BRILLIANT STAR INVESTMENT LIMITED v. NZI INTERNATIONAL ACCEPTANCES LIMITED & OTHERS

HCA006008/1988

Courts practice and procedure - striking out application - abuse of process of Court - whether 3rd defendant an improper and unnecessary party - whether even if prior appropriation of shares by 1st defendant mortgagee to itself invalid, subsequent sale of shares to 3rd defendant as purchaser for value without notice unimpeachable - alternatively whether 3rd defendant’s position in equity as to title to shares superior to plaintiff’s and it had in any event by getting in the legal estate secured an unimpeachable title – Held : 1. Plaintiff’s cause of action against 3rd defendant not obviously unsustainable; 2. Mere fact that plaintiff’s case weak and not likely to succeed no ground for striking out; 3. Summons for striking out dismissed; time for 3rd defendant to file defence extended.

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

H.C. Action No. 6008 of 1988

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BETWEEN

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JUDGMENT

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1. This is a summons brought pursuant to Order 18 Rule 19 Rules of the Supreme Court by the 3rd Defendant (‘pistola’) to be removed as one of the parties to the action and for all claims and references to it in the writ and statement of claim to be struck out as being an abuse of the process of the Court.

2. The action arises from certain steps taken by the 1st Defendant (‘NZI’) to enforce its rights as lender in respect of a loan for Australian $20 million made to the Plaintiff (‘BSI’) on 12th October 1987.  The loan was made to assist BSI purchase 18,200,000 shares of $1 each in Sun On Estate Co. Ltd. (‘Sun On’).  Sun On was a publicly listed company on the Hong Kong Stock Exchange and the 18,200,000 shares represented 70% of its issued share capital.

3. In terms of the loan agreement, BSI on 15th October 1987 executed a Share Charge whereby as security for the loan, it charged in favour of NZI, all its shares in Sun On for which it lodged share certificates with NZI.  Upon execution of these documents and in accordance with the terms of the loan agreement, BSI transferred the shares subject to the Share Charge to a nominee of NZI.

4. BSI’s decision to purchase the Sun On shares was taken before the stock market crash on 19th October 1987.  The loan was drawn down on 16th October 1987.  After the stock market crash, the underwriting arrangements for the purchase of minority shareholdings in Sun On were cancelled by the underwriters and the takeover did not proceed.  The loan arranged for the takeover was due for repayment on 16th April 1988.

5. Repayment was not made on 16th April 1988.  On that same day NZI made written demand for payment of HK$80,322,191.78 together with accrued interest and reserved all its rights under the security documents.  BSI alleges that thereafter negotiations for repayment took place and that NZI orally agreed not to exercise its rights against BSI for repayment while the negotiations proceeded.  The statement of claim further alleges that NZI also orally agreed that if the negotiations became inconclusive, the loan would only become repayable upon reasonable notice being given.

6. In fact final demand was made by NZI for repayment on 19th April 1988.  Clause 8 of the Share Charge provided that NZI was entitled to declare all or any part of the security created by the charge immediately enforceable upon the occurrence of any event of default.  Payment not having being made in terms of the final demand, NZI was of the view that BSI was in default and on 3rd June 1988, pursuant to Clause 8, declared the security created by the Share Charge immediately enforceable.

7. The next enforcement step taken by NZI occurred on 5th August 1988 when it gave written notice to BSI, that in exercise of its right under Clause 9(1) of the Share Charge, it was appropriating the 18,200,000 secured shares in Sun On.  The provisions of Clause 9(l) were central to the parties legal submissions and it is desirable to set out that provision in full :-

“9. Upon or at any time after the security created by this Charge has become enforceable, the Lender may, without prejudice to any other rights it may have :-

(1) dispose of or appropriate to its own use and benefit (the last mentioned being treated as a sale at a fair market value less costs incurred in such sale as such value is calculated by an independent firm of accountants nominated by the Lender) the Security Assets or any part thereof; and/or”

8. Clause 9(1) clearly creates two-fold rights in favour of NZI as Lender.  First, there is a power of disposition which in effect represents the Lender’s right on default to sell the shares charged by way of security.  Secondly, instead of exercising its power of sale NZI may appropriate the shares to itself.  In the latter event, the provision that the price is to represent fair market value as calculated by an independent firm of accountants, was no doubt designed to give BSI similar protection to that which it would enjoy at common law if the first mentioned power of disposition were exercised.  After NZI appropriated the 18,200.000 shares at HK$3.70 per share the unpaid balance of HK$80,322,191.78 was reduced to HK$7,625,280.33.

