PAUL’S MODEL ART GMBH v. U.T. LTD AND OTHERS

HCA 1501/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

HIGH COURT ACTION NO 1501 OF 2000

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J U D G M E N T

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INTRODUCTION

1.  The plaintiff commenced this action in February 2000 for (i) breach of agreement by some of the defendants, and (ii) inducement of its breach by the other defendants (summarized in para 25 to 26 below).  The defendants deny the claim and allege instead that the plaintiff (and another) breached the agreement.  The dispute in this action arose out of the sale of collectible die-cast models (mainly cars and motorcycles) and related products.

THE PARTIES AND THEIR RELATIONSHIP

2.  Before dealing with the dispute, to facilitate the comprehension of this judgment, the relevant parties are:

(a) the plaintiff (also the 1^st defendant by counterclaim) (“Paul’s Model Art”) was a company incorporated in Germany and operated primarily by a German national, Paul G Lang (the 2^nd defendant by counterclaim) (“Lang”);

(b) the 1^st defendant (also the plaintiff by counterclaim) (“UT Ltd”) was a company in Hong Kong and operated by the 2^nd defendant (“Kwan”).  UT Ltd owns (or controls) a Mainland company, Dongguan Unique Toys Co Ltd (“Dongguan UT”);

(c) besides operating UT Ltd, Kwan also owned and controlled Trendy Holdings Ltd (“Trendy”) which owned and controlled the Davidson group of companies (in particular, Davidson Ltd in Hong Kong, and Dongguan Davidson in the Mainland), Trendy also owns 40% of the shares of the 4^th defendant (“Gateway Global”), a BVI company.  Gateway Global has several subsidiaries (for convenience, they will be called: Gateway Europe (a German company), Gateway Florida and Gateway California (both US companies), Gateway UK (a UK company) and Gateway Canada (a Canadian company));

(d) the 3^rd defendant (“Lam”) was the other shareholder of UT Ltd (until 21 August 1998 (see also para 25(b)(1) below));

(e) the 5^th defendant (“Gateway HK”) is also a Hong Kong company effectively owned by Gateway Global.

In the paragraphs below, UT Ltd, Kwan and Lam will collectively be called “the JV defendants” while Gateway Global and Gateway HK will collectively be called “the Gateway defendants”.

3.  It is common ground:

(1) Lang and Kwan began their business relationship in 1992 when Lang started to engage Kwan’s company to make moulds for die-cast models;

(2) their business cooperation became closer in 1994 when Lang and Kwan started two Hong Kong joint-venture businesses, UT Models Ltd (“UT Models”) and Minichamps Hong Kong (marketing and distribution);

(3) the parties also signed what for convenience can be called “the 1994 agreement”.  Details concerning the 1994 agreement will be discussed below;

(4) since then, Kwan also became involved in the sale and distribution of the said models through UT Models (besides being involved in the production of die-cast models);

(5) the product brand names were (i) various brands sold by Paul’s Model Art, and (ii) “UT Models” sold by UT Models.

(UT Models and Minichamps Hong Kong ceased business in December 1996)

4.  Under the 1994 agreement:

(a) UT Ltd was to develop and manufacture models for only 5 companies (3 of which were Lang’s companies (including Paul’s Model Art), the other two being UT Models (the joint-venture company) and a yet-to-be set up US company);

(b) in return, the said 5 companies were to engage UT Ltd as their exclusive supplier of the models.

The products to be marketed under the 1994 agreement were set out in a schedule attached to it. This schedule has been relied on by the parties (see especially para 78 and 79 below) in the construction of the agreement entered into on 28 December 1996, the subject matter of this action (“the 1996 agreement”).

5.  The parties differ as to what brought about the termination of the 1994 agreement and the beginning of a new business relationship pursuant to the 1996 agreement.  This will be mentioned again below, but very briefly, the change was probably prompted by:

(1) their different perception as to who has benefited more from the business dealings under the 1994 agreement.  From Paul’s Model Art’s perspective, Kwan and Lam has acquired from it better manufacturing knowledge and skill and better overseas sales and/or distribution connections. From Kwan’s/Lam’s perspective, their quality manufacturing process has enabled Paul’s Model Art’s business to prosper;

(2) the payment problem encountered by Paul’s Model Art in Europe which led to a substantial trading debt which it owed to Kwan/Lam in the period before the 1996 agreement.

SUMMARY OF PARTIES’ CASE

6.  Paul’s Model Art’s case is in gist that:

“… the Defendants were involved in a scheme to establish, construct and operate a new corporate and distribution structure (with [Gateway Global] at the apex) to manufacture, market and distribute die-cast model cars in breach of [the 1996 Agreement] … and to conceal that from [Paul’s Model Art]” (para 2, plaintiff’s closing submissions).

7.  On the other hand, the defendants contend in effect that Paul’s Model Art has construed the 1996 Agreement in an unduly wide manner.  They contend that, upon a proper construction of the same, they were entitled to do what they did because any prohibition:

(1) was only brand-based (except in relation to the “non-competition” provision) so that there was no breach if Paul’s Model Art’s brands have not been used (para 12(1), D1-3’s opening submissions);

(2) only bound UT Ltd, so that Kwan and/or Lam were not prohibited to (and not prohibited from procuring or causing other companies to) manufacture, produce, distribute or sell the goods concerned as long as the same did not involve UT Ltd (para 7, D1-3’s closing submissions).

THE 1996 AGREEMENT

8.  As stated above, the dispute in this action revolves around the 1996 agreement, in particular the parties’ respective production, sale and distribution rights therein (para 9(5) and (7) below).  It was entered into between:

(i) Paul’s Model Art;

(ii) Lang;

(iii) UT Ltd;

(iv) Kwan;

(v) Lam.

Besides, the two joint-venture companies under the 1994 agreement (UT Models and Minichamps Hong Kong) were also contracting parties.

9.  It is undisputed the 1996 agreement can be viewed as containing the following operative parts:

(1) cancellation of all previous agreements (this is directed primarily at the 1994 agreement) (clauses 2.1 and 2.2);

(2) dissolution of UT Models (clauses 3.1.1 and 3.3) and related consequential arrangements regarding the production moulds (clauses 3.1.2 and 3.1.3), licence agreements (clause 3.2) and payment obligations (clause 3.4 to 3.6) and right to use the “UT Models” brand (clause 3.7);

(3) dissolution of Minichamps Hong Kong (clause 4.1.1) and related consequential arrangements regarding the stock-in-trade (clause 4.1.2) and payment obligations (clauses 4.1.3 and 4.2);

(4) grant of licences/sub-licences between Paul’s Model Art and UT Ltd and related payment obligations (clause 5);

(5) provisions concerning the parties’ respective territorial:

(i) production and sale rights (clauses 6.8 to 6.11 and 6.14)); and

(ii) distribution rights (clauses 6.11 to 6.14),

for 10 years since the date of agreement (clause 6.1) and related provisions for moulds (clauses 6.2 to 6.6);

(6) personal obligations to ensure compliance (clauses 3.5, 3.6, 4.1.3 and 6.15);

(7) schedules specifying the products mentioned in the above clauses.

(As stated in para 3(2) above, UT Models (sub-para (2)) above and Minichamps Hong Kong (sub-para (3) above) were the joint-venture businesses under the 1994 agreement.)

10.  The terms of the 1996 agreement which are important to the issues in this action are set out below.

11.  Clause 6.1:

“The duration of the provisions of this Clause [6] shall be 10 years commencing from [28 December 1996] … ” (emphasis supplied).

Clause 6.8:

“UT Ltd. agrees that it will not manufacture, directly or indirectly, products which are in competition with the Products and products developed and produced by PMA during the continuance of Clause [6].

Until now PMA produced modelcars and modelbikes in various scales in high collector quality standard. Under the brandname -Minichamps- PMA is producing items listed in schedule [2] (the PMA-products).

UT Ltd./UT is producing and planning to produce items listed in schedule [2] (the UT Ltd. products).

