RYDER INDUSTRIES LTD v. TIMELY ELECTRONICS CO LTD

HCA 2358/2007 & HCA 109/2009
(Heard together)

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2358 OF 2007

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JUDGMENT

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Background

1.  The two matters which are addressed in this judgment were consolidated by an order of the Registrar made on 26 January, 2011.  The primary matters in dispute are the subject matter of HCA 2358/2007 and this will be referred to as necessary as “the Main Action”.  HCA 109 of 2009 concerns a guarantee given by the Defendant in that action in regard to the liabilities of the Defendant in the Main Action.  This action will be referred to as “the Guarantee Action”.

2.  The Plaintiff in each action is Ryder Industries Ltd, a Hong Kong company.  At the time relevant to the disputes between the parties the Plaintiff was known as Saitek Ltd and for convenience in this judgment the convention adopted by the parties will be followed and the Plaintiff will generally be referred to as “Saitek”.  Reference will be necessary during the course of the judgment to an associate of Saitek established in China as a Wholly Foreign Owned Enterprise, and for convenience, and again following the convention of the parties, this will be referred to as “Saitek WFOE”.  Saitek’s main claim against Timely in the Main Action is for a contractual debt (HK$6,502,555.15) and contractual interest on that sum owing under a cooperation agreement between the parties, made as described below.

3.  Reference will also be made to an operating division of Saitek doing business in China by way of a “Commission Processing Enterprise”. This body was established by Saitek in conjunction with the local authority in China.  It operates under the name of Saitek Baoan Shanghe Saitek Electronics and Plastics Factory.  Although not a separate company this will be referred to in the judgment as “Saitek CPE”.

4.  The Defendant in the Main Action is also a Hong Kong company, and will be referred to as “Timely”.  The Defendant in the Guarantee Action, Mr Chan Shui Woo is the majority shareholder of, and a director of, Timely.

5.  Timely also has an associated wholly-owned company incorporated in the PRC which is a Wholly Foreign Owed Enterprise and which operates a factory at Kung Ming Property Development Main Company, Baoan, Shenzhen.  This will be referred to as “Timely WFOE”, and the factory as “the Kung Ming Factory”.

6.  The factual background may be stated shortly. Saitek CPE was established in about 2002 in China but found itself with substantial spare capacity at its factory in or about 2005.  At about that time a former employee of Saitek, Mr Albert Mak Fook Chi (who gave evidence at the trial) introduced Timely to Saitek and therefore Saitek CPE.  At that time Mr Mak had left the employment of Saitek and was a consultant to Timely.

7.  Mr Mak instigated discussions between the parties in regard to the introduction by Timely of customers seeking a manufacturing facility for mobile phones in China at Saitek CPE.  Saitek CPE did not have all of the equipment necessary to carry out this manufacturing function and felt themselves unable commercially to invest in the purchase of the remaining necessary equipment.  Factory facilities and part of the necessary equipment was available however, and so the discussion became one which contemplated the formulation of a form of joint venture between Saitek and Timely.  The general nature of this envisaged Timely supplying, in addition to customers, the machinery not then available to Saitek CPE to enable the manufacturing to take place.  Timely was also to provide management and supervision of the manufacturing process.

8.  These discussions resulted firstly in a written Memorandum of Understanding and, subsequently, in a written contract (“the Agreement”) made between the parties to the Main Action which was signed in late October 2005.  There is no dispute between the parties as to the content of this Agreement, and nor is it disputed that it was to run for a fixed period, mainly from 1 September, 2005 to 31 August 2007.  It is common ground that this Agreement is governed by Hong Kong law.  Under that Agreement Saitek was to provide the factory facilities at the premises of Saitek CPE, part of the necessary equipment, and was to arrange the logistics, including customs declarations freight and insurance for the import of materials and the export of finished goods.  The overall process under the Agreement was termed the “STC” operation standing it appears for “Saitek Timely Communication”.

9.  The precise terms of the Agreement will be touched on in more detail below, but salient to the present outline of the facts is that it was agreed between the parties that revenue would be set against income, and the proceeds distributed between the parties from time to time.  This was effected by the formulation of a periodic mutual account (a “Running Balance”) expressed in favour of one or the other party.  As matters transpired, by mid-2006 this Running Balance was considerably in favour of Saitek, and the sums due had been accruing and unpaid for some time.

10.  In those circumstances the parties negotiated towards a settlement of the outstanding sums under the Running Balance and agreed on an approach that was recorded in writing in a document entitled “The 1st Supplemental Agreement”.  Saitek contends, and Timely does not dispute, that this constituted a variation to the Agreement.  The 1st Supplementary Agreement introduced an interest obligation in regard to the outstanding unpaid balance sums, providing for interest to be paid at 1% above base lending rate (BLR).

11.  A further modification to the Agreement was made in March 2007 when the parties agreed what has been referred to as “the 2^nd Supplementary Agreement”. That agreement, recorded in Meeting Minutes of 26^th March 2007 set out the agreed status of the Running Balance owed by Timely to Saitek.  The main claim which Saitek makes is the sum of HK$5,615,394.97 referred to in the 2^nd Supplementary Agreement, together with the monthly sums which are said to have accrued in the March 2007 to August 2007 period less certain payments made by or on behalf of Timely.

12.  The amount of that Running Balance is undisputed as to quantum.  Contractual interest is claimed on this sum also.

13.  Saitek also makes claims in respect of certain maintenance fees (not included in the Running Balance) for the maintenance of the machines, in the amount of RMB1,670,210.29.

14.  In due course the performance of the Agreement and the STC Operation business was terminated by mutual agreement of the parties in July 2007.

15.  At about the time that the Agreement was terminated Saitek detained the machines of Timely which were still in the premises of Saitek CPE in China, and Timely brings a counterclaim in the Main Action seeking damages representing the loss of the value of the machines, and in addition, damages representing the loss of business flowing from the detention of the machines.  Saitek asserts a lien over those machines which have not been returned.

