GLOMEX TRADING CO. LTD. v. BILLION PEARL INVESTMENTS LTD.

1994, No. A3964

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H E A D N O T E

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Commercial law - Action between immediate parties on cheques - Total failure of consideration - Drawer of cheque not receiving the benefit he had bargained for under an agreement.

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At an all-in price of US$380,000, S, a Taiwanese company, made a written contract with B, a Hong Kong company in May 1993, (i) to sell B production equipment for manufacturing children's personal-computer-teaching- machines in the People's Republic of China; (ii) to install and adjust the equipment at a factory site in Sun Kong near Beijing to the point where it was ready to go into production, and (iii) to transfer to B all the technical know-how needed for manufacturing the product.

In August 1993, the parties made another written agreement for B to buy similar equipment for installation at Wei Hai at an all-in price of US$350,000, but otherwise on terms identical to those in the May contract.

Before the equipment was installed and brought the point where it was ready to go into production at either Sun Kong or Wei Hai, B, by a written Sales Confirmation, bought 4,000 kits of parts at US$24.53 per kit from S for processing by the production equipment at Sun Kong and Wei Hai once it got into production. Pursuant to the terms of the Sales Confirmation, B paid S part of the price of the kits under a letter of credit, and the balance by one cheque for HK$189,616 post-dated to 10th January 1994, and another for HK$137,945 post-dated to 4th February 1994.

Despite taking delivery of some of the kits, B, on or before 10th January 1994, countermanded payment on both cheques.

S sued B on the two cheques, getting judgment by default. B applied before a master to have the judgment set aside, B's main ground being that there had been total failure of consideration in respect of the cheques, since the kits were worthless to B on account of S having failed (i) to bring the equipment to the point where it was ready for production, and (ii) to transfer technical know-how.

On appeal from the master's decision dismissing B's application for the judgment to be set aside, Held, following Rover International Ltd v. Cannon Film Sales Ltd [1989] 1 WLR 912, the master's decision should be reversed as this was one of those rare cases where, instead of treating the cheques as cash, the court would allow B to defend S's claim on them on the basis of total failure of consideration, since, instead of getting what it bargained for, namely, kits to be processed by the equipment S had supplied, B got kits which were worthless to it, because S had failed to bring the equipment to a state where it was ready to manufacture, and had failed to transfer the technical know-how necessary for manufacturing.

1994, No. A3964

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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J U D G M E N T

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1. The plaintiff is a Taiwanese trading company without any branch in Hong Kong. The defendant is a company with a registered office and branch in Hong Kong.

2. By the present appeal, the defendant seeks to reverse a master's order which refused to set aside a judgment by default in the plaintiff's favour for the sum of HK$325,562.23 arising out a cheque dated the 10th January 1994, for HK$189,616.90 ("the first cheque"), and another dated 4th February 1994, for $137,945.33 ("the second cheque"), both being drawn in the plaintiff's favour by the defendant. Together, those two cheques came to a total of $327,562.33, but due, presumably, to an oversight, the plaintiff got judgment for HK$325,562.33 only, (plus interest and costs). The defendant countermanded both cheques on 10th January 1994.

3. The defendant seeks to take the point that it was never served with the specially indorsed writ claiming on the two cheques, despite an affidavit dated the 13th May 1994 from the plaintiff's solicitors to the effect that the defendant had been served with the writ at its registered office, which was also the place where it conducted its business, on the 27th April 1994.

4. The defendant's solicitors had known as long previously as the 15th April 1994 that the plaintiff, through its solicitors, was threatening to take legal action against the defendant on the two cheques unless the defendant paid up the amounts being claimed. On the 19th April 1994, the plaintiff's solicitors wrote to the defendant's solicitors warning that unless payment was made within three days, legal proceedings would be commenced against the defendant and the defendant's solicitors were asked whether they had instructions to accept service of court proceedings.

