KIDS WORLD LTD. v. XL MACHINE LTD. AND OTHERS

HCMP 125/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 125 OF 2002

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J U D G M E N T

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1. This is an application for summary judgment under O. 14 r. 1. The indorsment to the writ records the claim as being for a sum of US$1,165,970.14 being the amount of an outstanding loan made by the plaintiff (Kids World) to the 1st Defendant (XL Machine) and guaranteed by the 2nd defendant (Bernstein) and the 3rd defendant (Levine). Bernstein and Levine are the directors of XL Machine. An amended statement of claim was filed on 10 April 2002 which shows that the claim is based, first upon a deed made on 18 February 2000 (the deed), and second on an oral agreement allegedly made in June 2000. There is an issue as to whether the payments were made by Kids World or its wholly owned subsidiary Multi-Toys (HK) Ltd. (Multi-Toys) but nothing turns on that for the purposes of this decision.

2. The deed records that a loan was to be advanced to XL Machine in the sum of US$150,000. There is no dispute that the advance was made. Under the deed Kids World was appointed agent for XL Machine in handling purchase orders for toys. In fact the whole of the books of account of XL Machine were held by and administered by Kids World. Under the deed Kids World were to handle the paperwork in relation to all orders and XL Machine was required to procure its customers to send all orders "care of the agent at the agent's address". All Letters of Credit in relation to orders were to be made payable to Kids World. There was provision for agency and other fees Kids World were entitled to deduct and after collection of payment and deduction of the sums to which it was entitled Kids World were to pay the sums remaining to XL Machine. So it is plain that after the making of the loan there was to be a continuing relationship between the parties in which Kids World would be handling orders for XL Machine, as its agent, collecting payment from purchasers of the goods and remitting the balance to XL Machine.

3. The case for the Kids World is that after the initial loan of US$150,000 was made, further advances were made to XL Machine. The defendants deny that further advances were made. Their contention is that any further payments made by Kids World to XL Machine were in fact remittances of funds collected by Kids World from XL Machine's customers, in accordance with the deed. Thus, in order to succeed Kids World must establish that the payments it seeks to recover were loans and not merely remittances in terms of the agency arrangement.

4. Various sets of draft accounts have been prepared by Kids World based upon the books it held for XL Machine. It is not possible to find in any of those accounts the sum claimed by the writ. A demand made on 9 November 2001 requiring payment of a sum of US$2,157,471. A schedule is attached to the amended statement of claim which purports to set out the further advances, detailing 25 payments. These are not the only payments made by Kids World to XL Machine during the existence of the relationship between the two companies.

5. The total claimed in the writ, and set out in the schedule, is a lesser sum than the sum for which demand was made. There is no explanation for the reduction. The schedule covers advances made during the period the period from 8 March 2000 to 20 June 2001. No accounts appear to have been prepared to that date. Accounts to 31 May 2001 show a loan account in debit in Kids World's favour of US$1,236,654, but a current account in credit in XL Machine's favour of US$509,298, thus, a net situation of US$727,356. The next set of accounts are at 17 August 2001 and show a loan account in debit to Kids World of US$1,264,174 and the current account now also in debit to the sum of US$168,172, a net situation of US$1,432,346.

6. It is right that two of the three sets of accounts prepared by Kids World were given to Bernstein and Levine and that no complaint was raised about them. But that was before the issue now between the parties had arisen and before they were aware of the basis of the complaints that they now make. It is plainly arguable that their acceptance of the accounts at the time they were given, does not constitute a binding admission of the veracity of the accounts.

7. Mr Ng was quite unable to say why the 25 sums set out in the writ should be distinguished as advances, as against remittances from payments recovered from clients, other than to point to a series of mostly email correspondence in which defendants sought payments of sums from Kids World for various purposes related to XL Machine's business, and those sums were paid by Kids World, with no specific identification of the payments as a loan or payment of a remittance due under the agency agreement. In fact Mr. Ng was obliged to acknowledge that in none of the correspondence is the expression "loan" or "advance" used by either party.

8. The only sum due under the deed is the sum of US$150,000 recorded as an advance. The guarantee is a guarantee of sums payable by XL Machine to Kids World under the deed. The deed makes no provision for the payment of any sums by XL Machine to Kids World, other than the repayment of the loan and interest. The deed made no provision for either the payment, or guarantee, of any future advances that might be made.

