SWIRE LOXLEY LIMITED AND OTHERS v. ALAN JOHN BRINK AND OTHERS

A.6374/84

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Headnote

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Contract - Business Acquisition.

Agreement to indemnify purchaser for loss incurred on breach of warranty that since an agreed date (i.e. of an audited balance sheet) prior to completion there has been no material alteration in the assets and liabilities of the company or any material reduction in the net assets or any material deterioration otherwise in its financial position.

1984, No. 6374

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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JUDGMENT

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Introduction

1. The Plaintiff sues the Defendants for damages for breach of warranties given by the Defendants in an agreement made between the parties whereby the Plaintiff purchased from the Defendants the issued share capital of a company API (Hong Kong) Limited and thereby also acquired control of its subsidiary Austral China Contractors Limited. The Plaintiff also sues in the alternative for damages said to be suffered by the Plaintiff in consequence of misrepresentations by the Defendants in relation to that sale. The Defendants counterclaim against the Plaintiff (and API (Hong Kong) Ltd.) for damages suffered as a result of their being unable to qualify to collect the full contingent purchase price under that contract and, as regards the 1st Defendant, against the Plaintiff and API (Hong Kong) Ltd for damages for breach of an employment contract and outstanding director's fees and expenses said to be due by the Plaintiff to him.

2. The Plaintiff company is a member of the Swire Group of Companies, and, at all relevant times, P.W.2 Christopher Strachan, was its Managing Director, P.W.3, Christopher Coulcher, its Financial Director and the Financial Controller was P.W.4 Rosa Hung. A defence witness, D.W.2 Miss Lydia Dunn was at that time a director of the Plaintiff company.

3. The Defendants are husband and wife. The 1st Defendant is the founder of API (Hong Kong) Limited (API) a company which engages in the sale of carpets and furnishings. All the share capital of API was owned by the 1st and 2nd Defendants. API had a paid up capital of $2,000,000. Austral China Contractors Limited (ACC) was a subsidiary of API engaged in the China trade. The 1st Defendant was the Managing Director of API and conducted and controlled its business. The 2nd Defendant did not engage in the business at all. API's internal accountant was D.W.4 So Man-ngan.

An outline of events prior to takeover: -

4. API had been built up by the 1st Defendant (D.W.1) over a period of about 10 years and it had been a fairly successful business with good agencies and connections in the trade. It had however over-expanded in 1982 and early 1983 and, in addition, Hong Kong was then entering a less prosperous period and sales, in consequence, were not as high as anticipated. The result was that the company lost somewhere between $1.2 - $1.3 million in the financial year ending the 31st of March 1983. D.W.1 also wanted to slowly divest himself of the company over a period with a view to retirement in a few years and at the same time provide a partner in responsibility and an organisation with provision for financial support to enable future expansion. In early June of 1983 he placed an advertisement in the South China Morning Post which was answered by P.W.3, on behalf of the Plaintiff, which was then seeking to diversify into other businesses.

5. P.W.3 and D.W.1 met and thereafter P.W.3 prepared a report (Bundle Pages 37-40) and when P.W.2 returned from leave, there was a further meeting with D.W.1 on the 30th June 1983. At that meeting there was a discussion in general terms about the business and its overseas suppliers and as both sides were interested in continued talks thereafter some financial information about API was given to the Plaintiff.

6. P.W.3 saw API as a company operating on high margins which could be acquired at little cost, but not a great deal happened until the 18th of August 1983 when P.W.2 wrote to D.W.1 confirming continued interest in acquisition. That letter states both parties' objectives and advises that it is Swire's policy to obtain 100% ownership wherever possible but in no case less than 51%. It records that the Plaintiff had no expertise in the type of business in which API was involved and required a continuous involvement from D.W.1 for a period of at least three years in the event of a sale.

7. On the 20th of August 1983, D.W.1 wrote to P.W.1 (page 87) and made a counter proposal in relation to terms. He also supplied the unaudited accounts of API for the year ended the 31st of March 1983 (1981/82 financial year having been previously supplied), the unaudited accounts of ACC, details regarding the main agencies and the very contentious sales and profit projections of D.W.1 for the following 4 years showing an estimate of profits for 1984 of $500,000. The audited accounts of API and ACC (pages 47 - 68) were supplied on the 6th September 1983 (page 115) with details of monthly sales during the year 1981/82.

8. There then followed, at various times, particulars about the bank accounts of API and the credit terms of all agencies, totals of monies owing (but not details) and particulars about bank overdraft interest and import loans. It was specifically denied by the Plaintiff that a document giving particulars of Bills payable and Trust Receipts outstanding as at the 8th September 1983, broken down into past due and future due, was supplied as the Defendants say it was. There was no covering letter or specific evidence establishing delivery of that document produced by the Defendant and on balance I accept that the Plaintiff did not receive it.

9. Using the figures which had been supplied, P.W. 3 (in particular) and P.W.2 prepared a submission to the Plaintiffs Board of Directors. Whilst that final paper was in preparation D.W.2 Miss Lydia Dunn made it clear that the Plaintiff would only consider a takeover of API if all of its shares could be purchased and thereafter negotiates continued with D.W.1 on that basis.

10. A final submission was made to the Plaintiff's board and then on the 4th of October 1983, P.W.2 wrote to D.W.1 (page 177) offering to purchase all 200,000 shares of API for $1 million cash on the signing of an agreement plus a further sum in 3 years calculated on a formula of the average of 3 years earnings times 2 years purchase. That letter also offered, subject to board approval, to employ D.W.1 as Managing Director of API for a period of 3 years.

11. Further information was then exchanged and contact was made with API's major suppliers to test their reaction to a takeover. Drafts of a sale and purchase agreement (the first draft was dated the 26th October 1983) were exchanged and discussed between the parties and their solicitors and finally on the 20th December 1983 the final sale and purchase agreement was signed by the parties as was an employment contract between API and D.W.1.

The Sale and Purchase Agreement of the 20th December 1983

12. The contract provided for the sale of the whole of the issued share capital of API (HK) Ltd. to the Plaintiff which thereby acquired the beneficial ownership and control of ACC. The consideration was to be paid by two instalments, the first as to $1 million in cash upon completion (which took place on the 3rd January 1984) and the balance pursuant to the formula to which I have referred.

13. The agreement provides in Clause 9(3) that it constitutes the whole agreement between the parties and in Clause 2 that the purchaser purchases in reliance on the various representations and warranties set out in an attached schedule. They are the warranties founding this action. The vendors, in Clause 5, expressly represent and warrant the various matters set out in that schedule which is the 5th Schedule and agree in Clause 5(7) to indemnify the purchaser for loss incurred for anything found to be other than as warranted or represented.

