THE KA WAH BANK LIMITED v. PRODUCT SCOUTING INTERNATIONAL LIMITED AND ANOTHER

Banking - personal guarantee of director of Company's account - terms of guarantee - whether principal debt affected by ultra vires or frustration doctrines - if not whether guarantee merely an indemnity - if a guarantee whether liability thereunder discharged by variation of securities between bank and customer or furnishing of other security by guarantor - whether in dealings with customer duty owed by Bank to guarantor - Held: 1. Original debt not affected by ultra vires or frustration doctrines; 2. Letter signed by 2nd defendant was a guarantee and not an indemnity; 3. liability of guarantor not released by variation of securities with or provision of other security by guarantor; Judgment for bank against guarantor for $3,024,556.81 plus interest.

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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JUDGMENT

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1. In this action the trial proceeded against the 2nd defendant only, judgment having already been entered against the 1st defendant on 27th December 1984, for the sum of $3,024,556.81 together with interest and costs. The 2nd defendant appeared in person. He was also the major shareholder of the 1st defendant. The various interlocutory proceedings suggest that the 1st defendant had insufficient funds to instruct a solicitor, which in the case of a body corporate is, under Rules of the Supreme Court Order 5 Rule 6, Cap. 4, mandatory. For that reason, the 2nd defendant intimated, no defence was filed by the 1st defendant and as a result default judgment was entered in the terms already set out. Accordingly, I am now only concerned with the action against the 2nd defendant.

2. The action arises from the fact that on 8th April 1981 the 1st defendant was granted certain credit facilities by the plaintiff when there was executed a standard form document intituled "General Agreement for Commercial Business." Later the 2nd defendant personally guaranteed the indebtedness of the 1st defendant to the plaintiff, executing on 24th February 1982, a standard form Letter of Guarantee. The guarantee provided that it was to be a continuing security and that the 2nd defendant was liable as a principal debtor and not merely as a surety. Under the guarantee the plaintiff was also at liberty, without affecting its rights against the 2nd defendant, to determine, enlarge or vary any credit granted to the 1st defendant and to compound with, give time for payment and enter into composition or arrangements with the 1st defendant and generally grant it any time or indulgence.

3. The credit facilities granted to the 1st defendant were repayable upon demand. The plaintiff made demand on the 1st defendant on 28th May 1984 for the same sum for which it later obtained judgment, namely $3,024,556.81. On 28th May 1984 similar demand was also made on the 2nd defendant under the Letter of Guarantee. The Statement of Claim averred that in breach of the guarantee and despite repeated requests and demands the 2nd defendant had failed to pay the same sum due under the guarantee.

4. In a lengthy defence the 2nd defendant pleaded that the General Agreement for Commercial Business between the plaintiff and the 1st defendant was subject to the doctrines of ultra vires and frustration; that the Letter of Guarantee was not a guarantee but only an indemnity; if it was a guarantee it became invalid upon the plaintiff on 17th December 1982 ceasing to grant credit to the 1st defendant; that on 17th October 1983 the plaintiff exchanged the Letter of Guarantee for the 2nd defendant's passport; that on 17th October 1983 the plaintiff exchanged the Letter of Guarantee for a transfer of shares held by the 2nd defendant in another company; that the guarantee ceased to be valid when on 20th September 1982 the plaintiff failed to request the 1st defendant to furnish additional securities; that the guarantee ceased to be valid on 28th October 1981 when the plaintiff accepted the speculative and inflationary value of a mortgage of a Chunghomkok residential property; that the guarantee ceased to be valid on 24th February 1982 because there was no provision therein providing for the positive liability of the plaintiff to the 2nd defendant thereunder.

