CENTURY MAIN INVESTMENTS LTD. v. POLYLINE DEVELOPMENT LTD. AND ANOTHER

HCA 20343/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 20343 OF 1998

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J U D G M E N T

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Background

1. The 1st and 2nd Defendants are associated companies carrying on business in development of village houses, commonly called "Ding houses" in the New Territories under the Government's small house policy for indigenous villagers. The Plaintiff is an investment and trading company. The parties had previously entered into seven joint venture agreements to develop Ding houses.

2. In September 1992, the Plaintiff and the 1st Defendant entered into a similar joint venture agreement to develop 32 lots of village land in Po Sham Pai Village (hereinafter called the "Po Sham Pai Joint Venture Agreement") through a corporate vehicle called Linker Hong Kong Limited (hereinafter called "Linker") in which they held equal shares. This joint venture did not proceed as smoothly as the parties had hoped because of the delay in obtaining building licences and certificates of exemption necessary for building of the Ding houses. Eventually in July 1996, the parties agreed to put an end to the joint venture by allotting each party with 16 lots of the land.

3. The Plaintiff attempted to sell the lots, but without success. Then by a Chinese memorandum dated 29 October 1996 (hereinafter called the "1996 Memorandum"), the Plaintiff agreed to sell all the 16 lots to the 1st Defendant at $1.6 million per lot to be paid by four instalments. This memorandum was then translated into two formal agreements dated 19 November 1996 (hereinafter called the "First Formal Agreement" and the "Second Formal Agreement"). Under the First Formal Agreement, the 1st Defendant agreed to purchase the ten lots without building licences and certificates of exemption at the total price of $16 million to be paid by four instalments. The last two instalments, i.e. the third and fourth instalments in the amount of $5,600,000 and $2,400,000 were to be paid respectively two days from and two months from the date of issue of certificates of exemption. Under the Second Formal Agreement, the remaining six lots with building licences and certificates of exemption were sold at the total price of $9,600,000 to be paid by four instalments. The two agreements provided for payment of a total sum of $1.6 million, i.e. $100,000 in respect of each lot, to the staff of the Plaintiff (hereinafter called the "Staff Payment").

4. The present dispute arose out of the 1st Defendant's failure to pay the last instalment of $2.4 million under the First Formal Agreement and the $1.6 million Staff Payment to the staff of the Plaintiff under the two Formal Agreements. In respect of the $2.4 million, the 1st Defendant claims that under the Po Sham Pai Joint Venture Agreement, Linker was under an obligation to pay the 1st Defendant the last instalment of the purchase price for the 32 lots which had not fallen due at the time of the sale of the ten lots back to the 1st Defendant and the Plaintiff's contribution to that instalment of the purchase price was also $2.4 million. The issue is therefore whether the 1st Defendant is entitled to set off the payment of the last instalment of purchase price to the Plaintiff against the Plaintiff's contribution under the Po Sham Pai Joint Venture Agreement. In respect of the claim for Staff Payment, the defence is that the Plaintiff has no locus standi to sue for its staff. In addition, the Plaintiff also claims costs and interest pursuant to section 57 of the Bills of Exchange Ordinance in respect of two dishonoured cheques issued by the 2nd Defendant as payment for the 1st Defendant under the First Formal Agreement.

The parties' conduct subsequent to the Formal Agreements

5. About half a year later, on 10 May 1997, the Plaintiff and the 1st Defendant signed a similar memorandum to terminate a joint venture in Yuen Leng Village (hereinafter called the "Yuen Leng Joint Venture"), but with the 2nd Defendant buying the lots from the Plaintiff. The memorandum was translated into a similar formal agreement which expressly provided for a set off from the purchase price to be paid by the 2nd Defendant against a sum of $1,140,000 which the Plaintiff would be obliged to pay the 1st Defendant as its contribution to the purchase price of the lots to be paid by Linker under the Yuen Leng Joint Venture.

