Tsang Ling chu v. Director of Lands

Crown Lands Resumption Reference No. 23 of 1994

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HEADNOTE

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Property law - Crown Lands Resumption - Workshop Premises - Business Losses - Valuation of Plant and Machinery - Valuation of Goodwill - Crown Lands Resumption Ordinance, Cap. 124, s. 10(2)(d)

Premises for construction machinery repair workshop resumed by and reverted to the Crown on 3rd October 1992. The workshop was allowed to operate until April 1994 when, upon eviction from the premises, the stock, machinery and equipment (including 4 excavators) of the business were auctioned off for $0.52 million. The applicant proprietor of the business claims, inter alia, losses of goodwill valued at $1.404 million and for forced sale of stock, machinery and equipment valued at $5.904 million. The respondent's expert valued the stock, machinery and equipment of the business at $2.879 million from which the value of the 4 excavators should be deducted as irrelevant assets.

Both parties accept valuation of goodwill on the basis of wages and salary cost and a multiplier of 2 to be used. The respondent calculates goodwill by the wages cost of the sole proprietor fixed on notional basis whilst the applicant suggests calculation by the wages cost of three long term employees at the actual cost of $15,000 per month with a 13th month year end bonus.

Held: (1) In accordance with s. 10(2)(d) of the Crown Lands Resumption Ordinance, the applicants are entitled to compensation that would restore them to the business position where it would be had there been no resumption, i.e. an amount of compensation so as to enable the applicants to acquire the same quantity and quality of trading stock together with the goodwill of an equivalent business in April 1994. (2) In the absence of more reliable materials, goodwill may be assessed on the total wages and salary costs of the business. Since the applicant is content to calculate on the basis of just three long term employees and not take into account other casual workers, goodwill assessed at $1.4 million as calcuated by the applicant but rounded down. (3) On the facts of the case, the 4 excavators are necessary assets of the business. (4) Based on past experience, the auction price may be used as basis for assessment of the value of stock, machinery and equipment. On the facts of this case, a multiplier of 5 should be applied to the auction price to arrive at the value of the stock, machinery and equipment at $(0.52 x 5) = $2.6 million. Hence compensation for forced sale of stock, machinery and equipment at $2.08 million. (5) After adding other items claimed, total compensation determined at $3.76 million.

IN THE LANDS TRIBUNAL OF HONG KONG

Crown Lands Resumption Reference No. 23 of 1994

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JUDGMENT

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The Applicant is the sole proprietor of a workshop known as Wrench Engineering Co. ("the business") at rented premises situated at No. 8, Ground Floor, Sui Lun Street, Ma Tau Kok ("the subject premises"). The business was mainly concerned with the repairs of construction machinery. The subject premises were resumed by the Crown pursuant to section 3 of the Crown Lands Resumption Ordinance, Cap. 124 ("the Ordinance") under a Notice of Resumption dated 26th June 1992, published in Volume CXXXIV Hong Kong Government Gazette on 3rd July 1992 as G.N. No. 2264 of 1992 and reverted to the Crown on 3rd October, 1992. Nonetheless, the Applicant was allowed to carry on the business at the subject premises rent free until April 1994 when the Applicant was evicted. There upon, it is not disputed by the Respondent, there was total extinguishment of the business.

2. Despite advice given by several members of the Tribunal at various stages, the Applicant decided not to engage legal representatives or valuers of any speciality to help him to prepare his case. The Tribunal has also repeatedly emphasized in open court that the burden was on the Applicant to prove each and every element of his claim. During the trial, the Applicant was given ample opportunities to adduce more evidence, if any, and to canvass more effectively for his case. Whilst additional materials, more effective advocacy and expert assistance for the Applicant would be desirable, and the same can be said for all cases arising from the same resumption exercise that the Tribunal has heard so far, the Tribunal is satisfied that there are sufficient facts and materials for the Tribunal to determine the claim.

3. It is common ground that the Applicant is entitled to compensation for business loss calculated under section 10(2)(d) of the Ordinance as -

"the amount of loss or damage to a business conducted by a claimant at the date of resumption on the land resumed or in any building erected thereon, due to the removal of the business from that land or building as a result of resumption."