14. Certain of the warranties in the 5th Schedule need be set out. They are:-

 

Clause 4 "Accounts

 

 

Clause 5 "Business since the Relevant Date

 

Clause 10 "Inventory

Clause 11 "Accounts Receivable

Clause 31 "Miscellaneous

                (i)      -------

                (ii)      Prejudicial matters

The Employment Contract

15. It was agreed that D.W.1 was to become employed as Managing Director of API after acquisition. On this aspect, D.W.1 had wanted an unbreakable three year contract. The Plaintiff would not agree because, as a matter of policy, the Swire Group required all its employees to be subject to a six-months termination clause in their various employment contracts. This condition was insisted upon and finally D.W.1 reluctantly agreed to it. I do accept however that in the discussions between P.W.2 and D.W.1 about the matter P.W.2, whilst explaining that all Swire employees were subject to this condition in their contracts, said that the right of dismissal would really only be normally executed in the case of sickness, conviction or theft from the company or the like.

16. In the event, the provision in the Sale and Purchase Agreement was:-

D.        Mr A. Brink shall execute and the parties hereto shall procure that the Company shall execute the contract of employment in the form set out in the Seventh Schedule under the terms of which Mr Brink shall be employed as the Managing Director of the Company. "

17. Such an agreement (Page 498) was signed on the 3rd January 1984 on completion and it provides:-

"1.         Employment

 

        The Company shall employ the Manager and the Manager shall serve the Company as Managing Director (subject as hereinafter provided) as from the date hereof (hereinafter called "the Commencement Date") until such employment is terminated either by the Company giving at any time not less than six months' written notice to that effect to the Manager or by the Manager giving not less than six months' written notice to that effect to the Company provided that in the latter case such notice shall not expire earlier than the third anniversary of the Commencement Date. "

Events after the Contract

18. Prior to the signing of the agreement the Plaintiff was concerned as to how the major suppliers of API would react to the change in share holding of API and so towards the end of October P.W.2 send telexes to Feltex and Heuga to test the water. Feltex telexed back (Page 226) confirming a wish to continue association and went on to say "The only problem has been shortage of API finance".

19. This was not taken as a warning at that time that API was in financial difficulties with its suppliers but rather that word had got back to those suppliers that finances were needed for expansion. The matter came up again however when Feltex telexed P.W.2 on the 30th November 1983 enquiring as to the takeover position and wanting to know where the Plaintiff stood regarding orders placed and API's debt with them. P.W.2 contacted D.W.1 about this time and was told that the money referred to was for carpets supplied to John Lok & Partners on a contract at Harbour City. Suppliers sometimes supplied on a contract and delayed payment until API was paid itself for that contract. It was known that API had not been paid for the Harbour City project and so that explanation was at that time accepted.

20. Just after the contract was signed, but before completion of it, a telex was received from Heuga on the 22nd December 1983 (Page 465) enquiring whether the Plaintiff was accepting responsibility for API's debts. It made reference to "large outstandings with API going back some considerable time" and advised that Heuga was accepting API orders on a confirmed payment basis only. This alarmed P.W.2 and he telexed for particulars from Heuga (Page 467) which were supplied on the 23rd December 1983 (Page 468) and show bill of exchange maturity dates spreading back for over 12 months of approximately 500,000 gilders.

21. Surprisingly P.W.2 did not challenge D.W.1 about this debt to Heuga prior to completion on the 3rd January 1984 and so it took place as planned and then after completion that debt was paid when others were paid.

22. P.W.2 and P.W.3 had been concerned about outstanding indebtedness and so during January 1984 a schedule was drawn up and debts amounting to $4,719,669.26 were paid by the Plaintiff on account of API to various creditors (Page 647). In some cases high interest rates (18 - 20%) were being incurred. Some of these rates were negotiated down for swift payment. The Plaintiff claims that it was not aware prior to completion of the high interest rates which were being incurred on these bills. I accept that that is so. The evidence shows that primarily these bills were paid in the one go in January to avoid these heavy interest charges although at the same time the Plaintiff was conscious of a need to protect its own reputation and paid with that in mind also.

23. After acquisition steps were taken for an audit and the production of a balance sheet as at 31st December 1983 to accord with the Swire Groups' accounting periods. A stock check was undertaken and then the first meeting of Directors was held on the 17th January 1984. At that meeting, various matters were discussed including arrangements for preparation of on-going figures and a budget. A forecast of sales of $38 M was produced by D.W.1. That forecast was considered optimistic and further details were called for (the actual sales for the year ended the 31st December 1984 (Page 748) was some $17 M). The results of the stocktake had disclosed significant shortages which were then still to be investigated and it was agreed that because of existing poor warehouse conditions stock in a particular public warehouse be moved to the Plaintiff’s own godown and at that time to have a further stocktake to try and establish more accurate figures.

24. By mid March, the Plaintiff company had become aware of pressure from API's bankers and, likely prompted by a request by D.W.1 for payment to him of outstanding fees, on the 19th March 1984 (Page 567) P.W.3 on behalf of the Plaintiff wrote a letter to D.W.1 which I set out in full as it clearly reci esthe position as supported by the evidence and reflects the stand of the Plaintiff at that time. The letter reads:-

"During the course of S. L. 's negotiations with the company, on at least two occasions, the question was asked as to whether there was any pressure from your bankers concerning the state of their accounts and facilities with you. We recall your reply suggested that there was no immediate pressure, but that in order to expand the business and be in a position to quote on certain contract, you did require more finance. Indeed this was one of the original explanations for your seeking a partner who would either directly inject more funds into the business or enable such funds to become available.

 

Also during the course of negotiations we had the opportunity of speaking to your major principals but no reference was made by them or by yourself at that time to debts being overdue.

 

When the acquisition was completed, we discussed the question of the financial requirements and you advised us that an increase in overdraft facilities from HK$1.7 million to HK$2.2 million and in documentary credit facilities from HK$2.5 million to HK$3.5 million would be adequate for future business. This increase in facilities supported the original contention that it was necessary to finance the company's expansion.

 

In January it came as a shock on realisation that your major suppliers had outstanding debts of a considerable size and, indeed, substantial interest charges were being levied by them upon these outstanding, amounts. In order to maintain credibility with these suppliers, it was necessary for S.L. to make quick settlement and obtain the best deal in relation to the interest charges. The net result was by the end of January, in addition to the facilities negotiated with the bank, which by then were fully utilised, S.L. had lent to API the sum of approximately HK$4.7 million.

 

During this period and the course of negotiation, monthly cash forecasts were obtained from which it was not shown that payments were overdue as these payments were not reflected as due to be made in those months. The information supplied in respect of creditors was correct although no attempt was made to explain that a substantial part of the creditor amounts were very overdue.

 

In February it came as a further surprise to note that in addition to trade creditors, a substantial amount of expense items such as rent and director's emoluments were overdue.

 

Whilst we appreciate that during the course of negotiation, it may not have been in your interest and in your principal's interest to disclose the true state of the company's affairs, it is quite clearly in everyone's interest now that there is no misunderstanding over the company's financial state. We now know that despite the payments made by S. L. on behalf of API in January and. February, there is still a further shortfall to be made up of approximately HK$1.5 million in April.

 

Whilst we appreciate the difficult trading conditions at the present time, we have always taken a long term view of API's business and recognize the mutal advantages to all parties concerned in its development as part of the Swire Group. However, it is clearly necessary for us to recall the situation as we now see it in order to avoid any further misunderstandings and also to enable a more open approach between us to the problems of the business.