5. The 2nd defendant also counterclaimed for loss and injury of reputation which he quantified as $3,200,000 for losses sustained in related business contracts and commercial opportunities and $1,000,000 for injuries to reputation and personal position. The plaintiff filed a reply and defence to counterclaim in which it particularised a proposed restructuring of the 1st defendant's indebtedness which was agreed to by the plaintiff subject to various conditions, on 17th October 1983. These conditions included the reassignment of the mortgaged property at market value to another party; repayment of the balance by monthly instalments over 6 years; and the pledging by the 2nd defendant of 40% of the shares in Product Vision Hong Kong Ltd. The plaintiff admitted that there had been a suggestion that the 2nd defendant lodge his passport with the plaintiff but this suggestion was overruled by senior officers of the plaintiff. The defence to the counterclaim also pleaded that the 1st defendant failed to reassign the mortgage and failed to make the monthly instalment repayments.

6. After having heard the evidence adduced by the plaintiff I was satisfied that the 2nd defendant had entered into a duly executed Letter of Guarantee of the indebtedness of the 1st defendant to the plaintiff. I was further satisfied that the 2nd defendant was liable thereunder as a principal debtor and that it was a continuing security. I was also satisfied that the Letter of Guarantee, as pleaded, allowed the plaintiff subsequently to vary the terms of any credit to the 1st defendant without thereby releasing the 2nd defendant from liability. The Letter of Guarantee appeared to have been carefully and widely drafted, no doubt with an awareness of such decisions as National Bank of Nigeria Ltd. v. Oba M.S. Awolesi (1964) 1 WIR 1311 to which I was referred. On the plaintiff's evidence it was also established on the balance of probabilities that the 1st defendant was indebted to the plaintiff in the sum claimed which was repayable upon demand; that demand had been made on the defendants; judgment obtained against the 1st defendant; and that the 2nd defendant had not paid any of the monies claimed to the plaintiff.  On those findings the liability of the 2nd defendant was prima facie established.

7. I turn now to consider the defence of the 2nd defendant. The defence pleaded may perhaps be more easily followed if I were first to summarise some of the evidence adduced by the 2nd defendant in support of his defence and counterclaim. The 2nd defendant explained that he was the sole director of the 1st defendant and held 98 shares in that Company with the remaining 2 shares being held by a secretarial firm. In effect the 1st defendant was the 2nd defendant's one man Company. In 1982 the principal business of the 1st defendant was importing car telephones from Japan and selling them locally. There were also hopes that some could be re-exported to European markets. The plaintiff provided letters of credit and other commercial banking facilities for this business. The evidence of the 2nd defendant was that serious cash flow problems arose when changes to Hong Kong communication laws restricted local sales and similar legal changes in Europe affected the development of the re-export market.

8. The 1st defendant then attempted to diversify. The two chosen fields were mini-cruisers and video games. Substantial sums were paid for the importation of mini-cruisers and video games. According to the 2nd defendant the promising sales of these products ceased again due to new Hong Kong legislation. The mini cruisers were required to be licensed by the Marine Department while various licensing restrictions were imposed on the operation of video games centres by the Urban Services Department. In a further attempt to diversify, a Hong Kong product Display Centre was promoted and substantial promotion liabilities incurred. A final attempt to diversify led to the formation of product Vision Hong Kong Ltd. A contract was entered into with the Hong Kong Telephone Co. Ltd.  which granted exclusive rights to store and maintain manufacturers and products data in its computer. The 2nd defendant stated that his Company proposed to sell to hotels and business institutions the right to display such information on view data terminals at their premises. I was told that sales contracts with many hotels and other institutions were negotiated.

9. One of the 2nd defendant's complaints was that over several crucial months he was unable to negotiate direct with the senior management of the plaintiff to obtain the loans these various projects required. Finally when he had negotiated a bridging loan which he hoped to use for the proposed Hong Kong Product Display Centre he discovered that the plaintiff proposed to apply the loan to settle outstanding bills in the account of the 1st defendant. He therefore refused to draw the loan down. The non-availability of proceeds from the bridging loan added to the already grave liquidity position resulted in the exclusive rights from the Hong Kong Telephone Co. Ltd. being forfeited. In effect the 1st defendant ceased to trade.

