SECRETARY FOR JUSTICE v. GLOBAL MERCHANT FUNDING LTD

HCMA 716 /2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

MAGISTRACY APPEAL NO. 716 OF 2013

(ON APPEAL FROM ESS NO. 43438 OF 2011)

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Hon Lunn VP:

1. I agree with the judgment of Kwan JA. For the reasons set out in her judgment, the appeal is dismissed with costs to the respondent. Of the questions posed for this Court in the Case Stated, Question 1: “Did I err in holding that the MCA is not a loan within the meaning of section 2 of the Ordinance (the Money Lenders Ordinance, Cap. 163)?” is answered in the negative. It is not necessary to answer either of the other questions.

Hon Kwan JA:

2. This is an appeal by way of case stated brought by the Secretary for Justice.  The appeal arises from the acquittal by Li Kwok Wai, Permanent Magistrate, on 13 July 2012 of a charge laid by an information against Global Merchant Funding Limited (“GMF”) under section 29(1)(a) of the Money Lenders Ordinance, Cap 163 (“MLO”) for carrying on business as a money lender without a licence on and between 9 May and 21 October 2011.  One business of GMF at the material time was to advance funds in the form of Merchant Cash Advance (“MCA”) to merchants including small and medium enterprises in Hong Kong.  The magistrate found that the prosecution failed to prove that MCA is a loan controlled under the MLO and that GMF did not operate a money lending business as alleged in the summons laid on behalf of the Secretary for Justice.

3. The Secretary brought this appeal pursuant to section 105 of the Magistrates Ordinance, Cap 227, contending that the magistrate’s determination was erroneous in point of law.  With the agreement of both sides on 4 March 2014, Line J directed the appeal to be heard by the Court of Appeal pursuant to section 118(1)(d) of that ordinance.

4. The magistrate signed the Case Stated on 5 November 2013.  These three questions of law arising from the acquittal were stated for the opinion of the court:

“(1) Did I err in holding that in the absence of a definite time for repayment an important hallmark of a loan is missing?

(2) Did I err in deciding that [GMF’s] inability to comply with section 18(2)(i) and section 19(1)(a) of the [MLO], by reason of the impossibility of calculating the “interest rate” expressed in “per cent per annum”, indicates that the MCA business is a sale and purchase and not a loan?

(3) Did I err in holding that the MCA is not a loan within the meaning of section 2 of the [MLO]?”

5. It is common ground that the key question in this appeal is question 3.  GMF’s leading counsel, Mr Simon Westbrook, SC[1], submitted that the answers to questions 1 and 2 will not affect the correctness of the acquittal.  Mr Clifford Smith, SC[2] for the prosecution did not dissent from this.  So I will address the key question first.  Before I do so, it is necessary to set out the relevant facts and material contractual provisions.

The facts

6. The summons charged that between 9 May 2011 and 21 October 2011, at the place of business of GMF in Wanchai, it carried on business as a money lender without a licence.

7. The following facts were taken from the facts admitted under section 65C of the Criminal Procedure Ordinance, Cap 221, and accordingly found as proved by the magistrate.

8. GMF was incorporated in Hong Kong in August 2008 and commenced business in March 2009. One business of GMF at the material time was to make MCA to merchants.  Among its target customers were retailers of fashion and catering business, as well as any other business that accepted credit card payments by their consumers.  At no time was GMF licensed to carry on business as a money lender.

9. At all material times, by way of agreement, called the Merchant Cash Advance Sale and Purchase Contract (“MCA Contract”), and as provided for by the terms thereof, GMF purchased a fixed amount of the merchant’s future credit card receivables, known as the “Purchased Amount”.  The price paid by GMF was in the form of a one-off upfront MCA, known as the “Purchase Price”, which was at a discount to the Purchased Amount.  The merchant arranged for GMF to collect the Purchased Amount through the merchant’s credit card processing bank, whereby GMF received a fixed percentage of the merchant’s credit card sales until the Purchased Amount was collected in full.

10. On or about 9 May 2011, Lam Ching (“Lam”) trading as Amy House entered into an MCA Contract with GMF.  Amy House was a fashion shop and Lam its sole proprietor.  On 11 May 2011, in accordance with the MCA Contract, Lam received $80,000 as the Purchase Price from GMF.  Between May and October 2011, the credit card sales of Amy House were split by the processing bank between GMF and Amy House and GMF collected the Purchased Amount in the total sum of $97,600.  On 22 October 2011, GMF notified Amy House by letter that the MCA transaction had been completed.

11. Unionjoy Enterprise Limited (“Unionjoy”) entered into an MCA Contract with GMF on 18 May 2011.  It was engaged in the business of selling clothing.  On 19 May 2011, in accordance with the MCA Contract, Unionjoy received $50,000 as the Purchase Price from GMF.  Between May and September 2011, the credit card sales of Unionjoy were split by the processing bank between GMF and Unionjoy and GMF collected a total sum of $60,000 as the Purchased Amount.  On 3 September 2011, GMF notified Unionjoy by letter that the MCA transaction had been completed.

