THE OFFICIAL RECEIVER v. JAMES CONRAD LOUEY AND ANOTHER

HCMP 2770/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2770 OF 2003

____________

____________

____________

______________

J U D G M E N T

______________

1.  This is an application by the Official Receiver pursuant to section 168H of the Companies Ordinance, Cap. 32.  The originating summons was issued on 27 June 2003.  The Official Receiver seeks disqualification orders against James Conrad Louey (“the 1^st respondent”) and Cheng Yin Bong Jason (“the 2^nd respondent”), on the basis of their conduct as directors of Phantom Records Limited (“Records”) and Phantom Music Limited (“Music”).

2.  Records was ordered to be wound up on 18 August 1999 on the petition of a former employee presented on 2 July 1999, based on an award obtained against Records in the Labour Tribunal on 15 January 1999.  The Official Receiver was appointed the liquidator on 27 October 1999.

3.  Music was ordered to be wound up on 19 July 2000, also on the petition of a former employee presented on 26 May 2000, on the basis of an award obtained in the Labour Tribunal on 24 May 1999.  The Official Receiver was appointed liquidator on 29 September 2000.

The allegations against the respondents

4.  The Official Receiver has made these allegations against the respondents that their conduct was such as to make them unfit to be concerned in the management of a company.  There is no allegation of dishonesty.

5.  As against the 1^st respondent, these allegations are made:

(1)     As a director of Records, he caused Records to enter into an unfair preference within section 266B of Cap. 32 or a preference and/or a transaction to the detriment of its general creditors for the benefit of himself.  On 13 January 1999, Records made a payment of $352,440.00 to the 1^st respondent by cheque No. 003180 dated 12 January 1999 drawn on its current account with The Hongkong and Shanghai Banking Corporation Limited (“the HSBC”), at a time when Records was insolvent.

(2)     As a director of Music, he failed to take all reasonable steps to secure compliance by Music with the requirements of section 121 of Cap. 32.  No books of account of Music were recovered by the Official Receiver as liquidator except copies of three sets of audited accounts for the period between 3 March 1994 and 31 August 1994, for the year ended 31 August 1995 and for the period ended 31 March 1996.

(3)     As a director of Records and Music, he failed to co-operate with the Official Receiver and liquidator of Records and Music in the administration of the estate of these companies and the investigation of their affairs, and to provide a statement of affairs of Music pursuant to section 190 of Cap. 32.

6.  The 1^st respondent has denied all three allegations.

7.  As against the 2^nd respondent, these allegations are made:

(1)     As a director of Records, he caused Records to enter into an unfair preference within section 266B or a preference and/or a transaction to the detriment of its general creditors by signing the aforesaid cheque for payment to the 1^st respondent and dealing with the assets of Records without due consideration for its financial position.

(2)     As a director of Music, he failed to take all reasonable steps to secure compliance by Music with the requirements of section 121.  No books of account of Music were recovered by the Official Receiver except copies of the three sets of audited accounts as aforesaid.

8.  On 13 July 2002, the Official Receiver laid information against the 2^nd respondent that between 13 July 1999 and 19 July 2000, he as a director of Music, failed to take all reasonable steps to secure compliance by Music with the requirement to preserve its proper books of account required to be preserved by it for seven years from the end of the financial year to which the last entry made related, contrary to section 121.  He pleaded guilty on 11 November 2002 and was convicted in the magistrates’ court and fined $1,500.00.

9.  At the outset of the hearing, the 2^nd respondent denied both allegations.  When it came to closing submissions, his counsel Miss Che informed the court that he admits his failure to take all reasonable steps to secure Music to comply with section 121 after 31 March 1996 and that such failure makes him unfit to be a director.  So he only denies the first allegation.

10.  In respect of the first allegation for each of the respondents, it should be noted that the Official Receiver has not confined his case to an unfair preference under section 266B.  It is clear from the summary of allegations of unfitness in the Official Receiver’s 1^st report served on the respondents that there is an alternative case, namely, that the impugned payment was a preference to the 1^st respondent in general terms, not just in terms specific to statutory unfair preference, in that it was alleged to be a transaction for the benefit of the 1^st respondent to the detriment of the general body of creditors of Records and without due consideration for the financial position of the company.  Miss Ismail for the Official Receiver has drawn attention to this in her opening submissions and made reference to Re Sykes (Butchers) Ltd. [1998] 1 BCLC 110.

The Phantom group of companies

11.  Between 1992 and 1995, the 1^st and 2^nd respondents established the Phantom group of companies.  These companies included Phantom Group Limited (“Group”; formerly known as Avalon Corporation Limited), Phantom Gallery Limited (“Gallery”), Phantom International Limited (“International”), Phantom Trends Up Limited, Phantom Images Limited, Phantom Entertainment Limited (“Entertainment”), Music and Records.  The 1^st respondent was the main provider of funds for these businesses.  He had provided seed money and loaned money to the group from time to time.  His total injection of funds to the group amounted to $42,901,679.35 when he made his 1^st affirmation in these proceedings in September 2003.  Of the funds injected, $200,000.00 went to Music directly and $5,670,000.00 went to Records directly. 

12.  Group was the ultimate holding company of Records and Music.  It was incorporated in November 1992.  The 1^st and 2^nd respondents each held a 45% shareholding in Group.  They were its first directors.  The 2^nd respondent resigned as a director on 7 December 2000.

13.  The companies in the Phantom group had their registered office at 3^rd Floor, Seaview Centre, Nos. 139 to 141 Hoi Bun Road, Kwun Tong, Kowloon, Hong Kong.  Apart from the registered office, these companies also occupied the 2^nd Floor of the same building.  Group was the tenant of the registered office.  International was the tenant of the 2^nd Floor office.

14.  According to the résumé of the 2^nd respondent produced by the 1^st respondent, the Phantom group grew from three people to over 70 people in three divisions – integrated marketing, entertainment and premiums/greeting cards.  The integrated marketing division had branch offices in Beijing and San Francisco and associated offices in Sydney, Melbourne and London.  The entertainment division had branch offices in Beijing and Taipei.

The background of Records

15.  Records was incorporated in Hong Kong on 5 September 1995 under its former name Cason Holdings Limited.  On 14 November 1995 its name was changed to Records.  It commenced business on 1 October 1995.  It was engaged in the business of music production; the management of artists and agency; the sale, distribution, marketing, promotion and publishing of music records and compact discs.

16.  According to an application to the Business Registration Office dated 1 November 1995, Records carried on a branch business under the name of “Phantom Publishing Company”.  The nature of this business was music publishing and the date of commencement of business was 1 November 1995.  Phantom Publishing Company was admitted as a member of the Composers and Authors Society of Hong Kong Limited (“CASH”) on 17 May 1996, and had empowered CASH to administer the performing rights of musical works vested in it.

17.  The first directors of Records were the 1^st respondent, the 2^nd respondent and Tse Hing Kit (“Tse”).  They were all appointed on 27 October 1995.  The 2^nd respondent was also the company secretary.  Tse resigned on 1 February 1996.  The respondents resigned on 15 April 1999, when the business of Records was sold to Chiu Kin Man (“Chiu”).  On the same day, Chiu and Gallery were appointed directors.  The Official Receiver has not been able to locate Chiu.

18.  The authorised share capital of Records was $10,000.00, divided into 10,000 shares of $1.00 each.  Only ten shares were issued at all times.  In October 1995, seven were held by Music and three were held by Sound Factory Limited (“Sound Factory”).  On 30 May 1996, Music transferred its seven shares to Entertainment.  On 18 March 1997, Sound Factory transferred its three shares to Entertainment and Entertainment transferred one share to the 2^nd respondent.  The 2^nd respondent held his share on trust for Entertainment by a declaration of trust dated 18 March 1997.

19.  According to the annual return of Records made up to 5 September 1998, signed by the 1^st respondent as the director and the 2^nd respondent as the secretary and filed at the Companies Registry on 5 June 1999, nine shares were held by Gallery and one share was held by Chiu as at the date of that return, which was before the sale of the business to Chiu.  There is no explanation for this apparent discrepancy.

20.  By a board resolution of Records on 15 October 1997, it was resolved that the branch business of Phantom Publishing Company was transferred to Entertainment.  The Business Registration Office was notified that this branch business of Records ceased business on 15 October 1997.  In November 1997, Entertainment registered a branch business in the name of Phantom Publishing Company with 15 October 1997 as its date of commencement of business.

21.  The membership of Phantom Publishing Company with CASH was terminated on 13 January 2000.  According to the records of CASH, there is a list of 60 musical works (“the CASH List”) in respect of which the performing rights are vested in Phantom Publishing Company.

