INDUSTRY AUTOMATION LDC v. UNI LINK LTD AND OTHERS

HCA 12467/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 12467 OF 1998

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J U D G M E N T

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Introduction

1.  The Plaintiff is a wholly owned subsidiary of Asia Pacific Fund II (Fund).  The Fund is a limited partnership incorporated in the Cayman Islands.  Although the details have not been explained apparently this form of company can have a specified business life.  In this case it was 10 years, which could be extended twice for a period of 1 year if 75% of the partners voted in favour.  The duration of the Fund’s business life has been extended twice and expired on 31 December 2007.  The Plaintiff is now liquidating its assets.  Nothing turns on this.

2.  The Fund invested in private and public securities in Asia.  Schroder Capital Partners (Asia) Limited (Schroders) is a general partner of the Fund.  It is also the investment adviser to the Fund.  Schroders’ role was to identify investment opportunities for the Fund, assist in their acquisition, monitor them and realise them profitably within a period of 3 to 5 years, by flotation on a stock exchange or sale. 

3.  The Fund incorporated the Plaintiff to invest in the 5^th Defendant, Tarxen Promotion Company Limited (Company).  This investment came to be identified and made in the following circumstances.

4.  In 1995 the Company owned 60% of a joint venture in Wuxi called Wuxi Nanfang Conveyors Co. Limited (JV).  A Chinese company called Nanfang Hanging Conveyors Factory held the other 40%.  At the time the JV was the biggest manufacturer of conveyors in China.  The Company was owned by the Cheung Family.

5.  In 1995 Mr. Kyle Shaw met the 2nd Defendant, Madame Cheung.  At the time Mr. Shaw was a director of Tudor Global Trading Inc. (Tudor).  He began to discuss with Madame Cheung the possibility of Tudor investing in the Company with a view to it being listed in Hong Kong, Singapore or the United States.

6.  Madame Cheung was receptive to this idea and discussions concerning the proposal progressed during early 1996 and resulted in the Company and Global signing a letter of intent on 27 February 1996.  This provided that Tudor was to acquire 50% of the Company in consideration of it subscribing for shares in the Company for US$2,465,000 and making a payment to the Company’s shareholders of US$3,431,000.  Clause 3 of the letter stated that it was intended that the Company merge with a company called Autoveyor (Singapore) Pte. Limited (Autoveyor) at the same time as Tudor became a shareholder in the Company and that an initial public offering (IPO) for Autoveyor would then be sought.

7.  Shortly thereafter Mr. Shaw moved to Schroders where he became a partner.  There does not appear to be any material dispute about what took subsequently took place.  The discussions continued and it appears from a facsimile from Schroders of 14 November 1996 to Madame Cheung (Zhang as she is referred to in this and some of the other documents) that Mr. Shaw went to Wuxi to visit the JV’s factory.

8.  The discussions culminated in the signing of another letter of intent dated 10 January 1997 this time between Schroders and the Company.  The general intent of the letter was the same as that signed in February 1996 with Tudor, but certain terms changed.  The Fund was to acquire 30% of the Company’s fully diluted share capital.  The consideration was to be calculated by reference to the audited net profit of the Company for 1996.  As the letter of intent was signed in January 1997 audited financial statements were not available for this period.  It was, therefore, provided that there should be an initial partial payment and a subsequent adjustment when the audited financial statements were available.

9.  The parties proceeded to negotiate a share subscription agreement.  This went through at least 7 drafts and was signed on 5 February 1977 (Agreement).  The Agreement contained a similar provision concerning consideration in clause 2 to that which appeared in the letter of intent.  Clause 2 reads as follows:

“	2.1	The Company shall as soon as possible after the signing hereof appoint Ernst & Young, Shanghai to conduct an annual audit of the Company and its subsidiaries (the “Group”) for the 12 months ended 31 December 1996 (the “E&Y Audit”), and shall cause Ernst & Young to address the E&Y Audit to the Investor and present a copy thereof to the Investor immediately when it is ready.
	2.2	The E&Y Audit shall include an audit of the consolidated net assets and consolidated profit and loss of the Group prepared in accordance with generally accepted accounting principals in Hong Kong consistently applied.
	2.3	The Consideration shall be adjusted (the “Adjusted Consideration”) in accordance with the following formula:
		Adjusted Consideration = [(B x 4.45) x 30%] – Consideration – HK$3,888,000
		Where : B = the consolidated net income after taxation of the Group for the 12 months ended 31 December 1996 as disclosed in the E&Y Audit.
	2.4	As soon a practicable (but in any event within a period of three weeks) after the E&Y Audit is presented to the Investor in accordance with Section 2.1, the amount representing the Adjusted Consideration shall be paid by the Investor to the Company (if the Adjusted Consideration is more than the Consideration) or shall be refunded by the Company to the Investor (if the Consideration is more than the Adjusted Consideration), as applicable.”

