ELTRON DEVELOPMENT LTD v. DIRECTOR OF LANDS

LDLR 4/2013

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

LANDS RESUMPTION APPLICATION NO 4 OF 2013

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DECISION
(APPLICATION FOR LEAVE TO APPEAL)

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Background

1.  This case arises from an application (“the Application”) by the applicant for determination of compensation pursuant to section 10(2)(a) of the Lands Resumption Ordinance, Cap 124 (“the Ordinance”). The Application relates to two subdivided shop units (collectively referred to as “the Property”) on the ground floor of Chung Nam House at Mut Wah Street in Kwun Tong, Kowloon.

2.  The Application was opposed and the matter went on trial by this Tribunal with judgment handed down on 21August 2015ordering that:

(1)  the respondent do pay the applicant compensation for the Property in the sum of $35,000,000; and

(2)  the matters of professional fees, interest and costs shall be adjourned to a date to be fixed, with liberty to apply for any other ancillary and consequential matters.

3.  Thereafter, having considered written submissions filed by the parties, the Tribunal handed down a further judgment on 28 January 2016 (“the Further Judgment”) ordering that, in respect of the issue of interest (“the Issue”), interest at Prime + 1% be adopted, with the following consequential orders:

(1)  That the respondent shall pay the applicant interest on the sum of HK$20,764,000 (being the provisional payment made under section 16A of the Ordinance) from the date of reversion (ie 2 June 2012) to the date of payment, at the rate of 1% above HSBC’s prevailing prime rate (ie 6% per annum);

(2)  That the respondent shall pay the applicant interest on the sum of HK$14,236,000 (being the balance of the statutory compensation under the Ordinance) from the date of reversion (ie 2 June 2012) to the date of the Judgment at the rate of 1% above HSBC’s prevailing prime rate (ie 6% per annum) and thereafter at judgment rate until payment;

(3)  That credit be given to the payment of interests previously paid to the applicant (if any).

4.  On 24 February 2016, the respondent took out an inter partes Summons for leave to appeal against the Further Judgment in respect of the Issue. In support, the respondent has prepared a draft Notice of Appeal setting out in detail the proposed grounds of appeal and the questions of law arising insofar as the Issue is concerned.

Proposed Grounds of Appeal

5.  Section 11(2) of the Lands Tribunal Ordinance provides that:

“Subject to section 11AA and the provisions of any Ordinance relating to appeals from the Tribunal, any party to proceedings before the Tribunal may appeal to the Court of Appeal against a judgment, order or decision of the Tribunal on the ground that such judgment, order or decision is erroneous in point of law.”

6.  The grounds of appeal raised by the respondent are that the Tribunal erred in law and in the exercise of its discretion in the determination of interest rate pursuant to section 17(3A) of the Ordinance, the Tribunal:

(1)  failed to take into account alternative approach in the determination of rate of interest; and/or

(2)  failed to take into account relevant evidence including the rental income of the Property at the time of resumption.

7.  In Happy Dragon Restaurant Limited v Director of Lands [2014] 3 HKC 538 (“Happy Dragon 2014”), the Tribunal stated:

“37. The Prime + 1% practice (in the absence of evidence to show that this rate is too high or too low) represents a “broad brush” approach to determine what rate of interest is just and appropriate: it would be neither practical nor proportionate (even in a case involving large sums) to attempt a minute assessment of what will precisely compensate the recipient. In particular, the courts do not need to have regard to the rate at which a particular recipient of compensation might have borrowed funds (see Fiona Trust & Holding Corporation v Yuri Privalov [2011] EWHC 664 (Comm)).”

8.  More particularly at §36 of the Further Judgment, I referred to the paragraph further down the judgment as follows:

“57.    As held in The Hong Kong Electric Co Ltd v Commissioner of Rating and Valuation, supra, the practice of awarding interest at Prime + 1% amounts to no more than a presumption which can be displaced if its application would be “substantially unfair either to one party or the other”. The burden of displacing this presumption lies on the party seeking to displace it….” (emphasis added)

9.  With respect to Mr Jenkin Suen (“Mr Suen”), counsel for the respondent, those grounds of appeal as put forward above never appeared in his written submissions on 21 December 2015 or in his reply on 18 January 2016 to displace “the presumption”.

