XCHRX SHENZHEN BENELUX ENTERPRISE CO. LTD. v. BENELUX MANUFACTURING LTD.

HCA11437/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 11437 OF 1998

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DECISION

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1. This is an application for summary judgment. The Plaintiff is a company incorporated under the laws of the PRC and is listed on the Shenzhen Stock Exchange. The Defendant is a company incorporated under the laws of Hong Kong and is a subsidiary of a company formerly known as Benelux International Ltd. ("BIL") which is listed on the Hong Kong Stock Exchange.

2. At all material times, the Plaintiff and the Defendant were related in that the Defendant is a minority (23.55%) shareholder in the Plaintiff. However, whilst the management of the Plaintiff has remained constant, there was in 1997 a change in the control of the Defendant company from the Chau brothers to new management put in place by the new controlling shareholders.

Processing Agreement

3. The business relationship of the parties in question started in 1991 with a written document called a "Processing Agreement" whereby the Plaintiff agreed to perform processing, assembly and packaging work for the Defendant on materials supplied by the Defendant for the production of audio and video cassette tapes and floppy disks. Although the written Processing Agreement was for a specified period only, it was renewed for further periods, first expressly, and later impliedly by conduct of the parties.

4. Under the Agreement, the Defendant was to pay for raw materials which it would then provide to the Plaintiff. The Plaintiff would not have to pay for these materials prior to working on them, but would set-off the price of the materials from the price of the products (comprising cost of materials and processing fee) on sale back to the Defendant after processing (cl. 6.1).

5. The Plaintiff's evidence was that in practice, there was a mutual invoicing of the cost of the raw materials. The Defendant would invoice the cost of the materials to the Plaintiff, and the Plaintiff would invoice the Defendant with the cost of the entire manufactured product. By mutual set-off, the Defendant's liability to the Plaintiff was in effect the processing fee.

Loan Agreement

6. The Plaintiff alleges that by 1995 however, the Defendant was unable to pay for materials, and it asked the Plaintiff to help in obtaining finance. In or about February 1995, there was an oral agreement between the parties whereby it was agreed that the Plaintiff would apply for Letters of Credit from banks on the Mainland purportedly to pay for materials sold to the Plaintiff by the Defendant. After drawdown by the Plaintiff, the Defendant would repay the Plaintiff the amounts drawn down, together with interest charged by the banks and bank charges, after delivery by the Plaintiff of the products made with those materials.

7. This oral agreement has been referred to as "the Loan Agreement". It is not admitted by the Defendant (Affirmation of William King Jakel, paragraph 11). However Sandy Chau Kar Sun, previously a director of the Defendant and Chairman of BIL, has made an Affirmation in support of the Plaintiff's case, admitting that he had made the Loan Agreement on behalf of the Defendant (paragraph 7).

8. There has been no Affirmation from the Defendant in opposition to that Affirmation from Mr Chau. What the Defendant attacks is the legality of the Loan Agreement, which issue is dealt with later in this Decision.

Account Stated

9. The Plaintiff's primary case is that by 31 October 1997, the parties had agreed that a total sum of HK$36,208,551.99 was due from the Defendant to the Plaintiff as at 30 September 1997.

10. Mr Ronny Tong SC, Counsel for the Plaintiff, submitted that this was a real account stated (Halsbury's Laws of England 4th ed. re-issue Vol. 9(1) paragraph 1049), i.e.

"... where general items of claim between the parties are brought into account on either side, the figures on both sides were adjusted between the parties and a balance between them is struck. The result is then the same as if each item had been paid and a discharge given for each, and in consideration of that discharge, the balance is agreed to be due. The consideration for the payment of the balance is the discharge of the items on each side."

11. I am satisfied that the evidence supports such an account stated. The account is evidenced in an annex to a fax letter dated 31 October 1997 from the Defendant's accounts department. The Defendant's accounts department had been taking part in an exercise to attempt to reconcile the inter-companies accounts of the two companies.

12. The account annexed to the fax letter refers to the results of the reconciliation as at 28 August 1997 and makes adjustments for certain items for the month of August to arrive at the balance as at 31 August 1997. To this were added items for the month of September 1997, and the pleaded amount of $36,208,551.99 was arrived at. The Plaintiff has adopted that account by suing on it in the Statement of Claim.

Authority

13. The Defendant has argued that although the fax letter was sent in the name of the Defendant's accounts department, it was sent by Mr Hung Ka Ming, a junior accounts clerk who had no authority to agree or settle inter-company accounts.

