QIYANG LTD AND OTHERS v. MEI LI NEW ENERGY LTD AND OTHERS

HCA 420/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 420 OF 2011

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D E C I S I O N

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Background

1.  I have before me three summonses: (1) the 1^st defendant’s summons dated 7 August 2012 seeking an order that final judgment be entered against the 3^rd plaintiff pursuant to Order 14 of the Rules of the High Court; (2) the 3^rd plaintiff’s summons dated 25 January 2013 seeking leave to file and serve the 4^th Affirmation of Jaime Che (“Che”); and (3) the 3^rd plaintiff’s summons dated 28 January 2013 seeking leave to file and serve an Amended Reply and Defence to Counterclaim.  Ms Chan SC, counsel for the 1^st defendant, agreed that the 4^th Affirmation of Che and the draft Amended Reply and Defence to Counterclaim be admitted for the purpose of fairly disposing of the 1^st defendant’s summons, while reserving the defendants’ rights.  The 3^rd plaintiff’s two summonses are adjourned.

2.  The background leading to this litigation and the 1^st defendant’s summons is as follows.  The 3^rd plaintiff is a company listed on the Hong Kong Stock Exchange.  It holds all the issued shares in the 1^st plaintiff, which was formed for the purpose of acquiring Union Grace Holdings Limited (“Union Grace”) and its wholly owned subsidiary, Thunder Sky (HK) Ltd, from Winston Chung (“Chung”), his wholly owned company (the 1^st defendant), and five other vendor companies owned or controlled by Miao Zhenguo (“Miao”).  Union Grace was in the business of manufacturing and sale of lithium‑based battery products and related battery business.  The acquisition process commenced in around January 2010.  The parties entered into an acquisition agreement dated 18 January 2010 (“Acquisition Agreement”).  Under the Acquisition Agreement, the vendor’s shares in Union Grace were transferred to     the 1^st plaintiff as purchaser.  The total consideration consisted of 783,517,010 shares in the 3^rd plaintiff (“consideration shares”), convertible bonds issued by the 3^rd plaintiff in the amount of $1,493,296,5 and cash  of $100,000,000.  The 3^rd plaintiff was the purchaser’s guarantor, while Chung and Miao were the vendors’ guarantors.  The acquisition was completed on 25 May 2010 when Union Grace became a wholly owned subsidiary of the 1^st plaintiff.  Thunder Sky (HK) Ltd, which has since changed its name, is now the 2^nd plaintiff and the main operating arm of the business acquired.

3.  For the purpose of implementing the Acquisition Agreement, the above mentioned parties or some of them together with other companies, mostly under the control of Chung, entered into eight other related agreements:

(1)      Supplemental Acquisition Agreement dated 30 April 2010;

(2)      Master Supply Agreement dated 18 January 2010;

(3)      Confirmation Letter Agreement dated 25 November 2010;

(4)      Patent Licence Deed dated 18 January 2010;

(5)      Supplemental Patent Licence Deed dated 12 February 2010;

(6)      IP Licence Deed dated 19 May 2010;

(7)      Guarantee dated 26 March 2010; and

(8)      Service Agreement dated 2 June 2010.

4.  In accordance with the Terms And Conditions Of The Bond (“Terms and Conditions”), the 3^rd plaintiff had the right to redeem the whole or part of the convertible bond by issuing an irrevocable redemption notice to the holder of the bond.  There was a partial redemption of the convertible bond issued to the 1^st defendant, which resulted in a re‑issue of a convertible bond certificate to the 1^st defendant in the amount of $760,751,606 under certificate number 18 dated 10 February 2011.

5.  Subsequently, dispute arose between the plaintiffs and the defendants over the performance of the Acquisition Agreement and related agreements.  On 8 March 2011, the 3^rd plaintiff issued another redemption notice to redeem the bond under certificate number 18, but did not deliver a cheque in the redemption amount to the 1^st defendant in accordance with the Terms and Conditions. Then, four days later, the plaintiffs commenced the present proceedings.  A statement of claim was filed on 14 June 2011.  The defendants filed their defence and counterclaim dated 23 August 2011.

6.  In another action, HCA 1283 of 2011, Che, Miao and others obtained judgment against Chung in an amount in excess of $210 million. On 20 June 2012, they presented a bankruptcy petition, HCB 4005 of 2012, against Chung, which is now awaiting judgment.

7.  At the same time as the bankruptcy petition was proceeding, the 1^st defendant commenced a new action, HCA 1071 of 2012, against the 3^rd plaintiff, the subject matter of which was identical to its counterclaim in the present action.  On 9 July 2012, the 1^st defendant applied for summary judgment under that new action.  That application was dismissed by Deputy High Court Judge Le Pichon and the new action was struck out on the grounds of an abuse of process of the court.  On 7 August 2012, the 1^st defendant took out the present summons seeking judgment against the 3^rd plaintiff on its counterclaim.

General principles applicable to an application under Order 14 rule 5

8.  It was stated in the marginal note in the 1^st defendant’s summons that the application was made under Order 14 rule 1.  As submitted by Mr Scott SC, leading counsel for the 3^rd plaintiff, the application should have been made pursuant to Order 14 rule 5 as it was made by the 1^st defendant as counterclaimant and not as plaintiff.  I agree.  The two rules are not without distinction.  The hurdle which a counterclaimant has to overcome to obtain summary judgment against a defendant under Order 14 rule 5 is higher than that which a plaintiff has to discharge in obtaining judgment against a defendant under Order 14 rule 1. As was pointed out by the learned authors in Hong Kong Civil Procedure 2013, Vol 1 at paragraph 14/5/1, this rule should not be resorted to except in a clear case for the following reason:

“In most cases in which the defendant might desire to apply for summary judgment on the counterclaim, the plaintiff will have already served his statement of claim; and unless the claim or claims made by the plaintiff can be shown to be unsustainable or not bona fide or wholly unconnected with the defendant’s counterclaim, the defendant may not be able to depose to his belief that there is no defence to his counterclaim or part thereof in respect of which he seeks to apply for summary judgment.”

