DISTRIBUTION LTD v. AMANN & SOHNE GMBH & CO KG AND ANOTHER

HCA 1459/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1459 OF 2006

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J U D G M E N T

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Introduction

1.  The plaintiff is a company incorporated in Hong Kong with limited liability.  It is a family company owed by Mr Edmund Wong Tak Yan (“Mr Wong”) and his wife.  The plaintiff carries on and has at all material times carried on business as, inter alia, a distributor and seller of industrial sewing threads.

2.  Prior to March 1990 Mr Wong as sole proprietor of Distribution HQ carried on business as a distributor and seller of sewing threads.  The plaintiff was incorporated on 28 July 1989.  After March 1990 the plaintiff took over the business previously carried on by Mr Wong as sole proprietor of Distribution HQ.

3.  The 1^st defendant is a company incorporated in Germany and carries on business as a manufacturer of sewing threads.  The 2^nd defendant is a company incorporated in Hong Kong and carries on business as a distributor of sewing threads.  The 2^nd defendant is a wholly owned subsidiary of the parent company of the 1^st defendant.

4.  The Amann Group commenced business in 1854 in Germany and is one of the leading industrial sewing thread manufacturers in the world.

5.  In about 1994 the Amann Group acquired one of its biggest rivals as manufacturers of industrial threads, Ackermann Threads also of Germany.  The 2^nd defendant was at that time part of the Ackermann Group and later on in May 2002 the 2^nd defendant changed its name to its present name.

6.  SERAFIL is the brand name of a high quality industrial sewing thread manufactured by the 1^st defendant at all material times.

7.  By an agreement dated 4 January 1999 made between the plaintiff, the 1^st defendant and the 2^nd defendant (“the distribution agreement”) the plaintiff was appointed “sole distributor” for the 1^st defendant for the sale of SERAFIL in ticket sizes from 7 to 80 for Hong Kong, the Mainland and Macau (“the territories”) for the industries as specified in the distribution agreement as follows:

“Shoes and handbags, regardless of their composition

Car seats and Safety harnesses

Wire/Cable manufacturing

Wet suit

Book-binding

Parachutes, Para-gliders and Hang-gliders”

8.  It was also agreed that the plaintiff would not sell SERAFIL in the said ticket sizes to any entity outside the territories and to the three customers reserved for the 2^nd defendant as follows:

“Neil Pryde

 Pop Wind (producing for ECCO, Denmark)

 Full Sports”

9.  It was also agreed that the 2^nd defendant was the “sole distributor” of all other Amann products for the territories including SERAFIL in finer ticket sizes (120 to 200).  It was agreed that the 2^nd defendant would not sell SERAFIL in ticket sizes 7 to 80 in the territories except to the three specified customers. 

10.  By a letter dated 31 January 2006 from the 1^st and 2^nd defendants to the plaintiff (“the notice of termination”) the plaintiff was given six months’ notice of termination of the distribution agreement which meant that the termination would be effective on 31 July 2006.

11.  The plaintiff’s claim against the defendants is for damages for wrongful termination of the distribution agreement by serving the notice of termination which gave six months’ notice.

12.  The defendants deny that the distribution agreement was wrongfully terminated as on the defendants’ case the six months’ notice given was reasonable.

13.  The defendants also counterclaim against the plaintiff for the balance of the price of goods sold and delivered.

14.  At the commencement of the trial the plaintiff accepted its liability to the 1^st defendant on its counterclaim in the sum of EUR271,328.54 and to the 2^nd defendant on its counterclaim in the sum of HK$19,227.54.  On the agreed exchange rate of EUR 1 to HK$9.90 the plaintiff accepted liability on the 1^st defendant’s counterclaim in the agreed sum of HK$2,686,152.50.

15.  The trial proceeded on the plaintiff’s claim for damages against the 1^st and 2^nd defendants for wrongful termination of the distribution agreement by serving the notice of termination giving six months’ notice of termination.

16.  The question of liability and the quantum of damages were both in issue between the parties.

Liability

The main issue

17.  Although a number of issues were raised on the pleadings, by the time of the closing submissions only one main issue remained.

18.  The distribution agreement did not expressly provide for the manner in which the distribution agreement could be terminated.

19.  It was accepted and, in my view, correctly conceded that there was an implied term in the distribution agreement that there was a right of termination of the distribution agreement by the plaintiff on the one part and the 1^st defendant and the 2^nd defendant on the other part by the giving of notice of a reasonable period of time.

20.  Mr McLeish, for the defendants, also rightly conceded that there was also an implied term in the distribution agreement that there was an obligation on the 1^st defendant to fulfil, as far as reasonably practicable, orders placed by the plaintiff for SERAFIL in ticket sizes 7 to 80 so as to enable the plaintiff to meet orders for the same placed with it for delivery by the plaintiff during the subsistence of the distribution agreement to entities in the territories.

21.  The plaintiff’s case is that twelve months’ notice of termination was reasonable whereas the defendants’ case is that six months’ notice of termination was reasonable.

22.  The remaining main issue on the question of liability is what is the length of a reasonable period of a notice of termination in all the circumstances?

23.  There is also an issue as to whether as a matter of construction of the distribution agreement the plaintiff was an exclusive distributor of SERAFIL in ticket sizes 7 to 80 in the territories to the exclusion of even the 1^st defendant. 

