HK court sets boundary for payment validation when business activities end
A Hong Kong court recently dealt with a heated dispute between two company directors over payment validation during winding-up proceedings. The majority shareholder claimed the other director had been wrongfully paying himself a substantial monthly sum without proper approval.
The worker argued that the director had abused his position to siphon off company funds while marginalising the worker from management since 2016. According to the worker, the director had no employment contract and was not entitled to the HK$130,800 monthly payments he had been receiving.
At stake was whether these payments qualified as legitimate business expenses or represented an improper use of company resources during a period when the business relationship was deteriorating and winding-up proceedings were underway.
The case involved a Hong Kong trading company with offices in Hong Kong and Shenzhen that had been operating since 2003. The company primarily served as a trading company and sourcing agent for an American related company called TDC USA Inc. The two directors were its only shareholders since 2003—the worker holding 53.5% of shares and the director holding 46.5%.
Their relationship started deteriorating around 2016. The worker alleged that the director wrongfully pushed him out of the company's management and took control of operations. The worker claimed the director engaged in various acts of mismanagement, including unauthorised withdrawals of funds and refusal to recognise certain invoices properly issued by TDC USA Inc.
In November 2021, the worker filed a petition to wind up the company on "just and equitable" grounds under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32). By this time, the company's Hong Kong office had already reduced staff from around eight employees to just three, including the director at the centre of the dispute.
In October 2022, the court made a consent order allowing the company to continue making payments in the ordinary course of business. However, in January 2024, following complaints from the worker, the court clarified that this order excluded the director's remuneration, though he could apply for a validation order specifically for these payments.
The director then applied for a validation order in May 2024, seeking to retrospectively approve the payments he had received since the petition was filed. He argued he had been an employee of the company since 2002 and was entitled to salary for his ongoing work as managing director.
The director presented tax returns, Mandatory Provident Fund records, and letters to the Immigration Department to support his claim of employment status. He stated that despite the winding-up petition, the company continued to operate and generate income, and he continued performing his duties by negotiating with clients, dealing with the Inland Revenue Department, and looking for new business opportunities.
The director pointed out that the worker had been aware of and had not objected to his remuneration for many years. The company's audited financial statements, which were signed by the worker, recorded the payments as "director's remuneration," and the director had been paying salaries tax on these amounts.
The worker strongly opposed the application, arguing the director was never an employee of the company and that the payments were improper. The worker highlighted that while the company had written employment contracts for other employees, no such contract existed for the director.
According to the worker, the director's claim to be an employee was a recent fabrication made only after objections were raised about the payments. The worker noted that the director's lawyers had initially argued he was entitled to director's remuneration, not salary, and only changed their position later.
The court acknowledged this was a factual dispute that would need to be addressed at a full trial. The judge noted: "While [the worker's counsel] disputes the precise nature of these payments, in my judgment, that does not obviate the payments as being made in the ordinary course of the Company's business even after the presentation of the Petition, or that they were likely to injure the Company whilst the Company was still active."
A crucial turning point in the case was the end of the company's trading activities. The director admitted that "the last shipment [of goods by the Company] was made in around April 2023" and despite his efforts to find new business, "there were no more trading business after April 2023."
The court noted it wasn't until a January 2024 hearing that the director confirmed to both the court and the worker that the company had stopped trading in April 2023. By that time, the director had continued receiving his full monthly payment of HK$130,800.
The director stated he had tried to find new clients, including travelling to the United States between August and October 2023, but these efforts didn't result in new business. He explained: "In August to October 2023, I have attended the United States to meet a number of potential clients for potential business opportunities... Unfortunately, the above business opportunities did not mature into actual business relationship."
The judge acknowledged the director continued handling company affairs after trading stopped, including negotiating with the Inland Revenue Department and dealing with the company's failure to file audited financial statements on time. He also oversaw a lease of company property for HK$12,500 per month until its termination in April 2024.
However, the court found there was "a significant change in the nature of the Company's affairs and his role." By November 2023, the two shareholders had reached a preliminary agreement for the company to be wound up voluntarily, which led to further court directions regarding the proposed members' voluntary liquidation.
The court examined whether the continued full payment to the director was justified after the company stopped trading. The judge noted the director's fiduciary duties to act in the company's best interests and questioned whether his continued service warranted the same level of payment.
The judge wrote: "By the end of October 2023, in the light of the fact that the Company was unable to generate any further business for some 6 months despite [the director's] apparent efforts... it was incumbent upon [the director], as a director of the Company, and indeed its managing director, to seriously consider whether it was still in the interests of the Company to continue employing him or paying him a substantial remuneration for his services."
The court accepted that after October 2023, the director continued to be involved in company affairs, but observed that the remaining tasks were mainly administrative. The company already employed a part-time accountant who could have handled or assisted with many of these matters.
The judge noted: "In the circumstances, there is some force to [the worker's counsel's] submissions that after the Company ceased trading, the Company no longer required [the director] acting full time and being paid his usual remuneration, which was not an insubstantial sum."
The court emphasized that the director should have informed and consulted with the worker about whether the company still needed a full-time managing director at the same level of remuneration. If they couldn't agree, the director should have asked the court for guidance.
The judge concluded: "I am not satisfied that it could reasonably be said that it was necessary or expedient in the interests of the Company for [the director] to be continued to be paid his monthly remuneration of HKD 130,800 beyond the end of November 2023, at least without obtaining the informed consent of [the worker] (which would not have been forthcoming) or further directions of the Court."
The court validated the director's payments only up to the end of November 2023, declining to approve any payments after that date. Since neither party was entirely successful in the application, the judge ordered the costs to be determined as part of the main winding-up proceedings.
The court's decision shows how director remuneration may be affected when a company ceases trading activities, even while formal winding-up proceedings are still in progress.
