BANK OF CHINA (HONG KONG) LTD. v. KOFIELD LTD. AND ANOTHER

CACV 4105/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 4105 OF 2001

(ON APPEAL FROM HCA NO. 5 OF 2001)

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J U D G M E N T

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Hon Le Pichon JA:

1. This is an appeal from the order dated 7 November 2001 of Deputy High Court Judge Lam dismissing the defendants' appeals from the order dated 1 June 2001 of Master B Kwan granting summary judgment in four actions brought by The China and South Sea Bank Limited against the principal debtors (being the 1st defendant in each of the actions) and the 2nd defendant Lam Chin Chun ("Mr Lam") as guarantor. The aggregate amount of the judgments is something of the order of $72 million, with interest running from 7 December 2000 at rates ranging from 11.5% to 17.5% which to date would amount to another $10 million.

2. The China and South Sea Bank Limited is a banking corporation incorporated under the laws of the PRC and conducts business in Hong Kong through its Hong Kong branch. It is one of a number of Chinese banks within the Hong Kong and Macau Bank of China consortium. Whilst there is disagreement as to whether there were 14 or only 12 such banks, the existence of the consortium is common ground. By virtue of the Bank of China (Hong Kong) Limited (Merger) Ordinance, Cap. 1167, The China and South Sea Bank merged with and was subsumed into the Bank of China (Hong Kong) Limited thus requiring a name change for the plaintiff in these proceedings which took place on 5 October 2001.

3. In all four actions, the plaintiff claimed against the principal debtors all of whom were companies owned by Mr Lam in respect of various undertakings (being time loans) and facility letters for the sums owed thereunder and against Mr Lam under standard form guarantees.

The defence

4. The defence relied on is an agreement which the defendants say was reached between Mr Ngai On Sai, Deputy Manager of the Business Affairs Department of the Hong Kong - Macau Office representing the Bank of China Group and Mr Lam representing his companies on or about 11 August 1998. The terms of that agreement ("the 2nd agreement") were set out by Mr Lam in his 1st affirmation:

"(a) The Bank of China Group would arrange a facility of HK$6,000,000 to pay off the workers of Commercial & Industrial.

(b) The banking facilities would first be sorted out. After taking into account what was used by members of the Bank of China Group, the properties pledged by members of my Group in favour of the Bank of China Group would then be sold to cover the shortfall. Any further shortfall after such sales would be secured by Infinity's interests in Xin Zhong Yin Garden.

(c) After sorting out the banking facilities arrangements would then be made in relation to my interests in Xin Zhong Yin Garden. The arrangements envisaged was the purchase by the Bank of China Group of my interest in Xin Zhong Yin Garden at 75% of the prevailing market value.

(d) No proceedings would be pursued by any member of the Bank of China Group against any member of my Group pending such work out."

In order both to understand and to put into context the 2nd agreement, it is necessary to go into the background, commencing with the year 1993. The relevant events as stated in Mr Lam's 1st affirmation are summarised below.

Background

5. In early 1992, one of Mr Lam's company acquired a site for development in Dongguan. The Bank of China Group became interested in the site. From 1993 until his resignation on 22 October 1997, Mr Tsang Kam Lan ("Mr Tsang") was one of the directors of Bank of China Group Investment Limited ("BOC Group Investment"), the direct investment arm of the Bank of China. During the same period, Mr Tsang together with a Mr Lam Kwong Siu were both Deputy Chief Executives of the Bank of China Hong Kong - Macau Regional Office ("The Hong Kong - Macau Office"). This was a very powerful unit within the Bank of China. According to the 1997 Annual Report of the Bank of China is "an organisation despatched by the Bank of China's Beijing Head Office to lead, manage, co-ordinate and supervise the Hong Kong and Macau Bank of China consortium" of Chinese banks referred to earlier. At that time i.e. in 1993, Mr Hau Man Cho ("Mr Hau") and Mr Lee Hung Sang ("Mr Lee") were respectively the Executive Deputy Manager and the Deputy Manager of the Investment Department of the Hong Kong - Macau Office.

