PRIME DEAL (HK) ENTERPRISES LTD. v. THE HONGKONG AND SHANGHAI BANKING CORPORATION LTD. AND ANOTHER

HCA2142/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.2142 OF 2002

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REASONS FOR DECISION

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The applications before the court

1. On 1 June 2002, on the ex parte application of the plaintiff, I granted an interlocutory injunction restraining the 1st defendant from paying out and the 2nd defendant from obtaining payment under two standby letters of credit dated 24 May 2001 (SDCKTG 107617) and 18 May 2002 (SDCKTG 113925) in the respective sums of EUR 250,000 and EUR 100,000 ("the Letters of Credit"). The Letters of Credit were issued by the 1st defendant in favour of the 2nd defendant as the beneficiary thereunder.

2. On that day, I also made an order granting leave to the plaintiff to serve the 2nd defendant out of the jurisdiction, the 2nd defendant being based in Italy.

3. On 5 June 2002, pursuant to my Order, the plaintiff issued a summons returnable on 7 June 2002 for the continuation of the injunction. On that day, Sakhrani J adjourned the summons and continued the ex parte Order made on 1 June 2002. This was further extended by Deputy Judge Carlson on 21 June 2002.

4. Meanwhile, by a summons dated 18 June 2002, the 2nd defendant applied (1) to discharge the 1 June 2002 Order, (2) for a declaration that the court had no jurisdiction over the 2nd defendant in respect of the subject matter of the action and (3) for such other relief deemed appropriate by the court. The stated grounds in support of this summons were that the appropriate jurisdiction for the dispute were the courts at Rimini, Italy (in view of an exclusive jurisdiction clause agreed between the plaintiff and the 2nd defendant) and that the plaintiff had been guilty of material non-disclosure.

5. On 2 July 2002, after hearing submissions from Mr John Kerr (for the 2nd defendant) and Mr Nigel Aiken, SC (for the plaintiff), the 1st defendant being absent, I made the following Order, namely that :

(1) The summons dated 5 June 2002 be dismissed.

(2) The Order dated 1 June 2002 be discharged.

(3) The action herein between the plaintiff and the 2nd defendant be stayed until further order and the plaintiff's claim against the 2nd defendant be adjudicated by the courts of Rimini, Italy in accordance with the exclusive jurisdiction clause.

6. The stay is, strictly speaking, unnecessary in view of the setting aside of the 1 June 2002 order (which included leave to serve out of the jurisdiction), but I have made this order so as to make clear that in view of the exclusive jurisdiction clause, the plaintiff must pursue its claims against the 2nd defendant as pleaded in the Statement of Claim in the courts of Rimini.

7. I now give the reasons from my decision.

The facts before the court at the ex parte hearing on 1 June 2002

8. In view particularly of the allegation of material non-disclosure made by the 2nd defendant in the present applications, it is necessary to set out the facts that were before the court on 1 June 2002 at the ex parte hearing before me. These were contained in the affirmation of Ching Lung Kei ("Mr Ching"), a director of the plaintiff.

9. The facts were essentially these :

(1) By a Licence Agreement dated 21 May 2001, as amended on 10 July 2001 ("the Licence Agreement"), the 2nd defendant gave a licence to the plaintiff to develop a network in Shanghai for the sale of its products sold under the trademark "Terranova". The 2nd defendant, an Italian company, has since 1960 engaged in the business of the production and wholesale and the retail distribution of fashion products including men and women's clothing, fashion accessories, underwear, watches, and perfume, both in Italy and elsewhere in the world. It uses the trademark "Terranova" for its products.

(2) The plaintiff was appointed the distributor of the 2nd defendant's products in Shanghai. As stated in clauses 1.2 and 1.3 of the Licence Agreement, the plaintiff (named in the agreement as an "Independent Operator") was given the right to operate in Shanghai, marketing and selling the 2nd defendant's goods under the label "Terranova" in designated shops. It was envisaged under the Licence Agreement that the plaintiff would purchase the 2nd defendant's products and pay for them by means of a standby letter of credit (clause 2.4).

