Do liquidators have a right to invalidate unfairly preferential payments to a company’s debtor after the bankruptcy order of the debtor has been annulled, or are they estopped by record?

Too Late to Prove, Never Too Late to Invalidate

In Re Starline International Group Ltd [2013] 3 HKLRD 349, liquidators of a company sought to invalidate 19 unfairly preferential payments to a company’s ex-directors. The challenge they faced was with the fact that these ex-directors, who had been made bankrupt simultaneously with the winding-up of the company, had already succeeded in annulling their bankruptcy orders. A notice in respect of the annulment had been gazetted and advertised inviting creditors who had not proved their debts to lodge such proofs of debts but the liquidators had not done so; neither did they appear at the hearing of the annulment, which was also gazetted.

The liquidators claimed that they only learned about the annulment application subsequent to the annulment order being made. They then filed proofs of debts in the ex-directors’ bankruptcies for the unfairly prejudicial payments, which were rejected. The application to invalidate the unfairly prejudicial payments was then made. The issue was whether the liquidators should be estopped from applying to invalidate those unfairly preferential payments on the ground of annulment of the bankruptcies.

What an Annulment Entails

Estoppel by record occurred 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, such that the said issue of fact shall not be tried again subsequently. In determining whether the liquidators were estopped from pursuing their application, the court had to consider the effect of an annulment on debts not yet proved before the annulment order was made. This issue had not been tried in the Hong Kong courts, so the court considered the English authority of More v More [1962] Ch 424.

More v More decided that an annulment on payment in full of proved debts revived the right of a creditor who did not prove to sue the debtor as soon as the bankruptcy was annulled. Annulment, the court held, was different from discharge from bankruptcy. Discharge released the bankrupt from all bankruptcy debts; there was however no provision for annulment to have any effect on unknown debts. A bankrupt is only entitled to be discharged from liabilities over his unpaid debts after the bankruptcy has taken its course pursuant to the statutory regime. An annulment, on the other hand, puts the bankrupt in the same position as if no bankruptcy order had been made against him. In such a situation, if there were debts which the bankrupt had not repaid in the course of obtaining his annulment, such debts remained outstanding and capable of founding a bankruptcy petition. The court reasoned that a bankrupt should not be entitled to the same benefit (release from his undischarged liabilities) in an annulment as he would in a discharge, since the bankruptcy had not run its course.

Before and After

The ex-directors tried to argue that a debt should not be recoverable after an annulment. They relied on an English case, Brandon v McHenry [1891] QB 538 in which a proof of debt was rejected by the trustee in bankruptcy, whose decision was not appealed against. Subsequently, there was an annulment and it was held that the same debt would not be recoverable post-annulment. This case was distinguished in Re Starline International Group Ltd as the proof of debt in Brandon v McHenry had been rejected before the annulment whereas that in Re Starline International Group Ltd followed after. The trustee’s rejection of the proof of debt before the annulment is a valid act within section 33(4) of the Bankruptcy Ordinance, which states inter alia that where a court annuls a bankruptcy order, anything duly done by a trustee is valid. As the rejection was done within the meaning of that section, the rejection was still valid after the annulment of the bankruptcy and so the claim for the debt could not be enforced after the bankruptcy was annulled. In Re Starline International Group Ltd, however, an annulment did not have any effect upon a debt ‘unknown’ (for not having been proved) at the time of the annulment.

Fair and Just

The ex-directors also put forth other points such as the claim that the liquidators ought to have known about the annulment application because of the publicity (the advertisements in the gazette) given to it. The court rejected this line of argument, holding that it was irrelevant to the estoppel issue. One could not equate the gazetting and advertising of the annulment application with constructive knowledge on the liquidators’ part.

The ex-directors then complained of unfairness and the injustice that would follow if the bankruptcy was reopened, because the annulment involved injection of funds by a third party. The court found no unfairness to the ex-directors since the debts recoverable by the liquidators were not debts they had paid or satisfied. As to injustice, there was no explanation from the ex-directors as to the source of funds; in the circumstances, the court would be entitled to infer that such funds might be linked to the ex-directors’ assets and it was for the ex-directors to prove otherwise.

 

Not Too Far Gone

Re Starline International Group Ltd demonstrates that not all claims against a bankrupt who has got out of bankruptcy would fail – the distinction between annulment and discharge of bankruptcy is crucial. It would be best for liquidators to check how the bankruptcy order was disposed of for there may still be a chance of recovering assets.

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: insolvency@onc.hk                                                      T: (852) 2810 1212 W: www.onc.hk                                                                F: (852) 2804 6311 19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2014