In practical terms, the Applicant is entitled to reimbursement that would restore him to the business position where they would be had there been no resumption. During the course of trial, the Applicant agreed compensation for loss of fixtures and fittings at $43,210. He offered no evidence on his claim for loss of profit rent but left it to the Tribunal to determine. He alleged the following other business losses:-

4. The Respondent's assessment of the Applicant's loss was revised several times during the course of these proceedings. Eventually, in final submission, the Respondent contends that the compensation due to the Applicant should be as follows:-

5. Before we proceed further, we should point out that the subject premises were part of a major resumption of more than one hundred properties for the Hong Kong Housing Society's Urban Improvement Scheme ("the Scheme"). In addition to Sui Lun Street, the Scheme site extended to Wang Cheung Street, Ma Tau Kok Road, Pak Tai Street, San Shan Road and Pau Chung Street in Ma Tau Kok. The present case is one of nearly thirty applications by business operators affected by the Scheme for compensation who felt unable to accept the Crown's offer for settlement. Whilst each case must be decided on its own facts, an understanding of the background circumstances helps us to appreciate the general picture and understand the differences between the parties on specific issues. Having considered and otherwise dealt with a number of these claims, examined photographs of the area in general and of the individual streets and heard quite a few estate surveyors and witnesses involved, we believe we now have a fairly good idea of the locality and the resumption process.

6. The area affected by the scheme was essentially an old residential area. Most buildings were constructed immediately after the Second World War. All the buildings we have had to consider were not higher than six storeys and did not have a lift. The upper floors were mainly tenement flats with perhaps the odd business or other trade. We have heard evidence that some of the buildings were issued with occupation permits for "domestic use" from the ground floor upwards. But nearly all ground floor units in the area were used as shops, restaurants or workshops. Many of these enterprises and over-grown small operations were run by families who, as can be expected, are poor managers; the takings of the day went straight to meeting family, personal and trading expenses. Few, if any, had an accounting system; single entry records at best. And because it was a run down area, landlords and local residents were more tolerant of environmental, building and land use abuse. Most, if not all, ground floor units in the area had some sort of cockloft and an open yard which might be covered and protected from the elements by some overhead structure. Retail and food businesses in the area would hardly be able to find somewhere else with comparatively cheap rent or purchase price and yet more storage or useful space. Moreover, the area was also partially industrial, with a significant number of factory buildings right outside the fringes of the plots affected by the Scheme. This means that the clientele for retailers and food businesses were not limited to local residents, but also factory workers who filled the streets in the area during lunch hour and for a period before and after work.

7. Of particular importance to note is Wang Cheung Street and Sui Lun Street. These two streets were cul-de-sacs parallel and immediately next to each other. Vehicular traffic could only enter and leave either street by Pau Chung Street. The two streets were effectively the parking lots and common compound for the shop premises on the ground level there. Vehicles holding scrap metal, raw materials and even cranes were stationed in these two streets as temporary storage or even make-shift workshop. Premises of a few hundred square feet area with restricted length and width on the ground level of these streets could spill their repair, production or manufacturing activities out into these streets from time to time and enjoyed use of much more space. The two streets, therefore, were of particular attraction to some "nuisance" trades, e.g. scrap dealers, garages, laundries, craft workshops, etc.

