RE BLUE SKY INDUSTRIES LTD

HCCW 1407/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 1407 OF 2002

____________

____________

_______________

J U D G M E N T

_______________

1. Blue Sky Industries Limited ("the Company") is a dealer in toys which it purchases in Hong Kong for re-sale to customers in the United States.

2. Enrich Industrial Limited ("the Petitioner"), Business Way Corporation Limited ("the 1st Supporting Creditor"), United Printing & Paper Products Limited ("the 2nd Supporting Creditor") and Regent Oriental Industrial Limited ("the 3rd Supporting Creditor") are companies that sold and supplied toy products to the Company and their respective demands against the Company arose from those transactions.

3. In this case there are 4 separate claims against the Company for amounts allegedly owed by the Company for goods and/or work supplied. The claimants are the Petitioner and the 1st, 2nd and 3rd Claimants. At the outset of the hearing I ruled that the Petitioner's claim should be heard and dealt with first. The Supporting Creditors can bring their claims in due course if appropriate.

4. On 20 December 2002 the Petitioner presented a petition to wind up the Company based upon a statutory demand for the payment of the sum of HK$560,889.40 made on 28 October 2002. The indebtedness allegedly arose in respect of goods sold and delivered to the Company in 2002.

5. On 6 January 2002 the Company lodged an application for a validation order and on the same date one of its shareholders and directors, Wesley Kenneth Crawford ("Crawford Senior"), made a supporting affirmation in which he asserted that:-

(a) the Petitioner had sold and delivered goods to the Company to the value of the sum of HK$560,889.40;

(b) the Company had made a partial payment of the sum due in the amount of HK$185,516.20 prior to the issue of the statutory demand;

(c) the Company was entitled to a 3% discount of the full sale price equivalent to HK$16,826.68;

(d) the Company acknowledged that it is indebted to the Petitioner in the net sum of HK$358,546.52.

6. On 3 March 2003 the hearing of the Petition was adjourned conditional upon the Company paying into court the undisputed petitioning debt of HK$358,546.52 with the hearing to be restored on 24 March if the condition was not met. No payment into court has ever been made.

7. On 13 March 2003 the other director and shareholder of the Company, Wesley Scott Crawford ("Crawford Junior"), affirmed that:

(a) the claims of the Petitioner and each of the 3 supporting creditors are unmeritorious;

(b) there were 4 partners in the Company - Crawford Senior, Crawford Junior, Domice Chow and Eddie Chow - with the 2 Chow brothers running the Company in Hong Kong;

(c) in October 2002 he discovered that about HK$2 million of the Company's funds had been paid out to or on behalf of the Chows and 2 companies (United Star Industries Limited and Grandmass Industries Limited) for which the Chows failed to provide a satisfactory explanation;

(d) on 31 October 2002 the running of the Company was taken over by Crawford Senior and Crawford Junior in place of the Chows;

(e) that funds of the Company had been used to pay a rental deposit for the 1st Supporting Creditor;

(f) that the Company's accountant controls the Petitioner;

(g) that the Petitioner and all vendors of goods to the Company paid an unauthorised 3% cash commission on transactions with the Company to Eddie Chow;

(h) that the Company questions the validity of its alleged indebtedness to the Petitioner and the 3 supporting creditors;

(i) that the 2nd Supporting Creditor has never supplied goods to the Company;

(j) that Crawford Senior would therefore be withdrawing his admission of liability by the Company to the Petitioner.

8. On 20 March 2003 Crawford Senior withdrew his admission that the Company was indebted to the Petitioner.

9. Yuen Ching Fan, a clerk of the Company, affirmed on the same date (20 March 2003) that commission of 3% had been paid to Eddie Chow on transactions between suppliers appointed by the Chows.

10. Between 20 March and 19 May 2003 Wong Kwan Lin Pauline, a senior clerk of the Company made 4 affirmations. In essence she set out 4 basic positions:-

(i) By 2002 she had noticed many suspicious situations involving transactions between the Company and its suppliers e.g. over-payments to suppliers, inflated prices by suppliers, 3% rebate in cash to Eddie Chow on amounts paid to suppliers, the sharing of equipment and goods with the 1st Supporting Creditor, and the use of the Company's funds to make payments on behalf of unrelated companies controlled by relatives of the Chows. Reports by her of these matters to Crawford Junior led to the expulsion of the Chows from the Company in October 2002.

