LUK NGAI LING v. LAU SIU HUNG

HCCW 306/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 306 OF 2006

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BETWEEN

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D E C I S I O N

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1.  On 24 February 2010 I handed down judgment in respect of an application to reverse the decision of the liquidators of the Company rejecting the applicant’s proof of debt. I did not consider that there was any bad faith or gross negligence on the part of the liquidators and made an order nisi that the applicant’s costs be paid out of the assets of the Company. The applicant seeks a variation of that order. It submits that the liquidators should be personally liable to pay the costs on the basis that the application should be treated as normal adversarial litigation. The reason the applicant is concerned to vary the costs order is because she says, correctly I understand, that the liquidators have currently realised no assets out of which her costs can be paid.

2.  Mr Tommy Lo who appeared for the applicant argues that the decision of Barma J in OceanTime Development Ltd HCCW 334 of 2004 (unreported judgment of Barma J of 6 September 2006) shows that if a creditor is successful in an application to reverse the adjudication of a proof the correct costs order is that the liquidator pay the applicant’s costs and that the liquidator will normally be entitled to recoup such costs from the assets of the company.  The result is that if there is a shortfall in the assets available to pay those costs it is the liquidator who suffers not the creditor.  I accept that it appears that the decision in OceanTime is as Mr Lo describes it.  It is not clear from the judgment the extent to which there was any argument about whether or not this is the correct approach.

3.  The liquidators, who are represented by Mr Jerry Chung, argue that this is not the correct approach.  He submitted that the costs order nisi is correct and is consistent with Rule 24 of the Proof of Debt Rules, which apply in the present case for the following reasons.  Section 264 of the Companies Ordinance provides that “In the winding up of an insolvent company the same rules shall prevail and be observed with regard to the respective rights of secured and unsecured creditors and to debts provable ……….. as are in force for the time being under the law of bankruptcy ….”  Rule 24 of the Proof of Debt Rules expressly provides that if a creditor is dissatisfied with the decision of the trustee in respect of a proof he may apply to the court to have the decision reversed.  The Rule goes on to provide that the “trustee shall not be personally liable for any costs in respect of the rejection by him in whole or in part of any proof unless it is proved to the satisfaction of the court that he has acted mala fides or in gross negligence”.

4.  Mr Lo, who appeared for the applicant, submitted that this Rule does not apply to a winding up of the Company for 2 reasons.  First, he argued that the wording of section 264 was not wide enough to include the determination of the costs of an application to reverse a liquidator’s adjudication of a proof.  Secondly, he argued thatby Rule 105 of the Companies (Winding-up) Rules, which provides that “The Official Receiver shall in no case be personally liable for costs in an appeal from his decision rejecting any proof wholly or in part” the legislature has expressly dealt with the costs of an application to reverse a decision in respect of any adjudication of a proof and as a consequence section 264 does not import Rule 24 into the corporate insolvency regime.

5.  I disagree with Mr Lo’s submissions.  Mr Lo accepted that section 264 applied to his client’s right to have his proof adjudicated and to appeal a rejection.  This in my view must be right.  It seems to me that this being so it is artificial to argue that it does not extend to the question of how the costs of an appeal should be dealt with.  Section 264 is to be interpreted functionally and it is clearly intended to incorporate into the statutory regime for the regulation of corporate insolvency the rules that apply to bankruptcy.  Neither do I accept that Rule 105 should be read as by implication meaning that a liquidator is not to be provided the same protection as the Official Receiver or a trustee in bankruptcy when adjudicating a proof.  Mr Lo was unable to point to any reason why the Official Receiver and trustees should be protected when adjudicating a proof, but a liquidator not so protected.  The argument also overlooks the fact that Rule 105 goes further than Rule 24 and does not contain the qualification in respect of decisions, which the court concludes involved bad faith or gross negligence.

