RE CENTURY GROUP LTD

HCCW 59/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO. 59 OF 2004

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J U D G M E N T

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1. This is an application for a validation order by Century Group Limited ("the Company") made by way of summons dated 14 February 2004. The winding-up petition against the Company was presented by Virtyre Limited, the landlord of the Company's main premises, on 16 January 2004. The validation order sought is intended to enable the Company to continue trading by carrying on its principal (and perhaps only) business of operating a hair salon and beauty parlour by the name of Jacques Dessange, which it operates under licence from a French company of that name.

2. By way of background, I should state briefly that the basis of the debt on which the petition is founded has its origins in the landlord and tenant relationship between the parties. In essence, by an action commenced last year, the petitioner claimed against the Company in respect of arrears of rental in an amount of in excess of $3 million, which was payable upon the entering into of a deed of surrender in relation to part of the premises that were previously occupied by the Company. It appears from evidence filed in those proceedings that the Company accepted that it was under an obligation to pay a minimum of HK$106,000 per month, plus 5% of its gross turnover, by way of rent for the remainder of the premises with effect from August or September 2004.

3. On the basis of that evidence, the petitioner applied in the action for an interim payment order in respect of the amount admittedly due for the period up to the issue of the writ.

4. In the event, Deputy Judge Muttrie made an interim payment order in favour of the petitioner in the amount of slightly over $600,000 in respect of rent already due, and ordered further that the Company should continue to pay to the petitioner the sum of $106,000 per month pending the outcome of the action. Notwithstanding the making of this order the Company did not pay any of the amounts it was ordered to pay. The petitioner thereupon issued a statutory demand which went unanswered, leading to the presentation of the petition against the Company.

5. The basis on which the Company seeks a validation order is that it suggests that it is for the benefit of its creditors as a whole that it should be permitted to continue to trade. Under s. 182 of the Companies Ordinance (Cap. 32) ("the Ordinance"), any disposition of the property of a company made after the commencement of its winding-up shall, unless a court otherwise orders, be void in the case of a company which is wound up by the court. The principles governing the exercise of the court's jurisdiction under this section have been considered in a number of cases. Most recently in Hong Kong there has been the decision in Re FiveOceans Supply Services Limited (HCCW 1379 of 2001, unreported, CFI, 30 April 2003), in which Deputy Judge Poon referred to the two principal English decisions on this point, Re Gray's Inn Construction Co. Ltd [1980] 1 All ER 814 and Denny v John Hudson & Co. [1992] BCLC 901. Those cases established that the court has a general discretion which is limited only by the general principles which apply to any kind of discretion, and which is subject only to the need to exercise that discretion in the context of the liquidation provisions of the Ordinance.

6. It is well established that the basic principle of law in respect of liquidations is that the assets of the insolvent company should be distributed amongst its unsecured creditors pari passu. But it is also recognized that there are times when it will be for the benefit not only of the Company, but also of its unsecured creditors, that it should be able to dispose of some of its property after the petition has been presented but before the winding-up order is made.

7. In such cases it may be, in the case of a trading company, that it might be beneficial for the Company and its creditors that the Company should be permitted to carry on its business in the ordinary course pending the making of a winding-up order against it. But as is pointed out in the English cases, the desirability of the Company being able to carry on its business is often a matter of speculation and in each case the court must carry out a balancing exercise and consider where the interests of the unsecured creditors lie.

8. In general, the court will be more disposed to the making of a validation order in respect of an insolvent company where it is satisfied that the carrying on of the business is likely to generate net cash or net assets for the benefit of the creditors, and thus to reduce any deficiency that might otherwise exist on the winding up of the Company.

9. In the present case, it is accepted (and it could not seriously be disputed) on the basis of the audited accounts of the Company for the year ending 31 December 2002 that the Company is insolvent, and has a substantial deficit of liabilities over assets. In these circumstances, the court should grant a validation order to enable the Company to carry on trading only if it is satisfied that the continuation of trading is likely to generate net income for the Company.