22.  According to the last annual return of Entertainment made up to 9 November 1997, the 1^st and 2^nd respondents were its directors.  Of the issued shares, 9,999,999 shares were held by Group and the remaining share was held by the 2^nd respondent.  The 2^nd respondent resigned as director on 21 December 2000.  The 1^st respondent resigned as director on 1 November 2001.

23.  As for Gallery, according to its last annual return made up to 23 November 1997, the 1^st and 2^nd respondents were the directors and the issued shares were held by Group as to nine shares and by the 2^nd respondent as to the remaining share.  Both respondents resigned on 15 April 1999, although a Form D4 being a notification of resignation of director filed on 13 July 1998 showed that the 2^nd respondent had resigned earlier on 25 June 1998.  Chiu and Records were appointed the directors of Gallery on 15 April 1999.

24.  By a board resolution of Records in December 1995, it was resolved that the authorised signatories of its current account at the HSBC were the 1^st respondent, the 2^nd respondent and Chan Chi Hong (“Chan”).  Chan was the general manager of Records at all material times, until the business was sold to Chiu.  It was also resolved that any one of the authorised signatories could sign for an amount up to $5,000.00 and any two of the authorised signatories could sign for an amount above $5,000.00.

25.  By a subsequent board resolution of Records on 1 April 1997, the bank mandate was altered.  The only authorised signatories were the 1^st and 2^nd respondents.  For an amount up to $5,000.00, any one of the authorised signatories could sign.  For an amount above $5,000.00, the signatures of both were required.  This form of bank mandate persisted until the business was sold to Chiu.

26.  Up to 30 June 2006, seven proofs of debt were received in the liquidation of Records in the total sum of $5,860,485.97.  Three were filed by former employees for the total claim of $88,217.00, and one was filed by the Protection of Wages on Insolvency Fund Board for $97,300.97.  The largest claim was that submitted by the 1^st respondent, for $5,670,000.00.

27.  Up to 30 June 2006, the total assets realized by the liquidator for the estate of Records amounted to $187,721.45.  This included a payment of $176,220.00 made by the 1^st respondent on 19 September 2003, which was after the issuance of these proceedings for disqualification orders, in settlement of the liquidator’s unfair preference claim of $352,440.00 on a without admission of liability basis.  The expenses so far incurred in the liquidation of Records amounted to $474,072.23.

28.  Records is an insolvent company within section 168H(2)(a), as it went into liquidation when a time when its assets were insufficient for the payment of its debts and other liabilities and the expenses of the winding up.

The background of Music

29.  Music was incorporated in Hong Kong on 3 March 1994 under its former name Star Grand Limited.  Its name was changed to Music on 19 January 1995.  The respondents and Tse were appointed the first directors on 20 December 1994.  The 2^nd respondent was also the company secretary.  Tse resigned as a director on 1 February 1996.  There was no record in the Companies Registry of the respondents’ resignation as at the date when Music was wound up on 19 July 2000.

30.  According to the last annual return of Music made up to 3 March 1998, of the 100 issued shares, 99 were held by Entertainment and the remaining share was held by the 2^nd respondent.  The shares held by Entertainment were transferred to it from Group in April 1997.

31.  Music was in the business of providing studio-recording services.  In the 2^nd respondent’s answer to the questionnaire of the Official Receiver in May 2003, he stated that Music had started to wind down its operation from about March 1998 and it had ceased operation in around June 1998.  The petitioning creditor, who was a studio engineer employed by Music, stated in his application to the Protection of Wages on Insolvency Fund that his last day of work was 12 September 1998.

32.  As at 23 June 2003, no assets were realised in the liquidation of Music.  Two proofs of debt were filed, one by the Commissioner of Inland Revenue for $4,800.00 and the other by the Protection of Wages on Insolvency Fund Board for $17,578.00.  There has been no change in this position.

33.  Music is also an insolvent company within section 168H(2)(a).

The 1^st respondent

34.  The 1^st respondent made three affirmations in these proceedings and was cross-examined.  He is middle aged.  He met the 2^nd respondent in Australia in the late 1980s and they became friends.  In 1990, the 1^st respondent returned to Hong Kong and worked in the Kowloon Motor Bus Company (1933) Limited (“KMB”) as the assistant personnel manager.  KMB is wholly owned by Transport International Holdings Limited (“TIH”).  The shares of TIH are listed on The Stock Exchange of Hong Kong Limited.  Members of the 1^st respondent’s family are known to have a long association with KMB.

35.  The 1^st respondent was promoted to the head of the human resources department of KMB and occupied that position from June 1993 to December 2005.  In January 2006, he was promoted to the commercial director of KMB.

36.  Since April 2001, the 1^st respondent has been a non-executive director of Roadshow Holdings Limited (“Roadshow”), a publicly listed company in Hong Kong and in which TIH has a substantial interest.

37.  Due to his positions in KMB and Roadshow, the 1^st respondent was appointed a director to four associated companies.  He became quite well known on account of his positions at KMB and Roadshow and the publicity of his involvement in social and charitable events.

38.  The 1^st respondent established some of the companies in the Phantom group to pursue his interest and hobby in popular music.  He described himself as a non-executive director in Records and Music and his position in the group as a “silent investor”.  According to a list of personnel of Records attached to the minutes of the board meeting of Records held on 21 November 1995, the 1^st respondent’s position in Records was chairman of the board and the 2^nd respondent’s position was president, secretary and treasurer.

39.  The 1^st respondent has produced two character references on his trustworthiness.  The authors were not called to testify.  Mr. Griffiths, SC submitted on his behalf that in view of the character references, the court should approach the case on the assumption that the 1^st respondent is unlikely to deliberately act dishonestly or without commercial probity.  I do not think it would be right to approach the case from any assumption of the kind.  I need to find, on the evidence before me, whether the allegations of misconduct are established against the 1^st respondent.  I do not find the character references, which are concerned with the 1^st respondent’s involvement in charitable works or in companies wholly unrelated to the Phantom group, particularly helpful in this regard.

The 2^nd respondent

40.  The 2^nd respondent made two affirmations in these proceedings but as he elected not to give evidence at the hearing, he is not allowed to rely on his affirmations.  He did not challenge any of the evidence adduced by the Official Receiver and the 1^st respondent.

41.  As the 1^st respondent has produced a résumé of the 2^nd respondent, a bit more is known about his personal background.  The 2^nd respondent is 40 years old.  He has obtained these degrees in Australia in the 1980s: bachelor of commerce (accounting, finance & systems), bachelor of law, and graduate diploma in applied finance & investment.  He qualified as a barrister at law in New South Wales and is an associate of the Australian Society of Certified Public Accountants and an associate of the Securities Institute of Australia.

42.  After graduating from university, he worked as a tax consultant in Deloitte Ross Tohmatsu.  He then joined the Australian Gas Light Company as group taxation accountant.  He returned to Hong Kong in 1991 and the 1^st respondent offered him a position in KMB as personal assistant to the general manager.  When the department of legal, environment and projects was created in KMB, he was promoted to head that department in December 1992.  He left KMB in July 1994 to work full time in the Phantom group of companies.  His position in the group was managing director.  He claimed to have left the group in May 1998 and in June 1998 he joined Hung Wan Construction Company Limited as a business consultant.

The events in 1998 and 1999

43.  On 2 December 1997, the board of Records approved the financial statements for the period from its incorporation in September 1995 to 31 March 1996.  There was a deficit of $2.4 million.  The auditors gave a qualified opinion stating that full provision should have been made for an amount of $1.1 million due from a shareholder, Sound Factory.  The deficit as at 31 March 1997 grew to $4.8 million according to the management accounts.

44.  Between July 1998 and October 1998, Records terminated the employment of six employees – Fung Ka Chiu Tony (“Fung”), Chang Ka Yee, Sham Siu Ling, Tong Pak Wai (“Tong”), Fung Wai Choi and Tang Peng Cheng.  Two of them, Fung and Tong, have made affirmations in these proceedings and their evidence was not challenged.  I accept their evidence as set out below.

45.  Fung was employed to look after the computer system of all the companies in the group.  On 14 August 1998, Chan told him as Records had financial problems, it was necessary to cut staff so Records no longer required his service.  By then, it was apparent to Fung that Records was closing down, and many employees had left already.  When he left the employment of Records on 13 September 1998, there were only about five employees.  He was not paid his salary for September 1998 and other amounts such as severance pay, year end bonus and annual leave pay.