6. After reaching the above agreement for the sale of the Yuen Leng lots, the 1st Defendant requested the Plaintiff for extension of time to 1 June 1997 and for additional instalments in paying the third and fourth instalments under the First Formal Agreement. The Plaintiff acceded to the request. The amount payable under the two instalments was $8 million. In mid May 1997, the 1st Defendant's accounting clerk, Miss Cheng, telephoned Mr Hui, the Assistant General Manager and Director of the Plaintiff to inquire if the $2.4 million payable by the Plaintiff towards the purchase price of the lots to be paid by Linker under the Po Sham Pai Joint Venture may be set off against the $8 million due to the Plaintiff under the First Formal Agreement. To that Hui confirmed his agreement. Hui does not dispute that he discussed about a set off with Cheng, but says that he was referring to the set off in the Yuen Leng Joint Venture and denied that Cheng had made it clear that the set off was in respect of the Po Sham Pai Joint Venture. On 30 May 1997, the 1st Defendant again requested for further variation in payment terms in respect of the third instalment, to which the Plaintiff also agreed.

7. Hui's denial is inconsistent with the conduct of the solicitors acting for the parties at the time. Pursuant to the telephone agreement reached on 30 May 1997, the 1st Defendant's solicitors wrote to the Plaintiff's solicitors on 30 May 1997, seeking confirmation of the set off and the proposal to vary the payment terms and enclosing five post-dated cheques issued by the 2nd Defendant in payment of the balance of $5.6 million for the 1st Defendant. The Plaintiff's solicitors promptly replied on the following day confirming the set off and accepting the variation in payment terms. Then two months later, on 30 July 1997, the Plaintiff's solicitors sent a draft deed of variation, incorporating the change in payment terms, to the 1st Defendant's solicitors for their approval. A number of reminders were sent but the 1st Defendant's solicitors did not respond.

8. Of the five post-dated cheques issued by the 2nd Defendant, only the first three were met. $2.6 million under the third instalment remained outstanding. The parties then agreed to reschedule the payments. Despite the further relaxation in payment terms, the 1st Defendant was unable to pay. Then the Plaintiff instituted the present action against the 1st Defendant for breach of agreement and against the 2nd Defendant in respect of the two dishonoured cheques. Subsequently the parties reached full and final settlement in respect of the outstanding payment under the third instalment together with interest, leaving the payment of $2.4 million under the fourth instalment outstanding.

The Government's small house policy

9. Under the Government's small house policy for indigenous villagers in the New Territories, a male indigenous villager, called a "Ding", has a right to build one small house as his residence on a piece of agricultural land in the New Territories owned by him. Such a house may be built without compliance with the Building Ordinance and Regulations, provided a building licence and three certificates of exemption have been obtained. To participate in such a development, a developer has to, firstly, purchase a piece of agricultural land. Next, he has to procure a Ding for his right to build by paying him a Ding fee so that he would agree to be registered as the owner of the plot of land and to apply for the building licence and certificates of exemption. In that connection, the Ding has to attend an interview with the Lands Department. The agricultural land registered under the name of a Ding who has the right to build is called "Ding land". The Ding land with building licence and certificates of exemption is ready for building or redevelopment. Such a plot of land is more valuable than a plot of Ding land without the licence and certificates, which in turn is more valuable than a piece of agricultural land. When the building licence and certificates of exemption have been issued, the developer may construct a Ding house. He may have to construct access roads or make welfare payments to the village head for other matters such as cutting of trees etc. When the construction of the house is completed, it may be sold to the public, after payment of premium to the Government. The sale is completed with the Ding formally assigning his interest in the land to the purchaser.