10. In the evidence initially filed on behalf of the Company by one of its directors, Mrs Severine Hattu, the Company simply indicated the nature of the future payments that it wished to make, which it was said were to be made in the ordinary course of its business, and also sought the court's approval for payment of a number of debts that had already been incurred. That evidence did not provide any basis on which the court could assess whether or not the Company, if it were allowed to carry on, would operate profitably for the benefit of its creditors as a whole.

11. In the event, at the first hearing of this matter on 25 February 2004, the Company was given an opportunity to file further evidence to demonstrate its financial position and to make out its case that continued trading would be for the benefit of the Company and its creditors. Such further evidence was eventually filed and consisted of a number of affirmations, the principal of which were affirmations by Mr Patrice Hattu, another director of the Company, and Ms Miranda Tsoi, his personal assistant who was responsible for maintaining the books of the Company. There were also filed a large number of affirmations from employees of the Company speaking to the amount of the respective debts that were due to them.

12. That evidence suggested that the Company was, although insolvent, operating at a small profit in recent months. Mr Hattu made reference to the management accounts of the Company that had been prepared by Ms Tsoi from which it appeared that, notwithstanding that the Company had made net losses in the years ended 2001 and 2002 and had made losses every month until August 2003, from September 2003 onwards, the Company had shown a modest profit. The profit started out at a relatively small sum of some $17,000, but by the end of the year had reached, for the month of December, something in excess of $100,000. It was suggested by Mr Hattu that on the basis of this material, the Company was carrying on business profitably and that it should be allowed to continue to do so since that would be for the benefit of the creditors as a whole.

13. The quality of the financial information provided by the Company was the subject of much criticism by Mr Wong, who represents the petitioner. He pointed out that the Company had failed to indicate what its current financial position was, in that it had not given any indication of its current cash holdings.

14. Although the Company provided copies of its bank statements up to the end of February 2004, and there was also provided today a print out of its bank balance (obtained from an internet search) which indicated that it had in its bank account some HK$995,000, it was a matter of some concern to the petitioner that Mr Hattu had stated in his second affirmation that as a result of the presentation of the winding-up petition and the consequent freezing of the Company's main operating bank account, the Company had been retaining its income, in so far as it was in the form of cash, and apparently had been using that cash to make payments from time to time. No details were given of those payments and Mr Hattu apparently takes the view that it is not his obligation to give such information to the petitioner or the court.

15. Criticism was also made of the management accounts that were produced. The principal criticism made by Mr Wong was that they were less than complete in that they omitted certain items which one would have expected to appear in them.

16. The first item that was said to have been left out was the payment of the element of rent based on a percentage (in this case 5%) of the gross income of the Company from its hair salon business.

17. As to this, it was suggested for the Company that this did not in fact relate to the ongoing operation of this business and that it was simply a mechanism by which the Company's past debt to the petitioner (presumably in respect of the amount payable under the deed of surrender) was to be settled. However, it appears from Mr Hattu's own evidence that the rental for the Company's premises consisted of both payment of $106,000 per month and an additional monthly payment of 5% of its gross income. This element, of 5% of the Company's gross income, does not appear in the expense analysis that is produced in relation to the management accounts, at least for the month of December 2003, which is the only month in the second half of 2003 for which a detailed breakdown of expenses was shown.

18. It seems to me that whether this is properly regarded as part of the costs of operating the hair salon business, or simply as a payment that the Company is obliged to make on a month-by-month basis, the 5% is clearly a matter that ought to have been taken into account.

19. Ms Cheung, for the Company, sought to persuade me that it was possible to draw a distinction between the expenses of the hair salon operations on the one hand, and the other expenses that the Company might incur on a regular basis on the other, and to focus only on whether the hair salon business was operating profitably. With respect, I am unable to accept that any such distinction ought to be drawn. In considering whether or not the Company is operating so as to generate a net profit and net income for the benefit of its creditors, it seems to me that it is impossible to do otherwise than to look at the overall expenses of the Company, however arising, and to offset these against its overall income. It seems to me, therefore, that this element of 5% ought clearly to be taken into account.

