FO SHAN SHI SHUN DE QU CONSONANCY INVESTMENT CO LTD v. YAT KIT JONG AND LAM HOK CHUNG RAINIER, JOINT AND SEVERAL LIQUIDATORS OF WONGS INVESTMENT DEVELOPMENT HOLDINGS GROUP LTD (In Liquidation)

HCCW 332/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO 332 OF 2012

____________

____________

_____________

D E C I S I O N

_____________

Background

1.  Wongs Investment Development Holdings Group Limited (“the Company”) was ordered to be wound up in 2013.  The applicant (“Consonancy”) lodged a proof of debt on the strength of an arbitral award for RMB87.18 million. The debt represented a loan of RMB80 million to Xiancheng Group Co Ltd (“the Borrower”), for which the Company was a guarantor.  There was a written Loan Agreement and a written Guarantee Agreement.

2.  The Liquidators rejected the proof of debt. They questioned the existence of the loan and guarantee and, if they genuinely existed, their validity and enforceability under PRC laws.  The Liquidators also asserted that the 2 years (counting from maturity of the loan) to call upon the guarantee had expired when the Liquidators were given notice of the commencement of the arbitration proceedings. 

3.  Consonancy appeals against the Liquidators’ rejection.

4.  Mr Justice Anthony Chan has given leave to the parties to adduce expert evidence on PRC law for the appeal.  This hearing is to determine the scope of the expert evidence.

5.  The Liquidators set out 5 pages of questions (“the Questions”) for the expert to give opinion on.  They are wide ranging issues, from asking whether specific legislative provisions apply to general questions like whether there are other provisions applicable. 

6.  Consonancy, on the other hand, wants only expert evidence on 4 questions but insisted them to be in an “open-ended format” instead of being “pre-set”.  Mr Yim, counsel for Consonancy, submits that to allow the Liquidators to ask “rhetorical and/or leading questions” of which answers have already been researched would not assist the court in adjudicating the live issues of the case. He submits that the Liquidators have resorted to complex PRC legal arguments in order to post-legitimize their wrongful rejection of the proof of debt.

Legal principles for adducing expert evidence

7.  Expert evidence must be confined to the live issues between the parties.  Typically the live issues are defined by pleadings.  In this case where there are no pleadings, the affidavits will define the issues.

8.  Where the proposed expert evidence is plainly inadmissible or irrelevant, the court will refuse to admit it.  But where the court cannot form a clear view on relevance of the proposed expert evidence or where it considers that the proposed evidence is clearly relevant, it should grant leave for the expert evidence to be adduced at the trial.  Wong Hoi Fung v American International Assurance Co (Bermuda) Ltd & anor [2002] 4 HKC 225, Chu J (as she then was), at §11.

9.  The expert should not be left to define for himself the questions he has to answer from reading lengthy pleadings (or affidavits in this case).  Questions for the expert should preferably be framed as “yes” or “no” or “multiple choice” questions. See Kam Hing Trading (HK) Ltd v The People’s Insurance Company of China (HK) Ltd & anor [2009] 4 HKC 531, Registrar Au-Yeung (as she then was).

Application of the legal principles

10.  Before I analyze the proposed questions for the expert, I wish to deal with the submission of Mr Yim in paragraph 6 above.

11.  An appeal against the rejection of proof is by way of rehearing.  The Liquidators are cast in the role of an adversary defending the assets available for distribution against a liability which, in their view, is not legally enforceable. He is a party litigant though he is required to act fairly in conducting the litigation.  In hearing the appeal, the court is bound to decide the rights of the claimant in the light of all the evidence before it, and not merely to express a view that the Liquidators were right or wrong in rejecting the proof of debt on the evidence then available before them.  The onus is on the claimant to show on a balance of probabilities that a real debt is due to him.  Re Moulin Global Eyecare Holdings Limited, HCCW 470/2005, 19 December 2013, §§30-31, Au-Yeung J.

12.  Having a duty to act fairly to protect the assets of the estate, it is entirely legitimate for the Liquidators to put Consonancy to strict proof of the existence and validity of the loan and guarantee as set out in paragraph 2 above.  The Liquidators are not confirmed to the reasons for rejection given in correspondence or their memorandum. Mr Yim cannot complain that the Liquidators seek to “post-legitimize” their rejection of the proof of debt.

13.  Mr Yim’s submission that the Liquidators asked “rhetorical and/or leading questions” of which answers have already been researched is, with respect, difficult to understand.  It is always the duty of both parties to identify the issues and draft the questions in the manner set out in paragraph 9 above. That said, I find that the Questions fall short of the legal requirements for seeking to adduce expert evidence in that they open up issues never referred to in either party’s affidavits.  There are also open-ended questions asked of the expert.  I will demonstrate why.

