Re Moulin Global Eyecare Holdings Ltd and Others

HCMP 2460/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2460 OF 2006

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Before:  Hon. Barma J in Court

Date of Hearing:  2 February 2007

Date of Decision:  2 February 2007

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D E C I S I O N

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1.In June 2005 Mr Roderick John Sutton and Mr Desmond Chung Seng Chiong (“the Liquidators”) were appointed as joint and several liquidators of Moulin Global Eyecare Holdings Limited (“MGEH”).  MGEH is the holding company in a large group of companies, which is involved in the manufacture, distribution and sale of eye care and eyewear products.

2.Since their appointment, the Liquidators have taken control of a considerable number of companies in the group.  They have been appointed as joint and several liquidators of five other group companies that are, like MGEH, in compulsory liquidation.  They have also been appointed as joint and several liquidators of 12 further group companies which have been put into voluntary liquidation.  Of these, 10 are in creditors voluntary liquidation while the other two are in members voluntary liquidation. 

3.They are in control of a further seven group companies by virtue of the fact that they are in control of the directors of those companies, which are either persons who act as their nominees or corporations which are controlled by them.

4.After their appointments, the Liquidators and their staff undertook an investigation into the affairs of the various companies of which they are liquidators and also of other companies in the group.  These investigations revealed that the group was in serious financial difficulty; that its cash reserves were misstated, apparently as a result of irregular accounting practices; that there was evidence of seriously questionable transactions involving one of the companies of which they are liquidators, Oaktree Investments Limited (“Oaktree”), which is in creditors voluntary liquidation; that there was doubt as to the existence of a significant portion of the group’s supposed debtors; that there was evidence of false accounting by the group’s management, including the putting through of fictitious transactions through accounts recording inter-company debt between one or more of the companies now under the control of the liquidators; and that there had been destruction and falsification of books and records of companies within the group.

5.Apart from this, the liquidators have ascertained that the group, as a whole, had debts of some HK$2.8 billion owing to banks in Hong Kong and overseas at the time of MGEH’s liquidation but had only some HK$7.8 million in cash balances in Hong Kong at that date.  The recoverability of much of the debt owed to group companies by third parties is regarded as doubtful.

6.However, since the commencement of the liquidation, Ample Faith Limited, which is one of the companies the liquidators control by virtue of their control of its directors, has, through a merger in the United States, disposed of a valuable eyewear distribution business for some US$143 million.  According to the books and records of Ample Faith and Moulin Global Eyecare Trading Limited (“MGET”), which was the main retailing company in the group or trading company in the group, and which also acted as a treasury company for the group, Ample Faith owes MGET some HK$760.4 million.  As a result of the disposal by Ample Faith of its eyewear distribution business, it is in a position to repay all of its creditors, which include MGET, in full, and make a distribution to its shareholders.

7.As a treasury company within the group, MGET has inter- company balances with many group companies, including many of those which are under the liquidators’ control.  When it receives payment from Ample Faith, MGET will have sufficient funds to pay substantial dividends to its creditors, including its fellow group companies.  Where a dividend is paid to a group company the result will be that that company, in turn, will have funds with which to pay a dividend to its own creditors.  The ultimate effect of the repayment by Ample Faith to MGET will be that many group companies, which may not presently be in a position to pay any appreciable dividend to their creditors, will be put in a position to pay substantial dividends, or substantially enhanced dividends, to their respective creditors.

8.In the case of each group company, its creditors may be divided into three groups.  The first consists of what I may describe as the external creditors, that is to say, creditors who are not related to the group, such as banks, other lenders and trade and other creditors.  The second consists of related companies, which for one reason or another, are not at present under the control of the Liquidators.  The third consists of the companies which are the subject of this application, the group companies which are under the control of the Liquidators as described above.

9.The Liquidators have identified some 58 companies that have inter-company debt balances inter se.  Of these, 18 are the companies of which they are Liquidators and seven are the companies which are under their control through controlled directorships.  Of the remaining 33 companies, six have overseas or other administrators or liquidators appointed, 11 have had their debts compromised or forgiven as part of the process of selling off parts of the group’s business, 13 do not, as far as the Liquidators are aware, appear to have anyone in control of them, and the status of three companies appears to be unknown and something of a mystery.