20. A second item which Mr Wong mentioned as having been omitted from the management accounts, which would tend to increase the amount of expenses that the Company has to bear each month, was an amount of about some $20,000 payable in respect of other office premises of the Company which were referred to in Mrs Hattu's first affirmation, in which she sought permission to enable payment to be made to what appears to be a related company, Hallman Ltd, in respect of rent payable for other office premises in respect of which the Company was said to have entered into an arrangement with Hallman Ltd by way of sub-lease or sub-licence at the end of last year.

21. There is no evidence that this arrangement has come to an end, and in the circumstances it would appear that the Company remains obliged to pay these amounts to Hallman Ltd on a monthly basis. It may be, as Ms Cheung said, that the Company is not paying these amounts at present, but if that is the case, then the result would simply be that Hallman Ltd will have a claim against the Company in respect of which it will be entitled to prove in the event that the Company goes into liquidation. That being so, it seems to me that this too is an item that should be taken into account.

22. When these two items are taken into account, the effect is that the profits shown for the months of September and October 2003 are wiped out, and the profits shown for November and December 2003 are very significantly reduced.

23. Mr Wong suggested that a further item should be taken into account in respect of sundries which Ms Hattu had referred to in her first affirmation as amounting to some $35,000 per month. That item does not appear in that sort of amount in the management accounts for December 2003. However, it seems to me that the December 2003 management accounts seem otherwise to contain a fairly full breakdown of the expenses of the hair salon business and I am prepared to accept for present purposes that this amount may not necessarily be one that is incurred in that magnitude on a regular basis, or that the amount stated in the affirmation covers other itemised expenses in the management accounts, and that perhaps Mrs Hattu was dealing with items in respect of which she had not given a specific description in her affirmation, but which the Company regularly needs in the operation of its hair salon business.

24. At the end of the day, however, it seems to me that on the evidence which has been put forward by the Company, one sees a company that has been unprofitable for virtually the entirety of its existence, which has suffered accumulated losses of some $10 million odd by the end of 2002, and which appears to have suffered a further substantial loss during the course of 2003 with only two months of modest profits at the end of that period.

25. When one takes into account the reduced sales figures for January and February 2004 which were provided by Mr Hattu in his second affirmation, one is left with a picture of a company that is, at best, barely breaking even in some months, and which has, more often than not, made a loss on its operations.

26. In these circumstances, it seems to me that it would be highly speculative for the court to conclude that the continued carrying on of the business of the Company is likely to generate any real benefit for the unsecured creditors of the Company, and in these circumstances, it seems to me that there is not shown such degree of likelihood of benefit as would justify the making of a validation order in this case.

27. On that ground alone, it seems to me that it would be inappropriate to grant a validation order for the Company in respect of its ongoing expenses.

28. In the light of that conclusion, it seems to me that it follows that it would not be appropriate to grant a validation order in respect of past debts which are said to have been incurred in the course of trade.

29. In relation to this aspect of the application, the evidence suffers from the fact that it is not suggested very clearly anywhere in the evidence that there has been any pressure placed on the Company to settle these debts in order to enable it to carry on trading. While I would accept that, in the case of some such debts, it might be open to the court to draw such an inference (for example, in relation to the debts owed to its employees in respect of arrears of salaries and wages), it seems to me that, even if there had been evidence that it were necessary for all of these debts to be paid to enable the Company to carry on business, in the light of my conclusion that the Company is not able to satisfy me that it is carrying on business profitably so that it would be for the benefit of the creditors to enable it to continue to do so, there is no justification for the making of a validation order in respect of these past debts, payment of which would enable the Company to continue operating, when the court has come to the view that it is not appropriate for the Company to continue to carry on trading.

30. For those reasons, I would dismiss this application. I should add that there were a number of other points raised by Mr Wong in opposition to this application which I do not propose to deal with in this judgment, as it is unnecessary to do so.

31. I would note, however, that it appears to be the Company's case in opposing the winding-up petition only that it wishes to put forward some other mechanism for repayment of the debt that is due to the petitioner and that it does not appear to be suggested that the debt is disputed or that the Company is other than insolvent. I was informed by Mr Wong that the petitioner does not find the proposal acceptable. These, in my view, are all matters that will be considered by the Companies Judge when the petition comes on for hearing in the very near future.