The applicable legal principles

24.  The applicable legal principles are not disputed.

25.  The onus is on the plaintiff as the distributor to prove that the six months’ notice given by the notice of termination was not a reasonable period (Crawford Fitting Co. and others v Sydney Valve & Fittings Pty Ltd and another (1988) 14 NSWLR 438 at 448).

26.  The reasonableness of the period of notice depends upon the circumstances existing when the notice is given and not at the time the contract is made (Australian Blue Metal Ltd v Robert Frank Hughes and others [1963] AC 74 at 99; Martin-Baker Aircraft Co. Ltd and another v Canadian Flight Equipment Ltd [1955] 2 QB 556 at 581; Decro-Wall International S. A. v Practitioners in Marketing Ltd [1971] 1 WLR 361 at 376 and 377; GC Nanda & Sons (HK) Ltd v Air India Ltd [2003] 1 HKLRD 817 at 827; Good Earth Agricultural Co. Ltd v Novus International Pte Ltd [2007] 1 HKLRD 685 at 696 and 697).

27.  As to what is a reasonable period of notice, it is appropriate to apply the ‘chief purpose’ test which was applied in Crawford Fitting, Good Earth Agricultural and GC Nanda.  The ‘chief purpose test’ was described in the majority judgment of McHugh JA (as he then was) in Crawford Fitting at 448 as follows:

“The chief purpose of a notice for a reasonable period, therefore, is to enable the parties to bring to an end in an orderly way a relationship which, ex hypothesi, has existed for a reasonable period so that they will have a reasonable opportunity to enter into alternative arrangements and to wind up matters which arise out of their relationship.  Matters to be wound up will include carrying out existing commitments, bringing current negotiations to fruition, and, where appropriate, obtaining the fruits of any extraordinary expenditure or effort carried out within the scope of the agreement.  The line between ordinary recurrent expenditure and effort and extraordinary expenditure and effort will not always be easy to draw.  But in general it will be determined by what the parties would reasonably have contemplated was extraordinary effort or expenditure.”

28.  In construing the distribution agreement, regard must be had to the “matrix of fact” at the time the agreement was entered into (Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912.  As Lord Hoffman said at 912:

“Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.”

29.  It is also useful to bear in mind what Lord Hoffman succinctly said in Jumbo King Ltd v Faithful Properties Ltd & others (1999) 2 HKCFAR 279 at 296:

“The construction of a document is not a game with words.  It is an attempt to discover what a reasonable person would have understood the parties to mean.  And this involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve ………………………………………………..  .…………………………………………………………………But the overriding objective in construction is to give effect to what a reasonable person rather than a pedantic lawyer would have understood the parties to mean. Therefore, if in spite of linguistic problems the meaning is clear, it is that meaning which must prevail.”

The witnesses

30.  I heard evidence from Mr Wong and Mr Bodo Thomas Boelzle (“Mr Boelzle”).  Both witnesses gave their evidence honestly and truthfully and, in my view, gave a fair account of the events as best as they could.  This case does not depend on the credibility of the witnesses.  I accept their evidence.  I would, however, observe that Mr Boelzle only became involved personally in the relationship between the plaintiff and the defendants when he was in charge of marketing and sales of the 1^st defendant in 2004.  The evidence that he gave in relation to matters prior to that time were based on what he understood the position to be relying on the documentation that he had seen and on hearsay.

The evidence and findings

31.  The first question to consider is whether the plaintiff was the sole and exclusive distributor of the 1^st defendant for SERAFIL in ticket sizes 7 to 80 for the territories, save for the three customers reserved for the 2^nd defendant under the distribution agreement.

32.  It seems to me that this depends on the proper construction of the distribution agreement.

33.  The defendants dispute that the plaintiff was the exclusive distributor, to the exclusion of even the 1^st defendant, for SERAFIL in ticket sizes 7 to 80 for the territories, save for the three customers reserved for the 2^nd defendant under the distribution agreement.

34.  In about 1985 Mr Wong as sole proprietor of Distribution HQ began to import sewing threads manufactured by the 1^st defendant under the brand name SERAFIL.

35.  It is common ground that SERAFIL is a continuous filament polyester thread which is of high quality.  The continuous filament gives it greater strength than threads made of filaments that are not continuous.  SERAFIL was mainly used in high end leather goods like shoes and handbags and in furs.  It was also used for wet suits and sails and hang-gliders due to its high strength and quality.  One of the attributes of SERAFIL was its sewability in the sense that in a given product using SERAFIL as the sewing thread maximum performance in a sewing machine would be achieved with no problems of skipped stitches, elongations or breakages.  It is also common ground that in terms of quality SERAFIL is and at all material times was the best product on the market.  Mr Wong has described SERAFIL as a hero product.

36.  On the undisputed evidence, Mr Wong started off with a relatively small business as sole proprietor operating from his home and without any supporting staff.

37.  Mr Wong gave evidence that he built up the market for SERAFIL in the territories by his efforts and his business became profitable enough for him to incorporate the plaintiff and transfer the business to the plaintiff.

38.  In about 1985 Mr Wong introduced SERAFIL in the territories and spent much time and effort in getting manufacturers and owners of leading brands to use SERAFIL in their products. 

