HEYBRIDGE LTD AND OTHERS v. CHAN SZE SZE GABRIELLE AND ANOTHER

cacv 172/2007

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 172 of 2007

(on appeal from HCA NO. 9563 of 2000)

______________________

______________________

_____________________________

REASONS FOR JUDGMENT

_____________________________

Hon Rogers VP:

1.  I agree with the reasons for judgment of Le Pichon JA.

Hon Le Pichon JA:

2.  This was an appeal from a judgment dated and entered on 4 April 2007 (“the Order”) of Saunders J, following a 13-day trial arising out of a partnership dispute.  In broad terms, as described by the judge, the plaintiffs were suing the defendants for undistributed profits, and the defendants were suing the plaintiffs by counterclaim for wrongful termination of the partnership.  At the conclusion of the hearing, the appeal was dismissed with reasons to be handed down which we now do.

3.  In order to understand the nature of the appeal, it is necessary to set out the background, the issues before the judge, his findings and the terms of the Order.

Background

4.  The partnership in question came about in the following circumstances.  Ms Chan, the first defendant, found herself in a position to secure a contract with the BBC for the manufacture and supply of the characters of a BBC children’s television production called the “Tweenies”.  However she did not have the capital available to purchase a letter of credit to enable her to place an order with a toy manufacturer and without that she could not conclude the contract with the BBC.  Ms Chan came to be introduced to the third plaintiff (“Sun Shine Toys”), a manufacturer of toys, and its principal owner, a Mr Chang.  Ms Chan proposed a partnership comprising three working partners: Sun Shine Toys would be responsible for manufacturing the toys, Ms Chan for selling the products to the BBC, and Mr Cho, the second plaintiff, was to attend to partnership business generally, liaising between the factory and distribution.  The agreed profit sharing ratios were 45% to each of Sun Shine Toys and Ms Chan and 10% to Mr Cho.  There was some discussion for the formation of BVI company in which the partners would be shareholders but this idea was not implemented.

5.  The judge found that the partnership commenced in May or June 1999 and came to an end on 10 March 2000 when Sun Shine Toys terminated the arrangement.  During this period, orders totalling $36.8 million had been supplied to the BBC.  At the time of the termination of the partnership, there was one order placed by the BBC with the partnership and, in turn, by the partnership with Sun Shine Toys, that was outstanding.  Sun Shine Toys refused to fill that order resulting in the partnership having to procure another toy manufacturer to do so, thereby incurring additional expenditure of $1,217,121.89.

6.  I should mention that Mr Chang died shortly after the proceedings began without having made any witness statement.  The issues therefore fell to be decided without any evidence from Mr Chang.

The judgment below

7.  The judge identified six issues arising from the partnership dispute that had to be resolved.  Those issues and the judge’s findings thereon may be summarized as follows.

(1) composition of the partnership

8.  On the pleadings, the plaintiffs’ case was that the partners were Heybridge Ltd (“Heybridge”) an offshore company owned by Mr Chang, Mr Cho and Ms Chan while the defendants maintained that the partners were Sun Shine Toys, Mr Cho and “Billion Oriental Ltd, trading as GC & Co”, the second defendant (“Billion Oriental”).  At the trial, although the composition of the partnership was a central issue, the conflicting views concerned the identity of the third partner, whether it was Ms Chan or her company Billion Oriental.

9.  The judge found that the parties to the partnership were Sun Shine Toys, Ms Chan and Mr Cho with profit sharing ratios of 45:45:10 respectively.

(2) the basis of manufacturing cost

10.  The judge found that the cost for producing the toys was to be determined by the amount quoted by Sun Shine Toys to Ms Chan on behalf of the partnership, accepted by her in that capacity and subsequently invoiced to the partnership and not, as the defendants had submitted, the cost of manufacturing the toys at the actual price of the raw materials, plus 10%, on an open book basis.

(3) the 5% “handling cost”

11.  The defendants claimed to be entitled to a 5% handling charge which was to be deducted from the sums invoiced to the BBC.  The judge held that was no agreement reached between the parties entitling the defendants or either of them to deduct a 5% administration charge.

12.  In this connection, I would observe that in the taking of any partnership accounts, any amount so deducted must notionally be repaid to the partnership.  Insofar as the judge held (at § 122) that any such deductions must be repaid to the plaintiffs, that cannot be right as the deductions were partnership profits.

(4) termination of the partnership and the outstanding order

13.  The partnership, being a partnership at will, was determined with immediate effect when Mr Chang, acting on behalf of Sun Shine Toys, gave notice of dissolution on 10 March 2000.  The judge so held.