46.  In mid September 1998, Fung telephoned the 1^st respondent at the request of his colleagues to enquire about their outstanding wages for August 1998, as he knew the 1^st respondent personally.  The 1^st respondent did not give a positive answer when Fung asked when the outstanding wages of August would be paid.  Fung told him that he and his colleagues might go to the Labour Department for assistance.  The 1^st respondent’s reply was that he could do nothing about it.

47.  Tong was employed as a driver.  Records had two motor vehicles, a van and a private car.  He usually drove the private car.  About one to two months before he left Records in October 1998, the head of the administration department asked him to return the private car to a car dealer.  Since then, as there was no car to drive, he did not have much to do so he sometimes acted as a messenger.  He knew that the office was shrinking and a number of staff had left.

48.  Some time in September 1998, Records and Music and other companies in the group moved to premises in Siu Lek Yuen, Shatin, leased personally by the 1^st respondent.  However, the registered office of these companies was not changed.  It was only on 26 April 1999, after Records was sold to Chiu, that Chiu filed in the Companies Registry a notification of situation of registered office that with effect from 15 April 1999, the registered office of Records was at an address in Wu Sang House, Mongkok, Kowloon.

49.  In September 1998, a Mr. Choi, who was in charge of another company in the Phantom group responsible for producing greeting cards, asked Tong to work in the godown in the Siu Lek Yuen premises to look after the stock.  When Tong worked in the godown, he was the only staff left in Records.  There was no electricity supply and telephone, and the working environment was very bad.  On or about 10 October 1998, Chan telephoned him and terminated his service with immediate effect.  No reasonable explanation was given.  His wages for September were paid and he asked Chan about his wages in October and other payments on termination.  He could not remember Chan’s reply.

50.  After Records and Music had moved out of the registered office, two sets of distraint proceedings were issued by the landlord in respect of the premises occupied by the Phantom group of companies on 5 October 1998 and 23 November 1998, which led to the seizure of the goods and chattels of Group and International.

51.  On 8 October 1998, Fung, Chang Ka Yee and Sham Siu Ling served their notices on Records to claim severance pay.  On 16 November 1998, Tong also served his notice on Records to claim severance pay.

52.  A letter for a conciliation meeting was sent by the Labour Department to Records on 30 October 1998.  Chan attended the meeting on 16 November 1998 on behalf of Records.  According to Fung, Chan admitted that Records terminated the employment of its employees but did not say when the outstanding amounts would be paid.  He only said he would reflect the situation to the employer, without specifying which of the director or directors he would report to. 

53.  On 10 December 1998, Records submitted an “Employee Termination Report Form” to Hang Seng Life Limited (“Hang Seng Life”) for a total of 12 employees, including the 2^nd respondent and Chan, setting out the effective dates of termination of these employees and other relevant particulars.  Hang Seng Life was the administrator of a “Defined Contribution Scheme”, which was the subject of an insurance arrangement taken out by Entertainment.  Records was an associated company under that scheme.  The report was prepared by Chan and signed by the 1^st respondent.  According to it, all the employees who were members under the scheme had their employment terminated by 30 October 1998; the effective date of termination of 2^nd respondent was stated as 1 April 1998 and that of Chan was 2 September 1998.  Based on the information in the report, Hang Seng Life prepared the termination statements and the refund of members’ entitlement and forfeited balance.

54.  By a letter dated 12 December 1998 signed by the 1^st respondent on behalf of Records, the scheme administration department of Hang Seng Life was notified that the contact person of Entertainment, Music, Records and Gallery was changed to Chan with immediate effect and that the correspondence address was changed to an address in Taikoo Shing.

55.  On 18 December 1998, Fung, Tong and the other four employees lodged their claims against Records in the Labour Tribunal. Their total claims amounted to $141,664.80.

56.  On 21 December 1998, the 1^st respondent signed a letter on behalf of Entertainment to the scheme administration department of Hang Seng Life to terminate the scheme on the same date, stating that it had already terminated all scheme members.  Hang Seng Life was requested to issue a cheque for any remaining balances or forfeitures.

57.  Also on 21 December 1998, other employees of Records lodged claims with the Labour Department.  A letter for a conciliation meeting was sent on 28 December 1998.  This time, the letter was returned undelivered.  The conciliation officer tried to telephone Records but the line was disconnected.

58.  On 29 December 1998, Hang Seng Life issued a cheque to Records in the sum of $352,229.22 being the refund of the forfeited balance due to the termination of the scheme with effect from 21 December 1998.  The cheque was sent to Chan at the address in Taikoo Shing as notified earlier, under a covering letter dated 31 December 1998. 

59.  On 12 January 1999, the cheque of Hang Seng Life was deposited into the current account of Records at the HSBC.  Records issued a cheque dated 12 January 1999 in favour of the 1^st respondent for $352,440.00.  The 1^st respondent wrote his name as the payee on this cheque, the amount was written by Chan.  The 1st and 2nd respondents, as required under the bank mandate, signed the cheque jointly.  The proceeds of the cheque were paid into the 1^st respondent’s bank account on 13 January 1999.

60.  Records did not appear at the hearing of the claims brought by Fung, Tong and four other employees in the Labour Tribunal on 15 January 1999.  The Tribunal made an award against Records in favour of the employees in the total amount as claimed.  Later, Tong founded his winding-up petition against Records on the basis of his award.

61.  No representative of Records turned up at the conciliation meeting on 26 January 1999 for the claims of employees made subsequently.  The conciliation officer telephoned Chan and related the details of the claims to him.  Chan promised to reply after asking the director (he did not say which one) whether Records would effect payment to the claimants.  Later, Chan confirmed to the conciliation officer that Records had ceased operation and could not pay the claimants.

62.  According to a business transfer agreement in Chinese dated 15 April 1999 made between Chiu and the 2^nd respondent on behalf of Records, Chiu agreed to purchase Records and take up all its assets and liabilities.  Chiu acknowledged in the agreement he was given to understand by the 2^nd respondent that the assets of Records amounted to $300,000.00 and its liabilities were $350,000.00, but as the 2^nd respondent agreed to cancel Chiu’s personal loan in the sum of $50,000.00, Chiu accepted that the business transfer was a fair transaction.  By the agreement, he acknowledged receipt of all up-to-date books of account and relevant documentary records of Records; approximately 50 items of computer, recording facilities, hi-fi facilities, video facilities and furniture; and due and payable account and invoices of about $350,000.00.

63.  As mentioned earlier, the 1^st and 2^nd respondents resigned as the directors of Records and of Gallery upon the transfer of business on 15 April 1999.

The statutory provisions on disqualification orders

64.  To make a disqualification order under section 168H(1), the court would need to be satisfied that (1) the respondents were the directors of Record and Music, (2) these companies became insolvent within the meaning in section 168H(2), and (3) their conduct as a director of these companies makes them unfit to be concerned in the management of a company.  The first two matters are not controversial.  If the court is satisfied of all three matters, disqualification is mandatory under section 168H(1).

65.  In determining whether the respondents’ conduct as directors of Records and Music makes them unfit to be concerned in the management of a company, the court is required under section 168K(1) to have regard in particular to the matters mentioned in Parts I and II of the Fifteenth Schedule to Cap. 32.  I set out the provisions in that schedule that are of particular relevance in this instance:

“Part I – Matters applicable in all cases

…

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

…

Part II – Matters applicable where company has become insolvent

…

3.      The extent of the director’s responsibility for the company entering into any transaction or giving any preference, being a transaction or preference liable to be set aside under section 182 or 266.

…

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;”.

Unfitness as justifying disqualification

66.  There is no statutory provision laying down any test as to what constitutes unfitness.  This has been referred to as a “jury question”.  In Re Copyright Ltd. [2004] 2 HKLRD 113 at 122I to 123I, paras. 28 to 31, I have set out at some length how the question of fitness was addressed and discussed in various English authorities.  I do not propose to repeat myself here.

67.  There is also a useful summary in a Scottish decision cited by Mr. Griffiths of the matters relevant to the consideration of the question of unfitness in ordering disqualification, Secretary of State for Trade and Industry v. Walker [2004] ScotCS 25, 3 February 2004, at para. [2].

68.  In short, I must first make findings of fact whether the allegations of misconduct are established.  If they are made out, I then consider whether the misconduct is sufficiently serious as would render the respondents unfit to be concerned with the management of a company.  In addressing this question, I should look at the conduct of the individual concerned cumulatively and take into account any extenuating circumstances.  I bear in mind that not every breach of duty or impropriety calls for a disqualification order (Re Deaduck Ltd. (in liquidation), Baker v. Secretary of State for Trade and Industry [2000] 1 BCLC 148 at 168f to h).

