CHAN CHEUK KIT v. SMARTA INNOVATION TECHNOLOGY CO LTD AND ANOTHER

DCCJ 3564/2021

[2024] HKDC 49

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO 3564 OF 2021

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J U D G M E N T

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Decision

1.  This is the trial of a contract dispute.

2.  The 1^st Defendant (hereinafter referred to as either “D1” or “the Company”)  has not entered into appearance in these proceedings up to this trial hearing.

3.  The 2^nd Defendant (“D2”)  was legally represented and filed a Defence, which was subsequently amended.  Since 27 October 2022, D2 has acted in person.  He did not file any witness statement as directed. D2 was absent from the case management conference held on 22 February 2023, and the PTR on 30 October 2023. He did not attend this trial either.

4.  This Court is satisfied that both Defendants were duly notified of this trial hearing, and it is appropriate to proceed in their absence. See : Order 35 rule 1 of the Rules of District Court (“the RDC”).

Plaintiff’s case

5.  In essence, the Plaintiff (“P”)  claims for the recovery of a loan of HK$1.5 million with interest from D1 and D2 under contract. 

6.  According to P, on 9 February 2021, he entered into an agreement with D1 and D2 to purchase D2’s shares in D1 (“the Agreement”).  D2 also acted as a guarantor to guarantee the due performance of D1’s obligation under the Agreement. 

7.  At all material times, D2 was the sole shareholder and director of D1. 

8.  Under the Agreement, among other things,

(1)  P agreed to purchase D2’s 51% shares in D1 (“the Shares”)  at a consideration of HK$2 million.  An initial payment of HK$1.5 million was made on 9 February 2021 (“the first payment”).  The balance of HK$500,000 shall be paid upon the completion of the shares transfer. 

(2)  Under clause 5 thereof (as quoted below), if the shares transfer cannot be successfully completed (成功入股), the first payment shall be treated as a loan from P to D1 and D2.  In that case,

(a)  P would then be entitled to charge a monthly interest of 1% on the loan.

(b)  The loan and interest shall be repaid to P within 3 months from the date of deposit of the loan into D1’s designated bank account.

“(5)  如甲方在放款3個月內沒有成功入股乙方公司,該筆款作為乙方及丙方自願向甲方借款, 借款利率為借款本金的1%/月,借款利息為港幣壹萬伍仟元整(HK$15,000.00)/月,從款項到達乙方賬號之日起算; 本金,利息應於三個月期滿後三日內支付。...” (emphasis supplied)

(3)  Under clause 8 (as quoted below), D1 warranted that the Company did not have any outstanding debts/liabilities or ongoing litigation when the Shares were transferred to P upon the completion.

“(8)  乙方須保證上述甲方入股公司沒有任何負債或法律訴訟在進行中,若日後有任何在完成股份轉讓日或之前已存在之債務或訴訟所引起之有關財務法律責任,需由乙方全權負責。” (emphasis supplied)

(4)  Under clause 6 (as quoted below), D1 shall in accordance with the Agreement assist P to have the shares transfer effectively completed, failing which, D1 shall repay the loan and interest at 1% per month for the first 3 months, and thereafter at 3% per month in case of default of repayment.

“(6)  乙方應按約定協助甲方順利入股乙方公司,如甲方在3個月期限內未能入股乙方公司, 乙方應按約定還本利息,乙方未按期還款的,應從借款限期日之次日起,按逾期還款金額月息3%向甲方支付違約金。” (emphasis supplied)

9.  On 7 May 2021 (i.e. 2 days before the completion date)[1], P received a letter from D2’s solicitors, Messrs H.Y. Leung & Co, enclosing a bundle of documents, among which was D1’s audited report for 2020/2021 (“the Audited Report”)  indicating that there was an outstanding net current liabilities of HK$4,054,567[2] (as at 31 March 2021).

10.  In passing, it is observed by this Court that there is no evidence that the magnitude of such liabilities of the Company had actually been reduced by any or any significant extent before the completion date on 9 May 2021.

11.  On 11 May 2021[3], P instructed his solicitors, Messrs. Tse Yuen Ting Wong, to write to Messrs H.Y. Leung & Co pointing out, among other things, that D1 had not provided all the relevant documents as required under clause 5, and also D1’s failure to comply with clause 8 of the Agreement given the Company’s current liabilities[4] as shown in the Audited Report.  The letter also stated that, as such, P decided not to complete the shares transaction, but would demand according to the contract terms for the immediate repayment of the loan and interest.