6.  Mr Lo’s submission also overlooks the function a liquidator is called upon to perform when adjudicating proofs and the general law on a liquidator’s liability for costs of litigation.  When called upon to adjudicate a proof a liquidator is exercising a specific function required of him by statute.  If he has doubts about a proof he should reject it and leave the creditor to prove his claim: The Law of Insolvency, 4^th Ed, para 23-014.  It would be surprising in these circumstances if as a result of carrying out this function in good faith a liquidator found himself personally liable for a creditor’s costs of proving his claim.  Whilst in most cases one would only expect an adjudication to be challenged if a company has some assets there might be cases such as the present where there are currently no assets, but the creditor is motivated by a hope that some assets may in the future be found or in order to create a cross-claim with which to defend a possible claim by the company.  In my view it would be undesirable if a liquidator who rejected a proof in these circumstances found himself liable for the costs of a successful appeal.  This prospect might influence a weak liquidator’s adjudication of a proof.  It would also be inconsistent with the well established principle that as a general rule (which in practice means absent bad faith or gross negligence) a liquidator is not personally liable for the costs of litigation: Insolvency Litigation, Doyle, para 4.03.  In response to this point Mr Lo took me to Loose on Liquidators, 3^rd Ed, page 106, which refers to the need for a liquidator to act with caution when involved in litigation and if necessary to get directions from the court and possibly indemnities for his costs from creditors.  I understood Mr Lo to be suggesting that this indicates that a liquidator should appreciate that he can find himself liable for costs and that he may have to look to the assets of a company, which may not be sufficient to cover his liability.  This may be so in the case of adversarial litigation, but in my view what this illustrates in the present context is the reason why a liquidator will not, unless he acts in bad faith or is grossly negligent, be liable for the applicant’s costs.  He is not in a position to protect himself, because he is carrying out a statutory adjudication function and he cannot refuse to do so unless other creditors indemnify him or seek the court’s direction as to what he should do.

7.  In my view Rule 24 does apply to an application to reverse or vary a liquidator’s adjudication of a proof filed in a company winding up. Unless there is bad faith or gross negligence in my view the correct costs order is that the applicant’s costs and the liquidator’s costs are paid out of the assets of the company with, if necessary, a direction that the applicant’s costs are paid in priority to the liquidator’s costs of the appeal.  In my view this is the position even if Rule 24 does not apply for the reasons given in paragraph 6 of this decision.  In so far as Barma J’s decision in Ocean Time is inconsistent with this approach I would respectfully disagree with it.

8.  The way in which the court normally seeks to deal with the situation in which a successful party has concerns about whether he will be able to recover all his costs out of the assets of the Company is to order that the applicant’s costs are paid before those of the liquidator: Insolvency Litigation supra para 4.04.  I will vary my costs order nisi to order that the applicant’s costs and the liquidator’s costs of both the appeal and this hearing are paid out of the assets of the Company and that the applicant’s costs are paid in priority to those of the liquidator’s costs of the appeal and today’s costs.

Mr Tommy Lo, instructed by Messrs Jimmie K S Wong & Partners, for the Applicant

Mr Jerry Chung, instructed by Messrs Johnnie Yam, Jacky Lee & Co., for the Respondent

HCCW 306/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 306 OF 2006

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J U D G M E N T

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1.  I have before me an application issued on 17 June 2009 by Luk Ngai Ling to reverse a decision dated 27 May 2009 rejecting a proof of debt by Lau Siu Hung one of the joint and several liquidators of the Company.

2.  The proof of debt was for HK$4,250,727.50, which the applicant says was the sum advanced by her as a director’s loan to the Company, which had been established by her and her sister. The last audited financial statement for the Company is for the year ending 30 June 2005 and shows the director’s loan as being HK$8,501,455. The applicant says that the loan arose as a result of payments made by her and her sister in respect of the Company’s expenditure. The payments were made out of a joint account in their name and one other director and used to fund the Company’s business and those of other companies operating related businesses, namely, old people’s homes.

