Hong Kong: Debtors of an insolvent company - Who should you pay?

Section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“CWUMPO”) renders the disposition of a company’s property after the presentation of a winding-up petition against it void, subject to any validation order granted by the court.  This provision serves to preserve the company’s assets at the date of the winding-up petition for the general benefit of creditors, and to ensure that the statutory scheme of pari passu distribution can be implemented.   

In Re Hsin Chong Construction (Asia) Limited (In Liquidation) [2024] HKCFI 3310, the Hong Kong Court examined the interesting question of whether payments made by a debtor of a company to a different entity, after a winding-up petition is presented against the company and at the company’s request, would be considered as “disposition of property” of the company caught under section 182 of CWUMPO and therefore void.  

The Facts

Hsin Chong Construction (Asia) Limited (the “Company”) was the main contractor carrying out the construction work under a contract (the “Main Contract”), pursuant to which the Company issued an invoice to Capital Court Limited (the “Debtor”).

Subsequently, after a winding-up petition was presented against it, the Company requested that the Debtor arrange all payments due to the Company to be made to a sister company (the “Affiliate”) with the effect that such payments “shall represent full settlement for work done by [the Company]” under the Main Contract.  The Company provided official receipts to the Debtor for the Debtor’s payments to the Affiliate (collectively, the “Sum”), which were however never received by the Company.

The Company was eventually wound up.  The liquidators of the Company filed an application for (1) a declaration that these payments made by the Debtor to the Affiliate were void and (2) an order requiring the Debtor to repay the Sum to the Company.  The Debtor argued that the Affiliate acted as the Company’s agent in receiving the Sum, and the payments of the Sum did not constitute “disposition of the Company’s property” under section 182 of CWUMPO.    

The Decision  

Define “disposition of property” under section 182: Substance over form

In determining whether a payment constitutes “disposition of the company’s property” under section 182 of CWUMPO, the Hong Kong Court adopts a substance-over-form approach, judged by the impact on the value of a company’s asset resulting from the transaction in question.  A disposition occurs when there is a destruction or reduction in value of the company’s property to the prejudice of its creditors, causing an immediate and equivalent accrual in value to another party.   

In particular, the court rejected the Debtor’s argument that a payment to a properly authorised agent of an insolvent company was not a disposition.  If, as a result of that payment, the company’s property is transferred or dissipated so that the interests of the general body of creditors are prejudiced, it matters not that the transfer to the third party is wrapped in contractual clothing which deems such payment a discharge of the payor’s obligation.

On the facts of the case:

• The Company was entitled to be paid the Sum but the money was never received by the Company to form part of its free assets available for the benefit of the general creditors. 
• The payment of the Sum was presumptively a “disposition” for the purposes of section 182 and so void.  The burden was on the Debtor to demonstrate why the court ought to make a validation order.
• No validation order had been applied for. Validation orders may be made where the applicant shows that the disposition is likely to be or actually has been for the benefit of the general body of creditors.  The interests of the general body of creditors are determinative. No validation order would have been obtained based on the evidence adduced by the Debtor had it been applied for.

The court’s jurisdiction to order immediate recovery of void disposition

The invalidation of disposition of the company’s property and the recovery of the property disposed of are two distinct matters.  Section 182 of CWUMPO avoids dispositions but is silent about recovery.  What is the appropriate remedy in respect of the invalidated disposition is a matter not regulated by the statute and that has to be determined by the general law. 

The Hong Kong Court has confirmed that it has jurisdiction under section 182 of CWUMPO to grant immediate payment orders as substantive relief to correct wrongful dispositions of a company’s property, without confining the remedy to restoring the right of action against the Debtor parted with by the Company. 

As to whether the court should exercise its discretion to make such immediate payment order, the Debtor argued that its proposed claim against the Company on the basis of estoppel and/or the “mutual intention” that the Affiliate was to receive the Sum as the Company’s agent was relevant.  In particular, the Debtor submitted that, if it did have a valid cause of action against the Company, it would be entitled to a set-off that would extinguish the liquidators’ entitlement to payment under section 182.  It would therefore be unfair or unjust to make an immediate payment order (upon which the liquidators may distribute the funds to the creditors of the Company) before the determination of its application for leave to commence proceedings against the Company. 

The Debtor’s arguments were rejected by the court for the following reasons:

• Insolvency set-off only applies where the cross-claims are mutual, i.e. they must exist “between the same people in the same capacity”.  There is a fundamental distinction between assets of a company and rights conferred upon a liquidator in relation to the conduct of the liquidation.  The right to obtain relief section 182 is an incident of the office of liquidators.  A set-off is not applicable here for want of mutuality.
• The Debtor’s proposed claim is contingent on the liquidators succeeding in their section 182 application and the court granting consequential relief.
• To accede to the Debtor’s request is to give some form of security to the Debtor before it even starts the action, which cannot be right. 

Commentary  

This judgment highlights that payments due to an insolvent company but are instead made to a ‘third party’ purportedly designated/authorised by the company may be caught under section 182 and thus be void. One will run the risk of, practically, having to pay the debt twice, with the uncertainty of what redress he may have against the company or the ‘third party’.   

The full judgment is available at: https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=164358.