Liquidators entitled to “go behind a judgment” in adjudicating proofs of debt

Introduction

One of the main responsibilities of a liquidator in winding up by the court is to adjudicate claims of creditors. This process begins with the liquidator fixing a date by which creditors are to prove their claims.¹ Once a proof of debt is received, the liquidator will have 28 days to respond in writing. He may either admit or reject the proof in whole or in part. The liquidator may also require additional evidence from the creditor to substantiate its claim. If eventually the liquidator rejects a proof, he must state the grounds of the rejection.² Those who are dissatisfied with the liquidator's rejection of their proofs of debt may apply to the Hong Kong court to reverse the decision within a 21-day period.³ The court will then conduct a hearing de novo, treating the matter as though it is being determined for the first time. However, the court does not lightly disturb the liquidator's decision. A body of case authorities has stressed the importance of an applicant having to discharge his burden of proving a real debt by credible evidence.

Re Primlaks (H.K.) Ltd (in Liquidation)⁴ is a recent illustration of the court's approach. The subject proof of debt in this case was lodged by a petitioning creditor claiming sums of US$9,333,672.35 and HK$15,872.21. These sums represented a judgment debt plus interest under a default judgment⁵ entered against the company in respect of four alleged loans that were advanced in the early 1990s. Despite the existence of the judgment, the liquidators of the company admitted US$1,007,959.60 only and rejected the rest. The liquidators based their decision on the ground of lack of contemporaneous documents evidencing the existence of the loans. The liquidators also observed that credit entries of such loans were recorded in the books of the company's fellow subsidiaries, which suggests that they were loans advanced to the subsidiaries instead of the company.

Unsatisfied with the result, the creditor took the matter to the Hong Kong court with a view to reversing the liquidators' decision.

Applicable principles

The court approached the creditor's application with the following established principles in mind:

• An appeal against a liquidator's adjudication is a hearing de novo, at which the court may confirm, reverse or vary the liquidator's decision.
• The purpose of the hearing is for the court to determine to what extent the applicant should be allowed to rank as a proving creditor. Therefore, the court is bound to decide the rights of the applicant in the light of all of the evidence, which is before the court, and not merely to express a view as to whether the liquidator was right or wrong in rejecting the proof on the evidence then available to the liquidator at the time he rejected it.
• A liquidator who defends his decision to reject a proof is no longer acting in a quasi-judicial capacity, but is cast in the role of an adversary.
• The onus of proof is on the applicant to show, on a balance of probabilities, that a real debt is due to him.
• The requirement for a liquidator or trustee in bankruptcy in admitting or rejecting a proof is to require some satisfactory evidence that the debt on which the proof is founded is a real debt, and this is a relatively low threshold. Nevertheless, the liquidator or trustee is entitled to go behind mere form so as to get at the truth.
• On an appeal against the rejection of a proof, the applicant's burden is to prove a real debt, to be established by credible evidence.
• Hence, there may be cases, for example where probative evidence is scarce, where the incidence and standard of proof has some significance. The burden remains with the applicant to establish proof of the claim on the balance of probabilities on whatever evidence is produced.
• The applicant is not entitled to say that his claim should be admitted because this is all the evidence that he has and because the best evidence has been lost or destroyed. Even in such a situation, the burden remains with the applicant to prove his claim on the balance of probabilities on the evidence as is produced.
• But the court is not bound to accept at face value any accounts of a company previously prepared and is entitled to go behind them to form its own conclusion as to the truth. Even if the accounts in question have been audited, where there is evidence to show that the accounts are or may be inaccurate, or to cast doubt on the way in which the auditor carried out his duties, this will be a factor to take into consideration.

The court also highlighted that in deciding whether to admit or reject a proof of debt, a liquidator carries out a quasi-judicial function. In such position, he does not act on behalf of the company and hence may go behind a judgment or a stated account which before the winding up would have been binding on the company. The usual grounds under which a liquidator may go behind a judgment include fraud, collusion or miscarriage of justice, i.e. for some reason there ought not to have been a judgment.

The court's ruling

The court first addressed the creditor's argument that there was no basis for either the liquidators or the court to look behind the default judgment and form its own view on whether the alleged debts exist. The creditor pointed out that the default judgment (which formed the basis of the winding-up petition) and a charging order absolute⁶ in respect of the judgment sum were never challenged by anyone, including the liquidators. Nor was there any allegation or suggestion that there was any fraud, collusion or miscarriage of justice in obtaining the default judgment.

These contentions were rejected by the court in their entirety. The court held that a liquidator is not required to challenge the judgment (or a charging order granted in respect of the judgment) before looking behind the judgment. The court also found that it was sufficiently clear that the liquidators' case is based on an alleged miscarriage of justice in the default judgment in the sense that had the company properly defended the proceedings, it would have succeeded in establishing that the alleged loans were not owed by the company. The court accepted that where a proof of debt is based on a default judgment, the ground of "miscarriage of justice" may be particularly relevant. This is because a default judgment, by its very nature, involves a one-sided presentation of the facts, the objectivity and accuracy of which may be subject to challenge or further scrutiny.

In the end, having considered all the evidence, the court confirmed the liquidators' decision in rejecting the creditor's proofs and dismissed the creditor's application with costs. In so ruling, the court observed that there was no documentation recording or evidencing the existence of the alleged loans or their terms. The creditor also failed to adduce any evidence explaining the genesis of the loans, such as whether they were entered orally or in writing. Worse still, the available contemporaneous documents, in many instances, apparently show information which directly contradicts the creditor's case.

Commentaries

In the 21st century, one rarely negotiates and reaches agreements without leaving any form of documentary record or electronic footprint, especially when dealing with agreements worth millions of dollars. However, the situation in the older times could be materially different. For example, the more convenient means of communication like emails and text messages were either not prevalent or even not available at all. In some cultures, businessmen may prefer striking deals on the basis of mutual trust and respect, and they never see a need to reduce agreements to writing.

Be that as it may, liquidators shall apply a principled approach to the task of adjudicating proofs of debts. Given their duties to the general body of creditors, liquidators must carefully examine all available evidence and in appropriate cases be prepared to "go behind a judgment". It is, however, incumbent on the creditors to discharge their burden of proof by credible evidence.

1. See section 226(e) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance and Rule 93 of the Companies (Winding-up) Rules (CWUR).
2. Rules 94 and 104 of CWUR.
3. Rule 95 of CWUR.
4. [2024] HKCFI 752.
5. A default judgment is one that is obtained as a result of procedural default on the part of the defendant, without any adjudication on the merits of the plaintiff's claim.
6. Where a creditor has obtained a judgment against a debtor, the creditor can enforce the judgment by applying for a charging order against properties of the debtor. The grant of a charging order absolute creates an equitable charge over the subject properties of the debtor in favour of the creditor, which serves as security for payment of any money due under the judgment.

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