 

It is now noted that a sum of approximately $500,000 is outstanding to you mainly in respect of director's emoluments and other expenses and that it is your wish that this sum be settled shortly. In the circumstances, it is inappropriate to have this paid now and we cannot sanction settlement of this debt until such time as the company can actually afford to make such settlement.

 

Whilst we reconfirm that it is not our intention or the style of Swire to interfere with the day-to-day running of the Company, it has clearly become necessary as a matter of record to state the situation as it developed from the point of negotiation through to the present time. We have already recorded the fact that some claims may be necessary against former shareholders in respect of the warranties given in the sale and purchase agreement.

 

The main purpose of this communication is not really to point out the problems of which clearly you were aware, but to achieve a relationship in future in which open and honest communication will exist between us. We believe in the future of API and its management and look forward to making it as successful as possible with your co-operation. "

25. D.W.1 did not respond to that letter. He says that he was surprised to get it but regarded it as a letter "far the record" following a conversation he had had on the telephone with P.W.3 of a much less pointed and aggressive nature.

26. In early May 1984 more detailed figures revealing the extent of the losses of API began to be available and by the 23rd May P.W.3 was able to report that during the 9 months period from 31st March 1983 to 31st December 1983 the losses of API were much more than had been anticipated and were in excess of $4 million compare with a loss in the previous period of $1.382 million.

27. Arrangements were made for D.W.1 to be dismissed as Managing Director. That was delayed as he was abroad visiting suppliers but after his return he was called to Swires' offices on the 26th July 1984 and he was summarily dismissed by D.W.2, Miss Lydia Dunn.

28. API had been trading at a significant loss during the period 31st of March 1983 to the 31st of December 1983 and indeed as at the latter date it was insolvent having lost in excess of twice its capital. Losses were effectively being financed through reduction in stock holdings and through deferrments of payment to creditors. There was an amount of $490,000 due to D.W.1 himself as at the 31st of December 1983 representing an accrual in respect of arrears of salary not drawn amounting to $440,000 and an amount of $50,000 in respect of the company's acquisition of shares in ACC from both D.W.1 and D.W.2. That is the sum claimed by D.W.1 in his counterclaim. Loans against Trust Receipts of $2,516,202 are shown in the balance sheet for 31st of December 1983 as compared with $1,993,580 as at the 31st of March 1983. Bills payable as at the 31st of December 1983 were $4,724,839 as opposed to $5,067,321 as at the 31st of March 1983. Although there was a difference there of only $180,140, I accept the evidence of P.W.1 (as to whom I shall shortly refer) that an analysis of the individual amounts payable as at the two dates shows approximately $3 million of the amounts due at the 31st of December 1983 were in fact carried forward from the 31st of March 1983. Deferrment of creditors is apparent. Stock diminished in the quantity to which I shall refer.

29. As a result of API's inability to discharge its liabilities under bills of exchange as they fell due, it was incurring substantial interest charges. P.W.1 estimated those interest charges at $460,000. D.W.2 (to whom I shall also shortly refer) in his calculations to arrive at explanations for reduction in net asset value between the two relevant periods, put interest on bills of exchange at $782,264 and interest on bank overdraft at $193,368. On either calculation, substantially increased interest charges were incurred during the period. There was an increase of $1,170,624 in the level of creditors and accruals between the 31st of March 1983 and the 31st of December 1983 principally due to $578,000 attributable to the company having fallen into arrears with its rental payments and increased accruals for interest payable of approximately $400,000.

The Defence Case Generally

30. The 2nd Defendant did not give evidence but D.W.1 for both Defendants says he gave the Plaintiff all such information as it required relating to the affairs of API prior to the sale and that the information which was given was accurate. It is argued that the information that was supplied made the Plaintiff aware of the deteriorating position in the affairs of API and the extent of that deterioration prior to takeover and that that being the case the Plaintiff is estopped for relying on the warranties because it was in fact aware of the changes which had taken place. Any misrepresentation is denied.

31. D.W.1 agreed to the warranties in the contract with the benefit of legal advice but he says they did not particularly concern him as any problems API had were due to shortage of funds and the Plaintiff was about to rectify that. He did not anticipate any stock shortages and the only bad debt was the one from John Lok & Partners (and that was only overdue and not bad as such). It is argued, as is the case, that the Plaintiff was aware that API was losing money and had already incurred losses of $700,000 to August of 1983. It was aware API needed working capital and, it is said, should have been aware that sales were too low to support fixed overheads of $560,000 per month (leaving aside variable expenses) and that therefore it was apparent that losses to the 31st of December would be incurred of a substantial and material nature.

32. There is no contest that monthly sales figures were supplied to the Plaintiff by the Defendant. Given that the level of overheads was $563,000, and that that was maintained through to December, it is argued that on the commonly assumed 28% gross profit margin, it is a matter of arithmetic that monthly sales in excess of $2 million would have been required to support expenses of $560,000. The sales for September, October and November were $1.9 million, $1.7 million and $1.55 million respectively and indeed had not exceeded $2 million in any month since March 1983. As the Plaintiff knew this, the Defendant argues, the Plaintiff ought to have known that losses were being incurred.

33. The Defendant maintains that P.W.2 and 3 were aware of the poor financial situation of API but believed that the company could be made profitable again quickly, more particularly if the Hongkong & Shanghai Bank carpet contract, which was then in the pipeline, was won. It is said that P.W.2 and 3 were looking for credit in the Swire organisation for rescuing API and had the warranties to fall back on if that did not happen in fact. When there was trouble, it is suggested that P.W.2 and 3 enlisted the aid of P.W.4 to report to them as to what was going on, to follow their instructions, and cover up their mistakes until a profit was made - which of course never happen. In that climate, it is said, Miss Lydia Dunn and the Swire Board were not informed of the true position until late May 1984 i.e. more than 4 months after P.W.2 and 3 had authorised the first loan of $4.7 million to API to repay debts without any minute or details of that loan (as is true) having been recorded anywhere. D.W.1 says that the company was starting to "turn around" in early 1984 but that trouble began to brew when he asked for repayment of the $490,000 which was due to him and there then was formed a conspiracy to have him dismissed and to cover up mistakes made in the acquisition. There is no satisfactory evidence to support these allegations.

The Claim regarding Material Reduction in net Assets and Material Deterioration in the financial position of API- Part I

34. Principally the Plaintiff says that there has been a breach of Clause 5 of the 5th Schedule to the agreement in that between the time of the audited balance sheet of the 31st March 1983 and the contract of the 20th December 1983 there had been a material alteration in the assets and liabilities of the company; a material reduction in net assets and a material deterioration in the financial position of the company. The Plaintiff says it is entitled to $4,471,178 as damages as that is the figure which a comparison of the audited balance sheets as at the 31st March 1983 and as at the 31st December 1983 discloses is the figure by which the net asset worth of the company diminished in that period.