12. Big Food Yamagimachi Diet Limited (“Big Food”) entered into an MCA Contract with GMF on 25 May 2011.  Big Food was engaged in the catering business.  In accordance with the MCA Contract, Big Food received $300,000 from GMF as the Purchase Price on 3 June 2011.  Between May and October 2011, the credit card sales of Big Food were split by the processing bank, Wing Lung Bank, between GMF and Big Food and GMF collected a total sum of $375,000 as the Purchased Amount.  On 21 October 2011, GMF notified Big Food by letter that the MCA transaction had been completed.

13. The staff of GMF had explained the MCA product to Amy House, Unionjoy and Big Food in accordance with the contract signed.  It was made clear to Amy House, Unionjoy and Big Food that this was not a loan but a sale and purchase agreement as per the contract terms.  Amy House, Unionjoy, Big Food did not, nor did any other merchant, make any complaint to the police about the MCA product marketed by GMF.

14. The magistrate also found that at the material time GMF had provided a brochure of 13 pages to potential merchant customers, giving a description of the MCA product.  The brochure was headed “The Newest Source of Cash for Hong Kong Businesses” and page 3 set out four bullet points about MCA:

“• Helps Hong Kong businesses to improve cash flow and expand businesses

• Quick source of cash for businesses that accept credit and debit card payments

• GMF buys a fixed amount of the business’s future credit card sales to provide cash in advance

• MCA is a Sale and Purchase transaction, not a loan!”

The contractual provisions

(a) The MCA Contract

15. The MCA Contract, which was headed “Sale and Purchase of Future Card Receivables” (defined in the contract as the “Transaction”), contained these material provisions:

“The Seller hereby agrees to sell to the Buyer a fixed amount of the Seller’s future receivables (the “Future Receivables”), relating to the payment of monies by the Seller’s customers, for the purpose of the Seller’s goods or services, through the use of any of the following cards: Visa/Mastercard/CUP.

The amount paid by the Buyer to the Seller in consideration for the Future Receivables shall be in the form of a one-off, upfront Merchant Cash Advance or “MCA” (the “Purchase Price”).

The total amount of the Future Receivables sold by the Seller to the Buyer shall be known as the “Purchased Amount”. The Purchased Amount will be collected by the Buyer through the deduction of a specified percentage of the Seller’s periodic batch settlements from the Seller’s card processor (“the Processor”, as defined more fully in the Terms and Conditions) until the Purchased Amount has been collected in full. The specified percentage shall be known as the “Retrieved Percentage”.

The Seller shall give an irrevocable authorisation to the Processor to deduct or split a cash sum from each periodic batch settlement, equal to the periodic net batch settlement amount multiplied by the Retrieved Percentage (the “Split Settlement(s)”). This irrevocable authorisation will take the form of a letter (the “MCA Processing Instruction Letter”), and will be completed by the Seller and given to the Buyer, who will then send it to the Processor, on behalf of the Seller. The Processor will continue to pay the Split Settlement(s) to the Buyer until the Purchased Amount has been collected in full.

In consideration of the mutual obligations of the parties in relation to the Transaction, each of the Buyer and the Seller agrees that:

1. The MCA Processing Instruction Letter will be sent by the Buyer to the Processor, and shall constitute an irrevocable authorisation by the Seller to the Processor to remit all of the Split Settlements into a designated bank account of the Buyer (the “Designated Account”) rather than to the Seller’s existing bank account, until the Purchased Amount has been collected in full by the Buyer.

…

3. The Processor will be acting on behalf of the Buyer with respect to the receipt of the Split Settlement(s), until the Purchased Amount has been collected by the Buyer.

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5. The period for the collection of the Purchased Amount by the Buyer is not fixed, and is dependent on the actual level of the Seller’s Relevant Card Transactions (as defined in the Terms and Conditions).

6. According to the information provided by the Seller to the Buyer during the Seller’s application for the Transaction, the Seller and the Buyer agree that, for the purposes of this Contract, the average monthly volume of the Seller’s card transactions during a period of 12 months prior to the date of this Contract shall be deemed to be HK$73,461[3] per month. This implies a theoretical historical weekly collection rate (the “Historical Weekly Collection Rate”) of HK$4,238 per week (i.e. HK$73,461 multiplied by 12, divided by 52 and then multiplied by the Retrieval Percentage[4]).

7. The “Actual Weekly Collection Rate” shall be defined on any given date as the total amount collected by the Buyer since the start of the Transaction, being the date on which the Purchase Price is paid to the Seller, up to such date, divided by the number of weeks taken by the Buyer to collect such amount.

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9. The Seller and the Guarantor(s) shall be jointly and severally liable to pay the Purchased Amount to the Buyer in full[5].

10. The first Split Settlement shall be collected by the Buyer within seven (7) days of the date on which the Purchase Price is paid by the Buyer to the Seller. If no such Split Settlement is received by the Buyer, then the Buyer shall be entitled to modify or terminate the Contract and/or the Transaction, and the Seller shall immediately thereafter return the Purchase Price to the Buyer.

