XCHRX SHANDAN LTD. v. SIU WING KEUNG t/a CRYSTAL SHOES

1994, No. A4861

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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JUDGMENT

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The Background

1. On 25 October 1993, the plaintiff, as landlord, and the defendant, as tenant, entered into a written lease relating to shop unit 1016 on the first floor of a building known as Park Lane Square, which is situated on Nathan and Kimberley Roads in Kowloon. The lease was for a period of two years from 15 April 1993, which is when the defendant entered into occupation, at a rent of $33,592 a month.

These Proceedings

2. Problems arose early in the lease period; even before the lease agreement was executed. The defendant did not pay rent for part of September 1993, or for the period from 1 October 1993 to 31 January 1994. The plaintiff took distraint proceedings against the defendant in the District Court, as a result of which the defendant paid up. The defendant then paid rent for February and March 1994. On 28 April 1994, the defendant abandoned the leased premises, and returned the keys on 30 April 1994. He gave no explanation for this conduct at the time; in particular, he made no assertion that he was entitled to terminate the lease agreement.

3. The plaintiff commenced proceedings against the defendant, claiming arrears of rent in the sum of $76,253.84, interest, legal expenses and damages. The defendant gave notice of intention to defend. The plaintiff applied for judgment under Order 14, and this was granted on 6 March 1995. The defendant now appeals against this decision.

The Defendant's Case

4. In his affirmation in opposition to the claim for judgment under Order 14, the defendant produces a copy of a draft defence and counterclaim. Outside this, he does not say very much.

5. In the draft defence, the defendant says that, in about November or December 1992, Mr Alan Wong, a representative of Jones Lang Wootton (JLW), the leasing agent for the building, orally represented to the defendant that, upon completion, there would be entrances to the building from both Nathan and Kimberley Roads, the Nathan Road entrance would ensure a good supply of customers and the plaintiff would supply a first class shopping centre environment. In reliance on, and in consideration for, these representations, the defendant entered into the agreement of 25 October 1993. The defendant alleges that a collateral contract existed between the parties under which the plaintiff agreed -

a) to maintain and to keep the said Nathan Road entrance of Park Lane Square;

b) not to cause or allow the said Nathan Road entrance or any part thereof to be blocked or alternatively denying pedestrian access to Park Lane Square from Nathan Road through the said Nathan Road entrance; and

c) to provide a first class [shopping centre] environment at Park Lane Square.

6. The words in square brackets are omitted from the defence, but, in view of what is said earlier, I assume they are meant to be there.

7. The defence goes on to say that, in breach of paragraphs a) and b), "the plaintiff has decided to demolish and redevelop the West Wing of Park Lane Square. One of the effects of the said decision is that the Nathan Road entrance will be blocked during and possibly after the demolition and redevelopment.", and, in breach of paragraph c), the plaintiff has failed to provide a first class shopping centre environment at Park Lane Square. In this respect, the defendant cites particulars that indicate that the premises were not complete and ready for occupation. It is alleged that, by virtue of these matters, the defendant "has accepted the breach of the plaintiff and has been discharged from further performance of the tenancy agreement.", and, consequently, on 30 April 1994, the defendant vacated the premises and delivered the keys to the plaintiff.

8. The defendant produces a letter dated 2 July 1993 from his solicitor in which the particulars, similar but not identical to those mentioned in the draft defence, are raised. The letter says that no further rent will be made until the defects are remedied and the shopping centre becomes fit for normal business.

9. The defendant paid to the plaintiff a deposit of $112,442.76, which, it says, it is entitled to set off against the plaintiff's claim

The Plaintiff's Response

10. In an affirmation filed on behalf of the plaintiff, it is said that JLW "was the leasing agent for the plaintiff in respect of Park Lane Square. Their responsibility was the introduction of potential tenants and in the initial negotiations with them. At no time was JLW authorised by the plaintiff to give any warranty or to enter into any contract collateral to the tenancy agreement between the plaintiff and the defendant." JLW would have been expected to introduce Park Lane Square to potential tenants as a first class shopping environment. It is agreed that the plaintiff decided to redevelop Park Lane Square, but the Nathan Road entrances would not be closed until March 1995. On 10 November 1994, nothing had been done. The complaints contained in the letter by the defendant's solicitor dated 2 July 1993 related to matters that were temporary, were caused by tenants fitting out and decorating, and disappeared once the tenants finished this work. After the defendant paid the arrears of rent after the distraint proceedings, he paid full rent for March 1995 without complaint. He abandoned the premises on 30 April 1994 without giving any explanation.

