COOL TECH LAUNDRY LTD v. UNIBO TRADING LTD

HCCW 733/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO. 733 OF 2005

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D E C I S I O N

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1.  On 17 September 2005 Cool Tech Laundry Limited (“the Petitioner”), presented a petition to wind up Unibo Trading Limited (“the Company”).  The basis of the petition is that the Company is unable to pay its debts, this allegation being founded on the Company’s failure to respond to a statutory demand served on it on 9 August 2005 in respect of a debt of HK$329,937 which the Petitioner alleges is owing to it and which arises out of the provision of garment washing and dyeing services performed by the Petitioner for the Company in about March 2005.

2.  The Company now applies to strike out the petition on the basis that it is scandalous, frivolous and vexatious, or otherwise an abuse of process.  The Company contends that the alleged debt is disputed by it bona fide on substantial grounds, or that it at least has genuine and serious cross-claims against the Petitioner which exceed the amount of the debt on which the petition is based. 

3.  The Company is a manufacturer and trader of garments carrying on business in Hong Kong.  One of its major customers is (or was) the well-known United Kingdom clothing retailer, Next plc, which operates a chain of high street stores in most cities in the United Kingdom and in many other cities internationally.

4.  According to the Company, towards the end of 2004 it was in receipt of orders from Next Sourcing Limited, which, as its name implies, is a company associated with and operating as a sourcing office for Next plc, for a substantial quantity (in excess of 55,000 pieces) of linen cropped trousers or shorts with waist ties for ladies.  I shall refer in this judgment to Next plc and Next Sourcing Limited collectively as “Next”.

5.  These garments required to be washed and pigment dyed.  The Company says that it entered into an oral contract with the Petitioner for the provision by the Petitioner of the necessary washing and dyeing services.  It is the Company’s case that the Petitioner knew that the garments which it was to wash and dye were intended for resale to Next and that the Petitioner agreed that its services should be carried out to the standards required by Next, such that the garments should be of the same quality as samples which had been provided by the Petitioner and approved by Next earlier.  The Petitioner appears to accept that the work it was to carry out should meet Next’s standards.

6.  In March 2005 the Company supplied some 26,380 pieces of garments to the Petitioner for washing and dyeing pursuant to this contract.  The washing and dyeing of these garments was delayed due to problems with the dyeing of the waist ties.  According to the Company, the result of this delay was that it was unable to meet Next’s delivery schedule and had to air freight the garments to Next, resulting in the incurring of additional shipment costs of some HK$73,865.55.

7.  The Company says that there was, however, a more serious problem.  On about 18 March 2005, Next appears to have informed the Company that quality tests that it had carried out in the previous week on washed and dyed garments showed that they were inferior in quality and did not meet Next’s standards.  Further tests were carried out on other garments shortly afterwards, the results for which were similar.  The upshot was that Next cancelled the bulk of its orders with the Company, cancelling orders for some 43,450 pieces of garments.  The Company says that this caused it to suffer further losses, which it quantifies at HK$2,080,961.83.

8.  According to the Company, there was then a meeting between Next, the Company and the Petitioner on 21 or 22 March 2005 at which Next produced the reports from the first set of tests, stated that the garments did not meet its standards and that it would be cancelling most of its orders with the Company.

9.  The Petitioner was later asked to return the remaining unwashed and undyed garments in its possession, which it did.  Thereafter the Petitioner issued two invoices both dated 22 April 2005 for the services which it had rendered, in the total sum of HK$330,157.  It is this amount, plus accrued interest, which forms the basis of the statutory demand.  According to the Company, attempts to resolve matters amicably came to nothing and the Petitioner issued the statutory demand on 9 August 2005, notwithstanding a letter which it had received from the Company’s solicitors indicating that the Company had claims against the Petitioner which exceeded the amounts of the invoices.

10.  Following the presentation of the petition, the Company has, on 4 January 2006, issued a writ against the Petitioner claiming the amounts of HK$73,865.55 and HK$2,080,961.83 as damages for breach of contract by the Petitioner on the basis of a breach by the Petitioner of its agreement to wash and dye the garments supplied to it in such a way as to meet Next’s standards, or alternatively on the basis of a breach of an alleged implied term to the effect that the Petitioner would exercise reasonable care and skill in its performance of the washing and dyeing process.

11.  The relevant legal principles applicable to this application were not really in issue between the parties.  Where a company is able to show, by adducing sufficiently precise and believable evidence, that the debt on which the petition against it is based is disputed bona fide on substantial grounds, the petition will be dismissed and the petitioner left to establish its claim by bringing an action in the usual way (see Re ICS Computer Distribution Limited [1996] 1 HKLR 181).