10.  Mr Benjamin Chain (“Mr Chain”), counsel for the applicant, refers to section 11(2) of the Lands Tribunal Ordinance cited above at §5 that any appeal to the Further Judgment should be limited to point of law. Referring to Flywin Co Ltd v Strong & Associates Ltd (2002) 5 HKCFAR 356 (“Flywin”), Mr Chain submits that as those grounds of appeal as cited at §6 have not been taken before the Tribunal with proper evidence, the leave to appeal should be refused. At §38 of Flywin, Mr Justice Bokhary PJ (as he then was) for the Court of Final Appeal said:

“… What is involved is a general principle. Where a point is taken at the trial, the facts pertaining to it are open to full investigation at the evidence-taking stage of the litigation. That is as it should be. Therefore where a party has omitted to take a point at the trial and then seeks to raise that point on appeal, the position is as follows. He will be barred from doing so unless there is no reasonable possibility that the state of the evidence relevant to the point would have been materially more favourable to the other side if the point had been taken at the trial.”

11.  I agree with Mr Chain that the present application for leave to appeal should be refused on this point alone. Nevertheless, as I anticipate the respondent, being charged with the responsibility for undertaking resumption pursuant the Ordinance from time to time, might be raising similar arguments in future, I consider it is opportune to deal with them now.

Failure to Take into Account Alternative Approach

12.  Firstly, Mr Suen refers to Komala Deccof & Co SA and Others v Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) [1984] HKLR 219 (“Komala Deccof”). While the Court of Appeal awarded interest at Prime + 1% over a commercial debt withheld by the respondent, Mr Suen submits, by reference to Tate & Lyle Food and Distribution Ltd and Another v Greater London Council and Another [1982] 1 WLR 149 which was cited with approval at §20 of  the judgment, that:

(1)  the rationale for adopting Prime +1% is that it was considered to be “the rate at which plaintiffs in general could borrow money”; and

(2)  the court should look at the rate at which plaintiffs with the general attributes of the actual plaintiff in the case could borrow money as a guide to the appropriate interest rate.

13.  Then Mr Suen submits that pre-judgment interest should be awarded just to compensate a plaintiff for the return which he could have expected had he invested the amount in question. At this juncture, I am afraid that Mr Suen may have confused himself because what a plaintiff can get as return from his investment is completely different from “the rate at which plaintiffs in general could borrow money” as cited in Komala Deccof. See also §32 below.

14.  While Mr Suen acknowledges the position of the courts both in Hong KongIsland Development Ltd vThe World Food Fair Ltd & Another (2006) 9 HKCFAR 162 and Happy Dragon 2014 on which the Further Judgment was based that Prime +1% was adopted in the absence of any other evidence, he submits there is another line of authorities which adopt or favour a different approach in the award of interest based on changing commercial environment and practice, albeit based on the same rationale to compensate the plaintiff for being kept out of his money. In this latter regard, Mr Suen refers to a report on “Pre-Judgment Interest on Debts and Damages” (“UK Report”) published by the Law Commission in the United Kingdom in 2004 in which it recommended that the interest rate on pre-judgment interest should be set at the Bank of England base rate plus 1% but that the court should have a discretion to depart from such rate for good reasons.

15.  Mr Suen then refers to Revenue and Customs Commissioners v Royal Society for the Prevention of Cruelty to Animals [2006] EWHC 422 (Ch) and Libertarian Investments Limited v Thomas Alexej Hall (2013) 16 HKCFAR 681 (“Libertarian Investments”) in which this English base rate + principle was followed.

16.  More particularly, Mr Suen relies on Waddington Limited v Chan Chun Hoo Thomas (No 2) [2014] 4 HKC 356 (“Waddington”) and points out that Recorder Patrick Fung SC (as he then was) referred to Chan Pak Ting v Chan Chi Kuen [2013] 1 HKLRD 634 and Chan Pak Ting v Chan Chi Kuen (No 2) [2013] 2 HKLRD 1 in which Bharwaney J considered the substantial downturn in economic landscape in Hong Kong since 1996 which resulted in a constant state of low interest rates and worked out a series of new discount rates on a much lower scale in personal injuries cases. Recorder Fung SC proceeded to rely on Libertarian Investments and the UK Report and held as follows:

(1)  The current UK base rate is 0.5%, the current 12-month HIBOR is 0.87% and the current prime rate in Hong Kong is 5%. The interest rates in Hong Kong have steadily been at low level for the past decade or more. There is no longer justification for adopting the conventional figure of prime plus 1% for pre-judgment interest on judgment sums.

