LAU YEE MING KATE v. SILVA JEWELLERY AND FASHION ACCESSORY LTD

DCCJ 5970/2005

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 5970 OF 2005

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JUDGMENT

1.  Silva (the Defendant) was in the business of retail of jewellery, ornaments and accessories.  Lau (the Plaintiff) was Silva’s franchisee under a franchise agreement.  Upon the early termination of the agreement, Lau expected Silva to return various deposits and to repay various sums of money.  Silva refused to do so.  Hence this action.  Silva used to have legal representation until last April.  Lim, director of Silva, represented the company at the trial.

BACKGROUND

2.  In September 2004, Lau came across Silva’s advertisement of the franchising of its retail business in a magazine.  After discussion, the parties entered into 2 written agreements – a location franchise agreement and a leasing agreement – in November 2004.  Lau had the franchise to open and to operate a shop inside the Kowloon Canton Railway Station at Tai Wai, New Territories.

3.  Upon entering into the agreements, Lau made various payments to Silva, including:

(1)	a non-refundable set up fee in the sum of HK$145,000 (clause 4.01(a) of the franchise agreement);
(2)	a leasing deposit in the sum of HK$38,415 (clause 16.01 of the franchise agreement & the leasing agreement);
(3)	an operation deposit in the sum of HK$30,000 (clause 4.01(e) of the franchise agreement); and
(4)	a vetting fee in the sum of HK$2,500 (the leasing agreement).

4.  Lau also paid the legal costs for the leasing of the shop.  During the franchise period, Lau was responsible for paying the operation cost including rates, rent, management fee and other utility charges (clause 16.01 of the franchise agreement).

5.  In return for the franchise and the operating service provided by Silva, Lau agreed to pay to Silva a monthly marketing fee of HK$1,800 if her monthly sales revenue reached HK$35,000 (clause 3.02(A) of the franchise agreement) and 5% share of the monthly sales revenue if it reached HK$60,000 (clause 4.01(b) of the franchise agreement).

6.  Lau commenced business in January 2005.  Her shop was named On On Company.  After 8 months, Lau requested for early termination of the agreements.  Parties executed a written termination agreement dated 30 August 2005.  The business continued for another 2 months.  At the end of October 2005, the shop and the unsold inventory were handed over to Silva.

7.  Apart from the return of those refundable deposits and the pro rata refund of the vetting fee mentioned above, Lau requested for various payments including:

(1)	pro rata refund of the operating cost in the total sum of HK$2,571.41;
(2)	payment for redemption of unsold products collected by Silva upon handover in the sum of HK$9,320;
(3)	payment for redemption of unsold products in August 2005 in the sum of HK$5,070, which was adjusted during trial to HK$5,023;
(4)	remittance of Lau’s business receipts in the credit card service account of Silva for September and October 2005 with late charges in the total sum of HK$43,787.10; and
(5)	balance of repayment of Lau’s business receipts in the credit card service account of Silva for July and August 2005 in the sum of HK$429.

8.  When the trial began, Lim of Silva confirmed no more dispute regarding the rates, rent and management fee as well as the balance of the credit card receipts for July and August 2005.  During trial, Lim also confirmed no more dispute regarding the pro-rata refund of the vetting fee.  During closing submissions, Lim further conceded Lau’s claim for the pro-rata refund of the legal costs of the leasing of the shop.

ISSUES

9.  Over the remaining items of claim, the dispute is as follows:

(1)	For alleged breach by Lau of the agreements, Silva disputes liability to refund the leasing and operation deposits as well as that to pay for redemption of the unsold inventory for the last 2 months.
(2)	On the basis that the records and statements submitted by Lau were allegedly inaccurate, Silva disputes liabilities to remit to Lau her business receipts for the last 2 months now in their credit card service account.
(3)	Silva also counterclaims against Lau for damages on the basis of alleged breach by Lau of the agreements and damage to Silva’s business reputation.

TERMINATION OF THE FRANCHISE

10.  Before considering the above issues, I should give an account of the circumstances surrounding the termination of the franchise.

11.  In her evidence, Lau referred to the various incidents since the commencement of the operation of the franchise business.  These included what she considered to be unreasonable behaviour and manner of Lim as well as interference with her operation of the shop.  The trigger point was however Silva’s introduction of an operation manual in August 2005.

12.  Being the franchisee, Lau was supposed to operate in accordance with such operating manuals as Silva might from time to time publish.  Silva might also from time to time revise the franchise manual to implement new or different requirements.  But the modification and change should not alter the fundamental status of Lau as the franchisee and her rights under the franchise agreement (clause 7.01 of the franchise agreement).