11. If, by the end of each 14-day period since the start of the Transaction, the Actual Weekly Collection Rate is less than the Historical Weekly Collection Rate by 20% or more, then the Buyer shall, without prejudice to receiving the Split Settlement(s), be entitled but not obliged to take any of the following measures against the Seller at its sole discretion:

a. Demand the payment of a sum of money equivalent to the deficit equals to the Actual Weekly Collection Rate minus the Historical Weekly Collection Rate, multiplied by the number of weeks that have passed since the start of the Transaction[6]. The Seller shall pay such sum to the Buyer within seven (7) days of such demand. For the avoidance of doubt, such sum shall be applied to reduce the then remaining balance of the Purchased Amount; or

b. Terminate the Contract, whereupon the entire then remaining balance of the Purchased Amount shall become immediately payable by the Seller to the Buyer; or

c. Terminate the Contract, whereupon the entire outstanding balance of the Purchased Amount shall be applied to any or all of any other transactions outstanding as of that date with the Buyer. …

For the avoidance of doubt, the remedies contemplated under this Clause 11 are intended for the benefit of the Buyer in the event the Seller fails to comply with its obligations to ensure accurate processing of all future Relevant Card Transactions, in addition to its obligations as set out herein. The entitlement of the Buyer to receive any sums pursuant to this clause 11 shall not in any way be deemed as being equivalent to a minimum monthly collection amount.”

(b) The Terms and Conditions

16. The Buyer and the Seller executed the MCA Contract subject to the Buyer’s standard Terms and Conditions annexed to the contract.  The Terms and Conditions contained these relevant provisions:

“1.Definitions and Interpretations

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1.2 In these Terms and Conditions, the following words and expressions shall have the following meanings:

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(e) “Processor” shall mean the card processor designated by the Buyer in respect of the processing and settling of the Relevant Card Transactions;

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2.Conditions Precedent

2.1 Prior to the payment of the Purchase Price by the Buyer to the Seller pursuant to the Contract, the Buyer must receive and be satisfied with the following documents, provided that the Buyer may waive any of such requirements at its sole discretion:-

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(e) a copy of the Seller’s agreement with the Processor in respect of the processing and settling of the Relevant Card Transactions (the “Processing Contract”);

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(h) the MCA Processing Instruction Letter;

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2.2 For the avoidance of doubt, the Buyer shall have no obligation to buy from the Seller, and the Seller shall have no right to sell to the Buyer, any Future Receivables unless and until the Buyer has received and is satisfied with the documents as per clause 2.1 of these Terms and Conditions.

3.Representations and Warranties

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3.2 In respect of each of the Seller’s Future Receivables and the Processor, the Seller represents and warrants that:

(a) the Processor has no right to prohibit the Seller’s assignment of any part of such Future Receivables nor any set-off right in respect of it;

(b) the Future Receivables are free from all mortgages, liens, charges or other encumbrances and the Seller’s Future Receivables are sold by the Seller to the Buyer with full title and without subject to any third party’s rights; and

(c) the Seller has no obligations to the Processor save under the Processing Contract.

4.Processing Covenants

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4.2 By entering into the Contract, the Seller:-

(a) irrevocably authorises the Processor to transfer the Split Settlement to the Designated Account from time to time until such time as the Purchased Amount has been collected in full;

(b) agrees that the Processor may rely upon the Seller’s instructions in the form of the MCA Processing Instruction Letter, without reference to the Seller, in remitting the Split Settlement to the Buyer;

(c) agrees that the Processor will act on the Buyer’s behalf, and as instructed by the Buyer, with respect to the receipt of the Split Settlement;

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6.Future Receivables, Business and Assets Covenants

6.1 The Seller agrees that the Seller shall at all times during the terms of the Contract:

(a) not sell, factor or discount any of its Batch Settlement Payments to any third party without the prior written consent of the Buyer;

(b) not create any mortgages, liens, charges or other encumbrances in respect of any of its Batch Settlement Payments without the prior written consent of the Buyer;

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7. Sale and Purchase

7.1 The Seller acknowledges that it is selling to the Buyer, and the Buyer is buying from the Seller, a sum of the Batch Settlement Payments equal to the Purchased Amount, subject to the terms of the Contract.

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7.8 For the avoidance of doubt, each of the Seller and the Buyer acknowledges and agrees that the Purchase Price paid by the Buyer to the Seller is for the purchase by the Buyer of the Future Receivables as set out in the [MCA Contract] and is not a loan or a credit facility offered by the Buyer to the Seller. Accordingly, the Seller and the Buyer agree and acknowledge that the Contract and any transactions contemplated therein shall not be subject to the Money Lenders Ordinance …

7.10 The Buyer shall be entitled at any time to request the Seller to complete, sign and deliver to the Buyer, in the form as required by the Buyer, a written assignment of the Future Receivables at the Seller’s expense.

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8. Termination Events

8.1 For the purposes of these Terms and Conditions, each of the events or circumstances as described in this clause 8.1 shall be regarded as a Termination Event:

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(h) the Seller shall use any card processors apart from the Processor without the prior written consent of the Buyer;

(i) the Seller shall revoke the MCA Processing Instruction Letter;

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(l) the Actual Weekly Collection Rate is less than the Historical Weekly Collection Rate by 20% or more by the end of each 14-day period since the start of the Transaction;

(m) the Seller fails to pay the sum as demanded by the Buyer pursuant to clause 11(a) of the [MCA Contract];

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8.2 At any time after a Termination Event the Buyer shall have the right, without prejudice to any other rights, power or remedy the Buyer may have pursuant to the Contract, these Terms and Conditions and in law, to terminate all or any obligations the Buyer may have to the Seller under the Contract by written notice to the Seller.

