TSANG KA YUEN CERTIFIED PUBLIC ACCOUNTANT v. DIORVA KNITTERS LTD

HCA 2140/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2140 OF 2003

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HCA 3293/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 3293 OF 2003

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BETWEEN:-

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J U D G M E N T

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I.       Introduction

1.  The Diorva group trades in fabrics, garments and yarn.  The group includes companies operating in the Mainland, Macau and Saipan.  Diorva Knitters Ltd. (DKL) used to be the group's holding company.  But, since 1 July 1997, the ultimate holding company has been Diorva Holdings Company Ltd., a BVI company.  Diorva Garments Ltd. (DGL) is a subsidiary of DKL.

2.  Between 1997 and 2003 Mr. Tsang performed certain audit services for the Diorva group. 

3.  Mr. Tsang says that Diorva agreed that he could charge for work at an hourly rate of $2,800.  Mr. Tsang's bills for the relevant services amount to $4,430,800 in total, including 1,055 hours work in connection with an Inland Revenue Department (IRD) investigation of DKL and 127 hours work on a similar investigation of DGL.

4.  Diorva has not paid those bills. Mr. Tsang sues for the unpaid sums by these consolidated proceedings.

5.  Diorva denies ever having agreed to an hourly rate of $2,800.  Diorva claims that such a rate would have been exorbitant given Mr. Tsang's minimal auditing experience in 1997 when first engaged by Diorva.

6.  In any event, Diorva contends that the amount of hours billed is excessive and unreasonable.  By way of example, Diorva says that Mr. Tsang should have spent (and charged for) no more than 280 hours on the IRD investigations of DKL and DGL.

II.      Discussion

A.      Issue 1: Did Diorva agree to a hourly rate of $2,800?

A.1    Mr. Tsang's initial engagement

7.  Mr. Tsang became qualified to have his own accountancy firm on 1 January 1997.  Prior to that, he worked for S. W. Wu & Co. (SWW), Diorva's auditor until around 1995.  During his time with SWW, Mr. Tsang worked on audits of the Diorva group.

8.  In about March 1997, Mr. Leung Woon Ming (Diorva's then Financial Manager and himself a certified public accountant) met Mr. Tsang and asked whether he could act as auditor of the Diorva group.  Mr. Tsang said that he was prepared to do so at a fee of $2,800 per hour.

9.  Mr. Leung consulted Mr. Ng Yuen Kwan (a director of DKL and DGL) on whether Mr. Tsang's proposed rate was acceptable.  Mr. Ng agreed.  Mr. Leung then told Mr. Tsang that his hourly fee was acceptable.

10.  Following Mr. Leung's acceptance of his hourly rate, Mr. Tsang sent 2 engagement letters to Mr. Leung for Diorva's signature.  The letters differed only in that one was addressed to the directors of DKL, while the other was to the directors of DGL.

11.  The engagement letters were copied (practically verbatim) from a precedent (SAS 140) recommended by the Hong Kong Society of Accountants (now the Hong Kong Institute of Certified Public Accountants).

12.  The letter included the following paragraphs:-

"Audit

....

1.2      We have a statutory responsibility to report to the members whether in our opinion the financial statements give a true and fair view of the state of the company's affairs and of the profit or loss for the year and whether they comply with the Companies Ordinance (or other relevant legislation).  In arriving at our opinion, we are required to consider the following matters and to report on any in respect of which we are not satisfied:

a.   whether proper books of account have been kept by the company and proper returns adequate for our audit have been received from branches not visited by us;

b.   whether the company's balance sheet and profit and loss account are in agreement with the books of accounts and returns; and

c.   whether we have obtained all the information and explanations which we think necessary for the purpose of our audit.

In addition, there are certain other matters which, according to the circumstances, may need to be dealt with in our report.  For example, where the financial statements do not give full details of directors' remuneration or of loans to officers, the Companies Ordinance requires us to disclose such matters in our reports.

....

