Great Genius Industrial Ltd v. Lg Corporation Ltd and Others

HCMP 203/2020

[2020] HKCFI 2890

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 203 OF 2020

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BETWEEN

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J U D G M E N T

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1.By Originating Summons dated 9 March 2020, the plaintiff applies for leave under section 732(1) and (2) of the Companies Ordinance[1] to commence, on behalf of the 1^st defendant (“the Company”), an action in the Court of First Instance against the 2^nd to the 4^th defendants (respectively “De Groot”, “Wong” and “Lexington”, and collectively “the defendants” by which term I do not include the Company).

2.The Originating Summons originally named the Company as the only defendant.  By leave granted by Linda Chan J on 6 April 2020, De Groot, Wong and Lexington were added as defendants.

3.According to a draft Statement of Claim which sets out the proposed causes of action on which the plaintiff seeks leave to pursue on behalf of the Company against the defendants:

(1)  The plaintiff was at all material times and is controlled by Fung Kin Ip Johnny (“Fung”) and his wife, Chan Wai Yi (“Chan”).

(2)  Lexington was at all material times and is controlled by De Groot and his wife, Wong, through a company called Lexington Marketing Limited.

(3)  The plaintiff and Lexington each holds 50% of the shares in the Company.  The two couples were and are the directors of the Company.

(4)  The Company is the registered proprietor of a Hong Kong Short-term Patent No 1253655 (“the HK Patent”) for an invention being “A Resealable Drinking Straw” (“the Straw”) as well as the applicant for patents for the same invention in the United States (“the US”), China, the United Kingdom (“the UK”) and Taiwan, and for utility model protection in Japan.

(5)  Fung was the sole inventor of the Straw.

(6)  In essence, it was agreed that the plaintiff would continue to produce the Straw and other products (together, “the Products”), while Lexington would market them.  The plaintiff would sell the Products to the Company at cost and the Company would sell them with at least a 15% marked-up. The profits so earned by the Company would be shared by the plaintiff and Lexington equally as shareholders.  This is called the agreed modus operandi (or, in the affirmation of Fung, “the Arrangement”), and was recorded in an email of 12 January 2019 (“the Email”). Subsequently, a further commission fee of 3% (on the selling price to customers), subject to various conditions, for Lexington was also agreed.  (I would remark here the pleaded modus operandi is not very clear but it would appear that the plaintiff’s case is that any orders obtained by Lexington through its marketing efforts were to be referred to, and taken by, the Company and not by Lexington itself.)

(7)  The implied obligations of the defendants under the agreed modus operandi included rendering to the Company a true and full account of all of the sales of the Straws achieved, paying over to the Company the gross sale price achieved on the sale of each Straw, and not to exploit “the Patent”[2], otherwise than authorised by the Company.

(8)  The complaints of the plaintiff against the defendants are under three heads:

(a)  Lexington had been selling Straws to customers (including but not limited to customers in Japan and the US, one of which was called Hip Products LLC (“Hip”) with which the Company had entered into a distribution agreement) without reference to the Company.  De Groot and Wong had breached their fiduciary duties owed to the Company as directors. It is also alleged that Lexington dishonestly assisted De Groot and Wong in their breaches of fiduciary duties and knowingly received the profits from the sale of Straws derived from such breaches.

(b)  Infringement of the HK Patent: the plaintiff refers to sales of the Straws under invoice no 19021, and to Hip under Lexington quotation number Q190628-03.  The plaintiff also refers to the “making, stocking and putting on the market of Straws, made in accordance with the invention described in the Patent” by the defendants by themselves or by procuring third parties to do so, and the “continued manufacture, keeping and sale of such Straws in the ordinary course of the Defendant’s business” but without particulars.  This is a claim against all three defendants, although similar allegations of dishonest assistance and knowing receipt by Lexington of the acts of infringement of De Groot and Wong are also pleaded.

(c)  Breach of confidence: the plaintiff refers to a “3D technical drawing” (“the Drawing”) of the Straw which was “required” for its manufacturing.  The Drawing was communicated to the defendants for limited purposes and they had a duty to keep it confidential.  It is alleged that the defendants unlawfully disclosed the Drawing to third parties to set up a production line for the Straws at another factory.  This is also a claim against all three defendants, although similar allegations of dishonest assistance and knowing receipt by Lexington of the acts of De Groot and Wong are also pleaded. 

4.The defendants’ case is set out by De Groot in his second and third affirmations:

(1)  The Company was a simple joint venture to develop and sell silicone products, with no formal written joint venture or shareholders agreement between the parties.