69.  As to the standard of proof, this is the civil standard of proof on the balance of probabilities, but in assessing probabilities the court will bear in mind that the more serious the allegation the less likely it is that the event occurred, and hence the stronger should be the evidence before the court is to conclude that the allegation is established on the balance of probabilities (Re H (Minors) (sexual abuse: standard of proof) [1996] AC 563 at 586E; Re Copyright Ltd., supra. at 123J to 124B, para. 32; Re Bunting Electric Manufacturing Co. Ltd. [2006] 1 BCLC 550 at 561f to 562b, paras. [52] to [54]).

The statutory provisions on unfair preference

70.  It would be convenient to discuss the material statutory provisions on unfair preference before I consider the evidence to see if the allegations are made out.

71.  In section 266B(1) of Cap. 32, it is provided that a reference in section 266 to a fraudulent preference shall be deemed to be a reference to an unfair preference as provided for in section 50 of the Bankruptcy Ordinance, Cap. 6.

72.  The relevant provisions in section 50 of Cap. 6 read as follows:

“(1)   Subject to this section and sections 51 and 51A, where a debtor is adjudged bankrupt and he has at a relevant time (defined in section 51) given an unfair preference to any person, the trustee may apply to the court for an order under this section.

(2)     The court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if that debtor had not given that unfair preference.

(3)     For the purposes of this section and sections 51 and 51A, a debtor gives an unfair preference to a person if-

(a)     that person is one of the debtor's creditors or a surety or guarantor for any of his debts or other liabilities; and

(b)     the debtor does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the debtor's bankruptcy, will be better than the position he would have been in if that thing had not been done.

(4)     The court shall not make an order under this section in respect of an unfair preference given to any person unless the debtor who gave the unfair preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in subsection (3)(b).

(5)     A debtor who has given an unfair preference to a person who, at the time the unfair preference was given, was an associate of his (otherwise than by reason only of being his employee) is presumed, unless the contrary is shown, to have been influenced in deciding to give it by such a desire as is mentioned in subsection (4).”

73.  “Relevent time” in section 50(1) is defined in section 51 and the relevant provisions are as follows:

“(1)   Subject to subsections (2) and (3), the time at which a debtor enters into a transaction at an undervalue or gives an unfair preference is a relevant time if the transaction is entered into or the unfair preference given-

…

(b)     in the case of an unfair preference which is not a transaction at an undervalue and is given to a person who is an associate of the debtor (otherwise than by reason only of being his employee), at a time in the period of 2 years ending with that day; and

(c)     in any other case of an unfair preference which is not a transaction at an undervalue, at a time in the period of 6 months ending with that day.

(2)     Where a debtor enters into a transaction at an undervalue or gives an unfair preference at a time mentioned in subsection (1)(a), (b) or (c) …, that time is not a relevant time for the purposes of sections 49 and 50 unless the debtor-

(a)     is insolvent at that time; or

(b)     becomes insolvent in consequence of the transaction or preference …

(3)     For the purposes of subsection (2), a debtor is insolvent if-

(a)     he is unable to pay his debts as they fall due; or

(b)     the value of his assets is less than the amount of his liabilities, taking into account his contingent and prospective liabilities.”

74.  The reference to “that day” in section 51(1)(b) and (c) is the day of presentation of the bankruptcy petition on which the debtor is adjudged bankrupt.  Under section 266(1) of Cap. 32, the relevant time for a fraudulent preference is within six months before the commencement of the winding up of a company.  Section 266B(1) of Cap. 32 provides that a reference in section 266 to a period of six months shall be deemed to be a reference to a period of (i) six months; or (ii) two years in the case of a person who is an associate as provided for in section 51B, of Cap. 6.

75.  For the meaning of “associate”, one goes to section 51B and the relevant provisions are:

“(1)   For the purposes of sections 49 to 51A, any question whether a person is an associate of another person shall be determined in accordance with this section.

…

(4)          A person is an associate of a debtor whom he employs or by whom he is employed and for this purpose, any director or other officer of a company shall be treated as employed by that company.

…

(9)     In this section, “company” includes any body corporate (whether incorporated in Hong Kong or elsewhere) …”.

76.  There is no dispute that at the time the transaction was made the 1^st respondent was a creditor of Records (thus satisfying section 50(3)(a)) and an associate of Records (as he was a director and hence within section 51B(4)).

77.  As the 1^st respondent was an associate, by virtue of section 266B(1) of Cap. 32, the relevant time under section 50(1) would be a period of two years ending with the day of the commencement of the winding up of Records, namely, the date of the presentation of the petition on 2 July 1999.  The Official Receiver had proceeded earlier on the basis that the relevant time was six months ending with the presentation of the winding-up petition.  Even if it were six months, the transaction would still fall within that period.  But the correct period should be two years in this instance.

78.  The next question is whether the Official Receiver can rely on the presumption in section 50(5) so as to place the burden on the respondents to show that in entering into the transaction, they were not influenced by a desire of putting the 1^st respondent in a position which, in the event of Record’s liquidation, would be better than the position he would have been in if the transaction had not been done.

79.  Miss Ismail submitted that the statutory presumption applies.  Mr. Griffiths and Miss Che have accepted this position.  I am satisfied that this is correct.

80.  The Hong Kong provisions in this respect are different from the provisions in the United Kingdom (sections 239(6), 249 and 435 of the Insolvency Act 1986).  Under the Insolvency Act, it is clear that the statutory presumption applies in the case of a director, as a director is a “person connected with the company (otherwise than by reason only of being its employee)” and a person is “connected with a company” if he is a director or shadow director or an associate of such a director or shadow director.  In Hong Kong, there is no separate provision like section 239(6) relating to the applicability of the statutory presumption for unfair preference in the winding-up provisions of the Companies Ordinance.  Instead, the provisions in the Bankruptcy Ordinance are incorporated by reference under section 266B(1).

81.  The material words are the words in parenthesis in section 50(5) – “otherwise than by reason only of being his employee”.  There is some ambiguity about this provision in the case of a director, due to the wording in the latter part of section 51B(4).  In my view, a director, although treated as employed by a company under section 51B(4) and hence is an associate of a company by whom he is ‘employed’, is not an associate “by reason only of being [the company’s] employee”.  The words in parenthesis in section 50(5) should only apply to an employee who does not hold any other position or office in the company.  Most of the provisions in section 51B for determining an associate of a debtor in an unfair preference have no application where the debtor is a company instead of a natural person.  One of the most common situation in which an association with a debtor company may arise is by serving as a director of that company.  If section 50(5) were construed as not applying to this situation, this would render the presumption largely ineffective in an unfair preference concerning a company.

Matters required to be established for unfair preference

82.  To make out a case of unfair preference the Official Receiver would need to establish the following matters:

(1)     Records was insolvent as at 13 January 1999, when it made the payment by cheque to the 1^st respondent;

(2)     the payment by cheque to the 1^st respondent had the effect of putting him into a position, which, in the event of Records’ insolvent liquidation, would be better than the position he would have been in if the payment had not been made; and

(3)     Records, acting by its directors who were the respondents, was influenced in deciding to make the payment by a desire to produce the effect in (2).

83.  The respondents have disputed the matters in (1) and (3).  They do not appear to have challenged (2).

84.  In respect of (1), the Official Receiver would have to establish insolvency within the meaning of either section 51(3)(a) or (b).

85.  As for the matter in (2), whether an act has the effect provided for in section 50(3)(b) would appear to involve a purely objective test (Trustees of the Property of Hau Po Man Stanley (in bankruptcy) v. Hau Po Fun Ivy [2005] 2 HKC 227 at 233B).  It is clear that the payment by cheque to the 1^st respondent had the effect of putting him in a better position he would have been in if the payment had not been made, in the event of an insolvent liquidation of Records.  I hold the matter in (2) established.

86.  In relation to (3), two elements are required to be established: a desire to produce the effect of improving the creditor’s position in an insolvent liquidation, and such desire had influenced the decision to enter into the transaction.

87.  A desire of improving the creditor’s position in an insolvent liquidation is a subjective state of mind.  Desire is different from intention.  Whereas intention is objective in that a person is taken to intend the necessary consequences of his actions, a person is not to be taken as desiring all the necessary consequences of his actions and one can choose the lesser of two evils without desiring either (Re MC Bacon Ltd. [1990] BCLC 324 at 335f to 336a; Re Hau Po Man Stanley, supra. at 233C).  There is often no direct evidence of the requisite desire and the existence of this state of mind may be inferred from all the relevant circumstances, even “contrary to the denials of those whose state of mind is inquired into to determine what state of mind is attributed to the company making the decision” (Re Fairway Magazines Ltd. [1993] BCLC 643 at 649f).

