GEMTACT CO LTD v. LING CHI HUNG AND ANOTHER

HCA 363/2000

 IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 363 OF 2000

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J U D G M E N T

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1.  The Plaintiff was a private company incorporated in Hong Kong on 12 May 1992 and carried on the business of the sale and distribution of footwear. 

2.  The 1^st Defendant (D1) was and is still, a director of the Plaintiff, allegedly having sole control and management of the affairs and business of the Plaintiff, and was a substantial shareholder, director and, it is alleged, the alter ego of the 2^nd Defendant (D2).

3.  D2 was and is a private company incorporated in Hong Kong on 26 November 1997, which carried on the business of the sale and distribution of footwear, allegedly in competition with the Plaintiff.

4.  By this action the Plaintiff claims the following reliefs:

(1)     A declaration that the 1^st Defendant being the director and fiduciary of the Plaintiff was in breach of his fiduciary duty owed to the Plaintiff.

(2)     A declaration that D2 was and is the alter ego of the 1^st Defendant and is liable to indemnify or account to the Plaintiff for all losses or damage suffered by the Plaintiff by reason of the breach of the 1^st Defendant’s fiduciary duty.

(3)     An account of the profits made by the Defendants whether by selling or distributing to the Plaintiff’s customers or otherwise and profits which the Defendants had made from those profits, or alternatively, for damages to be assessed on the basis of the profits that the Plaintiff would otherwise have made but for the 1^st Defendant’s breach.

(4)     An injunction to restrain the Defendants their employees servant or agents from selling or distributing to the Plaintiff’s customers.

(5)     An order that the Defendants be charged with interest at such rate and for such period as the Court shall deem fit.

(6)     Further or other relief.

(7)     Costs.

5.  For most of the course of this litigation, D1 and D2 were represented.  However their legal representatives ceased to act.  Prior to trial D1 applied to represent D2 as well as himself, but his application was refused.

6.  He renewed the application before this court at the start of the trial and given the circumstances, the Court granted leave to D1 to represent D2. 

Factual Background

7.  Most of the facts were not disputed.  In 1980, Fuda Company Limited (Fuda) was set up to import Japanese, and Italian shoes and wholesale them to retailers in Hong Kong.  Towards the end of the 1980s, business decreased and the Italian shoe manufacturers and the directors of Fuda set up Annetic Company Limited (“Annetic”) to manufacture shoes in China; the registered office of Annetic is in Hong Kong.

8.  In 1992, D1 was engaged by Fuda to promote its wholesale business in Hong Kong, because of his known skill in marketing.  Miss Mary Chiu (PW1) and Lam Yuk-leung were shareholders and directors of Fuda.

9.  It was decided to form a new company and D1 would have 25% of the shares.  He was to be fully responsible for running the company and was paid a fixed salary.  The new company was Gemtact Co Ltd, the Plaintiff (Gemtact).  The shareholders of Gemtact were Fuda with 75% and D1 with 25% of shares; the directors were D1 and Lam Yuk Leung.  D1 has never paid up his shares, nor invested any money in the company.

10.  Gemtact acted as the wholesaler of footwear manufactured by Annetic and sold its products to Hong Kong retailers.  Apart from D1, a clerk was employed, but no other staff. 

11.  Gemtact’s profit was the difference between Annetic’s factory price and Gemtact’s sales price, which was 30 to 35% more than the factory price.  Gemtact would settle Annetic’s bill with a 4 to 5 months post-dated cheque.

12.  In 1993 and 1994, the retail industry in Hong Kong was poor and this adversely affected Gemtact’s business.  D1 suggested promoting business in China and wholesaling Annetic’s products there.  This was done and business increased dramatically.

13.  Gemtact’s largest customer was a company, Dragon Sea, which had retailing outlets in Guangdong province.  Annetic supplied approximately 3,000 pairs of shoes to Dragon Sea each month, which increased the business of Gemtact and Annetic.