PMA will not produce directly or indirectly, products which are in competition with the products and products developed and produced by UT LTD. referring to the UT-Program during the continuance of Clause [6].” (emphasis supplied).

12.  Terms of the 1996 agreement concerning re-sales can be found in clauses 6.9 to 6.11 and 6.14:

“UT Ltd. shall be entitled to sell and distribute the Products that UT Ltd. produced by and on behalf of PMA directly to countries specified in Schedule [3].” (clause 6.9);

“UT Ltd. agrees to avoid to sell any of the UT / PMA products to a purchaser who UT Ltd. knows or ought to know may re-sell the Products to countries outside those specified in Schedule [3].

PMA agrees to avoid to sell any of the UT / PMA products to a purchaser who PMA knows or ought to know may re-sell the Products to countries outside those specified in Schedule [4].” (clause 6.10);

“Countries not specified in Schedule [3] including but not limited to Japan and Australia are specifically and expressly excluded from distribution set out in Clause [6] and no rights of distribution or sale are granted by PMA to UT Ltd. in respect of these countries.” (clause 6.11);

“UT Ltd. will avoid to sell any of the UT Ltd. Products described in Clause 6.8 to any person who UT Ltd. reasonably believes may resell the same in Germany, Belgium and such other countries and territories where PMA is the agent of the UT Ltd. Products.” (clause 6.14).

13.  The parties’ distribution rights and obligations are contained in clauses 6.12 and 6.13:

“Unless and until the expire or earlier termination of the provisions of Clause [6], PMA or one of the subsidiaries of PMA is appointed by UT Ltd. as:-

6.12.1 The sole and exclusive distributor of the Products described in Clause 6.8 (the ‘UT Ltd. Products’) in Germany and Belgium;

6.12.2 The sole and exclusive selling agent for UT Ltd. products described in Clause 6.8 (the ‘UT Ltd. Products’) in the countries set out in Schedule [4] (the ‘Agency Territories’).” (emphasis supplied) (clause 6.12);

“UT Ltd. shall on the 15^th day of each following month effect payment to PMA of a sum equal to 5% of the received amounts (without any deduction whatsoever) of the UT Ltd. products sold in the foregoing month to the purchasers in the agency territories set out in Schedule (4). For handling costs for european licenses UT Ltd. is not obliged to pay to PMA unless otherwise decided by the parties. … ” (clause 6.13).

14.  The words:

(a) “manufacture”, “produce” and “distribute” (clauses 6.8, 6.9 and 6.12.1);

(b) “sell” (clauses 6.9, 6.10, 6.11, 6.12.2 and 6.14),

appear in some of the terms of the 1996 agreement.  It appears the parties do not dispute the meaning of the word “produce” was:

“[to develop] product lines, [to arrange] manufacturing and [to distribute] to wholesalers or retailers” (para 6, plaintiff’s opening; para 7 to 10, D1-3’s reply submissions).

However, because the word “distribute” has expressly been used in some of the clauses of the 1996 agreement, I doubt if the word “produce” should also mean “distribute” as well.

15.  The “personal covenants” concerning Lang, Kwan and Lam are contained in clause 6.15:

“Kwan and Lam hereby (jointly and severally) agree with PMA and Lang that they shall cause and procure that UT Ltd. complies with all the provisions of Clause [6].

Lang hereby agree with UT Ltd. that he shall cause and procure that PMA complies with all the provisions of Clause [6].” (emphasis supplied)

MAIN POINTS OF DISPUTE

16.  There is no substantial dispute as to what UT Ltd and Kwan did after the 1996 Agreement was executed (except in relation to a Kolara Ltd (“Kolara”) (this will be discussed below)).  The main dispute is whether what they did amounted to breaches of the 1996 Agreement.

17.  In particular, the parties disagree as to whether the territorial division provided for in the 1996 agreement was product type-based (as Paul’s Model Art contends), or brand-based (as the defence contends).

18.  A proper resolution of the above dispute depends primarily on whether their acts (which Paul’s Model Art claims were repudiatory acts) were acts prohibited by the 1996 Agreement.  This in turn depends on the construction of the relevant contractual clauses.

19.  However, because of the clarification of the state of the law in recent authorities (see below for more detail), it is also necessary to examine some of the factual background surrounding the 1996 Agreement.  Parts of the background are factually disputed.

20.  Further, insofar as it may be necessary to do so, Paul’s Model Art also asks the court to “lift the corporate veil” and to hold that it was Kwan/Lam who procured the various companies under their control to breach the 1996 agreement.

21.  On the other hand, the defendants also argue that the contractual provisions relied on by Paul’s Model Art amount to restraint of trade provisions and were thus unenforceable.

WITNESSES’ CREDIBILITY/RELIABILITY AND FINDINGS OF FACT

22.  Quite a number of witnesses have been called to testify for the parties (especially for Paul’s Model Art).  Their testimony covers various factual matters.  For the purpose of this judgment, the following aspects are more important:

(1) circumstances leading to, and existing at the time of, the 1996 agreement (these are said to be relevant to its construction);

(2) events subsequent to the 1996 agreement (these are said to be relevant to the parties’ liability and quantum of loss).

23.  The factual matters referred to in para 22(1) above will be discussed under the heading “Construction of the 1996 Agreement”. However, only some of the matters will be mentioned specifically.  To avoid doubt, those which have not been mentioned have also been taken into account; they are not mentioned only because of their lesser weight and the need to keep this judgment to an appropriate length.

24.  The factual matters referred to in para 22(2) above will be discussed under this heading.  Before doing so, a few words have to be spent on the parties’ respective case to make the witnesses’ testimony easier to understand.

25.  Paul’s Model Art alleges the defendants’ breach to be as follows:

(a) Kwan and Lam began “a scheme to [set up] a new corporate … structure … to manufacture, market and distribute … [the products] … ” (see para 6 above for a fuller quote);

(b) specifically, the said scheme was carried out in the following manner:

(1) Kwan and Lam sold their UT Ltd shares to another company in August 1998;

(2) between March 1998 and June 1999, Trendy and the Gateway defendants were set up (these were controlled by Kwan);

(3) the Davidson companies were set up (they operated the Mainland factories);

(c) further, after the writ herein was issued (February 2000), Kolara was set up in March 2000.

The other defendants knowingly participated in the said scheme (the case against the Gateway defendants is said to be “inducing breach of contract” by buying “offending” products from UT Ltd and Kolara with knowledge of the breach (for distribution and sale purpose): para 237, 238 and 240 to 241, plaintiff’s closing submissions).

26.  Paul’s Model Art further complains that, through the above scheme, UT Ltd products (“UT products”) and Paul’s Model Art products (“PMA products”) were manufactured, then distributed/sold, by the JV defendants.  This amounted to a breach of the 1996 agreement (clauses 6.8, 6.10, 6.12 and 6.13, and 6.15) even though the distribution/sale was effected through the Gateway defendants (especially Gateway Global), the Davidson companies, and/or Kolara (after March 2000) (as the case may be).

27.  Paul’s Model Art says that “direct” sales by UT Ltd to Germany, and to the “Schedule 4” countries without paying commission were only a small number of such sales.  The majority of wrongful (indirect) sales was the sales of:

(1) UT products to the Gateway defendants, which then sold them to the “Schedule 4” countries (under the brands “Gate” and/or “Autoart”);

(2) PMA products to the Gateway defendants, which then sold them to countries outside of the “Schedule 3” countries.

(para 36 and 36A, plaintiff’s re-re-amended opening)

The defendants deny the above claim.

28.  In the counterclaim (brought by UT Ltd against Paul’s Model Art and Lang), it is alleged that, between July 2000 and December 2006, the sale of UT products worth about US$7.397 million were wrongfully sourced from suppliers other than UT Ltd.

29.  The defence to the above counterclaim is in short that:

(a) Paul’s Model Art and Lang did so only because UT Ltd wrongfully refused to supply these products (which ought to have been supplied pursuant to clause 6.2, the 1996 agreement).  In other words, such acts were merely to mitigate Paul’s Model Art’s loss;

(b) in any event, UT Ltd has not adduced sufficient evidence of loss of profits (or of the other claims for damages).

