KOWLOON DEVELOPMENT FINANCE LTD v. PENDEX INDUSTRIES LTD AND OTHERS

Press Summary (English)

Press Summary (Chinese)

FACV No. 21 of 2012

IN THE COURT OF FINAL APPEAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

FINAL APPEAL NO. 21 OF 2012 (CIVIL)

(ON APPEAL FROM CACV NO. 156 OF 2011)

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J U D G M E N T

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Mr Justice Chan PJ:

1.  I agree with the judgment of Lord Hoffmann NPJ.

Mr Justice Ribeiro PJ:

2.  I agree with the judgment of Lord Hoffmann NPJ.

Mr Justice Bokhary NPJ:

 3.  I agree with the judgment of Lord Hoffmann NPJ. 

Mr Justice Hartmann NPJ:

4.  I agree with the judgment of Lord Hoffmann NPJ.

Lord Hoffmann NPJ:

5.  This appeal arises out of two rather clumsily drafted consent orders which have resulted in a straightforward claim for money lent turning into a litigation saga which has lasted ten years.  The answer to the point raised in this appeal is in my opinion tolerably clear and we did not find it necessary to call upon Mr Anthony Houghton SC on behalf of the respondent.  But the argument of Mr Daniel Fung, SC for the appellants, suggested that there are certain aspects of the law on rectification which could usefully be clarified.

6.  Kowloon Development Finance Limited (“KDFL”) is a licensed moneylender.  Between 1997 and 2002 it advanced some $20 million to Pendex Industries Limited (“Pendex”) on the terms of facility letters which were from time to time revised and renewed.  The loans were secured by the personal guarantees of the directors, Chan Wah Sun (“Mr Chan”) and Yu Kah Yee, who were husband and wife, and by a mortgage on a property at Shatin.  Repayment was to be by monthly instalments in amounts which KDFL, after consultation with Pendex, would fix from year to year.

7.  In 2003 Pendex experienced financial difficulties and fell behind with its payments.  It tried to negotiate a rescheduling of the debt repayments but its initial proposals were not acceptable to KDFL, which issued an originating summons claiming payment of the outstanding capital and interest.  Further negotiations resulted in an agreement as to discharge of the arrears and the amounts of the monthly sums which would be payable in 2004.  The agreement was embodied in a Tomlin order made by consent by Master Lung on 8 January 2004.  The relevant provisions are as follows:

“1. All the Defendants do pay the Plaintiff the sums of money upon signing this summons as follows:-

(i) HK$340,000.00 being part of the outstanding loan and interests accurred [sic];

(ii) HK$28,000.00 being the agreed legal costs and disbursements incurred by the Plaintiff …

(iii) HK$ 9,600.00 being the outstanding insurance premium of the Property.

2. All the Defendants do pay the Plaintiff 12 monthly mortgage instalments commencing on 21^st January 2004 by 24 post dated cheques and presented the same to the Plaintiff upon signing of this summons as follows:-

[There followed a table of sums for which the cheques were to be payable.  For the first six months the monthly payments were to be HK$170,000 and for the second six months $190,000, making a total of $2,160,000 during the year.]

3. All the Defendants do pay the Plaintiff interests on the outstanding loan in the sum of HK$21,591,264.12 at the rate of 10 per cent per annum from the date of arrears up to 18^th December 2003 and at the rate of 8 percent per annum thereafter;

…

6.      This arrangement will be commenced from the date of this Summons till 21^st December 2004.  If all the Defendants do pay the plaintiff the total sum of HK$2,537,600.00 [being the sum total of the amounts payable by the end of 2004] during the aforesaid period, the Plaintiff will review the amount of repayment of Mortgage instalments annually thereafter;”

8.  Paragraph 6 makes it clear that although the claim was for the full amount of HK$21,591,264.12 outstanding at the date of issue of the originating summons, and although Master Lung’s order provided that “all further proceedings herein be stayed except for the purpose of carrying this Order … into effect …”, the agreement in the Schedule was in the nature of a truce rather than a general treaty of peace.  The truce would expire at the end of 2004.  If the defendants complied with the terms, KDFL would revert to annual reviews of the instalments repayable.  If they did not, clause 6 implied that hostilities could recommence.  Whether this would take the form of an application to lift the stay or the commencement of a fresh action was not spelled out.  During the negotiations, KDFL’s solicitor proposed the insertion of a clause which read:

“7. If all the Defendants do not comply with any term of the aforesaid arrangements during any time of the aforesaid period, the Plaintiff shall be at liberty to restore this action and all the legal costs and disbursements arising therefrom shall be borne by the Defendant on an indemnity basis.”

