The directors of a company are planning to change the business of their company significantly from that of fast-food retailer, to a company that supplies fine foods, and exotic tasting delicacies. The company does several studies on behalf of the directors before embarking on the new business, the reports appear that this will be very profitable as a venture. The company invests a lot of money into the new project, and the executive directors are very busy a whole year getting up the business.

Things do not go well, and at the end of the year it is quite evident that this new venture is not going to succeed due to the number of competitors, the high costs and the small target market. The company has lost a lot of money and owes quite a bit as well. The Chief Financial Officer tells the directors that the company is in serious financial trouble, but he will see if he can fix it! The directors leave it to the CFO to come up with a solution. But one month later the creditors move in on the company and place it under external administration. The creditors discover the company has been unsustainable for more than six months and should not have been trading. Explain with reference to law.

• What are the liabilities of the directors in this situation for the losses and the poor business decisions?
• Do the directors have any defences to the fact that so much money has been lost on this venture.
• Will the directors be liable to creditors for the insolvency of the company? Refer to appropriate law in your answer.

Transcribed Image Text:

Te or Not To Fiddle 1/5 Sino-Foreign Investment Joint Venture Company Hur Tze Huan YBLC Ltd. (YBLC) was a foreign investment company in China, located in a small border town Antu in North East China. The Russian and North Korean borders were just less than 100 km away. It was strategically located because the Chinese Railway joined the Trans-Siberian Railway near Antu. PPLC Ltd. (PPLC) was a Malaysian company with lumber business in East Malaysia, Ka limantan, Australia and the United States of America (USA). It had decided to set up a joint venture timber based company, YBLC, in Antu to exploit the pine timber resources in north- eastern China as well as those of the Siberia. YBLC was considering the use of the railway link to both areas for logs supply and the port of Darlian as an export point for timber products, YBLC was the largest of a few foreign investment-ventures in Antu. YBLC was a typical joint venture set up in the 1990s. The foreign partner contributed the fund for capital and operational expenses and retained a controlling interest of 51% ownership. The local partner, Antu township government, contributed the land and took up 49% of the share- holding. The local partner had the management power, and therefore, appointed a Chinese general manager (GM), on the arguments that the locals were familiar with the Chinese laws, customs and culture. The foreign partners sent their production engineer, marketing manager, purchasing managers and the financial controller who doubled up as deputy general manager. The GM then recruited all the assistant managers and the labour force. In China, there was no equivalent of Commissioner of Company (COC), as found in Malaysia or the British Commonwealth countries, as an administrative and regulatory body for all the companies. The administration of the China Company Law for joint ventures was in the hand of Foreign Economics and Trade Commission (FETC), with representative offices at national, provincial, county, district and town level. Therefore, the economic officers at every level had the monitoring and supervisory roles over foreign investment joint venture companies. Mr Lee was the economic officer (EO) in charge of foreign investment joint venture in Antu at that time. Therefore, all the documents of annual returns, including the financial statements, were to be sent through him for filing at the Provincial FETC at the provincial capital. He, together with one other town officials and the GM, was appointed to the Board of YBLC to represent the interest of the township government. It could be assumed that the Chinese partner was the Chinese government, with Mr Lee as the team leader. It could be further assumed that the Chi- nese government's influence on business was everywhere, ranging from complete government control in state own enterprises to partial influence in joint venture. It should be noted that the International Accounting Standards (IAS), and later together with International Financial Reporting Standards (IFRS), had been adopted by the Chinese account ing fraternity at that time. To Pe So F Mr T was the financial controller (FC) at that time. Besides the budgetary, accounting and reporting functions, he was to assist the GM in the day-to-day