HUNG FUNG ENTERPRISES HOLDINGS LTD AND ANOTHER v. THE AGRICULTURAL BANK OF CHINA

HCA 16459/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 16459 OF 1998

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J U D G M E N T

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1.  The Defendant is appealing against the Master’s decision in dismissing its summons for security for costs dated 14 October 2008. 

Background

2.  The Defendant is a Mainland bank.  The 1^st Defendant is a Hong Kong company, and the 2^nd Defendant a Mainland company.

3.  In mid-1996, the Defendant advanced HK$35 million to the 1^st Defendant under 3 facility letters.  The all monies security were: 1 piece of land in the New Territories owned by the 1^st Plaintiff (“NT Land”), and properties in Shenzhen consisting of 2 pieces of land (“Shenzhen Land”) and a factory (“Shenzhen Factory”) beneficially owned by the 2^nd Plaintiff (collectively “Old Security”).  The Shenzhen Land was under development at the time for the building of residential flats.

4.  In July 1996, the 1^st Plaintiff proposed to the Defendant to exchange the Old Security for 5 pieces of land owned by the 2^nd Plaintiff (“New Security”).  The Plaintiffs alleged the Defendant’s representatives had orally agreed to the exchange in either July 1996 or October 1996 (“Oral Agreement”).  The Plaintiffs produced a fax dated 23 April 1997 by the Defendant stating that: (1) the Defendant agreed that the 1^st Plaintiff continue to use the approved facilities; (2) the 1^st Plaintiff should resume normal use of the facilities and to repay the sums due; and (3) the Defendant agreed to process the exchange of the 2 Shenzhen land certificates for the purpose of sale of flats, but disagreed to replace the Hong Kong land and village house and dwellings.

5.  In the meantime in July 1996, the land certificates of the New Security were delivered to and retained by the Defendant for two years before they were returned to the Plaintiffs in September 1998.

6.  The Plaintiffs claimed that they had agreed with purchasers for sale of the Shenzhen Land but the Defendant refused to release the land certificates for completion in breach of the Oral Agreement.  Hence, the Plaintiffs lost the opportunity to make profits and plough back for further development of the Shenzhen Land.

7.  In 1998, the Plaintiffs commenced this action to claim damages of over HK$77 million for the breach of the Oral Agreement, misrepresentation and conversion of the New Securities. 

8.  The Defendant denied the Oral Agreement.  It alleged that the New Security were delivered by the 1^st Plaintiff voluntarily to persuade the Defendant to consider the exchange of the securities.  The Defendant counterclaimed the outstanding loan and interest of HK$44 million.  The Defendant also counterclaimed vacant possession of the NT Land.

9.  The outstanding indebtedness is not disputed by the Plaintiffs.  In the Defence to Counterclaim, the Plaintiffs pleaded equitable set-off by their original claim.

10.  The Defendant has already obtained judgments under two of the facility letters (HK$26 million and HK$7 million plus interest) in the Shenzhen Court.  The Oral Agreement was not raised in the Mainland proceedings.  The Shenzhen Factory has been sold for about RMB 6 million in enforcement. 

11.  The Shenzhen Land was valued at about RMB 20 million in 2005 by the court appointed surveyors in Shenzhen (before taking into account the issue of whether the land premium of RMB 20 million was paid).  There were also complications in enforcement as the some of flats had already been allocated in favour of third parties.  The matter is still pending in the Shenzhen Court.

12.  The NT Land is valued at between HK$0.6 million and HK$2.2 million depending on the issue of termination of the Short Term Waiver (permission of use by the Government) on 30 September 2003.

13.  The holding company of the 1^st Plaintiff has been wound up.  The present proceedings were stayed between August 2003 and October 2007 pending the action by the liquidators against other third parties (HCA 2957/2003).  Judgment was given in favour of the liquidators and the stay was lifted in October 2007.

14.  The trial has been fixed to commence on 4 January 2010 with 26 days reserved.

Plaintiff’s case

15.  Mr Tong SC, for the 1^st and 2^nd Plaintiff, submitted that security should be refused on the following grounds:

(1)     the Defendant has made a substantial counterclaim and is as much an “attacker” as the Plaintiffs and it is fortuitous that the Plaintiffs have commenced the action first;

(2)     there was substantial and unexplained delay of 1 year between the lift of the stay and the application for security;

(3)     the Defendant is already in possession of valuable security belonging to the Plaintiffs;

(4)     the Plaintiffs’ financial difficulties were caused by the Defendant’s wrongful breach of the Oral Agreement;

(5)     the security sought of over HK$14 million is grossly excessive.