35. The Defendants do not accept the accuracy of the balance sheet of the 31st December 1983 (Pages 690A-p). The audit was conducted by Price Waterhouse, the company accountants, on figures supplied by API and the auditors certified that, subject to the matters referred to in their report (690D), the accounts gave a true and fair view of the company and the group at the 31st December 1983. The qualifications of the auditors related to the John Lok debt to which I have referred and the provision made in those accounts for old and slow moving stock are only qualifications to the extent that collectability of the John Lok debt and the accuracy of the stock write down could not be verified.

36. The Defendants challenge the provision for old and slow moving stock and write off of the difference between book stock and actual stock in the December accounts (i.e. $1,273,486 and $396,341 respectively) and the figure included for exchange losses ($642,367). In other respects however the balance sheet figures are not seriously questioned and I have no difficulty accepting the accuracy of these accounts save for the adjustment to which I shall hereafter refer.

37. On any view of the figures however, either as to the whole of the claimed net asset reduction or part of it, the amounts in dispute under the various heads of dispute, on the most favourable light from the defence point of view, still leave a considerable balance as a reduction in net asset worth. As regards the reduction, in whatever quantum it be, the defence is that the Plaintiff knew, or should have known, the state the company was in when it took it over and that there had been a reduction in net assets which was material and continuing and that as a consequence that the warranty was "inappropriate" and the defence should not in the circumstances be held to it and the Plaintiff is estopped from claiming under it.

38. There was a great deal of evidence as to what was supplied and not supplied by way of financial information prior to takeover just as there was as to how that information which was supplied could or should be construed. D.W.1 says he supplied all information that was requested of him and that appears to be so. The Plaintiff says however that that information was in some cases inaccurate or incomplete.

39. Both sides called expert witnesses. Mr D.R. Hague (P.W.1) of Price Waterhouse gave evidence for the Plaintiff and Mr K. Morrison (D.W.3) of Pannell Kerr Forster gave evidence for the Defendants. Both are accountants of considerable experience and both have had experience in company acquisition. They both are accountants who are expert in company matters and at the end of the day, with some exceptions to which I shall turn, there was not a lot of difference between them. There was no real contest that there had been an alteration in the net asset value of the company in the 9 month period prior to acquisition.

40. P.W.1 prepared a report which is P1. At Appendix 1 of that report he compares the group (i.e. API + ACC) and company (API) balance sheets as at the 31st December 1983 and the 31st March 1983. At Appendix 3 he compares API's balance sheets at both dates but because he has disregarded ACC's results in comparisons with other figures as being of little consequence, the better comparison document to commence with is that at Appendix 1.

41. Quite simply, on a comparison of the two balance sheets at the various dates the company showed net assets as at the 31st March 1983 of $1,920,353 compare with the group net liability of $2,550,825 at the 31st December 1983. There had been a decline in the net assets through that 9 month period of $4,471,178.

42. API was technically insolvent at the 31st December 1983 and could not have continued in business without outside support. One only has to compare the two balance sheets to see that the principal changes which had taken place in that 9 month was a decrease of some $3 million in stock and an increase in creditors of $1.3 million.

43. I find it unnecessary to record the complexities and details of the reasons for the decline. D.W.1 himself confirms that sales were down, the John Lok debt was not paid and the Hong Kong financial scene was then deteriorating and that in turn generated problems in that API used spot rates of exchange to buy goods overseas and the Hong Kong dollar was then depreciating. Additionally, because the economy was slowing up, buyers were not as interested in carpets and furnishings as they otherwise might have been and so the market was more competitive leading to reduced prices and lower profits. In broad terms P.W.1 has offered the view, which I accept, that there was reduced sales in the order of 60% and a reduction in gross profit margin which together contributed to a decline of approximately $1.75 million. D.W.2 in his analysis of the contributing factors to the reduction in net asset value arrives at much the same figure with the product of his calculation of reduced profit margin, reduced sales and reduction in other income.

44. There is no real contest between D.W.3 and P.W.1 that part of the reported loss of $4.5 million is attributable to the additional stock provision of $773,468 made in the balance sheet as at the 31st December 1983 over the level of general provision in March 1983 of $500,000. Both experts agree that there was a substantial decline in the value of the Hong Kong dollar during that period and that because bills payable to suppliers were denominated in foreign currencies; the liability of the Defendants in Hong Kong dollar terms increased. Both witnesses have quantified those losses by various calculations but again there is not a great deal of difference between them in that P.W.1 put those losses at $540,000 whereas D.W.3 puts them at $642,000. I accept P.W.1's calculation in relation to increased interest charges of $462,000. Rental charges increased by $316,000 on a proportional basis during the 9 months. Other factors in the nature of reduction in other income compared with the 1982-1983 period, increase in the rate of directors' emoluments and stock taking discrepancies and such like account for the balance in the deficiency in the asset worth.

45. I need now turn to those figures which are in contention in the December 1983 accounts.

1. Stock Write-Off

46. An item by item stocktake was arranged for the 3rd January 1984. Stock clerks from the auditors were arranged and details were finalised by P.W.4 who was in charge and D.W.4 Mr M. N. So.

47. Stock was stored in 2 different warehouses; one had the carpets whilst the other the furniture and underlay. The conditions in the latter warehouse were particularly poor. The stock count took place but bad conditions, the weather, inadequate and untrained staff and the like produced quite unsatisfactory results.

48. After this count, the books could not properly be reconciled and so it was decided that the contents of the particularly bad public warehouse be moved to the plaintiff's Cheung Sha Wan Godown as soon as possible. That warehouse held about 50% of the total stock.

49. On the 25th of February 1984 that stock was moved and a docketing system was used in the count and the resulting figure was "rolled back" to the 31st of December 1983 by deducting sales from that day to the day of the stocktake. The "rolled back" figure for stock to the 31st December 1983 showed a difference of $250,674.45 between the book record and the actual count. The carpet in the other warehouse which had been counted on the 3rd of January 1984 produced a difference of $183,543.56 between the recorded stock and actual stock as at the 31st December 1983. After adjustments the total difference was $396,341 between book record and physical count as partially "rolled back" to the 31st December 1983.

50. The book value of stock before any adjustment was $6,548,855 (Page 854). Of the $396,341 difference between the book value and the physical value as at the 31st December 1983, $107,282 worth of items were being used as fixed assets by the company and no appropriate adjustment had been made to reflect this reclassification. To that extent therefore, the book stock figure as at the 31st of December was overstated by that amount. There is no evidence on the point but as I see it the book stock value need quite properly be reduced to that extent but there would need to be a credit of that amount elsewhere. The items are fixed assets. They are not "lost". The totals in the books would be the same though the column be changed.

51. D.W.4 and P.W.2 both described the stocktake on the 3rd of January 1984. The event was a shambles. There was inadequate and untrained staff. There was insufficient time for proper preparation and inadequate supervision. Probably most importantly the personalities present were not familiar with the stock and I accept the evidence of D.W.4 that likely mistakes were made in counting or identifying products. He said that in previous years though there had only been a sample count there had not been material discrepancies and by and large the book records were adopted as the correct figure.

52. Given that part of the write off figure would be a. credit elsewhere in the books of account, the unsatisfactory nature of the first stock count on the 3rd January and the errors which may have resulted in the "rolled back" count in February (which was a 50% count only) I am not satisfied that the Plaintiff has shown that $396,341 was a correct figure to write off for stock.

