THE OFFICIAL RECEIVER v. YU WAI NGOK

HCMP 3049/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 3049 OF 2000

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J U D G M E N T

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1. I have before me an application of the Official Receiver by Originating Summons for a disqualification order against the 1st and 2nd Respondents under Section 168H of the Companies Ordinance (Cap. 32). The Respondents are husband and wife and they are the only directors of Observers Travel Enterprise Company Limited ("the Company") which was ordered to be wound up by the court by an order made on 21 August 1996.

2. The Respondents appeared in these proceedings in person. They have filed an Acknowledgement of Service in July 2000 stating that they do not intend to contest the application but would adduce mitigating factors with the view to justifying a short or shorter period of disqualification. In September 2000, each Respondent filed an affirmation dealing with the grounds relied on by the Official Receiver in support of the contention that the Respondents' conduct as the directors of the Company makes them unfit to be concerned in the management of a company. Having considered the Respondents' affirmations, and at the outset of the hearing, I explained to the Respondents the provision of Section 168H of the Ordinance and indicated to them that if they wished to contest the application by contending that their conduct is not unfit and that a disqualification order should not be made against them, I would allow them to do so notwithstanding the Acknowledgement of Service. The Respondents informed me that they do not wish to contest the application as they have no capital to start a company to act as directors after the Company has gone into liquidation. They have also told me that they were not willing to give oral evidence or be cross-examined by the Official Receiver and they would leave it to the court to attach whatever weight the court thinks fit to what they have deposed in their affirmations.

The background and basis of this application

3. The Company was incorporated in Hong Kong on 27 March 1981. Its principal business activity was the provision of outbound travel agency services. The 1st and 2nd Respondents were appointed directors of the Company on 26 October 1981 and they have remained as directors throughout. They are also shareholders of the Company.

4. The share capital of the Company in 1994 was 300,000 ordinary shares of HK$10.00 each. In 1995, the share capital was increased from HK$3 million to HK$10 million by the creation of 700,000 ordinary shares of HK$10.00 each. The 700,000 shares were allotted to the existing shareholders by capitalising the sum of HK$7 million from the Company's asset revaluation reserve and applying the amount in paying up in full the 700,000 new shares. The asset revaluation reserve came from the Company's property at Sunderland in Kowloon Tong, which was revalued from its cost of acquisition of HK$7 million to HK$17 million in March 1994.

5. A petition to wind up the Company was filed on 10 July 1996 in Companies Winding-up No. 383 of 1996. As stated earlier, the winding-up order was made on 21 August 1996. By an order dated 25 October 1996, joint and several special managers of the Company were appointed.

6. Up to the date of the Official Receiver's first report in June 2000, the total proof of debt filed with the Official Receiver in the winding-up amounted to HK$11,412,836.86 and US$679,307.30, a total of approximately HK$16.7 million. The assets realised by the Official Receiver as at the date of the first report in June 2000 were HK$235,814.84. The Company is insolvent as its assets are insufficient for the payment of its debts and liabilities and the expenses of the winding-up.

7. Three grounds are relied upon by the Official Receiver in support of the contention that the conduct of the Respondents has made them unfit to be concerned in the management of a company. The first relates to breach of fiduciary duties arising out of the purchase of a property at Apartment C on Park Level of Block 12 Park Chalet of the Sea Ranch, Lantau Island ("the Property") by the Company from the 1st and 2nd Respondents on 14 February 1996 at HK$4.5 million. The second ground relates to the misuse of the bank accounts of the Company by causing cheques to be issued without due regard to the likelihood of their being honoured upon presentation. The third ground is the failure to submit a statement of affairs under Section 190 of the Ordinance. I shall set out my findings in relation to each ground in the order as stated.

Breach of fiduciary duty

8. The 1st and 2nd Respondents bought the Property in March 1992 at the consideration of HK$1,030,000.00. They were registered as joint tenants. On 14 February 1996, the 1st and 2nd Respondents sold the Property to the Company at HK$4.5 million. It is the Official Receiver's contention that the price of HK$4.5 million was unreasonably high; that the purchase of the Property was not made for the business of the Company and it was made at a time when the Company was insolvent; and that the source of funds for the purchase of the Property came from tour costs refunded to the Company. Miss Fiona Li, who appeared for the Official Receiver in this application, submitted that there is clear breach of fiduciary duty of the Respondents.

9. On the market value of the Property at the time of the sale to the Company in February 1996, the Official Receiver has adduced three valuation reports. The first was a memorandum from the Commissioner of Rating and Valuation dated 12 April 2000 in which it was stated that the assessment of the Commissioner on the market value of the Property on vacant possession basis as at 14 February 1996 was HK$850,000.00. The second valuation report was dated 22 February 1996 and this was prepared by a firm of surveyors on the instructions of the Hong Kong Chinese Bank Limited. I should mention that subsequent to the purchase of the Property by the Company, the Company mortgaged the Property to the aforesaid bank on 28 February 1996 to secure general banking facilities. The surveyors of the bank had valued the Property on vacant possession basis at HK$1 million. The last report was a valuation report obtained by the Official Receiver from Richard Ellis in November 2000 and the valuation given was also HK$1 million. I note also from the land search record that the Property was sold after the winding-up order was made, in December 1996, at HK$1,110,000.00.

