JCG FINANCE CO. LTD. v. GROUP LIFE INVESTMENT LTD. AND ANOTHER

CACV 221/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 221 OF 2002

(ON APPEAL FROM HIGH COURT ACTION NO. 2417 OF 2001)

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J U D G M E N T

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Cheung JA: (giving the judgment of the court)

The appeal

1. The plaintiff applied for summary judgment against the 2nd defendant for, among other things, the sum of $80 million. The master granted leave to the 2nd defendant to defend the action conditional upon, among other things, the 2nd defendant paying into court the sum of $8 million. The 2nd defendant appealed against the judgment. Deputy High Court Judge To allowed the appeal in relation to the granting of the condition of payment of $8 million. The plaintiff now appeals against this decision. It is seeking final judgment against the 2nd defendant, alternatively, it is asking that the condition of payment of $8 million be reinstated.

Facts

2. The plaintiff is a deposit-taking company, it made advances to two companies, namely Tung Kee Investment Limited ("Tung Kee") and Unity Win Investments Limited ("Unity Win"). As of 31 July 1999 these two companies were indebted to the plaintiff in the sum of $146,442,046.92.

3. In order to restructure this debt, a Debt Restructuring Deed dated 13 August 1999 ("the Deed") was entered into by the plaintiff, Tung Kee, Unity Win, Yield Win Property (China) Limited ("Yield Win") and the 1st and 2nd defendants.

4. Pursuant to the Deed, the 1st and 2nd defendant executed a Security Assignment of Shares dated 13 August 1999 ("the Assignment") in favour of the plaintiff. Under the Assignment, the 1st and 2nd defendant agreed that they will pay on demand to the plaintiff the principal sum of $80 million plus interest from the date of the Assignment and all monies due from Tung Kee and Unity Win to the plaintiff as well as all incidental costs and expenses on an indemnity basis. As security for payment of the indebtedness the 1st and 2nd defendants charged their shares in Yield Win in favour of the plaintiff. There were other obligations imposed on the 1st and 2nd defendants under the Assignment. These, however, were not relevant for the purpose of this appeal.

5. By two letters dated 9 August 2000 the plaintiff demanded the 1st and 2nd defendants to pay the principal sum of $80 million together with interest and other charges. The 1st and 2nd defendants failed to pay this amount. The plaintiff issued the present action against them. The plaintiff obtained judgment against the 1st defendant in default of its acknowledgment of service.

The defence

6. The gist of the 2nd defendant's defence is that there was agreement that the plaintiff would look to Beijing Jinlong Building Company Limited ("Beijing Jinlong") for payment. Further the 2nd defendant was merely acting as a guarantor for the debt. The plaintiff had commenced arbitration proceedings against Beijing Jinlong and subsequently had reached a compromise with Beijing Jinlong. This was done without the 2nd defendant's consent. As a result, the 2nd defendant's liability as a guarantor was discharged.

The background

7. Tung Kee is the parent company of Unity Win. In 1997, Unity Win and a Chinese party formed a joint venture company, namely Beijing Jinlong to refurbish and convert the Jinlong Building in Beijing into a service apartment. Beijing Jinlong borrowed money from the plaintiff which was secured by the mortgage of the Jinlong Building ("the Jinlong Building mortgage"). The money was used to refurbish the Jinlong Building. Beijing Jinlong made repayments to the plaintiff until 1999 when it defaulted in the payment. Arrangements were then made for the debt to be restructured as alleged by the plaintiff. Concurrent with the restructure was the transfer of Unity Win's shareholding in Beijing Jinlong to Yield Win.

8. The 1st and 2nd defendants were the two shareholders of Yield Win. The 1st and 2nd defendants' shares in Yield Win were charged to the plaintiff as security under the Assignment. Beijing Jinlong had since repaid $20 million to the plaintiff. However, it later again defaulted in the repayment. The plaintiff commenced arbitration proceedings against Beijing Jinlong and reached a settlement with it on 21 November 2000 to defer repayment of the debt.

Nature of the liability

9. The judge did not consider that the first defence raised i.e. whether there was an agreement that Beijing Jinlong would be responsible for the debt is a credible one. Certainly this point was raised at the fore front of the 2nd defendant's case and the plaintiff had not responded to it when it was first raised in the solicitors' correspondence. We do not, however, need to dwell on this point because we consider there is a substantial question concerning the nature of the liability of the 2nd defendant under the terms of the Assignment and Deed. Clause 2 of the Assignment provides that :

“	2.1	The Assignors (i.e. 1st and 2nd defendants) covenant with the Lender (i.e. the plaintiff) that they will on demand pay to the Lender:-
	2.1.1	The principal sum of $80 million plus interest...;
	2.2	The Assignors agree with the Lender as a primary obligation, to indemnify and keep indemnified the Lender on demand by the Lender from and against all and any losses, damages, costs and expenses incurred by the Lender arising from any failure by the Assignors to carry out, perform or meet any of the Assignors' obligations as particularized in clause 2.1 above...." (emphasis added)

10. The plaintiff relied on clause 2.2 and submitted that since the clause refers to the 2nd defendant agreeing with the plaintiff, as a primary obligation, to indemnify the plaintiff, the obligation of the 2nd defendant was not merely in the nature of a guarantee but one of an indemnity.

