NG CHAN NING v. MI FUNG BEADS CO LTD AND OTHERS

HCCW 224/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 224 OF 2004

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J U D G M E N T

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1.  This is an application by Mi Fung Beads Company Limited (“the Company”) for a validation order under section 182 of the Companies Ordinances (“the Ordinance”).

2.  The petition in this case was presented on 17 February 2004 by Mr Ng Chan Ning, one of the shareholders in the Company.  The Company is a family company, and the petition was presented under sections 168A and 177(1)(f) of the Ordinance.  The shareholders of the Company consist of the Petitioner and the 2^nd and 3^rd Respondents who are respectively his brother and father.  As its name suggests, the Company’s main business is that of dealing in beads and sequins, of which it is a trader, distributor and wholesaler in Hong Kong.

3.  The petition seeks relief under section 168A of the Ordinance in the form of an order for the purchase by the Respondents of the Petitioner’s shares in the Company.  It also seeks a winding-up order on the just and equitable ground under section 177(1)(f) of the Ordinance.

4.  In his petition, the Petitioner alleges that it was the mutual understanding between the shareholders that they should all participate in the business of the Company as directors, and that they would support the Company financially.  It is alleged that the parties had reposed mutual trust and confidence in each other in relation to the carrying on of the Company’s business.

5.  What is now said is that this mutual trust has been lost or destroyed, and complaints are made about the Company’s dealings with two companies of similar name in Shenzhen which the Petitioner says are owned and controlled by his brother, the 2^nd Respondent.  He says that following complaints as to these dealings, he has been excluded from the management of the Company, and in consequence of this, he seeks the relief which is sought in the petition – a buyout of his shares or the making of a winding-up order in respect of the Company.

6.  Following the presentation and advertisement of the petition, the Company found that the usual consequence ensured – its bank accounts were frozen, making it difficult for the Company to carry on its business.  Two of its bankers, the Dah Sing Bank and Citibank, have apparently demanded repayment of banking facilities which they have extended to the Company.

7.  Faced with these problems, the Company applied for a validation order by its summons dated 19 March 2004.  That application first came on for hearing before me on 30 March 2004, when I made a limited validation order to enable the Company to continue trading for a short period.  While affording the Petitioner an opportunity to file evidence in opposition to the order sought and permitting the Company to reply to any evidence which might be filed.  The order was subject to safeguards to enable the Petitioner to monitor the expenditure made pursuant to the validation order then granted.  At the same time, I gave leave to the Company to amend its summons to specify in more detail the payments and transactions in respect of which validation orders were sought.

8.  Today’s hearing was the adjourned hearing of the application under the summons as amended.  What is now in issue are validation orders in respect of the payment of salaries and general office expenditure, to enable the Company to continue trading in the future.  A validation order is also sought to enable payment to be made in respect of goods which have been ordered and used in the ordinary course of business up to and including 29 February 2004.  As to these payments, this would involve for the most part payment of debts which arose prior to presentation of the petition, although a portion of the debts that are proposed be discharged would relate to post petition debts incurred between the presentation of the petition on 17 February 2004 and the date in respect of which validation is sought – 29 February 2004.  Validation orders are also sought in respect of payments going forward in respect of estimated direct material costs which are said to be required to be purchased for projected orders which the Company anticipates will generate profits for it.  A further validation order is sought in respect of proposed repayments of bank loans by the Company to its bankers.  Finally, a validation order is sought in relation to the disposition of certain property owned by the Company which is its presently be charged to its bankers as security for banking facilities granted by them.

9.  At today’s hearing, the first and principle issue that divided the parties was whether or not the Company should be regarded as solvent for the purposes of this application.  Mr Lam appearing for the Company submitted that it was clear from the financial statements which had been exhibited to the evidence filed in support of the application for the validation order that the Company was solvent and it was, moreover, trading profitably.

