THE OFFICIAL RECEIVER v. CHOW HUEN CHUN CRISPIN AND ANOTHER

HCMP 5002/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 5002 OF 2003

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J U D G M E N T

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1.  This is an application of the Official Receiver for a disqualification order against Mr Chow Huen Chun Crispin and Mr Chow Tien Yuen, the 1^st and 2^nd respondents herein, under section 168H of the Companies Ordinance, Cap. 32. 

2.  The 1^st and 2^nd respondents were and are the directors of Regal Motion Industries Limited (“Regal”) at all times.  The 1^st respondent is the younger brother of the 2^nd respondent.  Regal was incorporated on 22 May 1987.  The 1^st respondent holds 40% of the shares in Regal, Alpha Properties Limited (a company owned by the 2^nd respondent and his wife) holds 10% and the remaining 50% is held by Ms Siu Chi Fan who is the former girlfriend of the 1^st respondent.  The business of Regal was trading in frozen food stuff imported from the United States and other parts of the word for re-export to Mainland China.  Regal went into creditors’ voluntary winding up by delivery of a statutory declaration under section 228A to the Registrar of Companies on 18 November 1999.  Liquidators were appointed by a special resolution passed on 14 December 1999.  Up to the date of the Official Receiver’s 1^st report on 18 January 2004, the total liability of Regal according to the statement of affairs amounted to HK$6,303,122.00 and the assets realised by the liquidators are only HK$896,546.00.  Regal is insolvent.

3.  Between January 1989 and July 2001, the 2^nd respondent was the director of Alpha J & I International Company Limited (“Alpha”) and a 99% shareholder.  At the time he ceased to be a director, his share was transferred to his wife.  The business of Alpha was trading in piece goods and textiles.

4.  In May 1999, the respondents were investigated by the Commercial Crime Bureau of the Hong Kong Police on an allegation of fraud in obtaining letter of credit facilities from a bank.  In October 1999, they were arrested and subsequently charged.  This is DCCC No. 110 of 2001.

5.  On 4 July 2001, both respondents pleaded guilty before His Honour Judge Day, the 1^st respondent to 31 charges of false accounting contrary to section 19 of the Theft Ordinance, Cap. 210 and the 2^nd respondent to 3 charges of false accounting.  On 5 July 2001, the 1^st respondent was sentenced to 28 months’ imprisonment and the 2^nd respondent to 15 months’ imprisonment.

6.  The following facts relating to the criminal charges to which the respondents had pleaded guilty are taken by and large from the Reasons for Sentence of Judge Day.  The allegations related to Regal and Alpha.  Between July 1996 and January 1999, Alpha opened 22 letters of credit in favour of Regal on the basis of goods purchased from Regal.  The total amount involved was HK$15.5 million odd, according to the Official Receiver’s investigation from the primary documents provided by the bank (this amount is different from the amount referred to in the Reasons for Sentence which was HK$19.9 million odd).  And between January 1998 and December 1998, Regal opened 9 letters of credit in favour of Alpha on the basis of goods purchased from Alpha.  The total amount involved on the Official Receiver’s investigation was HK$4.5 million odd (the figure in the Reasons for Decision was HK$2 million odd).  In each of the instances where such letters of credit were opened by Alpha or Regal, the invoices issued by them were false, the arrangement was a sham, no goods were in fact sold, and proceeds of the letters of credit received by the beneficiary were returned to the applicant of the letters of credit, less the costs of applying for the letters of credit.

7.  The purpose of the arrangement was to use the credit lines available to Regal and Alpha to solve the cashflow problems of these companies.  Both companies had paid back all the loans to the bank by July 2000, after a High Court action was brought against Regal and a bankruptcy petition presented against the 1^st respondent.  In the end, the bank did not suffer any loss, so this was not a case where money was fraudulently obtained and dissipated.