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8.4 Without prejudice to the generality of clause 8.3 of these Terms and Conditions, the Seller shall immediately after the termination of the Contract by the Buyer pursuant to clause 8.2 pay the then remaining balance of the Purchased Amount to the Buyer.

8.5   As security for the performance by the Seller of its obligations under the Contract, by signing the Contract, the Seller appoints the Buyer … to be the Seller’s attorney for any of the following: … (d) to do any other acts or things the Buyer considers to be necessary in order to collect, realise or perfect the Buyer’s ownership of the Future Receivables or to secure the performance by the Seller of any of its obligations under the Contract.”

Question 3: is MCA a loan within the meaning of section 2 of the MLO

(a) The test

17. One starts with the definitions of “loan” and “interest” in section 2 of the MLO.  Section 2(1) provides that in the MLO, unless the context otherwise requires:

“ “loan” is defined to include “advance, discount, money paid for or on account of or on behalf of or at the request of any person, or the forbearance to require payment of money owing on any account whatsoever, and every agreement (whatever its terms or form may be) which is in substance or effect a loan of money, and also an agreement to secure the repayment of any such loan”; and

“interest” does not include “any sum lawfully agreed to be paid in accordance with [the MLO] on account of stamp duty or other similar duty, but save as aforesaid includes any amount (by whatever name called) in excess of the principal, which amount has been or is to be paid or payable in consideration of or otherwise in respect of a loan”.”

18. Mr Smith submitted that the Purchase Price under the MCA Contract is an advance and clearly comes within the definition of a loan in section 2, and the Purchased Amount, being in excess of the Purchase Price and payable in respect of the advance, falls within the definition of interest in the same section.  This is correct as far as the economic effect of the transaction is concerned.  But what matters here is the legal effect of the transaction.  As stated in Chitty on Contracts, vol II, Specific Contracts (31^st ed), at §§38-256 and 38-257,

“…at common law, not every form of indebtedness amounts to a loan. … Even where money passes from one party to the other, this does not necessarily make the transaction one of loan for there are many ways of raising cash besides borrowing money. The purchase of bills or book debts at a discount is not a lending of money, even where the seller gives a collateral security which has the effect of making him personally liable for the amount raised. Nor does the ordinary hire-purchase transaction amount to a loan of money; although the economic effect of such a transaction may be the same as that of a loan, the legal effect is quite different.

… But it must be stressed that what matters is the real legal nature of the transaction and not its economic nature, and the courts will not go behind the actual agreement made unless there is evidence that the parties did not intend the relationship between them to be governed by the ostensible agreement which they have made. …”[7]

19. It is trite law that “in determining the legal categorisation of an agreement and its legal consequences the court looks at the substance of the transaction and not at the labels which the parties have chosen to put on it” (Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 at 160b, per Dillon LJ).  However, it is also pertinent to bear in mind that the task of looking for the substance of the parties’ agreement may arise in a case where the written agreement is a sham intended to mask the true agreement, and also in a case without any question of sham.  It is not in dispute that we are in the latter situation.

20. Here, the court looks for “some objective criterion in law” by which it can test whether the agreement the parties have made does or does not fall into the legal category in which the parties have sought to place their agreement (Welsh Development Agency, supra at 160f).  In this kind of situation, one should look “only at the written agreement” in order to ascertain from its terms whether it amounts to a transaction of the legal nature which the parties ascribe to it, instead of seeking to discover from extrinsic evidence the true agreement where there is a sham.  In other words, it is an “internal consideration” of the agreement itself, on the basis that the parties intended to be bound by its terms, and by nothing else (Welsh Development Agency, supra at 186d and e, and 187e per Staughton LJ).

21. Where there is no one clear touchstone by which it can necessarily and inevitably be said that a document which is not a sham and which is expressed as an agreement for sale and purchase must necessarily, as a matter of law, amount to a loan, it is necessary to look at the provisions in the agreement as a whole to decide whether in substance it amounts to an agreement for sale and purchase of future receivables or an agreement for a loan, see by analogy the words of Dillon LJ in Welsh Development Agency, supra at 161f to g.

22. As Lord Wilberforce said in Lloyds & Scottish Finance Ltd v Cyril Lord Carpets Sales Ltd [1992] BCLC 609 at 617f to g:

“My Lords, the fact that the transaction consisted essentially in the provision of finance, and the similarity in result between a loan and a sale, to all of which I have drawn attention, gives to the appellants’ arguments an undoubted force. It is only possible, in fact, to decide whether they are correct by paying close regard to what the precise contractual arrangements between them and the respondents were. Given that the trading agreement was a real contract, intended to govern the individual transactions which followed …, the ultimate question must be whether what was done can be fitted into the contractual framework which that agreement set up with such reasonable adaptions as should be needed in commercial practice and as should not transfigure the nature of the contract.”

