RE GREENWALLS BIOENGINEERING LTD

HCCW 1032/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 1032 OF 2003

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J U D G M E N T

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1. This is an application by the Respondent Company, Greenwalls Bioengineering Ltd ("the Company"), for security for costs in respect of the winding up petition which has been brought against it by the Petitioner, Silver Ben Development Ltd.

2. The petition, which was presented on 17 September 2003 was founded on the failure by the Company to comply with a statutory demand dated 5 August 2003, which had been served on the Company by the Petitioner. According to the statutory demand, the Company was indebted to the Petitioner in the sum of some HK$912,856.29, which was said to have been advanced to or paid on behalf of the Company by the Petitioner or through the Petitioner's nominees between March 2000 and September 2002. The petition has been set down for hearing and is due to be heard on 26 April 2004.

3. The Company denies that it is indebted to the Petitioner, and asserts that the alleged debt is disputed in good faith and on substantial grounds. It is said that no loans or advances were made by the Petitioner to the Company, and that while some advances were made by one of the Petitioner's shareholders who was a director of the Company, and who was at one time one of its shareholders, such advances were far less than the amount claimed, and were in any event intended to be capitalised in due course and so would not be repayable.

4. The present application was made at a fairly early stage in these proceedings on 24 October 2003. It is founded on s. 357 of the Companies Ordinance, which provides:-

"Where a limited company is plaintiff in any action or other legal proceedings, any judge having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the company will be unable to pay the costs of the defendant if successful in his defence, require sufficient security to be given for those costs, and may stay all proceedings until the security is given."

5. It is to be noted that the jurisdiction to order security for costs against a limited company, such as the Petitioner in these proceedings, only arises where it is established by credible testimony that there is reason to believe that the company will be unable to pay the costs of the successful defendant. This is not an insignificant hurdle as Ma J (as he then was) pointed out in Brand Farrar Buxbaum LLP v Samuel - Rozenbaum Diamond Ltd [2003] 1 HKLRD 600, what is required to be established is that the company will be unable to pay such costs, not just that it might be unable to do so.

6. When the jurisdiction to order security for costs under s. 357 is established, the decision whether or not to make such an order, and the level of security to be ordered are matters which are within the discretion of the court. That discretion is to be exercised on the basis of the same broad principles as apply to an application for security for costs under O.23 of the Rules of the High Court, and has been considered in numerous authorities, such as Sir Lindsay Parkinson & Co Ltd v Triplan Ltd [1973] QB 609 and Keary Developments Ltd v Tarmac Construction Ltd [1995] 3 All ER 534.

7. Thus, the first question that I ask myself is whether there is, on the basis of credible evidence, reason to believe that the Petitioner will be unable to pay the costs of the Company if the petition fails.

8. In support of its application, the Company filed the 2nd Affirmation of Cheng Leung Yan, in which it was stated that the Petitioner had a nominal and paid up share capital of HK$10,000. The affirmation went on to state that the Company had, through a professional search agent conducted a property transaction search against the Petitioner, which showed that the Petitioner had no record of any transactions in respect of real property in Hong Kong between 1992 and 23 September 2003.

9. Taken on its own, this evidence is wholly insufficient to establish that the Petitioner would not be able to meet any costs order which might be made against it. It deals only with the paid up capital of the Petitioner, and the fact that it appears to own no real property in Hong Kong. It says nothing about the actual financial position of the Petitioner the absence of any real property assets does not mean that the Petitioner has no other assets with which to meet any costs order against it.

10. However, the Petitioner has, in response to the application, disclosed its management accounts as at 31 October 2003. These indicate that in the 10 months to 31 October 2003, the Petitioner was operating a business which generated profits of some $638,000 odd, thus eliminating previous accumulated losses and leaving it with retained profits of some $160,000. Moreover, it appears from the balance sheet that the Petitioner has recorded assets of some $2,648,769.56, as against liabilities of some $2,477,977.92, and is, at least on the basis of its balance sheet, solvent. It also has cash assets of just under $830,000, which appear to be evidenced by bank passbooks and statements which have also been disclosed.