8.  Nevertheless, as Judge Day had observed, the 1^st and 2^nd respondents went to considerable lengths to defraud the bank.  Each was prepared to be part of the schemes whereby documents were falsified and large sums of money advanced under false pretences.  This was a serious fraudulent scheme, carried out over a prolonged period and involving in total a substantial sum of money.  In effect, both lied to the bank and obtained facilities that the companies would not otherwise have received.  Their behaviour was dishonest and on a wider scale served to undermine the basis of the letter of credit system.

9.  By a letter dated 4 November 2003, the Official Receiver gave notice to the respondents of his intention to apply for a disqualification order against each of them.

10.  The criminal charges and conviction formed the primary complaint of the Official Receiver in these disqualification proceedings.

11.  The other alleged wrongdoing related to the accounting records.  It was alleged that the respondents were responsible for Regal’s failure to take reasonable steps to cause proper books of account be kept, as required under section 121(1), and each had failed to comply with the obligation imposed on them under section 274, in that proper books of account were not kept by Regal throughout the period of two years immediately preceding the commencement of the winding up.

12.  The Official Receiver submitted that by reason of these two complaints, the court should find the respondents unfit to be concerned with the management of a company.

13.  Disqualification under section 168H is mandatory if the court is satisfied of these matters:

(1)     the respondent has been a director of a company which has at any time become insolvent whether whilst he was a director or subsequently; and

(2)     that his conduct as a director of that company, either taken alone or taken together with his conduct as a director of any other company or companies, makes him unfit to be concerned in the management of a company.

14.  Here, it is not in dispute that the respondents are or have been directors of Regal and that Regal has become insolvent.  The only question is whether the conduct of the respondents as directors of Regal, either taken alone or taken together with their conduct as director of any other company or companies, would make them unfit to be concerned in the management of a company.

15.  Mr Edwin Choy, who appeared for the respondents, submitted that the mandatory disqualification should not apply in this instance.  His argument was as follows.

16.  Firstly, the court should not take into consideration the conduct of the respondents being the subject of the criminal charges and conviction, as such conduct did not contribute to the insolvency of Regal.  I see no reason why not, assuming that the fraudulent scheme to obtain credit did not contribute to the insolvency.  The wording in section 168H(2)(b) does not have the effect of restricting the conduct to be considered, as the court is required to do under section 168H(1)(b), to conduct in relation to any matter connected with or arising out of the insolvency of the company concerned.  This is made even clearer if one looks at section 168K, in which it is set out the matters for determining the unfitness of directors and reference is made to the 15^th Schedule.  That schedule is divided into two parts, Part I sets out matters applicable to all cases and Part II sets out matters applicable where the company has become insolvent.  I do not understand how it could be said that dishonest acts being the subject of the criminal conviction were not connected with the respondents’ conduct as directors of Regal and/or Alpha.  In this instance, leaving aside the accounting records allegations, the relevant matter in the 15^th Schedule would include “any misfeasance or breach of any fiduciary or other duty by the director in relation to the company” in paragraph 1 of Part I in the 15^th Schedule.

17.  On the wording of the relevant provisions in Cap. 32, there is no basis for suggesting that the acts of a director unconnected with the cause of insolvency of the company should be excluded from the court’s consideration, when considering if his conduct is such as to make him unfit in the management of a company.  I also mention that any misconduct of the respondents qua director may be relevant to the finding of unfitness, even if it does not fall within a specific provision of the companies legislation (Re Bath Glass (1988) 4 BCC 130 at 133). 

18.  Secondly, it was submitted that in the present case, Judge Day had declined to exercise his discretion under section 168E to make a disqualification order against each of the respondents when he passed sentence.  Under section 168P(4), a court may make a disqualification order in the course of a proceeding for the prosecution of an offence, and it may make such an order if it thinks fit, whether or not any person applies for such an order.  It was submitted that as the judge had refrained from exercising his discretion under section 168E, the civil court in considering an application under section 168H should pay limited attention to the conviction, unless it is proven that the offence of dishonesty had led to the ultimate failure of Regal.  No authority was cited in support of this proposition.  I fail to see why that should be the case.  In any event, I am not prepared to infer that Judge Day had declined to exercise his discretion under section 168E.  Although I do not have the transcript of proceedings before the judge, it does not appear from his Reasons for Sentence that he had considered section 168E.  Mr Choy also informed the court that the prosecution did not invite the judge to exercise his power under that provision.