9.  The defendants’ solicitors objected to this clause.  It is not clear what exactly they objected to.  Perhaps it was the prospect that a single dishonoured cheque would be fatal, even if they could find the money.  Perhaps it was the costs.  At any rate, KDFL’s solicitor advised his client that it would do them no harm to remove it and it was deleted.  The solicitor appears to have advised KDFL that they could always start a fresh action.  I think that this was sound advice.  Clause 6 clearly showed that compliance with the 2004 terms was not to discharge the post-2004 indebtedness.  In the event, the defendants complied with the 2004 terms and no difficulties arose.

10.  Further negotiations took place after October 2004 to agree the monthly amounts to be repaid in 2005.  What the parties said to each other during these negotiations was a matter in dispute at the trial of this action and I shall return to it later.  For the moment it is sufficient to say that they bore fruit in the shape of another Tomlin order dated 20 January 2005 in the same action which KDFL had commenced in 2003.  This time the order was made by Master S Kwang.  The operative part read as follows:

“1. The Defendants do pay to the Plaintiff HK$9,600.00 being the Fire Insurance Premium of the property …

2. The Defendants do pay the Plaintiff HK$325,000.00 in 12 equal monthly instalments, by way of 12 post-dated cheques commencing from 21 January 2005;

3. Notwithstanding the order of Master Lung dated 8^th January 2004, all further proceedings in this action be stayed, save that the Plaintiff be at liberty to apply for the purposes of carrying into effect of this Order; and

4. The Defendants do pay the Plaintiff HK$8,000.00 as the costs of this application.”

11.  Despite the rather awkward language of clause 1, it appears to have been accepted that HK$325,000 was the sum payable each month and not the total for the year.  The former was a considerable increase over the $190,000 payable in each of the last six months of 2004, but the latter would have been an improbably large reduction compared with the total of $2,160,000 which had been payable and paid in the previous year.  I shall come back later to the reason why the instalments had been increased.  The defendants provided post-dated cheques in the sum of $325,000 each but the February and later cheques were dishonoured.  In September 2005, KDFL decided to recommence proceedings.

12.  On 13 September 2005 KDFL issued a summons in the 2003 action, seeking an amendment of Master Kwang’s order by substituting something along the lines of the deleted para 7 from the draft of the 2004 order, or alternatively giving KDFL liberty to execute for the unpaid balance of the 2005 instalments, or alternatively setting aside the order for mistake or irregularity.  None of these applications was very promising.  It was hard to see how the Master could simply amend the consent order.  Rectifying it or setting it aside would be a matter for a fresh action rather than a summons in the existing one.  On 12 December 2005 the summons came before Master de Souza and he gave it short shrift.

13.  On 31 December 2005 KDFL sent the defendants a letter before action, demanding repayment of the full capital and interest outstanding.  On 12 January 2006 Pendex wrote back expressing surprise.  They said that in their view, the effect of Master S Kwang’s order was that payment of the 2005 instalments discharged the whole debt and they asked for the mortgage to be released.

14.  Pausing at that point, it seems to me that KDFL could simply have commenced an action for the whole outstanding debt.  The court would then have had to decide whether, as a matter of construction, Master S Kwang’s order had the effect claimed by the defendants.  I think it is very improbable that a court would have concluded that a reasonable observer, reading the order against the background known to the parties and in particular the scheme of repayment under the facility letters and the 2004 order, would have come to such a conclusion.  The 2005 order says nothing about the discharge of any debt.  It would, I think, have been construed as simply carrying forward the 2004 truce into 2005, substituting the new instalment amounts and, as in the case of the 2004 order, leaving the rest of the indebtedness to be paid off in accordance with subsequent annual reviews.

15.  On 12 April 2006, KDFL commenced new proceedings claiming to have the order of Master S Kwang set aside on the ground of mistake and payment of the sum of $19,394,898.73, said to have been outstanding as at 20 March 2006, with interest thereafter.  The statement of claim was afterwards amended and re-amended to include a claim for rectification of the order, substantially to make it clear that the remaining debt had not been discharged.

