FUJI PHOTO FILM CO LTD v. JAZZ PHOTO (HONG KONG) LTD

HCCW1165/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO. 1165 OF 2003

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D E C I S I O N

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1. This is an application made by Jazz Photo (Hong Kong) Ltd ("the Company") under section 182 Companies Ordinance. Under the summons, validation of the following three categories of payments are sought:

(1)	Salary, double pay, holiday and redundancy payments for five employees covering the period between November 2003 and March 2004, together with what has been described as general operational expenses for the period up to March 2004.
(2)	Salary and redundancy payments for five other employees. The sum initially sought was $305,711. This is now reduced to $213,097.64 based on an award of the Labour Tribunal, made by consent.
(3)	Purchases for goods to be supplied to an associated company in the UK ("Jazz UK").

Applicable principles

2. Counsel are in agreement as to the applicable legal principles. So far as the considerations governing a validation order application, they have been succinctly set out in the judgment of Fox LJ in Denney v John Hudson & Co [1992] BCLC 901, 904-5. Le Pichon J (as she then was) has also in the case of Re Sally Aw Sian [1999] 2 HKC 270 set out the principles that govern the exercise of the court's discretion under s. 182 Companies Ordinance. It is not necessary to repeat them here.

3. It is however necessary to point out that under a s.182 application, two matters are of importance. The first is the prospect of the winding-up petition. The second is the financial ability of the company. It is on these two areas that I propose to make some brief observations.

Relevant consideration

4. So far as the prospect of the winding-up petition is concerned, the present petition is based on a judgment given in the United States by the District Court of New Jersey. It is now under appeal, but no stay of execution has been granted. In fact, applications for stay have twice been refused.

5. The petition is defended primarily on three grounds. Firstly, it is said that the petition was presented with an ulterior motive to wipe out a competitor. Secondly, it is pointed out that the judgment is currently under appeal. Lastly, the Company says that it has an outstanding claim against a US company ("Imation"), which, if successful, would generate a substantial income to the Company, enabling it to meet its liability.

6. It is not necessary for the present purpose to dwell into a detailed analysis of the arguments or any in-depth assessment of the merits of the petition or the defence. It is sufficient to observe that the petition does prima facie carry some prospects of success. On the other hand, it is also fair to say that the defence cannot be readily dismissed as having no substance at all, so that a validation order cannot even begin to take off.

7. In my view, the more important consideration in this case is the financial ability of the Company. There is however very scant information on this in the evidence before the court. The updated account of the Company has not been exhibited. All we have is an unaudited management account for the year ending December 2002. The Company has exhibited cash flow statements for 2002 and 2003, but as counsel accepts, cash flow statements only represent a part of the picture of the Company's financial position. They are not informative as to whether the Company is solvent or not.

8. There is also no evidence on the funds and assets of the Company, including, in particular, what sort of funds and assets the Company may have or is proposing to use to meet the payments proposed under this application. Generally speaking, such information is vital to an application under s.182 so that the court can assess the impact of the proposed payments on the Company's financial position, hence the effect on the general body of creditors.

9. It is to be noted that even on the 2002 management account, it would appear that the company has suffered a loss for that year. Even though counsel has pointed out that the Company had incurred substantial amount of legal costs in that year, it remains a fact that the Company had made a loss in 2002.

10. As for the submission that the Company's financial position had been adversely affected by the ex parte Mareva injunction that the petitioner had obtained in the Writ action, it cannot be overlooked that the injunction was only in place for a short period of 13 days between 22 July and 4 August 2003. As a matter of fact, the injunction had been varied on 29 July 2003 enabling the Company to make payments for wages and other trade bills. It cannot really be said that the Company's business or financial position had been adversely affected by the grant of the injunction.

11. It would appear that the overall picture from the evidence before the court is that the Company has not been in a healthy financial state even prior to the enforcement proceedings brought by the petitioner, namely, the Mareva injunction, the Writ action and the present winding-up petition. As the authorities suggest, the burden is on the Company, being the applicant, to show that it is not prejudicial to the general creditors' interest to sanction the proposed payments. The fact that this is a creditor's petition and that the Company does not appear on the evidence to be financially sound are matters that the Court has to bear closely in mind in considering the application.

