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13 Jun 2017

Creditors allowed to take over the company’s proceedings from the liquidators

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Chen Muhua and Chan Yuen Wa v The Joint and Several Liquidators of Joy Rich Development Limited – HCCW 146 of 2013 (date of decision 29 May 2017)

This is the first decision where the Hong Kong Court has granted leave to creditors or members of a company to defend an action in the name of a company in liquidation.

The applicants Chen Muhua and Chan Yuen Wa (the “Applicants”) are sisters. Chan Yuen Wa is the sole director and shareholder of Joy Rich Development Limited (the “Company”). The sisters have both claimed in the liquidation as creditors.

The main asset of the Company is a valuable residential property located at the Middle Gap Road (the “Property”). All the assets of the Company, including the Property, are subject to a charge (the “Charge”) which secures a debt in the sum of over HK$200 million.

A mortgagee action was commenced by the holder of the Charge in action HCMP 430 of 2013 (the “Mortgagee Action”). The sisters have contended that the Charge should be set aside because it was not created in the ordinary business of the Company to secure genuine debts. They have asserted that:

  1. a Mr Ben Lau (who had previously cohabited with Chen Muhua at the Property) was behind the financial shenanigans;
  2. Mr Lau was a shadow director of a web of private companies as well as listed companies, which included the Company, the Company’s lenders and their parent companies;
  3. The Charge was part of a fraudulent scheme through which Mr Lau siphoned off monies from the Company’s lenders to his own pockets under the disguise of loan transactions with companies also controlled by him.

The liquidators of the Company (the “Liquidators”) had previously challenged the validity of the Charge on registration issues but that was unsuccessful. The Liquidators then decided not to defend the Mortgagee Action further due to the Company’s lack of funds and the failure of the Applicants to provide Company’s documents which may shed light on the alleged misconduct of Mr Lau. After that, the Applicants have attempted to intervene in the mortgagee action but their leave application to intervene was dismissed by the Court on the grounds that the application had no legal basis.

The Applicants’ application was made pursuant to s200(5) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) as “persons aggrieved by the liquidators’ decision”. The Court will only interfere with a liquidator’s decision under that provision if the liquidator has not exercised his power in good faith or has acted in a way in which no reasonable liquidator could have acted.1 In the present case, there was no allegation that the Liquidators have misbehaved in any way. The Liquidators did not seriously insist on their decision and did not seriously contest the application so long as adequate protection (as explained below) is afforded to the estate of the Company.

When a company is in liquidation, the general principle is that the liquidator is the person who has the authority to bring proceedings on behalf of the company. If the liquidator believes that the action is too risky to pursue or there is no funding, a creditor or a member who considers that the action has merits may apply to the Court to obtain permission to proceed on behalf of the company. The power of the Court to give such permission to creditors or members is supported by authoritative English and Australian cases.2

To justify that a creditor or a member of a company can take over an action for and on behalf of the company, the applicant has to show that his case has some arguable foundation. He must be ready to accept all of the risks connected with the action, and give adequate indemnities to the liquidators and the company.

The threshold of showing that there is some arguable foundation is not high. In the present case, even though the Court has expressly cast doubt on the Applicants’ purported defence, the Court concluded that the Applicants’ case has certain evidential foundation and there is a serious question to be tried in respect of the enforceability of the Charge as against the Company.

The Court allowed the Applicants to defend the Mortgagee Action in the name of the Company with the following conditions:

  1. The Applicants be solely responsible for their costs of the Mortgagee Action and any adverse costs orders;
  2. an indemnity given by the Applicants to the Liquidators and the Company on costs to be incurred in the Mortgagee Action;
  3. a sum to be paid into Court to cover the Liquidators’ fees, costs and other expenses, to be topped up as requested by the Liquidators;
  4. an indemnity given by the Applicants to the Liquidators and Company on post liquidation interest of the Debt for a period of time which the Court considers just and appropriate; and
  5. the Liquidators be entitled to be informed by the Applicants from time to time as to the progress of the Mortgagee Action.

The fruits of an action allowed to be conducted by the creditor/member will become part of the company’s assets. From the liquidators’ perspective, such application is of benefit to creditors so long as adequate safeguards are provided to the company and themselves. This seems to offer another way to tackle funding problems in liquidation case, especially when the liquidators do not consider the action in question has a good chance of success.

Stephenson Harwood acted for the Liquidators in this action.

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1 See Re Wickson Holdings Ltd [2011] 2 HKLRD 373

2 For example, Cape Breton Company v Fenn (1881) 17 Ch.D. 198; Fargro Ltd v Godfroy (1986) 1 WLR 1134; Aliprandi v Griffith Ventures Pty Ltd 6 A.C.S.R. 250

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