(ii) A generalised allegation that "given the relationship between themselves and the Chow brothers, it is obvious that the prices of goods supplied were deliberately inflated at the expense of the Company, the Company will put these parties to strict proof that the invoices are genuine, because experience has shown that pertaining to the same goods there could be duplicate purchase orders to and invoices from different companies, meaning that at the most only one of them could have been genuine."

(iii) The transaction that gave rise to the statutory demand involved the duplication of charges and concealment of payment rendering the Petitioner's claim unjustified - as expanded upon below.

(iv) The claims of the 3 supporting creditors are false and unsubstantiated.

11. The real nub of the dispute is, first whether the Company is truly indebted to the Petitioner in the amount of the demand, and secondly, if so, whether there is a sufficient counterclaim against the Petitioner to set-off the amount of the debt.

12. It appears not to be in dispute that the Company has in its bank accounts in Hong Kong funds well in excess of the statutory demand notice. The issue is therefore not an inability to pay but a refusal to do so and whether such refusal is justified. It is incumbent upon the Company to establish that there is a bona fide dispute of the debt on substantial grounds or that there is a genuine cross-claim that would produce a sum at least as much as the debt of which there can be no substantial dispute. Whether the dispute of the debt is a substantial dispute is the central issue that I have to resolve. I am not concerned to decide the dispute but only to determine whether a sufficient dispute exists; I should not try the dispute on affidavit.

13. The test to be applied is whether the debt is bona fide disputed on substantial grounds. As was said in Re ICS Computer Distribution Ltd [1996] 3 HKC 441 at 444:

"....... there is a distinction between a consideration of whether the company has established a defence on substantial grounds and a consideration of whether the evidence is believable. Taken to the ultimate, the difference is between whether there is evidence and whether that evidence is believable.

....... the basic point (is) that the company's evidence must establish a substantial case. If the evidence fails to establish that case the company cannot satisfy the test by arguing hypotheses of fact on which it is said that such a case exists or could exist."

14. The factual evidence relating to the specific transactions are referred to in the respective affirmations of Fu Wai Kee of the Petitioner and Pauline Wong of the Company:

(a) The Company placed a purchase order (No. DT-220054) with the Petitioner on 4 June 2002 (Exhibit "WKLP-6") itemising and describing the goods and quantity and stating the price as "To Be Advise".

(b) The Petitioner issued 2 invoices to the Company under that purchase order:

(i) Invoice No. 33795 dated 31 August 2002 in the sum of $371,032.40.

(ii) Invoice No. 32433 dated 31 August 2002 in the sum of $389,283.00.

(c) The Company maintains that the 2 invoices are in respect of the same matters and are evidence of the Petitioner double charging the Company for the same matter. The Petitioner maintains that the 2 invoices involve cumulative charges for different aspects of the order, the total cost of which should be $760,315.40 as evidenced by its letter to the Company (Exhibit "FWK-4").

(d) It is common ground that the Company paid to the Petitioner the sum of $389,183.00 by 2 instalments namely $100,000.00 on 23 September 2002 and $289,283.00 on 26 September 2002.

(e) The Company claims that it paid a further sum of $185,516.20 by cash cheque to the Petitioner or its sub-contractor on 22 October 2002 in part payment of Invoice No. 33795 as evidenced by the endorsement on the invoice (Exhibit "WKLP-2"), the cheque stub of the Company ("WKLP-11") and the endorsement on Invoice No. 0000124 dated 31 July 2002 from one Tak Kai (presumed to be a sub-contractor of the Petitioner) to the Company (Exhibit ("WKLP-1")).

(f) The Petitioner denies that it has ever received the sum of $185,516.20 or the cheque drawn by the Company. It maintains that the entire sum of $371,031.40 under Invoice No. 33795 remains outstanding.

(g) The Petitioner further denies that it has double invoiced the Company. It says that the 2 invoices were in respect of separate material and workmanship to fulfill the Company's order.