10.  The parties anticipated that the Company’s net profit after tax would be in the order of HK$18,000,000.  This was a prediction based on the previous year’s performance.  There are apparently no audited financial statements for 1995.  The last audited financial statements of the Company was for the financial year ending 31 March 1994.  The parties did have the JV’s financial statements for its financial year ending 31 December 1995, which had been audited by Ernst & Young.  Ernst & Young’s audit report is dated 18 October 1996.  The financial statements show a profit before tax of Rmb of 29,743,543.  It will be recalled that the Company’s sole asset was its interest, 60% in 1995, of the JV.  Sixty percent of Rmb24,743,543 would be approximately HK$18,000,000.

11.  It was clear from the outset that Schroders and the Company saw Schroders involvement as having a number of benefits.  It provided an immediate injection of cash, which could be used to expand the operations of the JV.  It also provided skills necessary to initiate a listing of the Company.  The latter had dual benefits.  A listing would raise more cash for investment in the JV and add value to the Company’s shareholders interest in it, which would become trade-able on a stock market.  Mr. Anil Thaldani, the Chairman of Schroders, explained that it was always intended that the Plaintiff’s involvement with the Company would be of limited duration, in the order of 3 to 5 years, and that its investment would be realised either by an IPO or a sale of the Company.  He said that it did not matter to the Plaintiff, which it was.  What mattered was to identify which was the more profitable exit route.  It is clear that Schroders’ interest was in making a short-term profitable investment.  They were not making a long-term strategic investment in the Company.

12.  On 18 May 1997 the Company engaged Ernst & Young to provide audit services.  This is evidenced by a letter from Ernst & Young to the Company dated 9 May 1997 and signed by Tony Chan, a director of the Company and Madame Cheung’s son, on 18 May 1997.  According to the introductory paragraph of the letter Ernst & Young were engaged “to act as auditors and examine the consolidated financial statements of the Group in connection with the preparation of the financial information memorandum for the proposed public listing of the shares of the Company on the Hong Kong Stock Exchange.”  The rest of the letter sets out the detail of what this will involve and Ernst & Young’s fees.

13.  Those audit services required by the letter of engagement were never completed.  It in order to understand the relevance of this it is necessary to consider in more detail clause 2 of the Agreement.  Clause 2.2 refers to “an audit of the consolidated net assets and consolidated profit and loss of the Group prepared in accordance with the generally accepted accounting principles in Hong Kong consistently applied” (emphasis added).  Clause 2.3 includes a definition of “B”, which is a variable in a formula, which provides for the adjustment of the consideration paid by the Plaintiff for the allotment of shares in the Company: “the consolidated net income after taxation of the Group for the 12 months ended 31 December 1996 as disclosed in the E&Y audit”.  It was assumed by the parties that as a consequence of the Ernst & Young auditing consolidated financial statements of the Group for the purposes of a listing there would be an audited net income figure for the Group available for the purposes of the calculation to be done under clause 2.3 of the Agreement.

14.  It is common ground that the reason Ernst & Young did not complete the intended audit was because they could not obtain access to the JV’s factory in Wuxi.  They were prevented by persons associated with the Chinese party to the JV, in particular Huang Wei Xing the 4^th  Defendant^[1].  There is no evidence about what they wished to check at the factory.  It could not have been inventory as by the time Ernst & Young visited Wuxi it was June 1997 and, therefore, 6 months later than the end of the period of to be audited.  Perhaps it was accounting records.  I do not know as no evidence has been adduced.  As a consequence I do not know how significant the impact of Ernst & Young’s inability to enter the Factory was on their inability complete the audit.  There relevance of this is explained in the section of this decision dealing with the Plaintiff’s claim that the Agreement was frustrated.

15.  How the Chinese party managed to stop Ernst & Young entering the factory is explained in the witness statement of Madam Cheung.  Madam Cheung gave evidence on her own behalf and that of the 5th Defendant.   The only other witness who gave evidence was Mr. Thadani, who I have referred to above.  Mr. Thadani told the court that he had no reason to question Madam Cheung’s explanation.  Madame Cheung was cross-examined about what took place, but it is not suggested that her explanation was materially inaccurate.  In summary she explained that what took place was as follows.