5. Even if the staff of the defendant working at the defendant's place of business on the 27th April 1994 are not mistaken when they say they are unaware of any writ having been served on the defendant there that day, there is no dispute that the defendant's solicitors knew that same day or the next day that proceedings had been commenced against the defendant, since the plaintiff's solicitors wrote to the defendant's solicitors to that effect by letter dated 27th April 1994.

6. On 13th May 1994, the defendant's solicitors wrote to the plaintiff's solicitors, saying that their client had not received any writ and went on to announce that the defendant's solicitors had now been instructed to accept service of any writ. The plaintiff's solicitors, having obtained judgment by default on the 16th May 1994, sent a copy of that judgment to the defendant's solicitors on the 17th May 1994, a situation no doubt communicated to their client by the defendant's solicitors straight away.

7. Despite knowing on or about the 17th May 1994 that judgment had been entered against it, the defendant, through its solicitors, took no steps until the 28th June 1994 when it filed a Notice to Act.

8. Even assuming that the defendant has a good arguable case on the merits, I would only be prepared to set the judgment aside on terms, in the light of the defendant's foot-dragging and apparent playing for time.

9. The defendant claims that it has two defences to this action on the cheques, the first such defence being that the cheques were only delivered to the plaintiff on a condition which the plaintiff has broken, and the other, a total failure of consideration.

10. Defences of that nature are frequently pleaded to claims on cheques, but seldom succeed on the facts. As a general principle, the courts treat cheques as cash, and are reluctant to allow a set-off or counterclaim based on a contract underlying a cheque, unless the set-off or counterclaim is for an ascertained, liquidated sum, or where there has been a total failure of consideration. See : Nova (Jersey) Knit v. Kammgarn Spinnerei [1977] 1 WLR 713; Montebianco v. Carlye Mills [1981] 1 Ll Rep 509; and ASA Engineering Co. Ltd. v. Supper Link Co. Ltd. (unrep)., Civ. App. No.33 of 1991.

11. To see whether the defendant might have a good arguable case on either cheque on the merits, I will now describe the facts of the underlying transactions insofar as revealed by the documentary evidence before me.

12. The plaintiff, on the 23rd August 1993, entered into a contract in writing with the defendant to sell the defendant the production equipment necessary for making children's personal-computer-teaching-machines and software cards. An itemised list of equipment was appended to the contract. The sale price was US$350,000. That price included the transfer of technical know-how and setting up the machinery by the plaintiff, ready for production in Wei Hai in China. What the plaintiff had to do by way of bringing the equipment to the stage where it was ready for production, and what was involved by way of transfer of know-how, can best be seen by setting out Clauses V, VII and XI of the written agreement in which the plaintiff is described as "the Seller" and the defendant "the Buyer" :-

"V. Terms of Payment :

After the contract goes into effect, the Buyer shall open a 100% irrevocable sight L/C for the amount of US$315,000 the balance of US$35,000 shall be paid to the Seller once and for all after all the equipment is shipped to the factory site, and after completion of installation and adjustment and test under the guidance of the professional technical personnel assigned by the Seller and upon being found to have satisfied acceptance test of the whole production line conducted by both the Buyer and the Seller after the adjustment and test. the examination period is 72 hours of continuous steady production.

VII Trial Run:

(1) Upon receiving the letter of credit, the Seller shall supply the formula of the raw materials and the list of various raw materials to the Buyer. The raw materials for the trial - run shall be provided free of charge by the Seller (to produce about 50 units).

(2) The Seller shall assign technical personnel to the mainland for guidance of installation, trial - run and training. The installation and trial - run must be completed in 15 days. For the training, the personnel of the Buyer shall have learnt to master all the skills in 30 days. The Buyer shall bear all such costs as return air tickets between Hong Kong and the mainland and traveling, food and accommodation in the mainland.

XI Technical Transfer

The Seller shall supply free of charge and without reservation the complete technical knowhow for producing children PC teaching machines and software cards. The Buyer shall have technical personnel of certain level of professional competence to undergo systematic training conducted by the Seller so that they can perform independent operation in a short term and produce up-to-standard products and develop new products.

