THE OFFICIAL RECEIVER v. CHAN CHUN YAN AND ANOTHER

HCMP 2606/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2606 OF 2002

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J U D G M E N T

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1. This is an application by the Official Receiver under section 168H(1) of the Companies Ordinance, Cap. 32, for a disqualification order against the 2nd respondent, Mr Albert Tsang Hon Kin ("Mr Tsang").

2. The 1st respondent, Mr James Chan Chun Yan ("Mr Chan" or "James Chan"), filed an acknowledgment of service stating that he would not contest the application for a disqualification order against him. At a hearing before a Master on 3 December 2002, which Mr Chan did not attend, a disqualification order was made against him for five years.

Outline of the facts

3. I will begin with an outline of the facts which are not in dispute.

4. Copyright Limited ("the Company") was incorporated in Hong Kong on 7 March 1995 with a registered office in Discovery Bay, Lantau. The first shareholders and directors were James Chan and his wife Ms Cheng Oi Wah Kelly ("Ms Cheng" or "Kelly Cheng"). On 8 May 1996, Ms Cheng resigned as a director and Mr Tsang was appointed as a director. The authorised share capital at the time was HK$10,000.00 divided into 10,000 shares of HK$1.00, all of which were issued and paid up. According to the annual return on 7 March 1997, the shares were held by four persons in equal proportions: James Chan, Kelly Cheng, Mr Tsang and the wife of Mr Tsang. By an ordinary resolution of the Company dated 8 May 1997, the share capital was increased to HK$3 million by the addition of 2,990,000 shares. On 22 October 1997, all the additional shares were allotted to the four existing shareholders, again in equal proportions. Until the Company was put into liquidation, James Chan and Mr Tsang had remained the only directors.

5. The Company had operated two retail outlets. They were as follows:

(1) a bookstore called "Library" at Shop G30, DB Plaza, Discovery Bay, Lantau, from August 1996; and

(2) a computer mega store called "Base 2" at Level 6, Grand Century Place, KCR Mongkok Station, from November 1997.

6. Both outlets ceased operation in March 1998 when James Chan absconded. On 8 July 1998, a petition was presented to wind up the Company. A winding-up order was made on 5 August 1998.

7. Up to the date of the first report of the Official Receiver made in this application on 18 September 2002, the total proof of debt filed with the Official Receiver in the liquidation of the Company amounted to HK$2,819,384.06 and the assets realised by the Official Receiver amounted to HK$165,764.40. The Company is insolvent for the purpose of section 168H(2).

8. Mr Tsang was and is a practising barrister. He came to be involved in the Company in this way.

9. Before Library was opened for business in August 1996, James Chan and Kelly Cheng had operated a stationery shop called "Bob Bob Chai" in Discovery Bay since the early 1990s. Mr Tsang, who resided in Discovery Bay, came to know the couple when he and his family bought stationery from the shop. Bob Bob Chai later expanded its business into computer sales and became an authorised dealer of Compaq. In early 1996, James Chan approached Mr Tsang to solicit his interest in investing in a bookstore to be set up in DB Plaza. The idea of owning a bookstore appealed greatly to Mr Tsang. After several meetings with James Chan, he agreed to invest in this business and become an equal shareholder in the Company, which was to be the vehicle in operating the bookstore. On that basis, he became a director in the Company and he and his wife were allotted half of the shares in the Company. Mr Tsang was under the impression all along that the Company was incorporated in 1996 for the purpose of operating the bookstore business. He has only learned that the Company had been incorporated one year before business was commenced when the Official Receiver filed his report in the present proceedings.

10. From the beginning, it was agreed that James Chan would be the director responsible for the day-to-day management of the business of the Company and Mr Tsang would be the non-executive director. Mr Tsang and his wife invested a total of HK$600,000.00 in the business of Library, which was paid in six instalments from May 1996 to February 1997. Mr Tsang had not drawn any remuneration from the Company at any time.

11. In April or May 1996, a tenancy agreement was signed to rent shop premises for the bookstore, with an area of about 520 sq. ft., at a monthly rental of HK$24,500.00. One full-time staff was employed. In May 1996, an account was opened by the Company with HSBC with James Chan and Mr Tsang as the authorised signatories. It was provided in the mandate that any one of them could sign cheques up to HK$50,000.00 and for cheques exceeding HK$50,000.00 both would be required to sign. Another account of the Company opened at the Wing Lung Bank Limited in November 1997 followed the same mandate for the signing of cheques.

12. In February 1997, James Chan suggested to Mr Tsang to embark on a much more ambitious project in setting up a computer mega store, which was to be the largest computer store in Hong Kong. In March 1997, Mr Tsang decided to invest in the new business called Base 2 and acquire a 50% interest. It was agreed to use the Company to operate this business, with the same division of responsibility between James Chan and Mr Tsang as before. James Chan and Kelly Cheng were each to draw a salary of HK$20,000.00 per month from the Company. Premises were found for Base 2 at the Grand Century Place, which was a new building. A six-year lease was signed by the Company to rent premises of over 16,000 sq. ft. at a monthly rental of HK$378,488.00. As the occupation permit for the building was not issued at the time, the Company set up a temporary office in Central in June 1997 and employed a few marketing officers to secure advertising business for Base 2. In September 1997, decoration work on the shop premises commenced and Base 2 was opened in November 1997 with publicity in the media. About thirty employees were employed.