10. The process of purchasing agricultural land, converting it to Ding land and obtaining building licence and certificates of exemption is often complicated and takes time. During this process, the Ding may not legally sell his interest in the land to intending purchasers or developers. The conversion process involves negotiation with village heads about welfare payments or benefits to the village. It also involves securing the risk against the Ding changing his mind after the land has been registered in his name. Thus the process is usually undertaken by local developers who have experience with the Lands Department and good connections with village heads and indigenous villagers who can help to identify and liaise with Dings who have available right to build and to compel their subsequent assignment of the land to the ultimate purchasers. An outside developer wishing to participate in this kind of redevelopment projects usually has to team up with a local developer. The 1st and 2nd Defendants are such local developers and the Plaintiff is such an outside developer or investor. The joint venture agreements, the 1996 Memorandum and the two Formal Agreements have to be understood and interpreted against this factual matrix.

Whether the Plaintiff's liability to contribute to the purchase price by Linker survived the Formal Agreements

11. In respect of this claim, the issue is whether the Plaintiff's liability to contribute to the purchase price to be paid by Linker in respect of the 10 lots survived the dissolution of the Po Sham Pai Joint Venture. The Formal Agreements and 1996 Memorandum are silent in this respect. According to the witnesses on both sides, this issue has never been raised at any of the meetings or discussions before the Formal Agreements were signed. The Plaintiff relies on its silence as evidence that its obligation has been abrogated by the Formal Agreements, while the 1st Defendant argues that the obligation survived by inference and necessary implication. The truth would have to be ascertained from inferences to be drawn from the agreements and the subsequent conduct of the parties.

12. Under Clause 4 of the Po Sham Pai Joint Venture Agreement, the original purchase price for the 32 lots in 1992 was $1.2 million per lot. The price was expressly for the lots together with building licences and certificates of exemption or undertaking by the 1st Defendant to obtain the same at its own expenses. The price was to be paid by three instalments. The first instalment of 40% had been paid at the time of the agreement. Another 40% would be paid upon the Dings obtaining an interview from the District Lands Office and the balance at the time of issue of building licences and certificates of exemption. The point to note is that the payment is tied to the conversion process. The last instalment was $240,000 per lot and was payable to the 1st Defendant for its effort and expenses in obtaining building licences and certificates of exemption in respect of the lots.

13. When the Po Sham Pai Joint Venture Agreement was superseded by the two Formal Agreements, Linker has paid the first two instalments but not the last instalment as the building licences and certificates of exemption had not yet been issued. There is no dispute that had the joint venture run its full course, the Plaintiff should pay the 1st Defendant $2.4 million as the Plaintiff's contribution to the last instalment of the purchase price to be paid by Linker in respect of the ten lots which it subsequently sold back to the 1st Defendant.

14. The parties entered into the joint venture in 1992 which did not proceed as smoothly as the parties had hoped, presumably due to the lack of progress in obtaining building licences and certificates of exemption. The parties decided to put an end to the joint venture by dividing the 32 lots which were the only assets of Linker. Thus the allocation of the 16 lots of land must be with a purpose to achieve an equal distribution of their partnership property.

15. The 16 lots allotted to the Plaintiff were not entirely from the original 32 lots because the parties agreed to swapping some of the lots so that the Plaintiff was allotted the lots with building licences and certificates of exemption or with a better prospect of getting them soon. The Plaintiff was allotted six lots with building licences and certificates of exemption and ten without. The 1st Defendant was left with lots without building licences and certificates and those where the prospect of obtaining them was not as promising as those allotted to the Plaintiff. Thus the lots allotted to the Plaintiff were more valuable than those allotted to the 1st Defendant and the 1st Defendant had to incur time and further expense in obtaining the licences and certificates. The 1st Defendant was not compensated for the difference in value for the six lots with licences and certificates allotted to the Plaintiff. On the other hand, the ten lots without licences and certificates would be of no value to the Plaintiff as an outside developer and with no expertise and means in converting the land into Ding land with building licences and certificates of exemption. The ten lots were registered in the name of the Dings and the Plaintiff has no legal estate in them when effectively the Plaintiff has paid 80% of the purchase price on the basis that they were land with licences and certificates. These ten lots could be worthless without the conversion and subsequent assignment by the Ding to the Plaintiff or its assignees, i.e. the ultimate purchasers of the developed Ding houses. As explained above, the local developer's expertise in the conversion process, his connection with the village heads and ability in securing or compelling the Dings to honour their undertaking to bring about the conversion and subsequent assignment are very important in the development. In view of the very substantial difference between the value of the lots with and without building licences and certificates of exemption and the Plaintiff's lack of means and expertise in completing the conversion process, if the allocation was to achieve as equal a distribution of the partnership asset as possible, a reasonable assumption in the minds of the parties must be that the 1st Defendant's obligation to convert the lots into Ding land with licences and certificates must survive the dissolution of the joint venture, so that the Plaintiff may compel the 1st Defendant to exercise their best endeavours, skill and expertise to bring about the conversion of its ten lots or to compensate it for the loss. Likewise, the Plaintiff's obligation to contribute to the last instalment of the purchase price which Linker was obliged to pay under the Po Sham Pai Joint Venture Agreement must also survive the dissolution.