10. On those facts, the ultra vires pleading was sought to be based on the allegation that the plaintiff provided credit for car telephone and video games businesses which had, because of changing legislation, become illegal. The contents of the letters of credit were notice, it was submitted, to the plaintiff of the nature of business for which the products covered by those letters of credit were to be used. The frustration pleading was related to the ultra vires issue.  It was submitted that the 1st defendant's initially lawful business in car telephones, video games and mini-cruisers was frustrated by the changes in legislation.

11. The 2nd defendant denied that the Letter of Guarantee existed but submitted that if it did the document was not a guarantee but an indemnity. The 2nd defendant developed this submission on the basis that the plaintiff first obtained security for its loan under the mortgage of the Chunghomkok property on 30th June 1981. Later on 24th February 1982 the letter of Guarantee was executed. I was referred to the distinction between a guarantee and an indemnity including a reference in 'Paget's Law of Banking' (9th Edn.) 498. If the document were a guarantee it was alternatively further submitted that the obligation of the 2nd defendant thereunder were discharged for the variety of reasons earlier set out. The 2nd defendant also pleaded the English Unfair Contract Terms Act 1977 and referred me to 'Anson's Law of Contract' (25th Edn.) 186. However, when it was explained that the Act does not apply in Hong Kong and we have no similar Ordinance, he reasonably abandoned that ground. On the concept of reasonableness, in the context of standard term contracts, he also referred me to 'Anson' (supra) at pages 185 and 186.

12. Dealing first with the issue of ultra vires, this was not advanced on the ground that the businesses were beyond the scope of the objects clause of the 1st defendant's memorandum of association, but on the ground that they were illegal businesses. However, quite apart from several other factors adverse to this ground, the 2nd defendant agreed that the products themselves were not illegal; it was only if they were used in a particular manner that licences had to be obtained and compliance had to be made with other legal requirements. The related frustration pleading also does not fall within the well settled boundaries of the doctrine of frustration. It is true that supervening illegality may be an instance of frustration but that did not occur in the present case. The general test of frustration is whether there is a radical change in the contractual obligation.

13. The contractual obligation between the plaintiff and the 1st defendant and between the plaintiff and the 2nd defendant, was not concerned with the supply of the products already named, but with the debtor-creditor relationship of banker and customer and banker and guarantor. The contract entered into between the former two parties, for the plaintiff to supply credit to the 1st defendant, was a lawful contract and within the objects clause of the plaintiff. I am prepared to infer that it was also within the objects clause of the 1st defendant. The contract was not only lawful but intra vires. That same lawful contract was certainly not frustrated by any radical change in the contractual obligation between the plaintiff and the defendants. At most the 2nd defendant's evidence on these issues, even if accepted in its totality, related to various independent transactions involving other or third parties. Even in relation to those other transactions the facts would not have supported a plea of ultra vires or given rise to frustration. In relation to the relevant contracts between the plaintiff and the defendants I hold that the defences based on ultra vires and frustration fail.

14. Moving on to the nature of the Letter of Guarantee, I am satisfied that prima facie it is a guarantee in the terms pleaded by the plaintiff. I have considered the authorities cited and far from supporting the submission that it was an indemnity they reinforce my view that the document is a guarantee and I so hold. As to whether the guarantee was discharged by any of the facts asserted by the 2nd defendant I have also considered the contents of 'Paget' (supra) 497 et. seq. The credit facilities granted to the 1st defendant were advanced at the discretion of the plaintiff and were repayable upon demand.  Any arrangement for payment by instalments was pending demand and upon default any outstanding payments were repayable upon demand.  The refusal of the plaintiff to continue to grant credit did not discharge the guarantee. To the contrary in reality it simply increased the probability of demand being made on the 2nd defendant under the guarantee.