Group accounts*

2.   As auditors of the holding company we are required to report, in similar terms to those outlined in paragraph 1.2 above, on the group accounts, which comprise the financial statement of the holding company and its subsidiary and associated companies.  In order to express an opinion on group accounts which include the financial statements of subsidiary or associated companies of which we are not the auditors, it will be necessary for us to communicate directly with the other auditors concerned to satisfy ourselves that:

a.   so far as is practicable, there is uniformity within the group in the application of accounting policies;

b.   the group accounts give the information required by the Companies Ordinance, Hong Kong accounting standards and any other legislation or non-statutory requirements affecting the presentation of financial statements; and

c.   all material aspects of the group accounts have been subjected to an audit examination, the nature and extent of which is adequate and reasonable, in our view, for the purpose of forming an opinion on the group accounts.

....

Taxation services*

4.1   It was agreed that we should carry out the following taxation services on your behalf and on the basis that you will make full disclosure to us of all the relevant information.

4.2   We shall in respect of each accounting period prepare on your behalf a computation of profits, based upon the general interpretation and appreciation of the relevant provisions of the Inland Revenue Ordinance prevailing at the time of preparation of the returns.  Subject to your approval, this will then be submitted to the Inland Revenue Department, together with such statutory forms and information as may be required.  We shall on your behalf lodge objections against excessive or incorrect assessments to profits tax where notice of such assessments is received by us.  Where appropriate, we shall also make formal application for postponement of tax in dispute and shall advise as to appropriate payments on account.

4.3   We shall be pleased to advise you on matters relating to the company's profits tax liability, the implications of particular business transactions and on any other taxation matters which you refer to us.

Fees

5.   Our fees are computed on the basis of the time spent on your affairs by the partners and our staff, and on the levels of skill and responsibility involved.  Unless otherwise agreed, our fees will be charged separately for each of the main classes of work described above, will be billed at appropriate intervals during the course of the year and will be due on presentation.

Agreement of terms

6.1      Once it has been agreed, this letter will remain effective, from one audit appointment to another until it is replaced.  We shall be grateful if you could confirm in writing your agreement to the terms of this letter by signing and returning the attached copy, or let us know if they are not in accordance with your understanding of our terms of appointment.  If within one month from the date of this letter we have not received the attached copy, duly signed by you, and we have not received any other communication from you concerning the contents of this letter, the provisions contained in it shall be deemed to have become effective.

6.2*    Since the terms of our engagement as auditors of the subsidiaries listed in the attached appendix are the same, we will not send separate letters to the board of directors of each subsidiary.  We would therefore be grateful if you would forward copies of this letter to the boards of directors of each such subsidiary and confirm that these boards have also agreed and confirmed their acceptance of this letter.

....

*These sections should only be included where appropriate."

13.  Note that the engagement letters contained optional provisions (marked by an "*").

14.  Mr. Ng signed the letters on behalf of DKL and DGL respectively.

15.  In the second half of 1997 Mr. Tsang was appointed auditor of most of the other companies within the Diorva group under similar engagement letters.

16.  Following execution of the engagement letters, Mr. Tsang performed statutory audits of DKL for the financial years ending on 31 December 1995, 1996, 1997 and 1998.  Audited accounts for those years were issued in March 1997, July 1997, August 1998 and June 1999 respectively.  For those accounts, Mr. Tsang invoiced DKL $200,000; $160,000; $160,000 and $160,000 respectively.  DKL paid those invoices.

A.2    The tax investigation

17.  In July 1998 the IRD informed Mr. Leung that it intended to conduct a tax investigation of the Diorva group.  A meeting took place at Diorva's offices on the impending financial investigation audit.  The meeting was attended by Mr. Ng, Mr. Leung, Mr. Tsang and IRD representatives.

18.  After the meeting, Mr. Ng requested Mr. Tsang to handle matters relating to the financial investigation audit for the Diorva group.  Mr. Ng wanted Mr. Tsang to handle the matter personally as it was thought that it would be less wasteful if Mr. Tsang did not take time explaining the substantial and complicated inter-company transactions within the Diorva group to his subordinates.

19.  Mr. Tsang said that he was willing to act for Diorva in the tax investigation at the same hourly rate of $2,800.  Mr. Ng agreed.  No further engagement letter was considered necessary as it was thought that the optional provisions in section 4 of the engagement letters previously signed could simply be adopted.

