his father Mr Wong Che-keung. From the evidence it appears that Mr Wong Che-keung was involved in the negotiations for restructuring the company, but that his son took the more active part. Roger Wong is neither a director nor a shareholder in Kings and was put forward as an independent witness who had no interest to serve. He believed that if a moratorium could be achieved Kings could be saved. Nevertheless, the company was existing on a day-to-day basis with moneys injected into Kazan and paid to Kings from the sale of his mother's property in Conduit Road and from shares held in Winland. 28. Mr Wong said that when he asked Mr Chapman as to whether it would amount to throwing good money after bad having regard to Kings' financial situation, Mr Chapman mentioned that a debenture could be given to Kazan for the bridging finance and that it was for this reason that Kings was able to be kept going on a day-to-day basis until a formal restructuring of the company's affairs. This resulted in the meeting of directors of Kings on the 14th June 1986 which passed the resolution for the debenture to be executed. Evidence of Ho Man-Kwong 29. Mr Ho is an accountant employed by K.K. Young & Co. who were the auditors of Kings. He prepared a report for the directors of Kings dated the 8th April 1986 upon the proposals for restructuring, the company. With regard to the situation concerning the cheques exchanged between Kings and Kazan, he said he could give no explanation as to why postdated cheques were replaced by current cheques but that the old debt was replaced by a current debt. However, he agreed that it was an unusual kind of commercial transaction which he had never come across before. 30. Mr Ho was an unimpressive witness and did not add anything to the case. Nothing that he said in any way detracted from the evidence given by Mr Etches. Law as to Fraudulent Preference
31. The issue that I have to determine which is a question of fact is whether the object of giving the debenture was to prefer Kazan over the general body of creditors. The conditions that amount to a fraudulent preference are conveniently set out in a passage in Halsbury's Laws of England, 4th Edn. Vol.3, paragraph 908 under the heading "Avoidance of Fraudulent Preference" as follows:
32. The onus of proof is upon the liquidators to establish that in giving the debenture, the dominant intention of the debtor Kings was to give preference to the creditor Kazan over the general body of creditors, see Sir William Henry Peat v. Gresham Trust Limited(l). In that case at page 262 Lord Tomlin said
33. In order that an act may constitute a fraudulent preference it must be made voluntarily and not under pressure, see In Cutts (a bankrupt) Ex parte Bognor Mutual Building Society v. Trustee of T.W. Cutts(2). However in the instant pressure being applied to Kings in giving the debenture so that this point does not arise. 34. At the time when the debenture was given Kings was unable to pay its debts as they fell due and a winding up order was made two months later. My task is therefore to consider whether the dominant intention of Kings in granting the debenture was to prefer Kazan. 35. Apart from the evidence of Mr Roger Wong who, as I have said, was the only member of the Wong family who gave evidence, I am entitled to look at all the other circumstances as to whether the onus of proof has been discharged. If any doubt arises it must he resolved in favour of the debenture holder. Conclusions as to Whether the Debenture Constituted a Fraudulent Preference 36. It is clear and I accept the report of Ernst & Whinney that Kings was hopelessly insolvent on the 31st May 1986 with massive debts. Nevertheless, Kings had a profitable core business and was enabled to continue on a day-to-day basis as a result of the injection of funds for essential payments such as wages and for services from moneys paid by Kazan. However, it was but pious hope that either the lead bank, Nanyang, or any other bank would, in the circumstances, make further loans to Kings. 37. Mr Swaine referred me to In re M'Innes - Ex parte Bumstead and Co.(3) for the proposition that if the hope of saving the company was an over-sanguine one, nevertheless that did not decide whether a preference had been made. I accept that the Wong family was desirous of saving Kings and that genuine efforts were made to effect a reconstruction by enlisting the services of Johnson, Stokes & Master and Ernst & Whinney. However, it became apparent during the course of negotiations with the creditors that there would be no money forthcoming to save the company and that the only way, as I have said, for the business to continue was merely on a day-to-day basis. Although the creditors may have been supportive of Kings in the early stages, by the time the petition to wind-up was presented, creditors had filed writs claiming over $5m. The hopes of Mr Roger Wong and his family were, in my judgment, quite unjustified upon the facts. Again I reject the evidence of Mr Chapman who was of the opinion that there was still a chance, albeit a slim chance, for a successful restructuring of the company. This was not a case of the debtor being over-sanguine, but being wholly unrealistic. 