30.  UT Ltd argues that it was not obliged by clause 6.2 to supply UT products to Paul’s Model Art (as opposed to PMA products).

31.  The tests for assessing witnesses’ credibility have been variously set out in cases such as:

(i) Wong Siu Ming Jason v Chung Man Wai Rebecca HCA 64/2010 (30 August 2012), para 10;

(ii) Lee Fu Wing and Another v Yan Paul Po Ting and Another [2009] 5 HKLRD 513, para 53.

These tests have been adopted here.

(a)     Plaintiff’s case

32.  The testimony of Lang, Kwan and Mr Morot-Gaudry (“Morot”) (president of Minichamps North America Incorporated) is particularly relevant to this aspect.

33.  For the reasons set out below, I do not accept:

(1) Kwan to be truthful in relation to his role in Kolara (there is no dispute about his involvement in the Davidson companies or the Gateway defendants) (see also para 41 below);

(2) Morot to be reliable, especially in relation to his knowledge of the corporate structure and control of Gateway and the Davidson companies.

34.  Although the involvement of Kwan in the Gateway defendants is undisputed, a few words should be spent on it.  From the company records, Kwan has been a majority shareholder (60% together with his wife’s shareholding).  Kwan was also known to be a senior officer making the major decisions and in charge of its operations.  It can (and should) be inferred that Kwan was very much the “mind” behind the Gateway defendants (despite the suggestions to “dilute” such impression made from time to time by Kwan and his co-shareholder, Mr Ibrahim, also known as Mr Yee (“Yee”)).

35.  As regards Kolara, the defence case is that this company purchased Dongguan UT in November 2000, and Kolara was unrelated to Kwan.

36.  Paul’s Model Art relies on the following circumstantial evidence to show Kwan’s continued connection to this company after November 2000:

(a) in 2001, Kwan still: (i) handed out business cards showing the Dongguan address, (ii) arranged factory tours there, (iii) referred to the Dongguan factory as “our factory” in his e-mail; further, Gateway internal e-mails were sent to a staff of Kolara;

(b) among the corporate documents disclosed by Kolara’s secretarial service provider (“Dynamic Consultants”), the minutes of the first directors’ meeting show the obliterated words of Kwan’s name:

(c) a debit note for Kolara was sent by the secretarial service provider to Kwan in October 2004;

(d) a private investigator, I-OnAsia Ltd, reported in January 2005 it paid a visit to UT Ltd’s Dongguan factory in November 2004.  Various indicators showed Kwan to be the person-in-charge (discrete enquiries of the staff, the provision of Gateway Global’s telephone number as a means of contact, surveillance showing Kwan to have visited the factory in December 2004).

37.  I agree with Paul’s Model Art that the above matters show:

(1) Kwan’s attempts to explain away his connection to Kolara ought not be accepted as truthful;

(2) it is proper to infer that Kwan was very much still in charge of the affairs of Kolara/the Dongguan companies (especially their operation) after the “sale”.

38.  The defence criticizes the investigator’s report is multiple-hearsay and should be ignored.  I disagree.  It may be hearsay evidence in nature, but I do not consider it to contain any unreliable (or untruthful) evidence.

39.  As regards the documents from Kolara’s secretarial service provider (para 36(b) above), the defence also criticizes them to be hearsay in nature, and the author not having been called to testify.  The defence also argues that mistakes (or misunderstanding) cannot be ruled out.  I agree that that may be so if those documents were the only piece of evidence; but here there are other pieces of consistent evidence; the possibility of mistake (or misunderstanding) is thereby excluded.

40.  On the other hand, I agree with the defence Morot’s testimony is at best unreliable.  The cross-examination shows:

(1) he was not in a position where he had the opportunity to access his company’s (or Gateway’s) management-related information;

(2) he has exaggerated parts of his testimony;

(3) he has apparently “massaged” parts of his witness statement (compared to the contents of parts of his affirmation).

41.  Lang’s testimony has been “tainted with” his ill-feeling towards Kwan and Lam.  For example, his testimony about the alleged wrong-doings of Mr Schmadalla (a former employee who later joined the business of the JV defendants) is by and large unsubstantiated by independent evidence (his earlier legal action against Schmadalla was dismissed by the German court).  Consequently, I find his testimony to have little value where it has not been supported by undisputed contemporaneous documents (by and large, the same can be said of Kwan’s testimony).

(b)   Counterclaim

42.  The dispute raised in relation to the counterclaim is essentially legal in nature.

43.  It is accordingly unnecessary to make any specific factual findings, or assessment of credibility/reliability under this sub-heading.

CONSTRUCTION OF THE 1996 AGREEMENT

44.  Most of the relevant legal principles are trite.

45.  The well-known passage in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-3 reads:

“… subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of ‘legal’ interpretation has been discarded. The principles may be summarised as follows.

(1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(2) The background was famously referred to by Lord Wilberforce as the ‘matrix of fact’, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax (see Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] 3 All ER 352, [1997] 2 WLR 945.

(5) The ‘rule’ that words should be given their ‘natural and ordinary meaning’ reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in Antaios Compania Naviera SA v Salen Rederierna AB, The Antaios [1984] 3 All ER 229 at 233, [1985] AC 191 at 201:

‘... if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.’” (emphasis supplied)

(and subsequent similar observations in other authorities, such as Jumbo King Ltd v Faithful Properties Ltd and Others (1999) 2 HKCFAR 279, 296.)

46.  The above approach was recently re-stated by the Court of Final Appeal (perhaps even taken a bit further (or at least made more explicit)) in Fully Profit (Asia) Ltd v The Secretary For Justice FACV 17/2012 (13 May 2013):

“We have been referred to the very well-known statement of principle regarding the construction of contracts contained in the speech of Lord Hoffmann in [the Investors Compensation Scheme Ltd decision], to which can be added the judgment also of Lord Hoffmann NPJ in [the Jumbo King Ltd decision]. What emerges from these cases – and other authorities on contractual interpretation – is the overall importance of context when construing contractual terms. The statements of principle in Investors Compensation Scheme and in Jumbo King refer time and again to the relevant background against which the relevant contract and contractual terms must be viewed. It is in my view not particularly helpful in most cases to refer to the ‘ordinary and natural meaning’ of words because, as very often experience tells us, there can be much debate over exactly what is the ordinary or natural meaning of words. The surer guide to interpretation is context. Here, I would just add that in the area of statutory and constitutional interpretation, it is context that is key; context is the starting point (together with purpose) rather than looking at what may be the natural and ordinary meaning of words.

The word ‘house’ is a good example of where there is no ordinary or natural meaning; at least this is open to much debate. The number of authorities referred to in the judgments below and in the parties’ written Cases before us amply demonstrate this point and, for my part, very little assistance can be derived from these authorities. This Court has already stated that a ‘search for a free-standing meaning of the word house, valid for all time in all circumstances, is fruitless.’ Reference was made in Wah Yick to the judgment of Lawrence J in Annicola Investments Ltd v Minister of Housing and Local Government where he said the word had a ‘distinct fluidity of meaning’, and that it is best construed in relation to the context in which it is found, …” (emphasis supplied) (para 15 and 16).

47.  It is with the above in mind that this aspect will be examined below.

(a)     Background matrix

48.  As stated above, it was observed in Marble Holdings Ltd v Yatin Development Ltd (2008) 11 HKCFAR 222, 232:

“… parties often fail to express themselves well or clearly in which case the surrounding circumstances are of particular value” (para 20 thereof).

49.  I agree with the defence observation that the language used in the 1996 agreement is far from being a model of clarity. Having said so, this does not diminish the need for the court to ascertain its true meaning (although this increases the difficulties of the task).  Thus, the background leading to, and surrounding, the execution of the 1996 agreement should be borne in mind when construing the meaning of its terms.