8. The Scheme was actually in the winds well before the resumption notices were issued in July 1992. Earlier, the Housing Society had begun to buy out some of the landlords and tenants in the area. After the resumption was gazetted in July 1992, the intention clearly was all the owners, occupiers and business operators would clear out in October 1992. Some did. Apparently, the landlords and tenants on the upper floors were dealt with first. The business operators on the ground level were given several extensions of time for moving out. Eviction was postponed first to the end of 1992, then to the beginning of 1993, then to September 1993 and eventually to April 1994. During all this time, the tenants were allowed to occupy and business operators permitted to trade (if there was still business) without having to pay rent. At first, claims for compensation were handled by the staff of the Housing Society which had a field office in situ. Later, processing of these claims was taken over by the Lands Department. It was in September 1993 that the Housing Society and the Lands Department sent staff to the ground floor businesses to take stock and inventory with the view to clearing them out then. Many of the claimants say that they handed over original documents and papers substantiating their claims to the Housing Society or the Lands Department during this period, hence they no longer have all the proof for their claims now. There is no doubt that a number of representatives of those affected by the Scheme had several meetings with officials of the Lands Department. They also sought help or mediation from local politicians and OMELCO. There were definitely letters passing between the parties, including offers of ex-gratia compensation. Some of the disputes were settled. Some claimants allege that they were given the impression that if they wanted to preserve their right to full compensation they had to cease trading, auction off their stock and not continue business in another locality. Others say that the ex-gratia payments they received on account from the Government were not enough to cover the costs of setting up elsewhere and the Government refused to lend them money, so that they were unable to re-locate. In any event, even if they could move to elsewhere, with higher rent, more restricted land use, different clientele and perhaps difficulties with labour supply, business would not be the same. But we hear from counsel for the Respondent that the Housing Society and the Lands Department had not advised the claimants to close their businesses altogether. We think there may be some misunderstanding there. In many cases, counsel for the Respondent says, the Housing Society and the Lands Department do not have the documents which the claimants allege they have handed over. We cannot determine who is right or wrong in fact in this respect; but, as a result of the transfer of responsibilites from Housing Society to the Lands Department, the possibility of some bureaucratic mix-up cannot be ruled out. In any event, it is pointless to argue and ponder over irretrievable papers now.

9. It was in April 1994 that the authorities managed to evict the remaining affected ones. There was a furore at the time, with angry words uttered, force displayed and the attention of the mass media attracted. The claims we have to deal with are mainly concerned with those who moved out in April 1994. Probably due to the confusion and urgency at the time to clear the remaining business operators, their stock and inventory were not checked again. Some operators were able to remove their stock as they planned, some were locked out first and then allowed to retrieve their possessions. Some claimants say that their business books and records were left and lost in the resumed premises as they left in a hurry or were forced out. Upon eviction, most of the business operators had their stock, plant and machinery transported to a place in the New Territories and auctioned off by one common auctioneer. It is now undisputed fact that there is no reliable inventory of the actual stock, plant and machinery sold by auction for each claimant. This is a problem which we face in virtually every case before us.

10. We now consider each of the outstanding items of claim.

Goodwill

11. A classic definition of business goodwill can be found in the formidable work - Land Compensation and Valuation Law in Hong Kong by H.H. Judge Cruden at pp. 79-80 as follows:-

"Goodwill is the value of that element of profitability which arises from either one of two factors or a combination of both. Those factors is first, the specific business connections in respect of the resumed premises and secondly, those due to the personality of the owner. In some cases a resumption may only affect or extinguish the former species of goodwill. The personal goodwill of the owner may only be partially affected or not affected at all if the business can promptly be relocated to a new suitable site." (Page 16 of the judgment in Callwin International Electric Co. Ltd. v. Director of Engineering Development MTR 3 of 1984).

This definition must be properly understood. Whilst goodwill is often valued by reference to profits, it is profitability on account of shop location and personal connection that is the true measure of goodwill. In Shun Fung Ironworks Ltd v. Director of Buildings and Lands, the Judicial Committee of the Privy Council at page 15 of the Board's advice further observed that:-

"However, this must not lead the tribunal into the error of equating the amount of a claimant's loss with the price he could obtain if he sought to sell the future profit stream to an outside commercial investor. Even on the willing seller basis, a prudent landowner running his own business might be prepared to pay more to keep his land and business and the expected profits than would an outside investor to acquire them. He might be prepared to accept a lower rate of return than an outsider who has no personal links in the business. In appropriate circumstances a tribunal may properly recognize this and make a modest allowance accordingly."