The making of a counterclaim presupposes that the plaintiff has a valid claim which constitutes a valid built‑in defence to a counterclaim.  Hence, the counterclaimant has to show that the plaintiff’s claim is unsustainable or not bona fide or wholly unconnected with the defendant’s counterclaim.  Failure to take timely action to strike out the plaintiff’s claim may be treated as indication that the plaintiff has a valid defence to the counterclaim.  But this procedural advantage should not be over emphasised.  Ultimately, it is the justice of the case which matters.

9.  The test in an Order 14 application is as simple as whether the defendant’s assertions are believable.  That question has to be answered not by taking those assertions in isolation but by taking them in the context of so much of the background as is either undisputed or beyond reasonable dispute: Re Safe Rich Industries Ltd CACV 81/1994, unreported, per Bokhary JA, as he then was.

10.  Summary judgment under Order 14 is not intended to be a mini trial on affidavits.  Where there are complicated factual issues in dispute, Order 14 is clearly not the correct procedure: Paul Y Management Ltd v Eternal Unity Development Ltd [2008] HKEC 1359 at paragraph 19 and Hong Kong Civil Procedure 2013, Vol 1at paragraph 14/4/9.

11.  Where a defendant can show he has a bona fide cause of complaint against the plaintiff, as grounds of defence and counterclaim, arising from the same subject matter, he should be given unconditional leave to defend: Shenzhen Baoming Ceramics Co Ltd v Companion‑China Ltd [2000] 2 HKLRD 288 at 293‑294.

12.  The authorities show that there are four different classes or groups of orders which the court would make where a defendant to a counterclaim, ie the original plaintiff, raises a set‑off or counterclaim as a defence (which for avoidance of confusion is hereunder referred to as “counter‑counterclaim”): Hong Kong Civil Procedure 2013, Vol 1 at paragraph 14/4/14.  These are:

(1)  where the plaintiff can show an arguable set‑off, equitable or otherwise, he is entitled to leave to defend to the extent of the set‑off;

(2)  where the plaintiff sets up a bona fide counter‑counterclaim to the defendant’s counterclaim arising out of the same subject matter as the action and connected with the grounds of the counter‑counterclaim, the order should not be for judgment on the counterclaim, subject to a stay pending trial of the counter‑counterclaim, but should be for unconditional leave to defend the defendant’s counterclaim, even if the plaintiff admits the whole or part of that counterclaim;

(3)  where there is no defence to the counterclaim but a plausible counter‑counterclaim of not less than the counterclaim is set up, judgment should be for the defendant on the counterclaim with costs stayed until trial of the counter‑counterclaim; and

(4)  where the counter‑counterclaim arises out of a separate and distinct transaction or is wholly foreign to the counterclaim, judgment should be for the defendant with costs without a stay.

The court has no discretion in cases falling under class 1 but to grant leave to defend.  But, because of the lack of clarity between classes 2, 3 and 4, the court has freedom to respond to the perceived justice of the individual case.

The 1^st defendant’s counterclaim and grounds for summary judgment

13.  The 1^st defendant’s case on the counterclaim is that upon issuing the redemption notice, the 3^rd plaintiff was obliged under the Terms and Conditions to deliver a cheque for $760,751,606 to the 1^st defendant, but it failed to do so.  The issuance of the redemption notice was admitted by the 3^rd plaintiff.  The 3^rd plaintiff has not put forward any defence to the counterclaim other than a general allegation that it was entitled to set off the damages suffered by the 1^st to 3^rd plaintiffs.

14.  Ms Chan SC, leading counsel for the 1^st defendant, submits that such a general allegation does not amount to an arguable defence to the counterclaim because: (1) the 3^rd plaintiff does not have any claim against the 1^st defendant and there could be no set‑off for claims made by the 1^st and 2^nd plaintiffs against the 2^nd to 7^th defendants; (2) any possible claim by the 3^rd plaintiff would be for reflective loss of the 1^st and 2^nd plaintiffs and is unsustainable; (3) the redemption notice is of the nature of a promissory note such that set‑off is excluded under well‑settled legal principles; and (4) set‑off is also excluded by the Terms and Conditions which is binding on the 3^rd plaintiff.  The 3^rd plaintiff disputes each of these grounds.

Whether set‑off is only available between the same parties in a litigation

15.  It is well settled that a legal set‑off requires both the claim and counterclaim be for liquidated sums which can be ascertained as at the date of the pleading: Axel Johnson Petroleum AB v MG Mineral Group AG [1992] 1 WLR 270 at 272F‑274C, per Leggatt LJ.  As the 3^rd plaintiff’s claims are for damages, it must be relying on equitable set off.  The thrust of Ms Chan SC’s argument is that equitable set‑off requires the cross‑claims to be between the same parties: Muscat v Smith [2003] 1 WLR 2853 (CA) at paragraph 42‑45 and Edlington Properties Ltd v JH Fenner & Co Ltd [2006] 1 WLR 1583 (CA) 520.  She further submits that throughout the Amended Statement of Claim, there was no claim by the 3^rd plaintiff against the 1^st defendant; all claims were directed at breaches of the Acquisition Agreement or related agreements by the 2^nd to 7^th defendants; and the only breaches pleaded against the 1^st defendant were breaches of clause 6.2 of the Acquisition Agreement for which no remedy was pleaded against the 1^st defendant and breaches of clause 8.3 which was about breach of undertaking to the 1^st plaintiff.

16.  On the law, Mr Scott SC argued that it is more than arguable that both Muscat v Smith and Edlington Properties Ltd, which were landlord and tenant cases involving an assignment of certain rights, have limited bearing in the present case.  Having read the judgment in Muscat v Smith in some detail, I am unable to agree with Mr Scott SC.  It is clear from paragraph 36 of his judgment that the case was decided on the general law of equitable set‑off. Buxton LJ said:

“36. The point is therefore a short one. It will, however, be necessary to preface it by some account of the general law of equitable set‑off in order to address the argument presented to us; and then to turn to the effect on this case of the assignment.”