16.  On 31 December 1995 the Company and the Chinese partner reached an agreement that provided for the following:

(1)	The transfer of part of the Chinese partner’s interest in the JV to the Company resulting in an increase in the Company’s interest from 60% to 78.2%.  The Company was to pay the Chinese partner US$576,448.60.
(2)	The Chinese partner was to inject premises into the JV.  The Company was to pay the Chinese partner US$682,872.59.
(3)	The Company was to pay a further US$261,567.81 “to actualize the principles of mutual benefit, cooperation and joint development”.

17.  These sums totalled US$1,490,000.  It was not clear when items 1 and 3 were to be paid, but the minutes of the meeting record the 2nd item as being payable “on the first financial year end”, which given the resolution was signed on 28 December 1996 and the JV’s financial year ended on 31 December was probably the end of 1997.  Nothing turns on this.

18.  The general manager of the JV was the 4th Defendant, Huang Wei Xing.  He was associated with the Chinese partner.  When he became aware of the Plaintiff’s involvement and the proposed listing he became uncooperative.  In particular he told the Company’s representatives that the Chinese partner would not agree to Ernst & Young having access to the JV’s factory in Wuxi in order to carry out audit field work unless the Chinese partner was paid the US$1,490,000 it was owed.  In addition he made demands for an increase in his own salary.  The picture that Madame  Cheung painted was of a man whose greed was stimulated by what he assumed was the large sums of money that had become available as a result of the Plaintiff’s investment.  She also suggested that others associated with the Chinese partner were taking advantage what they say as an opportunity to squeeze money out of the foreign investors.

19.  The Company’s directors all agreed that the US$1,490,000 should not be paid until after the audit for 1996 had been completed.  This lead to an impasse with Mr. Huang and the Chinese partner who used their de facto control of the factory to prevent Ernst & Young entering the factory.  Madame Cheung contacted various officials to try and get pressure put upon Mr. Huang and the Chinese partner to allow the audit to proceed.  These were unsuccessful and the audit was never completed.

20.  In order to list the Company it was necessary for audited financial statements to be available for a period shortly before an IPO took place.  The problem with the Chinese partner prevented the listing progressing.  Schroders became increasingly frustrated with this.  By the middle of 1998 they appear to have concluded that the problem was insoluble.  They also took the view that the inability to obtain audited financial statements constituted a repudiatory breach of the Agreement.  On 9 July 1998 Wilkinson & Grist wrote on behalf of the Plaintiff to Gallant Y.T. Ho on behalf of the Company asserting in paragraph 1(e) to (g) that:

“	(e)	The failure by Tarxen to produce audited accounts for the 12 months ended 31st December 1996 pursuant to clause 2 of the SSA, and its failure to furnish audited annual financial statements and monthly financial statements pursuant to clause 4 of the SA go to the root of the contract as evidence by the SSA and the SA between them, Tarxen and the Covenantors (as defined in the SSA), and clearly evidence an intention by Tarxen and the Covenantors not to be bound by their respective obligations under the said contract.
	(f)	It is therefore apparent that your clients and Mr. Chan Ting are unwilling to procure that Tarxen produce such audited accounts.  Indeed, your letter confirms that neither Tarxen nor the said Covenantors intend to perform their respective obligations under the said contract.
	(g)	Accordingly, our client regards Tarxen and the said Covenantors as having repudiated the said contract and hereby elects to rescind the same and demands payment of the sum of HK$22,159,728.00 plus interest and costs from Tarxen and the said Covenantors.”

21.  On 27 July a writ was issued.

The Claims

22.  It is pleaded in the Further Re-Amended Statement of Claim that the Company failed to appoint Ernst & Young to audit the financial statements for 1996 and as a consequence breached clause 2 of the Agreement.  This claim is no longer pursued.  The pleaded claims pursued at trial were as follows:

