DRACCO NETHERLANDS B.V v. SIMBA TOYS GMBH & CO. KG

HCA 304/2014

[2024] HKCFI 3061

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 304 OF 2014

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BETWEEN

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DECISION

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Background Facts

1.  The plaintiff (“P”) and the defendant (“D”) entered into a licence agreement (the “Agreement”) dated 10 February 2011. In consideration of the payment of a license fee (the “Licence Fee”) by D (as the “Licensee”) to P (as the “Licensor”), P granted D the right to produce and distribute certain toys under the “Filly” brand in pan-Europe.

2.  P alleges that D had failed to make full payment of the License Fee by 31 October 2013. P then purported to terminate the Agreement on 15 January 2014 relying on the Agreement. It was contended that D was not entitled to sell its outstanding stock, despite a “Sell-Off Period” was provided in the Agreement. Despite the contention of P, D continued to sell the products at a reduced price, which is alleged to have severely damaged the goodwill of Filly.

3.  P’s allegations and complaints against D include:

(1) Alleged under-reporting and non-payment of Licence Fees by D between January 2011 and December 2013;

(2) D’s subsequent sell-off at undervalue or improper disposal of unsold items; and

(3) Alleged infringement of intellectual property rights by D during the term of the Agreement.

4.  D (represented by Mr C.W. Ling) on the other hand contends:

(1) P was not entitled to terminate the Agreement with retrospective effect from 1 November 2013 or 31 December 2013.

(2) Under the Agreement, D had 90 days from the expiry of the Agreement to dispose of any unsold products. Following the expiry of the Agreement, D had begun selling the unsold products.

(3) P had breached its covenant for quiet enjoyment during and after the term of the Agreement.

5.  On 21 February 2014, P instituted proceedings against D and sought, inter alia, an “injunction to compel D to allow its business records and documents relating to P’s products to be inspected by an auditor appointed by P”.

6.  In his Reasons for Decision dated 28 March 2014 (the “2014 Decision”), Chung J refused to grant the aforesaid injunction on the balance of convenience in reliance on the Peruvian Guano test. He then observed that despite the P’s attempt to argue to the contrary:

“… there is no reason to think that the ambit of discovery of documents will be any less comprehensive than the inspection provided for by clause 11d.”[1]

7.  Various interlocutory applications including security for costs had been taken out in the meantime. However, there had been no substantial progress for the action since 2014. As of the date of the hearing (some 10 years after the commencement of the action), parties had only completed discovery.

Applications

8.  There are two applications before the court:

(1) summons dated 8 March 2024 filed by P for direction for a split trial or a trial of the preliminary issues set out in the summons (the “Preliminary Issue Summons”); and

(2) P’s summons dated 6 September 2024 seeking leave to adduce further evidence in support of the Preliminary Issue Summons (the “Further Evidence Summons”).

9.  Under the Preliminary Issue Summons, P seeks a direction that the following be tried as preliminary issues under Order 33 rule 3 and 4(2) of the Rules of the High Court (Cap 4A):

“Whether, as prayed for at (1) and (2) in the Amended Replacement of the Re-Re-Amended Statement of Claim [Amended Replacement] an Order shall be made for an Audit of the Defendant's business records and documents relating to the Products covered by the Agreement and an Account rendered as at 1 April 2014 of all sales of the Products achieved by the Defendant and its subsidiaries and affiliates, of the proceeds of those sales and the Licence Fees due and payable to the Plaintiff in accordance with the Licensing Agreement to determine:

(1) whether the License Fees due to the Plaintiff for the Products were incorrectly categorised:

(i) Category B Products “Playsets for figurines” were categorised as Category A as particularised under Revised Annexure 2-1; and

(ii) Category C Products were categorised as Category B as particularised under Annexure 2-2; and

(iii) Category C Products were categorised as Category A, as particularised under Annexure 2-3;

(2) whether different royalty rates were claimed for the same item in different royalty statements including a 3% reduction in the Licence Fee for Products in Category B, that were purportedly related to sales generated under TV-promotions when those Products had not been invoiced prior to the TV-promotions as was required under clause 1(f) of the Agreement;

(3) whether the Plaintiff supplied the Defendant with figurines that were part of related playsets, but the number of figurines so supplied exceeded the number of playsets sold, indicating that the number of playsets with figurines sold had been under-reported;