13.  The franchise agreement provided that Lau had the option of returning stocks unsold for 8 weeks to Silva in exchange for new stocks of equal value (handwritten provision).  Silva also covenanted to redeem all unsold stock upon the termination of the franchise agreement (clause 13.01(E) of the franchise agreement).

14.  The new operation manual introduced in August 2005 contained a set of new redemption rules.  The new rules provided that only the first batch of compulsory stock items (i.e., of new fashion) would be redeemable.  Stock items would not be redeemable.  Display items would only be redeemed when the franchise was terminated.  Items damaged or in bad condition would not be redeemed.

15.  It would appear that the new redemption rules effectively altered Lau’s contractual right to have the unsold stock redeemed pursuant to the franchise agreement.  This would be an infringement of the proviso of clause 7.01 mentioned above.  According to Silva’s pleading (para.4(b) of the Rejoinder), Lau allegedly accepted the new redemption rules at her free will.  During trial, Lim changed to say that it was his mistake or oversight of the relevant provisions of the franchise agreement when he sought to introduce the new redemption rules.  In any event, Lim’s explanation would not excuse what could have amounted to repudiation of the franchise agreement.

16.  However whether the introduction of the new redemption rules indeed constituted repudiation of the franchise agreement became immaterial because Lau did not seek to terminate the agreement on this basis.  The agreement was terminated by mutual agreement.  Noting that Lau actually paid Silva for the stock which, if unsold, could neither be kept nor disposed of at her liberty (see clause 13.01(E)), I am not surprised that Lau would take issue about the new redemption rules and finally decided to terminate the franchise early.

THE OPERATION AND LEASING DEPOSITS

17.  Pursuant to clause 4.01(e) of the franchise agreement, the HK$30,000 operation deposit is 100% refundable in 7 days upon termination if and only if the franchisee performs according to the terms of the agreement.

18.  Likewise, the leasing agreement provides that the HK$38,415 leasing deposit is 100% refundable in 7 days after termination if the franchisee is not (1) in breach of any clause of the franchise and leasing agreements; (2) in any kind of default; and (3) failing to perform any reasonable duties to the business and the franchisor.

19.  Silva alleged that Lau was in breach of the franchise agreement, including clauses 8.01, 5.07 and 5.09 thereof.

Clause 8.01

20.  It was pleaded that Lau failed to give statements and records that accurately reflected the business of the shop.   This was said to be breach of clause 8.01 of the franchise agreement.

21.  In summary, clause 8.01 provided that the franchisee should: (a) maintain at the place of business full and accurate business records; (b) submit financial statements, records and reports; (c) submit monthly sales report; and (d) give instant and full information on inventory items and explain or account for missing items.

22.  Silva specifically referred to the inventory reports submitted by Lau on 16 September and 3 November 2005.  The request for these inventory reports first came by Lim’s e-mail in September after the termination agreement was signed.  Lau was required to submit within days the monthly inventory records for the period between January and August 2005.  The records were allegedly for compiling business data requested by the KCRC, the landlord of the shop, for reference purpose.

23.  Lau acceded to Lim’s request.  The stock checklists which she kept contained entries made by her and the salespersons manually.  They were produced at the trial.  However, in relation to this KCRC request for information, Lim required all data to be entered in a systematic format.  She therefore had to put those data into an Excel format.  She managed to do so and sent the electronic copies of the reports to Lim, one (for January to August) on 16 September and one (for September) on 14 October.

24.  Soon Lim by e-mail suggested that the inventory records, sales records, credit card vouchers, etc so far submitted by Lau were in “serious trouble”, particularly for the months of July to September.  He indicated to Lau that lawyer would be consulted.  Notwithstanding that, Lau acceded to Silva’s request and submitted the inventory record for October 2005 as well.  In early November 2005, Lau sent a further summary of the inventory levels for the entire period of operation.  According to her, she had effectively done her best because the invoices, vouchers and receipts had already been handed over to Silva by then.

25.  Two things should be noted: First, it is not for Lau to prove the lack of breach of clause 8.01 to be entitled to the refund of the deposits upon early termination of the franchise.  It is for Silva to allege and to prove such alleged breach so as to deny Lau’s such entitlement.  Secondly, the deposits were held by Silva to secure Lau’s performance of the franchise and leasing agreements.  This does not mean that any breach or inaccuracy in Lau’s records should disentitle her from retrieving the deposits.  In my judgment, in the absence of a clause providing for forfeiture of the deposits in certain event (such as breach), the question should really be whether Silva could apply the deposits to cover any loss that might be caused to Silva as a result of any breach by Lau.