13. The business of Base 2 was short-lived. By the time the shop was officially opened, the Asian financial crisis had taken its toll on the economy of Hong Kong. Mr Tsang and his wife invested a total of HK$6,230,000.00 in the business of Base 2, of which HK$5.5 million was paid between March 1997 and November 1997 and the remaining HK$730,000.00 was paid from 5 January 1998 to 12 February 1998, after Mr Tsang had learned in January 1998 that Base 2 had cash flow problems. After mid February 1998, Mr Tsang refused to inject further funds into the business of Base 2, despite repeated requests from James Chan and Kelly Cheng. By then, Base 2 was in serious cash flow difficulties. A total of 204 cheques issued by the Company were returned, the majority of which were issued in January to April 1998.

14. On 18 or 19 March 1998, James Chan telephoned Mr Tsang and asked if the Company could be wound up in his absence. He was told by Mr Tsang that this could not be done. James Chan and Kelly Cheng did not turn up for work the following day, and the staff could not get into the shop of Base 2. They left with their children and went into hiding, taking with them all the books and stocks from Library. Most of the staff of Library and Base 2 did not receive their wages in March 1998. A report was made to the police. Mr Chan was arrested by the police about six months later. Eventually, after further investigation by the police he was not charged with any offence.

Books of account of the Company

15. On 17 September 2001, James Chan was convicted of two offences in Cap. 32: for failing to take reasonable steps to keep and preserve proper books of account as are necessary to give a true and fair view of the state of the Company's affairs and to explain its transactions, under section 121; and for failing to keep proper books of account as are necessary to exhibit and explain the transactions and financial position of the trade or business of the Company throughout the period of two years immediately preceding the commencement of the winding up, under section 274. He was fined a total of HK$1,400.00. Mr Tsang was not charged with any offence under Cap. 32.

16. No audited financial statement of the Company had been prepared since its incorporation on 7 March 1995. No annual general meeting was held at which a profit and loss account and balance sheet were made out and laid before the meeting. According to James Chan, other than the daily cash books given to the police, all the other books and records were kept in the office of Base 2 and they had been disposed of by the landlord in the distraint action in June 1998. However, in response to the enquiries of the Official Receiver, the solicitors for the landlord stated that no books or records of the Company had been found in the premises of Base 2 according to the landlord's record.

17. The available accounting records of the Company have been examined by a Treasury Accountant in the employ of the Official Receiver's Office. Throughout the period of trading, there is no available general ledger of the Company or sub-ledgers for accounts receivable and payable. The available trading and loss accounts are not accompanied by a balance sheet. Other available records such as the accounting transactions summary and the accounts report are incomplete and not supported by vouchers. The Treasury Accountant does not think the available accounting records in their present state provide sufficient financial information and form a reliable basis for the preparation of financial statements of the Company. From the available accounts report of Library for 1 August 1996 to 30 April 1997, the Treasury Accountant is unable to ascertain the overall financial position of Library, and its assets and liabilities for that period. Further, owing to the deficiencies in the available accounting records, the Treasury Accountant is unable to ascertain whether the statement of affairs of the Company submitted by Mr Chan out of time on 23 March 1999 truly reflected the financial position of the Company as at the date of the winding up.

The statutory provisions

18. Section 168D(1) provides that in the circumstances specified under section 168H, the court shall make against a person a disqualification order, that is, an order that he shall not, without leave of the court, be a director of a company, a liquidator of a company, a receiver or manager of a company's property, or in any way be concerned or take part in the promotion, formation or management of a company.

19. Section 168H(1) provides as follows:

"The court shall make a disqualification order against a person in any case where, on an application under this section, it is satisfied -

(a) that he is or has been a director of a company which has at any time become insolvent whether while he was a director or subsequently; and

(b) that his conduct as a director of that company, either taken alone or taken together with his conduct as a director of any other company or companies, makes him unfit to be concerned in the management of a company."

20. This provision was based upon section 6 of the Company Directors Disqualification Act 1986 in England. Unlike the previous regime in section 300(1) of the Companies Act 1985, which provided for a discretionary disqualification jurisdiction, disqualification is mandatory under section 6 and our section 168H(1), once the court is satisfied that a person's conduct as a director of the insolvent company, either taken alone or with his conduct as a director of any other company, renders him unfit to be concerned with the management of a company (Re Bath Glass Ltd (1988) 4 BCC 130 at 132 and 133). It is provided in section 168H(4) that the minimum period of disqualification is one year.

21. Section 168K(1) provides as follows:

"Where it falls to a court to determine whether a person's conduct as a director of any particular company or companies makes him unfit to be concerned in the management of a company, the court shall, as respects his conduct as a director of that company or, as the case may be, each of those companies, have regard in particular -

(a) to the matters mentioned in Part I of the Fifteenth Schedule; and

(b) where the company has become insolvent, to the matters mentioned in Part II of that Schedule,

and references in that Schedule to the director and the company are to be read accordingly."

22. In the application against Mr Tsang, the matters specified in the 15th Schedule to Cap. 32 relied on by the Official Receiver are as follows:

"Part I - Matters applicable in all cases

1. Any misfeasance or breach of any fiduciary or other duty by the director in relation to the company.

...

3. The extent of the director's responsibility for any failure by the company to comply with any of the following provisions -

...

(h) section 121;

...

4. The extent of the director's responsibility for any failure by the directors of the company to comply with [section] 122 ...

Part II - Matters applicable where company has become insolvent

1. The extent of the director's responsibility for the causes of the company becoming insolvent.

...

5. Any failure by the director to comply with any obligation imposed on him by or under any of the following provisions -

(a) section 190;

...

(da) section 274;".