(4) whether a series of Products were sold FOB at 17% or 19% when the correct rate was 20% and the Licence Fee for a series of Products sold Wholesale was incorrectly calculated at 15% or 16.5% when the correct rate was 18%;

(5) whether the Defendant failed to pay to the Plaintiff the Licence Fees due and owing for Products sold by or on behalf of the Defendant in the 1st Quarter of 2014;

(6) whether the Defendant failed to apply the Agreed Ratio to the Licence Fee paid to the Plaintiff for the Category C Products as a result of which the Licence Fees were understated as particularised under §8 in the Amended Replacement;

(7) whether discounted prices were incorrectly adopted and/or deductions incorrectly made in calculating some of the License Fees;

(8) whether License Fees were not based, as they should have been, on the pricing to the Hungarian customer;

(9) whether deductions were made from the Licence Fee payments as reimbursements for Products returned to the Plaintiff during the currency of the Agreement after the accounts had already been settled and the Licence Fees paid by the Plaintiff;

(10) what inventory of Products were sold after the 1st November 2013 and at what price(s).” (emphasis added)

10.  D opposes both the Preliminary Issue Summons and the Further Evidence Summons.

Legal Principles

11.  The relevant legal principles are trite: all issues should be tried at the same time. In Re Tai Ping Yeung Motors Ltd [2001] 2 HKC 611 at pp 614-5, Le Pichon JA observed as follows:

“Preliminary Issues - Applicable Principles

The annotation in the Supreme Court Practice 1999 is a useful starting point. At para 33/4/10 it is stated that:

‘An order for the separate trial of separate issues is a departure from the beneficial object of the law that all disputes should be tried together, and therefore, generally speaking, such an order should only be made in exceptional circumstances or on special grounds (per Jessel M.R. in Piercy v Young (1880) 15 Ch.D. 475 at 479 and 480; per Scrutton L.J. in Bottomley v. Hurst and Blackett (1928) 44 T.L.R 451 at 452.’

This approach was echoed by Lord Wilberforce in his speech in Tilling v Whiteman [1980] AC 1 at 17H-18A:

‘I, with others of your Lordships, have often protested against the practice of allowing preliminary points to be taken, since this course frequently adds to the difficulties of courts of appeal and tends to increase the cost and time of legal proceedings. If this practice cannot be confined to cases where the facts are complicated and the legal issue short and easily decided, cases outside this guiding principle should at least be exceptional.’

Indeed, as Lord Roskill observed in his speech in Allen v Gulf Oil Refining Ltd [1981] AC 1001 at 1022A:

‘The preliminary point procedure can in certain classes of case be invoked to achieve the desirable aim both of economy and simplicity. But cases in which such invocation is desirable are few. Sometimes a single issue of law can be isolated from the other issues in a particular case whether of fact or of law, and its decision may be finally determinative of the case as a whole. Sometimes facts can be agreed and the sole issue is one of law.’

Lord Roskill went on to urge those whose task it is to decide whether or not trial of preliminary points should be ordered to be ‘extremely cautious’ before acceding to pleas for the making of such orders as a result of attractively advanced submissions founded upon pleas of supposed economy.” (emphasis added)

12.  The comment by Lord Scarman in Tilling v Whiteman at 25C is also instructive: “Preliminary points of law are too often treacherous short cuts. Their price can be, as here, delay, anxiety, and expense.” I respectfully agree with the observations of Le Pichon JA, Lord Wilberforce, Lord Scarman and Lord Roskill quoted above.

13.  Thus, the party applying for trial of preliminary issues should demonstrate what exceptional or special grounds there are before such an order should be made.

14.  In considering whether there should be a trial of preliminary issues, the often-cited list of questions posed by Neuberger J (as he then was) in Steele v Steele[2] are also instructive:

(1) Could the determination of the preliminary issue dispose of the whole case or at least one aspect of the case?

(2) Could the determination of the preliminary issue significantly cut down the cost and the time involved in pre-trial preparation and in connection with the trial itself?

(3) If the preliminary issue was an issue of law, how much effort, if any, was involved in identifying the relevant facts for the purpose of the preliminary issue? (not relevant to the present case)

(4) If the preliminary issue was one of law, to what extent was it to be determined on agreed facts? (not relevant to the present case)

(5) Whether the determination of the preliminary issue could unreasonably fetter either or both of the parties or the court in achieving a just result at trial?

