PACIFIC DUNLOP GARMENTS LTD v. FUNDAMENTAL GLOBAL LTD AND OTHERS

HCA1655/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1655 OF 2008

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BETWEEN

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J U D G M E N T

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1.  This action concerns the sale and purchase of all the shares (“Shares”) of a Hong Kong company by the name of Eunice Lingerie Ltd (“EHK”). The plaintiff (“P”) was the purchaser in the transaction and the 1^st to 3^rd defendants (“Ds”) were the vendors. Ds are BVI companies and they used to own all the shares in EHK. In November 2009, their shares were transferred to the 4^th defendant (“D4”). D4 was joined in these proceedings so as to be bound by the results of this action.

2.  This trial concerns liability only.

Background

3.  The background facts are undisputed.  As its name suggested, EHK was in the business of manufacturing and sale of lingerie. It has a wholly owned Mainland company called Eunice Lingerie (Zhongshan) Ltd (“EZS”), which is a wholly foreign-owned enterprise established under the laws of the Mainland.  In turn, EZS owns a large piece of land (“Property”) at the Jin Li Industrial Zone, Sanjiao Town, Zhongshan City, Guangdong, China.  There is a factory built on the Property where the manufacturing of lingerie was carried out by EHK. 

4.  P is in the business of production and distribution of garments.  It operates a number of factories in the Mainland.

5.  At about the end of 2005, EHK and EZS were operating at a loss and Ds wanted to stop the operation of the business.  The Shares became available for sale.  In due course, an interest was shown by P, who was looking for a property in Zhongshan for the purpose of its business expansion, and the parties began to negotiate on the sale.  The negotiations were mainly carried out between Ms Anita Chan (“A Chan”) and Ms Linda Chan on behalf of Ds and Mr Robert Ng (“Ng”) on behalf of P.  A Chan is the sister of a director of the 1^st defendant, whilst Ng is a director of P and qualified as a professional accountant.  He has been a fellow member of the Australian Society of Certified Accountants since 1981 and is familiar with the acquisition of company shares. 

6.  Initially, Ng wanted to rent the Property.  He then considered buying it.  However, a purchase of the Property would attract tax liability and Ds would require P to pay all the tax in the event of a sale of the Property.  At the time, Ds did not know precisely what was the amount of such tax but they knew that it was in the region of a few million (RMB).  Eventually, the parties agreed on the sale and purchase of the Shares in order to avoid the tax. 

7.  On 18 January 2006, a “Binding Heads of Agreement – Sale and Purchase of all the Shares In [EHK]” (“Agreement”) was signed by the parties.  It was drafted by Ng and according to which the Shares were sold at HK$31.5 million.  Pursuant to clause 2 of the Agreement, the purchase price was to be paid in the following manner:

(1) Non-refundable deposit of HK$540,000 on 18 January 2006;

(2) 12 further non-refundable monthly instalments of HK$180,000 each to be paid on the 1^st day of each month from 1 March 2006 onwards;

(3) The final instalment of HK$28.8 million to be paid in Hong Kong on 1 June 2007 or such later time as agreed by the parties.

8.  Clause 2 also provided that EZS shall grant a licence to P to occupy the Property from 1 March 2006 to 28 February 2007.

9.  Clause 4 (“Clause 4”) is of central importance in this action and it provided as follows:

“4) The Purchaser has the option to acquire all of the shares of Eunice Lingerie Ltd which owns all of the shares of Eunice Lingerie (Zhongshan) Ltd at the final installment of HK$28,800,000 on 1^st June 2007, or such later time if delays are caused by the Vendor in effecting the transfer of the said shares or the said Physical Property. Vendor will provide the necessary and reasonable warranties in such transaction including

· The Vendor has good title to the shares.

· Power and capacity of the Vendor to enter into and complete the Agreement

· No option etc. has been granted in respect of the share capital of Eunice Lingerie Limited and Eunice Lingerie (Zhongshan) Ltd

· Litigation (if any)

· Intellectual property rights and industrial knowhow (if any)

· Eunice Lingerie (Zhongshan) Ltd owns the Physical Property

· Eunice Lingerie Ltd and Eunice Lingerie (Zhongshan) Ltd are debt free and there are no outstanding charges or liens against these two companies at the transfer date. In case on the transfer date, it is discovered that Eunice Lingerie Ltd and/or Eunice Lingerie (Zhongshan) Ltd are not debt free, the Vendor will indemnify the Purchaser of the actual amount of the debt outstanding.

Should issues arise in transacting the shares which cause unacceptable risks to either the Purchaser or the Vendor, then both parties agree to transact to sale and purchase of the sale Property instead of the shares. The purchase price will be the same as the sale of shares.

Each Party will bear its own share of any duties, taxes and charges as imposed by the relevant Authorities in Hong Kong and China.”

10.  Finally, clause 12 of the Agreement provided that the parties would use their best endeavour to sign an “official contract” by mid February or as agreed by both parties and that Ds’ lawyer would “make arrangement” for the said document.

11.  Pursuant to the terms of the Agreement, the deposit and the 12 monthly instalments were duly paid by P.  At the request of Ds, P paid 2 further sums to them, totalling HK$2,025,000, so as to top-up the total amount paid prior to completion to an amount equivalent to 15% of the purchase price. 

12.  On 15 February 2006, a draft formal sale and purchase agreement prepared by Ds’ solicitors was sent to P.  However, no such agreement was eventually executed because the parties were unable to agree on the terms of the formal agreement. 

13.  As evident from the terms of the Agreement, P was very keen to obtain possession of the Property to fulfil its business plan.  At the end of February 2006, EHK moved its operation out of the Property and duly handed over the Property to a nominee of P (“Nominee”). 

14.  P did not pay the balance of the purchase price by 1 June 2007. 

15.  Meanwhile, despite numerous chasers from Ds, P did not respond to the draft formal agreement until 15 months later on 23 May 2007 when a revised draft was sent by it to Ds.  In the revised document, Mr Chan Kin Ning (“KN Chan”) (a director of the 1^st defendant) and Mr Yeung Pang Chiu (“Yeung”) (a director of EHK) were each required to provide a personal guarantee up to 100% of the purchase price to back-up the warranties contained in the formal agreement.  Further, a sum of HK$2 million out of the balance of purchase price was to be retained by P for 12 months after completion on account of the warranties. 

16.  The issue of personal guarantee was one of the main stumbling blocks between the parties.

17.  It appears from the documents that P did not carry out any kind of due diligence process until after the revised draft formal agreement was sent to Ds in May 2007.  However, the examination of the books and accounts of EHK and EZS gave rise, P contends, to unacceptable risks to it as purchaser of the Shares.  Accordingly, it demanded (the first demand was made on 4 July 2007) that the transaction be turned into one of acquisition of the Property pursuant to Clause 4. 

18.  Ds did not agree that P had a right to acquire the Property instead of the Shares.  Moreover, although they very much wanted to complete the transaction, they were advised by their Mainland accountant that a sale of the Property would result in tax liability of around RMB6.5 million on their part.  Ds tried to reach a compromise with P by proposing that such tax be borne equally between them.  However, the proposal was declined.

19.  In light of the impasse, on 10 October 2007 Ds’ solicitors issued a letter to P (“Letter”) alleging that it was in breach of the Agreement by failing to pay the consideration in full on 1 June 2007, giving P “one last opportunity” to complete the transaction and demanding the payment of the balance of purchase price with interest on or before 8 November 2007. It was also stated that the Property should be vacated by P and returned to Ds in the event of failure to complete the transaction. 

20.  There was no completion on 8 November 2007.  On 4 December 2007, EZS wrote to the Nominee demanding the vacation and return of the Property.  In May 2008, litigation was started in the Mainland by EZS to recover the Property from the Nominee. 

21.  The Mainland litigation has turned out to be a lengthy and frustrating affair for EHK and EZS.  In short, despite being the victor EZS is still unable to recover possession of the Property from the Nominee. Currently, the Nominee is paying a sum of RMB 108,000 per month pursuant to an order of the Mainland court for the occupation of the Property.  It is noteworthy that under clause 3 of the Agreement P was given an option to terminate the Agreement (which was never exercised) and in which event it should enter into a lease agreement with EZS for the period between 1 June 2007 to 28 February 2009 at the monthly rent of RMB 180,000. 