14.  Between 1992 and 1997, Gemtact did not pay out any bonuses, nor was any of the capital invested retrieved for benefit of the directors.  Eventually Fuda wished to pursue other ventures and in early 1997 proposed selling its share of Gemtact to D1.  According to Miss Chiu, Gemtact was making a profit at that time, although that was disputed at trial by D1.

15.  At the beginning of October 1997, D1 agreed to buy Gemtact and the parties discussed how to transfer Fuda’s 75% shareholding to D1.  Details were discussed and agreed during two meetings.

The First Meeting

16.  On 30 October 1997, a meeting was held to discuss how best to effect the hand-over.  The Minutes of the meeting, prepared by D1, recorded that he agreed to take up Fuda’s shareholding of 75% and various terms were proposed for consideration.

17.  It was agreed that in January 1998, the company would give the accounts for the period 1 April to 31 December 1997 to the accountants for auditing, to determine the Profit and Loss position of Gemtact.  They were to incorporate Profit and Loss for all businesses in the Mainland and the company income was to be taken as the Profit and Loss account assessed by the accountant.  (Clause 2)

18.  The proposal for stock value was that until the end of October 1997, the value of stock in the Mainland was agreed at RMB$800,000 and the value of stock in Hong Kong was agreed at HK$880,000.

19.  By January 1998, it was expected that some of the stock would have been sold; the value of stock at that time was estimated at approximately $1.3 million.  A depreciation rate was to be proposed and calculated for stock sent to D1.  As for distribution of stock, D1 agreed to put Mr Lam’s interest as the primary consideration and he was to direct the stock ratio for the parties to take up. 

20.  Clause 4 provided that D1 hoped to pay to the Plaintiff the agreed value of shares and assets, by 3 equal instalments.  Payment dates were 15 February, 15 April and at 15 of June; presumably that meant 1998.  Although the year is not stated, the context of the Minutes shows it was 1998.

21.  Clause 5 proposed a new distribution method for the company’s fixed assets.

22.  Clause 6 provided that the price of goods owed by Gemtact to Annetic would be the responsibility of D1 and not later than 4 months from the delivery date, he would pay all loans which fell due before January.  The plan set out total payments for each month.  The period was between November 1997 and May 1998.

23.  Clause 7 provided that the Plaintiff was to assist D1 to obtain rights to the brand “Il Fantino” and to transfer it from Annetic to Gemtact.

24.  By Clause 8, the Plaintiff was to assist D1 and Annetic to produce approximately 7,000 pair of shoes between mid-March 1998 and early April 1998.

25.  A further meeting was suggested by D1 “as soon as possible” to confirm all decisions. 

26.  Although D1 argued that the Minutes of this meeting did not constitute an agreement between him and the Plaintiff, it is clear that the basic agreement to transfer the company from the Plaintiff to the Defendant, had been formed and that a plan to implement the transfer had been outlined.  Certain figures required assessment and confirmation and it would be possible to alter the proposals after further discussion, if necessary.  D1 argued that the use of such phrases in the Minutes as “hopes” meant that the plan was a draft one only. 

27.  It is clear from the evidence that despite his denials D1 had had day to day control of the Plaintiff and was in a better position than Fuda to judge its profitability.  A Note to the minutes required D1 to produce the Profit and Loss Account to Mr Lam for verification by the end of November.

28.  Although couched in somewhat informal language the whole plan had been outlined, with provision for fine-tuning at a later meeting.  It is not disputed that D1 drew up the Minutes and he, as “Party B”, wanted Fuda to confirm all decisions as soon as possible.

Second Meeting

29.  A second meeting was held on 20 February 1998.  It was decided, leaving aside the question of depreciation, that the company profit would be split with 75% to Mr Lam and 25% to D1.  A shop in the Mainland was to be closed before the end of March.