D2’s pleaded case

12.  In my view, D2’s pleaded defence to liability can be summarized into 3 main points as follows:-

(1)  P was in repudiatory breach of the Agreement by refusing to execute the required documents for the shares transfer.  As such, P should not be allowed to take advantage of his default to treat the first payment as loan or charge interest accordingly. (“defence point 1”). 

(2)  Upon construction of clause 8 of the Agreement, P was obliged to complete the shares transfer notwithstanding any pre-existing liabilities or pending litigation of D1 (“defence point 2”).

(3)  P was estopped from denying that he was bound to complete the shares transaction because of an alleged common assumption, and the parties’ conducts proceeding thereon as particularized in the Defence.  D contended that, in gist, P had already obtained significant managerial control over D1 upon or soon after entering into the Agreement. (“defence point 3”).

13.  In addition, D2 also counterclaimed for P’s specific performance of the Agreement to complete the shares transfer, damages in lieu and/or in addition to specific performance, and other incidental reliefs.

14.  On the other hand, it is worthy to note in D2’s Defence that :-

(1)  P’s deposit of the sum of HK$1.5 million into D1’s designated account was admitted;

(2)  Although D2 did not admit D1’s outstanding liabilities as stated in the Audited Report, he did not go on to plead any positive case to suggest that the figures therein are incorrect in any respect.

15.  In my judgment, for the proper resolution of the present dispute, the issues would boil down to whether clause 5 of the Agreement was legitimately engaged, thereby enabling P to treat the first payment as a loan under the contract.

P’s witnesses

16.  According to P, he got acquainted with D2 in about August 2020 when both of them participated in the setting up of Hong Kong Mask & PPE Association Limited (“the Association”).  Apart from P himself, he arranged two other witnesses to give evidence for him.  One being his father, Mr Chan Yat Man (“Chan Senior”), who first came to know of D2 through the introduction by P in January 2021.  Chan Senior is a merchant having his own business and being a director and shareholder of a company called Homebridge Industrial Limited.  Another witness is Ms Lilian Siu.  At all material times, she was responsible for attending (as P’s representative)  certain directors’ meetings in the Association, in which D2 was the Chairman and P was the Vice-Chairman at the time.  They have prepared altogether 3 witness statements to substantiate P’s case and rebuke the contentions or allegations made against P in the Defence.   All three of them have attended this trial to testify.

P’s application to provisionally strike out D2’s Counterclaim

17.  At the outset of this trial, Miss Josephine Tjia, P’s counsel, made an application to provisionally strike out D2’s counterclaim pursuant to Order 25 rule 4(2)  of the RDC.

18.  A similar application was also made at the PTR, but the then presiding deputy judge considered it appropriate to defer the matter for the trial judge’s further direction and disposal.

19.  In my view, such application is longer necessary at this stage, when D2 did not show up at the trial to maintain his Counterclaim, nor adduce any evidence to substantiate the averments made therein.  As such, the Counterclaim ought to be dismissed outright (not just provisionally), and I so ordered.

20.  In P’s application, the Court was also invited to go one step further to exercise its case management power to strike out D2’s Defence (after striking out of the Counterclaim), and to grant leave to P to enter judgment on his claim without a full trial, mainly because of D2’s long absence in these proceedings.

21.  However, this Court has already read the papers in advance, and considered Miss Tjia’s opening submissions setting out comprehensively her arguments as to why clause 5 was properly engaged and other fallback arguments.  This Court do see it just and proper to determine substantively whether the key issue in this case should indeed be resolved in P’s favour on the evidence before it.

22.  After the exchanges between the Bar and the Bench on this matter, Miss Tjia fairly agreed that P’s application should be withdrawn.  Accordingly, leave was granted for P to do so with no order as to costs.

Is clause 5 engaged?

23.  After carefully considering the evidence and construing the terms of the Agreement as a whole against its relevant factual background, this Court comes to a clear view that clause 5 is properly engaged allowing P to seek recovery of the sum of HK$1.5 million and the contractual interests.

24.  As point out above, clause 5 is the invoking clause which turned the first payment originally intended for the purchase of the Shares into a loan under the specified contractual mechanism.

