MEDITERRANEAN SHIPPING CO (HK) LTD v. TEXWAY INDUSTRIES LTD AND ANOTHER

HCA 1220/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1220 OF 2002

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J U D G M E N T

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Background:

1. This is an application for summary judgment under O.14 and O. 14A. The facts are not at all in dispute and may be shortly stated.

2. By a tenancy agreement in writing made on 1 March 1999 the 1st defendant (Texway) granted a tenancy of premises in Island Place Tower in North Point to the plaintiff (Mediterranean). The term of the tenancy was for 3 years from that date. The tenancy required Mediterranean to pay rent in the usual way and also contained a provision requiring Mediterranean to pay a deposit to secure its observance of the terms of the tenancy. That sum amounted to $607,477.00 being 2 months rent. The 2nd defendant (Fujian) being the parent of Texway, agreed to guarantee the refund of the deposit to Mediterranean. The terms of the provision in relation to the deposit required that, there being no breach of the agreement, it must be refunded within 14 days of the expiration of the lease.

3. Prior to the grant of the tenancy to Mediterranean, Texway had mortgaged the premises to the Sin Hau Bank Ltd., now known as the Bank of China (Hong Kong) Ltd (the Bank). There is no suggestion that the tenancy was in breach of the mortgage, but no evidence that the consent of the Bank was sought to the tenancy. In September 2000 the Bank exercised its powers under the mortgage and took possession of the premises. On 6 September 2000 the Bank's solicitors required Mediterranean to pay rental to the Bank in future, failing which proceedings for recovery of the premises would be instituted. On 5 November 2001 Mediterranean's solicitors wrote to Texway informing them that they were paying rent to the Bank and that there was no breach of the tenancy. They said that when the tenancy expired they would treat it at an end and would require a refund of the deposit. Texway were offered the opportunity, at the end of the tenancy, to inspect the premises to satisfy themselves that there were no outstanding matters.

4. On 28 February 2002 the tenancy expired by the efluxion of time. Mediterranean remained in possession and negotiated with the Bank for a new tenancy. On 19 March 2002 Mediterranean's solicitors wrote to Texway pointing out that Texway did not inspect the premises on expiry of the tenancy, that they continued to occupy under a "lease/licence" from the Bank and that a refund of the deposit was required. In terms of the guarantee demand was made on the same day to Fujian. There is no evidence that either Texway or Fujian responded to those letters in any way and on 28 March 2002 the writ was issued with a statement of claim attached.

5. On 9 July 2002 Mediterranean entered into a new tenancy agreement with the Bank, the document recording that the term of the tenancy ran from 1 March 2002. This information was first disclosed to Texway and Fujian on an affidavit filed on 8 August 2002.

The practical situation:

6. Texway now acknowledges that, in the light of the new tenancy agreement, and subject to confirmation form the Bank that there are no outstanding claims against Mediterranean, the deposit must be repaid. In fact, for reasons which are irrelevant, the sum due has been paid into court by Fujian. Mr. Carolan accepts, correctly, that if Texway is liable, so is Fujian on the guarantee.

7. Thus, to a very large extent, the only issue now between the parties is that of costs. To determine that I must look at the merits of the parties positions.

8. It is the argument for Texway and Fujian that until such time as they could be satisfied that vacant possession of the premises had been given, and that there was no claim by the Bank for breach of the tenancy agreement, they were not obliged to pay the deposit to Mediterranean, notwithstanding the requirement in the agreement that the deposit must be refunded within 14 days of the expiry of the lease.

9. Mr. Carolan contended therefore, until the time the new tenancy agreement was made, the cause of action pleaded by Mediterranean did not exist, and the writ ought not to have been issued. Consequently he said, there was no basis for summary judgment and therefore no right to costs.

The issue:

10. The issue depends upon the situation in relation to the deposit, upon the Bank exercising its rights as mortgagee and taking possession of the premises. It was agreed, I am confident correctly, that there is no difference at law between the position of the Bank as assignee of the premises under a mortgage, and a purchaser who takes by transfer by way of assignment.

