Introduction

In the recent case of Re Ashit Sud (Debtor) [2022] 2 HKLRD 898, the Court explained when a creditor would be considered acting unreasonable in rejecting a debtor’s settlement proposal. At the end of the hearing, the Court made a winding-up order against the Company in question and a bankruptcy order against the director of the Company, Mr Ashit Sud, who had provided guarantees.

Background

Since June 2020, the Company, the Union Bank of India (the “Petitioner”) and two other creditors had been engaged in discussion concerning repayment of the outstanding debts owed by the Company. The Company raised a one-time settlement proposal (the “Proposal”), which however was rejected by the Petitioner and other creditors. In particular, the Petitioner informed the Company that it could not consider the Proposal as it lacked an upfront payment which was a mandatory condition of the Petitioner bank’s mandatory policy. The Petitioner subsequently served a statutory demand in the sum of US$38 million in July 2021 on the Company and Mr Sud respectively (the “Statutory Demands”). The debts were not paid and the Petitioner presented a winding up petition against the Company and a bankruptcy petition against Mr Sud (the “Petitions”). Between the date of the Statutory Demands and filing of the Petitions, the Petitioner appropriated about US$1.9 million out of sale proceeds of a third party security, but more than US$34 million remained outstanding.

The Company and Mr Sud sought to dismiss the Petitions on the following grounds:

1.       The Petitioner was estopped from presenting the Petitions (“1^st Ground”);

2.       The Petitioner’s rejection of the Proposal was unreasonable (“2^nd Ground”); and

3.       The amount of debt owed was overstated in the Statutory Demands for the purpose of section 178(1)(a) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“CWUMPO”) and section 9(2) of the Bankruptcy Ordinance (Cap. 6) (“BO”) (“3^rd Ground”).

1^st Ground

The Company and Mr Sud argued that the Petitioner was estopped from presenting the Petitions as there was, allegedly, a mutual understanding between the Company and the creditors that the debts would not be enforced if the Company was willing to offer one of its property as security and deposit an upfront amount, which constituted a separate security proposal independent of the Proposal. Mr Sud also alleged that they had relied on such mutual understanding and acted to their detriment by obtaining a valuation report. Therefore, it was inequitable for the Petitioner to resile from the mutual understanding.

The Court found that the evidence adduced by the Company and Mr Sud did not support the estoppel argument, instead, it was merely a “contrived reading of the correspondence”. The Court was of the view that the correspondence only reflected a continuum of changing contours of the Proposal and a request for an offer to be improved in the course of negotiation cannot imply parties’ intention of not enforcing the old debt. Acts taken by the Company and Mr Sud did not suffice to found any claim in estoppel. The alleged detriment was held by the Court as entirely self-induced.

2^nd Ground

The Company and Mr Sud relied on section 178(1)(a)(ii) of the CWUMPO and section 6D(3) of the BO and argued that the creditors acted unreasonably in rejecting the Proposal, and in particular the Petitioner was unreasonable in requesting a 10% upfront payment.

The Court clarified that the test for “reasonable satisfaction” under section 178(1)(a)(ii) of the CWUMPO and section 6D(3) of the BO was the same and it was objective and to be evaluated at the date of the hearing. Citing case authorities, the Court made it clear that the relevant principles and considerations applicable to section 6D(3)(c) of the BO in determining a petitioner’s refusal of the debtor’s offer as being unreasonable included:

1.       The court has to be satisfied that no reasonable hypothetical creditor in the petitioner’s position, and in light of the actual history, would have refused the offer;

2.       The position should only be considered as between the petitioner and the debtor without regard to the position of other creditors;

3.       The petitioner is entitled to have regard to his own interests and is not required to balance his interests against those of the debtor, nor to show patience or generosity. Acting reasonably is not the same as acting justly, fairly or kindly;

4.       The debtor should be full, frank and open with the petitioner in respect of his statements of his position;

5.       In considering a debtor’s ability to repay the debt, no regard should be given to future contingencies such as profit or income from future contracts if he is permitted to carry on his business; and

6.       Future income is only relevant as part of the total circumstances.

 

Noting that whilst requirement of an upfront payment could be objectionable, the Court made it clear that coherent in-house policies are legitimate. Mr Sud made no disclosure of his financial circumstances. There was also no evidence to show that the Petitioner’s in-house policy of requiring an upfront payment was demonstrably incoherent or unacceptable. The suggested approach of comparing the economic outcome of the offer with the return for creditors in liquidation / bankruptcy was wrong. Importantly, the Court made it clear that if the Company was insolvent and unable to pay its debts, it was the creditors who had a real interest in the Company and could decide whether it was in their interest to have the Company wound up. It was not for the Company to assert otherwise. The Court did not agree that the only reasonable choice open to the Petitioner was to accept the Proposal and in rejecting it, the Petitioner was not being unreasonable.

3^rd Ground

Instead of contesting that an overstated statutory demand was invalidated entirely, the Court clarified the correct approach to be adopted was for the debtor company to comply with the demand as to the amount which was not genuinely disputed and then contest the remainder. Notably, the Court held that overstating amount due in the statutory demand did not ipso facto invalidate the statutory demand nor render the debtor company any less solvent so long as a debt which exceeded the statutory limit was due and admitted or not genuinely disputed. After the Petitioner appropriated about US$1.9 million towards the Company’s debt, a sum in excess of US$34 million remained outstanding and undisputed. Accordingly, the amount due overstated in the Statutory Demand served on the Company was held by the Court to be not affecting the applicability of section 178(1)(a) of the CWUMPO. As a last note, the Court remarked that in any event, a statutory demand was merely a means of proof of insolvency – when a debt which was not substantially disputed remained unpaid, there would be the inference that the debtor company was unable to pay its debt under section 178(1)(c) of the CWUMPO.

Regarding the amount overstated in the Statutory Demand served on Mr Sud, the Court found that the amount stated was correct and following the Petitioner’s appropriation of US$1.9 million between then and the filing of the bankruptcy petition, the amount owed by Mr Sud to the Petitioner was at least US$34 million. Overstating the amount did not cause any injustice to Mr Sud who had not made any repayment. Accordingly, the Court held that the Statutory Demand served on Mr Sud remained valid.

Key takeaway

The decision serves as a useful reminder of the approach adopted by the Hong Kong courts in determining when a refusal to enter into a settlement proposal made by the debtor company will be viewed as unreasonable. It appears that for a debtor to be able to argue such, it will be incumbent for him to make a full and frank disclosure of his financial circumstances to the creditors so that the creditors can make an informed decision as to whether it will be in their best interests to petition the winding-up / bankruptcy of the debtor.

 

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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 © 2022