In the bankruptcy proceedings in respect of Mr Gabriel Ricardo Dias-Azedo (the "Bankrupt"), the Court of First Instance recently exercised its discretion under sections 37(2) and 97 of the Bankruptcy Ordinance (Cap. 6) (BO) in favour of two creditors and granted them a priority claim against the Bankrupt's estate for their costs in preserving his assets incurred before receiving notice of the bankruptcy petition.
The Bankrupt, a former managing partner of a professional services firm, fled Hong Kong in 2009 after allegedly defrauding his clients and friends of millions of dollars. Ms Angela Rita Gardner (the "Petitioner"), a distant cousin of the Bankrupt, obtained a Mareva injunction against the Bankrupt because he had failed to account for or return any of her US$9 million investments. In 2010, the Petitioner entered default judgment and then presented a bankruptcy petition against the Bankrupt on the ground that he failed to comply with a statutory demand based on the default judgment. Mr and Mrs Arthur Antonia Da Silva (the "Funding Creditors"), long-time friends of the Bankrupt, were notified of the bankruptcy petition the next day. Despite the Funding Creditors' opposition, a bankruptcy order was made1 and trustees in bankruptcy were duly appointed.
Before the Funding Creditors had notice of the bankruptcy petition and the trustees' appointment, they had incurred substantial legal costs in tracking down and pursuing the Bankrupt's assets. As a result, several of the Bankrupt's properties, including some which were not specifically identified in the Mareva injunction obtained by the Petitioner, were preserved through various enforcement proceedings undertaken on behalf of the Funding Creditors.
The Funding Creditors applied to recover their costs from the Bankrupt's estate and in the same priority as costs of the petition pursuant to sections 37(2) and 97 BO.
Section 37(1) BO governs the normal priority of the expenses of a bankruptcy. Taxed costs of a petition enjoy a high priority and are to be met just after "the fees, charges and percentages prescribed in the Bankruptcy (Fees and Percentages) Order (Cap 6 sub. leg. C) and payable to the Official Receiver, and costs, charges and expenses incurred or authorized by, the Official Receiver…".
Section 37(2) BO confers on the court a discretion to modify the normal rules of priority set out in section 37(1). The provision provides:
(2) Whenever the court is satisfied that property of a bankrupt…has been preserved for the benefit of the creditors by means of legal proceedings brought by a creditor against the bankrupt without notice of presentation of the petition, the court may in its discretion order the payment of the costs of such legal proceedings or any part of them (taxed as between party and party) out of the estate, with the same priority as to payment as is herein provided in respect of the taxed costs of the petitioner[emphasis added].
Section 97 BO is broadly drafted and, on its face, provides the court with "full power to decide all questions of priorities and all other questions whatsoever, whether of law or fact", although there is authority suggesting that this provision "does not give power to the court to confer upon any particular party any advantage or priority over other parties if such advantage or priority does not exist"2.
Correct Construction of Section 37(2) BO
Direct authorities on section 37(2) BO are scant and not particularly illuminating. The Petitioner, who opposed the Funding Creditors' application for priority, invited the learned judge to consider a number of authorities in which section 38(5B) BO and section 265(5B) of the Companies Ordinance (Cap. 32) were discussed, because these provisions also concern the discretion of the court in deciding priority issues where assets of the estate are, among other things, "preserved" by a creditor. However, it was held that these provisions do not assist when section 37(2) BO is to be construed.
The learned judge recognised that the court's discretion to vary the statutory order of priority should be exercised cautiously as it will affect the principle of pari passu distribution. Noting the word "preserved" in section 37(2) BO "has no single recognised legal meaning which fits all situations", the learned judge held that the word should be given its "natural and ordinary meaning", "which is to keep safe from harm, injury, damage or loss". In the present case, the Funding Creditors "preserved" the properties of the Bankrupt by means of legal proceedings so as to keep them "safe from unlawful dissipation or removal from the jurisdiction"3.
The Petitioner argued that "the Funding Creditors' legal proceedings were not… for the benefit of the creditors"; they "were motivated by purely selfish desires". The learned judge held that section 37(2) BO does not require the applicant to have "a benevolent or altruistic intent or motive" at all. The focus should be "on the effect of the legal proceedings taken by the applicant, not his subjective intention or motive".
It was held that "the Funding Creditors' legal actions in Hong Kong and UK did have the effect of preserving the Bankrupt's properties". In his Lordship's view, on a balance of probabilities, additional properties "previously unknown to [the Bankrupt's] creditors, or some of them would not have been tracked down, or tracked down so promptly, and those known assets would be at risk of being dissipated". The court held that ultimately, "[t]he Petitioner, as well as the Bankrupt's other creditors, stood to benefit from this enlargement of the pool without undertaking any financial risk". The Funding Creditors should be rewarded for its pro-active endeavours in preserving the Bankrupt's properties.
In the exercise of its discretion, the court made an order under section 37(2) BO in favour of the Funding Creditors.
It is conceivable that situations may arise in both personal and corporate insolvencies justifying the conferment of priority to particular claims against the insolvent estate. Because of this, the decision noted in this article is potentially relevant to not only bankruptcy cases in future (given there are not many authorities illustrating the application of section 37(2) BO) but also to company liquidations.
1 Re Gabriel Ricardo Dias-Azedo  5 HKLRD 474.
2 In Re Wu Kit Ping Stella T/A Lee Yuen Electrical Co.  2 HKC 614 at paragraph 17. Interestingly, the court in Re Yun Yip Auto Services Ltd (HCCW 84 of 1990, 18 June 2002) accepted that a similar (but not identical) provision applicable to corporate insolvencies, namely section 220 of the Companies Ordinance, does give the court a discretion to, in effect, vary the order of priority under rule 179 of the Companies (Winding-up) Rules. With due respect to the Honourable Mr Justice Patrick Chan (as his Lordship then was), if the ruling in Re Wu Kit Ping Stella is correct, that is, the word "decide" in section 97 BO does not include a discretion on the court to confer an otherwise non-existent priority, it is unclear what the section can amount to in practice other than statutory surplusage.
3 Re The Nam Tai Lung Firm, Ex parte The Tak Shun Bank (1936) 28 HKLR 35.