running of the operations of the company. More importantly, he was the custodian of the foreign partner's interest in Antu. The GM. Mr Zhang was at that time a Communist Party member of the local chapter, and he had declared openly whenever the opportunity arose, that his loyalty lied with the party and the country. He, therefore, doubled up as the company's Commissar. The Commissar appointment was peculiar in the Chinese administration system. For every official position, e.g. the city mayor, there would be correspondingly a city Commissar, who is supposed to represent the Chinese Communist Party. The Commissars, or party secretary, were widely influential and powerful, though to a lesser extent in joint venture companies. The following conversation took place shortly after the 2001 year end closing and the account- ing and financial statements showed a loss in the income statement for the preceding year. The GM, Mr Zhang, under the pressure of the EO-cum-director, Mr Lee, was wondering on the best approach to ask the FC, Mr T, to alter the profit and loss position of the financial state- ments. (Please note that in China, the senior staff of companies and Government officers were by custom addressed by their official position or title) In the GM's office in the morning Mr Zhang: Good morning, EO Lee. How are you this morning? Please sit down. Have a cup of tea. Mr Lee: Thank you, GM Zhang. Mr Zhang: Please tell me, EO Lee, what brings you here? Mr Lee: As a matter of fact, GM Chang, there is quite an urgent favour I want to ask from you. CASE STUDIES 100 Mr Zhang: Please go on Mr Lee: Mr Zhang: Mr Lee: And we are making a loss again? Mr Zhang: That was shown in the draft copy of the accounts that FC T gave me. Mr Lee: That is the financial result I cannot accept Mr Zhang: Why EO Lee? We are into the second year of operations only last year. Losing 2 years in a row is quite common for a new company. Mr Lee: I have heard that last year's financial report has been finalised? Yes, it has Mr Lee: Mr Zhang: EO Lee, please be patient. You have been with us all these years. You have been attending board meetings. You know we have been doing our best. According to FC T. we made a loss because we have not been getting sufficient logs to feed into the operations. Our factory is still operating under capacity. That may be so. But my superior at the provincial capital has been asking me as to why all the joint venture companies under me are not making money! Mr Zhang: Mr Lee: Come on GM Zhang. I have enough of that FC T. Can you trust that foreign accountant? They are all the same, they like to make an account showing a loss, to avoid paying tax. I have spoken to our bank manager. He said there is always plenty of cash in the account, never less than RMB 1 million at any one time. Mr Zhang: What you said is true, EO Lee. But since this is a joint venture, what FC T said should be followed. Besides, I have heard that these foreign accountants have to follow some rules called 'international accounting standards. Mr Lee: Nonsense, GM Zhang. Nonsense. You mean we don't have accounting standards in China? I have spoken to my friend who is a Chinese accountant. He said accounts can be changed easily. No problem at all. Besides, I have promised. my superior in the provincial capital in the year end before last, that this 'drag on head' enterprise will make a profit last year. I will lose face if you give me another bad report card, to say the least. EO Lee......this may not be as easy as you think. (Furious) Come on, GM Chang, have I not done enough for the company? I spent most my time and energy for the company. Remember those instances in which I went beyond my duty to run to the provincial capital or to Beijing to solve your problem? This is the least you can do for me! Mr Zhang: Alright, EO Lee. I will see what I can do. I will talk to FCT this afternoon You do that. You better do that! (He stormed out of the GM's office) Mr Lee: At the GM's office in the afternoon Good afternoon, CM Zhang, you want to see me? Mr Zhang: Yes, I have some urgent matters to discuss with you. But first, sit down and have a cup of tea. Is that so? How can I help you? Mr Zhang: What do you think of EO Lee as a person? He is a helpful guy. Why do you ask? Mr Zhang: What I mean is, is he helpful to the company? Has he not done quite a lot for the company? Mr T Mr T Mr T Mr T Yes. I give him credit for helping with the company registration matters. He also helps in the refund of the VAT (Value Added Tax). I remembered the occasions he went to Chang Choon and Beijing to sort out the VAT refund for us, amounting to RMB 3 million. Mr Zhang: I am glad you remember all the good things he had done for the company. So what does he want? An increase in director fees? Or an appreciation