19.  I should add that for completeness, although it was not argued by Mr Choy, I do not consider there is any abuse of process in this instance, where the Official Receiver commenced proceedings for disqualification order under section 168H, after the respondents had been convicted of charges and the criminal court had not exercised its discretion to make disqualification orders against them under section 168E (Secretary of State for Trade & Industry v Rayna & Ors [2001] 2 BCLC 48, at 57h to 60c; Re Denis Hilton Ltd [2002] 1 BCLC 302 at 310b to 311i).  The picture available to the court at the stage of the criminal trial might not be the full picture.  As stated by the English Court of Appeal when refusing leave to appeal against the decision in Rayna, “since the power to disqualify is not only penal but also for the protection of the public, it seems all the more desirable that the full and precise aspects which rendered the applicants unfit should be investigated with a view to determining the proper period of disqualification” (Secretary of State for Trade & Industry v Newstead & Ors [2001] EWCA Civ 1083, para. 16).

20.  I have no difficulty in coming to the view that the conduct complained of being the subject of the criminal conviction would render the respondents unfit to be concerned in the management of a company.

21.  This leaves the accounting records allegations.

22.  First, I need to determine if there was a failure to keep proper books of account before I consider the respondents’ responsibility for any failure.

23.  The Official Receiver produced a forensic accounting report prepared by Mr Neill Poole of RSM Nelson Wheeler Corporate Advisory Services Limited dated 19 November 2002.  Mr Poole conducted a review of the books and records of Regal made available to him and noted among other things the following:

(1)     Regal’s auditors qualified their reports for failing to keep proper books and records of the subsidiaries of Regal for each of the years ended 30 June 1993 to 30 June 1998;

(2)     for each of the financial year ended 30 June 1993 to 30 June 1998, the auditors qualified their opinion on inter alia the ground that group accounts were not prepared because the accounts of the subsidiaries and affiliated companies were not available;

(3)     a significant number of the records for 1999, particularly for the period after May 1999 to the liquidation of the Company in December 1999, are not in existence.  This period was a critical time when Regal was facing insolvency issues.  There was clearly a failure to comply with section 274.

24.  As no group accounts were prepared, the directors and shareholders were not aware of the consolidated position of the group.  The directors were unable to form a view on the carrying value of the investments in subsidiaries, which was a material component of the net asset of Regal and had potential impact on whether the financial statements showed a true and fair view of the state of affairs of Regal.

25.  I accept the findings of Mr Poole there were deficiencies in the accounting books and records kept by Regal, as summarised in appendix D to his report.

26.  The purposes of the requirement to keep accounting records which are sufficient to show and explain the company’s transactions are twofold as explained in Secretary of State for Trade & Industry v Arif & Ors [1996] BCC 586 at 593H to 594A,

(1)     it is to ensure that those who are concerned in the direction and management of companies which trade with the privilege of limited liability do maintain sufficient accounting records to enable them to know what the position of the company is from time to time.  Without that information, they cannot act responsibly in making decisions whether to continue trading; and

(2)     if the company fails, the accounting records are to enable the liquidator to identify and recover or exploit the company’s assets.  His task would be made extremely difficult if not impossible if the company had failed to comply with its obligation in section 121(1).

27.  Mr Choy submitted that there was no contravention of section 121 because there is a defence in section 121(4)(a) in that a director may prove he had reasonable grounds to believe, and did believe, that a competent and reliable person was charged with the duty of seeing that the requirements under the statute were complied with and was in a position to discharge such duty.

28.  Whether the directors themselves may be convicted of an offence under section 121(4) is neither here nor there, as in the 15^th Schedule Part I paragraph 3, the court is to take into account the extent of the director’s responsibility for any failure by the company to comply with section 121.