16. The fact that the sale under the two Formal Agreements involved the same original parties to the Po Sham Pai Joint Venture Agreement and that the purchase price made no distinction between lots with building licences and certificates of exemption from those without raises a strong inference that the parties' original rights and obligations under the Po Sham Pai Joint Venture Agreement must have permeated into the First Formal Agreement, so that the Plaintiff remained liable to pay the $2.4 million as its contribution under the Po Sham Pai Joint Venture Agreement.

17. The conduct of the parties subsequent to the dissolution also supports the above inference. When Cheng spoke to Hui on the telephone about the set off, Hui agreed. Hui's explanation is that he thought Cheng was talking about the set off in the Yuen Leng Joint Venture. This is hardly credible as the amount to be set off under the Yuen Leng Joint Venture was only $1.14 million and not $2.4 million. Secondly, Hui also has an almost impossible burden of explaining why his solicitors, after having taken instruction from him, confirmed the set off. His solicitors were fully informed in writing of the terms of the set off by the 1st Defendant's solicitors and then took instruction from Hui. His explanation was that he again thought his solicitors were talking about the Yuen Leng Joint Venture. I have no doubt about Cheng's evidence. At the time, she was working out the amount due under the First Formal Agreement. She must have talked with Hui on the basis of the Po Sham Pai Joint Venture and the amounts referable to that joint venture. I consider Hui's explanation far too convenient for two coincidences to happen on him at the same time.

18. Miss Lam, for the Plaintiff, refers to the formal agreement in respect of the Yuen Leng Joint Venture which expressly provided for a set off of the Plaintiff's contribution to the purchase price under the original joint venture agreement. She submits that without an express set off provision under the First Formal Agreement the inference is that the Plaintiff's obligation to contribute to the purchase price to be paid by Linker must have been extinguished. The quick answer is that the parties to that sale were not the same parties to the Yuen Leng Joint Venture, hence their solicitors saw it fit to insert the provision for set off.

19. I draw no adverse inference from the lack of response by the 1st Defendant's solicitors to the Plaintiff's solicitors' request for approval of the deed of variation. The parties were acting on the terms as varied. The first three of the five post-dated cheques issued by the 2nd Defendant were honoured as and when they were presented. I do not think the lack of response by the 1st Defendant's solicitors could be indicative that the terms contained in the deed of variation was incorrect.

20. Having considered the totality of the evidence and the inherent probability of the parties' case, I consider Cheng a more credible witness. I accept her evidence and reject Hui's. Hui's agreement to the set off is a clear recognition of the Plaintiff's pre-existing obligation under the Po Sham Pai Joint Venture. From the inference to be drawn from the factual background and Hui's agreement to set off the $2.4 million, I find as a fact that when allotting the 32 lots of land, the parties agreed that the 1st Defendant would undertake to obtain building licences and certificates of exemption in respect of those lots without building licences and certificates of exemption, while the Plaintiff would undertake to pay the 1st Defendant when the same were obtained. The rights and obligations of the parties in this respect survived the dissolution of the joint venture. The 1st Defendant was therefore entitled to set off the $2.4 million which the Plaintiff would be obliged to pay under the Po Sham Pai Joint Venture Agreement as its contribution to the purchase price of the 32 lots of land to be paid by Linker. Hence, all amounts due under the First Formal Agreement have been settled.

