RE FORLUXE SECURITIES LTD.

HCCW000310A/1998

HCCW 310/98
HCCW 311/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) ACTION NO. 310 OF 1998
COMPANIES (WINDING-UP) ACTION NO. 311 OF 1998
(Heard together)

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	IN THE MATTER of the Companies Ordinance Cap. 32 of the Laws of Hong Kong
	AND
	IN THE MATTER of FORLUXE SECURITIES LIMITED
	IN THE MATTER of FORLUXE FINANCE LIMITED

Coram: Hon. Yuen, J. in Chambers

Dates of Hearing: 15 February 2001

Date of Decision: 7 July 2001

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DECISION

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1. On 20 December 2000, I gave a decision regarding the distribution of securities held by or for the account of Forluxe Securities Ltd ("FSL") and Forluxe Finance Ltd ("FFL").

2. By a summons issued on 8 February 2001, the liquidators sought further directions regarding allocation of the liquidators' fees and expenses and for the working out of the above order.

3. On 15 February 2001, that summons was heard. The Court asked for further evidence on some aspects and on 22 February 2001, Mr Hill filed his 9th Affidavit exhibiting various documents. There was also supplied under separate cover an opinion of London Counsel on FSL's claim under a Brokers Fidelity Insurance Policy. This opinion is privileged and has been kept sealed. It is not to be read without leave of the Court.

4. The main directions sought relate to the allocation of the liquidators' fees and expenses. These have been divided into 7 categories.

General Liquidation/Statutory Work

5. The 1st category is General Liquidation/Statutory Work. The liquidators have attributed their time costs to FSL or FFL where it has been possible to so designate the work. Where such a designation has not been possible, the costs have been apportioned equally between the companies. In my view, that must be the correct approach.

6. As for apportionment of these costs between trust assets and general assets, in my view, a fair apportionment would be in proportion to the value of such respective assets, as on the whole, the process of liquidation is for the purpose of collecting and distributing assets. This is particularly appropriate in the present case as most administration expenses have been incurred in dealing with clients' claims to trust assets.

7. Whilst on this aspect of costs for General Liquidation/Statutory Work, I note from Mr Hill's 8th and 9th Affidavits that the Committees of Inspection have apparently not been as diligent as they should have been in the process of vetting the liquidators' costs and expenses. This is regrettable because committees of inspection have an important role to play in the liquidation process.

8. Whilst the vetting and approval of fees during the period of provisional liquidation has to be performed by the court under the statutory regime, that work for the post-provisional liquidation period is primarily the duty of the committee of inspection.

9. In the present case, correspondence sent by the liquidators to the committees of inspection have been exhibited. The majority of the members have failed to respond at all. This attitude is unhelpful.

10. If the committees have any queries or comments concerning the fees claimed, they should raise them with the liquidators. That would enable them to form an informed opinion as to whether they should approve the fees, and if so, to what extent.

11. If the committees simply do not respond, the liquidators may have to seek approval from the Court. This would lead to further delay as the Court, unlike the members of the committee of inspection, has to deal with many liquidations, not just one. Further, it would lead to more costs being incurred which would deplete the assets available for distribution. The losers at the end of the day would only be the clients and creditors themselves.

Share Portfolio Management and Administration

12. I now turn to the 2nd category, being Share Portfolio Management and Administration. As between FSL and FFL, these costs should be allocated by reference to whether the shares were held for FSL or FFL.

13. As for allocation as between trust assets and general assets, it is noted that there are shares in Categories D and E referred to in my Decision of 20 December 2000, viz where there are more shares than claims (Category D) and where there are shares but no claims (Category E). I have in my Decision held that the surplus of shares in Category D and all shares in Category E are free (i.e. general) assets of the companies. Therefore, the costs of Share Portfolio Management and Administration should be borne in accordance with the proportion between the value of the shares which are trust assets and the value of the shares which are general assets.

Claim on the Brokers Fidelity Insurance Policy

14. The 3rd category relates to the Claim on the Brokers Fidelity Insurance Policy. The assured is FSL. Therefore, as between FSL and FFL, the costs for pursuing this claim should fall to FSL.