14. However on 12 March 1997, Mr Sandy Chau a director of the Defendant and Chairman of BIL had written to the General Manager of the Plaintiff stating, amongst other things, that the Plaintiff's figures for unpaid items (at that time, as at the end of February 1997) were more or less correct, and that the Defendant's accounts department would provide confirmation after checking details. The Defendant must be taken to have held out its accounts department (in whose name the fax was sent) as having the authority to agree items on the inter-company accounts.

15. As for the accounts department, even on the evidence of Mr Liu Kwok Wah, the Defendant's Finance Manager, Mr Hung's specific role was to try to reconcile the accounts of the two companies. The fax letter shows that he was doing exactly that - he had started with the results of a previous reconciliation, made relatively small adjustments and presented them to the Plaintiff, who adopted his figures.

16. I find therefore that the Defendant's accounts department acting through Mr Hung had actual, or at least apparent, authority and the Defendant has no arguable case otherwise.

Defendant's acknowledgment of substantial indebtedness

17. In any event, the contemporaneous evidence shows that the Defendant had, at the highest levels, acknowledged on more than one occasion its substantial indebtedness to the Plaintiff throughout a long period.

18. In the Defendant's Balance Sheet as at 31 March 1996, a sum of $35,064,033 was listed under Current Liabilities as due to an associated company. The only associated company was the Plaintiff. This indebtedness of $35.064m was shown in the Notes to the Financial Statements of the listed holding company BIL for the year ended 31 March 1996.

19. In the Defendant's Balance Sheet as at 31 March 1997, a sum of $38,640,137 was listed under the Defendant's Current Liabilities as due to the Plaintiff. Again this was shown in the Notes to BIL's Financial Statements.

20. Although the auditors did issue a disclaimer for 1996, that was because the financial statements had been prepared on the basis of a going concern, and the validity of that depended mainly on the support of the bankers and the possibility of an injection of funds by potential investors. There was no disclaimer for the accounts as at year end 31 March 1997.

21. Then, in minutes of a meeting of BIL at which the directors of the Defendant and the General Manager of the Plaintiff were present, there was an acknowledgment that the Defendant owed the Plaintiff about $38m, albeit subject to more precise figures to be produced by accountants.

22. Further, in October 1996 Ernst & Young were retained by the Benelux Group to make a presentation to the banks for the purposes of a proposed restructuring. The information therein was provided by the Defendant's management. At paragraph 2.3, the Defendant's indebtedness to the Plaintiff was stated in the sum of $39m as at 31 July 1996.

Estoppel by convention

23. Moreover it is clear from the documentary evidence that the parties had all along conducted their affairs on the basis that the Defendant was substantially indebted to the Plaintiff. It is clear from the minutes of the meeting of 27 January 1997 that the Defendant acknowledged its indebtedness to the Plaintiff and asked the Plaintiff to forbear from instituting proceedings.

24. It is clear that this position extended into April 1997 when Mr Sandy Chau wrote again to the General Manager of the Defendant admitting that the debt had been due for a substantial period and expressing the Defendant's gratitude to the Plaintiff for its support.

Defendant's case

25. The Defendant's case was that the Plaintiff is not entitled to enter summary judgment because of 12 disputed items conveniently listed as Items (A) to (L). Some of these items are not affected by the finding of an account stated, but some are. At the hearing, Mr Anderson Chow Counsel for the Defendant indicated that for the purposes of the application only, he would not rely on Items (C) and (G).

Principles

26. The principles to be applied on applications for summary judgment are well-established. The burden is of course on the Defendant to show a triable issue, or that for some other reason there ought to be a trial of the issue. However the Court does not decide whether the defence is to be believed, just whether its case is believable, and the Court should not embark on a mini-trial.

Items (A) and (B) - the illegality defence - $25m.

27. Part of the indebtedness is attributable to payments due by the Defendant under the Loan Agreement (Item A) and interest thereon (Item B).

28. The existence of the oral Loan Agreement is clear from the Affirmation of Mr Sandy Chau Kar Shun filed on behalf of the Plaintiff that he had made this Agreement when he was controlling the Defendant. As I have said, there is no evidence in rebuttal of this piece of evidence. Further as early as October 1996, the Defendant's funding of the purchase of materials is also referred to in Ernst & Young's Presentation to the Banks at paragraph 2.3:-

"To enable the Group to obtain raw materials over the past several months, the Group's non-consolidated PRC listed associated company Benelux Shenzhen [the Plaintiff], has funded the purchase of raw materials which have been sold to the Group on an open account basis. As set out in Appendix 2.1(a) the Group (via BML [the Defendant]) owed Benelux Shenzhen [the Plaintiff] HK$39 million as at 31 July 1996 (compared with HK$35 million as at 31 March 1996 and HK$16 million as at 29 February as disclosed in the First Report).

