CASH SMART ENTERPRISES LTD v. BRIGHT PROSPECTS ASSOCIATES LTD & OTHERS

cacv 395/2003 & CACV 397/2003

CACV 395/2003

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 395 of 2003

(on appeal from HCA NO. 148 of 2003)

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CACV 397/2003

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 397 of 2003

(on appeal from HCA NO. 148 of 2003)

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REASONS FOR JUDGMENT

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Hon Rogers VP:

1.  I agree with the judgment of Le Pichon JA.

Hon Le Pichon JA:

2.  These are appeals from the order of Barma J. dated 5 December 2003 granting summary judgment to the plaintiff against the 1^stand 2^nd defendants.  At the hearing, the appeals were dismissed with costs for written reasons to be handed down later.  This we now do.

Background

3.  The plaintiff was a special-purpose company whose only business was to enter into and carry out the subscription agreement it entered into on 26 July 2001 with, inter alia, the 1^stand 2^nd defendants.  Implementation of the subscription agreement involved the issue of a convertible note (“the note”) by the 1^st defendant to the plaintiff and the execution of a note instrument (“the instrument”) by the 1^st defendant which set out the conditions subject to which the note was issued.  The subscription agreement, note and instrument were varied by the first supplemental agreement, a revised convertible note and a revised note instrument all dated 18 January 2002 and the second supplemental agreement dated 23 July 2002 (collectively “the agreements”).

4.  The agreements came about following a decision to try to float the business of a theme park in Panyu operated by a Sino-foreign co-operative joint venture.  The foreign partner of that joint-venture was the 1^st defendant which was owned by the 2^nd defendant.  The 2^nd defendant made arrangements for the 3^rd defendant and two other individuals to acquire between them 30% of the shareholding in the 1^st defendant.  Following the liquidation of Gilbert Holdings Ltd (“Gilbert”), a listed Hong Kong company in August 2000, the 1^st and 2^nd defendants entered into an agreement with its liquidators for a restructuring of Gilbert, using a Bermudan company called Surge Holdings Ltd (“Surge”) into which the foreign partner’s interests in the theme park joint-venture would be injected.  Surge was to be listed on the Stock Exchange of Hong Kong through listing by introduction following Gilbert’s restructuring.

5.  The listing of Surge needed financing and discussions between the parties culminated in the subscription agreement and related documentation.

6.  In paragraphs 9 to 40 of his judgment, the judge summarised the background leading to the execution of the subscription agreement and described in meticulous detail the contents and effect of each of the agreements as well as the events leading up to the issuance of the writ in these proceedings on 13 January 2003.  It is unnecessary for the purposes of these appeals to rehearse the detail which appears in that judgment.  The more significant terms of the agreements are highlighted below.

7.  Under the subscription agreement, the plaintiff agreed to subscribe to the note at a face value of $35 million.  In return, the plaintiff was entitled to nominate two directors to the board of Surge who were to remain in that position unless the plaintiff’s shareholding fell below 5% of the issued share capital.  The plaintiff agreed to its name and a description of the subscription agreement being included in all submissions to for Hong Kong Stock Exchange in connection with the proposed listing, with the plaintiff being given the opportunity to review and comment and the 1^st defendant was obliged to inform the plaintiff of any material changes to matters relating to the listing and the restructuring proposal.  The plaintiff was given joint control over the designated account into which the subscription monies were paid in that the account could only be operated on the joint signatures of one representative of each of the plaintiff and the 1^st defendant and the plaintiff was to be provided with, inter alia, the management accounts, audited profit and loss accounts and balance sheet.  The plaintiff was also granted a put option by the 2^nd and 3^rd defendants entitling it to require the 2^nd and 3^rd defendants to acquire from the plaintiffall of the shares it was to acquire on conversion of the note in the event that listing were not achieved by 28 September 2001.  The 2^nd and 3^rd defendants guaranteed the performance by the 1^st defendant of its obligations to the plaintiff under the subscription agreement and related documents.