14.  Questions as to existence of the loan and guarantee are matters of fact and do not require expert evidence.  PRC law was raised in only 3 paragraphs of the affidavit of Mr Jong, one of the Liquidators:

“ 3.18 I also understand that, separately, there are legal issues regarding the validity of the Consonancy Loan Agreement. I will leave these to those qualified to opine on the relevant law. However, I note that Article 61 of the General Provisions on Lending issued by the People’s Bank of China … states that ‘no financing business involving lending or borrowing, or lending or borrowing in a disguised form, may be handled between enterprises in violation of the State provisions.’

3.44 I also understand there are legal issues regarding the validity and enforceability of the Consonancy Loan Guarantee Agreement. I will leave explanation of these matters to those qualified to opine on the relevant law, but I am aware that at the time of the Consonancy Loan Guarantee Agreement was signed, the PRC Government had imposed very strict regulations with regard to the provision of overseas’ security for onshore lending, including where security is provided by an offshore security provider (such as the Company in this case) for a debt owed by an onshore debtor (such as the Xiancheng Group in this case) to an onshore creditor (such as [Consonancy] in this case).

3.45 In this case, [Consonancy] has not shown that there was any special quota obtained from the State Administration of Foreign Exchange (‘SAFE’) nor that there was any registration or approval obtained from SAFE in relation to the creation of the cross border security.  In the circumstances, the Liquidators have concerns as to enforceability of the Consonancy Loan Guarantee Agreement.”

15.  Such averments make it hard for a reader to understand in what way the loan/guarantee fell foul of PRC law.  And yet a number of legislative provisions are referred to in the Questions.  Open-ended questions are asked, such as whether there are any other relevant PRC law and regulations that might impact the validity and enforceability of a loan/guarantee agreement between 2 PRC private companies.  The skeleton submission of Mr Powell did not correlate such questions to the relevant parts of the affidavits.

16.  To this, Mr Powell’s submission is that the Liquidators are in a difficult position, as they came on to the scene after the loan was made and could not find the Loan and Guarantee Agreements amongst the Company records.  Mr Jong is not qualified to put on affidavit the relevant PRC law.  There are also no pleadings to define the issues in the appeal. 

17.  This is not an answer.  Mr Jong did refer to some PRC legislative provisions eg §3.18 of his affidavit. Ironically, in the course of his submission, Mr Powell handed up a series of legislative provisions referred to in the Schedule.  Obviously, someone has done some research or given advice on possible applicable PRC law.

18.  There was simply no reason why Mr Jong could not have put on affidavit why he thought or that he has been advised that those provisions were relevant, and relevant to which issue.

19.  In answer to the court’s enquiries as to whether or not it is the Liquidators’ case that certain legislative provisions have been violated, Mr Powell frankly admits that he does not have a case yet. 

20.  It is not legitimate to seek to adduce expert evidence where there is no issue raised (be it by pleadings or affidavit).  The attempt of the Liquidators is akin to asking the expert for advice in the hope that something can come up to enable the Liquidator to set up a case against the claimant.  This is putting the cart before the horse.  A party cannot fish for evidence under the disguise of putting the other party to strict proof or seeking to adduce expert evidence on non-issues. 

21.  In the course of the arguments, Mr Powell has reduced the scope of the Questions.  There is no issue that PRC law applied.  Q1 & Q3, Q5 and Q7 (being 3 of the 4 sets of questions agreed to by Consonancy) are no longer pursued.  I shall analyze the remaining questions.

Analyses of individual questions

22.  Q2.1 asks whether the Loan Agreement complied with the formalities and/or other requirements of PRC law with which the parties must comply whether executing a loan agreement between 2 PRC private companies and if yes, how might the validity and enforceability of the Loan Agreement be affected if these formalities and other requirements were not satisfied.

23.  Neither Mr Jong's affidavit nor even Q2.1 alleged that the Loan Agreement failed to comply with any formalities or “other requirements” of PRC law. The term “other requirements” is simply open-ended.  Consonancy was deprived of an opportunity of rebuttal. 

24.  In my view, the burden is on the Liquidators to show that PRC law had been violated.  In proposing to ask Q2.1, the Liquidators have gone beyond merely putting Consonancy to strict proof.  They are asserting a positive defence that the Loan Agreement failed to meet formal or other requirements.  Not having raised that defence on affidavit, there is no issue for the expert to give an opinion on.  Q2.1 is refused.