50.  Paul’s Model Art contends that the background is important for the following reasons:

(a) it was preceded by the 1994 agreement, which was in the nature of a manufacturing agreement; that is, UT Ltd was to develop and manufacture models for 5 companies only (the majority of which were Lang’s companies);

(b) Schedule 2 of the 1996 agreement was derived from the Schedule to the 1994 agreement;

(c) the 1996 agreement represented the result of the parties’ negotiation to end the manufacturing relationship under the 1994 agreement, and be replaced by a new business relationship;

(d) the new business relationship covers the following aspects:

(i) mould production;

(ii) the grant and/or procurement of production licenses;

(iii) 10-year long territorial production and sale rights;

(iv) 10-year long territorial distribution rights;

(e) the ambit of the production, sale and/or distribution rights were to be deduced, not only by the language of clause 6, but also the schedules to the 1996 agreement (one of which has its roots in the 1994 agreement).

51.  The background set out in para 50(a) to (c) above is in substance undisputed.  In relation to para 50(d) and (e) above, the defence rather describes the 1996 agreement was:

“… for [UT Ltd] to be released from the manufacturing restriction imposed … under the 1994 Agreement, terminate the joint venture, and for [UT Ltd] to be able to produce its own line of products under the ‘UT Models’ brand” (para 17, D1-3’s, closing submissions).

52.  Whatever may be the language preferred by the parties in describing their relationship, it cannot be disputed the parties expected their former relationship (as evidenced by the 1994 agreement) could not continue “as is”.  Thus, the 1996 agreement must have been intended to be a means of “regulating” how they should “go their separate ways”.

53.  Precisely how their “new” relationship was to be “regulated” is a matter which constitutes the (or at least the main) issue in this action, and will require an examination of the 1996 agreement itself.

54.  Before discussing the details concerning the 1996 agreement, a few words should be spent on how the world was “carved up” by it:

(1) “Schedule 3” countries are “Asia (except Japan), Oceania (except Australia and New Zealand), the US and Canada”;

(2) “Schedule 4” countries are “Eastern and Western Europe (as further defined by the 1996 agreement), Germany and Belgium”;

(3) “countries not specified in Schedule 3 including but not limited to Japan and Australia” (this phrase is used in clause 6.11 (relating to UT Ltd’s right to distribute and sell Paul’s Model Art’s products)).

55.  Dispute concerning factual matters which took place in the period before the 1996 agreement have been raised during trial. But some of them should not impact significantly on the construction of the 1996 agreement, and thus would not be set out here. Such disputed matters include:

(a) the cause of Paul’s Model Art’s indebtedness to UT Ltd during the period immediately before the 1996 agreement;

(b) Paul’s Model Art registering some of the product licences in its name, instead of the name of the then joint-venture businesses.

Further to the above, the parties’ post-2006 agreement conducts (such as whether the JV defendants have any interest in the Gateway defendants and/or Kolara) are also irrelevant to this issue.

56.  One aspect which can also belong to the background matrix is the parties’ knowledge of a fact: Lewison: The Interpretation of Contracts (2011) 5^th Ed, para 3-09 (esp at pp 97-8).  But Lewison discussed that aspect in the context of “pre-contractual negotiations”.

57.  In the context of this action, this aspect is also put forth by the parties as part of the pre-contract negotiations.  It will thus be discussed under the sub-heading below.

(b)     Negotiations/draft agreement

58.  This is an area over which the parties disagree as to which set of the relevant legal principles.  Paul’s Model Art contends that the set of principles set out in para 59 to 60 below are applicable to the facts of this action; the defence contends, on the other hand, the set of applicable principles should be those set out in para 61 to 64 below.

59.  In the passage quoted above (from the Investors Compensation Scheme decision), Lord Hoffmann said:

“The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.” (para 45 above).

60.  Lord Hoffmann’s reference to “reasons of practical policy” has been elaborated in Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101.  Having discussed the various pros and cons of excluding such evidence:

“… pre-contractual negotiations seem to me capable of raising practical questions different from those created by other forms of background. … statements in the course of pre-contractual negotiations will be drenched in subjectivity and may, if oral, be very much in dispute. It is often not easy to distinguish between those statements which (if they were made at all) merely reflect the aspirations of one or other of the parties and those which embody at least a provisional consensus which may throw light on the meaning of the contract which was eventually concluded …

…

… there is no clearly established case for departing from the exclusionary rule. The rule may well mean …that the parties are sometimes held bound by a contract in terms which, upon a full investigation of the course of negotiations, a reasonable observer would not have taken them to have intended. But a system which sometimes allows this to happen may be justified in the more general interest of economy and predictability in obtaining advice and adjudicating disputes” (emphasis supplied) (para 38 and 41).

61.  While the defendants do not dispute the above general legal propositions, they rely on authorities which decided in effect that, in certain circumstances, deletions in earlier contractual documents can be referred to as an aid of construction of the contractual provisions, or as a fact to show what matters the parties have not included in the contract:

(a) Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337;

(b) Punjab National Bank v De Boinville [1992] 1 WLR 1138;

(c) Mopani Copper Mines plc v Millenium Underwriting Ltd [2008] 2 All ER (Comm) 976.

62.  The Codelfa decision involved a building contract.  In discussing what matters could be considered when determining whether to imply a term into the contract, the High Court of Australia observed:

“… a difficulty arises with respect to the evidence of prior negotiations. … But insofar as they consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable. The point is that such statements and actions … are superseded by, and merged in, the contract itself. …

There may perhaps be one situation in which evidence of the actual intention of the parties should be allowed to prevail over their presumed intention. If it transpires that the parties have refused to include in the contract a provision which would give effect to the presumed intention of persons in their position it may be proper to receive evidence of that refusal. … ” (emphasis supplied) (p 352).

63.  In the Punjab National Bank decision, the English court of appeal drew a distinction between (i) considering deleted words as a guide to the meaning of words elsewhere in a contract, and (ii) the fact of deletion.  Having done so, it said:

“The law on this topic [whether regard could be had of deletions] still contains what Diplock J. described in Louis Dreyfus & Cie v Parnaso Cia Naviera SA [1959] 1 QB 498] as ‘a pleasant diversity of authority … ’ …

… ‘the weight of the authorities is now in favour of the view that the court may not look at deletions.’ …

… Diplock J. in the Louis Dreyfus case looked at deleted words in a printed form, as a guide to the meaning of similar words in a neighbouring paragraph. This seems to me, if I may say so, eminently sensible. … If the deleted paragraph provides a clue to what that sense was, there is a strong case for considering it.

In London & Overseas Freighters Ltd v Timber Shipping Co SA [1972] AC 1 …

… is a case of using the fact of deletion as an aid to construction. It is a different process to that of Diplock J. who used the deleted words as a guide to the meaning of similar words elsewhere. [Having referred to Mottram Consultants Ltd v Bernard Sunley & Sons Ltd [1975] 2 LL Rep 197, 209]. … Once again, in my opinion, if I am permitted to say so, this is eminently sensible. The fact of deletion shows what the parties did not want in their agreement. …

In the present case the contract is not wholly a printed form; parts of it are printed, parts have the appearance of being incorporated from some previous source, and parts of being specially prepared for this occasion … But against that the endorsement … forms part of the contract, and actually states what is to be deleted and how it is to be replaced. It would seem to me contrary to all reason to ignore what is deleted in such a case …

So I would hold that, if the parties to a concluded agreement subsequently agree in express terms that some words in it are to be replaced by others, one can have regard to all aspects of the subsequent agreement in construing the contract, including the deletions, even in a case which is not, or not wholly, concerned with a printed form” (emphasis supplied) (pp 1147-9).

It seems implicit in the above passages the English court found the words to have been deleted subsequent to the conclusion of the agreement.  Despite the finding, the English court did not seem to thinking the applicable principles should be different from those for deletions made in the course of negotiation.