26.  Were the records inaccurate and did that cause Silva any loss?  According to Lau, she or her salespersons had the practice of reporting the daily sales amount to Lim or Esther Chau of Silva on the telephone.  Lim confirmed this in court.  Lau kept contact with Chau about the business though, according to Lim, Chau normally would not contact him except for serious matters.  Lau also kept daily records of the sales revenue and, as mentioned above, the stock checklists at the shop.  They were open to Lim and Chau to inspect when they came to visit the shop during the franchise period.  Lau said Lim used to visit the shop once or twice per month prior to the termination agreement.  After the termination agreement, he came more often, frequently without advance notice, and stayed relatively longer.

27.  Over the 8 months of operation before the termination agreement, Silva also issued to Lau monthly bills together with remittance of the credit card business receipts without query.  Even after the termination agreement, Lau was fair enough to inform Lim by e-mail when she discovered over-remittance of credit card receipts by Silva to her.  There is no evidence of complaint about the records Ms Lau kept until after the termination agreement.

28.  Regarding the alleged serious problems with the inventory records submitted after the termination agreement, Lau was fair enough to admit the possibility of mathematical error, particularly in view of the fact that she rushed up with the formatted inventory reports in 4 days.  By e-mail, she actually requested Lim to identify the alleged problems and offered to discuss face to face.  Lim however refused.  While Lim disagreed that the alleged problem was mathematical error, he never sought to be more specific than that.  As mentioned above, Silva had seized the invoices, vouchers and receipts.  Lau was no longer, whereas Silva should be, in a position to verify the records.  In court, Lim even said the KCRC accepted the data they submitted on the basis of Lau’s records.  It was Silva which still suspected that Lau had concealed from Silva certain improper things and matters.

29.  Allegations in relation to Lau’s records were not made clear until the letter from Silva’s solicitors in December 2005.  By then, the action had already been commenced.  It was suggested that, amongst other things, Lau had sold products other than those from Silva, made questionable withdrawals of items of stock and manipulated accounts.

30.  The evidence relied on in support of Silva’s allegation was a report from their accountant.  However the report came in as late as March 2007.  The compiler of the report did not testify during trial.  The accountant’s report on its face suggested discrepancies in Lau’s records.  The accountant offered possible explanations for the discrepancies.  Yet how this proves the alleged deliberate understatement of sales turnover, sale of outside products or accounts manipulation is not sufficiently, if at all, apparent or elaborated.  While it is alleged that Silva has thus suffered loss, Lim was not able to quantify the alleged loss.  Lim’s written closing submission to the effect that he expected to fail in discharging the burden of proof is simply regrettable.

Clauses 5.07

31.  Clause 5.07 provided that the franchisor reserved the right to visit the shop and to investigate performance and the accounts at all times.

32.  According to Lim, he sent Chau to the shop to check the operation and to carry out customer survey, in view of what was said to be surprisingly low sales turnover since August 2005.  This led to the incident on 7 October 2005 when Chau attended the shop but her stay there was refused by Lau and her husband.  This ended up with police intervention.  Lim, who thereafter attended the shop, were asked to discuss the matter at the police duty room at the station together with Lau, her husband and Chau.

33.  Lau did not deny the above incident.  She also admitted that she summonsed for the police at the time.  But she explained why.  Prior to the incident, Lim sent her the letter dated 3 October regarding the forthcoming attendance of Chau at the shop on 7 October.  However, the letter spoke of Silva’s decision that Chau would operate the shop from 7 October till the end of the month.  Further Silva would charge Lau for Chau’s service at the shop during such period.  Clearly enough, this was not a proposal to send Chau to conduct a performance investigation or customer survey at the shop.  This was a notice informing Lau of Silva’s decision to send Chau to take over the operation of the shop until handover.

34.  While the franchisor on the one hand reserved the right to conduct clearance check for 2 months before handover, Lau was on the other hand supposed to operate the business as usual during these last 2 months (clause 13.01(C) of the franchise agreement).  Lau’s opposition to the unilateral take-over of the shop’s operation during this period is understandable.