10. It was alleged by the Respondents in their affirmations that the price of HK$4.5 million was based on the property prices in Discovery Bay, also in Lantau Island, in February 1996 and that was HK$6,000.00 per square foot. Leaving aside the question whether property prices of Discovery Bay could be regarded as truly comparable to property prices of Sea Ranch, the Official Receiver has obtained an opinion from Richard Ellis in November 2000 showing that the average price per square foot for low rise apartments in Discovery Bay in February 1996 was only HK$3,920.00. I note also from the letter of the 1st Respondent to the Official Receiver in May 2000 that no valuation report was obtained by the Company or the Respondents before the sale of the Property to the Company.

11. I accept the valuations put forward by the Official Receiver and I find that the purchase price paid by the Company for the Property was unreasonably high.

12. I turn to consider the financial condition of the Company at the time the purchase was made. In respect of this, the Official Receiver has adduced evidence from the treasury accountant of the Official Receiver's office being the affirmation of To Yin Fong filed on 21 June 2000. The treasury accountant considered the question whether the Company was insolvent as at 14 February 1996 from a liquidity analysis and on the basis of the shareholders' funds. After reviewing the audited financial statements of the Company for the year ended 31 March 1995 and two sets of management accounts as at 30 September 1995 and 29 February 1996, the treasury accountant came to the view that the Company had insufficient current assets to meet current liabilities when they fell due during the period from 31 March 1995 to 29 February 1996. As for the shareholders' funds, the Company had a shareholders' deficit of $8,497,980.00 as at 29 February 1996 whereas it had shareholders' funds of HK$5,559,602.00 as at 30 September 1995. This reduction of HK$14,057,582.00 was caused by, inter alia, losses of HK$12,518,480.00 incurred during the period from 1 October 1995 to 29 February 1996. Of the losses of HK$12,518,480.00, there was an amount of HK$2,374,388.00 which was a loss on disposal of fixed assets but recorded as an operating expense during the period of October 1995 to February 1996. The balance of HK$10,144,092.00 arose from the operation of the business during the five-month period. Thus, the average monthly losses after excluding the loss on disposal of fixed assets were about HK$2 million for the five-month period. Unless the Company had incurred losses in excess of HK$8,497,980.00 (being the figure of the shareholders' deficit as at 29 February 1996) within the very short period of 15 February 1996 to 29 February 1996, there could not have been any positive shareholders' funds as at 14 February 1996. The treasury accountant is of the view that the Company was insolvent as at 14 February 1996.

13. I accept the opinion of the treasury accountant and I find that the Company was insolvent at the time of the purchase of the Property.

14. Next, I turn to consider the purpose alleged in the Respondents' affirmations for the purchase of the Property by the Company from them. It was alleged by the Respondents that the Property was purchased by the Company to provide living quarters for the directors, namely the Respondents, as the Company had sold its property at Sunderland in Kowloon Tong, which had been occupied by the Respondents as their residence, in late 1995 at HK$14 million and there was a surplus of HK$7 million recorded in the accounts. According to the findings of the special managers when they reviewed the statement of affairs submitted by the 1st Respondent, the Company's property at Sunderland was sold on 4 January 1996 so the purchase price receivable by the Company would have been reflected in the management accounts of the Company as at 29 February 1996. As I have stated above, the treasury accountant did not find any surplus on the disposal of fixed assets in the management accounts as at 29 February 1996. What was recorded in the accounts was a loss on disposal of fixed assets of HK$2,374,388.00. I reject the Respondents' claim that there was any or any actual surplus in the funds of the Company at the time of the purchase of the Property. As I have stated earlier, I accept the analysis of the treasury accountant of the Company's accounts and I have found that the Company was clearly insolvent when the Property was purchased on 14 February 1996.

15. I am unable to attach any weight to the Respondents' assertion in their affirmations that the Property was purchased because the Company had a need to provide living quarters to the Respondents after the Company's property in Sunderland was sold. The purchase of the Property was obviously not made in the interest of the Company as it had incurred substantial operational losses of HK$10 million over the five-month period before the purchase. The purchase price of HK$4.5 million was paid out of the tour costs refunded by another travel agency to the Company in February 1996 and three cheques of HK$1.5 million each was issued by the Company to the Respondents. The Respondents have not provided any information or explanation as to how they had utilised the HK$4.5 million received from the Company. Having regard to the earlier findings that the Property was sold at a price that was unreasonably high, and that the purchase was not made in the interest of the Company which was clearly insolvent with heavy operational losses at the time, it seems to me that the compelling inference must be that the purchase of the Property was made for the personal benefit of the Respondents in clear disregard of the interests of the general creditors of the Company. The misapplication of HK$4.5 million of the Company's money for the Respondents' personal benefit is a serious breach of fiduciary duty. I find that the first ground of the Official Receiver has been established.