The alleged grounds for disqualification

23. Miss Fiona Lee, who appeared for the Official Receiver, has advanced the following grounds to justify a finding of unfitness of Mr Tsang for a disqualification order to be made:

(1) The first group of allegations may be categorised as the accounting records offences. It is alleged that:

(a) Mr Tsang had failed to take reasonable steps to keep and preserve proper books of account as are necessary to give a true and fair view of the state of the Company's affairs and to explain its transactions in accordance with section 121;

(b) he had failed to comply with the obligation to keep proper books of account as are necessary to exhibit and explain transactions and financial position of the trade or business of the Company throughout the period of two years immediately preceding the commencement of winding up in accordance with section 274;

(c) he had failed to take reasonable steps to cause to be made out and laid before the annual general meeting a profit and loss account and balance sheet in accordance with section 122; and

(d) there was insufficient financial management information to enable Mr Tsang to properly monitor the financial position of the Company.

(2) There was lack of commercial probity on the part of Mr Tsang in investing in Base 2 with insufficient financial information to enable an informed decision to be made.

(3) There was abrogation of responsibility on the part of Mr Tsang, as opposed to a proper degree of delegation and division of responsibility. It was incompetence or breach of duty on his part to leave all management matters to others.

(4) Mr Tsang had not discharged his duty to supervise and control his co-director Mr Chan and was responsible for the misuse of the bank accounts of the Company by Mr Chan in issuing cheques without due regard to the likelihood of their being honoured upon presentation.

(5) Mr Tsang was responsible for the causes of the Company becoming insolvent in view of the matters alleged in (1)(d), (2), (3) and (4).

(6) Mr Tsang had failed to submit to the Official Receiver a statement of affairs in the prescribed form within 28 days of the making of the winding-up order in accordance with section 190.

24. It is pertinent to note that there is no allegation of dishonesty against Mr Tsang, although it is alleged that there was a lack of commercial probity.

25. Mr Wong Yan Lung, SC, who appeared for Mr Tsang, mounted a vigorous challenge to the application. He submitted that the Official Receiver's case for a disqualification order against Mr Tsang cannot be made out on the facts or on the law for the following reasons:

(1) the charges against Mr Tsang are based on erroneous assumption of facts;

(2) crucial factual allegations cannot be proven;

(3) even if proven, they cannot possibly justify a finding of unfitness and the resulting disqualification order as a matter of law.

26. Mr Tsang has filed an affirmation in opposition. He was cross-examined by the Official Receiver.

27. Before I consider each of the grounds alleged by the Official Receiver in establishing unfitness on the part of Mr Tsang, it would be appropriate to refer to the English authorities to see how the courts have approached the question as to what would amount to unfitness for the purpose of the statute.

Unfitness as justifying a disqualification order

28. It is important to remind myself at the outset that the crucial question to be determined in this application, whether the director's conduct is such as to make him unfit to be concerned with the management of a company, is a question of fact or what has been referred to as a "jury question". Thus, statements in various cases as to the approach that should be adopted in deciding this question are but statements of useful guidance and should not be taken as "judicial paraphrases of the words of the statute which fall to be construed as a matter of law in lieu of the words of the statute" (Re Sevenoaks Stationers (Retail) Ltd [1990] BCC 765 at 773D to F).

29. Any misconduct of the respondent qua director may be relevant to the finding of unfitness, even if it does not fall within a specific provision of the statute (Re Bath Glass, supra. at 133). Unfitness may be demonstrated by conduct which does not involve any breach of duty (Re Barings Plc (No. 5) [1999] 1 BCLC 433 at 486e). The court must first make findings of fact whether the allegations of misconduct are made out, and if so whether the proven allegations would render the director unfit. In addressing the question of unfitness, the court is to decide whether the conduct of which complaint is made by the Official Receiver, "viewed cumulatively and taking into account any extenuating circumstances, has fallen below the standards of probity and competence appropriate for persons fit to be directors of companies" (Secretary of State for Trade and Industry v. Gray [1995] 1 BCLC 276 at 284f).

30. To reach a finding of unfitness, the court must be satisfied that the established misconduct of the director is sufficiently serious (Re Bath Glass, supra. at 133). Where the case for a disqualification order is based solely on allegations of incompetence, the Official Receiver would need to satisfy the court that the conduct complained of demonstrates incompetence of a high degree. Various expressions have been used by the courts to emphasise this high burden in establishing unfitness based on incompetence, such as "total incompetence", incompetence "in a very marked degree", "some really gross incompetence" (Re Barings Plc (No. 5), supra. at 483i to 484b).

31. The reasons for the above approach would appear to be as follows. Firstly, the consequence of a disqualification order is serious; the order will prevent the respondent being concerned in the management of any company and involves a "substantial interference with the freedom of the individual" (Re Barings Plc (No. 5), supra. at 484b; Re Lo-Line Electric Motors Ltd [1988] Ch 477 at 486A to C). Secondly, the primary purpose of the jurisdiction for a disqualification order is to protect the public against the future conduct of companies by persons whose past records as directors of insolvent companies have shown them to be a danger to creditors and others (Re Lo-Line Electric Motors Ltd, supra. at 486A to C; Re Barings Plc (No. 5), supra. at 482h to i; Re Dawson Print Group Ltd (1987) 3 BCC 322 at 324).

32. The standard of proof for this kind of application is proof on the balance of probabilities, as these are civil proceedings. However, the court must bear in mind that "the more serious the allegation, the more the court will need the assistance of cogent evidence" and "the harder it will be to satisfy the court of the truth of that allegation on the balance of probabilities". Hence, the serious nature of an allegation of unfitness must be borne in mind in considering whether that allegation is made out (Re Living Images Ltd [1996] 1 BCLC 348 at 355f to h; Re Verby Print for Advertising Ltd v. Secretary of State for Trade and Industry [1998] 2 BCLC 23 at 31e to g).