64.  In the Mopani decision, which was concerned with deleted words in a reinsurance slip, the court observed:

“In [the Punjab National Bank decision] [the court] reviewed the authorities [and] pointed out that in the Louis Dreyfus case Diplock J looked at the deleted words in a printed form as a guide to the meaning of similar words in a neighbouring paragraph … [and] … the Timber Shipping case and … the Mottram Consultants case as using the fact of deletion as an aid to construction … In [the Punjab National Bank decision] there was an endorsement to a policy which formed part of the contract and which stated what was to be deleted and how it was to be replaced [and, after quoting the last-quoted passage in para 63 above, continues as follows] … The present case is not one falling within that category. But the underlying principle appears to be that the court may look at what the parties have, by way of contract, deleted if the fact of deletion shows what it was that they did not want to agree” (emphasis supplied) (para 117 to 118 thereof)

(see also similar observations at para 120 to 122 thereof).

65.  The summary of the applicable law given in Lewison concerning this aspect is:

(1) the court will often look at words which the parties have deleted from their contract in order to construe the words which remain, although they are an unsafe guide to meaning.  The learned author observed an increasingly liberal trend about this (para 3.04 thereof);

(2) however, the use to which deleted words can be put is limited.  At best, they may negative the implication of a term in the form of the deleted words (para 3.04 thereof, p 82);

(3) evidence of pre-contractual negotiations is not generally admissible; but evidence of pre-contractual negotiations is admissible to establish that a fact was known to both parties (para 3.09 thereof).

66.  In the context of this action, the main difference between the parties is in short this:

(a) Paul’s Model Art argues that the “deletion” made by Kwan was very early in the negotiation process, and hence too remote relative to the time when the parties entered into the 1996 agreement, to be considered a proper case of “deleted words”;

(b) the defence argues that the mere fact of the deletion supports its case that the parties were aware of Paul’s Model Art’s wish to define the contractual rights by product types, and that they were unable to agree about this.

Because the difference is essentially factual, it is necessary to resolve the factual dispute before one can decide which set of legal principles is applicable.

67.  A brief chronology is needed to enable the factual dispute to be properly understood:

(1) the negotiation process commenced with Paul’s Model Art (through its accountant, Mr Peters fax transmitted a draft agreement to Kwan (“the faxed draft”);

(2) Kwan says the faxed draft was sent in September 1996 while Paul’s Model Art says it was sent in mid-November 1996;

(3) the period from the sending over of the faxed draft to 20 November 1996 is also disputed: Paul’s Model Art said nothing happened while Kwan said he had lengthy telephone conversations with Lang;

(4) whether there was a meeting (between 20 and 24 November 1996) to negotiate the 1996 agreement is also in dispute: Paul’s Model art says there was such a meeting at the Mandarin Hotel where another draft was given to Kwan (“the Mandarin draft”); Kwan denies such a meeting;

(5) it is undisputed Lang came to Hong Kong in mid-November 1996 and stayed at the Grant Hyatt Hotel.  What is in dispute is whether there was a 3-day meeting for negotiating the 1996 agreement: the defence says so but Paul’s Model Art says otherwise.

Whether the faxed draft and/or the Mandarin draft was “home-made” or drafted by lawyers is also disputed; but the significance of this is minimal.

68.  Hence, leaving aside the precise timing and location of the negotiation meeting (that is, which period in November 1996 and whether it was held at the Mandarin Hotel or elsewhere), there is no dispute (so far as the witnesses’ testimony is concerned):

(a) the parties negotiated face-to-face once;

(b) at least one draft was prepared, shown to the parties and discussed among them;

(c) whether to:

(i) grant distribution rights to Paul’s Model Art based on brand names;

(ii) include companies owned directly or indirectly by the contracting parties;

were topics which have been discussed expressly between the parties during the negotiation process.

69.  The time period within which these events took place was short (relative to the time of the 1996 agreement (28 December 1996)):

(1) the faxed draft was sent to Kwan either in September 1996, (about three months earlier) or in November 1996 (about one month earlier);

(2) the face-to-face meeting was held about one month earlier.

70.  Taking into account the matters set out in para 68 to 69 above, it is proper to treat them as admissible evidence for the purpose of construing the terms of the 1996 agreement.  However, they are only admissible for the purposes set out in para 65 above.

(c)   Meaning of the relevant clauses

71.  The case of Paul’s Model Art is that this aspect should be approached differently for:

(a) PMA products;

(b) UT products.

72.  In relation to the UT products, Paul’s Model Art argues that:

(1) clause 6.12 (distribution rights and obligations) was not brand-based, but was product type-based;

(2) where clauses 6.12, 6.10 and 6.14 (both re-sale prohibitions) were applicable, clause 6.8 (manufacturing and production non-competition) was not relevant;

(3) the defendants’ breach here was procuring (or assisting) the re-sale in the “Schedule 4” countries (through the Gateway defendants and/or Kolara).

73.  In relation to the PMA products, Paul’s Model Art argues that:

(a) clause 6.8 prohibited the manufacture of competing products (under any brand);

(b) clause 6.10 prohibited the sale of those products to any intermediary who would re-sell outside the “Schedule 3” countries;

(c) the defendants’ breach lied in procuring (i) Davidson to manufacture the PMA products for sale by the Gateway defendants, (ii) Kolara to supply the PMA products to the Gateway defendants for sale.

74.  The breach of Kwan and Lam lied in causing or permitting the above breaches (contrary to clauses 3.5, 3.6, 4.1.3 and/or 6.15).

75.  The defence case, on the other hand, is that:

(1) the only product type-based contractual provision was the “non-competition” clause (clause 6.8) whether as regards manufacturing or production.  UT Ltd was not to manufacture or produce products of Paul’s Model Art (irrespective of their brand(s));

(2) the other contractual provisions were all brand-based.  In other words, distribution rights (clause 6.12), sale and/or re-sale prohibition (clauses 6.10 and 6.14) did not prohibit the defendants from dealing in products which did not bear the brands of/owned by Paul’s Model Art.

(see also para 7(1) above)

76.  Although the parties appear to be in agreement regarding whether clause 6.8 was product type-based, they disagree regarding whether the defendants have acted in breach of it.  This will be dealt with under the sub-heading “(a) Clause 6.8 (‘non-competition’ provision)” below (see also para 7(2) above).

77.  As stated above, the main dispute regarding clauses 6.12 (distribution rights) and 6.10 and 6.14 (sale and/or re-sale prohibition) is whether these were product type-based (Paul’s Model Art) or brand-based (the defendants).

78.  In support of its case, Paul’s Model Art emphasizes the following:

(a) the background to the 1996 agreement was the parties’ joint-venture relationship (which it calls a “manufacturing agreement”). The parties’ intention under the 1996 agreement was to dissolve the joint-venture and separate out their respective intended distribution in future;

(b) Schedule 2 to the 1996 agreement.  This was referred to in clauses 6.8 and 6.12 to define the parties’ distribution rights.  Schedule 2 was not worded in terms of the brands; it rather:

(i) was headed “Program of PMA and UT”;

(ii) referred to “industrial orders” (that is, orders from the auto-makers);

(iii) has column headings which referred to the companies (but not their brands);

(c) the text of clauses 6.8 and 6.12.  This was also not worded in terms of brands;

(d) the 1994 agreement itself (and the attached Schedule 2) was product type-based;

(e) (in the absence of express and/or specific provisions) it was unlikely Paul’s Model Art was a distribution/sale agent (clause 6.12) for only certain of UT Ltd’s brands;

(f) (further to sub-para (e) above) UT Ltd might have used brands not mentioned in the 1996 agreement at any time during the 10-year contractual period;

(g) the commercial purpose of the 1996 agreement. In view of sub-para (e) and (f) above, it would not serve such purpose by limiting the contractual restrictions in terms of brands;

(h) clause 5.1 (obtaining production and sale licences from the auto-makers) was also not brand-based as it referred to “product lines”.