22.  This action was commenced on 4 September 2008. 

Issues

23.  It is agreed by the parties that there are 3 issues to be determined in this trial, which is confined to liability only pursuant to an order dated 17 May 2012:

(1) Whether P was entitled to exercise the option under Clause 4 to purchase the Property instead of the Shares;

(2) Whether P was in repudiatory breach of the Agreement by failing to pay the balance of the purchase price;

(3) Whether Ds are in a position to procure the sale of the Property to P since it is owned by EZS and such a transaction will be governed by Mainland laws.

24.  It can be seen that the first two issues are the two sides of the same coin.  Mr Cheung, who appeared for Ds, agreed that the resolution of these issues turns upon the central issue in this case (“Central Issue”), namely, whether there were unacceptable risks to P in the acquisition of the Shares the existence of which would allow it to opt for the Property under Clause 4. 

25.  For completeness, in respect of the 2^nd issue, Mr Cheung has clarified that Ds relied upon the Letter by which time became of the essence and it was made clear that failure to complete the transaction would result in termination of the Agreement (acceptance of repudiation).  Mr Chang, who appeared for P, took no issue with this point. 

26.  The 3^rd issue goes to the relief of specific performance in the event that P’s case is upheld.  The parties have agreed that this issue should be dealt with in this trial because the court would have received the relevant evidence. 

27.  The resolution of the Central Issue turns upon (a) the proper construction of the “option” under Clause 4 and (b) the “unacceptable risks” relied upon by P.  Those risks have been identified by Mr Chang as follows:

“(1) The draft auditor’s report of Eunice HK (for the period ending 30 June 2007) was heavily qualified by the auditors given the paucity of the information and documents made available to them.

(2) Incomplete accounting records of Eunice Zhongshan were provided by the Defendants to the Plaintiff.

(3) Eunice HK made shareholder’s loans to Eunice Zhongshan which were not registered with the Mainland authorities, in breach of foreign debt and foreign exchange rules in the PRC.

(4) Discrepancies in the book value of PP&E and buildings in the draft audited report of Eunice HK and audited report of Eunice Zhongshan suggested possible understatement of property value which may lead to extra income tax liability in the PRC.

(5) Eunice Zhongshan sold plants and equipments without reporting to the PRC tax authorities, resulting in potential tax liability.

(6) The Defendants’ failure and/or refusal to provide adequate warranties to the Plaintiff, limiting their cap on liability at HK$1 million and also refusing to provide personal guarantees – bearing in mind that the 1st to 3rd Defendants are BVI ‘shell’ companies.”

28.  There is no major factual dispute in this case. However, I shall deal with a few more controversial factual matters below. 

29.  Expert evidence from Mainland lawyers have been adduced by the parties to assist the court in resolving some the disputes concerning the unacceptable risks and the relief of specific performance.

Factual issues

30.  Amongst the witnesses who have given evidence in this case, only Ng’s credibility has been put in issue.  I regret to say that he has been shown to have lied in an affirmation (“Affirmation”) which was used in an unsuccessful attempt to join KN Chan in these proceedings.  That application was based on the allegation that KN Chan had agreed to provide a guarantee for the transaction.  The revised draft formal agreement produced by P (see para 15 above) was used to support that claim.  It was wrongly asserted in the Affirmation that the revised draft came from “[Ds] and/or A Chan”. 

31.  Expectedly, the allegation was hotly disputed by KN Chan and evidence was filed by him pointing out that the same was “plainly untrue”.  Surprisingly, in Ng’s affirmation in reply to that of KN Chan there was nothing said to correct the inaccuracies in the Affirmation. 

32.  In cross-examination, Ng said that that he was only made aware of the “error” in the Affirmation when it was pointed out to him by Mr Cheung.  That is plainly untrue given the fact that he had read KN Chan’s affirmation and replied to it. 