9. The amended statement of claim refers to an "oral agreement" allegedly made in June 2000 that further advances made by Kids World to XL Machine would be subject to the same terms as the deed. There is simply no evidence at all from Kids World as to the date place or terms of that agreement. In these circumstances Kids World relies on a document signed by Bernstein and Levine and faxed to Kids World on 2 August 2001.

10. The best that could be said of that is that on the evidence, in May 2001, the parties began discussions in relation to payments made by Kids World to XL Machine, and the draft document was the product of those discussions. The document was a draft further deed, intended to secure further advances that were said to have been made to XL Machine. Amendments to the draft had been made and it was signed by Bernstein and Levine, although not in the place designated for parties to sign. The capacity in which they signed it is not made clear. It was faxed to Kids World with an email that invited comment. There was no reply to that email.

11. Mr Ng argues that the fact that there was no reply meant that the amendment was accepted by Kids World and that accordingly Bernstein and Levine were bound by the terms of the document. Putting aside for the moment issues of consideration, the submission simply cannot stand to support an O. 14 argument. The law is clear and fundamental. Acceptance must be communicated to the offeror: Chitty on Contracts 28th Ed. Vol 1 para 2-041. The amendments to the document, which were substantial, changing it from an on demand advance to an advance re-payable over a specified term, can be argued to constitute a counter offer. There is no evidence that the amended terms were accepted or that any acceptance was communicated. In fact, on 30 August 2001 Mr. Ronald Cheung, a director of Kids World, wrote to Bernstein and Levine in terms which make at least arguable, if not plain, that a repayment schedule was yet to be agreed. That is entirely inconsistent with acceptance by silence of the repayment schedule in the document.

12. Finally, it is arguable that there is no evidence at all of any consideration to support the document. It is not executed as a deed, and on Kids World's own evidence no further advances were made after 20 June 2001. The claim is that the advances were made to XL Machine and that the liability of Bernstein and Levine arises from a guarantee. There is no clear evidence of any consideration for the extension of the guarantee to cover the alleged further advances. It was argued that an amendment made by Bernstein and Levine to the document before it was returned in which the entitlement of Kids World to make deductions from payments received by it on behalf of XL Machine was to XL Machine's advantage, and therefore constituted consideration. The argument is there, but it is not so clear as to entirely rebut the argument that there is no consideration, so as to entitle Kids World to summary judgment.

13. While the document may be evidence of admissions by Bernstein and Levine of sums advanced, it does not, without any question at all, provide the basis of a cause of action against XL Machine, still less the basis of a cause of action on a guarantee by Bernstein and Levine.

14. But the matter does not end there. This is a case in which, prior to the issue of the writ, Kids World knew that there was a substantial dispute between the parties and that in any claim there would be significant questions of set off.

15. The evidence shows that the relationship between the parties had broken down and that towards the end of 2001 the parties were engaged in correspondence between legal advisors. In October 2001 a Minneapolis attorney had written to Multi-Toy setting out details of claims to be made against Multi-Toy that were estimated to exceed US$2.5 million. It is not disputed that a claim against Multi-Toy was equally a claim against Kids World. In November 2001 a very detailed letter was sent to solicitors for Kids World by XL Machine's Hong Kong solicitors in which the solicitors were invited to accept service of a writ that had been issued in the High Court against Kids World. A copy of the writ was enclosed. There was no response to that letter, other than that Kids World changed solicitors. The offer to accept service of the writ brought no response from the new solicitors, who instead issued the writ now before me and brought O. 14 proceedings based upon that writ.

16. At the centre of the dispute between the parties is the issue as to whether payments made by Kids World to XL Machine were remittances from XL Machine's customers. It is clear also that there are serious issues to be tried as to whether Kids World are in breach of their duties of fidelity as an agent. Mr Francis demonstrated to me, from the evidence filed by Kids World, an arguable case of secret profits being made by Kids World in breach of that duty. It is also abundantly clear that there are significant issues as to fitness for purpose and quality of the goods. All of these issues were canvassed in the correspondence prior to the issue of the writ.

17. In addition to these issues the writ issued by XL Machine, and the proposed counterclaim, seek an accounting between the parties. As I have pointed out, all the relevant accounting documents for XL Machine are held by Kids World. In January 2002 the solicitors for XL Machine requested inspection of documents held by Kids World. This brought the quite extraordinary response that documents exchanged with manufacturers were the property of Kids World. This response is extraordinary for it demonstrates a fundamental misunderstanding on the part of both Kids World and its advisors of the relationship of principal and agent. It is right that there has subsequently been some inspection but Kids World still maintains the position that there are documents which are excluded as being owned by them in their own capacity and not as agents.