16.  The Guarantee Action is based on provisions recorded in the 2^nd Supplementary Agreement.  It is contended by Saitek, and not disputed, that Mr SW Chan undertook to guarantee repayment of the debt of Timely arising out of the Running Balance. Neither the sums said to be due under the Running Balance, nor the amount said to be due under the guarantee have been paid to Saitek and the defence in each case is the same.  Timely contends that it is not bound to pay the sums claimed under the Running Balance due to the Agreement being affected or tainted by illegality.  That defence to the Main Action is said to provide a defence also in the Guarantee Action.

17.  In addition Mr SW Chan counterclaims for repayment of a sum of HK$2 million which was paid pursuant to the making of the 2^nd Supplementary Agreement, but which is alleged to have been paid under a mistake of law.

18.  In summary therefore the parties are not in dispute as to the terms of the Agreement, although the implication of some of the provisions is disputed; nor are they in dispute as to the contractual variations to that Agreement.  There is no dispute as to the amount of the Running Balance, and no dispute that the relevant sum has been guaranteed as to payment by Mr SW Chan.  Timely’s defence comprises assertions that the Agreement which underlies the debt or its performance was illegal, or so tainted by illegality under PRC law that it is therefore unenforceable in the Hong Kong Courts.  Timely also relies on a set off of the sums claimed by way of its counterclaim.

The Agreement

19.  The Agreement was a brief document which included the following provisions:

(1)  Clause II

“Both Saitek and Timely have a mutual interest in the manufacturing of mobile phones and Saitek will provide the resources listed below to support the manufacturing process in return will share the portions of the revenue with Timely.”

(2)  Clause IIIB

“Responsibility of Saitek and Timely:

Saitek will provide the following facilities for the manufacturing of mobile phone products.

· The 3^rd & 4^th floor and ½ of 2^nd floor of Building 8B2, District 72, Baoan will be dedicated for the STC operations for mobile phone manufacturing. The facilities and the associated utilities will be properly equipped for manufacturing of mobile phone, per the mutually agreed attachment/appendix.

Saitek will provide the following major equipment…

Saitek will be responsible for the task and costs of:

· Customs Declaration

· The logistics/fright costs of importing the components from Hong Kong to Saitek Baoan, and the freight costs to export the finished goods to Hong Kong (Timely will pay the transportation costs between the Saitek and Timely factories)

The insurance charges during transit to import the raw materials from Hong Kong and re-export the finished products to Hong Kong (except the insurance charges to cover the risk in transits between Kung Ming and Baoan will be the responsibility of Timely)

Except for above listed responsibilities of Saitek.  Timely will bear all other responsibilities regarding STC operation, including the responsibility for payment collection from customers.”

(3)  Clause IIIC

“Payment terms and transactions:

· Timely to pay Saitek a Monthly rental for the premises: HK$80,000 in the beginning of each month.

· Timely to pay Saitek a Monthly depreciation charge for the equipment: HK$150,000 …

· Timely will pay Saitek the Utility charges, Wages and Salary for the workers and technical, and security staff dedicated to the project, Export Inspection fees, and other STC expenditures …

· Saitek will, upon receipt of the payments from the customers, pay Timely their share of the Sales Revenue within 7 days according to … [certain percentages] …

· Due to customer reason, Timely may place Mobile Phone P.O. to Saitek directly. In such case, Timely will pay Saitek their share …

·   Do not encourage non-STC PO to be run in STC. If customer contracts/orders are not signed with Saitek, Saitek will not provide any customs declaration service, and Timely will pay Saitek … for the prior month shipment …”

(4)  Clause D

“… All costs incurred for the maintenance (including spare parts) of within the STC premise will be the responsibility of Timely.”

The 1^st Supplementary Agreement

20.  This was made in September 2006 and provided at Clause 1 that: “Timely will pay off all overdue debts to Saitek before September of 2007…”.  By Clause 3 it was agreed that: “Timely agree to pay BLR + 1% as the interest for all overdue balances, and the interest will be charged on monthly basis based on actual outstanding debts confirmed by mutual parties” .

The 2^nd Supplementary Agreement

21.  The 2^nd Supplementary Agreement was recorded in the following terms:

“(1) With reconciliation and final adjustment, both Timely and Saitek agree the net outstanding payable to Feb 2007 is HK$5,615,394.97 … Timely will pay off debts before 31 December 2007.

(2) Timely promise to reduce at least HK$400,000 of the outstanding debts each month from March 2007.

(3)   Both Timely and Saitek agree to do a detailed and professional evaluation of STC machines status, and an overhaul maintenance may be required before end of August 2007 …”

The 2^nd Supplemental Agreement also evidences SW Chan’s guarantee in the following way:

“SW Chan will personally guarantee all outstanding debts are paid off by end of agreement date”.

Illegality: Introduction

22.  In a written opening submission counsel for Saitek, Mr Richard Zimmern, appearing with Mr Jason Yu, identified four areas of illegality pleaded on behalf of the Defendants as follows:

“l Did the arrangement under the Agreement whereby Timely paid “rental” to Saitek CPE render the Agreement and/or that part illegal under PRC Law (“Alleged Rental Illegality”)?

l Did the Agreement envisage the transfer of goods imported tax-free (ie bonded goods) from Saitek CPE to Timely WFOE without approval? If so, would the Agreement and/or that part of the Agreement be rendered illegal under PRC Law (“Alleged Transit Illegality”)?

l Did the Agreement envisage Saitek CPE accepting orders from mainland customers? If so, would the Agreement and/or that part be illegal under PRC Law (“Alleged Mainland Orders Illegality”)?

l If Saitek CPE used materials imported by Saitek WFOE for the production of mobile phones, would such render the Agreement and/or that part illegal under PRC Law (“Alleged WFOE Import Illegality”)?”