53. I am unable to properly determine what the correct figure should be. On D.W.4's evidence the amount could be quite small if book stock broadly tallied with physical stock as he said had been the case on past occasions.

54. As my objective is to determine whether the net asset worth of API had depreciated to the extent that the Plaintiff says it had, I do not consider it right to enhance a differential by inclusion of sums which may well not be correct or indeed be either in whole or in part artificial. I therefore propose adjusting the figure which the Plaintiff says is the differential in net asset value i.e. $4,471,178 by that amount of $396,341.

2. General Provision for Old and Slow Moving Stock

55. There was a significant reduction in the value of stock held by the company between the 31st March 1983 and the 31st December 1983. In March 1983, the stock was valued at $8,404,671 whereas as at December 1983, it was valued at $5,288,040. This reduction in stock was the combined consequence of a decrease in the volume of stock itself on hand and an increase in the level ofprovision made against old and slow moving stock.

56. In the report attached to the accounts of the company for both years, concern was expressed by the auditors as to the valuations which were placed n slow moving stock at both days and in both cases the auditors made it clear that they were unable to satisfy themselves as regards the valuation placed on stock and, in consequence, they were unable to state that in their opinion the accounts of the company gave a true and fair view of the results of the company at both dates.

57. In the December 1983 accounts there was provision made for old and slow moving stock in the sum of $1,273,486. The object of provision is to reduce the value of stock in the accounts to the lower of cost and net realisable value. In past years the provision which ARI had made was $500,000 and the Defendant claims that the extra provision was not justified and results, in the net assets of the company appearing to be less in December 1983 than it should be because the stock figures are not accurate.

58. After takeover P.W.4 undertook an exercise to determine the provision which ought to be made under this head. Out of the total physical stock, slow moving stock was identified on the basis of stock which was more than 1 year old and for which there had been no movement for at least 6 months. I am satisfied that that is a reasonable approach.

59. When the book value of that stock had been identified, P.W.4 and D.W.4 (save for a few exceptions) discussed the provision which ought to be made against that stock and subjectively they assessed saleability, movement, market etc. and arrived at figures varying from 25% to 100%.

60. Common sense would dictate that the assessment of the percentage deduction ought to be made on the basis of sale in the ordinary course of business. D.W.4 claims that P.W.4 told him the assessments were to be on the basis of sale "within 2 weeks". P.W.4 denies any such instruction but she does say that she wanted the stock cleared quickly and would be content with 1/2 or 1/3 prices to clear the warehouse and she agrees that D.W.4 was instructed to make his assessments on that basis.

61. If the evidence stood there it may at first appear that P.W.4 could have over provided by using the yardstick of quick clearance. The auditors themselves however had suggested an increased provision and had indeed offered $2.2 million as the appropriate figure to write off and that is a matter which has to be borne in mind.

62. That which I find to be a sound approach however is that adopted by P.W.1 who looked at what should have been the position in March 1983 accounts. He caused an aging analysis of stock as at the 31st of March 1983 to be compared with figures as at the 31st of March 1982. I accept his figures which appear at Appendix XII of his report (P.1). It is clear from those figures that there was a substantial increase in the amount of stock which was over 24 months old from $714,000 in 1982 to $1,530,000 in 1983 representing an increase of 121% during that period. Despite this increase however, there was no increase in the amount of general provision made against stock at the 31st of March 1983, which, in 1982, had been $500,000. Had the level of provision at the 31st of March 1983 expressed as a percentage of stock in excess of 2 years old remained constant that would have resulted in an increase of approximately $600,000 in the amount of provision made at that date. Given that that figure can only be an approximation, which of its very nature is subjective, and accepting as I do that $600,000 is a reasonable proximation of the level of underprovision made against stock as at the 31st of March 1983 the consequence is that this understatement would have resulted in the net assets of the company being overstated by 31% as at the 31st of March 1983 and the reported losses for the year ending on that date being understated by 43%.

63. As I have already indicated, P.W.4 when preparing her provisions for slow moving stock as at the 31st of December 1983, prepared an analysis showing stock lines on which there had been no movement within the previous 6 months. In that category was stock valued at $4.2 million and, of that figure, calculations revealed that there had been no movement on stock valued at approximately $3.1 million for more than 12 months and further stock valued at $600,000 had no movement for a period of 21 months or more. The analyses were not prepared upon the same basis but, in terms of percentage, as at the 31st of March 1983 stock over 12 months represented 38 of stocks on hand while the comparable figure as at the 31st of December 1983 shows that the amount of stock over 12 months old had increased to 68% of stock indicating that the provision against stock as at the 31st of March 1983 was inadequate.

64. As I see it, there was underprovision at March 1983 of at least $600,000. That is in breach of Clause 4(A)(1) of the contract. To bring the books up to date as it were in December 1983 P.W.4 arrived at a figure of $1,273,486 as being the right amount to write off. That necessarily include the element of underprovision in March 1983 and her figure really only enhances that theoretical figure by $173,486 to December 1983 (i.e. $500,000 + $600,000 + $173,486) and hearing in mind the stock values on hand that is certainly not unreasonable. P.W.1 effectively supports this via another route in that he says that with the benefit of hindsight the provision in the December 1983 accounts was not excessive as at the 31st December 1984 there remained on hand stock valued atapproximately $2.3 million which API had identified as slow moving in December 1983 and against which provision had been made.

65. I am satisfied that the write off of $1,273,486 in the December 1983 accounts was a fair and just figure and properly made as part of the exercise in determining the net assets of API at that time.

3. Exchange losses

66. The Defendants maintain that included in the alleged material alteration is the sum of $642,367 representing exchange losses which were not realised on the 31st December 1983 or if they were, as a matter of construction, realised, the Plaintiff was aware of such contigent losses prior to the signing of the agreement. The loss appears in the December accounts under "expenses" (Page 690P).

67. The evidence establishes that the Plaintiff ought to have been aware that exchange losses of even unusual proportions were being incurred by API prior to takeover. The Plaintiff through its witnesses denies receipt of the document headed "Bills Payable and Trust Receipts Outstanding as at 8/9/83" (Page 116) which the Defendants claim was sent to it. That document contains information relative to exchange rates but I need say no more about it because I am not satisfied the Plaintiff did receive it prior to takeover. I do not accept however that P.W.2 and P.W.3, both commercial men of ability and experience, would not have appreciated, had they thought about it at all, that the substantial decline in the Hong Kong dollar which occasioned throughout the period between the 31st March and the 31st December 1983 must have affected the financial situation of API. It was known that API purchased most of its goods from overseas; it was known API used spot rates of exchange; it was known that bills were outstanding and that they were denominated in various foreign currencies and any reasonable businessman would have known that an addition to the cost of goods purchased would undoubtedly contribute to decrease in gross profit.