11. I note, however, that the assets recorded in the balance sheet include the amount of $912,000 odd that is said to be owed by the Company to the Petitioner. If that is removed from the balance sheet, as it would have to be if the Company is right in its case, this is not indebtedness to the Petitioner, this would leave total assets of some $1,736,000 odd, leaving a net deficit of liabilities over assets of slightly over $700,000.

12. However, it should also be noted that of the liabilities recorded in the balance sheet as at 31 October 2003, there are directors loans totalling some $1.883 million odd. Such loans are typically advanced on a long-term interest free basis, with no fixed terms of repayment, and are often regarded as a form of support for the company from its directors, who may also be its shareholders.

13. Taking these accounts into consideration as a whole, it seems to me that they disclose, as Mr Wou for the Petitioner submitted, a picture of a small company in reasonably good financial health, generating net income of some HK$60,000 per month, and with fairly substantial amounts of cash in hand. They do not suggest a company which is impecunious or which is unlikely to be able to meet its obligations, including any likely award of costs in these proceedings, out of its operating income and accumulated cash at bank. So far as the likely costs of this action are concerned, the Company has estimated these at some $851,000. I can only say that I regard this amount as very high, given the nature of these proceedings. Having considered the draft skeleton bill of costs, it seems to me that the costs provided for in respect of counsel's fees for the trial of the petition and for this application are likely to be substantially reduced on taxation. Moreover, it seems likely that reductions are also likely to be made on taxation in respect of the fees of the solicitors involved, having regard to the time that is said to have be expended on various matters.

14. It seems to me that the only real basis on which it could be said, or might be argued, that the Petitioner would not be able to meet its liability to pay costs in the event that the petition is unsuccessful would be if one were to assume that the Petitioner would use its available funds to pay off the loans from its directors rather than to meet its other obligations. However, there is nothing in the evidence before me to suggest that this is likely to be the case. Even if this were regarded as a possibility, it seems to me that this would at best show that the Petitioner might not be able to meet an order for costs against it, or rather that it might choose not to do so - but this would not be, in my judgment, enough to establish jurisdiction to order security under s. 357.

15. For the foregoing reasons, I am not satisfied on the evidence before me, that it can be said that the Petitioner would be unable to pay the Company's costs if the petition proves to be unsuccessful. That being so, I decline to make any order for security for costs.

16. I would only add that, had I been satisfied that the Petitioner would be unable to pay the Company's costs in the event that the petition were dismissed, I would have exercised my discretion by ordering that some security should be provided, as I do not consider that this is a case in which particular weight should be given, one way or another, to the relative merits asserted by the parties for their respective cases, and I would not have considered that, on the evidence available, an order for security would be likely to stifle the Petitioner's claim. However, I would only have been prepared to order security in an amount substantially lower than that sought by the Company, for the reasons which I have already briefly mentioned.

Representation:

Mr Jean-Paul Wou, instructed by Messrs K Y Lo & Co., for the Petitioner

Mr Peter Pannu, instructed by Messrs Chong & Partners, for the Company

Attendance excused, for the Official Receiver

HCCW 1032/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 1032 OF 2003

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D E C I S I O N

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1. I have before me an application for a validation order by Greenwalls Bioengineering Ltd ("the Company"). The Company asserts that the Petition that has been presented against it is of no merit and is capable of being struck out. That is not a matter which is before me today, and it will have to be determined in due course in an appropriate manner. What I do have before me is the application for a validation order, which initially appeared to have been consented to by the Petitioner, although there was some discussion at the last hearing and today as to the precise form of the undertaking that the Company should give, if such an order is made.

2. Having considered the material and the further evidence in the recent affirmation by the director of the Company, I have come to the view that on balance, it is in the interest of the creditors that the Company should be permitted to carry on trading, pending the resolution of the winding-up petition.