25.  On the available evidence, this Court finds that D1 was in breach of its warranty given under clause 8 since there were still outstanding debts or liabilities on 9 May 2021, i.e. the date by which the shares transfer has to be completed, the latest (“the Completion Date”)  according to clause 9 of the Agreement, which provided that:-

“(9)  乙方收妥第一期入股款項三個月內須簽妥正式出售股之轉讓文書及完成是項股份轉讓交易。” (emphasis supplied)

26.  It was pleaded in the Defence that the figure of the outstanding liabilities only reflected the Company’s financial position as of 31 March 2021, but not on 6 May 2021.  However, notably, when D2 instructed his solicitors to send the Audited Report to P on 7 May 2021 (knowing full well D1’s warranty and his guarantor’s obligation under the Agreement), it would be natural to expect D2 to instruct his solicitors to clarify the updated figure of D1’s outstanding liabilities (if it really became significantly lesser by 6 May 2021), but no clarification of that sort can be seen in his solicitors’ letter, not even up to the time when his Defence was filed. P also testified at the hearing that he heard nothing further from D2 about the outstanding debts or liabilities of the Company before his solicitors sent out their letter on 11 May 2021 as mentioned above.

27.  Therefore, after carefully considering all the evidence before me, I find that more likely than not the net current liabilities of the Company on 9 May 2021 would be of a similar magnitude as those stated in the Audited Report, i.e. around HK$4 million, and this amount would also serve as prima facie evidence of the Company’s debts or liabilities (負債)  as mentioned in clause 8 on that date.

28.  Although the Defence further pleaded that prior to entering into the Agreement, D2 had told P that he had no intention to get back a sum of HK$2,654,488 as owed by D1 to him as director (which figure was also mentioned in the Audited Report), such allegation is denied by P.   Fundamentally, D2 did not show up to prove his case.  Such plea and all the other factual averments made in the Defence without any evidence adduced by D2 in support are rejected by this Court.

29.  Without prejudice to anything aforesaid, even if this sum of about HK$2.65 million was disregarded purely for the sake of argument but not the otherwise, prima facie the Company still had an outstanding liability to the tune of about HK$1.4 million (in stark contrast to no debts or liabilities as warranted under clause 8).

30.  For completeness sake, D2 further contended that among the current liabilities as stated in the Audited Report, a sum of HK$1.7 million was stated to be ‘due to a related party’,  and out of which, HK$1.5 million came from the first payment, and the balance of HK$200,000 was subsequently paid into D1’s account by P in March 2021.

31.  The latter allegation was likewise denied by P, and Chan Senior also corroborated P’s case testifying that the sum of HK$200,000 was in fact a personal loan lent by him to D1 and has no direct relevance to the Agreement. I accepted P and his father’s unchallenged evidence in this regard.

32.  As for the sum of HK$1.5 million paid by P under the Agreement, even assuming that that sum was really so booked as contended by D2 (though there is strictly speaking no evidence before me to show that this was indeed so), such sum would in my view still be qualified as a debt or liability (負債)  under clause 8 according to its plain and ordinary meaning.  This is because, irrespective of how the sum was booked in reality, as between P and D1, D1/D2 had obtained an equivalent amount of cash at their own disposal, and there is a myriad of possibilities of how they would make use of the same, such as investing into the Company’s plants and machines, paying its suppliers or employees, or even using it or any part thereof to reduce D1’s liabilities as owed to D2 as its director, so on and so forth.  However, this Court needs not to speculate.  What really counts is that according to the unchallenged evidence of P before me, P would have no say as to how D2 (being D1’s sole director)  actually managed D1’s business operation or finance, nor how to book its accounting transactions.  And when D1 had made an assurance that no debt or liability would be outstanding on the Completion Date, it had to stick to its bargain as seen in the above light.

33.  In the light of the aforesaid, the occurrence of the breach of D1’s warranty as provided under clause 8 would, in my view, mean that D1 also failed its obligation under clause 6 to assist P to effectively complete the shares transfer in accordance with the Agreement.

34.  Speaking business common sense, whether the Company still has substantial outstanding debt or liability to discharge on the Completion Date would naturally be a matter of importance to P, qua the purchaser of the Shares.  Thus, the warranty given by D1 about the Company’s creditworthiness is particularly material.

35.  In fact, the Audited Report is one of the essential documents that must be provided by D1 within 3 months of the receipt of the first payment as specified in clause 4 (as quoted below). If this cannot be done, the shares transfer would be deemed not having been successfully completed.  No doubt, the Audited Report would help P verify whether D1’s warranty of the Company having no outstanding debts or liabilities on the Completion Date could be fulfilled or not.