10.  The evidence initially filed in support of the application suggested that the Company had, on the basis of unaudited accounts as at 29 February 2004, a balance sheet which showed net assets of some HK$21 million.  However, it became clear in the course of the hearing on 30 March 2004 that the net asset value of the Company was probably substantially lower, having regard to the fall in the value of its real properties which was a consequence of the general fall in the property market in Hong Kong over the past few years.  This was one of the criticisms made by the Petitioner of the evidence filed by the Company. 

11.  In response, the Company has, its latest evidence, produced a revised set of management accounts as at 29 February 2004 which takes account of the falling value of these properties, by having regard to the prices which have been offered for these properties by 3^rd party buyers, in respect of proposed sales, which appeared to be at full market value and to independent 3^rd parties.

12.  The result of this provision being made is that the Company will suffer a substantial loss in the financial year 2003/04.  However, I note that this loss is caused by the provision that is made in response to the criticism made by the Petitioner of the Company’s earlier evidence.  This apart, at the trading level, it appears that the Company is trading profitably although its profit for the current year appears to be modest. 

13.  Following the making of these provisions for the diminution in the value of the Company’s properties, it remains the position on the management accounts as so adjusted that the Company nonetheless has net assets of some HK$4.7 million.

14.  It is also pertinent perhaps to note that included in its liabilities are shareholders loans totalling a little over HK$10 million of which HK$6 million odd is owed to the 3^rd Respondent and HK$4 million odd is owed to the Petitioner.

15.  If, as the Company suggests is likely, the 3^rd Respondent does not call in shareholders loans, this would suggest that the Company has a reasonable cushion with which to operate going forward into the future. 

16.  It is true that this latest set of accounts is found in financial statements that have not been audited, but that, it seems to me, is not a criticism of any particular weight in this case, since one cannot reasonably expect audited accounts to be produced in respect of the current financial period. 

17.  Three main criticisms were made of the financial information provided by the Company.  The first relates to the fall in the value of its properties.  As I have noted, this criticism has already been addressed by the further evidence filed by the Company, and even allowing for that fall in value, the Company remains solvent. 

18.  It is however also said that provision should be made in respect of two substantial assets in the Company’s balance sheet.  These are respectively its inventory and its trade receivables.  The inventory stands at a value of some HK$16 million.  It has dropped in line with recent falls in turnover in the last few years.  The Petitioner suggests that this amount should be substantially discounted to take account of irresolvable stock and other matters.  The Company on the other hand has put forward evidence which indicates that there has already been a discount made in respect of inventory to the value of 23% of its stocks.  Moreover it is said by the Company’s accountant that the treatment and valuation of the inventory is in line with normal business practices and normal accounting practices in respect of the business that the Company carries on. 

19.  As for the receivables, while the Company accepts that some of the HK$7 million of receivables that are shown as owing to it have been outstanding for some time, it points out that none of its debtors are known to it to be insolvent or to be the subject the winding-up proceedings.  The evidence from the Company’s accountant is that the treatment of these receivables is normal in terms of the industry practices and that the aging of receivables is not substantially longer than is normal in this line of business.

20.  It is, moreover, pointed out that the Company has had receivables in its accounts for some years, and that there had not on any previous occasion been added thought to be any need to make any provision in respect thereof.  In the circumstances, I do not think that there are any good reasons for me to doubt the reliability of the evidence put forward by the Company as to its financial state: Indeed, Mr Wong, appearing for the Petitioner, did not seriously object to the making of a validation order to enable the Company to continue trading, subject to appropriate safeguards being provided for.

21.  Thus on the evidence before me, it seems to me that the Company has demonstrated that it is, on the basis of its balance sheet, solvent.  Moreover, it does appear from the evidence which have been put forward that it is trading currently at a modest profit and there is evidence to indicate that there are orders in hand which are expected to generate further profits for the Company in the months to come. 

