THE CHINA STATE BANK LTD. v. KING PACIFIC INTERNATIONAL HOLDINGS LTD. AND OTHERS

HCA1694/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.1694 OF 2001

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(By original Writ and Order carry on)

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J U D G M E N T

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Introduction

1) These are Order 14 proceedings. The plaintiffs, who I shall hereafter refer to as "the Bank", have sued the 1st defendant ("the Company") to whom it had extended general banking facilities in respect of two separate outstanding amounts of US$823,356.59 and HK$89,714.63 together with contractual interest on those amounts. On 23 March this year the Company, which is now in liquidation, consented to judgment to the full extent of the claim together with an order for costs on an indemnity basis.

2) The 2nd and 3rd defendants who were director and chairman respectively of the Company are sued as guarantors of the Company's indebtedness on these accounts.

3) The 2nd defendant who had hitherto been represented by solicitors has not appeared, nor is he represented today, to defend the summons and so for reasons which I can state shortly in due course I propose to enter judgment against him in the amounts claimed by the Bank.

4) The 3rd defendant has put up a vigorous defence and the real substance of this judgment is concerned with whether he should be given leave to defend.

The documents

5) I need to refer to the documents that form the basis of this matter which I can take in narrative form and because they also show how this action has come about. The starting point is a letter dated 15 July 1998 from the Bank to the Company whereby it extended to it general banking facilities on the terms and conditions appearing in the letter (pages 101 to 106 of Bundle II). I need only summarise the material parts of those terms. The Company was given three facilities :

(i) an overdraft facility of up to HK$10,000,000;

(ii) a fixed loan of US$2,000,000; and

(iii) a further fixed loan of US$1,000,000.

The interest rates applicable to these facilities and the other terms attaching to them appear in the letter which for present purposes I need not relate further. Under paragraph 6 of the letter which contains the conditions precedent to the provision of these facilities, the Company was required to provide a signed copy of the duplicate of the letter together with board resolutions indicating acceptance of the terms of the offer set out in the letter, a guarantee for not less than US$1,000,000 together with accrued interest, default interest and other costs and expenses referred to in the guarantee duly executed by the 2nd and 3rd defendants and, thirdly, a deed of indemnity, charge-over deposits and set-off in the Bank's favour charging by way of a first fixed charge deposit for not less than HK$5,000,000 and US$2,000,000 executed in the Bank's favour together with supporting broad resolutions.

6) The letter of guarantee was executed by the 2nd and 3rd defendants. It is also dated 15 July 1998 - see pages 93 and 94 of Bundle II). Particular reliance is placed by Mr Au, who appears for the Bank, on Clauses 2, 5, 9 and 13. It is helpful to set out these clauses here :

"2. I/We expressly agree that the Bank shall have full discretionary power, without any exempt from or notice to me/us, and without in any way affecting my/our liability under this guarantee, at any time to determine enlarge or vary any credit, accommodation or facility to the Principal, and to hold over, vary, exchange, abstain from perfecting, renew, or give up, in whole or in part and from time to time, any bills, notes, mortgages, charges, liens or other securities received or to be received from or for all on behalf of the Principal, either alone or jointly with any other person or persons, often any other person or persons or bearing the name of the Principal, and without my/our consent or knowledge in any way to grant time or indulgence to, or compound or make any arrangements with the Principal or any person or persons liable on any such bills, notes, mortgages, charges, liens or other securities, or any person liable jointly with or as surety for the Principal, or any other person or persons.

......

5. This guarantee shall be in addition to and shall not prejudice or affect and shall not be in any way prejudiced or affected by any collateral or other security including but not limited to mortgages, debentures, charges, guarantees and liens now or hereafter held or judgment or order obtained by the bank for all or any part of the moneys hereby guaranteed nor shall such collateral or other security, judgment or order or any lien to which the Bank may be otherwise entitled or the liability of any person or persons not parties hereto for all or any part of the moneys hereby secured be in anywise [sic] prejudiced or affected by this guarantee. In particular it shall not be necessary for the Bank to resort to or seek to enforce any security or personal guarantee or liability whether of the Principal or any other person or persons before claiming payment from me/us. The Bank shall have full power at the Bank's discretion to give time for payment or to make any other arrangements with any such person or persons without prejudice to this guarantee or any liability hereunder. All moneys received by the Bank from me/us or the Principal or any person or persons liable to pay the same may be applied by the Bank to my account or item of account or to any transaction to which the same may be applicable.