9. Clearly NZI, under Clause 9(1), had two alternative enforcement powers.  Equally clearly on 5th August 1988 it elected not to exercise its power of disposition or sale but to appropriate the shares to itself under the second of those powers.  One of BSI’s allegations in the statement of claim, with which I am not directly concerned, is that NZI having elected to appropriate, failed to obtain a valuation by an independent firm of accountants.  Several days after the appropriation, NZI entered into an agreement to sell the shares to Pistola at a price of HK$4.10 per share.  BSI in its statement of claim pleads that the shares were worth approximately HK$4.14.

10. The total consideration in the agreement between NZI and Pistola was HK$74,620,000 of which HK$14,924,000 was to be paid by way of deposit and the balance on completion.  Completion was to take place on or before 31st August 1988.  If completion occurred after 24th August 1988 Pistola was obliged to pay interest on the balance until completion.

11. Under the Hong Kong Code on Takeovers and Mergers the sale of 70% of the share capital in publicly listed Sun On, triggered the requirement of Pistola as purchaser, to make an unconditional offer to purchase for cash the remaining shares at a price of not less than HK$4.10 per share.  Notice of the sale to Pistola and of the intention after completion to offer to purchase the remaining shares, was published in the ‘South China Morning Post’ on 15th August 1988.  On 16th August 1988 NZI by letter also advised BSI that the agreement for the sale of the shares to Pistola had been signed.  On the same day Pistola paid NZI the deposit of HK$14,924,000.

12. On the morning of 24th August 1988 Pistola received from BSI’s solicitors a letter in which they gave notice that BSI were beneficially entitled to the shares and that NZI had no title in the shares to pass to Pistola.  Pistola immediately referred this letter to NZI who replied by letter later on 24th August 1988 that BSI had no such claim.  NZI’s letter also repeated certain-warranties as to title, it had given in the agreement for the sale of the shares to Pistola.  After receipt of that letter on 24th August 1988 Pistola completed the purchase on the same day by paying the balance of the purchase price.

13. The statement of claim is first concerned with alternative allegations against NZI that it was not entitled to appropriate the shares to itself.  The principal pleading involving Pistola, is contained in the latter following paragraphs :-

“21. On or about 24th August 1988 the 1st and/or 2nd Defendant transferred the Shares to the 3rd Defendant, when the 3rd Defendant knew or had been put on notice of the fact that the 1st Defendant had not been entitled to appropriate the Shares to its own use and benefit.

22. In the premises the 3rd Defendant holds the Shares, and all dividends and other benefits and rights whatsoever in respect of the Shares, on trust for the plaintiff.”

14. Before proceeding to the law, leading Counsel for Pistola emphasised a number of factual and procedural matters.  It was pointed out that the Statement of Claim does not allege that there were any negotiations between BSI and Pistola.  All the pleaded negotiations are between BSI and NZI or the 2nd Defendant.  Further, BSI never gave notice to Pistola of any objection to NZI’s title to the shares until 24th August 1988.

15. BSI’s solicitors on 5th October 1988 in reply to a request from Pistola for further and better particulars, stated that its belief that NZI had sold the shares was based on the ‘South China Morning Post’ notice dated 15th August 1988 and the letter from NZI, earlier mentioned, dated 16th August 1908.  in the same further and better particulars, BSI stated that on 24th August 1988 it put Pistola on notice.  Counsel pointed out that 9 days elapsed from when BSI knew of the sale until it gave notice to Pistola.

16. Counsel for Pistola conceded that BSI’s pleading in the statement of claim that NZI had not duly appropriated the shares was arguable and certainly there was no ground on which NZI could have that pleading struck out.  It was also conceded that completion of the purchase of the shares occurred, if on the same day, after Pistola had notice of BSI’s objection to title.  However, it was submitted that it was equally clear that Pistola had well before such notice, entered into an unconditional agreement for the purchase of the shares and paid the deposit.