22.  In these circumstances, where the company is solvent, it seems to me that the appropriate approach to take to the question of whether or not a validation order should be granted is that described by Madam Justice Yuen as she then was in Re Taipat Resins Ltd (unreported, CFI, 26 August 1999), in which she applied the principles laid down in Re Burton and Deakin Ltd [1997] 1 WLR 390 that is, where a company is solvent and a validation order is sought if the directors consider that a particular disposition falling within their powers as directors is necessary or expedient in the interests of the company, and if the court considers that the reasons given are such that an intelligent and honest person could hold that view, the court would normally sanction that that disposition notwithstanding that it may be opposed by a contributory unless there is very clear and compelling evidence to suggest that the disposition is likely to be injurious to the interests of the company.

23.  As I have noted, Mr Wong did not seriously suggest that the Company should not be allowed to carry on business.  He said that the main concern that the Petitioner had was to ensure that there was no dissipation of the Company’s assets and that the business was carried on properly.   Specific complaint, however, was made in relation to two items.  The first related to directors’ salaries and the second related to entertainment expenses. 

24.  So far as directors’ salaries are concerned, it seems to me that if the directors are in fact carrying on the business of the Company and are providing their services to the Company, it would be in order for them to be permitted to make payments of their salaries or other remuneration to themselves.

25.  As for the entertainment expenses, it seems to me that this is a matter which can be best addressed by the imposition of appropriate safeguards on any validation order made, so as to enable the operation of the order to be monitored by the Petitioner.  It is important to bear in mind that in this case, one is considering a company that is, on the evidence, solvent and is trading, as I have said, profitably, and that this is also a case in the nature of a minority shareholders petition, in which it may well be that the primary relief sought is that a buy-out rather than a winding-up order.

26.  I think it is also right to bear in mind that any validation order made would extend only to payments made in the ordinary course of the Company’s business and would thus not extend, for example to repayment of shareholder’s loans, and particularly to loans made by shareholders who are still involved in the operation of the Company.

27.  Where a payment is made or purportedly made pursuant to the validation order which proves not to be in the ordinary course of the Company’s business.  It would, if some mechanism for monitoring is provided, be open to the Petitioner to challenge that payment, or in the event of the Company eventually going into liquidation, for a liquidator to do so, on the basis that the payment, not being made in the ordinary course of business, was outside the scope of the validation order and so was not protected thereby. 

28.  If a payment which on the face of it is made in the ordinary course of the Company’s business proves ultimately to have been made in bad faith or in some way in an abuse of the directors’ powers, this no doubt could also be the subject of investigation at a later stage should that be necessary.

29.  On this basis, it seems to me that it would be appropriate in this case to permit the Company to carry on trading, and for that purpose to grant the validation order in relation to the payment of the usual expenses that it will incur in the ordinary course of its business.  Although a figure had been suggested by way of limitation of that amount by the Company at some HK$720,000 per month and Mr Wong for the Petitioner has suggested that a lower limit should be provided, it seems to me that as long as a mechanism for monitoring of such expenses is provided for in the order, it is not strictly necessary to impose any particular limit on the payments to be made on a month by month basis.  What is or will be important is that payments which are made are in fact made in the ordinary course of the Company business and its in best interests.

30.  It seems to me also that on the basis of the Company is solvent.  It would be appropriate to allow the payment of existing debts at that 29 February 2004.  While the bulk of these debts may well be that situate incurred prior to the presentation of the petition, so that the creditors in question may be regarded as unsecured creditors, it seems to me that it is open to the directors reasonably to take the view that it is in the interest of the Company to pay such debts rather than to run the risk of enforcement proceedings or perhaps the presentation of a creditor’s petition, being taken by the creditor’s concerned.

31.  I also note from the schedules identifying the creditors in question that some at least of these creditors appear to be creditor in respect of when there ongoing business, as they are also listed in the schedule of suppliers in respect of whom it is sought to obtain a prospective validation order for materials to be purchased to enable current orders to be fulfilled.