Then he continued in paragraphs 42 to 45:

“42. Mr Smith [the tenant] therefore has to assert his set‑off by appealing to general principle, reaching well outside the law of landlord and tenant. There is no case supporting, or coming anywhere near to supporting, a general principle making set‑off available where the defendant has a claim against someone other than the plaintiff; and such a rule would be contrary to elementary principles of the law of contract; contrary to the essential nature of set‑off; and contrary to assumptions made in cases of high authority, including many that bind this court.

43. First, the law of contract. The breaches of which Mr Smith complained, and which he wished to set off in this action, were committed by Mr Walker [the former landlord], not by Mr Muscat [the present landlord]. For that reason, it is necessarily and properly accepted in Mr Smith’s pleadings and in his argument that he could not bring an action for damages against Mr Muscat. That is because there is no privity of contract between Mr Smith and Mr Muscat in respect of those breaches. To permit Mr Smith’s claim none the less to be effective against Mr Muscat by way of set‑off would undermine that basic rule.

44. Second, the set‑off with which we are concerned is and is only one that operates as an incident of litigation. Such a set‑off is merely a sub‑species of counterclaim: see the analysis of Slade LJ in the National Westminster Bank case [1993] 1 WLR 72, 76E‑G. It is a special and privileged type of cross‑claim because it operates in the litigation to extinguish the claim and prevent its original establishment, rather than to provide a sum to be balanced off against the claim once established: see the account given by Lord Denning MR in the Federal Commerce case [1978] QB 927‑974. That distinction is of course of crucial importance to Mr Smith in defending the possession action in the present case. But a counterclaim plainly cannot be asserted against someone other than the claimant: so by the same token neither can the sub‑species that is set‑off be so asserted.

45. Third, authority. The dearth of specific statements supporting the proposition that a cross‑claim must be a claim against the original claimant is attributable to the fact that that proposition has always been taken for granted. All of the recent cases discussing whether the cross‑claim was sufficiently closely connected with the claim to be set off against it in the same litigation presuppose that the claims, whatever they are, lie between the same parties. That stands out from, for instance, the various discussions cited in the judgment of Forbes J in British Anzani (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] QB 137, 154D‑H. Counsel for Mr Smith sought to suggest that a wider rule could be found in the dictum of Lord Denning MR in the Federal Commerce case [1978] QB 927, 974:

“We have no longer to ask ourselves: what would the courts of common law or the courts of equity have done before the Judicature Act 1873?  We have to ask ourselves: what should we do now so as to ensure fair dealing between the parties?”

But that observation went only to a more liberal attitude to the question of whether a cross‑claim sufficiently impeached the claim to create a set‑off: the issue discussed in the passage with which this dictum culminates, and to which reference has already been made in paragraph 44 above.  It certainly cannot be relied on to convert the rule of set‑off into some more general equitable doctrine, and much less into a form of palm‑tree justice.”

17.  Next, Mr Scott SC argues that the present case is on all fours with a line of authorities on transaction set‑off including Dole Dried Fruit and Nut Co v Trustin Kerwood Ltd [1990] 2 Ll Rep 309, Bim Kemi v Blackburn [2001] 2 Ll Rep 93, Townearn Industrial Ltd v Globe Holdings Ltd [2003] 1 HKC 186and Benford Ltd v Lopecan SL [2004] 2 QB 618.  If by that submission he is suggesting that a transaction set-off is available to a defendant who has a counterclaim against someone other than the plaintiff in the same litigation, with respect, that is inconsistent with the line of authorities he quoted.  For example, in the Dole Dried Fruit case, the defendant had a counterclaim against the plaintiff in the same litigation in a claim which arose out of the same transaction.  I think what was decided in the Dole Dried Fruit case was the degree of closeness required between the counterclaim and the claim as to permit a set-off.

18.  The dicta of Buxton LJ in Muscat v Smith are very strong dicta to the effect that equitable set‑off is only available to the same parties in a litigation who have a claim against one another and not available to a defendant who has a claim against someone other than the plaintiff.  As the dicta show, the principle in Muscat v Smith is supported by authorities and well established general legal principles.  It is therefore a principle of general application and not as Mr Scott SC suggests as being limited to landlord and tenant cases. 

19.  Next, I consider Mr Scott SC’s argument insofar as he purports to advocate for an extension of the principle in Muscat v Smith.  He quotes extensively from the judgment of Morrison J in Benford Ltd v Lopecan.  In Benford Ltd v Lopecan SL, the claimant sold and delivered trucks to the defendant which were ordered by the defendant in its capacity as distributor under the umbrella of the distribution agreement.  The claimants sued for price of goods sold.  The defendant asserted that the claimants had breached the distributorship agreement by appointing other companies to distribute its products in territories covered by its distribution agreement with the defendant and by reason of such breach the defendant was unable to sell the trucks ordered and counterclaimed for damages.  Two of the issues before the court were (1) whether the defendant had any real prospect of defending the claim for the price of the goods sold; and  (2) whether there should be a stay of execution of any judgment on the claim pending determination of the counterclaim.  Morrison J held that it was very arguable that the defendant had a defence to the claim for the price of goods sold; hence it was not necessary to determine the second issue; but if the court had ordered delivery up of the trucks or payment of the price it would have granted a stay.  That judgment contained an analysis of the Dole Dried Fruit case and Bim Kemi v Blackburn and a useful summary of the difference between what is termed “independent set‑off” and “transaction set‑off”.  It would be adequate to refer to the part of the judgment quoted by Mr Scott SC.  Morrison J said in paragraphs 10 to 17:

“10. The real argument between the parties hinges on the question whether the counterclaims which are being brought in this case and the defences which are being advanced constitute what the courts now call a transaction set‑off, on the one hand, or an independent set‑off, on the other. The two have quite different effects. A transaction set‑off operates as a defence (see the case of Glencore Grain v Agros Trading)whereas an independent set‑off involves, so to speak, striking a balance of account, where the two claims are looked at independently. The transaction set‑off, as I say, operates as a defence as such and extinguishes the claim.

