In the recent case of Re Shun Kai Finance Co Ltd [2015] HKCU 424, the Court of Appeal clarified that the threshold requirement for misfeasance proceedings under section 276 of the Companies Ordinance (Cap. 32) and derivative actions against liquidators.

Background

In 2003, Shun Kai Finance Company Limited (“Shun Kai Finance”) went into liquidation on the petition of a judgment creditor Japan Leasing (Hong Kong) Limited (“Japan Leasing”) which itself had gone in creditor’s voluntary liquidation in 1998. Both Japan Leasing and Shun Kai Finance had been licensed money lenders. 

In 1993, Japan Leasing agreed to grant loan facilities to Shun Kai Finance where Shun Kai Finance would grant loans to third party borrowers. Between 1997 and 1998, Japan Leasing alleged that Shun Kai Finance had defaulted on repayment obligations and sought to exercise its rights under the loan agreement by requesting third party borrowers to pay Japan Leasing directly.  Shun Kai Finance then issued proceedings in 1998 against Japan Leasing claiming damages for breaches of the loan agreement.  Although Japan Leasing was placed in liquidation, it defended the proceedings and filed a counterclaim against Shun Kai Finance. Those proceedings were stayed following the winding-up of Shun Kai Finance in 2003. Subsequently, in 2006, the Liquidator of Shun Kai Finance settled the proceedings against Japan Leasing with the sanction of the court (the “Settlement”).

A shareholder of Shun Kai Finance (the “Appellant”) alleged that the Settlement was at a significant undervalue. She argued that but for the Settlement, Shun Kai Finance would have had a surplus available to shareholders, and she would have had an interest in the liquidation. She, therefore, challenged the Settlement by commencing two proceedings:

• A claim under section 276 of the Companies Ordinance (Cap. 32) (“CO”) against the Liquidator (“s.276 Action”); and
• A common law claim for negligence against the Liquidator, his present employer and his former partnership (“Common Law Action”).

The Court of First Instance dismissed the two actions and held that the Liquidator acted reasonably in entering into the Settlement. The evidence adduced by the Appellant did not reveal a prima facie complaint. The actions had no prospect of success. The Court of Appeal upheld the decisions of the Court of First Instance on the following principles.

Principles

Section 276(1) CO states that “If in the course of winding up a company it appears that…liquidator…of the company, has…been guilty of any misfeasance or breach of duty in relation to the company which is actionable at the suit of the company, the court may…examine into the conduct of the…liquidator…and compel him to…contribute such sum to the assets of the company by way of compensation in respect of misapplication, retainer, misfeasance, or breach of trust as the court thinks just.” The reference to “it appears” in the section indicated that there was a threshold requirement which the Appellant must surmount before the court was obliged to “examine into the conduct” of the Liquidator.

The Appellant submitted that the principles for striking out under Order 18 rule 19 of the Rules of the High Court were the appropriate standard for the threshold requirement in the s.276 Action. It is well known that striking out under Order 18 rule 19 is difficult as the courts adopt the standard of an “arguable case” and usually assume facts in favour of the claimants. The Court of Appeal, however, rejected the Appellant’s argument and clarified  that the appropriate standard for an action under s.276 should be a prima facie case, not in the sense of some formal evidential burden of proof, but that it must be shown there was sufficient basis for the relief sought under section 276,  i.e. that there was something which warranted an inquiry.

Ruling

In the s.276 Action, the Court of Appeal emphasized that the court would not interfere with the Liquidator’s commercial decision unless there could be seen to be some lack of good faith, error in law or principle, or some real and substantive ground for doubting the prudence of the Liquidator’s proposal. The Liquidator was entitled to exercise his commercial judgment to reject the Appellant’s offer of litigation funding and accept the settlement offer of Japan Leasing. None of the Appellant’s complaints was sufficient to cast doubt on the Liquidator’s good faith and prudence in reaching the Settlement. The s.276 Action was dismissed.

As to the Common Law Action, the Court of Appeal dismissed the Common Law Action because the common law derivative action did not fall within an exception to the rule in Foss v Harbottle. The Court of Appeal also rejected the Appellant’s application for leave to bring a statutory derivative action because it would not be prima facie in the interest of Shun Kai Finance to allow the Appellant exceptionally to sue in place of Shun Kai Finance. As the Liquidator was not liable, his present employer and his previous partnership were not vicariously liable. Even if the Liquidator was liable, his present employer and his previous partnership should not be liable because the Liquidator was appointed in his personal capacity and owed no duties to his employer or the partnership in the performance of his duties.

Implications

This decision of the Court of Appeal should be welcomed by liquidators as the threshold for challenging liquidators’ decisions is a prima facie case and not just merely an arguable case. As long as liquidators exercised commercial judgments without bad faith, error in law or substantive doubts of their prudence, they should be able to resist challenges by disgruntled creditors or shareholders.