(1)	Paragraph 9(1):
	“	By reason of the facts and matters pleaded in paragraphs 6(2), 6(4) to 6(7) herein, the amount of the consideration payable by the Plaintiff to the 5th Defendant for the Plaintiff’s Shares was dependent on the 1996 Audit and, accordingly, the obligation of the 5th Defendant to appoint Ernst & Young, Shanghai to conduct the 1996 Audit and the obligation of the 1st, 2nd, 3rd and 4th Defendants to procure the 5th Defendant to appoint Ernst & Young, Shanghai to conduct the 1996 Audit went to the root of both the Share Subscription Agreement and the Shareholders Agreement and were conditions thereof.”
(2)	Paragraph 9(2):
	“	It was further an implied term of the Share Subscription Agreement that following the appointment of Ernst & Young Shanghai the Defendants would cause or procure that firm to carry out and complete the 1996 Audit and would cause or procure the provision to Ernst & Young Shanghai of all information and access to the books and records of the 5th Defendant and Nanfang necessary to enable the 1996 Audit to be carried out and completed and to enable the Adjusted Consideration to be calculated”
(3)	Paragraph 10.A(1):
	“	By failing and/or refusing to appoint Ernst & Young, Shanghai to conduct the 1996 Audit, and by failing and/or refusing to procure the 5th Defendant to appoint Ernst & Young, Shanghai to conduct and complete the 1996 Audit, each of the Defendants evinced an intention not to be bound by the Letter, the Share Subscription Agreement and the Shareholders Agreement and thereby renounced the same or alternatively were in repudiatory breach thereof.”
(4)	Paragraph 10.A(3):
	“	By reason of the foregoing matters, by a reply letter from Messrs. Wilkinson & Grist to Messrs. Gallant Y.T. Ho & Co, notice was given on behalf of the Plaintiff, and the Plaintiff, as it was entitled to do, accepted the said repudiatory breach of the Share Subscription Agreement as terminating the same and discharging the Plaintiff from any further obligations thereunder.”
(5)	Paragraph 11:
	“	Further or in the alternative:-
		(1)	If, which is denied, the 1st, 2nd, 3rd and 4th Defendants did procure the appointment and the 5th Defendant did appoint Ernst & Young Shanghai to conduct the 1996 Audit in accordance with the Share Subscription Agreement, the Defendants, in breach of their implied obligations set out in paragraph 9(2) above, have wrongfully failed to cause or procure Ernst & Young Shanghai to carry out and/or complete such audit and have failed to cause or procure that all necessary information and/or access was provided to Ernst & Young Shanghai to enable that firm to carry out and complete the 1996 Audit, with the result that the machinery for the calculation of the Adjusted Consideration has broken down.
		(2)	The Defendants claim that it is impossible for the 1996 Audit to be carried out as a result of the refusal of co-operation by the 5th Defendant’s joint venture partners in Nanfang and the management controlled by them.
		(3)	By reason of the aforesaid matters the Adjusted Consideration cannot be calculated and the Share Subscription Agreement has been frustrated and the Plaintiff, on surrendering the Plaintiff’s shares to the 5th Defendant, is entitled to recover the said sum of HK$18,271,728.  The Plaintiff is ready, willing and able to surrender the said shares and the certificates relating thereto on payment of the said sum of HK$18,271,728 together with interest thereon.”

23.  In paragraph 12 it is pleaded “If, which is denied, the Share Subscription Agreement has not been frustrated, the machinery for the calculation of the Adjusted Consideration has broken down and the Plaintiff has thereby suffered damage.  In these circumstances the Plaintiff is entitled to an order that the Adjusted Consideration be calculated by the Court.”  No claim pursuant to paragraph 12 has been pursued.

The Issues

24.  The issues for determination are:

(1)	Does clause 2.1 of the Agreement impose an obligation on the Company to procure the carrying out and completion of an audit by Ernst & Young of the Company’s financial statement for the year ending 31 December 1997?
(2)	If not is such a term to be implied into the Agreement?
(3)	If the answer to either (1) or (2) is in the affirmative, was there a repudiatory breach of the Agreement by the Company, which was accepted by the Plaintiff or did the Plaintiff affirm the Agreement?
(4)	If the answer to either of questions (1) or (2) is in the negative, did Ernst & Young’s failure to audit the financial statements for the year ending 31 December 1997 frustrate the Agreement?
(5)	Is Madame Cheung in breach of an obligation to procure the Company’s compliance with the terms of the Agreement.  If she is what is the consequence?

The Evidence

25.  As I have already stated only one witness was called by the Plaintiff, Mr. Thadani, and one for the 2nd and 5th Defendants, Madame Cheung.  Mr. Anil Thadani gave evidence for the Plaintiff.  As he candidly admitted he had very little first hand knowledge of the material matters.  He had been ultimately responsible for monitoring the Plaintiff’s investment.  In practice this meant receiving periodical reports from Mr. Shaw who was the partner of Schroders handling the transaction.  My impression was that Mr. Thadani was giving evidence only because Mr. Shaw was no longer with Schroders and was not willing to give evidence.  Mr. Thadani’s evidence was useful in explaining how Schroders saw an investment of the sort that is the subject of this Action, but no more than that.  As I have already noted Mr. Thadani accepted that he had no reason to doubt the veracity of Madame Cheung’s explanation for Ernst & Young’s inability to finish an audit of the 1996 financial statements.