39.  I have no doubt, as Mr Wong said and as I accept and find, that Mr Wong in the early years did spend much time and effort in promoting SERAFIL and in convincing manufacturers in factories across the border in the Mainland to use this high quality sewing thread in their products.  Because of its higher cost when compared with other threads, he had difficulty in persuading manufacturers to use SERAFIL.  But because of its high quality and sewability he was able to persuade manufacturers to accept SERAFIL. 

40.  SERAFIL became accepted as a product which manufacturers and owners of leading and high end luxury brands wished to use for their products like handbags and shoes. 

41.  Mr Wong said, and I accept, that it was important to him to obtain an exclusive right to sell SERAFIL in the territories as others might wish to sell SERAFIL as well.  He said that in 1986 an agreement was reached with the 1^st defendant whereby Distribution HQ was given the exclusive right to sell SERAFIL in the territories.  In return Distribution HQ promised not to sell products competing with SERAFIL.  This agreement was twice extended in 1987 and 1988.

42.  Mr Boelzle, who gave evidence on behalf of the defendants, did not have any personal knowledge of the matters prior to his being in charge of the 1^st defendant’s marketing and sales in 2004.  His evidence of matters prior to 2004 was based on his reading of the relevant correspondence and emails and on hearsay.

43.  It is clear from the letter dated 24 June 1987 from the 1^st defendant to Distribution HQ that the 1^st defendant was “extending the exclusivity for SERAFIL until June 30, 1988” and also sought the confirmation of Mr Wong that he “will not sell any competitive products against SERAFIL”. 

44.  I accept Mr Wong’s evidence and find that in 1986 the 1^st defendant agreed that his firm was to be granted the exclusive right to sell SERAFIL in the territories and that in return Mr Wong agreed not to sell competing products in the territories.  It was this agreement that was “extended” for another year by the said letter dated 24 June 1987.  This agreement was further extended for a further year until 30 June 1989 by the letter dated 14 March 1988 from the 1^st defendant to Distribution HQ.

45.  Although from 30 June 1989 until the entering of the distribution agreement of 4 January 1999 Mr Wong did ask for further extensions in writing of the exclusivity agreement this was not forthcoming.

46.  As Mr Wong said, and as I accept and find, all sales of SERAFIL in the territories after 30 June 1989 continued to be made through his firm and later through the plaintiff after it took over the business of the firm.  I also accept that in return he promised not to sell sewing threads in competition with SERAFIL in the territories.  Mr Wong said, and I accept and find, that there was a mutual understanding that there was an exclusivity agreement as before even though there was no written agreement to that effect. 

47.  In evidence Mr Boelzle accepted that after 30 June 1989 Mr Wong carried on as a distributor the same as before although there was no exclusivity agreement in writing.  He accepted that apart from Mr Wong and the plaintiff there were no other distributors of SERAFIL in the territories.

48.  As a matter of fact the 1^st defendant never directly supplied SERAFIL to any customers in the territories at any time prior to the distribution agreement.  That remained the position after the distribution agreement.

49.  I find that after 30 June 1989 the 1^st defendant regarded Distribution HQ as a distributor as before. 

50.  By the fax from the 1^st defendant signed by Mr Hinz dated 18 August 1989 to Distribution HQ assurances were given to Mr Wong that he was the 1^st defendant’s distributor.  At that time one Marco Fur (Asia) Ltd had made some direct enquiries with the 1^st defendant and this led to Mr Wong complaining about the same to the 1^st defendant by his fax dated 18 August 1989.  In his reply also on 18 August 1989 Mr Hinz stated:

“Thank you for your today’s fax, relative to your repeated request for exclusivity.  I can fully understand your scare, as you have invested a lot of effort into our business and you more and more have concentrated on Serafil and some other Amann items.  For us there is no doubt that you are our man in Hongkong and I assure you that we are not intending to “side step” you as our local distributor.  I have just had a discussion with Helmut Cordes and Peter Brüssel to clarify “the whole thing” and to find out, whether we might have done something wrong.

We have had some inquiries, esp. from Marco Fur, but this was nothing unusual for us, the more as we have immediately informed you about it.  All business which would arise out of those inquiries would automatically run through Edmund Wong.

So, please be rest assured, that nothing will go beside you.

What I cannot tell you today is, what will be in 3 or 5 years.  But I have told you in one of my faxes that you always would be part of our intentions, should we have those.  But I think this must do for the moment.  Please, Mr. Wong, if there is a further doubt or problem draw on me.”

51.  I also find that after the plaintiff took over the business of Distribution HQ the 1^st defendant regarded the plaintiff as its distributor for SERAFIL in the territories.  This is supported by the 1^st defendant’s promotion material for SERAFIL in 1994.  The plaintiff was described as “sole distributor” for the territories as evidenced by the fax from the plaintiff to the 1^st defendant dated 22 December 1994.

52.  What led to the making of the distribution agreement was explained by Mr Wong.  He said, and I accept and find, that the acquisition of Ackermann by the Amann Group in 1994 did not initially cause any problem to the plaintiff as the 2^nd defendant’s business was mainly in sewing threads for the garment industry which was wholly different from the plaintiff’s business.  Also, the Amann brands and the Ackermann brands of sewing threads were both maintained at that time so there was no question at that time of both the plaintiff and the 2^nd defendant selling SERAFIL.

