BRIO ELECTRONIC COMMERCE LTD v. TRADELINK ELECTRONIC COMMERCE LTD

CACV 271/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 271 OF 2013

(ON APPEAL FROM HCA 1714 OF 2010)

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J U D G M E N T

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Hon Cheung CJHC :

1.  I agree with the judgment of Barma JA and the order he proposes.

Hon Lam VP :

2.  I also agree with the judgment of Barma JA and the order he proposes.

Hon Barma JA :

3.  This was an appeal from the judgment of Deputy High Court Judge Whitehead SC dated 22 November 2013, by which he awarded the plaintiff, Brio Electronic Commerce Limited, HK$5 million as damages for the breach by the defendant, Tradelink Electronic Commerce Limited, of non-solicitation undertakings in its contract dated 31 December 2006 with the plaintiff (“the 2006 Agreement”).  The damages awarded were in accordance with a liquidated damages clause in the 2006 Agreement.  In this appeal, the defendant does not challenge the finding that it was in breach of contract.  It contends, however, that the term fixing the damages for the breach at HK$5 million was not an enforceable liquidated damages clause, but an unenforceable penalty.  It therefore seeks to have the award of damages against it set aside, and the action dismissed on the basis that the plaintiff did not adduce any evidence as to its actual loss arising from the breaches that were found to have occurred, and so had not proved any actual damages.

4.  The defendant is a listed company which was, until 2003, the sole operator of a system (“TDEC”) which enabled importers and exporters using it to make online submissions of official declarations in respect of goods imported into and exported from Hong Kong in place of filling in and submitting paper forms.  The plaintiff is in the business of providing computer hardware, software, system integration and consultancy services.  Since about 1999, the plaintiff had offered its clients a software package designed by it which enabled the clients to carry out a number of import or export related tasks, such as freight booking, generation of transport documents such as bills of lading or air waybills, and the making of the necessary trade declarations through TDEC, with a single set of data inputs, thus saving time and minimising the risk of errors and inconsistencies (as the necessary information would only have to be recorded once, rather than separately into separate programs for different tasks).  According to the plaintiff, its software was superior to that of the defendant, because of the additional functions that it performed.  Among the plaintiff’s clients were major courier companies such as DHL, Fedex and UPS. The plaintiff said that only importers and exporters with fairly substantial operations are likely to use TDEC, and that the market, in terms of potential clients for the use of software like that of the plaintiff and defendant, was thus limited.  The consequence of this, the plaintiff contended, was that the parties’ respective customer bases were therefore very important to them and would be jealously guarded.

5.  In 2003, the Government decided to begin to open up the market for the provision of electronic trade declaration facilities, and granted a second licence to provide such facilities to another company in addition to the defendant.  With the advent of competition, the defendant entered into an agreement with the plaintiff dated 23 September 2003 (“the 2003 Agreement”) by which the plaintiff agreed to cooperate solely with the defendant, and not with the defendant’s new competitor.  At this time, the plaintiff says that it had about a 5% share of the market for online trade declarations.  By entering into the 2003 Agreement, the defendant ensured that none of the plaintiff’s clients would connect with the service provided by the defendant’s competitor (Clause 2 of the 2003 Agreement).  In return, the defendant agreed not to seek to persuade the plaintiff’s customers (whose identities it would necessarily become aware of) from leaving the plaintiff to use the defendant’s own services instead (Clause 3 of the 2003 Agreement).  The parties appear to have recognised that it would be difficult to quantify or prove the loss that might be caused if this were to happen, stating in the contract that they each recognised that the other would be “irreparably injured” by a breach of the obligations just referred to, and agreed to the provision of remedies such as injunctions and specific performance without the need to prove actual damage (Clause 5 of the 2003 Agreement).  The 2003 Agreement was for a term of just under 5 years, expiring on 31 December 2008.

6.  According to the plaintiff, during 2006, about half way through the term of the 2003 Agreement, the defendant poached two of its most important customers, DHL and Fedex.  The plaintiff complained and demanded compensation from the defendant, seeking damages of some HK$14.76 million.  The defendant initially offered only HK$200,000 by way of compensation.  In the end, the parties settled their dispute by the defendant paying the plaintiff just under HK$1.9 million, and the entry into of the 2006 Agreement.

