MANAGEMENT INVESTMENT & TECHNOLOGY CO LTD v. EARNWAY TECHNOLOGY LTD

HCA 4389/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 4389 OF 1999

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ASSESSMENT OF DAMAGES

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1. This is an assessment of damages under RHC Order 37. Pursuant to the Order of Master Lung dated 26th February, 2003, interlocutory judgment was entered for the Plaintiff that day, the Defendant having failed to appear on the checklist review, and failed to comply with the directions made by Master Lung at the earlier hearing of 5th February, 2003.

2. Judgment was that the Defendant pay the Plaintiff damages to be assessed, together with interest and costs. A Notice of Appointment of Assessment of damages was issued on 9th July, 2003, and was on the same day served by ordinary post on the Defendant, as explained in the 6th Affirmation of Mr. Singh of the Plaintiff's solicitors. The matter therefore comes before me today.

3. Mr. Wellington Chao of the Plaintiff's solicitors appeared for the Plaintiff. The Defendant was absent, and indeed appears to have taken no part in these proceedings since at least the beginning of this year, although a defence and counterclaim had earlier been served. That pleading raises no positive case on loss and damage.

The Issues

4. These proceedings concern a mould manufactured by the Defendant pursuant to a contract entered into with the Plaintiff. The Plaintiff is a manufacturer of domestic appliances, including in particular domestic bathroom weighing scales. The mould purchased from the Defendant was to be used by the Plaintiff to manufacture the plastic top cover for sets of bathroom scales.

5. Prior to placing the order with the Defendant, the Plaintiff had itself on 21st February, 1996 entered into a co-operation agreement with a German seller of domestic appliances, including bathroom scales, Leifheit A.G. By that agreement, Leifheit engaged the Plaintiff to manufacture bathroom scales for it, and Leifheit contributed substantially towards the capital costs which would need to be incurred by the Plaintiff for the purpose of setting up production of these bathroom scales. This included a contribution to the cost of the Defendant's mould which was to make the top cover of US$18,700.00. I will return to this agreement and its terms later. In response to this agreement with Leifheit, the Plaintiff, or 28th May 1996, entered into the contract with the Defendant to produce the mould as shown in the Plaintiff's order of that date.

6. The bathroom scales produced by the Plaintiff turned out to be sub-standard, and the Plaintiff puts the blame for this entirely on defects in the mould manufactured by the Defendant. Considerable efforts were made by the Plaintiff and the Defendant to improve the quality of the bathroom scales sent to Leifheit, which focused on the top cover produced by the Defendant's mould. Despite these efforts, Leifheit eventually cancelled its agreement with the Plaintiff, and the substantial manufacture of these bathroom scales anticipated by the Plaintiff did not take place.

7. In its defence and counterclaim, the Defendant argued that defects in the mould were not the cause of these problems, or otherwise the Defendant was not to blame. Those issues were resolved by the judgment entered for the Plaintiff, and I am therefore only concerned today with what damages flow from the Defendant's breaches of its agreement.

Losses Claimed

8. The contract price to be paid by the Plaintiff to the Defendant for the mould, as set out in the Plaintiff's order of 28th May, 1996 was HK$216,000. Of this, an initial sum of HK$108,000 was paid at the time of the Order, and a further sum of HK$54,000 was paid when the mould produced its first plastic cover for the bathroom scales. The final payment due under the contract of HK54,000 was never paid by the Plaintiff. The Plaintiff claims recovery of the sums it did pay.

9. Further, the Plaintiff claims loss of profits. The allegation is made on page 6 of the Statement of Claim that, in the ordinary course, it would have been expected Leifheit to have purchased some 100,000 sets of bathroom scales from the Plaintiff, if the project had been successful: i.e. if the mould from the Defendant had not been defective. From this is deducted 4,000 sets of scales which were in fact purchased by Leifheit, and paid for, before Leifheit cancelled its agreement with the Plaintiff. A claim is therefore made for loss of profit on 96,000 sets of scales. The Statement of Claim sets out a calculation of loss of profit for each scale in the sum of HK$25.2693, and accordingly a claim for loss of profit of HK$2,425,852.80 is made. This claim was maintained in the same form by Mr. Chao at the hearing.