Some of this balance was in respect of L/Cs opened in the PRC by Benelux Shenzhen [the Plaintiff] on behalf of the Group)".

29. The Defendant does not deny that payments had been received in this way. As for the amount claimed which is affected by this argument, the Plaintiff does not dispute that a sum of $20m together with $2,235,000 interest are attributable to the Defendant's outstanding indebtedness under the Loan Agreement (Huang, 2nd Affirmation, paragraph 42). According to Mr Chow, further accrued interest up to 31 March 1998 brought the figure up to $2.8125m. Mr Tong is prepared to accept for present purposes that about $25m out of the $36m indebtedness is attributable to the alleged indebtedness under the Loan Agreement, although he pointed out that $5m paid by the Defendant had been attributed by the Plaintiff to repayment under the Loan Agreement.

30. Mr Chow has submitted that the Loan Agreement is void for illegality as a fraud on the banks providing the Letter of Credit facilities. The Plaintiff's submission of estoppel by convention does not preclude the Defendant from raising this argument. A plea of estoppel by convention cannot avail a party, any more than can a plea of estoppel by representation, so as to make a transaction appear legal which, if the full circumstances are proved, has been declared by the law to be illegal (Spencer Bower & Turner, Estoppel by Representation 3rd ed. paragraph 168).

31. The Defendant's case is that the Agreement was illegal because the Plaintiff had obtained the Letters of Credit from their Mainland bankers on the pretense that the money was for the purchase of materials from the Defendant, when in fact the Plaintiff was not obliged to pay for the materials, and when on the evidence, some of the materials covered by the Letters of Credit clearly had not been sold by the Defendant to the Plaintiff. The Agreement was a scheme whereby the Plaintiff and the Defendant agreed to obtain money from the banks through the use of false or fraudulent documents.

32. It is quite clear from the Letters of Credit that each had a date of expiry and required, amongst other things, the presentation of specific documents (including cargo receipts) evidencing delivery of certain goods, with latest delivery dates indicated. The Special Instructions in the Letters of Credit stipulated that the documents must be presented for negotiation within 15 days after shipment effected but within the validity of the credit.

33. Using the 1st Letter of Credit as an illustration, the documents purportedly show that 4.5m sets of materials were delivered by the Defendant on 29 March 1995 and the Plaintiff acknowledged receipt. However the Plaintiff admits that a substantial part of those materials were not delivered on that date. Indeed, it accepts that some of the goods might have been delivered even before the Letter of Credit was even issued.

34. Yet it was on the strength of documents like these that the banks made payment to the Defendant, as intended by the parties. In Brown Jenkinson & Co Ltd v Percy Dalton (London) Ltd [1957] QB 621, leaking barrels of orange juice were presented for delivery from England to Holland. The shipowners gave a clean bill of lading for the goods, instead of a claused bill of lading, upon an indemnity given by the shippers, as the banks would not have accepted a claused bill of lading. The shipowners later had to make good the loss due to the damaged and sought payment from the shippers under the indemnity.

35. The Court of Appeal (the Master of the Rolls dissenting) held that the shipowners had thereby made a misrepresentation of fact with intent that it should be acted upon by the banks. Although there was no intention to defraud and no loss had been suffered, the parties had committed the tort of deceit, and the shipowners were precluded from enforcing the indemnity against the shippers.

36. It is at least arguable by the Defendant that no real distinction in principle can be drawn between that case and this one. On the face of it, the Plaintiff in acknowledging (on the cargo receipts) receipt of the goods on a particular date was accepting that the Defendant was thereby entitled to be paid, and it was obtaining finance from the banks for the payment for those goods. This was even though in fact, the Plaintiff was not at the time under a liability to pay the Defendant for the goods, and even though some of the goods had been delivered at a time when the documentary credit had not even been issued.

37. The fact that the banks suffered no loss because the Plaintiff paid the banks is neither here nor there. In a documentary credit transaction, the banks have an independent obligation to the seller if the seller presents documents complying with the terms of the documentary credit. In the event, the Plaintiff paid the banks, but the legality or otherwise of the agreement is not determined by events that occurred subsequent to its formation and execution.