(2)  It is not necessary in the present case for any further evidence or submissions to be received on this aspect, and the court has come to the conclusion that adopting a figure of 2.5% per annum will do justice between the parties.

17.  Therefore, Mr Suen submits that this Tribunal ought to have taken into account the above alternative approach and awarded interest at the rate of (a) the Bank of England base rate plus 1% (ie 1.5% per annum)[1], (b) 2.5% per annum (as adopted in Libertarian Investments and Waddington), or (c) such other appropriate rate as the Tribunal deems fit.

18.  With respect, I am not persuaded that a local real estate investor like the applicant can be readily accessible to borrowing in terms of the Bank of England base rate in the absence of evidence. It simply cannot be assumed that a local real estate investor is also a sophisticated trader in the money market exposing himself/herself to unnecessary exchange rate risk in borrowing in foreign currency. In any event the interest rates pertaining in the United Kingdom bear no direct relationship with the interest rates applicable in Hong Kong. Even covered interest rate parity by use of forward contracts to cover (eliminate exposure to) exchange rate risk cannot always hold due to the effects of various risks, costs, taxation, and ultimate differences in liquidity of domestic and foreign assets.

19.  In the above regard, Libertarian Investments is readily distinguished because all along in that case the currency in which the funds misappropriated were in British pound whereas in the present case the Property resumed has been traded in the local currency. Similarly, I find no reason to follow Waddington in which proceedings were in the nature of a multiple derivative action brought by a minority shareholder in a parent company (“Playmates”), a company incorporated in Bermuda and listed on the Stock Exchange of Hong Kong, for wrongs allegedly done to and damage suffered by the parent company’s indirectly via another wholly-owned subsidiary, also a BVI incorporated company. It is noted that Playmates’ core activities are in the creation, design, marketing and global distribution of branded toys, ie it is engaged in businesses in the global sphere. Again, the applicant in the present case is a mere local real estate investor.

20.  As rightly conceded by Mr Suen, however, Deputy High Court Judge Eugene Fung SC (“Mr Fung”) was faced with a similar issue in Wan Chi Hing v Strong Master Corporation Limited, HCA 1554 & 1555/2013 (unreported, dated 8 December 2015) (“Wan Chi Hing”). At §§24-25 of the judgment, Mr Fung stated:

“24. It is unclear to me from To J’s judgment what evidence was adduced by the defendant in that case to support the departure from the “prime plus 1%” practice. To J did not regard the authorities cited by the defendant as representing a departure from the principles in Komala as approved by the Court of Final Appeal in Polyset. It seems to me that there must have been some evidential basis for To J to come to 2.85% as the pre‑judgment interest rate in the case.

25. In the present case, no evidence has been adduced by Strong Master to show that there is some other rate which is more appropriate than the conventional “prime plus 1%”. The citation of Tadjudin is not sufficient for this purpose because, as I said earlier, it is not clear to me what evidence was laid before To J for him to arrive at 12‑month HIBOR + 2%, or 2.85%.”

21.  I fully agree with Mr Fung[2].

22.  Mr Suen further submits that his argument is reinforced by section 17(3B) of the Ordinance which provides for the fixing of the interest rate, being:

“(a)   in respect of a working day must not be lower than the lowest of the interest rates paid on deposits at 24 hours’ call by note-issuing banks at the close of business on that day; and

  (b)   in respect of a non-working day must not be lower than the lowest of the interest rates paid on deposits at 24 hours’ call by note-issuing banks at the close of business on the last working day before that day.”

23.  Although on proper construction, this provision does not mean that the minimum rate of interest as set out therein should be adopted unless the applicant could establish a good reason, Mr Suen suggests that the provision does contemplate that “interest rates paid on deposits” may be appropriate in at least some of the time.

24.  I trust this point has been adequately dealt with in the Further Judgment at §§37-38. There was simply no evidence for me to displace the adoption of interest at Prime +1%.

Failure to Take into Account Relevant Evidence

25.  For the second ground of appeal, Mr Suen refers to however §55 of Happy Dragon 2014 where the Tribunal said:

“In order to compensate the applicant fully and fairly, we agree with the applicant that the investment approach is more appropriate in the circumstances of the applicant’s case. Without the use of the compensation money, the applicant would either need to borrow the money from a bank or suffer the loss of the return from the use of the money in making investments…..”