18. The subsequent revelation of invoices from a manufacturer to Kids World at a different rate than the invoices disclosed to XL Machines demonstrates the likelihood of a claim for secret profits. It is right that the lower invoice was produced by Kids World. But the mere existence of two invoices with different amounts raises an issue that requires explanation by Kids World.

19. The sudden change in the accounts prepared by Kids World of the current account being in substantial credit in XL Machine's favour as at 31 May 2001, to a substantial debit against XL Machines by 17 August 2001 demonstrates the real need for an independent accounting between the parties.

20. The answer to the contention that the defendants ought to have leave to defend on the basis of a counterclaim and set off was that the two matters were not so closely interlinked that a set off arose. A general equitable set off arises if there is a cross-claim flowing out of and inseparably connected with the dealings and transactions which also give rise to the claim. The cross claim must be for a sum of money but may be liquidated or unliquidated: Halsbury's Laws of England 4 Ed (Reissue) Vol 42 para 430. In Esso Petroleum Co Ltd v Milton [1997] 1 WLR 938 the court said:

"For equitable set off to apply it must therefore be established, first that the counterclaim is at least closely connected with the same transaction as that giving rise to the claim, and second that the relationship between the respective claims is such that it would be manifestly unjust to allow one to be enforced without regard to the other."

21. Mr Ng relied upon Esso to say that there was not a sufficient connection. In that case it was held that a claim for future losses as a result of repuditory breach of contract was insufficiently connected to an unarguable claim for a debt due. That is undoubtedly right but it is a far cry from this case. In the first place, notwithstanding the argument strongly pressed by Mr. Ng, it simply cannot be said that the amount due is unarguable. There may be a debt due, but it is certainly arguable as to whether it is due under the deed and oral agreement upon which Kids World sues, for the evidence falls far short of establishing that the parties intended that some of the payments made after the initial loan were further loans and not simply remittances of sums due under the agency agreement. If it is not due as pleaded, as a loan under the deed and oral arrangement, but as a result of an accounting the cause of action will not have been established. And it is even arguable, having regard to the issue of a potential secret profit, the evidence as to the quality of the goods, and the requirement for an accounting, that there may be no debt due.

22. Second, the whole of the claim by Kids World is based upon a deed which establishes a relationship of principal and agent between the parties. The response to the claim is equally based on that arrangement and arises out of past dealings between the parties. The amount claimed is in dispute, and the counterclaim is inextricably linked to the calculation of the amount claimed. That there were both loans and a current account is clear. Both appear, quite distinctly in the accounts prepared by Kids World for XL Machine. In the accounts they are set off. In the circumstances justice requires that they should continue to be set off and the true sums due determined by a proper accounting. It would be manifestly unjust to allow kids World to have judgment without regard to the cross claim. I have no hesitation in finding that this case does not fall within the scope of the judgement in the Esso case.

23. Mr. Ng argued that the payments simply could not be remittances and had to be advances because the accounts showed that XL Machine operated at a loss and therefore had nothing due to it. The submission by itself establishes the dependency of the claim on the resolution of the cross claim. If on a true accounting between the parties sums were due to XL Machine then the payments that were made are likely to have been mere remittances under the agency arrangement and the balance may not be subject to any guarantee by Bernstein and Levine. The two issues are inextricably linked.

24. It is no answer to say, as Mr Ng did, that the separate action issued by XL Machine ought to take its own course. The issues greatly overlap and ought to be heard together. It is of no moment that the writ issued by XL Machine has not been served. That is partly because Kids World chose not to instruct its solicitors to accept service and partly because XL Machine were not at that time in possession of the information needed to substantiate the cross claim, and were still in the process of formulating the full extent of the claim. The writ not having been served, will either expire with the effluxion of time or be discontinued and is no bar to the counterclaim in these proceedings.

25. There will be an order granting the defendants leave to defend, conditional only upon the immediate discontinuance of the writ issued under Action No.5135 of 2001.

26. I will now hear counsel on the issue of costs.

(Submissions re costs)

27. The defendants seek costs and ask for an interim payment of costs pursuant to O. 62 r. 9A. Cost are sought on an indemnity basis. The plaintiff says there should be the usual order for costs, namely costs in the cause, or at worst, defendants' costs in any event, and that there should be no order for interim payment.