32.  I note also that this part of the application was not strongly opposed by Mr Wong and I therefore propose to grant a validation order in respect of such payments.  So far as future purchases of materials are concerned, it seems to me that if they are made in the ordinary course of the Company’s business it would follow from my decision that it is in order for the Company to carry on its business that a validation order covering such items should also be made subject to the same safeguards in terms of monitoring.

33.  So far as monitoring is concerned, there have been a number of cases in which the courts have granted validation orders in respect of solvent companies which are the subject of a shareholder’s dispute in which a winding-up order is sought on the just and equitable ground to enable them to continue trading, so long as appropriate safeguards are put in place to enable the Petitioner to monitor the use to which the Company’s funds are being put in order to avoid any problems arising as to the propriety of such payments.  With this in mind, it seems to me that it would be appropriate to include in the validation order which I propose to make a requirement (which may be by way of undertaking or as part of the order) that information should be provided as to all payments and transactions entered into pursuant to the validation order which I granted that to the Petitioner or his solicitors to enable them to monitor the working of the validation order.  It may be necessary to fine time the precise means by which this is to operate, and it would be sensible to have periodic reporting in arrears, rather than to require information to be provided on each occasion that a sum of money is spent or a transaction is entered into.

34.  That leaves the proposal by the Company to repay its bankers and to dispose of its real property in order to enable such repayments to be made.  On the evidence, the position appears to be that two banks that it is Dah Sing Bank and Citibank have in fact demanded repayment of loans and other facilities that they have made available to the Company.

35.  In the case of Dah Sing Bank, these consists of an overdraft on the current account operated by the Company with it in the sum of some HK$3.2 million plus trust receipt loans some HK$1.6 million, totalling HK$4.8 million. 

36.  In the case of Citibank, the total amount of the loans outstanding is also some HK$4.8 million.  In this case, they consist of an overdraft of some HK$2 million, trust receipt loans of some HK$1.6 million and an instalment loan of some HK$1.15 million.

37.  These loans are to some extent secured by property owned by the Company.  In the case of Dah Sing Bank, it appears to have a charge over Units B13 at Harbour Centre, Tower One, No. 1 Hop Cheung Street, Kowloon.  It also has security over a fixed deposit of some HK$2 million which stands in the name of the 3^rd Respondent, maintained no doubt with that bank.  There are also personal guarantees executed by the 3^rd Respondent and the Petitioner respectively.

38.  So far as Citibank is concerned there is a charge over Unit 509 of Harbour Centre, over a fixed deposit (also in the 3^rd Respondent’s name) of some HK$1.8 million and personal guarantees issued, in this case, by the 2^nd Respondent and the Petitioner respectively.

39.  It is said for the Company that given the fact that the banks have demanded repayment of these loans, it thought to be desirable to repay them if possible.  Mr Lam says that to do so by selling the properties by which the loans are secured would not be injurious to the Company.  Such sales would not diminish the Company’s net assets since the sales that are proposed to be made are at full market value and would thus go to reduce the indebtedness to the banks to the maximum extent possible given the values of the properties.  It is also pointed out there would be an interest saving in respect of the interest that is payable to the banks in respect of such facilities, although that would to some extent be off set by the fact that rent might have to be paid for alternative premises for the Company. 

40.  On balance, it seems to me that the reasons that have been given are such that an honest and intelligent person could reasonably hold them and given the fact that the banks appear to have demanded repayment of their loans, it seems to me that it would be reasonable to allow the directors to do so, if necessary by selling these properties.  

41.  I should also mention that in relation to the fix deposits which have been placed the security for the loans advance or facility advanced by Dah Sing Bank and Citibank.  It was suggested that by Mr Wong that to allow that covered itself its properties and order to effect repayment of these indebtednesses to this bank.  It would might/will have impact on the interest of the Company’s creditor as the whole since the banks might otherwise have had records to this strict deposit and thus have received the less from this proceed of sale of any property.  The suggestion was that the assets of the Company would be swelled to the extent of these fix deposits, as the 3^rd Respondent, would then be an unsecured creditor in respect of the amount of his fixed deposits which had been used for the benefit of the Company. 