(3) Under clause 3.3 of the Licence Agreement, the plaintiff was required to open an irrevocable standby letter of credit in the sum of EUR 250,000 for the purposes of guaranteeing "its obligations established by this present contract and of all that is in any way due to [the 2nd defendant] by way of compensation for damages and penalties and of its own commitments relative to payment deferrals". The requisite standby letter of credit was therefore not just for the purpose of ensuring payment for the purchase of the 2nd defendant's goods.

(4) The reference to "penalties" in clause 3.3 is made clear by clause 3.2, which, in its amended form, states as follows :

"In some circumstances the INDEPENDENT OPERATOR has to pay the following penalties, without prejudice to any possible reimbursement of major damages in favour of the COMPANY [the 2nd defendant] :

a) for every single shop, Euro 100,00= (one-hundred) daily if it does not transmit the Sale Data, as defined by clause 2.3;

b) for every single shop, Euro 1.000,00= (one-thousand) daily if it does not observe its obligations to dismiss and remove signs, trade marks and other indicia of TERRANOVA net work as defined by clause 2.2;

c) Euro 100.000,00= (one-hundred-thousand), for every single shop, if it does not observe its obligations of communication on Promotional sales and Seasonal sales, as defined by clause 2.5;

d) Euro 200.000,00= (two-hundred-and-thousand) if it does not observe its obligations of non competition as defined by clause 3.4."

(5) Pursuant to its obligations under clause 3.3, the plaintiff caused to be issued to the 2nd defendant, the Letters of Credit. Although the Licence Agreement only provided for one letter of credit in the sum of EUR 250,000 to be issued, the parties subsequently agreed that the plaintiff would cause to be issued a further letter of credit in the sum of EUR 100,000.

(6) According to the plaintiff, following the issue of the first of the Letters of Credit, business proceeded quite smoothly. Payments would be made for the 2nd defendant's products at the expiration of the stipulated credit period. Occasionally, the plaintiff was late in payment but never by more than seven days, with no complaints made by the 2nd defendant as to such late payments.

(7) On 22 April 2002, the 2nd defendant asked the plaintiff to renew the first Letter of Credit as it was due to expire on 1 August 2002. On 18 May 2002, the plaintiff instructed the 1st defendant to issue a further Letter of Credit in the sum of EUR 100,000.

(8) On 28 May 2002, some ten days after the issue of the second Letter of Credit, the plaintiff's manager received a telephone call from the 1st defendant informing the plaintiff that the 2nd defendant had applied for payment under the Letters of Credit in the total sum of EUR 350,000. The plaintiff was shocked at learning this because it could think of no reason why the 2nd defendant should be entitled to withdraw the whole of the amounts under the Letters of Credit. According to Mr Ching, the 2nd defendant was owed only some EUR 19,744.77.

(9) Despite attempts to contact the 2nd defendant both by telephone and e-mail, there was no response.

(10) In these circumstances, the plaintiff claimed that by presenting documents for payment under the Letters of Credit when nothing was owed save for the said sum of EUR 19,744.77, and when the plaintiff could think of no reason why the 2nd defendant could legitimately obtain payment under the Letters of Credit, a fraud was being perpetrated by the 2nd defendant. Accordingly, the plaintiff contended that the fraud exception to the general rule that the autonomy of a letter of credit required payment to be made even where there was a dispute in the contract underlying it (established by the House of Lords in United City Merchants (Investments) Limited v. Royal Bank of Canada [1983] AC 168, at 183 - 184 per Lord Diplock), applied.

10. Such was the factual position that was before me at the ex parte hearing on 1 June 2002. Although Ms Alexandra Norton (for the plaintiff) indicated to me that there was an exclusive jurisdiction clause in the Licence Agreement whereby all "controversies" between the parties should be adjudicated upon by the court at Rimini, I was of the view, given the strength of the evidence before me, that an interlocutory injunction should be granted and leave to serve out of the jurisdiction given.

The facts before the court at the inter parties hearing on 2 July 2002

11. In support of its summons dated 18 June 2002, the 2nd defendant filed two affidavits both from Mr Seamus Donegan, a partner of the 2nd defendant's solicitors. He deposed to facts on instructions from his clients in Italy. One of these affidavits responded to a 2nd affirmation from Mr Ching.

