The Official Receiver v. Lui Fu Sing and Another

HCMP 1922/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1922 OF 2008

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BETWEEN

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Before: Hon Chung J in Court

Date of Hearing: 13 May 2010

Date of Handing Down Judgment: 8 June 2010

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J U D G M E N T

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Introduction

1.This is an application made by the Official Receiver (“the OR”) pursuant to s. 168H, Companies Ordinance (Cap. 32) for a disqualification order (which term is defined by s. 168D(1), Cap. 32).  The relevant part of s.168H states:-

“(1)	The court shall make a disqualification order against a person in any case where, on an application under this section, it is satisfied-
	(a) that he is or has been a director of a company which has at any time become insolvent whether while he was a director or subsequently; and (b) 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”.

2.The application is opposed and the respondents deny each and every ingredient of the above provision.  They also assert that the burden of proving these ingredients rests with the OR and the OR has failed to establish them.

3.The 1^st respondent (“Lui”) and 2^nd respondent (“Chan”) were the only directors of Weld-Tech Electrical Supplies Co. Ltd. (“Weld-Tech”), a company whose business was the retail of electrical building materials, such as lightning protection and earthing products and surge protection device.

Background

4.Weld-Tech was set up and operated by the respondents in about 1995.  According to the respondents, Lui was in charge of (among other things) the administration and management of Weld-Tech while Chan was responsible for marketing work.

5.Further, the respondents were also the only directors and shareholders of a Unitech Electric & Lightning Technologies Ltd. (“Unitech”).

6.In October 2004, a creditor petitioned for Weld-Tech to be wound up for inability to pay its debt.  Weld-Tech was wound up in February 2005 as a result.

7.The OR reported in October 2008 the amount of proofs of debt (totalled about HK$9 million, GBP26,900, SG$201,300 and US$785,300) far exceeded the amount of realised assets (about HK$7,500).

8.Subsequently, in May 2009, the OR reported that part of Weld-Tech’s debts was reduced from about HK$9 million to HK$2 million because of the sale of two of its properties.

S. 168H(1)(a) : Was Weld-Tech Insolvent ?

9.Based on the above, the OR argues that Weld-Tech is and was insolvent.

10.The respondents’ written submissions do not contend otherwise; nor was this mentioned in the respondents’ affirmations.  In fact, they accepted during the hearing Weld-Tech was insolvent as at the date of the petition (October 2004).

11.However, they challenge the OR’s conclusion, which is based on the affidavit of a Mr Mak, an accountant, that Weld-Tech was insolvent as at the end of March 2003.  Mak’s conclusion is in turn based on an assumption that the amounts due from Lui as at 31 March for the years from 2001 to 2004 were irrecoverable (see n. 3, Annex I, Mak’s affidavit).  The respondents contend that the assumption is not supported by evidence, and because the burden of proof rests with the OR, the OR cannot simply rely on an assumption.  In any event, the respondents argue that any insolvency was “technical”.

12.Once it is accepted Weld-Tech was at least at some stage insolvent, the contention relating to Weld-Tech’s pre-petition solvency is in truth irrelevant (see s. 168H(1)(a), Cap. 32)).  However, the OR goes further and points to an admission made by Lui in a meeting in June 2008 concerning the cash flow of Weld-Tech:-

“[Lui] said that [Weld-Tech] had serious cash flow problems since the proposed IPO re-structuring of [Weld-Tech] failed in 2003” (para. 9, Notes of Meeting dated 16 June 2008 (“June 2008 Meeting Notes”)).

From an accounting point of view, there may be a difference between solvency and cash flow difficulties.  But “serious cash flow problems” in 2003, followed by a creditor’s petition for winding up in 2004 (which succeeded), cannot properly regarded as being “technical” in nature.

13.In relation to para. 11 above, there is no indication Lui has repaid the loans; nor was he prepared to undertake to do so as at the hearing (when he was expressly asked about this).  Hence, what the OR is relying on cannot properly be said to be an assumption only.  The above facts are sufficient for an inference to be made that the amounts due to Lui are irrecoverable.