53.  However, later on the 1^st defendant decided to consolidate the Amann and Ackermann brands.  As regards sewing threads for leather goods, SERAFIL was to be kept and the Ackermann sewing threads for leather goods was to be eliminated.  To avoid the distribution of the same SERAFIL brand of sewing threads through two competing companies Mr Wong said, and I accept and find, that it was agreed in late 1996 between the plaintiff, the 1^st defendant and the 2^nd defendant that only the plaintiff would serve leatherware customers and the 2^nd defendant would serve clothing and garment customers.  In pursuance of this agreement there was a transfer of leatherware customers from the 2^nd defendant to the plaintiff in late 1996.

54.  Mr Wong said, and I accept and find, that despite the agreement reached in late 1996 he found that the 2^nd defendant was in breach of the same by itself approaching leatherware customers and selling SERAFIL to them.  The plaintiff complained about this to the 1^st defendant and this led to a meeting in Hong Kong on 27 November 1998 between Mr Wong for the plaintiff, and representatives of the 1^st defendant and the 2^nd defendant to discuss the matter.

55.  The distribution agreement dated 4 January 1999 was entered into pursuant to the meeting held on 27 November 1998. 

Construction of the distribution agreement

56.  The purpose of the distribution agreement was as stated therein to define “the separation of tasks between [the plaintiff] and [the 2^nd defendant]”.

57.  It was expressly agreed that the plaintiff was appointed “sole distributor” for the 1^st defendant for SERAFIL in ticket sizes from 7 to 80 for the territories for the industries as specified therein.  It was only in respect of SERAFIL in those ticket sizes that the plaintiff was appointed “sole distributor”. 

58.  Prior to the distribution agreement in fact Distribution HQ and then the plaintiff remained as distributor for SERAFIL at least until late 1996 before the 2^nd defendant sold SERAFIL also to leatherware customers leading to the making of the agreement in late 1996. 

59.  In my judgment the proper meaning of the words “sole distributor” in the distribution agreement is that the plaintiff was appointed sole and exclusive distributor of SERAFIL in the specified ticket sizes for the territories save for the three customers reserved for the 2^nd defendant.  That is what in my judgment a reasonable person would have understood the parties to mean bearing in mind the factual matrix at the time of the agreement.  The fact that there was no covenant against competition imposed on the plaintiff does not affect the proper construction of those words.  The word ‘sole’ means what it says.  The plaintiff was the sole distributor to the exclusion of everyone else including the 1^st defendant for SERAFIL in those specified ticket sizes, save for the three customers reserved for the 2^nd defendant.  That is what a reasonable person would have understood the words “sole distributor” to mean in my judgment. 

60.  In my judgment as a matter of construction of the distribution agreement the words “sole distributor” should be construed to mean sole and exclusive distributor to the exclusion of everyone else.

61.  Mr Wong also gave undisputed evidence that in September 2005 the 2^nd defendant’s managing director Mr Thwaites told him that he wanted to add the company COACH as an additional and fourth customer to be reserved for the 2^nd defendant under the distribution agreement.  As the plaintiff had already been supplying SERAFIL to COACH for several years, Mr Wong rejected Mr Thwaites’ proposal.

62.  Mr Wong said that Mr Thwaites sent him a letter repeating his proposal of adding COACH to the three specified customers reserved for the 2^nd defendant under the distribution agreement.  Mr Wong then discussed the matter with Mr Hoffmann, a director of the 1^st defendant, who assured him that any change to the distribution agreement had to be by agreement of all the parties.   I would observe that Mr Hoffmann never suggested that under the distribution agreement the 1^st defendant could supply SERAFIL to COACH directly. 

63.  The contemporaneous email sent by Mr Wong to Mr Thwaites on 12 September 2005 supports the evidence of Mr Wong which was undisputed and which I accept.

64.  I would observe that all along both before and after the distribution agreement the defendants never regarded the plaintiff as being anything other than a sole and exclusive distributor of SERAFIL in the specified ticket sizes for the territories save for the three customers reserved for the 2^nd defendant.

Length of a reasonable period of a notice of termination

65.  Each case, of course, depends on its own facts.  The authorities cited were decided on their own facts.  They do not assist in determining what the reasonable period was to terminate the distribution agreement in all the circumstances.

66.  What was the reasonable period of notice required to terminate the distribution agreement?

67.  Both counsel put forward a number of factors to advance their respective case as to the length of notice required to terminate the distribution agreement.

68.  The factors relied on by the plaintiff in support of its case that twelve months rather than six months was a reasonable period are:

(a)  the length of the relationship of the parties which in effect lasted for 21 years;

(b)  the plaintiff was the sole and exclusive distributor of SERAFIL in the limited ticket sizes in the territories;

(c)  the plaintiff had made great efforts to create and develop a market for SERAFIL in the territories and that at the material time it was running its business on premises of about 3,239 sq ft with 14 employees;

(d)  the plaintiff depended heavily on SERAFIL in that the sales of SERAFIL accounted for about 78% of its sales and its annual profit was about HK$5.2 m, out of which a substantial percentage was attributable to the sales of SERAFIL;

(e)  the plaintiff faced serious difficulties to obtain substitute business due to the unique characteristics of SERAFIL;

(f)  Mr Boelzle’s view that one year was reasonably required for a smooth transfer of business in a good manner and faith, and in a friendly manner.

