Liquidators do not require Court Approval for Litigation Funding Agreements

Re Patrick Cowley and Lui Yee Man, Joint and Several Liquidators of the Company, is another welcome decision of the Hong Kong Companies Court supporting third-party funding in the insolvency context, write Robin Darton of Tanner De Witt and James Wood, Barrister-at-law.

Background

On 27 May 2020, the Hong Kong Companies Court held in Re Patrick Cowley and Lui Yee Man, Joint and Several Liquidators of the Company [2020] HKCFI 922 that it is not necessary for a liquidator to obtain the court’s approval before entering into a third-party litigation funding agreement.  In that case, the relevant insolvent company did not propose to assign its causes of action outright to the funder.  Rather, in exchange for the funding, the insolvent company acting at the direction of its liquidators (the “Liquidators”) were to assign pursuant to the funding agreement a defined portion of any proceeds of the proposed litigation to the funder if the litigation proved to be successful, including a portion of any damages recovered and financial settlements.

Why directions were sought

Although the use of third-party litigation funding has experienced significant growth in a number of jurisdictions, funders have continued to be cautious in Hong Kong because under Hong Kong law champerty and maintenance remain not only torts but also criminal offences.  The long established “insolvency exception” to champerty and maintenance has been recognised here, including by our highest court, the Court of Final Appeal in Unruh v Seeberger (2007) 10 HKCFAR 31.  That case referred to the exception existing in bankruptcy but it is clear the same principles extend to corporate insolvencies (see Re Cyberworks Audio Video Technology Ltd [2010] 2 HKLRD 1137 and also the House of Lord’s decision in Norglen Ltd (in Liquidation) v Reeds Rains Prudential Ltd [1999] 2 AC 1, 12D).

Given this caution, it had become common practice for insolvency practitioners to seek the approval of the Companies Court to enter into funding agreements, and for funders to require such approval.  Whether the Liquidators actually required the Companies Court’s approval before entering into the funding agreement was also uncertain in view of other decisions of the Court of First Instance including, for example, Osman Mohammed Arab & Anor v Chu Chi Ho Ian  [2016] HKCU 149 and the very recent decision in Re A [2020] HKCFI 493. 

In Osman Mohammed Arab, the court observed at [47]:

“As it is well-known to insolvency and bankruptcy practitioners, the sanction of the court is required for such funding agreements, even if signed, to take effect. Under section 82(3) of the [Bankruptcy] Ordinance, the Trustees may apply to the court for directions in relation to any particular matter arising under the bankruptcy. It is common practice for trustees to apply for sanction under that section on an ex parte basis, sometimes simply in writing, as observed by Harris J in re Cyberworks Audio Video Technology Limited in the context of corporate insolvency.” (Emphasis added.)

Whereas in Re A, the court observed at [178]:

“… Their [liquidators and trustees-in-bankruptcy] need to have approval of funding arrangements by, say, assignment of causes of action for value, are recognised and provided for by statutory rules…” (Emphasis added.)

Unsurprisingly, against this background, the third-party funder in Re Patrick Cowley was not prepared to enter into the funding agreement unless the Liquidators first obtained court sanction or confirmation from the court that sanction was not required.

The decision of the Companies Court  

Notwithstanding the observations in Osman Mohammed Arab and Re A suggesting that court sanction is required, Harris J decided in Re Patrick Cowley that there is no requirement, whether statutory or otherwise, for a liquidator to seek approval of a funding agreement and whether a funding agreement should be entered into is essentially a commercial decision for the liquidator.

Although the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap. 32 (“Ordinance”) does not specifically refer to funding agreements, the Judge observed at [8] that pursuant to paragraph 1 of Part 3 of Schedule 25 of the Ordinance it is not necessary for a liquidator to obtain the sanction of the court before assigning a chose in action (a chose in action being property of the company).  This provision in the Ordinance covers the situation where the funding agreement is structured as an outright assignment of a chose in action as in Re Cyberworks. The decision in Re Cyberworks was the first reported case dealing directly with the law of maintenance and champerty in the insolvency context and confirming that third-party funding was indeed an option for liquidators.

As noted by Harris J in Re Patrick Cowley at [9], not all funding agreements involve an assignment of a chose in action and he referred to another of his decisions concerning third-party litigation funding, namely Re Company A & Ors (unrep., HCCW 384/2006 & others, 8 October 2015).  In that case, like in Re Patrick Cowley, the third-party funder provided funding (in that case to seven insolvent companies) for prospective litigation in return for a share of the proceeds if the litigation proved successful.  In Harris J’s view, the prospective litigation in Re Company A & Ors could not be realistically advanced without external funding and because the litigation would remain under the control of the liquidators, it was unobjectionable and fell within the “insolvency exception”.

Harris J was prepared to entertain the directions application in Re Company A & Ors and to grant sanction because that was the first occasion where the Companies Court was asked to clarify the law of maintenance and champerty for the type of funding agreement in issue.  The decision in Re Company A & Ors, however, did not address the question of whether it was necessary for liquidators to obtain the court’s sanction in the future.

