RE SWANK INTERNATIONAL MANUFACTURING CO LTD

HCMP2580/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.2580 OF 2003

---------------------

----------------------

--------------------------------------------------------

REASONS FOR JUDGMENT

--------------------------------------------------------

Introduction

1. This is the petition of Swank International Manufacturing Company Limited ("the Company") seeking the court's confirmation of a reduction of its capital pursuant to section 58 of the Companies Ordinance. At the hearing on 29 July 2003, I allowed the application. These are my reasons.

The company

2. The Company was incorporated in Hong Kong on 14 April 1981 as a private company limited by shares. On 21 August, the Company caused the inclusion of the present Chinese name as part of the Company's name. At its inception, the Company had an authorized capital of HK$3,000,000.00 divided into 300,000 shares of HK$10 each. Throughout the years, by virtue of various resolutions, its share capital had been increased from time to time. At the date of the petition, the authorized share capital of the Company was HK$3,000,000,000.00 divided into 15,000,000,000 shares of HK$0.20 each, of which 2,232,044,810 shares were in issue and paid or credited as fully paid. The paid up capital of the Company was therefore HK$446,408,962.00. The Company has been listed on the Hong Kong Stock Exchange since about 1990.

3. Under Article 63(B) of its Articles of Association, the Company may, by special resolution, reduce its share capital, any capital redemption reserve fund or any share premium account.

The proposed reorganization

4. In April 2003, the Company proposed a capital reorganization thus :

(1) Reducing the capital by cancelling HK$0.199 in respect of each ordinary share; thereby reducing the nominal amount of each ordinary share to HK$0.001 each;

(2) Increasing the authorized ordinary share capital to restore it to its original amount of HK$3,000,000,000.00 by the creation of an additional 2,985,000,000,000 new ordinary shares of HK$0.001 each;

(3) Consolidating every 10 ordinary shares of HK$0.001 each arising from the capital reduction, sub-division and capital increase (i.e. including authorized but unissued ordinary shares) into one consolidated share of HK$0.01 each.

5. On 7 April 2003, a circular ("the Circular") was despatched to the shareholders of the Company containing, inter alia, the details and reasons for the proposed reduction of capital as described above. The Circular also set out the notice convening an extraordinary general meeting ("EGM") of the Company on 2 May 2003.

6. At the EGM on 2 May 2003, the Chairman of the meeting, Ms Louie Mei Po reported that since the 2002 Annual Report of the Company was despatched to shareholders only on 30 April 2003, the Stock Exchange suggested that the meeting be adjourned to allow shareholders time to study the report. The EGM was thus adjourned to 11 June 2003. The Notice of Adjourned Meeting were duly sent to the shareholders of the Company.

7. On 11 June 2003, the adjourned EGM was held, at which the special resolution for the reduction of capital was passed without amendment.

8. The effect of the proposed reduction of capital is this. As at 31 December 2002, the Company had incurred accumulated losses of approximately HK$1,299,513,000.00. The Company proposed that the credit of HK$444,176,917.19 arising from the proposed reduction of capital would be set off against the accumulated losses of the Company as at the date when the capital reduction became effective, to the extent permitted by the court, thus reducing the accumulated losses by the amount of the credit arising.

Directions

9. On 9 July 2003, I gave directions for advertising notice of this hearing and dispensing with the settlement of a list of creditors. Notice of hearing was duly advertised on 11 July 2003. No creditors have indicated that they wish to appear at the hearing. In fact, none appeared. The petition is thus not contested.

The law

10. The law applicable is well-established. The Company proposing to reduce its capital must first meet the two statutory requirements under section 58 :

(1) it is authorized by its articles to reduce the capital; and

(2) the requisite special resolution has been passed.

These requirements are clearly met by the Company. The Company must next satisfy the court that the following criteria are met :

(1) the shareholders are treated equitably;

(2) the reduction proposals are properly explained;

(3) the creditors are safeguarded; and

(4) the reduction is for a discernible purpose.

See Re Lippo China Resources Limited [1998] 1 HKLRD 20 at pp.23J-24A. I will deal with them in turn. As will be seen in a moment, it is convenient to consider criterion (4) first before criterion (3).

Equitable treatment of shareholders

11. The proposed reduction affected all the Company's shareholder in the same way by reducing the par value of their shares by identical amounts. This criterion is met.