14.  As to the defendants’ complaint concerning the outstanding order, the judge held that Sun Shine Toys acted in two capacities: it was a partner of the partnership as well as the manufacturer and contracting party with the partnership for the supply of toys.  The judge held that Sun Shine Toys was contractually obligated to complete that order and its failure to do so resulted in the partnership having to incur additional expenditure of over $1.2 million.  The judge therefore held that Sun Shine Toys was liable for damages for breach of contract.

15.  It is clear that the loss was a loss sustained by the partnership as a whole.  The breach was said to have had the effect of reducing the partnership profits by that amount.  The counterclaim of $547,704.40 represented 45% of that sum.  The judge went on to hold that that amount represented Ms Chan’s share of the reduced profit and, in § 132 of his judgment, held that Sun Shine Toys must pay that sum to Ms Chan “by way of damages for breach of contract”.  He also noted that although Mr Cho had suffered a similar loss, Mr Cho had elected not to pursue Sun Shine Toys for that loss.  The judge opined (at § 133) that

“	in the accounting that must follow this judgment he would not be able to claim that sum, which is now statute barred.”

As will become apparent, these 2 rulings do not appear to be sustainable.  See §§ 24 to 30 below.

(5) the taxation indemnity

16.  The judge ruled that each of the partners must indemnify the others in relation to income tax demands made by the Inland Revenue Department in respect of profits to the intent that each partner must pay his/her or its appropriate income tax on the profits ultimately shared in accordance with the partnership sharing ratios.

(6) the tooling mould

17.  Ms Chan counterclaimed from Sun Shine Toys the sum of US$28,980, being the cost of the tooling mould paid for by Ms Chan to Sun Shine Toys and which Sun Shine Toys had wrongfully failed to return.  The judge ruled (in § 141) that Ms Chan was entitled to that amount and that she was entitled to set off that sum from any other amount “due to Sun Shine Toys or Heybridge by way of gross profits.”

18.  Having resolved the issues arising, the judge went on to say this:

“	144.	A number of conclusions have been reached in this judgment.  It will be necessary to apply those conclusions to the accounts between the parties.  On the evidence before me at the present time I am not able to conduct that exercise.  Both parties have, in the prayers for relief, sought an order for an accounting.  In my view that is the appropriate course.
	145.	I will leave it to the parties to agree the terms upon which accounts are to be taken, having regard to the findings in this judgment.  In the event that they are unable to agree either party may, by summons, seek directions as to the terms for the accounts.  Leave is reserved to apply in respect of this or any other matter arising from the findings that I have made this judgment.”

The Order

19.  Notwithstanding § 145 of the judgment, it would appear that the parties never attempted to agree a draft judgment or order as envisaged by the judge to embody the terms for the taking of the partnership account.  Rather, by letter dated 23 May 2007 to the plaintiffs’ solicitors, the defendants’ solicitors complained that no sealed copy of the Order had been received.  The concluding paragraph read as follows:

“

We write to put on record that unless the proposed draft of the said [Order] to be lodged with the Court of Appeal of the High Court Registry is served on us by you for reference within the next 7 days, we shall proceed to submit our proposed draft of the said [Order] with the Court of Appeal of the High Court Registry for approval without further notice.”

The references to the ‘Court of Appeal’ is a mystery.  Be that as it may, 3 days later, the plaintiffs’ solicitors served two sealed copies of the Order on the defendants’ solicitors.