11. What is the nature of the set‑off alleged in this case? It can be seen from the pleadings that part of the set‑off is intimately connected with the claim.The purpose of the distribution agreement was to enable the defendants to sell the goods which they were procuring, ordering and buying from the claimants. They were to have exclusive access to a market for the Claimants’ goods. The distribution agreement, as was correctly submitted by counsel for the claimants, did not constitute a contract of sale in itself, it transferred rights to the parties, including, in particular, the right of the defendants to sell the goods which he had bought from the claimants in the designated agreed territories.

…

13. Is that a transaction set‑off? It seems to me that it is, or, to put it more neutrally, it is strongly arguable that it is. I start with the text book which has helpfully been provided to me, called “The Law of Set Off” by Rory Derham, the third edition. At p 83 of the book it is made plain by the learned author that, so far as the Courts are concerned, the approach in a set‑off situation is not to ask the question, “Would it be just or fair to deprive the defendant of a potential set‑off?” These are not questions which determine whether there is a transaction set‑off situation or not. It was put much more elegantly by the late Mr Justice Hobhouse, where he said in the case of Leon Corporation v Atlantic Lines & Navigation Co Inc (“The Leon”) [1985] 2 Lloyd’s Rep 470 at p 474):

 “Equitable principles derive from a sense  of what justice and fairness demand.  This does not mean that equitable set‑off has been reduced to an exercise of discretion.  Since the merging of equity and law equitable set‑off gives rise to a legal defence.  This defence does not vary according to  the length of the Lord Chancellor’s or arbitrator’s foot.  The defence has to be granted or refused by an application of legal principle.”

14. The legal principle involved is set out clearly, in my judgment, in the case of Glencore Grain v Agros Trading, a decision of the Court of Appeal, reported at [1999] 2 All ER 288, where the Court analyses and helpfully summarises the effect of the seminal decision given by Lord Justice Hoffmann, who I think was responsible for coining the phrase “transaction set‑off and independent set‑off” in the case of Aectra Refining and Marketing Inc v Exmar NV [1995] 1 All ER 641. As always, in these cases it is not so much the definition of the principle which is difficult, it is the application of the principle to the facts in question. There must be, as it seems to me, a close commercial relationship between the claim on the one hand and the defence and counterclaim on the other.

15. In Dole Dried Fruit and Nut Co v Trustin Kerwood Ltd [1990] 2 Ll Rep 309, the Court examined a case which was not that dissimilar to the present one. It was a distributorship agreement. The defendants’ case was that they were appointed by the plaintiffs as sole and exclusive agents for the importation and distribution in England of the plaintiff’s prunes and raisins. They acquired those products, and the defendants claimed damages for repudiation of the distribution agreement. Three weeks later the plaintiffs commenced separate proceedings in which they claimed $735,000 as the price of goods sold and delivered under a series of sale contracts. The defendants did not dispute the plaintiff’s claim but they said that they were entitled to set‑off their counterclaim for unliquidated damages. In the Court of Appeal Lord Justice Lloyd said this:

“The whole purpose and intent of the agency agreement was that the parties should enter into contracts for the purchase and sale of the plaintiffs’ goods.”

I interpose, so here.

 “The sale contracts were thus concluded in fulfilment of agency agreement.”

So here.

  “In those circumstances the claim and the counterclaim are sufficiently closely connected to make it unjust to allow the plaintiffs to claim the price of goods sold and delivered without taking account of the defendants’ counterclaim  for damages for breach of the agency agreement.  If that is right, then the defendants are entitled to rely on their counterclaim as a set‑off.  It follows that they have an arguable defence for the purposes of [Order 14].  Accordingly I would dismiss the plaintiffs’ appeal.”

…

16. But the Court of Appeal reconsidered the matter in Bim Kemi v Blackburn [2001] 2 Ll Rep 93, where the Court held, firstly, that the degree of closeness required for an equitable or transaction set‑off was that of an “inseparable connection”, but it was not necessary that the cross‑claim should arise out of the same contract. All that was required was that it should flow from the dealings and transactions which gave rise to the subject of the claim; secondly, and I take this from the headnote:

 “The principle that the cross‑claim should be one flowing out of and inseparably connected with the dealings and transactions which also gave rise to the claim was apt to cover a situation where there were claims and cross‑claims for damages in respect of different but closely connected contracts arising out of a long‑standing trading relationship which was terminated; that fact would not per se so establish the requisite ‘inseparable connection’ but in an appropriate case it might well be manifestly unjust to allow one claim to be enforced without taking account of the other …”

In his judgment, Lord Justice Potter, at para 36, said:

 “Like the Judge, I consider that Mr Turner’s submissions for Blackburn are correct.  In so holding, again like the Judge, I regard it as appropriate to apply the test propounded by Lord Brandon in the Bank of Boston case unconstrained by the former concept, difficult to define and apply, of ‘impeachment of title’, which has since been replaced, or at least redefined, in terms of a cross‑claim which ‘flows  out of and is inseparably connected with the dealings and transactions giving rise to the subject in the claim’. While the circumstances of every case call for individual consideration, it seems to be that the Dole Fruit case provides a useful parallel with the situation in this case.  There, the Court was satisfied there was a sufficiently close connection in the case of a claim for the price of goods sold and delivered pursuant to a contract made under the ‘umbrella’ of a distributorship agreement which had been repudiated.”

And he then went on to say that, in the present case, the connection was less close, but nonetheless the test of a close and inseparable connection was satisfied. That does, I think, infer that the case of Dole is not to be regarded as an oddity but, rather, has been given the stamp of approval by the Court when considering the question of set‑off.