If the Seller does not supply the technology as provided for herein or if fraud is found or facts are withheld, the Seller shall compensate the Buyer for all direct economic losses."

13. Under the terms of the written agreement, the plaintiff had to ship the equipment to Wei Hai before the 10th November 1993.

14. The defendant did duly pay the plaintiff the agreed US$315,000 under a letter of credit as the first payment, and the plaintiff, for its part, duly shipped all the goods to Wei Hai, in time.

15. From the documentary evidence before me, it looks as if at all material times, for present purposes, the plaintiff knew that the defendant had made an onward sale of all the equipment to a firm called Hai Shan whose personnel would need the benefit of the transfer of the technical know-how and assistance in getting the equipment set up if the equipment was ever to go into regular production. Doing the best I can with such information as I have, I gather that the plaintiff was quite happy to allow Hai Shan to be the recipient of all the technology-transfer provided for under the written agreement between the parties.

16. Besides the contract dated the 23rd August 1993, the parties had entered into a similar written contract on the 7th May 1993, ("the first contract"), for the supply of almost identical equipment at a price of US$380,000 for delivery to Sun Kong near Beijing. The terms of that contract as to technical assistance for start-up and transfer of technology were identical to those in the contract dated 23rd August 1993 (which, from now onwards, I will refer to as "the second contract"). I only refer to the first contract because it forms part of the factual matrix.

17. By an agreement in writing describing itself as a "Sale Confirmation", ("the Sale Confirmation"), dated 21st October 1993, the Plaintiff agreed to sell the defendant 4,000 kits of parts at US$24.53 per set for processing into children's personal-computer-teaching-machines, using the production equipment the plaintiff had supplied the defendant at Beijing under the first contract and at Wei Hai under the second contract.

18. It is clear from the Sale Confirmation that the parties had contemplated 2,000 of the 4,000 sets would be sent to Beijing and 2,000 to Wei Hai. Later, that was varied to all 4,000 going to Wei Hai, but nothing turns on that particular variation.

19. For an understanding of the defendant's case, reference needs to be made to the parts of the Sale Confirmation headed, "Method of Payment", and, "Warranties Clauses". ("Party A" is the defendant, "Party B", the plaintiff) :-

"Method of Payment :

Party A shall tele-transmit 50% of the price after signing of the Agreement, the balance of 50% shall be paid by Party A by 60 days post-dated cheques to Party B.

Warranties Clauses :

Party B warrants that the 4,000 sets of computer parts are of good quality, the quantity will be correct. If the parts are out of order, Party B shall be responsible for the loss if the substandard product percentage is more than 0.5%. If the damage to the parts is made during the processing work done by the factory of Party A, the loss will be borne by Party A."

20. By about the 29th October 1993, the defendant realised it had over-ordered, and wanted to cancel its purchase of 2,000 of the kits. 2,000 such kits at US$24.53 per kit would have cost the defendant US$49,060. Reasonably, the parties agreed that the order for 2,000 of the kits should be treated as cancelled, with the defendant only having to pay the plaintiff US$17,857 for the raw material the plaintiff had already bought for the purpose of making those 2,000 kits. The Hong Kong dollar equivalent of US$17,857 is HK$137,945. That figure of HK$137,945 is the amount of the second cheque on which the plaintiff has got judgment.

21. Precisely when the defendant issued the second cheque to the plaintiff is unclear, but it was certainly on a date after 26th November 1993 which was when the plaintiff faxed the defendant asking for the US$17,857 to be remitted. Sometime after 26th November 1993, the defendant issued the second cheque, post-dated to the 4th February 1994, to the plaintiff.