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9. This guarantee shall be a continuing security of the Bank and shall not be determined except the expiration of three calendar months from the date when written notice of my/our intention so to do shall have been received by the Bank from me/us and in the event of death of me or any one of us the liability of my/our personal representatives and of my/our state shall continue until the expiration of three calendar months notice in writing of the intention of my/our personal representatives to determine this guarantee shall have been received by the Bank from my/our personal representatives.

......

13. I/We agree that any statement or demand signed by any officer or person duly authorized by the Bank should be conclusive evidence against me/us of the amount for the time being due to the Bank from the Principal in any action or other proceeding brought against me/us upon this guarantee."

I will need to make specific reference to some of these provisions when I consider aspects of the argument which have been addressed to me by Mr Au in particular. This guarantee was for the required amount of up to US$1,000,000.

7) A further guarantee was given by the 2nd defendant only, for an additional amount of up to HK$4,000,000 plus interest on 15 April 1999 which is at pages 96-99 of bundle II. Nothing further turns on this guarantee.

8) By 2 February 2000 the Company's indebtedness to the Bank stood at US$2,822,833.34 and HK$8,645,001.92. Due to the fact that the Company was experiencing financial difficulties, it was obliged to return to the Bank for further assistance. This was forthcoming in the form of a revised facility letter (Bundle II, pages 124 to 128). The effect of the revision was to reduce the Company's overdraft from HK$10,000,000 to HK$8,000,000 and to re-schedule the repayment terms on the loans so as to give the Company more time to repay its indebtedness. This all appears in paragraph 1.1 of the revised facility letter see page 124, Bundle II. The fixed charges on the two US dollar and Hong Kong dollar deposits provided when the original facility was made were continued. All of this is plain from the documents and is not in dispute.

9) The next step comprises the demand letters from the Bank addressed to the Company and to the 2nd and 3rd defendants. All three are dated 28 March 2001.

10) The letter addressed to the Company, Bundle II, pages 130 to 131 which relies on the repayment terms in the facility letter and the subsequent revised facility letter requires repayment of the Company's outstanding indebtedness as at 25 March 2001 in the amounts of US$820,854.10 and HK$88,893.83. The other two identically dated letters made demands for repayment from the 2nd and 3rd defendants pursuant to the terms of their letters of guarantee to pay the Company's outstanding debts. See Bundle II, pages 133 and 134 (D2) and pages 136 and 137 (D3).

11) Once payment was not forthcoming from any of the defendants, a writ was issued on 17 April 2001 and this summons for summary judgment was taken out on 5 September 2001.

12) The Company having consented to judgment this matter is now only pursued against the two remaining defendants. This therefore is how the matter now comes before me, originally having been listed before the master but subsequently adjourned and now before a judge as a matter at first instance.

Judgment against the 2nd defendant

13) As this defendant has not appeared to pursue the matters raised in his Defence and Amended Defence nor has he filed any evidence in support of his pleaded case, accordingly, I am left just with the Bank's affirmation evidence in support of its case against this defendant. This comes from Mr Yeung Chi Leung, pages 29 to 47 of Bundle I and that of Mr Cheung Kwok Pui, pages 79 to 91-4 of Bundle I. These affirmations and their accompanying exhibits have satisfied me that, the Bank's case against the 2nd defendant has been proved and, in the absence of anything from this defendant, nor that there is any defence. Accordingly, there must be judgment in favour of the Bank against the 2nd defendant in the sum of US$823,356.95 and HK$89,714.63 together with interest on the principal sums of US$750,333.33 and HK$82,093.18 at the respective rates of US$233.46 and HK$40.48 per day (subject to fluctuation) from 3 April 2001 to today and thereafter at the judgment rate until payment. The 2nd defendant must pay the Bank its costs of this action on an indemnity basis in accordance with the terms of the facility letter.

The case against the 3rd defendant

14) I now turn to the substantial part of this judgment. The arithmetic of the claim against this defendant is identical to that of the 1st and 2nd defendants coming as it does from the original facility letter and the revised facility letter, Bundle II, page 124 supra. The 3rd defendant's liability is, prima facie, established from the letter of guarantee, Bundle II, pages 93 and 94. In these circumstances the onus lies on Mr Swaine, who appears for him, to demonstrate that there are triable issues which merit the grant of leave to defend. At one stage, before the matter was listed for hearing before me, it appeared that leave to defend was being sought by this defendant on a number of points. Now, Mr Swaine has quite rightly confined himself to only one. He submits that the 3rd defendant has a potential set-off and counterclaim against the plaintiff which if leave is granted can be added by way of amendment to the existing Defence. It arises from what he says is the recognised duty which a creditor owes to a guarantor, at least in equity, as a duty not to prejudice the guarantor by any positive act or negligence on the part of the creditor which results in an unfairness or injustice to the guarantor. Mr Swaine appreciates that such a duty does not appear in common law and he has not been able to find any decided case in support of such a common law duty. Notwithstanding that, he feels is able to submit that there is no reason to conclude that no such duty could ever arise in a particular set of circumstances and he invites me to say that the particular facts of this case may give rise to such circumstances. Having regard to the facts, which I must refer to presently, he submits that the matter merits proper investigation in a conventional trial. It would be wrong in all the circumstances to shut the defendant out at this paper stage.