12. Mr Lam also submits that there had been delay in making this application. Generally speaking, validation orders should be sought as soon as possible. This will enable the court to assess whether a company should continue trading and operation on in a full or limited scale or not at all, as opposed to what Mr Lam now complains, a fait accompli.

13. In the present case, there has been a lapse of four months since the presentation of the petition. It is not necessarily a great deal of time because each case has to be assessed in terms of its own facts. But what is plain is that the Company ought to explain by way of affidavit why it had waited for 4 months before bringing the application. Mr Hingorani has endeavoured to meet this criticism by informing the court that the Company was awaiting the outcome of the US proceedings on the appointment of a trustee. That may well be the reason, but this should have been explained in the affidavit as opposed to being put before the court by way of submission.

14. Looking at the context of the present case, the proposed payments relate to salaries and office expenses and purchases. They are prima facie expenditure in the ordinary course of business, and, in some cases, recurrent in nature. That being the case, I do not consider that the four months' delay is fatal to this case.

15. I turn now to the three categories of proposed payments.

Schedule A payments

16. Schedule A relates to staff payments and office operation expenses, which covers also business trip expenses and audit fees. As a starting point, salary payments and office operation expenses are recurring expenses that a company would incur in the ordinary course of its business. It is also important to bear in mind that the presentation of a winding-up petition, however strong its merits may be, does not mandate that a company should forthwith cease operation, dismiss its staff, give up its office premises and go into non-activity. Even where a winding-up order had been made, liquidators may in appropriate cases continue the operations of the company and/or retain some of its staff for the purpose of winding up the company and other legitimate purposes. It cannot therefore be said that a company should invariably lay off its staff and/or cease trading completely pending determination of a contested winding-up petition.

17. In my view, in the present case, the Company is entitled to incur expenses for the purpose of sustaining its existence and operation, but it should be confined to a reasonable level. What is reasonable will depend on the circumstances of each case, including the nature and the scale of the company's operation both before and after the presentation of the winding-up petition, and the financial status of the company.

18. The first item under Schedule A payments is salary and double pay payments for five employees for November 2003 to March 2004, and redundancy and holiday payments for two of them who are to be laid off. So far as the salaries are concerned, I had in the course of counsels' submissions queried an apparent increase in the case of Miss Hidy Chow. Counsel has explained it is not a case of salary increase, but that Miss Chow was paid four-fifth of her salary in November and December 2003 by reason of her being on maternity leave. Subject to this fact being confirmed by way of a supplemental affidavit, I am prepared to accept this explanation.

19. It would appear from Schedules A and B that the Company used to employ 10 employees. In November 2003, it had laid off five employees and it is proposing to lay off another two in March 2004. Effectively it was retaining half of its strength shortly after the presentation of the petition, and is going to retain only three staff by March 2004. The cash flow statements exhibited in evidence suggest that the Company has some trade receivables. Taking all these into account, I accept that it is not unreasonable for the Company to continue its operation on a modest scale. As noted above, the Company is not expected to cease operation and dismiss all the staff forthwith upon the presentation of a petition. I consider that the salary payments, together with the appropriate MPF payments, for the five employees for November 2003 to March 2004 should be sanctioned. Although Miss Szeto is a director of the Company and is receiving a comparatively higher salary, I do not consider that, on the evidence before the court, there is justifiable basis for affording different consideration to her case such that her salary payment should be disallowed.

20. On the redundancy and holiday payments for two of the employees whose employments are to be terminated in March 2004, I note that in each case the redundancy payment comes up to more than five times the monthly salary. There is of course a statutory formula for working out redundancy payment, but it is not clear how it is being worked out in the present case because the evidence gives no explanation or the details of the calculations. The court is simply not in a position to say whether these are proper payments. I am not saying that the proposed redundancy payments cannot be validated with proper documentation and calculations being shown. But presently on the evidence available, the court cannot properly deal with the application.

21. As for the double pay for all five employees, counsel says this is a contractual obligation on the part of the Company. The evidence, however, does not support this. In the 2002 cash flow statement, there is no entry under the column of double pay. Under the Employment Ordinance, a double pay or what is usually called the end of year payment is a kind of bonus and its payment is subject to agreement between the employer and employee. Often, such payment is a matter of discretion on the employer's part.