20.  The Order made by the judge reads as follows:

“	This action having been tried before the Honourable Mr Justice Saunders without a jury at the Court of First Instance, Hong Kong Special Administrative Region and the said Mr Justice Saunders having on the 4th day of April 2007 ordered that judgment as hereinafter provided be entered for the 2nd and 3rd Plaintiffs on the claim for undistributed profits and for the 1st and 2nd Defendants on the counterclaim for damages of breach of the partnership agreement (hereinafter called the “Judgment”).
	IT IS THIS DAY ADJUDGED THAT judgment be entered for the 1st and 2nd Plaintiffs against the 1st and 2nd Defendants for the undistributed profits in the total sum of HK$3,298,106.99 under the eleven invoices, namely SS200181, SS200199, SS200292, SS200328, SS200200, SS200253, SS200091, SS200329, SS200347, SS390254 & SS390372 at the agreed ratio of 45% and 10% respectively (i.e. HK$1,484,148.15 for the 1st Plaintiff and HK$329,810.70 for the 2nd Plaintiff) and for the 1st and 2nd Defendants on the counterclaim against the 3rd Plaintiff for damages for breach of the partnership agreement between the parties in the sum of HK$547,704.40 pending the agreed terms upon which accounts between the parties are to be taken.
	AND IT IS FURTHER DIRECTED THAT in the event that if the parites (sic) are unable to agree, either party may, by summons, seek directions as to the terms for the accounts, leave is reserved to apply in respect of this or any other matter arising from the findings that the Judgment was made.
	IT IS FURTHER ADJUDGED THAT the 1st and 2nd Defendants’ counterclaim against the 1st and/or 3rd Plaintiff to have the profit reassessed on the basis of materials plus 10% be dismissed.
	IT IS FURTHER ADJUDGED THAT the 5% administrative costs where it has been deducted and not refunded must be repaid to the Plaintiffs by the 1st and 2nd Defendants.
	IT IS FURTHER ADJUDGED THAT each of the parties must indemnity (sic) the others in relation to the income-tax demands made by the Inland Revenue Department to the intent that each partner shall pay his/her or its appropriate income tax on the profits ultimately shared as between the 3rd Plaintiff as to 45%, to the 2nd Plaintiff as to 10%, and the 1st and/or 2nd Defendant as to 45%.  Leave is reserved to apply in relation to the precise terms of the order.
	IT IS FURTHER ADJUDGED THAT the 1st Defendant may set off against any sum due to the 3rd Plaintiff the sum of US$28,980.00.
	IT IS FURTHER ADJUDGED THAT all questions of costs and (sic) reserved pending the outcome of the accounts.”

This appeal

21.  The failure of the parties to heed § 145 of the judgment has resulted in this appeal.  This is regrettable and both sides are to blame in that regard.

22.  To recap, given his findings as to the composition of the partnership and its dissolution on 10 March 2000, quite properly, the judge considered that the appropriate relief was for an account to be taken, applying the conclusions reached in the judgment.  The judge was unable to undertake that task on the evidence before him at the time. For example, it was not known whether the 5% handling fee had been deducted when past distributions had been made.  If so, an adjustment would clearly have to be made.  It was envisaged that the terms for the taking of the account should be agreed and set out in the order and, failing agreement, the parties were at liberty to apply to the judge.

23.  As noted above, that did not happen and what appeared to have prompted the appeal was the order that payment be made to Heybridge of undistributed partnership profits when, on the judge’s finding, the true partner was Sun Shine Toys.  It was said that it was not open to the judge to enter judgment for Heybridge.  It was then said that as Sun Shine Toys had made no claim for any such profits, denying that it ever was a partner throughout, the judge did not have jurisdiction, under Order 20 rule 5(5) or otherwise, to allow any amendment of the statement of claim to permit Sun Shine Toys to plead in the alternative because any claim by Sun Shine Toys to partnership profits would have been time-barred by the date of the judgment.

24.  All that can be said about the Order that has been entered and sealed is that it left a great deal to be desired if it was intended to give effect to the judgment.  The recital failed to reflect the composition of the partnership as found by the judge and the body of the Order failed to order that an account be taken.  Leaving aside the misalignment of the parties and the relief granted, the first operative paragraph treated a partner as being entitled to a specific percentage (reflecting his profit-sharing ratio) in each partnership asset and ordered payment of specific sums by reference to a particular transaction such as the particularised invoices and the loss sustained by the partnership attributable to the outstanding order when, as regards the particularized invoices, the judgment itself did not attempt to quantify the entitlement of Heybridge/Sun Shine Toys and Mr Cho.  That piecemeal approach is wrong.  That approach, no doubt adopted by the parties at the trial, led the judge into error in his treatment of the sum of damages of over $1.2 million in respect of the outstanding order recoverable by the partnership from Sun Shine Toys in § 132 of its judgment.

25.  The purpose of the taking of partnership accounts is to ascertain the net profits of the partnership by deducting outgoings and liabilities from all partnership income and receipts and to calculate what is due to each of the partners, making appropriate adjustments to allow for what has already been paid to each of them on account.  The accounting exercise must relate to all partnership dealings and transactions between Sun Shine Toys, Mr Cho and Ms Chan as co-partners from May/June 1999 and, in carrying it out, effect must be given to the conclusions reached by the judge relating to (1) the basis for calculating the manufacturing costs, (2) the 5% handling fee, and (3) Sun Shine Toys’ liability for breach of contract concerning the outstanding order.  To order specific sums to be paid by reference to a particular transaction before an account is taken is to put the cart before the horse.

26.  The upshot of the submissions of Mr Lam, who appeared for the defendants, is that not only would the defendants not have to account to Sun Shine Toys for the latter’s 45% share in the undistributed profits, Sun Shine Toys must pay Ms Chan the sum of $547,704.40 referred to in § 15 above as well as US$28,980.  Although the judgment (at § 143) contemplated that this last amount was to be set off against “any sum due to the 3^rd Plaintiff”, according to Mr Lam, there could be no set off because nothing apparently is due to Sun Shine Toys from either of the defendants.  I consider the result to which Mr Lam’s submissions would lead to be singularly unattractive, being contrary to all notions of justice.