69.  The defendants relied on the following factors in support of their case that six months’ notice was not unreasonable:

(a)  the plaintiff was not subject to any non-competition covenant whether during or post the distribution agreement, and in fact was able to negotiate terms for the supply of a competing product TERA, establish a stock of the same and begin active competition with the defendants prior to the end of the six months’ notice given;

(b)  the plaintiff had not incurred any extraordinary effort or expense that it had not yet been able to recoup;

(c)  the plaintiff’s difficulty in achieving comparable profitability after the end of the six months’ notice was due to the superior quality and competitive price of SERAFIL and not the length of the notice;

(d)  the plaintiff had the flexibility to downsize its use of its office and warehouse premises and to reduce its staff head-count as it wished;

(e)  the informality of the distribution agreement.

70.  I must bear in mind that the chief purpose of a notice for a reasonable period is to enable the parties to bring to an end in an orderly way a relationship which ex hypothesi has existed for a reasonable period so that they will have a reasonable opportunity to enter into alternative arrangements and to wind up matters arising out of the relationship.

71.  I have considered all the factors relied on by counsel in advancing their respective case.

72.  I have found as a fact that the plaintiff, and before it Distribution HQ, was the sole and exclusive distributor of SERAFIL in the territories for a long time since about 1985 to the time when the notice of termination was given in 2006, for a period of 21 years, subject to the rights of the 2^nd defendant under the distribution agreement.

73.  The length of time that a distributorship agreement has been in existence is a factor to consider but it seems to me that, as Longmore LJ said in Alpha Lettings at paragraph 32 of his judgment, it is not in any way critical.

74.  There can be no doubt that over the years Mr Wong spent a great deal of time, effort and expense to promote and market SERAFIL.  However, as Mr McLeish rightly submitted, the prospect of obtaining profits in the future is not a relevant factor to be taken into account as to the reasonableness of the notice period except so far as it is consequential upon the incurring of extraordinary expenditure or effort within the scope of the agreement (per McHugh JA in Crawford Fitting at 448).  Here, the plaintiff does not seek to rely on any extraordinary expenditure or effort and hence this is not a relevant factor.

75.  It is clear from the undisputed evidence of the financial statements in the audited accounts of the plaintiff and of Mr Wong that the bulk of the plaintiff’s sales and profits were in respect of sales of SERAFIL.  In 2005 SERAFIL accounted for over 76% of the plaintiff’s turnover.  As shown in exh. P2, for the period from June 2005 to January 2006 SERAFIL sales accounted for 78.76% of all the plaintiff’s sales.

76.  However, the purpose of a reasonable period of notice is not to permit the plaintiff as distributor to earn further income (per McHugh JA in Crawford Fitting at 451).  The fact that the plaintiff has been heavily dependent on SERAFIL sales in its business means that a reasonable period of notice should be given to enable it to have a reasonable opportunity to enter into alternative arrangements and to wind up matters.

77.  Mr Wong said, and I accept and find, that he faced difficulties with customers in entering into alternative arrangements for the supply of comparable goods.  There was no truly comparable product because of the high quality and sewability of SERAFIL.  TERA produced by Gutermann which was a comparable product was in fact lower in quality and more expensive than SERAFIL.  This was accepted by Mr Boelzle.  There was also the difficulty in obtaining the right colour shade and in persuading customers to switch to another brand with different colour shades.  These difficulties must have been anticipated at the time of the termination notice and, in my view, this would have justified a longer period than six months’ notice for the plaintiff to adjust to the anticipated change caused by the termination of the relationship.

78.  There must be some time given to the plaintiff to adjust to the termination of the relationship.  However, it is relevant to bear in mind that the manner in which the plaintiff purchased goods from the 1^st defendant over the years was to build up a large inventory of stock of SERAFIL in different colours and sizes.  This was important as the plaintiff mainly sold to customers on a ‘just in time’ basis as the manufacturers to whom the plaintiff sold the same did not usually keep much stock.  Hence, the plaintiff had to keep substantial stock waiting for orders which it could deliver to the factories right away after receiving orders.  Mr Wong accepted that the plaintiff operated in this manner.  The plaintiff did not usually wait for an order and then source the goods from the 1^st defendant as manufacturer.  For that reason the plaintiff had to replenish its stock on a regular basis.  Mr Wong said, and I accept, that each month he would place two or three large orders with the 1^st defendant to replenish stock. 

79.  It is evident, therefore, that the plaintiff did not have large orders awaiting delivery when the notice of termination was given and that is a factor to consider in determining what was the reasonable period.

80.  The plaintiff was also not subject to any non-competition covenant under the distribution agreement and that is also a factor to bear in mind in determining the period of reasonable notice.  Be that as it may, as a matter of fact, save for the purchase by the plaintiff from the local distributor of Gutermann in August 2005 of a competing product TERA (which was not a truly comparable product) for sale to the plaintiff’s customers who had specifically asked for this item, the plaintiff did not in fact sell competing goods until the receipt of the notice of termination.

