DORRING INDUSTRIES LTD v. DAHWA HOLDINGS (a firm)

[If a party to a commercial contract asserts that it was brought into existence for some purpose other than the creation of legal relations between the parties, he must prove that that purpose was the common purpose of both parties; and the burden of so proving is a heavy one.]

1987, No. A2334

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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BETWEEN

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JUDGMENT

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1. The plaintiff in this action is a company called Dorring Industries Limited ("Dorring"). Dorring is a local company but under Japanese management. The defendant is a local firm called Dahwa Holdings ("Dahwa").

2. Dorring says it has sold and delivered goods to Dahwa; its claim, for HK$345,000, is for what it says is the unpaid balance of the price. The goods were 25,000 kits of completely knocked down (CKD) parts for cassette mechanism model MF-36 without motor, R/P head and erase head. The unit price was HK$15.80 per kit, so that the total price was HK$395,000. Dorring says that Dahwa has made a partial payment to Dorring of HK$50,000, so that a balance of HK$345,000 remains owing from Dahwa to Dorring. Under the payment terms of the contract between Dorring and Dahwa, says Dorring, payment of the HK$345,000 is now due.

3. Dahwa denies all this. It says it did not buy any goods from Dorring. Dorring, says Dahwa, sold the goods to one trading entity in the People's Republic of China called Shenzhen Shen Yu Trading Corporation ("Shen Yu") for sale on to another one called Shanghai Huamei Radio Factory ("Huamei") at a price of RMB 500,000. Dahwa, it says, agreed to assist Dorring in and about the procedures required for the import of the goods into China, and for the remittance from China to Hong Kong of the moneys payable by Shen Yu to Dorring, converted into Hong Kong dollars. It says its payment of HK$50,000 to Dorring was by way of loan, not by way of part payment of the purchase price of the goods.

4. Although the parties have taken up these widely differing positions, most of the material facts are not in dispute. But before I state them, it will be convenient to say something about the persons involved in the drama.

5. The protagonist is Misao Saito ("Saito") who is the managing director of Dorring. The antagonist is Leung Chik Wail ("Leung") who is one of the partners in Dahwa. Minor but not unimportant parts are played by one Yoshinobu Tatewaki ("Tatewaki"), a manager, on Dorring's side, and one Miu Yu Bun ("Miu"), the manager, for a while, of Dahwa's China Trade Department, on Dahwa's side. Saito and Leung gave evidence before me. Tatewaki and Miu (who had been sacked by Dahwa over this transaction) did not. (Dorring had served Miu with a subpoena to attend the trial but had not succeeded in notifying him of the date eventually fixed for it. Dorring applied tome to receive in evidence a written statement made by Miu. I refused to do this. It was apparent that what he had to say was acutely controversial. I could have attached little or no weight to his statement in the absence of cross -examination.)

6. Other minor parts are played by David Ng ("Ng") and Kwan Kai Cheung ("Kwan"), both on Dahwa's side. Ng was the controlling partner in Dahwa; Kwan was the manager of Dahwa's accounts department. Both Ng and Kwan gave evidence before me. But neither of them knew anything about the transaction except what Leung had told them. Their evidence was of very little, if any, assistance. So, in so far as oral testimony is concerned, the contest is between Saito and Leung.I shall assess the impression these two' witnesses made on me later in this judgment, after I have set out my findings of fact, which I now do.

7. In or about June 1986,  a local company, United Chinese Hong Kong Enterprise Limited, approached Dorring with an enquiry for CKD kits for cassette recorders. Dorring was interested in the business; it could obtain the kits in Hong Kong from Sanyo, the Japanese manufacturer, to whose requirements they were surplus. Sanyo agreed to earmark 27,800 of these kits for Dorring. But then the enquirer backed off. Dorring looked for another possible buyer. It found Huamei, who wanted 25,000 of the kits. But difficulties arose. First, Huamei could not import the kits directly. Arrangements would have to be made for the supply of the kits through another Chinese entity authorised to import them, and whom Humai could pay in RMB. Secondly, Dorring wanted to be paid in Hong Kong or US dollars. Thirdly, Dorring wanted someone with PRC connections to assist it to get over the other difficulties.