20.  Upon his engagement to act for Diorva in the audit investigation, Mr. Tsang handled all correspondence between the IRD and the group.  He received his instructions through Mr. Leung.  Mr. Leung in turn reported to Mr. Ng, although that would be on an irregular basis as Mr. Ng was often absent from Hong Kong on Diorva business.

21.  Between July 1998 and December 2000 the IRD asked Diorva to provide information and supporting documents.  But, as a result of Mr. Ng's instructions, Diorva was uncooperative.  It disclosed only minimal information and a few documents to the IRD.

22.  On 15 March 2000 the IRD assessed DKL's profits tax for 1993-94 to 1998-99 at $15,864,500.  The IRD also assessed DGL as liable for profits tax of $2,887,000 for 1994-95 to 1988-99.  Mr. Tsang (who was formally designated as Diorva's tax representative to deal with the IRD by letter dated 17 March 2000) objected to both assessments on Diorva's behalf.  He then dealt with the IRD in relation to the latter's ensuing close scrutiny of Diorva's business and tax position.

23.  On 1 August 2002 the Commissioner of Inland Revenue determined that the IRD's original assessments should be reduced to $4,867,708 for DKL and $2,887,000 for DGL.  Revised assessments were issued in December 2002.  Mr. Ng decided that Diorva would not appeal against these revisions.  This ended the tax investigation of Diorva which had begun in July 1998.

A.3    The consolidated accounts and special audit

24.  In 2001, while the tax investigation was ongoing, Diorva's bankers asked the group to provide consolidated accounts for 3 years of business.  The bankers told Mr. Leung that they needed these accounts to assess Diorva's profitability.  Without such accounts, Diorva's banks said that they would have to consider cutting back Diorva's credit facilities.

25.  To avoid such outcome, in November or December 2001, Mr. Leung (on Mr. Ng's instruction) asked Mr. Tsang to prepare audited consolidated accounts of the Diorva group for the financial years ending on 31 December 1999, 2000 and 2001.  Mr. Leung (acting on Mr. Ng's authorisation) further requested Mr. Tsang to conduct a special audit of certain mainland companies.

26.  Mr. Tsang said that he would perform the work at his usual hourly rate of $2,800.  Mr. Leung agreed, having first referred the matter to Mr. Ng for approval.  It was not thought necessary to issue a fresh engagement letter as Mr. Leung and Mr. Tsang believed that the provisions in section 2 of the original engagement letters covered the work being requested in 2001.

27.  Mr. Tsang delivered draft consolidated accounts for the 3 financial years requested on 15 March 2003.  Finalised accounts (including an audit report) were ready for signature by Diorva on 22 March 2003.

A.4    Assessment of evidence

28.  Mr. Tsang and Mr. Leung both gave evidence to the effect that, whenever any work was requested of Mr. Tsang, it was orally agreed by all concerned (including Mr. Ng) that Mr. Tsang would be engaged at his usual hourly rate of $2,800.

29.  Mr. Ng also gave evidence.  He denied ever having authorised Mr. Leung to agree an hourly rate of $2,800.  Mr. Ng says that, although he was aware that Mr. Tsang was charging on a time basis, he never agreed to any particular rate and indeed never asked what Mr. Tsang's rate was. 

30.  Mr. Ng also alleges that he only authorised the preparation of Diorva group consolidated accounts for 1 financial year, not 3.

31.  It will be seen from the above account of facts that I have preferred the evidence of Mr. Leung and Mr. Tsang to that of Mr. Ng.  Mr. Leung's evidence corroborated and complemented that of Mr. Tsang.

32.  In contrast, I do not think that Mr. Ng's recollection of events can be treated as reliable.

33.  For example, Mr. Ng was apparently confused about the period when Mr. Leung acted as Diorva's Financial Manager.  Mr. Leung said that he acted as Financial Manager from January 1996 to April 2003.  This was not disputed during Mr. Leung's cross-examination.

34.  Despite being given many opportunities to correct himself, Mr. Ng insisted in the witness box that Mr. Leung did not become Diorva's Financial Manager until 2000.  One would have thought that, if Mr. Ng was right and Mr. Leung's evidence about his dealings as Financial Manager with Mr. Tsang between 1996 and 2000 were all wrong, Mr. Leung's statements would have been challenged as untrue.