6. In early 1993, Mr Lam met with Mr Tsang, Mr Lam Kwong Siu, Mr Hau and Mr Lee. Mr Lam was informed that the Bank of China was interested in taking a minority interest (a one-third share) in the Dongguan development but that it had to be given exclusive control of the whole project, at least on the face of the documents if approval was to be forthcoming from the Bank of China's Beijing Head Office. Mr Lam (and his companies) were to hold the remaining two-thirds interest. Mr Lam was required to have his residence in Hong Kong which was registered in the name of his wife mortgaged to the Bank of China Group to show his devotion to the Group and despite the fact that the bulk of Mr Lam's fortune had been invested in this project, he would have no control and could not raise finance with his interest for other business activities. It was in these circumstances that an agreement was reached between the parties in early June 1993 ("the 1st agreement"). Its terms were set out in paragraph 15 of Mr Lam's 1st affirmation:

"(a) The Bank of China Group would take a one-third interest in the prime site in Dongguan.

(b) The Bank of China Group would have complete control over the development of that site. In exercising such control, the Bank of China Group would not prejudice or jeopardize my interests.

(c) The Bank of China Group would extend banking facilities in favour of my group. Until the taking of account on completion of the development or the purchase of my interest by the Bank of China Group, no steps would be taken to enforce recovery of the banking facilities so extended.

(d) The Bank of China Group would at my request, purchase forthwith his group's interests at 75% of the prevailing market value."

7. A joint venture company, Applecrest Properties Limited ("Applecrest"), was incorporated under the laws of the British Virgin Islands to hold controlling interests in the companies in which the land rights in the Dongguan site were vested and its shares came to be held by Excellent Investment Limited ("Excellent"), Jenshing Limited ("Jenshing"), Sun Chung Estate Company Limited ("Sun Chung") all of which were direct or indirect subsidiaries of the Bank of China Group and Infinity Development (Holdings) Company Limited ("Infinity"), a company belonging to Mr Lam. Mr Tsang was chairman and director of Sun Chung and Mr Lee was a director of Excellent and Jenshing. On 22 September 1993, the parties entered into a shareholder's agreement with Applecrest. Applecrest's issued share capital consisted of 1,000 "A"shares which carried all the voting rights and 2,000 "B" shares which did not have any voting rights nor any right to nominate directors to the Board. Excellent, Jenshing and Sun Chung between them held all the "A" shares and Infinity all the "B" shares. But in terms of providing finance for Applecrest, there was no distinction between "A" and "B" shares. Contribution was pro rata to the number of shares held. By September 1995, Infinity had contributed about $240 million against $113 million by the three companies of the BOC group.

8. According to the defendants, after the 1st agreement, generous banking facilities were made available by the Bank of China Group to Mr Lam and his companies simply on Mr Lam's asking. Such facilities included those underlying the four actions. It is evident from the lead action (CACV 4105/2001) that whereas the facilities being sued upon consisted of seven time loans made to Infinity between April and June 1996 and three facility letters issued between 1996 and 1998, the guarantees being sued upon against Mr Lam numbered no less than nineteen, dating between December 1993 and November 1997 and totalling over $216 million.

9. Chronologically, the next event to note is the incorporation of Industrial and Commercial Associates Group Limited ("Industrial and Commercial") in Hong Kong in May 1996. The issued capital was held by Mr Lam and Infinity. Industrial and Commercial was formed with a view of providing cohesion amongst middle strata Chinese industrial and commercial concerns during the 1997 handover and was strongly backed by the Bank of China Group. Members of the Bank of China Group sat on varies committees of Industrial and Commercial.

10. Apart from the Dongguan development which was named Xin Zhong Yin Garden, Mr Lam's group engaged in other joint ventures with the Bank of China Group such as a joint venture relating to the 2nd and 3rd floors of Fortress Tower in North Point and a joint venture in Infinity Traffic Investments Company Limited involving toll roads in Xin Hui. The relationship went beyond that of a bank with his customers: on occasion, Mr Lam was asked by Mr Tsang and his then colleagues to give accommodation and assistance.