26.  Then, Mr Suen submits the cost of borrowing is not necessarily the only appropriate measure for all cases, and the return on the deposit of the compensation money (which is a form of return on investment) may also be appropriate in some circumstances. Mr Suen suggests the Tribunal could ask what is “the loss of return the applicant has suffered from being deprived of the use of the money for making investments”.

27.  Mr Suen theorizes the situation where a landowner like the applicant whose property had, prior to the resumption, been rented out to a tenant, the loss of return on such investment would have been the rental income lost to the land owner before he received the compensation money.  Under the “investment approach”, the cost of borrowing the compensation money would be less appropriate. This is because borrowing by itself does not confer on the applicant any investment return. It is the use to which the borrowed money is put that produced such benefit.

28.  Further or alternatively, but for the fact that the applicant has been kept out of money, he could have used the compensation money to acquire a substitute property of the same value. Assuming that the return of the investment is similar, his loss of return on such replacement investment would have been the rental income lost to the land owner.

29.  Then Mr Suen suggests that there was evidence before the Tribunal that the Property was subject to a tenancy agreement yielding a rental income of $100,000 per month for a period of two years from 1 October 2010 to 30 September 2012. In the midst of such tenancy agreement, the Property was resumed by the Government on 2 June 2012. Based on annual rental income at $1,200,000, the rate of return would have been $1,200,000 divided by $35,000,000 (ie the market value of the Property as determined by the Tribunal) that is equal to 3.43% per annum.

30.  Therefore, Mr Suen argues that the applicant’s return on investment would only have been around 3.43% per annum. An award of 6% per annum by the Tribunal would, on such basis, constitute a windfall to the applicant to the tune of around 6% - 3.43% = 2.57% per annum.

31.  I cannot agree with Mr Suen.

32.  Firstly, I would like to point out that when Mr Suen cited §55 of Happy Dragon 2014, he had taken out words out of the context. The last sentence of the paragraph states clearly that:

“Using the “broad brush” approach in the long established practice as discussed above, the interest rate of Prime + 1% does represent the theoretical cost to the applicant of borrowing the compensation money withheld by the respondent.”

The word “or” in front of “suffer the loss of the return from the use of the money in making investments…..” refers to the consequence of not borrowing money from a bank rather than an alternative.

33.  On the other hand, “the loss of the return from the use of the money in making investments” refers not to a single rate of return but a cost of capital, as it is sometimes called, which varies depending on the quality of the investment which comprises a function of a risk free opportunity cost, expected income and capital growth, liquidity, operating expenses, psychic income, risk and other factors pertaining to the investment. For instance, the higher the expectation of income and/or capital growth, the more an investor is prepared to pay for the investment, ceteris paribus and, as an consequence, the initial yield the investor is prepared to accept is lower. In any event, however, the investor would not commit to a particular investment if his total expected return would not be higher than his cost of borrowing, ie the expected return, or cost of capital should be higher than the cost of borrowing.

34.  In addition to the above, I find Mr Suen’s argument wholly misconceived. It is basic property valuation principle or Finance 101 that the initial rental or the yield derived therefrom of a property (an investment) does not represent the total required return from the property. For a current income flow, say rental of C₀ per period being expected for n periods, the value, or more properly, the present value P₀ is:

Current rental	C0
YP @ i for a period n	YP factor
Market Value	P0
where i is the initial yield3

This can be expressed as

so that if n becomes too large or approaches infinity,

35.  However, this initial yield, i, incorporates a series of implicit measurements of expected income and capital growth. In real life or alternatively if a constant growth element, g, is explicit or expected in the cash flow for a required return of r, so that

where C₂ = C₁ (1+g), C₃ = C₁ (1+g)², etc., the equation above can be reduced to

by the Gordon growth model.

36.  Where

Therefore,   r – g = i (1 + g)

or  r  = i + ig + g

or  r  ≈ i + g

or  r  ≈ r – g⁴  (or if C₁ = C₀, i = r – g at the first instant)

37.  In other words, the initial yield of 3.43% suggested by Mr Suen is just a function of the required return less the expected income growth during the holding period of the investment so that the true rate of return expected should be much higher.

