Introduction

In the recent case of Re Hsin Chong Construction Co., Ltd. [2021] HKCFA 14, the Court of Final Appeal (“CFA”) overturned the decisions of the Court of First Instance and the Court of Appeal (“CA”) below. The CFA found, contrary to the CA and Court of First Instance, that the disposition of Hsin Chong’s residual rights and interests under a joint venture agreement after the commencement of winding up was void. 

Background

Hsin Chong Construction Co., Ltd. (the “Company”) and Build King Construction Limited (“Build King”) entered into a joint venture agreement (the “JV Agreement”) in November 2013 to form and operate a joint venture (the “JV”). The JV was subsequently awarded a government contract for a major project in June 2016 with the Company taking a 65% interest and Build King the remaining 35%.

The Company found itself in financial difficulties commencing in 2017/2018. On 27 August 2018, a winding up petition was issued against the Company, which led to the Company’s bank account being frozen.

As a result of the Company’s insolvency, Build King, on 13 December 2018, invoked its right under Clause 17 of the JV Agreement to exclude the Company from the JV. The Company was then banned from taking part in the management of the JV and Build King took over the benefits of the Company in the JV. However, pursuant to Clause 17 of the JV Agreement, the Company was entitled to receive the amount equal to the sum that it provided in the working capital and the proportionate share of any profits earned by the JV calculated up to the date that the Company was excluded (the “Residual Rights”).

Following the exclusion, the Company and Build King entered into a supplemental agreement on 17 December 2018 (the “Supplemental Agreement”), whereby Build King agreed to acquire, amongst other things, the Company’s Residual Rights under the JV Agreement for a sum of HK$53.6 million, to be paid in two instalments. The Supplemental Agreement also specified that the sum would be paid to the bank account of Cogent Spring Limited (“Cogent Spring”), a wholly owned subsidiary of the Company as the Company’s bank accounts were frozen. Build King subsequently transferred HK$20 million to Cogent Spring’s account, representing the first instalment pursuant to the Supplemental Agreement. Those funds were then dissipated in making various payroll and MPF payments owed by the Company as well as legal costs and miscellaneous expenses involving other entities in the Group.

Build King applied for a retrospective validation order confirming that the Supplemental Agreement should not be avoided by section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (the “CWUMPO”), which provides that “In a winding up by the court, any disposition of the property of the company, including things in action … made after the commencement of the winding up, shall, unless the court otherwise orders, be void.”

At first instance, the trail Judge held in favour of Build King, finding that its payment was made to the Company to discharge its obligations as purchaser under the Supplemental Agreement and for that reason, not a disposition of the Company’s property, and that any subsequent misapplication of the funds was internal to the Company or its directors. The rulings were upheld by the CA. The Company (now in liquidation) appealed to the CFA.

CFA’s rulings

The CFA unanimously allowed the Company’s appeal. In reaching this decision, the CFA stressed that it is important to precisely identify the Company’s property and the disposition in question. The Company’s Residual Rights under the JV Agreement constituted the property concerned. By the Supplemental Agreement, those rights were converted into a contractual chose in action consisting of a right to payment of that consideration which was the Company’s property. When Build King made its payment to Cogent Spring’s bank account, a disposition of the chose in action took place. Section 182 of CWUMPO therefore kicked in and rendered the Supplemental Agreement and the payment made thereunder void unless otherwise ordered by the Court. It mattered not that the transfer or dissipation was wrapped in contractual clothing. Further, the value of the first instalment never accrued to the Company but went entirely to Cogent Spring to be dissipated in favour of various third parties. As a result, the interests of the Company’s unsecured creditors were prejudiced. Accordingly, the CFA set aside the validation orders and declared that the Supplemental Agreement and dispositions made accordingly were void under section 182 of CWUMPO. The effect of the rulings would be that the Company could revert to a claim against Build King for the value of its Residual Rights under the JV Agreement as determined on a final account.

Conclusion

This case serves as a reminder that validation orders may only be granted when it is shown that the disposition is for the benefit of the general unsecured creditors. As such, it is important to correctly identify the property in question and assess the transaction as a whole when entering into contractual relationship with a company against which a winding up petition has been presented. The prudent course would be to seek the Court's sanction prior to effecting such disposition, not after.