17. Therefore, applying the principles to the facts of this case, it seems to me to be very arguable that the defendants have a defence to the claim for the price of goods sold and delivered because the sale contract was under the umbrella of the distribution agreement and the claims and cross‑claims are closely connected in a commercial sense. It is true that the evidence as to the amount of damages which are to be claimed in the counterclaim have not yet been fully quantified or properly formulated, and it is fair to point out that the evidence in relation to the damages claim is thin, but this is the Commercial Court and it, the Court, is familiar with the damage which may be caused to a distributor by the wrongful repudiation of his distributorship agreement as is alleged, whether in removing Cordoba or the way the Claimants are alleged to have repudiated the Distributorship Agreement. It is not speculative to suggest that the amount of the cross‑claim could be substantial, and could well exceed the amount of the claim.” (emphasis supplied).

20.  In summary, a transaction set‑off operates as a defence and extinguishes the claim.  To qualify as a transaction set‑off, there must be a close commercial relationship between the claim on the one hand and the defence and counterclaim on the other.  The degree of closeness required for a transaction set‑off is an inseparable connection, but it was not necessary that the cross‑claim should arise out of the same contract.  All that is required is that it should flow from the dealings and transactions which gave rise to the subject matter of the claim.  This is a looser test and is apt to cover a situation where there were claims and cross‑claims for damages in respect of different but closely connected contracts arising out of a long-standing trading relationship which was terminated. 

21.  It is not entirely clear whether, in a case such as the present one involving a number of co-plaintiffs and co-defendants in the same litigation, the principle in Muscat v Smith applies narrowly to a co-plaintiff vis-à-vis a corresponding co-defendant only or broadly to the co-plaintiffs as one party and the co-defendants as another party as Mr Scott SC contends. 

22.  Ms Chan SC criticises such liberal extension of a general equitable doctrine as much less than a form of palm‑tree justice.  I do not think so.  Putting aside for the time being counsel’s disagreement that set-off as a defence is only available between the same plaintiff and the same defendant, the basis of that defence is that the claim and counterclaim are closely connected.  As was held by the Court of Appeal in Bim Kemi v Blackburn, all that was required was that the counterclaim flows from the dealings and transactions which gave rise to the subject matter of the claim.  Not only that it need not arise from the same contract, the Court of Appeal even extended it to cover a situation where there were claims and cross-claims for damages in respectof differentbut closely connected contracts arising out of long a standing relationship which was terminated.

23.  The principle in Muscat v Smith is premised on a very simple scenario where A owed an obligation to B, and C owed an obligation to A.  Under such a scenario, A cannot set off an obligation he owed to B by an obligation owed to him by C.  This is full of common sense and is consistent with established legal principles.  The situation should be no different where the co-parties within one group are so related to one another as to form one party because all benefits under the transactions accruing to one group go to their common funds and all their liabilities are also to be discharged from that common fund.  Thus, where B and C in fact form one conglomerate and the underlying transactions from which the obligations arise are so interconnected as to form one transaction, there is no reason why set-off is not available among the three parties.  The same applies where A consists of a number of co-parties.  

24.  It may well be that set-off between co-plaintiffs as one party and co-defendants as the opponent party is already covered by the principle in Muscat v Smith.  Perhaps, just as the dearth of specific statements supporting the proposition that a cross‑claim must be a claim against the original claimant is attributable to the fact that that proposition has always been taken for granted, the lack of specific statements supporting Mr Scott SC’s proposition may well be attributable to the fact that this wider application of the principle has also been taken for granted and never challenged.  Furthermore, commercial transactions are ever growing in complexity to meet with the needs of the modern society.  In a situation where a number of co-plaintiffs and co-defendants are involved  in the same transaction or closely related transactions and where the    co-plaintiffs are so related to one another as to form one party while the co-defendants are also so related as to form the opponent party, there is no reason why the principle in Muscat v Smith should not be extended to meet what justice and fairness in the modern commercial reality demand.  Such an extension of the legal principle, if in fact it is an extension, demonstrates that the law is living and developing to meet with the growing needs of commercial reality.  It is far from being palm-tree justice.  Either way, in an appropriate factual situation, Mr Scott SC’s proposition may present a plausible defence which deserves to be fully argued and explored at trial.

Whether the claim and counterclaim are inseparably connected

25.  If the defence of set-off is available to the 3^rd plaintiff, it has to prove an inseparable connection between its claim and the 1^st defendant’s counterclaim.  On the fact, the eight related agreements were entered into for the purpose of implementing or giving effect to the Acquisition Agreement.  It is very arguable that all the transactions involving the Acquisition Agreement and the eight related agreements constituted one series of related transactions and an integral whole of the acquisition with the plaintiffs as the buyers party and the defendants the vendors party.

26.  The 3^rd plaintiff is the holding company of the 1^st and 2^nd plaintiffs. It provided the consideration for the purchase of the shares in Union Grace by the 1^st plaintiff.  It brought about the conclusion of the eight other related agreements between the plaintiffs and the defendants, including the 1^st defendant.  As the operative arm of the plaintiffs’ group, the 2^nd plaintiff entered into some of the eight related agreements with the defendants.  The plaintiffs can therefore be treated as one entity or the buyers party as a whole.  They are also the plaintiffs in this litigation. 

27.  On the other hand, the 1^st defendant, Chung as the 2^nd defendant and the other five companies owned by Miao were the vendors under the Acquisition Agreement. Chung together with the 1^st, 3^rd to 7^th defendants, of which he was the owner, are parties to the related agreements.  In addition, Chung was also the defendants’ guarantor.  They are also the defendants in this litigation.  Thus, all of them can be treated as one entity or the vendors party as a whole.