88.  As for influence, this requirement is satisfied if it was one of the factors which operated on the minds of those made the decision.  It need not have been the only factor or even the decisive one.  It is not necessary to prove that if the requisite desire had not been present, the company would not have entered into the transaction (Re MC Bacon Ltd., supra. at 336c to d).

89.  Here, as the statutory presumption in section 50(5) applies, Records is presumed to have been influenced in deciding to make the payment by the relevant desire, unless the contrary is shown.  Miss Ismail has referred me to a number of cases where directors had to rebut the statutory presumption for voidable preference.  Examples where the presumption was not rebutted were where the director was unable to show proper commercial considerations for the transaction, as in Wills v. Corfe Joinery Ltd. [1998] 2 BCLC 75; and Re Conegrade Ltd. [2003] BPIR 358.  Conversely, where proper commercial considerations were shown, as in Re Fairway Magazines Ltd., supra., the presumption was rebutted.

If Records was insolvent at the relevant time

90.  The Official Receiver would only need to establish that at the time of payment on 13 January 1999, Records was either insolvent on a cash flow test (section 51(3)(a)) or on a balance sheet test (section 51(3)(b)).  It is not necessary to establish insolvency on both tests.

91.  The 1^st respondent said in his 1^st affirmation that he considered Records solvent at all times.  This was based on the following:

(1)     Records and Music were going through “their incubation period”, they were “expected to make substantial gain when their products hit off”;

(2)     Records held valuable copyrights of songs and music that could “enjoy exponential growth” in future and they had not been reflected in the financial statements;

(3)     he had injected sufficient funds into Records in the nature of director’s loans, alternatively Records could obtain inter-company loans from the Phantom group whenever Records appeared to have cash flow problem; and

(4)     Records held assets being studio equipment and copyrights of songs and music that could be liquidated to meet any outstanding liabilities.  The 1^st respondent’s expert, Mahmood Rumjahn, valued the studio equipment at the relevant time in January 1999 at $395,186.56 and the copyrights at $245,000.00, making a total of $640,186.56.

92.  The 1^st respondent’s case here is adopted by the 2^nd respondent.

93.  The matters in (1), (2) and (4) are all based on the premise that Records held valuable assets in January 1999.  The fact remains that three months later, in April 1999, all the shares of Records were sold to Chiu, on the acknowledgment that the liabilities of the company exceeded its assets by $50,000.00.  So at that time the respondents would appear to have acted on the basis that Records was insolvent on a balance sheet test.

94.  The Official Receiver has engaged his own expert in the music industry, Anders G. Nelsson, to provide a report in answer to Mr. Rumjahn’s report.  The respondents did not cross-examine Mr. Nelsson on his report.  Mr. Nelsson valued the studio equipment in the range of $45,000.00 to $75,000.00 as in January 1999 on the basis of prices offered by second-hand dealers for the equipment as a complete lot, and noted that in the business transfer agreement signed with Chiu on 15 April 1999, recording facilities under a list of assets of Records were stated to be worth approximately $90,000.00, which is not far from the higher end of his estimated value.  For the copyright value of songs in 1999, he valued the songs in appendix 2B, which was the CASH List referred to earlier, at about $50,000.00 to $60,000.00; he attached no value to the six songs in appendix 2C, which were songs performed by the 1^st respondent; and on the assumption that Records owned the master tapes of the songs listed in appendix 2A at the material time with documents to show ownership and the master tapes were available, he estimated the price of an outright sale of the songs in appendix 2A at between $50,000.00 to $100,000.00.

95.  I am not able to attach weight to the valuation of Mr. Rumjahn for a number of reasons.

96.  Firstly, Mr. Rumjahn was unable to inspect any of the equipment he was asked to evaluate, as all the alleged items would have been sold when Chiu bought the business of Records.  The Official Receiver’s agent has not recovered any documents to suggest that Records did at one time own the alleged items.  Mr. Rumjahn only made his assessment of the 54 items of equipment as per the model and description given in a list provided by the 1^st respondent’s solicitors in the letter of instructions dated 23 December 2004.  He was instructed that in January 1999, all items of equipment were less than five years old.  The Official Receiver had written to the 1^st respondent’s solicitors on 22 September 2005 asking for the source of information for compiling the list.  There was no response to this inquiry.  It was not until the 1^st respondent and Chan came to testify at the hearing that they gave evidence about the equipment.  They did not actually say they had provided information for compiling the list, the 1^st respondent claimed he recognised the equipment on the list, and Chan said the equipment as listed were removed by Chiu.  With no documents to assist their memory, and no explanation as to how the list was put together, I have grave reservations if the 1^st respondent and Chan can indeed recall after so many years that Records did own each of the 54 items of equipment in January 1999.

97.  Secondly, there is a similar problem about the ownership of the copyrights and master tapes listed in the other three appendices to Mr. Rumjahn’s report.  The source of information of how the list in appendix 2A was compiled is not known, and no explanation was given despite the request of the Official Receiver for information.  Most of the titles in appendix 2A were listed in the names of “Phantom Publishing” and “Sound Factory”.  As stated earlier, Records had transferred the branch business of Phantom Publishing Company to Entertainment in October 1997, and Sound Factory had transferred its shareholding in Records to Entertainment in March 1997.  Hence, in January 1999, Records did not appear to own the reproduction right in the titles listed in that appendix.  As for the titles listed in appendix 2B, quite clearly the performing rights were vested in Phantom Publishing Company, and it was accepted by the 1^st respondent in cross-examination that Records did not own the copyrights.  There is no evidence that Records owned the copyrights of the songs in appendix 2C or that these songs were ever commercially released.

98.  Thirdly, leaving aside the question of ownership of the assets, the valuation of Mr. Rumjahn of the studio equipment is seriously flawed.  His valuation was given on the basis of offer prices (and the highest value), not concluded sales, he was able to find in the web pages from E-Bay.  E-Bay is not a professional dealer, it is an auction site which acts as a middle-man.  Any one selling an item there has almost complete freedom to name a price and it is up to the purchaser to bid whatever he feels the item is worth.  Further, with some of the items where financing was offered on E-Bay, Mr. Rumjahn was unable to tell if they were new or second-hand.

99.  Fourthly, the marketability of the equipment was assessed by reference to new, not second-hand, equipment.  Mr. Rumjahn did not appear to have taken into consideration any of the difficulties mentioned in Mr. Nelsson’s report on the marketability of second-hand studio equipment – that a purchaser’s desire to buy second-hand equipment and the market value of such equipment might be seriously affected by the rapid progress of computerised digital recording made in the past decade; that the recording studio and record industries have been in a state of decline for the past seven or eight years as part of a worldwide slump; that it is a ‘buyers market’ at present and this also applied to some extent in 1999; that spare parts of such equipment would become increasingly difficult to find and the equipment would deteriorate quickly without proper maintenance and if not stored in climate-controlled conditions.

100.  Fifthly, any income obtained from the exploitation of copyrights would have to be split between the music publisher and the composers and lyricists, unless the writers have sold the rights to the publisher outright, which is rare.  This split of income has not been taken into account by Mr. Rumjahn.  In fact it was stated in the royalty report of the CASH List that Phantom Publishing Company was only entitled to 50% of the royalties.

101.  I do not accept at the relevant time in January 1999, Records had valuable assets that could be liquidated to meet any outstanding liabilities as asserted.  Records was clearly insolvent on a balance sheet test, having regard to the available financial statements as at 31 March 1997 (which showed a deficit of $4.8 million) and the list of assets and liabilities as stated in the business transfer agreement of 15 April 1999 (even without taking into account the substantial advances made to the company by the 1^st and 2^nd respondents).  This would be sufficient to establish insolvency for the purpose of unfair preference.

102.  It is unnecessary to find also that Records was insolvent on a cash flow test.  In any event, I do not attach significance to the assertion made that the 1^st respondent was ready and willing to pay the bills of Records and it was therefore immaterial to enquire if the assets of Records did or did not exceed its liabilities.  The 1^st respondent had no binding commitment to provide further financial support to Records.  He would not have broken any obligation to the company if he chose not to or was unable to do so.

Is the presumption rebutted

103.  It was submitted on behalf of the 1^st respondent the fact that after 12 January 1999 he continued to make payments for Records is a strong indication that he had no subjective intention to prefer himself unfairly.  The 1^st respondent settled the bills of Metro B Corporation Limited for Records by three cheques issued on 29 December 1998 ($33,500.00), 30 January 1999 ($30,000.00) and 15 February 1999 ($30,000.00).  He produced copies of his personal cheques from October 1999 to June 2000 showing that he had paid the salary of Chan who worked for him personally after Chan’s employment with Records was terminated in September 1998.  He also considered Records to be solvent at all times.