10.In order to get to the point where the Liquidators will be able to make distributions to creditors of the companies of which they are liquidators, however, it will be necessary for the debts of those companies to be ascertained.  Ordinarily, this would be done by the usual process of the Liquidators calling for proofs of debt to be lodged in each liquidation, considering the proofs that are lodged, adjudicating them and dealing with any appeals that might arise as a result of such adjudication.  I am given to understand that this process is already under way in respect of all of the companies for which the Liquidators have been appointed and has reached a fairly advanced stage in relation to debts lodged by external creditors.  To the extent that there are other group companies, not under the control of the Liquidators, which have lodged proofs of debt, the position is the same.

11.However, in relation to the 25 companies which are in their control the Liquidators seek, by this application, to obtain the court’s approval for them to, with one exception, accept the inter-company balances between these companies as accurate and as representing the true state of the account between the respective group companies notwithstanding that they have reason to believe that the inter-company accounts have been compromised by reason of the problems which they have uncovered in the course of their investigations, to which I have referred above.

12.The exception relates to Oaktree in relation to which the Liquidators propose to admit Oaktree as a creditor of two of the companies of which they are in control, namely, MGET and a company called Moulin Holdings (HK) Company Limited, but otherwise to disregard the debts owed to or by Oaktree by or to certain other group companies.

13.By this application, the Liquidators seek the court’s approval of this approach.  If this approach is not approved, the Liquidators ask for directions as to the approach that should be adopted by them in determining the inter-company indebtedness as between the various companies under their control.  If the approach is approved, the Liquidators’ primary position is that the court should deal with the matter under either section 200(3) or 199(1)(e) and/or (f) of the Companies Ordinance (Cap. 32) (“the Ordinance”).  As a fall back position they submit that they should be directed to put forward schemes of arrangement in relation to each of the companies of which they are liquidators with a view to achieving the same result.

14.In his first affidavit in support of the application, Mr Sutton has explained the reasons for proposing this approach.  He refers to numerous respects in which there would appear to have been false or fraudulent accounting practices, which have had the effect of distorting the true state of the inter-company account between the various companies under the Liquidators’ control.  For present purposes, it suffices for me to refer to three main areas of concern.

15.The first relates to Oaktree.  The Liquidators’ investigations have led them to conclude that Oaktree was used as a key company in a scheme which involved it participating in apparently fraudulent transactions involving itself and MGET which had the effect of making Oaktree appear to have significant cash reserves of some HK$380 million at the latest relevant date when, in fact, these were non-existent.  Such transactions were structured by causing MGET to pretend to purchase goods from friendly suppliers who issued invoices to MGET although no goods were, in fact, ever supplied.  The false invoices were then used by MGET to obtain trade finance facilities from banks, which were not recorded in its books, with the banks paying the friendly suppliers directly.  The proceeds of such facilities, when received by the suppliers, were paid by them to Oaktree which booked them as “temporary receipts.”

16.Fresh fictitious transactions were entered into when the facilities matured so as to obtain funds with which to settle the maturing facilities with repayments being booked as “temporary payments.”  The receipts by Oaktree from the suppliers would result in an indebtedness arising in favour of the suppliers concerned.  The funds received would be transferred to MGET resulting in that company becoming a significant debtor of Oaktree.  As a result of their investigations, the Liquidators consider that, save to the limited extent to which I have referred above, all balances involving Oaktree are fictitious and should be disregarded.

17.The second area relates to a very substantial number of questionable transactions that were put through the inter-company loan accounts.  An example of such transactions involves a fictitious sale by MGET to a fictitious buyer.  This fictitious transaction would be recorded in MGET’s books, resulting in an entry in the books showing that a sale had taken place with the fictitious buyer as a debtor of MGET.  The fictitious buyer’s debt was then transferred to a fellow group company so that the group company replaced the fictitious buyer as MGET’s debtor.  The group company then offset the debt recorded in its own books by recording a debt owed to it by another group company.  This process could be repeated several times but generally ended with a debt being owed by a group company in respect of which no records are available.  In some cases, the effect was that a genuine debt owed by one group company to another on its inter-company account was removed or reduced.  There were, it seems, a vast number of such transactions, each of which could involve the accounts of a number of different companies.

18.Apart from these matters, a third point to note is that the Liquidators have identified a number of respects in which the cash reserves of various companies in the group would appear to have been inflated, specific instances of what appear to be false accounting and, most significantly, the apparent destruction or falsification of books and records.

19.The result of these discoveries is that the Liquidators cannot have any confidence in the books and records of the companies they control as an accurate record of the inter-company indebtedness.  However, with the exception of the position in relation to Oaktree, the Liquidators do not consider that it is feasible for them to attempt to restate the accounts so that they will be made accurate as, in most cases, the fictitious transactions are mixed with genuine transactions in a way that makes it difficult to readily distinguish the real from the fictitious.