(i) Invoice No. 33795 was for printing and coating of boards and covers and the provision of packaging and other material. The work was sub-contracted to a printing specialist who invoiced the Petitioner under its Invoice No. K1108 for the work (Exhibit "FWK-3") for the Renminbi equivalent of HK$371,032.40. From that it would appear that the Petitioner was making no profit from the Company in respect of that part of the overall process. The invoice K1108 appears to have been issued by the same company whose partial name appears on the Company's cheque stub "WKLP-11" referred to above. There appears therefore to be a close connection between

(A) Invoice No. K1108 (Exhibit "FWK-3") from the mainland supplier to the Petitioner dated 31 August 2002;

(B) Invoice No. 0000124 (Exhibit "WKLP-1") from the mainland supplier to the Company dated 31 July 2002; and

(C) Invoice No. 33795 (Exhibit "WKLP-2") from the Petitioner to the Company dated 31 August 2002.

(ii) Invoice No. 32433 was for importation and transport costs and the price of imported paper for boards and covers.

(h) The Company has produced (Exhibit "WKLP-10") what it says is a breakdown presented to the Company of the components of Invoice No. 32433 demonstrating:

(i) That the figure of $389,283.00 represents a reduction from the original amount of $429,282.80 due to a discount of $40,000.00 granted by the same Mr Fu.

(ii) That the amount invoiced under Invoice No. 32433 is a composite amount covering printing, production of the component parts of the final product, the cost of paper and packaging, moulding, transportation, etc.

(iii) That Invoice No. 32433 clearly covers the material and other charges invoiced separately under Invoice No. 33795 i.e. that the Petitioner double invoiced the Company.

15. The Company's evidence in respect of these various invoices was mainly set out in Pauline Wong's third affirmation that was affirmed and filed on 24 April 2003. The Petitioner chose to file only one further affirmation in answer to that - the second affirmation of Fu Wai Kee on 25 April 2003. In that short affirmation he said that Invoice No. 33795 was in respect of work sub-contracted by the Petitioner in the same sum, and that the 2 invoices together represented the combined cost of the purchase order from the Company. He made no reference at all to the very substantial documentary evidence from the Company. It is also the case that the Company has given no explanation as to whether it has received the Petitioner's calculations in its letter Exhibit "FWK-4" or as to whether it ever answered the same.

16. The Petitioner relies heavily on the Company's admission of its indebtedness to the Petitioner of HK$358,546.52. Pauline Wong has given an explanation as to how she provided the information to Crawford Senior which led to the admission. Essentially she says that the 2 Crawfords are seldom in Hong Kong (being based in the United States) and that upon the issue of the Petition she was instructed by Crawford Junior in January 2003 to check the unsettled invoices issued by the Petitioner, and it was upon that checking that she concluded that there were 25 unsettled invoices to the value of HK$560,889.40 i.e. the amount of the statutory demand. She also apparently checked "the Company's records "from which she discovered the alleged partial payment of HK$185,516.20 which was apparent on the face of Invoice No. 33795 and that the 3% trade discount had not been deducted.

17. Pauline Wong says that subsequent to the hearing in March 2003 she was instructed to check all the Company's purchase orders and invoices with the Petitioner. Upon such checking she then discovered the material disclosed in her second affirmation. In her third affirmation she discloses the breakdown list of Invoice No. 32433 and deals further with the part payment in answer to Fu's first affirmation.

18. The Petitioner was highly critical of the timing of the admission and its withdrawal in the context of Pauline Wong's various searches of the Company's records. The withdrawal was made on 20 March 2003 at least a fortnight before Pauline Wong's second affirmation. The Petitioner submits that the withdrawal could not therefore be a result of her searches or material uncovered by her.

19. In his first affirmation containing the admission, Crawford Senior makes a number of important admissions, namely:

(a) That the claimed amount of HK$560,889.40 "indeed represents the price of goods sold and delivered to the Company."

(b) The actual net amount owed by the Company to the Petitioner should be reduced only by the amount of a part payment and a 3% trade discount.

(c) The Company has at no time disputed its liability towards the Petitioner in that net amount, and refused to comply with the statutory demand only because of (b) above.