Non-executive directors and the residual duty to supervise

33. In considering the allegations of misconduct in this application, it is essential to have regard to the fact that Mr Tsang was at all times a non-executive director and had delegated the day-to-day management of the Company to his fellow director who worked full time for the Company with remuneration. What Mr Tsang is alleged to have done or omitted to do must be evaluated in "the context of and by reference to the role in the management of the company which was in fact assigned to him or which he in fact assumed, and by reference to his duties and responsibilities in that role" (Re Barings Plc (No. 5), supra. at 484c to d).

34. The general propositions with respect to directors' duties, as comprehensively set out by Jonathan Parker J in Re Barings Plc (No. 5), supra. at 489a to c and approved by Morritt LJ on appeal in [2000] 1 BCLC 523 at 535i to 536c, are as follows:

"(i) Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable them properly to discharge their duties as directors.

(ii) Whilst directors are entitled (subject to the articles of association of the company) to delegate particular functions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions.

(iii) No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the facts of each particular case, including the director's role in the management of the company."

35. As succinctly stated by Lord Woolf M.R. in Re Westmid Packing Services Ltd [1998] 2 BCLC 646 at 653b:

"Each individual director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising and controlling them.

A proper degree of delegation and division of responsibility is of course permissible, and often necessary, but total abrogation of responsibility is not."

36. It is not in dispute that Mr Tsang did have a residual duty of supervision and control. The precise extent of that duty is in dispute, as is the question whether the duty has been breached.

37. I turn to consider each of the allegations of misconduct.

The accounting records offences

38. The statutory provisions concerned are sections 121, 122 and 274. None of these provisions impose strict liability on a director. I set out the relevant provisions below:

"121. Keeping of books of account

(4) If any person being a director of a company fails to take all reasonable steps to secure compliance by the company with the requirements of this section, or has by his own wilful act been the cause of any default by the company thereunder, he shall, in respect of each offence, be liable to imprisonment and a fine:

Provided that -

(a) in any proceedings against a person in respect of an offence under this section consisting of a failure to take reasonable steps to secure compliance by the company with the requirements of this section, it shall be a defence to prove that he had reasonable ground to believe and did believe that a competent and reliable person was charged with the duty of seeing that those requirements were complied with and was in a position to discharge that duty; ..."

"122. Profit and loss account and balance sheet

(3) If any person being a director of a company fails to take all reasonable steps to comply with the provisions of this section he shall, in respect of each offence, be liable to imprisonment and a fine:

Provided that -

(a) in any proceedings against a person in respect of an offence under this section, it shall be a defence to prove that he had reasonable ground to believe and did believe that a competent and reliable person was charged with the duty of seeing that the provisions of this section were complied with and was in a position to discharge that duty; ..."

"274. Liability where proper accounts not kept

(1) If where a company is wound up it is shown that proper books of account were not kept by the company throughout the period of 2 years immediately preceding the commencement of the winding up, or the period between the incorporation of the company and the commencement of the winding up, whichever is the shorter, every officer of the company who is in default shall, unless he shows he acted honestly and that in the circumstances in which the business of the company was carried on the default was excusable, be guilty of an offence and liable to imprisonment and a fine."

(emphasis supplied)

39. I have summarised the evidence of the Treasury Accountant. I find that the deeming provisions in respect of "proper books of account" in sections 121(2) and 274(2) apply and that proper books of account were not kept by the Company for the purposes of sections 121 and 274. It is not disputed that no annual general meeting was held at which the directors had caused to be laid out a profit and loss account and a balance sheet.

40. I do not regard it as relevant in this application that only James Chan, and not Mr Tsang, was charged with contravention of sections 121 and 274 in the prosecution brought by the Official Receiver. As the Official Receiver has explained, the Official Receiver acts under the authorisation of the Secretary for Justice to lay information for these accounting record offences. In making a decision to prosecute, different considerations are taken into account as to whether there is sufficient evidence to prove all the ingredients of the offence, as proof according to the criminal standard is required. In the present application, the applicable standard of proof is the civil standard.

41. Notwithstanding the deficiencies in the accounting records, I would still need to look at Mr Tsang's involvement and role in the management of the Company, and the duties he assumed, to determine "the extent of [his] responsibility" for any failure by the Company to comply with sections 121 and 122, as provided in the 15th Schedule to Cap. 32.

42. Mr Tsang did not get involved with the Company until May 1996 when he was appointed as a director. However, as the Company did not start trading until three months later, the period within which Mr Tsang could have any meaningful involvement in keeping books and accounts of the Company was a period of 20 months, from August 1996 to March 1998 when the Company ceased to operate its two businesses. It was a relatively short period of involvement. Mr Tsang gave evidence that he was under the wrong impression that the Company was newly incorporated in mid 1996, this is also relevant as on that erroneous understanding, the first annual general meeting to approve accounts could have been held within 18 months of its incorporation.

43. According to Mr Tsang's affirmation, when the business of Library was set up, he had checked with James Chan or Kelly Cheng about its business "practically on a weekly basis" and was assured by them that it was running smoothly. Over the following months, he often went to the bookstore to check on its business. He had looked "briefly" at the daily cashbook kept in the shop and noted that it recorded the daily sales. As he was more concerned with the monthly sales figures, he asked James Chan for the monthly accounting statements after the store had been in operation for about two months. James Chan said he was busy but assured Mr Tsang the statements were being prepared.

44. On 10 January 1997, five months after Library was in operation, James Chan sent Mr Tsang a closely typed year-end management report of Library consisting of nine pages. It is necessary to look at this report in some detail.

45. At the top of page 1 of the report, under the heading "auditors", the name of "Y S Cheng & Co." appeared. Below that was the heading of "accountant & accounting clerk", and the names of "Mr Lo, Mr Yeung" were stated. Also on page 1 is the section headed "introduction", with the following statement: "Detailed accounting reports (year-ended on 31st December, 1996) including Trading & Profit & Loss Account, Balance Sheet, Cash Flow Statement, Accountant Statement and Financial Report, etc. will be included in a separate Auditor's Report."

