Introduction

Under section 255 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“CWUMPO”), a liquidator may make an application to the Court to determine questions arising from the winding up of a company. In a recent case Guangdong International Trust & Investment Corp Hong Kong (Holdings) Ltd [2018] HKCFI 2498, the liquidators apply to the Court under section 255 of CWUMPO to determine the mechanism to distribute foreign assets among creditors in light of a novel set of facts.

Background facts

The Guangdong International Trust & Investment Corporation Hong Kong (Holdings) Limited (“Company”), a company incorporated in Hong Kong, went into creditor’s voluntary liquidation in 1998. The liquidators of the Company (“Liquidators”) were tasked with dividing the following assets (“Company Assets”) to the creditors of the Company (“Creditors”):

1.       the Company’s cash balances in a Mainland bank account (“Mainland Account Balance”); and

2.       the Company’s assets in Hong Kong (“HK Assets”) which were of a lesser value than the Mainland Account Balance.

 

Generally, a liquidator will pool all the assets of the Company together and distribute them pari passu. Essentially, the pari passu principle means that all unsecured creditors are entitled to share available assets of the Company or any proceeds of sales from any of the assets equally in proportion to the debts due to each of them.

In the present case, the Liquidators faced regulatory issues in dividing all the assets of the Company proportionally among the Creditors, as the Mainland Account Balance can only be transferred to other Mainland bank accounts in Renminbi under Mainland laws and regulations. Therefore, Creditors with Hong Kong bank accounts only, or Creditors who were unwilling to receive dividends in Renminbi, were unable to join the pool for distribution of Mainland Account Balance.

As such, the Liquidators proposed to the Court to distribute the assets of the Company in the following manner (the “Proposed Distribution Mechanism”): -

1.       to distribute the Mainland Account Balance to Creditors who were willing to accept Renminbi dividends and had Mainland bank accounts pari passu; and

2.       to distribute the HK Assets to all Creditors excluding those who had received the Renminbi dividends pari passu.

 

Therefore, the following issue arises: should the court approve the Proposed Distribution Mechanism in which the Mainland Account Balance could not be distributed to Creditors who did not have Mainland Bank Accounts and/or were unwilling to accept dividends in Renminbi?

The Court’s Decision

The Court granted an Order in favour of the Proposed Distribution Mechanism, and regarded such a mechanism consistent with conventional liquidation principles in the insolvency regime of Hong Kong.

The operation of pari passu principle is qualified

At first glance, the Proposed Distribution Mechanism appeared to breach the pari passu principle, as it did not pool all assets of the Company together and distribute them pari passu to all Creditors.

This view was considered to be misconceived by the Court because it was based on the wrong assumption that distribution of assets can be made freely without taking into account the inherent restrictions attached to each asset. For example, a liquidator cannot freely assign a property that is inherently unassignable to a third party. In the instant case, Mainland laws and regulations must be considered in making any distribution of dividends out of the Mainland Account Balance. Furthermore, as a matter of principle, the insolvency legislation in Hong Kong (such as CWUMPO) does not override the Mainland laws governing the transfer and distribution of assets in the Mainland. Therefore, the Court held that there were no grounds for Creditors without Mainland bank accounts to oppose the Proposed Distribution Mechanism as they were not eligible for any distribution under Mainland laws and/or regulations in the first place.

The pari passu principle is a matter of substance, rather than procedure

It was held that the pari passu principle was not concerned with the precise procedural mechanisms in achieving the substantive result of a proportional distribution of assets among creditors. The requirement of having a Mainland bank account under the Proposed Distribution Mechanism was merely a procedural mechanism which did not detract from the substance of proportional division of the Mainland Account Balance among all eligible creditors.

Exceptions to the pari passu principle should be taken into account

The Court cited Vinodh Coomaraswamy JC’s following observation in a Singaporean case Beluga Chartering v Beluga Projects (Singapore) [2013] 2 SLR 1035 at paragraph 67:-

“I therefore do not consider it correct today - if it ever was - to describe the pari passu principle as the fundamental or default policy of insolvency distribution underlying our statutory insolvency scheme.”

While the pari passu principle is a central principle in insolvency, it is not inflexible and comes with certain recognized exceptions. In the instant case, for a creditor with a Mainland bank account who chose not to receive any distribution in Renminbi, his position was akin to that of a creditor who voluntarily entered into a subordination agreement. The effect of the subordination agreement was that the debts of a company to the creditor who was a party to such agreement would be “subordinated” to the company’s obligations to other creditors. Such contractual subordination is a well-established exception to the pari passu principle.

Liquidation is administrative in nature

In the Court’s decision to grant an Order in favour of the Proposed Distribution Mechanism, the Court applied another conventional liquidation principle, i.e. liquidation does not create or diminish rights or obligations for the company or the creditors. It is a merely administrative process of collective execution against the assets of the company for the benefit of all creditors. Therefore, a liquidator can only handle the company’s assets as he finds them. The Liquidators in the present case did not enjoy any new property rights on the Liquidators under Hong Kong insolvency law, and their powers were qualified by the limitations already attached to the assets of the Company.

The pari passu principle in appropriate cases is capable of judicial departures

In any event, the Court considered that the instant case was appropriate for a departure from the pari passu principle, as the Liquidators had no other viable methods to distribute the Mainland Account Balance. Furthermore, the Proposed Distribution Mechanism was conducive to the closure of the lengthy liquidation process and was in the overall best interests of the Creditors. Such departure was also in line with conventional liquidation principles, such as the general principle that liquidation does not expand or destroy existing rights and obligations.

Distribution is subject to the hotchpot rule

The hotchpot rule is a well-established part of English insolvency law intended to ensure equal treatment of creditors of the same class. It requires a creditor to account for whatever it has recovered abroad before it can claim dividends through English insolvency proceedings. If his recovery rate in a foreign country exceeds the recovery rate payable to other creditors in the English insolvency proceedings, he will not be allowed to share the dividend payable in the English proceedings.

In the instant case, the amount of the Mainland Account Balance way exceeded the value of Hong Kong Assets. The Proposed Distribution Mechanism correctly applied the hotchpot rule so that Creditors who have received Renminbi dividends are not eligible to receive further dividends from the Hong Kong Assets in the Hong Kong proceeding.

Conclusion

The Court’s ruling in the instant case shows that while the operation of the pari passu principle is limited by inherent restrictions on the assets, its application is essentially a matter of substance and the principle is not violated merely because of some unusual procedural matters. Liquidators should bear this case in mind in proposing methods of distributing assets in foreign states.

 

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 © 2018