22. In relation to the 2,000 kits which the defendant still wanted under the Sale Confirmation, the defendant, on 4th November 1993, sent the plaintiff a telegraphic transfer for US$24,530, being 50% of the cost of the 2,000 kits and, at or about the same time - the precise time is not important - sent the plaintiff the first cheque for HK$189,616.90, post-dated to the 10th January 1994, being the Hong Kong dollar equivalent of US$24,530 The plaintiff, as mentioned earlier, also got judgment on the first cheque.

23. By the 10th January 1994, the defendant had received 1,750 of the 2,000 kits it had ordered by the Sales Confirmation for Wei Hai. By that date, too, the plaintiff had managed to find a buyer, willing to pay US$6,620 for one of the parts (mask rom) in each of the 2,000 kits that the defendant had over-ordered. It is common ground that HK$51,177.24, being the equivalent of US$6,620 has to be deducted from the HK$137,945.33 of the second cheque, leaving a balance of HK$86,767.76 recoverable by the plaintiff on that cheque. It is also common ground that, from the first cheque for $189,616.90, there has to be deducted $2,868.38 in respect of the shortfall 250 of kits for Wei Hai. That leaves a balance of $186,747.62 recoverable on the first cheque. On the aspect of quantum, there is thus common ground that judgment should not have been for more than $273,515.38($86,767.76 + $186,747.62), plus interest and costs.

24. A fax sent by the plaintiff to the defendant on the 10th January 1994 contains the following paragraph :-

"3) Please pay attention to this: 250 sets of some parts which will be taken to Wei Hai by hand for trial run and acceptance test of the equipment and products. The details are as follows :-

MASK ROM	250 pcs	CARD BOX BASE PLATE	250 pcs
IC(82C55)	250 pcs	FILM SWITCH (UPPER)	250 pcs
CLAW PIECES	250 pcs	FILM SWITCH (LOWER)	250 pcs
SWITCH	250 pcs	SPRING A	250 pcs
DIODE(IN5819)	250 pcs	B	250 pcs
MAIN BASE PLATE	250 pcs	C	250 pcs
BASE PLATE FOR		ROM CARD FOR TESTING	15 pcs
CLAW PIECES	250 pcs
BEARERS	250 pcs"

25. It will be recalled that the first cheque was post-dated to the 10th January 1994. With nothing more brought to the court's attention than the apparent coincidence that the plaintiff's fax was dated 10th January 1994 and the first cheque bears that date too, the defendant contends that the first cheque was handed over to the plaintiff on condition it was only to be payable if the full 2,000 kits were delivered to the defendant on or before the 10th January 1994. According to the defendant, the first cheque was handed to the plaintiff as an escrow against delivery of the full 2,000 kits on or before 10th January 1994, and because there were still 250 kits short on that date, the defendant was within its rights under s.21(2)(b) of the Bills of Exchange Ordinance, Cap 19 ("the Ordinance") to countermand the cheque. I now set out so much of that section as is relevant :

"21. Delivery

(1) Every contract on a bill, whether it is the drawer's, the acceptor's or an indorser's, is incomplete and revocable, until delivery of the instrument in order to give effect thereto:
Provided that where an acceptance is written on a bill, and the drawee gives notice to or according to the directions of the person entitled to the bill that he has accepted it, the acceptance then becomes complete and irrevocable.

(2) As between immediate parties, and as regards a remote party other than a holder in due course, the delivery -

(a) in order to be effectual, must be made either by or under the authority of the party drawing, accepting, or indorsing, as the case may be;

(b) may be shown to have been conditional or for a special purpose only, and not for the purpose of transferring the property in the bill;

but if the bill is in the bands of a holder in due course, a valid delivery of the bill by all parties prior to him, so as to make them liable to him, is conclusively presumed."