11. An affirmation by Mr Allan Wong was filed on behalf of the plaintiff. He says that the responsibility of JLW "was to introduce potential tenants to the plaintiff and to enter into negotiation with these potential tenants on the plaintiff's behalf. JLW's role was confined to the preliminary stage and all formal contractual documentation including the letter of offer and the draft tenancy agreement was prepared and handled by the plaintiff and Larcom Property Management Limited. JLW has no authority to give any warranty binding on the plaintiff or to enter any agreement relating to the leasing of the Square on the plaintiff's behalf." In summary, Mr Wong says that he does not recall details of his conversation with the defendant, that he would have drawn attention to the entrances in Nathan Road, but would not have singled this out, and would have said that the building would provide a first class shopping environment. He would not have said anything that would have given the impression that the plaintiff would not do anything to alter the entrance or layout of the Square.

12. Another affirmation by the defendant deals entirely with the alleged collateral contract. He does not deny that the matters complained about in his solicitor's letter of 2 July were temporary and disappeared when the tenants had finished fitting out and decorating. He does not contest that it was the plaintiff's intention that the Nathan Road entrances would not be closed until March 1995. He does not offer any explanation as to why he did not say to the plaintiff that he was abandoning the lease because of this problem.

The Collateral Contract

13. There is one aspect of this matter that can be disposed of immediately; that is, the allegation that the plaintiff did not provide a first class shopping environment by reason of the particulars tending to show that the premises were not ready for occupation. The defendant does not deny that these problems disappeared, and that they did so, and no longer concerned the defendant, is shown by the fact that the defendant complained about them in July 1993, but executed the tenancy agreement in October 1993. He surely would not have signed the lease agreement if he were still concerned about the complaints he made in July 1993. Mr Sakhrani did not, very sensibly, seek to rely on these alleged defects; he did not mention them to me at any stage. He argued his case on the basis of (as he contended in his skeleton submission) "the existence of a collateral contract that the Nathan Road access to the Park Lane Square II shopping mall where the defendant's shop was located would be maintained and kept open during the currency of the tenancy agreement."

14. Although there are several difficulties in his way (not least being a "whole agreement" clause in the lease), for the purposes of this appeal, I am content to assume that there was a collateral contract as contended for by Mr Sakhrani. The defendant's lease was to expire on 14 April 1995. The plaintiff's plan involved closing the Nathan Road entrances in March 1995. The defendant does not say that he knew this when he repudiated the lease. He says that he learnt "sometime after early 1994", through the media, that the plaintiff had given notice of eviction to all tenants of Park Lane Square I in December 1993 requiring them to vacate that building on or before 30 June 1994. The defendant does not say that he made any inquiries of the plaintiff about this. If he had, presumably he would have been told that the plan was that the Nathan Road entrance would be closed in March 1995, a month or so before his tenancy was due to expire.

15. It is not suggested by the defendant that, when he abandoned the lease in April 1994, the plaintiff had breached the collateral contract by closing the Nathan Road access. He alleges that the breach of the collateral contract was the decision to demolish and redevelop, saying that one of the effects of this would be that the Nathan Road entrance would be blocked off. It cannot be so that a decision to demolish and redevelop was a breach. It is possible that, if the defendant were able to say that the plaintiff had told him, or had otherwise conveyed to him, in plain terms, before he abandoned the lease, that it intended to close off access to Nathan Road a month or so before his lease expired, he could say that the plaintiff was guilty of an anticipatory breach of the collateral contract. But even this is a doubtful defence to the plaintiff's claim. Even if it could be said that there was clear and unambiguous conduct by the plaintiff towards the defendant demonstrating an intention to deprive the defendant of the access to Nathan Road for a period of perhaps six weeks at the end of the lease, this would not deprive the defendant of substantially the whole benefit which it was the intention of the parties he should gain from the lease, and, therefore, would not be a renunciation of the lease by the plaintiff entitling the defendant to treat himself as discharged from his obligations.

