KO CHI KEUNG v. LEE PING YAN ANDREW

HCA 18029/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 18029 OF 1999

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J U D G M E N T

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Background

1. The Plaintiff and the Defendant were classmates in university. They were friends for over 20 years. Whether they remain friends after this action remains to be seen.

2. The Plaintiff was and is the managing partner of an accountant firm, Messrs Li, Ko and Yan ("the Firm"). The Defendant, together with his wife ("Hui"), on the other hand, were the owners of or in control of a group of companies ("the Group"). There were principally 4 core companies in the Group, the most substantial of which was a company called CariPAC Limited ("the Company"). The Defendant was the Managing Director of the Company. The majority shareholder of the Company was a company called Cari Holdings Limited ("Holdings"). The Defendant and his wife held the majority of the shares of Holdings. There was a Mr Ivan Tong ("Tong") who held 2% of the shares of and in Holdings.

3. The Firm had acted as auditors and generally suppliers of accountancy services for the Group since about 1993. The Plaintiff joined the Firm in 1994.

The Agreement

4. In about 1999, the Defendant was desirous of restructuring the Group so that its holding company would be listed on the Growth Enterprises Market. He sought assistance from the Plaintiff and Tong. As a result, they entered into a Head Agreement on 25th May 1999 ("the Agreement").

5. By the Agreement, the Plaintiff, the Defendant and Tong agreed, inter alia, that:-

(a) Holdings were to be "transformed into an overseas company ("listco") following a corporate re-organization";

(b) "[the Plaintiff and Tong] would be prepared to be appointed as non-executive directors of the listco";

(c) The Defendant would remunerate the Plaintiff as follows:-

"I) With effect from 1/4/99, a monthly advisory fee of HK$30,000 be paid to [the Plaintiff] or its (sic) nominee by [the Company] until a service agreement be entered into for listing purposes;

II) With immediate effect, [the Defendant] transferred (sic) 2.5% of his existing shareholding in [the Company] to [the Plaintiff] at a nominal consideration and;

III) Upon successful listing, [the Defendant] would procure the listco, subject to advice, to grant stock option to [the Plaintiff] under a formula outlined hereunder."

6. The "formula" referred to was that the entitlements of the Plaintiff and Tong would be in the proportion of 3 to 2.

7. It is not in dispute that no service agreement was ever entered into. Neither was the Plaintiff ever formally appointed non-executive director of listco. Approval for listing was granted in April 2000 but the actual listing of listco had been postponed indefinitely.

Subsequent Agreements

8. On 29th July 1999, the Plaintiff and the Defendant entered into a further agreement ("the Supplemental Agreement") by which it was agreed that "with retrospective effect from 1st July 1999":-

(a) The monthly fee should be increased to HK$45,000;

(b) The "Bonus Shares (of the old shares)" should be increased from 2.5% to 5%;

(c) There should be a "success fee" of 1% of the amount raised; and

(d) 100% of out of pocket expenses would be reimbursed on a monthly basis.

9. On 7th September 1999, the Plaintiff proposed to render "void" the Agreement and the Supplemental Agreement. This was agreed to by the Defendant on 9th September 1999. This agreement ("the Cancellation Agreement") reads as follows:-

"[The Defendant] and [the Plaintiff] mutually agreed that the above-mentioned agreements as attached were void (sic), as far as all those terms and conditions between (sic) both of them, with retrospective effect from 1st September 1999."

10. On 14th September 1999, the Plaintiff and the Defendant agreed to render both the Cancellation Agreement and the Supplemental Agreement "cancelled and void" by writing those words across the face of the said two agreements.

The Claim

11. On 20th September 1999 the Plaintiff wrote to the Defendant ("the Termination Letter"). After reciting the Agreement and thanking the Plaintiff of his commitment to the listing exercise, the Plaintiff sought to terminate the Agreement with effect from 31st August 1999. Hence this action.

12. By his Re-Amended Statement of Claim, the Plaintiff sought, inter alia, the following reliefs:-

(a) Damages for breach of the Agreement;

(b) A Declaration that the Defendant had been holding 2.2% of the shares in listco or 2.2% of the quantity of listco shares used to swap for 100% of the Holdings shares and/or such number of listco shares as represented a 2.2% interest in Holdings on trust as constructive trustee for the benefit of the Plaintiff;

(c) All necessary accounts, inquiries and tracing orders.

13. By his Amended Defence and Counterclaim, the Defendant denied liability on the grounds of:-

(a) Misrepresentation made by the Plaintiff;

(b) Breach of warranties.

He also contended that the Agreement was discharged by reason of the Cancellation Agreement. Alternatively, the Agreement was lawfully terminated by the Termination Letter.