(2)  The only agreement between the parties, apart from the corporate structure of the Company, was that for the sale of any product developed by the Company, it would receive a sum equivalent to a 15% mark-up of the production cost.  The Company would not have its own staff. Lexington would handle the daily operations of the Company, and would receive a commission equivalent to 3% of the sale price of the products of the Company that were sold to customers introduced by it.  If a sale by the Company was introduced by the plaintiff, the latter would also receive a 3% commission.

(3)  It is denied that there was the agreed modus operandi as alleged, or that the Email (which was not copied to him or Wong and the last email in the chain was said to be subject to further review by the shareholders) represents any binding agreement between the parties.  There was no supply or distribution agreement between the plaintiff and Lexington on products developed by the Company, nor was there any agreement that the plaintiff was to be the exclusive manufacturer of any such products.

(4)  There had been direct orders between the plaintiff and Lexington without the involvement of the Company.

(5)  The Straw was developed from the joint efforts of the plaintiff and Lexington, with the relevant tooling costs reimbursed by the Company, but it would be difficult to patent.

(6)  For sales of the Straws by Lexington not sourced through the Company, it did pay a 15% mark-up.  The plaintiff, however, did not pay the 15% mark-up for the products that it sold.

(7)  The HIP quotation did not materialise into a sale.  On the other hand, Fung did try to contract with HIP directly for the sale of the Straws.

5.In reply, Fung essentially denies the aforesaid allegations of De Groot.

6.Since the Company is equally split between the two camps at board and shareholders levels, it is obvious that no resolution could be passed for the Company to pursue any alleged causes of action it may have against any of the defendants.  Hence this application by the plaintiff.

7.Section 733 provides as follows:

“ (1)  On application by a member of a company or of an associated company of a company, the Court may grant leave for the purposes of section 732(1), (2) or (3) if it is satisfied that—

(a)  on the face of the application, it appears to be in the company’s interests that leave be granted to the member;

(b)  in the case of—

(i)  an application for leave to bring proceedings under section 732(1) or (2), there is a serious question to be tried and the company has not itself brought the proceedings; or

(ii)  an application for leave to intervene in proceedings under section 732(3), the company has not diligently continued, discontinued or defended the proceedings; and

(c)  except where leave is granted by the Court under subsection (5), the member has served a written notice on the company in accordance with subsection (3), and the notice complies with subsection (4).

(2)  The Court may refuse to grant leave if it is satisfied that—

(a)  in the case of an application for leave to bring proceedings under section 732(1) or (2), the member has, in the exercise of any common law right, brought proceedings on behalf of the company in respect of the same cause or matter; or

(b)  in the case of an application for leave to intervene in proceedings under section 732(3), the member has, in the exercise of any common law right, intervened in the proceedings in question to which the company is a party.

(3)  The written notice must be served on the company, at least 14 days before the member applies for leave in respect of the company—

(a)  in the case of a company as defined by section 2(1), by leaving the notice at, or by sending the notice by post to, its registered office; or

(b)  in the case of a non-Hong Kong company, in a manner that the notice is sufficiently served on the company by virtue of section 803.

(4)  The written notice must state—

(a)  the member’s intention to apply for leave for the purposes of section 732(1), (2) or (3) in respect of the company; and

(b)  the reasons for that intention.

(5)  The Court may grant leave to dispense with the service of a written notice for the purposes of subsection (1)(c).”

8.The two principal issues that arise in an application under section 733 of the Companies Ordinance are: (i) whether the proposed action appears to be in the interests of the company; and (ii) whether there is a serious question to be tried.  In Zhang Heng v Kingstone International Wealth Management Limited[3], Kwan JA[4] said:

“10. For leave to be granted to commence a statutory derivative action, the material requirements for present purpose are: (1) on the face of the application, it appears to be in the interest of the company that leave should be granted; and (2) there is a serious question to be tried and that the company has not itself brought the proceedings.

11. There is no dispute about the law on the correct approach regarding the exercise of discretion to grant leave. This has been covered in a number of cases, including an earlier decision of the judge mentioned in the Judgment, namely, Hao Xioying v Green Valley Investment Ltd, HCMP 1394/2015, 10 August 2016, which quoted from relevant passages of the decision of Ng J in Re Primlak (HK) Ltd [2016] 2 HKLRD 31 and Ng J in turn drew on various decisions of judges at first instance[5]. The relevant legal propositions have been summarised by the judge in Green Valley Investment Ltd at §§10 and 11:

‘10. On serious question to be tried:

(a) The threshold is relatively low. The prospects of the company’s success are to be investigated only to a limited extent, and the court should be slow to find against the applicant unless such prospects are so slim that the company cannot be said to have any expectation of success. See Re Primlaks (HK) Ltd, HCMP 1789/2015, unrep, 28 January 2016, §§7-8 per Ng J.

(b) At the leave stage, it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law which require substantial argument and deliberation. In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance[6]. See Re Primlaks (HK) Ltd, §9.

11. As regard the interest of the company:

(a) Again, the threshold is low. In deciding whether it is prima facie in the interest of the company for leave to be granted, the court should have regard to the fact that “there should not be a trial within a trial and the court should not be forced to enter into the merits of claims where there are serious disputes”. See Re Primlaks (HK) Ltd, §21.

(b) If a “serious question to be tried” has been demonstrated, in most cases it will follow that it is prima facie in the interest of the company that proceedings are pursued. See Re Primlaks (HK) Ltd, §§20-21.

(c)  In assessing whether it appears to be in the interest of the company that the derivative action be pursued, the court ought to take into account whether any practical benefit is likely to result, even in circumstances where it may be clear that, eg, a director has breached his duties to the company.  This essentially involves assessing whether it appears that the company stands to gain in money or money’s worth in light of the costs which will have to be incurred.  See Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 at [56] to [60][7] per Palmer J; Pang Yong Hock v PKS Contracts Services Pte Ltd [2005] 2 LRC 72 at [21] per Tay Yong Kwang J (giving the judgment of the Singaporean Court of Appeal).’”

9.I shall deal with the proposed causes of action in patent infringements and breach of confidence first.

10.Noting the relatively low threshold as explained above, I am not satisfied that there is a serious question to be tried for these two causes of action.

11.It is trite that patent rights are territorial in nature.  A Hong Kong patent, whether a standard patent or a short-term patent granted under the Patents Ordinance[8], gives rise to monopoly rights in Hong Kong only: see sections 73 and 74 thereof.  Thus, for acts done outside Hong Kong, for example the manufacture of a product in Mainland China and shipped to the US for sale there, without the product passing through and with no other infringing acts committed in Hong Kong, there will be no infringement of any Hong Kong patents (but of course, those acts may infringe a Chinese or US patent, if in existence).

12.However, the draft Statement of Claim ([3(8)(b)] above) does not allege or suggest that any of the alleged acts of any of the defendants was committed in Hong Kong.  I note that Hip was a US company which, according to the distribution agreement with the Company was selling products in the US, Canada, the UK and Ireland.  Neither the invoice no 19021 nor the quotation no Q190628-03 is produced before me, and their “Hong Kong connection” is not pleaded.  It is not stated where the alleged but unparticularised acts said to constitute infringements took place.  Apart from the invoice no 19021 and the quotation no Q190628-03, all that Fung says in his affirmation is that he:

“discovered that Lexington, Mr. De Groot and/or Ms Wong are selling the Straws overseas, including but not limited to Japan and the USA” [emphasis added].

13.There is no allegation in the draft Statement of Claim of any acts committed by the defendants in Hong Kong which might or could have amounted to infringements of the Patent.  If and in so far as the Company has any patent rights in any jurisdictions outside Hong Kong (and I note that the draft Statement of Claim refers to no patents granted outside Hong Kong, but only applied for), any alleged infringements thereof are not justiciable in Hong Kong.

14.In my judgment, the draft Statement of Claim has not pleaded a case of patent infringement with any prospect of success.

15.As for the alleged breach of confidence, that claim rests on the Drawing which the plaintiff claims to be confidential.  The Drawing is said to be “required” for manufacturing the Straw. 

16.The pleaded claim for breach of confidence is to be read in the context of the pleaded fact that a HK Patent was applied for and granted for the Straw. 

17.An application for a standard or short-term patent must contain inter alia a specification which includes a description of the invention, one or more claims, and any drawing referred to in the description or the claims, and the application and the specification:

“shall disclose the invention to which it relates in a manner sufficiently clear and complete for it to be performed by a person skilled in the art”[9].

This is known as “enabling disclosure”. 

18.It is almost invariable that a specification would contain one or more drawings so as to describe and disclose the invention sufficiently as required.