23.  This formulation represents a convenient categorisation of the illegality issues, and although counsel for the Defendants, Mr Simon Chiu provided a more detailed summary of the issues, no agreement of a formulation of the issues was achieved by the parties.  In part this is because the issues framed on behalf of the Defendants were not only more detailed than those formulated on behalf of the Plaintiff, those issues also went beyond pleaded matters.

24.  It is therefore perhaps appropriate at this juncture to address the issue which arose during the trial as to the pleading of illegality.  Objection was taken on behalf of the Plaintiff to attempts by the Defendants to broaden the scope of evidence to encompass assertions that the Agreement had been formulated with an illegal objective in mind or in contemplation.  On behalf of Timely Mr Chiu contended that because illegality was a public policy matter, the “normal rules of pleading” could not be relied on to preclude the court making the findings of illegality based on such facts as might emerge at the trial.  Mr Chiu advanced this submission in part by reference to a decision of Sakhrani, J in Chan Yau v Chan Calvin (HCA 666/2007; judgment dated 15 May 2009), and the decision of Devlin J. in Edler v Auerback [1950] 1 KB 359 submitting that the court would take account of illegality whether pleaded or not.

25.  The Hong Kong judgment was one given in the context of an application for summary judgment, but the authority to which Sakhrani, J made reference; Snell v Unity Finance [1964] 2QB 203, was a decision on appeal after trial, as also was the decision in Edler v Auerback. The principle is indeed that courts will, ordinarily, refuse to enforce a contract which has an illegal objective, and this is so whether or not the illegality has been pleaded.  However the court will only do so where it is satisfied that all relevant facts are before it.

26.  It is clear however that this does not absolve a party from the mandatory requirement to plead illegality expressly (see for example Edler v Auerback at 371), and this obligation applies particularly, it seems to me, when the illegality in question is not illegality under the domestic (Hong Kong) law, but rather is illegality under a foreign legal system (in this case the People's Republic of China).  Illegality in such a circumstance is to a significant extent a question of fact, and as such, can only be acted on by the court if pleaded and proved.  The parties having exchanged pleadings, witness statements and supplemental/reply witness statements, and moreover having (in the case of the defendants at least) adduced several adduced reports of expert witnesses on Chinese law, it seemed to me only fair and proper that Timely be confined to the pleaded instances of alleged illegality.

Expert Evidence

27.  The illegalities said to be of relevance are matters of illegality under Chinese law, and expert evidence on this was called.  It is appropriate to have in mind the function of such evidence to inform the court of the relevant contents of the foreign law; explaining where necessary the foreign courts’ approach to the construction of the relevant legislation; and to assist the Court to make a finding what the foreign court would decide if required to decide the issue.

28.  A few further observations as to the expert evidence are appropriate.  Timely, who raised the issues of illegality, relied on the evidence of Mr Lin Bo Yee, a lawyer practising in Shenzhen.  Mr Lin produced no less than 4 reports, two of which preceded the service of the pleaded Defence, although the last of this series, a report dated 7 December, 2011 was not relied on by Timely, the reasons for which were not explained.

29.  Saitek relied on expert evidence given by Mr Winston Jin Chunquing who produced two reports in 2010.  Mr Jin (as did Mr Lin) told me in oral evidence of his qualifications and experience as a lawyer in the PRC.  Neither expert had seen fit to attach a CV to their reports to demonstrate their competence to give expert evidence, and surprisingly, neither party supplemented the expert evidence at any stage with a written cv.  Indeed, both sets of reports were written as being the opinions of the legal firms employing Mr Lin and Mr Jin respectively rather than as expressing the views of the individuals who attended the hearing.  Neither expert was challenged as to his competence to give expert evidence, but Saitek did ask me to conclude, on the basis of the oral evidence, that Mr Jin’s experience was to be considered more relevant.  The absence of a cv from either expert was, for this reason also therefore, potentially quite significant.

30.  Importantly in my view, neither expert set out in any detail the issues which they had been asked to address, nor did they clearly identify the facts with which they had been provided or asked to assume.  It was not apparent that either of them had been provided with copies of the witness statements.  In the case of Mr Lin’s earlier reports this is unsurprising; those reports were made before the pleadings had advanced to a stage at which any issues of law had arisen, and the reports were therefore somewhat abstract.  The later reports from the experts, and most certainly a joint report, should have defined precisely the issues on which the experts were rendering their opinions.  This is one of a number of matters addressed by the Code of Conduct for Expert Witnesses appended to the Rules of the High Court with which the parties and the experts ought to have sought to comply by the date of the hearing, even if this Code of Conduct was inapplicable at the time of the compilation of the individual reports.

31.  The parties did direct the attention of the experts to the requirement to prepare a joint report, but unfortunately this resulted in the production of two reports, not one.  Those reports attempted to identify areas of agreement with the views of the other expert, but also expanded the areas of disagreement.  Where disagreement was expressed, the reasons for disagreement were not always clear from the reports, obscuring rather than highlighting the issues.  A joint report as required by the Code of Conduct is a simple concept, and the experts should have been required by the parties to produce such a document.  Presentation other than in this joint format does not meet the objectives of narrowing issues and assisting the Court and the parties to understand what the differences between the experts actually are.  As became clear in due course, the differences between the experts in this case were relatively narrow in extent, and a joint report, preferably produced at the earliest possible opportunity, would have made this apparent. I would also encourage parties to contemplate, and prepare for the possibility of having the expert witness evidence heard as a discrete segment of the trial; that is, both experts of like discipline heard one after the other, with the evidence thereby more readily juxtaposed.

Illegality; Principles

32.  The underlying principles are not really in dispute between the parties.  So far as the enforcement of contracts and contractual remedies is concerned, illegality is an aspect of public policy. The courts will not, in the ordinary course of events, enforce a contract which is illegal under domestic law, and moreover, neither will a contract to be performed in a foreign jurisdiction, the performance of which would be illegal in that place of performance, be enforced; see for example Regazzoni v KC Sethia (1994) Ltd [1958] AC 301.  Similarly in Ralli Brothers v Compania Naviera Sota y Aznar [1920] 2 KB 287 a contract made under English law requiring partially illegal performance in Spain was not enforced by the English courts to the extent of the illegal part.