20.The process appears to have been going on for many years prior to the liquidation of the group companies and many hundreds of thousands, if not millions, of transactions will have to be investigated if the Liquidators are to try to reconstruct the accounts so that they provide a true picture of the inter-company debt position.

21.In investigating such transactions, the Liquidators will have to scrutinise supporting documentation and journal vouchers when available.  It is not always possible to ascertain what documentation or vouchers should be sought for this purpose, even assuming that they are available.  Because of the practice of putting a fictitious transaction through the accounts of a number of companies, the exercise has to be done, not just in relation to one, but in respect of every company in the chain for that particular transaction.

22.Mr Sutton estimates that in relation to MGET alone, which may perhaps be the most substantial case, the number of transactions that call for examination in relation to seven other companies in just the three years prior to liquidation, number close to 900,000.  Even assuming that each transaction could be verified in a matter of minutes, it would take three staff working full time for well over 10 years to go through all the transactions.  There are many more inter-company accounts to be examined.  The cost of such an exercise would be enormous, running into tens of millions of dollars, perhaps in excess of HK$100 million.  The length of time required means, moreover, that there would be wholly unacceptable delays in the declaration and payment of dividends to creditors and the finalisation of the liquidations.  Mr Sutton therefore says, and I accept, that it is not realistic to expect or require the Liquidators to attempt a full reconstruction of the accounts.

23.Mr Sutton has, with Mr Chiong, considered alternative solutions to simply accepting the inter-company accounts as they stand, which he refers to as the “as-is method” of ascertainment of such accounts.  These are, first, the “pooling method”, by which the liquidations are treated as a global liquidation of all the companies of which the Liquidators are liquidators, with creditors putting forward their total claims against all relevant companies and obtaining a dividend from a common pool;  second, the “zero balance method”, by which all inter-company debt is simply ignored and the balances between the companies under the control of the Liquidators treated as being, in every case, zero; and finally, the “sampling method”, by which an attempt is made to reconstruct the accounts based on the investigation of a sample of transactions.  Each of these alternatives has its own drawbacks.  Each involves the misstatement of the true inter-company debt position, no less than does the as-is method.  The pooling and zero balance methods would result in a distribution which is contrary to that which is likely to exist if the true position were capable of being ascertained as it would distort the relationship between the companies. 

24.By way of example, it may be observed that the principal manufacturing company in the group, the company by the name of Leadkeen would, ordinarily, be expected to be a major creditor of MGET, the main trading company.  The accounts, as they stand, reflect this.  However, the adoption of the zero balance method would result in this fact being wholly ignored to the detriment of the manufacturing company’s creditors.

25.The same effect would be engendered by adoption of the pooling method.  Moreover, the pooling method has the further effect of favouring creditors of companies with less assets at the expense of the creditors of companies with substantial assets, such as MGET, because the former would be able to participate in the distribution of the assets of the latter when, ordinarily, they would not be entitled to do so.  The pooling method is also regarded by Mr Sutton and Mr Chiong as being unfair to the creditors in the sense that creditors, particularly financial creditors, may have arranged their affairs on the basis of an examination of the apparent financial position of various companies within the group, so that to require them to participate in a global pool would be to upset the expectations that they might otherwise have held.

26.It might also be observed that the pooling method would also give rise to potential problems in the case of financial creditors who have a debt owed by one company but at the same time hold security from a number of other companies.  Whereas, under any other method they would be entitled to prove the liquidations of each of the companies against whom they have a claim and thereby perhaps effect a slightly greater recovery than they might otherwise do, if the pooling method were adopted, it is far from certain whether this will be the case and they will be reduced, effectively, to one claim against one pool of assets.

27.The sampling method has its own difficulties, not least how and to what extent sampling should be undertaken, and what conclusions should be drawn as a result of such sampling as is undertaken.  There are also, of course, the difficulties associated with the lack of documentation or the absence of documentation in certain cases.  The Liquidators, therefore, consider that the as-is method is certainly the most cost-effective and cheapest and almost certainly the fairest method on which to proceed so far as the inter-company debt is concerned.

28.They recognise, however, that whichever method is chosen, there will be an impact on the creditors of all of the companies of which they are liquidators.  This is because any change in the inter-company balances will impact on the amount of assets available for distribution in each company’s liquidation.  It will also impact on the size of the debts proved against any given company.  It will therefore ultimately impact on the amount of assets available for distribution to external creditors.  Cognisant of this, the Liquidators have, prior to the making of this application, written to all of the creditors of the companies in question outlining the issues that I have described above and solicited their views as to which of the various methods they preferred. 