19.In the HK Patent produced before me, six drawings were indeed disclosed.  On the other hand, I have not been provided with a copy of the Drawing.  I do not know therefore if any of those six drawings is in fact the Drawing, or substantially similar thereto.  I would have thought that if, as claimed, the Drawing is “required” for the Straws, i.e. the patented invention, to be manufactured, it (or a substantially similar drawing) would have been disclosed in the specification, otherwise it is difficult to see how there has been sufficient enabling disclosure of the invention.  This may or may not have happened but I have to be satisfied that there is a serious question to be tried on the question of breach of confidence, including the fact that the Drawing has remained confidential notwithstanding the application for and the grant of the HK Patent, and I am afraid that, in the context of the pleaded fact that a patent having been applied and granted for the Straws, I am not satisfied that, as the draft Statement of Claim is presently drafted, this claim has any prospect of success. 

20.Even though as I said above the threshold for a serious question to be tried is relatively low, it is still a threshold that has to be met, and in my judgment this claim for breach of confidence as drafted has failed to meet it.

21.That leaves the question of the alleged dealings in the Straws by Lexington (and the participation of De Groot and Wong therein) without the involvement of the Company.  

22.The core dispute between the parties on this is what was, or was not, agreed between the two camps regarding the operation of the Company, and the rights and obligations of the plaintiff and Lexington regarding the Straws.  This is a question of fact.  If indeed what the defendants had done was allowed by whatever the parties had agreed regarding the operations of the Company and its products, in particular the Straw, then the alleged wrongdoing may be difficult to sustain.

23.Both Fung and De Groot in their affirmations point to various matters which are said to be supportive of his camp’s case, and/or contradictory to the other’s.  I am satisfied that there is clearly a serious question to be tried in respect of what was agreed between the two camps as to the operation of the Company and given that this dispute is most probably to be litigated whether I grant leave to the plaintiff or not, I do not propose to say more about the merits of each side’s case.

24.The next question is whether this proposed action appears to be in the interests of the Company.

25.Mr Leon Ho, counsel for the defendants, submits that it is not.  He submits that the dispute between the two camps is a shareholders’ dispute in which the Company should not involve.  He cites a number of authorities in support, and I only need to refer to the following:

(1)  In Poon Yat Wah v Hui Chi Leung[10], G Lam J said:

“Secondly, it seems to me the winding-up petition is quintessentially a shareholders’ dispute. It is well established on the authorities that a company should not take part in and expend substantial funds on such a petition. To suggest that Poon should pursue a statutory derivative action in the name and on behalf of the company, using the company’s financial resources, against Hui for his presentation and continuing conduct of the petition would be to circumvent this long-standing principle. Mr Suen has not been able to point to any ground for doing so.”

(2)  In Khela v Phoenix Homes Limited[11], Neilson JA of the Court of Appeal for British Columbia[12] said:

“I am satisfied the chambers judge made no error in dismissing Mr. Takhar's application for leave to commence a derivative proceeding, and in concluding that the personal contractual dispute between the principles of Phoenix Homes must first be determined. If, having resolved that dispute, Mr. Takhar is able to establish an arguable case for a derivative proceeding with respect to the 208 Street Properties, nothing in this proceeding precludes him from bringing a new application under ss. 232 and 233 of the [Business Corporations Act]”.

26.While each case must depend on its own facts, these authorities suggest that it is generally not appropriate to use the derivative action procedure to resolve what is really a dispute between shareholders on the agreement between them.[13]  In my judgment this is the case in the present dispute between the two camps, which ought to be resolved between them first without involving the Company, which is not even alleged to be a party to whatever agreement there was between the two camps.  If the dispute is resolved in favour of the plaintiff, then, as suggested in Khela, it may then, if considered appropriate, seek leave to commence a derivative action against the defendants.  But to allow the plaintiff now to proceed to sue the defendants in the Company’s name and using its resources, the whole basis of which is in genuine dispute between the shareholders, does not appear, in my judgment, to be in the interests of the Company.  Depending on the result of any such resolution between the two camps, the Company may or may not be involved in litigation at all, and even if so, only once.

27.For these reasons, I dismiss the Amended Originating Summons with an order nisi that the plaintiff is to pay the costs of the defendants (and of the Company, if any) of the Amended Originating Summons, including all reserved costs, to be taxed if not agreed.

28.I thank counsel for their assistance.

Mr Au Lut Chi, instructed by Ernest Li & Co, for the plaintiff

The 1^st defendant in person, absent

Mr Leon Ho, instructed by K&L Gates, for the 2^nd, 3^rd and 4^th defendants