The Staff Payments of $1.6 million

21. Under the 1996 Memorandum, the parties agreed that the Staff Payments shall be paid to the Plaintiff as staff reward and welfare. However, when the Memorandum was translated into the two Formal Agreements, the payments are made payable to the staff of the Plaintiff. Clause 11 of the First Formal Agreement provides:

"In consideration of the above [the 1st Defendant] shall pay an additional sum of HK$1,000,000.00 to the staff of [the Plaintiff] five months from the issue of the Certificate of Exemption."

Clause 11 of the Second Formal Agreement contains a similar provision in respect of a sum of $600,000 to be paid upon completion of the transaction, i.e. five months from the date of the agreement.

22. Miss Lam submits that Recital 5 of the two Formal Agreements makes express reference to the 1996 Memorandum and that it was the common intention of the parties, as embodied in the 1996 Memorandum, that the payments should be made payable to the Plaintiff as staff reward and staff welfare. Though the 1996 Memorandum was referred to in the recital, it was not annexed to the Formal Agreement. On the Plaintiff's case, when Hui signed the agreements on behalf of the Plaintiff, the 1st Defendant had already signed but the 1996 Memorandum was not attached to the Formal Agreements. If so, the 1996 Memorandum never formed part of the agreements. Two general rules are applicable here. Firstly, the earlier informal agreement is superseded by the subsequent formal agreement. Secondly, all previous negotiations of the parties and their declarations of subjective intent are inadmissible as evidence of the background except in an action for rectification. Thus not only that the 1996 Memorandum does not form part of the agreements, it could not be referred to for the purpose of ascertaining the intention of the parties.

23. Mr Chan submits that Clause 11 is clear and free from ambiguity and there is no room for any term to be implied for business efficacy under the principle laid down in The Moorcock. The $1.6 million, if payable, shall be paid to the staff of the Plaintiff only. The staff consisted only of a few identifiable persons. Hence, he submits that only the staff may enforce the agreement but not the Plaintiff.

24. With respect, I cannot agree. While Clause 11 is free from ambiguity, the clause cannot stand on its own. The staff are not parties to the Formal Agreements nor have they provided consideration for the 1st Defendant's promise to pay. Furthermore, it is uncertain when all the certificates of exemption will be issued. It could take years, which was why the joint venture was brought to an end. The staff would be changing during the years, as had the general manager, whose attitude, according to the 1st Defendant, was what caused the present litigation. Another element of uncertainty is as to how the money is to be distributed and in what proportion as between the various members of the staff and which members would be qualified to the distribution. If a member of the Plaintiff staff sought to enforce Clause 11 on its own as an independent contract against the 1st Defendant, he would be met with defence such as lack of privity, consideration and certainty.

25. In my judgement, in construing a contract, the court should give effect to the parties' intention rather than to frustrate their expectation. Thus the court should try its best to save the contract by giving it a construction which will preserve its legality and enforceability and in doing so give effect to the intention of the parties, rather than to take a blue pencil and strike out provisions which might on the face appear to have a vitiating element and hence frustrate the reasonable expectation of the parties or some of them. The parties' intention is, of course, to be ascertained from the meaning which the contract would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

26. According to Chan of the 1st Defendant, the payments are to be made to the staff through the Plaintiff, though in view of the change in personnel, he now thinks it better to pay the staff direct. Chan agrees that no names of any members of the staff who would be entitled to a share of the payments were mentioned in the meeting when the 1996 Memorandum was concluded. He agrees that it was not intended that the payments would be divided equally among the staff, some members of the staff would get more and some would get less. He says that the distribution would have to be discussed with the Plaintiff. This is the evidence of the party who is supposed to make the payments. The evidence shows that it could not have been the intention of the parties that individual employees could go to court to enforce the contract nor can the court be in the position to determine the amount of their entitlement. On the other hand, the Plaintiff is a party to the contract and is in a position to enforce the payments. It is in the best position to determine the criterior for the award, which employee is eligible and the amount to be awarded.