35.  Lim said that while the party was inside the police duty room on 7 October, he did explain Silva’s contractual right to visit the shop and to investigate the performance as well as to conduct customer survey.  He said that Lau affirmatively denied him such right then and there.  However, the suggestion to exercise such contractual right, if true, came only then.  Further, Lim confirmed in court that Chau had visited and conducted such performance investigation and customer survey during the franchise period.  After the 7 October incident, Silva no longer sent Chau to the shop for such purpose.  There is simply no evidence that Lau ever, or would have, objected to or hindered Chau’s visit for such purpose.  Yet this, I find, was not Silva’s purpose of the 7 October visit in the first place.

Clause 5.09

36.  Clause 5.09 provided that any person who worked for the shop should get prior approval from the franchisor.  It was pleaded that Lau had unreasonably rejected Silva’s request to dismiss the saleslady, Tam, who had been employed without Silva’s prior approval and had not performed satisfactorily at the shop.

37.  Lau explained that during the 10 months of business, the shop was operated with the assistance of various salespersons at different times.  Tam was the last one who was employed on 8 July 2005.  She was on a 3-month probation ending on 7 October.  Lau said that all the salespersons working at the shop had been approved by Silva.  In fact, Tam had also attended training provided by Chau.

38.  As mentioned above, by letter dated 3 October, Lim informed Lau of Silva’s decision to send Chau to operate the shop for the rest of the business period.  By the e-mail message dated 5 October to Lau, Lim asked her to note that 6 October was the last working day of Tam.  He also stated that police assistance would be sought if unauthorised people insisted on staying at the shop.  By letter from her solicitors, Lau objected to Silva’s assertion of right to dismiss Tam out of its own will for no reason and to assign another person in Tam’s place.

39.  On 7 October, Chau came to the shop.  She also produced a letter of the same date from Lim.  That letter on its face was to inform Lau that due to unsatisfactory performance of Tam during the probation period, Silva was not able to approve Tam’s employment.  Tam’s last day of service would be 7 October and she was supposed to hand over any keys to the shop on the same day.  Silva also asserted their right to terminate Tam’s employment according to clause 5.09 of the franchise agreement.  By the same letter, Silva threatened to take legal action if Tam continued to work after 7 October.

40.  Clause 5.09 required any person working for the shop to have prior approval of Silva.  Lim’s correspondence with Lau only suggested dissatisfaction with Tam’s performance during the probation period so that they were not prepared to “approve” her becoming a permanent staff.  By “permanent” staff, he could only be referring to the 3 weeks remaining in October 2005 before Lau had to hand over the shop.  However clause 5.09 did not stipulate the requirement of prior approval of Silva for someone who had already been working for the shop to continue working whether during or beyond probation. It was On On Company, not Silva, which was the contracting employer and which paid the salaries.  Silva could not assert the right to terminate Lau’s employee purportedly by virtue of clause 5.09.

41.  Silva’s dissatisfaction with the performance of any staff working for Lau, whether during probation or not, could only be transcribed as their dissatisfaction with the performance of Lau in operating the shop.  In my judgment, this could not amount to breach of clause 5.09.

REDEMPTION OF UNSOLD PRODUCTS

42.  Pursuant to clause 13.01(E) of the franchise agreement, in case of early termination, the franchisor shall redeem unsold jewellery products from the franchisee at 50% of the cost price.  But the franchisor reserved the right to confiscate all jewellery products if the early termination was due to the franchisee’s default or breach of the agreement.

43.  As mentioned above, the agreements were terminated by mutual agreement pursuant to clause 13.  The franchise was not terminated due to the franchisee’s default or breach pursuant to clause 12.  Therefore, Silva could not be exercising any right to ‘confiscate’ the unsold jewellery products.

44.  There is also no dispute that Silva had seized all the unsold products upon handover of the shop at the end of October 2005.  According to the pleading, Silva disputes liability unless and until Lau delivers accurately prepared records and statements in respect of the business condition of the shop up to October 2005.  Clause 13.01(E) however does not contain such a condition precedent to Lau’s entitlement.  In fact, the products unsold by August 2005 had already been redeemed and paid for without query.  In any event, for reasons already explained above, I do not find that the alleged failure of Lau to submit accurate records is proved.

CREDIT CARD RECEIPTS

45.  For the operation of the shop, Silva agreed to provide a credit card machine service (clause 3.01(7) and schedule 2(5) of the franchise agreement).  Customers using credit cards to settle their purchases from the shop would actually be paying into the credit card service account of Silva.  Silva would remit to Ms Lau by the 15^th of each month the total amount of the business receipts after deducting various expenses for the month.  Any late remittance of such credit card receipts by Silva would be subject to 5% surcharge.  Silva would issue monthly bills setting out the calculations.  There is no dispute about this being the arrangement between the parties at the time.  Silva did remit these business receipts to Lau every month up to August 2005.