23. As to whether the court is free to disregard the labels which the parties have attached to a transaction in determining the substance of it where there is no question of sham, it is permissible to have regard to the labels or descriptions used in the agreement.  Dillon LJ had this to say in Welsh Development Agency, supra at 162i:

“Indeed the similarity in result between a loan and a sale to which Lord Wilberforce referred[8] would make it virtually impossible to decide which the transaction was if it was not permissible to have regard to the words the parties had used in their agreement in describing that transaction on which they had agreed. There is nothing illegal in a party raising finance by a sale of book debts or goods, rather than by a mortgage or charge, if he chooses to do so.”

24. And Staughton LJ said this in the same case at 188a to b:

“In my judgment the correct process, when one is following the internal route, is to look at the operative parts of the document, in order to discover what legal transaction they provide for. If some parts appear to be inconsistent with others in this respect, a decision must be made between the two. This is what I understand by ascertaining the substance of the transaction.”

25. Lastly, it is helpful to have regard to what Mayo J said in Pang Kam Yiu t/a Tai Kung Weaving Factory & Ors v Edward Wong Finance Co Ltd [1985] 2 HKC 62 at 64I to 65C, specifically in the context of deciding whether a transaction is a loan within section 2 of the MLO:

“Some assistance in this matter can be derived from the New South Wales case of Talcott Factors Ltd v G Seifert Pty Ltd [1964] NSWR 1205. In this case a similar submission was made and reliance was placed upon the definition of a ‘loan’ appearing in s 3(1) of the Moneylenders and Infants Loans Act 1941 which is couched in almost identical terms to the definition of ‘loan’ in s 2 of our Ordinance. Nagle J considered the definition and held that what was required was to consider the overall nature of the transaction rather than taking any of the words contained in the definition individually and out of their context. In other words what was required was to consider in overall terms what it was that the parties to the transaction were attempting to achieve and then decide whether the transaction was a ‘loan’ according to the definition. This obviously makes good sense. Clearly every discounting transaction is not necessarily a loan within the definition. What the definition section is attempting to define is a wide range of activities which can under certain circumstances constitute loans. This being the cases, it is a perfectly valid exercise to consider all of the previous case law on this subject and then determine whether the particular transaction in question is a ‘loan’ for the purposes of the Moneylenders Ordinance.”

(b) Salient features of the transactions

26. Before I consider applying the test to the transactions in question, it is appropriate that I should mention some salient features about them.  There is no controversy about these features.  Mr Smith did not contend that was not what the transactions purported to be, although he maintained that the substance and legal effect of the transactions are that they were loans and not contracts of sale and purchase.

27. The transactions are different from the traditional forms of discounting such as bill discounting, block discounting and the sale of book debts, which are concerned with invoices and debts already in existence.  The subject matter of the transactions is future receivables or expectancies.  They are incapable of assignment at law but equity recognizes an assignment of rights of property not yet in existence provided valuable consideration is given and the right to the chose in action is sufficiently identifiable under the agreement.  As stated by Lord Watson in Tailby v Official Receiver (1888) LR 13 App Cas 523 at 533:

“The rule of equity which applies to the assignment of future choses in action is, as I understand it, a very simple one. Choses in action do not come within the scope of the Bills of Sale Acts, and though not yet existing, may nevertheless be the subject of present assignment. As soon as they come into existence, assignees who have given valuable consideration will, if the new chose in action is in the disposal of their assignor, take precisely the same right and interest as if it had actually belonged to him, or had been within his disposition and control at the time when the assignment was made. There is but one condition which must be fulfilled in order to make the assignee’s right attach to a future chose in action, which is, that, on its coming into existence, it shall answer the description in the assignment, or, in other words, that it shall be capable of being identified as the thing, or as one of the very things assigned. When there is no uncertainty as to its identification, the beneficial interest will immediately vest in the assignee.”

28. An effective contract to transfer specified future property is one by which so soon as that future property comes into existence, a transfer of it is effected without the need for any further act.  And the contract is regarded as a present assignment, albeit of future debts, and therefore the rights of the factor take effect from the date of the agreement not the later date when the debt comes into existence (The Law of Personal Property Security, by Beale, Bridge, Gullifer and Lomnicka at §5.113).

29. In this instance, valuable consideration was given before the future receivables came into existence.  Under the MCA Contract, the “Purchase Price” or MCA was paid by GMF to the merchant upfront at the outset of the transaction.  It was also clear from the contract which property was intended to be transferred, without the need for further identification or appropriation.  This was done by specifying the exact percentage of the merchant’s periodic batch settlements with the credit card processor that will be collected by GMF, as expressly stipulated in the MCA Contract and the MCA Processing Instruction Letter (called “Split Settlement”), until the total amount of the future receivables has been collected in full.  So, the requirements of an effective contract to transfer specified future property are met.

