LUK WAI FUN v. CEO INVESTMENT LTD AND ANOTHER

HCCW 344/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 344 OF 2006

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D E C I S I O N

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1.  This is a summons for a validation order issued by the 2^nd respondent on 15 August 2006.

2.  On 22 September 2006, I made a validation order in respect of those items which are not in dispute.  Today I am concerned with the balance of the items in the schedule to the summons, being salaries and commissions, laboratory test fee and petty cash expenses.  Some of these expenses had been settled by the 2^nd respondent who seeks reimbursement from the company.

3.  The petition is brought under section 177(1)(f) and section 168A of the Companies Ordinance, Cap. 32.  This is a shareholders’ dispute.

4.  The company concerned, CEO Investment Limited (“the Company”), was only incorporated in November 2005.  It moved into rented premises in February 2006 and started business.  The Company operated as a distributor of a line of cosmetic products under a particular brand in co-operation with KCC Asia Limited (“KCC”).  It was only in March 2006 that the Company bought the first batch of the cosmetic products from KCC and commenced sales of the product.  Not long after, the petitioner fell out with the 2^nd respondent.  The petitioner claims that she was excluded from participation in the management.  The 2^nd respondent has alleged that the petitioner quit her work abruptly on 26 April 2006, and she was removed as a director at an extraordinary general meeting on 5 July 2006 because of her behaviour which was disruptive to the business.

5.  On 6 July 2006, the petition was presented, seeking a winding-up order, alternatively a buy-out order whether of the petitioner’s shares in the Company or of the 2^nd respondent’s shares, and other reliefs under section 168A.  As mentioned, the summons for a validation order was issued a month after the presentation of the petition.

6.  As usual in this kind of business association, both the petitioner and the 2^nd respondent are required to sign cheques to operate the bank accounts of the Company, which were frozen on the presentation of the petition.  Without a validation order, the business of the Company would suffer and it may have to cease operation if the 2^nd respondent is not prepared or unable to continue to support the Company on her own, pending the hearing of the petition which may not take place for some time.

7.  The 2^nd respondent says that notwithstanding the shaky start to business, the Company should be given an opportunity to carry on with the operation and a validation order made to enable it to continue to function.  It is contended that it would be in the interest of all concerned to keep the Company afloat pending resolution of the petition.  It would be of no good to any one if the Company should go out of business now so that the Company would have to go into liquidation eventually, regardless of how the petition is to be decided.

8.  The Company would seem to have the support of KCC, which has agreed to remit $200,000 by a credit note dated 1 August 2006 to reduce the liability of the Company.

9.  I have looked at the management accounts, the trial balance, the profit and loss account of the Company for the entire period of its operation, from January to October 2006.

10.  For the first 6 months, the total net sales income was only $146,000 odd.  It is understandable that profit of the Company could not be expected to pick up immediately in the first few months of its operation.  The sales figures during July to September 2006 went into decline, they dropped from HK$37,000 to HK$11,000.

11.  I do not have the exact sales figure for October 2006.  This may be less than HK$11,000, as the total sales income for the first 10 months in 2006 only amounted to $220,486.

12.  Again, the decline in the sales figures is understandable, in view of the shareholders’ dispute, the freezing of the bank accounts, and the disruptive effect on business due to the presentation of the petition.  It is not surprising that staff morale and sales performance would have been affected.  I note that in November 2006, the sales figure has gone up to $68,126.

13.  The profit and loss account showed a net loss of $627,465 from January to October 2006.  The balance sheet as of 31 October 2006 showed cash in bank of $285,289, total current assets of $816,815, total current liabilities of $606,341 and net equity of $343,043.

14.  The Company would appear to be solvent on a balance sheet test.

15.  The petitioner has raised a number of matters in her affirmations to support her contention that the business should not be allowed to continue.  It is alleged that the products bought from KCC are defective.  It is pointed out that the Company had already lost half a million dollars in the first 6 months in 2006.  The suggestion appears to be that the business has no future, so no further liabilities should be incurred.

16.  It is in dispute if the products are defective as alleged.  This is one of the issues raised in the petition.

17.  As to the losses suffered to date, it seems to me that this should be looked at in the context of the entire situation.  I do not agree with the submission of the petitioner’s counsel that I should look at the financial position from July to October 2006 in isolation.  I am not prepared to assume that of the current assets, a deposit of $300,000 odd paid by the Company to KCC would certainly be non-refundable.