14.I therefore agree with the OR and find that there is no merit in this part of the respondents’ contentions.

S. 168H(1)(b) : Are the Respondents Unfit to be Directors ?

15.4 types of “misconduct” have been put forth in support of this application:-

(a)	failure (i) to take all reasonable steps to secure Weld-Tech to comply with s. 121, Cap. 32 (to keep proper books of account for 7 financial years), and (ii) to cause Weld-Tech to keep proper books of account throughout the 2 years preceding the commencement of the winding up (s. 274, Cap. 32) (“the accounts misconduct”);
(b)	failure to submit a statement of affairs (s. 190, Cap. 32) (“the statement of affairs misconduct”);
(c)	as Weld-Tech’s directors, failure to act in the best interest of Weld-Tech in (i) executing a guarantee to guarantee the bank debt of Unitech, and (ii) selling Weld-Tech’s properties to Unitech without obtaining full payment (“the fiduciary duty misconduct”);
(d)	issuing a cheque for payment after the commencement of the winding up (s. 182, Cap. 32) (“the s. 182 misconduct”).  The cheque was payable to a related party which, according to the respondents, was to paid for ordinary business expenses.  But the purpose of payment cannot be verified.  The respondents did not produce verifying evidence despite being asked to do so.

(a)     Lui

16.In relation to the accounts misconduct, Lui has put forth various explanations.

17.In an affirmation dated 27 November 2008 (“Lui’s 1^st affirmation”), Lui said there was insufficient time to comply with the request dated 9 March 2005 to furnish the documents.  A letter was sent to seek time extension to 30 March 2005 for doing so.  Nothing further was heard about this.  Lui also said the OR interviewed him on 16 June 2008 and 3 boxes of accounting documents were delivered to the OR on 15 July 2008.

18.In a later affirmation dated 24 March 2009 (“Lui’s 2^nd affirmation”), Lui said Weld-Tech’s accounting department used to be headed by a Mr Lau.  All accounting matters were entrusted to him.  Disputes later developed among the shareholders and the relationship with Mr Lau deteriorated.  Mr Lau left Weld-Tech in about February 2005 and kept with him a lot of the accounting records.  Lui was unable to retrieve those records from him or elsewhere.

19.According to the June 2008 Meeting Notes, Lui said the accounting documents were with him but were stored in a warehouse.  He agreed to deliver them for inspection within 14 days when asked to do so by the OR.

20.When Lui was cross-examined during the hearing, he claimed he had given all the accounting documents to the OR.  He also claimed he was told not to do anything further.  According to him, the OR only asked him for the accounting documents for the 2 years before the winding up.

21.In relation to the statement of affairs misconduct, Lui has again given different explanations.

22.He asserted in Lui’s 1^st affirmation he was careless and did not know of the need to submit a statement of affairs.  He claimed to mistaken it to be the same as the books of account.

23.In Lui’s 2^nd affirmation, however, he claimed he had been told by the liquidators that he no longer needed to submit the statement of affairs because Weld-Tech’s business had already ceased.

24.During his cross-examination, Lui was shown quite a few documents:-

(1)	letter of Messrs. KC Ho & Fong, the provisional liquidator’s solicitors, (“the provisional liquidators”) dated 9 March 2005;
(2)	the provisional liquidators’ letter dated 10 March 2005;
(3)	Lui’s undated letter faxed on 10 May 2005;
(4)	the provisional liquidators’ letter dated 24 April 2008;
(5)	the provisional liquidators’ letter dated 21 July 2008.

In brief, Lui was repeatedly asked in the above letters to submit his statement of affairs.  His letter sought a time extension from the provisional liquidators.

25.Lui claimed during his cross-examination the provisional liquidators verbally informed him there was no need for the statement of affairs.

26.In relation to the fiduciary duty misconduct, Lui contended in Lui’s 1^st affirmation the properties were sold to Unitech at market prices and at arms length.  He also referred to a letter dated 13 May 2005 from Unitech’s solicitors to similar effect.