30.  Clause 3, provided that D1 and Mr Lam would take 50% each of the total stock, agreed at a value of about 1.6 million.  Mr Lam would have priority in choosing the stock (Clause 4), subject to D1’s request that the stock be taken first from that held in Hong Kong, and thereafter any deficiency to be made up from the Guangzhou warehouse.  D1 would provide a list of Mainland stock within 1-2 days of the meeting.

31.  Clause 5 related to the repayment by D1 of capital invested in Gemtact by Mr Lam.  D1 agreed to repay HK$1,085,128 in exchange for all rights and shareholding in Gemtact.

32.  Clause 6 confirmed that D1 would settle the price of goods owed to Annetic, about $3.2 million, and, in accordance with what was agreed at the first meeting, would clear all amounts due at the end of January, before the end of June.  The balance would be settled by 3 payments in April, May and June, each payment being about $700,000.

33.  Clause 7 provided that all running expenses of Gemtact would be frozen so that existing accounts could be dealt with.  This was subject to a condition that if the shares could not be transferred “today”, the Accounts Payable to Gemtact before the transfer, would be borne by Gemtact.

34.  Clause 8 provided that if after the end of March D1 returned his share of the capital and if Gemtact was able to issue post-dated cheques to settle the price of goods owed to Annetic, this would square the account of Gemtact, so that the operation of Gemtact could resume early.

35.  D1 discussed with Mary Chiu how he might use Renminbi to square the account owed to Annetic and she agreed to enquire.

36.  In expectation of the finalised agreement being carried out, as set out in the Minutes of the first meeting and confirmed in the Minutes of the second, the salaries paid to D1 and the sole staff member of Gemtact were stopped, after their salary payments were made for January 1998. 

37.  After the second meeting it remained only for the accounts to be finalised and for payments to be made by D1 in April, May and June as agreed.  No payment was ever made by D1.  The Plaintiff alleged that without advising the Plaintiff, D1 decided to set up his own factory and run an identical business in parallel, thus avoiding his agreement to buy Fuda’s holding in Gemtact.

38.  This fact was not communicated to the Plaintiff by D1 and the Plaintiff only found out, by accident, of D1’s actions.

Incorporation of the 2^nd Defendant

39.  On 26 November 1997, Luxe Glory Limited (D2) was incorporated; shareholders were D1 with 8,000 shares and Liu Yi Qiu with 2,000 shares.  The directors were D1 and Liu Yi Qiu, a director and majority shareholder of Dragon Sea, Gemtact’s largest customer. 

40.  In March and April 1998, D1 had not paid any of the monies he had agreed to pay, nor had he returned stock as promised.  Gemtact’s business had stopped and no further orders were placed with Annetic.

41.  When Miss Chiu enquired why Dragon Sea no longer placed orders with Annetic, Mr Liu told her that he had stock and if he needed more he would order them through D1, but no more shoes were ordered by Dragon Sea.  Only after Miss Chiu learned about D2, in about March 1998 did D1 tell her he could not afford to buy Fuda’s 75% shareholding.  The matter was left in abeyance for about 6 months and during this period Fuda learned of D1 incorporating D2 in November 1997 and investigated further.

42.  The main business of D2 was the operation of a shoe factory in Jianmin, manufacturing shoes for Dragon Sea.  Miss Chiu found out that D1 had employed staff members from the Plaintiff, as workers for D2.  They were, allegedly, Mr Chan Wai Kwong, a development supervisor in the development department, Mr Sin Wai Chuen, Mr Sin Wai Tong and about 50 staff from the Plaintiff’s factory.

43.  The Plaintiff further discovered that D2 bought materials from Annetic’s suppliers e.g. soles, glue, thread and transport.  It appeared that this was done so that the shoes manufactured by D2 would be similar to those manufactured by Annetic.