7.  The 2006 Agreement was for a two-year period ending on 31 December 2008, the same date as the 2003 Agreement was to have ended.  It was therefore evidently intended to regulate the relationship of the parties for what was left of the term of the 2003 Agreement.  It contained provisions that were very similar to the 2003 Agreement.  In particular, Clauses 3 and 4 of the 2006 Agreement (which respectively set out the plaintiff’s and the defendant’s obligations in relation to their common clients who accessed TDEC through the plaintiff’s software) were in much the same terms as Clauses 2 and 3 of the 2003 Agreement.  Clause 4(a) prevented the defendant from seeking to dissuade such customers from using the plaintiff’s software (although it permitted generalised, non-targeted, promotional materials to be sent, and did not seek to prevent the defendant from dealing with such customers who approached the defendant of their own volition provided that the defendant informed the plaintiff of any such approaches as soon as possible).  Clause 4(b) prevented the defendant from developing, whether by itself or in conjunction with others, software that had similar functionalities to that offered by the plaintiff.  Clause 4(c) prevented the defendant from entering into a similar agreement with third parties that was aimed at such customers.

8.  The liquidated damages clause with which we are concerned was at Clause 6(d) of the 2006 Agreement.  It provided that the defendant agreed that the plaintiff would be irreparably injured by a breach of any of the terms in Clause 4, and that (in the event of a breach) the defendant should immediately make full payment of an amount of HK$5 million to the plaintiff.  A materially identical liquidated damages clause going the other way, in favour of the defendant in the event of a breach by the plaintiff of Clause 3, appeared as Clause 6(c). The same sum of HK$5 million was also agreed as damages in the event of a breach of mutual confidentiality obligations contained in Clause 9 of the 2006 Agreement (see Clauses 9(d) and (e)).

9.  Subsequently, the 2006 Agreement was extended for a further year, so that it would expire on 31 December 2009.  This was achieved by a supplementary agreement dated 11 December 2008.

10.  The plaintiff’s case as to the way in which the 2006 Agreement came about was contained in the evidence of Mr Eldon Yeung, who was the plaintiff’s representative responsible for negotiating the settlement of the 2006 dispute about the poaching of DHL and Fedex, and thus for negotiating the terms of the 2006 Agreement.  Mr Yeung said that he dealt mainly with Mr Alfred Yuen of the defendant, and also with Mr Justin Yue (who was the CEO of the defendant, and who was primarily involved with drafting the 2006 Agreement).  The plaintiff’s case was that the genesis of the 2006 Agreement lay in the breaches by the defendant of the 2003 Agreement, and that it was part of the overall settlement of the disputes arising out of those breaches.  Mr Yeung explained that the losses that the defendant would suffer as a result of poaching of its customers were not limited to the loss of the commission it would earn as a result of connecting the customers concerned to the defendant’s system (such commission amounting to some HK$2.5 million per year, so that HK$5 million represented two years’ loss of commissions).  There were, according to Mr Yeung, other losses as well, as the plaintiff also provided other services to those customers.  More importantly, having already lost two of its most important customers, the plaintiff was very concerned at the prospect of losing further customers (particularly substantial ones), as continued loss of clients might well result in its business no longer being viable, as it would find it difficult to enter into an agreement with either the defendant or the defendant’s rival if it did not have a sufficiently substantial client base to bring to the negotiating table.  In other words, absent a worthwhile client base, the plaintiff would have difficulty in persuading the defendant (or its rival) to do business with it at all. Similarly, the lack of a significant client base might well make it harder for the plaintiff to attract new customers, thus rendering its services less marketable.  The further loss of clients might, therefore, put the plaintiff out of business altogether.  Mr Yeung said that he mentioned these matters to Mr Yuen and Mr Yue during his negotiations with them.  The Deputy Judge preferred Mr Yeung’s evidence in this respect to that of Mr Yue, and there is no challenge to his having done so.

11.  The plaintiff alleged that the defendant was in breach of Clause 4 of the 2006 Agreement by having sought to persuade five of the plaintiff’s customers to cease using the plaintiff’s services to connect to TDEC and switch instead to the defendant’s own services.  In the event, the Deputy Judge found that the breach was established in relation to two out of the five customers in respect of which it was alleged – Radica and Hankyu.  He did not find the breach established in relation to the most substantial of the customers in respect of which the complaint was made – the courier services company UPS.  However, having found that there had been a breach of Clause 4, the Deputy Judge went on to award damages as provided for by Clause 6(d).

12.  Although the defendant contended that Clause 6(d) was a penalty and therefore unenforceable, the Deputy Judge did not accept this argument.  He concluded that Clause 6(d) was not a penalty, and did so because in his view, the 2006 Agreement was a commercial agreement entered into by parties who were very familiar with the trade with which the 2006 Agreement was concerned after lengthy negotiations, that the genesis of the clause was the prior breach of the 2003 Agreement, that the assessment of damages for a breach of Clause 4 was a highly uncertain and difficult exercise, and that the agreed amount of HK$5 million was the parties’ best pre-estimate of the damages that were likely to be suffered in the event of a breach of Clause 4, which was by no means extravagant or unconscionable.