27.Lui’s 2^nd affirmation explained that:-

(a)	because Weld-Tech and Unitech belonged to the same group of companies, Weld-Tech’s execution of the guarantee should be considered beneficial to the interest of the group of companies;
(b)	because of Unitech’s inability to get listed in the stock exchange, it became indebted to the bank creditor, and the bank creditor exercised its powers to sell off the properties earlier sold by Weld-Tech to Unitech.

28.This part of the OR’s case is that there was no satisfactory evidence of full payment by Unitech to Weld-Tech.  Consequently, the OR believes that the guarantee and sale of Weld-Tech’s properties were simply to facilitate Unitech to obtain banking facilities.

29.The facts in support of para. 28 above are:-

(1)	HK$2 million has been entered in Weld-Tech’s books as a “loan to Unitech”;
(2)	apart from a letter dated 23 June 2004 from Weld-Tech and Unitech asserting the said loan has been “settled”, and objective evidence to support the repayment of about HK$365,000, there is no evidence verifying the repayment of the balance (about HK$1.634 million).

30.In relation to the s. 182 misconduct, Lui’s 2^nd affirmation pointed out that the cheque was dishonoured.  Hence, there was simply no “transaction” to be set aside.

31.During his cross-examination, Lui admitted that he already knew about the petition when he drew the cheque on Weld-Tech’s behalf.  The cheque was dishonoured because the bank refused to honour it in view of the (then) pending winding up proceedings.

(b)     Chan

32.In short, Chan’s explanation for the misconduct is that his main responsibility at Weld-Tech was marketing and he entrusted the administrative and management work to Lui.

33.In relation to the s. 182 misconduct, similar to Lui, Chan agreed that he was aware of the petition by the time he signed the cheque which was later dishonoured.

(c)      Findings

34.By virtue of the reasons set out below, I am satisfied the OR has established his case regarding the respondents’ misconduct (see para. 15(a) to (d) above).

35.As regards the accounts misconduct (para. 15(a) and 16 to 20 above), I reject Lui’s explanations as being untruthful.  He kept on changing his explanation at various stages.

36.As regards the statement of affairs misconduct (para. 15(b) and 21 to 25 above), I reject his explanation as being untruthful for the following reasons:-

(a)	it is inherently implausible for the provisional liquidators to inform him there was no need to comply with the related statutory requirements;
(b)	his explanation is inconsistent with the contemporaneous correspondence between him and the provisional liquidators (see para. 24(1) to (5) above);
(c)	the contemporaneous documents support this part of the OR’s case.

37.In relation to the fiduciary duty misconduct (para. 15(c) and 26 to 29), the alleged benefit to the group of companies is not a valid answer to the OR’s complaint that the execution of the guarantee was not in Weld-Tech’s interest.  In this connection, I agree with the OR’s argument that the more important interest to consider is the interest of Weld-Tech’s creditors: see Gore-Browne on Companies (2010), Vol. 1, Ch. 15, para. 10B, text to n. 2.

38.Further, up to the time of hearing, there was still no independent verification of the outstanding sum of about HK$1.6 million having been repaid by Unitech.

39.Finally, in relation to the s. 182 misconduct (para. 15(d) and 30 to 31), the cheque drawn by the respondents was not honoured only because the paying bank refused to do so.  It is disingenuous for the respondents to attempt to make use of this to argue there has not been any misconduct on their part.

40.The drawing of a cheque can amount to a “disposition of … [a thing] in action” within the meaning of s. 182, Cap. 32: it was so observed in Hollicourt (Contracts) Ltd. v. Bank of Ireland [2001] Ch 555, para. 19:-

“… where a company pays a creditor by cheque drawn on an account in credit between the date of a petition and the winding up order, there is a disposition of the company’s property in favour of the creditor falling within [s. 182]”,

and para. 27:-

“[citing In re Loteka Pty Ltd. [1990] 1 Qd R 322, at 329 and 330] … It is the payee of the cheque that receives the benefit of the proceeds of the cheque. … although there is a disposition of property of the company, it took place not when the cheques were paid but on the date or dates on which each cheque was issued … ”.