79.  On the other hand, the defence argues the above provisions were brand-based, relying on the following:

(1) the witnesses’ testimony shows that Paul’s Model Art only made and marketed one brand “Minichamps” at the time of the 1996 agreement (some products also used “Paul’s Model Art”).  At the very least, the 1/43 scale “Minichamps” brand was its main business focus.  Lang’s assertions that some products were branded “McLaren”, “First Class Collection”, “Michael Schumacher Collection” and “Cycle Line” should not be accepted;

(2) UT Models (the then joint-venture), on the other hand, was producing the “UT Models” brand successfully;

(3) the 1996 agreement, and Schedule 2, have to be construed in light of the above pre-existing circumstances;

(4) so understood, the description was only intended to refer to the two lines of products then under the “Minichamps” and “UT Models” brands respectively;

(5) the language of clause 6.8 (“Under the brandname –Minichamps-[Paul’s Model art] is producing items listed in schedule [2]”) is consistent with the above construction;

(6) if, as Lang asserts, Paul’s Model Art had another brand (or other brands) than “Minichamps”, the specific reference to the “Minichamps” brand reinforces the above argument;

(7) the reference to “UT” in clause 6.8 (“UT Ltd/UT is producing and planning to produce … ”) must have been a reference to the brand (see also clause 1.1), not UT Model (the then joint-venture).  Thus, when read together with Schedule 2, clause 6.8 must have been referring to the products in the UT Ltd column in Schedule 2 under the “UT Models” brand;

(8) the language difference between clause 5.1 (“… permit UT Ltd to produce and sell for UT Ltd’s own product lines”) and clauses 6.8 (“UT Ltd products”).  The former shows the provision to be product type-based;

(9) the faxed draft contained the phrase “… or other brand name if chosen by [UT Ltd]”.  This was crossed out by Kwan.  The subject was obviously discussed between the parties and not agreed upon.

80.  In brief, some of both parties’ grounds have their respective attractiveness.  In other words, because of the manner in which the 1996 agreement was drafted, parts of the document can be considered to be supportive of the case of Paul’s Model Art (see para 78(b), (c) and (h) above for examples), while other parts of it can be viewed as supportive of the defence case (see para 79(5), (7) and (8) above for examples).

81.  Having said so, however, I consider the commercial purpose of the 1996 agreement to be a weighty matter (see para 78(e) to (g) above for this part of Paul’s Model Art’s case).

82.  Although the two sub-clauses of clause 6.12 were worded differently, it is undisputed both referred to “UT Ltd products”.  The territorial ambit of clause 6.12 was Germany, Belgium, and eastern and western Europe (as further defined by the 1996 agreement) (see also para 54(2) above) (collectively “the PMA commission territories”). In effect, Paul’s Model Art was appointed UT Ltd’s “sole and exclusive distributor” and “sole and exclusive selling agent” for those territories.

83.  On the other hand, (among other provisions) clause 6.14 prohibits UT Ltd from selling its products “described in Clause 6.8” to third parties who (to UT Ltd’s reasonable belief) might resell them to the PMA commission territories.

84.  To construe those provisions to bear a product type-based meaning (that is, product types under the UT Ltd column, Schedule 2) would effectively mean:

(a) UT Ltd could not manufacture for (or sell to) third party purchasers (including those purchasers who were international auto-makers) the product types mentioned in clause 6.8 (irrespective of their brand name(s)) if the same were reasonably believed to be re-sold in the PMA commission territories (clause 6.14) (see also para 89 below);

(b) but UT Ltd itself could sell the same in the PMA commission territories (though it could not manufacture) provided UT Ltd had paid the contractual monthly fee to Paul’s Model Art (clauses 6.12 and 6.13).

Such a meaning would be excessively burdensome on UT Ltd and would not serve the proper purpose of providing a means of “regulating” how the parties should “go their separate ways” (para 52 above).

85.  On the other hand, if those provisions were construed as being brand-based:

(1) UT Ltd could manufacture for (or sell to) third party purchasers the product types mentioned in clause 6.8 even if the same were reasonably believed to be re-sold in the PMA commission territories (clause 6.14) as long as they were not brands of/owned by UT Ltd (or Paul’s Model Art (clause 6.8));

(2) UT Ltd could itself also sell the same in the PMA commission territories provided UT Ltd had paid the contractual monthly fee to Paul’s Model Art (clauses 6.8, 6.12 and 6.13).

86.  Considerations similar to para 84 and 85 above apply equally to clause 6.10 (re-sales to countries outside of “Schedule 3”countries (for UT Ltd) and to those outside of “Schedule 4” countries (for Paul’s Model Art)).

87.  By reason of the above matters, I agree with the defence that clauses 6.10 to 6.14 should be construed to bear a brand-based meaning.

88.  It should be mentioned that I find no need to resort to the pre-contract negotiations (or the pre-contract faxed draft) in arriving at the above conclusion.  In any event, because of the limited use to which the same can be put to, I would not have found those matters to be of great assistance in determining this aspect.

89.  It should also be mentioned that, in coming to the above conclusions (para 84, 86 and 87 above), account has been taken of:

(a) there are (and were) other competitors, that is, suppliers (be they manufacturers or producers) of similar products, in the market (albeit, according to both parties, the quality of their products was not as good (or as popular) as theirs);

(b) Paul’s Model Art has been relatively more versed in obtaining licences from the auto-makers, and has better connections to the purchasers (especially European purchasers, be they distributors, wholesalers or importers) than UT Ltd, Kwan and Lam;

(c) the JV defendants have been more versed in the manufacture of products than Paul’s Model Art.  They have been manufacturing both for their own business and as an OEM supplier.

ACTS AMOUNTING TO BREACH

(a)     Clause 6.8 (“non-competition” provision)

90.  I agree with Paul’s Model Art that clause 6.8 (among the other contractual terms) was far from well drafted.  For one thing, the four paragraphs of that clause appear in the wrong order.  They should rather appear in the following order:

(1) two paragraphs therein dealt with the PMA products:

“Until now PMA produced modelcars and modelbikes in various scales in high collector quality standard. Under the brandname -Minichamps-PMA is producing items listed in schedule [2] (the PMA-products). [originally the second paragraph therein]

UT Ltd. agrees that it will not manufacture, directly or indirectly, products which are in competition with the Products and products developed and produced by PMA during the continuance of Clause [6]. [originally the first paragraph therein]” (emphasis supplied);

(the first of the above two paragraphs was in the nature of a recital)

(2) the remaining two paragraphs therein dealt with the UT products:

“UT Ltd./UT is producing and planning to produce items listed in schedule [2] (the UT Ltd. products). [originally the third paragraph therein]

PMA will not produce directly or indirectly, products which are in competition with the products and products developed and produced by UT LTD. referring to the UT-Program during the continuance of Clause [6]. [originally the fourth paragraph therein]” (emphasis supplied).

(the first of the above two paragraphs was also in the nature of a recital)

91.  The parties’ arguments regarding what acts could be covered by this clause have been put forth on two bases:

(1) whether what the defendants did should fall within the meaning of “direct” and/or “indirect” manufacturing (or production);

(2) an implied term that neither UT Ltd nor Kwan and Lam should procure others (corporate or otherwise) under their control or direction to breach the 1996 agreement.

92.  In relation to the meaning of “direct” and “indirect” manufacturing (or production), Paul’s Model Art argues that:

(a) “directly” manufacture referred to the state of affairs at the time of the 1996 agreement (UT Ltd receiving the orders, then arranging for manufacture of the same by the Mainland factory and so on);

(b) “indirectly” manufacture referred to a wider or looser arrangement (or concept).  It thus should be capable of including the manufacture by any company under the effective control of Kwan and Lam;

(c) in this connection, clause 6.8 should be read together with clause 6.15 (Kwan and Lam’s personal covenant).

93.  The defendants disagree and contend that:

(1) “directly” manufacture was intended to forbid UT Ltd from becoming a manufacturer of the goods in question;

(2) “indirectly” manufacture was intended to cover the state of affairs existing at the time of the 1996 agreement; that is, taking order as a contractor, then sub-contracting the manufacture.