(6) To what extent was there a risk of the determination of the preliminary issue increasing costs and/or delaying the trial? In that regard the court could take into account the possibility that the determination of a preliminary issue might result in a settlement.

(7) To what extent the determination of a preliminary issue was relevant? The more likely it was that the issue would have to be determined by the court, the more appropriate it was to have it as a preliminary issue.

(8) To what extent was there a risk that the determination of the preliminary issue, if apparently helpful in terms of saving costs and time, could lead to an application for the pleadings to be amended to avoid the consequences of the determination?

(9) Was it just and right to order a preliminary issue?

Discussion

15.  For the following reasons, I am not persuaded that the application for a split trial/preliminary issue should be acceded to:

(1) P initiated the present preliminary issue application due to the alleged incomplete discovery provided by D. Mr Neville Sarony SC leading Mr C.C. Ho (counsel for P) submitted that D has known since 2014 that their business records and documents were being sought and ought not destroy them:

“As the action has progressed, it became increasingly clear that without a full and proper audit the Plaintiff cannot identify accurately the full picture of the substantial amount of licence fees that are payable. The Plaintiff’s own investigations and the very limited discovery that has been made, has revealed a critical necessity for an audit. “the ambit of discovery of documents” to which Chung J referred can in no way fulfill the comprehensive audit that the Plaintiff sought,… the unreliability of the Defendants’ discovery process was nothing but a futile exercise serving no practical purpose in identifying the extent of the incorrect accounting or the assessment of the Plaintiff’s damages. The Plaintiff’s initial application for an injunction came at the earliest stage of the proceedings. As matters transpired, with the benefit of hindsight, had the audit been granted at that stage, a huge amount of costs and time would have been saved.”[3]

(2) However, despite some suggestion of bad faith or even malice involved in the destruction/loss of documents on D’s part, there is at this stage insufficient evidence for the court to come to such conclusion. Under Order 24 rule 7 of the Rules of the High Court, if a deponent by affidavit states that he does not have the documents, this will be conclusive at the interlocutory stage.

(3) Even if the court were to give an order for account, the accounting exercise would equally be based on the same documents that had already been produced by D.

(4) As a result, I do not see how an order for preliminary issues can improve the quality of discovery by compelling D to provide what it has sworn on oath to be complete disclosures.

(5) It was further submitted that only by auditing of the records and documents of D under clause 11(d) of the Agreement will the Plaintiff be able to identify fully all the miscalculations and assess the extent of its damages. Clause 11(d) of the Agreement was heavily relied upon by P as the basis for the Preliminary Issue Summons:

“ The Licensor or Licensor’s Agent shall be entitled at any time to have the Licensee’s business records and documents relating to the Products inspected by an auditor who is under an obligation of secrecy. The cost of the said inspection shall be borne by the Licensee if an accounting error to the Licensor’s disadvantage is discovered, pursuant to which the amount actually due to Licensor exceed the amount actually paid to licensor by more than 5% of this latter amount. Moreover, Licensor may at all times request an inventory report showing current inventory of Products.”

(6) Mr Henrik Andersen (“Henrik”), a director of P claims that an auditor can “examine all Filly licensed products by image, product contents and NPD categorizations. This will enable the auditor to check on the accuracy of the royalty reports and make a complete calculation of the discrepancies identified. … The audit can fully and finally draw up an account of all and any sums outstanding arising from the agreement between the parties. Such audited account would stand independently of any other claims or matters in dispute between the parties.”

(7) However, the court should not order a trial of preliminary issues involving disputed facts[4]. Given that there are disputes on the basis of calculation, an order for account can only be given after that dispute has been resolved.

(8) What P seeks is essentially part of the reliefs sought in its claim under the Amended replacement of the re-re-amended Statement of Claim (the “ARRASoC”)[5]. I do not see how it is appropriate that the court should in effect grant judgment as to that part of P’s claim before liability is even established.

(9) I also accept Mr Ling’s submission that clause 11(d) does not anticipate that an auditor is to be appointed by the parties or by the court to take over the task of fact-finding such that parties would be bound by the conclusions of the auditor. Whatever conclusions that the auditor may come to, such conclusions are still open to challenge by either party, if they choose to do so. For example, based on the pleadings, P and D clearly have different interpretations and contentions as to how various products are to be categorised. Any conclusion of an auditor appointed under Clause 11(d) of the Agreement would not bind either party.