12. In Callwin International Electric Co. Ltd. v. Director of Engineering Development MTR 3 of 1984, at page 17, the Tribunal stated that:-

"There are several methods of valuing goodwill and each has its advantages and disadvantages. Some methods are more appropriate for certain cases than others. The selection of a particular method will often depend on the factual situation. At times it may be helpful to use more than one method so that each may be a check on the goodwill figure arrived at by the other. This is a complex area of valuation."

The Tribunal also observed that:-

"Any assessment of goodwill includes an element of arbitrariness for it involves projections into the future often on the basis of minimal information of even existing factors. The employment of scientific methods should tend to improve the soundness of the ultimate assessment. However, in most cases it will merely narrow the range within which a realistic assessment may be made. In making a final assessment within that range experience and at times even intuition will be of importance." (Page 16 of the judgment and quoted in Land Compensation and Valuation Law in Hong Kong by H.H. Judge Cruden at page 81.)

13. The method we adopt is the one explained in Land Compensation and Valuation Law in Hong Kong by H.H. Judge Cruden at pp. 80-81 and which we have applied in WONG Sau Hing, LEE Wing Tau, LI Sai Kuen and LEE Sai Ho trading as Shing Kee Metal Dealer v. Director of Lands, CLR No. 20 of 1994. First, we endeavour to establish the normal profit trends of the business before resumption. Conceivably, the reported profits of the business, the rental value of the premises at which the business is conducted or the wages and salary costs of the business may be used as basis for this purpose because each of them may somewhat relate to the profitability of the business. Once the annual profit trend of the business has been arrived at, it must be related by multiplication to the aniticipated future life of the business, had the business premises not been resumed. Then the product is discounted to take into account the fact that the business operator will have the sum representing capitalized profits immediately available for investment or other use.

14. The business in this case did not trade on goods or materials. It was a trade workshop which depended on work orders. Unfortunately, the trading accounts of the business are no longer available. But both parties used wages and salary costs for calculating goodwill. Mr. James Ng, expert valuer for the Respondent, in his report Exhibit R3 worked on the basis of statistical nominal wages for one worker in the trade, i.e. $86,931 per annum, multiplied by 1.2 for 20% employer's margin and then by a factor of 2. The Applicant says he is content with this approach but disputed the calculations. His arguments, so far as we understand, are that firstly each employer expects every employee to earn money so that the more employees the more profits for the employer, and secondly each employee is paid according to his actual skills which should be treated as a function of his profit earning capacity for the employer, so the calculation of goodwill should take into account the total wages and salary cost of the business. In his case, the business employed more than three workers, but he is prepared to calculate goodwill on only his three workers who got severance payment on cessation. His claim under this head comes to $1.404 million which is based on $15,000 per month for 13 months a year for each of his three steady workers with an added employer's margin of 20% and multiplied by a factor of 2, i.e. $15,000 x 13 months x 3 x 1.2 x 2 =$1.404 million. The Respondent's expert later accepted through counsel's final submission that $15,000 per month for wages cost reasonable. So the only remaining differences separating the parties are whether 13 instead of 12 months wages and 3 instead of 1 worker should be used in the calculation of goodwill.

15. We find the Applicant's arguments compelling. A 13th month salary or wages as year end bonus is virtually the norm for all small businesses in Hong Kong. Moreover, it is basic business common sense that the goodwill of a profitable shoe factory with 100 workers cannot be equated with that of a solitary shoemaker operating from a stall at a street corner. An employer would hire an additional worker only if there is enough work and return to justify the cost. In some professional firms, such as solicitors' firms, each employed professional is called a fee-earner. The managing partners certainly would not accept that the goodwill of their firm is limited to the earning capacity of one employed professional. The Applicant's calculation based on three workers is clearly on the conservative side, for he had other workers who could have been taken into account. In WONG Sau Hing, LEE Wing Tau, LI Sai Kuen and LEE Sai Ho trading as Shing Kee Metal Dealer v. Director of Lands, CLR No. 20 of 1994, we used half the annual salary and wages cost of the scrap dealers' business as a cross check for the calculation of goodwill because the employees in that case were nealy all coolies, not production or skilled labour, hired to move the goods. In the present case, each of the three workers employed by the Applicant was obviously skilled and directly productive. In any event, Mr. Ng as expert for the Respondent is content to take $15,000 per month per worker without further adjustment.