3.  The original proof of debt was supported by only one document: the audited financial statement for the year ending 30 June 2005. This was rejected by the liquidator on the ground that the audited financial statement was not sufficiently reliable evidence that the sum claimed was due to the applicant. As the matter progressed other issues arose. The applicant says that much of the expenditure giving rise to the debt was in respect of what has been called messing expenses, which was primarily food and associated items. Whilst such expenses incurred by members of staff are fully documented with invoices and receipts in the case of the expenses recorded in the Company’s transfer vouchers as being paid by the 2 directors there are no such invoices or receipts. This only added to the liquidator’s concern that the claim was not being fully documented. He had another further concern, namely, the equal division of the director’s loan. The applicant had not established that she in fact paid half the expenses recorded as a director’s loan.

4.  When the application commenced I asked the parties why this matter had come to court at all as so far as I could see from the Court file the liquidation had only realised something in the order of HK$11,000 on the sale of the Company’s assets and on the face of the matter the application was pointless. Initially neither party was able to give me an explanation although on pressing it became apparent that the liquidator had obtained a judgment against an unrelated company for HK$3,000,000 and was pursuing other actions against the applicant’s sister and a company owned by the applicant and her sister. Mr. Chung who appeared on behalf of the liquidators was unable to give me any information about the claims. It appears that the applicant is pursuing her claim in order that she can recover some of the money she says was advanced by her in the event that anything is recovered by the liquidator.

5.  The parties agree that this is a consideration de novo of the applicant’s claim. I need to be satisfied on the balance of probabilities that the sum claimed is due. During his address to the court Mr. Chung clarified the liquidators’ position in respect of the claim. It is as follows:

(i)  the liquidator is not asserting the directors’ loan account is bogus;

(ii)  however, the liquidator has not seen any contemporaneous documents which clearly demonstrate any payments made by the directors on behalf of the Company, such as receipts, and does not feel he can properly admit the proof debt in these circumstances; and

(iii)  the liquidator does not have a positive case to advance to suggest that what the applicant says is unreliable.

6.  The liquidators were particularly concerned that the applicant sought to rely on audited financial statements, which contained an auditors report in slightly unusual terms although not in a respect, which I consider material. They did not consider it safe to rely on the financial statements alone to prove the debt. Mr. Chung drew my attention to the judgment of Kwan J (as she then was) in Kong Po Kong v Chan Kin Hang, Danvil (HCMP 230/2009 11 September 2009). In paragraph 34 Kwan J. refers to an audit confirmation as a self-serving document and suggests, so Mr. Chung reads the paragraph, as calling into question the evidential value of an audited financial statement when it comes to proving a director’s loan. In my view paragraph 34, particularly, when read in the context of what is said by her Ladyship in the previous paragraph does not suggest that an audited financial statement has little or no evidential value when it comes to proving debts recorded in it. It is evidence, the question is how much weight should it be given.

7.  The audited financial statements from the commencement of the business sometime in 1999 consistently record directors’ loans of in the order of HK$8,000,000 to HK$11,000,000. There is no reason to think that right from the outset the directors caused inflated loans to be recorded. It is not in dispute that the Company was one of a number of companies owned equally by the applicant and her sister operating old people’s homes in various parts of Hong Kong, although I have not been given any details about them. It seems inherently likely that the applicant and her sister being the owners of the Company would have financed its establishment. The fact that they financed it out of a joint bank account of which they were the beneficial owner and into which they say, and this is not disputed, they placed surplus funds available from the more profitable companies to finance their businesses generally does not seem to me surprising, neither is it particularly surprising that they now have difficulty reconstructing which of them withdrew particular sums from the joint account to pay for the Company’s expenses.

8.  I can understand the liquidator’s concern that he had not been provided with any supporting documents. However, the liquidator is not asserting that there is any reason to think that the accounts have been fabricated. I think his approach is most appropriately characterised as putting the applicant to strict proof of her claim. Taking into account the consistent inclusion of the directors’ loan in the financial statements, the commercial background to the establishment and operation of the Company, the evidence of the sister which corroborates the applicant’s version of the arrangements between them I am satisfied that the applicant has proved on the balance of probabilities the debt claimed.

9.  I will therefore make an order that the applicant’s proof of debt for HK$4,250,577.50 be admitted. I make an order nisi that becomes absolute if not challenged within 14 days of the date of handing down of this decision that the applicant’s costs be taxed and paid out of the assets of the Company.