28.  The plaintiffs purchased no factories or other tangible assets from the defendants.  The only assets they acquired were intangible assets such as supply rights, distribution rights, customer goodwill, exclusive patent and intellectual property usage rights.  The Acquisition Agreement would be meaningless unless it was entered into together with the eight related agreements and vice versa.  The 3^rd plaintiff would be providing the consideration shares, the convertible bonds and cash for nothing if no acquisition was to take place or if the related agreements, particularly the Master Supply Agreement, were not entered into or were breached.  Similarly, the Master Supply Agreement would be meaningless if the plaintiffs had not acquired the intangible assets and intellectual property rights.  In effect, the transactions under the Acquisition Agreement and the eight related agreements constituted one integral whole or one series of related transactions with the plaintiffs together constituting one contracting entity and the defendants and vendors together constituting the other contracting entity. 

29.  The 1^st defendant’s claim for redemption money under the Terms and Conditions and the 3^rd plaintiff’s claim for set‑off in respect of breaches of the related agreements were inseparably connected to each other and flowed from the dealings and transactions between the plaintiffs’ group and the defendants’ group.  It simply defies common sense to allow the 1^st defendant to claim part of the consideration under the Acquisition Agreement, ie the redemption money in respect of the bonds redeemed or to be redeemed, without taking into account the 3^rd plaintiff’s counterclaim for damages for breach of the Acquisition Agreement under which the convertible bonds were issued to the 1^st defendant.

30.  The present case is on all-fours with the Dole Dried Fruit case and Bim Kemi v Blackburn.  The issue of the convertible bond and the Terms and Conditions were part and parcel of the Acquisition Agreement and the related agreements.  The connection between the related agreement and the Acquisition Agreement in the present case is no different from, if not stronger than, that between the sales of goods agreements under the umbrella of the distribution agreement in Dole Dried Fruit case and Bim Kemi v Blackburn.  In my view, it is very arguable that the 3^rd plaintiff’s claim for breaches of the various agreements is inseparable from the 1^st defendant’s claim for the redemption money under the redemption notice, the Terms and Condition and the Acquisition Agreement; and the 3^rd plaintiff is entitled to claim set‑off as a defence against the 1^st defendant’s counterclaim.

The damage suffered by the 3^rd plaintiff

31.  It is Ms Chan SC’s contention that no claim was pleaded by the 3^rd plaintiff against the 1^st defendant and no damage was suffered by the 3^rd plaintiff because there was no dispute that all intellectual property rights relating to the electric battery products belonged to the 2^nd plaintiff and all the business and manufacturing operations were carried out by the 2^nd defendant.  Mr Scott SC argues that is incorrect as a matter of pleading.  He refers to a number of paragraphs in the Amended Statement of Claim, such as paragraphs 48, 54, 63, 71 and the prayers.  I do not find it necessary to quote any of those paragraphs here; suffice it is to say, I have read those paragraphs and I agree with Ms Chan SC.  The only breaches pleaded by the 3^rd plaintiff against the 1^st defendant were breaches of clause 6.2 of the Acquisition Agreement for which no remedy was pleaded against the 1^st defendant, and breaches of clause 8.3 which was about breach of undertaking to the 1^st plaintiff.  The 3^rd plaintiff, being the party which paid the consideration for the acquisition on behalf of the 1^st and 2^nd plaintiff, suffered no damage as the result of any breach by the 1^st defendant.  All damage was suffered by the 2^nd plaintiff which is the holder of the intellectual property rights etc and the operating arm of the plaintiffs’ group. 

32.  Next, Mr Scott SC refers to the expert report by the plaintiff’s expert, FTI, in which FTI opined that the 3^rd plaintiff suffered impairment in the value of the 3^rd plaintiff’s intangible assets.  In reply, Ms Chan SC argues that according the FTI report, the losses were estimated either on the basis of impairment in the value of the shareholding in Union Grace or on the basis of loss of profit arising from breaches of the Master Supply Agreement entered into by the 2^nd plaintiff.  Hence, the only party which may have suffered any loss, whether in terms of loss of business opportunities, loss of profits or loss of goodwill is the 2^nd plaintiff and the loss allegedly suffered by the 3^rd plaintiff was reflective loss.  Specifically, Ms Chan SC referred to paragraph 1.3.3 of the FTI report in which the expert referred to the loss as reflected by the changes in the market value of the 3^rd plaintiff’s shares when the breaches came to light.  Mr Scott SC objects to this line of argument being raised as it had never been pleaded by any of the defendants and it is impermissible for the 1^st defendant to even raise an issue not found in its pleadings but introduced by way of legal submission.  Nonetheless, he was prepared to deal with that argument.  He relies on paragraph 1.3.3 of the FTI report.

33.  In paragraph 1.2.8, the expert carefully distinguished between the 3^rd plaintiff from the other co‑plaintiffs. He identified the 3^rd plaintiff as “Sinopoly” and all the other plaintiffs collectively or singly as “the plaintiffs”.  Thus, on the face, wherever FTI referred to Sinopoly’s loss, it meant loss suffered by the 3^rd plaintiff.  FTI concluded his assessment in paragraphs 1.3.2 to 1.3.5 as follows:

“1.3.2 First, I have considered the impairment in the value of Sinopoly’s intangible assets set out in the financial statement. This impairment, which has been agreed by Sinopoly’s auditors, reflects the reduction in the value of the intellectual property acquired under the Agreements and which was included in Sinopoly’s accounts at that time at fair value. It is the Plaintiffs’ case that the diminution of value of its intangible assets was a direct consequence of the Defendants’ alleged breaches.

1.3.3 Second, I have considered changes in Sinopoly’s market value around the time when the alleged breaches came to light. Specifically, I have considered the change in value between 21 February 2011, when Sinopoly’s shares were suspended from the Hong Kong stock exchange, and 4 April 2011, when trading in its shares resumed.

1.3.4 Both of these methods are what are known as “top down” analyses of the Plaintiffs’ losses. In other words, they infer the value of the Plaintiffs’ losses from observed changes in the value of the company and its assets. Implicitly, it is assumed that all of any observed decrease in value is to the account of the Defendants.

1.3.5 In a third analysis, I have considered the Plaintiffs’ potential losses using a “bottom up” approach that seeks to calculate the value of the Defendants’ alleged breach of the MSA [the Master Supply Agreement]. This is one breach out of several that the Plaintiffs may wish to take into account in Suit 420 [this action] and may therefore be expected to understate their total losses.”

