UNITED PLASTIC & METAL MANUFACTORY (a firm) v. TOYMARK CO. LTD.

HCA 6520/99

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 6520 OF 1999

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J U D G M E N T

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1. The Plaintiff's claim is for HK$1,836,293.80 being the price of goods sold and delivered between July and August 1998.

2. An application for summary judgment was taken out on 14th May 1999.

3. On 6th August 1999, the application came before Master Lau who granted the Defendant leave to defend on condition of its paying into Court the sum of HK$1,734,461.80.

4. The Defendant appeals against that Order, seeking unconditional leave to defend. The Plaintiff cross-appeals, seeking final judgment.

5. The Defendant admits that it has not paid the sum claimed for the goods sold and delivered. By way of defence it seeks to rely on a set-off based on a counterclaim which is said to be of a considerably greater value than the amount claimed by the Plaintiff. Accordingly, everything turns on the viability of the alleged counterclaim and set-off in the present Order 14 context.

6. The Defendant is in the business of designing, marketing and selling plastic and die cast toy products. Before the relationship between the parties broke down, the Defendant would provide the Plaintiff with engineering drawings and prototypes from which the Plaintiff would manufacture the moulds and also produce the toy products on behalf of the Defendant. The sum of HK$1,836,293.80 claimed by the Plaintiff represents the unpaid price of toys produced and delivered by the Plaintiff to the Defendant.

7. Initially, the total amount claimed by the Defendant by way of counterclaim was in the sum of HK$8,702,988.00, made up as follows:-

(1) $2,326,000.00, said to be incurred by the Defendant as a direct result of the Plaintiff "failing to transfer the moulds, prototypes and engraving patterns owned by [the Defendant] to another factory as instructed by [the Defendant]";

(2) $2,100,600.00 said to represent the cost of prototypes made to the Defendant's order and design, belonging to the Defendant but unlawfully retained by the Plaintiff;

(3) $3,852,000.00 said to represent the cost of certain engraving patterns belonging to the Defendant and retained by the Plaintiff;

(4) $379,159.00 said to be the value of other materials belonging to the Defendant and retained by the Plaintiff including PVC boxes and labels; and

(5) $43,162.00, being compensation allegedly paid to the Defendant's clients as a result of the Plaintiff's delay and mistakes in the production of toys it was manufacturing to the Defendant's order.

8. Faced with these allegations, the Plaintiff firm filed an Affirmation by one of its partners, So Kwok Bun, dated 4th August 1999. He describes the Counterclaim as an invention without any basis. In relation to the claim for failure to transfer moulds, Mr. So produces receipts showing that the moulds were returned between 28th June 1998 and 5th November 1998 when no longer needed for production. He explains that what remains outstanding is completion of a procedure involving the mainland's customs authorities referred to as a "transfer factory" procedure. This involves securing the approval and registration by mainland Customs of a transfer of the moulds to the Defendant's factory. He states that his firm has always been ready and willing to do its part to complete the procedure but that lack of cooperation on the part of the Defendant's factory has meant that Customs approval has not been obtained.

9. In relation to the other claims, Mr. So deposes to the prototypes all having been returned to the Defendant after being used to produce the relevant moulds. He also explains that the engraving patterns are merely plaster of Paris enlargements of the prototypes produced by the factory in the course of making the moulds and that once they have served their purpose, they are generally destroyed so that the plaster of Paris can be re-used. As to the claim for $379,159.00 in respect of PVC boxes, labels, etc., allegedly retained by the Plaintiff, Mr. So states that the bulk of these had been returned to the Defendant in August and September, as shown in documents exhibited in the Defendant's own evidence. He states that of such materials, a quantity worth only HK$56,603.00 has been retained and that the Plaintiff is willing to give credit for such amount. He states that the sums allegedly paid by way of compensation were never demanded and have not been substantiated as sums for which the Plaintiff should bear any responsibility.

10. Having seen Mr. So's evidence, the Defendant substantially changed its case as set out in the 2nd Affirmation of Chiu King Yin. The total amount of the claim was reduced from HK$8,702,988.00 to $5,156,132.00, now said to be made up as follows:-

(1) The Defendant continues to assert a counterclaim for $2,326,000.00. However, this is no longer based on the allegation that this reflects loss caused by the Plaintiff's failure to transfer the moulds, prototypes and engraving patterns to another factory as instructed by the Defendant. Instead, the same amount is claimed on the basis that it is the "penalty faced by the Defendant" for the Plaintiff's failure to effect a 'transfer factory' procedure for the moulds.