38.  By reference to the private retail price index published by the Rating and Valuation Department, for a period of 10 years prior to March 2012, the private retail price had increased from 83.5 to 375.6 or an annual growth at about 16.5%. And since March 2012 until March 2016, the index has increased from 375.6 to 513.5 which is equivalent to an annual growth at about 8%.

39.  Therefore no matter the expected growth rate as at the date of resumption was 16.23% or 8.13%, the return of the Property should be:

(1)  3.43% + 16.23% = 19.66% or

(2)  3.43% + 8.13% = 11.56%.

I am sure that Mr Suen is not suggesting the respondent is prepared to pay interest to the applicant at either 19.66% or 11.56% when he refers to “the loss of the return from the use of the money in making investments”.

40.  Thus, more often than not, this initial yield is only regarded as a unit of comparison used to value property investment instead of the actual return from the property investment.

41.  It is highly regretted that the respondent, being charged with a government department endowed with a wealth of valuation expertise, has missed such an elementary concept in property valuation when giving instructions to counsel.

Leave to Appeal being Refused

42.  According to section 11AA(6) of the Lands Tribunal Ordinance,

“Leave to appeal shall not be granted unless the Tribunal, the Court of Appeal or the registrar hearing the application for leave is satisfied that—

(a)  the appeal has a reasonable prospect of success; or

(b)  there is some other reason in the interests of justice why the appeal should be heard.”

43.  Towards the end of his submission, Mr Suen concedes that the Tribunal committed no error in law in awarding interest at Prime +1%. He simply likes to point out that there are conflicting authorities between the traditional and alternative approaches in the award of interest. It is in the interest of justice that the matter be considered by the Court of Appeal to resolve the conflict and clarify the position.

44.  With respect, I do not find indeed there are conflicts at all. For instance, by virtue of Happy Dragon 2014 or even Wan Chi Hing, the Prime +1% is just a presumption that can be displaced by evidence. The Tribunal is ready and willing to consider evidence when they are available. However as pointed out by the Court of Appeal in Komala Deccof at §14 thereof:

“The onus of showing what is exceptional rests on the losing party.”

45.  Further at §15, the Court of Appeal said:

“…… the award of interest is a matter of discretion ….”

46.  In this regard, Mr Chain refers to CLP Power Hong Kong Limited v Commissioner of Rating and Valuation, HCMP 3207/2015 (unreported, dated 14 March 2016). Although in this particular case, the Court of Appeal was dealing with an application for leave to appeal against an order for cost instead of interest rate, Mr Chain submits that the same principle applies. At §5 of the judgment, the Court of Appeal had the following to say:

“(a)  It is well established that this court will not interfere with the costs decision of a lower court unless it can be shown that the lower court has erred in principle or its decision was plainly wrong…

…

(d)  Quite obviously, the Tribunal had exercised its discretion bearing in mind the success of CLP as well as …

(e)  In substance, CLP tried to invite this court to come to a different view on how the discretion should be exercised. As explained in the cases cited above, this is not a proper approach.”

Conclusion

47.  Having regard to the above, I decide that the respondent’s appeal has no reasonable prospect of success, and the respondent failed to satisfy that there is some other reason “in the interests of justice” why the appeal should be heard.

48.  As the application for leave to appeal is refused, I shall make an order for costs that costs should follow the event, to be taxed at High Court scale if not agreed.

49.  My order is as follows:-

(1)  the respondent’s application for leave to appeal be dismissed;

(2)  the respondent do pay the applicant costs of the application for leave to appeal, with certificate for counsel, to be taxed at High Court scale if not agreed.

[1] The Bank of England base rate has been at 0.5% per annum since March 2009.

[2] Once again, I find Tadjudin should be distinguished as well as the plaintiff in that case was employed by Bank of America as an analyst at the level of vice president and paid with denomination in US currency.

[3] In North America the term is more often called ‘capitalization rate’ whilst in Commonwealth areas the term is also referred to as ‘all risks yield’.

[4] See also, Andrew Baum, Real Estate Investment: A Strategic Approach, 3^rd Edition (2015), para 4.4.2; Peter Wyatt, Property Valuation, 2^nd Edition (2013), para 4.3.1.; Sheridan Titman & John D Martin, Valuation: The Art and Science of Corporate Investment Decisions, 3^rd Edition (2015), pp 264-266.