94.  The defendants’ above case has also been couched as the so-called “companies argument”.  That is, clause 6.8 only named only UT Ltd and Paul’s Model Art as the obligated parties.  The clause did not bind Kwan or Lam; a fortiori, it did not bind the Gateway defendants or Kolara.  This is so irrespective of the phrase “directly or indirectly”.

95.  To reinforce the argument, the defendants draw attention to the following:

(a) the language of the 1996 agreement distinguished between UT Ltd on the one hand and Kwan and Lam on the other;

(b) none of the contractual provisions was worded in a way to extend their coverage to other companies owned and/or controlled Kwan and Lam;

(c) on the contrary, a proposal to such effect (which also appeared in the faxed draft) has been discussed but not agreed upon (Kwan crossed out the proposal in the faxed draft);

(d) Kwan and Lam were merely the shareholders of UT Ltd.  There is no legal principle for construing a contract so that the rights and obligations of a contracting company should also bind its shareholders;

(e) all the alleged wrongful acts were those of the Gateway defendants and/or Kolara (even if Kwan had any interest in Kolara);

(f) no contractual term should be implied to the above effect; it was neither reasonable nor necessary for business efficacy to do so, and the fact that the parties agreed not to agree upon such matter negated such implication (see also sub-para (c) above).

96.  In determining this dispute, it is important to bear the following in mind:

(1) at the time of the 1996 agreement, the parties were well aware of the identity of the individuals behind, and in control of, the respective companies which had agreed to be bound by the 1996 agreement:

(a) Lang in the case of Paul’s Model Art;

(b) Kwan and Lam in the case of UT Ltd;

(2) those individuals were also made parties to the 1996 agreement;

(3) further to sub-para (2) above, those individuals were bound by personal covenants to “cause and procure” the respective companies which they controlled to abide by the relevant contractual provisions.

97.  In the light of the above, the construction contended for by the defendants is too restrictive.

98.  A company may be a separate and independent entity in terms of legal concept.  But as a matter of business reality, a company with a corporate structure like UT Ltd’s is not much more than the individuals controlling it (in this case, Kwan and Lam).  The draftsman of the 1996 agreement must have had this reality in mind when he included clause 6.15 in the 1996 agreement.

99.  I agree with the defence that the 1996 agreement must have been a “home-made” document (that is, not one drafted by legally trained personnel).  Its draftsman’s decision to set out the contractual obligations separately for the related individuals (clause 6.15) and the respective companies controlled by those individuals (such as clause 6.8) may not promote an easy understanding of the contractual intention.

100.  But if clause 6.8 (and the related clause 6.15) were to carry such a restrictive meaning, its provisions could easily be overcome.  For example, UT Ltd (or Paul’s Model Art, as the case may be) could have transferred its business to someone else (corporate or otherwise) (and perhaps also have itself wound up after the transfer).

101.  By reason of the above matters, I conclude that the commercial purpose of the 1996 agreement required that both those individuals and companies should not engage in “direct” or “indirect” manufacture (or production).  If those individuals should do so through other companies controlled by them, such would fall within the meaning of “indirect” manufacture (or production) for the purpose of clause 6.8.

102.  Accordingly, there is no need to consider if a term to similar effect ought to be implied into the 1996 agreement.  If it were necessary to do so (that is, if (contrary to para 101 above) it had been concluded that clause 6.8 were to be construed as contended for by the defence), I would have determined against such an implied term.  This is because, as a matter of contractual intention, the express terms in the 1996 agreement were not meant to bind the conduct of Lang, Kwan or Lam.  There would therefore have been no room for such a term to be implied.

(b)     Other provisions

103.  As stated in para 87 above, I concluded that clauses 6.10 to 6.14 should bear a “brand-based” meaning.

104.  Paul’s Model Art’s complaints in relation to those clauses have been summarized in para 25 to 27 above.  In short, it is complained that there have been sales by UT Ltd through the Gateway defendants and/or Kolara.  But the complaints are premised on those clauses bearing a “product type-based” meaning.

105.  Because of the above conclusion regarding the meaning of those clauses, I agree with the defence that this part of the plaintiff’s claim is not established.  As has been pointed out by the defence,

“all the products the subject of the claim were under the brands ‘Autoart’ or ‘Gate’, and thus fall outside the definitions of ‘PMA Products’ and ‘UT Ltd Products’ and outside the scope of [the 1996 agreement]” (para 55(1), D1-3’s closing submissions).

106.  For completeness, if I had concluded that those clauses were product type-based, I would have disagreed with the defence concerning the so-called “companies argument” (see para 94 above) for the same reasons set out under the previous sub-heading (para 96 to 101 above).

LIFTING THE CORPORATE VEIL

107.  Because of the conclusion reached under the two preceding sub-headings, I have rejected the so-called “companies argument”. Accordingly, there is no need to deal with the arguments of Paul’s Model Art about “piercing the corporate veil” to hold the JV defendants liable for:

“[orchestrating] … an elaborate corporate structure (comprising Kwan himself at the apex, Davidson, Kolara and to the extent necessary Gateway) to evade pre-existing legal obligations on each of them” (para 86, plaintiff’s closing submissions).

108.  If I had concluded in favour of the defence case (see para 94 and 95 above), I would have rejected this aspect as well for the following reasons.

109.  The case put forth by Paul’s Model Art can be summarized as follows:

(a) the use of a corporate veil to perpetrate fraud or evade legal obligations and liabilities are good grounds for piercing the veil;

(b) the motive for setting up the corporate structure is relevant;

(c) if the corporate veil is pierced, it will be the person(s) behind it which is/are the relevant actor(s) or recipient(s);

(d) the corporate structure set up here was to evade the obligations or liabilities of the JV defendants under the 1996 agreement.

The authorities cited in support of the above legal propositions include:

(1) Winland Enterprises Group Inc v Wex Pharmaceuticals Inc [2012] 2 HKLRD 757;

(2) China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] 3 HKC 123;

(3) Lee Sow Keng v Kelly McKenzie Ltd [2004] 2 HKLRD 517, para 11 and 15;

(4) Gilford Motor Co Ltd v Horne [1933] 1 Ch 935, 955;

(5) Kensington International Ltd v Congo [2005] EWHC 2684;

(6) Adams v Cape Industries [1990] Ch 433, 539;

(7) Ben Hashem v Al Shayif [2008] EWHC 2380, para 163-4;

(8) VTB Capital Plc v Nutritek International Corporate [2013] UKSC 5.

(The parties’ respective further submissions referred to Prest v Petrodel Resources Ltd and Others [2013] UKSC 34.  But I agree with the defence this authority does not take the matter any further than the earlier authorities.)

110.  In short, I agree with the defence that, if Kwan (and Lam) were not co-obligees to the provisions of the 1996 agreement, there would have been no proper basis to invoke the doctrine where the effect would be to make them such co-obligees: the VTB Capital decision, para 131 to 148.

RESTRAINT OF TRADE

111.  In view of the conclusions reached above in relation to the construction of the 1996 agreement, this aspect can be dealt with briefly.

112.  It is trite that, as a starting point, the law favours free trade (and recognizes the economic advantages of competition): Hummingbird Music v Acconci [2010] 1 HKLRD 596, para 23; OBG Ltd and Another v Allan and Others [2008] 1 AC 1, para 142.  As is usual in the business world, the collectible die-cast models business is also competitive; para 89(a) above is repeated here.

113.  Clause 6.8 has been construed as product type-based.  However, as Paul’s Model Art correctly points out, the restriction was mutual: it restricts UT Ltd as much as it restricts Paul’s Model Art.  For this reason, I agree with Paul’s Model Art that the restriction was nothing more than part of an ordinary commercial contract, entered into at arm’s-length, and is legitimate.

114.  Because clauses 6.10 to 6.14 are construed as brand-based; their ambit is thus narrower than if they had borne a product type-based meaning.  Any restriction which those clauses may impose is a reasonable protection of Paul Model Art’s goodwill and/or trade mark.

