To ask or not to ask? That is the question (2)

As discussed in our previous blog post, the decision for provisional liquidators to apply for directions on the distribution of funds can be a difficult one to make. In the Hong Kong Court of Appeal decision Joint And Several Provisional Liquidators Of Hsin Chong Construction Co Ltd (Provisional Liquidators Appointed) v. the Chinese University Of Hong Kong And Others [2021] HKCA 1581, the Court of Appeal allowed the appeal by the provisional liquidators and provided guidance on the appropriate situations where an application under section 200(3) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) may be brought.

Background

The company (Company) acted as the main contractor in constructing student hostels for the first respondent (First Respondent). The Company further engaged the second to seventh respondents (Second to Seventh Respondents) as sub-contractors for the construction works.

When Provisional Liquidators (PLs) were appointed over the Company, they were unsure as to whether they could make contributions to the Second to Seventh Respondents out of funds received from the First Respondent under the main contract. The doubts arose out of questions over the status of part of the funds received, and whether those funds formed part of the Company's assets.

In dismissing the application, the Court of First Instance (CFI) reminded the PLs that an application under section 200(3) is reserved only for cases where a genuine difficulty arises in the course of the liquidation. The CFI took into account that the fact that the relevant funds were paid to the Company at the PLs' request, and there was no criticism of or challenge to the PLs' decision. The CFI found that the PLs had in effect decided to classify the relevant funds as an asset of the Company. Further, the CFI construed the PLs' terms of appointment as requiring prior Court sanction before bringing a section 200(3) application.

The Court of Appeal's Decision

The Court of Appeal (CA) reversed the CFI's decision.

The CA emphasised that section 200(3) application should be distinguished from other actions brought by the PLs on behalf of the Company. While the PLs' terms of appointment required them to obtain prior sanction before commencing/defending proceedings, such a requirement did not apply to a case where the PLs, as officers appointed by the Court, brought applications for directions in their own name.

On the general principles applicable to section 200(3) application, the CA agreed with the CFI that PLs should not seek to have the Court make a commercial decision for them. The issues of the application should commonly be legal and of significance. On the other hand, the PLs had a duty to seek directions when there was a difficulty during the course of administration. If the Court took the view that an application is legitimate, the Court should provide some advice or direction so that PLs, being its officers, would not be left "floundering".

On the facts of the case, the CA differed from the view of CFI and held that all three questions raised by the PLs were genuine legal questions, albeit not difficult. While there was no dispute against the views of the PLs on the classification of the relevant funds, disputed views arise on the question of entitlement. The Fourth Respondent put forward a different perspective on whether the sub-contractors were entitled to direct payment or should share pari passu with the Company’s other creditors. The CA therefore allowed the appeal and considered the questions to be properly raised.

Key takeaways

The fact that the CFI and the CA took different views illustrates the difficulties that liquidators sometimes face. Further judicial guidance (in the context of a suitable future case) will be helpful. In the meantime, the following key points emerge from the CA decision:

• While liquidators should not abuse a section 200(3) application to ask the Court to make a commercial decision for them, there is a duty on liquidators to seek the Court's directions when there are difficulties in the course of a liquidation. This is admittedly sometimes a fine line.
• Liquidators' power to make a section 200(3) application is not subject to the prior sanction requirement in their terms of appointment. There is a distinction between proceedings under the name of the liquidating company and proceedings under the liquidators' own name.
• A section 200(3) application is clearly appropriate in the case of a significant legal question. Even though the question may not be difficult, the liquidators will not be seen as incompetent in seeking directions from the Court.