11. In construing clause 2 one has to regard the factual background which includes the plaintiff's loans to Beijing Jinlong, the Jinlong Building mortgage, the restructure of the debt and the terms of the Deed.

The Deed

12. The relevant clauses of the Deed provide that :

“	3.2	The Borrower (i.e. Tung Kee and Unity Win) acknowledges and confirms that as at 31 July 1999 it was indebted to the (plaintiff) in respect of the Loan for the total amount of HK$146,442,046.92 including interest, plus costs.
	3.1	In consideration for the Borrower, Yield Win, Group Life (i.e. 1st defendant) and Chateryield (i.e. 2nd defendant) entering into the Agreements the (plaintiff) agrees that the indebtedness referred to in clause 3.1 shall be repaid and satisfied by the Borrower and Yield Win in accordance with the terms of this Deed;
	3.3.	Yield Win shall repay the (plaintiff) the sum referred to in the clause 4 and guarantee payment of the sum referred to in clause 6;
	3.4	The Borrower shall repay the (plaintiff) the sums set out in clause 5.1;
	5.2	If Yield Win defaults in payment of any of the sums due under clause 4 the Borrower will pay to the (plaintiff) all sums remaining due under clause 4. The (plaintiff) will not be entitled to enforce the Borrower's obligations under this clause 5.2 unless:
5.2.1		the (plaintiff) has used reasonable endeavours to enforce, as expeditiously as possible, the Jinlong Building Mortgage; and
5.2.2		a period of two years from the date of Yield Win's default has expired." (emphasis added)

13. Under clause 3.2 of the Deed, the plaintiff agreed that the sum of $146,442,046.92 was to be satisfied by Yield Win, Tung Kee and Unity Win in accordance with the term of payment specified in the Deed. It is clear from the terms of clause 3.2 of the Deed that the primary obligation to repay the debt lie with Yield Win, Tung Kee and Unity Win.

14. The Agreements referred to in clause 3.2 include the Assignment executed by the 2nd defendant. The amount referred to in clause 4 was for the sum of $80 million together with interest and costs. The guarantee referred to in clause 6 was in respect of money due to the plaintiff after the enforcement of another security held by the plaintiff.

15. Under the restructuring, Yield Win had to pay the plaintiff the sum of $80 million by instalments within two year period and also the amount under the guarantee. In default, Tung Kee and Unity Win had to pay the plaintiff that sum. However, the plaintiff cannot enforce Tung Kee and Unity Win's obligation until it had taken steps to enforce the Jinlong Building mortgage and a two year period had lapsed from the date of default of Yield Win. The restructuring is that Yield Win will be the first one to be liable to the plaintiff.

16. It is clear from clauses 3 and 5, that the parties who were primarily responsible to the plaintiff for the indebtedness of $146,442,046.92 and the payment of $80 million were Yield Win, Tung Kee and Unity Win.

17. It is certainly arguable that since the Assignment had its origin from the Deed and these two documents were executed at the same time, the obligation of the 2nd defendant was that of a secondary liability despite the use of words like 'primary obligation' and the absence of reference to guarantee. After all, it is expressly stated in clause 3.2 that the consideration for the 1st and 2nd defendants to enter the Assignment was the plaintiff agreeing with Yield Win, Tung Kee and Unity Win that the debt would be repaid in accordance with the terms of the Deed. It is certainly arguable that primarily the 2nd defendant's obligation was to furnish the security of shares for the re-structuring. This it had done. Its secondary liability to pay the money would be deferred until the other parties had defaulted in repayment in accordance with the terms of the Deed.

18. It is well established that under a guarantee, the guarantor assumes a secondary liability to the creditor for the default of another who remains primarily liable to the creditor : Yeoman Credit Ltd. v. Latter [1961]2 All ER 294. But irrespective of the label put on the liability of the 2nd defendant, the plaintiff has to establish first that it had looked to Yield Win, Tung Kee and Unity Win to repay the money and they had defaulted before it can seek to recover the money from the 2nd defendant. While the plaintiff had produced documents showing the default of Yield Win, there was an absence of information on whether the plaintiff had pursued Tung Kee and Unity Win in accordance with the terms of the Deed. On the evidence, the plaintiff in fact specifically denies that it had enforced the Jinlong Building mortgage. In the absence of such evidence, how can it be said, for the purpose of an Order 14 application, that the liability of the 2nd defendant had arisen.