44.  On 9 January 2001, having read a newspaper advertisement, PW1 went to a shoe shop in Sham Shui Po and saw D1 in the shop.  She returned to the shop after D1 had left and purchased 6 pairs of shoes, which were being sold for $100 a pair.  The shoes were of a pattern similar to those manufactured by Annetic and all six pairs of shoes bore the “King Marco” trademark, a mark which had been registered by the Plaintiff in the PRC.  Other shoes on sale appeared to be from inventory stock of the Plaintiff.  PW1 could identify the shoes because of special stickers on the boxes.  Also the Plaintiff’s brands “Il Fantino” and “King Marco” were applied to shoes, which in all respects, appeared identical to those manufactured by the Plaintiff.  The shoes bought by PW1 were produced as exhibits.

45.  Normally a pair of shoes was $130 ex factory; $180-190 was Gemtact’s wholesale price and $400 (approximate) was the retail price.  Miss Chiu said there were hundreds of similar shoes in the shop.

Defence case

46.  D1’s position was that he had never been solely or wholly in control of Gemtact and, further, that the Minutes of the two meetings were not intended to and did not represent a final agreement between the parties.  He contended that the transfer of the ownership of the Il Fantino trademark to D1 had been the lynchpin of the agreement.  It was his case that as Fuda had failed to hand over the ownership of the label he was not obliged to abide by the agreement.

47.  Although he admitted incorporating D2 and setting up a shoe factory in China, he denied that it was intended to be run in competition with Plaintiff.  He denied poaching the Plaintiff’s staff or endeavouring to copy the footwear made by the Plaintiff company. 

48.  He submitted that the shareholders of Fuda tried to insist on a higher price for their shareholding than had been agreed at the two meetings, and that too was a reason why he had not proceeded with the deal.  There was no supporting evidence for that allegation. 

49.  D1 was not an impressive witness.  He provided no good explanation for incorporating D2 at the same time he began negotiating for the acquisition of Fuda’s shareholding in the Plaintiff.  Nor did he explain why he failed to mention at the 2^nd meeting that he had set up a shoe factory in China, which thereafter supplied Dragon Sea, with the quantity of shoes formerly provided by Annetic through Gemtact.

50.  He admitted he had no experience in running a shoe factory, which makes it all the more surprising that he established one in China, but explains why he would have needed to employ staff who had the knowledge he lacked, thus giving credence to the staff poaching complaint.

51.  Although he submitted that the Minutes did not constitute a valid agreement because of the informal wording, D1’s behaviour and attitude show that he did accept the agreement as being properly formed and as containing all the necessary terms.  It was he was responsible for the composition of the agreement, which overall was beneficial to him and it was he who wanted the new arrangement in place as soon as feasible.  Apparently, at some stage at or around the time of the 1^st meeting, D1 concluded that he could ignore the agreement and achieve his objective by setting up a parallel operation, hiving off the Plaintiff’s biggest customer and manufacturing identical goods.

52.  As a shareholder and director of the Plaintiff he was obliged to reveal his activities and account for any profits gained.  When questioned by PW1 as to why there were no further orders from Dragon Sea he did not provide an honest explanation, nor did he take the opportunity to explain that he did not wish to proceed with the acquisition.  By the time Fuda discovered what had happened he had run the Plaintiff’s business into the ground.  Given the time frame and his lack of frankness it appears highly likely that he ensured the collapse of Gemtact’s operations to give his new venture the opportunity to flourish.

53.  Having considered the evidence, I am satisfied that at the time of these events (and up to the present) D1 was a director and shareholder of Gemtact and was in a fiduciary relationship as director with the Plaintiff.  Despite owing a fiduciary duty to the Plaintiff he, in breach of that duty, used corporate information, assets and opportunities to set up another company, D2, to divert business from the Plaintiff with a view to make a profit for himself and D2, thus causing loss to the Plaintiff.

54.  The agreement between the Plaintiff and D1 had been finalised by the conclusion of the second meeting when all matters necessary to effect the transfer of Fuda’s shareholding had been agreed.  I do not accept the evidence of D1 that the transfer depended on his being able to obtain the “II Fantino” trademark; nor do I accept his evidence that Fuda insisted on a higher transfer price.  There is little doubt that he agreed to the transfer because he considered it of benefit to him, but that, later, he devised a plan to obtain the Plaintiff’s business without having to pay for it.