26.  Madame Cheung was cross-examined fairly extensively by Mr. Kwan on the problems in dealing with Mr. Huang and Mr. Shaw’s involvement in the attempts to overcome this difficulty.  Although her answers were often discursive rather than to the point I found her to be an honest witness.  Mr. Kwan has not suggested that her explanation of the problems in completing the audit is untrue.

27.  Neither witness was able to explain what has happened to the Company’s interest in the JV.  Schroders, perhaps understandably given their purported acceptance of a repudiatory breach of the Agreement, seem to have lost interest in it in the middle of 1998.  Madame Cheung did not offer any explanation.  Both camps seem to have walked away in frustration from an investment that has gone wrong.

28.  I now turn to deal with the issues.

Clause 2.1

29.  Mr. Kwan submitted that clause 2.1 of the Agreement obliged the Company not only to engage Ernst & Young to carry out an audit of its financial statements for the year ending December 1996, but to procure their completion.  By this Mr. Kwan meant ensure that it was completed.  This was a strict obligation.  It was not enough, he contended, for the Company to take reasonable steps to assist Ernst & Young.  If the audit was not completed for any reason clause 2.1 had not been complied with.  Mr. Kwan argued that this was this was the natural meaning of the clause when read against the background in which the agreement was entered.

30.  Mr. Kwan put great emphasis in his submissions on the need to consider the meaning of the clause in context.  He drew my attention to Investors Compensation Scheme v West Bromwich Building Society [1998] 1 WLR 896; Jumbo King Ltd. v Faithful Properties Ltd & others (1999) 2 HKCFAR 279; Ying Ho Co Ltd. v Secretary for Justice (2004) 7 HKCFAR 333; River Trade Terminal Co. Ltd. v Secretary for Justice (2005) 8 HKCFAR 95; Ming Siu Chung v Ming Shiu Sum (2006) 9 HKCFAR 334 and BCCI v Ali [2002] 1 AC 251.

31.  There can be no dispute about the relevant legal principles, but in my view Mr. Kwan was using them erroneously and inviting me to make the type of error described by Hardie Boys J. in Benjamin Developments Ltd. v Robt Jones (Pacific) Ltd. 3 NZLR 189 at page 203 line 5 to line 25:

“

With respect, what the Judge appears to have done is allow the background to create the uncertainty of meaning and then use it again to resolve that uncertainty in a manner which is, in my view at least, contrary to the plain meaning of the words.  Such an approach is not in accordance with the authorities.  The factual background of a transaction is certainly relevant in determining which of two possible meanings should be given to a word or an expression.  For the Court’s duty is to give effect to the contractual intention, and if the words used do not make that clear then it is permissible, indeed necessary, to ascertain their objective, in the expectation that in its light the intended meaning will be revealed.  Prenn v. Simmonds was such a case, as was Reardon Smith and the other well-known case in the House of Lords in this area, L Schuler AG v Wickman Machine Too Sales Ltd. [1974] AC 235.

Where however the contractual intention is clear from the words used then the Court must give effect to it.  It is not permissible to inquire into preliminary or background matters in order to find a different meaning; that would amount to the Court holding that the parties really meant something different from what they chose to say.  See for example the observations of Mason J in the High Court of Australia in Codelfa Construction Pty Ltd. v. State Rail Authority of New South Wales (1982) 149 CLR 337, 352 and the judgments, particularly that of Robertson J, in this Court in Masport Ltd. v. Morrison Industries Ltd. (Court of Appeal, Wellington, CA 362/92, 31 August 1993).”

32.  In my view the meaning of clause 2.1 is quite clear.  The Company was to engage Ernst & Young.  It was to engage Ernst & Young to carry out an audit.  The language does not suggest that the Company was guarantying that an audit would be completed come what may.  One does not need an understanding of the background to ascertain what clause 2.1 means.

33.  In any event I see nothing in the circumstances in which the agreement came to be made that would suggest that clause 2.1 should be read in any other way.  It is not in dispute that both parties anticipated that an audit would be completed, but that in itself does not cause me to read clause 2.1 as submitted by Mr. Kwan.