8. Saito, on behalf of Dorring, approached Leung. Leung agreed to help. In August 1986 Leung introduced Dorring to Shen Yu. On 2nd November 1986, Shen Yu informally agreed to buy 25,000 kits from Dorring at a unit price of RMB 20 each (a total of RMB 500,000) CIF Shanghai, and sell them on to Huamei at the same price. Shen Yu was to take a turn of RMB 40,000. Huamei was to remit RMB 122,000 to Shen Yu to cover import tax (I am not satisfied this sum was intended to cover anything else), and was to pay the balance by unspecified instalments after the goods had arrived. Shen Yu would pay Dorring US$25,00  on receipt of the RMB 122,000 from Huamei, and would pay the balance to Dorring in Hong Kong dollars after Huamei had completed payment. If all went well, Miu (who was, I suppose, to do the work) was to be rewarded with HK$50,000. A formal contract was expected but not concluded between Dorring and Shen Yu; a formal contract was concluded between Shen Yu and Huamei.

9. The contract between Shen Yu and Huamei was dated 5th November 1986.  Among other things, this provided that the price of RMB 500,000 was to include "custom tax"(whatever that was). It also contained the following provision as to payment :-

"10.      Payment : Within 50 days after the Buyer receives the goods to pay by instalments until full payment. Buyer shall directly remit the import tax of RMB 122,000.00 to. the Seller and the Seller will handle the importing procedures."

10. Finally, it contained a provision that Shen Yu would be responsible for obtaining the import licence. It did not contain any provision throwing onto Huamei the costs of doing so, and therefore I treat the contract as providing that as against Huamei Shen Yu would bear its own costs of obtaining the import licence.

11. The contract of 5th November 1986 was supplemented by a Trading and Technical Agreement made between Dorring and Huamei on the following day, 6th November 1986. This recognised that the components were to be supplied by Dorring to Huamei and provided for technical and other support to be given by Dorring to Huamei. It contained a provision the effect of which was that Huamei would have to pay Dorring, through Shen Yu, RMB 2.60 for each kit (if any) subsequently supplied by Huamei to a company called Shanghai Duo Ling Company Limited (in the end, no sets were in fact supplied by Huamei to that company).

12. On 11th November 1986, Huamei remitted to Shen Yu the RMB 122,000 for import tax which it had agreed to remit to Shen Yu.

13. On 20th November 1986, Huamei so informed Dorring, and asked Dorring to contact Shen Yu and arrange custom clearance and transportation (shipment) to Shanghai.

14. Dorring had not yet entered into any formal contract to sell the goods to Shen Yu. Saito was prepared to go to China to sign the necessary contract. But before he could do so, Shen Yu intimated to Leung that it would prefer. to deal with a supplier under Chinese management, rather than one under Japanese management; in fact, that it would prefer to deal with Dahwa rather than with Dorring. On 20th November 1986, Leung so informed Saito. Both agreed that the deal would have to be restructured. The arrangement eventually made, on 28th November 1986, was that Dorring and Dahwa would enter into a form of contract in writing under which the goods were expressed to be sold by Dorring to Dahwa at a price of HK$395,000. This was done. The contract was dated 1st December 1986. It bore Dorring's reference "DSC-86-001" and I shall so refer to it. Leung asked Kwan if Dahwa would be responsible for payment under it and Kwan told him that it would not. On this basis, Leung was prepared to sign it.

15. The contract DSC-86-001 contained the following terms as to partial payments :-

"The first payment will be made within 10 days after the Final Buyer, SHANGHAI HUAMEI RADIO FACTORY, China paid to SHEN YU TRADING CORPORATION (SHENZHEN), Shenzhen China and will be continued to pay as within 10 days after said Corporation in Shenzhen, China receipt of payments from the said Final Buyer every time. The partial payment will be completed within 10 days after the Corporation in Shenzhen, China receipt of the Final Payment from the Final Buyer."

The contract contained the following additional term :-

"The above mentioned Unit Price and Total Amount are subject to the payment of RMB .500,000.00 to be made by SHANGHAI HUAMEI RADIO FACTORY as the Final Buyer to SHEN YU TRADING CORPORATION (SHENZHEN) addressed 17th Floor, Shenzhen International Trading Centre, Shenzhen, China according to their Contract, dated on 5th November 1986. In case that any additonal amount in RMB YEN is paid by said Final Buyer to Shun Yu Trading Corporation (Shenzhen) according to the Agreement between said Final Buyer in Shanghai, China and Dorring Industries Limited, dated on 6th November 1986, DAHWA HOLDINGS shall be converted into Hong Kong Dollars and the payment shall be made to us without any delay."