68. D.W.4's evidence was that API's practice was to make an exchange adjustment at the end of the financial year according to the rate prevailing at that time. Exchange losses and interest were dealt with in the backs as financial expenses and not part of the cost of sales. D.W.3, whose evidence I accept on this point said that it is a common practice in many companies. P.W.4 was even more emphatic in that she said that interest and exchange losses should not be added to cost of sales but should be treated separately as API did and practically joined issue with P.W.3 who had said that it was "reprehensible" to enter exchange losses in the books when the bills were paid.

69. What is clear is the Plaintiff did not ask or find out itself how exchange losses were treated. I am satisfied that there was no accounting irregularity in the manner employed by API in booking exchange losses at the end of the financial year and I am satisfied, as I have said, that the Plaintiff ought to have known losses were likely in the financial climate of Hong Kong at the time.

70. The figure which was included in the accounts was $642,367. There is no evidence from the Defendants that that figure, as a figure, is inaccurate. That is the audited loss in exchange to the 31st December 1983. The Defendants say those losses were not realised as at that date and that in consequence those losses should not be taken into account. Unrealised exchange losses (and gains) were however taken into account at a balance sheet date. When foreign currency payable remained unpaid at a balance sheet date a comparison was made between the relevant exchange rate at that date (i.e. 31/12/83) and the rate ruling at the transaction date. The resulting difference was then debited or credited as the case was to the profit and loss account. That exercise was undertaken as at the 31st December 1983 and the resultant figure was a loss of $642,367 and that loss quite properly was entered as an expense in the December 1983 accounts and that being so the balance sheet as at the 31st December 1983 is not inaccurate as alleged in that regard.

The Claim regarding Material Reduction in Net Assets and Material Alteration and Deterioration in the Financial Position of A.P.I. - Part II

71. I find it proved that there was a reduction in the net assets of API between the 31st March 1983 and the 31st December 1983 of $4,074,837 i.e. $4,471,178 less $396,341 for the unproved book stock adjustment.

72. It is apparent on a comparison of the balance sheets as at the two dates that there has also been a marked alteration in the structure of the assets and liabilities of the company. Stock fell from $8,404,671 to $5,684,381 ($5,288,040 per December balance sheets plus unproved stock adjustment of $396,341) whilst on the other hand creditors and bank indebtedness increased from $9,943,348 to $11,879,196 to particularise just two of the major changes.

73. It is also clear of course that the financial position of the company otherwise deterioriated in that the reported losses of $4,500,338 during the period was so much greater than the loss of API of $1,383,594 + the profit of ACC of $29,160 for the 12 months to the 31st March 1983.

74. The next question is whether those reductions and alterations were material.

75. In Levison & Ors. v Farin & Ors. (1978) 2 All E. R. 1149 it was held in relation to a similar warranty to that in Clause 5 of Schedule 5 that on the facts of that case an adverse change in the net asset value of that particular company of about 20% on a stated net asset value of £44,000 (i.e. about £8,600) was material.

76. In this case the net assets of the company have altered from assets of $1,920,353 as at the 31st March 1983 to liabilities of $2,550,825 (P1 Appendix 1) adjusted (stock write off excluded) to $2,154,484. The change has been a decline of some $4.4 million over the period which is a figure of more than double the paid up share capital of the company. Such a reduction in net assets cannot be otherwise than material and I so find as I do that the changes which took place overall in the assets and liabilities and the financial position of the company by virtue of their very nature and extent are also material.

77. The Defendants maintain that the Plaintiff knew, or should have known, the state the company was in when it was taken over and that there had been a very significant change for the worse in net assets and that losses were continuing and that as a consequence it is estopped from suing upon the warranty.

78. It may be, as for example in relation to exchange losses, that in some instances particular employees of the Plaintiff were aware, or should have been aware, of particular matters which might well have indicated to them that API was not doing as well as it ought and that its performance was falling short of that forecast. There was, for example only, a clear indication from a supplier prior to completion of the contract that API was in difficulties with that particular supplier at least. That warning was not pursued. An explanation and determination of what facts were known and not known or ought or ought not to have been known by the Plaintiff prior to completion is a mammoth task which need not be undertaken for the purpose of this judgment. That which is clear from the evidence is that though there may be areas where the Plaintiff might have spotted some deterioration or faltering performance, on no reasonable view of the evidence could it be said that the Plaintiff was aware or ought reasonably to have been aware of the extent of any deterioration that was taking place and certainly not to the degree that dial take place. Even the Defendants themselves were not aware of that. Indeed, the enormity of the deterioration aside, it is more likely than not that the Plaintiff was not aware that changes, amounting to material changes, were taking place. That quantum of change, to amount to material change, I hasten to add, would be much less than has been demonstrated to be the case here.

79. There was no audit prior to take over and I see no reason why they should have been. There are practical difficulties and time lags in taking such a course and I accept the evidence that it is not necessary, particularly in a case where warranties of the sort obtained here are given. It is even moreso where the purchaser is keeping on the vendor to run the business and is buying that business relying on that persons own knowledge of his company and skills in the particular trade in which the company engages. For my part I would have thought it commercially sensible to seek a warranty of the type the Plaintiff secured here and I do not presume to criticise it in any way for having done so.

80. Given that I am satisfied that the Plaintiff was not aware that material changes had taken place in the asset worth over the 9 month period no real question of estoppel arises if indeed any such question ever arose. The fact of the matter is that at the end of the day, as regards the claim for breach of warranty, it is a matter of whether or not the clear unambiguous words of an express promise, in a formal negotiated contract, entered into by the Defendants after long and protracted negotiations, of their own free will with the benefit of legal advice, has been breached.

81. There is no question in this case of mistake, duress, undue influence or misrepresentation by the Plaintiff. Evidence of the parties' intention is not admissible to explain or qualify the clear words of the contract. It is not for me to decide whether this warranty or any other warranty in the contract is "appropriate" or not (although I have earlier expressed an opinion); the contract term is precise and unambiguous and should of course be construed according to its ordinary meaning.

82. I conclude as Gibson J. did in Levison & Ors. v. Farin & Ors. at page 1156 that "the warranty deals with a material adverse change; not with the causes of such changes". The issue then is was there a change in assets or a deterioration over the period and if so was that change or deterioration material. The answer to both questions is affirmative and the only matter then to consider is whether there is any exception within Clause 5 itself. In that regard two matters only are excluded i.e. the purchase of the shares in ACC and the dissolution of the partnership.

83. Clause 5 provides:- "Save as mentioned above -----there has been no material alteration ---------". The two matters I have referred to are the only matters mentioned. The word used in the clause under consideration in Levison & Ors. v. Farin & Ors. were "save as disclosed" and in that regard Gibson J. had this to say at page 1157: -

"I do not say that facts made known by disclosure of the means of knowledge in the course of negotiation could never constituted disclosure for such a clause as this but I have no doubt that a clause in this form is primarily designed and intended to require a party who wishes by disclosure to avoid a breach of warranty to give specific notice for the purpose of the agreement, and a protection by disclosure will not normally be achieved by merely making known the means of knowledge which may or do enable the other party to work out certain facts and conclusions. "

84. The learned judge there recognise that there could in that case be disclosure to avoid a breach of warranty but that that disclosure need be specific. In this case the words in the contract are more stringent and exclude all matters disclosed or otherwise other than "save as mentioned above" and if I am right on that, even if there had been disclosure by the Defendants of information, facts and circumstances, that would serve them no avail under the contract unless those matters were specifically referred to in it. They are the clear words of the contract. If I am wrong on that view however, then, though the Defendants may have supplied some information which may have enabled the Plaintiff to work out,  to whatever degree, a conclusion relating thereto, that information was not so precise as to come to specific notice outside the contract that there had been a particular material change or deterioration in a particular regard.