14. At the invitation of the Court, Mr Anderson Chow, Counsel for the Defendant, very properly abandoned all the defences of the Defendant at the trial and agreed to limit the issues as follows:-

(a) What was the effect of the cancellation of the Cancellation Agreement? In particular, did it revive the Agreement?

(b) If the Agreement was revived, was it terminable on reasonable notice; and if so, what period of notice would be reasonable?

(c) What damages is the Plaintiff entitled to?

(d) What relief is the Plaintiff entitled to in respect of the "bonus shares"?

Whether The Agreement Cancelled?

15. Only the Plaintiff and Tong gave evidence. The Defendant elected not to go into the witness box. I am satisfied that both the Plaintiff and Tong are essentially witnesses of truth. In any event, their evidence was not seriously challenged by Mr Chow.

16. The factual matrix surrounding the making of the Cancellation Agreement is this. Towards the end of August 1999, it was clear that all was not going well. The Group was short of funds and there was no major investor willing to commit support. The preparation of the necessary accountancy and audit work was behind schedule and the working relationship of the Plaintiff, the Defendant and Tong was tense if not over stressed. The Defendant wanted to cancel the Agreement although he also said he would nevertheless "honour" his obligations.

17. The Plaintiff said he was willing, in these circumstances, to enter into a new agreement with the Defendant which would redefine their working relationship and, in particular, the Plaintiff's future role with the Group. He was also prepared to cancel the Agreement even though there was no indication as to when, if at all, a new agreement would be made. This appeared to be a noble thing to do; but given the then relationship of the parties, it was hardly surprising.

18. The circumstances surrounding the cancellation of the Cancellation and Supplemental Agreements, however, are not so clear cut. There was some suggestion that Tong, for some reason, was not happy about the cancellation. The Plaintiff sought legal advice from a solicitor friend and he was told the Cancellation Agreement would not be valid without the consent of Tong. Or perhaps the Plaintiff had a change of heart. But for whatever reason, the parties not only did cancel the Cancellation Agreement but also the Supplemental Agreement. That suggests two things. First, the parties obviously had given the matter some thought. Secondly, they wanted not simply to restore things as they were before the Cancellation Agreement but they genuinely wanted to limit the Agreement to what it was before the Supplemental Agreement. Hence the cancellation of the Supplemental Agreement.

19. Mr Chow argued valiantly that the cancellation of the Cancellation Agreement could not, as a matter of law, "revive" the Agreement. But he also accepted that it would be possible for the parties to enter into a new agreement on the same terms with effect from day one, that is, 25th May, 1999.

20. It is not necessary for me to decide, as a matter of law, whether the cancellation of the Cancellation Agreement, had the effect of restoring the Agreement. What I need to decide is whether on the evidence the parties had agreed to restore the Agreement.

21. Mr Chow argued that the cancellation of the Cancellation Agreement constituted a written agreement and since the document was silent as to whether the Agreement was to be restored, there was no agreement that the Agreement should be revived. This argument ignores the reality of the situation. First, since it is not in dispute that the effect of the Cancellation Agreement was to "cancel" the Agreement only with effect from 1st September 1999, there was no agreement in existence after 9th September 1999, the date of the Cancellation Agreement. If there was no intention to restore the Agreement, there would be no need to further "cancel" the Cancellation Agreement let alone the "Supplemental Agreement". One does not cancel something which is not there. The parties could simply leave the matter as it was or come to another agreement as to how the accrued liabilities of the Defendant should be dealt with.

22. Secondly, by cancelling the Supplemental Agreement at the same time, the parties were effectively saying that the original agreement should stay minus the variation effected by the Supplemental Agreement. There would be no need to cancel the Supplemental Agreement if the Agreement never existed in the first place.

23. Thirdly, the continued existence of the Agreement was consistent with the Defendant's declared commitment to his obligation under the Agreement and the Plaintiff's hope that he would still have a role to play in the Group.

24. Indeed, the evidence goes further. The Plaintiff in paragraphs 167 to 170 in his first statement dealt with this matter in detail. He gave similar evidence in the witness box. The effect of his evidence was that there was an explicit agreement to "restore" the Agreement to its original form so that it could be properly terminated by consent of everyone involved including Tong. There is nothing to contradict the Plaintiff's evidence which I accept.

25. This result is also entirely consistent with the parties' conduct after the 14th September 1999 which suggested both the Plaintiff and the Defendant regarded the Agreement as still binding. There was, of course, the Termination Letter which plainly accepted the existence of the Agreement. There was also a letter dated 30th September 1999 by which the Plaintiff through his then solicitors demanded the Defendant to fulfil the Agreement. In reply, the Defendant's solicitors not only did not dispute the existence of the Agreement but sought to rely on the terms thereof and accused the Plaintiff of being in breach of the Agreement. In November 1999, the Defendant promised to settle the monthly fee in arrears the following week but failed to do so.