These terms gave Dahwa the same credit that Dorring had been prepared to give Shen Yu. If Huamei did not pay, Dahwa would not have to pay either. So this risk remained with Dorring. Dahwa would not otherwise have accepted the arrangement.

16. On the same day, 1st December 1986, on which the contract DSC-86-001 was made, Dorring entered into a formal contract to buy the 27,800 kits from Sanyo as it had informally agreed to do in June 1986, and as Sanyo had been pressing it to do. (Dorring had told Sanyo it had a customer for the goods.) The price per kit was HK$8.021583, a total price of HK$223,000; and, indeed, on 29th November 1986 (the day after Saito and Leung had come to the arrangement set out in the contract DSC-86-001) Dorring had sent Sanyo its cheque for HK$23,000, drawn on the Bank of Canton, by way of deposit, leaving an outstanding balance of HK$200,000 due to Sanyo on the transaction between Sanyo and Dorring. If Dorring had not had a customer for the goods, Sanyo would not have released them without payment in full, or security for payment.

17. Also on 1st December 1986, Dahwa, as seller, entered into a contract with yet another Chinese entity called Shenzhen Sez Foreign Trade (Group) Corporation ("SSFC"), as buyer, under which Dahwa agreed to sell the goods to SSFC; SSFC had an import quota entitling it to a licence to import the goods. The goods were simply described as "components of cassette mechanism (not including key parts)" and the details of quantity and price were said to be set out in an attached inventory. In fact, no such inventory appears to have been attached to the contract. The total price payable was stated to be US$25,000. Under the contract between Dahwa and SSFC, the goods were to be delivered in Shenzhen; the provisions contained in the contract as to terms of payment were not completed. The contract bore Dahwa's chop and was signed by Miu in Shenzhen. Huamei paid Shen Yu, who paid SSFC, around RMB 78,000 for participating in those arrangements.

18. On 8th December 1986, Tatewaki and Miu went to Sanyo's godown at Tsuen Wan, where the goods were. The goods were released to them. Miu signed a delivery note, which also bore Dahwa's chop, acknowledging receipt of the goods by Dahwa. The goods were loaded on to an 8-ton lorry which had been hired by Dahwa to take the goods from Tsuen Wan to Shenzhen. On the same day, 8th December 1986, Dahwa issued an invoice to SSFC for the goods.

19. On 9th December 1986, Dorring issued an invoice DI-89-209 to Dahwa for the goods. The terms of payment were stated to be as per the contract DSC-86-001. The invoice bore Dahwa's chop and was countersigned by Miu.

20. On 23rd January 1987, Huamei paid Shen Yu RMB 78,000, described as a part payment of the price for the goods.

21. On 4th March 1987, Dahwa advanced to Dorring HK$50,000, expressed to be in partial payment of. the invoice DI-86-209 above-mentioned. This was dealt with by Kwan, not Leung.

22. On 19th March 1987, Huamei paid Shen Yu RMB 300,000, being the balance of the money due to Shen Yu. (It will be remembered that the total price of the goods was RMB 500,000; that RMB 122,000 had been paid on 11th November 1986 and that RMB 78,000 had been paid on 23rd January 1987.)

23. Dorring in due course pressed Dahwa for payment of the sum which Dorring claimed to be due to it under the contract DSC-86-001. Although it is not in dispute that the goods were duly delivered to Huamei, and that Huamei paid Shen Yu for them, Dorring had (and still has) received nothing from Dahwa except the payment of HK$50,000. It got nowhere.

