Lau Siu Hung and Another v. Krzysztof Marszalek and Another

HCCW484/2009

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO 484 OF 2009

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J U D G M E N T

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1.In this application the liquidators (“Ls”) of Starline International Group Ltd (in liquidation) (“Starline”) apply to invalidate 19 payments[1] made to the ex-directors of Starline by that company as unfair preferences pursuant to ss 266 and 266B(1)(b)(ii) of the Companies Ordinance, Cap 32. 

2.The factual background to this application is largely uncontroversial and is as follows. 

Background

3.Starline was in the business of trading in high-tech products such as flash drives, having started it business in late 2004.  The respondents (“R1” and “R2”) were the only directors of Starline and they each held 50% of the shares in that company. 

4.A creditor’s petition to wind-up Starline was presented to the court on 10 August 2009.  The petitioner was Standard Chartered Bank (HK) Ltd (“SCB”) and the petition was filed because Starline had defaulted in the repayment of loans granted by SCB.  The outstanding amount exceeded US$2.28 million.  The petition was not defended and a winding-up order (“Order”) was made on 14 October 2009. 

5.On the day the Order was granted, Ls were appointed by the Official Receiver (“OR”) as the provisional joint and several liquidators of Starline.  By an order dated 1 March 2011, Ls became the joint and several liquidators of that company. 

6.In parallel with the winding-up proceedings, SCB also instituted bankruptcy proceedings against R1 and R2 on 10 August 2009 on the basis of their personal guarantee in respect of Starline’s debts. Bankruptcy orders were made against them on 14 October 2009. 

7.On 11 November 2011, R1 and R2 applied for annulment of their bankruptcy orders on the basis that their creditors would be paid in full.  On 23 December 2011, a notice of intended dividends was gazetted and advertised by the OR due to the annulment application.  The notice invited creditors who had not proved their debts to lodge their proof of debt by 9 January 2012.  Ls did not lodge any such proof.

8.The hearing of the annulment was also gazetted and advertised.  Ls did not appear at that hearing on 14 March 2012.  On 22 May 2012, the annulment order was granted by the court. 

9.The evidence filed by Ls is that they only learned about the annulment application on 28 May 2012 when it received a letter from a firm of solicitors acting for a defendant in an action involving Starline.  There is no challenge to this evidence.  However, Mr Beresford, who appeared for R1 and R2, suggested that Ls ought to have known about the annulment application earlier had they exercised due diligence in the discharge of their duties.  I shall return to this matter at a later stage. 

10.On 12 June 2012, proofs of debts were filed by Ls in the bankruptcies of R1 and R2 in respect of some of the payments which are the subject matters of these proceedings.  Those proofs were, unsurprisingly, rejected by the OR.  An appeal was filed by Ls in respect of the rejection.  On 18 February 2013, the appeal was withdrawn pursuant to an order of that date. 

11.The present application was made on 8 August 2012.  The Summons was amended on 13 December 2012.  The amendment extended the unfair preference challenge to cover more payments. 

The statutory provisions

12.The statutory provisions relating to unfair preference are contained in ss 266-266B of the Companies Ordinance, Cap 32 (“Cap 32”) and ss 50-51B of the Bankruptcy Ordinance, Cap 6 (“Cap 6”).  The latter are incorporated in the former by reference. 

13.There is a useful summary of the relevant provisions applicable to a case of unfair preference involving an ex-director of the company in liquidation in Re Phantom Records Ltd, unrep, HCMP 2770/03 at paras 71-75.  There is no dispute between the parties on these matters and I do not propose to set them out.  It is common ground that in order to succeed in this application 5 elements must be satisfied (see Re Aloha Coffee Co Ltd (in liq) [2013] 1 HKLRD 356 at 361, para 7) :

(1) R1 or R2, as the case may be, was a creditor of Starline at the time when the impugned payments were made – Cap 6, s 50(3)(a);

(2) The impugned payments had the effect of putting R1 or R2 into a position which, in the event of Starline going into insolvent liquidation, would be better than the position they would have been in if those payments had not been made – Cap 6, s 50(3)(b);

(3) In deciding to make the impugned payments, Starline was influenced by a desire to put R1 or R2 into a better position as stipulated in s 50(3)(b) of Cap 6 – Cap 6, s 50(4);

(4) The impugned payments were made within the period of 2 years before the commencement of the winding-up of Starline, ie, between 11 August 2007 and 10 August 2009 – Cap 32, s 266B(1)(b)(ii) and Cap 6, s 51B(4); and

(5) Starline was insolvent at the time of the impugned payments or became insolvent as a consequence of the impugned payments – Cap 6, s 51(2)(a).