28. As I have said, this is a case in which Kids World knew, not only before the issue of the O. 14 summons, but also before the issue of the writ that there was a substantial dispute between the parties. The claim now brought could have been properly litigated by accepting service of the writ issued by XL Machine and filing a counter-claim. In Skink Ltd (In Liquidation) [1994] 2 HKC 286 at 291 Godfrey JA said:

"A plaintiff who starts O. 14 proceedings believing that the defendant has no defence to the action should be advised, as soon as possible, as soon as a credible defence is shown, to give up trying to obtain summary judgement; to do otherwise is simply to waste time and money."

In the same case, at first instance, (see [1994] 1 HKC 646 at 659) Kaplan J warned that too often O.14 applications were a reflex action which he plainly considered unjustified.

29. Kids World's solicitors knew, when they issued the O. 14 summons that the matters between the parties were in substantial dispute. They knew that from the correspondence and from the fact that a writ had been issued against their client. They were warned by the defendants' solicitors on an number of occasions that the O. 14 summons was likely to fail and, if it did, that costs would be sought on an indemnity basis.

30. It is no answer to an application for costs where an O. 14 summons has failed to say, "Well I had an argument and I was entitled to make it". It is incumbent upon solicitors to make a realistic assessment of the likelihood of success of an argument that may be made on an O. 14 summons. They must have regard to the requirement in O. 14 r. 1 that for such an application to succeed that there be no there must be no defence to the claim. An O. 14 summons is not a case of "testing the waters" to see if the application succeeds. Only where it can be safely said that there is no defence at all should O. 14 procedures be embarked upon. That was plainly not the case in these proceedings.

31. Mr Francis sought indemnity costs but I do not think that order is justified in this case. The requirement for indemnity costs is that the proceedings are scandalous or vexatious, or have been instituted maliciously, or for an ulterior motive, or in an oppressive manner. Those criteria are not met in this case, although it may be the case that such an order will be made in unjustified O. 14 proceedings.

32. Where there is a good argument for an O. 14 summons but it fails on the merits, as was the case in Skink, the usual order will be costs in the cause. However, where an O. 14 summons is issued or pursued in the face of a plain defence and counterclaim, as has been the case here, the waste of time and money ought to be reflected in a costs order. I do not need to rely upon O. 14 r. 7 to make a costs order, as I am satisfied that any order for costs may be made on granting leave to defend: see Hong Kong Civil Procedure 2002 para 14/7/13.

33. There will be an order that the plaintiff must pay the defendants' costs, to be taxed on a party and party basis.

34. The defendants sought an order first that the costs be paid forthwith, and second that there be an interim payment of costs pursuant to O. 62 r. 9A. That rule provides:

"9A.- (1) If a party makes or resists an application at any stage of proceedings before the Court, the Court may -

(a) if the Court considers the application or resistance to the application, as the case may be, to be frivolous or vexatious or

(b) for any other reason that the Court in the circumstances considers just,

when ordering costs against that party in respect of the application, order that party to pay forthwith to any other party to the application an amount which in the opinion of the Court approximates the costs that would be allowed on taxation."

35. Mr Francis relies on r. 9A(1)(b) and argues that because Kids World has collected all the funds due to XL Machine and declines to pay any further funds to it the defendants are potentially deprived of their own funds with which to fight the litigation. Mr. Ng argues that the terms of the rule are limited by the terms of R 9A(1)(a), and that the test of "frivolous or vexatious" must be met before an interim payment can be made. That cannot be right. The terms of Rule 9A(1)(b) are sufficiently wide to allow the court to do justice between the parties.

36. In the particular circumstances of this case, where the Kids World has collected and controlled the disbursement of XL Machine's funds, and pursued a quite unmeritorious and time consuming procedure, the justice of the situation requires an interim payment. Mr. Francis and Ms. Leung have put before me schedules of the costs incurred by their clients. Mr. Francis' schedule exceeds HK$400,000. Mr. Francis tells me, without complaint from Mr. Ng, that party and party costs are likely to exceed HK$300,000. O. 62 r. 9A(2) contains provision for an adjustment should the taxed costs exceed or be less than the interim payment.

37. There will be an order pursuant to O. 62 r. 9A that the plaintiff must forthwith pay the sum of HK$250,000 to the 1st and 3rd defendants jointly and the sum of HK$50,000 to the 2nd defendant, by way of an interim payment of costs, with the balance, if any, being paid forthwith upon the completion of taxation.