XCHRX TANG YIU MAN RAYMOND AND ANOTHER v. EASTERN KOWLOON PROPERTY SQUARE LTD.

HCA3319/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 3319 OF 1998

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J U D G M E N T

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1. In June 1996, the Defendant entered into a loan agreement (the "Loan Agreement") with a Mr S.B. Tang ("Tang") whereby the Defendant would lend about $32 million to Tang. Clause 3 of the Loan Agreement required :

(a) a personal guarantee to be executed by the 1st Plaintiff; and

(b) a share mortgage to be executed by the 2nd Plaintiff as "security documents".

2. The guarantee dated 21 June 1996, the subject matter of this action, was entered into between the 1st Plaintiff and the Defendant. Recital (3) of the guarantee stated that :

"This guarantee is given by the guarantor in favour of [the Defendant] as security for [the said loan]." (underline supplied)

Clause 2 stated that :

"This guarantee shall be a continuing security ...." (underline supplied)

and Clause 3 stated that :

"Should any purported obligation of the Borrower, which if valid or enforceable would be the subject of this Guarantee, be or become wholly or in part invalid or unenforceable against the Borrower by reason of any defect in or insufficiency or want of powers of the Borrower or irregular or improper purported exercise thereof or breach or want of authority by any person purporting to act on behalf of the Borrower or because the Lender's rights have become barred by reason of any legal limitation, disability, incapacity or any other fact or circumstance whether or not always known to the Lender or if for any other reason whatsoever the Borrower is not or ceases to be legally liable to discharge any money, obligation or liability undertaken or purported to be undertaken on its behalf the Guarantor shall nevertheless be liable to the Lender .... in respect of that purported obligation or liability as if the same were wholly valid and enforceable and the Guarantor was the principal debtor in respect thereof. The Lender is not to be concerned to see or enquire into the powers of the Borrower or its officers, employees or agents purporting to act on its behalf. The Guarantor hereby agrees to keep the Lender fully indemnified against all damages, loss, costs and expenses arising from any failure of the Borrower to carry out any such purported obligation." (underline supplied)

3. Tang defaulted in repayment of some $10 million of the said loan. The Plaintiffs commenced this action seeking a number of relief including declaratory orders to the effect that :

(a) the guarantee and share mortgage being securities given to secure the said loan are void and unenforceable; and

(b) the Defendant should surrender these documents to the Plaintiffs.

4. This action is premised on the illegality of the said loan arising from an alleged contravention of various provisions of the Money Lenders Ordinance, Cap.163, including :

(a) the Defendant was not a licensed money lender;

(b) no note or memorandum containing the particulars of loan required by s.18(2), Cap.163 was issued by the Defendant; and

(c) the said loan required payment of (1) compound interest and (2) higher rate of interest upon default.

5. The Defendant counterclaims against the 1st Plaintiff for payment of the outstanding sum.

6. On 21 June 1999, the Defendant took out an application pursuant to Rules of High Court, O.14A and O.14. The O.14A part of the application asked for a determination that the "guarantee" was in truth in the nature of a contract of indemnity and not a contract of guarantee. If the Court so determined the said issue, the Defendant asks for a further determination that the matters raised in the Plaintiffs' pleadings are incapable of amounting to valid defences to the Defendant's counterclaim, and therefore judgment should be entered. I understand that the O.14 part of the application is to be approached in a similar way.

7. Mr Chong, Counsel for the 1st Plaintiff, argued in answer that the issue set out in the Defendant's application misses one of the principle lines of defence set out in the Plaintiffs' pleadings, namely, that the "guarantee" (whether a contract of guarantee or contract of indemnity) was tainted with illegality of the loan and therefore not enforceable. Mr Chong relied, for that purpose, on a number of authorities in support which do not need to be set out in detail.

8. As I understand from Mr Whitehead for the Defendant, the Defendant agrees to proceed with this application (and this application only) on the assumption that the said loan was illegal as contended for by the Plaintiffs. The Defendant's argument is that even in such case, the contract of indemnity will still be enforceable by the Court. For this argument, Mr Whitehead relied on the Phillips & O'Donovan : The Modern Contract of Guarantee, 2nd Ed., page 25, text to note 99 and page 226, text to note 86. The first passage in Phillips & O'Donovan said :

"... the guarantor's liability will be affected by the discharge of the principal or by the fact that the principal contract is void or unenforceable, but an indemnifier's liability is less likely to be affected by these matters. ..."

The second passage of Phillips & O'Donovan reads :

"... Thus it has been held that the indemnifier will remain liable where the principal transaction is unenforceable due to a failure to comply with the Money Lender's Acts, ..."

The second passage of Phillips & O'Donovan referred to Argo Caribbean Group Ltd. v. Lewis [1976] 2 Lloyd's Rep. 289. I consider it necessary to examine in more detail the facts and the actual decision in the Argo case since it seems to be important to the Defendant's case in this application : see paragraph 7 of the Defendant's written submissions.