letter to his boss? Mr T Mr Zhang: None of these, FC T, what he wants is for you to do him a small favour. Mr Th And what would that be? Mr Zhang: He wants you to change the P&L to show a profit, so that he can show to his boss in the provincial capital, that he has turned the company around to a profitable state. MFT: Why would he want to do that? Mr Zhang: Presumably that is for his good report card. You know in the China Civil Services, now they are going for the merit system. Anyone with a good record to show will get a fast promotion. CASE STUDIES 102 Mr T Mr Zhang: MrT: It is not that we do not want to help him in his career. I have explained to you many times about the international accounting standards (IAS) and the Malaysian Accounting standards which are based on IAS, which are also adopted by China. And I have explained to you about the real reason of making a loss is that we are under capacity. I have made a new budget to rectify this aspect. With the increase purchase of logs spreading evenly through out the year, we will be up to full capacity. With the overseas markets expected to remain strong, we may be on our way to substantial profits in this year. Can you ask him to wait for one more year? MrT: I am afraid he can't. He seems very adamant with his demands. The principle we are all here to uphold is that the financial statements must be in accordance with the underlying records and must show a true and fair view of the affairs of the company. Furthermore, we have our accounting body's code of practice to uphold. I may lose my practice license if I change the accounting report without a basis. I assure you the final draft of the financial statement reflects true and fair view of the financial position of the company. We are making a slight loss last year, but our cash position is good, due to our stringent credit policy and good cash management practices over the last year. Mr Zhang: If you do not help him, we may lose a very good ally on the Government side. The damage could be irreversible. I am not an accountant, but can you at least look into the accountant standards again, and see if you can change the position from slight loss to slight profit? I can look into the possibility again, but I can tell you the probability of doing so is very low. Besides, I may have to inform my boss in the HQ about it. Mr Zhang: Oh, No. Please do not involve your HQ people. If you can help, help in your per sonal capacity. Notes: 1. A company could have a predetermined level of cash reserves by careful cash budgeting or planning, even if the company is suffering from losses, within a short-term time frame. Careful debtor (account receivable) and creditor (account payable) manage ment, arrangement for bank overdraft and director's loan were some of the measures that could be taken to ensure adequate cash-flow within a company. 2. The VAT refund on export was given partly for off-setting input taxes paid, but mainly as an export incentive. 3. Chang Choon is the capital of Ji Lin province, in which Antu is situated. Te or Not To Fiddle 1/5 Sino-Foreign Investment Joint Venture Company Hur Tze Huan YBLC Ltd. (YBLC) was a foreign investment company in China, located in a small border town Antu in North East China. The Russian and North Korean borders were just less than 100 km away. It was strategically located because the Chinese Railway joined the Trans-Siberian Railway near Antu. PPLC Ltd. (PPLC) was a Malaysian company with lumber business in East Malaysia, Ka limantan, Australia and the United States of America (USA). It had decided to set up a joint venture timber based company, YBLC, in Antu to exploit the pine timber resources in north- eastern China as well as those of the Siberia. YBLC was considering the use of the railway link to both areas for logs supply and the port of Darlian as an export point for timber products, YBLC was the largest of a few foreign investment-ventures in Antu. YBLC was a typical joint venture set up in the 1990s. The foreign partner contributed the fund for capital and operational expenses and retained a controlling interest of 51% ownership. The local partner, Antu township government, contributed the land and took up 49% of the share- holding. The local partner had the management power, and therefore, appointed a Chinese general manager (GM), on the arguments that the locals were familiar with the Chinese laws, customs and culture. The foreign partners sent their production engineer, marketing manager, purchasing managers and the financial controller who doubled up as deputy general manager. The GM then recruited all the assistant managers and the labour force. In China, there was no equivalent of Commissioner of Company (COC), as found in Malaysia or the British Commonwealth countries, as an administrative