38. Mr Tong SC submitted that the Plaintiff was not relying on the illegal contract (assuming it to be illegal). He submitted that the Plaintiff was suing on account stated. However, it is at least arguable that an account stated will not lie if the original debt was illegal(Halsbury's Laws Vol. 9(1) paragraph 1051). The Plaintiff's original claim would have to be under the Loan Agreement whereby the parties agreed that they would adopt that plan to obtain funds from the banks.

39. Mr Tong SC further submitted that partial deliveries were allowed under the Letters of Credit and since the goods were generic goods, the Defendant could have "attributed" any quantity of goods to the respective Letters of Credit in order to obtain drawdown.

40. However it is at least arguable that on the face of the documents, the picture that was being painted for the banks was that of an ordinary commercial transaction of sale and purchase of goods, with documentary credits being issued, goods being delivered by the Defendant in the performance of that transaction, and the Plaintiff acknowledging in the cargo receipts that those goods were delivered in accordance with the terms of the Letters of Credit, so that funds could be released to the Defendant.

41. The banks dealt with the documents, and there was nothing in the documents to make the banks aware that they were to finance the purchase of materials not by the Plaintiff but really by the Defendant (as the Plaintiff was not obliged to pay the Defendant for those materials yet), with some of those materials already delivered even before the Letter of Credit had been issued, but which would somehow be "deemed" to be delivered afterwards for the purposes of obtaining funds.

42. The Plaintiff also submitted that the banks were not misled because the banks on the Mainland would not approve payment until they had the documents sometimes referred to as the Unified Declaration Forms and sometimes referred to as the Customs Confirmation Forms, and those documents would have shown the actual dates of delivery.

43. However, it would be noted that the first 6 of the 9 Letters of Credit involved could be negotiated in Hong Kong, and the banks in Hong Kong would not have the forms in question. More importantly, these forms were not even referred to in the Letter of Credit. Therefore, under the UCP and in law, it is at lease arguable by Mr Chow that the obligation of the banks to pay the Defendant was not affected by the existence or contents of these forms. Certainly there is at this stage no documentary evidence in support of the Plaintiff's assertion that the banks were aware of the true state of affairs and nevertheless decided to make payment.

44. It would not be appropriate for the court to express any further views of the above points at this stage of an application for summary judgment. In my view the Defendant has discharged its burden to show a triable issue on this issue, and further by reason of the facts raised I find there ought to be a trial on this issue, which accounts for about $25m out of the $36m claim.

45. It should be noted that there is a further matter which is related to the issue of the Loan Agreement. An amount of $5m had been paid by the Defendant to the Plaintiff, the nature of which is in dispute. It has been regarded by the Defendant as processing fee, but by the Plaintiff as repayment of the loan although the Plaintiff has on 2 occasions acknowledged receipt (of $1m and $1.5m respectively) on receipts on which the Defendant had written that the amounts were in payment of "processing fees". Clearly a trial would be necessary for this further matter to be resolved.

Item (D) - "Error" in books

46. The Plaintiff had apparently first credited the Defendant with a certain amount, which the Defendant thought was over-generous by about $1,516,214. The Defendant therefore credited the Plaintiff by the same amount.

47. It turned out eventually that the Plaintiff was correct after all, so that the Defendant was entitled to that sum. The Defendant asked the Plaintiff to, as it were, "re-credit" the Defendant in the books.

48. The Defendant says the Plaintiff has failed to do so. The Plaintiff says (Huang 2nd Affirmation, paragraph 43) that it has already given credit to the Defendant for that amount. That is supported by a fax from the Plaintiff to the Defendant which is undated but which is at p.1138 of the Bundles. In any event, the issue appears to have been resolved in 1995, so it would have been included in the account stated between the parties. The Defendant has adduced no real evidence to the contrary.

49. Accordingly the Defendant has failed to show that there is any triable issue that it is not liable to the Plaintiff in this amount.

Items (E) and (I) - Sales allegedly not booked

50. These items can conveniently be dealt with together. The Defendant alleges that it should be credited with $7,561,277.93 (Item E) and $2,215,677.78 (Item I) that had not been booked in the Plaintiff's books. This was for the sale of certain micro-cassettes.

51. However these allegations are in relation to sales which pre-date the account stated, and so would have been included in it. It is most unlikely indeed that such substantial figures would have been left out in the reconciliation of accounts, because the correspondence from the Defendant's accounts department shows that much smaller items had been investigated.