29.Of the external creditors, some 54.8 per cent of the 18 companies in liquidation responded to the inquiry.  Of those who responded, on an overall basis, some 99.51 per cent, in other words a near unanimous majority, were in favour of the as-is method.  Mr Sutton and Mr Chiong have also broken down these figures in respect of each of the companies of which they are liquidators.  If only external creditors are concerned, there were 10 companies in respect of which no external creditors provided a response.  In relation to the remaining eight companies, in seven there was an overwhelming or unanimous majority in support of the as-is method but in the case of one company, MGETS, which had two relatively small external creditors, each having a debt valued at less than $100,000, the result was that the creditors were evenly split, one supporting the as-is method and the other supporting the zero balance method.  In the case of that company, in terms of value there was a majority, but not a 75 per cent majority by value, in favour of the as-is method.

30.However, once the inter-company debt is factored into the equation, the position is that in every case, assuming the inter-company  debt to be voted in favour of is the as-is balance as one would expect, there is both a simple majority by number and a three-quarters majority by value of creditors of each relevant company in favour of the as-is method.

31.Following the institution of this application, the Liquidators were directed to give notice of the application and of this hearing to all creditors in terms which made it clear that it was open to any creditor to attend and make submissions if it wished to do so.  No creditor has indicated any desire to make submissions and none have appeared today to oppose the Liquidators’ proposals.  The Official Receiver has also been informed of this application and has indicated, by a letter to the court, that he has no objection to the application, having regard to the fact that the creditors have already been consulted.

32.For all of these reasons I am satisfied that the as-is method is not just an appropriate method to adopt in valuing the inter-company balances but is the most appropriate method to adopt in the circumstances of this case and that it would therefore be in order for the Liquidators in each of the liquidations concerned to recognise the inter-company indebtedness as between that company and the other companies of which they are in control on that basis.

33.One question that has arisen, however, is whether or not it is necessary for the matter to be put before the creditors by way of a formal scheme of arrangement, pursuant to section 166 of the Ordinance, or whether it is open to the court to approve the proposal either by giving directions pursuant to section 200(3) of the Ordinance or by sanctioning a compromise of the inter-company indebtedness as between the various companies inter se pursuant to sections 199(1)(e) or (f) of the Ordinance as the case may be, depending on whether the particular company is in any given case the debtor or creditor under the inter-company account.

34.Section 166 provides a mechanism whereby a company can, by securing the passing (with the requisite majorities) of a resolution of its creditors at a meeting of creditors, enter into a compromise or arrangement with its creditors which binds them all without the necessity of obtaining the consent of each and every creditor who is to be bound.

35.Sections 199(1)(e) and (f) provide a liquidator of a company with the ability to compromise particular debts of the company with the sanction of either the committee of inspection or of the court.  These provisions are, in their terms, probably wide enough to encompass an arrangement that could have been the subject of a scheme under section 166.

36.In general, where a proposed compromise or arrangement is one, which could be dealt with under section 166, the court’s tendency is to require the use of a scheme of arrangement under section 166, as this will generally give the creditors a better opportunity to voice their views and persuade their fellow creditors to their way of thinking.  However, there are exceptional cases in which the court has been willing to permit the use of the section 199 procedure in place of the section 166 procedure.

37.The first question that arises is whether this is in fact a case in which a scheme of arrangement could be said to be required.  Is it a case where there is a compromise or arrangement such as to call for a scheme?  For my part, I am inclined to think that it is not.  The reason for this is that it is clear from the cases in which the question of whether a section 166 scheme or a section 199(1) compromise, sanctioned by the court, should be used, that the key question is whether or not there is proposed to be effected any alteration in the rights of the creditors as a result of the proposed arrangement or procedure which is to be adopted.

38.In my view, when the proposal that the Liquidators are putting forward in this case is analysed, it does not in fact involve a variation or alteration of the rights of the creditors of any of the companies of which the Liquidators are liquidators.  I say this because in each case the creditors will remain entitled to participate in the distribution of the assets of the company concerned on a pari passu basis, without any reduction or alteration in the proportion to which they are entitled to receive payment.

39.This is not a case in which the creditors are being asked to agree to a variation of the pari passu method of distribution.  The impact on the creditors arises from the fact that the Liquidators will be compromising debts in such a way as to affect the size of the ultimate pool available for distribution to creditors of a particular company.  In that sense, therefore, the creditors are affected.  However, their rights to participate in the pool are not, in my view, affected by the proposals which have been put forward.