17. Pistola also recognised that there was an obvious difference between the purported appropriation price of HK$3.70 per share and the pleaded value in the statement of claim of HK$4.14 per share.  But it was submitted BSI’s pleaded value of the shares was very close to the price of HK$4.10 paid by Pistola.  Any issue relating to the lower price of HK$3.70, it was submitted, did not concern BSI and Pistola but was a matter for BSI to pursue, in any accounting it might seek from NZI, for the proceeds received as mortgagee on the sale of the secured shares.  Finally, it was pointed out that BSI did not either in the statement of claim or in correspondence or other factual evidence, allege that it had at any time offered to repay the debt under the loan agreement to NZI.

18. On these facts leading Counsel for Pistola made two principal but related submissions in support of striking out.  The first proposition was that even if NZI’s purported appropriation was invalid, the sale of the shares to Pistola was valid.  Secondly, it was submitted that Pistola was a purchaser for value, which had entered into the agreement for sale and purchase of the shares and paid the deposit, before it received notice of BSI’s objection to NZI’s title.

19. In support of the first proposition, that even if the appropriation was invalid the sale to Pistola was valid, I was referred to ‘Snell’s Principles of Equity’ (28th Edn.) 398 which on the validity of mortgagees sales states :

“And although a mortgagee cannot validly sell to himself, if he purports to do so and then resells to a purchaser, the latter sale will be treated as a valid exercise of the mortgagee’s power of sale.”

Snell cites Henderson v. Astwood (1894) AC 150 as authority for that statement and I was referred to the relevant passages of that Privy Council judgment.  There are factual similarities and differences between the facts in that case and the position before me but it was submitted for Pistola that the principle enunciated by the Privy Council is equally applicable to the present case.

20. In Henderson v. Astwood on the default of Astwood, the mortgagor, Davies the mortgagee exercised his power of sale over the mortgaged land, selling it to the highest bidder at public auction for what apparently was the full market value.  In fact the purchaser was the mortgagee’s son-in-law.  The mortgagee executed a conveyance of the land to his son-in-law but no money passed between them.  Later the son-in-law resold the land to a third party, Henderson.  In the conveyance to Henderson the parties solicitors elected to recite that the son-in-law had purchased as agent for the mortgagee who was now selling to Henderson in exercise the power of sale contained in the mortgage.

21. The undisputed fact before the Privy Council was that the mortgagee at public auction had purported to sell the property to himself.  The law is well settled that a mortgagee may not sell the mortgaged properly to himself either directly or through an agent.  On that ground the Privy Council held that the purported sale to the son-in-law as agent for the mortgagee was inoperative.  The Privy Council overturned findings of fraud against the mortgagee and also disagreed that Henderson’s solicitor had notice of actual fraud.  The Privy Council went on expressly to hold that the solicitor had no reason to suspect that the mortgagee had done anything dishonest, declaring that the solicitor had acted throughout with strict propriety.

22. The Privy Council held that the mortgagee’s power of sale had not been exhausted by his prior purported but inoperative exercise of the power.  The mortgagee later duly exercised the power of sale.  Henderson then purchased the property for value.  Henderson was the absolute owner.  The mortgagor’s right to redeem had been extinguished upon the mortgagee duly exercising his power of sale.  The mortgagor was left with the right to call upon the mortgagee to account for the proceeds of the sale.

23. Leading Counsel for Pistola recognised that Henderson v. Astwood was concerned with the exercise of a power of sale and not with the alternative exercise of powers of appropriation and sale.  However, it was submitted that what the Privy Council had in effect held was that while the purported sale by Davies as owner could not be upheld, the sale by Davies as mortgagee was valid.  Accordingly, it was submitted, assuming in favour of BSI that the appropriation was invalid, NZI’s co-existing power of sale remained unaffected and empowered NZI to sell the shares as mortgagee to Pistola.  Accordingly, Pistola as purchaser was in as good a position as Henderson.

24. Pistola’s second submission that it was a purchaser for value of the shares without notice of BSI’s objection to title was next developed.  The status of Pistola, it was submitted, was clearly that of a purchaser for value which created a proprietary or equitable interest in its favour.  This status, it was submitted, was to be contrasted with the position of BSI whose claim, founded on the alleged negotiations with NZI and the 2nd Defendant, did not create any equitable interest but only a mere equity.  On this analysis Pistola’s equitable interest prevailed over the mere equity of BSI.

