KWOK YING LUNG v. KO CHI HUNG AND ANOTHER

HCMP 209/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 209 OF 1999

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D E C I S I O N

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Background

1. By way of Originating Summons the plaintiff sought possession of a property at Bisney Road which was mortgaged to the plaintiff by way of a second legal charge dated 15/7/1998 ('legal charge'), which was for a loan of $1.1 million to be repaid after six months, i.e. On 14/1/1999. It is expressly provided in the legal charge that the defendants would pay interest in the sum of $55,000 per month until full discharge of the loan. The Bisney Road property has been sold by the defendants and they have paid the sum of $1.6 million into court pending the resolution of the present matter.

2. The defendants raised the defence that the plaintiff was an unlicensed money lender and that the rate of interest is extortionate. When the matter was heard before Master, he was of the view that there is evidence that the plaintiff was doing business as a money lender, and went on to rule that the defendants should repay the loan with interest at the rate of 12% p.a.

3. Both parties appealed the decision. The defendant sought the re-opening of the transaction, or alternatively, the order of 12% p.a. interest be varied. The plaintiff asked for the order of the Master be set aside, or alternatively, the interest rate of 12% p.a. be varied.

4. On appeal, Cheung J. said that there were two issues, and that the case could not be decided without hearing evidence from the parties on these two issues. There is the issue of whether the plaintiff is an unlicensed money lender. There is the further issue of whether s.25 of the Money Lenders Ordinance had been engaged. In this regard, he said 'The issue is whether the transaction in question should be treated as extortionate because the 5% per month, or 60% per annum, interest charged by the Plaintiff is in excess of the 48% per annum interest provided in s.25(3). The learned Judge set aside the order of the Master and directed that the matter be adjourned for argument and that the deponents of the affidavits be tendered for cross examination at the adjourned hearing.

Preliminary Issue

5. Initially, before me, it was agreed by both parties that the effective rate of interest should be dealt with as a preliminary issue. If I were to find that it is above 60%, the legal charge would be unenforceable by virtue of section 24. Although this issue was not raised before the learned Judge, I was satisfied that I should consider this issue since the parties had ample time to prepare their respective cases and there was no prejudice to the parties. I accepted this agreement and proceeded to hear the evidence of the experts as to the calculation of the interest.

6. However, at the adjourned hearing, counsel for the plaintiff sought to withdraw this agreement, submitting that even if I were to find the rate of interest to be above 60%, there were two further crucial elements involving disputes of fact to be resolved. The plaintiff alleges that the solicitor who handled the transaction did not represent the plaintiff who was ignorant of the law, and the defendant induced the plaintiff to enter into the loan and actively participated in it.

7. Counsel for the plaintiff made submissions based on the authority of Chitty on Contracts (27th Ed.). Briefly they were that where there are legally objectionable features of a contract which are unknown to one party, and that party becomes aware of the illegality he must refuse to carrying on with the contract, but he has a quantum meruit claim for what he has done under the contract - paragraph 16.011. Ignorance of the law is irrelevant. However, where a contract is not unlawful on its face and is capable of performance in a lawful way but the parties, in ignorance, intended to perform it in an unlawful manner, the contract may be enforced on the basis that while the parties contemplated an unlawful act, they did not intend to do it. Knowledge of the law becomes of evidential significance as to the intended mode of performance - paragraph 16.012.

8. Counsel referred to paragraph 16-013, and the case of Binder v. Alachouzos, (1972) 2 QB 151, which involved a compromise of an allegedly illegal contract, where there was a dispute of fact whether the moneylending contract was illegal.

9. Counsel also referred to paragraph 16-014, which sets out examples of criminality, which includes doing something forbidden by statute, and to paragraph 16-139, which considers the ex turpi principle. Chitty comments that the maxim is 'merely an application of the general common law principle that one who knowingly enters into a contract with an improper object cannot enforce his rights thereunder.'

10. Counsel then referred to the paragraphs in Chitty under the heading 'Pleading and Practice', in particular the discussion of contracts ex facie illegal. Counsel emphasised the comments found in paragraph 16-174, that 'where the court is satisfied that all relevant facts are before it and it can clearly see from them that the contract had an illegal object, it may not enforce the contract, whether the facts were pleaded or not ...'

11. The gist of Counsel's submission is that I have not heard evidence as to the surrounding circumstances of the contract which would enable me to come to a conclusion as to its legality. Such a conclusion requires two findings, a finding as to the rate of interest and a finding on facts as to the circumstances of the contract.

Ruling

12. On the issue of whether the plaintiff's claim is unenforceable in law, I do not accept the submission that oral evidence should be adduced and I find authority for this in Chitty (28th Ed.) paragraph 17-140, where unenforceability by statute and common law is discussed and distinguished, and it is stated that '...Unenforceability by statute, on the other hand, arises where a statute itself on its true construction deprives one or both the parties of their civil remedies under the contract in addition to, or instead of, imposing a penalty upon them. If the statute does so, it is irrelevant whether the parties meant to break the law or not.' Chitty then refers to the significant distinction between contracts unenforceable at common law and those rendered illegal by statute. In the latter case, 'one has to consider, not what acts the statute prohibits, but what contracts it prohibits; but one is not concerned at all with the intent of the parties; if the parties enter into a prohibited contract that contract is unenforceable and ignorance by the parties of the law does not make it the less so.'

13. The purpose of the Ordinance is clear - '... to provide protection and relief against excessive interest rates and extortionate stipulations in respect of loans; ' S.24 is applicable to any person, whether money lender or not. If I find that the effective rate of interest is above 60%, then by the provisions of s.24 the agreement is unenforceable and that is the end of the matter. If I find that the rate of interest is not above 60%, then the issue of whether the plaintiff is a moneylender comes into play and I have to consider the provisions of s.23 and 25, and oral evidence would become necessary.

14. Counsel for the plaintiff submitted that the case of Wong Ming Wai v. Tsui Kam Ming t/a Tung Tai Construction Co. (unrep.) 1997, HCA No. 8846, was decided by the learned Judge after hearing oral evidence. However, the judgment in that case makes it clear that there was a factual defence - whether the sum paid was in full and final settlement - and a legal defence - whether the plaintiff's claim is unenforceable in law because it contravenes s.24.

The Issue

15. Whether the effective rate of interest under the legal charge is 60% p.a. as asserted by the plaintiff or 66.38% as asserted by the defendants.

The law

16. As noted above, the purpose of the Money Lenders' Ordinance is 'to provide protection and relief against excessive interest rates and extortionate stipulations in respect of loans ...'

17. Under Section 2(l) the 'effective rate' 'in relation to interest, means the true annual percentage rate of interest calculated in accordance with Schedule 2.'

18. Section 2(2) provides that 'for the purposes of this Ordinance, where by any agreement for the loan of money the interest charged on the loan is not expressed in terms of a rate, any amount paid or payable to the lender under the agreement (other than simple interest charged in accordance with the proviso to section 22) shall be appropriated to principal and interest in the proportion that the total amount of principal bears to the total amount of interest, and the rate per cent per annum represented by the interest charged as calculated in accordance with Schedule 2 shall be deemed to be the rate of interest charged on the loan.'

19. As to Schedule 2, paragraph l states that ' Any amount paid or payable to the lender under the agreement (other than simple interest charged in accordance with the proviso to section 22(l)) shall be appropriated to principal and interest in the proportion that the total amount of principal bears to the total amount of the interest.' Paragraphs 2,3,4 and 5 go on to specify in some detail the method of calculation.

20. Part IV of the Ordinance is headed 'Excessive Interest Rates,' and consists of Section 24 relating to the prohibition of excessive interest rates and Section 25 relating to the re-opening of certain transactions.

21. Section 24 provides that '(1) any person (whether a money lender or not) who lends or offers to lend money at an effective rate of interest which exceeds 60 per cent per annum commits an offence.'

22. '(2) No agreement for the repayment of any loan or for the payment of interest on any loan and on security given in respect of any such agreement or loan shall be enforceable in any case in which the effective rate of interest exceeds the rate specified in subsection (1).'

23. The loan is irrecoverable if it is in excess of 60%. Section 25 is subject to section 24(2), which clearly states that if a particular loan breaches the provisions of section 24, the matter cannot be re-opened by the Court - Wong Ming Wa v. Tsui Kam Ming trading as Tung Tai Construction Co. (CACV 179/1999).

24. If the effective rate of interest is found not to exceed 60%, then the issue is whether the transaction should be re-opened under the provisions of section 25(3) on the basis of the effective rate of interest exceeding 48%.

Expert Evidence

25. Mr. Fong gave expert evidence for the defendant. Mr. Fong confirmed the contents of his affirmation and gave oral evidence as to his calculation of interest in accordance with Schedule 2, and he stated that any amount paid or payable shall be appropriated into principal and interest in respect of the $55,000.

26. Mr. Fong said that s.2(2) means that where there are instalment payments of a loan where a rate has not been expressed, e.g. a loan of $20,000 to be repaid by three instalments of $8,000 each, the calculation of the interest rate must follow Schedule 2 and the Ordinance permits of no other calculation of the interest rate. There is bound to be a difference between a simple interest calculation ($4,000 interest/$20,000 loan, which is 20% p.a.) and the effective rate of interest.

27. In this case, if simple interest is used then the lending rate is 60%. However, in calculating the effective rate paragraph 1 of Schedule 2 must be followed.

28. Dr. Chan gave expert evidence for the plaintiff. He took the position that while Schedule 2 should be followed, paragraph 1 could be omitted, that it is not necessary to appropriate repayments between principal and interest. The plaintiff relies on S. 2(2) to support its argument that only when a rate has not been expressed in an agreement then the principal and interest shall be appropriated in accordance with Schedule 2 when repayment is made. When a rate has been expressed, is not necessary to appropriate the principal and interest in accordance with paragraph l of the Schedule. Dr. Chan acknowledged that there is no express support for this in the Ordinance, and that it is an assumption he has made which he believes to be correct.

29. In his oral evidence Dr. Chan expanded on his affirmation by saying that in a situation where the monthly repayment is equivalent to or less than the monthly interest, there is no need to appropriate between interest and principal. Appropriation is required only when the monthly payment is more than the monthly interest payment. In cross examination, he agreed that there is no such provision in the Ordinance and that he made this as a matter of assumption.

30. Dr. Chan said that since the calculation of compound interest is difficult and practically impossible to compute, the simple interest rate should be adopted for ease of calculation.

31. The plaintiff's second expert, Mr. Tam, agreed with Dr. Chan's calculation that the effective rate in this agreement is 60%. He relied on S. 2(2) for the proposition that appropriation is only necessary when a rate has not been expressed in the agreement. In this agreement, the interest rate charged is clearly expressed in terms of a rate - $55,000 is the interest per month and this amounts to 5% per month. His conclusion is that 'the amount paid or payable to the lender shall not be appropriated to principal and interest according to clause l of Schedule 2.' The appropriation should in fact be 0% to principal and 100% to interest.

32. Counsel for the defendant submitted that Mr. Fong's opinion is logical and is consistent with the provisions of the Ordinance. Paragraph 2 of the 2nd Schedule clearly states that the 'outstanding principal at any time shall be taken to be the balance remaining after deducting from the principal the total of the portions of any payments appropriated to principal in accordance with paragraph 1. Paragraph 2 makes particular reference to paragraph l, which provides for appropriation between principal and interest in the course of calculating the effective rate of interest. There is no basis for the plaintiff's experts to argue that appropriation under paragraph l is not required and to start their calculation process from paragraph 2 onwards. It is not a fair and proper interpretation of the Ordinance. In order to find the effective rate of interest, the steps set out in Schedule 2 must be followed and there is no discretion to skip any of those steps. In the present case, the $55,000 paid every month should be appropriated to interest and principal in the proportion that the total amount of principal bears to the total amount of interest in accordance with paragraph 2 of the Schedule. Adopting the calculation found at paragraph 5 of Mr. Fong's affirmation, the interest portion should be $12,692.31 and the principal portion should be $42,307.69. This would affect the outstanding balance of the principal in the calculation of the effective rate of interest - paragraph 2 of the Schedule.

33. Mr. Fong's calculation of the effective rate of interest in accordance with Schedule 2 is not challenged.

34. Counsel for the plaintiff described S.2(2) as a hurdle to the application of the Second Schedule. The Second Schedule is to be strictly adhered to, except when S. 2(2), described as a 'the special rule' by Counsel, is applicable, then there is no need for appropriation or apportionment. Paragraph l of the Second Schedule is not actually skipped, but rather the formula provided under the various paragraphs in the Second Schedule are strictly followed. As stated in Dr. Chan's affirmation, the apportionment is in effect $55,000 interest and $0 principal. No principal is repaid and the principal outstanding at all times is $1.1 million. Support for this can be found at page 104 of Dr. Ying's article. The Second Schedule is subject to S. 2(2). Mr. Tam's evidence is that since interest has been expressed in terms of a rate ($55,000 per month in relation to a principal of $1.1 million with a repayment period of six months) which is 5% per month, then 'any amount paid or payable to the lender under the agreement' shall not 'be appropriated to principal and interest in the proportion that the total amount of the principal bears to the total amount of interest.'

35. Counsel then submitted that S.2(2) and Clause l of the Second Schedule, taken together, must by implication support the contrary proposition. If the interest is not expressed in terms of a rate then the amount paid shall be appropriated to principal and interest, then if interest is expressed in terms of a rate then the amount paid shall not be appropriated to principal and interest.

36. Counsel asks the rhetorical question - if any amount paid or payable to the lender on the loan must be appropriated in any event, whether the interest charged on the loan is or is not expressed in terms of a rate, then what is the purpose of S. 2(2)?

37. Counsel for the plaintiff summarised her argument. The plaintiff is not an expert and he did not understand the meaning of the effective interest rate and the defendant should not be unjustly enriched because of the plaintiff's ignorance. She referred to the definitions of 'principal' and 'interest' in the Ordinance. The interest of $55,000 per month equates to 5% per month and that by virtue of S.2(2) the amount paid shall not be appropriated to principal and interest in accordance with paragraph 1 of Schedule 2, the principal outstanding at all times being $1.1 million. According to paragraph 2 of Schedule 2, the apportionment is $55,000 to interest and $0 to principal. On this basis, and following the formula laid out in paragraphs 3 and 4 of Schedule 2, the effective rate of interest is 60%. Using the orthodox formula of 5% x 12 months, the effective rate of interest is 60%.

Ruling

38. From time to time, reference was made to Dr. Louis K.W. Ying's article entitled 'Effective Rate of Interest' published in the Hong Kong Law Journal (l986) at page 95. In his article, Dr. Ying argues the need to amend the second schedule. Briefly, Dr. Ying argues that the effective rate calculated by reference to the Second Schedule is not the true or effective rate that finance professionals understand and accept, and that the procedures ignore the compound interest element in the calculation, with the result that the effective rate of interest so calculated understates the true rate of interest on the loan, which allows lenders to lend at interest rates that actually exceed 48 or 60 per cent per annum. His conclusion is that the second schedule must be amended so that the statutory 'effective rate of interest' is properly defined.

39. Sections 2(2) and 18 make reference to Schedule 2. Section 2(2) refers to an agreement for the loan of money where the interest charged is not expressed in terms of a rate. Section 18 refers to the form of agreement for repayment of money lent by a money lender, and subsection (2) provides that 'The note or memorandum shall contain all the terms of the agreement and in particular shall set out ...(i) the rate of interest charged on the loan expressed as a rate per cent per annum, or the rate per cent per annum represented by the interest charged as calculated in accordance with Schedule 2 ....'

40. While it is not disputed that $55,000 per month on the loan of $1.1 million produces a simple interest rate of 60% per annum and that throughout the agreement the loan of $1.1 million remained owing, I am of the view that these facts are not grounds for holding that the agreement has satisfied the requirements of the Ordinance as to the effective rate of interest. The Ordinance recognises the existence of simple interest with its reference in Section 2(2) to simple interest chargeable under the proviso to Section 22, relating to late payment. S.2(2) makes it clear that if the interest charged on the loan is not expressed in a rate, and I understand this to mean for example 5% per annum, then 'any amount paid or payable to the lender ... shall be appropriated to principal and interest in proportion that the total amount of principal bears to the total amount of interest, and the rate per cent per annum represented by the interest charged as calculated in accordance with Schedule 2 shall be deemed to be the rate of interest charged on the loan.' I do not accept the argument that the $55,000 per month can be appropriated $55,000 to interest and $0 to principal. It is an attractive argument, but it does not accord with the provisions of the Ordinance as to the effective rate of interest.

41. The Ordinance provides that, in the absence of a specific percentage rate per annum being stated in the loan agreement, whatever the provisions in the loan agreement as to payments by instalments and/or interest, the effective rate of interest is that calculated in accordance with the mechanism set out in the Ordinance. The effective rate of interest is not a simple rate and it is not a compound rate, it is a creature of statute which imposes a uniform method of calculation of interest in those loan agreements where the interest rate is not identified as a percentage rate per annum. I am satisfied that in this case all the paragraphs under Schedule 2 are required to be followed in order to calculate the effective rate of interest under the agreement between the plaintiff and the defendant. I accept Mr. Fong's calculations in accordance with Schedule 2 which results in an effective rate of interest of $66.38% per annum, which renders the loan agreement unenforceable under the provisions of Section 24.

42. I do not find Counsel's 'contrary' argument to be persuasive. The provisions of the Ordinance are clear - if interest is expressed in terms of a rate (and that means exactly what it says - 5% or 10% per annum for example) there is no need for appropriation. In every other case, appropriation must be carried out in accordance with the provisions of Schedule 2. In this way, the legislature controls the rate of interest charged.

43. While I have some sympathy for the plaintiff, the Ordinance must be complied with. Ignorance of the provisions is not a defence.

44. I make a costs order nisi to be made absolute within 21 days, that the costs of the hearings before me on the preliminary issue are to be paid by the plaintiff to the defendant with certificate for counsel, to be taxed if not agreed.