12.  Where the arguments raised by the company do not give rise to a defence, whether by way of equitable set off or otherwise, but do give rise to a cross-claim, the company will have to show that the cross-claim is genuine and serious and exceeds the amount of the debt on which the petition is based.  See Re Bayoil SA [1999] 1 WLR 146 and Re Landune International Limited [2005] 4 HKLRD 46.  In either case, the quality of the evidence that the company will be required to adduce is likely to be of a similar standard.  Where it is clear and obvious either that the debt is bona fide disputed on substantial grounds, or that there exist genuine and serious cross-claims in excess of the amount of the petition debt, it is open to a company to apply to strike out the petition, as the Company has done here.

13.  Although the power to strike out the petition is one that should be exercised sparingly and with caution, where the court is satisfied that it is clear and obvious that their petition will fail, for example because it is clear and obvious that the debt on which it is based is disputed bona fide on substantial grounds, the court can and will exercise its discretion to strike out the petition as the very fact of presentation of a petition can, and generally does, have serious consequences for the company that is the subject of it.

14.  As I have noted, the Company’s defences and/or cross-claims are based on two matters - the loss and damage suffered as a result of the cancellation of the Next orders, which is alleged to be due to the Petitioner’s breach of its contract with the Company, and also the loss arising from the incurring of additional air freight charges as a result of alleged delay on the petitioner’s part.

15.  Having regard to the amount of the alleged damages arising from the alleged delay, this claim would not of itself, even if well founded, justify striking out the petition, since the amount of the claim is such that, even after allowing for it in full, there would remain a debt which exceeds the statutory minimum required for the presentation of a petition.  I shall therefore focus on the Company’s case that it has a defence or cross-claim due to the cancellation of the Next orders.  While I do not think that it makes any real difference whether this is characterised as a defence or a cross-claim, it seems to me, having regard to the nature of the claim, that it is more accurately to be regarded as one which operates by way of defence, either by way of abatement of the price payable to the Petitioner, or by way of equitable set-off, the claim being clearly closely and intimately connected with the transaction out of which the debt relied upon by the Petitioner is said to arise.  The more substantial question, however, is whether or not the Company has discharged its burden of adducing believable and sufficiently precise factual evidence to establish the existence of the necessary dispute or cross-claim.

16.  In my view the Company has clearly done so.  It was not disputed by the Petitioner that in performing the services which it contracted to perform, it should meet the standards required by Next.  It is clear from the test report supplied by Next that the garments which were washed and dyed by the Petitioner fell far short of its standards.

17.  Mr Hung, appearing for the Petitioner, submitted that the evidence adduced by the Company was not sufficiently precise to justify the court in concluding that there was a bona fide dispute of substance in respect of the debt on which the petition is based.  He drew my attention in his skeleton argument and submissions to the following matters:-

(1)     Only a total of ten garments were tested.  It was, he suggested, surprising that, based on such a small number of tested pieces, Next should be entitled to reject some 46,000 out of 55,000 of pieces of garments which had been ordered.

(2)     It appeared that Next had in fact accepted some 8,000-odd pieces of the garments of the same styles as some of those which had been rejected.  This inconsistency was said to cast considerable doubt on Next’s right to reject the garments which it had rejected.

(3)     There had apparently been a request by Next to waive the cancellation of one order without liability – this was likewise inconsistent with a right to reject.

(4)     Given the existence of a tolerance of plus or minus five per cent in quantity under the contract between Next and the Company, and that between the Company and the Petitioner, it was not open to Next, and thus not open to the Company, to reject the entire order when only 10 samples had been tested and found to be defective.

(5)     The views of Next and the Company as to Next’s right to reject were not binding on the Petitioner.

(6)     There was a question a to whether the garments which had been tested came from the main production run which had been dealt with by the Petitioner or were earlier samples which had been provided for other tests.

(7)     There was no substantiation of the amount of the damages which the Company claimed to have suffered.

(8)     The Company had offered to pay the Petitioner part of the washing and dyeing costs in respect of the garments which had been accepted by Next, a course of action which cast serious doubt, according to the Petitioner, on the bona fides of the dispute which the Company now says exists.

18.  There was also one further point which Mr Hung developed in his submissions before me which I shall refer to later in this judgment.