15) He seeks to make good his point in part from a decision of the Supreme Court of New South Wales in Graeme Webb Investments Property Ltd v. St George Partnership Banking Ltd (12 April 2001). I will return to the facts and reasoning of the court in that case in a moment, but before I do so it would be helpful to rehearse, albeit briefly, Mr Swaine's line of argument.

16) He submits that the 3rd defendant had and has a legitimate interest to subrogate to the rights of the Bank against the principal debtor, the Company. The letter of guarantee does not preclude that but merely has the effect of postponing such a right. Reference is made to Clause 4, Bundle II, page 93 which is to this effect. Mr Swaine submits that this right is capable of being protected by reducing to the point of extinction the Bank's claim against the 3rd defendant.

17) What Mr Swaine has in mind is the Bank's conduct in extending banking facilities to the 1st defendant at the end of February 2000 by means of the revised facility letter (Bundle II, page 124) at that time, when the 1st defendant was experiencing financial difficulties and in the face of, according to Mr Swaine, clear evidence of fraud on the part of the Company's than management. By adopting that course instead of calling in the loans, the Bank has deprived the 3rd defendant of the prospect of recovering from the Company by subrogation when it still had the means to satisfy such a claim by him. Acting in the way that the Bank did amounts to a breach of its duty to the 3rd defendant. All of this is canvassed in the 3rd defendant's affirmation, paragraphs 8 to 15, starting at page 54 of Bundle II.

18) As appears from these paragraphs, the matters which the 3rd defendant has in mind relate to a purported investment by the Company in the Wu Han Waterplant which he says was fraudulent and part of a deliberate scheme by the 2nd defendant in collusion with China Fortune and others to gain control of the Company which involved an on-going expropriation of the Company's assets. As a result, he says that he was removed from the board of the Company on 2 February 2000 and since then he has been engaged in extensive litigation with the 2nd defendant and those supporting him. He has listed the various actions and petitions started by him and he cites, from paragraphs 9 to 12, the widespread media publicity which this litigation had attracted.

19) Reliance is then placed on the fact that following this date, the Bank should have realised that he was no longer concerned in the affairs of the Company. In order to execute the revised banking facilities several documents were required by the Bank such as board minutes which he purported to sign as "Chairman" when he in fact was not present at that meeting. Attention is drawn by him to the fact that when one compares the signature on that board minute dated 7 March 2000 with the minute of 15 July 1998 that the two signatures are different. Mr Swaine submits that it was incumbent upon the Bank's staff to check on these matters to ensure that all these important documents had been regularly executed. Particularly, at a highly turbulent period in the Company's affairs.

20) In paragraph 15 of his affirmation, the 3rd defendant sets out what the Bank ought to have done at about the time when it had decided to extend further banking facilities to the Company. Firstly, it is said that the Bank should have curtailed further lending and sought repayment from the Company and ensured that such assets that the Company had were not lost or dissipated and, secondly, at least informed the 3rd defendant of what it knew, or ought to have known, concerning how the further facility letter of 24 February came to be executed with particular regard to the fact that the board resolution, which authorized the Company's acceptance of the terms of the revised facility, was one procured irregularly, to put it at its most neutral, where the resolution itself purports to record the 3rd defendant's presence at that meeting and the minute bears the 3rd defendant's forged signature as chairman of the meeting.

21) The Bank's failure to take note of all these matters amounts to a breach of duty which the 3rd defendant says has now caused him to suffer losses represented by his inability, by subrogation, to recover anything meaningful from the Company. His set-off is what he would have been able to recover had the Bank acted with appropriate care and taken steps to deal with this matter at the time in the way that the 3rd defendant has suggested.

22) That is the factual basis upon which the 3rd defendant mounts his defence.