30. Another salient feature is that the future receivables relate to credit card transactions.  This relies on the established contractual relationship that provides for the liability of the credit card processor to pay the merchant, and is a separate and independent contractual relationship from one which the merchant’s customer had with the credit card processor and one which the customer had with the merchant.  The three bilateral contracts in credit card transactions have been recognized by the courts, most notably in In re Charge Card Services Ltd [1989] 1 Ch 497, where Browne-Wilkinson V-C gave this explanation at 509C to F:

“The general features of credit card transactions

(A) There is an underlying contractual scheme which predates the individual contracts of sale. Under such scheme, the suppliers have agreed to accept the card in payment of the price of goods purchased: the purchasers are entitled to use the credit card to commit the credit card company to pay the suppliers. (B) That underlying scheme is established by two separate contracts. The first is made between the credit company and the seller: the seller agrees to accept payment by use of the card from anyone holding the card and the credit company agrees to pay to the supplier the price of goods supplied less a discount. The second contract is between the credit company and the cardholder: the cardholder is provided with a card which enables him to pay the price by its use and in return agrees to pay the credit company the full amount of the price charged by the supplier. (C) The underlying scheme is designed primarily for use in over-the-counter sales, i.e., sales where the only connection between a particular seller and a particular buyer is one sale. (D) The actual sale and purchase of the commodity is the subject of a third bilateral contract made between buyer and seller. In the majority of cases, this sale contract will be an oral, over-the-counter sale. Tendering and acceptance of the credit card in payment is made on the tacit assumption that the legal consequences will be regulated by the separate underlying contractual obligations between the seller and the credit company and the buyer and the credit company. (E) Because the transactions intended to be covered by the scheme would primarily be over-the-counter sales, the card does not carry the address of the cardholder and the supplier will have no record of his address. Therefore the seller has no obvious means of tracing the purchaser save through the credit company. (F) In the circumstances, credit cards have come to be regarded as substitutes for cash: they are frequently referred to as “plastic money.” (G) The credit card scheme provides advantages to both seller and purchaser. The seller is able to attract custom by agreeing to accept credit card payment. The purchaser, by using the card, minimises the need to carry cash and obtains at least a period of free credit during the period until payment to the card company is due.”

31. So, from the perspective of the MCA contracts, what was purportedly acquired by GMF was the obligation of the credit card processor to pay the merchant under the merchant’s agreement with the card processor (referred to as “the Processing Contract” in the Terms and Conditions; the Processing Contract between Big Food and Wing Lung Bank was produced as exhibit P14), and which the merchant gave an irrevocable authorization in the MCA Processing Instruction Letter to the credit card processor to deduct the Split Settlement from each periodic batch settlement and pay into GMF’s designated account.  It is relevant to note that the Processing Contract specifically contemplated the possibility of the merchant assigning its rights under the agreement, and expressly provided in clause 12 that the merchant cannot assign the benefit of the agreement without the prior written consent of the card processor.

32. By the underlying contractual scheme in credit card transactions, the credit card processor had bound the merchant to accept the card and had authorized the cardholder to pledge the credit of the card processor.  By the signature of the cardholder on the voucher, the merchant was bound to accept the card in payment, the card processor was bound to pay the merchant, and the cardholder was bound to pay the card processor.  The cardholder’s obligation to the merchant was absolutely, not conditionally, discharged by the merchant accepting the voucher signed by the cardholder, thus reflecting the popular perception of the role of credit cards in modern retail trade as “plastic money” (In re Charge Card Services Ltd, at 513G to H, 517B to C).  There is therefore no question of GMF pursuing cardholders. The receivables relate solely to future debts that may be owed by the card processor to the merchant.

(c) Applying the test

33. I turn to consider how the test should be applied in the present case.

34. The terms of the contract expressly provided for an agreement of sale and purchase of future receivables, not a loan.  The agreement of a discount at the outset, with no interest to be charged regardless of how long it takes for the Purchased Amount to be collected in full by GMF, is entirely consistent with a sale and purchase transaction, but inconsistent with a loan transaction with interest accruing from day to day on the outstanding amount.

35. There is no question of the written agreement being a sham to mask the true agreement.  In determining the substance of the agreement, it is permissible to have regard to the words the parties had used in the agreement to describe the transaction.  The burden lying on the prosecution to establish that the transactions expressed in terms of sale were in substance loans is a heavy one (Welsh Development Agency v Export Finance Co Ltd [1991] BCLC 936 at 949d, per Browne-Wilkinson V-C).  As Lord Wilberforce said in Lloyds & Scottish Finance Ltd v Cyril Lord Carpets Sales Ltd at 615a to b:

“To suppose, in the face of this, that the assignments were made not by way of sale but by way of security, would be to impose upon the parties a form of transaction totally different from that which they had selected, namely one of sale and which there is no evidence whatever that either of them desired. Indeed there was evidence – uncontradicted – from the respondents’ witnesses and accepted by both courts below that the respondents ‘had no intention of creating any charge over book debts or merely making a series of loans’. It would be a strange doctrine of ‘looking for the substance’ or ‘looking through the documents’ which would produce a contractual intention so clearly negated by the documents and by oral evidence.”