15. The question whether the plaintiff agreed to accept the passport in exchange for the guarantee loomed large in the evidence. I accept the evidence adduced by the plaintiff, that although at one time an officer of the plaintiff suggested that the passport be lodged, that suggestion was not implemented being rejected by more senior officers of the plaintiff. If the passport had been physically accepted by the plaintiff, it would have still been necessary for the 2nd defendant to establish that it was accepted in substitution for the guarantee. If the passport were delivered to the plaintiff I am satisfied, on the evidence, that by that alleged date, it would have been delivered merely unilaterally by the 2nd defendant. Quite apart from the direct evidence, commonsense cries out that the plaintiff would have been most unlikely to agree to surrender the unlimited contractural liability of the 2nd defendant, merely for a passport which had no security value. The 2nd defendant recognised the doubtful usefulness of lodging his passport, even as evidence of his good faith to remain in Hong Kong, for he himself stated that he could very simply obtain a new passport from his own Consulate. I hold that none of the discussions or actions in respect of the passport discharged the 2nd defendant's liability under the quarantee.

16. I accept the plaintiff's evidence that the pledging of shares in Product Vision Hong Kong Ltd.  was not in consideration of releasing the guarantee. In any event I am satisfied that the pledging of shares was merely an element of a conditional proposal which never became unconditional because the 1st defendant failed to perform two very important conditions forming part of that proposal. The guarantee was clearly not discharged under that arrangement. The alleged failure of the plaintiff to obtain other securities from the 1st defendant when its position deteriorated and the mortgaging of a property of alleged speculative value are based on the same misconception reflected in the remaining allegation that the plaintiff in granting credit to the 1st defendant owed a duty to the 2nd defendant.

17. This misconception may in part be due to the 2nd defendant's repeated and correct submission that the defendants were separate legal entities and that simply because the 2nd defendant was the principal shareholder of the 1st defendant he was not thereby subject to its liabilities or deemed to share its knowledge.

18. From what the 2nd defendant stated at the trial I gather that from other legal proceedings he is now acutely aware of the consequence of separate legal personality and that a company is a legal entity distinct from its shareholders. This Court, of course, recognises and applies those long settled principles. Indeed, it was no doubt because of those very principles that the plaintiff took the step of obtaining the personal guarantee from the 2nd defendant of the 1st defendant's account.

19. The same misconception may also have resulted from the 2nd defendant's commendable attempt to read legal textbooks relevant to some of the issues in this action. Obviously he has spent much time reading 'Anson', 'Paget' , 'The Supreme Court Practice' and the works of Professor Goode. I was referred to 'Anson' at page 186 where reference is made to Lord Denning's eventually unsuccessful judicial attempt to evolve an abuse of contract doctrine. Although those efforts in part led to English legislation to meet some of the standard form and exclusion clause abuses on which the former Master of the Rolls so often dwelt. As may be seen from the cases mentioned by 'Paget' at page 525 the weight of authority is against a duty of care being owed by a bank to a guarantor. Certainly on the present facts, even if there such a duty, I would not have found the plaintiff in breach. In the considerable research which the 2nd defendant clearly has undertaken he may also have been misled by the unusual circumstances which culminated in the Court of Appeal's decision in Lloyds Bank Ltd. v. Bundy (1975) QBD 326 which I notice is referred to in some detail by 'Paget' at pages 500 and 501. That judgment will probably remain restricted to its very unusual facts and does not assist the 2nd defendant in the present action. I accordingly hold that these remaining defences also fail.

20. Finally, turning to the counterclaim I simply record that it is in turn based on the same facts pleaded in the defence. In view of my findings on the evidence I am equally satisfied that the counter-claim must also fail.

21. In the result there will be judgment for the plaintiff against the 2nd defendant on the claim in the sum of $3,024,556.81 together with interest at the plaintiff's current rate from 17th May 1984 to the date of judgment. The 2nd defendant's counterclaim is dismissed. The plaintiff is entitled to its costs, to be taxed if not agreed.