16. The multiplier of 2 used by the Applicant is consistent with conventional wisdom that the multiplier, i.e. the projected number of years of profitability, ranges between two to five. For a small multiplier, we do not propose to deduct for interest for advance cash pay-out; but would round down from $1.404 million to $1.4 million. Accordingly, we determine the goodwill of the business at $1.4 million.

Profit Rent

17. Before the profit rent can be calculated, the full market rent of the subject premises has to be ascertained. In WONG Sau Hing, LEE Wing Tau, LI Sai Kuen and LEE Sai Ho trading as Shing Kee Metal Dealer v. Director of Lands, CLR No. 20 of 1994, for the Ground Floor of No. 5 Sui Lun Street, we adopted a unit rate of $280 per square metre and one-eighth for the yard. Mr. James Ng, expert valuer for the Respondent suggests a unit rate of $210 per square metre and one-sixth for the yard. Since No. 8 Sui Lun Street is diagonally opposite No. 5 Sui Lun Street, we find the rates suggested by the Respondent unjustifiably low. Arguably, some very slight adjustment should be made to the rate of $280 per square metre for No. 5 Sui Lun Street to reflect that the subject premises are further inward. However, property valuation not being an exact science and a discrepancy range of 10% is usually permissible, we do not propose to make an adjustment that is within the discrepancy range.

18. In the premises, we determine the profit rent at $40,000 calculated as follows:-

Stock, machinery and equipment

19. To effect repairs on large construction machines, the Applicant's workshop had to make replacement metal parts. Hence the business had quite a number of machines, equipment, tools, raw materials and stock. In September, 1993, officers of the Lands Department went to the subject premises and made a record of the stock, machinery, equipment, tools and raw materials held by the business at that time. There are altogether 361 items of them in all; see the list in Exhibit R3 and a faired list in pp. 7-16 in Exhibit R1. The inventory is not disputed by the parties. The Applicant has put in a lot of efforts to show the Tribunal the stock, machines, equipment, tools and raw materials he had. The particulars and supporting documents are in three bundles marked as Exhibits AB AC and AD. The Applicant claims for losses suffered as a result of forced sale of these stock machinery, equipment, tools and raw materials which were sold by auction in April 1994 for a gross sum of $520,000. It is now well established law that since the stock, machinery, equipment, tools and raw materials were forcibly sold off in April 1994, the Applicant is entitled to compensation being the value to him at the time of sale less the auction proceeds he has received. In our view, the value to the Applicant in April 1994 is the price paid by the Applicant at various times previously to obtain the machinery, equipment, tools and raw materials stock less depreciation for wear and tear. Alternatively, the value should be the cost to obtain from the open market the same quantity and quality the Applicant had in April 1994. In either case, it is the replacement value.

20. Mr. Yan of American Appraisal Hong Kong Limited for the Respondent assessed the value of the machinery, equipment, tools, raw materials and stock at $2,879,335 or rounded down to $2,870,000. However, the Respondent takes exception to 4 excavators included in the Applicant's claim. The Respondent contends that the 4 excavators acquired at an alleged total cost of about $2.7 million were not justified investment or acquisition for the business. For this reason, compensation for loss due to forced sale of stock, machinery, equipment and tools should exclude the value of the 4 excavators estimated at $1,266,280.. The revised value is put at $1,613,055 which, after deducting the relevant portion of the auction proceeds received, gives the compensation amount at $1,321,742. The Applicant stated in evidence that he bought those machines after China and Britain had just signed the Memorandum of Understanding on PADS and there were high expectations in the trade for a boom in the construction industry. He explained that in his trade it was necessary to show possession of substantial assets to gain the confidence of major construction contractors from whom he hoped to obtain business. The excavators are not only a form of valuable assets, but also standby replacement for machinery which he would need time to repair. To obtain repair orders, it would be advantageous to be able to show that he can even supply replacement machines whilst repairs on ones broken down are being carried out. Unfortunately, not long after he acquired the 4 excavators, further arguments delayed the PADS project and he did not get the orders hoped for. In fact, towards the end of 1993 and the beginning of 1994, his business had to take petty orders for fabrication of cash boxes for public light buses to keep his key workers. We accept the Applicant's explanation and find that the 4 excavators were necessary assets for the business.