33.  Nor is it disputed that, in any event, illegality of performance alone is not enough to defeat a claim.  The party seeking to enforce the claim must have had knowledge of the illegality, and to have participated in the illegal conduct.  The Defendants refer me to the judgment of Sankey LJ in Foster v Driscoll [1929] 1 KB 470 at 578 in support of this principle while the Plaintiff refers me to the judgment of Waller LJ in Colen v Cebrian UK Ltd [2004] ICR 568, at paragraph 21 in particular, to similar effect.

34.  Moreover, as is clear from the decision of the Court of Appeal in England in Euro Diam Ltd v Bathhurst [1990] 1 QB 1 (at 35), such a defence must be “… approached pragmatically and with caution, depending upon the circumstances”.  A distinction must be drawn between circumstances in which the plaintiff's claim is founded on an illegal contract, and those in which there is merely some reprehensible conduct on his part.  In such cases an illegality defence will not succeed.

35.  Finally, before turning to the specific illegalities alleged, I note that both parties commended to me the decision of the Court of Appeal in England in ParkingEye Ltd. Somerfield Stores Ltd. [2013] 2 WLR 939 and in particular paragraphs 28-39 in the judgment of Sir Robin Jacob from which I draw the following:

(1)    The decided case which deal with illegality are inevitably fact specific, and the statements of principle are not always either consistent or easily reconciled one with another (at paragraph 28, citing Les Laboratories Servier v Apotex Inc. [2013] Bus LR 80).

(2)    Domestic illegality as a defence to a claim invokes the policy objectives of the Court.  Those have been summarized (Les Laboratories Servier (Supra)) as: “furthering the purpose of the rule which the illegal conduct has infringed; consistency; the claimant should not profit from his or her own wrong; deterrence; and maintaining the integrity of the legal system”. (at paragraph 39).

(3)    The nature of the contract may be such as to make it wholly legal or wholly illegal.  But a contract which is not formed for an illegal purpose and which is performed over a period of time may be susceptible to some illegality arising in its performance.  Whether such illegality taints the whole contract such that it would not be enforced by the Court requires consideration of the proportionality of not enforcing the contract and the furtherance of the policy objectives underlying the illegality defence (at paragraphs 35-39).

(4)    The necessity or otherwise for an illegal mode of performance to be adopted, and the question whether illegal performance was the object of the contract are relevant factors, as is the question as to whether the claimant plaintiff has to plead or rely on any illegality as a basis for the claim.

36.  It is the third and fourth aspects of this list which are particularly germane here.  This was a contract which was, on its face, legal and one which, on its face, was to be performed over a period of time.  Saitek points out, it is not necessary for it to plead or rely on any illegal conduct as the basis for its claim.

37.  Before turning to the specific allegations of illegality it is appropriate that I record, in the context of illegality arising during the course of performance of a contract that the Court of Appeal in England in Colen v Cebrian (supra) expressed the view (at [23]):

“The above passages demonstrate that an analysis needs to be done as to what the party's intentions were from time to time.  If the contract was unlawful at its formation or if there was an intention to perform the contract unlawfully as at the date of the contract, then the contract will be unenforceable.  If at the date of the contract the contract was perfectly lawful and it was intended to perform it lawfully, the effect of some act of illegal performance is not automatically to render the contract unenforceable.  If the contract is ultimately performed illegally and the party seeking to enforce takes part in the illegality, that may render the contract unenforceable at his instigation.  But not every act of illegality in performance, even participated in by the enforcer, will have that effect.  If the person seeking to enforce the contract has to rely on his illegal action in order to succeed then the court will not assist him.  But if he does not have to do so, then in my view the question is whether the method of performance chosen and the degree of participation in that illegal performance is such as to “turn the contract into an illegal contract ...”

The Alleged Illegalities

The “1^st Illegality”

38.  This has been given various short form descriptions by the parties including “the rental illegality” and “the factory within a factory” illegality.  By the stage of closing submissions Timely described this illegality as involving Saitek acting “in substance” as “a Facility and Service Provider” to Timely.

39.  It is perhaps debateable whether this formulation of the allegation has been adequately pleaded but it is unnecessary to consider whether that is the case in the circumstances.  I do not accept that the arrangement entered into has been shown to be illegal as a matter of Chinese law.

40.  The underpinning to the allegation by Timely is that the arrangement under the Agreement involved Saitek providing premises at Saitek CPE which were rented to Timely and within which Timely was to operate an independent factory.  The agreed arrangement involved Timely in payment of “rental” to Saitek for the premises, a payment which was to be made irrespective of the revenue, if any, from the business.  This allegation finds its origin in the express terms of the Agreement which refer to Timely paying “rental” to Saitek “for the premises”.

41.  What is alleged by Timely in closing is that the arrangement was designed to evade PRC law; “the strict regime of examination and supervision” provided under the “Interim Measures for the Management of Examination and Approval of Processing Trade”, a set of Customs Regulations referred to in short form as the Interim Measures.

42.  Timely relies on the legal opinions given by its expert, Mr Lin.  So far as relevant this appears primarily to be contained in his report of 11^th January 2008.  In “Part Three Legal Opinion” of his report Mr Lin expresses the view that a lease of the premises by “Saitek Plastic Factory”, (meaning Saitek CPE) to Timely would be legal, but that Timely could only lawfully carry on (what I understand to be) an independent business through a mainland body such as a WFOE or a CPE.  Mr Lin’s opinions as to the legality or otherwise of the arrangements under the Agreement were premised on two (relevant) assumptions; that there was a lease by Saitek to Timely and that the STC operation conducted at Saitek CPE was in effect run independently by Timely.

43.  Two sub issues appear to be central to this alleged illegality therefore: was the arrangement between Saitek and Timely in fact a lease of the premises; and was Timely operating an independent business otherwise than through a CPE or a WFOE.  In my view neither proposition has been made out by Timely.