“(4)  乙方應在收到入股款項三個月內將公司一切有關的文件,例如:公司註冊證書、 圖章、憲法、會議記錄及核數報告等交與甲方,及應甲方要求提供公司相關資料, 如未完成前述任何一項均視為甲方沒有成功入股乙方公司。”

36.  In the light of the aforesaid, when clauses 4, 5, 6, and 8 are read alongside with each other against the whole Agreement, they can be fairly and reasonably construed to mean that in the event that the Shares could not be transferred to P with the warranty honoured at the same time on the Completion Date, this would prima facie amount to a scenario as reasonably contemplated by the parties under clause 5 that the shares transfer was not successfully completed. 

37.  In other words, in my view, the term of “unsuccessful completion of the shares transfer” (沒有成功入股)  as provided in clause 5 would not necessarily be confined to D1’s failure to provide the Company’s documents in accordance with clause 4, but would be wide enough (as submitted by Miss Tjia)  to cover the present situation where P chose not to complete as prompted or induced by D1’s breach of the warranty as provided under clause 8. 

38.  In my view, the above construction also fits well with the practical object of the Agreement against the factual background of this case.

39.  At first, P was attracted by D1’s business prospect that he was told by D2 in October 2020 that D1 had secured a lucrative licence from a supplier Mainetti (HK)  Ltd for mass-producing 2 to 3 million of face masks.  This prompted him to negotiate with D2 about their potential co-operation, which eventually led to the signing of the Agreement. 

40.  But when it came to about early February 2021 (before the Agreement was entered into), according to P and Chan Senior’s testimony, D1 had run into some financial or cashflow difficulties (which to a certain extent is also supported by some contemporaneous documents disclosed in the trial bundle).  Under such factual matrix, it would appear to this Court that one practical object of the Agreement would be for P to secure an immediate escape route to back out of the shares purchase transaction if the Company’s financial health cannot be properly restored to a level acceptable to him by the Completion Date, as reflected by the putting in place D1’s warranty under the contract. 

41.  It is worthy to note that the first payment of HK$1.5 million already amounted to 75% of the shares purchase price.  Even if the shares transaction cannot be successfully completed, D1 can still take the benefit of the short-term loan (as converted from the first payment for the shares purchase)  in facilitating them to carry out their business operations or projects and/or to ease their cashflow problem at the time.

42.  Viewed thus, as a matter of freedom of contract, the subject contractual construction would not be harsh to Ds when the warranty they proffered to P could not live up to its worth in the first place. 

43.  On the other hand, if D1 cannot fulfill the warranty of the Company’s creditworthiness, it does not seem commercially sensible (against the present factual matrix discussed above)  that P would still be compelled to proceed with the completion to take up the Shares which value was now substantially lower than what he had bargained for. 

44.  To construe the otherwise would effectively allow D1 (and D2 behind)  to take the benefit of its own wrong (by the default in complying with the warranty), thereby yielding unreasonable commercial consequences, which this Court should not lightly ascribe to be within the parties’ reasonable contemplation when the contract was made. See : Lewison on The Interpretation of Contracts (6^th ed), para 7.17.

45.  For completeness sake, this Court have not lost sight of the latter part of clause 8, which provided that “... 若日後有任何在完成股份轉讓日或之前已存在之債務或訴訟所引起之有關財務法律責任，需由乙方全權負責。” (emphasis supplied)

46.  In my judgment, bearing in mind the factual background and practical object of the Agreement, this provision can reasonably be construed to cater for a contingency that when it was subsequently discovered after the actual completion of the shares transfer (日後)  of some pre-existing debts or liabilities which had somehow been unknown to P or D1 or both before the completion, it was made clear that it would still be D1’s responsibility to discharge liabilities of such kind.  In other words, the provision under this part of clause 8 can equally be consistent with this Court’s construction of the other provisions of the Agreement as discussed above.

47.  Given the above proper perspective, I now turn to defence point 1.  In the light of the above analysis, this Court has no hesitation to find that P has committed no breach of the Agreement (let alone repudiatory breach as contended by D2)  by refusing to complete the shares purchase owing to D1’s prior breach of warranty under clause 8 in the circumstances discussed above.

48.  For the avoidance of doubts, the term ‘warranty’ here was adopted from P’s English translation (as pleaded in the Statement of Claim)  of the term (保證)  in Chinese as actually stated in clause 8.  Here, the term of ‘warranty’ (保證)  used in this judgment should not be equated with the legal technical term of ‘warranty’ used in contradistinction to the term ‘condition’, where the breach of the former would entitle the innocent party to claim for damages only, whereas the breach of the latter would enable the claim for both the termination of contract (upon the acceptance of the breach)  and damages.