3. It seems to me that in this case, although the Company was unprofitable in its first year of operation, it appears from the Company's audited accounts that it was profitable by the second year. Its management accounts indicate an improvement in the level of profitability in the current, third, year of its operation. That is a matter which gives me some comfort as to the manner in which the Company's business is progressing.

4. Although I note, as Miss Chung for the Official Receiver has pointed out, that the actual orders on hand in the form of existing contracts are not likely to be able to cover all of the expenses of the Company over the next year, the Company does rely on anticipated contracts in the next year that are expected to provide further income, sufficient to cover the balance of the expenses over that period, with sufficient profit left over to make it desirable in the interest of creditors that the Company should be allowed to carry on its business.

5. Although I recognise that that income is not certain to be achieved, it seems to me that having regard to the Company's track record so far, that record is rather different from the situation in Lee Po Wang Samson v Ever-rise Engineering Limited (HCCW 714/2001, unreported, 30 October 2001, Kwan J) to which Ms Chung referred me. In that case there were very substantial losses in the initial years and only a recent change in that company's fortunes. In this case, however, the Company is a relatively young company - it has only been in operation for some 2 1/2 years and it has been profitable, it seems, in the second and the current (third) year of its operation. That being so, it seems to me that it is not unreasonable for me to take the view that there are reasonably good prospects that its continued trading will be for the benefit of its creditors as a whole.

6. I would therefore propose to make a validation order in the usual form in relation to payments in the ordinary course of the Company's business out of its bank account. I would also make a validation order in the ordinary form relating to dispositions of property in the ordinary course of business at full market value.

7. It seems to me that in terms of paragraph 3 of the proposed draft order, this is more appropriately worded as a proviso. It seems to me that in accordance with the practice in Hong Kong, which is in my view a reasonable one, the banks themselves should not be under any obligation to have to check the appropriateness of any transactions which are put through the bank accounts of the Company.

8. In the event that any payments are made that are not in the ordinary course of business, these will be subject to challenge if the Company is made the subject of a winding-up order, and any payments made will be recoverable, if not made in the ordinary course of business, from the recipients thereof.

9. So far as the undertaking is concerned, although I have some sympathy for the position of the directors of the Company who, it is said, have provided from their own funds further advances in the interim period between the presentation of the Petition and the hearing of this application for a validation order, it seems to me that having regard to the fact that the Company's financial position in terms of confirmed future receipts is still a little uncertain, although I have accepted that on the balance of profitabilities, it will be in the interest of the creditors for it to continue trading, I think in all the circumstances that having regard to the relatively small amount of the further advances against the overall advances that have already been made, it would not be an undue hardship if I were not to permit those amounts specifically to be validated, and except them from the terms of the proposed undertaking.

10. I would therefore require an undertaking, which I understand will be given, that no repayments will be made in respect of any directors' or shareholders' loan pending the resolution of this winding-up petition. That means, in effect, that the additional advances that have been made will be caught by that undertaking and will not be repayable in the meantime.

11. So far as the further refinement as proposed by Mr Wou is concerned, I am inclined to think that although Mr Wou is probably entitled to raise the point for argument today, and is not strictly precluded from doing so by his clients' earlier indication of their being agreeable to the undertaking in the form proposed by the Company, it seems to me that the additional wording he proposes (to prevent payments to directors) is not strictly necessary in this case, in that there do not appear to be any items of regular expenditure which are described as being in the ordinary course of business which are on their face payable to directors by way of fees or other payments.

12. In the circumstances, I think it will be sufficient if the validation order takes the usual form, so that if any payments are made which are not in the ordinary course of business, these can be dealt with and avoided in due course in the event that the Company is wound up.

13. In terms of the precise wording of the order, I have a number of comments on the draft order submitted which I will deal with, after which I shall hear the parties on costs.

Representation:

Mr J P Wou, instructed by Messrs K Y Lo & Co., for the Petitioner

Mr Vincent Chin, instructed by Messrs Chong & Partners, for the Respondent

Miss S Chung, for the Official Receiver