20. The admission on 4 January 2003 was a serious one made in the face of several important matters, namely:

(a) The statutory demand made on 28 October 2002.

(b) The concerns of Pauline Wong expressed in her first affirmation when she said she was aware of serious irregularities in the Company in the course of 2002 which she reported to Crawford Junior and which resulted in the expulsion of the Chow brothers from the Company in October 2002. These included:

(i) many suspicious transactions between the Company and its suppliers;

(ii) the Company paying more to suppliers than they had sought;

(iii) exorbitant prices charged by suppliers including the 1st Supporting Creditor;

(iv) a cash rebate paid to Eddie Chow of 3% of all amounts paid to suppliers;

(v) the transfer of samples, goods and equipment of the Company to the 1st Supporting Creditor;

(vi) the payment by the Company of some of the expenses of 3 companies owned by nephews of the Chows but unconnected to the Company;

(vii) the double charging of the Company for the same transaction, namely -

(A) An invoice number 0000124 from a third party to the Company dated 31 July 2002 for RMB390,560.40 (Exhibit "WKLP-1".

(B) An invoice number 33795 from the Petitioner to the Company dated 31 August 2002 for HK$371,032.40 (equivalent to RMB390,560.40) (Exhibit "WKLP-2").

(C) Both invoices were endorsed to the effect that a part payment of HK$185,516.20 had been paid on 22 October 2002 by cheque number 397341.

(c) The discovery by Crawford Junior in October 2002 that at least HK$2 million of the Company's funds had been misappropriated by the Chow brothers for the benefit of themselves and companies controlled by them - see paragraph 9 of Crawford Junior's affirmation.

21. The admission was therefore made despite knowledge as early as October 2002 of the matters under paragraph 20(b)(i) - (vii) and (c) above i.e. these matters were known to the Crawfords about 3 months prior to the admission by Crawford Senior.

22. In his second affirmation affirmed on 14 and filed on 20 March 2003 Crawford Senior, in seeking to withdraw the earlier admission made on 6 January 2003, said:

"....... in the light of the matters which come to light after I filed my last affirmation, I do withdraw the admission I made in favour of the claim of Enrich Industrial Limited herein. I verily believe that I have every right to withdraw the said admission, as the Company should dispute the whole of the claim of Petition."

He therefore gave as the reason for his withdrawal matters that had become know between 6 January and 14 March 2003. The only evidence of that is from paragraphs 12-16 of the affirmation of Crawford Junior which chronicled the following events after October 2002:

(a) Suppliers came forward claiming payment for goods supplied.

(b) The Petitioner was managed and controlled by the Company's accountant, Li Siu Lok who with knowledge of the Company's business was deciding orders and prices for the Petitioner's dealings with the Company.

(c) The Petitioner and other vendors to the Company paid 3% rebate to Eddie Chow without the knowledge or concern of the Company.

(d) The Company's accounts prepared by Li Siu Lok did not reflect the true financial position of the Company and did not disclose payments to the Chow brothers and their 2 companies.

(e) The 1st Supporting Creditor, whose office is situated in the same building as the Company's offices, had its rental deposit paid by the Company.

23. The attitude of the Crawfords and the Company is encapsulated in paragraph 16 of Crawford Junior's affirmation which states:

(a) "....... the Company has no reason to believe that the alleged indebtedness to Enrich Industrial Limited as well as the alleged creditors in these proceedings is genuine."

(b) "....... there is a substantial counterclaim against Enrich Industrial Limited by the Company because the prices were fixed with insiders' information."

(c) "....... Enrich Industrial Limited is liable to reimburse the 3% kickback paid to Eddie Chow over the years."

(d) "Regarding the alleged indebtedness of the other creditors, the Company has every right to dispute the same in the light of what I have said above."

24. I will deal first with the admission which I treat as a serious and considered admission. It was made at least 3 months after Crawford Junior and Pauline Wong had had ample opportunity to investigate the affairs of the Company in the absence of the Chows with access to all the books and records of the Company. It was made against a back drop of what Crawford Junior and Pauline Wong had, after investigation of the Company's records, described as an unfolding discovery of manipulation of the Company and misappropriation of its funds by the Chows for their own benefit including falsification of finances and double invoicing. The admission was not made on the spur of the moment or without the opportunity to first consider the Company's situation. In the context of the information available to Crawford Senior it is difficult to conceive of such an admission being made without foundation and prior measured consideration. In particular, it was made with knowledge of the alleged double invoicing by the Petitioner which was later to form the major part of Pauline Wong's second and third affirmations.