(see also Byles on Bills of Exchange and Cheques (2007) 28^th Ed., para. 21-027 to 21-028 and 34-008 and Chalmers & Guest on Bills of Exchange, Cheques and Promissory Notes (2009) 7^th Ed., para. 13-049).

41.Thus, I do not consider the respondents’ conduct to be mere attempts (despite the OR’s submission to such effect).  There is accordingly no need to approach this aspect relying on Re Copyright Ltd. [2004] 2 HKLRD, 113 at para. 29 and 30.  If it were necessary to do so, I would have agreed with the OR.

42.Chan’s explanation that his main duties rested in marketing is an insufficient answer.  A director’s overall responsibility is not delegable: Re Regal Motion Industries Ltd. [2005] 1 HKLRD 461, para. 31 to 34.  It is incumbent on a director to be kept informed about the financial affairs of the company.  The gist of Chan’s affirmation is that he left all the administrative and management matters (including the books of account) to Lui.  That cannot be proper conduct.

Conclusion

43.The respondents’ liability has been established.  They have not (correctly) argued that even if the “misconduct” has been proven, they should still be fit to be concerned in the management of a company.

44.In case it is not apparent, the law regards directors to owe responsibilities to the public (in the form of creditors, shareholders and employees).  The public needs to be protected from persons whose conduct has shown that they have abused the privileges to trade through a company with the protection of limited liability, and with the use of capital subscribed by third parties: Secretary of State for Trade and Industry v. Langridge [1991] Ch. 402, 413G cited in Wong Wing Cheong Peter v. The Official Receiver [2002] 3 HKLRD 235 (on s. 168I, Cap. 32).

45.The respondents’ “misconduct” proven in this application shows that they have abused those privileges.

Duration of Disqualification

46.S. 168H(4), Cap. 4 states:-

“Under this section the minimum period of disqualification is 1 year, and the maximum period is 15 years”.

47.The OR seeks a disqualification order for a period from 6 to 10 years whereas the respondents argue the period should be between one and two years.

48.One of the objectives of such an order has been stated in para. 44 above.  The other is the general deterrence in giving a clear message to the business community if they break the trust reposed in them they will receive proper punishment: SFC v Fung Chiu & Others, HCMP No. 2524 of 2006 (27 November 2008), paragraph 12; The Official Receiver v. Philip Leigh Tose and Others, HCMP112/2002 (4 March 2009), para. 22.

49.In assessing the length of the disqualification period, the court’s practice has been to divide the period into 3 brackets: lower (1 to 5 years), medium (between 5 and 10 years) and upper (more than 10 to 15 years): The Official Receiver v. Steven Todd Krause [2008] 5 HKLRD 147, para. 21 to 26 (on s. 168G, Cap. 32).  It has also been the practice, which accords with the general sense of fairness, that as much as possible similar disqualification periods should be imposed for similar cases: see, for example, Philip Leigh Tose, para. 24 to 38.

50.Having taken the above matters into account, I consider the appropriate period for both respondents to be 5 years.  Despite Chan’s contention his role is less “culpable” because he was more responsible for marketing, I do not consider this to be a valid argument.

51.The respondents have not only failed to show remorse for their acts, they have opposed this application on unmeritorious grounds.  No discount will be given to them as regards the length of the disqualification period.

52.Finally, under r. 10, Companies (Disqualification of Directors) Proceedings Rules (Cap. 32K), the order is to take effect from the beginning of the 21st day after the day on which the order is made, but the term of the disqualification order would begin from the day on which it is made.

Costs Order

53.The parties agree that the usual rule that costs should follow the event is applicable.  There will accordingly be a costs order that the costs of this application be paid by the respondents to the OR.

54.I propose summary assessment of those costs.  For that purpose :-

(1)	the OR be at liberty to lodge with court and serve a statement of costs within 7 days;
(2)	the respondents be at liberty to lodge with court and serve a statement of objections within 7 days thereafter.

Mr Calvin Cheuk, instructed by Official Receiver, for the Applicant

Mr Danny P Y Fung, instructed by Messrs Fan Wong & Tso, for the Respondents