25. If BSI’s claim was more than a more equity and amounted to an equitable interest, I was referred to Snell (supra) at page 44 et seq. and reminded that the basic rule that competing interests rank according to the time of their creation, is subject to a number of qualifications.  In particular, for present purposes, an important qualification is that a purchaser for value who at he time of purchase has no notice of a prior equitable right, is entitled to priority in equity as well as at law, over the person who had the prior equitable right.  The purchaser for value without notice takes title unaffected by the prior equitable right of which he did hot have noticed.  So even elevating the mere equity into an equitable right would hot assist BSI.

26. Leading Counsel for Pistola further submitted that if the competing equities had been equal Pistola’s title would still prevail, because of its subsequent acquisition of the legal estate in the shares.  This submission was based on the position that when Pistola entered into the agreement to purchase the shares on 12th August 1988 and paid the deposit on 16th August it did not have notice of BSI’s objection.  Notice of objection was only given on the morning of 24th August 1988 and completion of the purchase was effected later on that day.  On these facts the time of purchase was 12th August 1988.  On the priority it was submitted Pistola had achieved by getting in the legal estate Snell (supra) at page 48 was cited :

“(b) Subsequent acquisition of legal estate.  A purchaser without notice who at the time of purchase fails to obtain a legal estate or the better right to one will nevertheless prevail over a prior equity if without being a party to a breach of trust he subsequently gets in a legal estate, even if he then has notice of the equity.  Between himself and the owner of the prior equity the equities are equal, and there is no reason why the purchaser should be derived of the advantage he may obtain at law by superior activity or diligence.”

Where a purchaser does not get in the legal estate Snell goes on to observe that although he will not take free of prior equitable interests, he will take free of any “mere equities”.

27. I was referred to Bailey v. Barnes (1894) 1 Ch 25 as authority for the wide application of the principle, that where equities are equal, the legal title prevails.  Lindley L.J. in that judgment declared at page 37 :

“it was contended that this doctrine was confined to tacking mortgages.  But this is not so.  The doctrine applies in favour of all equitable owners or incumbrancers for value without notice of prior equitable interests, who get in the legal estate from persons who commit no breach of trust in parting with it to them.”

No question of breach of trust, it was submitted, arises.  For while a mortgagee owes a duty to the mortgagor in regard to the manner in which the sale is conducted, a mortgagee is not a trustee of the power of sale- Snell (supra) page 398.  Although the mortgagee is trustee of the proceeds of sale, he is not trustee of the power of sale.  On that ground, it was submitted, the principle enunciated by Lindley L.J. applies to the present facts.

28. The superior claim of Pistola over BSI is also supported, it was submitted, by the statement in Hong Kong’s Professor Tyler’s recent 10th Edition of ‘Fisher & Lightwood’s Law of Mortgage’ page 396 :

“The mortgagor’s claim to impeach a sale by the mortgagee being a more equity, it will be defeated by a purchaser for value of any interest, legal or equitable, without notice of the irregularity.”

It was pointed out that when on 15th August 1988, BSI became aware of the sale of the shares to Pistola, it could have applied for an injunction.  However, it did not do so.  In any event, citing Fisher & Lightwood (supra) at page 392 it was submitted that payment into Court of the debt due would probably have been required and at no stage has BST ever offered payment.  Generally on where the better equity lies, I was referred to Latee investments Ltd. v. Hotel Terrigal Pty. Ltd. (1964) 113 CLR 265 and in particular that portion of the judgment of Kitto J., which commences at page 276.

29. Counsel for BSI reminded the Court that it was important to consider the legal submissions advanced in relation to the reality of the factual position the Court was at this stage obliged to accept.  Counsel recognised that Clause 9(1) of the Share Charge empowered NZI either to sell or appropriate but submitted that it had clearly elected to appropriate.  No where on the documents had NZI asserted that it had elected to exercise its power of sale as mortgagee.  Under the subsequent agreement for the sale of the shares to Pistola, NZI had purported to sell those shares not as mortgagee but as owner.