44.  So far as the “lease” allegation is concerned the high water mark of Timely’s allegation is the reference in the Agreement to the payment of monthly “rental” for the use of the premises.  As is submitted on behalf of Timely this was to be payable irrespective of the amount of business conducted through the STC with the period over which it was to be paid specified as two years.

45.  It is not correct to construe this part of the “Payment Terms” provisions of the Agreement in isolation however.  The Agreement summarised a commercial co-operation between the parties as was clearly spelled out at clause II.  Timely were not being granted exclusive possession, nor indeed were they said to be able to use the premises for general business purposes other than the STC operation.  Their occupation was as part of the STC operation and only STC production was contemplated.  Seen in that context and considering the Agreement as a whole I do not accept that the use of the word “rental” in a clause dealing with the Payment Terms has created a lease of these premises.

46.  Nor do I accept that the Agreement envisaged Timely operating a separate or independent business under the Agreement.  The Agreement was, plainly, an arrangement whereby the two parties contemplated both mobile phone assembly and other types of business being conducted.  In each type of business however revenue (after expenses) was to be shared.  It is true that the Agreement provided that the wages of the workforce (other than customs staff who were Saitek group personnel) were to be paid by Saitek with reimbursement to be made by Timely to Saitek.  That does not mean that Timely were running a separate business however.  The Agreement envisaged the system that was put into practice, namely that the STC business was conducted by Saitek CPE, with revenue shared.

47.  It was clear from the evidence of Mr Marco Chan, Timely’s Marketing Director that the staff were sourced from both Saitek CPE and Timely, with the seconded Timely personnel mainly supervising or overseeing the production process.  Mr Lam Fui Yan, a former Financial Director of Saitek was asked why it was that Timely staff were “placed under the name” of Saitek CPE; seconded to Saitek CPE and paid by Saitek CPE in other words.  His answer was that this was done to stay within the law.  The workers at Saitek CPE were required to be employees of Saitek CPE.  The staff at Saitek CPE were therefore CPE staff.  The work undertaken was, it appears, solely work falling within the ambit of the Agreement, at least to the extent that revenue from such business was shared by the parties.  There is no evidence of any independent or separate business operation by Timely.

48.  The proposition that Timely were conducting separate business operations seems to me to fail both as a construction of the Agreement and on the facts.  It seems to me to follow therefore that neither of the critical “assumed facts” on which Mr Lin’s conclusions were based are established in regard to this alleged illegality.  The assumed basis for Mr Lin’s opinion, that the arrangements under the Agreement were illegal under the laws of the PRC is, in my judgment incorrect therefore, and his conclusion does not follow.  I believe that the parties made their Agreement intending it to be legal.  That this was likely to be the intention of the parties would follow from the fact that the person who introduced the parties and who appears to have instigated the arrangements that led to the Agreement, Mr Albert Mak Fook Chi had formerly been a senior manager of the Plaintiff before becoming a consultant and was very familiar with the relevant PRC regulations.  Moreover I accept the evidence of Mr Jin that he has, in his practice as a lawyer, designed various business models which are in effect the same as that described in the Agreement.  This does not necessarily mean that the arrangement was legal of course, but it does provide support for the view that the parties were intending to achieve a legal way of conducting their business.

49.  I do not need to go so far as to conclude that the evidence establishes that the Agreement was definitely legal under the laws of the PRC, although I believe that is probably the position.  The evidence is more than sufficient to establish, in my mind, that Timely’s contention that the Agreement was illegal in this way is not made out.  This limb of the defence accordingly does not succeed.

The 2^nd Illegality

50.  This allegation centres on the fact that semi-finished processed goods were transported from the Saitek CPE premises to the Kung Ming Factory of Timely WFOE for processing (testing, it appears) before being returned to the Saitek CPE premises.  Several of the witnesses of Saitek were unwilling to accept that they had knowledge of this taking place, but that it did take place was acknowledged by Mr Lam Fui Yan among others, and the evidence overall shows, clearly in my view, that it was commonplace in the conduct of the STC business.  The “problem” that this caused arises out of the fact that the materials imported to China for processing under the STC business was imported duty free.  This is permitted provided that the materials so imported (referred to as “Bonded Goods”) are kept under supervision and ultimately re-exported out of China.

51.  In fact the oral evidence suggested that it was commonplace for businesses operating with Bonded Goods to transfer them between factories for processing.  Mr Henry Wu Chang Lun the General Manager of Saitek WFOE said as much in his witness statement, and Mr Lam Fui Yan agreed with a proposition put to him by counsel that this was commonplace.  There is no dispute that the process can be performed legally.  Because the goods in question are Bonded Goods and therefore technically subject to the supervision of the customs authorities a mechanism exists whereby written authorization, (a “Bei An”) may be applied for and issued.  However, because that process is relatively time consuming it is, according to the witnesses, a process which is frequently honoured in the breach.  Timely’s case is a curious one; Timely were aware of the requirement for a Bei An but understood that because of the time required to process this, the obtaining of a Bei An certificate was in a practical sense, unworkable.  As set out in Opening therefore “Hence Timely HK did not apply for it and Saitek knew and condoned it”.  The “illegal performance” was said therefore to be that of Timely itself, not of Saitek.

52.  Both expert witnesses were in agreement that such conduct would be in breach of the Customs Law of the PRC, leaving the offending party liable to a penalty under that law.  The parties were divided as to how “serious” this form of breach might be considered to be, as were the experts.  The evidence of Saitek’s factual witnesses and of Mr Jin suggests that the primary concern of the Customs Authorities is to see that materials imported duty free are ultimately re-exported (or, if not, that relevant import duty and tax is paid).  Several of these witnesses, and Mr Jin also, said that there is less official concern with the transfer of goods for processing without the Bei An certificate provided the goods are ultimately exported, or duty is paid.  That would seem to be consistent with Timeley’s conduct in not applying for the Bei An certificate.  This is not to suggest that the process of transfer to another factory for processing without authorisation is even tacitly permitted.  Plainly it is not.