Issues

14.Mr Beresford has helpfully and fairly submitted that the issues taken by R1 and R2 in this application are as follows:

(1) In relation to 1 out of the 9 impugned payments made to R1, namely, a sum of US$300,000 paid by Starline to R1 on 9 December 2008, it was in truth a payment to a BVI company by the name of Tekram Corporation (“Tekram”) and the statutory regime of unfair preference has no application to that payment;

(2) In respect of 5 out of the 10 impugned payments to R2, a total sum of US$1.34 million paid by Starline to R2 from 10 November 2008 to 9 April 2009, they were repayments of a loan granted to Starline by R2.  The loan was made up of 3 payments from R2 to Starline made on 28 and 29 July 2008 in the sums of US$1 million, US$291,514.99 and US$76,485 totalling US$1,367,999.99.  It is contended that the first of the 5 elements set out in para 13 above cannot be established in respect of these 5 payments;

(3) In respect of all the impugned payments, Ls are estopped by record from making the present application by reason of the annulment of the bankruptcies of R1 and R2.

15.The estoppel argument is primarily one of law. Putting that aside for the moment, the factual disputes here are limited. However, for purpose of resolving the disputes on the payments of US$300,000 (“1^st Payment”) and the US$1.34 million (“2^nd Payment”), I should set out briefly the picture on the finance of Starline at the material times.

Starline’s finances

16.I start with the uncontroversial evidence that on 31 December 2007 Starline’s board of directors declared an interim dividend in excess of US$1.4 million.  However, the sum exceeded Starline’s retained earnings and was adjusted to US$1.316 million by Starline’s auditors.  That sum was made up of the profits for 2007 (US$193,533) and the retained earnings of 2006 (US$1,122,501).  According to the auditors, the dividend was then credited to the current accounts of R1 and R2.  It appears from the audited financial statements of Starline as at 31 December 2008 (“Statements”) that after credit of the interim dividend Starline remained indebted to R1 and R2 in the sum of US$112,317.  The debts owed to R1 and R2 increased to US$885,872 as of 31 December 2008. 

17.According to the Statements, as at 31 December 2007, Starline’s net assets stood at US$1,282, being the entirety of its issued share capital, and its net current liabilities were at US$816,284.  As of 31 December 2008, the net current liabilities ballooned to over US$6.8 million and the net assets became net liabilities of US$6.04 million. 

18.It appears from the evidence that in 2007 the products (USB flash drives) supplied by Starline to a major customer, Dexxon, were found to be defective.  Discussions ensued between the parties on the compensation to be paid to Dexxon (liability on the part of Starline was not disputed).  On 20 January 2009, a preliminary agreement (“Agreement”) was signed between the parties whereby Starline agreed to compensate Dexxon by way of a credit note in excess of US$4 million and a lump sum settlement fee of US$1 million. 

19.I should add that in the evidence filed by R1 and R2, it was suggested that Starline was coerced into signing the Agreement.  I agree with Mr Chung, who appeared for Ls, that such evidence flies in the face of the documentary evidence and is rejected. 

20.The impugned payments (9 to R1 and 10 to R2) were made over a period of about 1 year from 11 August 2008 to 21 July 2009.  In total, US$1 million and HK$285,000 were paid to R1, and US$1.64 million and HK$2.01 million were paid to R2.  I must say that in light of the financial circumstances of Starline, in particular, the liabilities owed to Dexxon, it appears that there was a concerted effort to strip the cash from Starline. 

21.In the statements of affairs filed by R1 and R2 in their bankruptcies, it was declared that their assets as of 14 October 2009 were valued at below HK$10,000.

22.According to the statement of affairs of Starline signed by R1 as its ex-director, as at 14 October 2009, that company had assets of HK$293,738.42 and net liabilities in excess of HK$37.1 million.

The 1^st Payment

23.The evidence concerning this payment is as follows.  On 9 December 2008, a sum of US$300,000 was paid by Starline to R1.  On that same day, an equal amount of money was paid by R1 to Tekram.  R1’s evidence is that the US$300,000 was a repayment of a debt owed to Tekram.  He made the payment to Tekram on behalf of Starline. However, Tekram later returned the money to Starline. 