Implied Term

34.  Mr. Kwan next argued that if I did not agree with his reading of clause 2.1 the court should find that a term be implied to the same affect.  There is no dispute about the circumstances in which a term is to be implied.  The test of implication is necessity: Tai Hing Cotton Mill Ltd. v Liu Chong Hing Bank Ltd. [1986] AC 80 (PC).  The term must be necessary in order to make an agreement workable in such manner as the parties would have chosen if they had applied their mind to the contingency that had arisen; what is commonly referred to as the “officious bystander” test: Shell UK Limited v Lostock Garage Ltd. [1976] 1 WLR 1187.  The implication must give effect to the presumed common intention of the parties.  If the court has doubts whether one party would have agreed to the term, the court should not imply it Luxor (Eastbourne) Limited v Cooper [1941] AC 108.

35.  It seems to me far from clear that if the parties had contemplated at the time the Agreement was made whether the Company should be placed under an obligation to ensure that an audit was completed either of them would have thought this was appropriate and it seems to me highly doubtful that the Company would have agreed.  No doubt if they had contemplated exactly the permutation of events that transpired they would have come up with some mechanism for dealing with it, but I cannot say with any confidence what that might have been and it is not for the court to create terms, which it considers reasonable in such circumstances.  At one point in his written Closing Submissions Mr. Kwan seemed to be relying on a passage in a judgment of Chadwick L.J. in Bromarin AB & another v IMD Investments Ltd. [1999] STD 301 at page 310g-j to suggest that this is what the court should do, but in his oral submissions he accepted that this would be an erroneous approach.

36.  I, therefore, reject the claim that there has been a breach of contract.

Affirmation

37.  If I had concluded otherwise I would have found that the breach was repudiatory, but that the Agreement was not terminated because the Plaintiff affirmed the Agreement for the reasons set out below.

38.  The Defendants argued that if there had been a repudiatory breach of the Agreement the right to terminate the Agreement had been lost because the Agreement had been affirmed.  Mr. Ng argued that given the Plaintiff’s argument a repudiatory breach arose if audited financial statements had not been produced in a reasonable period.  Once a reasonable period had expired the Plaintiff has a reasonable period to make its election.

39.  Mr. Ng submitted that what is a reasonable period for producing the financial statements depended on the circumstances, with which I agree, and that in the circumstances a reasonable period had expired in July.  Mr. Ng relied on the following undisputed matters.  It was Mr. Shaw’s intention stated clearly before the Agreement was signed to seek a listing before the end of 1997.  Ernst & Young provided a draft letter setting out the terms of their proposed engagement dated 9 May 2007, which the Company signed accepting the terms on 18 May 1997.  The letter stated that they would produce their first draft report on 16 June 2007.  Ernst & Young tried unsuccessfully to visit the factory at Wuxi on 21 and 27 June 2007.  There were no further attempts by Ernst and Young to visit the factory.  Mr. Shaw knew this.  Mr. Shaw was also fully aware of the problems with the Chinese party and the attempts to resolve the problems.  It follows, submitted Mr. Ng that by July the Plaintiff knew that there was no prospect of audited financial statements being produced in the near future and no prospect of a listing taking place in 1997.  Thus a reasonable period for the production of the financial statements must have expired long before the purported acceptance of the alleged repudiatory breach on 9 July 1998.

40.  By continuing to exercise the rights of a shareholder long after it became clear that audited financial statements would not be completed within reasonable time the Plaintiff affirmed the Agreement.

41.  I agree.  If the Plaintiff is correct that clause 2.1 imposed an obligation on the Defendants to procure audited financial statements, that obligation must have been to procure them with a reasonable period having regard to their purpose, namely, to determine any necessary adjustment to the consideration and to enable the parties to move forward promptly with a listing.  I note that in paragraph 58 of his written Closing Submissions Mr. Kwan puts it higher than this.  He says that the audit had to be conducted as soon as possible.  It must follow that such a period had expired well before July 1998 and certainly before the end of 1997.  Mr. Kwan submitted that they should have been completed by October 1997 at the latest.

42.  It would seem to common ground, and I so find, that the Plaintiff continued to exercise the rights of a shareholder and press for performance of the Agreement long after any repudiatory breach occurred.  What is the consequence of this?

43.  The law is quite clear.  If an innocent party unreservedly continues to press for performance after becoming aware of the breach he will be held to have affirmed the contract : Chitty on Contracts, 29th ed., Vol. 1, para. 24-003.

44.  In my view by failing to accept the repudiation that the Plaintiff alleged took place by the end of October 1997 and continuing to press for performance of the Agreement it clearly affirmed the Agreement and lost any right it had to terminate it.