18.  The business may not be vastly profitable in the short term, but I am not persuaded that it would suffer heavy losses if it were to continue.  Looking at the sales figure in November 2006, there may be a chance that the revenue generated would at least be sufficient to pay for the expenses.  I think on balance it would be in the interest of all to keep the Company afloat until the petition is to come on for hearing.

19.  I turn to the amounts sought to be validated in the summons, being the expenses already incurred in the ordinary course of business during April to July 2006.

20.  For the amount incurred for salary, the petitioner claims it is unreasonable to validate the payment of salaries as set out in the schedule to the summons, other than to pay the 5 employees who were employed since the Company was set up.

21.  Only 5 sales staff were employed when the petitioner was there, after she left the number shot up to 15.  It is alleged that there is no justification for the increase in number of employees and in the amount of wages paid to some of them.  It is also alleged that the total monthly wages had gone up from $34,000 to $106,300.

22.  I think these criticisms are unjustified.  The figure of $106,300 was the total amount of wages of 14 employees who had worked in July 2006.  It is clear from the evidence that they did not work for the entire month of July.  9 of them only worked for part of that month, and 1 had worked for just 1 day.  $106,300 would have been the total monthly wages to be borne by the Company had these 14 employees worked for the entire month, which was not the case.

23.  The petitioner has also submitted that she would not object to the payment of salary if the 2^nd respondent should undertake to provide legible copies of the identity cards of the staff to her solicitors.  The salaries sought to be validated related to the staff employed during April to July 2006.  They may or may not remain in the employment of the Company as at present.  I do not see any useful purpose to be served by ordering the 2^nd respondent to provide legible copies of the identity cards of the staff, and I decline to impose this as a condition for making a validation order.

24.  I will make a validation order for the balance of the salary set out in the schedule.

25.  For the laboratory test fee, this was incurred due to the allegation of the petitioner that the product was defective, so the Company decided to obtain its own laboratory test.  The expenses are reasonably incurred and they would be validated.

26.  The remaining item is that of petty cash expenses of $13,578 for 3 months from May to July 2006.  No breakdown was given in the schedule for these expenses.  This is not a large amount.

27.  The 2^nd respondent has filed a total of 6 affirmations in support of her application.  She is aware of the petitioner’s refusal to consent in the absence of supporting documents for petty cash expenses.  Even if she were unable to produce all or some of the documents in support, she should at least furnish an explanation of how the amount was made up.  In the absence of explanation, I decline to validate this item.

28.  Save for the petty cash expenses, I grant a validation order for all the remaining items in the summons.

29.  The 2^nd respondent’s counsel informed the court that she would not seek a validation order in respect of the expenses incurred in the operation of the business from August to November 2006, and that she would reserve her position to seek a validation order for the expenses for this interim period if the business should prove profitable in future.

30.  For the recurrent business expenses, the 2^nd respondent seeks an order from December 2006 onwards that such expenses be validated at a maximum of $71,800 a month.  I was provided a schedule of how this amount is arrived at.  This is opposed by the petitioner for the reasons mentioned earlier and on the basis that the Company will not have enough cash to pay recurrent expenses after making two more payments or so.  This is on the assumption that no revenue would be generated from the business at all.  I do not think this is a likely scenario.  The Official Receiver has adopted a neutral stance in the application.  I will make a validation order for recurrent expenses, but this will be capped at a lower figure than the figure put forward by the 2^nd respondent.

31.  I order that a validation order be made in respect of expenses incurred in the ordinary course of business at a maximum of $65,000 a month.  A draft order should be submitted by the 2^nd respondent’s solicitors for the approval of the court.

32.  The petitioner has objected to the 2^nd respondent using a personal account to operate the business of the Company and bypassing the need to seek a validation order.  Any amount of the Company paid into the personal account would need to be accounted for.  The 2^nd respondent may well have done so as the bank accounts of the Company have been frozen.

33.  With the granting of a validation order that would allow payments into and out of the Company’s bank accounts for recurrent business expenses, there would be no need for the use of a personal account.  I would expect the 2^nd respondent to desist from this practice.

34.  For the costs of this application, I order that should be in the cause of the petition.