25.  Q2.2 asks whether Articles 52 and/or 54 of the Contract Law of the People’s Republic of China apply to a loan agreement between 2 PRC private companies. 

26.  Article 52 provides that a contract is invalid if “(i) either party enters into the contract by means of fraud or coercion and impairs the State’s interests; (ii) there is malicious conspiracy causing damage to the interests of the State, of the collective [some words missing] or of a third party; (iii) there is an attempt to conceal illegal goals under the disguise of legitimate forms; (iv) harm is done to social and public interests; or (v) mandatory provisions of law and administrative regulations are violated.”

27.  Article 54 gives the rights to a party to alter or rescind any contract which is made under substantial misunderstanding or if the making of the contract lacks fairness, or if a party makes the other party enter into a contract against its true will by means of deceit, coercion or taking advantage of its difficulties.

28.  As confirmed by Mr Powell in the course of his submission, the Liquidators rely on §3.44 of Mr Jong’s affidavit.  The Liquidators have not even alleged that any of the vitiating factors in Articles 52 or 54 might invalidate the Loan Agreement.

29.  Mr Powell submits that if the Liquidators are precluded from putting the question to the expert, the Liquidators will not have a case to put before the court.  In my view, this is a clear statement that the Liquidators do not have a case for rescission due to any of the vitiating factors.  Q2.2 must be refused as being irrelevant, seeking legal advice and fishing expedition (paragraph 20 above).

30.  One part of Q2.3 asks questions about the need for a PRC private company to obtain a business license and whether the validity and enforceability of an agreement will be affected if a PRC private company engages in activities outside the scope of business in the business license. 

31.  This question is relevant. Consonancy’s business was investment in various fields of business and provision of consultancy service for investors and it lent money to the Company.  The Liquidators challenge Consonancy as having no business and is only a bogus company submitting a bogus claim against the Company.

32.  I allow expert evidence to be adduced on this part of Q2.3.

33.  Another part of Q2.3 asks whether the PRC private company’s scope of business has to be stated in the business license and what the consequences to the company are if its activities fell outside the scope of its licensed business.  It is not the business of the Hong Kong court to enquire into these questions and so expert evidence on this aspect is refused.

34.  Q2.4.1 asks whether the validity and enforceability of the Loan Agreement is affected by Articles 11 and 19 of the Provisions of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Private Lending Cases.

35.  Article 11 provides that “where a party claims the validity of a private lending contract signed as required for production or business operation among legal persons and other organizations, except under the circumstances as set forth in Article 52 of the Contract Law or Article 14 of these Provisions, the People’s Court shall support such a claim.”

36.  Article 19 provides that “where the People’s Court finds that any the following circumstances when trying a case concerning private lending disputes, it shall strictly examine the reason, time and place of loan, source of funds, payment methods, fund flow and the relationship among the economic status and other facts of the borrower and the lender, and comprehensively judge whether it is a false civil lawsuit.”

37.  It is not clear how this Article will assist the Liquidators in showing that the Loan Agreement was invalid or unenforceable. Nor is it clear how the PRC court differs from the way the Hong Kong court examines the evidence.  Q2.4.1 is refused.

38.  Q2.4.2 asks whether 3 sets of legislative provisions affect the validity and enforceability of the Loan Agreement, ie the Official Reply of the Supreme People’s Court on “How to Handle the Failure of the Borrower of a Loan Contract between Enterprises to Repay the Loan within the Specified Time Limit” as revised in 2008;Articles 3 and 11 of the Law of the People’s Republic of China on Commercial Banks as amended on 27 December 2003; and Article 61 of the General Rules for Loans (Order No.2, 1996 of the People’s Bank of China).

39.  It is not clear from Mr Jong’s affidavit how the first 2 sets of legislative provisions assist in the present case.  Article 61 of the General Rules for Loans presumably is the same as the Article 61 referred to in §3.18 of Mr Jong’s affidavit.  Mr Jong’s affidavit has not identified which State provision has been violated and Article 61 has not specified the sanction for its violation. The question concerning Article 61 is one of the four questions that Consonancy agrees to seek expert evidence on. Even so, I am unable to see the relevance of this question.  

40.  The 3 sets of legislative provisions being irrelevant, Q2.4.2 is refused.

41.  Q2.4.3 asks whether a loan granted by one PRC private company to another must be for a legitimate purpose and if yes, how the validity and enforceability might be affected if the loan was not granted for a legitimate purpose.