11. In August 1997, there were changes within the Hong Kong - Macau Office. Mr Liu Jin Bao was appointed to the post of senior Deputy Chief Executive responsible for the daily management of the Hong Kong - Macau Office and Mr Gao Xi Qing assumed the position of Deputy Chief Executive. Mr Liu was concurrently the general manager of the Hong Kong branch of the Bank of China. Mr Tsang ceased to be Deputy Chief Executive of the Hong Kong - Macau Office some time in 1997. He was also replaced as director of BOC Group Investment by Mr Gao in October 1997.

12. In September 1997, Applecrest was experiencing a shortage of funds and at a directors' meeting, Mr Lam was authorised to raise funds in the securities market for that purpose. Discussions were held with a subsidiary of Kong Tai International Holdings Company Limited ("Kong Tai"), a company listed on the Hong Kong Stock Exchange. That subsidiary agreed to acquire 10% of the assets in business of Applecrest for $70 million be settled by the issue of 350 million new shares of Kong Tai, "subject to execution of a final agreement to be approved by the respective boards of directors of the parties". There was a public announcement to that effect in early February 1998. To counteract the public announcement, on 16 February 1998, the Hong Kong - Macau Office issued a press release stating that Mr Lam had entered into a memorandum of agreement "purportedly" on behalf of Applecrest with Kong Tai. This led to the breakdown in the relationship between Mr Lam and the Bank of China Group. By the latter half of 1997, Mr Tsang was no longer in control. Facilities were tightened and Mr Lam had no further funds with which to pay staff in Commercial and Industrial.

13. By late May/early June 1998, the relationship had seriously deteriorated. A series of demand letters were issued by no less than three banks within the consortium against Mr Lam's companies as the principal debtors and Mr Lam or Infinity as guarantor. The position is summarised in Table I below.

TABLE I

The aggregate amount of repayment sought by The China and South Sea Bank alone was HK$85,678,180.26 and US$540,642.96, in round terms, approximately HK$90 million. The claims of Po Sang Bank and The China State Bank amounted to another HK$20 million.

14. Meanwhile, by a letter dated 4 June 1998, the Hong Kong - Macau Office intimated to Mr Lam in response to a letter from him that proposals were being formulated to resolve the matter. Discussions with a view to settling the dispute between the Bank of China Group and Mr Lam subsequently took place on 2 July 1998 between the General Manager of the Business Division of the Hong Kong - Macau Office and Mr Lam. The acquisition of Infinity's interests in Xin Zhong Yin Garden was raised but nothing was agreed. Then, several weeks later, on or about 11 August 1998, Mr Ngai On Sai, the Deputy Manager of the Business Affairs Department of Hong Kong - Macau Office took the matter up. By that time, Commercial and Industrial which had long enjoyed the support of the Bank of China Group was in dire trouble. The employees were threatening to wind up the company and that would have created unwanted publicity for the Bank of China Group. It was in these circumstances that the 2nd agreement, the terms which have already been referred to, were reached.

15. The following events then took place:

• Within two weeks of the 2nd agreement, The China and South Sea Bank issued a 3rd facility letter to Infinity, extending to it a $6 million loan which together with interest was expressed to be subject to the plaintiff's "overriding right to demand for immediate payment". The final maturity date was three months after the draw down date but was capable of being extended at Infinity's option for not more than three times of three months each. This facility required the provision of a guarantee by Mr Lam and the execution of a deed of second share charge, assignment and subordination to charge the 2,000 "B" shares in Applecrest and to assign and subordinate Applecrest's debt owing to Infinity.
• Within a month or so of the 2nd agreement, The China and South Sea Bank received separate authorisations dated 4 and 24 September 1998 from Infinity to apply certain deposits held by it to set off Infinity's indebtedness. In this way, Infinity reduced its indebtedness by $15 million.
• In October 1999, four surrender letters pertaining to four properties were executed by Mr Lam's companies in favour of the plaintiff. This was followed by another five surrenders letters pertaining to seven properties in December 1999.