29.  According to the evidence of the respondents, the 2^nd respondent had very limited involvement in Regal throughout.  It was not challenged by the Official Receiver that the 2^nd respondent was a non-executive director of Regal.  The 1^st respondent was responsible in part for day-to-day management.  Both respondents said they have no accounting background or training and had relied on professionals to do the accounting work.  The accounts were looked after by the accounting staff, Miss Ma, later she was replaced by Miss Lam.  The staff were considered efficient and capable and there was no reason to doubt their competence and integrity.  The respondents were not aware of any problems with the accounting books of Regal.  The accounts were audited every year and the auditors had never raised any issue with the 1^st respondent on any aspect of Regal’s method of accounting.  On being provided with annual financial statements, the 2^nd respondent said he took “no more than a fleeting glance” because he considered he owed no duty to the operation of Regal “irrespective of [his] role as nominee director”.

30.  As to the non-existence of accounting records in the period in 1999, the 1^st respondent alleged that it was due to Ms Siu’s refusal to provide any accounts of the operations in the Mainland since January 1999, so it was difficult for books and records of Regal to be completed for that period.  For the same reason, group accounts could not be prepared because subsidiaries and affiliated companies of Regal in the Mainland were uncooperative in providing the necessary financial records, despite repeated demands by the 1^st respondent during meetings with them.  However, he was unable to give particulars of the occasions on which he had made such demands when he was served with interrogatories by the Official Receiver.  He later claimed that demands were made “over the telephone”, not in meetings as he first alleged, and he no longer has record of his notes of the telephone discussions.  In his oral evidence today, the 1^st respondent gave yet another version and said that he had made requests in writing to the partners in the Mainland for the financial information of subsidiaries and affiliated companies.  He is unable to produce any such written requests made.  I am not impressed with this part of the 1^st respondent’s evidence.  As for the 2^nd respondent, although he said in evidence today he had asked the other directors, the 1^st respondent and Ms Siu, about the financial information not provided to the auditors leading to their qualified opinion, it would appear from his evidence that he did nothing much apart from just raising questions.  I am somewhat skeptical of this part of his evidence.

31.  The Official Receiver’s position is not that the respondents could not delegate certain duties, but this should not absolve them from all responsibility to keep themselves properly informed of the financial position of Regal, particularly as during 1997 and 1998 Regal had experienced significant delay in payments by customers and there was such pressure on cashflow that the respondents had to resort to their schemes to obtain credit from the bank by false documents.

32.  I was referred to a number of authorities in which the court had considered the culpability of directors where there had been delegation of responsibilities, some of them were cited in my own judgment in Re Copyright Limited, HCMP No. 2606 of 2002, 17 September 2003, paragraphs 34 and 35, being the dicta in Re Barings plc (No. 5) [1999] 1 BCLC 433 at 489a to c; Re Westmid Packing Services Ltd [1998] 2 BCLC 646 at 653b.

33.  Each case must depend on its own facts if the delegation was proper and whether the duty to supervise the discharge of delegated functions was discharged.  I bear in mind that although it is permissible to delegate, overall responsibility is not delegable (Re Barings plc. (No. 5), supra. at 487f to g). 

34.  Where there was failure to discover what was going on, the court is to inquire whether in the circumstances such failure was attributable to ignorance born of culpable failure to make enquiries or, where enquiries were made, of culpable failure to consider or appreciate the result of those enquiries (Re Park House Properties Ltd [1997] 2 BCLC 530 at 554f to g).

35.  Applying normal commercial standards, I do not think the respondents had done what they should do to keep themselves properly informed of the financial position of Regal.  They did nothing or at least very little with regards to the books of account which were not properly kept.  Notwithstanding the qualifications made in the auditors’ report for over five years, they had permitted the situation of not maintaining proper books of account to remain.  They failed to ensure that the book-keepers did their job, by supervising them or putting proper systems in place.  They had a duty as directors to see to it that the book-keepers were provided with information to enable books of account to be maintained accurately and up to date (Re Firedart Ltd [1994] 2 BCLC 340 at 347b to c).

36.  The 2^nd complaint made by the Official Receiver is made out.  Both respondents are responsible for Regal’s failure to take reasonable steps to comply with section 121(1) and each had failed to comply with the obligation imposed on them by section 274, although the 2^nd respondent was culpable to a lesser degree by reason of his lesser involvement in the management.