24.In the reply evidence filed by Ls, the alleged return of the money by Tekram was challenged.  By way of further evidence, R1 said in his 2^nd affirmation (“Affirmation”), para 14, as follows:

“Since the 2^nd Respondent and I do not have access to the Company’s account, I am unable to access and/or provide and/or locate copies of all or any relevant bank statements and/or transfer slips to demonstrate that the US$300,000 had indeed been returned to the Company albeit not necessarily in the exact same amount on one occasion. That said, it is to the best of my recollection and belief bearing in mind that the transfers happened almost 4 years ago that the said sum was returned to the Company.”

25.Ls’ evidence is that R1 and R2 had failed to provide them with the general ledger and the 2009 accounting records of Starline.  Without such material, Ls were hampered in their investigation of the affairs of that company.  Further, the unfair preference challenge was made based mainly on information obtained directly from Starline’s bank.  I see no real answer to this evidence and no reason not to accept it. 

26.I have no hesitation in rejecting R1’s evidence in respect of the 1^st Payment.  His story is inherently incredible. He has provided no detail concerning the alleged debt, such as the relationship between Starline and Tekram and the purpose of the loan.  There is no explanation why the repayment had to be channelled through him or why the money was later returned to the debtor.  There is no explanation why no evidence was obtained from Tekram to verify R1’s claim.  I note that where it appears to suit his case, R1 was able to provide some documentary support – see para 21 of the Affirmation.

27.Further, it appears from the evidence that R1 had certain connection with Tekram.  On 15 December 2008, a sum of US$321,376 was paid to R1 from Starline’s account.  On the next day, the exact sum was deposited into Starline’s account by Tekram.  On that day, there was another payment by Starline to R1 in the sum of US$93,746.  Again, that payment was matched by a deposit from Tekram to Starline on the same day.  Given these unusual circumstances, which have not been explained, the lack of proper explanation by R1 in respect of the 1^st Payment is wholly unacceptable. 

28.Despite the fact that the 1^st Payment was paid over to Tekram after it was received by R1, I do not accept that it was not in truth a payment to R1 and therefore it is caught by the unfair preference provisions.

The 2^nd Payment

29.The 3 payments made by R2 to Starline on 28 and 29 July 2008 (see para 14(2) above) are not disputed.  Mr Beresford’s argument here is as follows:

“The Liquidators deny that this money was owed to the Second Respondent. If that is the case, then there is no basis for a claim for an unfair preference and this claim should be dismissed. The reversal of the burden of proof as to the mental state of a respondent does not extend to relieving the Liquidators of the necessity of proving the basic elements of the claim, including that the recipient was a creditor of the Company.”

30.I agree with Mr Chung that Ls did not dispute R2’s claim in respect of the payment of US$1 million – it was a loan from him to Starline.  He did, however, dispute the proposition that the other 2 payments were part of a loan by reason of the peculiar amount of those payments. 

31.I do not see anything in Mr Beresford’s argument and it is rejected.  Even on R2’s own case, he was a creditor of Starline when the 2^nd Payment (made up of 5 transactions) was made: see R2’s affirmation dated 5 October 2012, para 6.

Effect of annulment of bankruptcy

32.The answer to the estoppel by record argument turns upon the effect of annulment of bankruptcy.  A helpful statement of the applicable principle of estoppel by record can be found in Halsbury’s Laws of England, 5^th ed, vol 12, para 1169:

“Estoppel by record, also known as estoppel per rem judicatam, arises:

…

(3)   in some cases where an issue of fact affecting the status of a person or thing has been necessarily determined in a final manner as a substantive part of a judgment of a tribunal having jurisdiction to determine that status, and the same issue comes directly in question in subsequent civil or criminal proceedings between any parties whatever.”

33.The relevant statutory provisions on annulment are contained in s 33(1)(b) of Cap 6:

“(1) The court may annul a bankruptcy order if it at any time appears to the court that -

…

(b)  to the extent required by the rules, the provable debts and the expenses of the bankruptcy have all, since the making of the order, been either paid or secured to the satisfaction of the court.”

34.It is trite that the jurisdiction of the court in annulling a bankruptcy should be exercised with great caution and only in special circumstances.  It appears from the terms of s 33(1)(b) that such discretionary power would only be exercised if the bankrupt has or is in a position to fully repay his debts. 

35.There is no dispute between the parties that the general effect of annulment is that the bankrupt is put in the same position as if there had been no bankruptcy order made against him. 