13.  Before us, Mr Edward Chan S.C. (appearing with Mr Jonathan Chang for the defendant) contended that the Deputy Judge was wrong to conclude that Clause 6(d) represented a genuine pre-estimate of damages so as to be an enforceable liquidated damages clause.  He submitted that, properly understood against the factual background in which the 2006 Agreement was entered into, Clause 6(d) should rather be regarded as an attempt to deter the defendant from breaching Clause 4, and thus a penalty and unenforceable.

14.  Mr Chan accepted that the burden was on the defendant to establish that Clause 6(d) was a penalty clause.  He submitted that in order to determine whether or not the clause was a penalty, guidance could be derived from the classic speech of Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79, at 86-88, in which he formulated the following propositions as being the matters that should be considered:

“1. Though the parties to a contract who use the words ‘penalty’ or ‘liquidated damages’ may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages ...

2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage …

3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms an inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach …

4. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:

(a) It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach …

(b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid …

(c) There is a presumption (but no more) that it is penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more of all of several events, some of which may occasion serious and others but trifling damage’ …

On the other hand:

(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility.  On the contrary, that is just the situation when it is probable that pre-estimated damages was the true bargain between the parties …”

15.  He went on to suggest that assistance could also be derived from the approach suggested by Arden LJ in Murray v Leisureplay Plc [2005] EWCA Civ 963, where (at paragraph 54 of the judgment) she put forward five questions as a step by step guide to the questions the court should ask itself in order to determine whether a clause was a penalty:

“i) To what breaches of contract does the contractual damages provision apply?

ii) What amount is payable on breach under that clause in the parties’ agreement?

iii) What amount would be payable if a claim for damages for breach of contract was brought under common law?

iv) What were the parties’ reasons for agreeing the relevant clause?

v) Has the party who seeks to establish that the clause is a penalty shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purposes of the Dunlop case, and, if he has shown the latter, is there some other reason which justifies the discrepancy between [ii) and iii)] above?”

16.  However, in the same case, the other members of the English Court of Appeal (Clarke LJ and Buxton LJ) disagreed with this proposed approach, as it brought rigid and inflexible elements (requiring in every case a comparison between the damages provided for by the contract with the loss that would have been suffered in the particular case under consideration), and then, if there should be a discrepancy between those amounts, requiring the discrepancy to be justified (whether by virtue of its being a genuine pre-estimate of damages or for some other reason) (see per Buxton LJ at paragraphs 113 and 114, and per Clarke LJ at paragraph 105).  In our courts, Lam JA (as he then was) has expressed support for this broader approach: see Ip Ming Kin v Wong Siu Lan (unreported, 28 May 2013, CA, CACV 201/2012, at paragraph 60).

17.  For my own part, I also agree that the particular questions formulated by Arden LJ represent too rigid an approach to what is a question that should be considered in broad and general terms.  There are several reasons for this.  As Arden LJ recognised (at paragraph 51 of her judgment in Murray), and Clarke LJ and Buxton LJ emphasised, the level of review is low, and there is no necessity for there to be an accurate assessment of the damages that would have been awarded at common law.  This in itself suggests that the comparison is likely to be of limited utility.  Moreover, to require such a comparison to be made would remove one of the commercial advantages that a liquidated damages clause is recognised as achieving – the dispensation with the need to adduce evidence on damages and to calculate them, particularly in cases where proof of the amount of damages suffered may be difficult to achieve to any degree of precision.  Further, it is well recognised that in considering whether a clause is a valid liquidated damages clause or a penalty, one must consider the matter from the standpoint of the parties at the time when they entered into the contract.  At that point in time, the precise manner in which the contract might be breached, and the consequences of a breach are not always capable of accurate prognostication.  A given contractual obligation can be breached in a number of ways, with differing consequences for the innocent party.  Further, even a particular breach of an obligation might have varying consequences, depending on the circumstances that obtain when the breach occurs.

18.  The main thrust of Mr Chan’s submission was to emphasise the fact that the defendant’s obligations under clause 4 could be breached in relation to many different customers, and in many different permutations.  For example, there might be an attempt to dissuade a single customer from dealing with the plaintiff, and the consequences to the plaintiff would depend on whether or not the attempt was successful, and also on the identity and importance of the customer.  Or there might be an approach to several customers, or all of the plaintiff’s customers – depending on the permutation, the consequences in terms of damage could vary substantially.  Mr Chan suggested that in relation to the customers in respect of whom a breach was found to have been established (Hankyu and Radica), the actual damages likely to be suffered by the plaintiff were small. Radica was a less significant customer, using the plaintiff’s software to connect with TDEC only some 10-20 times a month, while Hankyu did not, in the end, switch to the defendant’s software.