85. In my judgment the Defendants are in breach of the warranty in Clause 5 of the 5th Schedule to the agreement of the 20th December 1983. There were substantial losses which resulted in a material deterioration in the financial position of the company and a material reduction in its net asset value.

Measure of Damage

86. The Plaintiff paid $1 million cash to the Defendants and, as no profits were made prior to D.W.1's dismissal as Managing Director or would have been made as at the 31st March 1986, the Plaintiff has therefore acquired API & ACC for $1 million. At the same, it has also acquired considerable debts and liabilities which were required, for one reason or the other, to be discharged and which would have had to have been paid in any event. The precise extent of those liabilities was not quantified by the evidence nor could it reasonably have been expected to have been. I am satisfied however that those financial responsibilities acquired by the Plaintiff either directly or indirectly upon acquisition well exceed $3.5 million. The Plaintiff discharged $4,719,669 of API's trade debts alone in January 1984 and a further $2,870,838 between March and May of that year and that in addition to arranging increased banking facilities for API.

Clause 5(7) of the contract provides:-

"(7)    The Vendors agree to be liable for and to indemnify the Purchaser in respect of and to the extent of any loss or expenses suffered or incurred by reason of any matter or thing being at any time found to be other than as warranted and represented in this agreement (including legal cost on a full indemnity basis arising out of any dispute in relation thereto). Any amount payable by the Vendors under this Clause 5 may be deducted by the Purchaser from the purchase consideration. The liability of the Vendors hereunder shall not be diminished or extinguished even though the market value of the company, taking into account all representations and breaches of warranty, equals or exceeds the consideration payable hereunder and the Vendors shall place the Purchaser in, so far as money can do it, the position it would have enjoyed had the warranty or representation in question being true. "

87. Even had there been no provision in the contract the Plaintiff would have been entitled to be put in a position it would have been in had the warranty in Clause 5 of Schedule 5 not been breached by the Defendants.

88. As a consequence of the breach the Plaintiff acquired a company with a net asset value less by $4,074,837 than it was promised by the Defendants would be the case upon acquisition. That is the proper measure of the Plaintiff's damage for the Defendants breach of that warranty.

Breach of Other Specific Warranties

89. The plaintiff also alleges that the Defendants are in breach of certain specific warranties in the contract but the Plaintiffs counsel rightly agrees that if the Plaintiff succeeds, as it has substantially done, on its claim under Clause 5 of the 5th Schedule then the other claims merge with it and any damage suffered as a result of a specific breach of one of those other warranties is part and parcel of the total damage suffered as a consequence of the breach of Clause 5.

90. That being the case it is not necessary to dwell upon them save to record that they all would have succeeded to the extent claimed save for the alleged breaches related to Clause 4 in that it was not shown that the accounts were not true and accurate to the extent that $396,341 should have been written off as an adjustment of stock, Clause 4 and indeed Clause 10 were however breached by the Defendants as regards the accuracy in provision for old and slow moving stock as I have already indicated.

91. The matter regarding the amount due by John Lok & Partners should be mentioned. Included in the accounts receivable as at the 31st March 1983 was $1,164,801 which was due from John Lok & Partners in relation to a contract for the supply and fitting by API of carpets as Harbour Centre Phase I. There is a contentious credit note which was issued by API in favour of John Lok & Partners dated the 31st December 1983 for $210,237.37 (Page 838). That credit note resulted from a settlement of adjusted quantities of carpet laid at Harbour City. The balance of $957,564 was paid in part in July 1984 and the remainder in May 1985. I accept that the Plaintiff did not know about the credit note at the time of completion and believed, at that point, that the entire outstanding debt from John Lok would be paid in full. I do not believe D.W.4's evidence that the credit note was backdated to 31st December 1983 because he himself spoke of it in correspondence on the 13th January 1984 (Page 839) in the past tense.

92. Leaving aside any issues of collectability within 6 months, the Defendants, by releasing part of the John Lok debt are in breach of Clause 11 and the Plaintiff suffered loss to the extent of the amount released but that loss is part of the Clause 5 Schedule 5 claim and not in addition to it. 

Misrepresentation

93. The Plaintiff claims that in addition to the representations in the contract itself, in order to induce the Plaintiff to enter into that contract the Defendants misrepresented the true financial position of API. In particular it is alleged that on the 20th August 1983 D.W.1 wrote to the Plaintiff representing that sales and profits for the following 4 years would be as therein set out and in particular that the net profits for the financial year 83/84 would be $500,000 and that the level of expenditure for August 1983 and subsequent months would be lower due to staff reductions and other cuts in overheads.

94. There was no profit but substantial losses as the evidence established and the projected expenditure for the period to the 31st March 1984 was $7.5 million whereas, in the event, expenses for the 9 months to the 31st December 1983 were $7,133,000 which is an overall increase in those expenses of $1.546 million.

95. Additionally, it is alleged that the Defendant delivered cash forecasts which failed to disclose that substantial debts were overdue for payment and actually orally represented that there was no pressure from bankers and that no major debts due to suppliers were overdue and that high interest rate were being charged on those sums. It is said that D.W.1 represented that increases in overdraft facilities from $1.5 million to $3.5 million would be adequate for the future business of the company when such was not the case.

96. D.W.1 denies that the forecasts were inaccurate or lacking in disclosure and that, insofar as sales and profit projections were concerned, those were his personal estimates, honestly made in good faith, and that the figures which he did supply were as accurate as could be at the time and that if hindsight has shown otherwise in some instances, as indeed it has, he had no reasonable way at the time of appreciating that such would be the case. He says in any event the Plaintiff was making its own detailed calculations, estimates and assessments (as indeed it was) prior to take over and was relying on those estimates and assessments of its own and was not induced to enter into the contract by any representation of the Defendants.

97. It is true that the Plaintiff was making assessments of considerable thoroughness and detail prior to take over. Those assessments, in a number of instances, to varying degree of import, were based upon information and particulars supplied by the Defendants which founded or influenced, as the case may be, the assessments of the Plaintiff. In that regard, to the individual extent related to a particular figure or forecast, in the instances where the evidence established that the information was false, the Defendant misrepresented the position.

98. By virtue of Section 3 of the Misrepresentation Ordinance Cap. 284 it is for the Defendants to show on the probabilities that they had reasonable ground to believe, and did believe, the fact represented was true. The Defendants have not discharged that burden. In view of my findings in relation to the contract provisions however it is not necessary to deal with each misrepresentation and the extent and effect of it. I am satisfied that there has been misrepresentation which induced the Plaintiff to enter into the contract and in that regard the Plaintiff would succeed also.