The law

23) I think Mr Swaine is driven to accept that there is no common law duty of care cast on a creditor not to prejudice a guarantor by any positive act or by negligence. He recognises that because there is no decided authority in support of such a proposition although he suggests that there is no reason to conclude that none could ever arise in a particular set of circumstances and he has suggested that the facts of this case are sufficiently arguable, for Order 14 purposes, that this may be such an occasion. A convenient starting point is the Privy Council decision in the Hong Kong case of Tan Soon Gin v. China and South Sea Bank Ltd [1990] 1 HKLR 546. Whilst the facts of the case are of no assistance, the complaint made by the guarantor in that matter was similar to the one now made by the 3rd defendant in this action, which was that the mortgagee bank owed the guarantor a duty of care by exercising its power to sell mortgaged shares in order to satisfy the debt owed to it by the principal debtor and that it had breached that duty by failing to act as the value of shares fell until they had become worthless. The complaint therefore is an identical one. The answer was provided by Lord Templeman who gave the opinion of the board at page 550B-E :

" The creditor is not obliged to do anything. If the creditor does nothing and the debtor declines into bankruptcy the mortgaged securities become valueless and the surety decamps abroad, the creditor loses his money. If disaster strikes the debtor and the mortgaged securities but the surety remains capable of repaying the debt then the creditor loses nothing. The surety contracts to pay if the debtor does not pay and the surety is bound by his contract. If the surety, perhaps less indolent or less well protected than the creditor, is worried that the mortgaged securities may decline in value then the surety may request the creditor to sell and if the creditor remains idle then the surety may bustle about, pay off the debt, take over the benefit of the securities and sell them. No creditor could carry on the business of lending if he could become liable to a mortgager and to a surety or to either of them for a decline in value of mortgaged property, unless the creditor was personally responsible for the decline. Applying the rule as specified by Pollock, C.B. in Watts v. Shuttleworth (surpa) at p. 247, it appears to their Lordships that in the present case the creditor did no act injurious to the surety, did no act inconsistent with the rights of the surety and the creditor did not omit any act which his duty enjoined him to do. The creditor was not under a duty to exercise his power of sale over the mortgaged securities at any particular time or at all."

This authority is therefore cited in support of the proposition that no common law duty of care exists as between creditor and guarantor. O'Donovan and Phillips (The Modern Law of Guarantee, 3rd Edition) draw the attention to recent decisions in New Zealand and Canada that have held that the creditor owes a common law tortious duty of care to the guarantor and that the creditor will be liable in damages to the guarantor if, for example, the creditor fails to take reasonable care in appointing a receiver or liquidator or negligently delays in recovering the principal debt. Nevertheless the learned authors, accept the position established by the Privy Council (supra) and tend to the view that if the guarantor is to be discharged, that may only be so by the application of equitable principles.

24) With this in mind, Mr Swaine has referred to Graeme Webb Investments Property Ltd to which I have already drawn attention because of the consideration given to those equitable principles by the Court of Appeal of the Supreme Court of New South Wales. These principles are discussed at page 20 of the report. Reference is made to the case of Black v. Ottoman Bank (1862) 15 ER 573, a decision of the Privy Council which stated the general principle that a surety would be discharged if there has been "some positive act" by the creditor to the prejudice of the surety or such degree of negligence to imply connivance and amount to fraud, see Dawson v. Lawes (1854) 23 LJ Ch. 434, at 441. Fraud, in this context, is defined as conduct which is unfair to a surety, citing the case of Mayor of Durham v. Fowler (1889) 22 QBD 394, at 419. Having been referred to that decision, the Court of Appeal had difficulty in finding any clear examples either in England or Australia of the discharge of a guarantor on this basis. It identified three classes of cases :

"The first is where one of the bases for the decision is that the creditor must not act to the prejudice of the guarantor, but the fact that the guarantor has been discharged can be explained adequately on other well-established grounds. The second is where the principle in Black v. Ottoman Bank has apparently been recognized, but its application has been negated on the fact. Finally, there are cases which have cast doubt on the principle either by expressly disapproving of it or by refusing to apply or even analyse the principle even though the fact of the case might have justified its application."

25) What the cases discussed in Graeme Webb Investments show is that the creditor can sit back bide his time and seek to recover his debt and, if unsuccessful, look to the guarantor at his own choosing. Inactivity on the part of the creditor therefore will not avail the guarantor. A different situation may arise where the creditor decides to do something which proves to be ill-advised to the point of being negligent in such a way that it can be demonstrated by the guarantor that this amounts to unfairness to the guarantor and to his prejudice. It is then that in equity a court may step in and provide the guarantor with a remedy. That, as I understand it, is the effect of the cases.

The Bank's response

26) Mr Au does not take great issue with those propositions of law. He says that having regard to the terms of the facility letter, the revised facility letter and the guarantee, that the Bank was entitled to act as it did with the result that there can be no answer to the Bank's claim against the 3rd defendant. The letter of guarantee has given the Bank a very wide discretion and attention is drawn to Clauses 1, 2, 5 and 16 and it now seeks to exercise its right pursuant to Clauses 2, 5, 13, 14, 19 and 21.