104.  The 1^st respondent claimed that at all material times, he genuinely thought that the claims of the former employees against Records had been settled.  He had told the employees who telephoned him to seek payment to contact Chan and the 2^nd respondent as he was merely a non-executive director, and neither Chan nor the 2^nd respondent had got back to him suggesting any problems on the employees’ claims.  In his 1^st affirmation, he positively asserted he had made enquiry with Chan on this matter and Chan told him and he verily believed the 2^nd respondent had already settled the entire dispute with all the ex-employees.  He pointed out that the 2^nd respondent had “at the time” injected a “huge sum” personally in meeting the demands of the employees, and, on this basis, he believed that the claims “in the Labour Tribunal were not genuine and were bound to fail”.

105.  The 1^st respondent asserted in his 1^st affirmation it was only when he was invited to give a statement of affairs of Records that he learned of the winding up of Records and that the outstanding wages had not been settled.  He only discovered “the outcome” of the proceedings in the Labour Tribunal when he first became aware of the winding up of Records.  He had not made enquiries of the 2^nd respondent or Chan of the progress of the Labour Tribunal proceedings as he genuinely believed and entirely trusted that the 2^nd respondent and Chan would handle these matters in full.  Had he known of the Labour Tribunal judgment against Records in time, he claimed that he would have sought legal advice and made a decision whether to appeal or pay up the amount awarded.

106.  By reason of his absence of knowledge of the Labour Tribunal awards, the 1^st respondent had thought at all material times that apart from certain supplier creditors, he was the only creditor of Records.  He was willing to advance money to Records to settle the debts of the supplier creditors and as he was advised by Chan that the refund of Hang Seng Life was of “no use” and could be used to repay part of his advances to Records, he issued the cheque in question to himself.  As he did not know about the awards in the Labour Tribunal when the cheque was issued, he could not take them into account at the time.

107.  In the submissions of Mr. Griffiths, it was recognised that the awards of the Labour Tribunal were not made until three days after the cheque was issued to the 1^st respondent.  It was then submitted that the 1^st respondent was not aware of the “details” of the wages claims at the time, only what the ex-employees had told him on the telephone when he referred them to the 2^nd respondent and Chan.

108.  Chan made an affirmation confirming the matters that happened at Records when he was under the employment of the company and later of the 1^st respondent, as deposed to by the 1^st respondent in his affirmations.  He claimed that when the labour dispute arose in the end of 1998, he was instructed by the 2^nd respondent to attend the Labour Tribunal once “for an adjournment”.  As he trusted that the 2^nd respondent would handle the dispute, he did not follow up since his primary duty was not in human resources management.

109.  It is necessary to analyse the evidence more closely to see whether the 1^st respondent’s asserted beliefs in the solvency of Records and that the claims of the ex-employees could, for one reason or other, be disregarded, would stand up to scrutiny.

110.  According to the 1^st respondent, from the middle of 1997, the 2^nd respondent had, with his approval, attempted to seek local and foreign investors to invest in the Phantom group of companies.  In March 1998, he indicated to the 2^nd respondent that he would stop further investments to the group because after investing close to $43 million, he still could not see any prospect of making a profit.  From April 1998, the 2^nd respondent was not paid his salary.  In about late June 1998, the 2^nd respondent told him that the general banking facility granted to Records in early June 1998 was terminated.  It was apparently under such circumstances that the 2^nd respondent injected $1.5 million personally into Records, as appeared from the 2^nd respondent’s answers to the Official Receiver’s questionnaire.  This would appear to be the “huge sum” mentioned earlier by the 1^st respondent in his 1^st affirmation as the money injected by the 2^nd respondent in meeting the demands of the employees.  There is nothing in the evidence to indicate that the 2^nd respondent had injected any other sum or that the money he injected in the first half of 1998 had not been exhausted by the end of the year.

111.  According to Chan, around the middle of 1998, the 2^nd respondent had gradually attended the office of Records less and less.  He claimed, however, that he still reported to the 2^nd respondent as and when required by telephone or outside the office.  I have great reservations about this part of Chan’s evidence and much of the other aspects of his evidence.  He was shown up badly in making a patently misleading statement in his affirmation criticising the Official Receiver’s sale of the master tape rights of a group of artists at $10,000.00 as too low, when it was he who had bought the rights at this price.  In any event, the 1^st respondent admitted that from September 1998, he had tried to “drive the bus”, or in other words, take control of certain matters of Records.  He attended to the moving of the offices to Shatin in September 1998.  In December 1998, it was the 1^st respondent who signed the letters to Hang Seng Life to seek a refund of the forfeited balance and to notify the change of the contact person from the 2^nd respondent to Chan.  Chan admitted in cross-examination that after September 1998, he would take instructions from the 1^st respondent when the 2^nd respondent was not around.

112.  The 1^st respondent admitted that as the fund raising project of the 2^nd respondent was not successful, and he had made clear he would not invest further into the group, he and the 2^nd respondent knew that Records and Music had to be downsized in order to survive.  As mentioned earlier, from July 1998, Records began to terminate the employment of its staff.  By 30 October 1998, all the employees had their employment terminated.  In September 1998, Records and Music and other companies in the group had moved to premises in Shatin leased personally by the 1^st respondent, and the landlord of the Kwun Tong offices levied distress against the chattels of Group and International in October and November 1998.  The bank statements of Records showed no material transactions in its account from November 1998.  Records had little or no cash in its bank account at the end of 1998.  Chan had told the labour conciliation officer in late January 1999 that Records had ceased operation and could not pay the claims of the employees.

113.  As stated in Re Conegrade Ltd., supra. at 372H, whether or not people were influenced by the relevant desire is a subjective matter, but it has to be determined objectively, and if they did desire a particular result, it matters not that they thought an insolvent liquidation was a remote risk.  I do not accept the 1^st respondent’s evidence that the business of Records and Music was merely going through an “incubation period” at the end of 1998 or that they were “expected to make substantial gain when their products hit off”.  His evidence that the companies moved premises to focus on the “record side of things” and not because they were unable to pay rent of the premises in Kwun Tong is not credible.  His assertion that he still regarded Records as a company in operation when it was sold in April 1999 is quite simply disingenuous.  With the termination of employment of all its employees, and the removal of its books and equipment to godown premises in Shatin, Records was no longer an operational business in the objective sense.  Records was sold three months later on the acknowledgment that the liabilities of the company exceeded its assets by $50,000.00.  I agree with Miss Ismail the 1^st respondent’s evidence in cross-examination that the statement of assets and liabilities in the agreement with Chiu was drawn up that way by not mentioning all its assets to make the company more attractive to the purchaser is just nonsensical.

114.  As I have found, the 1^st respondent knew from his telephone conversation with Fung in mid September 1998 that employees were asking for payment of outstanding wages in August.  The 1^st respondent did not give a positive answer when such wages would be paid and he had said he could do nothing about this when he was told that the employees might go to the Labour Department for assistance.  He admitted, with some reluctance, that Chang Ka Yee, who had worked as a receptionist, had also telephoned him at about this time to ask for payment of her claims.  I reject his evidence in cross-examination that he was not told by any of the employees they would go to the Labour Department.

115.  I do not accept that the extent of the 1^st respondent’s knowledge of the employees’ claims was limited to what the employees had told him on the telephone when he referred them to the 2^nd respondent and Chan.  His allegation that Chan acted for Records in handling the employees’ claims without his permission or consent at most times is incredible.  His evidence that Chan had merely communicated with the 2^nd respondent on these matters and never with him is just a convenient way of distancing himself from the matter, it does not accord with what he had said in his affirmation.  According to his 1^st affirmation, he had made enquiry with Chan on the employees’ claims; he also knew claims were brought in the Labour Tribunal (the conciliation meeting was postponed at the request of Records and attended by Chan on 16 November 1998, and the employees lodged claims against Records on 18 December 1998), as he had asserted in his affirmation it was his belief at the time that “the claims in the Labour Tribunal were not genuine and were bound to fail”.  

116.  I found that the 1^st respondent had no basis for his asserted belief.  He must have known that by the end of 1998, the “huge sum” injected by the 2^nd respondent earlier that year was simply not available to meet the latest claims of the employees.  He himself had not injected any funds for the purpose of meeting these employees’ claims.  It is pertinent to note that the first of the three payments to Metro B Corporation Limited on 29 December 1998 was settled with his personal cheque, not with a cheque of Records.  According to his evidence in cross-examination, Chan had told him the employees’ matter was “being taken care of”.  He confirmed Chan did not tell him the matter “had been taken care of”.  Further, he did not ask how it was being taken care of.  He had simply turned a blind eye to this matter.  He could not rely on the convenient excuse it was not his business to inquire as a mere non-executive director.  As he had actively taken steps to seek payment from Hang Seng Life and had caused the refund plus most of the credit balance in Records’ bank account to be paid to himself, he had the duty to satisfy himself there were no other creditors.

