RE EAST SUN BUTTON INTERNATIONAL LTD.

HCMP 5514/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 5514 OF 2001

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REASONS FOR JUDGMENT

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1. This is a petition brought by East Sun Button International Limited ("the Company") seeking confirmation of a reduction of its share capital under sections 58 and 59 of the Companies Ordinance, Cap. 32.

2. The background giving rise to the reduction of capital may be stated as follows.

3. The Company was incorporated in Hong Kong on 7 February 1992. The original authorised share capital was HK$10,000.00 divided into 10,000 shares of HK$1.00 each.

4. Subsequently in 1992, the Company acquired from an unrelated party, East Sun Button Factory Limited, the button manufacturing and distribution business which it now carries on. The consideration for the acquisition, being HK$92,979,956.00, was paid in cash and financed by loans from the Company's immediate holding company, YKK Hong Kong Limited ("YKK"). By virtue of this acquisition, the Company took over net tangible assets to the value of HK$21,382,129.00. The Company wrote off in its accounts the amount of the consideration which was not supported by tangible assets, namely HK$71,597,827.00 by taking this into its first profit and loss account as abnormal items in the year ended 31 December 1992, thereby giving rise to a substantial deficit in shareholders' funds. This approach of writing off the amount of the consideration not supported by tangible assets was acceptable according to accounting guidelines in effect at the time, in particular Guideline 2.204 issued by the Hong Kong Society of Accountants. As there was no clear basis on which the goodwill obtained by virtue of the acquisition could be assigned any realistic economic life, the goodwill was dealt with by immediate elimination rather than by amortisation.

5. Thereafter, the Company increased its share capital on 14 October 1992 to HK$100,000.00 by the creation of 90,000 ordinary shares of HK$1.00 each. On 10 December 1992, the share capital was further increased to HK$1 million by the creation of 900,000 ordinary shares of HK$1.00 each. Then on 29 December 2000, the share capital was increased to HK$99,256,458.00 by the creation of 98,256,458 ordinary shares of HK$1.00 each. The present share capital is HK$99,256,458.00 divided into 99,256,458 shares of HK$1.00 each, all of which have been issued and paid up. 99,256,457 shares are held by YKK and the remaining 1 share is held by Hing Kwok Industrial Company Limited ("Hing Kwok").

6. Although the accumulated shareholders' deficit has been reduced to some extent over the years, the Company still has a substantial accumulated shareholders' deficit of HK$51,041,596.00 as at 30 June 2001. The principal reason for this is the immediate elimination of the goodwill arising out of the acquisition in 1992. Also, there were two years (1998 and 1999) in which the Company had operating losses.

7. On 11 October 2001, the Company passed a special resolution by which it was resolved that the share capital be reduced from HK$99,256,458.00 divided into 99,256,458 ordinary shares of HK$1.00 each to HK$51 million divided into 51 million ordinary shares of HK$1.00 each and that such reduction of capital be effected by cancelling and extinguishing the 48,256,458 ordinary shares of HK$1.00 each numbered 51,000,000 to 99,256,458 inclusive which have been issued and are fully paid and standing in the name of YKK. The purpose of the reduction of share capital is to apply the credit arising from the reduction, namely HK$48,256,458.00 to reduce the accumulated shareholders' deficit. This is the reduction that the Company is asking the court to confirm.

8. At the hearing of the summons for directions on 20 November 2001, I gave a direction under section 59(2) of Cap. 32 dispensing with the settlement of a list of creditors, having been satisfied that the proposed reduction does not involve the diminution of any liability in respect of unpaid share capital or the payment to any shareholder of any paid-up share capital of the Company. The usual directions for advertisement of the hearing of the petition were given. No creditors have given notice of intention to appear and none have appeared at the hearing.

9. The principles on which the court would exercise its discretion to confirm a reduction of capital under sections 58 to 60 of Cap. 32 are well established. If the following criteria are satisfied, the court would exercise its discretion to confirm a reduction of capital:

(1) the shareholders are treated equitably;

(2) the reduction proposals are properly explained;

(3) the creditors are safeguarded; and

(4) the reduction is for a discernible purpose.

See Re Lippo China Resources Limited [1998] 1 HKLRD 20 at 23J to 24A.

10. I turn to consider each of the criteria.

Equitable treatment of shareholders

11. YKK is the owner of effectively the whole of the share capital of the Company. The reduction does not affect the single share held by Hing Kwok. The special resolution for reduction of share capital was agreed to by YKK. The requirement of equitable treatment of shareholders is clearly satisfied.

Proposals clearly explained

12. This does not pose any problem in the present situation, there being only two shareholders in the Company and the capital reduction was decided upon by YKK.

Safeguard to creditors

13. The Company has offered an undertaking for the protection of all its creditors who have dealt with it on the basis of its current share capitalisation by ensuring that in the event of the Company disposing of its entire undertaking, any recovery of that part of its accumulated losses which may prove not to have been permanent, namely that part of the loss attributable to goodwill written off on the acquisition in 1992, will be placed in a special reserve, which will be maintained for as long as such creditors remain unpaid and do not consent to its being dispensed with. I accept the undertaking offered by the Company. I am satisfied there is sufficient protection for its creditors with this undertaking.

Reduction for a discernible purpose

14. The credit arising from the reduction of share capital is to be applied to reduce the shareholders' deficit. The extinguishing of accumulated losses is a recognised purpose for the reduction of share capital in section 58(1)(b) of Cap. 32. The reason for the elimination of the shareholders' deficit is to place the Company and its parent company in a position in which they would be able to more readily and effectively assess the performance of the Company without the need to examine the historical reasons for past losses. Further, this would put the Company in a position to distribute future profits should it be considered appropriate to do so. I am satisfied that the reduction is for a discernible purpose.

Orders

15. For the above reasons, I have exercised my discretion and confirmed the reduction of share capital by making an order in terms of the draft submitted. I have also approved the minute of reduction for registration by the Registrar of Companies.