8.  Under the instrument, the principal amount of the note was to be repaid in the event that automatic conversion of the note into shares in Surge did not occur on or before 21 September 2001.  Condition 6 of the instrument provided for automatic conversion of the outstanding principal amount of the note into shares of Surge at a price of $0.168 per share.  However, such automatic conversion was subject to conditions as to capitalisation, offer price etc which were capable of being waived by the plaintiff.  There were also provisions for the repayment of monies payable under the note and instrument in two instalments should automatic conversion not take place and for adjustments to be made to the conversion price designed to ensure that the interest in Surge to be acquired by the plaintiff would be maintained at about 11%.  The note was to bear simple interest at 4% and the plaintiff was to be indemnified by the 1^st defendant against, inter alia, its legal fees and costs in the event of the 1^st defendant default under the note.

9.  The listing did not proceed as speedily as had been anticipated and by the first supplemental agreement dated 18 January 2002, the time limits were extended to 5 March 2002 for automatic conversion and to 15 March 2002 for the listing.  Other changes were also reflected: listing would be by way of an initial public offering rather than by way of introduction, the number of shares to the issued would be reduced and the original placing price correspondingly revised upwards to an offer price of between $0.54 and $0.65 per share with automatic conversion at $0.54 per share.  However, it was provided that in the event of the offer price exceeding $0.54, the plaintiff was to make a top-up payment to ensure that it paid the same price per share as placees and subscribers to the public offer.  It was also provided the 1^st defendant would bear all reasonable costs and expenses incurred by the plaintiff in connection with the first supplemental agreement.

10.  About two weeks later, the plaintiff’s solicitors sent a bill for legal fees in the amount of $191,283 in relation to the revised arrangements for settlement by the 1^st defendant.  The bill was rendered in traditional narrative form.  The description of work done was extremely detailed, with particulars of the disbursements incurred.

11.  Notwithstanding the revised deadlines, they could not be met and that led to the parties’ entry into the second supplemental agreement on 23 July 2002, extending the conversion date to 31 July 2002 and the listing date to 15 August 2002.  The second supplemental agreement contained important changes including a lockup period of six months in respect of shares acquired by the plaintiff on automatic conversion, compensation by the 2^ndand 3^rd defendants to the plaintiff in respect of any shortfall that the plaintiff would otherwise suffer between the value of the shares it received on conversion and the price of $35 million which the plaintiff paid them in the event of the offer price being lower than $0.54 and full conversion taking place notwithstanding this.  The 1^st defendant also agreed to pay all reasonable costs and expenses incurred by the plaintiff in connection with the first and second supplemental agreements.

12.  Within days of the second supplemental agreement, the plaintiff’s solicitors sent a bill for legal fees in the amount of $81,407 in relation to the second supplemental agreement to the 1^st defendant for settlement.  Again, it was rendered in traditional narrative form.  The 1^st defendant failed to pay either of the bills.

13.  By 30 July 2002, when it became apparent that the key conversion deadline and requirements could not be met, the plaintiff, the 2^nd defendant and a Mr Leung entered into a put option deed under which the plaintiffwas given a put option in respect of the shares in Surge that it would acquire on conversion.  It entitled the plaintiff to require the 2^nd defendant to purchase the whole of its shareholding arising from conversion at a price of $36.4 million.  The option was exercisable only during a window of one week commencing one year after the date of Surge’s listing subject to certain acceleration provisions.

14.  On the 31 July 2002, the note as revised was converted into 66 million shares in Surge at $0.54 per share.  Interest at 4% from 26 July 2001 totalling $1,423,013.70 became payable.  On 19 August 2002 the offer price was fixed at $0.34 per share which was $0.20 per share below the conversion price.  Accordingly, the 2^nd and 3^rd defendants became liable to pay the shortfall of $13.2 million to the plaintiff under clause 5.2 of the second supplemental agreement within 14 days.  No such payment was made.

15.  On 13 January 2003, the plaintiff commenced proceedings claiming:

(1)$1,423,013.70 in respect of the note interest, together with default interest of $90,000.74 as at 14 May 2003 (and accruing at $311.89 per day thereafter);

(2)$272,330 in respect of the plaintiff’s legal costs in connection with the supplemental agreements; and

(3)$13.2 million being the shortfall amount payable under clause 5.2 of the second supplemental agreement.

16.  Whilst the first two claims were made against all the defendants, judgment was sought against the 1^st and 2^nd defendants as primary debtor and guarantor respectively.  The third claim was made against the 2^nd and 3^rd defendants but the judgment in relation to it was sought against the 2^nd defendant only.

