FUJI XEROX (HONG KONG) LTD v. VIGERS HONG KONG LTD

HCA 3735/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 3735 OF 2003

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J U D G M E N T

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1.  The Plaintiff claims monies due under two Rental Agreements and one Document Solution Agreement from the Defendant, and the Plaintiff also claims interests on those amounts.

2.  The Defendant counterclaims against the Plaintiff saying that clause 14C of the 1^st and 2^nd Rental Agreements, which are similar, are penalty clauses and further or alternatively, that these said clauses were unfair and unconscionable and not enforceable against the Defendant under section 5 of the Unconscionable Contracts Ordinance, Cap. 458.

3.  The Defendant also counterclaims that clause 12C of the 1^st and 2^nd Document Solution Agreements (hereinafter referred to as “DSA”) was also unconscionable and therefore not enforceable under Cap. 458.  At the conclusion of the trial, however, counsel for the defence conceded that Cap. 458 is not applicable in this situation, and only pursued their claim that clause 14C of the two Rental Agreements are penalty clauses.

Background

4.  The Plaintiff is a company carrying on the business of, inter alia, the renting of office equipment, e.g. photocopier, facsimile machine, etc.  The Defendant company is a company carrying on the business of property, management, valuation and consultancy services.

5.  The Defendant had rented equipment from the Plaintiff and this dispute arose out of three such contracts:

(a)	the 1st Rental Agreement –
	This agreement is dated August 2, 2001 by which the Defendant rented a facsimile machine from the Plaintiff for a minimum rental period of 36 months commencing on September 1, 2001 for $500 a month.  The minimum rental period would have expired on September 1, 2004.  The Defendant had stopped paying rental as from January 1, 2003.
(b)	The 2nd Rental Agreement –
	This agreement is dated September 6, 2001 for the rental of another facsimile machine for a minimum rental period of 3 years commencing on October 1, 2001 at a monthly rental of $500.  The Defendant had stopped paying rental from January 1, 2003.
(c)	The 2nd DSA –
	This 2nd DSA superseded the 1st DSA signed in January 2002 for the lease of 16 pieces of equipment for a minimum contract period of 5 years with a quarterly rental of $231,600.  The Defendanthad only paid rental up to June 20, 2002.  After negotiations in April 2003, both parties agreed that the 2nd DSA would supersede the 1st DSA and would take retrospective effect from July 1, 2002.  This 2nd DSA was for a minimum contract period of 24 quarters (6 years) from July 1, 2002.  A sliding rental scale was adopted from $159,000 for the first four quarters to $244,642 for the last four quarters.  The Defendant had failed to make any payments under the 2nd DSA.

6.  The Plaintiff therefore claims monies due and owing to them under the above 2 rental agreements and the 2^nd DSA.

Defence

7.  The Defence asserts that they had informed the Plaintiff in about May 2003 of their intention to terminate the agreements and that between May 2003 until about July 2003, both parties had negotiated for the early termination of the above agreements and to assign the agreements to another company called Fairock which the Defendant claimed was a subsidiary within the same group as the Defendant, but the Plaintiff was not satisfied that Fairock was indeed a subsidiary, so had refused to terminate the agreements or to assign the said agreements.

8.  The Defendant says therefore that the Plaintiff had failed to mitigate their losses by collecting the equipment in June 2003 and re-renting them or by selling them or by assigning the said agreements to Fairock.

9.  The Defendant had also originally claimed that clause 14C in the 1^st and 2^nd Rental Agreements and clause 12C in the DSA were unconscionable under the Unconscionable Contracts Ordinance, Cap. 458, but they had abandoned this counterclaim at the close of their case.

10.  The defence had also pleaded that clause 12C of the 2^nd DSA and clause 14C of the 1^st and 2^nd Rental Agreements were unenforceable as they were penalty clauses and not liquidated damages clauses, but at the trial, the defence did not argue against the Plaintiff’s position that clause 14C of the 1^st and 2^nd Rental Agreements are irrelevant to these proceedings, and thus had appeared to have abandoned this argument.

Acceptance of termination

11.  I agree with the submission of Mr Lam, counsel for the Plaintiff, that after a careful analysis of the English cases leading up to the Hong Kong case of Shum Kit Ching v Caeser Beauty Centre Limited (2003) HKC 235, it is clear that the general rule is that an innocent party is not obliged to accept a repudiation in order to minimize his loss, but equity would intervene in extreme cases where:

(1)	damages would be an adequate remedy to the innocent party;
	and
(2)	to elect to keep the contract alive would be unreasonable or wholly unreasonable, for example where the innocent party had no legitimate interest to insist on the performance of the contract rather than claim in damages.  (see Ocean Marine Navigation Limited v Koch Carbon Inc. (the “Dynamic”) [2003] 2 Lloyds Report 693).