12. The evidence before the court on 2 July 2002 revealed the following facts and matters :

(1) Far from the impression given by Mr Ching in his earlier affirmation that the plaintiff had done nothing to justify the 2nd defendant drawing under the Letters of Credit, it was deposed to by Mr Donegan that the plaintiff was in fact in substantial breach of the Licence Agreement.

(2) It is unnecessary for me to detail all the various breaches alleged. Details of these are contained in Mr Donegan's affidavits and most involve the use (or misuse) of the "Terranova" mark or the failure to develop it. These breaches appear to be supported by contemporaneous documents.

(3) What is of particular significance in the context of the present summonses is the fact that the alleged breaches cover all four of the contingencies set out in clause 3.2 of the Licence Agreement, quite apart from constituting breaches of other parts of that Agreement. I merely highlight two of these breaches.

(4) First, regarding clause 3.2(c) of the Licence Agreement, the 2nd defendant alleges that the plaintiff failed to inform it of promotional or seasonal sales pursuant to clause 2.5. The plaintiff's case is that there were no such promotional or seasonal sales although discounts were given since opening the stores in Shanghai. The 2nd defendant is of the view that such discounts come within clause 2.5. In my view, this is reasonably arguable.

(5) Secondly, as far as clause 3.2(d) of the Licence Agreement is concerned, the 2nd defendant alleges that the plaintiff has been in breach of, inter alia, clause 3.4 thereof by being directly in competition with the 2nd defendant. The complaint centers around the use and promotion by the plaintiff of its own mark, called "Gelati", in selling clothes. The range of clothes under the "Gelati" mark was arguably in direct competition with the range of clothes under the "Terranova" mark that the plaintiff was obliged under the Licence Agreement to promote. Although Mr Ching deposes to the fact that the two ranges of apparel were quite different, elsewhere in his affirmation he does make the point that "the products sold by "Terranova" and "Gelati" were the same and from the same company, namely the 2nd defendant". The breach is, according to the 2nd defendant, compounded by the fact that the plaintiff has, in its promotional literature for "Gelati", linked that mark to the "Terranova" mark in such a way as to take advantage of the goodwill and reputation of the "Terranova" mark. The impression given is that the two marks are connected. Even the same fashion photographs (sent by the 2nd defendant to the plaintiff to promote the "Terranova" mark) were used in the "Gelati" material.

(6) I have highlighted these two breaches because under clause 3.2 of the Licence Agreement, they alone entitled the 2nd defendant to claim penalties amounting to over EUR 350,000.

(7) I have not ignored the plaintiff's response to the allegations of breach and it suffices merely to say that they are denied. The plaintiff also relies on correspondence to show that even if breaches did occur, they had somehow been waived : see, for example, the e-mail dated 19 April 2002. What is of particular interest, however, on the plaintiff's later affirmation evidence, is that the original agreement relied on at the ex parte stage became, at the inter partes stage, not quite as simple as Mr Ching's 1st affirmation had portrayed. In his 2nd affirmation, important variations to the Licence Agreement were alleged (some made orally).

13. This being the state of the evidence at the hearing on 2 July 2002, ought the 1 June 2002 Order be discharged or continued? It is first necessary to deal with the applicable law regarding interlocutory injunctions where letters of credit are involved.

Law

14. Where, as in the present case, a party (the plaintiff) seeks an interlocutory injunction to restrain payment under a letter of credit as against both the issuing bank or paying bank (the 1st defendant) and the beneficiary (the 2nd defendant), the following principles apply :

(1) Often in such cases, two separate issues have to be considered by the court : first, whether an interlocutory injunction should be granted so as to prevent payment being made under the letter of credit; secondly, in the event that no injunction is granted restraining payment, whether the beneficiary should in any event be restrained from dealing with the proceeds of the letter of credit. Though the issues are obviously interrelated, they have to be considered separately and different principles apply.