26. While subsequent conduct of the parties cannot be looked at in aid of construction of a written contract, clear admissions such as the above have been held to be admissible evidence in support of the existence of a contract. In Port Sudan v. Chettiar [1977] 2 Lloyd's Rep. 5, C.A., Lord Denning (at p. 11 1st col.) after citing Slatterie v. Pooley (1840) 6 M & W 665, said:-

"Following that case, it seems to me that if a party, by words or conduct, admits at a later date that a contract was concluded between him and the other; or admits that it contained such and such a term; then that admission is receivable in evidence and be given such weight as the Court thinks proper. Likewise the subsequent conduct of the parties is admissible to show that the contract was made and what were its terms: see what was said in this Court in Ferguson v. Dawson [1976] 2 Lloyd's Rep. 669; [1976] 1 WLR 213, particularly by Lord Justice Browne at pp. 680-682 and 1221-1229."

27. Similar approach was adopted in Mears v. Safecar Securities Ltd. [1983] 1 QB 54, C.A.: see in particular, the judgment of Lord Justice Stephenson at pp. 77A to 79C.

28. For these reasons, I am satisfied that as at the date of the Termination Letter, the Agreement was still binding and effective between the parties. It follows that by unilaterally terminating the Agreement without the consent of the Plaintiff, the Defendant was in breach of the Agreement.

Liability For Monthly Fee

29. Next, it was contended that as the Agreement provided that the monthly fee was to be paid by the Company and since the Company was not a party to the Agreement, no such fee was payable by the Defendant.

30. I do not agree. The Defendant was the Managing Director of the Company. Obviously, he was in a position to cause or procure the Company to pay and that plainly was his obligation. In my view, the Defendant is liable for the monthly fee in the event which happened that he failed or refused to cause or procure the Company to pay.

Notice To Terminate

31. The next issue is what should be the amount of damages payable on the Defendant's breach? The Agreement was silent as to its duration. However, it is clear both from its terms and the surrounding circumstances that it was not meant to go on for a substantial length of time.

32. The Agreement obviously was entered into for the purpose of the public listing of listco. It spoke of the monthly advisory fee being payable until a service agreement was entered into for listing purposes. The parties must have anticipated that the Agreement would only subsist until then. Although I have not heard any evidence as to precisely when listing was expected to take place, Miss Cruden accepted that the earliest date envisaged was 1st November 1999. That being the case, the minimum period of employment is about 7 months, counting from 1st April 1999.

33. Miss Cruden has tried to argue that Tong got a better deal from the Defendant in that the Defendant had promised to settle Tong's claim on the basis that Tong would be paid his monthly fee until 30th June 2000 and that perhaps was a good indication of what the Plaintiff should get in this action.

34. I do not agree. What was agreed between the Defendant and Tong by way of compromise is a matter entirely between them and is totally irrelevant as far as this action is concerned. If the Defendant had been overly generous with Tong, that was his privilege. The Plaintiff can hardly complain.

35. I cannot imagine that as a contract for service, it was intended that the Agreement could not be terminated upon reasonable notice. No one is indispensable and the Defendant must be entitled to engage some other advisor or advisors in place of the Plaintiff. Doing the best I can, I find that one month is a reasonable period in all the circumstances. As Mr Chow quite rightly pointed out, the Plaintiff was engaged on a monthly fee basis, it is reasonable that he be dismissed without cause on a month's notice. Since the Plaintiff was never paid any monthly fee at all, I find that he is entitled to be paid a monthly fee of HK$30,000 for a total period of 6 months and 20 days from 1st April 1999 to 20th October 1999.

Bonus Shares

36. Miss Cruden tried to argue that as the parties were anticipating a listing of Holdings or a company formed to take over Holdings, it must be an implied term that the Plaintiff was entitled to shares in listco as opposed to Holdings.

37. I do not see how such a term can be implied in view of the very clear express intention of the parties set out in the Agreement. It is clear from the Agreement that the parties intended that the Plaintiff should obtain his bonus shares "immediately". The shares were described as the Defendant's "existing shareholding in Holdings".

38. Even when the parties sought to vary the Agreement, they expressly referred to the bonus shares as "old shares" under the Supplemental Agreement.

39. I have no doubt that the parties were anticipating that in due course, Holdings or an overseas company would be listed and under the restructure proposal, the Plaintiff would swap his shares in Holdings for shares in listco. But that was never agreed. The Agreement provided that upon listing, the Defendant would procure listco to grant stock option to the Plaintiff under a formula therein set out. Obviously, the parties appreciated the distinction between the shares of Holdings and shares of listco and took care to deal with them separately.

40. Miss Cruden sought to rely on the evidence of the Plaintiff as to what happened after the Agreement. Such evidence is of no assistance to her cause. First, it is trite law that a Court cannot rely on subsequent conduct of the parties to interpret a contract: Whitworth Street Estates v. James Miller and Partners [1970] AC 92, H.L., Shuler A.G. v. Wickman Machine Tool Sales [1974] AC 235, H.L.