15. As between trust assets and general assets, it is obvious that any payments received from the insurers would form part of the general assets of FSL for the benefit of its unsecured creditors. Therefore, the costs should be borne by the general assets.

Sale of seat on Stock Exchange

16. The 4th category relates to the sale of FSL's seat on the Hong Kong Stock Exchange. This is an asset of FSL and its unsecured creditors have benefited from the sale. Therefore, these costs should fall to FSL and should be borne by the general assets.

Costs of proceedings in HCA 7543/1998

17. The 5th category relates to proceedings in HCA 7543/1998. The Plaintiffs are both FSL and FFL and the Defendants are James Mui Kwong-ngok, Gordon Mui Kwong-yin and Peggy Lee Pui-yin who were all directors of FFL. James Mui was a director of FSL but Gordon Mui and Peggy Lee also took part in the day to day running of that company.

18. Judgment has been obtained by FFL against James Mui for about $32m., and against Gordon Mui for a little over $50,000. Judgment has been obtained by FSL against James Mui for about $5.9m., against Gordon Mui for $50,000 and against Peggy Lee for $954,000. There has also been judgment for interest and costs. However, it would appear that very little may be recovered under these judgments.

19. Although there is one action with FSL and FFL as plaintiffs, the liquidators' fees can apparently be apportioned between the two companies on an actual basis by reference to the individual companies. Their solicitors have apportioned their costs in accordance with the value of the companies' respective claims, which is approximately 20% to FSL and 80% to FFL. This seems to be a fair apportionment as one of the main considerations in funding litigation must be the size of the claims in such litigation.

20. As for apportionment between trust assets and general assets, the liquidators have suggested that the trust assets should bear the costs because of the claims for restitution of the shares and monies taken. However I take the view that that would not be fair to the beneficiaries of the trust assets. Although the claims were for both shares and money, the default judgment obtained was for a money judgment. Therefore, any amounts recovered from the defendants would accrue to the benefit of the general body of creditors. I would therefore allocate the costs equally between the trust assets and the general assets on the basis that when the litigation commenced, both shares and money were being claimed from the defendants and one would not have known the extent of success on either type of claim.

Expenses of interviews with former officers and preparation of s.221 examination

21. The 6th category relates to the questioning of the Muis for the purpose of tracing the shares and any proceeds of sale. As between FSL and FFL, the liquidators have apportioned the costs equally, unless certain work related only to one of the companies in which event those costs have been allocated to that company. That seems proper because of the close relationship between the companies and the way that they have been run as described in my Decision of 20 December 2000. It would hardly have been possible to restrict questioning to one company without involving the other.

22. The solicitors' costs have been apportioned in accordance with the value of claims by clients, which work out at 60% for FSL and 40% for FFL. I do not however consider that that is a viable apportionment in this case because the poor state of the companies' documentation and record-keeping as described in my Decision. In my view, an equal apportionment would be fair and proper. Insofar as any costs have been taxed and paid on the basis of the apportionment done by the solicitors, I would order that those are to be re-apportioned.

23. As for apportionment between trust assets and general assets, the liquidators have indicated that the purpose of the questioning was to discover what had happened to the shares. That being the case, I take the view that all costs should be borne by the trust assets as the clients claiming those assets would have been the primary beneficiaries of any tracing exercise arising from the questioning.

Application to Court for Berkeley Applegate order

24. Finally, there are the costs of the application to the Court for a Berkeley Applegate order. I do not need to repeat here the rationale for making a Berkeley Applegate order. Clearly such an order should be made. As the application relates entirely to trust assets, all costs should be borne by the trust assets wherever they lie and to be borne pari passu.

Distribution

25. I have also been asked to order that all shares be sold and the proceeds distributed unless there is a specific request by any clients that actual shares should be distributed to them. This would of course ease the work of the liquidators and I am mindful of the fact that there are about 600 clients.

26. However I do not see how I can override the beneficial interests of the clients that way. I would order that for those shares which are less than a board lot, such shares be sold and proceeds distributed in place of the shares, but for other shares, that the shares themselves be delivered to the clients.

