XCHRX LUCKY HORSE GARMENT FACTORY LTD. v. CHAN LIE HUNG t/a LUEN SANG TEXTILES CO. (a firm)

HCA18682/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.18682 OF 1999

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J U D G M E N T

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The applications

1. This is the plaintiff's appeal against the master's decision granting the defendant unconditional leave to defend the action. The plaintiff further asks for the determination of a preliminary question of law under Order 14A.

The Agreement

2. By a document in writing dated 7 April 1998 and entitled "Letter of Guarantee" ("the Agreement"), the defendant agreed to obtain from the plaintiff a transfer of 2,000 dozens of quotas ("the quotas") for the export of textile goods ("the goods") to USA. The Agreement provided that :

"We (i.e. the defendant) hereby give to you the following guarantees :-

(1) that we shall utilize a minimum of ninety-five percent (95%) of the said quota on or before Sept.30,98;

(2) that goods utilizing the said quota shall be of Hong Kong Origin and that should there be disputes over the goods or actions taken by the authorities under the Import and Export Ordinance and/or in cases of infringement of the textile origin and export control rules, we will indemnify you against all actions, claims, costs, penalties, losses and damages;

...

(5) that should we breach any of the guarantees aforesaid resulting in loss to you, or in the event of actions taken by the authorities mentioned in (2) above caused by us, our servants, agents or the ultimate contractor/s, then, in addition to the indemnities mentioned in (2) above, we further guarantee to transfer on a Type-B Transfer Basis (Permanent Transfer) to you or your nominees/assigns on or before April 30, 99 the ultimate quantity of quota that you lost or were short-allocated."

The transfer

3. Pursuant to this Agreement, on 8 April 1998, the plaintiff transferred the quotas to the defendant. The conditions of transfer provided, among other things, that the defendant shall comply with the conditions governing the allocation and utilization of the quotas as stipulated in the Quota Allocation Certificate and in the relevant notices to exporters issued by the Trade Department from time to time.

4. The defendant exported the goods using the quotas. The goods were manufactured by a company called Golson Limited ("Golson"). An export licence was required for the export. The printed condition of the export licence provided that the goods must be of Hong Kong origin.

5. The Trade Department informed the plaintiff on 15 July 1999 that the declared manufacturer, Gloson, was unable to establish that the goods were of Hong Kong origin and as a result the goods had failed to comply with the quota utilization conditions. The plaintiff was invited to make written representation. The letter further stated that the declared exporter, namely, the defendant, and the declared manufacturer, namely, Gloson, were also invited to make written representations. This was followed by correspondence between the plaintiff and the Trade Department.

6. In the letter dated 6 August 1999, the Trade Department repeated that the origin of the goods could not be established because of the unreliable records produced by Golson.

7. In a letter dated 10 September 1999, the Trade Department stated that Gloson and the defendant had failed to comply with the consignment check requirements and failed to produce sufficient evidence to prove that the goods were of Hong Kong origin. As a result, the Trade Department discounted the performance covered by the quotas transferred to the defendant for the purpose of subsequent quota allocation and the plaintiff's quotas for 1999 in respect of that product had been adjusted downwards by 2024 dozens.

8. The plaintiff claimed that the indemnity in Clause 2 of the Agreement was triggered, as action had been taken by the Government and the defendant was therefore liable to indemnify the plaintiff in the manner set out in Clauses 2 and 5. The plaintiff claimed that the defendant had refused to indemnify its loss and as a result the plaintiff had suffered loss and damages.

The defendant's case

9. In essence, the defendant's case is that the indemnity would come into play when the goods are not of Hong Kong origin, otherwise the use of the words in Clause 2 "that the goods shall be of Hong Kong origin" would be superfluous. Although the clause does not expressly provide that the indemnity would arise when the goods are not of Hong Kong origin, this clearly was the intention of the parties. Whether the goods are of Hong Kong origin is a question of fact. The matter cannot be dealt with in an Order 14 hearing because evidence is required on this issue.