55.  I am satisfied that the Plaintiff is entitled to the declarations sought by this action.  There shall be a declaration that D1 as the director and fiduciary of the Plaintiff was in breach of his fiduciary duty owed to the Plaintiff.

56.  A further declaration is granted that D1 was and is the alter ago of D2 and is liable to account to the Plaintiff for all losses or damages suffered by the Plaintiff by reason of the breach by D1 of his fiduciary duty.

57.  There will be an injunction to restrain the Defendants, their employees, servants or agents from selling or distributing to the Plaintiff’s customers.

Assessment of damages

58.  The Plaintiff submitted that, the total value of the loss suffered by Gemtact was $6.4 million and asked the Court to dispense with a formal assessment of damages.

59.  This request was based on two grounds, first, that there were sufficient figures in the Minutes, if accepted as correct, to enable a proper assessment of the losses sustained by the Plaintiff, and second, that given the parlous financial state of D1 and D2 it would add unnecessary costs to the litigation if a formal assessment of damages was ordered.

60.  The Plaintiff submitted that what Gemtact had suffered was the wreck of its company structure; the sale of its stock below cost; the loss of capital; further, the price of goods agreed as being owed to Annetic by Gemtact had never been paid.  The Plaintiff submitted there should be an order for damages in the order of $5.9 million to cover its loss and offered an undertaking not to sue D1 and D2 for an account of further profits, if such order was made.

61.  D1 did not propose any other basis for an assessment and, apart from asserting that the Plaintiff had tried to hide the facts about stock value, did not disagree with the proposal that the assessment be done on the basis of figures already available to the court.

62.  Accordingly, damages were assessed on the basis of the figures appearing from the evidence in court and the documents produced for purposes of the trial.

63.  The figures in the Minutes of the two meetings gave a clear picture of the worth of the Plaintiff at the time of the negotiations and showed the Plaintiff was not a losing venture financially.  The stock value was fixed at $1.6 million on a fifty-fifty basis.  The debts owed to the supplier showed $4.5 million of debt outstanding.  There were debts of $3.2 million owed to Annetic.  It was agreed three payments of $700,000 each would be made in April, May and June 1998.

64.  No evidence placed before the court showed these figures to be incorrect.  In fact the figures had been prepared by D1, who between 1992 and 1997, was responsible not only for the day to day management of Gemtact, but was also responsible for obtaining the financial information contained in the Minutes which formed the basis of the agreement and for drawing up the Minutes.

65.  The figures covered what the Plaintiff termed complete losses not accounted for by D1 and D2.  The minimum damages were submitted to be as follows:

(1)	the profit arrived at (according to the computation set out in paragraph 1 of the Minutes of the 2nd meeting);	$  404,560.00
(2)	the value of stock $1,600,000.00 (paragraph 3 of the same Minutes) less $315,820 for stock taken by Mr Lam (set out in paragraph 4)	$1,284,180.00
(3)	repayment of capital invested in the Plaintiff by Mr Lam (paragraph 5 of the Minutes).	$1,577,600.00
(4)	the price of goods owed to Annetic by Gemtact, (paragraph 6 of the Minutes)	$3,200,000.00
		$6,466,340.00

66.  Credit is given for D1’s payment to Annetic of $510,221.43, which, the Plaintiff conceded, had been made by two payments, one in Japanese Yen ¥80,000 and one in Hong Kong Dollars, $510,141.43, making $5,956,118.57.  It was this sum that the Plaintiff elected to treat as damages suffered as a result of the breach of fiduciary duty by D1 and participated in by D2.

67.  Given the unusual method of assessment I reduce the total to $5,900,000.00.

Damages

68.  Damages are assessed in the sum of $5,900,000.00, together with interest at judgment rate from date of the Writ until payment in full.

69.  There will be an order nisi for costs of the action to be to the Plaintiff to be taxed if not agreed.

70.  Liberty to apply.