Introduction

In Dextra China Limited & Anor v Lam Wing Kit, HCA 38/2010 & 967/2010, the Court of First Instance ruled in favour of the employer on its claim against various breaches of duties by an outgoing senior staff.  The steps taken by the employer therein may provide some insight as to how employers could guard against losses attributed to outgoing senior staff setting up new competing businesses or bringing away customers and/or suppliers.

Parties

The 1^st Plaintiff, Dextra China Limited (“Dextra”) is the holding entity of a group of companies engaged in manufacturing and sale of construction products.  The 2^nd Plaintiff, Dextra Building Products (Guangdong) Limited (“DBPG”) is Dextra's subsidiary responsible for manufacturing and trading of Dextra's sonic tubes and couplers in the Chinese market under the brand name “Sonitec”.  Dextra's Sonitec brand utilised a push-fit assembly system which, according to Dextra, at the material times had not been successfully duplicated by competitors.  The Defendant, Lam Wing Kit (“Lam”) was employed as Dextra's general manager, responsible for overseeing its Chinese business, since 2000, and was also a director of DBPG from September 2006.

Employment Agreement

The latest employment agreement entered into between Lam and Dextra expressly states that it is to be governed by Hong Kong law and provides amongst other things for the following:-

1.       “... the Employee shall devote all of his/her attention and energies to the business of the Company and shall not, during the term of this Agreement, be engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage that will significantly interfere with his/her duties.”

2.       “The Employee acknowledges that certain of the Company’s products and services are proprietary in nature and shall have produced and marketed through the use of customer lists, supplier lists, trade secrets, methods of operation and other confidential information possessed by the Company and disclosed in confidence to the Employee (hereinafter “Trade Secrets”) which may not be easily accessible to the other persons in the trade… The Employee therefore, covenants and agrees (all of which covenants and agreements shall survive termination of this Agreement, regardless of the reason, therefore) as follows... The Employee shall at no time during the term of this Agreement or any time subsequent to its termination, regardless of the reason therefor, disclose to any person or entity, or use for personal gain any of the Trade Secrets or any other confidential information of or pertaining to the Company or its products and services, disclosed to or obtained by the Employee during the term hereof... If at any time, the Employee wilfully disobeys a lawful and reasonable order or direction, or misconducts himself/herself, or is guilty of fraud or dishonesty, or is habitually negligent in his/her duties, or is infringing Hong Kong laws and regulations he/she shall be dismissed by the Company summarily without notice or salary in lieu.”

Dextra's Claim

Dextra alleged in the beginning of April 2009, while still employed by Dextra, Lam conceived a scheme to establish an independent entity in China to be named Agility Building Products Company Limited (“Agility”), intended to compete directly with Dextra's sonic tube business, by exploiting his awareness of the business, his access to confidential information and resources, and to Dextra's relationships with its customers and suppliers.  Reference is made to a business plan and minutes of meetings for setting up Agility, prepared by Lam, which describe how his scheme was planned to be carried out.  Lam was alleged to have:

1.       Made numerous business trips with various Dextra's sales agents in China for the purpose of generating and diverting sales or potential sales to Agility;

2.       Induced and arranged for the resignation and/or dismissal of Dextra's and DBPG's employees, including Luo Guan Jun (“Luo”) the purchasing manager of DBPG until he resigned in August 2009 and Richard Liang the sales manager of DBPG until he resigned in October 2009, in the period July to October 2009;

3.       Made false and discrediting statements about Dextra to third parties to induce them to transfer their business to Agility, and other actions intended to induce Dextra's sales team to generate sales for Agility whilst still employed by Dextra; and

4.       Engaged in theft and misuse of Dextra's confidential information, and information of a commercially sensitive nature which would not have been available to anyone outside Dextra's organisation without Dextra's consent, covering virtually all aspects necessary to establish and operate a competing business

In October 2009, Dextra's personnel visited the premises of one of its regular suppliers, Li Lian Da (“LLD”), they discovered a secret production line for sonic tubes and a stockpile of sonic tubes with Dextra's distinctive corrugated bell mouth system, and packaging identical to that used by Dextra.  It is alleged that these sonic tubes could only have been produced through use of Dextra's confidential information.