38. With regard to the cheques exchanged between Kings and Kazan, I have no hesitation in accepting the evidence of Mr Etches whose detailed analysis of the account was not seriously disputed. No explanation was given by either Mr Rover Wong or Mr Ho as to the reasons for these transactions and I am satisfied and accept the evidence of Mr Etches that there could be no possible commercial explanation for them and that the only purpose was to give the impression that the Kazan debenture was primarily in respect of new advances rather than past advances. I am quite satisfied that the cheque exchanges were a sham to give the impression that new advances were made. 39. The reasons given for the failure to disclose the existence of the debenture in the report of Ernst & Whinney and to the creditors as open to misinterpretation or that it would create some form of emotion amongst the creditors was a masterpiece of understatement. I am satisfied that Mr Chapman did explain the provisions of sections 266 and 267 of the Companies Ordinance to Mr Wong and that it was Mr Wong's decision, after receiving this advice, that the debenture should not be disclosed in the report. I reject Mr Wong's evidence that it arose as a result of Mr Chapman's suggestion. I found Mr Wong lacked candour in his evidence and he was also inconsistent when he was giving his evidence on various matters including the insistence by Mr Wong Che-keung that security be given whereas earlier his evidence was more modified. His reason for delaying the registration of the debenture was another example of his intention to withhold the existence of the debenture for as long as possible. I accept Mr O'Driscoll's evidence that he gained a wrong impression from Mr Wong with regard to the nature of Kazan and that had he been fully acquainted with the full facts, he would have insisted upon a disclosure of the debenture. However, even with the facts as he knew them, I am of the opinion and accept Mr Etches' evidence that the debenture should have been disclosed in order to present a full and fair picture of the situation of Kings at that time. Further I do not accept Mr Chapman's evidence that the failure to disclose the debenture would not have misled the creditors. In my judgment the failure to disclose amounted to a deliberate attempt to mislead in a vain hope that a restructure of the company would be successful. If the debenture had been disclosed, it would obviously have ruined any chance of success. The debenture was given for the express purpose of transforming Kazan from an unsecured creditor to a secured creditor which would inevitably result in the unsecured creditors receiving almost nothing. I am satisfied that it was not given for the purpose of making new advances. Another factor to be taken into account was the resignation of Wong Che-keung from Kazan on the date of the debenture and also from Hyperion a few days earlier which was obviously done to give the impression that Wong Che-keung was no longer concerned with those two companies. Both Kings and Kazan were so closely connected, being Wong family companies that it was clearly in the interests of the Wong family to have the debenture. Far from being an independent witness with no interest to serve Mr Roger Wong had every incentive to act in the manner that he did in order to protect the interests of his family. I find as a fact from the evidence and the surrounding circumstances that the dominant intention of Kings was to prefer Kazan as a creditor to the detriment of the general body of creditors. It is the only and irresistible inference that I draw. 40. I therefore find in favour of the liquidators that the debenture constituted a fraudulent preference and is therefore void. Conclusions on the Monetary Declarations Sought 41. In connection with the other declarations that have been sought by the liquidators, I accept the evidence of Mr Etches that the payment of $1,567,000 made between the 17th June 1986 and the 15th July 1986 was made by Kings to Kazan although it may have been funded by Mr Wong Che-keung which he claimed reduced his indebtedness to Kings by a payment from the sale of shares in Hing Fung Alliance Limited. However, these funds were received by Kings and instead of being retained for the general body of creditors were paid to Kazan. The payment clearly amounted to a fraudulent preference and is therefore void under section 266. 42. In respect of the sum of $550,000, this amount is made up as to a sum of $380,000 paid on the 15th July 1986 and a sum of $170,000 on the 24th July 1986. It was claimed that the sum of $170,000 was a repayment by Mr Wong Che-keung as part of his old indebtedness to Kings. An explanation was given by Mr Roger Wong that the entry in Kings' books was a mistake for it was to repay some indebtedness of Wong Che-keung to Kazan. However; the entries in Kings' books refute these allegations. I have no hesitation in rejecting Mr Wong's evidence which was most unconvincing. With regard to the sum of $380,000 Kings received two cheques from Kazan for the sums of $300,000 and $80,000 on the 16th July 1986 whilst Kings made an equivalent payment to Kazan on the preceding day. The payment by Kings accordingly amounted to a disposition of property within the meaning of section 182 of the Companies Ordinance and is therefore void. 43. During the period from the 15th January 1986 to the 7th July 1986, a sum of $760,361.66 was paid by Kings to Kazan by way of interest. It was contended that the interest was paid because interest was also being paid to other banks and financial institutions yet other creditors were receiving no payments. However, Kazan being a Wong family company was clearly not hostile to Kings and would not he expected to apply pressure as in the case of the banks. In those circumstances, the payments clearly amounted to a fraudulent preference and are therefore void. 44. I will hear the parties upon the order to he made and costs.
(1) [1934] A.C. 252 (2) [1956] 1 W.L.R. 728 (3) (1891) 8 T.L.R. 14 Representation: Mr P. Graham (Clifford Chance) for Applicants. Mr J.J. Swaine, Q.C. and Mr J.J.E. Swaine (Vivien Chan & Co.) for Respondent. |