(2) As regards the application for an interlocutory injunction to restrain payment under a letter of credit, the well-known starting point is that of the integrity and importance in commercial life of letters of credit. The matter was put thus by Lord Donaldson of Lymington in Bolivinter Oil S.A. v. Chase Manhattan Bank (C.A.) [1984] 1 WLR 392, at 393C-E :

".... The unique value of such a letter, bond or guarantee is that the beneficiary can be completely satisfied that whatever disputes may thereafter arise between him and the bank's customer in relation to the performance or indeed existence of the underlying contract, the bank is personally undertaking to pay him provided that the specified conditions are met. In requesting his bank to issue such a letter, bond or guarantee, the customer is seeking to take advantage of this unique characteristic. If, save in the most exceptional cases, he is to be allowed to derogate from the bank's personal and irrevocable undertaking, given be it again noted at his request, by obtaining an injunction restraining the bank from honouring that undertaking, he will undermine what is the bank's greatest asset, however large and rich it may be, namely its reputation for financial and contractual probity. Furthermore, if this happens at all frequently, the value of all irrevocable letters of credit and performance bonds and guarantees will be undermined."

(3) These words echo the sentiments expressed by Lord Diplock in the United City Merchants case at 183D-G.

(4) The existence of fraud provides an exception to the requirement of payment under a letter of credit. I have already referred to this above. But how is this exception dealt with in the context of an application for an interlocutory injunction restraining payment under a valid letter of credit? I mention "valid" because of course if there is cogent evidence to indicate a serious question to be tried as to whether the letter of credit was validly issued in the first place, this would by itself be sufficient to satisfy that limb of the American Cyamanid test.

(5) Where a valid letter of credit is concerned, in order to satisfy the court that an interlocutory injunction should be granted to restrain payment, the applicant must show by clear and cogent evidence both the fact of the fraud and the banks' knowledge of it. Clear and cogent evidence means that a mere assertion will certainly not be enough : there must be strong or compelling corroborative evidence and the usual form of this would be contemporaneous documents. Where feasible, the court will expect the alleged fraudulent party (the beneficiary under the letter of credit in the question) to have been given an opportunity to answer allegations relating to the fraud before an application for an interlocutory injunction is made. Sometimes this is not feasible but often it will be. The failure to give any or any proper explanation in answer to the queries raised when an answer can be expected will support the applicant's case. The above statements are derived from many cases. Included among them are the well known ones of Bolivinter at 393E-G and United Trading Corporation S.A. v. Allied Arab Bank Limited [1985] 2 Lloyd's Rep. 554, at 561(1). These cases have been followed in Hong Kong for many years : see for example the Court of Appeal judgment in Guangdong Transport Limited v. Ancora Transport N.V. and Another [1987] HKLR 923.

(6) Ultimately, the test is that put by Ackner LJ in United Trading Corporation at 561(1), "If the Court considers that on the material before it the only realistic inference to draw is that of fraud, then the seller would have made out a sufficient case of fraud." For the requisite "only realistic inference" to be drawn, compelling and clear evidence is required.

(7) This evidential burden or standard straddles, in my view, both the serious question to be tried and balance of convenience requirements of American Cyamanid. As to serious question to be tried, the evidential burden is a manifestation of the well-known principle that the more serious the allegation the more compelling the evidence must be : see Hornal v. Neuberger Products [1957] 1 QB 247, at 258 per Denning LJ; Re. H. (Minors) [1996] AC 563, at 586 per Lord Nicholls of Birkenhead. As to balance of convenience, it is a practical manifestation of the uniqueness of the fraud exception stated in the United City Merchants case where it is explained just why fraud is an exception to the general rule.

(8) The balance of convenience of course does not end with just proving the fraud. Here, the court will also have to examine other factors to see whether the balance of convenience is or is not in favour of stopping payment. In United Trading Corporation, the English Court of Appeal considered this question by examining not just the position of the applicant and the beneficiary but also, perhaps most important of all in this context, the position of the bank. Reference was made by Ackner LJ to the dicta of Kerr J in R.D. Harbottle (Mercantile) Limited v. The National Westminster Bank Limited [1978] QB 146, at 155. Owing to the strict mandate under which banks operate as far as their customers are concerned and also to the reputation and integrity so essential to the operation of banks, the consequences to the bank of stopping payment must be considered by the court.