16.  At the trial before Deputy High Court Judge Simon Mayo, which lasted 6 days, KDFL advanced four alternative cases.  First, that as a matter of construction, the two Tomlin orders had not discharged the outstanding debt.  Secondly, that one should imply a term into the orders to the effect that they did not discharge the outstanding debt.  Thirdly, that the orders should be rectified to make it clear that they did not discharge the outstanding debt.  Fourthly, that the 2005 order should be set aside on the ground of mistake and the plaintiff allowed to enforce the agreement as contemplated in the 2004 order.

17.  I have already indicated that in my opinion the first argument should have succeeded.  But the judge said (at para 175 of his written judgment) that “the interests of justice will be better served” if he left this point open and decided the rectification case instead.  He did not enlarge upon his reason, but I think he probably meant that the rectification case gave him the opportunity to express views on the merits and the credibility of the witnesses which would not have been relevant if he decided the case simply as a question of construction.  In the particular circumstances of the case, in which the judge had heard all the evidence on rectification and was in a position to make findings of fact, that was a reasonable decision.  He also did not deal with the implied term argument, which was really the construction argument dressed up in different clothes.

18.  The third argument was that the 2004 and 2005 orders ought to be rectified on the grounds of mutual, or alternatively unilateral mistake.  As we have seen, the 2004 order did not require any rectification.  Clause 6 was inconsistent with a discharge of the post-2004 indebtedness.  It was the 2005 order upon which the defendants relied and which KFDL needed to rectify. 

19.  I will come in a moment to the judge’s findings of fact, but first I should say something about the legal requirements of mutual and unilateral mistake in an action for rectification.  They sound like two varieties of mistake about the same thing, made in the one case by both parties and in the other by only one of them.  But they are actually the expression of quite different principles.  They deal with different kinds of mistakes.  In the case of mutual or common mistake – the adjectives are in this context interchangeable – the mistake is about whether a written document correctly reflects what the parties had, on an objective assessment, agreed it should contain.  As Denning LJ said in the well known case of Frederick E Rose (London) Ld v William H Pim Jnr & Co. Ld [1953] 2 QB 450, 461: “Rectification [for mutual mistake] is concerned with contracts and documents, not with intentions”.  In Lovell & Christmas Ltd v Wall (1911) 104 LT 85, 88 Cozens-Hardy MR described rectification for common mistake as “a branch of the doctrine of specific performance”.  By this he meant that if parties have agreed to execute a document in certain terms and by mistake it contains different terms, the court can specifically perform the prior agreement by rectifying the document.  There was accordingly at one time a view that the remedy of rectification was available only if the prior agreement was itself actionable (like an agreement to grant a lease) and not, for example, an agreement subject to contract.  But this was disavowed by the Court of Appeal in Joscelyne v Nissen and Another [1970] 2 QB 86.  Nevertheless, it is true to say that the concept of rectification for common mistake involves carrying into effect what the parties appear to have actually agreed that the document should say.  And in deciding what the parties have agreed, the common law adopts its usual objective stance, looking at what a reasonable observer would have understood the parties to mean and not concerning itself with their uncommunicated states of mind: Chartbrook Ltd and Another v Persimmon Homes Ltd and Another [2009] AC 1101.

20.  Rectification for unilateral mistake, on the other hand, is very much concerned with the subjective states of mind of the parties.  If the contract contains a provision which one party knows that the other party thinks is not there, or knows that the other party is mistaken about its meaning, the court may, as a matter of discretion, either refuse to allow him to enforce the contract as it would ordinarily be construed (Hartog v Colin and Shields [1939] 3 All ER 566) or go further and rectify the written agreement to give effect to what the mistaken party thought had been agreed (A Roberts & Co. Ltd and Another v Leicestershire County Council [1961] Ch 555).  A civilian system of law would deal with such a case as a breach of the principle of good faith in contractual negotiations.  To claim to enforce a contract in terms to which you know the other party never meant to agree is a breach of good faith.  The common law has no such general doctrine of good faith in negotiation but a number of individual rules which provide remedies against specific forms of bad faith.  Rectification for unilateral mistake is one of these: compare Bingham LJ in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433.