The quota system

10. In order to deal with this case it is necessary to refer to the operation of the quota system in Hong Kong. This is not a matter that was disputed by the defendant. In Hong Kong, because of the restrictions on the export of textile products to the United States of America, an exporter can only export textile products to that country if it has the requisite quota. Quotas are transferable by the quota holders to other companies. The quantity of quotas used up against the shipment in a particular period governs how many quotas the quota holder may receive in the subsequent year. For the allocation of 1999 quotas, a quota holder which used less than 95% quota holdings in 1998 in a category would be offered quota allocation equal to the amount it utilized in 1998.

11. If there is a breach of the textile export control system, the Director General of Trade may nullify or discount the shipment performance of the quota. If the discounting of the performance of the quota leads to a less than 95% utilization of its quota holding, the quota holder will receive a substantial reduction of his quotas for the following year. According to the plaintiff, as a result of this risk, it is the practice of the industry that the transferee of quotas is invariably required to give a full and blanket indemnity to the transferor for all losses and damages if the transferor holder's holding is affected as a result of the nullification or discounting.

12. According to a Notice to Exporters issued by the Director General of Trades, applicants for export licence are reminded that consignment checks may be conducted by the Customs and Exercise Department. In such checks, the declared exporter and the declared manufacturer on an export licence application must produce the necessary documents and goods to show that the goods have been and/or will be properly exported in accordance with the provisions of the export quota control system. In particular, they must produce the relevant documents to substantiate the origin of the textile products covered by the licence application. The notice further provided that in case the declared exporter and manufacturer cannot produce sufficient evidence to prove that the textile products are of Hong Kong origin, the shipment performance gained by these licences would become ineligible for calculation of quota allocation to the quota suppliers and transferors of temporary quotas. Under the consignment check system, unless otherwise specified, goods claiming Hong Kong origin must have undergone principal processes of manufacture in Hong Kong.

The principle

13. In Investors Compensation Scheme Ltd. v. West Bromwich Building Society [1998] 1 WLR 896, Lord Hoffmann set out the principles in construing a document. The starting point is that an interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would otherwise have been available to the parties in the situation in which they were at the time of the contract.

Construction of Clause 2

14. Mr Zimmern, counsel for the defendant, formatted Clause 2 in order to illustrate his point on how this clause works. I would adopt his format :

"that goods utilizing the said quota shall be of Hong Kong origin and

that should there be disputes over the goods or actions taken by the authorities under the Import and Export Ordinance and/or in cases of infringement of the textile origin and export control rules,

we will indemnify you against all actions, claims, costs, penalties, losses and damages."

15. It is clear from Clause 2 that the defendant guaranteed two matters :

(1) the goods covered by the quotas shall be of Hong Kong origin and;

(2) if there shall be dispute over the goods or action taken by the authorities, then the defendant will indemnify the plaintiff.

In my view, bearing in mind the background in which the quota system works, the liability of the defendant arises when actions had been taken by the Trade Department on the goods. The use of the word "and" between the first part and second part of Clause 2 does not contradict this interpretation. This is the only way in which one could give some sense to the clause. The disputes and the actions that may be taken are obviously referable to the goods not being of Hong Kong origin or not proved to be of Hong Kong origin. The burden of proving that the goods are of Hong Kong origin is on the exporter and the manufacturer. This is something that has to be done before actions are taken by the Government. This being the case, there is no need for the plaintiff to establish by evidence afresh that the goods are not of Hong Kong origin before it can rely on the indemnity.

16. If action had already been taken by the Government to discount the shipment performance because of problem concerning the origin of the goods, it will make no sense if the matter has to be dealt with again by hearing factual evidence at the trial on the origin of the goods. Whatever may be the finding of the court, what really matters is the decision of the Trade Department. It is the decision of the Trade Department that will result in the discounting of the shipment performance and a subsequent reduction of the quota allocation to the quota holder. The intention of the parties is that the defendant will indemnify the plaintiff after action has been taken by the Government.

Appeal allowed

17. Accordingly, the plaintiff is entitled to summary judgment with damages to be assessed. The appeal is allowed and the master's decision is reversed. There shall be costs nisi to the plaintiff of the appeal and of the costs below.

18. The Order 14A summons seeks a determination on whether on the true construction of the Agreement, the defendant is obliged to indemnify the plaintiff in the event of actions being taken by the authorities. As my decision on the summary judgment application effectively disposed of this issue, I shall make no order on this summons.