In August, the court in Re Carnival Group International Holdings Limited [2022] HKCFI 2668, ordered directors of the Chinese property development company to be joined as defendants for the purposes of potentially having costs awarded against them personally because of their conduct (see Hogan Lovells alert The carnival is over – directors face cost consequences of opposing winding up).
The Honourable Madam Justice Linda Chan has now ordered four of the director respondents to bear the costs caused by the company's continued opposition to the petition at the hearing in August, yet spared two other directors who had resigned and had no involvement in maintaining opposition to the petition.
Property woes
Carnival Group (the company, which is not affiliated in any way with Carnival Corporation & plc) was a Bermuda-incorporated investment and property development holding company with shares listed in Hong Kong (HK:996). It had subsidiaries in Hong Kong, the mainland and the BVI (the group). The group developed and operated restaurants and theme-based leisure complexes in the mainland.
The petitioner was described as an "immigration bondholder" who held a number of senior unsecured bonds, all of which matured by 2 June 2019. The company defaulted on the bonds. As at the date of the petition, the outstanding principal on the bonds was in excess of HK$30 million. The petition was supported by 99 other creditors who were owed more than HK$878 million.
A winding up order was made on 10 March 2020. The only ground advanced by the company in opposition to the petition was that there had been an ongoing restructuring in respect of the company's indebtedness which it said would result in a higher return to the unsecured creditors. The court was dismissive of the efforts and on 23 August 2022 after numerous adjournments, made the winding up order.
The directors were ordered to show cause as to why they should not be liable to pay the costs of and occasioned by the company's continued opposition to the petition.
Linda Chan J noted that three independent non-executive directors (INED's) had filed almost identical statements, all saying they believed the company should continue as a going concern with its listing status preserved to allow time for the proposed restructuring of a mainland subsidiary.
The three executive directors echoed these sentiments, arguing that the restructuring would 'raise HK$66 million and the proceeds would be 'prioritised' by the Company for repayment of interest due to the immigration bondholders with a view to facilitating discussion and possibly agreeing on a restructuring plan with the Company".
A hollow assertion
Linda Chan J noted that it was clear that creditors had seized the project as early as July 2021, which meant that "from July 2021 onwards, there was no basis for the directors to hold the view that it was possible to sell any units in the Project, still less to generate any proceeds for the Company". This was an assertion that rang "very hollow".
The court also criticised the directors for only having dealt with the onshore creditors, who were creditors of the subsidiaries and held the projects concerned as security, noting "it must be clear to the directors that unless all the amounts due to the onshore creditors were repaid in full, no proceeds would be available for payment to the Company." The directors "never approached the immigration bondholders (to whom HK$1.155 billion was owed) to discuss or obtain their in-principle agreement to restructure the debts owed to them". As such, it was difficult to see how they could come to the view that the company should oppose the petition.
Linda Chan J said the responsible thing to have done would have been to disclose the true financial state of the company (and the group) to the creditors and court and ask for time to progress the proposed restructuring.
For these reasons, the court held the four respondents liable to pay the costs incurred by the petitioner, the supporting creditors and the Official Receiver in dealing with the company's continued opposition to the petition.
"No disagreement"
Two other INED's who had earlier resigned, escaped any liability to pay costs. Both directors gave their reasons for resigning as wanting to spend more time pursuing their own businesses, with one resigning on 15 May 2021 and the other with effect from 3 September 2021, both resignations coming long after the original date of the petition (10 March 2020), and the latter coming several weeks after the July 2021 date when Linda Chan J said there was no basis for directors to hold the view that proceeds might be generated for the company.
It appears the court took the view that it was the date of the August 2022 hearing (23 August 2022) that represented the "line in the sand" for the court in terms of the company's continuing opposition to the winding up, thereby relieving these two resigning INED's from any personal cost liability.
In their resignation announcements, both directors stated that they had confirmed to the board they had "no disagreement with the Company" and that there were no other matters in respect of their resignations that should be brought to the attention of the shareholders of the company and the Stock Exchange.
Interests of creditors
In the August decision in Carnival, Linda Chan J stressed the obligation on directors to consider whether there is any reasonable prospect of the company avoiding going into insolvent liquidation. She added that "in the absence of a viable restructuring proposal which has the support of the requisite majorities of creditors, it would be incumbent upon the directors to take steps to put the company into liquidation so as to bring into operation the statutory scheme of winding up its affairs and assets."
Linda Chan J also noted the principle that "where a company is insolvent or of doubtful solvency, the interests of the company are in reality the interests of the creditors as it is the creditors' money which is at risk." The directors, she said, "must consider the interests of the creditors as paramount and take those into account when exercising their discretion."
The United Kingdom Supreme Court has recently given its view on when the directors' duty towards creditors is engaged. In BTI 2014 v Sequana SA and others [2022] UKSC 25, the court ruled that the duty to consider creditors is triggered only when a company is insolvent or on the brink of insolvency, rather than at some earlier time when signs of insolvency risk first appear (see Hogan Lovells client alert Creditor Duty – the position after the Supreme Court decision in BTI v Sequana and others).
In the case of Sequana, the company in question did go into administration, but not until nearly ten years after a controversial dividend was paid. In Carnival, the directors and INED's knew from March 2020 at the latest that a winding up petition was in place and should have been alive to the solvency position and the need to consider the interests of creditors.
In the absence of any wrongful trading regime in Hong Kong, the personal costs order in Carnival may prove to be a wake-up call for directors who will need to carefully analyse whether, in the face of similar creditor pressure, a restructuring proposal under discussion is really viable and justifies the directors in not taking steps to put a company into liquidation.
Authored by Jonathan Leitch and Nigel Sharman.