52. The Defendant has failed to show that there is any triable issue that it is not liable to the Plaintiff in these amounts.

Item (F) - Plant and machinery allegedly sold

53. The Defendant alleges that it had sold plant and machinery parts to the Plaintiff to the value of $2,415,250.23 which the Plaintiff had failed to credit the Defendant with.

54. It would appear that the plant and machinery supplied by the Defendant to the Plaintiff was divided into two categories:- certain plant and machinery were purchased by the Defendant for and on behalf of the Plaintiff, and others were the Defendant's own machinery which the Plaintiff was allowed to use.

55. It is not however clear into which category the plant and machinery in question belongs, as there has been no clear identification one way or the other. Having said that, I note that the plant and machinery had been delivered as long ago as 1994, and it would be surprising that this had not been resolved by the time of the account stated.

56. I find the Defendant's case on this issue shadowy but not so weak that it should be precluded from defending it. Accordingly on this issue, I would order that leave be given to the Defendant to defend, conditional upon payment into Court of the sum in question. As far as conditional leave is concerned, the Defendant is a subsidiary of a listed company and it has not sought to adduce evidence that it is unable to pay any amounts into Court.

Item (H) - Returned plant and machinery

57. This involves an amount of $872,687.02 which was the net value of certain plant and machinery which were returned to the Defendant in 1992-3. This was agreed upon by the parties and was clearly documented in delivery notes signed by the Defendant's staff. The Defendant has alleged that its records do not show receipt of these plant and machinery but it has never protested about the inclusion of this item.

58. The Defendant has failed to show that there is any triable issue that it is not liable to the Plaintiff in this amount.

Item (J) - Defendant's Sales to Plaintiff post October 1997 - $2,546,598.21

59. These post-date the account stated.

60. The Plaintiff says that it was not obliged to pay the Defendant for these sales because it has never received these invoices. Further since these goods formed no part of the Plaintiff's claim under Schedule II, no set-off (as stated in the invoices) was allowed. As I understand it, the Defendant says that these were outright sales, and thus not covered by the Processing Agreement.

61. It is a dispute of fact whether these invoices had been received by the Plaintiff and whether they were covered by the Processing Agreement. In the circumstances, I am of the view that there is a triable issue here.

Item (K) - Stocks retained by Plaintiff

62. The Defendant says that the Plaintiff has retained stock (comprising raw materials, work-in-progress and finished goods) in the sum of $8,012,619.42. This is based on an inventory taken by the Defendant in February 1998 which was based on a physical stock-take in March 1997. It claims that it had made a demand for the return of these stocks or their value when in March 1998 it sent a Debit Note to the Plaintiff with the words "claims for stocks".

63. It is difficult to read this Debit Note as a demand for the return of the stock when the raw materials, work-in-progress and finished goods had not been identified at all. Nor was it a real demand for their value. The Plaintiff could not be in a position to ascertain their true value if it does not know what stocks are being referred to.

64. Accordingly on the basis of the evidence before me, I cannot accept that the Defendant has made a valid or proper demand for these stocks or their value, such as to provide a defence to the Plaintiff's claim to the extent of the value alleged.

Item (L) - Fixed assets retained

65. Finally, there is a claim for $13,240,309.16 being the alleged value of fixed assets supplied by the Defendant and retained by the Plaintiff. A schedule of these fixed assets has been provided.

66. However the machines had been consigned under the 1994 Co-operation Agreement and until that is terminated, the Defendant cannot repossess the fixed assets. The Co-operation Agreement was for a period of 12 years from 1994. That period has not expired, nor is there any evidence that it has actually been terminated. Accordingly the Defendant has failed to show that it is entitled now to the return of the fixed assets, or failing their return, to their value, which in any event, appears exaggerated given they are 5 years old.

67. Accordingly, I do not accept that the Defendant has made out a triable case that it is entitled now to the return of these fixed assets or their value, such as to provide a defence to the Plaintiff's claim to the extent of the value alleged.

Order

68. Accordingly I will give judgment to the Plaintiff on its claim save in respect of Items (A), (B) and (J) for which the Defendant shall have unconditional leave to defend, and save in respect of Item (F) for which the Defendant shall have conditional leave to defend upon payment into Court within 14 days.

69. As for costs, I would make an order nisi that 50% of the costs should be to the Plaintiff in any event and that the balance should be costs in the cause.

70. It only remains for me to thank counsel for their assistance.