Introduction
As is well known, the court has power to order a trial of preliminary issues, or a split trial, in suitable cases with a view to saving time and costs.[1] Such cases include those where a single point of law is dispositive of the whole case. Another example is where a limitation defence can be determined without complex factual investigation. However, a recent decision of the Court of First Instance in Dracco Netherlands BV v Simba Toys GmbH & Co KG [2024] HKCFI 3061 vividly illustrates the dangers of casually invoking the power in the name of procedural economy.
The dispute
In that case, the parties were the licensor and licensee respectively under a licence agreement for the exploitation of certain intellectual property rights belonging to the licensor. The agreement provided for the reporting and payment of royalties on a quarterly basis in respect of sales made by the licensee during the relevant quarter. As a safeguard against under-reporting, the agreement contained an “audit clause”. The clause provided as follows:
“The Licensor … shall be entitled at any time to have the Licensee’s business records and documents relating to the Products inspected by an auditor who is under an obligation of secrecy. The cost of the said inspection shall be borne by the Licensee if an accounting error to the Licensor’s disadvantage is discovered, pursuant to which the amount actually due to Licensor exceed the amount actually paid to licensor by more than 5% of this latter amount…”
A dispute arose about the amount of royalties payable under the licence agreement, which led to its termination by the licensor. The case dragged on for almost ten years before the licensor sought specific discovery of sales and accounting documents from the licensee. Dissatisfied with the licensee’s disclosure, the licensor applied for a trial of a preliminary issue, namely, whether an audit should be ordered in respect of the amount of royalties due over the term of the agreement.
A shortcut?
The licensor, represented by senior counsel, submitted that an audit under the contractual mechanism would provide a quick and sure way of identifying all the miscalculations and assessing the quantum of damages. This would in turn save a large amount of time at trial. Rebuffing the submission, Deputy High Court Judge Phoebe Man refused to order a trial of the preliminary issue on several grounds. First, specific discovery had already been given by the licensor on oath, which was normally conclusive. Secondly, the dispute involved various disagreements on the basis of calculation, and the court should not order a trial of preliminary issues involving disputed facts. Thirdly, the audit clause did not grant the auditor the power of fact-finding, still less any power to bind the parties by his conclusions.
More haste, less speed
Two points about the case are worth highlighting. The first observation relates to the nature, purpose and limits of the audit clause. This is important because, in our experience, such a clause is fairly commonplace in IP licence and franchise agreements across many industry sectors.[2] As we saw above, the clause functions as a deterrence or disincentive against under-reporting of royalties by imposing on the licensee a financial penalty in case the discrepancy found by the auditor exceeds a certain agreed margin. Typically the penalty is measured by the cost of the audit, which may or may not be significant.
What the clause does not purport to do, however, is to equip the licensor with an additional means of seeking discovery in aid of future or ongoing litigation against the licensee via an audit. This is evident from the fact that, according to the wording of the clause, the auditor must work under an obligation of confidentiality. As a result, the auditor is not at liberty to disclose the content of any documents reviewed by him to the licensor (or the court).
This brings us to the procedural issue alluded to in the headline of this article. The decision under discussion is a timely reminder that “Preliminary points of law are too often treacherous shortcuts. Their price can be, as here, delay, anxiety and expense.”[3] The learned deputy judge further heeded the health warning given by Lord Roskill 40-odd years ago that the court should be “extremely cautious” before acceding to pleas for the making of such orders as a result of attractively advanced submissions founded upon pleas of supposed economy.[4] She referred to a useful checklist of factors which may guide the court’s exercise of discretion, such as whether the determination of the preliminary issue would dispose of the whole case or at least one aspect of it.[5]
As explained above, the audit clause in this case was not primarily designed to afford a means of alternative dispute resolution or discovery. As the deputy judge sagely observed, any conclusion reached by the auditor would still be open to challenge at trial. So ordering an audit would not achieve the purpose of saving time or costs. All this was quite apart from the fact that there were other issues in the case unrelated to the quantum of royalties. In conclusion, the licensor failed to demonstrate any exceptional or special grounds why all the issues should not be tried in one go.
The full judgment is available at： https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=164690&currpage=T
Mr Chun Wai Ling acted for the defendant/licensee.
Footnotes
[1] In the High Court, the relevant rules can be found in Order 33 Rules 3 and 4.
[2] In an earlier case, the licensor under a FRAND patent licence agreement sought specific discovery of documents provided by the licensee to the auditor in the course of an audit. The application was refused because the licensor failed to demonstrate that the discovery given was deficient: see Nokia Corporation v TCT Mobile Ltd, HCCL 19/2011, unrep., 5 August 2013, at [26], per Ng J.
[3] Tilling v Whiteman [1980] AC 1, at 25C, per Lord Scarman
[4] Allen v Gulf Oil Refining Ltd [1981] AC 1001, at 1022A, per Lord Roskill
[5] At [14] of the Decision