46.  Lim confirmed no dispute over the amounts of credit card receipts being claimed, except for the HK$1,800 marketing fee payable for October 2005 pursuant to clause 3.02(A).  Lau fairly conceded that.  The pleaded case of Silva is that these business receipts are not repayable unless and until Lau delivers accurate business records.  However there is no evidence that the agreed arrangement of remitting the credit card receipts was subject to such condition precedent.

COUNTERCLAIM

47.  The allegations under Silva’s counterclaim for damages are various.  First, in late September 2005 (i.e., again after the termination agreement), Silva wrote and complained to Lau about various aspects of the operation of the shop, including even the cleanliness of the shop.  Then there were alleged complaints by customers about inadequate or irresponsible service provided by Tam, failure to use specified wrapping kit, misrepresentation in relation to sale coupons and discount as well as damage to customer’s property inside the shop.  It was also alleged that Lau was or could be infringing the non-competition provisions of the franchise agreement.  At the time of the pleading, it was suggested that Silva believed that more supporting facts and evidence would emerge upon further contact or inquiry with the customers.  Now the customers were named but none of them testified.  Chau did not testify either.  Lim himself did not witness any of these alleged incidents.

48.  Lau said there was no such complaint about the operation of the shop until after the termination agreement.  She had not been informed of the alleged customer complaints also until then.  But she said she had given clear instruction to the salespersons regarding Silva’s sales coupon, warranty cards and discount offers.

49.  She did not dispute that the shop had to use specified wrapping kit.  Contractually she had to do so (see clauses 3.02(B)-(D) of the franchise agreement).  But she explained there were occasions on which the shop could run out of such kits.  The correspondence between the parties evidence that she was still chasing for supply of the wrapping kit even during the last week before the handover in October 2005.  Lau would not have done that, had she not cared to comply with the specifications.  On the contrary, there is no evidence that Lim paid heed to such repeated requests.

50.  Lau witnessed and remembered how a customer’s watch was damaged at the shop which was purely an accident not our of their fault.  Lau also recalled Tam’s report of Lim’s criticism of her talking on the telephone during business hours on one day in September 2005.  What caused the argument was Lim’s demand to check her telephone call which Tam resisted.

51.  Regarding the alleged breach of the non-competition provisions of the franchise agreement, it suffices for me to say that Silva’s case on such basis was not really advanced during trial.  The pleaded allegation is hardly substantiated.

52.  All these events complained about allegedly happened or were raised when the franchised operation was approaching the agreed early termination date.  The timing of the sudden expression of substantial dissatisfaction with the performance of Lau invites scepticism.  Considering all the evidence and seeing Lau and Lim give evidence in court, I prefer the evidence of Lau to that of Lim.  I am not satisfied that the complaints are substantiated or in any event sufficiently material to found the counterclaim.  Lim is also unable to specify and to quantify, for the purpose of the counterclaim, the alleged loss to Silva’s business reputation caused by these customers’ complaints.  In fact, Mr Lim chose not to say much about the counterclaim in his closing submission.

CONCLUSION

53.  I find that the claim is established.  With the adjustments conceded by Lau, the amount proved should comprise the following:

Refund of the leasing deposit		HK$	38,415.00
Refund of the operation deposit		HK$	30,000.00
Pro rata refund of the vetting fee		HK$	1,806.00
Pro rata refund of operating cost
(i)	Rates	HK$	1,219.35
(ii)	Rent, management and air-conditioning	HK$	413.06
(iii)	Legal costs of leasing of the shop	HK$	939.00
Redemption of unsold products (as at 31/10/05)		HK$	9,320.00
Redemption of unsold products (in 8/05)		HK$	5,023.00
Remittance of credit card receipts & late charges
(i)	For 9/05	HK$	16,581.60
(ii)	For 10/05 (minus HK$1,800)	HK$	25,405.50
(iii)	Balance for 7/05 & 8/05	HK$	429.00
TOTAL:		HK$	129,551.51

54.  The counterclaim fails.

ORDER

55.  Lau shall have judgment in the sum of HK$129,551.51 together with interest thereon at 1% above HSBC prime rate from the date of writ until today and thereafter at the judgment rate until full payment.  The counterclaim is dismissed.  There is no reason why costs should not follow the event.  I make a nisi order that Silva shall pay Lau’s costs of this action, including any costs reserved.  Costs shall be taxed, if not agreed, with certificate for counsel.  In the absence of appointment to argue costs in 14 days, this costs order shall become absolute.