The Deposit

16. As I have said, the defendant made a payment of $112,442.76 to the plaintiff. This was done in terms of clause 5(8) of the lease, which reads -

"The tenant shall deposit with the Landlord the sum of [$112,442.76] being the equivalent of three months' rental, air-conditioning charges, management fees, advertising contribution and one quarter of rates by way of rental deposit on or before the signing of this Tenancy. The Landlord shall hold such deposit as security for due payment by the Tenant of the rent and any other charges payable hereunder and the performance and observance of the terms and conditions to be observed and performed by the Tenant hereunder. At the expiration or sooner determination of the term hereby created if the Tenant shall have paid all rents and all other sums due hereunder and if there shall be no breach of any of the terms and conditions on the Tenant's part to be observed and performed the Landlord will refund the said deposit without interest to the Tenant within thirty days after the Tenant shall have delivered up to the Landlord vacant possession of the Premises."

17. Following the defendant's vacation of the premises and delivery of the keys on 30 April 1994, the plaintiff did not immediately accept that as a repudiation of the lease bringing it to an end. It did not do this until it issued and served the writ in May 1994. Consequently, the plaintiff claimed rent and other amounts due up to May 1994 totalling $76,253.84 and damages. Judgment was given for this. The plaintiff did not seek any order regarding the forfeiture of the deposit of $112,442.76, and, as far as I am aware, has not purported to forfeit this sum.

18. On the face of clause 5(8), the deposit is a security for due performance. In normal circumstances, a security can be utilised only to the extent of the underlying debt following a failure to perform. But it seems that in the case of a deposit by the purchaser on a contract for the sale of land, a different rule applies.

19. In Workers Trust and Merchant Bank Ltd v Dojap Investments Ltd [1993] 2 All ER 370, Lord Browne-Wilkinson said, at 373a -

"In general, a contractual provision which requires one party in the event of his breach of the contract third party pay or forfeit a sum of money to the other party is unlawful as being a penalty, unless such provision can be justified as being a payment of liquidated damages, being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach. One exception to this rule is the provision for payment of a deposit by the purchaser on a contract for the sale of land. Ancient law has established that the forfeiture of such a deposit (customarily 10% of the contract price) does not fall within the general rule and can be validly forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract.

The exception is anomalous . . . Ever since the decision in Howe v Smith the nature of such a deposit has been settled in English law. Even in the absence of express contractual provision, it is an earnest for the performance of the contract: in the event of completion of the contract the deposit is applicable towards payment of the purchase price; in the event of the purchaser's failure to complete in accordance with the terms of the contract, the deposit is forfeit, equity having no power to relieve against such forfeiture."

20. Even in the case of the sale of land, it was made clear in the Workers Trust Bank case that the rule only applies if the deposit is reasonable, and in order to be reasonable a true deposit must be objectively operating as earnest money and not as a penalty. The customary deposit of 10% was to be regarded as reasonable; a vendor who seeks to forfeit a larger amount must show special circumstances to justify it as a deposit.

21. In the contract featured inHowe v Smith (1884) 27 Ch D 89, there was no clause as to what was to be done with the deposit if the contract was not performed. In that case, Bowen, L.J. said - "The question as to the right of the purchaser to the return of the deposit money must, in each case, be a question of the conditions of the contract." Fry, L.J. said - "Money paid as a deposit must, I conceive, be paid on some terms implied or expressed. In this case no terms are expressed, and we must therefore inquire what terms are to be implied. The terms most naturally to be implied appear to me in the case of money paid on the signing of a contract to be that in the event of the contract being performed it shall be brought into account, but if the contract is not performed by the payer it shall remain the property of the payee."

