Hong Kong’s highest court clarifies law on dispositions after winding up

The Hong Kong Court of Final Appeal (the "CFA") has clarified in a recent judgment the application of section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance ("CWUMPO") and when the court will grant a validation order.

As will be familiar to many readers, s182 of CWUMPO provides that any disposition of a company’s property after the commencement of the winding up is void unless the court orders otherwise (by way of a validation order).

Factual background

Hsin Chong Construction Company Limited ("Hsin Chong") and Build King Construction Limited ("Build King") were parties to a joint venture agreement (the "JVA") relating to a Government construction project.

In August 2018, a winding up petition was presented against Hsin Chong. This entitled Build King to exercise a right under the JVA to exclude Hsin Chong from the joint venture, provided that it paid Hsin Chong a share of the accrued profits.

In December 2018, the parties entered into a supplemental agreement (the "Supplemental Agreement"). In accordance with this agreement, Build King purchased Hsin Chong's residual rights and interests under the JVA. Build King as purchaser transferred HK$20 million (the "Transaction") – being the first instalment of the agreed consideration – to a sister company of Hsin Chong (the "Sister Company"). The parties had agreed that the funds be transferred to the Sister Company since Hsin Chong's bank accounts had been frozen (banks typically freeze a company's accounts when they learn of the presentation of a winding up petition).

The funds transferred were later dissipated to satisfy, among other things, payroll and mandatory provident fund payments owed by Hsin Chong, as well as expenses involving Hsin Chong and other entities in the same group. Build King then sought an order from the court retrospectively to validate the Transaction.

Section 182 of CWUMPO

Section 182 of CWUMPO provides that in a winding up by the court, any disposition of the company's property made after the commencement of the winding up shall be void, unless the court orders otherwise.

Issues

The issues were:

1. Was the Transaction a disposition of Hsin Chong's property within the meaning of s182 of CWUMPO?
2. Should the Transaction be validated in any event?

Decisions of the lower courts

The Court of First Instance (the "CFI") held that the Transaction was not a disposition of Hsin Chong's property by Build King, but rather a discharge of Build King's obligations as purchaser under the Supplemental Agreement. The CFI granted a validation order in the alternative, finding that Build King had not breached any duties in completing the Transaction and that, if the court did not validate the Transaction, it would be punishing Build King without any benefit to Hsin Chong's unsecured creditors.

On appeal, the Court of Appeal found no valid ground to interfere with the CFI's decision.

Decision of the CFA

The CFA clarified the proper application of s182 of CWUMPO: once a winding up petition has been presented against a company, any transaction that is seen as disposing of the company’s property would be presumptively void. The burden rested on the party seeking to validate the transaction to show why a validation order should be granted. The court must consider the interests of the company's general body of creditors, and any validation order should benefit the company's unsecured creditors as a whole.

On the facts, the CFA found that the Transaction involved a disposition of Hsin Chong's property. The relevant property was, initially, Hsin Chong's residual rights and interests under the JVA. When Hsin Chong agreed, by way of the Supplemental Agreement, to sell these to Build King, these residual rights and interests were converted into a right to be paid under the Supplemental Agreement. The relevant property for the purpose of s182 of CWUMPO was therefore Hsin Chong's right, under the Supplemental Agreement, to be paid consideration for its sale of its residual rights and interests under the JVA. This property was dissipated when Build King made payment to the Sister Company instead of Hsin Chong.

The CFA emphasised that s182 of CWUMPO is intended to preserve the company's property so that it can be properly distributed amongst the general body of creditors. The provision does not require that the transacting parties be involved in a breach of duty before the transaction is rendered presumptively void. The fact that Build King had not breached any duties – a fact on which the lower courts had relied – was therefore irrelevant.

What was material was that none of the HK$20 million paid to the Sister Company reached Hsin Chong, and the funds were not made available for distribution to the general body of Hsin Chong's creditors. This offended the pari passu principle, and was to the prejudice of Hsin Chong's unsecured creditors.

The Supplemental Agreement and the Transaction were therefore void by virtue of s182 of CWUMPO, and the CFA set aside the validation order.

Comments

The CFA's judgment highlights the importance of correctly identifying the "property" concerned when considering s182 of CWUMPO – which is not always straightforward. As the CFA's reasoning shows, this exercise requires looking at a transaction as a whole and in context.

Any party dealing with a company against which a winding up petition has been presented should be extremely circumspect, and should carefully consider the impact of s182 – lest they find themselves in Build King's predicament.

This decision is also a reminder of the primacy of the pari passu principle.