33.  Further, according to his own evidence, Ng had at some stage in the course of negotiations (he was unable to recall precisely when) verbally raised with either A Chan or Linda Chan or both of them the issue of personal guarantee and the request was refused.  In such circumstances, it was quite wrong for Ng to have made an assertion that KN Chan had agreed to provide a personal guarantee.  There was simply no basis for it. Ng was given an opportunity to explain the matter but he was unable to do so. 

34.  A point which is not unrelated to Ng’s credibility is the way in which P dealt with the matter of formal agreement.  The evidence shows that P did not begin to fulfil its contractual obligation under clause 12 of the Agreement by making its best endeavour to reach a formal agreement with Ds.  This is clear from the lack of response for 15 months despite repeated chasers from Ds (see para 15 above).  Further, I do not accept Ng’s suggestion that P was entitled to sit on its hands and just wait for Ds to produce all the necessary material for P to examine for the purpose of the transaction.  That was not how commercial transactions were conducted.  Ng was too sophisticated and shrewd to taking that stance without reason. 

35.  The reason is apparent.  P had obtained possession of the Property (via the Nominee).  It was enjoying the full use of it whilst having paid no more than 15% of the purchase price.  There is a strong inference that, certainly after the Agreement was signed, P did not really want to have the Shares.  It was, however, determined to hold onto the Property. Such determination is reflected by P’s defiance towards the judgments of the Mainland court. 

36.  There was a table produced in October 2007 by the finance manager of P (one of its witnesses), who is also a qualified accountant, which showed that the tax payable on a sale of the Property would be about HK$4.58 million.  Ds would be responsible for the lion share of the tax – HK$3.76 million.  Given Ng’s training as an accountant and his shrewdness as a businessman, the inference is that he knew at an early stage that in the event of an acquisition of the Property the tax payable by P would not be very high.  

37.  The way in which P had conducted itself under the directions of Ng is not something to be proud of.  However, in a court of law, once an agreement is made a contracting party is entitled to take full advantage of its entitlements thereunder. 

38.  Three witnesses gave evidence for Ds – KN Chan, A Chan and Yeung.  Quite apart from the lack of challenge over their credibility, I was impressed by KN Chan and A Chan as witnesses.  They gave their evidence to the best of their recollection and without unfairness.  I believe their evidence.  In respect of Yeung, I have reservations over some of his evidence.  It was apparent to me that he was reluctant to be entirely candid with the business operation of EZS because of the potential infringement of Mainland rules and regulations.  There are two points which I should mention in particular about the evidence of Ds.

39.  Firstly, I have no doubt that Ds were keen to have the transaction concluded.  The Property was handed over and they had not been fully paid.  I believe that they tried very hard to satisfy P’s requests for the production of documents and to answers various queries raised by it over the financial affairs of EHK and EZS.  There were many meetings between the two sides to try to resolve the problems.  Ds’ representatives took along for the meetings Ds’ Mainland professional accountant.  There was also participation by EHK’s Hong Kong professional accountant.  However, the provision of documents was partly hampered by the hasty move from the Property and the termination of the employment of the factory staff, which resulted in disorganisation and inability to track down some of the documents. 

40.  However, I do not believe that Ds had provided all the requested materials which were in their possession.  It was admitted in Yeung’s evidence that some of the purchases made by EZS were not backed by “VAT invoices” as required under Mainland law.  Given the “problems” with EZS’s business operation, it is more probable than not that Ds were reluctant to allow P free access to the books of EZS.  Such conclusion is corroborated by the document at bundle B, p 167.

41.  Secondly, it has not been established that there was anything sinister in the transfer of the Shares to D4.  It was carried out after Ds had accepted the repudiation of the Agreement by P and I can see that there could be genuine commercial reason for the transaction.  In any case, there is no dispute that D4 is under the control of Ds.

Unacceptable risks

42.  The first question is whether “unacceptable risks” are to be looked at subjectively, ie, from the point of view of P or objectively against some kind of reasonable standard. 

43.  Mr Cheung has impressed upon this court that the question of proper construction of contractual provisions is to be approached with the following principles in mind, which are not disputed by Mr Chang.