30. In BSI’s submission the 12th August 1988 agreement while clearly between NZI as vendor owner and Pistola as purchaser, was also important for the express warranty made by NZI in Clause 6 of the agreement.  Clause 6, inter alia, declares that NZI had exercised its power as mortgagee to acquire title to the shares.  Accordingly, it was submitted, on 12th August 1988 Pistola entered into the agreement with the knowledge that NZI had previously exercised a power of appropriation under the loan agreement.  But Counsel conceded, that there was no evidence that Pistola then knew the particular provisions of the loan agreement, under which that power of acquisition was exercised.

31. Counsel for BSI submitted that it followed that Pistola, with such knowledge, could obtain no better title than NZI’s title.  It was submitted that in view of the assumptions in favour of BSI which the Court had to make at a striking out stage, NZI had no title to the shares.  This was on the assumption that the appropriation clause was invalid or alternatively if valid, NZI had failed to comply with the contractual appropriation machinery.  The alternative power of sale provisions were, it was submitted, irrelevant, because NZI had never purported to exercise those powers.

32. In BSI’s submissions the statement in Snell (supra) 398 that a resale by a mortgagee to a third party is valid, even where it follows an invalid sale by the mortgagee to himself, is wider than the judgment of the Privy Council in Henderson v. Astwood.  However, even if Snell does no more than state the principle enunciated by the Privy Council, it was submitted that the present facts were quite different.  Pistola’s submissions were attacked on the ground that they were based on the allegation that NZI had sold the shares in exercise of its mortgagee’s power of sale.  To the contrary, BSI submitted all the evidence was that NZI had first appropriated the shares to itself and then subsequently as purported absolute owner sold the shares to Pistola.

33. Henderson v. Astwood was not, in Counsel for BSI’s submission, authority for the proposition that an appropriation as mortgagee, followed by a sale as absolute owner to a third party could be deemed to be equivalent to the sale by a mortgagee in exercise of its power of sale to a third party.  In BSI’s submission, NZI purported to sell as absolute owner and not as mortgagee, nor pursuant to a power of sale in any mortgage.

34. Counsel for BSI then went on to deal with the equitable considerations which might be relevant if in fact NZI’s actions in transferring the shares to Pistola were found to amount to an exercise of its power of sale as mortgagee.  Counsel repeated that as early as 12th August 1988 when Pistola entered into the agreement to purchase the shares, it had actual knowledge by virtue of Clause 6 of the agreement that NZI had acquired the shares as mortgagee.  As to what occurred subsequently BSI did not concede at this striking out stage that the deposit had been paid.  It may well be that the deposit had been paid but that fact had to be either admitted or proven and the action had simply not yet advanced to that stage.

35. Similarly, while notice of the sale was given by letter to BSI on 16th August 1988 and a notice of objection was given much later on 24th August 1988, the Court could not infer that no steps had been taken by BSI in the interim.  Further, it was clear that on the very day Pistola received written notice of BSI’s objection it later that day completed the purchase from NZI even though it was not obliged under the agreement to complete until 7 days later, namely on 31st August 1988.  There were other matters of mixed fact and law, it was submitted, which could not properly be dealt with at this stage merely on the basis of Miss Cheung’s affirmation filed on behalf of Pistola.  Some of these matters might be suitable to be determined as a preliminary issue before trial but they were not appropriate for a striking out application.

36. In reply leading Counsel for Pistola submitted  that Clause 9(1) contained two alternative powers neither subordinate to the other.  The invalid exercise of one of those powers, did not extinguish the other which remained in full force and effect.  NZI had sold the shares to Pistola in exercise of its powers under the Share Charge.  Henderson v. Astwood, it was contended, was a complete answer to BSI’s submissions.  As to the facts BSI had filed no affidavit disputing Miss Cheung’s affirmation.  Finally, if NZI had exercised its power of sale as mortgagee, on the facts Pistola not only had the better equity but as against BSI had also got in the legal estate.

37. In considering the parties competing submissions, I remind myself that it is only in plain and obvious cases that a writ and statement of claim should summarily be struck out against a particular defendant.  The Court must be satisfied that BSI’s claim against Pistola is obviously unsustainable; there must clearly be no reasonable cause of action.  The mere fact that a case is weak and not likely to succeed is no ground for striking out.  The Court’s discretion under Order 18 Rule 19 is to be exercised in accordance with these and other well settled principles.