81.  Mr Boelzle gave evidence that in 2005 he conducted an appraisal of the 1^st defendant’s marketing and distribution strategies in the Far East and its expectations regarding the developing market particularly in China.  The 1^st defendant came to the decision that its interests would be best served by selling direct rather than using outside distributors.  He explained that it was the intention to use its own subsidiaries to distribute the 1^st defendant’s goods rather than sell directly by itself or through outside distributors.  For that reason he met Mr Wong in Hong Kong to inform him of the 1^st defendant’s decision on 21 October 2005.  As he said, and as I accept and find, Mr Wong agreed with the 1^st defendant’s assessment that the plaintiff could not grow the business in China without massive investment in sales people and infrastructure and the plaintiff was not prepared to make that investment.

82.  They discussed the termination of their relationship and it was proposed that the 1^st defendant was prepared to pay a bonus to the plaintiff for a smooth transfer of the business so that matters could be terminated in a friendly way.  Mr Boelzle said that at that meeting it was discussed that for the smooth transfer it could be done within one to two years maximum.  In evidence he said that realistically it would be one year because, as one would expect, after a while the relationship between the parties would be difficult. 

83.  On the undisputed evidence, after the meeting there were negotiations between the parties as to the amount of a bonus to be paid to the plaintiff for a smooth transfer on a friendly basis which would include the plaintiff introducing all of its customers to the 1^st defendant and to persuade them to continue using SERAFIL in their products and also for the defendants to learn from the plaintiff how to distribute the goods in the territories.  The negotiations did not bear fruit. 

84.  Mr Boelzle realized after his communications by email with Mr Wong that it would not be possible to end the relationship in a friendly way.  He recognized, however, that even ending the relationship in a less friendly way the plaintiff would require some time. 

85.  In his email sent to Mr Wong on 22 November 2005 Mr Boelzle in his negotiations suggested that the business should be transferred to the 2^nd defendant by the end of September 2006 and that the plaintiff would be paid a “bonus…… as a reward for a smooth business transfer….”. 

86.  Although Mr Wong said in evidence that it was not clear that the distribution agreement would come to an end, in my view, he must have realized after the meeting with Mr Boelzle on 21 October 2005 that the distribution agreement was going to come to an end.  I so find.

87.  Although no formal notice of termination was given until 31 January 2006, Mr Wong must have realized after the meeting on 21 October 2005 that the distribution agreement would be terminated.  The plaintiff could not have been left with any illusion that it would continue on as the 1^st defendant’s distributor for SERAFIL for too long.

88.  Mr Lam submitted that Mr Boelzle’s view was that one year was reasonably required for a smooth transfer of business in a good manner and faith, and in a friendly manner and that this was a relevant factor to consider.

89.  I do not regard Mr Boelzle’s evidence as an admission on the part of the 1^st defendant that the plaintiff would need one year to bring the relationship to an end in an orderly way and for the plaintiff to wind up matters arising out of the relationship.  Mr Boelzle was not talking about how long it would take for the parties to bring to an end in an orderly way the relationship.  He was talking about something more.  He said that realistically in one year there could be a smooth transfer on a friendly basis whereby the plaintiff would, on receipt of an attractive bonus from the 1^st defendant, introduce all of its customers to the 1^st defendant, persuade them to continue using SERAFIL in their products and teach the defendants how to distribute the goods in the territories.

90.  It seems to me, and I so find, that in all the circumstances nine months’ formal notice was a reasonable period for the 1^st defendant to give to terminate the distribution agreement.  That being so, I am satisfied and find that the period of six months given in the notice of termination was unreasonable.  Nine months’ notice should have been given.  In my judgment three further months’ notice should have been given which means that the termination should have been effective on 31 October 2006 instead of 31 July 2006. 

91.  In my judgment the defendants were in breach of the distribution agreement by serving the notice of termination which only gave six months’ notice and the plaintiff is entitled to damages.

92.  By a letter dated 27 June 2006 the 1^st defendant informed the plaintiff that it would not be delivering any Amann products including SERAFIL as from that date “because all current orders would be sold to the market after the agreement is already terminated and expired by 31 July 2006”.  As I have found that the serving of a six months’ notice of termination to expire on 31 July 2006 was unreasonable and in breach of contract, there was also a breach of the implied term that there was an obligation on the 1^st defendant to fulfil, as far as reasonably practicable, orders placed by the plaintiff for SERAFIL in ticket sizes 7 to 80 so as to enable the plaintiff to meet orders for the same placed with it for delivery by the plaintiff during the subsistence of the distribution agreement to entities in the territories.  There was an obligation to continue to supply SERAFIL in ticket sizes 7 to 80 so as to enable the plaintiff to meet orders for the same placed with it for delivery to entities in the territories during the subsistence of the distribution agreement which should have subsisted until 31 October 2006 if a reasonable period of notice to terminate the agreement had been given.

Quantum

93.  Although in the opening submissions of Mr Lam the plaintiff claimed damages for loss of profits and the cost of the remaining stock of SERAFIL kept by the plaintiff, by the time of the closing submissions the claim for the cost of the remaining stock of SERAFIL was abandoned.  Its only remaining claim was for loss of profits.  The amount claimed for loss of profits was also reduced by the time of the closing submissions.

94.  The defendants do not dispute that the plaintiff must have suffered loss of profits in the event that the court should hold that six months’ notice was unreasonable.  There is, however, a dispute as to the method of calculating the loss of profits.