Law

44.  The task of ascertaining the intention of the contracting parties must be approached objectively.  The question is not what one or other of the parties meant or understood by the words used, but the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.  The parties are taken to have intended what they have in fact said, so that their words must be construed as they stand: Chitty on Contracts, 31^st ed, Vol 1, 12-042 to 12-044 and 12-050 to 12-051.

45.  The objectivity in interpretation of contracts is further explained in The Interpretation of Contracts, Lewison, 5th ed, at 2.02:

“The modern starting point is Lord Hoffmann’s statement that:

‘Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.’

As he explained in Kirin Amgen Inc v Hoechst Marion Roussel Ltd:

‘Construction, whether of a patent or any other document, is of course not directly concerned with what the author meant to say.  There is no window into the mind of the patentee or the author of any other document.  Construction is objective in the sense that it is concerned with what a reasonable person to whom the utterance was addressed would have understood the author to be using the words to mean.  Notice, however, that it is not, as is sometimes said, ‘the meanings of the words the author used’, but rather what the notional addressee would have understood the author to mean by using those words.  The meaning of words is a matter of convention, governed by rules, which can be found in dictionaries and grammars.  What the author would have been understood to mean by using those words is not simply a matter of rules.  It is highly sensitive to the context of and background to the particular utterance.  It depends not only upon the words the author has chosen but also upon the identity of the audience he is taken to have been addressing and the knowledge and assumption which one attributes to that audience.”

Analysis

46.  One starts with the formulation “unacceptable risks to … [P]”.  Those words suggest that P would be the one who assessed the risks that it was confronted with.  It accords with commonsense. 

47.  However, I accept Mr Cheung’s submission that P did not have a free choice between buying the Shares and the Property. The Agreement was for the sale and purchase of the Shares, and P’s entitlement to buy the Property instead of the Shares would only arise when the conditions under Clause 4 were met. 

48.  I bear in mind that Ds were not prepared to sell the Property without an agreement by P to bear all the tax liability.  On the other hand, they could have insisted upon having a provision whereby P would bear all the tax in the event that the transaction turned into a sale of the Property. 

49.  Helpfully, I have been referred by the parties to some first instance New Zealand authorities dealing with similarly worded contractual provisions.

50.  Mr Chang has referred me to two of those authorities – Katz v Jones [1967] NZLR 861 and North Shore Demolitions Ltd v McKay [1978] 1 NZLR 454.  These authorities had been summarised in the third authority relied upon by Mr Cheung.

51.  Mr Cheung has referred me to the case of Lerner v Schiehallion Nominees Ltd [2003] 2 NZLR 671.  That case involved a sale of an apartment and the contract contained a condition subsequent – obtaining a building report satisfactory to the purchaser within 7 days of the signing of contract.  However, the contract also provided that “the party or parties for whose benefit the condition has been inserted must do all things which may reasonably be necessary to enable the condition to the fulfilled …”. A building report was obtained in due course which raised a number of issues of concern.  The purchaser cancelled the contract on the basis of non-satisfaction of the condition subsequent.  The judgment of Potter J contained an analysis of two lines of authorities on the proper construction of provisions involving the satisfaction of condition:

“Subjective or objective test for satisfaction of condition

[31] The question arises whether the words in cl 14:

‘… satisfactory to the purchaser …’

import a subjective or objective test.

[32] McMorland, Sale of Land, observes at p 143, para 5.02 that there has been very little judicial interpretation of such wording, but what there has been shows that the Courts are more inclined to an objective test as far as possible. He comments:

‘The concern is to prevent a party being able to use such a subjective wording as an unfettered route of escape from the contract, perhaps for completely unrelated reasons. If that could happen, the effect would be that one party was bound by the contract while the other effectively was not.’

[33] As a general proposition that approach must be right…

[34] A range of judicial views have been expressed. In Knotts v Gray, Martin v Macarthur, Johnstone v Bhikha (High Court, Auckland, CP 1978/91, 22 December 1992, Henry J), Stock v Wallis [1996] DCR 452 and Firestone Tire and Rubber Co of New Zealand Ltd v Harvard Construction Ltd (1997) 3 NZ ConvC 192,665 the Courts have applied an objective test to conditions such as ‘on terms and conditions satisfactory to the purchaser’, ‘on terms and conditions acceptable to the purchaser’, ‘on terms and conditions entirely satisfactory to the lessor’.