Defendant’s case

16.  Mr Shieh SC, for the Defendant, submitted that sufficient security should be ordered:

(1)     the damages claim for the breach of the Oral Agreement does not amount to an equitable set-off to the loan repayment claim as a matter of law;

(2)     in any event, the terms of the loan agreements precluded any set-off or counterclaim;

(3)     the value of the Old Security is insufficient on recent valuation to cover the current indebtedness;

(4)     the argument that the Plaintiffs’ financial difficulties were caused by the breach of the Oral Agreement is circuitous;

(5)     costs of the counterclaim of a simple debt recovery action is low as compared with the high costs of the Plaintiffs’ complicated and speculative damages claim.

Relevant principles

17.  It is common ground that an order for security for costs is in the discretion of the Court.  The Court shall not conduct a mini-trial on the limited materials to consider the merits of the case unless it can be demonstrated the high degree of probability of success or failure one way or the other (see Wison (Shanghai) Chemical Engineering Co Ltd v Simmons & Simmons [2008] 2 HKLRD 72, 77 (para. 18)).

18.  In BJ Crabtree (Insulation) Ltd v GPT Communications Systems (1993) 59 BLR 43, the English Court of Appeal held that security for costs ought not be imposed where there is ca claim and a counterclaim raising essentially the same issues.  Bingham LJ said at pp. 52-53:

“It is, however, necessary, as I think, to consider what the effect of an order for security in this case would be if security were not given.  It would have the effect, as the defendants acknowledge, of preventing the plaintiffs pursuing their claim.  It would, however, leave the defendants free to pursue their counterclaim.  The plaintiffs could then defend themselves against the counterclaim although their own claim was stayed.  It seems quite clear and, indeed, was not I think in controversy – that in the course of defending the counterclaim all the same matters would be canvassed as would be canvassed if the plaintiffs were to pursue their claim, but on that basis they would defend the claim and advance their own in a somewhat hobbled manner, and would be conducting the litigation (to change the metaphor) with one hand tied behind their back. I have to say that that does not appeal to me on the facts of this case as a just or attractive way to oblige a party to   conduct its litigation.

….

One comes back, I think, at the end of the day to the reflection that [section 726 of the Companies Act, equivalent to s.357 of the Companies Ordinance] is a rule intended to give a measure of protection to a defendant who is put to the cost of defending himself against a claim made by an impecunious corporate plaintiff.  It may in some cases be fair and just to make such an order even though the defendant is himself counterclaiming, but I am persuaded that it would be wrong to do so here because the costs that these defendants are incurring to defend themselves may equally, and perhaps more preferably, be regarded as costs necessary to prosecute their counterclaim .…

The fact that the Plaintiffs are plaintiff and the defendants are counterclaiming defendants instead of the other way round appears on the facts here to be very largely a matter of chance.”

And Parker LJ said at p. 55:

“It appears to me that the principal purpose of section 726 of the Companies Act is to ensure that a defendant who is sued by a limited company has a protection against costs if it appears that that company will be unable to pay the costs in the event of the action being unsuccessful.  It is thus directed to ensuring that the proposed defendant is not forced to defend himself against allegations without protection in costs.  Here the situation is that, if the money is not paid into court and the plaintiff's claim is therefore stayed, the defendant will still raise issues on the counterclaim which are precisely the same as the issues which he would raise on the claim. In the result, findings might be made on the counterclaim which clearly showed that the plaintiff's claim which had been stayed was a good and sound claim.  The result would then be that the stay would be lifted and there would then be judgment for the plaintiff on the claim (notwithstanding the fact that he had not paid the money into court) with appropriate orders as to costs. This being the situation, it appears to me that the only effect of the application for security will be that, if the money is not paid in, the defendant has the right to begin rather than the plaintiff.  That seems to me to be nothing less than the use of the rule to obtain some tactical advantage rather than to obtain protection.”

19.  In Success Wise Ltd v Dynamic (BVI) Ltd [2006 1 HKC 149, Recorder Yu SC cited BJ Crabtree v GPT Communication Systems Ltd and referred to the dictum of Parker LJ as irrefutable logic (para. 12).  Recorder Yu further explained the principle in terms of whether the defendant/ counterclaimant can be regarded, in substance, as an “attacker”, adopting the terminology of Ma J (as he then was) in Brand Farrar Buxbaum LLP v Samuel Rozenbaum Diamond Ltd & anor (No. 2) [2003] 1 HKLRD 600.