Proposals properly explained

12. It is clear from the Circular issued by the Company to all shareholders and the Special Resolution passed at the Adjourned Extraordinary General Meeting on 11 June 2003 that the proposal for capital reductions had been fully explained to all the shareholders and that the shareholders agreed upon the capital reduction. This criterion is also met.

Reduction for a discernible purpose

13. The Company's shares have been traded below their present nominal value for some time. The Company believed that a reduction of nominal value of the shares would facilitate future capital raising or asset acquisition. The Company also considered that having regard to the accumulated losses which it has suffered, the substantial part of its paid-up capital has been lost and is no longer represented by available assets, and should therefore be cancelled. If the accumulated losses of the Company are, so far as possible, eliminated, the Company considered that the capital reduction will facilitate new capital injection to the Company and also bring forward the date upon with the Company will be in a position to declare a dividend out of future distributable profits.

14. All of the above purposes are clearly established by ample authorities to be "discernible purposes". See Re Tian An China Investments Co. Ltd [1998] 2 HKLRD 474 at pp.476B-I, 478C-D; Re Cheuk Nang Technologies (Holdings) Ltd, HCMP1683/2001, 24 April 2001, p.3 of transcript (Yuen J); and Re Singapore Hong Kong Properties Investment Ltd, HCMP3094/2002, 20 November 2002, paras.23-27, pp.7-9 of transcript (Kwan J).

15. I am satisfied that the reduction is for a discernible purpose. I now come back to the third criteria, namely, whether the creditors' interests are safeguarded adequately.

Safeguard of creditors' interest

16. As noted above, the accumulated losses suffered by the Company as at 31 December 2002 were HK$1,299,513,000.00. These losses are shown at the latest consolidated audit accounts set out in the annual report of the Company for the financial year ended on 31 December 2002.

17. According to the first affirmation of Tam Wing Kin filed on 30 June 2003, the Company has sought to categorize the accumulated losses as either permanent or non-permanent losses in the following manner :

(1) to identify in relation to each financial period considered, the expenditure/losses recorded by the Company in each such period;

(2) to consider the nature of the expenses/losses made in each such period, with a view to establishing whether there is any prospect (however remote) of such item being recovered in the future;

(3) to treat as permanent in nature only those expenses/losses in relation to which there appears to be no prospect of recovery, and to give, if required by the court, an undertaking in respect of all other expenses or losses relied upon in support of the capital reduction.

18. The Company considered that of its accumulated losses as at 31 December 2002, losses amounting to HK$131,210,177.00 are permanent in nature and that further losses relied upon in support of the proposed capital reduction, totalling HK$1,124,490,679.00, are unlikely ever to be recovered although technically they may be regarded as non-permanent in nature.

19. In order to protect the interests of the creditors of the Company as at the date of the capital reduction, the Company proposed to give an undertaking in respect of any recoveries that may be made in respect of the losses other than those which are permanent in nature. The undertaking can be found at the Annex to this judgment.

20. At the direction hearing on 9 July 2003, Mr Barma, SC (who did not appear at the substantive hearing on 29 July) made a number of points regarding the undertaking. They are summarised below :

(1) This form of undertaking is not in the standard Grosvenor form but has been adapted. An undertaking in this form was recently approved by Kwan J in Re Goldbond Group Holdings Ltd (HCMP1891/2003, 27 June 2003).

(2) Further, in this case, as in Re Capital Asia Ltd [1999] 2 HKC 254, this undertaking bites on recoveries from assets in respect of which provisions have given rise to losses which are not clearly permanent in nature. Also, as in Re Capital Asia Ltd, all net recoveries (and not just the amount of the provision in respect of the particular asset) are to be credited to the proposed Special Capital Reserve.

(3) This undertaking provides for the cap on the undertaking to be automatically lowered not just in relation to fresh capital coming in, but also on disposal of the asset in the Schedules so as to turn the unrealised (and for this reason non-permanent) losses in relation to such asset into permanent losses, where such disposal does not result in a recovery of the entire amount of the provision which has been made (and thus of the non-permanent losses in respect of which the Company's capital has been reduced).

(4) The undertakings contain provisos that permit the release of amounts standing to the credit of the reserve to be created under it in specified circumstances where the creditors' interest will have been otherwise safeguarded.