21. In Callwin International Electric Co. Ltd. v. Director of Engineering Development MTR 3 of 1984, the Tribunal, comprised of H.H. Judge Cruden and Mr. Phillips, held that auction price is an acceptable basis for determining loss for purposes akin to section 10(2)(d) of the Ordinance. There, the trading stock of the applicant company was sold by auction in large lots to a single purchaser for the total of $1,410,000 which was only 27.4% of the agreed gross value of the entire stock. The Tribunal held that that was a reasonable auction price. It is common experience, also supported by expert evidence in the cases we have heard, that goods on auction should fetch 20% to 80% of the ordinary market value. In WONG Sau Hing, LEE Wing Tau, LI Sai Kuen and LEE Sai Ho trading as Shing Kee Metal Dealer v. Director of Lands, CLR No. 20 of 1994, taking a broad approach, we believed the price paid by the successful bidder in the auction in April 1994 reflects the variety and quantity of the trading stock, machinery and equipment on auction and took the auction price as the equivalent of 28.5% of the market value of the trading stock, machinery and equipment in that case. In the present case, if Mr. Yan's assessment at $2,879,335 inclusive of the 4 excavators is correct, the auction proceeds are less than 20% of the assessed market value. This, we think, is extraordinary considering that the stock, machinery, equipment and tools are mainly general purpose ones suitable for use by any engineering workshop. One explanation may be that the 4 excavators sold in April 1994 when the construction industry had not picked up attracted much less than their utility value. Another explanation may be that the Applicant bought them at a time when their prices were already pushed up too high in anticipation of construction boom. In either case, it is fair to say that the Applicant's investment in these machines was poorly timed. It is also relevant to note that valuers of American Appraisal Hong Kong Limited have had no opportunity to examine the 4 excavators; their assessment is no more than a shot in the dark. Relying on conventional wisdom of the auction market, we would not put the value of the Applicant's machinery, equipment, tools and stock higher than $520,000 x 5 = 2,600,000.

22. In the premises, we place the value of the machinery, equipment, tools and raw materials stock of the business at $2,600,000 and determine compensation payable to the Applicant for loss due to forced sale of the machinery, equipment, tools and raw materials stock at $(2,600,000 - 520,000) = $2,080,000.

Miscellaneous Items

23. The Applicant further claims transportation fees for auction at $123,800 auction exhibition ground and security charges at $28,000 and auctioneers' charges at $41,924.80. The claims for auction exhibition ground and security charges are not supported by receipts. The claim for transportation and auctioneers' charges is supported by receipts as shown in Exhibit AA. The Respondent does not accept the amounts claimed for transportation fees and auction exhibition ground and security charges. Mr. James Ng in his report Exhibit R3 worked out the costs for transportation based on a number of assumptions which we have found in previous cases to be unreliable. Taking into account the quantity and nature of the articles to be moved, we have no reason to doubt the claim for $123, 800 for transportation charges supported by receipt. We gather from evidence in related cases we have heard and from the Applicant that the auction exhibition ground and security charges at $28,000 are in fact an apportionment of a much larger amount which all the business operators affected by the Scheme and had to auction their goods had to share. We have no reason to doubt this and would allow the amount as claimed.

24. In summary, compensation for the following items is justified:-

The Order

25. Accordingly, we determine compensation for the Applicant at $3,760,000. Leave is reserved to apply for the rate of interest, if not agreed, to be determined under section 17(3A) of the Ordinance. There is an order nisi that the Respondent shall pay the Applicant's expenses incurred in prosecuting his claim which we assess at $12,000 to be made absolute unless application is made, within 21 days from the date of handing down of this judgment, to the contrary. Liberty to apply is also reserved for ancillary and consequential matters.