(10) There can therefore be no saving of costs by such account or audit.

(11) A determination of the preliminary issues would also not substantially reduce the trial time: the crux of P’s application lies in the advance calculation of the appropriate Licence Fees as pleaded in the ARRASoC[6]. As identified by Mr Ling, the remaining issues in dispute include:

(a) D’s alleged infringement of intellectual property rights by the use of unapproved packaging and marketing materials during the term of the Agreement in breach Clauses 2(e) and 3(a), as particularised in Annexure 8 of the ARRASoC[7];

(b) D’s alleged wrongful assertion of copyright ownership in relation to P’s product designs in breach of Clause 13(b)[8];

(c) D’s alleged failure to return all drafts, models, samples and materials created in the process of arranging and designing the products upon request in breach of Clause 13(c)[9];

(d) Consequential loss and damage to the goodwill and reputation of the “Filly” brand as a result of the above breaches as well as the sell-off at a discount (see ARRASoC §27) based on a reasonable estimate of performance of the “Filly” brand, alternatively, the life cycle of the products[10];

(e) D’s alleged failure to provide quarterly accounting statements for the first quarter of 2014[11];

(f) Validity of P’s purported termination of the Agreement with retrospective effect from 1 November or 31 December 2013[12];

(g) D’s excessive sell-off at a discount beyond its contractual entitlement causing damage to the brand and monetary loss[13];

(h) D’s counterclaim for P’s breach of its covenant for quiet enjoyment during and after the term of the Agreement[14].

(12) As such, a split trial in terms of the Preliminary Issue Summons would not determine the action.

16.  Bearing in mind the principles set out above in paragraphs 11 – 14, I am of the view that P has failed to show that:

(1) the preliminary issues can dispose of the whole case or at least one aspect of the case;

(2) the determination of the preliminary issue can significantly cut down the cost and the time involved in pre-trial preparation and in connection with the trial itself.

17.  It is not just and right to order a determination of preliminary issues.

18.  In fact, it became apparent during Mr Sarony’s oral submissions that what is being sought could/should be done through expert evidence, which is within the normal course of trial, and likely to be the next step for this action.

19.  I therefore gave directions on the timetable for taking out an application for expert directions as well as exchange of witness statements.

Further Evidence Summons

20.  The 3^rd affidavit of Henrik seeks to analyse the bulk of the documents already disclosed and more substantively mentioned a conversation in a face-to-face meeting at the Nuremberg International Toy Fair on 2 February 2024 between Jacob Andersen, Henrik’s business partner and Manfred Duschl (“Mr Duschl”), to which Henrik was a party by phone. The meeting was at the invitation of Mr Duschl, to discuss the possibility of settling the dispute. Mr Duschl was the CFO and Board member for the Simba Dickie Group, which includes the Defendant.

21.  The evidence sought to be adduced is along the lines of Mr Duschl having stated that D had carried out an audit which determined that D had done everything right, from their point of view. However, he had declined to give P a copy of the audit unless ordered to do so by the court.

22.  Leaving aside arguments on whether such a meeting was without-prejudice as it concerns settlement negotiations, I am of the view that this audit, even if disclosed, is not determinative of the disputes between P and D since P is unlikely to accept its accuracy, as P already is of the view that without the bulk of the relevant records, it cannot be accurate or reliable.

23.  As it is irrelevant to the determination of the Preliminary Issue Summons, I would not allow the evidence to be adduced at such a late stage.

Conclusion

24.  To conclude, no exceptional circumstances or special grounds have been demonstrated by P on why the normal rule of having all issues tried together should be departed from. The Preliminary Issue Summons is dismissed. The Further Evidence Summons is likewise dismissed.

Costs

25.  Costs follow the event. Mr Sarony argued that costs should be in the cause because if P had not taken out the Preliminary Issue Summons, it would be unlikely that they would be able to seek expert directions due to D’s attitude. However, I do not see how D could be said to have given such indication. I am of the view that the Preliminary Issue Summons was not properly taken out and P should bear the costs of both the Preliminary Issue Summons and the Further Evidence Summons.

26.  I therefore make a costs order nisi that P should bear D’s costs of the Preliminary Issue Summons and the Further Evidence Summons, with certificate for Counsel, to be taxed if not agreed.

27.  The above order nisi shall become absolute in the absence of application to vary within 14 days hereof.