19.  With respect, I do not think that this is the right approach to take.  It focuses on the actual breach that has been found to have taken place, and then seeks to compare the damages that might be suffered with the stipulated damages.  But what is required is to consider the likely outcome of a breach at the time the contract was entered into.

20.  Where a breach could have a range of outcomes or consequences, there is much to be said for the first proposition stated by Lord Dunedin in Dunlop – that a clause will be held to be a penalty where the amount stipulated for is extravagant compared with the greatest loss that could be proved to flow from the breach.  This approach recognises that the consequences of a breach cannot be foreseen with precision, and allows the parties to stipulate for a sum which will provide adequate compensation in the event of breach.

21.  In this case, as Ms Eu pointed out, one of the plaintiff’s major concerns (against the background of having lost two of its most important customers) was that it would suffer a further loss of customers as a result of breaches of Clause 4 by the defendant which might have a substantial deleterious impact on its remaining customer base, such that its business would no longer be viable – both because it would have few customers left, and also because it might no longer have a sufficient level of business to enable it to enter into  such arrangements with the defendant or the defendant’s competitors.  Further, as Ms Eu also submitted, breaches of Clause 4 would necessarily be seriously detrimental to the business relationship between the parties, such that it might no longer be possible for them to continue their cooperation.  In those circumstances, an assessment of the likely damage flowing from a breach of Clause 4 by reference to two years’ commissions was not unreasonable.  If the plaintiff were to find its business no longer viable, the loss of commissions and profits would extend for longer than two years.

22.  Mr Chan also suggested that the fact that the plaintiff had initially sought damages of HK$14.76 million for the breach of the 2003 Agreement, but ultimately settled for compensation of HK$1.9 million, spoke volumes against the genuineness of the stipulation for HK$5 million as a proper pre-estimate of damages.  But all that this shows is that the plaintiff settled its earlier claim for less than it had sought. It does not establish that the amount which the plaintiff eventually accepted was an accurate reflection of its losses.  It is (to put it no higher) just as likely that the plaintiff, finding it difficult to prove its losses, accepted an amount in settlement which was less than it would have liked.  Moreover, as Mr Yeung made clear in his evidence, the entry into of the 2006 Agreement, with its additional terms, including the liquidated damages clause, was also part of the settlement package – so that the plaintiff obtained better protection for its interests for the remainder of the term of the arrangement with the defendant.

23.  Mr Chan submitted also that given the number of customers of different size and importance, the stipulated sum should be viewed as a penalty, as it sought to give the same amount of compensation for a range of breaches, some of which might involve serious damage, while others would involve only slight damage. However, the nature of the damage would appear to be the same in all such cases, and as Lord Parker pointed out in Dunlop (at page 98), although breach of a non-solicitation covenant could occur on a number of occasions and might lead to different actual loss depending on whether or not the solicitation was successful, and the value of the customer whose business was lost, this was not something that had been held to raise any presumption or inference that the sum agreed was a penalty.  To hold otherwise would in effect require the parties to estimate in advance the amount of damages payable for every different way in which a breach might occur, an exercise which is not, in my view, called for.

24.  Finally, Mr Chan drew attention to the fact that the same sum of HK$5 million was also stipulated as the amount of agreed damages for a breach by the plaintiff of Clause 3 of the 2006 Agreement, and for a breach by either party of the confidentiality obligations in Clause 9 of that agreement.  However, we are not here concerned with whether any of those other stipulations are penalties. Having regard to Mr Yeung’s evidence, which was to the effect that he proposed an agreed damages clause of HK$5 million in respect of breaches by the defendant of its obligations under Clause 4 and explained briefly the basis on which he had arrived at this amount, that he agreed in return to a similar clause in respect of the plaintiff’s obligations under Clause 3, and that the inclusion of similar clauses in Clause 9 was at Mr Yue’s initiative, it does not seem to me that this is a point which bears upon the validity of Clause 6(d).

25.  For the reasons explained above, I do not consider that the defendant has discharged its onus of showing that Clause 6(d) is a penalty and thus ineffective.  On the contrary, I think that the Deputy Judge was right to have regard to the factors mentioned in paragraph 12 above, which pointed to the clause being a valid liquidated damages provision.

26.  I would therefore dismiss this appeal, and make an order nisi that the costs of the appeal should be paid by the defendant to the plaintiff, to be taxed on the party and party basis if not agreed, with a certificate for two counsel.

Hon Cheung CJHC :

27.  Accordingly we dismiss this appeal and make the costs order nisi as indicated in the preceding paragraph.