117.  In cross-examination, he mentioned that Chan told him the claims of the employees were “false”.  I reject this evidence, which was an embellishment, not found in his affirmations or in Chan’s affirmation.  Besides, the employees’ claims in the Labour Tribunal were not just for severance pay or other employment benefits, part of the claims was for wages in lieu of notice and wages in arrears.

118.  There was no basis for the 1^st respondent to assume, even if he did, that the employees’ claims could be disregarded when he issued the cheque to himself.  I do not accept his assertion on affirmation that he genuinely thought the claims of the former employees against Records had been settled.

119.  I do not regard the 1^st respondent’s settlement of the bills of Metro B Corporation Limited for Records, his avowed intention to pay supplier creditors, his payment of rent, rate and electricity of the Shatin premises (which were leased in his own name and the settlement of such expenses was to discharge his personal liability), or his employment of Chan for close to two years after Chan’s employment with Records was terminated, to be matters of significance.  Whatever the intention or action of the 1^st respondent might be towards other creditors, the fact remains he was not the only creditor of Records and he had no reason to think at the time that the employees did not have claims against the company.  I note also in the business transfer agreement signed with Chiu three months later, under the list of liabilities, it was stated there were “outstanding wages” of about $90,000.00.

120.  The 1^st respondent mentioned for the first time under cross-examination that the cheque was paid to him partly to repay the advances he made to Records and partly to enable him to pay the expenses of Records in future personally.  It would be more convenient for Records as this would allow him to pay its debts by drawing his own cheques, as cheques over $5,000.00 would need to be signed jointly with the 2^nd respondent.  This seems to me an afterthought of the 1^st respondent.  This was not mentioned in any of his affirmations or in his evidence in chief.  The only reason given in his 1^st affirmation for the money to be paid to him was the advice of Chan that the refund from Hang Seng Life was of “no use” any more and could be utilised to repay part of his advances.  I do not believe the alleged convenience factor to form any part of his intention when he paid himself the cheque.

121.  On the whole, I find the 1^st respondent’s evidence on the circumstances surrounding the payment of the refund to himself unsatisfactory.  He had adopted an evasive stance from the start.  In his answer to the Official Receiver’s questionnaire in March 2003, he even claimed he was not aware of the source of the funds for the payment to himself.  In response to further inquiries in June 2003, he said he did not know if Chan was still acting as the general manager of Records during November 1998 to January 1999 and that he did not have any contact with or give instructions to Chan to handle the affairs of Records in this period, which he admitted as incorrect under cross-examination but sought to qualify in re-examination.

122.  I find that at the time of the payment of substantially all of the cash balance in Records’ account, the 1^st respondent was aware of the unsettled claims of the employees and that these claims were pending in the Labour Tribunal.  He was aware that Records had no other available cash to settle the employees’ claims.  He took the available cash to satisfy part of the advances he had made to Records.  There was no compelling commercial reason for the payment apart from improving the position of the 1^st respondent.  I have borne in mind the standard of proof in Re H (Minors), supra.  He has not rebutted the presumption that in deciding to make this payment, Records was influenced by a desire to improve his position in an insolvent liquidation.  Even if the presumption were not to apply, I would have been prepared to infer from the evidence there was in existence a state of mind on the 1^st respondent’s part to desire the consequence of putting himself in a better position in an insolvent liquidation.

123.  The 2^nd respondent chose not to give evidence.  He merely sought to rely on the evidence adduced by the 1^st respondent.  He is not entitled to rely on his answers to the Official Receiver’s questionnaire in March 2003.  He co-signed the cheque to pay the 1^st respondent.  Chan confirmed in cross-examination that both respondents certainly knew about the employees’ claims in December 1998.  In the absence of evidence from the 2^nd respondent, I have no basis to infer that when he caused Records to make payment to the 1^st respondent, he was not influenced by a desire to put the 1^st respondent in a better position in an insolvent liquidation.  I hold in the 2^nd respondent’s case that he too has failed to rebut the presumption.

124.  I hold that the unfair preference charge in the first allegation against each of the respondents is established.

If the payment was detrimental to other creditors

125.  As I have mentioned at the outset, the Official Receiver has an alternative case to the unfair preference charge, namely, that the 1^st and 2^nd respondents had caused payment to be made for the benefit of the 1^st respondent, without due consideration for the financial position of Records, and to the detriment of the general body of creditors.  This was the detrimental payment charge alluded to in Re Sykes (Butchers) Ltd., supra and Re Deaduck Ltd., supra. 

126.  I find both respondents had turned a blind eye to the employees’ claims when they issued the cheque to the 1^st respondent.  The payment to the 1^st respondent was clearly to the detriment of the employees.  They were plainly worse off as there was no available cash to satisfy their claims after such payment.  So the charge against the respondents on this alternative basis is also established.

The allegation regarding failure to comply with section 121

127.  The second allegation against both respondents is that as the directors of Music, they had failed to take all reasonable steps to comply with section 121 to preserve for seven years proper books of account as are necessary to give a true and fair view of the state of affairs of the company.  Music was wound up on 19 July 2000.  The Official Receiver only managed to recover the audited accounts from its incorporation on 3 March 1994 up to 31 March 1996.  The last two sets of audited accounts dated 22 July 1997 and 2 December 1997 contained a qualified opinion from the auditors that they were unable to determine whether proper books of account were kept relating to the associated companies of Music.  A treasury accountant in the employ of the Receiver Officer’s Office found that such books of account of Music as have been recovered cannot give a true and fair view of the state of affairs or explain the transactions and financial position of the business at all times.  There is no dispute there was non-compliance with the requirements of section 121, the question is whether the directors had taken all reasonable steps to secure compliance by the company.

128.  The 2^nd respondent has admitted this allegation in the present proceedings and that such failure makes him unfit to be a director.

129.  The 1^st respondent has denied the allegation, contending that as a non-executive director he was entitled to rely on the 2^nd respondent and Chan, whom he had known as competent persons, to ensure that proper accounts were kept.  Unlike the 2^nd respondent and Chan, the 1^st respondent did not work full-time for the companies in the Phantom group of companies and did not assume a management role as a non-executive director.  Mr. Griffiths submitted that the 1^st respondent had reasonable ground to believe and did believe that the functions of keeping proper books of account for Music and complying with the statutory requirements had been delegated to competent and reliable persons.

130.  For the Official Receiver, it was submitted that the 1^st respondent had no reason to consider that the 2^nd respondent was properly discharging the statutory duties as to keeping proper accounting records after receiving the audited accounts of Music with the qualified opinion (in July 1997), and in any event after April 1998 (when the 2^nd respondent’s employment with Records was said to be terminated according to the report to Hang Seng Life) or at the latest by September 1998 (when the 1^st respondent took on an increased role as the 2^nd respondent was seldom around by then).

131.  By September 1998, Music would appear to have ceased operation.  The financial controller of the Phantom group of companies had also left prior to that.

132.  The purpose of requiring proper accounting records to be kept is twofold, as explained in Secretary of State for Trade and Industry v. Arif & Ors. [1996] BCC 586 at 593H to 594A.  In the event of failure of a company, the accounting records are there to enable its liquidator to identify and recover or exploit the assets of the company.  Here, the Official Receiver’s role as the liquidator of Music was rendered more difficult because of the failure of the company to comply with section 121.

133.  Whatever grounds the 1^st respondent might have before September 1998 for his belief that the task of keeping proper accounts had been delegated to competent persons, circumstances had changed significantly by September 1998 and these grounds had ceased to apply.  I accept that for this allegation, the 1^st respondent was not as culpable as the 2^nd respondent, as the responsibility of keeping accounts had been delegated to the latter earlier when he served as the managing director of the Phantom group of companies and was in charge of the financial and administrative affairs of Music.  Nevertheless, with the departure of the financial controller and the increased absence of the 2^nd respondent in the latter part of 1998, it should have been apparent to the 1^st respondent that some responsible person had to undertake the responsibility of keeping proper accounts for Music.  The 1^st respondent had given no instructions to Chan in this respect, and there is nothing in the evidence to indicate that Chan had assumed this responsibility from the 2^nd respondent or the financial controller.  The overall responsibility for so doing rested at all times with the directors and was not delegable (see the authorities cited in Re Copyright Ltd., supra. at 124C to 125A, paras. 33 to 35; and Secretary of State for Trade and Industry v. Hall & Anr. [2006] EWHC 1995 (Ch) at para. 17).  The fact that Music had ceased operation by then made no difference to this.  It was not permissible for the 1^st respondent to do nothing.  I hold that he had failed to take all reasonable steps to ensure that Music had complied with section 121 and the allegation against him is established.