(2) The counterclaim for $2,100,600.00 as the cost of the Defendant's prototypes retained by the Plaintiff has been reduced to $1,050,300.00, the Defendant stating that the amount initially claimed was a mistake, but with no further explanation.

(3) The claim for $3,852,000.00 representing alleged losses due to non-return of the engraving patterns has been reduced to $1,678,000.00. No explanation has been given for this change. However, it appears that the figure now claimed is based on Mr. Chiu's estimate of manufacturing costs for engraving patterns.

(4) The claim for $43,162.00 as reimbursement of compensation paid by the Defendant to its customers due to Plaintiff's delay and mistakes remains unchanged.

(5) There is a new claim for $2,067.00 in respect of penalties allegedly paid to shipping companies due to the Plaintiff's delay.

(6) Finally, the claim for $379,159.00 in respect of materials like boxes and labels retained by Plaintiff has been reduced to $56,603.00, that is, the value of the goods admittedly retained by the Plaintiff.

11. In reply, the Plaintiff relies on the Affirmation of So Kwok Lun dated 27th August 1999. So Kwok Lun is the brother of So Kwok Bun and the other partner in the Plaintiff firm.

12. So Kwok Lun points out that all the contracts for the manufacturing of moulds exhibited by Chiu King Yin were entered into between the Defendant and De Li Gao Mould Factory which, although related to the Defendant, was a separate entity. The contracts entered into between the parties to this Action were confined to contracts for the manufacture and supply by the Plaintiff of toy products and not moulds. He reiterates his brother's denials of the retention by the Plaintiff of any prototypes or engraving patterns.

13. Miss Gekko Lan, who appears of the Plaintiff, invites me to hold that the Defendant's alleged counterclaim and the evidence filed in support bear such highly questionable features that I should reject its case as a whole as incredible and an obvious fabrication.

14. Miss Monica Chow, appearing for the Defendant, while accepting that there are certain deficiencies in the evidence and the way in which the Defendant's case has evolved in the affirmations, invites me to hold that there remains at the core a counterclaim and set-off raising triable issues justifying the matter proceeding unconditionally to trial.

15. I will consider first each head of the counterclaim and then the Defendant's case as a whole.

The claim for $2,326,000.00 regarding moulds and the "transfer factory" penalty

16. In my judgment, this claim does not begin to get off the ground as a justification for the Defendant's failure to pay its admitted debt. As originally formulated, the Defendant was clearly alleging that it had suffered loss as the result of the Plaintiff failing physically to transfer to a designated transferee, moulds, engraving patterns and prototypes which the Defendant owned. The change in its case to the "transfer factory" penalty case is extremely suspicious. It now no longer involves prototypes and engraving patterns and only concerns potential penalties which have not been incurred. Yet, it is put forward as having exactly the same value as the original claim.

17. The nature of the claim as presently formulated is also extremely doubtful on the evidence filed. Thus, from exhibited translations of leaflets issued by mainland Customs authorities to give relevant guidance on this matter, it appears that the customs regime in question is one which allows the importation into the mainland of certain raw materials exempt from duty and value added tax, provided that when the imported materials are turned into manufactured goods, such goods are then exported to foreign markets. The leaflets indicate that if instead of exporting the finished goods, they are sold in China, the importer becomes subject to pay the exempted duty and tax and must report to the authorities to enable that duty to be assessed.

18. If, as appears to be suggested, the complaint against the Plaintiff is that, having imported into the mainland the raw materials used to manufacture the moulds, it then failed to report the transfer of the moulds to the Defendant's factory, it is not clear that any loss necessarily follows. As stated above, the evidence seems to suggest that if reported, this would have led to the levying of duty and tax on the Defendant in any event. The suggestion in the Defendant's evidence is that a reporting of the transfer under the "transfer factory" proceedings would have led to a continued or permanent exemption from duty. However, this is not made out in any of the materials referred to. No such regulation is referred to in the guidance exhibited. Miss Chow also suggested that the potential loss might consist of an additional penalty payable over and above the customs duty and tax, however, this possibility is not in evidence either.