(Emphasis added)

34.  FTI used three different methods in assessing that loss.  It assessed the loss as reflected, firstly, in the 3^rd plaintiff’s financial statements; secondly, in the market value of its shares before and after the breaches came to light; and, thirdly, part of the plaintiffs’ loss by assessing the value of the defendants’ breach of the Master Supply Agreement.  It is clear from paragraph 1.3.2 that in assessing the loss suffered by the     3^rd plaintiff, FTI assessed the impairment in value of the various intangible property rights acquired under the Acquisition Agreement and related agreements.  Though the 3^rd plaintiff’s auditors might have included the value of those intangible assets in the books of the 3^rd plaintiff, what the auditors did could not change the fact that the intangible assets were acquired by the 2^nd plaintiff, and any loss in that value was loss suffered by the 2^nd plaintiff and not the 3^rd plaintiff.

35.  In paragraph 1.3.3, FTI said that it used the market value of the 3^rd plaintiff’s own shares as a basis of assessment.  Though FTI was not using the market value of the shares of the 1^st and 2^nd plaintiffs in the assessment, such value must reflect the impairment in value of the intangible assets and the loss as result of breaches of the Master Supply Agreement suffered by the 2^nd plaintiff.  The same applies to the loss assessed under paragraph 1.3.4.  In substance, the loss was not suffered by the 3^rd plaintiff.

36.  Thus, although on the pleading, the 3^rd plaintiff has pleaded loss against the 1^st defendant, on the evidence, the loss allegedly suffered by the 3^rd plaintiff was reflective loss suffered by the 1^st and 2^nd plaintiffs.  It was not possible to argue that any loss was suffered by the 3^rd plaintiff. 

Whether the redemption notice constituted a promissory note

37.  The 1^st defendant’s purpose of launching this line of argument is to exclude the availability of set‑off as a defence from the 3^rd plaintiff.  It is well settled law that in an action on a promissory note, a defendant will not, save in exceptional circumstances or upon strong grounds, be allowed to set up a set‑off or counterclaim for damages and the plaintiff will be entitled to judgment for the amount claimed without a stay of execution.      This principle applies irrespective of whether the counterclaim is connected with or arises out of or is independent of the contract in respect of which the promissory note was given and whether or not the action is between the immediate parties to the bill: Hong Kong Civil Procedure 2013, Vol 1, paragraph 14/4/15; Fielding & Platt Ltd v Selim Najjar [1969] 1 WLR 357 at 361; Yuen Chak Construction Co Ltd v Tak Son Contractors Ltd [1997] 3 HKC 294 at 298G‑I; Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH [1977] 1 WLR 713 at 721.

38.  Section 89(1) of the Bills of Exchange Ordinance defined a promissory note as follows:

“A promissory note is an unconditional promise in writing made by one person to another signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money to, or to the order of, a specified person or to bearer.”

39.  The redemption notice reads:

“We hereby irrevocably elect to redeem the principal amount of the Convertible Bond (the “Bonds”) we issued to you dated [ ] in accordance with the Conditions (as defined in the Terms and Conditions) and the terms below and enclose a cheque payable to you of the amount so redeemed.

   (It then sets out the redemption date and amount.)”

40.  Ms Chan SC also relies on clauses 1.3 and 11 of the Terms and Conditions which provided as follows:

“1.3 The obligations of the Company arising under the Bonds constitute direct, unsubordinated and unconditional obligations of the Company and rank, and shall at all times rank equally among themselves and pari passu with all other present and future unsecured and unsubordinated obligations of the Company without any preference or priority among themselves. No application shall be made for a listing of the Bonds.”

4.1  All payments by the Company hereunder shall be made in immediately available funds free and clear of any withholdings or deductions for any present or future taxes, imposts, levies, duties or other charges.  …

11.   … Once a Redemption Notice is given, the Company shall deliver to the Bondholder at its address referred to in Condition 14 a cheque for the Redemption Amount against delivery of the Bonds … for cancellation or … for endorsement by the Company … .”  (emphasis added)

41.  She argues that the redemption notice bears all the qualities of a bill of exchange or promissory note in that it is in writing, made and signed by the 3^rd plaintiff, specifying a sum payable to the 1^st defendant and the redemption date and stating that the 3^rd plaintiff irrevocably elects to redeem the bond. She attempts to make good the unconditional nature of the promise to pay by reading the redemption notice in conjunction with clause 1.3 of the Terms and Conditions, which stated that the obligation of the 3^rd plaintiff was unconditional, and with clause 11 which stated that the 3^rd plaintiff shall deliver a cheque for the redemption amount once a redemption notice is given.

42.  On the contrary, Mr Scott SC argues that the redemption notice by itself contained no promise to pay any sum of money and it was impermissible to read it in conjunction with and/or construed it within the factual matrix of clause 11.  He further argues that clause 11 only set out the mechanism for redemption, ie by delivery of a cheque against delivery up of the bond.  To say the least, I think the parties envisaged there would be further steps to be taken before the bond would be converted into a cheque.  I agree with Mr Scott SC that it would be rewriting the parties’ contractual bargain to suggest that the redemption notice, even taken together with the bond and Terms and Conditions constitute a promissory note. I doubt if the redemption notice together with the bond and the Terms and Conditions would be accepted by the commercial community as a promissory note. At the highest, the redemption notice is evidence of a simple debt.  To put it more neutrally, it is at least strongly arguable that the redemption notice is, at the highest, evidence of a simple debt such that the defence of set‑off is available if the other requirements for set‑off are satisfied.

