On a recent Mayer Brown JSM application (on behalf  of the Liquidators of one of the Lehman Brothers  entities) to reduce and expunge proofs of debt, the  Hong Kong High Court has ruled that creditors who  receive an overpayment of dividends due in respect of  a proof of debt which has been “improperly  admitted” (rule 96, Companies Winding-Up Rules)  must give credit for those overpayments before  receiving further dividends in the liquidation (Re  Lehman Brothers Commercial Corp Asia Ltd (“LBCCA”) [2014] HKEC 849) (“Proof Application”).

In the Proof Application Harris J adopted the  English common law position that a creditor who has  been overpaid interim dividends is not entitled to  receive any further payment out of the estate until  the payments to the other creditors have been  levelled up to the amount received by the overpaid  creditor.

Factual Background

The liquidators of LBCCA admitted two proofs of  debt from a single creditor (“Admitted Proofs”).  Following admission of the Admitted Proofs the  liquidators paid interim dividends to the creditor  calculated on the value of the proofs as admitted. As  the liquidators’ investigations progressed it was  understood that the calculation of certain debts  against LBCCA had been carried out using one  method of calculation, but that another method was  to be preferred. The preferred method altered the  debt positions as between LBCCA and the creditor  which, in turn, called for one of the Admitted Proofs  to be reduced, and the other expunged in its entirety.

While the debts due from LBCCA to the creditor had  reduced, the interim dividends that had been paid  had been calculated at the full amount of the  Admitted Proofs. This resulted in the creditor  receiving a higher rate of dividend payment than was properly due. The question for the Court was whether  the overpayments could be recovered from the  creditor by way of set-off against future interim  dividend payments. The Court held that the  overpayments could be recovered in this way.

Jurisdiction to Manage Improperly  Admitted Proofs

A central function of a liquidator is to determine  whether a proof of debt should be admitted or  rejected in a liquidation. In fulfilling this function a  liquidator acts in a quasi-judicial capacity.  Liquidators have a duty to distribute the available  assets of the debtor to the general unsecured  creditors in proportions commensurate with the  liabilities of LBCCA to those creditors (Re Van Laun;  Ex Chatterton [1907] 2 KB 23). Once proofs have  been adjudicated a liquidator appointed in a  compulsory liquidation does not have the power to  unilaterally amend the value of or reject those proofs.  That jurisdiction resides with the Court, as set down  in CWR Rule 96 which states that “If the liquidator  thinks that a proof has been improperly admitted, the  court may, on the application of the liquidator, after  notice to the creditor who made the proof, expunge the  proof or reduce its amount” (“Rule 96”).

Rule 96 permits an application for a proof to be  reduced or expunged where the liquidator considers  that proof to have been “improperly admitted”.  Whether a proof has been improperly admitted is  determined on a case by case basis but the reference  to a proof being “improperly admitted” has been  found by the courts, in both England and Hong  Kong, not to carry with it any moral opprobrium; it is  simply a factual question of whether the proof ought  to have been admitted or not (Re Globe Legal Services  Ltd; Re Tse Lee Yuen Jewelry Ltd [1984] HKC 352).

Recovery of Overpayments

It is an integral part of the pari passu principle,  which is central to the Hong Kong insolvency regime,  that liquidators ensure that the property of a debtor  company is properly distributed to the company’s  creditors and that no creditor receives more than he  is entitled to. While the CWR designates how proofs  may be reduced or expunged, the rules do not  stipulate how overpayments of dividends to a creditor  should be treated or whether the overpaid creditor is  obliged to repay the excess to the estate. In contrast,  the statutory position in the UK has been amended  and where, in an English liquidation, a creditor’s  proof is reduced after dividends have been paid, that  creditor is liable to repay to the office-holder the  amount of the overpayments (Insolvency Rules 1986  r.11.8(3)).

Notwithstanding silence of the statutory scheme in  Hong Kong on this point, the common law has held  that a creditor who has received an overpayment  from a liquidation is not obliged to repay those funds  in the event his proof is expunged (Ex p Harper re  Tait (1882) ChD 537). Ex p Harper held that a  creditor whose proof was expunged was not entitled  to receive further dividends but that expunging  worked only prospectively, and did not have  retrospective effect. Accordingly, an overpaid  creditor may retain excess dividends that have  previously been paid. It was stated by Jessel MR that  “no injustice can be done, because any dividends  which have already been paid are allowed to be  retained by the creditor, and the expunging affects  only the right to receive future dividends.” (at 541).  This position is consistent with the finality of  dividends and accords with the principle that  dividends once paid cannot be disturbed.

The court in ex p Harper was not required to  consider whether the overpaid creditor was required  to give credit for the excess dividends that had been  paid because that case involved expunging a proof so  no question of future interim dividends or how those  dividends should be treated arose. However, the  position was considered in Re Searle & Hoare [1 92 4]  2 Ch 325. In this case the court held that, a creditor  who has received more than he is entitled to from an  insolvent estate is not permitted to receive future  dividends without first giving credit for the  overpayments that have been made. As stated by  Lawrence J, “The mere fact that the trustee cannot  recover either payments made to a person whose proof is subsequently expunged or overpayments  made to a creditor whose proof is subsequently  reduced does not, in my opinion, prevent the well  known principle in equity that a beneficiary who has  been overpaid is not entitled to receive any further  payment out of the trust fund until the payments to  the other beneficiaries are levelled up to the amount  received by the overpaid beneficiary” (at 328).  Accordingly, the common law provided that creditors  who received overpaid dividends were obliged to give  credit in respect of that overpayment when  participating in future dividends. This, it is  suggested, accords with the pari passu principle.

The Decision

As remarked by Harris J, there are no Hong Kong  authorities addressing the issue as to how overpaid  interim dividends should be dealt with. In the  absence of a statutory indication as to how the  position should be remedied, the Court adopted the  common law position and held that a creditor was  required to give credit for the amount of the overpaid  dividends by an effective set-off being applied against  future dividend payments payable to that creditor.

Accordingly, in paying future interim dividends to  the creditor, the liquidators of LBCCA could deduct  from the dividend due an amount representing the  value of the overpaid dividends.

Comment

In following the common law position in Hong Kong  the Proof Application provides useful guidance to  liquidators and creditors alike who may find  themselves in the position of having paid or received  (as the case may be) an excess level of interim  dividends. However, it remains the case in Hong  Kong that, absent a statutory liability to repay excess  dividends, a creditor who has received a final  dividend in excess of what is properly due to him  because of an overstated proof of debt is entitled to  retain the benefit of the overpaid dividend where  there are no further dividend payments against  which deductions might be made.