35.  It is not surprising that Mr. Ng should be somewhat confused about chronology and events.  He is a busy man.  By his own account, during the relevant time he was often away from Hong Kong.  He relied on meetings with Mr. Leung to keep him abreast of events.  Even then, he would be unlikely to focus on the detail of matters, as opposed to merely their broad gist.  The group’s turnover was in the order of $400 million.  In the hurly-burly of the Diorva group's considerable business, it is probable that Mr. Ng would forget certain matters or have false recollections about what was or was not said at a given time.

36.  The likelihood is instead that Mr. Leung's memory of events would be more dependable and accurate.  Mr. Leung had to concern himself with the minutiae of the Diorva group's finances and accounting as part of his day-to-day work.

37.  Mr. Leung gave evidence for Mr. Tsang.  Mr. Leung no longer works for Diorva.  But there has been no suggestion at trial that his evidence has been motivated by some unhappiness while working for Mr. Ng.  Therefore, in my view, Mr. Leung's evidence can be regarded as having been given impartially.

38.  Ms. Gwilt (appearing for DKL and DGL) submits that I should prefer Mr. Ng's evidence.

39.  She suggests that it is implausible that there was any agreement to engage Mr. Tsang at $2,800 per hour.  This must particularly be the case (Ms. Gwilt says) given that no hourly rate is specified in the engagement letters of April 1997.  Ms. Gwilt argues that it is unlikely that Mr. Tsang (who only qualified to sign off audited reports on his own in January 1997) would be charging a rate of $2,800 in April 1997.

40.  I am not persuaded by Ms. Gwilt's arguments.

41.  While it would have been prudent of Mr. Tsang to specify the agreed hourly rate in the engagement letters, there is no legal requirement to do so.  The failure to state the rate does not render its oral acceptance by Diorva any less binding contractually.  The oral acceptance of Mr. Tsang's hourly rate forms part of the factual matrix against which the engagement letter (which expressly refers to a time basis charge) has to be read.

42.  In support of the contention that $2,800 was too high, Ms. Gwilt relied on the expert evidence of Mr Patrick Wong, a certified public accountant.  But even Mr. Wong declined to comment on whether Mr. Tsang's rate was excessive.  All Mr. Wong was prepared to say was that, if Mr. Tsang had worked in Mr. Wong's firm in 2002, Mr. Wong would have capped Mr. Tsang's rate at $1,000 per hour.

43.  Mr. Wong said that in 2000, with his over 20 years of experience, he was charging $4,000 an hour.  In the difficult economic environment prevalent in Hong Kong in 2002, Mr. Wong reduced his fee to $2,500 an hour.  But (Mr. Wong said) even then partners in the Big Four accounting firms might be charging as much as 80% more than Mr. Wong.

44.  There was (Mr. Wong accepted) a wide range of fees being charged by accounting firms for their services.  According to Mr. Wong, there was no requirement that an accountant of a given seniority only charge so much and no more.  A person was entitled to charge what the market was agreeable to paying for his services.

45.  In those circumstances, I am unable to say that a charge of $2,800 per hour was unreasonable or implausible for someone of Mr. Tsang's experience in mid-1997.  This is especially the case where (as I have found on the basis of Mr Leung's evidence in particular) the client actually considered and agreed to pay the fee quoted.

A.5    Conclusion on Issue 1

46.  Diorva expressly agreed that Mr. Tsang would perform all relevant work at an hourly rate of $2,800.

B.      Issue 2: Are the hours billed by Mr. Tsang excessive and unreasonable?

B.1    Billing for tax investigation work

47.  Mr. Tsang claims $2,954,000 for 1,055 hours work in connection with the tax investigation of DKL between 1998 and 2002.  He claims $355,600 for 127 hours work in connection with the tax investigation of DGL over the same period.

48.  Mr. Tsang originally charged DKL $2.3 million and DGL $200,000 for the relevant tax investigation work.

49.  The figure of $2.3 million was calculated from a starting point of $3.299 million.

50.  According to Mr. Tsang that starting point was achieved by taking the figure of $2,954,000 and adding an uplift of between 10% to 15%.  The uplift constituted an element of "appreciation" (Mr. Tsang's expression) for the significant reduction in profits tax payable by DKL.

