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Focus: Insolvency – September 2008

Court allows appointment of receiver as liquidator despite potential conflict of interest

In brief: In January 2008, the Court of First Instance in Hong Kong approved the appointment of one of the receivers of an insolvent company as a joint and several liquidator despite the potential conflict of interest. Partner Simon McConnell and Senior Associate Mun Yeow look at the importance of the ruling in Re Orient Power Holdings Limited.

How does it affect you?

  • The decision is ground-breaking because it tackles the conventional thinking that a receiver and a liquidator have conflicting interests and duties towards the secured and unsecured creditors of the company.
  • The court was prepared to exercise its discretion in appointing a receiver as a joint and several liquidator if, on the facts of the case, the conflict of interests and duties could be managed and the interests of the creditors, secured or unsecured, could be served by such an appointment.
  • The court was not hesitant in taking an approach that was contrary to conventional thinking if it was dictated by commercial pragmatism.
  • The court would take into account the wishes of the secured and unsecured creditors in its decision regarding the investigation and liquidation process.

Background

The insolvent company, Orient Power Holdings Limited (OPHL), was originally incorporated in Bermuda in 1991 and registered as an overseas company in Hong Kong. It was the holding company of a group of 56 companies (together, the group) which owed about HK$1.1 billion in secured debt. It was listed on the Hong Kong Stock Exchange.

In 2005, OPHL and some affiliated companies faced substantial lawsuits. That led the group to enter into a debt restructuring arrangement with its creditors and provide security to the lenders for the group's liabilities by way of debentures.

The group's financial status did not improve and the secured creditors ultimately put the companies into receivership and appointed receivers.

The receivers investigated the group's business affairs, resulting in considerable first-hand knowledge of the group's operations. They also found that OPHL had a significant deficit and was insolvent. All readily available assets were recovered towards partial settlement of its large debts and, given the significant amount of the debt, a restructuring of debt was not possible.

In 2007, a winding-up order was made and the court appointed the official receiver as provisional liquidator in accordance with normal practice.

At the creditors' meeting convened after the winding-up order was made, a resolution was passed unanimously appointing Mr Sutton, who was one of the receivers, to act as a joint and several liquidator with another two independent insolvency practitioners. However, at the meeting of contributories, no resolution was passed regarding such an appointment.

The official receiver expressed reservations about the appointment of Mr Sutton as a joint and several liquidator as it was concerned with the potential conflict of interest between a receiver and a liquidator. When it became apparent that there was no contributories' resolution approving that appointment, the official receiver sought directions from the court on the appointment.

The matter came before Justice S Kwan.1 Primarily, the issue was whether Mr Sutton, one of the receivers of OPHL appointed by the secured creditors pursuant to the terms of the debentures, should be appointed a joint and several liquidator.

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General principles

If differences between the creditors and the contributories arise and cannot be resolved, the court is empowered to hold a determination hearing and make an order on the appointment of the liquidator. The court's power derives from section 194(1)(c) Companies Ordinance (Cap 32).

There are general principles that govern the exercise by the court of its powers in appointing liquidators in a determination hearing:

  • First, the discretionary power of the court in appointing a liquidator is wide and unfettered. Any previous resolutions passed at meetings of the creditors or the contributories do not bind the court but the court would have due regard to those resolutions.
  • Second, the court must appoint someone who would work in the 'best interests of all persons interested in the winding up'. If the appointment conflicts, or is likely to conflict with, the best interests of the winding up as a whole, the court should decline such appointment.
  • Third, a liquidator must remain impartial. He must act independently and be seen to be acting independently. Any appointment that would give rise to a prospect of a conflict of interest would normally be considered inappropriate.

In this case, the court noted that there was unanimous support among the secured and unsecured creditors for the appointment of Mr Sutton as a liquidator.

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The official receiver: conflict of interest

The official receiver was concerned that the appointment would give rise to a potential conflict of interest. A liquidator and a receiver operate in separate regimes and for different purposes. On one hand, a liquidator, as an officer of the court, protects the interests of and owes a duty of care to the unsecured creditors. On the other hand, a receiver, whether appointed by the court or a secured creditor under a security, protects the interests of, and owes a duty of care to, the secured creditors.