19. Furthermore, the legal basis for the alleged obligation on the Plaintiff to effect the "transfer factory" procedure is also unclear. If it is contractual, the Plaintiff points to the evidence suggesting that the contracts for the manufacture of moulds were, on their face, not entered into by the Defendant with the Plaintiff but with the "De Li Gao Mould Factory" so that no contractual duty falls on the Plaintiff. I consider however that this sub-issue is triable since the evidence is unclear as to whether the said factory is a distinct legal entity as opposed to the name under which the Plaintiff operated its factory in Dongguan.

20. In any event, however, Miss Chow accepts that no liability in respect of duty or tax or other penalty, whether liquidated or unliquidated, has accrued, so that there is nothing for the Defendant to set off. The sum in question is at best, a speculative estimate of what penalty the Defendant might face if and when it is charged by relevant mainland authorities. Miss Chow accepts that at most she might be in a position to seek a declaration that the Defendant is entitled to an indemnity but that this does not give rise to any set-off.

21. I therefore come to the conclusion that the first alleged counterclaim raises no triable defence by way of set-off. Even viewed simply as a counterclaim, I consider the evidence of it to be presently so unsatisfactory that I would not be prepared to grant any stay of execution based on such a counterclaim if the Plaintiff were to be awarded judgment.

The claim for $1,050,300.00 as the cost of prototypes retained by the Plaintiff

22. The case on this head of counterclaim has also shifted. It began as a claim for $2,100,600.00 based on the alleged cost to the Defendant of getting the prototypes made, as shown in a series of invoices said to have been rendered by the third parties who manufactured the prototypes. However, as Miss Lan points out, the $2,100,600.00 figure is double the total of the sums shown in those invoices. Moreover, the documents exhibited contain in someone's handwriting the figure "$1,050,300.00" which is the correct total amount.

23. Mr. Chiu, in his 2nd Affirmation merely apologises for "the mistake", giving no explanation as to how it came about. One possible inference is of course that the figure in his first Affirmation was put in simply to swell the alleged counterclaim without any regard for the accuracy or basis of the allegation or even that it was put in knowing that it was twice the sum that the invoices might have justified.

24. Miss Chow submits that such an inference should not be drawn, arguing that if such deviousness was intended, the invoices would not have been exhibited and the correct total not written on the document. She argues that there is clearly a triable issue here in that while the Plaintiff contends that all the prototypes have been returned to the Defendant, this is denied by the Defendant.

25. I am nonetheless left in considerable doubt as to the genuineness of this claim. It is true that the Plaintiff has not been able to produce any receipts showing that prototypes were returned. However, it explains that this is because the practice of the parties was not to document either the provision of the prototype to the Plaintiff or its return and that this was a practice which was carried on throughout their prior course of dealings.

26. Adding to my doubts in relation to this head of the counterclaim is the fact that its quantum is based solely on the sums shown in invoices delivered by prototype manufacturers to the Defendant for production of the prototypes. No basis has been put forward for thinking that this in any way represents the loss suffered as a result of their alleged non-return, it being common ground that the prototypes have been used in the manufacture of the relevant moulds to the Defendant's order. The value of such used prototypes, in the absence of any evidence that they are needed for any further economic purpose, is speculative, to say the least.

27. Again, I note that the Plaintiff seeks to argue that the possession of the prototypes should be regarded as the possession of the factory and not the Plaintiff. However, especially in the light of the contemporaneous correspondence and the Affirmation of So Kwok Bun, which clearly treated the Plaintiff as the entity dealing with the moulds, I consider this point at best to be arguable.

28. I conclude overall that there are strong grounds for doubting the genuineness of this head of the alleged set-off. I am certainly in serious doubt as to its alleged quantum and would not be prepared to treat it as justifying a set-off for anything approaching the full amount claimed.

The claim for $1,678,000.00 as the cost of engraving patterns retained by the Plaintiff

29. The evidence, which is not disputed, is that engraving patterns are made of plaster of Paris and constitute enlarged versions of the prototypes, produced in the course of manufacturing the moulds.