40.I do not think that there is anything in the authorities considering the situations in which a scheme of arrangement should be used that prevents me from reaching this conclusion.  In the English decision of Re Trix [1970] 1 WLR 1421, it is clear from the headnote that the court considered that the proposals there might result in a variation of the strict rights of pari passu distribution that the creditors would otherwise enjoy.

41.In the Hong Kong case of Re Wah Nam Group Limited (unreported, HCCW 166 of 2000, CFI, 2 July 2002),a decision of Kwan J, what was under consideration was a proposal whereby the listing of a listed company in liquidation should be disposed of for a consideration which would go into the pool for distribution to the creditors.  In such a case, it is generally necessary for the payment that is to be made by the acquirer of the listing to be split in some proportion between the creditors and the shareholders.  In general, the creditors get the lion’s share of the proceeds but some payment, which the courts have by way of guidance indicated should be a token payment of less than 10 per cent, is generally made available to the shareholders to induce them to agree to the restructuring of the company’s shareholding structure (for which their consent is essential)that is needed before any such proposal can be effected and put through.

42.In such a situation, although it was argued in the Wah Nam Groupcase that the concession to the shareholders should be regarded as simply a cost of realisation of an asset (the listed status of the company), Kwan J concluded, in my view rightly, that this would not be an appropriate analysis and that there was, in fact, the payment of a portion of the company’s assets, or their proceeds, to the shareholders who, in an insolvent liquidation, would ordinarily be entitled to no distribution whatsoever.  In those circumstances there was a variation of the rights of the creditors in that they were being asked to give up part of their right to the assets of the group in favour of the shareholders, and it was therefore a matter which required to be dealt with by way of a formal scheme of arrangement in the ordinary way.

43.However, it is clear that even in a case in which a scheme of arrangement is possible and is generally required, there may be exceptional circumstances which take the case outside the general principle and enable the court to, in the exercise of its discretion, approve an arrangement under section 199(1)(e) or (f) notwithstanding that it could also have been dealt with by way of a scheme of arrangement – see for example Re Bank of Credit & Commerce International SA (No. 2) [1992] BCC 715.

44.For the reasons which I have briefly indicated, it is my view in this case that there is no variation of the rights of the creditors of any of the companies in the Moulin Group, of which the Liquidators are liquidators, that would render the matter one which had to be dealt with by way of a scheme or arrangement.  However, even if I am wrong as to that and the position is that there is a variation of the creditors’ rights, such that the section 166 mechanism could (and ordinarily should) be used, I am quite satisfied in this case that I should not require that mechanism to be used and that there are good reasons for the matter to proceed by way of an application under section 199(1) of the ordinance.

45.My reasons for having come to this conclusion are as follows.  First, this is a case in which there has in fact already been substantial consultation between the Liquidators and the creditors with the creditors having been given an opportunity to express their views on, I would say, a fully informed basis, having regard to the terms of the detailed information memorandum that was sent by the Liquidators to the creditors concerned when soliciting their views on the way forward.  Secondly, there is an overwhelming majority in support of the proposal.  Thirdly, it seems to me that it is legitimate to take into account the fact that to have separate schemes of arrangement in respect of each of the companies in liquidation would mean that there would have to be 18 separate applications for schemes of arrangement, an exercise which would be likely to be very costly, as it would be necessary to draft scheme documents for each proposed scheme, take legal proceedings seeking leave to convene scheme meetings, arrange and hold such meetings, and finally to apply for the court’s sanction of the outcome of the scheme meetings.  The process would also be a time-consuming one, which would involve significant delay to the continued administration of the liquidations in this case, which are already at a fairly advanced stage.

46.For all of these reasons, even if (contrary to my view) this were a case in which a scheme of arrangement might have been required, it is an appropriate case in which the court should exercise its discretion to dispense with the need for that route to be taken and to permit the matter to proceed by way of an application under section 199(1)(e) and (f).

47.For all of those reasons, therefore, I will make an order substantially in terms of paragraph 2 of the originating summons in this matter, sanctioning, pursuant to sections 199(e) and/or (f) as appropriate, the proposed compromise which the Liquidators intend to make in respect of the various companies of which they are liquidators, so as to recognise the inter-company balance as between those companies, as shown in the records of the companies as being accurate and being the basis on which each company which has a claim in the liquidation of any other company, should be admitted to proof in that liquidation.

48.In case it is necessary for the matter to come back to the court, I will grant liberty to apply and I will make the order for costs sought by paragraph 7 of the originating summons.

Mr Richard Tollan of Messrs Johnson, Stokes & Master, for the Applicant