25. The reasons given by Crawford Senior for seeking to withdraw the admission do not deal at all with the question of specific indebtedness by the Company to the Petitioner. The reasons deal with generalised allegations of unauthorized activity and point only to possible claims against the Chows unrelated to any relevant dealings between the Company and the Petitioner.

26. The admission should only be disregarded if the Court is satisfied that there is a credible or convincing explanation for the application to withdraw. As was said in Tse Yuk-tin v Chee Cheung Hing & Co. Ltd [1984] HKLR 391 at 395 E-G:

"....... the court allows a party to withdraw an admission deliberately made or to resile from a conscious choice for good reason, and if good reason is shown. In particular it expects the party to put before it a convincing credible explanation of the circumstances in which the admission was in fact made, which is sought to be said to have been made under a mistake. A typical sort of case is where the party is able to say 'yes, when I said this, or when I admitted this, I believed that to be the case I have now got some totally fresh evidence in my possession which if true suggests that it was not the case, and I want to advance that proposition'.

In those circumstances the court, I think, can readily give leave to withdraw the admission and does so. Conversely if no credible or convincing explanation is given, that is a powerful factor in favour of the exercise of discretion against the application."

I regret that in this case I am not satisfied that Crawford Senior's explanation is sufficient to meet the criteria and I do not accede to the application to withdraw the admission.

27. The Petition has been brought on the ground that the Company is unable to pay its debt to the Petitioner. A great deal of evidence has been filed from which it is evident that the Company disputes the existence of the debt and also alleges that it is likely to have a considerable (albeit as yet unquantified) cross-claim against the Petitioner. The central issue for this court is whether the dispute of the debt is a substantial dispute. The function of this court is to determine whether a sufficient dispute exists but not to decide the dispute. I should not try the dispute on affidavit. Periwen Development Limited v Grandfield Pacific Hotel Limited HCCW No. 29 of 2001 (unreported).

28. I approach this matter on the basis of a disputed debt and claims by the Company which amount at least to a set-off which if valid would extinguish the debt. The issue is therefore one of disputed debt. As was said in Re ICS Computer Distribution Limited [1996] 3 HKC 441 at 442 G-H:

"The procedure of winding up a company for 'insolvency' by petition is a summary one. The test which the court applies is whether the debt is bona fide disputed on substantial grounds. These are the words which appear time after time in the cases. As a matter of practice, and not it may be noted as a matter of law, where the court is satisfied that this criteria is satisfied the Companies Court should not embark on a trial to determine the issue of the validity of the debt."

And at 444 B-E:

"....... there is a distinction between a consideration of whether the company has established a defence on substantial grounds and a consideration of whether the evidence is believable. Taken to the ultimate, the difference is between whether there is evidence and whether that evidence is believable. It seems to me that the onus must be on the company against which a petition is presented to adduce sufficiently precise factual evidence to satisfy the court that it has a bona fide dispute on substantial grounds. This seems to me to be the proper approach .......

....... the basic point (is) that the company's evidence must establish a substantial case. If the evidence fails to establish that case the company cannot satisfy the test by arguing hypotheses of fact on which it is said that such a case exists or could exist."

29. The rationale and criteria to be applied by the court is clearly set out in Periwen Development (supra) at 6-7 as follows:

"I ask whether the evidence of the company is believable. I caution myself about unsubstantiated and unparticularised assertions ....... The company's evidence should be looked at against so much of the background that is undisputed or is beyond reasonable dispute, in other words not with a wholly uncritical eye. I should look at the bona fides of the defence, to see whether it is obviously a 'put-up job'.