16. On 31 May 2000, Infinity and Mr Lam commenced proceedings (HCA 5491 of 2000) against the Bank of China Group in relation to the Kong Tai matter. The statement of claim in that action was struck out on 30 November 2000. (The appeal against the striking out was subsequently dismissed by the Court of Appeal in June 2001.) Within a week of the striking out, another series of demand letters were issued. The position is summarised in Table II below.

TABLE II

17. The writs in three of the four actions herein were issued on 29 December 2000, followed by the writ in the lead action on 2 January 2001. There followed proceedings by the Po Sang Bank against Mr Lam on 10 January 2001 and by The China State Bank against Mr Lam and his companies on 17 January 2001.

The judgment below

18. In the court below, the judge concluded that the defence raised was not believable. The judge noted that the terms of the 1st and 2nd agreements contradicted the loan documentation entered into between the parties but that in any event the 2nd agreement would have superseded the 1st agreement. He found it inherently implausible that the Bank of China Group would have agreed to grant banking facilities to Mr Lam's group concerning Mr Lam's other business activities and promised not to take any steps to enforce the recovery of such facilities until the completion of the Dongguan project and, further, that neither party saw fit to record the terms of the 2nd agreement in some form of writing when, at the time it was said to be made, the relationship was tense. As to whether there was concerted action by the banks against Mr Lam and his companies in 1998 and in 2000, the judge considered that the issue was whether the withholding of legal proceedings in 1998 could be regarded as circumstantial evidence to show that there was at least a triable issue relevant to the defence. He considered that the withholding of legal proceedings was equally consistent with a temporary suspension pending crystallisation of the net balance as with an indefinite moratorium until the finalization of the purchase of the defendants' interest in the Dongguan development and held that the non-commencement of legal proceedings in 1998 did not assist the defendants.

19. The judge accepted the plaintiff's submission that the defendants had put forward different versions of the agreements. He referred to the letter written by the defendants' previous solicitors on 2 January 2001 relating to the terms of the 1st and 2nd agreements which were repeated in the defences filed in the four actions on 31 January 2001. He considered that they were inconsistent with what is now in Mr Lam's 1st affirmation which was filed on 12 March 2001. The judge dismissed the appeal on the basis that he was satisfied that:

"... by reason of the inconsistencies with contemporaneous documents, the inherent implausibility of the defence case and the contradictory manner in which the case of oral agreements overriding written terms in the loan transactions were put forward on behalf of the defence, the case as enshrined in the affirmations of Mr Lam as to the 1st and 2nd agreement is not credible and I am duty bound to say so even in an Order 14 application."

This appeal

20. There is no dispute about the applicable legal principles. The only question which arises is whether the defence as to the existence of the 2nd agreement is believable.

21. Mr Wong SC for the defendants submitted that the judge failed to properly assess the evidence of the defendants' case. Had he done so, he would have found that the conduct of the parties after the 2nd agreement was entirely consistent with the terms of that agreement, such that summary judgment should not have been granted.

22. I now turn to consider salient features of the evidence that bear upon the credibility of the defence.

The 3rd facility letter

23. The 3rd facility letter issued by The China and South Sea Bank on 24 August 1998 is important in a number of respects. First, the grant of the $6 million facility (which was a term of the 2nd agreement) could not have come about without the approval and involvement of high office holders within the Bank of China Group and the Hong Kong - Macau Office. This is so because the facility was conditional upon the execution of a second share charge of the 2,000 "B" shares in Applecrest owned by Infinity. Infinity was not in a position to charge its shares without the consent of the other joint venturers (which were direct or indirect subsidiaries of the Bank of China Group) because clause 14.1 of the shareholders' agreement prohibited the pledge, mortgage or the creation of other encumbrances in respect of the shareholdings except in favour of the other shareholders. The fact that such consent was obtained was therefore a matter of considerable significance.