[35] The Courts have approached the matter on the basis that it is for the Court to determine, deciding objectively, whether or not the rejection of a particular term or condition by the party in whose favour the condition applies, was reasonable.

[36] A different approach was taken in Katz v Jones [1967] NZLR 861 where an agreement for sale and purchase was subject to the purchaser ‘arranging mortgage monies … suitable to me’. Tompkins J said at p 864 that in his opinion the words ‘suitable to me’ meant that the purchaser was to be sole judge of what finance he requires or of what finance is satisfactory for his purposes.

[37] In North Shore Demolitions Ltd v McKay [1978] 1 NZLR 454 where the Court considered a clause in an agreement for sale and purchase making the agreement conditional upon a local authority consent:

‘… on terms and conditions acceptable to the vendor’

Moller J considered three possible interpretations: a subjective one (that the purchaser had an unfettered right to declare unacceptable any condition that he personally did not like for any reason at all); an objective one (that the purchaser was limited to declaring unacceptable only those conditions which a reasonable man would find to be so); and a middle road (that the purchaser had to act bona fide, but within those limits he had a subjective freedom of choice). Moller J opted for the third alternative determining that it was the purchaser’s decision as to whether or not a condition was acceptable, judged according to his personal views but subject to an implied term that he had to act bona fide in reaching that decision. He rejected the objective approach on the basis that it did not give effect to the words in the condition ‘to the vendor’.

[38] For the reasons I have summarised at the commencement of this section of the judgment I believe the line of authorities from Knotts v Gray to Firestone Tire and Rubber Co of New Zealand Ltd v Harvard Construction Ltd, to adopt (sic) the correct approach. A party will be bound by the contract to which he has committed unless on the basis of a fair and reasonable decision in terms of a condition subsequent inserted in the contract for the benefit of the party seeking to rely upon it, he is entitled to be relieved of his obligations under the contract. In this case, I do not derive from the terms and conditions of the sale and purchase agreement nor from any of the surrounding circumstances, that it was the intention of the parties that the fulfilment of the condition in cl 14 should depend entirely upon the purchaser’s subjective opinion. The objective approach pays due respect to the expressed intentions of vendor and purchaser in entering into the agreement for sale and purchase.”

52.  Mr Cheung has told me that, according to his research, there is no higher authority from New Zealand on this issue. Very fairly, Mr Cheung did not contend that it is not permissible to have a contractual provision allowing a party to decide subjectively whether a condition has been satisfied.  He argued forcefully that the construction in question calls for an objective test. 

53.  Relying upon North Shore Demolitions Ltd, Mr Chang argued that the question of unacceptable risk should be decided subjectively by P.  However, he accepted that P must, by reason of an implied term in the Agreement, act bona fide in making that decision.  It has not escaped this court that no such implied term has been pleaded.  On the other hand, it is a matter of law and Mr Chang has not taken any pleading point. 

54.  I accept Mr Cheung’s analysis that what was said by the court in Katz v Jones on the subjective test was an obiter dicta.  However, I am unable to see any flaw in the same.

55.  Let me say at the outset that, like Potter J, I find the proposition that one of the parties may unilaterally put an end to the contract or change the nature of the transaction an unattractive one.  On the other hand, there is a distinction between deciding whether a building report is satisfactory and whether risks in buying certain shares are acceptable.  In my view, the former decision can be securitized with some objectivity, whereas the latter cannot. 

56.  Different people or companies must have different attitude to risks taking.  For a company, any risks taking decision must depend on a host of factors, eg, financial ability, the return, the business plan and the ethos of the management.  I simply cannot see how acceptability of risks can be assessed with a notional reasonable company.  What are the attributes of this reasonable company?  Is the court to assume that the management is conservative or adventurous or somewhere in the middle, and what does it mean when the management is neither conservative nor adventurous? 