Costs of present summons

27. Finally I would order that the costs of and incidental to this summons be dealt with in accordance with the method in paragraph 24.

	(MARIA YUEN)
	Judge of the Court of First Instance
	High Court

Representation:

Mr N.T.C. Hill, Liquidator, in person

HCCW000310/1998

HCCW 310/98, 311/98

HEADNOTES

(1) Forluxe Securities Ltd held shares acquired for its clients through CCASS as trustees for the clients under individual trusts (Re CA Pacific (No.1) [1999] 2 HKC 632 applied).

(2) However, the method of allocation adopted in CA Pacific (decision delivered on 20 December 2000) where there was a shortfall cannot and should not be applied because the documentation and operations of the Forluxe companies were prepared and carried out in such a haphazard manner that it is virtually impossible to identify between cash clients and margin clients.

(3) The speediest and most economical solution for allocation of shares where there was a shortfall was the pari passu ex post facto approach, where clients claiming shares in each line of stock would share rateably in the shares available.

(4) The SFC is entitled to a right of subrogation under s.118 Securities Ordinance to shares recovered by the clients, but only to the extent which its payment of compensation bears to the loss claimed.

 

HCCW 310/98, 311/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) ACTIONS NO. 310 and 311 OF 1998

---------------------------

IN THE MATTER of the Companies Ordinance Cap. 32 of the Laws of Hong Kong and IN THE MATTER of FORLUXE  SECURITIES LIMITED IN THE MATTER OF FORLUXE FINANCE LIMITED

 

Coram: Hon. Yuen, J. in Chambers

Dates of Hearing: 5- 6 December 2000

Date of Decision: 20 December 2000 (in Court)

 

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DECISION

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1. This is an application by the Liquidators of Forluxe Securities Ltd and Forluxe Finance Ltd for directions as to:-

(i) the allocation to clients of shares held by the companies,

(ii) the incidence of costs, remuneration and disbursements of the Liquidators and

(iii) the extent of the right of subrogation of the Securities and Futures Commission ("SFC") pursuant to s.118 of the Securities Ordinance.

Nature of clients' claims

2. Before I deal with the issue of allocation of shares, I first have to determine the nature of the clients' claims.

3. I have in Re CA Pacific (No.1) [1999] 2 HKC 632 found that stockbrokers who had acquired shares for clients through CCASS held the shares as trustees for the clients under individual trusts.

4. There is nothing in the facts of the present case which leads to a different conclusion.  The Securities Trading Agreement here contains clauses that point to an intention that the shares would be held on trust for the clients. 

5. In theory, therefore, clients of Forluxe ought to be in the same position as clients of CA Pacific regarding allocation of shares.  However, as will be seen below, the facts in this case do not permit that result.

Distinguishing this case from CA Pacific

6. This hearing took place one day after the hearing of an application by the liquidators in Re C.A. Pacific for directions as to the allocation of shares to clients.  The cases are similar in this respect:- that in both, there is a shortfall in some of the shares claimed by clients. 

7. In the decision in CA Pacific that I have just delivered, I held that a distinction should be drawn between cash clients (meaning those clients who were only clients of the securities company) and margin clients (meaning those clients who were also clients of the finance company).  I decided, for the reasons set out in that decision which I will not repeat here, that cash clients who had acquired shares in any particular line of stock should have priority, with the rest of the shares in that line being recovered by the margin clients, the clients in the same class sharing pari passu among themselves.

8. That distinction could be properly drawn in CA Pacific because the documentation and records were clear, and the evidence was that the distinction was generally implemented in practice as only shares attributable to margin clients were considered for the finance company's pledge to its lenders.

9. Unfortunately, that distinction cannot be drawn in the present case.  In the 3rd Affirmation of Mr Nicholas Hill, one of the Liquidators, he deposes to the fact that the documentation and operations of the Forluxe companies were prepared and carried out in such a haphazard manner that it is virtually impossible to identify between cash clients and margin clients.