19.  In my view, there is clearly a dispute of substance in relation to the Company’s liability to pay the debt relied upon by the Petitioner in its petition.  There is plainly evidence which suggests that the garments which were tested by Next were defective, in that they failed to meet the standards required by Next.  The reports having been prepared by or on behalf of Next and not the Company they clearly form, in my view, both precise and believable evidence which supports the Company’s case.  There is also equally plain evidence that Next cancelled the bulk of its orders with the Company in consequence of the failure of those garments to pass the tests to which they were subjected.  It is clear from the contemporaneous correspondence that some 80 per cent of the orders placed by Next with the Company were cancelled by Next and that the reason for the cancellation was ascribed by Next to problems that had arisen in the dyeing and washing process, which was performed by the Petitioner.  This, too, provides what I would regard as believable and precise evidence that supports the Company’s case that it has demonstrated the existence of a bona fide dispute of substance in relation to the debt asserted by the Petitioner.  There is also evidence to show that unwashed and undyed garments did not fail the same test, the Company having requested Next to test some such garments after the presentation of the statutory demand, presumably with a view to raising this point in the context of the winding up proceedings. 

20.  All of these matters constitute, in my view, sufficiently precise and believable evidence which suggests that there is at least a bona fide dispute of substance as to the Company’s liability to pay the Petitioner for its services.  It does not matter whether or not that dispute will, at the end of the day, be determined in favour of the Company.  Even if the court were to find after trial that the complaints of poor quality on Next’s part were not made out, or that Next was not entitled to reject the goods which it did, or that the Company was not entitled to reject the goods as against the Petitioner, at this stage, I do not think it can realistically be suggested that the defence raised by the Company is other than one which is bona fide and of substance.  That being so, it suffices that the dispute exists and is of sufficient substance to require that it be dealt with by ordinary action rather than by permitting the Petitioner to attempt to have it determined summarily in its favour in the context of winding up proceedings.

21.  As for the specific points made by Mr Hung to which I have referred, these do not, in my view, require me to come to any different conclusion.

22.  As to the suggestion that it was surprising that Next should be entitled to reject substantial portions of the order, on the basis of only 10 failed test pieces, it seems to me that the more pertinent point is that out of 10 pieces tested, all failed – a failure rate of 100 per cent.  This could scarcely have been comforting for Next.  It is hardly surprising that it should have been so concerned as to seek to cancel the bulk of the orders which it had placed with the Company.  Whatever the ultimate outcome of this dispute may be, there is clearly substance in the Company’s contention that Next was entitled to cancel the orders which it did.

23.  As for the point that it was surprising that Next should have accepted some of the goods but not others of the same style, I would accept that this is a point which does, to some extent, favour the Petitioner.  However, it is but one factor in the overall equation, and I do not think that it can regarded as being conclusive in the Petitioner’s favour.  Moreover, Mr Chow S.C., appearing for the Company, pointed out that the goods that were accepted had in fact already been shipped and suggested that it might have been the case that Next decided, for whatever reason, simply to keep them rather than incur the additional cost of shipping them back to Hong Kong.  The Company, Mr Chow pointed out, was not in a position to know why Next had kept some of the goods but rejected the rest when they would appear, on the face of it, to have been entitled to reject them as well.  There is, in my view, force in these observations.  But ultimately, it seems to me, the effect of this decision on Next’s part is a matter for consideration at a trial of the dispute between the Petitioner and the Company.

24.  I consider that the point about the apparent request by Next to waive the cancellation of a particular part of the order without liability stands in a similar position to this point. 

25.  As to the suggestion that the quantity of samples tested fell within a contractual provision allowing for delivery of five per cent more or less garments, I understood this argument to be to the following effect – given the allowance in terms of quantity, Next (and one supposes, the Company) should have permitted the Petitioner to continue with its services and to hope that, at the end of the day, sufficient garments of adequate quality would be available for supply to Next.  I cannot accept this argument.  The purpose of testing samples is clearly to provide a basis for assessing the quality of the batch of goods from which the samples are taken.  There is nothing to suggest that the samples which were tested were other than representative of the goods as a whole.  In these circumstances it must, in my view, be at least arguable that the whole batch of goods was of similar quality, or lack of quality, to the samples which had been tested.  That being so, it follows that an inference which can properly be drawn from the test results is that the whole batch of garments fell short of the quality required by Next, in which case the contractual provision allowing for some variation in the quantity to be delivered could not come into play so to as to assist the Petitioner.  Again, even if, at the end of the day, the Petitioner were to succeed in defending the action brought against it by the Company, at this stage the only appropriate conclusion, in my view, is that the defence which the Company has put forward to the debt on which the petition is based is both bona fide and of substance.