If the 1^st respondent had failed to co-operate with the Official Receiver

134.  The remaining allegation is against the 1^st respondent alone.  It is alleged that he had failed to co-operate with the Official Receiver in the administration of the estate of Records and Music and the investigation of their affairs and that he had failed to provide a statement of affairs of Music under section 190.

135.  The Official Receiver has exhibited the correspondence exchanged with the 1^st respondent and his solicitors and drawn attention to these matters:

(1)     the 1^st respondent had failed to provide reliable information: several of his responses to the Official Receiver’s questionnaire of 17 March 2003 (some of which are mentioned in the earlier part of this judgment); his assertions in the letter of his solicitors dated 4 May 2000 that he did not cause Records to make the impugned payment to him, that the financial status of Records was “quite sound” at the time, and such payment was part of the normal business operation – do not accord with the true factual situation as subsequently discovered;

(2)     he declined the Official Receiver’s request in 2000 to attend an interview, to deliver books and records and to submit a statement of affairs, asserting that he was just a non-executive director with no substantive knowledge or information for completion of the statement of affairs and never in possession of any books and accounts and that all inquiries should be directed to the executive director being the 2^nd respondent.  However, he did have relevant information relating to Records, such as the source of funds and circumstances of the preference payment, the nature of its operations between September 1998 and April 1999, and the continuation of Chan in his personal employment; and

(3)     he alleged in his affirmations in these proceedings that the copyright assets of Records at the time of its winding up were worth at least $500,000.00 and could have been realised to meet all outstanding liabilities if the liquidation had been properly conducted.  He did not provide this information to the Official Receiver’s agent when request for information was made at the outset of the liquidation in 1999 or subsequently, until after the disqualification proceedings were brought against him.  The Official Receiver incurred expenses to obtain an opinion from an expert in the music industry to address this allegation, which has also led to a raft of evidence being filed on both sides.  It was only in cross-examination that he finally admitted Records did not in fact own the copyrights vested in Phantom Publishing Company.

136.  I was also asked to take into account the conduct of the 1^st respondent in the disqualification proceedings, including his performance in the witness box, as an additional ground of his unfitness.  In Secretary of State for Trade and Industry v. Reynard [2002] 2 BCLC 625, the English Court of Appeal held that the relevant statutory provision (equivalent to section 168H(2) in Cap. 32) is wide enough to include in the expression “ a person’s conduct as a director … in relation to any matter connected with or arising out of the insolvency of that company” his conduct in the disqualification proceedings.  In determining the issue of unfitness or fixing the period of disqualification, there is no good reason for cutting down the width of those words to exclude the conduct of the director at the hearing of the proceedings.  Thus, a finding that the respondent director had attempted to deceive the court in his evidence was an indication he did not appreciate his duties as a director, and may throw light on his fitness to be a director.  The court here is not judging the performance of a witness, but assessing the fitness or unfitness to be a director (at 628i to 629c, 630d to 631d, 633e to h).

137.  As for the 2^nd respondent, reliance was placed on the fact that he has filed two affirmations to contest these proceedings and to challenge the 1^st respondent’s affirmations but elected not to give evidence at the trial.

138.  Miss Ismail has given advance notice in her opening submissions that the Official Receiver would invite the court to consider the conduct of the respondents in the disqualification proceedings and cited the above authority.  There is no procedural unfairness for the Official Receiver to rely on this additional ground and no complaint was made on behalf of the 1^st or 2^nd respondent.

139.  Mr. Griffiths submitted that the 1^st respondent had reasonable excuse for his failure to submit a statement of affairs for Music, and that he did not deliberately fail to co-operate with the Official Receiver in his inquiries.  The ability to co-operate would depend on the knowledge of the person in question.  The 1^st respondent, as a non-executive director, had no management role and no knowledge of the day-to-day affairs of Records and Music.

140.  Insofar as the 1^st respondent’s failure to submit a statement of affairs for Music is concerned, I hold that he has made out a reasonable excuse, for the reasons submitted by Mr. Griffiths.  Regarding the other matters relied on by the Official Receiver as constituting instances of non-cooperation, I do not agree they could be explained away on the basis that these acts or omissions were not deliberate.  I am satisfied there was no genuine or serious effort to co-operate with the Official Receiver and that the allegation is established.

141.  As for the 1^st respondent’s conduct in these proceedings, I repeat I am not here judging his performance as a witness.  It is only if I am satisfied that aspects of the unsatisfactory nature of his evidence may throw light on his fitness or unfitness as a director that I should take the same into account.  This is a question of degree.  I am not persuaded I should do so although I have criticised his testimony in various respects.  This is not a case in which I can safely say with ample justification the conduct of the respondent in the proceedings is so reprehensible as to further demonstrate his unfitness to act as a director.

142.  For the 2^nd respondent, I am not prepared to hold that his election in not testifying notwithstanding he has filed two affirmations is a relevant matter to take into account in considering his unfitness. 

If the allegations are sufficiently serious to justify disqualification

143.  I have found the allegations established for both respondents in respect of the unfair preference charge and the detrimental payment charge in the first allegation made against them.  I have also found the second allegation and the third allegation, for the most part, established against the 1^st respondent.  The 2^nd respondent has admitted the second allegation.

144.  I need to consider these established allegations of misconduct cumulatively and whether they are sufficiently serious as would render the respondents unfit to be concerned with the management of a company and thereby justify mandatory disqualification.  The most serious allegation against them is the first, and the 2^nd respondent is less blameworthy than the 1^st respondent in effecting the payment.  I note that in Re Deaduck Ltd., supra., a detrimental payment charge was held to be established, but the court was of the view that the particular circumstances did not justify a finding of unfitness, as the payment was made in the context of the director’s attempts to secure an informal solvent liquidation, and although this was a high risk strategy, it had been pursued for respectable commercial reasons and the payment was only after substantial payments had been made to unconnected creditors.  The present situation is not a case of that kind.

145.  Mr. Griffiths has urged me to take into account extenuating circumstances that the impugned payment was a comparatively small sum and that the 1^st respondent’s share of the total indebtedness of Records was some 95% of its debts.  They do not, in my view, constitute extenuating circumstances.  Miss Che submitted that this is not a case where there is any suggestion of dishonesty or intentional wrongdoing on the part of the 2^nd respondent.

146.  Although the respondents’ conduct was not dishonest, and no dishonesty is alleged, I find such behaviour commercially culpable.  They did not behave in the way that responsible employers would behave in terminating the employment of all the employees.  They took a cavalier attitude to the employees’ claims and brushed aside these claims when they withdrew virtually all the available cash to satisfy in part the 1^st respondent’s advances.  I hold that their misconduct here, coupled with the other allegations established against them, is sufficiently serious to justify a finding that the respondents are unfit to be concerned in the management of a company.

The period of disqualification

147.  Having regard to the general guidelines in In re Sevenoaks Stationers (Retail) Ltd. [1991] Ch. 164 and Re Westmid Packing Services Ltd. [1998] 2 BCLC 646, the Official Receiver seeks disqualification orders at the top end of the minimum bracket for the 1^st respondent and a lesser period for the 2^nd respondent.

148.  In mitigation, Mr. Griffiths urged me to take into account the amount of the preference payment in the light of the 1^st respondent’s substantial advances to Records, his unblemished record of over 13 years in the senior management and directorate of a large publicly listed company, and the two favourable character references.  Miss Che asked me to take into consideration the fact that these proceedings had taken more than six years from the date of the winding-up orders and the 2^nd respondent has had the matter hanging over his head for a significantly long time.  Further, the 2^nd respondent has been co-operative with the Official Receiver throughout his investigation.  There was no personal gain to him and he has left Hong Kong to settle in Australia.

149.  Taking all relevant matters into account, I impose a period of disqualification on the 1^st respondent of three years and a period of two and a half years on the 2^nd respondent.  The term of the disqualification period would begin from the day of the handing down of this judgment, but the orders are to be suspended for the period prescribed under rule 10 of the Companies (Disqualification of Directors) Proceedings Rules, to give the respondents a reasonable period to put their affairs in order so as to comply with the disqualification orders.  These orders will take effect from the beginning of the 21^st day after the day on which the orders are made.

150.  As costs should follow the event, I make an order nisi that each respondent is to pay the costs of the Official Receiver in these proceedings.