24. Second, it has to be borne in mind that only six weeks earlier The China and South Sea Bank had issued demand letters to Mr Lam and his companies seeking repayment of some HK$90 million. There was a clear threat of legal proceedings if payment was not received by 6 July 1998. There was no evidence of payment of any amount having been made between the date of the demand letters and the granting of the $6 million facility. Stated baldly, a bank which was owed HK$90 million and which had threatened legal proceedings against the borrowers and guarantors was nonetheless willing to grant further facilities of $6 million. That I find wholly incredible. It is noteworthy that Mr Cheung Hin Wah proffered no explanation for granting this facility in his lengthy affirmation filed in response to Mr Lam's 1st affirmation.

25. Mr Chan SC sought to explain away this difficulty by referring to certain setoffs and surrender letters whereby possession of various mortgaged properties was surrendered by Mr Lam's companies to the plaintiff. But these matters do not assist Mr Chan. The 3rd facility letter preceded the setoffs and surrender letters relied upon. So at the date of the 3rd facility letter, there was no way the plaintiff would have known that setoffs and surrender letters would be forthcoming. So why was it prepared to extend further facilities? Mr Chan SC drew attention to the fact that the rate of interest was high, being prime plus 4.25%. The facility was also secured by a second charge over Infinity's "B" shares in Applecrest. But in the context of the substantial amount that was outstanding, the key consideration was the borrower's ability to repay. That issue had not been addressed at all in the evidence.

26. For my part, the $6 million facility appears to be more readily explicable in the context of the 2nd agreement than otherwise and therefore lends credence to the defence.

Sorting out banking facilities

27. The evidence showed that within three weeks of the 2nd agreement, Infinity agreed to have certain deposits held with the plaintiff set off against its indebtedness. This was followed by a further set off some three weeks later such that some $15 million had been repaid by late September 1998. A year or so later, in October and December 1999, the 1st defendants in the four actions surrendered possession of altogether eleven properties which had been mortgaged to The China and South Sea Bank. All this was fully consistent with the existence and terms of the 2nd agreement.

The 'moratorium'

28. The threat of legal proceedings by the Po Sang Bank, the China State Bank and The China and South Sea Bank in May and June of 1998 inexplicably went dead for a period of some 18 months before another series of demand letters were sent in December 2000 by the same banks threatening legal proceedings and, as noted above, issuing three of them on 29 December 2000 and several others in January 2001. The absence of any explanation for this 'moratorium' as well as the fact that Po Sang Bank, The China State Bank and The China and South Sea Bank were part of the consortium of Chinese banks in respect of which the Hong Kong - Macau Office was the policy body, and that they appeared to be acting in tandem, cried out for explanation but the evidence placed before the court contained not one word about it. In my view, this inevitably reinforces the defendants' case that this was consistent with the terms of the 2nd agreement and otherwise wholly inexplicable.

Inconsistency

29. Mr Chan SC drew attention to the fact that in the defence filed on 31 January 2001 in each of the actions, there was no mention of the $6 million facility, nor the fact that banking facilities were first to be sorted out, nor the sale of the defendants' interest in Applecrest at 75% of the prevailing market value. In essence, what was being suggested was that the defendants were changing (and improving) their story as they went along. Wai & Co's letter which set out the reasons why the defendants were not liable was written in immediate response to the institution of the proceedings on 29 December 2000, only some three days earlier. It was a two-page letter meant to convey the gist of the defence. The defences filed on 31 January merely replicated what had been set out in that letter. Mr Lam's 1st affirmation, in contrast, was twenty-three pages long.

30. There is a distinction between inconsistency and incompleteness. The fact that the matters mentioned by Mr Chan were not referred to in Wai & Co's letter and the defence filed did not necessarily render them inconsistent with the defendants' much fuller explanation filed on 12 March 2001, after discovery of various documents particularly when one bears in mind that a change of solicitors took place on 28 February 2001. Mr Wong SC submitted that the nub of the defence is to be found in Wai & Co.'s letter. I agree.