27.  The nub of Mr Lam’s submissions is that it was not open to the judge to make any award in favour of Sun Shine Toys who had made no claim in its capacity as a partner because of the limitation period.  As mentioned in § 29 below, that is not strictly correct because throughout the 13-day hearing, the limitation period remained current.

28.  I have already described the stance taken by the plaintiffs and the defendants respectively as to the composition of the partnership.  All the partners were parties to the proceedings and, so far as the judge was concerned, having presided over a 13-day trial, he concluded thus:

“

15.

The first issue, the composition of the partnership, is an issue which arises in both the claim and the counterclaim.  Sun Shine Toys originally intended to nominate Heybridge as a partner in the transaction.  It is clear however that the true partner was Sun Shine Toys.  There is no dispute as to this and is nothing turns on the Heybridge/Sun Shine Toys difference.  There is no doubt that Mr Cho, in his personal capacity, was a partner.  The central and important issue is whether Ms Chan personally, or whether “Billion Oriental Limited, trading as G C & Co”, was the third partner.”

29.  It is clear that the judge did not consider that anything turned on the “Heybridge/Sun Shine Toys difference”.  Mr Lam has not made reference to the transcript or any other documents before the judge to demonstrate that it was otherwise.  Further, it is to be noted that the trial took place in January/February 2006 which was prior to the expiration of the limitation period.  Plainly had an application been made at the trial for an amendment to plead in the alternative, no limitation objection could have been raised.  It would have been within the judge’s discretion pursuant to Order 20, rule 5(1) to allow such an amendment and, given his observations at § 15 of his judgment, it is one that the judge would have granted readily.

30.  Moreover, in the proceedings, in addition to Heybridge and Mr Cho seeking an accounting, the defendants made claims against Sun Shine Toys and sought to recover what were interim partnership distributions as well as the taking of an account.  The notion that a partnership account should be ordered but that it should operate for the benefit of only some but not all the partners is novel.  In my view, if an account is ordered to be taken, it is binding on all the partners who, inter se, have reciprocal rights and obligations.

Conclusion

31.  I find Mr Lam’s submissions devoid of merit.  But, as I have said earlier, the Order is in some disarray.  For that reason, the Order has to be set aside and a fresh order substituted by the court below, taking into account what is set out in this judgment.  The fresh order should include, inter alia, provisions that reflect the following so far as the taking of the partnership account is concerned:

1.	That the partnership at will formed in about May/June 1999 between the second plaintiff, the third plaintiff and the first defendant in the profit-sharing ratios of 10:45:45 was dissolved on 10 March 2000.
2.	That an account be taken of all partnership dealings and transactions of the said partnership.
3.	That in the taking of the account:
	(a)	the manufacturing costs are to be ascertained in accordance with § 105 of the judgment;
	(b)	neither the first nor the second defendant is entitled to a handling charge of 5% on the sums invoiced to the BBC; and
	(c)	the third plaintiff is liable to the partnership for damages for breach of contract in the sum of $1,217,121.89.

I would therefore remit the matter back to the judge for an appropriate order to be drawn up in substitution for the order set aside.  I would add that the account should be taken before a Master of the High Court.

32.  So far as costs of this appeal are concerned, I would make an order nisi that there be no order as to costs.

Hon Lam J:

33.  I agree that for the reasons set out above, there should be an order in terms of paragraph 31 and 32 above.  The outcome of this appeal illustrates a fundamental principle of our law on partnership: in between the partners, upon dissolution of the partnership, an account has to be taken.  At paragraph 25, Le Pichon JA succinctly set out the rationale and the correct approach in the taking of partnership accounts.  I respectfully agree.  For those who need more enlightenment, reference can be made to the judgment of Lord Millett in Hurst v Bryk [2000] 2 All ER 193 at p.202 to 203.  This is not the first time I encounter partners claiming against each other regarding partnership affairs as if it is a simple claim for damages arising out of a single transaction.  Those advise and conduct litigations relating to partnership disputes should always bear in mind that it is wrong in principle to adopt a piecemeal approach in sorting out the position between partners in the winding up of the affairs of a firm.  Had the parties to this appeal focused on the correct principle at the court below and conducted the trial accordingly, I believe the learned judge would not have made the order as he did.  Both sides were at fault and I agree that in the circumstances, the appropriate costs order for the appeal is the order nisi proposed by Le Pichon JA.