Frustration

45.  The Plaintiff claims in the alternative that the Agreement has been frustrated.  Mr. Kwan argued that the inability to obtain audited financial statements was an unforeseen event, which frustrated the purpose of the Agreement.  Mr. Kwan put his argument in two ways.  In summary they were as follows.  First, Mr. Kwan argued that the commercial purpose of the Agreement was for the Plaintiff and the Company to acquire a stake in the Company and then for them to work together to list or sell the Company at a profit.  This was not possible if the financial statements were not audited.  The Agreement was thus frustrated.  Secondly, he argued that matter could be looked at more simply.  The payment of consideration was a fundamental element of the bargain between the parties.  It could not be calculated, therefore, the Agreement was frustrated.

46.  Lord Simon of Glaisdale explained the circumstances in which a contract is frustrated as follows in National Carriers v Panaplina [1981] AC 675 at page 700F:

“

Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged form further performance.”

47.  The first question to ask is this: what contractual rights and obligations are outstanding?  This question is to be answered on the assumption that clause 2.1 required the Company to do no more than appoint Ernst & Young for the purpose of carrying out an audit rather than procure that the audit was completed.  On this assumption in my view the only outstanding obligation of either party is that under clause 2.4, which requires a party to pay the other party such adjustment to the consideration as results from the operation of clause 2.3.

48.  I do not accept that the outstanding obligations or rights of the parties should be viewed as linked to the ability or otherwise of listing or selling the Company.  The Agreement was one part of a commercial venture that envisaged the Company being listed or sold; but it was one discrete part.  Another part was the shareholders agreement, which is the contractual document, not the Agreement that refers to the Company being sold or listed.  In addition to the contractual arrangements between the parties there were commercial hopes, expectations and plans, but they do alter the essentially simple and single purpose of the Agreement, namely, that shares are be allotted to the Plaintiff and paid for by it.  In my view on a proper analysis of the Agreement the inability to list or sell the Company has nothing to do with the any difficulty that may exist with calculating an adjustment to the consideration payable for the shares allotted to the Plaintiff.

49.  The next question to be asked is this: has it been demonstrated that events have occurred that impact on the outstanding performance of the Agreement beyond what could reasonably have been contemplated at the time the Agreement was executed and which would make it unjust to hold the parties to the Agreement?  In my view it has not been so demonstrated.

50.  In order for the adjusted consideration to be calculated it was necessary for there to be a net income figure derived from financial statements for the Group for the year ending 31 December 1996 audited by Ernst & Young.  It is not in dispute that Ernst & Young did not complete the audit process.  However, I do not accept that it has been demonstrated that audited financial statements could not have been produced that satisfied clause 2.

51.  Clause 2.2 required the preparation of a consolidated balance sheet and profit and loss account for the Group.  Ernst & Young were to audit the consolidated balance sheet and profit and loss account and provide an audit report commenting on whether or not they presented a true and fair view of the financial state of the Group as at 31 December 1996.  Audit reports sometimes contain disclaimers and qualifications.  This occurs if the auditors are for some reason not able to state categorically that the financial statements are true and fair.  Clause 2 did not require a report with no disclaimers or qualifications; what is commonly called a “clean” report.  If a qualified report had been produced it would then have been for the parties to decide whether the qualifications were sufficiently serious to cast doubt on the reliability of the accounts and whether or not they fell short of what clause 2 envisaged.

52.  The documentary evidence does not record any apparent concern in 1997 on the part of either party about the fact that it was not possible to calculate whether an adjustment to the consideration had to be made.  Neither witness suggested that this was considered a pressing issue in 1997.  The documentary evidence suggests that Mr. Shaw was concerned about the delay in the completion of the audit because of its impact on the proposed listing.  Neither party seems to have considered the possibility that Ernst & Young could have carried out an audit, which would be satisfactory for the purposes of clause 2 even if it was not satisfactory for the purpose of a listing.  The concern seems to have focused almost exclusively on the impact on the proposed listing.  No distinction was drawn between what was required from Ernst & Young under the terms of their engagement for the purposes of a listing (which would presumably have included a clean audit report) and what was required by clauses 2.2 and 2.3.

53.  As a consequence neither party suggested that Ernst & Young should do the best that they could with the financial information available.  There were, for example, management accounts for the Company for April 1996 to March 1997 appearing in the trial bundle.  I note that these show a net profit for the 9 months ending 31 December 1996 of HK$22,732,047.40, which is broadly consistent with the audited financial statements for the JV in 1995.  There was also a draft consolidated profit and loss account for the year ending 31 December 1996 showing a net profit for the Company for the year of HK$24,393,569, which were sent by the Company’s financial controller to Mr. Shaw on 6 October 1997.  Mr. Shaw does not appear to have replied suggesting that he believes the draft accounts to be inaccurate.