Lastly, Dextra claimed that prior to April 2009, Dextra's sale of sonic tubes and couplers in the Chinese market had been healthy and work trending upwards, whereas during the period in which Lam planned and carried out his scheme, Dextra experienced a significant drop in those sales.

Lam's Defence

In his Amended Defence, Lam pleaded that he was asked to increase business trips for promotion and for collecting debts due.  The reason for decline in sales could be Dextra's decisions to terminate its agent in Kunming, to stop delivery of products to customers where there was overdue payment of more than 90 days, and to stop delivery of products to customer where the product margin was less than 25%.  Lam further pleads that the restrictive covenants amount to an unnecessary restraint of trade, and in any event, Dextra was well aware that Lam had interests in other businesses, including a company to trade textiles, garments and fabrics as well as other investments.

Documents

After considering the documents retrieved from the devices and other contemporaneous evidence, the Court drew the following conclusions on Lam's liability:-

1.       Most of the items on the “shopping list” have been obtained and grouped together within the “Agility” sub-folder in Lam’s personal documents file.  They are either all expressly dealing with or are at least consistent with a business producing and selling sonic tubes, and tubes which resemble or are a copy of the Sonitec tubes produced by Dextra.

2.       It was Lam who liaised with the lawyer, and who drafted the first agenda and minutes of the meeting in May 2009.  Those documents consistently identify Lam as the largest shareholder of the alternative business.  That later versions of documents obscured Lam as a shareholder is consistent with his carrying out a new business clandestinely.

3.       It was Lam who had the relevant management experience, performed the various calculations, and was also responsible for setting up the domain name for “Agility” and related e-mail accounts.  Most of the steps identified in Lam’s diary, and the timetabling document, appear to have taken place broadly in the chronological order identified.

4.       The raft of costing and pricing tables, based upon but different from the Dextra model, is also consistent with the intention to set up a new and competing business.  The catalogue information effectively merely superimposed the “Agility” name and logo and contact details onto the Dextra document.  None of this is consistent with Lam’s attempted exculpatory explanation that he was engaged in a fake tender process for the benefit of Dextra.

5.       Factory premises had been rented.  Those premises were within the existing factory premises of LLD, which was part of the venture.  There are documents identifying that necessary manufacturing equipment had been purchased.  The spreadsheets tracking performance metrics identify that the business had actually commenced, that deliveries were made (starting with delivery note number one).

6.       That there is so much documentation identifying involvement in the new business by Dextra personnel, not just ex-personnel but also those still employed, makes it extremely difficult to accept any innocent explanation for the presence of these documents in Lam’s personal documents folder on his computer devices.

7.       There was a deliberate, albeit inadvertently unsuccessful, attempt to delete the incriminating materials from Lam’s computer devices.

The Court in particular noted that the fact that Lam might at the same time have been doing some genuine work for Dextra/DBPG does not change the fact that he was acting contrary to the duties he owed.

In the circumstances, Lam was found to have acted in breach of the various duties owed under his employment.  Those breaches include the dissemination of confidential information.  Dextra/DBPG was perfectly entitled to terminate Lam’s employment summarily.

Remedies

Lam was liable to pay RMB4,135,569 to Dextra to compensate the loss in sales suffered by Dextra by virtue of Lam's breach of the various duties owed under his employment.  Further, Lam was ordered to pay interests and Dextra's costs of both actions and DBPG's costs of HCA 38/2010 under an order nisi deliver up materials as set out in Schedule 3 to Dextra/DBPG's claim.  Further, an injunction order was made against Lam to prevent any furhter use of the materials as set out in the said Schedule 3.  The Mareva injunction previously obtained by Dextra/DBPG was extended by the Court.

Lessons to learn

The Dextra case is not a rare instance of a company suffering substantial losses consequential to, directly or indirectly, breaches committed by senior staff to his/her personal advantage before and after he/she starts or joins a competing business.  However, this case is noteworthy because of the overwhelming evidence provided by the employer, on which it successfully proved its case.  This case demonstrates the importance of (i) valid, enforceable, and comprehensive restraint of trade covenants and confidentiality clauses in the employment contract; (ii) regular inspection and monitoring to identify suspicious conduct of employees; and (iii) proper keeping and back-up of physical and computer files.

It would be crucial for employers, in particular for those in highly competitive markets, to include or improve such systems, after consulting professional advice, in order to allow them to act more promptly in contemplation of breaches of duties by outgoing senior staff.