22. It is therefore for the Company to prove that it is under a contractual obligation to make the double pay, such that it comes within its ordinary expenses. Counsel has, in submission, endeavoured to explain the position of the 2002 cash flow statement and suggests that if one takes the average of the entries for salary and housing allowance for the months of January and February, then one would more or less get the picture. I am not convinced. The Company, who carries the burden to make good the application, must do so by proper evidence. Gaps in evidence cannot be filled by submissions. Having regard to the documentary evidence that prima facie negatives the suggestion that double pay is contractually payable, it is incumbent upon the Company to explain by way of evidence, and the court cannot act on the basis of submissions. I am not prepared to validate the double pay payment.

23. The operational expenses under Schedule A cover three things: general office expenses, business trip expenses and audit fees. The general office expenses were initially put at a figure of $47,500, being estimates for January to March. The fourth affirmation of David Charles Chu shows that the Company is now operating from a business centre in Central, which it has also used as a correspondence address. Mr Hingorani explains in submission that the current level of operation from this business centre is only down to the figure of $10,380 per month, so for three months it would come up to a figure of $31,140, and sanction is sought for this amount.

24. Again, it is unsatisfactory for the fact to be disclosed in this form. That said, however, operation or office expenses can only be an estimate if sanction is sought beforehand. I consider that the monthly office expenses of $10,380 is not an unreasonable amount for a company to incur pending determination of the winding-up petition. I am prepared to the payment of the Company's general operation and office expenses for January to March 2003 up to the monthly amount of $10,380.

25. The business trip expenses carry two parts. The first part is about a trip that had been made. The remark column in Schedule A states that this is a trip made for the ITC legal case. I therefore proceed on the basis that this is in relation to the Imation claim in the US. That being so, the trip is prima facie beneficial to the Company in that progress is made in the Imation claim, the Company stands to receive a substantial payment. There are, additionally, documents showing that the sums were indeed expended. The payment of the sum involved, namely, $42,675, should be validated.

26. The other part of the business trip expenses relates to a proposed trip to be made in February or March. The evidence is silent on the purpose of this trip is and how it will be of benefit to the Company. Counsel explains in submission that this is a trip for meeting clients and attending an exhibition on photography and cameras. But this is hardly sufficient to satisfy the burden required of showing that the trip will bring benefits to the Company. There are also no documents to support the proposed expenditure. The sanction sought cannot be given in the circumstances.

27. The third part of the operation expenses concerns audit fees. Insofar as the part of the audit fee that has been due since October 2003, it is an expense incurred before the petition was presented. It is correct for Mr Lam to say that the auditor stands in the position of a general creditor, but the court cannot overlook that consideration had been provided by the auditor for this payment, and audit fees are within ordinary operation expenses of a company. I will sanction payment of the audit fee due, being $61,000.

28. As for the proposed fee for audit work to be undertaken, it stands in a different position. Firstly, there is no explanation or justification for the huge increase from $61,000 to $100,000. It is not known what is the reason for the proposed fee increase, or what benefits the Company stands to obtain in return for paying out $100,000 audit fee. I will not sanction the payment of the $100,000 proposed audit fees.

Schedule B payments

29. Schedule B payments relate to salary and severance payments for five employees who had been laid off in November 2003. They had brought claims against the Company in the Labour Tribunal, and the Labour Tribunal had made an award by consent. The Company now seeks validation of the payment of the award. In my view, this part of the application cannot really be criticized. On the one hand, it is said that the Company ought to reduce its scale of operation by laying off employees who are not required. On the other hand, it is said that the Company should not readily make payments for carrying out the redundancy exercise. It would seem to me to be putting the Company in an extremely difficult position. I accept that, if indeed the Company went into liquidation, these employees' rights to be paid as preferential creditors under s.265 of the Company Ordinance are limited. But that does not provide a justification for not giving full effect to an award of the court. The payment of the award, being the sum of $213,097.68, is sanctioned.

Schedule C payments

30. Schedule C payments concern purchases proposed to be undertaken for supply to Jazz UK. The total purchase costs come up to approximately $1 million, and the profits to be generated is said to be in the region of $85,000. The underlying documents for the purchases and the other details, including the terms, are not before the court. The court is thus unable to assess the financial implication for the Company if the application were to be granted or otherwise.