In an application for summary judgment, the defendant must show that he has a fair probability of establishing a bona fide defence to obtain leave to defend. To resist a petition, the company must show that it has a bona fide defence, not a fair probability of one. It is possible that a company might on an Order 14 application convince the court that it has a fair probability of a defence but at the petition stage it might not be able to establish it has a bona fide defence. The court must come to a conclusion in the winding-up petition whether there is or is not a bona fide defence. 'The court does not dismiss a petition on the basis that a company might be able at some stage in the future to scrape together a case that might be arguable'. If the court should refuse leave to defend in an application for summary judgment, that would be the end of the matter. But if a winding-up order is made, the company's claim against the petitioner may still be pursued by the liquidator as he thinks proper, so there is no injustice in adopting a higher threshold for the company requiring it to show that it has a bona fide defence, quite apart from the public policy considerations in a winding-up."

The latter point was also made in Re Safe Rich Industries Limited CA 81/94 (unreported).

30. It is common ground that the amount claimed in the statutory demand is no longer sustainable. The Petitioner admits that it failed to deduct the usual trade discount from the figure and that, on its case, the debt should in fact be reduced to HK$544,062.72.

31. The Company's case is put on 3 different bases that appear to be contradictory:

(a) The amount of the debt should be less because it does not take into account a partial payment of HK$185,516.20.

(b) The debt does not exist because the Petitioner has wrongfully invoiced the Company twice for the same item and the Company has already paid in full under one invoice.

(c) Even if there is a debt of some disputed amount, the Company has a substantial cross-claim against the Petitioner and/or the Chow brothers which more than eclipses any amount that the Company may owe the Petitioner.

32. Whilst the Company may have adduced just about enough evidence to show that it may have an arguable defence in an Order 14 application, I am not satisfied that it has demonstrated that it has a bona fide defence. I have referred earlier in this judgment to some of the unsatisfactory aspects of the Company's case. That, coupled with the question of the admission of debt and subsequent withdrawal of admission that I have dealt with above, has in my view left the Company in a position where it has failed to demonstrate to the requisite level that it has a bona fide defence to the Petition.

33. It is not the function of the court in a winding-up application to decide on disputed debts. It is no bar to a winding-up to show that the quantum of a debt is in issue.

34. Any claims that the Company may have against the Petitioner can be fully pursued by the liquidator so that a winding-up order would not prejudice the Company in that regard. Re Safe Rich (supra).

35. It is apparent that communications and trust between the Company and the Petitioner have been so damaged that suspicion is rife on both sides. It is also apparent from the affirmations of the 2 Crawfords that they wish to conduct an audit-like search of the Company before committing to any specific claim by the Petitioner. This is not the appropriate venue for that sort of activity. There is nothing in the evidence of the 2 Crawfords that materially assists in relation to the Petition. The evidence of Pauline Wong whilst raising some potentially suspicious activity, does not go nearly far enough to establish a bona fide defence.

36. I do not consider that the Company has been able to overcome its acknowledgement of the debt given the circumstances that I have set out above. In my view it is therefore appropriate to make the winding-up order sought.

37. In so far as the Company's claims are concerned that there was no debt because of double invoicing or alternatively that the debt should be substantially reduced because of a part payment, I am not satisfied that the Company has overcome the obstacle of showing a bona fide dispute of the debt on substantial grounds.

38. The Company claims that it has a substantial cross-claim against the Petitioner. It also claims to have substantial claims against the Chow brothers. Any cross-claims against the Petitioner would have to be clearly particularized and meet the standard of a bona fide dispute on substantial grounds. Neither comes close to being shown on the evidence so far adduced. In so far as any claims against the Chow brothers are concerned, whilst these may well be proven in due course, at the moment the evidence is so vague and generalised that it cannot meet the requisite standard of a bona fide case on substantial grounds. The Company faces the further hurdle of having to relate any such claims directly to the debt to the Petitioner, and there is far from sufficient evidence to demonstrate that at this stage.

39. I am satisfied that the Company has failed to show a bona fide dispute of the debt on substantial grounds or that there is at present a sufficiently demonstrated cross-claim that would produce a sum to meet the debt of which there can be no substantial dispute.

40. I therefore make an order to wind up the Company. I make an order nisi that the Petitioner should have its costs against the Company. There will be liberty to the 1st, 2nd and 3rd Supporting Creditors to apply.