46. There is another section on page 1 headed "Emergency", in which it was set out, among other things, the post-dated cheques that would be presented for payment in February 1997, the dates and respective amounts.

47. Under the heading of "management structure" on page 2, one finds a table giving the business turnover from August to December 1996. In the "accounting summary" on page 3, there was a breakdown of the total fixed running cost at about HK$46,000.00. It was further stated that on the basis that the fixed running cost was covered by 30% of the monthly turnover, it would require a monthly sales record of HK$150,000.00 to break even. As the turnover figures on page 2 showed that the lowest figure was HK$56,529.00 and the highest was HK$95,247.80, Library was apparently trading at an average monthly loss of about HK$23,500.00 for the first five months.

48. Page 4 listed the total purchases of stock from July to December 1996 with a break down per month and stated that 40% of the stock purchased was sold. Page 5 dealt with "proposal and performance", giving a projection of the average number of customers visiting the shop over the next three years and what this would mean in terms of profit. Page 6 to 8 set out a list of the matters to be followed up at the last meetings held in October 1996, giving details of the proposals and the results of each. Page 9 was headed "stock/sales control" and a list of matters were set out in which Mr Tsang was requested to make suggestions for improvement.

49. What is important about this report is that it set out meticulously how the business was operated. From reading the report, Mr Tsang had no reason to think that the accounts of that business were not kept or that they were not handled in a proper manner, as Mr Chan would not have been able to give such detailed figures in the report without proper records. Moreover, it was expressly stated in the report that further detailed accounting records would be prepared and they would be audited.

50. Mr Tsang gave evidence that he was led to believe by this report that Y S Cheng & Co., a firm of certified public accountants, had been engaged to audit the company's accounts. Further, Messrs Y S Cheng & Co. had drafted minutes of a board meeting for Mr Tsang to sign in October 1997 for the allotment of the additional shares in the Company. In response to the enquiries of the Official Receiver, Messrs Y S Cheng & Co. had written on 7 May 2002 and 18 June 2002 stating that they had never acted as the auditors of the Company, and they had never been requested to provide bookkeeping or auditing services for the Company. I accept Mr Tsang's evidence that he had good grounds for his belief that Messrs Y S Cheng & Co. was retained to audit the accounts. At that time, there was no reason why Mr Tsang should not trust his co-director.

51. In about May 1997, Mr Tsang received from James Chan the monthly accounting reports of Library that he had been asking for. They ran from August 1996 to April 1997. For each month, there were given on a daily basis the cash sales, credit card sales, inventory, book sales, discounts, sales return, and books costs. Again, there was nothing to indicate from these monthly accounting reports that there was any irregularity in the detailed figures provided.

52. When Base 2 was in operation, Mr Tsang knew that a full-time accountant was keeping the accounting records for that business. He understood that it would take a few months for the monthly statements to be ready and intended to study them when they were available. The business of Base 2 collapsed just after four months and no monthly statements were ever supplied to him. During the short existence of this business, Mr Tsang had visited the store three times. On each occasion, he went to the manager's office and enquired about the business. He was shown the daily cashbooks and accounting books kept inside the office. It appeared to him that things were in order.

53. There is some doubt about James Chan's assertion that the books and records kept in the office of Base 2 were disposed of by the landlord in the distraint action, as this does not tally with the statement of the landlord's solicitors that no such records were found in the premises at the time of distraint. Mr Tsang also has some doubts about this as he suspects James Chan might have some private motive for keeping the books and records out of reach of the investigating authorities. As for the suggestion in Miss Lee's closing submission that Mr Tsang could have taken action to preserve the books and records at the office of Base 2 by contacting the bailiffs after he found out that James Chan had removed the stocks and records kept at Library, Mr Tsang was not cross-examined on this and had no opportunity to explain if that was feasible or if that had even occurred to him. I attach no significance to the lack of action on his part.

54. I accept the evidence given by Mr Tsang as summarised in the foregoing paragraphs. His evidence in this regard was not seriously challenged. I find that daily cashbooks were kept for Library and Base 2, notwithstanding they cannot now be found. The detailed figures given in the management report and the monthly accounting reports of Library indicated that daily cashbooks must have been kept for that business. I find that a full-time accountant was engaged for the Company, notwithstanding there was no evidence from this person. It was not suggested to Mr Tsang in cross-examination that the names given for the accountant and the accounting clerk in the management report were false. As for the answers given by Mr Tsang to the Official Receiver's questionnaire in August 1998 that he had "no idea" if proper books of account had been kept in accordance with section 121 and he has "never seen the company accounts" in answer to the question when did he first see accounts of the Company which indicated that the Company was or was likely to become insolvent, I accept Mr Tsang's explanation on his answers. What he meant was that he had not seen audited accounts of the Company and he had understood these questions to refer to audited accounts. He did not check the wording of section 121 when he wrote his answers. He said he did not answer the questionnaire with care, having just lost "a fortune" in his investment, and his lack of care was borne out by the fact that he even got the year of the Asian financial crisis wrong in one of his answers.

55. I find that Mr Tsang was not in breach of section 121 and 122 and he was not to be blamed for the failure of the Company to comply with these provisions. He had taken reasonable steps to comply with the requirements of the statute. He had reasonable ground to believe and did believe that the functions of keeping proper books of account and complying with the statutory requirements had been delegated to competent and reliable persons. He did not abrogate his responsibility in the affairs of the Company as the non-executive director. He had asked for and was supplied with financial reports of the business, although the reports were not up-to-date and were given to him somewhat late.