53.  Several of Timely’s witness recounted in evidence a “raid” by the Commercial Bureau on the Kung Ming factory operated by Timely WFOE.  That factory was used by the STC to carry out part of the processing of the mobile phones and in this raid a very large quantity of mobile phone components were seized and impounded by the authorities apparently because their source of origin could not be verified.  It is Timely’s case that these were components which were in the course of processing as part of the STC business which had been transferred (outsourced) to the Kung Ming factory for processing.

54.  The goods in question were ultimately the property of a major customer of the STC business, one Kong Profit Technology Ltd., and the release of these goods from detention was arranged by Kong Profit seemingly with the payment of a substantial, and inferentially illicit, “administration fee”.  Timely say that Kong Profit, Saitek and Timely itself all knowingly contributed to that payment; Saitek accept that a monetary payment was made through a set off in the accounts, but do not accept that it was known by Saitek to be for an illicit purpose.  Saitek’s witnesses maintained this position under cross-examination.

55.  Notwithstanding the debate as to the severity of any potential penalty arising out of this type of breach Timely do not seek to rely on this alleged illegality as, by itself, constituting a defence to the claims of Saitek.  Rather it is said to be a factor in assessing the extent to which the Agreement was tainted by illegality.  That is an aspect to which I return below.

The 3^rd Illegality

56.  The gist of this allegation is that there were orders carried out as part of the STC business which were in reality orders carried out for mainland customers (referred to as “non STC Orders”).  Since the production took place, at least in part, at Saitek CPE this is said by Timely to have been illegal.  This was the conclusion reached by Mr Lin as set out in his expert report.  Part of the basis for his view lay in the definition of the business scope of a CPE (“the Processing Trade”) contained in the “Interim Measures for the Management of Examination and Approval of Processing Trade” (“the Interim Measures”) which, at Article 2, provides such a definition as being “the processing of materials provided by foreign clients”.  That article also defines “processing enterprises”.  Mr Lin expressed the view that work undertaken by Saitek CPE for mainland clients would be illegal therefore.  As Mr Lin stated in that report however, and as he confirmed in the course of his cross-examination, this conclusion was premised upon his understanding that Saitek CPE were accepting orders directly from local (mainland) companies.

57.  However that was not the true position.  All of the business which has been categorised as being “non-STC Orders” was in fact business placed contractually by Timely in Hong Kong.  In other words, the work commissioned by the mainland companies was routed via Timely.

58.  There is evidence to show that Saitek were aware of the existence of the mainland customers through the staff at Saitek CPE who, at certain stages sought copies of the purchase orders which had been placed by those mainland customers (these being relevant to the accounting as between the parties to the STC).  Building upon that foundation Mr Chiu submits on behalf of Timely that Saitek were clearly aware of this “illegality”.  He refers me to evidence given by Mr Marco Chan to the effect that orders were placed via Timely in this way with a view to concealing the illegality from the mainland authorities.  He submits that, so far as illegality is concerned it is a question of substance not of form, and that if the parties to a transaction know that the contract entailed Saitek CPE processing materials delivered in mainland China for delivery to mainland China, then the Interim Measures have been breached and the transaction is illegal.

59.  I do not agree.  Mr Lin's evidence does not say so; his opinion was given in the context of contracts having been placed directly by mainland companies with Saitek CPE.  Mr Jin was of the view that this was a legal arrangement, and I agree.  Indeed it seems to me overwhelmingly to be the case on the evidence that the parties themselves have put this into operation, not to conceal an illegality from the mainland authorities, but rather to ensure that the business was being conducted legally.  It appears to me that not only was the “form” legal, so was the substance.

60.  Moreover, although it appeared to be common ground that the processed products were initially delivered to the mainland customers on completion, according to Mr Marco Chan neither of the parties to this action would have known whether those processed materials were for export or for domestic consumption.

61.  This alleged illegality was expanded upon by Timely during the course of the evidence to suggest that processing by Saitek CPE of domestic orders would also be illegal since the machinery used in the processing was “bonded”, that is the machinery had been imported without duties being paid.  The relevant legal provisions are said to be those contained in the “Notice of the Ministry of Foreign Trade and Economic Cooperation of the General Administration of Customs on Relevant Issues concerning the Import of Equipment for Processing Trade” more conveniently referred to as “the Bonded Equipment Notice”.  By the Bonded Equipment Notice tax-free import of equipment to be used in a processing trade is permissible provided there is an independent factory which is exclusively for processing trade, “i.e. not engaged in the processing or production of products for domestic sale” or if this criterion is not met, an existing enterprise in which over 70% of the yearly production is exported.

62.  This was not a provision of law that was addressed by Mr Lin in any of his written reports, but he was taken to the provision as part of his evidence in chief.  He provided little elaboration as to the meaning of the provision other than expressing the view that he believed that the 2^nd part of the provision (existing enterprises exporting more than 70% of yearly production) must apply to non-CPE enterprises.  The gist of this new allegation therefore (as I understand it) is that there was illegal performance under the Agreement also in the use of bonded machinery in the production of goods for domestic sale. This, it seems to me, is a hopeless allegation.  For the reasons given above, the existence of Timely as a contracting party with Saitek CPE has the consequence that these were not products for domestic sale, and accordingly there is no question of the “misuse” of the bonded equipment at Saitek CPE.

63.  This alleged illegality is of particular importance because it is said that there was a very substantial value of non-STC orders placed, and given the Running Balance arrangement between the parties, the sums claimed by Saitek in these proceedings are in effect wholly the proceeds of these non-STC orders together with the “standing” premises and equipment charges.

64.  For the reasons given I do not accept that Timely have shown any relevant illegality in this regard.  As was pointed out by Mr Zimmern, the failure to establish this illegality is perhaps particularly significant in circumstances in which Timely contends that the whole of the claim falls foul of this defence.