22. Does the anomalous rule mentioned in the Workers Trust Bank case apply to the lease of land as well as the sale of land? The decision inWong Kam-kong v Intercontinent Mercantile Co [1968] HKLR 331 supports the contention that it does. This was a judgment of the Full Court. The plaintiff in that case claimed arrears of rent and other sums, but did not claim damages. The agreement provided for the payment of a sum "to secure the due performance and observance of the terms and conditions" of the lease, and that the deposit should be returned if the tenant duly performed, but that the deposit "shall be absolutely forfeited to the Landlord if the Tenant shall fail to perform or observe any of the terms and conditions" of the lease. Counsel for the plaintiff in that case "agreed that, if the plaintiff 's claim had been for damages, the deposit could have been set off against such a claim because a deposit is in lieu of damages for breaches, and a tenant should not have to pay damages for the same thing twice." The court said, at 339 - "We think it is clear from the authorities that at common law the deposit paid by the defendants to the plaintiff, under the terms of the agreement, is not recoverable, and could not therefore be used as a set-off against the plaintiff's claim unless it be upon some equitable principle."

23. I must say that this is not clear to me from the authorities in so far as it is suggested that what is said applies to a lease, and what is said is clearly not the same rule as that mentioned in the Workers Trust Bank case because in that rule equity has no power to relieve against such forfeiture.

24. It seems to me that the thrust of the decision in the Workers Trust Bank case is that the "ancient law" creating the "anomalous" rule does not apply outside sales of land, and, in my view, it is right that it should not do so. Sales of land are very different creatures from leases of land. In a sale of land, there is essentially only one event upon which a deposit may be forfeited; the failure of the purchaser to go through with the deal, and this may provide some justification for forfeiture. In a lease, there is a continuing relationship, and potentially numerous occasions on which a deposit would be liable to forfeit, involving breaches by the tenant, both great and small.

25. Unlike the relevant clause in the cases of Workers Trust and Wong Kam-kong, the clause 5(8) of the agreement before me does not contain a forfeiture provision, and have I not been referred to one elsewhere in the lease agreement. The rules in this case are no different from any other sort of contractual dispute; the rights and obligations of the parties depend upon the interpretation of the agreement. Clause 5(8), it seems to me, provides that the deposit is security, as it says, "for due payment by the Tenant of the rent and any other charges payable hereunder and the performance and observance of the terms and conditions to be observed and performed by the Tenant". If the tenant does not pay the rent, the landlord has his security. If the tenant breaches some other provision, the landlord has security against any loss he may suffer. But I cannot read this clause as saying that, if the tenant does not pay rent, the landlord may keep the money deposited as security for payment of the rent and recover the rent, whether as rent or as damages. And, of course, if the plaintiff is entitled to forfeit the deposit for non-payment of rent, he is entitled to forfeit for non-payment of any rent. One cannot say that forfeiture only applies if the default is greater rather than smaller. So if the defendant were to under-pay the rent by $100, and the rule applies, the plaintiff would be entitled to forfeit the deposit of $112,442.76, assuming it falls within the 10% rule. Clearly, this would not be just, and I cannot believe it is the law.

26. In does not surprise me that in The World Reality Limited v Kwan Ngar Yin (unrep.) Civil Appeal 150/1986, in which the plaintiff was represented by leading counsel, it was ruled that "From that figure [the amount due to the plaintiff for rent and other charges] there falls to be deducted by way of set-off a deposit . . . which the defendant, at the commencement of the term, had deposited with the plaintiffs as a guarantee of her obligations under the lease."

The Result

27. I find that the matter of the alleged collateral contract, even if proved, does not provide an arguable defence, but I believe that the defendant is entitled to require that the deposit he paid by way of security be brought into account against his liability to pay rent, damages or any other liability arising from a breach of the lease; or, at least, that this is arguable. It follows that the judgment entered against the defendant cannot stand. It is set aside, and the defendant is given unconditional leave to defend.

The Costs

28. On the face of it, there seems no reason why the usual order should not be made in respect of costs. Accordingly, I make an order nisi that costs be costs in the cause.