56. As for section 274, I find that Mr Tsang did not fail to comply with this provision in that he had acted honestly and the default in his case was excusable in the circumstances in which the business was carried on, for the same reasons I have given.

57. The last complaint under this head is that there was insufficient financial management information to enable Mr Tsang to properly monitor the Company's financial position. As I have found, proper books of account as required under sections 121 and 274 were not kept; nor were audited accounts prepared. The fact that the statutory requirements regarding accounting records were not met does not necessarily follow that there would be insufficient financial information for the directors to properly monitor the company's financial affairs. One would still have to consider the accounting records prepared to see if that finding was justified.

58. In the case of the business of Library, there were adduced in evidence the financial records supplied to Mr Tsang. Library was a small business and its affairs were relatively simple. From the information supplied to Mr Tsang, he should have a fair idea of the assets (made up of stocks purchased and the capital invested by the shareholders) and the liabilities of that business (in terms of fixed running costs), even though he did not have the exact figures on the accounts payable at a given time. Mr Tsang knew the profit margin for Library, that business had been trading at a loss, and that such loss was within what he had regarded as acceptable limits.

59. As for Base 2, the Official Receiver has not exhibited the available accounting records of this business although some of the items listed in the available accounting records in the affirmation of the Treasury Accountant would appear to relate to Base 2. Apart from those records, there were the daily cashbooks that Mr Tsang had examined and have not since been found. I am not prepared to find on the incomplete evidence that the accounting records of Base 2 were so deficient that the directors could not have been able to monitor the financial performance properly. In any event, the business of Base 2 was short-lived and its collapse came quickly, so any failure in that regard was only for a matter of a few months. Even if I were to find that the financial management information of Base 2 was insufficient for the directors to monitor the business properly, I would not have found in the particular circumstances that Mr Tsang had failed to discharge his duty having regard to his role and responsibilities as a non-executive director.

Investing in Base 2 with insufficient financial information

60. It is alleged by the Official Receiver that on the information provided, Mr Tsang could not have made an informed decision to invest in Base 2 and this was conduct lacking in commercial probity. The information provided was exhibited to the affirmation of the Treasury Accountant who expressed the opinion that such information is piecemeal and does not include any periodic financial statements of the existing business of Library "for reference", and so does not contain sufficient financial information to enable an informed decision to be made on Base 2.

61. The information in the relevant exhibit to the Treasury Accountant's affirmation does not include the management report of Library, which was supplied to Mr Tsang in January 1997 and was certainly available to him if it is contended that financial information relating to Library was relevant to an informed decision to be made about Base 2. I do not know why the Treasury Accountant was not asked to consider this after the management report was exhibited to Mr Tsang's affirmation.

62. I turn to consider the financial information provided and included in the relevant exhibit. Apart from the monthly accounting reports of Library from August 1996 to April 1997, which I have considered earlier, there were the following documents: a communication journal from James Chan to Mr Tsang dated 20 March 1997; proposed budget for first stage promotion; estimates for sales and revenue consisting of five pages; two memoranda of the capital contribution required; a quotation of Cometop Interior Decoration Limited dated 19 August 1997; and a promotion plan dated 21 July 1997.

63. In the estimates for sales and revenue, the budgeted capital was given at HK$11,450,000.00 with a break down of the proposed expenditure, of which Mr Tsang and his wife were to contribute about half. It was stated that the targeted annual turnover for Base 2 was HK$400 million with an annual profit of HK$20 million. There was a cash flow projection, made up of various regular expenses, the stock level, and sales from computer retail, marketing sources, corporate sources, services and maintenance. The projection of revenue from computer retail sales was based on James Chan's experience in his computer store in Discovery Bay and the number of households that had bought computers from his store over a two-year period. A projection of 10,000 shoppers per month in Discovery Bay was taken with the spending power attributed to them and this was multiplied by various figures ranging from five to forty to arrive at various estimates for the monthly turnover of Base 2. On those assumptions, it was estimated that 15 times the number of shoppers in Discovery Bay, or 150,000 persons a month, would bring about a break-even point for Base 2.

64. Miss Lee submitted that no or no valid basis was given for the above estimates and projections. Mr Tsang does not know the exact formula from which James Chan worked out the projection of shoppers' spending power. He explained that Mr Chan would have to resort to estimates, as a computer mega store was a new business venture in Hong Kong at that time. He reasoned that it was not unreasonable for Mr Chan to rely on his actual experience in the computer store in Discovery Bay and Mr Tsang emphasised that it was the largest computer store in Discovery Bay. He had confidence in the business acumen of Mr Chan, who was very hardworking. Mr Chan had a proven track record of how well he could do in the businesses that he and his wife set up in Discovery Bay. He did not think the forecast of Mr Chan was unreasonable although the targeted annual turnover of HK$400 million was "very optimistic".

65. I accept Mr Tsang's explanation. I do not find his decision in investing in Base 2 was conduct lacking in commercial probity.

66. As for the alleged insufficiency in the financial information provided for Library, I have already dealt with that in considering whether there was sufficient information to enable the directors to monitor the performance of that business properly. I also agree with the submission of Mr Wong that the absence of financial statements or management accounts of Library would have no practical effect in this situation. Library was merely a neighbourhood bookstore. Base 2 was to be a much larger investment. The two projects were wholly different in nature. Besides, at that time, Library was in operation for just half a year, accounts for the first few months of trading would not have been of real significance to assessing the creditworthiness and validity of the Company. The financial information of Library would not have been of much use as "reference".

