Section 42 of the Bankruptcy Ordinance (Cap. 6) (“BO”) provides that where a person is adjudged bankrupt, any disposition of property made by that person from the date of presentation of the bankruptcy petition is void unless made with the consent of the Court or unless subsequently ratified by the Court. The purpose of this section is to prevent the improper dissipation of the bankrupt’s assets once a bankruptcy petition is filed and to protect the principle of pari passu distribution. Third parties who have received payments from the bankrupt in breach of this provision are required under section 42(2) of the BO to hold those payments as part of the bankrupt’s estate.

The decision of Lam J. in Re Lee Priscilla Hwang [2014] 5 HKLRD 634 considers the question of locus standi to bring an application for validation of section 42 payments and shows that the Court will not entertain lightly any such application for validation, and will even dismiss the application, if it considers that not all interested parties were made parties to the application.

Background

A bankruptcy petition was presented against Priscilla Lee (“PL”) on 27 May 2009 and served on her on 1 June 2009. The bankruptcy order was made on 31 August 2009. Between the date of presentation of the bankruptcy petition and the making of the bankruptcy order, payments totalling approximately HK$1.63 million (according to PL’s own calculation) were made by OCHKL, a company of which PL was a director, directly to third parties. OCHKL purported to set off these payments against a loan of HK$5 million made by PL in February 2009. PL claimed that OCHKL had paid certain expenses on her behalf as her agent to third parties.

PL sought to validate the HK$1.63 million payments under section 42 of the BO, arguing that there was no relevant disposition in favour of OCHKL to which section 42 applied. The application was opposed by PL’s Trustees in Bankruptcy.

Arguments put forward by PL in support of her validation application

PL tried to argue that her HK$5 million loan to OCHKL was in substance a “prepayment of personal expenses” and that OCHKL had acted as PL’s bank or agent in making those payments.

Relying on the English Court of Appeal decision in Hollicourt (Contracts) Ltd (in liq) v Bank of Ireland [2001] Ch 555 (which held that the bank would not be liable in relation to payments in and out of an account in credit, as the bank’s role was merely that of an agent or part of the process by which dispositions were made), PL tried to argue that the only disposition falling within the scope of section 42 of the BO was the payments to the third parties and that there was no relevant disposition in favour of OCHKL that attracted the application of section 42.

Arguments put forward by the Trustees against validation of payments

The Trustees argued against validation of the payments on the basis that:-

  1. PL had no locus standi to make the validation application on the basis that all rights of action which relate directly to the bankrupt’s estate pass to the trustees upon bankruptcy and the only rights of action which remain with the bankrupt are actions which are personal in nature, such as actions relating to personal injury, personal inconvenience or damage to reputation. Accordingly, PL had no interest in the property in her estate and the result of the validation application would have no effect whatsoever on her financial position.
  2. There was no contemporaneous evidence to show that OCHKL acted as the agent of PL as alleged.
  3. OCHKL was simply a third party who agreed to pay certain expenses on behalf of PL. Whilst OCHKL was free to agree with PL that it would pay expenses on her behalf, section 35 of the BO operated to ensure that no set off against PL’s loan was available after OCHKL received notice of the bankruptcy petition on 1 June 2009. Accordingly, the Trustees argued that any payments made by OCHKL on behalf of PL after 1 June 2009 would be made at its own risk.
  4. Relying on the Court of Appeal’s decision in Bank of East Asia Ltd v Rogerio Sou Fung Lam and another t/a Lam & Co (a firm) [1988] 1 HKLR 181 (where the Court based its decision upon the assumption that payments of cheques both into and out of a bank account are dispositions), even if OCHKL acted as an agent, there was nonetheless a disposition of PL’s property when her credit balance with OCHKL was reduced, in addition to the disposition in favour of third party payees.

Decision

The Court dismissed PL’s validation application on the basis that the application was not properly constituted.

The Court found that neither OCHKL nor the third party payees were made parties to the application. The Court said this was no mere technical objection. This is because the third party payees might contend, as the Trustees did, that they had been paid by a separate person, i.e. OCHKL, who was not acting as PL’s agent and that the payments they received were not caught by section 42 of the BO and that they were not at risk of having to repay any sum to the Trustees.

The Court ruled that PL had no financial interest in the outcome of the application and thus had no standing to seek ratification of the payments made. In fact, the Court went as far as to rule that PL appeared to be seeking some sort of reputational redress and that this was not a proper basis for the application.

Conclusion

The Court’s decision shows that unless the applicant seeking section 42 validation has proper standing in making the application (and is not using the application for an ulterior purpose) and that all proper parties are made party to the application, the Court may not entertain any substantive arguments which the applicant might put forward and will dismiss the application outright on the basis that it was not properly constituted.