49.  Given the above construction of all the relevant clauses of the Agreement as a whole, the consequence of D1’s breach of the warranty provided under clause 8 is that P was not obliged to proceed with the completion of the shares transfer, but was permitted to take the contractual route as specifically provided under Clause 5 to convert the first payment into a loan. This would also answer defence point 2.  For, clause 8 should not be construed alone, but together with the other relevant clauses of the Agreement as a whole to yield such contractual effect as discussed above.

50.  For completeness sake, the fact that P did not notify Ds of his decision not to complete before the Completion Date would not preclude him from legitimately making such notification just two days afterwards on 11 May 2021. To draw an analogy with the case where the vendor must answer requisitions in good time before completion so that the purchaser was given reasonable time to consider the the vendor’s title and his own position, this Court would also find that (applying the aforesaid principle mutatis mutandis here)  D1 leaving P only two days before the completion date to consider the documents (as required to be provided under clause 4 which also appear to be quite voluminous)  would also be too short a time to be reasonable for P to consider them, seek advice from his lawyer, and instruct them after deliberation to inform Ds of his decision not to complete the shares transaction in the light of D1’ breach of the warranty under clause 8 before the Completion Date, if this Court really needs to form a view on this matter.  See : Jasmin Enterprises Ltd v Chan Yuk Hon [1998] 4 HKC 224, 226F-I.

51.  Especially, among the documents supplied by H.Y. Leung & Co on 7 May 2021, the bought and sold notes and the instrument of transfer were not signed by D2.  Prima facie, this would also tend to show that D1 was actually not yet ready or able to procure the shares transaction be successfully completed on the Completion Date.[5]

52.  As for defence point 3, D2’s contention can be rejected outright, because D2 has simply adduced no evidence to substantiate the same at this trial.  P also denied the allegations as made by D2 under such contention. 

53.  In these circumstances, this Court finds that:-

(1)  P’s case as set out in 5 to 11 above is established on the unchallenged evidence adduced by him at the trial.

(2)  D2’s Defence was not made out and it was rejected in its entirety.  As said, there is no evidence adduced by D2 to substantiate the factual matters as pleaded, and all the points of law or points of construction of the Agreement raised therein are rejected by this Court in the light of the above analysis.

(3)  Clause 5 was engaged in this case enabling P to recover the loan of HK$1.5 million and the contractual interests pursuant to clauses 5 and 6.

54.  P testified that the loan and the contractual interests have not been repaid by D1 or D2 up to this trial. 

55.  For completeness sake, the allegations that P had withdrawn the two sums of HK$20,000 and HK$160,000 from D1’s bank account, like the rest of the factual averments made in the Defence, are not supported by any evidence. P and his father gave clear evidence to rebuke such allegations, and this Court also accepts their unchallenged evidence in this regard.

56.  Since D1 has been in continual breach of the Agreement by failing to repay the loan and contractual interests to P, this Court also finds that D2 is liable as the guarantor under the Agreement to pay these amounts to P on the evidence adduced by P at the trial. 

57.  D2 never disputed that the loan of HK$1.5 million was provided not only to D1 but also to himself under clause 5, when engaged.  Nor D2 ever disputed his guarantor’s status under the Agreement.  Rather, he actually admitted (according to his own case as pleaded in paragraph 19 of his Defence)  that “[t]he 2^nd Defendant’s capacity as guarantor would arise, if and only if, Clause 5 of the Agreement becomes operative.”[6] 

58.  In these circumstances, this Court hold that P has established liability against both D1 and D2.  On the question of costs, I do not see any reason why it should not follow the event.

Disposition

59.  Due to the above reasons, it is ordered that:-

(1)  Leave to P to withdraw his Summons filed on 28 November 2023 with no order as to costs;

(2)  Judgment be entered in favour of P, and D1 and D2 shall pay P :

(a)  the sum of HK$1,500,000;

(b)  Interest for the amount of HK$45,000 (being 3 months’ interest on the said sum of HK$1,500,000)  pursuant to clause 5 of the Agreement;

(c)  Interest on the said sum of HK$1,500,000 at 3% per month pursuant to clause 6 of the Agreement, from 10 May 2021 up to the date of judgment and thereafter at judgment rate till the date of payment[7];

(3)  D2’s Counterclaim be dismissed;

(4)  D1 shall pay the costs of P’s claim, and D2 shall pay the costs of P’s claim and D2’s counterclaim in this action (including all the previously reserved costs orders, if any), with certificate for counsel, to be taxed if not agreed.

60.  Lastly, it remains for me to thank Miss Tjia for her helpful assistance.