(9) There is another aspect of the balance of convenience to which I ought to allude. In Guangdong Transport Limited, the Court of Appeal considered the question whether, even if the applicant were correct in its contentions on fraud, damages would provide an adequate remedy : see the judgment at 931F. This question must of course be considered for both the bank and the beneficiary. If damages were to be an adequate remedy, this would be a significant factor in refusing an interlocutory injunction.

(10) Where, for whatever reason, the court does not grant an interlocutory injunction restraining payment, the next question that arises is whether an order should be made restricting or restraining the beneficiary from dealing with the proceeds of the letter of credit. This is the 2nd issue I have earlier identified. This situation is expressly referred to in the authorities : see Bolivinter at 393E-F; the Bhoja Trader [1981] 2 Lloyd's Rep. 256; Gee : Mareva Injunctions and Anton Piller Relief (4th Edition) at 37.

(11) Here, the application for an injunction is akin to that of (if not actually) a Mareva injunction. In other words, an injunction would only be granted preventing the beneficiary from dealing with the proceeds of a letter of credit if there is a risk that he will dissipate the proceeds and thereby thwart any judgment that the plaintiff may obtain against him. It is important to bear in mind that such an injunction is not dependent on fraud being shown (or even alleged). Like all Mareva injunctions, all that is needed to be demonstrated is a good arguable case, usually a breach of contract (or any other cause of action), the risk of dissipation and the balance of convenience.

15. How are the above principles to be applied in the present case?

Should an interlocutory injunction be granted in the present case?

16. The only parties before me were the plaintiff and the 2nd defendant. The 1st defendant, the issuing bank under the Letters of Credit, did not appear in the proceedings, presumably content to abide by whatever result reached by the court.

17. Applying those principles earlier set out, I have come firmly to the conclusion that the interlocutory injunction granted by me on 1 June 2002 cannot be continued on the evidence now available before the court :

(1) The factual position before the court on 1 June 2002 that there was no discernable reason why the 2nd defendant could justifiably draw on the Letters of Credit, is now shown to be quite different. The evidence now before the court, to which I have referred above, shows a number of genuine disputes between the parties.

(2) These disputes, supported by contemporaneous documentation, not only give rise to a claim for damages by the 2nd defendant against the plaintiff (although as yet unquantified save for the sum of EUR 39,677.88 said to be the amount due from the plaintiff in relation to goods sold and delivered), but more importantly, they give rise to the application of clause 3.2 of the Licence Agreement. This was the reason for the 2nd defendant seeking payment under the Letters of Credit. As to this latter point, although the 2nd defendant's affidavit evidence does not actually say this, it is a fair inference to be drawn from the evidence and Mr Kerr confirmed this as being his client's instructions which could, if necessary, be stated in another affidavit. Mr Aiken referred me to a letter dated 6 June 2002 from the 2nd defendant to the plaintiff, on the basis of which he submitted that it was only at that date that the 2nd defendant first thought of the question of penalties and clause 3.2 of the Licence Agreement. It followed, he submitted, that clause 3.2 could not have been the reason why the 2nd defendant sought to draw on the Letters of Credit. In my view, that letter does not support the contentions he makes, at least not compellingly so. Mr Aiken also relied on the fact that there was a noticeable silence on the 2nd defendant's part when confronted by an e-mail from the plaintiff. While this is a point in the plaintiff's favour, it is not sufficiently compelling in the light of the evidence of its breaches as alleged by the 2nd defendant.

(3) On the facts I have already outlined above, the plaintiff cannot demonstrate that quality of evidence needed to obtain an interlocutory injunction to restrain payment under the Letters of Credit. To borrow from the words of Ackner LJ in United Trading Corporation, I do not consider on the material before me that the only realistic inference to draw is fraud. I need say no more about the merits of this case.

(4) Even if I had been satisfied that the requisite threshold of evidence as far as fraud is concerned had been reached, I still would not have granted the interlocutory injunction on a balance of convenience. There is no suggestion from the plaintiff that damages would not be an adequate remedy. The 1st defendant is a well-known bank. The 2nd defendant is a substantial company in Italy.