42.  It seems to be me that this does not follow.  If the banks in question were to have recourse to the deposits lodged with them by the 3^rd Respondent, it seems to me that he, on suffering the loss of his deposits would be entitled to stand in the shoes of the banks concerned in respect of any other security which the banks might hold.  It therefore follows that he would in all probability be entitled by way of subrogation to have recourse to the other security which the banks held – that is to say that the Company’s properties.

43.  In these circumstances, it does not seem to me that there is any real prospect of series predictors to the creditors arising as a result of the making of the validation order in respect of these properties. 

44.  I would therefore be minded to grant a validation order that enables the Company to repay both Dah Sing Bank and Citibank the sums which are owed to them, and for this purpose to dispose of the properties which have been charged to those banks.

45.  So far as a third banches, DBS Bank, is concerned, this bank appears is to be the Company’s perhaps principal banker, having regard to fact that the Company’s indebtedness to it runs to some HK$10 million.  Although the Company had also sought a validation order to enable it to repay these facilities to the DBS Bank and to sell properties which are mortgaged to that bank in order to achieve that repayment, it seems to me that there is insufficient evidence that it is really necessary for the Company either to repay these facilities or to sell the properties which are charged to the DBS Bank, subject to one point which I mention below.  Mr Lam accepted that there was no evidence that DBS Banker had in fact demanded repayment of loans which outstanding to it and although the banker not being quite helpful and had one stage to be hoped.  It prevents the petition that the DBS bank had been reasonably accommodating in terms of the facility.  It has granted to the Company and had not in fact demanded repayment of them.

46.  In this circumstances, I would not propose to grant a validation order enabling the Company to repay any of indebtedness to DBS Bank or to any other banks which had not in fact demanded repayment of facilities advanced by them to the Company.

47.  One final point, it is the Company seeks even if Mr Lam suggested that even if make the validation order in respect of repayment to the bank should be limited to as I have decided it should to Dah Sing Bank and Citibank that the Company should nonetheless be allowed to dispose of one of properties mortgage to the DBS Bank namely Unit 508 of Harbour Centre because it was said that this unit being an adjoining unit of Unit 509 which mortgage to Citibank if the subject of an offer which have been made at above a valuation provided by independent values.  On the basis that Unit 508 and 509 also together.

48.  It seems to me that given the existence of the offer which is disclosed the evidence before me and given the fact these two units signed into the link.  It seems to me that it would be opened to the directors to honestly and intelligently take the view that it would be appropriate to these bills of these assets served to maximize the value that can be achieved by the Company by the sale of the linked property Unit 509 and thus secure a greater reliable made an induction possible in this indebtedness to Citibank.

49.  I would therefore grant a validation order to enable the Company to repay indebtednesses to Dah Sing Bank and Citibank and in connection there with to enable dispose offered properties at their Units 508, 509 and B 13 of Tower one of Harbour Centre.

50.  I would not, however be inclined to make any further validation order in respect of repayment to other banks or in respect disposals of any other property on the evidence before me.  If it becomes necessary to dispose of these other properties or to make repayments to these others banks in future, the Company can take out an appropriate application in due course.

51.  Finally, I should also mention that Mr Lam sought, during submissions, an order validating proposed repayments by the Company to the 2^nd and 3^rd Respondents who are said to have advanced funds personally to the Company, and to have made payments from their personal accounts to creditors of the Company to enable it carry on trading, during the period that ots bank accounts have been frozen.  However, at this stage there is no evidence as to what payments have been made to whom and in what amount and I am not inclined to make an order in respect of such payment at this stage.  If this is a matter which the directors concerned wish to pursue, it is open to them to apply for a validation order in due course.

52.  I will leave it to the parties to draft an appropriate form of order, which is to be submitted to my clerk for settlement in due course.  I will now hear the parties in relation to costs.

Representation: