Re Sweetmart Garment Works Ltd

HCCW 755/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO. 755 OF 2005

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J U D G M E N T

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Introduction

1. On 30 November 2005, Sweetmart Garment Works Limited (“the Company”) went into compulsory liquidation on a creditors’ petition presented against it by Overseas-Chinese Banking Corporation Limited (“OCBC”) on 28 September 2005. A little over a month prior to the presentation of the petition, the Company had granted a mortgage over the “Florence”, a pleasure craft owned by it, in favour of another of its creditors, the Hong Kong branch of HSH Nordbank AG (“the Bank”).

4. The liquidators and the Bank having been unable to resolve their differences, on 14 May 2007, the liquidators issued the summons which is now before the court. By their summons, the liquidators seek the following relief:-

(1)	A declaration that the mortgage constituted an unfair preference of the Bank by the Company within the meaning of sections 50, 51, 51A and 51B of the Bankruptcy Ordinance (Cap. 6) and section 266B of the Companies Ordinance (Cap. 32) and is, accordingly, void;
(2)	An order that the Bank should pay to the liquidators the sale proceeds of the vessel, together with the interest accrued thereon; and
(3)	Costs.

The relevant statutory provisions

5. Section 266B of the Companies Ordinance provides that in any winding up that commences after the coming into effect of section 36 of the Bankruptcy (Amendment) Ordinance 1996 a reference in section 266 or 266A of the Companies Ordinance shall be deemed to be a reference to an unfair preference as provided for in section 50 of the Bankruptcy Ordinance, and that a reference in section 266 of the Companies Ordinance to “a period of 6 months” shall be read as a reference to either 6 months or 2 years, depending on whether or not the person to whom the preference is given is an “associate” as defined in section 51B of the Bankruptcy Ordinance. Where the person preferred is an associate of the company in liquidation, the longer period is to apply. The effect of sections 266 to 266B of the Companies Ordinance is to apply the unfair preference provisions contained in section 50 to 51B of the Bankruptcy Ordinance to companies in liquidation, with the necessary modifications.

6. Section 50 of the Bankruptcy Ordinance provides, relevantly, as follows:-

“	50.	Unfair preferences
		(1)	Subject to this section an sections 51 and 51A, where a debtor is adjudged bankrupt and he has at a relevant time (defined in section 51) given an unfair preference to any person, the trustee may apply to the court for an order under this section.
		(2)	The court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if that debtor had not given that unfair preference.
		(3)	For the purposes of this section and sections 51 and 51A, a debtor gives an unfair preference to a person if –
			(a)	That person is one of the debtors creditors or a surety or guarantor for any of his debts or other liabilities; and
			(b)	The debtor does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the debtor’s bankruptcy, will be better than the position he would have been in if that thing had not been done.
		(4)	The court shall not make an order under this section in respect of an unfair preference given to any person unless the debtor who gave the unfair preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in subsection (3)(b).
	….”

7. Section 50(5), which provides that where the person to whom the preference is granted is an associate of the debtor within the meaning of section 51B, the relevant desire required by section 50(4) shall be presumed unless the contrary is shown, is not applicable in the present case, as it is common ground that the Bank was not an “associate” of the Company.

8. Section 51(1) provides that in the case of a non-associate, an unfair preference is only susceptible to challenge where it is given at a time in the period of 6 months ending with the date of the presentation of the bankruptcy petition against the debtor. Section 51(2) requires, in addition, that the debtor should have been insolvent at the time of the giving of the unfair preference, or should have become insolvent in consequence of it. For this purpose, section 51(3) provides that a debtor is to be taken as being insolvent if he is either unable to pay his debts as they fall due, or the value of his assets is less than the amount of his liabilities (including prospective and contingent liabilities).

9. Section 51A sets out a (non-exhaustive) range of orders that the court may make in respect of an unfair preference caught by sections 50 and 51, and section 51B defines “associate” for the purposes of sections 50, 51 and 51A. As I have noted, it is not suggested that the Bank was an “associate” of the Company.

The issue for determination

10. It is not in dispute that the granting of the mortgage by the Company to the Bank had the effect of putting the bank in a better position in the Company’s liquidation than that in which it would have been had the mortgage not been granted. This was obviously the case – by the granting of the mortgage, the Bank was transformed from an unsecured creditor of the Company to a secured creditor.

11. It is also clear that the mortgage was granted within 6 months of the presentation of the winding up petition against the Company, and it is not (and cannot seriously be) disputed that the Company was insolvent at the time the mortgage was entered into.

12. The Bank does, however, dispute that the Company, in granting the mortgage to it, was influenced by the desire to put it in a better position than it would have been in had the mortgage not been granted. Whether or not the Company was influenced by such a desire was the sole issue for determination in these proceedings.

The relevant authorities

13. Before I examine the facts that bear upon this point, I should note that both Mr Maurellet, appearing for the liquidators, and Mr Pao, appearing for the Bank, were in broad agreement as to the approach that should be adopted when considering this issue. That approach is as stated by Millett J (as he then was) in Re MC Bacon Limited[1990] BCLC 324, and by Kwan J in Re Phantom Records Limited (unreported, CFI, HCMP 2770 of 2003, 7 December 2006).

14. In Re MC Bacon Limited, Millett J explained the difference between the old test of “dominant intention to prefer” and the new test of “influenced by the requisite desire” as follows (at 335e to 336d):-

“

This is a completely different test. It involves at least two radical departures from the old law. It is no longer necessary to establish a dominant intention to prefer. It is sufficient that the decision was influenced by the requisite desire. That is the first change. The second is that it is no longer sufficient to establish an intention to prefer. There must be a desire to produce the effect mentioned in the subsection.

The second change is made necessary by the first, for without it it would be virtually impossible to uphold the validity of a security taken in exchange for the injection of fresh funds into a company in financial difficulties. A man is taken to intend the necessary consequences of his actions, so that an intention to grant a security to a creditor necessarily involves an intention to prefer that creditor in the event of insolvency. The need to establish that such intention was dominant was essential under the old law to prevent perfectly proper transactions from being struck down. With the abolition of that requirement intention could not remain the relevant test. Desire has been