(5) In contrast to Re Capital Asia Ltd, the cap on the size of the Special Capital Reserve to be created, if necessary, pursuant to this undertaking is arrived at by deducting from the credit arising from the capital reduction the amount of the losses relied upon which are clearly permanent in nature, and limiting the size of the proposed Special Capital Reserve to the amount of the losses relied upon which are not clearly permanent in nature (in this case HK$312,966,740.19). Mr Barma submitted that this is right in principle since the items of permanent loss will ex hypothesi never be recovered, and so should be eliminated first. Were this not done, there would be a possibility that at some future date, the whole of the amount of the capital reduction would be recovered by reason of recoveries of non-permanent losses, with the result that (a) the credit arising would simply be moved from capital to a special capital reserve, and (b) more importantly, the permanent losses would not be eliminated, and would remain in the Company. In such a case, one of the purposes of the capital reduction, namely, the elimination of accumulated losses, will not have been achieved.

(6) The creditors' interests will be sufficiently and adequately protected by an undertaking limited to the value of the losses relied upon which are not clearly permanent in nature.

With respect, I agree with Mr Barma entirely.

21. The Company has by the 2nd affirmation of Mr Tam Wing Kin filed on 11 July 2003, raised the classification of permanent and non-permanent losses. Nothing which affects the merits of the petition arises out of the revision.

22. In the circumstances, I am satisfied that the creditors are adequately safeguarded. Only losses which are permanent in nature are set off against the credit arising from the capital reduction : In re Jupiter House Investments (Cambridge) Ltd [1985] 1 WLR 975. Insofar as any losses to be set off against the credit are not permanent in nature (in the sense that there may be some prospect of recovery), the Company pursuant to the undertaking will place any identified subsequent recoveries in a special capital reserve account which will be maintained for so long as pre-capital reduction creditors remain unpaid and do not consent to the reserve being dispensed with.

Conclusion

23. For the above reasons, I confirmed the reduction by making an order in terms of the draft order, subject to the undertaking offered.

Annex

UNDERTAKINGS

AND UPON the Company by its Counsel undertaking that in the event of its making any future recoveries in respect of the assets identified in the Schedule hereto, in respect of which provision for diminution in value or depreciation was made in the accounts of the Company for the accounting periods up to and including the period ending on 31 December 2002, beyond their written down value in the Company's audited accounts as at 31 December 2002, all such recoveries beyond that written down value up to an amount of HK$341,800,325.19 ('the limit'), will be credited to a special capital reserve in the accounting records of the Company ('the Special Capital Reserve') and that so long as there shall remain outstanding any debt of or claim against the Company which, if the date on which the proposed reduction of capital becomes effective ('the effective date') was the date of the commencement of the winding up of the Company, would be admissible to proof in such winding up and the persons entitled to the benefit of such debts or claims shall not have agreed otherwise, such reserve shall not be treated as realised profits for the purposes of section 79B of the Companies Ordinance (Cap. 32) and shall (for so long as the Company shall remain a listed company) be treated as an undistributable reserve of the Company for the purposes of section 79C of the Companies Ordinance (Cap. 32), or any statutory re-enactments or modifications thereof

PROVIDED that:

(1) the Company shall be at liberty to apply any amounts standing to the credit of the Special Capital Reserve for the same purposes as a share premium account may be applied;

(2) the limit in respect of the Special Capital Reserve may be reduced by the amount of any increase, after the effective date, in the paid up share capital or the amount standing to the credit of the share premium account of the Company as the result of the payment up of shares by the receipt of new consideration or the capitalisation of distributable profits;

(3) the limit in respect of the Special Capital Reserve may be reduced upon the disposal or other realisation, after the effective date, of any of the assets identified in the Schedule hereto by the amount of the provision made in relation to such asset as at 31st December 2002 (which amount is set out in the Schedule hereto) less such amount (if any) as is credited to the Special Capital Reserve as a result of such disposal or realisation; and

(4) in the event that the amount standing to the credit of the Special Capital Reserve exceeds the limit thereof after any reduction of such limit pursuant to provisos (2) and/or (3) above, the Company shall be at liberty to transfer the amount of any such excess to the general reserves of the Company and the same shall become available for distribution.

AND UPON the Company by its Counsel further undertaking that, for so long as the undertakings set out in the previous paragraphs hereof remain effective, it will:

(1) cause or procure its statutory auditors to report by way of a note or otherwise a summary of the undertakings in its audited financial statements or in the accounts of the Company published in any other form; and

(2) publish or cause to be published in any prospectus issued by or on behalf of the Company a summary of the undertakings

SCHEDULE