10. Prior to early 1998, the accounting records of the companies did not distinguish between cash clients and margin clients.  In the 3-4 months between that date and their collapse, the companies apparently did attempt some sort of internal classification, but the basis of the attempted  classification was by no means clear.  Further, the classification appears to be far from reliable.

11. Clients were identified as "A" and "M" clients in the companies' records, but there were some clients who appeared as both "A" clients and "M"clients. 

12. Further, the clients (whether "A" clients or "M" clients) appeared to have signed different combinations of 7 types of client documents, with different provisions and with no apparent logical connection. 

13. Moreover, some documents were undated, so that where a time limit for permission to pledge was given, it would be difficult or at least expensive to trace whether that period had expired at the time of pledge.

14. The companies' record-keeping was so poor that there were some documents bearing signatures of clients but comprising only a signature page, so that it would be impossible to discover to what terms the clients had agreed. 

15. Some clients for whom trading had been undertaken had not signed any documents at all, whereas some names purporting to be the names of clients in the companies' documents have been untraceable to actual persons.

16. When the underlying facts are so uncertain and unreliable, it would not be safe for the Court to draw any distinction between cash clients and margin clients when that distinction would lead to significant differences in recoveries.

17. Further, unlike the situation in CA Pacific where the shortfall was largely due to sale and retention of shares by CAP Finance's lenders, the shortfall here (in the region of about $46 million based on the value date of 31 December 1999) appears to be due partly to the disposal of clients' shares by the Mui family to satisfy their personal commitments, a use of the shares which was not, on any view, authorised by any clients.  Judgment has been obtained by the companies against them in a total amount of nearly $39 million.

18. In those circumstances, the Court cannot and should not adopt the method of allocation of shares adopted in CA Pacific.  With no distinction to be drawn between cash clients and margin clients, all clients should be considered identically. 

(i) Allocation of shares

19. That is not to say, however, that all shares now remaining should be merged in one pool and all clients should be able to take from that mixed pool.  It must be remembered that the clients' acquisition of shares (albeit shares in CCASS) was not a collective investment scheme - on the contrary, each client was a beneficiary of the shares that he had acquired under an individual trust.

20. With that in mind and within the factual confines of this case, the Liquidators have classified the shares held by the companies into 5 categories, which may be described briefly as follows:-

A where the shares available are equal to shares claimed;

B where there are more claims than shares;

C where there are claims, but no shares at all;

D where there are more shares than claims;

E where there are shares, but no claims.

21. For those clients claiming shares in categories A and D, it is clear that they should be able to recover the shares claimed, subject to the payment of proper and reasonable costs and expenses and subject to any lien of the securities company.  Any dispute as to the validity or extent of any charge on any client's shares claimed by the finance company should be referred to the Court.  This need not, however, hold up recovery of shares by other clients. 

22. The allocation and delivery of shares should of course also be subject to the SFC's right to statutory subrogation to the extent decided below.

23. For those clients claiming shares in category B, I have referred above to the reasons why the method of allocation in CA Pacific cannot be applied by reason of the facts in this case.

24. In that case, I have also explained why adoption of the rule in Clayton's case would be unjust, inapplicable and impractical.

25. Given the relatively small value of the shares available in this case ($19 million based on the value date of 31 December 1999), it would not be worthwhile to expend further costs on more sophisticated methods of allocation, such as the "North American" or "rolling charge" approach. 

26. The speediest and most economical solution here would be the pari passu ex post facto approach, where clients claiming shares in each line of stock would share rateably in the shares available.  In respect of the balance of their claims, they would of course be able to prove in the liquidations against the companies' free assets.

27. For those clients claiming shares in category C, they will not be able to recover any shares, as there are simply none available, although they would be able to prove in the liquidations against the companies' free assets, which would include proceeds from the surplus of shares in category D and all the shares in category E.

(ii) Incidence of costs and expenses

28. I have in CA Pacific (No.2) [1999] 2 HKC 652 ordered that the liquidators' fees and expenses be allowed to be paid out of trust assets, following the reasoning in Re Berkeley Applegate [1989] Ch 32 which I will not repeat here.