20.  In Brand Farrar Buxbaum, security for costs was sought against a corporate third party intervener in interpleader proceedings under s. 357 of the Companies Ordinance (Cap. 32) as if it were the “plaintiff”.  Ma J held that in the context of interpleader proceedings, one must look at substance and not form and decide who essentially was the “attacker” or plaintiff (pp. 605I-607E).  His Lordship said at p. 611 para. 26 that:

“… it should not be forgotten that the judgment creditor is at least also as much an  "attacker" or plaintiff. I refer here to the same facts and matters set out in para.19 above. In these circumstances, where both parties can be regarded as  "attacker" or plaintiffs, in my view, this is a legitimate factor to take into account in the exercise of discretion.  In Samuel J Cohl Co v Eastern Mediterranean Maritime Ltd (The Silver Fir) [1980] 1 Lloyd's Rep 371, both the plaintiff and defendant were ordered to provide security for costs to each other since both were resident outside the jurisdiction. If that had been the situation in the present case, I might then well have considered making a similar order.  It would, in other words, be entirely fortuitous that the judgment creditor was resident within the jurisdiction.”

21.  Recorder Yu said that if the counterclaimant was as much an “attacker” as the plaintiff and it is merely fortuitous that who started proceedings first, and it would be a factor in treating both claimant and counterclaimant in the same way as far as security is concerned (para. 19).

22.  On the nature of the defence of set-off, in Karpex (HK) Ltd v Yasmine Printing (China) Ltd [2008] 1 HKLRD 199, 202-3 (para. 10), Cheung JA referred to the principles summarized in BICC Plc v Burndy Corp & Anor [1985] 1 All ER 417, 424-425:

“(1)   The first is set-off at law, or legal set-off as it is sometimes called, of mutual debts under the Statutes of Set-off, where the claims on both sides have to be liquidated debts or money demands which can be ascertained with certainty at the time of pleading.

(2)     The second form of set-off arose as explained by Parke B in Mondel v Steel (1841) 8 M & W 858, [1835] All ER 511 and was a development of the common law: where an action was brought for an agreed price of a specific chattel sold with a warranty or a work which was to be performed according to contract, the defendant was allowed to plead by way of defence in reduction of the claim that the chattel, by reason of non-compliance with the warranty, or the work in consequence of the non-performance of the contract, was diminished in value.

(3)     The third form of set-off, often referred to as equitable set-off, arose in cases in which a court of equity would have regarded the cross-claims as entitling the defendant to be protected in one way or another against the plaintiff's claims; these were particularly cases where the cross-claim was related to the subject matter of the claim and there were factors which would have rendered it unjust in the eyes of equity that the claim should be enforced without regard to the cross-claim.”

23.  In Bank of Boston Connecticut v European Grain and Shipping Co Ltd [1989] 1 AC 1056, 1102, Lord Brandon stated:

“… the criterion which Lord Hobhouse applied (in Government of New Foundland v New Foundland Railway Co (1888) 13 App Cas 199 (PC)) … in deciding whether the government’s cross-claim for unliquidated damages could be set-off against the company’s claim was not that the cross-claim ‘impeached the title of the legal demand’ as in Rawson v Samuel … but rather it was a cross-claim flowing out of and inseparably connected with the dealings and transactions which also give rise to the claim.”

24.  In Bim Kemi AB v Blackburn Chemical Ltd [2001] 2 Lloyds’ LR 93; [2001] EWCA Civ 457, Potter LJ said at p. 98 (col. 2):

“Equity recognized a right to set off a cross-claim for unliquidated damages where the claim and cross-claim were so closely connected that it would be unfair not to allow a set-off.

25.  His Lordship referred to the Bank of Boston case and said at p. 100 (col. 2):

“… the Court has been content for the outcome to be governed by the notion of fairness involved in the proposition that it must be ‘manifestly unjust’ to allow one to be enforced without regard to the other.  For myself, I consider that Lord Brandon’s formulation [in the Bank of Boston case] to be preferred because on the one hand it emphasizes that the degree of closeness required is that of an ‘inseparable connection’, while on the other it makes clear that it is not necessary that the cross-claim should arise out of the same contract; all that is required is that it should flow from the dealings and transactions which give rise to the subject of the claim.”

Discussion

26.  Mr Shieh submitted that the breach of the Oral Agreement does not amount to an equitable set-off as there is no sufficient connection between the claim and the counterclaim:

(1)     the loan agreements and the Oral Agreement are separate transactions taken at different time;

(2)     the Plaintiff’s obligation for repayment is independent of the Defendant’s obligation (which is denied) to exchange the securities;

(3)     there is no allegation that the loan agreements were amended by the Oral Agreement.

27.  Mr Tong submitted the loan agreements and Oral Agreement are all bound up together, and it defies common sense to say they are separate when the Defendant had held on to both the Old Security and the New Security for over 2 years during the currency of the loan.