99. The damage, in whatever figure it may be, occasioned to the Plaintiff in consequence of misrepresentation is on no account greater than the damage it suffered in the difference between the net asset value as at the contract date compared with as at the 31st March 1983 and is part of that difference and not in addition to it. It is therefore not necessary to quantify the damage occasioned by those particular acts of misrepresentation as induced the Plaintiff, in whatever particular degree, to enter into the contract.

The First Defendant's Claim for Wrongful Dismissal

100. I have earlier set out the relevant provision in the employment contract between API and D.W.1 which provided, as relevant, that API could dismiss D.W.1 at any time upon giving him 6 months notice. There is no qualification to that provision in that contract which is itself clear and unambiguous.

101. It may be that P.W.2 in the early stages told D.W.1, in effect, that the contract termination provision would not be invoked save for illness or commission of an offence. It is clear however that prior to the signing of the employment contract D.W.1 appreciated that the specific provision for termination was one which Swires would not waive and that he, albeit reluctantly, accepted that condition and did so of his own free will with the benefit of legal advice.

102. There is no real question but that API had the right to terminate D.W.1's employment without cause upon giving him 6 months notice and that he is not entitled under that contract to any other longer period of notice.

103. D.W.1 was however summarily dismissed without notice of any sort and it is not alleged that he was dismissed with cause. D.W.1 was not given the required notice. API is in breach of the agreement in that regard and he is therefore entitled to the damage he has occasioned thereby.

104. There is no serious contest but that D.W.1 was owed a total of $490,000 as then accrued directors fees (and a sum of money relating to the acquisition of the shares of ACC). He is of course entitled to that as monies earned but not paid as at the date of his dismissal.

105. The normal measure of damage to an employee who has been wrongfully dismissed is the amount the employee would have earned under the contract for the period until the employer could lawfully have terminated it less the amount he could reasonably be expected to earn in other employment (Chitty on Contracts 25th Ed. para. 3522). In this case the measure of D.W.1's damage is that which he could have earned if the contractual 6 months notice had been given to him. He is not entitled to claim the balance of the 3 year term because within that period he might have been dismissed with 6 months notice at any time.

106. D.W.1 claims a total of $2,389,310 representing salary at $40,000 per month to the 3rd January 1987 (i.e. the full 3 years), new year bonuses, car, medical, housing, utility expenses and holiday pay.

107. D.W.1's salary under the contract was $40,000 per month. He is entitled to 6 months at that rate plus one additional month as a Lunar New Year bonus which was payable. He is employed now by a company with which he is associated called Austpacific Investment Ltd. That employment commenced on the 1st November 1984 and he is paid $20,000 per month, He is also supplied with free housing, a car, medical insurance and the like.

108. D.W.1 surrendered the API company car when he was dismissed and hired another at $5,900 per month. He is entitled to the cost of that car for the 3 months from his dismissal to the 1st November 1984 as he is his medical insurance for that period. His housing was supplied by the Plaintiff for 6 months in any event and he was not entitled to any other expenses or pay entitlement (including holiday pay).

The position therefore is as follows:-

 

109. Where an employee's contract of employment is prematurely determined by his employer, reasonable salary paid in lieu of notice will be outside the Salaries Tax charge. In general all sums paid either on the premature termination by an employer of an office or employment or in consideration of a variation of the terms of employment are exempt because they flow from, the breach of contract and not from the employment itself (Willoughby; Hong Kong Revenue Law 2-116 and cases there cited). It follows therefore that in estimating employees lost earnings, allowance must be made for tax which would have been payable on the earnings and the damages awarded reduced accordingly (Halsbury's Law of England Para. 652).

110. There must also be deducted D.W.1's actual earnings during the period from Austpacific Investment Ltd (i.e. from 1st November 1984 x 3 months x $20,000).

An adjustment is therefore necessary as follows:-

 

Both Defendants' Claim for Deprivation of Ability to Earn Balance of Purchase Price

111. There has been no profit of API either to the 31st January 1985 i.e. the date when the 1st defendant might lawfully have ceased to be employed by it, or indeed, to the 31st December 1985. There are therefore no profits with reference to which a calculation is to be made and monies paid under Clause 3 of the Sale and Purchase agreement.

112. The totality of the evidence in this case is such that the Defendants have not begun to show that it was probable that profits would have been made even as far forward as the 31st March 1986 (which is the date nominated in Clause 3 as the end of the period in any event to which the contract calculation regarding profits was to be applied) had D.W.1's employment not have been terminated in the way it was. Allowing that D.W.1 should have been given 6 months notice and allowing that time from the date he was actually dismissed i.e. the 26th July 1984 I can confidently say that the evidence has shown that had D.W.1 remained to serve out proper notice expiring on the 31st January 1985 he would not have caused profits to be made by API to that time.

113. The claim by the Defendants under that heads fails.

Net Amount Payable by Both Defendants (Including Interest)

114. D.W.1 is entitled to succeed on his counterclaim against API in the sum of $692,700. It is agreed however by the Plaintiff that the practical course in the circumstances is to allow that sum to be set off against the monies found to be due by both Defendants to the Plaintiff, i.e. $4,074,837. The net amount payable by the Defendants to the Plaintiff is therefore $3,382,137.

115. The Plaintiff advanced well in excess of that amount in the discharge of API's debts which it need not have done had API been in the financial condition represented and warranted by the Defendants that it was to have been. Looked at from another angle, it is also true that the Plaintiff, although it paid the lowest potential purchase price under the contract for API (i.e. $1 million), acquired a company whose assets, particularly stock, was worth much less than had been warranted and in that regard suffered loss.

116. Clause 5(7) of the contract provides that the Plaintiff is to be put in the same position in respect of a breach of warranty as if the warranty had been true. Had the warranty been true, the Plaintiff would have had the money that it advanced to the credit of API for other uses. It seems to me to be right therefore that the Plaintiff have interest on the value of the reduction in asset worth as from completion i.e. 3rd January 1984.

117. I have had no evidence as to the interest rates payable by Swires on borrowed money. Realistically the group must be amongst those who secure funds at prime rate and that is the rate I propose awarding.

118. There will therefore be judgment for the Plaintiff against both Defendants in the sum of $3,382,137 with interest from the 3rd January 1984 at prime rate to judgment.

Costs

119. The Plaintiff is of course entitled to its costs.

120. Clause 5(7) of the contract to which I have already referred provides, inter alia, that in relation to disputes the Defendants are to indemnify the Plaintiffs to the extent of losses or expenses actually suffered and specifically provides that that indemnity includes "legal costs on a full indemnity basis".

121. At the risk of repetition the Defendants signed the agreement with legal advice. The expression "costs on a full indemnity basis" is a term with a particular and established meaning in relation to cost of litigation and harsh though it appears to me in this case I cannot say it is against public policy that there be such a provision in this contract between the parties. That being so I consider myself bound by the decision of the Court of Appeal in G.T.E. Directories (HK) Ltd. v. Mo Yung Kwok Wah (Case No. 155 of 1985) and am obliged to give effect to the bargain between the parties and order that the Defendants pay the Plaintiffs costs to be taxed on an indemnity basis.