27) The ill-advised and improper conduct relied on by the 3rd defendant is the revised facility letter of 24 February 2000. Mr Au submits that the remedy here lay in the 3rd defendant's own hands. He was of course at the heart of the dispute between himself and his fellow directors. He was content to start litigation against the Company and his fellow directors but it was also open to him to give notice to the Bank at any time terminating his liability under the guarantee.

28) Mr Au's most substantial point, as I follow his submissions, is that even if some sort of duty in equity bound the Bank, the evidence is all one way demonstrating firstly, that they could never be held to have acted in breach of such duty and, secondly, that there was no loss or damage suffered by the guarantor.

29) Referring to the evidence, Mr Au draws attention to the fact that the Company's liability was incurred before the outbreak of any internal disputes between the 3rd defendant and his fellow directors. By that time the Company was already indebted in the sum of over US$2,800,000 and HK$8,600,000 as at February 2000. These amounts are well in excess of what the Bank now seeks to recover in this action. Turning to the revised facility letter itself, its effect was to reduce the limit of banking facilities provided to the Company. Further there was no additional lending to the Company since the date of the revised facility, and, the evidence is clear that when one examines the Bank's statements that this indebtedness has in fact been reducing since 2 February 2000. Mr Au also draws attention to the fact that all the media reports which Mr Swaine so heavily relies on came after 2 February 2000 by which time the debts had been incurred and had been reducing. As to the litigation which the 3rd defendant started in order to protect his position, these actions were not initiated until the end of February 2001, a whole year after the revised facility letter. It appears therefore that the outbreak of hostilities between the 3rd defendant and his associates all came about after the debts had built up and after the Bank had stopped providing further lending to the Company.

30) As to the irregularities which are relied upon, in particular, the 3rd defendant's falsified signature on the board minute, Mr Au submits that such was the result of an internal dispute between members of the board. That is not something which the Bank could or should concern itself with and, in any event, the Bank is entitled to rely on Turquand's Rule and need not concern itself with the internal management of the Company.

31) Finally, Mr Au submits that if all else fails the guarantor is in no position to prove any loss caused to him by an alleged breach of duty owed to him by the Bank. The way Mr Au puts the matter is that the Company's terminal decline was not something that was caused by the Bank but by the activities of certain members of the board which the 3rd defendant complains of. In any event, had he elected to exercise his right to terminate the guarantee at the time when the Company still had substantial assets, all of this could have been avoided.

32) Mr Au submits that it is because a debtor, such as this company, may find itself in financial difficulties that commercial lenders look for personal guarantees from directors or other persons of substance who can protect their investment.

Conclusion

33) I have come to the view that Mr Au is right in these matters. To give leave to defend would be to allow Mr Swaine's persuasive advocacy to impose itself on what is, I am afraid, a plain case. The Bank in this matter has at all times behaved perfectly properly, both in relation to the principal debtor (the Company) and, more relevantly, for present purposes towards the guarantor (this defendant). Once financial difficulties emerged, discussions were held between the Bank and those then representing the Company to re-schedule the Company's indebtedness. At the same time the Bank insisted on a reduction of its exposure by reducing the level of debt. Thereafter that indebtedness was clearly run down in a most substantial way, leaving relatively speaking, a fairly modest position compared to what it had been before the revised facility was extended. The evidence here does not begin to suggest that the Bank acted in any unfair or improper way vis-à-vis itself and the 3rd defendant. Even taking Mr Swaine's case at his highest on the law, there is not a scintilla of evidence to suggest improper conduct of the sort that Mr Swaine has contended for.

34) Clearly there was a very serious falling out amongst the various factions on the company's board but the state of the law does not require the Bank in such circumstances to go about conducting some sort of enquiry as to the state of play amongst the members of the board. No doubt it carries out its own "due diligence" in deciding how best to approach a company's indebtedness to it and on this occasion, it seems to me, that in commercial terms, it acted very sensibly by insisting that the level of debt be reduced and allowing more time for the indebtedness to be paid off by rescheduling the payments. As to the paper work coming out of the company's board room, the Bank is entitled to presume that the paper work is authentic. This afterall was a substantial public company. I am afraid that the 3rd defendant has failed to demonstrate that he has any arguable defence to place before the court and, accordingly, I am satisfied that judgment must be entered against him in the amounts claimed in the Statement of Claim.

35) The judgment will be in the same amounts both as to principal and interest as that entered against the 2nd defendant, together with an order for costs against him on a full indemnity basis. This order for costs will be an order nisi in the usual way.