The judgment below

17.  The judge entered summary judgment in respect of all three claims.  The defence raised by the 1^st and 2^nd defendants to the interest claim was that the agreements as well as the guarantee provisions were unenforceable by virtue of sections 23, 18 and 22 of the Money Lenders Ordinance because the transaction at the heart of the agreements was in substance a loan and the plaintiff was a moneylender who did not have a moneylender’s licence.

18.  After reviewing in detail the submissions made by the plaintiff and the defendants on the true effect of the agreements, the judge set out his approach to the question in paragraph 58 of his judgment:

“In my view, the court’s approach to the question of whether a particular transaction is or is not a loan is to be answered by first considering the terms of the agreements by which the transaction is governed, in order to ascertain the rights and obligations thereby created.  If those rights and obligations amount in substance to a loan of money, the transaction will properly be characterised as a loan.  In cases which such obligations do not point clearly in one direction or the other, or where, although as a matter of form the transaction is not one of loan, but there are provisions or circumstances which suggest that it may in fact and substance be a loan, it will be necessary to consider other evidence, such as evidence of the parties’ intentions in entering into the transaction.  In these latter cases, there may well be conflicts of evidence which are not capable of being determined in an application for summary judgment.”

19.  Applying this approach, the judge reached the conclusion that on an objective consideration of the substance and effect of the transaction constituted by the agreements, the terms of the transaction and the obligations thereby created pointed “inescapably to the transaction being in substance an agreement by the plaintiff to acquire an investment in Surge and not to make a loan of money to the 1^st defendant”.  In reaching this conclusion, the judge considered that “the single most compelling factor” was the automatic conversion of the amount outstanding into shares upon the conditions precedent contained in condition 6.1 of the instrument and revised instrument being complied with.  Having regard to the fact that neither party had a choice in the matter upon compliance with the conditions, it was a transaction “whereby the plaintiff was agreeing to acquire a stake in what was to be a newly listed company (Surge), rather than to lend money to the first defendant in order to enable it to fund that company’s listing”.

20.  In coming to his conclusion, the judge did not pay regard to the evidence of the 2^nd defendant because, in his view, that evidence was not admissible where the terms of the agreement are clear and not in dispute.  In any event, he was of the view that the evidence of the 2^nd defendant not take matters further.  The judge also rejected the further submission that the transaction might be partly an investment in shares and partly a loan.

21.  Given the judge’s conclusion that the transaction was not a loan, whether wholly or in part, the issue of the plaintiff being a money lender did not strictly arise.  The judge went on to rule that even if this transaction could be regarded as partly a loan, that in itself would not render the plaintiff a money lender.  In his view, the defences based on the Money Lenders Ordinance were not even arguably available to the 1^st and 2^nd defendants.

22.  As regards the plaintiff’s claim for legal costs, the judge noted that the 1^st and 2^nd defendants were only putting the plaintiff to proof of the reasonableness of such costs and had put forward no positive case that the bills were in fact unreasonable.  The judge granted summary judgment to the plaintiff on the basis that the 1^stand 2^nd defendants had failed to lay any evidentiary foundation such as would raise a triable issue as to the reasonableness of the costs.

23.  On the plaintiff’s shortfall claim, the judge granted summary judgment and rejected the contention of the 2^nd defendant that his obligation to pay the shortfall under clause 5.2 of the second supplemental agreement was discharged by the put option deed.  The judge reached the conclusion that the provisions were not inconsistent and that they addressed different risks.  Whilst clause 5.2 ensured that the plaintiff would be protected in the event of the shares being issued at a price lower than the conversion price, the put option addressed the carrying risk to the plaintiff since it was only exercisable within the one week window which could not occur until a period of time after the listing.

This appeal

24.  Mr Yuen S. C. who appeared for the 1^st and 2^nd defendants submitted that the judge was wrong to have entered summary judgment on any, much less all, of the plaintiff’s claims.  However, the arguments advanced on appeal were no different from those that had been made to the judge.

The Moneylenders Ordinance defence

25.  It was submitted that the judge’s analysis was faulty and that he had reached the wrong conclusion.  It would not appear to have been Mr Yuen S.C.’s case that the judge had overlooked material provisions in the agreements.  Indeed, the judge’s description of the provisions of each of the agreements was full and comprehensive.  In so far as Mr Yuen sought to suggest that the judge’s reference to “the single most compelling factor” meant that he had had regard only to that factor, that submission is plainly unsustainable given paragraphs 61 to 81 of the judgment which, painstakingly, dealt with Mr Yuen’s submissions as to the significance and meaning of various provisions in the agreements, such as the submission that the 1^st defendant had an option as to how the $35 million advance was to be repaid, the significance of the provisions in the instrument providing for repayment of the subscription monies in certain events and those relating to the payment of interest on the amount of the note as well as the fact that the $35 million was intended to finance the listing of Surge.