21.  The difference between the two grounds for rectification may be illustrated by the facts of Rose v Pim.  The plaintiff was a London merchant who placed a written order for Moroccan horsebeans in the belief that his Egyptian buyer would accept them under the description “feveroles”.  He had discussed this with the seller, another London merchant who was of the same opinion.  But the parties were mistaken.  In Egypt, horsebeans and feveroles are different.  The Court of Appeal refused to rectify the order by substituting “feveroles” for “horsebeans” because the document did not differ from what, to all outward appearances, the parties had agreed.  They had agreed on a sale of horsebeans and the order document said “horsebeans”.  On the other hand, if the seller knew that the buyer mistakenly thought that it was a term of the contract that horsebeans could be sold as feveroles, a court might have thought he had contracted in bad faith and that the order should be rectified on the ground of unilateral mistake.

22.  Some commentators have expressed surprise that a party might find that, as a result of rectification on grounds of mutual mistake, he is bound by a contract which is not only different from the terms of the final document but is one which, subjectively, he never intended to agree to.  That is what happened in the Chartbrook case.  But Chartbrook was by no means the first time that this had happened: see, for example, George Cohen Sons & Co. Ltd v Docks and Inland Waterways Executive (1950) 84 Ll L Rep 97.  Objective interpretation of contractual agreements is a fundamental principle of the common law.  In Daventry District Council v Daventry & District Housing Limited [2012] 1 WLR 1333, Toulson LJ (as he then was) expressed some sympathy with these academic comments on Chartbrook.  However, he also quoted the well known passage from the judgment of Blackburn Jin Smith v Hughes (1871) LR 6 QB 597, 607, which is the classic statement of the principle of objective interpretation:

“If, whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into the contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.”

23.  Thus in cases in which there is no intention to embody the agreement in some formal document, a party may well find himself bound by terms which, subjectively, he did not intend to agree to.  Why should it be different because the parties have agreed to record those terms in a written instrument?  The function of the court is to make the document accord with what the parties objectively agreed.  It is not necessary for this purpose to show that in resisting rectification the other party is acting in bad faith.  He may have been entirely in good faith in thinking that the written document reflects what was agreed, but that makes no difference.  Importing notions of good faith into rectification for mutual mistake does not recognise that the important difference between mutual and unilateral mistake lies in what the mistake must be about.  In mutual mistake, the mistake is about whether the document correctly reflects the terms previously agreed.  In unilateral mistake, it is about the mistaken belief of one of the parties, known to the other, about what the contract said or meant.

24.  Before leaving this discussion of general principles, I should emphasise that in claims for rectification of contracts for mutual mistake, it is necessary for the court to be confident that the formal document does not reflect what was previously agreed.  As Denning LJ said in Rose v Pim, 461, “if you can predicate with certainty what their contract was, and that it is, by common mistake, wrongly expressed in the document, then you rectify the document; but nothing less will suffice”.  It is common for commercial agreements to be preceded by heads of agreement, term sheets or the like, followed by further negotiations to arrive at a final expression of the contractual obligations of the parties.  As Hobhouse LJ explained in Britoil plc v Hunt Overseas Oil Inc & Ors [1994] CLC 561, you do not construe the earlier heads of agreement as if they were a contract and simply compare them with the final document.  If there is room for ambiguity in the heads of agreement or if they might have been varied in the course of subsequent negotiations, a claim for rectification must fail.  The heads of agreement are only part of the material upon which the court must decide whether it can “predicate with certainty” what an objective observer would have thought that the parties had agreed and continued to agree to record in the final document.

25.  I come now to the evidence and the judge’s findings of fact.  The witnesses for KDFL were Monica Wai (“Ms Wai”) and Cindy Yu (“Ms Yu”).  Ms Yu reported to Ms Wai, whom she described in evidence as “the decision maker”, but the actual negotiations which led to the two consent orders were conducted by Ms Yu for KDFL and Mr Chan for Pendex.  Ms Yu reported these to Ms Wai, who gave KDFL’s consent to the Tomlin orders, but she had no independent knowledge of the negotiations.  The judge accepted Ms Yu as an honest and careful witness.  Her evidence was supported by notes she had made at the time.  The object of the discussions was to agree upon an amount for instalment payments which would enable the entire advances to be repaid within a time acceptable to KDFL.  Thus the discussions which preceded the 2005 order began with Ms Yu telephoning Mr Chan and saying that the monthly payments would have to be substantially increased if the advances were to be repaid within a reasonable time.  Mr Chan offered $210,000 a month for the first 6 months of 2005 and $230,000 for the second.  After obtaining a valuation of the mortgaged property, Ms Yu calculated that if repayments were made at the rate offered by Mr Chan, it would take nearly 8 years for the debt to be reduced even to the value of the mortgaged property.  She reported this to Ms Wai, who said it was unacceptable and that the instalments should be in an amount sufficient to repay the debt within 5 years.  That worked out at $325,000 a month.