and regulatory body for all the companies. The administration of the China Company Law for joint ventures was in the hand of Foreign Economics and Trade Commission (FETC), with representative offices at national, provincial, county, district and town level. Therefore, the economic officers at every level had the monitoring and supervisory roles over foreign investment joint venture companies. Mr Lee was the economic officer (EO) in charge of foreign investment joint venture in Antu at that time. Therefore, all the documents of annual returns, including the financial statements, were to be sent through him for filing at the Provincial FETC at the provincial capital. He, together with one other town officials and the GM, was appointed to the Board of YBLC to represent the interest of the township government. It could be assumed that the Chinese partner was the Chinese government, with Mr Lee as the team leader. It could be further assumed that the Chi- nese government's influence on business was everywhere, ranging from complete government control in state own enterprises to partial influence in joint venture. It should be noted that the International Accounting Standards (IAS), and later together with International Financial Reporting Standards (IFRS), had been adopted by the Chinese account ing fraternity at that time. To Pe So F Mr T was the financial controller (FC) at that time. Besides the budgetary, accounting and reporting functions, he was to assist the GM in the day-to-day running of the operations of the company. More importantly, he was the custodian of the foreign partner's interest in Antu. The GM. Mr Zhang was at that time a Communist Party member of the local chapter, and he had declared openly whenever the opportunity arose, that his loyalty lied with the party and the country. He, therefore, doubled up as the company's Commissar. The Commissar appointment was peculiar in the Chinese administration system. For every official position, e.g. the city mayor, there would be correspondingly a city Commissar, who is supposed to represent the Chinese Communist Party. The Commissars, or party secretary, were widely influential and powerful, though to a lesser extent in joint venture companies. The following conversation took place shortly after the 2001 year end closing and the account- ing and financial statements showed a loss in the income statement for the preceding year. The GM, Mr Zhang, under the pressure of the EO-cum-director, Mr Lee, was wondering on the best approach to ask the FC, Mr T, to alter the profit and loss position of the financial state- ments. (Please note that in China, the senior staff of companies and Government officers were by custom addressed by their official position or title) In the GM's office in the morning Mr Zhang: Good morning, EO Lee. How are you this morning? Please sit down. Have a cup of tea. Mr Lee: Thank you, GM Zhang. Mr Zhang: Please tell me, EO Lee, what brings you here? Mr Lee: As a matter of fact, GM Chang, there is quite an urgent favour I want to ask from you. CASE STUDIES 100 Mr Zhang: Please go on Mr Lee: Mr Zhang: Mr Lee: And we are making a loss again? Mr Zhang: That was shown in the draft copy of the accounts that FC T gave me. Mr Lee: That is the financial result I cannot accept Mr Zhang: Why EO Lee? We are into the second year of operations only last year. Losing 2 years in a row is quite common for a new company. Mr Lee: I have heard that last year's financial report has been finalised? Yes, it has Mr Lee: Mr Zhang: EO Lee, please be patient. You have been with us all these years. You have been attending board meetings. You know we have been doing our best. According to FC T. we made a loss because we have not been getting sufficient logs to feed into the operations. Our factory is still operating under capacity. That may be so. But my superior at the provincial capital has been asking me as to why all the joint venture companies under me are not making money! Mr Zhang: Mr Lee: Come on GM Zhang. I have enough of that FC T. Can you trust that foreign accountant? They are all the same, they like to make an account showing a loss, to avoid paying tax. I have spoken to our bank manager. He said there is always plenty of cash in the account, never less than RMB 1 million at any one time. Mr Zhang: What you said is true, EO Lee. But since this is a joint venture, what FC T said should be followed. Besides, I have heard that these foreign accountants have to follow some rules called 'international accounting standards. Mr Lee: Nonsense, GM Zhang. Nonsense. You mean we don't have accounting standards in China? I have spoken to my friend who is a Chinese accountant. He said accounts can be changed easily. No problem at all. Besides, I have promised. my superior in the provincial capital