SIU PING v. CHAN WAI CHI LOUIS AND OTHERS

HCCW 82/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO. 82 OF 2010

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BETWEEN

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D E C I S I O N

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Introduction

1.  This is an application by the 3^rd Respondent (“Company”) for a validation order under section 182 of the Companies Ordinances in respect of rental and salary payments.

2.  On 19 February 2010, the Petitioner presented a petition against the Company for relief under section 168A, or alternatively, an order that the Company be wound up on just and equitable ground pursuant to section 177(1)(f) of the Companies Ordinance. The shareholders of the Company consist of the Petitioner, the 1^st and 2^nd Respondents. The Company’s main business is provision of skin-care services and sale of cosmetic products.

3.  The petition arose out of disputes between the Petitioner and the 1^st and 2^nd Respondents. The Petitioner’s complaints include, inter alia, her being excluded from management contrary to the mutual understanding among the shareholders that they should all participate in the business of the Company as directors, poor management by the 1^st and 2^nd Respondents and unreasonable increases to their salaries.

4.  The Company operates four cosmetic and skin-care service centres in Hong Kong and employs twenty-four employees. As a result of the presentation of the petition, the Company’s bank accounts are frozen and is unable to pay rent and management fees for the service centres and salaries, commissions and mandatory provident fund contributions of its employees. These payments are due on 1 March 2010. Hence, the present application is made.

5.  The Petitioner opposes the application on the grounds that there are insufficient evidence regarding the solvency of the Company and particularity of the salaries and rental payments. For similar reasons, the Official Receiver does not support the application. The particulars were made available at the hearing and the Petitioner no longer resists the application for lack of particulars.

The legal principles

6.  The legal principles governing the exercise of the court’s jurisdiction under section 182 of the Companies Ordinance are clear. Solvency of the company and the protection of unsecured creditors are the primary considerations in the exercise of the court’s discretion whether to make a validation order. The overriding principle is that the court must always do its best to ensure that the interests of the unsecured creditors will not be prejudiced: see Re Gary’s Inn Construction Co. Ltd [1980] 1 WLR 711 and Re Aw Sian Sally [1999] 2 HKC 270. The court should not validate any transaction which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances making such a course desirable in the interest of the unsecured creditors as a whole. Where a company is solvent and it is in the interest of the company and creditors that the company should continue its business, it is entitled to incur expenses for the purpose of sustaining its existence and operation. The burden is on the party seeking a validation order to prove that the disposal of the property was in the interest of the unsecured creditors: see Re Gary’s Inn Construction Co. Ltd and Re Pacific Coast Fisheries Pty Ltd [1980] 5 ACLR 354.

7.  Thus, if a company is solvent and if its directors consider that a particular disposition falling within their powers as directors is necessary or expedient in the interest 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 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 interest of the company: see Re Mi Fung Beads Company Limited (unreported) HCCW 224/2004 at paragraph 22 per Barma J.

8.  Even where the solvency of a company is open to question, the court will nonetheless validate dispositions which are in the interest of the general body of creditors of the company: see Re Luen Cheong Tai Construction Co. Ltd [2004] 1 HKLRD 735 per A Cheung J.

Solvency of the Company

9.  Mr Yuen, counsel for the Petitioner, submits that solvency of the Company is in serious doubt. He referred to the latest management account of the Company as at 30 September 2009, which showed a total current assets of $3.85 million, property and equipment of $1.92 million and a total liabilities of $8.63 million. The Company is in negative equity of $2.86 million. It suffered a net loss of $190,255 for the month of September 2009 and an accumulated loss for the first nine months of 2009 of $2.99 million. Hence, he argues that the Company is technically insolvent.

10.  However, it has not been actually argued and no evidence has been tendered to show that the Company is unable to pay its debts as they fall due. As the audited accounts of the Company show, the Company has for the previous two financial years been operating on deficits. As explained in the paragraph that follows, that is a peculiar feature of the mode of operation of this type of business.

11.  But for the filing of the petition, the Company would have been able to carry on its business as a going concern as usual and pay its rent and salaries as when they fall due. Mr Lam, counsel for the Company, explains that a special feature of the Company is that it sells facial packages to its customers by issuing service coupons. Those customers are treated as creditors and their prepayments for services not yet consumed are entered in the books of the Company as current liabilities due to creditors. Those prepayments stood at $8.58 million as at 30 September 2009. In the normal course of business, those prepayments will be extinguished as and when the services are consumed. There will be no question of the Company being unable to honour the coupons as and when they are presented for services, which is equivalent to paying those customers as and when their debts become due. The Company is either solvent or insolvent. It would be wrong to label it as “technically insolvent” on the peculiar facts of the case. I agree with Mr Lam that the Company is solvent.