The Evidence

10. Mr. Mak Kwok Hong, the Plaintiff's Vice President for Operations, gave evidence at the hearing. He had previously provided a signed witness statement, which I admit as his evidence in chief, although he was taken orally through his evidence in relation to loss and damage. Mr. Hong has been with the Plaintiff for 17 years, and came across as a credible and sensible witness, and I am prepared to accept his evidence. He does not appear to have had much dealing with either the Defendant or Leifheit in relation to the key issues, but gave evidence as to the Plaintiff's operations and how its profit is calculated.

11. Mr. Hong explained this by reference to exhibit "MKH-11" to his statement, and in particular page 123 of the bundle before me. Mr. Hong explained that the direct material costs for each bathroom scale were at the time HK$39.5342. The individual items of each bathroom scale which make up this total are set out on the preceeding pages, and were identified by Mr. Hong. The next two items are indirect costs and scrappage. These cover such items as solder wire and glue, which is consumed during the manufacture process. This is set at 5.3% of the direct material costs. Mr. Hong explained that this is a fixed figure established at the beginning of each year, based on the Plaintiff's production experience.

12. Scrappage is some material which is normally and inevitably wasted, faulty or broken during the manufacture process, and again is set at a rate of 4% of the total direct and indirect material costs at the beginning of each year. Mr. Hong gave evidence that it is not practical to give a precise cost for indirect costs and scrappage for each individual bathroom scales. This is impossible. Mr. Hong is plainly experienced in these matters, and I accept his evidence that his allowances of indirect costs and scrappage are appropriate, reasonably based, and the best figures that can be achieved in the circumstances.

13. On page 123 of the bundle, there is then set out labour costs attributable to each bathroom scale in a total sum of HK$4.4908 per set of scales. Mr. Hong explained that labour costs are established by the Industrial Engineering department of his firm, which sets standard labour times and rates for assembly processes within the Plaintiff's operations. The labour cost figures are based on the estimated labour time involved in the production of each bathroom scales, multiplied by the standard labour rate at that time of HK$3.55 per hour, as set by the Plaintiff's Industrial Engineering department.

14. Similarly, overhead costs of the Plaintiff are assessed at HK$13.9152 per unit. Mr. Hong explained that these are based on a standard overhead rate of HK$11 per labour hour. Again this standard is set at the beginning of each year by the Plaintiff's Industrial Engineering department. Accordingly, the Plaintiff's general overhead costs are shared out amongst the Plaintiff's production according to how the Plaintiff's labour time is spent on its various products and production lines. I accept the figures given by Mr. Hong, and accordingly that the overall costs attributable to the manufacture of each set of bathroom scales is HK$61.7007 (see MKH-11). The agreement with Leifheit was for the sale of scales at US$11.05 per piece, which when converted to Hong Kong Dollar, and after the deduction of costs at HK$61.7007, gives a profit per scale of HK$25.2693.

Purchases by Leifheit

15. Mr. Hong also gave evidence of his estimation of the number of units which he believed Leifheit would have purchased, if the project had been successful. This is set out in paragraph 32 of his witness statement, and was amplified by him at the hearing, and in response to cross-examination from the Bench. In his statement, Mr. Hong refers to the fact that Leifheit were investing a total of HK$340,119 (or US$ 43,605.00) into the Plaintiff's capital costs for the manufacture of the bathroom scales. Mr. Hong says, therefore, that it was reasonable to conclude that Leifheit must have had in mind to make substantial purchases of bathroom scales in order to justify making this capital investment with the Plaintiff.

16. I accept that this is reasonable to conclude Leifheit would have had in mind significant purchases of the scales to be making this capital investment. Nevertheless, Mr. Hong confirmed, in response to question from the Bench, that Leifheit had in fact only ever placed an initial order for 5,000 sets of bathroom scale. The agreement with Leifheit was for one year, although with provisions for it to be automatically rolled over for a further period. No minimum or anticipated purchase is set out in the agreement. Mr. Hong himself did not have discussions with Leifheit about their proposed purchase volumes. This would be dealt with by the Marketing Department. Mr. Hong also accepted that his theory that Leifheit must purchase 100,000 bathroom scales in order to recoup the capital investment made with the Plaintiff depends on economic conditions in the markets to which Leifheit was selling, and on the level of profit achieved by Leifheit.