The 4^th Illegality

65.  The question here is whether throughout the course of the STC arrangements Saitek CPE had been obtaining bonded materials from Saitek WFOE but processing the materials under Saitek CPE.  This is said to have taken place because of limitations on the amount of materials which could be imported by Saitek CPE.  Ostensibly, if imported by Saitek WFOE duty-free such materials should remain under the control of Saitek WFOE until they are re-exported.  Timely say that they were unaware that this was going on until the raid by the customs authorities in January 2007, their witnesses confirmed this, and I accept that to be the position.

66.  It is undisputed that outsourcing of bonded materials from a WFOE to a CPE would be a breach of the law of the PRC, specifically Article 23 of the “Measures of the Customs of the People's Republic Of China for the Supervision of Goods for Processing Trade”.  That Article provides for outsourcing by an operating enterprise to be subject to the approval of the customs office.  Absent such approval then such outsourcing is not permitted.

67.  Failing to comply attracts a sanction contained in the “Regulation of the People's Republic of China on the Implementation of Customs Administrative Punishment” the level of punishment depending upon the severity of the offence, and ranging from a reprimand or criticism to a fine and confiscation of gains.

68.  According to Timely this was likely to be considered as a serious infraction because the evidence produced by Saitek included a summary of the products exported by Saitek WFOE which indicated that mobile phones of approximately $18.5 million in value had been exported by Saitek WFOE between August 2005 and November 2006.  It is not disputed, that all of these would have been part of the STC operation.

69.  There seems to be no dispute that this import and processing arrangement happened in fact.  The primary issue is the legal consequence.  The evidence given by Mr Jin was that this would not have been considered a serious infringement had it been discovered.  He stated that the primary concern of the Customs officials was as to whether or not processed products made from bonded materials were, after processing, exported.  If they were not exported there was of course a breach of the import duty obligations; if they were exported there was no such breach.  The approach was described as being one of “three point control”; that is control at the import, processing and export points.

70.  Mr Jin’s evidence was that the penalties for this type of breach would be very minor, but this is a matter of speculation, not one based on experience of such penalties being imposed it appears.  Mr Lin did not set out to assess the seriousness of any such contravention.  The evidence shows that there is a wide range of potential penalties, but evidence as to the seriousness with which any such breach would be viewed is very limited. So far as that evidence goes, although a substantial amount of goods were involved, it does not persuade me that this mode of performance would be considered a very serious contravention of the law.

71.  Accepting that Timely have established illegality in this sense in the performance of the STC agreement and that Saitek were aware of this illegal performance, the question is whether such circumstances have tainted the Agreement such that the claims made by Saitek ought not to be enforced.

Conclusions on Illegality as Established

72.  I have found that there was illegality in the performance of the agreement, primarily on the part of Timely, in the arrangements described as the 2^nd Illegality, and illegality in performance on behalf of Saitek in regard to the 4^th Illegality. The question then is whether, as a matter of policy, these findings mean that the Court ought to decline relief to Saitek.  In my judgment the answer is clearly that it should not.  While I accept that there has been some illegal conduct, it is such that the parties largely share responsibility for it.  On the material available it is not conduct that could be described as iniquitous, nor has it resulted in actual criminal or other enforcement proceedings in the PRC.  There is no suggestion of any evasion of taxes or duties; the contraventions are, in a sense, administrative.

73.  Considering pragmatically whether such illegality “taints” the contract to the extent that it should not be enforced involves recognising that Saitek do not need to rely on the illegalities as a basis for the claims, and that, in my view, it would be disproportionate to decline to enforce the payment obligation under the Agreement, particularly where it has otherwise been performed.  Accordingly, in my judgment, the illegality defence fails, and the claims for payment succeed.

Repair and Maintenance

74.  The claims made by Saitek in the Amended Statement of Claim include a claim for “maintenance fees” amounting to approximately RMB 1.7 million in respect of maintenance of the Saitek's own machinery.  This obligation on the part of Timely is said to arise under clause 3D (3) of the Agreement which provided that “all costs incurred for the maintenance and (including spare parts) of within the STC premises will be the responsibility of Timely”.

75.  In September 2007 Saitek obtained quotations and sought payment from Timely of such amount.  According to be evidence of Mr Henry Wu however Timely refused to make any such payment and nor, it appears did Saitek pay for the maintenance as such.  Instead what appears to have happened is that a member of Saitek's engineering staff undertook certain work involving cannibalising spare parts from two production lines for use on other production lines.

76.  Saitek's case is not therefore that it is entitled to reimbursement of sums expended, but rather that there is an unfulfilled contractual obligation on Timely’s part to pay for such maintenance costs. There seems to me no factual dispute that some such maintenance was required and, in circumstances in which an independent quotation has been obtained, no room for serious dispute as to its extent or value.  Moreover in the meeting at which the 2^nd Supplementary Agreement was concluded the parties discussed the need for maintenance and, as described by Mr Henry Wu had undertaken a form of joint inspection of the relevant machinery before the quotations were obtained.

77.  However it appears that the maintenance which was discussed in March 2007 was considered to be separate from the routine maintenance referred to in the Agreement, hence the arrangement referred to in the 2^nd Supplementary Agreement (varying the Agreement) that this overhaul maintenance cost was to be shared between the parties.

78.  Timely rely on the provisions of paragraph 4 of the Meeting Minutes which stated that although ovehaul maintenance may be required, the overhaul maintenance costs would be shared between Saitek and Timely in a proportion to be discussed after the evaluation results were obtained.  Mr Chan refers in his evidence to an e-mail he sent to Mr Henry Wu on the 30^th July, 2007 stating that was no agreement as to the machine maintenance costs.

79.  I do not accept that the failure to reach agreement as to the sharing of such costs would necessarily absolve Timely from a contractual obligation.  However the relevant provision does not specify the proportion of such costs to be borne by Timely and I accept that no binding agreement was ever reached.  No mechanism was provided in the Agreement to resolve this situation.  Moreover, it appears that even had there been a breach of agreement by Timely, there would have been no damages suffered by Saitek, or certainly not in the amount claimed.