37.  I turn to consider the length of the disqualification period.

38.  Mr Choy submitted that the period of disqualification should be limited as the respondents had already been punished for their wrongdoings and served terms of imprisonment.  An extensive period of disqualification now would serve little purpose in protecting the public, as the respondents would no longer pose as threats to the commercial community.  I was referred to In re Lo-line Ltd [1988] 1 Ch. 477 at 486A to C, in which it was stated that the provision equivalent to our section 168H is meant to be protective, not punitive.

39.  The protection of the public is but one purpose of section 168H, it is not the only purpose.  The deterrent effect on others must not be overlooked.  In Re Westmid Packing, supra. Lord Woolf MR had this to say at 654i to 655d:

“In Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicolas Browne-Wilkinson V-C said that the primary purpose of section 300 of the Companies Act 1985 was to protect the public against the future conduct of companies by persons whose past records as directors of insolvent companies showed them to be a danger to creditors and others.  That statement has often been approved by this court.  But there is often a considerable time lag between the conduct complained of, its discovery and the disqualification proceedings actually coming to court … One result of delay when it does occur is that there are occasions when disqualification must be ordered even though, by reason of the directors’ recognition of his previous failings and the way he had conducted himself since the conduct complained of, he is in fact no longer a danger to the public at all.  In such cases it is no longer necessary for the director to be kept ‘off the road’ for the protection of the public, but other factors come into play in the wider interests of protecting the public, i.e. a deterrent element in relation to the director himself and a deterrent element as far as other directors are concerned.  Despite the fact that the courts have said disqualification is not a punishment, in truth the exercise is little different from any sentencing exercise.  The period of disqualification must reflect the gravity of the offence.  It must contain deterrent elements.  That is what sentencing is all about, and that is what fixing the appropriate period of the disqualification is all about.”

40.  In Re Sevenoaks Stationers (Retail) Ltd  [1990] BCC 765, the English Court of Appeal endorsed the division of the potential 15-year disqualification period (this is the same in Hong Kong) into three brackets:

(1)     the top bracket of over 10 years, reserved for particularly serious cases.  This may include cases where a director who has already had one period of disqualification imposed on him falls to be disqualified again;

(2)     the minimum bracket of two to five years (in Hong Kong the minimum is one year), applicable to cases where although disqualification is mandatory, they are, relatively, not very serious; and

(3)     the middle bracket of six to ten years applicable to serious cases which do not merit the top bracket. 

41.  The primary complaint of the Official Receiver in these proceedings involved dishonesty.  It was submitted by Miss Lee for the Official Receiver that the appropriate term of disqualification would be the high end of the middle bracket.

42.  I have taken into account the mitigating factors urged on me.

43.  I have noted the age and family background of the respondents.  It seems to me there are reasons for taking a more lenient view, although I would not have reduced the period of disqualification to the extent as submitted by Mr Choy.  Here, the bank did not suffer any loss in the fraud perpetrated by the respondents.  Both have been sentenced to imprisonment and paid dearly for their wrongs.  They have expressed remorse and the matter has been hanging over their heads for quite some time, since they were investigated by the police in 1999.  After their release from prison, they have tried to rebuild their businesses and both have commitments to their families.

44.  In my judgment, justice would be served in this instance by imposing a term at the bottom end of the middle bracket in the case of the 1^st respondent and the top end of the minimum bracket for the 2^nd respondent.

45.  The period of disqualification for the 1^st respondent is six years and that for the 2^nd respondent is five years. 

46.  Under rule 10 of the Companies (Disqualification of Directors) Proceedings Rules, the disqualification orders are to take effect from the beginning of the 21^st  day after the day on which the orders are made, but the term of each of the disqualification orders would begin from the day on which it is made (Re Cannonquest Ltd [1997] BCC 644 at 648E to 649A).

47.  I order that the 1^st and 2^nd respondents should pay the Official Receiver’s costs of these proceedings, to be taxed if not agreed.