95.  According to the income statement in the audited accounts of the plaintiff for the year ended 31 December 2005, the plaintiff’s net profits after tax for the years ended 31 December 2004 and 31 December 2005 were HK$5,253,703.40 and HK$5,248,166.76 respectively.  The net profits after tax for the two years was more or less the same.  This shows, as Mr Wong said and as I accept and find, that the sales of SERAFIL had reached a plateau around 2005.  It seems to me, and I so find, that the plaintiff would have made the same amount of profits for the year ended 31 December 2006.

96.  The plaintiff’s accounts show that there was a sharp reduction in profits in 2006 from the previous year.  According to the income statement in the audited accounts for the plaintiff for the year ended 31 December 2006, the net profits after tax for the year ended 31 December 2006 was HK$2,976,558.95 whereas, as I have said, the net profits after tax for the year ended 31 December 2005 was HK$5,248,166.76.  There was, therefore, a reduction of profits in that one year in the sum of HK$2,271,607.81.

97.  I am satisfied on the evidence of Mr Wong which I accept that the reduction of profits was because there was no more supply of Amann products to the plaintiff after 27 June 2006. 

98.  However, under the distribution agreement the plaintiff was appointed sole and exclusive distributor only for SERAFIL in ticket sizes 7 to 80 and not for all Amann products.  I am satisfied that the plaintiff is only entitled to claim damages for the loss of profits it suffered in relation to the non-supply of SERAFIL in those ticket sizes from 27 June 2006 to 31 October 2006 and not for the non-supply of other Amann products.

99.  Mr Wong accepted that the reduction of profits for the year ended 31 December 2006 in the sum of HK$2,271,607.81 was attributable not only to the non-supply of SERAFIL but also to the non-supply of other Amann products.  It is, therefore, necessary to ascertain how much of the loss of profits in that year was attributable to the loss of sales of SERAFIL.

100.  Mr Lam submitted that on the evidence 85% of the reduction of profits represented the loss of profits attributable to the loss of sales of SERAFIL.

101.  Mr McLeish did not dispute that 85% of the reduction of profits represented the loss of profits attributable to the loss of sales of SERAFIL and indeed he himself adopted this in his submissions on quantum.  He also accepted the plaintiff’s figures as set out in exhs. P1 and P2 for the purposes of quantum.

102.  The plaintiff’s case was that twelve months’ notice expiring on 31 January 2007 should have been given.  The loss of profits up to 31 January 2007, according to Mr Lam’s submissions, was HK$2,247,402.15.  This is arrived at by taking the net loss of profits for the year ended 31 December 2006 in the sum of HK$2,271,607.81.  85% of the said sum representing the loss of profits attributable to the loss of sales of SERAFIL comes to HK$1,930,866.64.  To this sum must be added the reduction of profits for the month of January 2007.  As there was no more supply of SERAFIL from 27 June 2006, the sum of HK$1,903,866.64 represented the loss suffered over a period of 6.1 months (from 27 June 2006 to 31 December 2006) with an average monthly loss of HK$316,535.51 (HK$1,930,866.64 ÷ 6.1).  Hence, on Mr Lam’s submissions, the loss of profits up to 31 January 2007 was HK$2,247,402.15 (HK$1,930,866.64 + HK$316,535.51).  The plaintiff claims this sum for loss of profits.

103.  Mr Lam further submitted that in the event that the court should find that a period of less than twelve months’ notice was reasonable to terminate the distribution agreement, a deduction using the average monthly loss of HK$316,535.51 should be made from the sum of HK$2,247,402.15.  Mr Lam submitted that “the fairest and most reasonable approach” must be to reduce the sum of HK$2,247,402.15 rateably and proportionally.

104.  As I have found that nine months’ notice expiring on 31 October 2006 should have been given, on Mr Lam’s submissions the loss of profits should be HK$1,297,795.62 (HK$2,247,402.15 - HK$949,606.53 being 3 months average monthly loss of HK$316,535.51).

105.  As rightly submitted by Mr McLeish, the approach adopted by Mr Lam assumes that the loss of HK$2,247,402.15 for the period of twelve months was evenly distributed over the whole of that period to arrive at an average monthly loss of HK$316,535.51.  As pointed out by Mr McLeish, correctly in my view, on the plaintiff’s own figures there was a considerable variation in the reduction of SERAFIL sales over that period.

106.  In my judgment it cannot be right to assume that the sales of SERAFIL was reduced more or less evenly over the whole of the period from 27 June 2006 to 31 January 2007.  On the evidence the plaintiff was selling considerably less SERAFIL on a month to month basis from June 2006 to January 2007.  This is clearly reflected in the plaintiff’s own figures in exh. P2.  Thus it can be seen for instance, that in June 2006 SERAFIL sales amounted to HK$2,365,777.94 with a drop to HK$1,640,422.94 in July 2006.  And by January 2007 the SERAFIL sales had dropped considerably to HK$48,999.10. 

107.  Exh. P2 also shows that the loss of SERAFIL sales was considerably greater for the months of November 2006 to January 2007 than for the months prior thereto.  This is hardly surprising in view of the fact that the plaintiff did not receive any further supply of SERAFIL as from 27 June 2006.  That being so, it is evident that the plaintiff was selling SERAFIL to manufacturers on a ‘just in time basis’ from its existing stock without replenishing the same.  As its existing stock was being depleted by sales on a continuing basis, there was less stock available for the plaintiff to sell. 