Specifically, the official receiver pinpointed some instances where a potential conflict of interest between a receiver and a liquidator may arise:

  • a liquidator is empowered under the law to re-fix the receiver's remuneration;
  • a liquidator who is receiver, may be regarded as partial towards the debenture holder in adjudicating proofs of debt;
  • a liquidator has a wide-ranging duty to investigate the reasons for a collapse and to pursue claims where any recovery will form a pool of general assets available to unsecured creditors, while the receiver will only explore the options which will lead to recovery for the secured creditors; and
  • a receiver has the power to manage and realise virtually all assets of the company under the security, whereas a liquidator can only distribute the remaining assets after the completion of the receivership.

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Secured creditors: can conflicts of interest be effectively managed?

In this case, the secured creditors argued that a pragmatic approach should be adopted and that such an approach would be the appointment of Mr Sutton as one of the joint and several liquidators. They argued that the investigation could not be done as quickly, efficiently and cost-effectively if Mr Sutton was not put in charge. It was because of Mr Sutton's role in the receivership that he had acquired substantial knowledge of the group's day-to-day operations and its dealings with customers, suppliers and other third parties. Appointing him as a liquidator could mean utilising this knowledge and potentially facilitating efficient and cost-effective future investigations.

The secured creditors likened Mr Sutton's proposed appointment to that of a 'special purpose liquidator'. Mr Sutton's powers as a liquidator could be curtailed in important respects by the court and by the other two independent liquidators. This would address the official receiver's concern about a potential conflict of interest arising. Specifically, Mr Sutton would operate subject to the following safeguards:

  • Mr Sutton would be empowered to investigate and identify any causes of action available to OPHL or to the liquidators against third parties.
  • His power to bring or defend proceedings would be subject to the approval of the court and the other liquidators.
  • The other two liquidators would have full access to the books and documents held by the receivers, except legally privileged information.
  • Consent from the other two liquidators would be required for the release of any information obtained by Mr Sutton in his capacity as liquidator.
  • Mr Sutton, in his capacity as a liquidator, would not review the receivers' performance and remuneration, their dealings with the assets and the validity of their appointment under the debentures.
  • Any issue of conflict should be referred to the court for directions.

A number of factors in this case supported Mr Sutton's appointment. There was unanimous support of both the secured and unsecured creditors for the appointment. Both the secured and unsecured creditors agreed to fund the appointment of the other two independent liquidators. Finally, there were no proposals from competing appointees and the other two independent liquidators did not object to Mr Sutton's appointment.

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Court's discretion: in favour of the secured creditors

The court made an order in favour of the secured creditors and allowed the appointment of Mr Sutton. The court accepted that the secured creditors did not want new liquidators who would have to start afresh. The work undertaken by the receivers was wide-ranging and complex and involved a team of more than 30 people. In the circumstances, 're-educating' new liquidators would be expensive. Also, it would be difficult to start investigations from scratch when considerable time had already elapsed, witnesses had moved away and previous sources of information had vanished.

Justice S Kwan agreed that the potential conflict of interest could be effectively managed by the safeguards outlined above. In her decision she emphasised the special circumstances of the case:

  • First, there were no financial resources left in the company to fund further investigation. The only way forward was with creditor funding.
  • Second, the secured creditors were only prepared to fund the appointment of Mr Sutton and the other two independent liquidators.
  • Third, there was a public interest to investigate properly the circumstances in which a listed company had become insolvent.

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Importance of the decision

This case is the first instance of an appointment of a receiver as liquidator of the same insolvent company. The interests of the liquidator and the receiver are traditionally different and on many occasions conflicting. So only in rare and exceptional cases would the court approve to have the offices of liquidator and receiver combined in the one person. The circumstances in this case were rare and exceptional enough to give rise to such an appointment.

In the present case, the court took a pragmatic and commonsense approach and was willing to take into account the commercial reality of insolvency and, as a result, the court was prepared to depart from conventional practice.

Footnotes
  1. Re Orient Power Holdings Limited (HCCW 191/2007).

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