12.  It is not in dispute that the machines supplied to the Defendant were new machines and according to PW1, Mr Yuen, the Customer Administration Manager of the Plaintiff company, there is no second-hand market in Hong Kong for these machines.  And the company can only use the parts from these machines as spare parts, and thus, if the Plaintiff company was to take back these machines from the Defendant, these machines would not be generating any income for the Plaintiff.

13.  The defence argued that the Plaintiff had to accept the termination as the performance of the contract relied on the cooperation of the Defendant, that is, the Plaintiff could not service the relevant machines and without servicing and replacement of, e.g. the ink, the machine would cease to be able to perform, thus the defence argued that the second exception propounded by Lord Reid in White and Carter v Mcgregor (1962) AC 413 applies.

14.  In White and Carter v Mcgregor, supra, the appellants in that case had agreed with the respondent, a garage proprietor, that they would display advertisements for him for three years.

15.  On the same day, the respondent informed the appellants, by letter, that he required the contract cancelled as his representative had misrepresented him, but the appellants refused and duly began the advertisements five months after the date of the contract.  The appellants sued the respondent for the sums due.  It was held by the House of Lords that the appellants were entitled to carry out the contract and claimed the full contractual price, and they were not obliged to accept the repudiation and sue for damages.

16.  In the course of his judgment, Lord Reid said at page 431:

“It may well be that if it can be shown that a person has no legitimate interest, financial or otherwise, in performing the contract rather than claim in damages, he might not be allowed to settle the other party with an additional burden with no benefit to himself.  If a party has no interest to enforce a stipulation, he can not in general enforce that: so it might be said that, if a party has no interest to insist on a particular remedy, he might not be allowed to insist on it.”

17.  Lord Reid at page 429 also said:

“Of course, if it had been necessary for the defendant to do or accept anything before the contract could be completed by the pursuers, the pursuers could not and the court would not have compelled the defender to act, the contract would not have been completed and the pursuers’ only remedy would have been damages.”

18.  Most importantly, Lord Reid at page 427, recognised that the general rule is:

“If one party to a contract repudiated in the sense of making it clear to the other party that he refuses or will refuse to carry out his part of the contract, the other party, the innocent party has an option, he may accept that repudiation and sue for damages for breach of contract, whether or not the kind for performance has come; or he may if he chooses disregard or refuse to accept it and then the contract remains in full effect.”

19.  The above quoted exceptions to the general rule propounded by Lord Reid had caused much confusion with some of the lower courts adopting the proposition of Lord Reid and other courts, for example, the Court of Appeal in Decro-Wall International S.A. v Practitioners in Marketing Limited (1971) 1 WLR 361 expressly rejecting the second exception proposed by Lord Reid.

20.  An attempt was made, most recently, in the case of Ocean Marine Navigation Limited v Koch Carbon Inc. (the “Dynamic”)[2003] 2 Lloyds Report 693, where Lord Simon amalgamated the principles developed over the years at page 698:

“	These cases establish the following exceptions to the general rule that the innocent party has an option whether or not to accept that repudiation:
	(i)	the burden is on the contract-breaker to show that the innocent party has no legitimate interest in performing the contract rather than claiming damages.
	(ii)	this burden is not discharged merely by showing that the benefit to the other party is more in comparison to the loss to the contract-breaker.
	(iii)	The exception to the general rule applies only in extreme cases: where damages would be an adequate remedy and where in election to keep the contract alive would be unreasonable.”

21.  We can see these principles distilled by Simon LJ in the “Dynamic” case was adopted in the more recent Hong Kong case of Shum Kit Ching, supra.

22.  I therefore agree with Mr Lam, in the present case, that it is not unreasonable for the Plaintiff to keep the contract alive as the Plaintiff does have a legitimate interest to do so in the circumstances.  I refer to the evidence of Mr Yuen which was unchallenged that the Plaintiff company could not sell the machines in any second-hand market in Hong Kong, and the company could only break these machines down and use the parts to service other machinery, and all these machines which were supplied to the customers are brand-new.

23.  As for the Defence argument that the Plaintiff is prevented from performing their contract because the machines are in the Defendant’s possession and, therefore, the Plaintiff would not be able to service these machines.  I do not find this argument attractive at all.  If it is so, then whenever the Defendant, whether unreasonably or reasonably, wishes to terminate the contract, the Plaintiff would be forced to accept the termination.  Furthermore, I accept Mr Lam’s argument that in the present case, even if Lord Reid’s second exception is good law, the Plaintiff’s income is not earned by servicing the machine, but by permitting the Defendant to possess and use them.  Even if the Defendant chooses not to use the machine, they are still liable to pay the rental.