Misuse of bank accounts

16. The Official Receiver has filed evidence showing there had been a number of returned cheques drawn on the Company's bank accounts with four banks. At the hearing, the Official Receiver informed the court that the allegation in respect of two of the bank accounts would not be pursued and that the returned cheques prior to June 1996 would not be relied upon.

17. According to the Respondents' affirmations, the Company ceased business on 8 June 1996. Because of this, the bank account was frozen and the bank had refused to honour the Company's cheques.

18. The cheques complained of were drawn on two bank accounts. In respect of the account at the Wing Lung Bank Limited, the returned cheques were dated 8, 11 and 12 June. The other account was with the Hong Kong Chinese Bank Limited and the cheques were dated 6 and 7 June 1996. The Official Receiver has not made enquiries with the 2 banks to ascertain whether the accounts were frozen because of the cessation of business of the Company.

19. On the available evidence, I am not satisfied that the evidence is sufficiently cogent to establish an allegation that the Respondents had misused the bank accounts of the Company by causing cheques to be issued without due regard to the likelihood of their being honoured upon presentation.

Failure to submit statement of affairs

20. Under Section 190 of the Ordinance, the Respondents were obliged to submit a statement of affairs of the Company to the Official Receiver within 28 days of the making of the winding-up order. What happened was that a statement of affairs was submitted on 30 September 1996. This was reviewed by the special managers against the available records of the Company to check whether it had substantially and accurately reflected the state of affairs of the Company. The special mangers took the view that proper books and records for the Company had not been kept, especially for the period from 1 March 1996 to 21 August 1996, during which there were no detailed bank books kept from which the transactions of the Company could be traced to the ledgers and therefore to the statement of affairs. In addition, the special managers had received claims for substantial amounts from parties whose names did not appear in the list of creditors in the statement of affairs. The special managers had advised the 1st Respondent of their concern on the books and records of the Company and the statement of affairs as then presented. Notwithstanding this, no steps were taken by the Respondents to revise or rectify the statement of affairs. To date, an acceptable statement of affairs has not been filed. The Respondents' answer to this is that they had sent all the accounts and records to a firm of accountants for the latter to prepare a statement of affairs. They have also alleged that the Official Receiver had mislaid or lost some of the documents contained in 20 large boxes that had been delivered to the Official Receiver's office.

21. I do not think this would constitute a reasonable excuse of the Respondents for their failure to submit a statement of affairs in an acceptable form. The obligation of company directors to maintain proper accounts and records is an important aspect of accountability. It was due to the lack of proper books and records particularly during the last six months before the winding-up order that had made it difficult if not impossible for the special managers to come to a view that the statement of affairs in the form as presented had correctly reflected the Company's assets and liabilities. I find that the third ground relied on by the Official Receiver has been established.

Unfit conduct

22. In my judgment, the first and third grounds relied on by the Official Receiver, which I have found to be established, are sufficiently serious in that the conduct of the Respondents must be regarded as making them unfit to be concerned in the management of a company. As I am satisfied of the two conditions in Section 168H(1), namely that the Respondents are directors of the Company which has become insolvent as defined by Section 168H(2) and that the Respondents' conduct is such that it makes them unfit to be concerned in the management of a company, I am duty bound under Section 168H(1) to make a disqualification order in respect of each Respondent.

23. Under Section 168H(4), the minimum period of disqualification is one year and the maximum period is 15 years. I was referred by Miss Li to the judgment of the English Court of Appeal in Re Sevenoaks Stationers (Retail) Ltd [1990] BCC 765. In that case, Dillon LJ divided the potential 15-year disqualification period into three brackets and he stated as follows:

"(1) The top bracket of disqualification for period over ten years should be 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 yet again.

(2) The minimum bracket of two to five years' disqualification should be applied where, though disqualification is mandatory, the case is, relatively, not very serious.

(3) The middle bracket of disqualification from six to 10 years should apply for serious cases which do not merit the top bracket." (At 771H-772A)

24. I would adopt this approach as it provides helpful guidance in laying down a period of disqualification in a particular case.

25. Miss Li has submitted that the Respondents' case should be regarded as falling within the middle bracket. I agree with this. In respect of the breach of fiduciary duty, the Respondents' conduct has demonstrated a complete lack of commercial probity. They had derived a substantial personal benefit at the expense of the general creditors of the Company. Taking also into account the third ground which is, relatively speaking, not as serious as the first ground, I am of the view that an appropriate period of disqualification for each Respondent should be six years.

26. Accordingly, I make an order that both the 1st and 2nd Respondents shall not, without leave of the court, be a director of a company or in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company for a period of six years effective from the beginning of the 21st day after the date of this order.

27. The Official Receiver seeks costs against the Respondents as they had taken HK$4.5 million from the Company and the Official Receiver is not satisfied that the Respondents cannot afford to pay costs. I see no reason for departing from the rule that costs should follow the event and I make an order nisi that the Respondents should pay the Official Receiver's costs of this application, to be taxed if not agreed.