Whether set‑off is excluded by the terms of the Convertible Bond

43.  Next, Ms Chan SC argues that properly construed the Terms and Conditions do not permit any defence of set‑off to be raised.  She refers to Esso Petroleum Co Ltd v Milton [1997] 1 WLR 938 (CA), in which the court held that the parties’ agreement to pay by direct debit was equivalent to a requirement to pay cash and excluded the right to set‑off. Hence, she argues that the 3^rd plaintiff’s obligation to deliver a cheque upon giving the redemption notice was equivalent to payment by cash which excluded the right to set‑off.  Such argument is premised on the basis that the redemption notice, the convertible bond and the Terms and Conditions constitute a promissory note.  For same reason as explained above, there are further steps to be taken before the convertible bond would be converted into a cheque.  Not until there was actual exchange of the convertible bond for a cheque was there payment by cash.  It is therefore very arguable that before that exchange takes place, at the highest the redemption notice is evidence of a simple debt such that the defence of set‑off is available if the other requirements for set‑off are satisfied.

44.  Next, Ms Chan SC argues that the use of the phrases “unconditional obligations” in clause 1.3 and “shall be made in immediately available funds” in clause 4.1 is inconsistent with a defence  of set‑off which would delay full payment.  I agree with Mr Scott SC’s submission that in the context of clause 1.3, the term “unconditional obligations” refers to distributions in an insolvency scenario that does not even relate to whether or not amounts due under the convertible bond can be subject to set‑off in the event of fundamental breaches of the Acquisition Agreement.  I also agree with Mr Scott SC that in the context of clause 4.1, that clause must be construed ejusdem generis.  That clause deals with payments in the nature of taxes and Government levies and does not relate to or preclude the operation of set‑off.  Putting it more neutrally, it is arguable that on the true and proper construction the clauses do not exclude set-off.  

Conclusion

45.  I reach the following conclusions.

46.  The applicable legal principle is that the defence of set-off is available to a defendant (the 3^rd plaintiff in the present case) who has a counterclaim (the original claim in the present case or a counter-counterclaim as I call it) against the plaintiff (the 1^st defendant in the present case) in the same litigation if the counterclaim (the original claim in the present case) is inseparably connected with the dealings and transactions giving rise to the subject matter in the claim.  The problem is the application of the principle to the facts of the case.

47.  On the fact, it is strongly arguable that on their true construction, the Terms and Conditions do not exclude availability of set-off as a defence; and that the redemption notice is not of the nature of a promissory note such that the defence of set-off is excluded.

48.  The 3^rd plaintiff has pleaded no defence to the 1^st defendant’s claim for redemption money under the redemption notice and Terms and Conditions other than the defence of set-off by reason of its original claim against the defendants.  Though the 3^rd plaintiff pleaded breaches by the 1^st defendant and loss suffered as a result, on the evidence such loss is   of the nature of reflective loss.  Thus, the 3^rd plaintiff has no real    claim against the 1^st defendant.  Any claim it may use to set off the     1^st defendant’s counterclaim for redemption money is the claims the 1^st and 2^nd plaintiff have against the 1^st to 7^th defendants.

49.  The central issue in the 1^st defendant’s application boils  down to this.  In a case such as the present one involving a number of  co-plaintiffs and co-defendants, whether the claims of one co-plaintiff (the 1^st and 2^nd plaintiff) against a co-defendant (the 1^st to 7^th defendants) could be used to set off another co-defendant’s (the 1^st defendant’s) counterclaim against a different co-plaintiff’s (the 3^rd plaintiff’s) claim depends on whether the principle in Muscat v Smith applies narrowly to a co-plaintiff vis-à-vis a corresponding co-defendant or broadly to the co-plaintiffs as one party and the co-defendants as another.  From the authorities quoted to me, it is not entirely clear whether the principle is to be applied narrowly or broadly.  I have not been referred to any authority one way or the other.  If a case meets the inseparable connection test, it is at least arguable that the principle should be applied broadly.  The present case certainly meets that test.  Accordingly, I think the defence of set-off is a plausible defence which needs to be fully argued and explored at trial.

50.  In view of the above conclusions, I think the 3^rd plaintiff’s defence of set-off falls within the third if not the second class of cases mentioned in paragraph 14/4/14 of Hong Kong Civil Procedure 2013, Vol 1.  The usual order would be judgment for the 1^st defendant on the counterclaim with costs stayed until trial of the claim.  In the present case, because of the lack of clarity as to where this case actually stands, the court has discretion to make such order as appropriate for the perceived justice of the case.

51.  The 1^st defendant’s claim is basically for the balance of the purchase price for the shares of Union Grace sold.  It only represented a small fraction of the consideration paid by the 3^rd plaintiff under the Acquisition Agreement.  The defendants had received the bulk of their consideration.  In the light of the FTI report, it is not speculative to suggest that the plaintiffs’ claim could be very substantial and could far exceed the amount of the defendants’, including the 1^st defendant’s, counterclaim.  Though the 3^rd plaintiff has not put up any defence to the counterclaim other than a set‑off, it would be manifestly unjust in the circumstances to allow the 1^st defendant to have judgment for the redemption money without taking into account the plaintiffs’ claim for damages for the 1^st defendant’s breaches of the Acquisition Agreement and related agreements.  Taking all of the above into account, I think it would not be just to enter judgment for the 1^st defendant.

52.  Furthermore, fourteen months lapsed without the 1^st defendant taking any action to strike out the 3^rd plaintiff’s claim.  Instead, it took out a new action against the 3^rd plaintiff on the same subject matter as its counterclaim a month after Miao and others presented a bankruptcy petition against him.  The 1^st defendant’s delay in taking action suggest that the present application was made for an ulterior motive and that the 1^st defendant’s application is an abuse of the legal process.  This is another reason for not entering judgment for the 1^st defendant.

53.  In conclusion, for the perceived justice of the case, it is appropriate that my discretion should be exercised in favour of the      3^rd plaintiff.  Accordingly, I dismiss the 1^st defendant’s summons.  The effect is that the 3^rd plaintiff has unconditional leave to defend to the extent of the set‑off.  I make a costs order nisi that the costs of the application including the costs of the hearing shall be the plaintiffs’ costs in the cause with certificate for two counsel.  Such costs are to be taxed if not agreed.