To Sue or not to Sue – A Liquidators’ Perspective

By Wong Teck Meng & Derek Lam

Time and time again liquidators of insolvent companies and trustees of bankrupts are faced with potential litigation which they must decide whether to commence or continue.  This is the first of two posts which aims to put into perspective the risks faced by liquidators and trustees alike and to highlight the difficulties encountered by an office-holder when deciding whether or not to pursue claims for the benefit of the general body of creditors. Since the position of each office-holder is different, the first part of the series will focus on litigation in a liquidation.  The second part will focus on the costs and risk of litigation in a bankruptcy.

Liquidators are frequently criticised by angry creditors who believe one of their roles is to pursue each and every possible piece of litigation for the benefit of creditors, but without fully understanding (or at the very least appreciating) the costs of doing so and the risks undertaken by liquidators if they do so.

Background

Pursuant to S.183 of the Companies Ordinance (“CO”):

“When a winding-up order has been made, or a provisional liquidator has been appointed, no action or proceeding shall be proceeded with or commenced against the company except by leave of the court, and subject to such terms as the court may impose.”

Pursuant to section 199 of the CO, liquidators may, with the sanction either of the court or the committee of inspection, bring or defend legal proceedings in the name and on behalf of the company.

The question of whether or not to bring or defend any action includes both commercial and risk considerations.  Before bringing or defending any actions, a prudent liquidator must consider the merits of the case, whether  the action has a reasonable prospect of succeeding, whether the party being sued is a “man of straw” or is good for the money and whether any recovery is likely to exceed the costs that are likely to be incurred.

These costs include legal fees, security for costs, Court fees, liquidators’ fees and other out-of-pocket expensesand, more importantly, any order for adverse costs that might be made against a liquidator personally.

Who is liable for costs in an unsuccessful action?

Where a liquidator conducts litigation in the name of the company and has acted reasonably, the costs of an unsuccessful action will be against the estate of the company in liquidation and not the liquidator personally.   Unfortunately, the majority of liquidations in Hong Kong have few or no realisable assets that a liquidator can utilise to meet any cost orders. Although these cost orders are a first charge on the liquidation estate, and rank in priority of the liquidators’ own cost and those of his/her legal advisors, the risk for the successful litigant is that the assets in the liquidation estate are insufficient to satisfy any cost orders in full.

In these actions, liquidators must be careful not to be named as a party to the action, and if they are named to ensure that they are named as agents of the company. However, a liquidator must also be careful of a third party costs order which may be made against him personally if his conduct was unreasonable or that he failed to exercise reasonable care and skill.

At all times prior to commencing or continuing proceedings a liquidator must be cognisant of the standard expected of a Court appointed office-holder who at all times, should act in an independent and professional manner.  If the manner in which a liquidator conducts the litigation lacks either, he may find himself made personally liable for a part if not all of  any adverse costs.

However, there are certain legal actions which a liquidation can only bring in his/her personal name.  Chief among these are void dispositions (s.182 of the CO) and unfair preferences (s.266 of the CO). These actions have to be brought by the liquidator personally and so he has to suffer the impact of any order for adverse costs, even though he retains the right to an indemnity out of the assets of the company.

The other QQ

In the recent case of The Joint and Several Liquidators of QQ Club Limited (in liquidation) v. Golden Year Limited (HCCW 245/2011) The liquidators were initially concerned that following the UK case of Lewis v IRC Re Lewis V IRC [2001], the Hong Kong Court would consider an unfair preference claim as not being ‘an asset’ of the company as at the commencement of the liquidation and therefore they might not be able to recover any costs, including their own legal costs.

In the Lewis case, the English Court of Appeal held that costs of unsuccessful avoidance proceedings were not an expense of the liquidation and were not recoverable from the assets of the company.  The reasoning was that the avoidance claim was not an ‘asset’ in existence as at the commencement of the liquidation.  The Court also held that funds recovered from unfair preference claims were not assets of the company but were held on trust by the liquidator for distribution to creditors.  As a consequence, the costs of a successful application were not regarded as an expense of the liquidation.  This judgment was based on the then Insolvency Act 1986.  Amendments to the UK legislation were introduced in 2003 so that properly incurred costs or expenses relating to the conduct of any legal proceedings which the liquidator has the power to bring or defend, could be recovered from the assets of the company.

However, the Hong Kong Court considers that the Hong Kong statutory framework is different from the English framework and in the QQ Club case held that the liquidators’ fees and expenses for successfully pursuing an unfair preference action claim fell within the opening paragraph of Rule 179 of the Companies (Winding-up) Rules (“CWUR”). That is, they rank higher than the Official Receiver’s costs and those of the petitioner.

The Court held that pursuant to Order 62 rule 6(2) of the High Court Rules, liquidators were entitled to recover any part of their costs not recovered from the respondent out of the company’s assets.  Though it is unclear whether this decision extends to other legal actions in which a liquidator brings an action in his personal name, it is difficult to see why other avoidance claims should be treated differently.

It does however, super prioritise part of the legal costs from the sixth “Next” of rule 179 of the CWUR to within the meaning of ‘fees and expenses properly incurred in preserving, realising or getting in the assets’ in the opening paragraph of that rule.

Conclusion

Prior to bringing or defending any legal action, liquidators should ensure that the liquidation estate has sufficient assets to meet the costs of their legal advisers.

Any liquidator litigating in his own name risks becoming personally liable for any adverse costs in the event that the action is unsuccessful..  It would be advisable for a liquidator in those circumstances to ensure that he has an effective indemnity against the company’s assets or perhaps from a third party.

If a liquidator litigates in the name of the company, he risks costs orders against the company which would rank higher in priority than his remuneration and the fees of his legal advisers.