54.  I note also that it has not been suggested by the Plaintiff that anything was repayable to it.  The Plaintiff says it simply does not know.  Mr. Kwan told me that the Plaintiff’s calculations showed that if the consolidated net income of the Group was more than HK$16,600,000 for 1996 further consideration was payable by the Plaintiff.  If it was less the Plaintiff was entitled to repayment of part of the consideration that it had paid.  Mr. Ng did not take issue with the accuracy of this calculation.

55.  If the profit figures referred to in paragraph 52 were correct it would have resulted in the Plaintiff having to pay further consideration.  Mr. Kwan suggested that this conclusion could not be properly drawn because the Chinese partner had produced financial statements for 1996 audited by Wuxi Liangxi Accounting Firm showing a net profit for 1996 of RMB 2,521,064.99.  As the Company’s profits for the year would be a percentage of those profits it suggested, Mr. Kwan submitted, that the management accounts might be wrong.  Accordingly, no assumption about what the position might be could be safely made.  In my view the evidence suggests strongly that the management accounts which are consistent with the financial statements audited for 1995 by Ernst & Young are a fair indication of what the final figure would be and that the figure of RMB 2,521,064.99, which was produced by the Chinese partner at a time when it was in dispute with the Company, is rather more likely to be a fabrication.  Mr. Kwan could not point to anything other than the financial statements audited in Wuxi to suggest that there might be an error in Ernst & Young’s figures.  I note that nowhere in the contemporaneous correspondence from Mr. Shaw does he suggest that he had suspicions that the figures produced by the Company.

56.  Even in the period leading up to the purported acceptance of the repudiatory breach on 9 July 1998 the letters from Schroders, although making reference to the absence of audited financial statements, made no reference to a concern about the difficulty in calculating an adjustment to the consideration, see for example, Schroders’ letter of 22 March 1998, 24 March 1998 and 8 April 1998.  The letter of 8 April 1998 is particularly instructive.  It lists alleged breaches of the Agreement and the shareholders agreement of 15 February 1997.  It states in the final paragraph that the alleged breaches are “so fundamental” as to entitle the Plaintiff to a total refund of its investment.  The list of alleged breaches does not include a reference to the adjustment of the consideration.  It appears that once the Plaintiff had decided that there was no realistic prospect of the Company being listed or sold it looked for a reason to claim its money back.  I see nothing in the evidence to suggest that this had anything to do with a genuine concern about the difficulty in operating clause 2.

57.  I dismiss the claim that the Agreement was frustrated.

Shareholders Agreement

58.  In paragraph 63 of the Plaintiff’s Closing Written Submissions judgment is sought in terms of the Prayer to the Further Re-Amended Statement of Claim.  In paragraph (1) of the Prayer the Plaintiff seeks a declaration not only that the Agreement has been terminated and the Plaintiff discharged from further performance, but also that shareholders agreement dated 15 February 1997 has similarly been terminated and the Plaintiff discharged from further performance.

59.  The ground on which such relief is sought is pleaded in paragraph 10A(1) of the Further Re-Amended Statement of Claim.  It is the same grounds for contending that there has been a repudiatory breach of the Agreement.  Mr. Kwan made no submissions in respect of this claim, which I dismiss.

Claims against the 2nd Defendant (Madame Cheung)

60.  It follows from my dismissal of the Plaintiff’s claims against the Company that the claims against the 2nd Defendant are also dismissed.

61.  If I had found in the Plaintiff’s favour in respect of its claim that there had been a repudiatory breach of the Agreement by the Company that had been accepted thus terminating the Agreement, I would have found that Madame Cheung was in breach of her agreement contained in recital D of the Agreement and that she was to pay by way of damages the shortfall, if any, between the amount recovered from the Company and the amount originally paid to it by the Plaintiff.

62.  There is no claim against Madame Cheung consequential on a finding that the Agreement is frustrated.

Judgment

63.  I dismiss the Action.  I make the following costs order nisi, which will become absolute unless the court receives notice that either party wishes to apply to have it modified within 14 days of the date of this judgment.  The Plaintiff shall pay the costs of the Action to the 2nd and 5th Defendants on a party and party basis.  The costs shall be taxed if not agreed.