9. A company called "Laytons" lent money to another company called "Fieldham". A company called "Argo" agreed to be a guarantor of the loan. The defendant also agreed to indemnify Argo for the debtor's breach of the loans agreement. The debtor failed to repay Laytons, and Argo paid ￡85,000 to Laytons. Laytons demanded payment from Argo, and Argo in turn demanded payment from the defendant. Argo later sued the defendant, and the defendant raised a number of defence including non-compliance with provisions of the Money Lenders Act 1927. It should also be noted that although Argo and Laytons were in the same group of companies, both the first instance Court and the Court of Appeal decided that Argo was not acting as Laytons' agent (see pages 294-295 of the report). The four issues which fell to be decided by the Court were set out in page 293 of the report :

" (1) Was the loan from Laytons to Fieldham a moneylending transaction within the Moneylenders Act, 1927, it being accepted for the plaintiffs that, if it was, it was unenforceable in that it failed to comply with the requirements as to a note or memorandum in writing contained in s.6 of the Act? (emphasis added)

(2) If it was a moneylending transaction, was it not merely unenforceable by s.6, but also rendered illegal by s.1(3)(b) of the Act, under which it is an offence for a licensed moneylender to carry on business at any other place than his authorized address, and/or s.12 which declares illegal a charge for expenses on a moneylender's loan, but it goes on to provide that if the loan is completed the amount of the charges may be set off against the amount actually lent? (emphasis added)

(3) If it was rendered illegal by either of these provisions, did such illegality taint the collateral contract between the plaintiffs and the defendant? (emphasis added)

(4) If the plaintiffs were successful in defeating the defence of illegality, could they, notwithstanding the unenforceability of the transaction as between Laytons and Fieldham, succeed on their claim under cl. 1(D) or cl. 9 of the agreement, it being accepted for that purpose that the Judge should follow, if the transaction in question was a guarantee and not an indemnity, the decision of Mr. Justice Oliver in Browne-Lecky v. Coutts [1946] 2 All E.R. 207, but Counsel for the plaintiffs reserving the right to challenge on appeal the validity of that decision?" (emphasis added)

The first instance Judge decided :

(a) in the defendant's favour on the first issue;

(b) in essence, there was no illegality vitiating the entire transaction;

(c) in view of (b) above, it was therefore unnecessary to decide on the third issue; and

(d) the defendant had given an indemnity and not a guarantee.

10. The learned Judge went on to give judgment in Argo's favour. The defendant appealed and challenged the decision on the fourth issue but did not challenge the one on the second issue. On the other hand, Argo cross-appealed the Judge's decision on the first issue. There is, therefore, a major difference between the Argo case and the present case in that, no issue of illegality was involved there (namely, that the question of illegality was rejected by the Court) but the issue of illegality is squarely and fairly in point here.

11. At the hearing, Mr Whitehead fairly accepted that he cannot rely on the Argo case in answer to Mr Chong's submission on illegality but he relied on the Argo case as authority that a contract of indemnity is still enforceable despite the underlying transaction not being enforceable.

12. However, Mr Whitehead said the decision in Heald and Another v. O'Connor [1971] 1 WLR 497 supported his argument that the illegality of the underlying transaction will not affect a contract of indemnity. The Heald case concerned a security given by a company as financial assistance for the purpose of purchasing its own shares, and also whether that contravened s.54 of the Companies Act 1948. The learned Judge decided that it contravened s.54, and continued to say :

" Does it result from that finding [that is, that the security was illegal] that the instrument sued on in the present case is also void and unenforceable? The answer to that question may depend on whether it is a guarantee or an indemnity. ..."

(See page 502G - H of the report.)

13. The Heald case was a decision of the Divisional Court, it is therefore only of persuasive authority. I consider that it is arguable, at least, that the learned Judge was putting the point (as set out in the passage quoted earlier) too widely (if not erroneously) because :

(a) in making that statement, he referred to Yeoman Credit Ltd. v. Latter [1961] 1 WLR 828 which was a case of void contract by reason of infancy and did not involve any question of illegality;

(b) the learned Judge's said statement is not consistent with the way in which the issues were framed and answered in the Argo case;

(c) the learned Judge did not refer to the so-called "doctrine of tainting" set out in Chitty on Contracts 1999, 28th Edition, Vol.1, paragraph 17-159 which stated :

"The maxim ex turpi causa non oritur actio is also applied to the case of an apparently innocent contract which is nevertheless vitiated by the illegality of another contract to which it is merely collateral-the illegality of the latter tainting the former. Thus in Spector v. Ageda the plaintiff loaned money to the defendant to repay a loan which had been made by a third party to the defendant and which was an illegal money lending transaction. The plaintiff knew that her loan was to be used to pay off the illegal loan and the issue which squarely faced the court was, Megarry J. stated, 'whether a loan knowingly made in order to discharge an existing loan that was wholly or partially illegal was itself tainted with illegality.' He answered the question in the affirmative; the second transaction was tainted by the illegality of the first and was accordingly unenforceable."

In fact, the learned authors of Chitty appeared to consider that the decision in the Heald case was supportive of the said statement in paragraph 17-159 because that case was referred to in footnote 19 thereof.

14. In these circumstances, I agree with Mr Chong that a mere determination of the true nature of the "guarantee" will not resolve all the issues in this action, especially the issues of whether :

(a) there was any illegality of the Loan Agreement; and

(b) if so, whether that illegality will taint the "guarantee" entered into by the 1st Plaintiff.

15. The points raised by the 1st Plaintiff in this application have already been disclosed not only in the pleadings filed and served before the application, but also in a letter sent before the commencement of the action. I consider that this application falls within O.14, r.7 : see the Supreme Court Practice 1999, Vol.1, footnotes to O.14, especially paragraph 14/7/4.

16. For these reasons, I agree with Mr Chong for the 1st Plaintiff that this application should be dismissed.