24.  I therefore find that the general rule applies, and the Plaintiff is not obliged to accept the termination, and this case cannot fall within the exceptional or extreme cases category, where an election to keep the contract alive would be unreasonable or “wholly unreasonable”.

The Penalty Clause

25.  The Defence maintains that clause 12C in the second DSA (page 20 of bundle B) is a penalty clause and thus the Plaintiff cannot recover the penalty sums claimed and must prove the damages they claim they suffered.

26.  Clause 12 of the 2^nd DSA reads as follows:

“	12.	Upon premature termination of this Agreement, the customer shall pay to FXHK the total of the following amounts, the payment of which constitutes an essential condition and fundamental term of this Agreement:
	(a)	All costs and expenses thereby incurred by FXHK including any costs in relation to the termination of this Agreement and repossession of the equipment.
	(b)	The total overdue charges and interest at the time of such payment.
	(c)	The total of the minimum guarantee copy volume charge and fixed charges of the unfulfilled minimum contracted period.”

27.  The minimum contracted period was agreed at 24 quarters, i.e. 6 years.  This 2nd DSA superseded the 1^st DSA, and it is not disputed that this was signed on 10 April 2003.

28.  The Plaintiff argues that this is not a penalty clause, but a genuine pre-estimate of the loss likely to flow from a breach of the contract by the Defendant.

29.  There is no doubt that this agreement was signed by the Defendant after legal advice, as can be seen from the correspondence by e-mail on the March 3, 2003 (at page 45 in Agreed Bundle B).  I wish, however, to note here that I am, of course, alive to the fact that just because the Defendant received legal advice does not necessarily give legitimacy to the clause.

30.  In Halsbury’s Laws of England, 4^th Edition, vol. 12(1), page 486 at paragraph 1065, it is said:

“The operation of the rule against penalties does not depend on the discretion of the court, or on improper conduct, or on circumstances of disadvantage. …  The rule is one of public policy and is sui generifs.  Its absolute nature inclines the court to invoke the jurisdiction sparingly.  The burden of proving that a payment obligation is penal, vest on the party who is sued on the obligation.”

31.  Thus, it is clear that the Defendant has to prove that this was a penalty clause and the case is somehow weakened by the fact that they had agreed to this clause after full consideration by themselves and the legal advisers.

32.  The Defence has not proved that this clause is penal in nature and having read the clause, it is clear that it is not.  I find that clause 12 is a genuine attempt by the Plaintiff to estimate the actual loss that the Plaintiff will suffer in the event of a breach by the Defendant.  As I have pointed out the Plaintiff stands to lose the future earnings of these new machines leased to the Defendant.

Assignment to Fairock

33.  The Defence had maintained at the beginning of this trial that the Plaintiff should have accepted the assignment of the machines by the Defendant to Fairock.

34.  There is no evidence to show that the Plaintiff had an obligation to accept such re-assignment if they are not satisfied with the bona fides of the company, and at the end of the trial, Mr Smith, counsel for the Defendant did not seem to have pursued this point with any vigour.

Conclusion

35.  There is no doubt that the Defendant entered into this contract with the Plaintiff knowing full well the consequences of a breach.  I find that the Plaintiff had lawfully refused to accede to the Defendant’s request to terminate the contract and refused to accede to the Defendant’s request to assign the agreements to Fairock.  I also find that clause 12C of the 2^nd DSA was not a penalty clause.  I find, therefore, that based on the agreements, the Plaintiff is entitled to:

(i)	Under the 1st Rental Agreement:
	$500.00 a month from 1 January 2003 to the date of judgment ($500.00 x 44) = $22,000.00
(ii)	Under the 2nd Rental Agreement:
	From 1January 2003 to the date of judgement at $500.00 a month ($500.00 x 44 = $22,000.00)
(iii)	Under the 2nd DSA:
	(a)	1 July 2002 to 30 June 2003, $735,939.81
	(b)	1 July 2003 to 30 June 2004, $693,200.40
	(c)	1 July 2004 to 30 June 2005, $755,632.00
	(d)	1 July 2005 to 30 June 2006, $823,640.00
	(e)	Total outstanding rental: $3,008,451.81
		(and continuing at $224,442.00 per quarter until date of judgment)

36.  The Plaintiff is also liable to pay to the Defendant under the two rental agreements and the 2^nd DSA, interest of 2.5% per month on the overdue monies payable under the respective agreements.  I shall leave the actual calculation of the interest to the solicitors for the Plaintiff.

37.  There will be judgment for the Plaintiff in the sums as specified in the above paragraph with interest to be calculated in the manner already stated above.

Costs

38.  There will be a costs order nisi that the Defendant do pay the costs of this action to the Plaintiff, to be taxed if not agreed.