42.  The loan was allegedly advanced to the Borrower for satisfying the “working capital requirement”.  Mr Jong’s affidavit did not state that that was an illegitimate purpose.  Rather, it was the destination of the funds (to an unrelated third party) that was a “mystery” to Mr Jong.  The expert evidence sought is not relevant to any issue and is refused.

43.  Q2.5 asks whether there are rules governing the charging of interest for loans by one PRC private company to another, including but not limited to the permissible rate of interest gained, punitive interest rates and how the validity and enforceability of such loan agreements be affected by the amount of interest charged under the loan agreement.

44.  Mr Jong has not challenged the interest rate on the loan or quantum in the event liability against the Liquidator is established.  Q2.5 is not relevant.

45.  Q4.1 and Q4.2 (concerning guarantee agreements) are in the same veins as Q2.1 and Q2.2 (concerning loans).  For the reasons given in respect of Q2.1 and Q2.2, expert evidence is not admissible.

46.  Q4.3 asks if Article 30 of the Guarantee Law of the People’s Republic of China and/or Article 45 of the Judicial Interpretation of the Supreme People’s Court on Some Issues Regarding the Application of the Guarantee Law of the People’s Republic of China are applicable to guarantee agreements between a PRC private company as obligee and a non-PRC private company as guarantor. If yes, how might the validity and enforceability of such a guarantee agreement be affected by these provisions?

47.  Article 30 of the Guarantee Law provides that the surety shall not be civilly liable if the parties to the principal contract (ie the Loan Agreement) conspire to defraud the surety (ie the Company) and the creditor to the principal contract resorts to deception or coercion to induce or cause the surety to provide a suretyship against its will.

48.  There is nothing in Mr Jong’s affidavit alleging conspiracy, deception or coercion.   Q4.3 is not relevant to any issue and is rejected.

49.  Article 45 of the Judicial Interpretation provides that “where a creditor (in this case, Consonancy) knows or should know about the debtor’s bankruptcy (in this case, the Borrower) but fails to lodge a claim of obligation or notify the guarantor, and thus (render it impossible for the guarantor to exercise his right of recourse beforehand) causes the guarantor’s inability to exercise its right of recourse, the guarantor shall be exempted from its guarantee obligation by an amount equal to the amount that may be recovered during the bankruptcy procedure.”

50.  According to Mr Powell, the Borrower is in liquidation in PRC but the Liquidators have not been notified.  He queries whether or not Consonancy should have informed the Liquidators and whether Consonancy would have lost its right against the Liquidators. Mr Powell admits that the Liquidators only came to know of this recently and so it was not addressed in Mr Jong’s affidavit which was filed in 2016. 

51.  With the greatest respect, this part of Q4.3 is a complete violation of all rules of procedure.  It is wholly unfair to make such evidential statement during submission, leaving Consonancy with no opportunity to respond to it.  I reject Q4.3.

52.  Q4.4.1 and 4.4.3 (with proposed amendments) ask whether Article 26 of the Guarantee Law of the People’s Republic of China is applicable and how the validity and enforceability of the Guarantee Agreement is affected if Consonancy failed to comply with the requirements of Article 26. 

53.  Article 26 provides that:

“Where the surety of a suretyship of joint and several liability and the creditor have no agreement on the term of suretyship, the creditor shall, within six months from the date of maturity of the principal debts, have the right to demand that the surety undertake suretyship liability.

If the creditor does not demand that the surety undertake suretyship liability during the term of suretyship agreed in the contract or provided by the preceding paragraph, the surety shall be relieved of the suretyship liability.”

54.  The 1^st paragraph of Article 26 simply does not apply because there was only one guarantor and there was a purported term of suretyship.

55.  As to the 2^nd paragraph of Article 26, Mr Jong pointed out that the Guarantee Agreement had a validity period of 2 years from the date of maturity of the loan.  However, the 2-year period had expired when the Liquidators were first informed of the Company’s liability under the guarantee.

56.  Mr Yim submits that this is a matter of construction of the Guarantee Agreement.  I agree. No expert evidence under the 2^nd paragraph of Article 26 is required. 

57.  Q4.4.2 (with proposed amendments) asks if, beyond those stipulated by Article 26 of the Guarantee Law of the People’s Republic of China, there was any action required, whether pursuant to an express clause in the Guarantee Agreement or otherwise, to be taken by Consonancy in order to trigger the Company’s obligations under the Guarantee Agreement within the guarantee period.

58.  With the greatest respect to Mr Powell, it is for the Liquidators to identify any relevant express clause in the Guarantee Agreement.  The rest of the question effectively asks the expert to create a case for the Liquidators, which is not permissible.  Q4.4.2 is rejected.