36.As regards the effect of annulment on debts which had not been proved before the annulment order was made, there appears to be no Hong Kong authority on the point.  However, there are helpful English authorities which were based upon very similar statutory provisions. 

37.Firstly, the authority of More v More [1962] Ch 424, where it was held that an annulment on payment in full of the proved debts revived the right of a creditor, who did not prove, to sue the debtor as soon as the bankruptcy was annulled.  The court was concerned with s 29(1) of the Bankruptcy Act 1914 which provided as follows:

“… where it is proved to the satisfaction of the court that the debts of the bankrupt are paid in full, the court may, on the application of any person interested, by order annul the adjudication.”

[emphasis added]

38.Secondly, the authority of London Borough of Lambeth v Simon [2007] BPIR 1629, where it was held that in contrast with discharge from bankruptcy, which provided that the discharge released the bankrupt from all bankruptcy debts, there was no provision for annulment to have any effect on unknown debts.  The fact that a bankrupt had obtained an annulment of the bankruptcy order without payment of certain debts had no effect on the same, they remained outstanding and capable of founding a bankruptcy petition. 

39.By the time of that judgment, s 29(1) of the 1914 Act had been superseded by s 282(1)(b) of the Insolvency Act 1986. The wordings of s 282(1)(b) are almost identical to those of s 33(1)(b) of Cap 6.  Indeed, the Hong Kong legislation was modelled on the UK equivalent.  The only difference between the two sub-sections is that the term “bankruptcy debts” as opposed to “provable debts” is used in the UK legislation. 

40.For completeness, the words “to the extent required by the rules” were the subject matter of consideration by the Hong Kong court in Re Lo Shiu Mui (No 2) [2010] 4 HKLRD 135.  In short, those words originated from UK legislation.  In the UK, there are rules bearing upon applications for annulment.  However, after importing the legislation into Hong Kong, no comparable rules have yet been made.  Therefore, the quoted words are currently redundant (see paras 18, 20-22 of Re Lo Shiu Mui (No 2)). 

41.The lynchpin of Mr Beresford’s submission is that different terminology has been used in the Hong Kong legislation – provable debts instead of “debts” (which was held in More v More to extend to all debts properly proved) and “bankruptcy debts”.  It was submitted that the subject matters of this application were debts provable in the bankruptcies of R1 and R2.  Ls had a duty to submit their proof of debts and if they failed to do so they are barred from advancing their claim over such debts after the annulment of bankruptcies.

42.Firstly, I am unable to see any real difference despite the variance in terminology.  In particular, the term “bankruptcy debts” employed in the UK legislation simply means provable debts: see Halsbury’s Laws of England, 4^th ed, 2002 Reissue, vol 3(2), para 491.

43.It appears to me that the switch from “debts” to “bankruptcy debts” in the UK legislation went hand in hand with the extension in the provisions from having all the debts paid to having the debts paid or secured. The extension is a sensible one because there may be disputes over the debts and the annulment needs not be delayed if the debts are secured. 

44.Secondly, I see no reason why a creditor who has not proved his debts should be deprived of relief by reason of the annulment of bankruptcy.  There is no such express stipulation under the annulment provisions.  I see no reason to read that into the same by way of construction.  A bankrupt is only entitled to be discharged from the liabilities over his unpaid debts after the bankruptcy has taken its course pursuant to the statutory regime.  It must not be overlooked that in the course of the bankruptcy the financial affairs of the bankrupt may be subjected to vigorous examination by the trustee to ensure that the creditors would not be cheated. 

45.An annulment puts the bankrupt in the same position as if there had been no bankruptcy order made against him.  Why would the bankrupt be entitled to the same benefit (release from his undischarged liabilities) as if the bankruptcy had run its course? 

46.Mr Beresford relied upon two English authorities, namely, John v Mendoza [1939] 1 KB 141 and Brandon v McHenry [1891] QB 538.  In respect of the former, the facts were quite unique.  In any case, it was considered in More v More and was not followed.

47.As regards the latter, there a proof of debts was rejected by the trustee, whose decision was not appealed against.  Subsequently, there was an annulment and it was held that the creditor could not, after the annulment, seek to recover the same debt. 

48.Mr Beresford sought to draw a parallel with the present case by relying on the fact that Ls had submitted proofs of debts to the OR, which were rejected, and the appeal against the rejection had been withdrawn. 

49.I do not believe that Brandon v McHenry assists R1 and R2 at all.  There is an important distinction in that the proofs of debts here were filed after the annulment.  Indeed, that case turned upon the effect of the UK equivalent of s 33(4) of Cap 6.  Again, the provisions are very similar.  For the present purpose, I shall set out the HK legislation:

“(4) Where the court annuls a bankruptcy order under this or section 201, any sale or other disposition of property, payment made or other thing duly done by or under the authority of the Official Receiver, a nominee or a trustee or by the court is valid, …”

50.It was held in Brandon v McHenry:

“… It seems to me that the rejection of a claim by the trustee is an act done by him within the meaning of the section, and therefore such rejection holds good after the annulment of the bankruptcy. If that is so, the claim so rejected cannot be enforced after the bankruptcy is annulled.”

51.The authority has no application to the present case. Further, as pointed out by Mr Chung, in rejecting the proofs submitted by Ls the OR took the view, in reliance upon More v More and London Borough of Lambeth v Simon, that an annulment did not have any effect upon a debt ‘unknown’ at the time of the annulment.

52.I agree with both More v More and London Borough of Lambeth v Simon and I hold that the law in Hong Kong is the same.

53.For completeness I should deal with 3 more points.  Firstly, Mr Beresford has cited no authority in support of his estoppel argument.  In contradiction to Mr Beresford’s submission, Mr Chung has referred me to Halsbury’s Laws of England, 4^th ed, 2002 Reissue, vol 3(2), para 624:

“An annulment order made on the ground that all the debts have been paid in full creates an estoppel by record, so that a creditor cannot recover a debt for which he agreed not to prove; but it does not debar a creditor, who has merely abstained from proving, from suing the debtor after the annulment, his right to sue no longer being suspended by the bankruptcy.”

54.Secondly, Mr Beresford complained that Ls ought to have known about the annulment application because of the publicity give to the same.  I do not believe that the point adds anything to the estoppel argument.  In any case, the criticism goes too far and one cannot simply equate the gazetting and advertising of the annulment application with constructive knowledge on the part of Ls. 

55.Thirdly, Mr Beresford complained about unfairness to R1 and R2 by reason of the inaction on the part of Ls.  I am unable to see any unfairness in the case before me.  The fact of the matter is that a bankrupt is not entitled to an annulment unless and until he has fully repaid his debts or put in place adequate security for the purpose.  The debts recoverable by Ls have not been paid or satisfied in any way. 

56.As regards Mr Beresford’s submission that the annulment involved the injection of funds by a third party and that the justice of the case is against the “reopening of the bankruptcy”, I see nothing in the point and I need only to quote with agreement an observation made by Master A Ho in the decision annulling the bankruptcy orders in question, Re KRZYSZTOF MARSZALEK, HCB 10950/2009 and Re YU SHUN LEUNG GRADY, HCB 10951/2009, at para 43:

“ In respect of the source of the Third Party Fund and whether it is linked to the assets of the Bankrupts, I tend to agree with the submissions of Mr Wong that an explanation is needed from Mr Wong Kam Wing or the Bankrupts to explain why Mr Wong Kam Wing had agreed to cancel the Escrow Agreement and to pay the Third Party Fund to the Official Receiver without recourse against the Bankrupts. Without the explanation, one may be suspicious as to why Mr Wong Kam Wing would agree to provide over HK$22 million for no consideration at all and without recourse against the Bankrupts whilst initially he intended the Third Party Fund to be a loan to the Bankrupts. In my view and in the absence of any explanation, it would not be unreasonable for the court to infer that the Third Party Fund may be linked to the Bankrupts’ assets. It is to be borne in mind also that the amount of money involved is quite substantial and the burden is on the Bankrupts to prove otherwise (see Wilcock v Duckworth above).”

57.For these reasons, I allow this application. 

58.I make an order in terms of paras 1 to 4 and 6 of the Amended Summons re-filed on 13 December 2012.  The issue of interest has not been addressed by the parties.  Written submissions not exceeding 2 pages are to be filed and served by them within 3 working days from today and the matter will then be determined on paper. 

59.Last but not least, I am grateful for the assistance of Mr Chung and Mr Beresford in these matters. 

Mr Chung Ming Shing Jerry, instructed by Johnnie Yam, Jacky Lee & Co, for the applicants

Mr Roger Beresford, instructed by Robertsons, for the respondents