26.  In my view, the judge’s reasoning was unassailable.  The 1^st and 2^nd defendants were nowhere near beginning to demonstrate that the judge had gone seriously wrong in his analysis, much less that he had overlooked any material point.  I agree with the judge that the fact that the advance was to be used to finance the listing was in itself neutral.  Whilst there were some provisions that might be consistent with the transaction being a loan, there were many provisions whose inclusion can only be consistent with an intention to protect the position of the plaintiff, “to ensure that the plaintiff gets, in real terms, a shareholding in Surge to the extent and value it [had] bargained for”.  Moreover, had the transaction had been no more then a loan, the provisions in the first supplemental agreement requiring the plaintiff to advance further monies (by way of a top-up payment) should the issue price exceed $0.54 per share would be inexplicable.  I agree with the judge that the agreements were in substance an investment by the plaintiff and not a loan.

27.  Mr Yuen then submitted that the judge should not have excluded the 2^nd defendant’s evidence and was wrong to have done so.  The test stated by the judge at paragraph 58 of his judgment quoted above is unexceptionable.  That was the test that was applied.  In a clear case such as the present, where there is no doubt and no ambiguity, the judge is not bound to have regard to extrinsic evidence.

The legal costs defence

28.  The two bills of costs were rendered in January and July 2002.  The bills were never queried at the time and no steps were ever taken to tax them.  At the end of March 2003, some 14 months after the first bill was submitted and after the close of pleadings, the solicitors for the 1^st and 2^nd defendants requested a breakdown of the two bills which, it is common ground, was never answered, whether before or after the date of the Order 14 summons which was issued in May 2003.

29.  The bills related to costs incurred by the plaintiff in connection with the first and second supplemental agreements and related documentation.  The solicitors who prepared all this documentation were solicitors to the defendants.  It is not a case where a party is being asked to pay legal costs in respect of a transaction to which he was not privy.  To the contrary, the defendants were in a position to form a view on a rough and ready basis as to the reasonableness of the legal costs sought from the legal costs that they themselves had to incur in relation to the common transaction and documentation.  If what was sought had been out of line, they would have been in a position to challenge its reasonableness.  This they never did.  Therefore, I do not accept that without the breakdown sought, the 1^stand 2^nd defendants were not in the position to challenge the reasonableness of the costs sought.  The defence raised is wholly unmeritorious and the judge was quite right in rejecting it.

The defence to the shortfall claim

30.  In rejecting the defence, the judge’s reasoning was that clause 5.2 of the second supplemental agreement and the put option addressed different risks.  Mr Yuen failed to demonstrate that that conclusion was wrong.  Clause 5.2 of the second supplemental agreement was plainly directed at the shortfall (if any) arising at the time of the automatic conversion.  The risk of the price of the shares not being maintained at the issue price in the 12 months or alternatively 6 months following listing was a different risk altogether.  It was designed to protect the plaintiff from a fall in value of the shares after listing in contrast to a lower price of the shares at listing.  Given that the plaintiff was not in a position to realise the shares immediately after conversion because of the six month lockup provision contained in the second supplemental agreement the put option gave some protection against a sustained fall in share price.  The option is only exercisable during the option period, namely, the period of one week commencing from the anniversary of the listing date or if it was accelerated by reason of clause 8.3 (default on the part of the grantor of the put option to pay the guarantor the amount as provided by clause 4) to the period of one week commencing from the expiration of the lockup period.  The put option is but another provision designed to protect the value of the plaintiff’s investment.  Whilst clause 5.2 also has thatobjective, the timeframe is totally different.  The put option ensures that it would be maintained at the time the option became exercisable which the parties chose to be a year (or six months if accelerated) from the listing date.

31.  If, as is my view, the judge was right about different risks being addressed, that is the end of the matter so far as the raising of a triable issue is concerned.  I do not accept that the resolution of that issue involves any dispute of fact as suggested by Mr Yuen.