41. Secondly and more importantly, the evidence does not in any event support a consensual arrangement whereby the Plaintiff would be given listco shares instead of Holdings shares. This is not least because listco was not even in existence at the time.

42. It was the Plaintiff's own evidence that on 16th June 1999, there was an all parties' meeting at which he presented the restructure proposal. He produced a chart which is similar to a chart in the bundles which showed that prior to the restructure, he was a 2.5% shareholder of Holdings and that after the restructure, he was a 2.5% shareholder of listco.

43. On or about 15th July 1999, Messrs Richards Butler, the then solicitors acting for the Group produced a first draft of a document called Memorandum on Reorganization Proposal. In that proposal, the term "Shareholders" was defined as "Mr Lee, Mr (sic) Hui and Mr Tong and [ ]". It was the Plaintiff's evidence that it was intended that his name should be inserted in the blank there. From the proposal, it will be seen that Shareholders plainly referred to shareholders of Holdings and not listco. The proposal was that the Shareholder should first transfer their shares to a British Virgin Island company ("BVI(1)") after assets of the other core companies of the Group had been injected into BVI(1). The shares of BVI(1) would then be transferred to listco. The consideration owed by BVI(1) to the Shareholders for the transfer of Holdings shares would then be capitalized and listco would then issue shares to the Shareholders. The intention clearly was that the Plaintiff should first be made a shareholder of Holdings.

44. It is also clear from the evidence that at some point of time after the making of the Agreement, because of concern about stamp duty, the parties had contemplated delaying the transfer of Holdings shares to the Plaintiff and instead allotting listco shares to the Plaintiff after listco had been formed and the reorganization having taken place. But that never blossomed into reality. This can be seen from the 2nd draft of the Proposal prepared on or about 20th July 1999 where the blank in the definition of Shareholders was crossed out. The Plaintiff, however, admitted, that he was not aware of that change.

45. Furthermore, on 22nd July 1998, Messrs Richards Butler stated that they understood the Plaintiff was to be a shareholder of Holdings but did not know whether the proposed transfers had been implemented.

46. However, when the parties came to agree the Supplemental Agreement, they did not seize the opportunity to clarify that the Plaintiff was entitled to shares in listco. Instead, they agreed that the Plaintiff's entitlement to "old shares" should be increased from 2.5% to 5%.

47. In my judgment, the Plaintiff was only contractually entitled to 2.5% of the Defendant's shareholding in Holdings and was not entitled to any shares in listco under the Agreement.

Trust Of Holdings Shares

48. That does not mean, however, that as a matter of law, the Plaintiff does not now have any right in any of the listco shares.

49. It is a well established principle which Mr Chow accepted that when a shareholder agrees to sell specifically identified shares, the equitable ownership of the shares passes immediately to the purchaser: Hawks v. McArthur [1951] 1 All E.R. 22; Wood Preservation Ltd. v. Prior [1969] 1 WLR 1077, C.A. Under the Agreement, the Defendant had agreed to immediately transfer 2.5% of his shares in Holdings to the Plaintiff at a nominal consideration. This promise was not conditional on any event: see paragraph 50 of the Plaintiff's second witness statement which was not challenged by the Defendant.

50. There is no dispute that beneficial interest in those shares passed to the Plaintiff upon the making of the Agreement. If so, these shares were held on trust by the Defendant in favour of the Plaintiff immediately after the Agreement was made. It follows that the Plaintiff has a proprietary right to trace these shares into whatever form they may now become. If, for example, the Defendant had traded these shares for shares in listco, then the Plaintiff must be entitled to call for the vesting in him of the equivalent shares in listco. Likewise, if there were dividends or other asset distributions made on those shares, the Plaintiff would be entitled to such dividends or other asset distributions.

51. Mr Chow urged me to simply award damages to the Plaintiff on the Holdings shares as valued at 25th May 1999. I see no legal basis for that. The Plaintiff is, of course, entitled to elect for damages but if he insists on his proprietary rights, he is entitled to trace his shares into whatever form of property they now become. If these shares have increased in value, he is entitled to that increase.

Reliefs

52. For all these reasons, I shall enter judgment in favour of the Plaintiff as follows:-

(a) The Defendant do pay to the Plaintiff damages for breach of Agreement in the total sum of HK$200,000 with interest at 1% above prime until judgment;

(b) A Declaration that the Plaintiff was beneficially interested in 2.2% of the Defendant's shareholding in Holdings as at 25th May 1999;

(c) All necessary accounts and inquiries, tracing and vesting orders as regards those shares in their present form held by the Defendant.

53. The Defendant's Counterclaim is dismissed.

54. I shall also make an order nisi for costs in favour of the Plaintiff.