59.  Q4.5.1 asked whether the validity and enforceability of the Guarantee Agreement is affected by Articles 7 and/or 8 of the Judicial Interpretation of the Supreme People’s Court on Some Issues regarding the Application of the Guarantee Law of the People’s Republic of China.

60.  Article 7 provides that the guarantor and the debtor shall assume joint compensation liability for the creditor’s loss on condition that the principal contract is valid while the guarantee contract is invalid and the creditor is not at fault.  If the creditor and the guarantor are both at fault, the civil liability that the guarantor should assume shall not exceed half of that which the debtor cannot pay off.

61.  Article 8 provides that if the guarantee contract is invalid due to the invalidity of the principal contract and the guarantor is not at fault, he shall not assume any civil obligation. If the guarantor is at fault, he shall bear not more than one third of the obligation that cannot be fulfilled by the debtor.

62.  Once again, Mr Jong’s affidavit has never raised the issue of quantum if liability under the Guarantee Agreement is established. There is no issue on which expert evidence is required.  Q4.5.1 must be rejected.

63.  Q4.6 (with proposed amendments) asks whether the validity and enforceability of the Guarantee Agreement is affected by the lack of any special quota, registration or approval obtained from SAFE in relation to the creation of the cross-border security.

64.  Mr Jong’s affidavit did not even allege what the special quota, registration or approval requirements of SAFE were.  This is forcing Consonancy to prove an unparticularised allegation under the disguise of strict proof of Consonancy’s case.  Q4.6 must be rejected.

65.  Q5 asks about the professional experience of the expert with reference to comparable PRC transactions of similar value.  Mr Powell conceded that this is irrelevant and inadmissible.

66.  Q6 asks whether there are any applicable PRC laws that permit or prohibit a PRC company from lending out the entire amount of its registered share capital.  This question arises because Mr Jong pointed out that the registered capital of Consonancy was RMB50 million and yet the loan was for RMB80 million.  Q6 is one of the 4 questions that Consonancy agreed to ask.  I direct that expert evidence be obtained for Q6.

67.  Q7 asks about how a notice of arbitration and other relevant documents should be served on the Company and whether there had been valid service.  As conceded by Mr Yim, the Liquidators had been given notice of the arbitration but not of the arbitration proceeding itself.  As this is no longer an issue, no expert evidence is required.

How many experts?

68.  Consonancy does not oppose to appointment of a single joint expert.  The Liquidators would only agree to appointment of a single joint expert if their preferred questions for the expert are adopted. 

69.  I do not think the Liquidators can tie the court’s hands in this manner.  Given the limited issues on which expert evidence is required, I see no prejudice to any party if a single joint expert is appointed.

Conclusion

70.  I order that expert evidence in the form of an opinion from a single joint expert be adduced on the following questions:

“ Q2.3.1: Whether a PRC private company was required to obtain a business license.

…

Q2.3.4: How might the validity and enforceability of an agreement be affected if it does not fall within the scope of business as stated in the PRC private company’s business license?

…

Q6: Whether there are any applicable PRC laws that permit or prohibit a PRC company from lending out the entire amount of its registered share capital.”

Costs

71.  The parties have spent 6 months only to obtain an order (by consent) to adduce expert evidence as a matter of principle and the time frame for adducing the expert reports, but could not agree the scope of the expert evidence.  Much time and costs have been wasted.

72.  The manner in which the Liquidators present their case on expert evidence also violates the established practice.  The legislative provisions that are handed up during the hearing are not even included in the bundle of authorities of Mr Powell.  The process is not only informal but prejudicial to Consonancy, who have not been given a chance to respond to the new issues by affirmation evidence.

73.  I have only considered the legislative provisions in the interests of proper case management instead of adjourning the matter. What should have been a half hour hearing turned out to be 2 hours for Mr Powell to explain the relevance of the Questions.  It is a waste of the court’s time. 

74.  The Liquidators are ambitious in seeking to raise a host of questions for an expert to answer, which do not really concern the live issues.  Only 3 questions out of 5 pages have been allowed.  The parties have obtained an order granting 60 days for the expert to prepare his report. It turns out to be clearly excessive.

75.  Consonancy also fails to focus on matters of substance when it objects to the Questions for the expert.  Both parties are at fault.

76.  I make an order nisi that there should be no order as to costs on the summons, including this hearing and the pre-hearing correspondence over the issue of expert evidence.  I also order, nisi,that the Liquidators’ own costs out of the estate on the issue of expert evidence should be reduced by half.