17. Nevertheless, Mr. Hong also gave evidence in examination in chief as to typical orders made by typical customers. He said that in his 17 years of experience, an order of 100,000 units, in situations such as this, was quite normal. Some orders were of course less than this, but some orders were also higher.

18. The Plaintiff next called its Vice President of Marketing Division, Mr. Lam Ying Lun, England to give evidence. Mr. Lam had most of the relevant discussions with the Defendant and with Leifheit in relation to this project. Mr. Lam had also submitted a witness statement, which I admitted as his evidence in chief, although he also gave evidence orally in relation to matters of loss in damage. He had worked with the Plaintiff for some 18 years, and came across as a credible and careful witness, whose testimony I accept.

19. Mr. Lam gave evidence that he had had discussions with Leifheit, at the commencement of this project, in which Leifheit had indicated to him that they intended to order somewhere between 50,000 and 100,000 sets of bathroom scales. In discussions with the Defendant, the mould was to be capable of producing some 3-500,000 bathroom scale covers before it would degrade. This is also referred to expressly in the Plaintiff's order to the Defendant. This suggested that a substantial production run was anticipated, and also suggested that the Defendant was aware of this.

20. Mr. Lam also gave evidence orally, as well as in his witness statement, of the effort that had been made to retrieve the relationship with Leifheit. Although production was supposed to commence in 1996, it was still in mid 1997 when discussions were going on and new samples were being sent to Leifheit. Considerable efforts were being made by the Plaintiff to get the Defendant's mould put right, but also to satisfy the high quality requirements of Leifheit. I accepted that the Plaintiff acted reasonably, and did all it reasonably could, to salvage the relationship with Leifheit, and accordingly to mitigate its losses. I also accept that the fact Leifheit were patient for over one year while efforts were made to try to get the top cover of the bathroom scales put right, evidences their intention to commit to a longer term project, if the problem could be worked out.

21. In response to questions from the Bench, Mr. Lam explained that the Defendant had been told about the high quality requirements for the top cover which would be produced by the mould, and knew their mould was to have a high capacity. Nevertheless, Mr. Lam also explained that the Defendants were never told about the identity of the customer, nor that any particular quantity would be, or were anticipated to be, ordered by the customer. The Defendants were never told that a customer was contributing towards the capital cost of the mould. Mr. Lam explained, and I believe, that this customer information would be confidential and not shared with the Defendant. I believe it is reasonable to conclude that the Defendant would have had in mind from all the circumstances that a significant production run of the scales was anticipated, although they did not have specific details. This would have been in the mind of the parties at the time of contracting.

22. There were a number of documents in the bundle which puzzled me, and which I asked Mr. Lam to explain (Mr. Hong having stated that he was not involved in them). By letter of 3rd March 1997 at page 138, Leifheit wrote to the Plaintiff complaining about the scales. This was evidently followed by further meetings and discussions, but I have in the bundle at page 139 a letter from the Plaintiff to Leifheit of 24th June 1997. I was concerned that, in this, when replying to the complaints of Leifheit, the Plaintiff referred to a number of factors, as set out in this letter, which put the blame to some extent on Leifheit, or otherwise on problems not associated with the Defendant and the mould.

23. Mr. Lam seemed to accept this from the face of the document, but explained that at this time the Plaintiff was trying to have a commercial negotiation with Leifheit, and give itself some negotiating room. He was trying to negotiate with Leifheit for them to accept a slightly different quality or lower quality product. He accepted that an easy route to take in a letter written at this time would be to simply to put the blame on the Defendant. Nevertheless, Mr. Lam explained that this was not the way things were done, and indeed Leifheit trusted the Plaintiff to organize its sub-contractors, including the Defendant, to produce a good product. To put the blame on the Defendant would have been to lose face, and cause a loss of credibility in the Plaintiff's ability to organise production. To have blamed the Defendant openly would have been destructive. Although this might seem an odd approach, overall I accept Mr. Lam's evidence, and I accept that what he was probably doing was his best to bridge the gap between the Defendant's defective mould and Leifheit's requirements, by negotiating with Leifheit and making all efforts to get the Defendant to improve its product.

24. Finally I asked Mr. Lam about a letter of 15th July 1997 from Leifheit in which Leifheit says that the samples were approved. Mr. Lam explained, and I accept, that this letter was written as a result of the sending of two additional top covers only to Leifheit. Significant effort had been made to get two samples up to specification, that Mr. Lam explained that in an ordinary production process it was impossible to attain this standard.