in the year end before last, that this 'drag on head' enterprise will make a profit last year. I will lose face if you give me another bad report card, to say the least. EO Lee......this may not be as easy as you think. (Furious) Come on, GM Chang, have I not done enough for the company? I spent most my time and energy for the company. Remember those instances in which I went beyond my duty to run to the provincial capital or to Beijing to solve your problem? This is the least you can do for me! Mr Zhang: Alright, EO Lee. I will see what I can do. I will talk to FCT this afternoon You do that. You better do that! (He stormed out of the GM's office) Mr Lee: At the GM's office in the afternoon Good afternoon, CM Zhang, you want to see me? Mr Zhang: Yes, I have some urgent matters to discuss with you. But first, sit down and have a cup of tea. Is that so? How can I help you? Mr Zhang: What do you think of EO Lee as a person? He is a helpful guy. Why do you ask? Mr Zhang: What I mean is, is he helpful to the company? Has he not done quite a lot for the company? Mr T Mr T Mr T Mr T Yes. I give him credit for helping with the company registration matters. He also helps in the refund of the VAT (Value Added Tax). I remembered the occasions he went to Chang Choon and Beijing to sort out the VAT refund for us, amounting to RMB 3 million. Mr Zhang: I am glad you remember all the good things he had done for the company. So what does he want? An increase in director fees? Or an appreciation letter to his boss? Mr T Mr Zhang: None of these, FC T, what he wants is for you to do him a small favour. Mr Th And what would that be? Mr Zhang: He wants you to change the P&L to show a profit, so that he can show to his boss in the provincial capital, that he has turned the company around to a profitable state. MFT: Why would he want to do that? Mr Zhang: Presumably that is for his good report card. You know in the China Civil Services, now they are going for the merit system. Anyone with a good record to show will get a fast promotion. CASE STUDIES 102 Mr T Mr Zhang: MrT: It is not that we do not want to help him in his career. I have explained to you many times about the international accounting standards (IAS) and the Malaysian Accounting standards which are based on IAS, which are also adopted by China. And I have explained to you about the real reason of making a loss is that we are under capacity. I have made a new budget to rectify this aspect. With the increase purchase of logs spreading evenly through out the year, we will be up to full capacity. With the overseas markets expected to remain strong, we may be on our way to substantial profits in this year. Can you ask him to wait for one more year? MrT: I am afraid he can't. He seems very adamant with his demands. The principle we are all here to uphold is that the financial statements must be in accordance with the underlying records and must show a true and fair view of the affairs of the company. Furthermore, we have our accounting body's code of practice to uphold. I may lose my practice license if I change the accounting report without a basis. I assure you the final draft of the financial statement reflects true and fair view of the financial position of the company. We are making a slight loss last year, but our cash position is good, due to our stringent credit policy and good cash management practices over the last year. Mr Zhang: If you do not help him, we may lose a very good ally on the Government side. The damage could be irreversible. I am not an accountant, but can you at least look into the accountant standards again, and see if you can change the position from slight loss to slight profit? I can look into the possibility again, but I can tell you the probability of doing so is very low. Besides, I may have to inform my boss in the HQ about it. Mr Zhang: Oh, No. Please do not involve your HQ people. If you can help, help in your per sonal capacity. Notes: 1. A company could have a predetermined level of cash reserves by careful cash budgeting or planning, even if the company is suffering from losses, within a short-term time frame. Careful debtor (account receivable) and creditor (account payable) manage ment, arrangement for bank overdraft and director's loan were some of the measures that could be taken to ensure adequate cash-flow within a company. 2. The VAT refund on export was given partly for off-setting input taxes paid, but mainly as an export incentive. 3. Chang Choon is the capital of Ji Lin province, in which Antu is situated.

Answer rating: 100% (QA)

What are the liabilities of the directors in this situation for the losses and the poor business decisions The directors of the company would be liable for the losses suffered by the company as a resu... View the full answer