57.  The impossibility of an objective assessment militates strongly against Ds’ case. 

58.  Further, one should not overlook that fact that there is mutuality in the option under Clause 4.  Ds also had the right to change the nature of the transaction in the event that selling the Shares gave rise to unacceptable risks to them. 

59.  At the time of the Agreement, the parties clearly recognised that there could be risks in the acquisition of the Shares. They had not had the opportunity to properly reflect upon or provide for those risks and hence the option was provided for.  In light of the clear wordings and the analysis set out above, this court is driven to the conclusion that the construction contended by P is the correct one. 

60.  With this conclusion, the second question – whether P, acting bona fide, had found that there were unacceptable risks in acquiring the Shares – is not difficult to answer. 

61.  One of the complaints of unacceptable risks concerns the heavily qualified draft audited report of EHK.  In any shares sale transaction, it would be a matter of course for the audited reports of the company in question to be provided to the purchaser.  This case was no exception.  On 29 August 2009, the first draft of the audited report of EHK covering the period from 14 August 2002 (date of incorporation of EHK) to 30 June 2007 was provided to P.  The document contained the following disclaimer:

“The evidence provided to us was limited because the Group suspended its business in February 2006 and certain information including the underlying books and records of the Company’s subsidiary could not be made available. Accordingly we have been unable to obtain sufficient documentary evidence to satisfy ourselves as to the completeness, accuracy, classification and disclosures of the financial statements for the period ended June 30, 2007. There were no other satisfactory audit procedures that we could adopt to confirm the completeness, accuracy, classification and disclosures of the Group’s financial statements.”

62.  That draft report was, with justification, not accepted by P.  A revised draft report was provided to P on 17 November 2007. The revised report was still qualified, due to information relating to EZS not having been made available to the auditors:

“Basis for qualified of opinion

Limitation of audit scope

a) The evidence provided to us was limited because certain information relating to the subsidiary, including its underlying books and records, could not be made available. In particular, we were unable to obtain reasonable assurance as to the accuracy of the following subsidiary’s accounts:

	HK$
Sub-contracting income	7,345,127
Cost of sales	5,942,396
China Enterprise Income Tax	404,578

Accordingly we have been unable to obtain sufficient documentary evidence to satisfy ourselves as to the completeness, accuracy, classification and disclosures of the financial information relating to its subsidiary for the period ended June 30, 2007. There were no other satisfactory audit procedures that we could adopt to confirm the completeness, accuracy, classification and disclosures of the subsidiary financial information.

…

In our opinion, except for the effects of such adjustments, if any, as described in the basis for qualified opinion section, the financial statements give a true and fair view of the state of the Company’s affairs as at June 30, 2007 and of its loss and cash flows for the period then ended in accordance with Hong Kong Financial Reporting Standards.”

63.  In all fairness, it is hardly surprising that P remained dissatisfied with the revised draft audited report of EHK.  Coupled with the fact that P had not been provided with all the books and records of EZS, one cannot escape from the conclusion that it had acted bona fide in taking the view that there were unacceptable risks in acquiring the Shares.  I have not overlooked the finding that after the Agreement was signed P did not really want to have the Shares (see para 35 above).  I do not believe that the change of heart precluded P from taking a bona fide view on the risks, and as noted above P was entitled to take advantage of its entitlements under the Agreement. 

64.  Finally, I do not believe that the warranties embodied in the Agreement could change the picture on the risks.  Without an unqualified audited report, there was no basic assurance that the assets of the companies, or a significant part of them, had not disappeared or that there was no false accounting employed by the management of EZS. 

65.  Accordingly, the Central Issue is resolved in favour of P. 

66.  For completeness, I should say that the 2^nd issue (see para 23 above) should also be resolved in P’s favour.  Although P had failed to pay the balance of the purchase price on 1 June 2007 in accordance with the Agreement, the Agreement was kept alive and on 4 July 2007 (para 17 above) it exercised the option under Clause 4 as it was entitled to.  In the premises, P was not in repudiatory breach of the Agreement. 

67.  I proceed to deal with the final issue.

Specific Performance

68.  It has not been necessary to resolve the first two issues by resorting to the expert evidence.  However, such evidence is of some relevance on the issue of specific performance. 