28.  Mr Shieh submitted that the Plaintiffs could have dealt with the Shenzhen Land in any event notwithstanding that the Defendant held on to the land certificates.  However, there is an issue as to whether the Plaintiffs could have done so.

29.  Mr Shieh further submitted there is no unfairness in allowing the Plaintiff to proceed with the debt claim only.  Taking a broad view, all the Defendant could in reality get at is the NT Land worth between HK$0.6 million and HK$2.2 million.  There is nothing unfair in separating the simple debt claim from the speculative counterclaim for damages.

30.  I agree with Mr Tong on nexus.  One does not simply look at the timing and occasions of the contracts, but also the inter-relationship of the parties and the transactions.

31.  Without going into the real reason why the New Security was held by the Defendant for over 2 years, both the Old Security and the New Security were involved in the entire continuing relationship between the parties.  Hence, the alleged Oral Agreement is bound up with the loan agreements.  The Defendant has sued for both the loan repayment as well as possession of the the NT Land.  Although the Oral Agreement was not relied on as a defence to possession of the land as such, there is sufficient nexus to qualify as equitable set-off.  It will be manifestly unjust not to allow the Plaintiffs to put up the Oral Agreement as defence to the counterclaim.  The value of the Old Security is a matter for consideration under security for costs rather than equitable set-off.

32.  Hence, I hold that the claim of breach of the Oral Agreement amount to an equitable set-off against the debt claim by the Defendant.

33.  As to the terms in the facility letters excluding the reliance on any set-off or counterclaim, Mr Tong pointed out that the clauses were not pleaded in the Defence and Counterclaim, and there is no application to strike out the defence of equitable set-off.  In any case, the Defendant cannot rely on the exclusion clauses by reason of ss. 5 and 8 of the Control of Exemption Clauses Ordinance (Cap. 71).

34.  Mr Tong referred to Stewart Gill Ltd v Horatio Myer & Co Ltd [1992] 1 QB 600, where terms disentitling the customer from withholding payment by reason of set-off in the supplier’s written standard contract of supply of goods and services under the relevant sections of the Unfair Contract Terms Act 1977, UK (c. 50).

35.  Mr Shieh queried the Plaintiffs’ qualification as “consumer”, and the albeit often used terms in the facility letters as standard terms. 

36.  Be that as it may, on the basis of the arguments before me, it is not clear and obvious that the Plaintiffs is not entitled to rely on the Control of Exemption Clauses Ordinance in answer to the exclusion clauses in the facilities letters.

37.  However, the defence of set-off is not the end of the matter.  The rationale in BJ Crabtree v GPT Communication Systems is whether a stay of the Plaintiff’s claim in not putting up the security will be anything but the use of the rule to obtain any tactical advantage.  Here, the breach of the Oral Agreement sounds in both a HK$77 million claim as well as defence to the counterclaim of HK$44 million.  One can at once see the claim and counterclaim (or defence to counterclaim) are not mirror image of each other.  The claim exceeds the counterclaim.  The stay of the claim is not a mere tactical advantage as far as the Defendant is concerned.  There is a positive forensic advantage in staying the claim notwithstanding the litigation of the defence of set-off in any event.

38.  Looking at it from the angle of attacker, the debt is not in dispute and the case is really the breach of the Oral Agreement.  Hence, the Plaintiffs are much more an attacker than the Defendant.

39.  And looking from the angle of issues and costs, no doubt there is much overlap between the Oral Agreement as a claim and as a defence, but where the issues include property valuation as well as quantification of the loss of a chance to make profits, there are bound to be further costs in pursuing the claim as opposed to merely raising it as a defence to a lesser counterclaim.

40.  There must have been difficulties over the Shenzhen Land as security, else the matter would have been resolved before the Shenzhen Court.  Hence, a caveat must be registered on the value of the Old Security. 

41.  The effect of breach of the Oral Agreement as cause of the Plaintiffs’ impecuniosities cannot really be assessed without going into the merits of the case.

42.  No doubt there has been delay on the part of the Defendant in not applying earlier, leading to steps already taken in the preparation and setting down for trial.  Be that as it may, I am not persuaded that the Plaintiffs have been seriously prejudiced in the overall consideration.

43.  In the event, I consider it fair to order some security against the Plaintiffs.  Applying the consideration of the additional time and costs in pursuing the claim beyond the defence of set-off, I consider the sum of HK$ 1.2 million to be fair and sufficient security.

Costs

44.  Taking into account the respective success on the issues, I make the order nisi that the Plaintiffs do pay half of the costs here and below to the Defendant.

45.  Lastly, I thank counsel for their helpful submissions and research.