108.  Mr Wong said that as at end 2005 the value of SERAFIL stock kept by the plaintiff was over HK$1.5 m.  By July 2006 the value of the plaintiff’s existing stock of SERAFIL was over HK$1.3 m.  And by February 2009 the value of the stock of SERAFIL that remained was only about HK$188,000.

109.   It is, of course, for the plaintiff to prove its loss by evidence.  In my view it would not be fair or reasonable to adopt the approach of Mr Lam by deducting from the sum of HK$2,247,402.15 an average monthly sum of HK$316,535.41 to arrive at the loss of profits suffered by the plaintiff up to 31 October 2006.

110.  Mr McLeish submitted that based on the plaintiff’s own figures, which he accepted, the net profit margin of the plaintiff’s SERAFIL sales for the period in question was 21.638%.  He explained this by reference to the table at paragraph 9 of ‘the defendants’ response to the plaintiff’s closing assessment of quantum’ (“the table”).  The table is set out as follows:

“
Jul	Serafil Sales Jul-05 to Jan-06	Less Serafil Sales Jul-06 to Jan-07	Reduction in Serafil sales Year-on Year	Loss of Profit (sales x 21.638%)
Aug	$1,801,909.02	-$1,640,422.94	$161,486.08	$34,942.36
Sep	$1,776,951.14	-$710,270.17	$1,066,680.97	$230,808.43
Oct	$1,975,739.98	-$258,139.75	$1,717,600.23	$371,654.34
Nov	$1,674,084.48	-$282,529.83	$1,391,554.65	$301,104.60
	$2,536,828.15	-$63,849.02	$2,472,979.13	$535,103.22
Dec	$2,203,636.84	-$36,192.52	$2,167,444.32	$468,991.60
Jan	$1,457,650.32	-$48,999.10	$1,408,651.22	$304,803.95
Total	$13,426,799.93	-$3,040,403.33	$10,386,396.60	$2,247,408.50	”

111.  The net profit margin of 21.638% was arrived at by taking HK$2,247,402.15 (the plaintiff’s claimed reduction in net profits from 27 June 2006 to 31 January 2007) and dividing the same by HK$10,386,396.60 (the total reduction in SERAFIL sales year on year as shown in the table) x 100. 

112.  Mr Lam further submitted that the court should not adopt Mr McLeish’s method for calculating the loss of profits as Mr Wong was not cross-examined on the same.  He relied on The Kowloon Motor Bus Co (1993) Ltd v K K Cargo Systems (HK) Ltd & another (Civil Appeal No. 372 of 2002; 4 April 2003). 

113.  In my view that case provides no assistance to Mr Lam.  The court was there concerned with the fact that the witnesses were not cross-examined.  It was never put to them that their evidence was inaccurate or untrue.  What the court said was that if a witness is not asked any question at all in cross-examination, the court is fully entitled to accept his evidence as being unchallenged.

114.  Mr McLeish has not challenged the figures put forward by Mr Wong in exhs. P1 and P2 in support of the plaintiff’s case on quantum.  Not only has Mr McLeish not challenged those figures, he has adopted and relied on them to arrive at what he submitted was a more appropriate way to calculate the percentage of net profit margin for the plaintiff’s SERAFIL sales.

115.  Ultimately, the question of the proper assessment of damages is for the Court and not for a witness to give his opinion as to what the proper method is.  Based on the plaintiff’s own figures Mr McLeish has made his submissions as to the proper method for calculating the loss of pProfits.  I see no merit in the criticism that this method was not put to Mr Wong.

116.  It seems to me that it would be more appropriate to use the method advanced by Mr McLeish in calculating the plaintiff’s loss of profits.  I shall adopt the net profit margin of 21.638% for the plaintiff’s SERAFIL sales.  That being so, on the table the loss of profits up to 31 October 2006 would be HK$938,509.73 (HK$34,942.36 + HK$230,808.43 + HK$371,654.34 + HK$301,104.60).

117.  I give judgment on the claim to the plaintiff against the 1^st and 2^nd defendants in the sum of HK$938,509.73 with interest thereon from 31 October 2006 to judgment at 1% above prime rate.

118.  I also give judgment on the counterclaim to the 1^st defendant against the plaintiff in the sum of HK$2,686,152.50 with interest thereon at the rate of 1% above prime rate from the time the sums making up the said amount became due until judgment.

119.  I also give judgment on the counterclaim to the 2^nd defendant against the plaintiff in the sum of HK$19,227.54 with interest thereon at the rate of 1% above prime rate from the time the sums making up the said amount became due until judgment.

120.  As agreed by counsel, I shall leave it to the solicitors for the parties to agree all matters in relation to interest on the amounts awarded to the 1^st and 2^nd defendants on the counterclaim.

121.  I also make an order nisi as to costs as follows:

(1)  costs to the plaintiff on the claim against the 1^st and 2^nd defendants such costs to be taxed if not agreed;

(2)  costs to the 1^st and 2^nd defendants on their counterclaim such costs to be taxed if not agreed.

122.  As agreed by counsel, I also order and direct that the plaintiff’s judgment and costs be set off against the judgment for the 1^st defendant and costs and the plaintiff’s judgment and costs be set off against the judgment for the 2^nd defendant and costs and that execution do issue in each case for the balance only.

123.  Finally, I would like to express my gratitude to counsel for their able assistance.