In deciding in Re Patrick Cowley that the Liquidators did not require court sanction, Harris J relied upon Paragraph 1 of Part 2 of Schedule 25 of the Ordinance and Paragraph 9 of Part 3 of Schedule 25 of the Ordinance.  Those paragraphs provide that a liquidator may “Bring or defend any action or other legal proceedings in the name and on behalf of the company” and “Do all things as may be necessary for winding-up the affairs of the company and distributing its assets” respectively. 

Accordingly, Harris J concluded at [10] that:

“Clearly, pursuing litigation to recover monies or other property owed to a company is covered by Paragraph 1 of Part 2 and the taking of steps necessary to facilitate the litigation comes within paragraph 9 of Part 3.  Funding litigation in my view comes within Paragraph 9.  At its most simple it would cover providing costs on account to solicitors.  The funds could be obtained from the sale of property of the company, which is permitted by Paragraph 1 of Part 3 or by borrowing against the property of the company, which is permitted by Paragraph 5 of Part 3.  As I have already explained, it can also be done by entering a funding agreement, which involves assignment of the chose in action in exchange for a share of the proceeds of the litigation as was done in Re Cyberworks.  It seems to me that there is no reason not read Paragraph 9 of Part 3 as extending to a liquidator entering into a funding agreement, which does not involve an assignment of a chose in action.  In my view it does.” (Emphasis added.)

And at [15] that:

“As I have found that Paragraph 9 of Part 3 gives a liquidator the power to cause a company to enter a funding agreement it follows that the court’s sanction of a funding agreement is not required in the case of a winding-up by the court.” (Emphasis added.) 

This clarification was added (it is believed) for the avoidance of doubt to clarify the position of a company in compulsory liquidation, given that the company which was the subject of the application before the court was in voluntary liquidation.  It should also be noted that in a compulsory liquidation (in contrast to a voluntary liquidation), the exercise of the power in Paragraph 1 of Part 2 of Schedule 25 (to commence litigation) requires the sanction of the court or committee of inspection by virtue of s.199(2) of the Ordinance, but once that sanction is obtained a liquidator can freely exercise the power in Paragraph 9 of Part 3 of Schedule 25 (to fund such litigation) pursuant to s.199(3) of the Ordinance.

Having regard to the uncertainty of the legal position and the understandable caution of funders, other propositions were advanced as possible bases for liquidators to enter into funding agreements, but the court considered that the broad powers in the paragraphs of Schedule 25 (as noted above) were sufficient and, indeed, the most appropriate.

Seeking directions from the Companies Court

Harris J also used Re Patrick Cowley as an opportunity to clarify in what circumstances a liquidator may seek the directions from the Companies Court under s.255(1) and (2) (in the case of a voluntary liquidation) and s.200(3) (in the case of a winding up by the court).

His Lordship, quite rightly, made clear in unequivocal terms at [16] to [24] that liquidators can only seek directions on a precisely identified legal question of significance that calls for the exercise of some legal judgment and that the issue raised by the proposed direction must be something other than a general endorsement of a proposed course of action.  Moreover, a liquidator cannot properly seek a direction which involves asking the Companies Court to approve what is largely a matter for the commercial judgment of the liquidator.  A decision which comes within a liquidator’s broad discretion, particularly if the decision is commercial in character, does not require the approval of the court, but also generally will not be amenable to a direction approving it.

Given the uncertain legal position prior to Re Patrick Cowley regarding the issue of the necessity of court approval for funding agreements, Harris J was prepared to give a direction to the Liquidators that no approval was required.  Now that this issue has been decided, however, it is unlikely that the Companies Court will entertain further applications for directions of a similar nature and insolvency practitioners and funders should act accordingly in the future.  Indeed, although not specifically referred to in the written decision, at the hearing of Re Patrick Cowley the Judge made clear that a funder ‘insisting’ on court approval being a condition precedent would not be considered a good enough reason to seek the court’s directions.

Final Remarks

Whilst it is now clear that third-party funding agreements in the insolvency context do not require court approval in Hong Kong, insolvency practitioners and funders would be well advised to take appropriate legal advice to ensure that a proposed funding arrangement does not offend the torts and offences of champerty and maintenance which continue to exist, noting for example the court’s observations (per Re Company A) on a liquidator maintaining control of litigation where there is no outright assignment.

Although liquidators took some comfort in the former practice of seeking approval from the Companies Court for funding agreements, such practice did not in fact give any real protection as sanction was given ex parte and it was still open to opponents in the actual contested litigation to challenge the arrangements as happened in Remedy v Yick Shing [2014] 5 HKLRD 614 and as was recognised by Segal J in the Cayman Islands judgment A Company v A Funder 2017 (2) CILR 710.

A copy of the judgement can be viewed here.

Robin Darton of Tanner De Witt and
James Wood of Denis Chang’s Chambers

The above is not intended to be relied on as legal advice and specific legal advice should be sought at all times in relation to the above.

If you would like to discuss any of the matters raised in this article, please contact:

Robin Darton
Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information on third party funding in litigation, please see the following article:

Legal update: Third Party Funding in Litigation, Doable?