Abrogation of responsibility

67. It is alleged by the Official Receiver that Mr Tsang has shirked his personal obligation to inform himself about the affairs of the Company and to join with his co-director in supervising and controlling the affairs of the Company in that he had left everything to others. This seems to be in the nature of a wrap-up charge. The Official Receiver has not specified any other matter relied on in support of this complaint apart from the allegations which I have categorised under the accounting records offences, the lack of sufficient information to make an informed decision to invest in Base 2 (all of which I have dealt with) and the complaint relating to the misuse of bank accounts (which I will deal with in the next section).

68. On the evidence before me, I do not think the allegation of abrogation of responsibility is made out. Although as a non-executive director, Mr Tsang did not take part in the day-to-day operation of the Company, it was not the case that he took no part whatever in the management or that he took no steps to keep himself informed of the affairs of the Company.

69. When the business of Library was in the stage of preparation, James Chan sent Mr Tsang a report dated 9 July 1996 on the progress of work and a proposal giving details of the merchandise to be purchased, the expenses involved and the investment required. It would appear that during the preparatory stage, monthly expenses reports were sent to Mr Tsang.

70. After Library was in operation, Mr Tsang sought financial information from Mr Chan as I have mentioned earlier and he read the daily cashbooks on the occasions he visited the shop. He was sent the year-end management report and the monthly accounti ng reports. It is apparent from the management report that he did take part in the management of the Company in a number of ways. For instance, there was reference to a meeting in October 1996 in which various proposals were discussed and Mr Chan set out in the management report the follow-up action and requested Mr Tsang's input on a number of suggestions. I find that Mr Tsang did have a fairly good grasp of the business performance of Library.

71. Similarly, when Base 2 was in preparation, Mr Tsang received from Mr Chan fairly detailed reports and proposals seeking his comments and advice on a number of matters. Mr Tsang said in his affirmation that he and his wife were "constantly consulted" on the design and layout of the store and the employment of staff. After the store was opened for business, he had enquired about the business and read the daily cashbooks when he visited the store. I think it is fair to say that up to the collapse of the business of Base 2, there was little ground for Mr Tsang to suspect the integrity and ability of James Chan and Kelly Cheng, who had invested almost as much as Mr Tsang and his wife in that business and were working full-time for the Company at a remuneration.

72. The fact situation here is different from Re Park House Properties Ltd [1997] 2 BCLC 530 in which it was found that there was "sheer inactivity" on the part of the non-executive directors who failed to take "any steps whatever in relation to the management of the company, or to acquaint themselves with what was going on". It was held in that situation that the non-executive directors were culpable and their incompetence or neglect was such as to justify a finding of unfitness. Similarly, in Westmid Packing Services, supra., the directors who allowed themselves to be dominated by the controlling shareholder and director were found culpable for failing to keep themselves properly informed of the financial position of the company had never studied the accounting records for the whole 13 years in which they were directors. The situation of the non-executive director in Re Continental Assurance Co. of London plc [1996] BCC 888 was again different. Notwithstanding that the director did not appreciate the growing indebtedness in the inter-company loans, it was held that he had failed to appreciate the obvious as he had signed and approved statutory accounts in which reference was made to such indebtedness.

Misuse of bank accounts

73. In the 1st report of the Official Receiver, the complaint initially alleged was that James Chan and Mr Tsang had misused the bank accounts by causing the Company to issue cheques to creditors without due regard to the likelihood of their being honoured on presentation. Mr Tsang filed an affirmation to explain that the returned cheques had nothing to do with him. There was only one cheque over HK$50,000.00 which he co-signed with Mr Chan in August 1997 that was returned; it was re-issued shortly afterwards and was honoured. Mr Tsang did not sign any cheque on his own that was dishonoured. As all the other returned cheques with the exception of a cheque issued on 19 March 1998 did not exceed HK$50,000.00, they could be and were signed by Mr Chan alone. As for the cheque exceeding HK$50,000.00 issued in March 1998, the bank voucher showed that this cheque was returned due to "insufficient funds and drawer's signature incomplete", so it was probably signed by Mr Chan alone.

74. In the 3rd report of the Official Receiver, there is a shift in position. It is alleged that Mr Tsang had not discharged his duty to supervise and control his co-director in relation to the drawing of cheques by the latter and so is responsible for the misuse of the bank accounts. It is also alleged that it is not apparent what steps were taken by Mr Tsang in relation to the drawing of cheques by his co-director in the light of his knowledge of the cash flow problems.

75. There were two bank accounts involved. For the account at Wing Lung Bank, there were 121 returned cheques; they started to emerge only in January 1998 and most of them were returned in February and March 1998. For the account at HSBC, there were 83 returned cheques, 29 were returned between August and December 1997 and the rest in January, March and April 1998. The period in which cheques were frequently returned was the first three months of 1998, when the Company had a serious cash flow problem due to the economic downturn in the Asian financial crisis.

76. Mr Tsang drew attention to a number of instances in which cheques were issued on the same dates involving sums of exactly HK$50,000.00. He believes this was a deliberate splitting up of cheques by Mr Chan so that Mr Chan could circumvent the bank mandate of requiring Mr Tsang's signature as well and sign them on his own. This did not come to Mr Tsang's knowledge until after these proceedings were started.

77. Mr Tsang gave evidence that the consumer sales of Base 2 had dropped drastically after December 1997 and were far behind the original forecast and sales continued to fall in January and February 1997. The turnover for December 1997 was only HK$4.2 million. On 4 January 1998, James Chan sent Mr Tsang a memorandum setting out the payments made by the four shareholders as capital contribution to the business of Base 2 and the expenses made with their contribution. In an item marked "urgent", it was stated that there was remaining stock to be paid, of which HK$1.8 million would need to be paid in one month and HK$450,000.00 would need to be paid in about 45 to 60 days. Against that item, it was stated that about HK$2 million would need to be contributed by the shareholders, to be borne equally. There was a hand-written postscript of James Chan to this memorandum responding to Mr Tsang's enquiry about the cash flow status on 2 January 1998. Certain statements prepared by an accountant was enclosed, the outstanding balance of all the accounts was given. It was also stated that there were accounts receivable of HK$1.9 million. It was not known when the debts would be paid but the accountant would be pressed to collect the outstanding sums before the Chinese New year.