Judgment

25. I am satisfied that the Plaintiff's claimed profit per set of bathroom scales is reasonably stated. As to the number of sets which Leifheit would have ordered, this must always be uncertain. The evidence before me was relatively limited. They only actually ordered 5,000. They received and paid for 4,000. They told Mr. Lam at the outset that they might order 50-100,000. This is strong evidence, and the only evidence we have of Leifheit's real intentions. Everything else was necessarily educated presumption from the circumstances or experience. My assessment would however have been much easier with some direct evidence from Leifheit, even just by letter, as to their plans, the market they would sell into, or other economic factors.

26. Leifheit and the Plaintiff made each a significant investment, and went to some lengths for over a year to try to get the scales right, before eventually giving up. Things might have turned out better for Leifheit, so they ordered more, they may have been worse, so they ordered less. Mr Hong says 100,000 is a reasonable typical order, although it can be more or less. His views are relevant, but he did not ask Leifheit about this. The figures Leifheit told Mr Lam suggest 75,000 would be a reasonable middle ground. However, I am persuaded by the other evidence that the best estimate overall would be a little higher. I allow 90,000.

27. The Plaintiff's loss of profit is therefore 90,000 sets, less 4,000 sold = 86,000. This is multiplied by the profit per set to give:

86,000 x HK$25.2693 = HK$2,173,159.80

From this must be deducted the cost of the mould: the Plaintiff would have had to pay the Defendant for the mould, if the project had been successful, and the Defendant had performed its obligations. The Plaintiff cannot both claim refund of the money paid, and its full profit. The difference between money for the mould received from Leifheit, and what the Plaintiff was to pay the Defendant is HK$70,140.00. This is explained by Mr Hong is paragraph 10 of his statement. This must be deducted from the profit:

HK$ HK$2,173,159.80 - HK$70,140.00 = HK$2,103,019.80

28. One other issue arises: Mr. Chao said there was a contingent claim. Leifheit own the mould, since they bought it under the contract with the Plaintiff, who bought it from the Defendant. The mould is apparently now with the Defendant, since it seems to have been rejected by Leifheit, who presumably do not want it. Mr. Chao says they may want it back, and so the Planitiff should have back the money it has already paid to the Defendant as a fund to meet this contingent claim. I am not convinced. The mould was produced 7 years ago, and finally rejected 6 years ago. Leifheit has shown no interest in it. The applicable limitation period was not discussed. No evidence was given to me as to the likely value of a 7 year old defective mould, designed for a product not being produced. This claim was not made in the Statement of Claim, where the Plaintiff asked for its money back, and even raised an issue of a failure by the Defendant to destroy the mould.

29. I am satisfied that a loss of profits reasonably and naturally flows from the Defendant's breaches, and was in the contemplation of the parties at the time of contracting. This was plainly a significant project, in which the Plaintiff was investing significant time and money. The Defendant would have know the mould was for one specific purpose only, and the Plaintiff could not use it for anything else. The mould was to have a life of 3-500,000 pieces. According to Mr. Lam, the Defendant knew the exacting quality requirements, even if it did not know the Plaintiff's customer and the contract with that customer. The Defendant was involved in this industry, and could have estimated the Plaintiff's losses if the mould failed, although it is not necessary as a matter of law to show that.

30. The Defendant's defence merely put the Plaintiff to proof of loss and did not raise any positive defence. I am satisfied that the Plaintiff has taken reasonable steps to mitigate its loss, and no case on this was raised by the Defendant nor any evidence given by the Defendant.

31. I therefore give Judgment to the Plaintiff for HK$2,103,019.80, together with interest and the Costs of this action. Mr Chao has now submitted that Leifheit would have ordered scales over 24 months from September 1997, with shipment being made (and so profit earned) 1 month after order. In the absence of any evidence from either party on this, I accept this as a reasonable assumption. The first profit would have been earned on about 1st October 1997, and the last on about 1st September 1999. The average is therefore about 15th September 1998, and I award interest on the entire loss of profit from that date to Judgment. This in fact allows a generous time for trying to put the mould right between 1996 and 1997, which if the mould had not been defective, would not actually have occurred. Therefore, the Plaintiff has made a generous allowance to the Defendant by this assumption.