26. Particulars of when, in what circumstances, and between which individuals such a condition was agreed to attach to the first cheque are totally lacking from the material the defendant has so far adduced. Why the parties would want to arrive at that sort of arrangement respecting the first cheque, in The light of their previous business dealings, is difficult to see. Certainly, there is nothing in the Sale Confirmation to indicate that the first cheque was to be held as an escrow. As to how a cheque can be treated as an escrow between the immediate parties to the cheque, see Bell v. Lord Ingestre (1848) 12 QB 318; Castrique v. Buttigieg (1855) 10 Moo PC94; Imperial Bank v. Heisz [1930] 1 DLR 339; and Great Sincere Trading v. Swee Hong [1968] HKLR 660.

27. The impression I get is that the defendant is being opportunistic in trying to claim significance in the fact that the date of the fax announcing 250 kits were to be taken to Wei Hai by hand for the trial run and acceptance test was the same as that on the first cheque. From that, the court as invited to infer the first cheque was of the conditional variety contemplated by s.21(2)(b) of the Ordinance. Since I see no realistic hope of the defendant ever succeeding to bring itself within the scope of s.21(2)(b) of the Ordinance on the basis of such slender material, I reject its contention that the judgment should be set aside on that ground.

28. Attention can now be directed towards the other defence that the defendant has sought to advance on the merits, namely, total failure of consideration. The line taken by the defendant here is that the kits it bought from the plaintiff under the Sale Confirmation are useless to it because the plaintiff has failed in its duty under both the first contract and the second contract to bring the equipment to the point where it can go into production, and has also failed to make the technology-transfer required by those contracts.

29. Where the rights and wrongs lie between the parties in relation to their disputes over the supply of the equipment, starting it up, and transferring know-how is not to be determined at this point, but, such material as there is, does reveal that there are major disputes between them over both contracts. For example, the defendant complained that the plaintiff supplied a spherical rather than a hexagonal mould under the first contract whilst the plaintiff complains that the defendant should by now have paid the balance of the purchase money under that contract.

30. Normally, the last thing a court would wish to allow would be for a claim on a cheque for the price of goods like production kits to get mixed up with relatively complicated claims between the same parties in relation to the supply of equipment for processing those kits, but, in the exceptional circumstances of the present case, this cannot be avoided if justice is to be done between the parties. I regard it as strongly arguable that it must have been within the contemplation of both parties at the time they entered into the Sale Confirmation that the kits to be supplied were for use in the manufacturing process to be performed by the equipment the plaintiff had sold the defendant under the first contract and the second contract. That was what the parties had bargained for. When, as it then turned out, the equipment never got into production, the kits were of no use to the defendant for the purpose for which the plaintiff knew the defendant had bought them. There is no suggestion the kits have any value as items which the defendant will be able to sell off to a third party. What the defendant bought were kits for use with its production machinery, and not kits for sale.

31. If, as the defendant alleges, the kits are worthless to it because of the plaintiff's defaults under the first and second contracts, the defendant, in my judgment, has an arguable case of total failure of consideration for the cheques on the basis of not getting what it bargained for :See Rover International Ltd v. Cannon Film Sales Ltd [1989] 1 WLR 912.

32. Whether the defendant will succeed on its counterclaims, time alone will show, but, meanwhile, I hold that the judgment against it should be set aside on the basis of reasonably arguable total failure of consideration. I only do that, however, on condition that the defendant, within four weeks, pays into court the sum of $273,515.38 previously mentioned to abide the result of a trial. I impose that condition in view of (i) the way in which the defendant dragged its feet before entering a Notice to Defend; (ii) the opportunistic way in which the defendant tried to make out that the cheques were for conditional payment; and (iii) in recognition of the inherent strength the plaintiff's case must have, based as it is on cheques, which are normally to be treated as cash.

33. In case the defendant considers itself not to be in a sufficiently sound condition financially to pay into court the $273,515.38 I have ordered, I grant liberty to apply, since it would be wrong for the defendant to be kept away from the judgment seat solely for want of means when it has shown a reasonably arguable defence to the plaintiff's claim.

34. This being a judgment handed down pursuant to O.42, r. 5B, I make a fourteen day order nisi that costs are to be in the cause.