78. Pursuant to the above memorandum and the requests of James Chan, Mr Tsang did make further payments as his contribution to ease the cash flow difficulties. As mentioned earlier, he had paid a total of HK$730,000.00 between 5 January 1998 and 12 February 1998 to try to keep the Company afloat. He then told Mr Chan to find other ways to solve the cash flow problem and was informed by Mr Chan that he was looking for additional partners and was about to reach agreement with a prospective investor.

79. It is not correct for the Official Receiver to say that no action was taken by Mr Tsang when he learned of the cash flow difficulties in January 1998. The most pressing thing was for the shareholders to inject further funds and this Mr Tsang had done, although not as much as Mr Chan had requested. Mr Chan and the accountant were monitoring the situation and looking after the accounts payable and receivable. That Mr Tsang had not looked at the bank statements was neither here nor there. Besides, the January bank statements would not have been available until the latter part of February 1998. There was nothing to indicate there might be any irregularity in the drawing of cheques. The present situation is very different from Re Hitco 2000 Ltd [1995] BCC 161 cited by the Official Receiver, in which the director had signed whole cheque books in blank and left it to the bookkeepers to decide which creditors should be paid in straitened financial circumstances and the history of bounced cheques was for well over a year.

80. I decline to find that there was failure of Mr Tsang to discharge his responsibility as a non-executive director in the supervision and control of Mr Chan in the drawing of cheques as alleged.

Responsibility for insolvency

81. For the reasons given above, I have not found the allegations proved as regards the accounting records offences, the failure to be kept properly informed of the financial position of the Company, the lack of commercial probity in investing in Base 2, the abrogation of responsibility by leaving all management matters to others, or the responsibility for the misuse of bank accounts by the co-director. Once these allegations fall away, I am quite unable to see how Mr Tsang could be held to be responsible in any or any significant way for the causes of the Company becoming insolvent.

82. I would add this. At the time Base 2 was planned in the first half of 1997, the general business atmosphere was ebullient and the majority of people were optimistic about the future. In the estimates for sales and revenue prepared by Mr Chan, it was envisaged that the income from leasing advertising booths alone would be in the region of HK$700,000.00 to HK$800,000.00 per month, enough to cover the monthly operating expenses of Base 2. It did not seem unrealistic for such forecast to be made in that economic climate. A significant factor in the failure of the business of Base 2 was the Asian financial crisis in the latter part of 1997. The magnitude of the resultant economic recession was unforeseen. With the onset of the economic downturn, the computer suppliers and manufacturers declined or postponed leasing advertising booths in Base 2 or to extend their credit lines or terms of payment. Contrary to expectation, only 20% of the booths were leased out, bringing in a monthly income of HK$116,000.00 only. This brought about the cash flow difficulties in early 1998.

83. The court should not apply hindsight in this situation and hold Mr Tsang to be blamed in some way for acting on the forecast and estimates of his co-director. That wrong commercial decisions were taken in retrospect does not mean that there was incompetence or gross incompetence on the part of the directors (Re Living Images Ltd, supra. at 356a to c; Re McNulty's Interchange Ltd (1988) 4 BCC 533 at 536).

Failure to submit statement of affairs in time

84. This allegation may be dealt with shortly. It is provided in section 190(5) that if any person, "without reasonable excuse", makes default in complying with the requirements of section 190 in submitting a statement of affairs in the prescribed form within the stipulated period shall be liable to a fine. It was in mid August 1998 that Mr Tsang was asked to submit a statement of affairs. By that time, Mr Chan had absconded for several months. The accounting records were either removed by Mr Chan or seized by the police. Mr Tsang had written to the agents of the liquidators on 27 August 1998 giving an explanation why he was not in a position to submit a statement of affairs and requested an extension of time to do so. There was apparently no response to his request for extension of time. I do not think there was any failure on his part to comply with section 190 in these circumstances.

Conclusion

85. For the reasons given above, I am not satisfied that any of the alleged misconduct is established. The next question whether one or more of the allegations of misconduct is sufficient to justify a finding of unfitness does not arise. I would merely add this if it were necessary to consider the question of unfitness. Even if established, the misconduct occurred within a relatively short period of time. There were strong elements of misfortune and misplaced trust. Looking at the matter in the round and taking into account extenuating circumstances, I have grave doubts whether there was gross incompetence for the court to find Mr Tsang unfit to be concerned in the management of a company.

Orders

86. I dismiss the Official Receiver's application for a disqualification order against Mr Tsang.

87. I make an order nisi that the Official Receiver do pay the costs of Mr Tsang in this application, to be taxed if not agreed. In so doing, I have considered the submission of Miss Lee that the proceedings were brought by the Official Receiver after due consideration of the evidence against Mr Tsang and the law and there is an element of public interest involved in the proceedings. These matters would seem to me to apply to all applications of this kind brought by the Official Receiver. Costs in this kind of application are at the discretion of the court, and are to be awarded on the principles usually applicable to civil litigation. The authority must take its chance on costs, just like any other litigant in these courts, there is no justification for a special costs rule in this type of litigation (Practice and Procedure of the Companies Court, by Boyle and Marshall, 1997 ed., para. 16.21; citing the decision of the English Court of Appeal in Re Southbourne Sheet Metal (No. 2) [1993] BCLC 135). I am unable to see any special circumstances here to depart from the usual rule that costs should follow the event.