69.  Mr Chang has produced a very helpful summary of the disputes in the expert evidence in the form of a table, which has been agreed by Mr Cheung.  The part relevant to specific performance is as follows:

"E. Transfer of land use rights in the PRC The relevant PRC laws and procedures governing the transfer of the suit Land, and whether Eunice Zhongshan will be able to effect such transfer in the event that the Hong Kong court makes an order to such effect.
	Plaintiff’s expert	Defendants’ expert
Procedure	Eunice Zhongshan is free to transfer the Land upon: (1) full payment of premium for grant of the land use right and has been issued the land use right certificate; (2) the land user has made the requisite investment in developing the land as per the land grant.	There is very huge uncertainty whether the authorities will approve Eunice Zhongshan’s transfer of the Land before the expiration of its licence.
Tax payable	The transferor and transferee shall pay applicable taxes in connection with the transfer.	The taxes payable in relation to the transfer would amount to HK$9,743,884."

70.   The dispute between the experts as elaborated in their viva voce evidence is confined.  On one hand, Mr Gui Gang (Ds’ expert) relied upon clause 35 of the Implementation Rules of the Wholly Foreign Owned Enterprise law of PRC to support his opinion that government permission is required for the transfer of the Property by EZS to P, and that there is huge uncertainty whether such permission will be obtained.  Mr Gui was unable to be specific regarding the uncertainty.  He said that it was likely that the Property was obtained by EZS at a very favourable price by reason of the investment it was going to make.  EZS’s business licence has not expired and the transfer in question would require approval by the authority. Different authority in different district may deal with a transfer application differently, and the ability of the applicant to establish “good communication” with the authority may make a difference. 

71.   Clause 35 provides as follows:

「土地证书为外资企业使用土地的法律凭证。外资企业在经营期限内未经批准，其土地使用权不得转让。」

72.   On the other hand, P’s expert, Mr Yan Tianhuai, relied upon clauses 39 and 40 of the Urban Real Estate Administration Law of PRC and maintained that government permission is not required in this case.  However, no authority has been cited by Mr Yan to demonstrate why, despite the clear wordings of clause 35, those provisions are not applicable in this case.

73.   I prefer the evidence of Mr Gui over that of Mr Yan.

74.   However, I have been referred by Mr Chang to some of the applicable principles of law on the grant of specific performance, which are undisputed. 

75.   Firstly, the courts will not require that to be done which cannot be done, but that is not to say that the mere anticipation of possible difficulties leads to a refusal of relief for specific performance. The court may still order specific performance in the ordinary manner, leaving the defendant to return to the court later for modification or variation by reason of subsequent difficulties that may arise in the future: Spry’s Equitable Remedies, 8^th ed, at p 128.

76.   Secondly, specific performance will not be refused on the ground that the consent of a third party is necessary, unless it further appears that it cannot be obtained: Dillion v Nash [1950] VLR 293 at p 298 per Sholl J.

77.   I am guided by these principles.  I bear in mind the unsatisfactory nature of Mr Gui’s evidence concerning the uncertainty in question.  Further, as Mr Chang has rightly pointed out, the parties had agreed to have the Property transferred in the event that the option under Clause 4 was triggered.  In the premises, I see no good reason not to order specific performance in this case.   

Conclusions

78.   By reason of the matters aforesaid, judgment should be given in favour of P against all the defendants.  However, in light of the potential difficulty in obtaining approval for the sale of the Property, I accept Mr Chang’s suggestion that the parties should endeavour to agree the terms of the judgment for the approval of the court.  Any unreasonableness will be penalised on costs.  I should make it clear that in respect of the relief of declaration, only necessary declaration should be included in the draft judgment.  Any disagreement on the terms of the judgment will be resolved by the court on paper, and for which purpose the parties are at liberty to submit a skeleton argument not exceeding two pages to deal with the disagreement.

79.   The counterclaim is dismissed.  The costs of this action and the counterclaim be to P to be taxed if not agreed.

80.   Last but not least, I am grateful for the assistance of both counsel in these matters.