31. The invoices or debit notes that has been put together in the affidavit show that, except in one case where 50 per cent is to be paid by way of deposit and with the remaining 50 per cent upon delivery, all the purchases are to be paid by cash on delivery. The Company has offered through counsel not to make payments for these purchases until it had received the corresponding payments from Jazz UK. It is unclear from the evidence why Jazz UK could not have paid the suppliers directly, whether by cheque, cashier orders, letters of credit or even direct transmissions of funds. Mr Hingorani however says that this would not be in accordance with the usual way in which business between Jazz UK and the Company was transacted. That in my view is neither here nor there.

32. The pertinent consideration, in my view, is whether the Company should continue trading and carry out its business, since it is not in dispute that sourcing supplies for its associated companies is within the ordinary trading activities of the Company. This in turn begs the question of whether continued trading is to the benefits of the general body of creditors.

33. In Re Luen Chong Tai Construction Company Limited (unreported) HCCW190/2002, 24 October 2003, at para.17, Cheung J pointed out that when considering payments or intended payments for keeping a contract of the company alive after the presentation of the petition, the court is concerned not only with whether the company would receive full market value or sufficient consideration for the payment, but is also concerned to find out whether the continuation of the contract would lead to a net profit or some other benefit to the company so as to ensure that the unsecured creditors would not be worsened by the continuation of the contract even though the company would receive goods or services of full market value from the contract. He concluded that the question ultimately is whether the continuation of the contract post-liquidation would lead to a reduction and thus dissipation of the company's assets.

34. So far as Schedule C payments are concerned, they are not exactly in the nature of keeping an existing contract alive because these are post-liquidation contracts. What is unclear from the evidence is whether the Company had already entered into binding contracts for the supply of the goods, or whether the Company is proposing to make the purchases. In the case of the former, the criticism Mr Lam made earlier on about the timing of the application is relevant because the Company has not explained why it should land itself in this position without first obtaining the sanction of the court. At the same time, as part of the balancing exercise, the court has also to consider the contractual liability that the Company is exposed to if the purchases under the debit notes or invoices were not carried out. In other words, if these are binding contracts, the court has to assess the impact of the purchases on the Company's creditors by reference to the possible profits from continuing with the contracts, and the potential risk of a claim from the suppliers if the contracts were not performed. In this regard, the likelihood of the Company making the projected profits is of importance. It therefore becomes necessary to ascertain the underlying terms for the purchases.

35. The evidence in support of the application is simply inadequate and does not permit the court to carry out the balancing exercise properly. I am not prepared to deal with this part of the application on the basis of the present state of evidence. If the Company is able to properly put together the evidence supporting these proposed payments or proposed transactions, they could show it to the petitioner by way of correspondence, and if they are found to be satisfactory, then an application can be made by consent to validate these payments. But if there is no agreement, then the Company will have to restore this part of the application if it wishes to pursue the matter.

36. The same goes for the redundancy payments under Schedule A. Both the Schedule C payments and the redundancy payments under Schedule A are adjourned sine dine with liberty to restore.

Costs

37. The petitioner asks for the costs of this application. I consider the appropriate costs order is for the costs to be in the cause of the petition. This application is necessitated by the presentation of the petition. If ultimately, a winding-up order is made, then the petitioner ought also to have the costs of this application. Conversely, if the Company succeeds in defending the petition, then it should be given the costs of this application.

38. I readily acknowledge that in some instances it would be appropriate to award costs of a s.182 application against an applicant. That would be, for instance, where the application fails completely, or is taken out without any justification at all. In those cases, costs was unnecessarily incurred and wasted. It would not be necessary to tie the costs liability to the outcome of the petition.

39. The present case is not one of those cases. Although the hearing could have been shortened; and the evidence could have been presented better, it remains a fact that this application is necessary and the Company has, to some extent, succeeded in obtaining validation. The costs of the application should be in the cause of the petition.

Conclusion

40. For the reasons indicated above, the Company's summons is granted to the extent as indicated in this Decision. The solicitors for the Company should draw up the order and forward it to the solicitors for the petitioner for comment and agreement before submitting for approval by the court.