26.  Ms Yu reported these calculations to Mr Chan, who said he had no option but to agree. Ms Yu’s evidence was that there was never any question of the entire debt being discharged by the payments in 2005.  This would have been quite inconsistent with the basis upon which the amount of the instalments had been calculated.  Mr Chan, she said, knew this perfectly well.

27.  Ms Wai also gave evidence to confirm those parts of Ms Yu’s evidence which were within her own knowledge.

28.  Mr Chan gave evidence for Pendex.  He said it had been agreed that if he made the payments for 2004 and 2005, no further payments would be required and the action would be discontinued.  The judge did not regard Mr Chan as an honest witness and rejected his evidence.  He found that Mr Chan at all times knew that KDFL had no intention of releasing the rest of the indebtedness.

29.  The judge started his discussion by saying “it seems likely that it was a common mistake”.  In my opinion there was ample evidence for this conclusion.  First, on the evidence of Ms Yu, which the judge accepted, an objective assessment of what the parties had agreed did not include any term that the post-2005 debt was to be released.  Secondly, the parties appeared to have agreed that the result of their agreement should be embodied in the Tomlin order.  Therefore, so far as the Tomlin order could be construed as implying such a release, it did so by mistake.

30.  The judge went on to consider unilateral mistake.  Having regard to the opinion he had formed of Mr Chan, that was how he preferred to decide the case.  He said Mr Chan always knew that it was never the intention of KDFL to release its debt and that it was misconduct (“sharp practice”) on his part to use the form of the Tomlin order (assuming it admitted of such a construction) to support a claim that they had done so.  Again, I think there was ample evidence for this conclusion.

31.  The Court of Appeal (Tang VP, Yuen JA and Lam J) upheld the judge’s decision on the ground of common mistake.  They had some doubts about the finding of unilateral mistake.  I entirely agree with the reasoning and conclusions of the Court of Appeal on the question of common mistake.  But in my opinion, however, the evidence before the judge was also sufficient to justify rectification on the ground of unilateral mistake.

32.  Mr Daniel Fung’s main submission before this Court was that common and unilateral mistake were mutually inconsistent.  KDFL was obliged to elect which one it wanted to rely upon.  In making this submission, I think that Mr Fung was inclined to assume that the difference was simply that in one case the mistaken belief was shared by both parties and in the other it was held by only one.  Obviously, if you assert that the mistake was common to both parties, it is inconsistent to say that it was only on the part of one of them.  It would not be unreasonable to say that you should make up your mind whether your case is the one or the other.  But the reason why I have taken some time to explain the difference between common and unilateral mistake is because this is an oversimplified statement of the difference between them.  The difference does not lie only in whether one or both parties held a mistaken belief but also in what the mistake must be about.  Accordingly, there is no inconsistency in asserting that the parties had made an agreement including a term which the document has mistakenly left out, but if no such objective agreement can be proved, the one party knew both that the term had been omitted and that the other party thought it had been included.  This is what happened in George Wimpey UK Limited v Vic Construction Limited [2005] BLR 135, in which a claim for rectification for common mistake was abandoned at the opening of the case but the claimant tried instead (unsuccessfully, in the end) to prove that he had made a mistake of which the defendant knew.

33.  Mr Fung said that in that case the claimant made his election in opening to rely on unilateral mistake.  But I see no reason why a party should not run both cases and submit to the judge that if he finds that the facts do not justify rectification for common mistake, he should consider whether they support a case of unilateral mistake.

34.  I would therefore dismiss the appeal.

Mr Justice Chan PJ:

35.  The Court unanimously dismisses the appeal with costs.