Whether the payments are necessary or expedient in the interest of the Company

12.  Having found the Company solvent, the hurdle which it has to overcome in seeking a validation order is much lower. The Court will sanction the payments if the Company’s directors consider the disposition which is within their powers as directors to make is necessary or expedient in the interest of the Company, and if the court considers that the reasons given are such that an intelligent and honest person could hold that view, unless there is very clear and compelling evidence to suggest that the disposition is likely to be injurious to the interest of the company.

13.  The total liabilities of the Company is $8.63 million as at 30 September 2009. The majority of the creditors of the Company are its customers who have purchased facial package services which have not yet been consumed. Their debts amounted to $8.58 million, which constituted almost 93.28% of the total indebtedness. The second group of creditors are the employees to whom salaries and commission in the sum of $426,980 is owed, i.e. 4.6% of the total indebtedness. The third group of creditors are the landlords to whom rent in the sum of $135,286 is owed, i.e. 1.47% of the total indebtedness. The Company is seeking to validate the payments to be made to the second and third group of creditors.

14.  There is a total balance of $632,418 as at 24 February 2010 standing in the bank accounts of the Company. In addition, the 1^st Respondent has in his possession cash in the amount of $140,000 on behalf of the Company. The total amount of cash available to the Company is $772,418. Ignoring for the time being, the issue of priority and the cost of liquidation, the dividend available to the general unsecured creditors is less than nine cents in the dollar.

15.  Most of the prepayments made by the customers had been used to finance the business of the Company in paying rental, salaries, costs of goods and other expenditures such as marketing and advertisement etc. If the validation order is made, the Company will be able to continue its business, some of those expenditures will be turned into goodwill while the prepayments will be reduced as services are being rendered. The Company will also be able to sell more facial packages and generate additional cash flow. However, if the application for validation order is not approved, the Company will be unable to pay its employees and rent. If the employees are not paid, they will leave the Company. For a business of this nature, employees are important assets of the Company as they are trained staff and have developed a relationship with its customers. Likewise, if the rentals for the service centres are not paid on time, there is a real risk that landlords will re-enter the premises or seek distraint. If that occurs, severe damage will be done to the image of the Company. The customers’ confidence that the Company will honour its coupons will be lost. The Company will no longer generate sales. Under either scenarios, the business of the Company will be seriously affected, the value of its business and its goodwill will be seriously injured. The expenditures used in building up the goodwill of the Company will all be lost. The damage to the Company may even be irreparable.

16.  The Company being solvent, the directors’ decision to make the payments so as to enable the Company to carry on its business is one which is both necessary and expedient in the interest of the Company. I consider the decision is made bona fide. No argument has been advanced that the payments are likely to be injurious to the interest of the Company, save as regards the sudden increases in the salaries of the 1^st and 2^nd Respondents, the lawfulness and the purpose of which is in dispute. Subject to that, the payments should be validated.

Whether validation is in the interest of the general body of creditors

17.  Under the latter scenario as described above, if the salaries and rentals are not paid, the Company will have to be liquidated. The customers will become general creditors. The assets of the Company will have to be liquidated to pay the cost of liquidation and preferential debts, which will necessarily include the salaries owed to the employees and government dues. In that situation, it is virtually certain that the customers will not even be paid any dividend. If the Company is liquidated, the contributories will also lose whatever goodwill that has been built up in the few years’ operation of the Company. Thus, the salaries and commission, for which payment validation is now being sought, will in any event have to be paid. If the payment is validated, the Company stands a chance of survival and the customers, who would constitute 93.28% of the general body of creditors, would stand a chance of receiving the services they had prepaid and the Company preserves the goodwill it has built up. For the Petitioner, preserving of the Company as a going concern will enable her to demand a good price for her shares to be sold to the 1^st and 2^nd Respondents, for which negotiations are continuing. If the Company is to be wound up, it is absolutely certain that the customers as creditors and contributories alike will be left with nothing. Thus, even assuming that the Company is insolvent, the payments are obviously in the interest of the general body of unsecured creditors and should be validated.

Conclusion

18.  One of the Petitioner’s complaints is about unlawful increase in the salaries of the 1^st and 2^nd Respondents. I think capping the payment of the salaries of the 1^st and 2^nd Respondents at the level before the disputed increase will best protect the interest of the creditors and the Petitioner and will strike the right balance between the interest of the 1^st and 2^nd Respondents on the one hand and that of the Petitioner on the other. Accordingly, subject to that rider, I grant the validation order sought by the Company. I shall leave it to the parties to draft an appropriate form of order, which is to be submitted to my clerk for endorsement in due course.

19.  The Company is essentially a partnership among three persons. The Petitioner knows how the Company is being operated and knows those payments are necessary and expedient in the interest of the Company. She ought to know that without the validation order, the Company will collapse which would be contrary to her interest and the interest of the customers as general body of unsecured creditors. The application should not have been opposed. I therefore order that the costs of the application be in the cause of the petition and that there be no order as to costs of today’s hearing.