80.  Accordingly, this head of claim by Saitek does not succeed.

Counterclaim

Lien

81.  It is not in dispute that Saitek retained at the CPE premises certain machinery which was the property of Timely.  Mr Henry Wu recounted in his evidence how some of the more portable items of equipment were removed by Timely in or about July 2007, with one large machine and other machines which he presumed to be of little value left behind.  It is Saitek's case that it was entitled to detain such items on the basis of either a common law (general) lien or a particular lien. Specifically it is contended that Saitek had undertaken maintenance work on the Respondent’s machinery and is therefore entitled to retain possession until such time as the charge for that “improvement” work has been paid by Timely.

82.  The contentions as to improvement work in reality referred to maintenance as was discussed with Mr Marco Chan during the course of his cross-examination.  Saitek contends that since the Trading Balance is still due and owing, the sums owed by Timely in respect of the wages of the maintenance staff at Saitek CPE suffice to support a lien over Timely's machines.  It is clearly doubtful that a general lien arises in the circumstances of this case, there being no relevant contractual provision or other relevant agreement, nor any general usage referred to, and counsel for the plaintiff did not strenuously contend otherwise.  I do not accept that the general lien has been made out.

83.  Broadly, a particular lien is the right to retain goods for which charges have been incurred until those charges have been paid.  The position was summarized by Harris, J in Hong Kong Aircraft Engineering Company Limited v The Joint And Several Liquidators Of Oasis Hong Kong Airlines Limited (In Liquidation) [2011] HKCU 380 at paragraphs 9 and 10 as follows:

“(1) The person asserting the lien must be in possession of the chattel;

(2) The possession of the chattel must be “lawful”: the transfer of possession to the person asserting the lien must have been with the express or implied authority of the chattel’s owner;

(3) The possession of the chattel must be continuous. The surrender of possession of the chattel usually results in the extinction of the lien. The lien is not regained if possession of the chattel is regained;

(4) The person asserting the lien must have done work on the chattel in respect of which he asserts the lien;

(5) The work on the chattel must usually have been completed and the sum in respect of which the lien arises must be due to the person asserting the lien.

This type of lien allows a person who has done work on a chattel to retain it until his charges for work done on the chattel have been paid.  The workman cannot, as he may in the case of a general lien, retain the chattel until all monies owing to him have been paid: Halsbury, 5th edition, 2008, vol. 68, §818, Palmer on Bailment, 3rd edition 2009, § 15-072 and Dinmore Meatworks Pty. Ltd. v Kerr [1962] 108 CLR 628 at 632.”

84.  It appears to me that those “requirements” have been met in the circumstances of this case.  There is no question but that Saitek are in possession of the chattels, and lawfully and continuously so.  Nor does it seem to be disputed that money has been expended by Saitek in the maintenance of the machinery in question.  In submissions Timely contends that the items of machinery were delivered to the parts of the CPE premises which were occupied by Timely and, therefore, were not delivered to Saitek.  That submission is of course premised upon Timely having exclusive possession of that part of the CPE premises which premise I hold to be incorrect.

85.  Timely also contends that there is not in fact been expenditure by Saitek on maintenance and repair because the cost of wages of the technicians said to have carried out this work would, under the Agreement have been borne by Timely.  That submission could amount to a defence only if the sums due under the Agreement had in fact been paid, by Timely which they have not.

86.  Accordingly I find that Saitek was entitled to a lien over the machinery of Timely and Timely’s claim for damages arising out of the detention does not succeed.

The Guarantee Action 

87.  There is no dispute as to the making of the guarantee and no separate defence is advanced other than those matters canvassed in regard to the principal claim under the Main Action.  Accordingly for the reasons given above I concluded that Saitek’s claim under the Guarantee Action also succeeds.

Interest

88.  The parties agreed in the 1^st Supplementary Agreement that interest would be payable by Timely on the overdue balance at a rate of BLR + 1%.  It is accepted by Saitek that this is to accrue on a simple interest basis.  Saitek are therefore entitled to recover interest at such a rate, and only two aspects require consideration.

89.  The first is the date for the commencement of the running of interest.  Saitek have invoiced Timely for such interest, calculated based upon a commencement date of 1^st September 2007, this being the day following the expiration of the Agreement.  I accept that to be an appropriate starting point for interest.

90.  As to rate, this is specified by the 1^st Supplementary Agreement, but the base component, BLR, has of course varied over time.  Although Saitek has invoiced Timely for interest up to November 2012, as discussed at the hearing I prefer to leave this for agreement between the parties in the first instance.

91.  Accordingly there will be an order for interest to accrue on Saitek’s awarded sum of HK$6,502,555.15 at the rate of 1% above BLR from 1^st September 2007 to the date of this judgment.  The parties have liberty to apply in the event that the relevant calculation cannot be agreed.

Conclusion

92.  There will be judgment for Saitek in both the Main Action and in the Guarantee Action as provided above in the principal sum of HK$6,502,555.15 plus interest.

Costs

93.  It was agreed that an order nisi should be made as to costs.  Following usual principles it is clear that Saitek is to be categorized as the successful party and should be entitled to its costs in the usual way.

94.  The hearing was adjourned on 31^st May 2013 due to the non-availability of the Plaintiff’s expert witness.  I ordered the costs wasted and thrown away by the adjournment to be to the Defendants in any event.

95.  Saitek were represented by two counsel and a certificate for two counsel is sought.  While I have no doubt that the presentation of the case has been enhanced by the additional assistance provided I do not think that this was a case of such complexity as to require the presence of two counsel and I decline to grant the certificate.

96.  Subject to the separate order in regard to the costs of the adjournment therefore the Plaintiff is to have its costs, on an order nisi basis, to be taxed if not agreed on a party and party basis.