Wan Yiu ling and Another v. Director of Lands

Crown Lands Resumption Reference No. 9 of 1995

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HEADNOTE

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

Ground floor premises on five year lease barely completed decoration in July 1992 for use as general restaurant when notice of resumption served. The restaurant commenced business and operated until October 1992 when title to the property reverted to the Crown on 3rd October 1992. The applicant proprietors of the restaurant claim, inter alia, losses of goodwill at $12.2 million and recovery of decoration expenses at $1.194 million. The respondent disputes the calculation of goodwill for the restaurant had no reliable profits record. The decoration expenses claimed also challenged for being unnecessarily large.

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 restore the applicants to the position where they were at the time of resumption. (2) Since by all accounts the restaurant was making profits, in the absence of reliable profits records, use the market rental of the subject premises for determining goodwill. Goodwill valued at $1.9 million being approximately the equivalent of rental liability for the unexpired term of the tenancy at the date of resumption discounted for interest on advance payment. (3) The amount of decoration expenses actually paid and documented for, at $900,000, allowed in full as compensation for loss. (4) After adding other items allowed, total compensation determined at $2.85 million.

IN THE LANDS TRIBUNAL OF HONG KONG

Crown Lands Resumption Reference No. 9 of 1995

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JUDGMENT

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The Applicants are the proprietors of a restaurant known as Lucky Money ("the business") at rented premises situated at No. 15, Ground Floor, Ma Tau Kok Road, Kowloon ("the subject premises"). 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.

2. Despite advice given by several members of the Tribunal at various stages, the Applicants decided not to engage legal representatives or valuers of any speciality to help them to prepare their case. The Tribunal has also repeatedly emphasized in open court that the burden was on the Applicants to prove each and every element of their claim. During the trial, the Applicants were given ample opportunities to adduce more evidence, if any, and to canvass more effectively for their case.

3. It is common ground that the Applicants are 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 Applicants are entitled to reimbursement that would restore them to the business position where it would be had there been no resumption. In this regard, they claim the following business losses:-

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

(a) If on total extinguishment basis

(b) If on relocation of business basis

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 Ma Tau Kok Road, the Scheme site extended to Sui Lun Street, Wang Cheung Street, , 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 are run by families who, as can be expected, are poor managers; business takings 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 legal or illegal cockloft and an open yard which might be covered and protected from the elements by legal or illegal structures. 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 workers who filled the streets in the area during lunch hour and for a period before and after work.

7. 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, during the change over from a Housing Society operation to Lands Department processing, 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.

8. 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.

9. We now consider each of the items of claim.

Goodwill

10. 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 are 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 Director of Buildings and Lands v. Shun Fung Ironworks Ltd. [1995] 1 HKC 417, the Judicial Committee of the Privy Council at page 436 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."

11. 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.)

12. The Respondent's case is that whilst compensation for loss of goodwill is due if there was total extinguishment, the business could have re-located thereby resulting in no loss of goodwill. We reject the Respondent's case on two grounds. First, as pointed out above, goodwill consists of the elements of personality and location. We would add that in some cases, the element of location may be far more important than personality. The most charming proprietor would not be able to generate business at a location where there is no demand for the goods or services his business provides. The element of location is, in our view, most important for the sort of low to middle class restaurant like the business in the instant case. Once it re-locates, the business is in another catchment area where even if the same kind of clientele is there the competition scenario may be quite different. Secondly, the costs for relocation should not be ignored. It would not be fair to expect every business to have standby cash or financial resources for re-location at any time the authorities see fit to resume the site on which the business has set up. As shall be seen, the Applicants had just invested huge amounts to set up the business when the resumption notice was gazetted. It takes months to start a restaurant afresh. We cannot assume that the Applicants could readily take over another restaurant in another area. In the premises, we treat this case as one for total extinguishment.

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 other cases arising from the Scheme. First, we 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 anticipated 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. According to the evidence of Mr. Tsui for the Applicants, they had a five year lease for the subject premises commencing 25th February 1992. At first they started a noodle shop at the subject premises. Because the noodle shop did well and they saw even better prospects with a general restaurant, the Applicants stopped the noodle shop in May 1992 and re-decorated the premises for general restaurant purpose. Part of the renovation was to change over from using electric heating to gas for cooking. The general restaurant commenced business at the end of June or early July, just about the time the resumption notice was gazetted. At that time the work for connecting town gas to the kitchen had not quite started and the Applicants had to use LP gas as a temporary measure. Once the resumption notice was gazetted, the Applicants could not go on with work for connecting town gas. The LP gas arrangement could not really meet the relevant safety laws. So, after struggling for a few months, the Applicants folded the restaurant on 22nd October 1992.