36. The courts’ approach has been to uphold freedom of contract.  In the absence of a sham, parties were permitted to structure transactions in whatever way they choose, and features which could be said to be indicative of a secured loan were explained away as not inconsistent with a sale.  A comprehensive summary of the approach in reported cases was given in The Law of Personal Property Security, by Beale, Bridge, Gullifer and Lomnicka at §2.30:

“If the agreement states that an absolute interest is transferred, it is open to the court to look at the rights and obligations created by the agreement in order to decide if this is truly the case. In the reported cases, the courts have consistently upheld the absolute nature of the transfer, despite features that might be thought to indicate that the transfer was by way of security. One such feature is that the purchase price paid for the receivables is discounted to reflect early payment: this could be seen as a provision for interest, but the courts have repeatedly distinguished a discount charge from payment of interest, on the grounds that it is fixed and paid once and for all whereas interest accrues from day to day. Another is that the seller of the receivables usually guarantees that they will be paid by the debtors: often providing bills of exchange to cover this guarantee liability. This might look as though it demonstrates the third of Romer LJ’s incidents of security[9]: that where the security realizes less than the secured obligation, that obligation still remains. Again, the courts have denied this, and have pointed out that the nature of receivables is that the buyer has no or little knowledge of the chances that the debts will be paid, and therefore will want, as far as possible, to make sure that he gets what he bargained for. Thus it is common for sales of receivables to be with recourse. Such provisions are not seen as indicative of security, despite the fact that a sale with recourse is economically indistinguishable from a secured loan. The buyer may also take bills of exchange or payment from the seller by way of direct debit or standing order, allowing the seller to collect and retain the proceeds of the debts ‘sold’. Not only does this support the recourse provisions, it also has the de facto effect that the buyer of the receivables not only does not collect them, but receives ‘payment’ of the receivables as a constant stream of income rather than as and when they are paid by the debtors. However, the courts have made it clear that payment by this method is not inconsistent with the sale of receivables: the parties are free to choose the most convenient method of payment. Further, once the receivables have generated enough to cover the purchase price and the discount charge, the seller may allow the buyer to keep any further money received from the debtors: this is expressed to be a further instalment of the purchase price. While this could be seen as an obligation to account for the surplus, and thus fall within the second of Romer LJ’s incidents of security, the courts have treated this feature as entirely consistent with a sale. It is very clear that, when considering outright assignments of receivables, the courts have consistently looked for the legal rather than the economic substance of the transaction and have upheld freedom of contract.”

37. Faced with this body of authorities, Mr Smith pointed to other features in the transaction to support his contention that the transactions ought to be re-characterized as loans.  He relied on clauses 10 and 11 of the MCA Contract.  Under clause 10, if the first Split Settlement was not collected by GMF within seven days of the payment of the Purchase Price to the merchant, GMF would be entitled to modify or terminate the contract and the merchant would be obliged to return the Purchase Price to GMF immediately.  Under clause 11, if the Actual Weekly Collection Rate is less than the Historical Weekly Collection Rate by 20% or more, GMF may demand payment of a sum of money to make up the deficit, in which event the merchant must pay this sum within seven days, or terminate the contract whereupon the entire then remaining balance of the Purchased Amount shall become immediately payable by the merchant to GMF.

38. In the situations falling within clause 10 or 11, there is no one against whom GMF could proceed to recover the Purchased Amount except the merchant, or a guarantor of the merchant’s own obligations.  There are no customers against whom GMF could proceed and no possibility of proceeding against the card processor in these situations if there have been no credit card transactions, or if the credit card transactions are not enough to generate the cash flow needed to pay the Purchased Amount.

39. Hence, Mr Smith submitted that the merchant’s liability to pay GMF is not one that arises by way of recourse in the event of a failure of some third party debtor to pay a debt that has been sold to GMF.  Rather, the merchant’s liability can arise only where there is a falling off in the number or value of credit card transactions.  So, in substance the transaction does no more than provide a means for GMF to recoup its cash advance, plus the difference between that amount and the Purchased Amount, out of a possible or hoped for income stream in the form of periodic batch settlements that may become due to the merchant from possible future credit card transactions.  But if the income stream does not materialize, or fails to flow sufficiently swiftly, GMF has no redress other than to demand immediate payment from the merchant.

40. Where there is the sale of a right to enforce a debt or other obligation against a third party, the seller might also give his own guarantee or be liable under a right of recourse, the subject matter of the sale nevertheless remains the obligation of a third party.  But under the MCA Contract, so Mr Smith submitted, GMF does not acquire any right to recover the Purchased Amount from anyone except the merchant or a guarantor of the merchant’s own liability.  This he said is incompatible with a sale and purchase transaction, there being no debt, whether present or future, that could be the subject matter of a sale.  And the fact that the merchant arranges to make payment through the card processor does not alter the nature of the merchant’s liability, which is that of a borrower under an agreement for an advance.

41. It seems to me this is looking at the transaction the wrong way round and fails to take into account the transaction as a whole.  The MCA Contract was structured for the purchase by GMF of a clearly identified and recognizable chose in action, namely, the obligation on the part of the card processor to pay the merchant under the Processing Contract the amount spent by the merchant’s customer with a credit card at the merchant’s card terminal.  The Purchased Amount is to be collected from the card processor, by the merchant giving an irrevocable authorization to the card processor to pay the Split Settlements into GMF’s designated account until the Purchased Amount has been collected in full.  The primary source of recovery of the Purchased Amount is not the merchant but the card processor.