26.  It is true that the views of Next and the Company as to Next’s right to reject are not binding on the Petitioner.  However, that does not detract from the fact that there is, in my view, a dispute of substance in relation to the petition debt.  Whether or not Next and the Company are right as to this is a matter which will have to be determined in proceedings other than the present winding up proceedings.

27.  I do not think that the point about the source of the tested garments or whether or not the garments tested were in fact from the first bulk dying process is a good one.  The company’s evidence is clearly to the effect that the garments which were tested and failed to pass Next’s quality standards were not from the earlier samples which were provided for the purpose of assessing the colour of the goods, and did come from the first part of the main production run, or main washing and dyeing process.  So much is apparent from paragraph 12 of the second affirmation of Chan Sau-ling, filed on behalf of the Company.  Moreover, the Petitioner’s own case, in fact, appeared (at one stage at least) to have been that the tested samples did come from the bulk washing and dyeing process, and that the earlier samples related to colour approval only.

28.  As to the quantum of damages, the Company has in fact provided a reasonably detailed breakdown of its damages and of the basis on which they are calculated.  While it has not at this stage provided all of the evidence which it may eventually need to rely on to prove such losses, it seems to me that it has done enough to demonstrate the existence of a claim which comfortably exceeds the Petitioner’s claim against it.  While the precise amount of the damages claimed asserted by the Company against the petitioner may be a matter for final determination at a later stage, I am satisfied from the material before me that, if the Company’s claim against the Petitioner is successful, the size of that claim will almost certainly be such as would provide a complete defence to the Petitioner’s alleged debt.

29.  Finally, the offer referred to by Mr Hung does not, to my mind, constitute an admission of liability on the part of the Company.  It is clear from the Company’s evidence that the offer was made in the context of an attempt to settle the matter amicably.  It was never taken up and has now lapsed.  That being so, I do not think it would be right to regard the making of an offer of this nature as something which casts such doubt on the genuineness of the Company’s claims as to justify the court in concluding that they are other than bona fide and of substance, particularly in light of the evidence which has been adduced in support of them to which I have already referred.

30.  A further point raised by Mr Hung at the hearing was that it was part of the agreement between the Petitioner and the Company that no contract would come into existence until after approval of the first batch of washing and dyeing.  Mr Hung suggested that this arose as a matter of trade custom.  Trade custom is indeed asserted in evidence filed on behalf of the Petitioner in response to this application.  Mr Hung suggested that, after the failed samples had been reported on, there must have been an acceptance of some other samples because it was common ground between the parties that a binding contract did exist.  And this could only, on his case, be the position if there had been an approval of some washed and dyed garments.

31.  This reasoning is fallacious.  There is no evidence at all to indicate that any other garments other than those in respect of which the test results had been produced, at least in relation to goods washed and dyed by the Petitioner, were ever tested and approved.  If anything, the argument is inimical to Mr Hung’s position.  In relation to the only tested pieces of which there is evidence, the evidence indicates that the tests were failed.  There being no evidence of other tests, it would seem to follow, if the trade custom exists, that there could have been no contract and therefore no entitlement to payment on the part of the Petitioner.  The position is, of course, entirely consistent with the Company’s case, which is that there was a concluded contract and that no trade custom such as that alleged exists.

32.  Finally, the Petitioner has also indicated in evidence that it was unaware of the cancellation of the Next orders, or the reasons for the cancellation.  Whatever may be the position as to this, I do not consider that this is relevant to the question of whether or not the company has demonstrated the existence of a bona fide dispute of substance in relation to the debt on which the petition is based.

33.  In these circumstances it seems to me, on the basis of the dispute as to defective workmanship alone, that the petition is bound to fail and must be dismissed. 

34.  That being so, it is, in my view, appropriate to strike it out as an abuse of process at this stage, rather than to permit it to continue in existence as it is clear that the presentation of a petition to wind up a company on the basis of a debt which is disputed bona fide on substantial grounds constitutes an abuse of process.  Moreover, it is clear from the correspondence which preceded the statutory demand and petition that the Petitioner was made aware of the Company’s position in respect of the debt relied on by it.

35.  In the light of my conclusions as to this aspect of the Company’s claims against the Petitioner, it is not necessary to deal with the claim for additional air freight charges, as this claim would not, as I have pointed out, have in any case been large enough to provide on its own a basis for striking out the petition.

36.  I would also add that it would appear from the Company’s evidence as to its financial position that it is far from being insolvent.  Indeed, it has paid the disputed amount into court in compliance with a condition that was imposed by the court when granting a validation order in its favour earlier in these proceedings.

37.  I therefore accede to the Company’s application and shall strike out the petition against it.  The petition is accordingly dismissed and I shall now hear the parties as to costs.