27. In the circumstances, it would not be difficult to find that Clause 11 is part of the entire package in the transaction and that the common intention of the parties was that the money shall be paid to the Plaintiff for the benefit of its employees and the Plaintiff has total discretion in its distribution among its employees. In the exercise of its discretion, the Plaintiff may take into account or even invite the views of the 1st Defendant. I have no difficulties in implying into the two Formal Agreements the above terms, which in my view, must be the obvious, but unexpressed, intention of the parties. Indeed they are, according to the evidence of Chan of the 1st Defendant. The implication of these terms is necessary to give effect to the intention of the parties.

28. Clause 11 of the First Formal Agreement provides that $1 million shall be payable five months from the date of issue of certificates of exemption. Unlike the 1996 Memorandum, Clause 11 does not provide for payment by instalments in accordance with the building progress or pro-rata payment as and when each certificate is issued to a particular lot. Thus the obligation would be to pay a lump sum and the obligation would only arise when all certificates of exemption have been issued. As at the date of hearing, certificates of exemption in respect of two of the ten lots sold under the First Formal Agreement have not yet been issued. The amount of $1 million under the First Formal Agreement is therefore not yet payable.

29. On the other hand, the amount of $600,000 under Clause 11 of the Second Formal Agreement was payable upon completion, i.e. 19 April 1997. This amount is therefore payable forthwith. Clause 8 of the Second Formal Agreement provides for interest at the rate of 30% per annum. The Plaintiff claims interest with effect from 1 October 1998. The claim for interest at the contractual rate must be allowed from 1 October 1998 until the issue of the writ of summons and thereafter at judgment rate.

Interest and costs in respect of the dishonoured cheques

30. Part of the Plaintiff's claim is in respect of two dishonoured cheques in the amount of $2.6 million issued by the 2nd Defendant as payment for the 1st Defendant under the third instalment. Subsequent to the issue of the writ of summons, the outstanding amount together with agreed interest has been paid in full and final settlement by 31 December 1998. The Plaintiff now claims for interest pursuant to section 57 of the Bills of Exchange Ordinance. The Plaintiff is prepared to give credit to the agreed interest it has received in settlement of the claim. In my judgment, as the parties have reached full and final settlement in respect of principal debt plus interest owed by the 1st Defendant, that must also discharge the 2nd Defendant's liability for interest in respect of the dishonoured cheques which were issued in purported payment of the principal debt which is the underlying consideration for the cheques. The Plaintiff's claim for interest pursuant to the Bills of Exchange Ordinance must fail. However, it is entitled to the costs of this action against the 2nd Defendant until 31 December 1998, i.e. the day when the third instalment under the First Formal Agreement was fully paid.

Conclusion

31. Accordingly, the Plaintiff's claim against the 1st Defendant is allowed to the extent of the $600,000 payable under Clause 11 of the Second Formal Agreement with interest at the rate of 30% per annum from 1 October 1998 until 27 November 1998 and thereafter at judgment rate until payment. As the subject matter of the 1st Defendant's counterclaim has been set off against its liability to the Plaintiff, the counterclaim is accordingly dismissed. The Plaintiff is only partially successful in this action, I therefore make an order nisi that the 1st Defendant shall pay half of the Plaintiff's costs.

32. The Plaintiff's claim against the 2nd Defendant is dismissed. I make a costs order that the 2nd Defendant shall pay the Plaintiff's costs up to and including 31 December 1998 and thereafter the parties shall bear their own costs.