19. Mr. Yuen, counsel for the plaintiff, argued that the 2nd defendant had not specifically referred to the absence of default in the Defence. The Defence is badly drafted and concentrated on the liability of Beijing Jinlong. However, in the affirmation of the 2nd defendant, it had clearly stated that it was merely acting as a guarantor of the debt of Beijing Jinlong, Tung Kee and Unity Win. This being the case the plaintiff was clearly put on notice of the nature of the 2nd defendant's case. One would therefore expect the plaintiff to show that the conditions relating to the 2nd defendant's liability had been fulfilled. This was not done.

20. In our view, for this reason alone, the 2nd defendant should be given unconditional leave to defend.

Combined guarantee and indemnity

21. There were other arguments raised in Mr. Yuen's written submission on the nature of the 2nd defendant's liability. We shall briefly deal with this. For the purpose of a summary judgment application, it is clearly not appropriate to determine conclusively at this stage whether the 2nd defendant's obligation was in the nature of a combined guarantee and indemnity as discussed in O'Donovan and Phillips, The Modern Contract of Guarantee, 3rd Edn. pp. 25-31. In any event, a clause which consists both of a guarantee and an indemnity obligation had been construed in the nature of a guarantee only : see Stadium Finance Co. Ltd. v. Helm (1965) 109 S.J. 471 where Russell L.J. observed that a clearer form must be in place if a primary obligation was intended to be imposed, bearing in mind that most people were not prepared to subject themselves to the nuisance of primary liability.

22. Mr. Yuen, referred to Andrews and Millett, Law of Guarantees, 3rd Edn. para. 1.15 which discussed the "principal debtor" clauses. It is clear that the discussion was focused on the effect of words that the surety is to be liable as "principal debtor" or treated as "primary obligator" included as part of the clause which preserves the guarantor's liability in circumstances in which he would otherwise be released. The judicial approach is that such additional words would not turn the guarantee into an indemnity. The passage cited does not help the plaintiff.

Variation

23. The 2nd defendant argued that dealings between the creditor and debtor which vary the contract between them in the absence of the guarantor's consent, has the effect of discharging the guarantor's liability under the guarantee. The ground upon which the surety is discharged is that his right at any time to pay the debt, and sue the principal in the name of the creditor, is interfered with : Rowlatt on Principal and Surety, 5th Edn. paras. 5-16, 8-01; Paget's Law of Banking, 11th Edn. pp. 621-622.

The 'preservation' clauses

24. The question is whether notwithstanding this principle, under the terms of the Assignment, the liability of the 2nd defendant is preserved notwithstanding any compromise reached between the plaintiff and the principal debtors. It is clear that a suitably worded agreement can have such an effect, see : O'Donovan and Phillips, pp. 345-352 and National Western Minister Bank plc v. Riley [1986] BCLC 268.

The Assignment

25. Clause 7 of the Assignment provides that ：

“ This security shall be a continuing security and shall remain in full force and effect until the Secured Indebtedness has been paid in full regardless of any intermediate payment or discharge in part and notwithstanding the liquidation, winding up or dissolution of the Borrowers or the Assignors or any change in the constitution of the Assignors or any settlement of account or other matter whatsoever and is in addition to and shall not merge with or otherwise prejudice or affect any contractual or other right or remedy or any guarantee, lien, pledge, bill, note, mortgage or other Security Interest (whether created by the deposit of documents or otherwise) now or hereafter held by or available to the Lender and shall not be in any way prejudiced or affected thereby or by the invalidity thereof or by the Lender now or hereafter dealing with, exchanging, releasing, varying or abstaining from perfecting or enforcing any of the same or any rights which it may now or hereafter have or giving time for payment or indulgence or compounding with any other person liable." (emphasis added)

Clause 20.2 provides that :

" Each of the Assignors agree to be bound by this Assignment notwithstanding that any mortgage or assignment herein contained may be determined or may be or become invalid or unenforceable against any other Assignors whether or not the deficiency is known to the Lender. The Lender shall be at liberty to compound with or otherwise vary or agree to vary the liability of or to grant time or indulgence to or to make other arrangements with each Assignors or any other person without prejudicing or affecting the rights and remedies of the Lender." (emphasis added)

26. The starting point is, of course, that these clauses in fact indicate the obligation of the 2nd defendant is that of a guarantee and not indemnity. The rationale is that if the contract were one of indemnity, there would be no need for such a provision, since an indemnifier is not discharged by such conduct of the creditor : O'Donovan and Philips page 27. This goes to strengthen the 2nd defendant's case on the construction of its liability which clearly must be resolved first. In any event, while these two clauses do give the impression of preserving the rights of the plaintiff in the event of a settlement with a third party, ultimately the case depends on whether the plaintiff had satisfied the conditions in the Deed before it can pursue its claim against the 2nd defendant.

Conclusion

27. The 2nd defendant has clearly raised a credible defence and as such it should be given leave to defend without the condition of payment into court. Accordingly, the appeal is dismissed with costs nisi to the 2nd defendant.