31. The plaintiff's submission that had found favour with the judge below was the apparent inconsistency between the 2nd agreement and contemporaneous documentation such as the terms of the 3rd facility letter and the surrender letters which contained acknowledgements that the loans therein mentioned were due and payable. There were also board minutes acknowledging that events of default regarding facilities from the plaintiff had occurred. But the alleged 'inconsistency' is a necessary feature of the defence put forward, the distinction being between facilities becoming due and payable and forbearance affecting the plaintiff's ability to issue proceedings for the recovery of such facilities. For my part, the 'inconsistency' argument does not begin to run.

Banque de Paris et des Pays Bas v Costa de Naray

32. The plaintiff bank in this case ([1984] 1 Lloyd's Rep. 21) agreed to enter into a loan agreement to finance the acquisition of a number of vessels owned by a company operated by the defendants. As part of that arrangement, the defendants provided personal guarantees. In Order 14 proceedings, Hobhouse J concluded that there should not be summary judgment but leave to defend should only be conditional. The main defence which the judge considered "not quite strikeable out" was that when the defendants were asked for personal guarantees, they were assured that they were only required for cosmetic purposes and there was no question of those guarantees ever being enforced. A second hearing was held in order to determine quantum and for that purpose, both sides submitted further affidavits. The judge concluded that the defendants had given a disingenuous and misleading picture of their life style and hence financial circumstances and ordered that leave to defend be granted on the condition that US$2 million be paid into court. The defendants appealed against that order and the bank cross-appealed. Because of the bank's cross-appeal, the Court of Appeal had to consider whether or not summary judgment ought to have been given. In this connection, the credibility of the defendants and their defence had to be considered. Ackner LJ noted that whilst the first demand under the guarantee was made in July 1982, the only defence left in the case was not raised until solicitors had been consulted who then wrote a letter in March 1983 raising that defence. Ackner LJ observed (at p. 23):

"A businessman of the experience of the defendants, faced with a demand under a guarantee of $4 million or $5 million, or any significant sum, knowing that he had only signed the guarantee on an assurance that it did not render him under any obligation at all, would not have waited for his lawyers to express his indignation, let alone his appreciation of the substance of the defence which he must have."

Mr Chan SC relied on those observations and invited the court to adopt the same approach in relation to the 2nd agreement. But what swayed the Court of Appeal in the Banque de Paris case as regards the defendants' credibility was the additional evidence which shed light on the propensity of the defendants to tell the truth. The defendants had sought to paint a picture of financial stringency without any prospect of either employment or finances but the bank adduced evidence from enquiry agents which showed the 2nd defendant as hardly poverty stricken, living (as he did) in a large house in Chester Square, and having two servants and a nanny. As Ackner LJ observed (at p. 23):

"... the Court must look at the whole situation and ask itself whether the defendant has satisfied the Court that there is a fair or reasonable probability of the defendants' having a real or bona fide defence."

33. It was said that in the present case, it was incredible that the defendants had not referred to the 1st or 2nd agreements in the statement of claim in HCA 5491 of 2000. The basis of that action was an agreement having been concluded with Kong Tai. It would not appear that the 1st or 2nd agreements were even relevant, much less pivotal, to it.

Conclusion

34. I feel compelled to agree with Mr Wong's submission the judge failed to properly assess the evidence adduced by the defendants. In my judgment, the evidence adduced was wholly consistent with the defence raised. Given the significance of the 3rd facility letter, the absence of any explanation of the moratorium and, more importantly, the incontrovertible involvement of the Hong Kong - Macau Office in the transaction which rendered the absence of any evidence from Mr Ngai the more telling, I have no hesitation in concluding that summary judgment should not have been given.

35. I would allow the appeal and set aside the judgment below. I would also make an order nisi for costs (here and below) in favour of the defendants.

Hon Rogers VP:

36. I agree.