42. The fact that the financier has another right of recourse against the merchant is nothing new in the sale and purchase of book debts, as demonstrated in reported cases.  Such a right of recourse does not change the character of the transaction.  As Mr Westbrook has submitted, the fact that GMF has no third party debtor other than the merchant to have recourse to if the Purchased Amount of future credit card receivables failed to materialize is an issue which would arise in any contract for the assignment of future goods not yet in existence at the time of the signing of the agreement.  Mr Westbrook prayed in aid these words of Lord Wilberforce in Lloyds & Scottish Finance at 616g to h, which I think are apposite to the present situation:

“… it is a fallacy (into which the appellants’ argument falls) to argue from this towards a conclusion that the transaction as a whole is one of security or charge. There are many contracts, of sale, or for building work, or otherwise, where some security is required by one party that the other will fulfil his promise. But this does not alter the nature of the contract itself or turn it into a contract by way of charge. In the present case, the fact that the purchasers wanted guarantees, or security, or reserves to ensure that they received the whole of what they had bought, cannot convert a transaction of purchase into one of charge.”

43. Likewise, the recourse provisions in clauses 10 and 11 are to ensure that GMF received the whole of what it had bought, should the receivables not produce their face value.  Further, clause 11 is to ensure an adequate or constant rate of return to GMF, by agreeing with the merchant the speed at which the future receivables should be delivered and making provision for recourse or compensation if the merchant should fail to deliver the receivables on time.  They do not alter the nature of the contract of sale and purchase or turn it into a loan.  Again, to borrow the words of Lord Wilberforce in Lloyds & Scottish Finance at 617g, what was provided for in these clauses can be “fitted into the contractual framework which that agreement set up with such reasonable adaptions as should be needed in commercial practice and as should not transfigure the nature of the contract”.

44. For the above reasons, the magistrate did not err in holding that the MCA is not a loan within section 2 of the MLO.  The appeal by way of case stated should be dismissed.

45. The other two questions are peripheral to the disposal of this appeal. I propose to deal with them briefly.

Question 1: the absence of a definite time for payment

46. Mr Smith submitted that to come within the definitions of “loan” and “interest” in section 2 of the MLO, it is not a requirement that there should be a definite time for payment, or that the rate of interest should be ascertainable by reference to a definite time for payment.  In any event, the terms of the MCA Contact (the combined effect of clauses 6, 7 and 11) were such that the payment was required to be made within a measurable time, failing which GMF could enforce remedies against the merchant.  So, the magistrate was in error in holding that in the absence of a definite time for repayment, an important hallmark of a loan is lacking.

47. It is not necessary to decide whether the above contentions of Mr Smith are correct in law.  If the combined effect of clauses 6, 7 and 11 is as contended by him, the pertinent consideration is whether this should alter the nature of the agreement from sale and purchase to one of lending.  For the reasons given in respect of question 3, I do not think the MCA Contract should be re-characterized as an agreement for a loan.

48. It is not necessary to answer question 1.

Question 2: inability to comply with sections 18 and 19 of the MLO

49. Section 18(2)(i) of the MLO requires a memorandum to be made and signed stating the rate of interest charged on the loan expressed as a rate per cent per annum.  Section 19(1)(a) requires the money lender on demand to provide a statement showing the amount of principal of the loan and the rate per cent per annum of interest charged.  The magistrate held that GMF’s inability to comply with these provisions, by reason of the impossibility of calculating the interest rate expressed as a rate per cent per annum, indicates that the MCA transaction is not a loan.

50. Mr Smith submitted that an inability to comply with sections 18 and 19 does not indicate that the transaction is not a loan, as it is open to the money lender to seek an exemption under section 33B, if he can show that this would be commercially justifiable and unobjectionable.

51. This seems to be a circular argument, as it presupposes that the transaction is a loan.  It does not add anything to ascertaining the substance and legal effect of the transaction.

52. It is not necessary to answer question 2.

Conclusion

53. I would answer question 3 in the Case Stated in the negative and dismiss the appeal with costs.  It is unnecessary to answer questions 1 and 2.

Hon D Pang J:

54. I agree with the judgment of Kwan JA.

[1] Appearing with Mr Derek C L Chan

[2] Appearing with Mr Anthony Chau, SPP

[3] This figure and other figures mentioned in the contract are taken from the MCA Contract of Amy House.

[4] The Retrieval Percentage for Amy House was 25%.

[5] In the case of Amy House, the guarantee was given by the sole proprietor of the business, i.e. the same individual who was the Seller.

[6] This is referred to in the brochure as “remedy payment”.

[7] For similar analyses, see Goode on Commercial Law (4^th ed), pages 787 to 788; The Law of Personal Property Security, by Beale, Bridge, Gullifer and Lomnicka (2007 ed), §§1.25 and 1.26

[8] In Lloyds & Scottish Finance, in the passage just quoted

[9] Re George Inglefield Ltd [1933] Ch 1 at 27