24. On 15th April 1987, there was a meeting between Saito and Ng at Dahwa's offices. Leung was not present; Kwan was. Ng and Kwan put it to Saito that the only obligation of Dahwa was to try and arrange for a remittance of RMB 500,000 from Shenzhen to Hong Kong for the account of Dorring. They put it to him that he would have to bear the custom tax, industrial tax and VAT incurred in relation to the transaction, and also handling fees of Shen Yu, that is to say, a) delivery charges from Shenzhen to Shanghai; b) repacking fee; c) warehouse charges; and d) export application (a reference, I believe, to the costs of the import licence). They also asked him to pay the charges for the delivery of the goods from Hong Kong to Shenzhen and of the application for import. They were prepared to pay Saito a balance of the RMB 500,000, after deduction of all these items, in RMB; or, if Saito desired, the equivalent at theday's current rate in Hong Kong dollars. They presented Saito with a form of agreement upon those terms for his signature. Saito refused to sign it.

25. There the battle lines were drawn. Dorring relied on the contract DSC-86-001, and the other documentary evidence supporting its case which I have outlined. above. Dahwa was willing to agree only to arrange for Leung to go to: Shenzhen with Saito to attempt to sort the matter out with Shen Yu. That was not acceptable to Dorring. On 24th April 1987, Dorring instituted this action.

26. There remains for consideration the crucial question of fact; whether, as Dahwa contends, the restructuring of the original deal for the supply of the goods from Dorring to Huamei was an exercise on paper only, not intended to create . any legal relations between Dorring and Dahwa. All the documents are on Dorring's side; and the burden of proving that they were not intended by the parties to have legal effect according to their tenor, which must rest on Dahwa, is a heavy one. If the court is to find that the documents are a cloak for the true transaction between the parties, Dahwa must satisfy it that both Dorring and Dahwa had the common intention to bring the contract DSC-86-001 into existence as a sham, not as a genuine contract intended to create the legal rights and obligations which it gives the appearance of creating. Upon this matter, I have to weigh the evidence of Saito on the one hand, who told me, in effect, that he signed the contract DSC-86-001 intending it to take effect according to its tenor, against the evidence of Leung, who told me, in effect, that both parties signed the contract DSC-86-001 intending it to be used to give third parties (in particular, the Bank of Canton, who Leung says Saito told him would not release the goods to Dorring without such a contract) the appearance of having created between Dorring and Dahwa legal rights and obligations, whereas it was actually not the intention of either Dorring or Dahwa to create any such legal rights or obligations. (There was no documentary evidence to support Dahwa's case about the Bank of Canton, and I reject it.)

27. Saito made a favourable impression on me and I prefer, and accept, his evidence. It follows that I accept what he told me was his purpose in entering into the contract DSC-86-001. Leung, on the other hand, made a less favourable impression on me. At best, I am not satisfied, on Leung's evidence, that Saito intended the documents to take effect only as a cloak for the true transaction, and to mislead third parties as to what that was. On the most charitable view I can take of Leung's evidence, I might be satisfied that he did for himself enter into the contract DSC-86-001 only for that purpose; but that would not be good enough to enable the court to award the day to Dahwa. The reason is that the burden on Dahwa must be to satisfy the court that it was the common purpose of both Dorring and Dahwa, in bringing the contract DSC-86-001 into existence, to disguise the true nature of the transaction. Since I have accepted Saito's evidence as to his own purpose, that is a conclusion which I am unable to reach.

28. These findings of fact conclude the case in favour of Dorring. Each of them, Dorring and Dahwa, was able to point to matters of which evidence had been given which tended to make the story of the other seem inherently improbable. But no useful purpose would be served by my exploring these byways. Whatever the inherent improbabilities of` each side's case, I am left in the end with all the documentary evidence on Dorring's side, and with a finding that I prefer the oral testimony of Saito to that of Leung. I have held that the burden rests on Dahwa to satisfy me that, in entering into the arrangements in question, neither Dorring nor Dahwa intended to be legally bound by them. Dahwa has not satisfied me that this is the case, certainly not so far as Dorring is concerned; and that, as I have already indicated, is really the end of the matter.

29. Dahwa suggested that the arrangements made were intended to deceive the Chinese authorities and were therefore illegal; but it led no expert evidence as to the legal position, under the laws of the People's Republic of China, relating to the import of goods from Hong Kong to China or the conversion of RMB into Hong Kong dollars in order to pay for them; and in these circumstances I do not think it would be right for me to go any further into this aspect of the case.

30. For the reasons I have endeavoured to state, I propose to direct that judgment be entered for Dorring for HK$345,000 with interest and costs.