30. The Plaintiff alleges that once the mould is approved by the Defendant and then completed, the engraving patterns serve no further purpose and tend to be destroyed so that the plaster of Paris can be re-used. The Plaintiff alleges that until the Defendant decided not to pay its debt, it had never previously asked for the engraving patterns to be returned. The Defendant alleges on the contrary that the Plaintiff was under an obligation to return the engraving patterns, among other things, because the Defendant owned copyright in the underlying drawings. Miss Chow submits that it is at least arguable that the Plaintiff was under such an obligation and that failure to return these engraving patterns has caused the Defendant loss which it is entitled to set-off against the admitted claim.

31. To my mind, this claim is, if anything, even more suspicious than the claim relating to the prototypes. It was originally put forward as a claim worth $3,852,000.00. However, once again, this was at odds with the documents exhibited as setting out the basis of the claim. Once again, those documents contained a handwritten total in the sum of $1,926,000.00.

32. The Defendant has given no explanation whatsoever for putting forward the claim as worth $3,852,000.00 as opposed to the true arithmetical total. Nor has it given any explanation for why it has now shifted from its estimate of $1,926,000.00 and further reduced the claim to $1,678,000.00. All that Mr. Chiu says is that he estimates that the cost of producing engraving patterns tends to be some 10% to 30% of the cost of making the mould.

33. Once again, this appears to me to be an extremely flawed basis for alleging that loss has been incurred. It may have taken 30% of the cost of getting a mould made to produce an engraving pattern as part of the mould manufacturing process. However, once the engraving pattern has served its purpose within that process, there is no evidence suggesting that it retains any residual economic value. Accordingly, even assuming in the Defendant's favour that no engraving patterns have been returned by the Plaintiff, it does not follow that the Defendant has suffered a loss represented by the estimated 10% to 30% of the cost of manufacturing the mould, or any loss.

34. I have therefore substantial doubts as to whether this claim is genuine either in its substance or its quantum.

The claims for $43,162.00 and $2,067.00 as reimbursement for compensation paid by the Defendant to its customers and paid as shipping charges

35. Miss Chow accepts that the evidence put forward by the Defendant in support of these relatively small claims is incomplete. It is often impossible to see from the evidence what items form the subject-matter of this counterclaim. In some cases, the documents show that the Defendant has incurred certain charges to its customers. However, in general, neither the documents nor the Affirmation of Mr. Chiu shows why the Plaintiff is to be held responsible for such charges.

36. Moreover, in certain cases, the documents exhibited show that the Defendant has put forward as part of its counterclaim, charges which, on the face of the documents, were debited not to the Defendant but to an associated company called New-Ray Toys Co. Ltd. I have to say that this is very unimpressive and reinforces the view that the Defendant is prepared indiscriminately to put forward invalid materials in an attempt to ward off judgment.

The claim for materials retained

37. As I have stated, this claim has now been reduced to $56,603.00 as the value of the goods admittedly retained by the Plaintiff and for which it will give credit. However, as Miss Lan submitted, the fact that this claim was originally advanced in the greatly inflated sum of $379,159.00 is telling. The Defendant's own exhibited documents themselves include delivery notes which show that the great bulk of these goods had already been returned to the Defendant. This must have been something that the Defendant and Mr. Chiu were fully aware of, not only because of the delivery notes but because they were in receipt of the re-delivered goods. Yet the claim was put forward regardless of its truth or accuracy.

Conclusion

38. As is apparent from my examination of each head of the Counterclaim, I have grave doubts as to whether the defence is anything more than a sham aimed at delaying payment of an admitted debt. I have come very close to concluding that I should simply award the Plaintiff final judgment on its claim. However, I have decided that in the circumstances, the learned Master's approach of giving conditional leave to defend was correct and that I should likewise make such an order.

39. The Master ordered that the Defendant have leave to defend on condition of its paying into Court the sum of HK$1,734,461.80 representing the Plaintiff's claim less the claims concerning compensation, shipping costs and the agreed credit of $56,603.00 in respect of boxes, labels and other materials retained. As Miss Lan has indicated a willingness on the Plaintiff's part to consider paying the compensation and shipping costs claims, I am prepared likewise to restrict the amount ordered to be paid into court to the sum of HK$1,734,461.80. I will hear counsel as to the terms of the Order.

40. Having heard counsel, I will order that the condition be that the Defendant provide a bank guarantee in the said sum of $1,734,461.80 in a form agreed by the parties or, failing agreement, acceptable to the Court.