NAMYANG COMMERCIAL BANK LTD. v. CHAN HON WING t/a KAM WING (HONG KONG) TRADING CO. AND OTHERS

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

MISCELLANEOUS PROCEEDINGS NO. 103 OF 1989

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D E C I S I O N

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1. The appellant bank granted general banking facilities to the 1st defendant on the security of two flats and a carpark space. One of the flats belongs to the 2nd defendant and the other together with the parking space to the 3rd and the 4th defendants. The provision of security was procured by two mortgages dated 14th September 1987 and the 24th June 1988 respectively.

2. The first above-mentioned flat is believed to be tenanted. The other flat is being occupied by the 1st defendant.

3. The 4th defendant is also the guarantor under two separate guarantees dated the 1st September 1987 and the 15th April 1987 for the same general banking facilities, granted by the bank.

4. The bank demanded payment on the 8th December 1988. Default has been made by each of the defendants, and the bank applied for interlocutory judgment against all.

5. The application was heard by the Master and a determination was made. The bank feels aggreived by the Master's decision on a point of law, giving rise to various requirements made of the bank in his Order. From that substantive determination of law, the bank now appeals.

6. Before the Master, only the 1st and 3rd defendants were in attendance. They acted in person. The other defendants were absent. In the appeal before me today, none of the respondents/defendants makes an appearance and they are all unrepresented.

7. The appeal may be said to go by default. I have had, as usual, the closely reasoned submissions of Mr Chan who is assisted by his learned Junior, Mr Wong. Counsel's contention is formidable but nevertheless unopposed. I am wholly persuaded that counsel must succeed in the instant appeal. But this judgment shall have to be read with the rider that matters have not been effectively well-tested as they should be in an adversarial setting.

8. The position seems tolerably clear that at common law a debtor has a right of election in appropriating the payment he makes to the creditor either as repayment in satisfaction of the principal or interest. In the absence of his election, the general unspecified payment may be applied by the creditor "in the first place to sink the interest, before any part of the principle is discharged.". See p 567 Fisher and Lightwood's Law on Mortgage, 10th edn.; Chase and Box, (1702) 2 Freeman Ch. 261; [1702] 43 E.R. 1197. In Florence Deeley v. Lloyds Bank Limited, [1912] A.C. 756, at p.783 Lord Shaw of Dunfermline had this to say :

"According to the law of England, the person paying the money has the primary right to say to what account it shall be appropriated; the creditor, if the debtor makes no appropriation, has the right to appropriate; and if neither of them exercises the right, then one can look on the matter as a matter of account and see how the creditor has dealt with payment, in order to ascertain how he did in fact appropriate it."

9. That is in totality the common law principle in the context of a creditor/debtor relationship.

10. Both deeds of mortgage were in substantially the same terms. There was no provision for appropriation by the bank mortgagee as creditor. Clause 4 referred to Part III or II of the First Schedule to the deeds. Together they regulated the rate of interest and the manner in which the same was to be exacted. The common law right of election as to appropriation of payments towards either principle or interest by the mortgagor as debtor was modified by Clause 8(d) whereby in each case the mortgagor or mortgagors expressly waived the right of election in appropriation. The bank's common law right of appropriation as mortgagee/creditor was, however, wholly undisturbed.

11. Turning to Clause 1 of each of the deeds of mortgage, interest may be charged on accrued interest taken in by the outstanding unpaid balance at periodical rests. Hence, whether or not the bank mortgagee/creditor had appropriated the payment, it should not alter the extent of ultimate liability under the general banking facilities. In effect, the principal debtor, 1st defendant or the mortgagor or mortgagors would invariably be paying interest on interest.

12. Default having been made under both deeds of mortgage, the bank demanded repayment. After the demand, a sum of $150,000 was paid by the debtors to the bank which appropriated $42,109.81 thereof "to sink the interest". When the Order 88 application came before the Master, he regarded himself as being guided by a recent decision in the English Court of Appeal, The National Bank of Greece SA v Pinios Shipping Co. No. 1 and Another, The Maira, [1989] 1 A.E.R. 213. I was given to understand by Mr Chan that the Master held that the relationship of banker/customer had come to an end upon the service of the notice of demand on the 8th December 1988. And it was decided that the deeds of mortgage together with their Clause 1 would fall with the terminated relationship, thus taking away the bank's contractual right to charge interest on interest. Unimpressed by the common law principle of application, the Master frawned at the application of any part of the $150,000 in satisfation of interest, in effect leaving an equivalent unpaid amount in the principal to continue to attract interest. It was found objectionable for the bank to gain an unfair advantage over charging more interest. The Master was of the opinion that equity should favour the debtor.