51.  Mr. Tsang then discounted the uplifted figure by a little over 30% to arrive at a rounded down figure of $2.3 million.  The discount was given because Mr. Ng asked for one, explaining to Mr. Tsang that the Diorva group was not doing well financially.

52.  The figure of $200,000 was calculated in similar fashion. The starting point was $396,700, representing the sum of $355,600 plus an uplift of between 10% to 15%.  With a special discount of a little over 30%, the $396,700 was rounded down to $200,000.

53.  Diorva asked for a breakdown of Mr. Tsang's figures for his tax investigation work.  He therefore provided Diorva with a table setting out his working hours in some detail.

54.  Diorva having refused to pay, Mr. Tsang has since revised his bills by foregoing his uplift and special discount.  He sent revised invoices to Diorva requesting payment of amounts corresponding to the hours set out in his tables of working hours.  These revised amounts are greater than the $2.3 million and $200,000 originally billed.

B.2    Billing for consolidated accounts and special audit

55.  Mr. Tsang originally charged Diorva for the consolidated accounts and special audit by 3 invoices, one invoice for each of the 3 financial years for which group accounts were requested and each invoice for $350,000.  The total initially invoiced was thus $1,050,000.

56.  Mr. Tsang was asked by Diorva to provide a breakdown of his time spent.  He did so by a detailed table.  This came to a total of $1,121,200.  That figure was based on 238 hours work by an audit clerk (Chim Sum Yee) at $600 per hour (total: $142,800); 340 hours work by a senior audit assistant (Lau Tai Fat) at $1,000 per hour (total: $340,000); and 228 hours work by Mr. Tsang himself (total: $638,400).

57.  Diorva having failed to pay the original bills with their discounted charge, Mr. Tsang issued revised invoices in May 2003. These were based on the tables provided to Diorva and charged a total of $1,121,200, broken down as follows: $373,800 for the financial year ended 31 December 1999; $375,600 for the financial year ended 31 December 2000, and $$371,800 for the financial year ended 31 December 2001.

B.3    Assessment of evidence

58.  Ms. Gwilt submits that it was unreasonable for Mr. Tsang to charge for more than 280 hours for his tax investigation work. It is unclear what Ms. Gwilt suggests is the maximum chargeable for work relating to consolidated accounts and the special audit.

59.  Ms. Gwilt contends that there was not much to do in connection with the tax investigation.  This is apparently because Mr. Ng had decided to be uncooperative.  In those circumstances, all Mr. Tsang had to do (Ms. Gwilt suggests) was to tell the IRD that no documents or information was going to be provided.  There was no need (Ms. Gwilt reasons) for Mr. Tsang to study and analyse documents or accounts.

60.  In any event, Ms. Gwilt submits that, having previously conducted statutory audits of Diorva companies, Mr. Tsang would have been familiar with the group's operations and should not have had to take up much time analysing any accounts or documents for the purposes of the tax investigation.

61.  Ms. Gwilt relies on evidence from Mr. Wong in support of her contention that 280 hours (comprising 80 hours by Mr. Tsang and 200 hours by an account assistant) would have been more than enough for the tax investigation.

62.  As far as the special audit and consolidated accounts are concerned, Ms. Gwilt's case hinges on Diorva's allegation that Mr. Tsang was only instructed to prepare consolidated accounts for 1 financial year.

63.  I am not persuaded by Ms. Gwilt's arguments.

64.  A conventional statutory audit is different from the work required by a tax investigation.  A statutory audit is conducted on the basis of sampling.  A tax investigation, however, entails a detailed scrutiny of all a company's accounts.  It therefore does not follow that, having conducted a statutory audit of a company, an auditor would have sufficient knowledge of the company's affairs to handle a tax investigation without further extensive analysis.