15. The Applicants claim that they made some $0.4 million profits from the general restaurant, i.e. about $100,000 per month for the four months it was in business. The Applicants had no proper trading accounts nor documents to prove taxed profits. At the suggestion of the Tribunal, Mr. Tsui produced two note-books, Exhibits A7 and A8, as records of receipts and payments of the general restaurant business. Counsel for the Respondent contends that these books are unreliable or incredible evidence because they do not bear the signature of the Applicants. Instead, the Respondent refers to a copy Profit and Loss Account previously submitted by the Applicants to the authorities showing profits of $98,380 for the period from 2nd July to 22 October 1992. This Profit and Loss Account bears the facsimile of signatures of the Applicants. The copy document is at p. 28 of R8. On the basis of this account, the profit of the business was approximately $25,000 per month. Unfortunately, the original of this document is now untraceable. Mr. Tsui denies he has ever signed the document.

16. Whilst we have no doubt that the business was making a profit, we are very reluctant to rely on the profit and loss accounts or trading records for a four month period as the basis for assessing goodwill. Four months is too short for reference, especially at the commencement of a business. H.H. Judge Cruden in Land Compensation and Valuation Law in Hong Kong at pp. 83-84 has alluded to the same difficulty in an earlier case. It is, therefore, necessary to look for some other measure. In the absence of other materials, we believe the only useful guide in this case is the rent payable for the subject premises. It is generally assumed that the profit of a normal thriving business is at least equal to the rental value of the premises at which it is conducted. By all accounts, the Applicants were making profits. According to the tenancy agreement for the subject premises, the Applicants were liable to pay $39,800 per month for the first three years to 24th February 1995 and $49,750 per month thereafter to 24th February 1997. Using these, the total rental liability of the business is $39,800 x 28 months + $49,750 x 24 = $2,308,400. This is averaged to become $2,308,400/52 x 12 = $532,707.69 per year which we take as the annual profitability. We generally apply an interest rate of 9% to calculate deferred reversionary interest, so we adopt the same rate to discount for interest on advance payment. The relevant factor for 4 years and 4 months discount at 9% is 3.4626. Annual profitability at $532,707.69 x 3.4626 equals to $1.845 million. We round this up to a final figure of $1.9 million.

17. Accordingly, we determine the goodwill of the business at $1.9 million.

Profit Rent

18. Before the profit rent can be calculated, the full market rent of the subject premises has to be ascertained. From the comparables cited by the Respondent, we find that the highest rent for similar early post-war shops along Ma Tau Kok Road is that in respect of the letting of the Ground Floor of No. 3 Ma Tau Kok Road rented at $36,500 per month from December 1992. The rent of the subject premises at $39,800 per month is therefore considered to be the full market rent. The Applicants rely on the rent for Shop C on the Ground Floor of 54 Pak Tai Street. We find this comparable unacceptable because it is much smaller in size. In the premises, we find no loss of profit rent and make no award on this item.

Fixtures and Fittings

19. By fixtures and fittings, the Applicants in fact include restaurant machinery and equipment installed with the decoration and fitting up of the subject premises. In support of their claim for $1,194,040 spent for decorating the subject premises for use as a general restaurant, the Applicants produced a decoration contract as Exhibit A9. The detailed work items can be seen in Exhibit A3. This is further backed up by payment receipts for a total of $0.9 million as Exhibit A10. According to the evidence of Mr. Tsui for the Applicants, the contract sum covered all work necessary to meet the licensing requirements for a general restaurant. The Respondent called a quantity surveyor, Mr. Leung who produced his expert report as Exhibit R6, to the effect that the decoration expenses for the subject premises should not exceed $509,500 at the time if billed according to model scale for the same area size. When questioned, Mr. Leung admitted that some of the assumptions and apportionments between labour and material costs were mistaken. We fully understand the difficulties faced by Mr. Leung. He had no opportunity of physically inspecting the work done on the subject premises. He did not have the actual work plans for the subject premises submitted to the authorities for licensing purposes. The model scale costs do not cover additional costs for variations; whereas according to Mr. Tsui the contract for the subject premises covers all work to meet licensing requirements which often require modification or remedial work. Moreover, the contract has specific completion schedule which justifies higher contract sum. We, therefore, conclude that Mr. Leung's calculations cannot really assist the Tribunal.

20. The receipts in Exhibit A10 show payments of $900,000 only. We believe the full contract sum was not paid because part of the work, the connection of town gas and associated piping work, did not have to be done. We think it is fair to take the decoration expenses as $900,000. Since the Applicants had to close their business only a few months after completion of the renovation work, we do not consider any discount for depreciation necessary and determine compensation for fixtures and fittings at $900,000.

Miscellaneous Items

21. The Applicants further claim transportation fees for auction at $40,000 auction exhibition ground and security charges at $28,000 and auctioneers' charges at $13,124.80. Mr. Tsui agrees that credit should be given for $3,000 received as auction proceeds. Except for the auctioneers charges which are not in doubt, none of these miscellaneous claims are supported by receipts.

22. Mr. Sham, surveyor for the Respondent, estimated the transportation costs at $10,000 for hiring two 3-ton trucks and 5 workers for the purpose. In the absence of documentary support for the Applicants' claim for transportation fees, and in view of the small quantity of chattels to be moved to the auction ground, we accept Mr. Sham's estimate in this regard. We gather from evidence in related cases we have heard 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.

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

The Order

24. Accordingly, we determine compensation for the Applicants at $2,850,000. 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 Applicants' expenses for prosecuting their claim which we assess at $9,000 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.