13. If Clause 1 of the deeds of mortgage survived the notice of demand on the 8th December, this continuing contractual provision for charging interest on interest would remove any suggestion of hardship. After all, the defendants signed and became parties to these deeds with open eyes and at arm's length, and they had not resisted the bank's appropriation of part of the $150,000 towards interest. Even if this contractual provision had otherwise been put an end to, the common law doctrine of appropriation between creditor and debtor was never abrogated. The defendants had not themselves exercised their common law right of election in appropriation. As a creditor the bank was, in the circumstances, perfectly entitled to appropriate, as it did, part of $150,000 paid after demand "to sink the interest". There was no warrant, therefore, for the Master to interfere with the bank's exercise of its common law right of appropriation.

14. The Malira is a decision not directly relevant to the point at issue. Matters peripheral to the decision as accepted by the English Court of Appeal in The Maira lend support to the contention of Mr Chan, today. In Maira, the banking documents, including a mortgage enabled a Greek bank to charge simple interest. On the force of a contended custom in banking practice, compound interest had been charged. The Greek bank demanded repayment and sought to continue to charge compound interest after demand. The customers did not object to compound interest previously levied but took exception to further charging of compound interest after then, account had been closed as a result of the demand. What was, in substance, decided is that after the demand, the relationship of banker and customer ceased and the Greek bank's right to charge compound interest based on the alleged custom must in any case have also come to an end. Hence, the Greek bank in The Maira was held not to be entitled to chary compound interest. But what is so instructive for the purposes of the instant appeal is that the English Court of Appeal acknowledged that upon cessation, the relationship of banker and customer was replaced by one of mortgagor and mortgagee. In another words, it was replaced by a new relationship of creditor and debtor. As mortgagee, the Greek bank was also said to be entitled to continue to charge simple interest. See The Maira, supra. p 228 Letter f/g p 230 Letters a to f, p.234 Letters b to d and p.235 Letter b/c.

15. The Maira confirms two crucial aspects in Mr Chan's contention, namely, first, after demand, the mortgage provisions for charging interest would continue to be effective. With such a contractual right to charge interest on interest, equity had no role to play. Secondly, even without any mortgage provision, the relationship of bank and customer would nevertheless be superceded by one of creditor and debtor, to which the common law right of appropiation applies. The bank had the right to appropriate part of the $150,000 in satisfaction of interest. In the circumstances, the basis for the Master's substantive determination would seem to be insupportable and his consequential orders for, inter alia, a supplemental affidavit cannot stand.

16. In this case, it was open to the bank to charge interest on interest and to appropriate $42,109.81 in satisfaction of interest.

17. Counsel has very kindly submitted a draft order which I indorse. It remains for me to order that :

(1)    Appeal allowed;

(2)    Order in terms of paragraphs 1 - 6 of the draft;

(3) Insofar as the Order made in the instant appeal conflicts with any part of the Master's Order, the same be accordingly varied and set aside and insofar as the Order made in the instant appeal falls in line with that part of the Order made by the Master, the same be affirmed;

(4) Costs of the action be costs to the plaintiff, such costs to be taxed on a full indemnity basis.

18. Mr Chan refers me to Clause 1(b) in both deeds of mortgage whereby costs and expenses incurred by the bank in relation to its claim are to be paid on a full indemnity basis. There does not seem to be any justification for interfering with this contractual provision between the bank and any of these defendants. But the instant appeal may not be put on the same footing. The point raised by the Master is not one which any of the defendants actively supported.

19. Mr Chan has been fair enough not to press for a full indemnity order of costs before me. Left with unimpaired discretion, I think the appellant bank should not receive more than the usual costs on appeal. Hence, lastly :

(5) Costs of the appeal be costs to the bank against the defendants. I would certify the proceedings fit for two Counsel.