GATEWAY DEFENDANTS: INDUCING BREACH OF CONTRACT

115.  The basis of this part of Paul’s Model Art’s claim against the Gateway defendants has been summarized above: para 25 to 27 above.

116.  The Gateway defendants dispute the claim on several grounds:

(a) there was no breach of the 1996 agreement for which they can be held to be liable as accessories;

(b) even if there was such breach,

(1) having sued the Gateway defendants as part of the scheme (devised by Kwan (and Lam)) to breach the 1996 agreement and to conceal the breach (para 6 and 25 to 26), Paul’s Model Art cannot put forth an inconsistent claim which sues them as entities separate from, and accessories to, the said scheme;

(2) there was no causative link between the breach and the part they played in the transactions concerned.

These grounds will be discussed in turn below.

117.  In relation to para 116(a) above, it has been found that there has been a breach of clause 6.8, but not the other clauses, of the 1996 agreement.  It should be noted the breach under clause 6.8 was the manufacture and production of the “offending” goods (this will be relevant to para 116(b)(2) above (see also the discussion at para 119 to 125 below)).

118.  In relation to para 116(b)(1) above, in view of the way the breach of contract claim has been brought (see para 6 and 25 to 26 above), I agree with the defence argument that:

“… one [cannot] be sued for inducing oneself to break [his own] contract … ” (para 4, D4-5’s reply submissions).

119.  Further, in relation to para 116(b)(2) above, the parties also disagree as to whether the tort of “inducing breach of contract” requires acts of “pressure, persuasion or procuration” (para 18, D4-5’s closing submissions).

120.  In support of their argument that this is an ingredient of the tort, the Gateway defendants refer to the following passages in the authorities:

“The essence of the tort is the procuring or inducing a breach of contract”: Halsbury’s Laws of Hong Kong (2010 Reissue) Vol 25(1), para 380.504;

“… the real question which has to be asked … : did the defendant’s acts of encouragement, threat, persuasion and so forth have a sufficient causal connection with the breach by the contracting party to attract accessory liability?”: the OBG Ltd decision, para 36 (quoted and applied in Meretz Investments NV and Another v ACP Ltd and Others [2008] Ch 244, para 139);

“… [inducing a contractual breach] requires the defendant’s conduct to have operated on the will of the contracting party: see Lord Nicholls’s speech in the OGB case … paras 174-180”: the Meretz Investments decision, para 177.

121.  On the other hand, Paul’s Model Art contends that the ingredient can cover conduct much wider than “acts of encouragement, threat, persuasion”. Inconsistent dealing with a contracting party with knowledge of the contract suffices.  Reliance is placed on the following passages:

“But the contract breaker may himself be a willing party to the breach, without any persuasion by the third party … if a third party, with knowledge of a contract between the contract breaker and another, has dealings with the contract breaker which the third party knows to be inconsistent with the contract, he has committed an actionable interference … The inconsistent dealing … if it is continued after the third party has notice of the contract, an actionable interference has been committed by him”: DC Thomson & Co Ltd v Deakin and Others [1952] 1 Ch 646, 694;

“There is considerable discussion in [the OBG Ltd decision] of the judgment of Jenkins LJ in [the Meretz Investments decision] and by no means all of its remains good law. However, there is, as I read the speeches in [the OBG Ltd decision] nothing which casts doubt on the correctness of the [above] passage”: Lictor Ansalt v Mir Steel and Another [2011] EWHC 3310 (Ch), para 49.

122.  The above passages can pose a vexing problem as to what act can properly be regarded as constituting the ingredient of “inducement” or “procuration”.

123.  However, the facts of this action make the problem less formidable.  As stated above, the only breach established was a breach of clause 6.8 (manufacture and production) (para 101 above); there was no breach of the other clauses (distribution and sale) (para 105 above).

124.  The thrust of the averments against the Gateway defendants is that they participated in the wrongful distribution and/or sale: para 17B(c) to (e), and 17B(h)(vii), (i) to (j), statement of claim.  Although reference has also been made to clause 6.8 (para 17B(f) and (h), statement of claim), this was pleaded together with the other clauses concerning Paul’s Model Art’s right of distributorship and sale agency.

125.  Such being the case, I agree with the defence that there is insufficient evidence to establish an inducement to breach clause 6.8 on the part of the Gateway defendants.  The totality of the evidence shows the Gateway defendants were concerned with the distribution and sale of the goods (rather than their manufacture or production).

UT LTD’S COUNTERCLAIM

126.  Clause 6.2 of the 1996 agreement provided:

“UT Ltd. and PMA hereby agree that UT Ltd. shall upon the request of PMA manufacture Moulds and/or the Products for PMA pursuant to the provisions of this Clause [6].” (emphasis supplied)

127.  Despite having a capital letter, the word “Products” has not been expressly defined in the 1996 agreement.  But, reading it together with the other provisions of clause 6 (which clause 6.2 in effect required one to), I agree with the defence that the word “Products” in clause 6.2 should refer to the PMA products in relation to Paul’s Model Art (and the UT products in relation to UT Ltd).  To construe that word in clause 6.2 to mean both the PMA products and the UT products would effectively ignore (or permit one to act contrary to) the “non-competition” provisions in clause 6.8.

128.  Paul’s Model Art relies on clause 6.12 (distribution right) to justify a construction of the word “Products” in clause 6.2 as meaning both products.  I disagree with this:

(a)     as the defence correctly points out, clause 6.12 merely conferred a right to “distribute”, not one to “produce” or “manufacture” the UT products;

(b) clause 6.12 did not expressly oblige UT Ltd to provide the UT products for distribution; it required UT Ltd to do so if UT Ltd should want to sell the goods in the PMA commission territories;

(c) the provisions which prohibited UT Ltd from selling to third parties who, to UT Ltd’s knowledge, would sell the goods in the PMA territories (for example, clauses 6.10 and 6.14) show that clause 6.12 was not intended to impose a “positive” obligation on UT Ltd’s part to provide goods for distribution.

129.  Thus, Paul’s Model Art’s sales of UT products in Europe between July 2000 and December 2006 (the end of the 10-year contractual period) amounted to a breach of the 1996 agreement.

130.  In view of the above conclusion, it is unnecessary to decide if the plaintiff’s pleading amounts to a “general denial” (as Paul’s Model Art contends to be the case) rather than an averment limited to the instance involving a “Roadster/Alfa Romeo Spider” die-cast model car.  If it were necessary to do so, I would have found in favour of the defence concerning this.

CONCLUSION

131.  Further to the above paragraphs, I agree with the defence that the evidence adduced by Paul’s Model Art has not sufficiently proven its claim against Lam.  The claim against Lam should be dismissed for that reason alone.

132.  The claim against the Gateway defendants is also dismissed.

133.  In relation to the JV defendants other than Lam, because of the conclusions reached earlier:

(1) UT Ltd and Kwan are liable for breach of clause 6.8;

(2) the claim based on the other provisions of the 1996 agreement has not been established; it is accordingly dismissed.

134.  Liability on the counterclaim has been established.

OTHER MATTERS

135.  At the end of the trial, despite no direction for a “split” trial (that is, a trial of liability only with damages to be assessed if liability is established) having been directed earlier, the parties agreed that I should deal with liability only, leaving damages to be dealt with later.

136.  I shall therefore leave the parties to consider, and attempt to agree to, the manner to proceed further with this action.  There will be liberty to apply for this purpose.

137.  The parties’ closing submissions also mentioned various other points.  These have not been expressly set out or dealt with in the above headings and sub-headings.  This is so only because of the need to balance between the length of the judgment and its comprehension.  It does not mean those other points are thought to be irrelevant (or have been overlooked).  To avoid doubt, those other points have also been considered.

COSTS ORDER NISI

138.  No costs order nisi will be made.

139.  If the parties are unable to agree to the costs order to be made, they are at liberty to put forth their submissions in this regard.  For now, I leave it to them to decide if that can be done as a “paper” exercise, or at an inter partes hearing.