38. On the submissions two matters have caused me to give Pistola’s summons further consideration.  The first concerns the action taken by NZI upon BSI defaulting under the loan agreement.  At that stage NZI clearly was entitled to exercise its powers under Clause 9(1) of the Share Charge.  If NZI had elected to exercise its power of disposition but had done so invalidly, that would not have extinguished that power and, as mortgagee, it could have later validly exercised that same power to sell the shares to Pistola.  If that had occurred, the facts would have fallen squarely within Henderson v. Astwood and I would have upheld Pistola’s submission that the same principle applied to its purchase of the shares.  In that event its title would have been unimpeachable.

39. The more difficult question is whether NZI’s election to exercise its alternative power of appropriation - which for the purposes of this striking out application I assume was exercised invalidly - also falls within the Henderson v. Astwood principle.  The legal position is more complicated because when NZI came to sell to Pistola it did not, as a matter of fact, purport to do so pursuant to its power of sale under Clause 9(1) but instead as owner of the shares consequent upon the prior appropriation.

40. Parenthetically I would observe that both Counsel agreed that the inclusion of NZI’s warranty in Clause 6 of the subsequent agreement for sale and purchase was put in simply to protect Pistola.  The provisions of Clause 6 do not establish that NZI was selling as mortgagee in exercise of its power of sale rather than vendor as absolute owner.  The appropriation price of $3.70 compared with the later sale price of $4.10 also tends to support the proposition that the transfer to Pistola was not effected by NZI in exercise of its mortgagee’s power of sale.

41. In any event it is at least arguable that NZI never purported at the material time to exercise its mortgagee’s power of sale.  If following the appropriation, NZI had then expressly purported to sell the shares to Pistola in exercise of its Clause 9(l) power of disposition or sale as mortgagee, Pistola may well have been in a powerful position to argue that the fasts fell within the Henderson v. Astwood principle.  The factual reality prima facie is to the contrary.  I am satisfied that it is at least arguable that NZI has never exercised its primary power of disposition or sale under Clause 9(1).  For these reasons I reject Pistola’s submissions on this first ground.

42. The second matter which raises difficulties is whether Pistola was a purchaser for value without notice.  This in turns raises a number of equitable principles including equitable interests contrasted with mere equities, the question of priority between competing equities and the consequences of a party having an equitable interest moving to get in the legal estate.  I accept that many of these equitable principles appear to assist Pistola.  Certainly if Pistola when it agreed to purchase the shares, was without notice of BSI’s objection to NZI’s title, the law is clear that it was later entitled to secure its position by getting in the legal estate even if by that time it did have notice of BSI’s objection.

43. The question of priority and the subsequent getting in of the legal estate, all arise on the assumption, that at the date of purchase Pistola did not have notice of BSI’s position.  In my view the only substantial attack BSI was able to mount on Pistola’s equitable arguments, relates to the position at the date of purchase.  As to that position, the provisions of Clause 6 of the agreement for the sale of the shares date 12th August 1988, become a two-edged sword.  As a matter of contract, the inclusion of Clause 6 was unnecessary.  However, in the circumstances it was obviously to the advantage of Pistola to obtain that warranty as to title from NZI as vendor.

44. However, for the purposes of this striking out summons, Clause 6 does provide evidence that at the crucial time when Pistola entered into the agreement to purchase the shares, it had actual notice that NZI had acquired the shares in exercise of its power as mortgagee.  Clause 6 does not go beyond that and at trial it may well be that the provisions in Clause 6 would become immaterial.  But at this stage it is not sufficient for Pistola to show that BSI’s case against it is weak it must, of course, establish that it is unsustainable.  I am not satisfied on this second largely equitable ground, that BSI’s position is obviously unsustainable.

45. In view of my conclusions on NZI’s exercise of its Clause 9(1) powers and on the notice Pistola possessed on the date it purchased the shares, I hold that this is not a proper case for striking out the action against Pistola.  So far as the summons is concerned, Paragraph (1) seeking a striking out order is dismissed.  Under Paragraph (2) the time for Pistola filing a Defence is extended to 14 days after the date of the delivery of this judgment.

46. There will also be an order nisi pursuant to Order 42 Rule 5B(6) RSC that Pistola pay BSI’s costs of and occasioned by this summons to be taxed if not agreed; the order to become absolute if application to the contrary is not made within 14 days.  Liberty to apply on any other consequential matters is reserved.

Representation: