FULL WISDOM HOLDINGS LTD AND OTHERS v. TRAFFIC STREAM INFRASTRUCTURE CO LTD AND OTHERS

CACV 266/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 266 OF 2003

(ON APPEAL FROM HCA NO. 1939 OF 2002)

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REASONS FOR JUDGMENT

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Hon Ma CJHC:

1. I agree with the reasons of Le Pichon JA for dismissing the present appeal. I would, however, wish to emphasise in particular the reiteration of the court's approach to dealing with evidence of foreign law, contained in paragraph 23 below.

Hon Le Pichon JA:

2. This is an appeal by the 5th to 7th defendants ("the personal defendants") from the order dated 28 August 2003 by Chung J whereby the judge granted summary judgment pursuant to Order 14 rule 3 and made the declarations sought by the plaintiffs in their Statement of Claim and also ordered the delivery up by the personal defendants to the 1st to 3rd plaintiffs all the property, books and records of any of the Hong Kong companies including those specified in the schedule to the order and which were in their possession, power or control. The declarations related to the appointment of the 1st to 3rd plaintiffs as directors of the 1st to 4th defendants ("the Hong Kong companies"), the removal of the 7th defendant as the secretary of those companies and the appointment of the 1st plaintiff in his place and the validity of resolutions passed by the 1st to 3rd plaintiffs as directors of the Hong Kong companies on 14 May 2002. At the conclusion all the appeal hearing, the appeal was dismissed for reasons to be given in writing later which we now do.

Background

3. The Hong Kong companies are wholly-owned subsidiaries of Traffic Stream (BVI) Infrastructure Ltd, ("Traffic Stream BVI"), which is a subsidiary of Traffic Stream (China) Infrastructure Co. Ltd ("Traffic Stream China"). Traffic Stream BVI holds interests in certain toll road projects in the PRC (involving the construction, development and operation of toll roads) through the Hong Kong companies. These infrastructure projects involved joint venture contracts being entered into between the Hong Kong companies and Mainland Chinese entities ("the Joint Venture Contracts"). There were about 13 sub-contracts. Under these contracts, certain sums were guaranteed to the 'foreign' party (i.e. the HK companies). The 5th and 6th defendants were the directors of the Hong Kong companies and the 7th defendant was the secretary of those companies until his removal by resolutions of the 1st to 3rd plaintiffs dated 14 May 2002. The 1st to 3rd plaintiffs were themselves appointed directors on 3 May 2002 in circumstances further dealt with below.

4. On 6 May 1998, Traffic Stream BVI authorised the creation and issue of US$119 million worth of a 141/4% Senior Secured Notes due 2006 ("the Notes") pursuant to an indenture of that date ("the Indenture") in order to finance the various said highway infrastructure projects in the Mainland. The terms upon which the Notes were issued were set out in the Indenture. They provided for ongoing liabilities due from Traffic Stream BVI to noteholders including payment of interest and repayment of principal. The 4th plaintiff ("the Bank") was appointed trustee under the Indenture. The parties to the Indenture are Traffic Stream BVI, the Bank and Chase Manhattan Bank Luxembourg SA as the paying agent. The Indenture which is governed by New York law contains a non-exclusive jurisdiction clause in favour of the New York courts. The Notes were placed with financial institutions and subsequently traded. The persons beneficially interested in the 1st to 3rd plaintiffs are the current owners of more than 90% of the Notes.

5. Also on the 6 May 1998 Traffic Stream BVI executed a share mortgage ("the Share Mortgage") charging all of the issued and outstanding capital stock of the Hong Kong companies to which it was beneficially entitled together with the dividends thereon to the Bank (and the Bank's nominee) acting for the holders of the Notes. This was a part of the security for Traffic Stream BVI's obligations expressly envisaged under the Indenture. The 5th and 6th defendants and South-East Asia Investment Holding Co. Ltd being the holders of the non-voting deferred shares in the Hong Kong companies mortgaged and charged the same together with the dividends thereon to the Bank. The Share Mortgage which is governed by Hong Kong law contains a non-exclusive jurisdiction clause in favour of the Hong Kong courts.

6. The Share Mortgage provided that should an event of default occur, the Trustee was entitled to exercise the voting rights attached to the shares. Although there was no definition of event of default in this document, section 501 of the Indenture defined "event of default". The Indenture and the Share Mortgage are obviously connected and indeed cross-refer to each other. It was the plaintiffs' case and appears to be common ground that events of default as defined in that section had occurred and were continuing.

US proceedings

7. On 3 June 1999, the Bank commenced an action against Traffic Stream BVI in the United States District Court for the Southern District of New York alleging defaults under the Indenture. Traffic Stream BVI basically admitted the existence of facts which would constitute events of default but sought to raise the defence of impossibility of performance. It contended that it was unable to perform the various obligations in question under the Indenture because the central government of the Mainland had changed its policy and, as a result, the Chinese partners to the joint ventures failed to make payments to it as agreed. This in turn led to its inability to fulfill the payment obligations in respect of the Notes. The court dismissed the submission of impossibility and granted summary judgment. On appeal, after a detour on a jurisdictional point which went as far as the Supreme Court, on 20 November 2002, the United States Court of Appeals affirmed the summary judgment granted by the US District Court. The mandate in favour of the Bank was issued by the US Court of Appeals on 11 December 2002.

8. Some three months prior to that, on 16 September 2002, the PRC State Council had issued a notice ("the State Council Notice"), the effect of which will be considered below. Suffice it to say that the defendants' stance was that it had the effect of rendering void ab initio all guaranteed return provisions in Joint Venture Contracts. This notwithstanding, Traffic Stream BVI took no steps to apply to the US Court of Appeals for a rehearing of its decision to affirm the District Court judgment or to seek any extension of time for such an application.

9. On 6 January 2003, the Beijing Global Law Office provided Traffic Stream BVI with a legal opinion ("the Opinion") as to the effect of the State Council Notice. Four days later, on 10 January 2003, Traffic Stream BVI filed a motion requesting the US Court of Appeals to recall the mandate of 20 November 2002 to permit Traffic Stream BVI to raise the new defences of illegality and mistake. That motion was denied on 22 January 2003.

10. On 7 March 2003, Traffic Stream BVI applied under rule 60(b) of the US Federal Rules of Civil Procedure to the US District Court to open and vacate the judgment on the basis that new defences based on illegality and mistake had come to light since the courts earlier ruling. The application was put on the basis that it was only in November 2002 that it came to the attention of the Hong Kong companies that the Chinese government had announced the new edict which made clear that the guarantee provisions contained in the underlying Joint Venture Contracts was, in fact, unlawful. The judge took the view that the defendants knew that they were not supposed to make the guarantees, that the local culture was that they were doing it anyway and the defendants therefore assumed the risk. The judge dismissed the application on the basis that the defendants knew that the guarantees were potentially unenforceable. The defendants appealed against the dismissal of the rule 60(b) application. Their appeal was dismissed by the US Court of Appeals on 4 June 2003.

Appointment of the 1st to 3rd plaintiffs as directors and the plaintiffs' requests

11. Clause 6.2 of the Share Mortgage entitled the Bank to exercise the rights and powers attaching to the ordinary shares and the non-voting deferred shares and otherwise to enforce its security upon an occurrence of event of default. I have already referred to the transfer of shares in paragraph 5 above. On 3 May 2002, the 1st to 3rd plaintiffs were appointed directors of the Hong Kong companies. They sought to inspect the books and records of those companies pursuant to their powers as directors on 10 May 2002. Their request was refused and the Hong Kong companies also refused to recognise the appointment of the 1st to 3rd plaintiffs as directors.

12. On 14 May 2002, the 7th defendant was removed as secretary of the Hong Kong companies by the 1st to 3rd plaintiffs. The defendants, however, refused to acknowledge the board resolutions and/or the appointments and the removal. They also refused to allow inspection of the property, books and records of the Hong Kong copies or to deliver up their statutory books or records. This led to that part of the claim seeking declaratory orders relating to the appointments and removal and certain other board resolutions as well as for delivery up of the items sought. In the plaintiffs' view, there was no defence. Accordingly, they took out an order 14 summons.

The proceedings below

13. The Hong Kong companies did not participate in the proceedings below which were resisted by the personal defendants only. The personal defendants submitted that they had at least an arguable defence based on illegality and mistake. Also at the date of the hearing below (22 May 2003), the decision of the US Court of Appeals on the appeal from the US District Court's decision dismissing the application to raise the new defence was not yet known.

14. The judge accepted the plaintiffs' submissions that the new defence was nothing more than a delaying tactic and was not capable of belief and, further, if it were capable of belief, it did not amount to a valid defence to the plaintiffs' claim. On the question of delay, it transpired that Traffic Stream BVI first knew of the State Council Notice on 19 November 2002. Yet it took no action to appeal the decision dated 22 January 2003 of the US Court of Appeals denying the motion to recall or to ask for a rehearing of that decision, or to appeal its decision of 20 November 2002 affirming the summary judgment. Then when Mr Albert (the legal adviser for Traffic Stream BVI in the US proceedings) applied to the US District Court to vacate its judgment based on the new defence, he admitted that the State Council Notice was merely" a clarification of the law that existed at the time the Notes and Indenture were executed". Moreover, Mr Albert did not deny that Traffic Stream BVI knew of the illegality at the time it entered into the Indenture when the matter was put to him.

15. As to the lack of credibility, the judge accepted the submission that Mr Albert's opinion on US law could not be relied upon: his legal opinions on various issues had been shown to be wrong in the decisions of the US courts. Further, prior to the decision of the US Court of Appeals denying the motion to recall becoming available, Mr Albert had represented to the court that that motion was the only means of challenging the Court of Appeals' judgment of 20 November 2002. That was obviously not true given the rule 60(b) application made subsequently (see paragraph 10 above). On the question of lack of merits of the new defence, the judge agreed with the plaintiffs that it could not be valid given that section 501(11)(C) of the Indenture, to which further reference is made below, makes provision for any of the Joint Venture Contracts being wholly or partially illegal, invalid or unenforceable. He considered that the mis-statements of Mr Albert regarding the substantive and/or procedural laws of Traffic Stream BVI's US court applications went beyond merely that his legal opinion happened not to have found favour with the US courts.

16. As to the defence of illegality and mistake which it was said was open to the Hong Kong courts to consider free from procedural constraints, having regard to his conclusion that the evidence adduced by the personal defendants regarding foreign law was incapable of belief, the judge concluded that the personal defendants had failed to show a triable issue as to whether the new defence was valid under US law and that the defence was not triable according to Hong Kong law. As to the defence of impossibility of performance, the judge concluded that for practical purposes the Hong Kong courts would not depart from the decisions made by the US courts in this regard.

This appeal

17. Mr Chua SC who appeared for the personal defendants submitted that the judge had erred in his approach to foreign law, and as to whether the present case was appropriate for summary judgment. But the crux of his submission revolved around a single point: that the personal defendants had an arguable defence based on mutual mistake. It is to be noted that in the appeal before this court, the personal defendants no longer sought to rely on the defence of impossibility which was one of the matters dealt with in the US proceedings. When asked to clarify whether the common assumption of legality was of the underlying Joint Venture Contracts or the Indenture or the Share Mortgage or all three, Mr Chua confirmed that the mutual mistake arose from a common assumption of the legality of the underlying Joint Venture Contracts which, it was submitted, had been rendered void ab initio by the State Council Notice. One of the difficulties of this submission is, of course, the fact that the Indenture does not appear to be dependant on the Joint Venture Contracts and, in fact, has little to do with payments to be made under them. This is all the more so in the case of the Share Mortgage.

18. I now turn to consider the various matters upon which Mr Chua based his submission that the State Council Notice rendered the underlying Joint Venture Contracts void at inception. The logical starting point is the State Council Notice itself.

The State Council Notice

19. On 10 September 2002, the General Office of the State Council issued Guo Ban Fa [2002] No. 43 relating to "the Proper Handling of Existing Foreign Investment Project with Guarantee of Fixed Return." The court was provided with an undisputed translation of this document. Part II of the document read:

" II. Adopting Various ways (to) Properly Handle Different Kinds of Projects of Fixed Return

According to the above principle, the following (measures) may be adopted in respect of different kinds of projects of fixed return:

(I) As to projects in which the fixed return to foreign investor is paid with the proceeds generated by the projects themselves, the Chinese and foreign parties should, basing on sufficient negotiation, amend the contract or agreement so as to replace the payment of fixed return with lawful proceeds distribution, such as early recovery of investment.

(II) As to projects suffering loss or having insufficient proceeds, which pay the foreign parties a proportion or large proportion of investment return by using funds outside the projects, or projects of which the investment return undertaken has not been paid to the foreign parties, depending on the circumstances of the projects, measures of 'revision', 'acquisition', 'change' or 'termination' may be adopted:" (emphasis added)

The State Council Notice then went on to describe in greater detail the various measures suggested. None of those measures appeared to be mandatory as appears from the language used: see, for example,

"'Revision'. Through ... negotiation, cancel or amend the terms ....

'Acquisition'. After consensus has been reached ... the Chinese party may acquire all the shares of the foreign party at a reasonable price ....

'Change'. ... application may be made for changing the original foreign investment to foreign debt of the Chinese party ....

'Termination'. As to enterprises suffering severe loss ... the performance of the joint operation contract may be terminated by the following statutory procedures ...." (emphasis added)

The thrust of this was no more than that the parties concerned were urged to adopt 'remedial' measures should the need arise. Part III provided as follows:

" III. Close Co-ordination, Strict Enforcement of Law, Maintenance of the Favourable Circumstances of Attracting Foreign Investment

In areas where projects of fixed return have not been properly handled, the People's Government of the provinces [autonomous regions (and) municipalities] where the projects are situated should adopt effective methods to handle existing projects of fixed return in pursuance of the above principles and opinions, and complete the rectifying work before the end of 2002 ....

With effect from 1 January 2003, for projects of fixed income in which the proceeds got by the foreign party exceed the distributable operational income and other lawful income of the projects, authorized forex banks cannot proceed for them with the purchase of foreign currency or payment out without the approval of the State Foreign Exchange Authority.

... From now on, no unit may violate regulations of the State by providing guarantee of fixed return to foreign investment parties, or borrowing money from foreign parties with the excuse of attracting foreign investment. Any breach discovered will be dealt with severity, the signed contract or agreement will be held invalid, and at the same time, the leaders and people-in-charge will be investigated with liabilities determined." (emphasis added)

20. It will be seen that it is nowhere expressly stated in the State Council Notice that a contract which provides for a guaranteed return is void ab initio. On the contrary, the fact that different measures were contemplated to 'remedy' the situation presupposed the continued existence of the contracts until such time as the relevant contract was reformulated through adopting and implementing one of the measures suggested. Were the contract void from inception there would be nothing left to reformulate. Moreover, one would expect the question of restitution to be dealt with if the transaction was to be rendered illegal from inception: it was not. The State Council Notice, in particular Part III, appeared to be directed at cases of loss making joint ventures only and targeting specific provisions rather than the entire underlying contract. There is also the point that it was 'prospective', the key date being 1 January 2003. Prior to that date, the parties were meant to undertake "rectifying work". That fact alone is incompatible with any suggestion that the State Council Notice had the effect of rendering all foreign joint ventures guaranteeing fixed returns void at inception.

21. In my view, these matters actually undermine the submission that the State Council Notice had the effect of rendering the underlying Joint Venture Contracts void from inception. In fact, Mr Chua had to accept that prior to the issuance of the State Council Notice, the underlying Joint Venture Contracts were legal.

Expert opinion on PRC law

22. The personal defendants relied upon the Opinion of the Beijing Global Law Office in support of its case that the State Council Notice had the effect of rendering the underlying Joint Venture Contracts void from inception. The legal reasoning appears in paragraphs 11 and 12 of the Opinion (as translated):

"11	Pursuant to the provision of Article 58 in 'People's Republic of China General Principles of Civil Law' ... Article 9 in 'People's Republic of China Contract Law Involving Foreign Economy' (... repealed since 1st October 1999), and Article 52 and Article 56 in 'People's Republic of China Contract Law' (passed in the 2nd meeting of the 9th National People's Congress on 15th March 1999, with effect from 1st October 1999), contract terms breached the law and Administrative Statute will have no legal effect at the very beginning.
12	In our opinion, the terms providing foreign investor with fixed investment return in the Sino-foreign Cooperation Joint Venture contract and memorandum breach the requirements of the 'Law of Joint Venture', the 'Implementation Rules' and the 'Notice'. These contract terms in breach of the law and Administrative Statute have no legal effect since the establishment of Sino-foreign Cooperation Joint Venture Contract and Memorandum. In addition, because of its illegality, approval should not be given by the approving authority. Even if these terms have been approved by the approving authority, they cannot become legal by having approval given by the approving authority. The approval given by the approving authority cannot compensate or rectify the illegality of those terms.

This legal opinion is provided for Traffic Stream (BVI) Infrastructure Limited to define the legal status and effectiveness of the 'Notice', and the illegality of the fixed investment return to foreign investors."

23. It is to be noted that whilst paragraph 11 sought to summarize the effect of PRC administrative and contract law, it is unclear if the writer ever considered the underlying Joint Venture Contracts themselves. In studying the validity of any opinion based on foreign law, the court does not simply accept any stated conclusions as being correct, even where there may be no legal opinion contradicting it. The court is entitled to (and indeed must) look at the basis of the legal reasoning as well as the terms of the State Council Notice in determining what weight, if any, should be attached to the Opinion. It is to be noted that there was no mention of any distinction between profitable and loss making joint ventures or of restitution and there was no attempt to address the 'prospective' nature of Part III of the State Council Notice. The Opinion was singularly lacking in legal analysis. In these circumstances, as a matter of principle, it would be wrong to attach any weight to it.

Mr Albert's opinions

24. The personal defendants also relied upon Mr Albert's opinions as demonstrating a triable issue of law. However, Mr Albert's opinions were based entirely on what was before him. They were thus founded upon the State Council Notice and the Opinion. In my view, for the reasons given above, no weight can be attached to the Opinion and/or the State Council Notice as having the effect contended for by the personal defendants and which Mr Albert, in his opinion letter of 4 February 2003, characterized as "supervening Chinese law ... that held [the joint venture agreements] to be void at the outset."

Section 501 of the Indenture

25. In pertinent part, it provided as follows:

" SECTION 501. Events of Default.

'Event of Default', wherever used herein, means any one of the following events (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order any court or any order, rule or regulation of any administrative or governmental body):

...

(11)	... (C) any of the Joint Venture Contracts becomes wholly or partially illegal, invalid or unenforceable and the Company fails to obtain a Rating Confirmation within 45 days after any such event occurs."

26. As I understand it, the personal defendants' case is that because of the mutual mistake, the Joint Venture Contracts were void at inception. That being so, Mr Chua submitted the whole Indenture goes including section 501. In any event, the plaintiffs cannot rely on section 501(11)(c) because that provision contemplated subsequent events and not supervening events rendering the underlying contracts void at inception by operation of law. Much reliance was thus placed on the use of the word "becomes" in section 501(11)(c). But it was accepted by Mr Chua that prior to the State Council Notice, the underlying contracts were legal and it was only the publication of that Notice that caused them to 'become' illegal. In those circumstances, it seems to be unarguable that section 501 and in particular, subsection (11)(C) did not apply.

27. In my view, having regard to the fact that the personal defendants have failed to establish an arguable case that the underlying contracts became void at inception by operation of law, the further question whether or not the Indenture itself became tainted or was a free standing agreement unaffected by any illegality of the underlying contracts does not arise. And if it did, section 501 of the Indenture is conclusive against the defendants. This being the case, the enforcement by the plaintiffs of their rights under the Share Mortgage was valid. The judge was quite right to have granted summary judgment.

Hon Cheung JA:

28. I agree.