29. I see no reason why a similar order should not be made in the present case.  The question of the quantum of those fees and expenses will have to be dealt with subsequently.

(iii) SFC's right to subrogation

30. Part X of the Securities Ordinance ("the Ordinance") contains provisions governing the establishment, maintenance and control of a fund known as the Unified Exchange Compensation Fund ("the Fund").

31. Members of the Exchange are obliged to deposit sums of money into the Fund which is administered by a committee. 

32. Section 109 of the Ordinance provides for claims to be made against the Fund in certain circumstances.  The relevant parts are as follows:-

"(1) Where, in consequence of any act done in the course of or in connection with the stockbroking business of an exchange participant [stockbroker], a person has a cause of action against that [stockbroker] in relation to any ... securities or other property entrusted to ... the [stockbroker] ..., that person shall be entitled ... to claim compensation from the compensation fund in respect of any pecuniary loss suffered by him.

(3) ... the total amount that may be paid ... to all persons who suffer loss through any default mentioned in ss.(1) shall not in any event exceed $8,000,000 in respect of each [stockbroker] concerned in or connected with the default; ...

(5) ... the amount which any claimant is entitled to claim as compensation from the compensation fund is the amount of the actual pecuniary loss suffered by him, including the reasonable costs of and incidental to the making and proving of his claim".

33. Section 112 provides time limits for claims against the Fund, beyond which limits claims are barred.  Section 112(1) gives a discretion to the committee to publish notices specifying a date by which claims must be made.  If no notices are published, s.112(2)(b) provides that claimants must lodge their claims within 6 months of being aware of the default giving rise to the claim.

34. Pursuant to those provisions, claims have been made against the Fund not only by Forluxe's clients, but also by CA Pacific's clients.

35. The Fund has made payments to these clients, I am told, by first making payments of up to $150,000 to each client, and then by making further payments proportionately to the claims, but subject to the statutory maximum amount.

36. It is consequent to these payments that the SFC has now asserted a right of subrogation to shares that are to be delivered by the Liquidators to the clients.  Directions have been given earlier by the Court for clients to make submissions against the SFC's position if they so wished, and this hearing (although held in chambers) has been opened to all clients, but no real opposition has been raised.  Nevertheless, it is incumbent on the court to consider the issue on this summons.

37. That the statute gives a right of subrogation to the SFC is not disputed.  What requires examination is the extent of that right.  That turns on the true interpretation of s. 118.

38. Section 118 provides:-

"On the Commission making any payment out of the compensation fund in respect of any claim under this Part, -

(a) the Commission shall be subrogated to the extent of that payment to all the rights and remedies of the claimant in relation to the loss sustained by him by reason of the default on which the claim was based; and

(b) the claimant shall have no right in bankruptcy or winding up or by legal proceedings or otherwise to receive in respect of the loss any sum out of the assets of the [stockbroker] concerned or any dealing partnership in which he is a partner, or where the loss was caused by the defalcation, fraud or misfeasance of a servant or partner of the [stockbroker], the assets of that servant or partner , until the Commission has been reimbursed the full amount of its payment".

39. Three different interpretations have been put forward for consideration.  The first interpretation is that suggested for the Court's consideration by the Liquidators.  This is that where the client is simply recovering his trust property, i.e. where the claimant's rights and remedies are proprietary in nature, the SFC is not entitled to any subrogation rights.

40. I would not agree with this interpretation.  Section 118(a) provides that the SFC shall be subrogated to all the rights and remedies of the claimant in relation to the loss sustained by him by reason of the default on which the claim is based. 

41. There is no restriction on the rights and remedies to which the SFC is subrogated, as long as

(a)   those rights and remedies are in relation to the client's loss,

(b)   that loss has been sustained by the client by reason of a default of the stockbroker and

(c)   the claim is based on the default.

42. The reference to the word "loss" is not confined to purely monetary loss.  The references to pecuniary loss in s.109 should be interpreted liberally to mean losses of a financial nature, as opposed to say, losses of a personal nature.

43. "Default" is defined in s.98(1) to include any breach of trust committed by the stockbroker, and "claims" are defined in s.109(1) to include any cause of action against a stockbroker in relation to securities or other property entrusted to the stockbroker. 

44. Thus interpreted, claims to the beneficial interest in missing shares entrusted to the stockbroker would be included, albeit proprietary in nature, with the result that the client's rights and remedies under these claims would be included in the SFC's right of subrogation.

45. The second interpretation is that postulated by counsel for the SFC.  He says that the effect of the words "the Commission shall be subrogated to the extent of that payment to all the rights and remedies of the claimant" gives the SFC priority to recoup from the recovered shares the full amount of its payment, even though the client would still be suffering a serious deficit in his shares.

46. An example would be as follows.  A client has entrusted the stockbroker with shares worth $500,000.  The stockbroker defaults and the client makes a claim for his loss.  The Fund compensates him with $150,000.  The client would still have lost $350,000.  If shares worth $100,000 are then recovered, the SFC (on Mr Shieh's argument) would take all of those shares in priority to the client.

47. I am not inclined to accept that submission.  There is nothing in the language of s.118(a) which gives the SFC a prior right.  That may be contrasted with the language of s.118(b) which states expressly that the claimant shall have no right to recover from the free assets of the stockbroker "until" the SFC has been reimbursed the full amount of its payment. 

48. Mr Shieh relied on the words "to the extent of that payment".  However these words merely mean that the SFC as subrogatee cannot get anything more by way of subrogation than what he has paid.  That is consistent with general principles of subrogation.  These words do not mean that he can get back his payment in priority. 

49. Therefore, a literal interpretation does not support the SFC's interpretation.  Nor can that result be achieved by a purposive interpretation.  There is no reason why the statute has to be read so that the SFC should be entitled to recoup its payment in priority to the client, irrespective of the full extent of the client's loss and the limited extent of any recovery.  Indeed, under the general law of subrogation, until an assured is fully indemnified, he can appropriate to himself all benefits accruing so as to diminish his loss (Goff & Jones, The Law of Restitution 5th ed 141).     

50. The third interpretation which I consider to be correct is that the SFC is entitled to a right of subrogation to the extent which its payment bears to the loss claimed.  This seems to be consistent with the application of the doctrine of subrogation exemplified in marine insurance cases such as TheCommonwealth [1907] P 216.  The value of a ship sunk in a collision was stated in the policy as ￡1350, but the amount insured was only ￡1000.  As it turned out, ￡1000 was recovered from the owners of the offending ship.  It was held by the Court of Appeal that the owner of the ship was entitled to be treated as its own insurers for ￡350, and therefore the ￡1000 recovered must be divided between the owner and the insurers in the proportion of their respective interests, being 350-1350ths and 1000-1350ths.

51. Similarly in the present case, the SFC cannot be full "insurers" of clients because of the statutory constraints.  By giving it a statutory right of subrogation without reference to full recoupment by the client, the legislature clearly did not intend the SFC to have to wait until the client has fully indemnified himself before it is entitled to any rights and remedies.  On the other hand, the loss suffered by the client may be far greater than the amount of the SFC's payment, and his rights and remedies cannot be restricted except by the clearest language.  In such circumstances, the only sensible interpretation to be given to s.118(a) is to  hold that the SFC is entitled to a right of subrogation to the extent which its payment bears to the loss claimed.

52. Applied to the example given earlier, that would mean that the SFC would take 30% of the shares recovered i.e.  150,000/500,000 and the client, 70% i.e. 350,000/500,000.  Mr Shieh accepts that the reasonable costs of and incidental to the making and proving of the claim should be included in the denominator, so that if those costs were say $50,000, the proportion would be 150,000/550,000 and 350,000/550,000 respectively.

53. The Liquidators are accordingly directed to have regard to this right of subrogation prior to delivery of shares to the clients.

54. I would request that counsel for the Liquidators draft an appropriate order for my consideration and approval.

 

 

	(MARIA YUEN)
	Judge of the Court of First Instance High Court

 

Representation:

Mr Godfrey Lam instructed by Stephenson Harwood & Lo for the Liquidators

Mr Paul Shieh instructed by Freshfields for the SFC