18. Mr Aiken, in the course of his fair and realistic submissions, argued that even if I were not minded to grant an interlocutory injunction restraining payment under the Letters of Credit, I should nevertheless consider granting an interlocutory injunction restraining the 2nd defendant from dealing with the proceeds (in other words, a Mareva injunction). There were no grounds here for such a type of relief to be granted and I do not do so.

Material non-disclosure

19. The principles here are well-known.

20. In the context of an ex parte interlocutory injunction to restrain payment under a letter of credit where the threshold to be reached by the applicant is high, based as it is on the necessity to have clear and cogent evidence of fraud, the duty of disclosure becomes correspondingly more acute. Applicants have to be all the more vigilant to ensure that all material facts going towards showing possible defences to a fraud claim (in practice demonstrating the existence of factors that may justify a drawdown under the relevant letter of credit) are placed before the court at the ex parte stage.

21. In the present case, I regret to say that there has been material non-disclosure on the part of the plaintiff. I have already referred to the fact that the various breaches of the Licence Agreement referred to by the 2nd defendant were supported by contemporaneous documents, many of them emanating from or to the plaintiff. I give merely one example. The plaintiff's promotional literature linking the "Gelati" mark with the "Terranova" mark is one of the main pieces of evidence relied upon by the 2nd defendant to establish its case on the breach of clause 3.4 of the Licence Agreement dealing with non-competition. All these documents should have been placed before the court at the ex parte stage. The somewhat simplistic (and therefore attractive) way in which the plaintiff put its case at the ex parte stage, was far from the picture presented at the inter partes stage, even on the plaintiff's own evidence.

22. In the circumstances, I would have discharged the ex parte interlocutory injunction on the basis of material non-disclosure alone. As for the question whether despite the material non-disclosure, I would have granted a fresh injunction, this is academic in view of my earlier findings. However, I would just say that even if the plaintiff had shown grounds for a re-grant on the merits, the material non-disclosure may well have been decisive in the refusal of a further grant. In my view, where it is sought to restrain payment under a letter of credit, the high threshold needed to be reached in turn emphasizes the vigilance needed to ensure that all material facts are placed before the court. The public policy in ensuring the integrity in commercial life of letters of credit compels this.

Setting aside leave to serve out of the jurisdiction

23. As I have said, on 1 June 2002, I also granted leave to serve out of the jurisdiction, principally under RHC Order 11, rule (1)(b) and (e).

24. As I have observed, the Licence Agreement contains an exclusive jurisdiction clause (clause 5) whereby all disputes between the parties under the Licence Agreement were to be litigated in the courts of Rimini. The law is quite clear where exclusive jurisdiction clauses are concerned. Unless strong cause is shown, the court will exercise its discretion to stay proceedings brought in a jurisdiction other than the chosen one : see The Eleftheria [1970] P 94; The El Amria [1980] 1 Lloyd's Rep. 390.

25. In the context of applications for leave to serve out of the jurisdiction, the existence of an exclusive jurisdiction clause dictating that the relevant dispute should be litigated abroad, will be decisive against the granting of such leave unless, as I have said, strong cause is shown to the contrary : see Mackender v. Feldia [1967] QB 590; Hong Kong Civil Procedure 2002 at paragraph 11/1/12. Of course, nothing in Order 11 actually mentions exclusive jurisdiction clauses but their existence as a crucial factor derives from the court's residual discretion in Order 11 cases and the important words of Order 11, rule 4(2) that no leave shall be granted unless it shall be made sufficiently to appear to the court that the case is a proper one for service out of the jurisdiction. In other words, leave to serve out of the jurisdiction will only be allowed if it is clearly within both the letter and spirit of Order 11 : see George Monro Limited v. The American Cyamanid and Chemical Corporation [1944] KB 432 at 437 per Scott LJ.

26. In the present case, Mr Aiken did not suggest that the disputes between the parties should not be litigated in the courts of Rimini. In these circumstances, the exclusive jurisdiction clause should be enforced, with the consequence that the leave to serve out of the jurisdiction granted on 1 June 2002 should be discharged.