65.  As far as Mr. Ng's uncooperative attitude is concerned, a accountant in Mr. Tsang's position would have to examine all of a company's accounts for the relevant years to determine what information was available and what was missing in connection with the IRD's inquiries.  Simply because a client wished to be uncooperative, would not absolve an accountant from fulfilling his professional duty of diligently examining accounting entries and advising his client as to the proper course of action to take in relation to missing or inadequate information.

66.  I do not see how Mr. Ng's stance affected the scope of Mr. Tsang's retainer and duty in any way.  Indeed, according to Mr. Wong, if a client hindered an accountant from the proper presentation of accounts and the performance of his professional duty, the accountant should consider resigning.

67.  Consider now what the tax investigation entailed.

68.  Between July 1998 and December 2002, according to Mr. Leung, Mr. Tsang had to analyse at least 2 van loads of documents relating to some 10 principal companies operating in Hong Kong, the Mainland, Macau and Saipan.  Diorva's accounts were in a mess and the reason that Mr. Ng wished to be uncooperative was in fact because so much critical information was missing.

69.  In such a situation, Mr. Tsang had to understand the detailed working of the Diorva group in order to make effective submissions, not just to the IRD, but also to the Ombudsman and the Court.  The latter 2 bodies became involved because Diorva complained to the Ombudsman's office about the IRD and sought an injunction to restrain the IRD from seeking documents and information.  Mr. Tsang assisted Diorva in the preparation of its case to the Ombudsman and the Court.

70.  At the end of his examination by counsel, I asked Mr. Leung whether he as Financial Manager was surprised by the $2.3 million which Mr. Tsang originally charged for his tax investigation work for DKL.  Mr. Leung said, frankly, that he was not.  The work involved was massive and he thought that the charge was a fair one, especially in light of the reduced profits tax which resulted from Mr. Tsang's efforts.

71.  Mr. Tai Sheung Yan who gave expert evidence in Mr. Tsang's support concurred.  He had examined Mr. Tsang's working papers and submissions to the Ombudsman (among other documents) and was adamant that the total 1,182 hours work charged to DKL and DGL for the tax investigation was not excessive.

72.  On this point, I cannot accept Mr. Wong's evidence that 280 hours would have sufficed.  For one thing, it does not seem to me that Mr. Wong had a clear idea of the amount of work which Mr. Tsang had to do.

73.  Mr. Wong based his calculation on the queries raised by the IRD in letters to Diorva.  He did not examine Mr. Tsang's working papers.  This appears to me a slim basis from which to deduce the number of hours which Mr. Tsang ought reasonably to have spent in connection with the tax investigation.

74.  For example, Mr. Leung pointed out that many IRD requests were made over the telephone, not just by formal letters.  Nor is it apparent that Mr. Wong had any idea of the volume of documents (at least 2 van loads) which Mr. Tsang had to sift through.

75.  I also cannot accept Mr. Wong's suggestion that much of Mr. Tsang's work could be delegated to an assistant.  This would have been contrary to Mr. Ng's express instruction that Mr. Tsang was to handle the matter personally.

76.  In my judgment, although Mr. Tsang obviously spent many hours in connection with the tax investigation, the time so used cannot be said to have been unreasonable or excessive.

77.  As far as the special audit and consolidated accounts are concerned, given that Mr. Tsang was instructed to prepare accounts for 3 financial years, Ms. Gwilt's argument based only on 1 financial year must fail.

B.4    Conclusion on Issue 2

78.  The hours billed by Mr. Tsang are not excessive or unreasonable.  The discounts offered to Diorva in Mr. Tsang's original invoices being unsupported by consideration moving from Diorva, Mr. Tsang is not prevented from advancing claims on revised invoices based on his hours actually spent.  It follows that Mr. Tsang is entitled to claim the unpaid amounts charged by his revised invoices.

III.     Conclusion

79.  Mr. Tsang succeeds on his claims in both actions.  There will be judgment in his favour for the total amount of $4,430,800 (that is, $4,075,200 in HCA No.2140 of 2003 and $355,600 in HCA No.3293 of 2003).

80.  Interest is to run on that total amount from 11 June 2003 (the date of the writs in the 2 actions) until today at 1% over Hong Kong dollar prime.  Thereafter, interest is to accrue on the judgment sum at the judgment rate.

81.  I will now hear the parties on costs.