The high price of failure

FOR $29 a month, Simon Chan, once an aspiring entrepreneur, owns and maintains a limited company. Given the chance, he would kill it. He is a partner in a 'sleeping', or inactive, clothing company which no longer generates any business, let alone profits. It is nothing but a record at the Companies Registry. But Mr Chan, 32, can do nothing about it.

Under existing company law, Mr Chan and his three partners cannot voluntarily wind up their short-lived venture as they are still in debt. Their creditors must take legal action to liquidate their business.

'But none of our creditors - the supplier, the leasing company and decoration workers - are suing us because it is cheaper for them to leave things as they are than taking legal action against us,' Mr Chan says.

'Though our business folded earlier this year, we still have to pay the annual company registration and audit fees to the Government, about $6,000, for the next six years.' Mr Chan, now running his father's textile business, is one of an increasing number of local entrepreneurs whose small businesses have gone bust in the past 12 months. But though it has been a 'good lesson', he is one of the lucky ones: he has not gone bankrupt.

Hong Kong's bankruptcy laws - often criticised as outdated and currently under review - mean those less fortunate who have gone bankrupt, are likely to die bankrupt.

The latest Official Receiver's Office annual report shows new insolvency cases this year up by 17 per cent to 751, of which 318 were personal bankruptcies, while 433 companies wound up.

Though small businesses are more prone to risks, they are not alone. This month, CF and Associates, a local property agency with several mainland property developments in its portfolio, suddenly collapsed. Now more than 100 Hong Kong investors are demanding immediate action against the 13-year-old company which took deposits for four developments in Danshui and Aotau cities, near Shenzhen.

Many investors fear they have lost $70 million in down payments for these developments, which failed to meet their construction completion deadline.

CF and Associates highlights one of the reasons why companies go bust in Hong Kong. The Official Receiver, Robin Hearder, says: 'The main reasons are: something goes wrong with contacts overseas, or goods supplied are not up to standards specified, or the person concerned doesn't pay them and they go into financial problems.

'High rents, bad management control, other financial difficulties such as difficulty in raising funds, these are all the main reasons.' The latest Jones Lang Wootton property index shows overall rent for offices in Hong Kong has shot up 40 per cent since last year, and nine per cent for retail space. These are problems which left Mr Chan and his partners thousands of dollars in debt and turned his dream into a financial nightmare.

His clothes shop, a $350,000 investment, shut down just four months after opening in November last year. His supplier failed to come up with the quality goods promised, and what he had in his store just didn't sell.

'Christmas and New Year came and went and we still didn't have enough customers. Then our supplier failed to fulfil his promise to replace our old stocks with newer designs and sizes,' Mr Chan says.

'We lost confidence in our supplier so we decided to pack everything in.' John Lees, a partner in accountancy firm Ferrier Hodgson and Marfan, says more companies are winding up in Hong Kong because the city itself has changed: 'Most of the insolvencies in the past were dealt with informally and more leniently, the banks didn't want to have their debts, but that seems to have changed.

'Now, a lot of directors fold the company and leave Hong Kong, leaving big debts behind them so banks and lenders have become more aggressive to cope with that.' In the past, the territory was a big manufacturing centre but now all the factories are on the mainland, Taiwan, Malaysia and the Philippines - 'But there are people who have hung on here and the rising costs have just put them out of business,' Mr Lees says.

'Also, it was easy to make a decent profit in China five years ago, now there is a lot more competition. A lot of the retailers have left Europe and America and are now dealing directly with the company in China.

'So the middleman here in Hong Kong not only has to put up with very fine margins, he also has to face a lot of bad debts. Because there are more and more liquidations, there are more and more bankruptcies taking place as well.' Philip Nourse, president of the Hong Kong Association of Property Management Companies, says: 'It is not uncommon for a tenant to fail to pay the rent and management fees simply because they have no more money.

'And perhaps it will take one or two months before the landlord and management company start tracing outstanding fees and realise that the tenants will never pay up.' But the degree of risk estate agents take depends on the state of the economy: 'In Hong Kong we have a healthy economy and the market is quite strong to find a replacement tenant.' But for the bankrupt, a new start is not so easy. Existing companies and bankruptcy legislation have long been criticised as outdated. For instance, current bankruptcy provisions are still based on an English law passed in 1914.

Mr Hearder says it is extremely difficult to get a discharge from a bankruptcy order and a bankrupt cannot obtain credit for more than $100.

In September 1990, the Law Reform Commission was asked by the government to review the law and practice relating to the insolvency of individuals and bodies corporate. Professor Ted Tyler, chairman of its insolvency sub-committee, says only two per cent of bankrupts in Hong Kong ever get discharged.

'One of our major recommendations is supposed to provide an automatic discharge [after three years],' says the former district court judge. Also, it is proposed that debt-ridden companies should be given a one-off chance to restructure themselves to avoid insolvency.

Mr Hearder says: 'Basically, [the recommendations] will call for a moratorium on all debts for a period of 30 days, so an outside person can go in to see what can be saved. He'll make a report to the creditors, hopefully, that way, a lot of businesses can be rescued rather than having to go into liquidation.' This recommendation is expected to be completed next month and submitted to the Commission, for consideration.

Other aspects of the sub-committee's work involve ending the common practice of bankrupts disposing of their assets before a bankruptcy petition is filed, and toughening the Companies Ordinance by giving the Government more power to penalise and disqualify company directors who have been convicted of indictable crimes such as fraud.

Meanwhile, protection is always a better cure but there are only a limited number of courses teaching Hong Kong people how to set up and run their business and their legal rights. Mr Hearder would like to see more.

'We go out and give talks to the Labour Department employees on a regular basis. Various conference organisers also run insolvency seminars and we get asked to produce a speaker for one of those seminars, and we are happy to do it,' he says.

'We think it is a very good idea to have more of these courses, but if we are asked to do it on a more frequent basis it'll be difficult because of the time involved.'