11. The law appeared to have been clearly settled by the decision of the Privy Council in Hua Chao Commercial Bank Ltd. v Chiaphua Industries Ltd. [1987] 1 AC 99. There it was held that a covenant to pay a deposit to secure the future performance of the obligations of a tenant under a lease was not a covenant which dealt with or touched or concerned the land demised and accordingly did not pass with the reversion. In other words, the covenant did not run with the land. The consequence is that the landlord is not obliged to pay the deposit to the new landlord, and the tenant must seek recovery of the deposit from the original landlord to whom it was paid. This may have adverse consequences to the tenant if, as in the Hua Chao case, the original landlord has gone into liquidation. The decision has been the subject of academic criticism; see The Law of Real Property Megarry & Wade 6th Ed para 15-024.

12. The issue is therefore whether in this case the Bank was entitled to demand from Texway the deposit, thus relieving Texway of any obligation of refund under the tenancy agreement. In Hua Chao the Privy Council said:

"Equally, there is not on any conceivable construction anything in the clause which entitles the assignee of the reversion to take over from his assignor the benefit of the sum deposited or which obliges the assignee, in enforcing the covenants against the tenant for the time being to give accredit for money which he himself has never received and to which he has no claim."

Although the clauses in the tenancy agreements in this case and Hua Chao are different there is no suggestion that anything turns on the differences.

The argument for Texway:

13. Mr Carolan said that there was one vital distinction between this case and Hua Chao. In Hua Chao the lease containing the deposit provision was granted prior to the mortgage. Thus, the mortgagee took the assignment by way of mortgage subject to the lease. In the present case the premises were already subject to the mortgage when the tenancy agreement was made. Mr. Carolan relied upon a passage in A Manual of the Law of Real Property Megarry, 7th Ed at 646 in which it is said:

"A lease granted by the mortgagor in breach of the mortgage deed will not bind the mortgagee unless he subsequently adopts the tenancy, as by accepting rent from the tenant."

14. The argument is that by its solicitors letter of 6 September 2000 the Bank "adopted" the tenancy agreement and in doing so adopted all the provisions of the tenancy agreement, including that relating to the deposit.

15. Mr. Chain, for Mediterranean, says that such an argument cannot stand because it fails to appreciate the fundamental difference between the concepts of privity of estate and privity of contract. That, he says, is the jurisprudential justification for the distinction between covenants which run with the land and those that do not. If a covenant is one entered into by a lessor with reference to the subject matter of the lease, or, to use the common law terminology, whether it is a covenant which touches and concerns the land, it is one in which there is privity of estate, and will accordingly run with the land and the obligations of the covenant will go to a subsequent assignee such as a purchaser or a mortgagee who takes possession. But if the covenant is merely a matter of contract between a tenant and the landlord then, as matter of privity of contract it remains so and, in the absence of a tripartite agreement between all involved, does not, on the assignment of the real estate, pass to a purchaser.

Determination:

16. It is certainly unarguable, at least in the Court of First Instance, which is bound by the Privy Council, that having regard to the decision in Hua Chao, where a landlord grants a lease requiring the payment of a deposit, and subsequently mortgages the premises, the obligations and burden of a clause in the lease requiring the payment of a deposit do not pass to the mortgagee who takes possession. In such a case the tenant is left to seek his remedy from the original landlord.

17. In my view it is quite illogical that there should be a different rule for a mortgagee who holds his mortgage before the tenancy agreement is made, and who may not know of the tenancy agreement until he takes possession. His "adoption" of the tenancy is not an adoption of the terms of the tenancy agreement but of the fact that the tenant occupies the premises and is permitted to remain for the remainder of the term of the tenancy subject to payment of rent. Rather than acceptance of rent evidencing the taking over of the existing lease by the mortgagee, it has been held to be evidence of a new tenancy: Halsbury's Laws of England 4tth Ed (Reissue) para 501.

18. It is no answer for the old landlord to say that he must wait until there is vacant possession of the premises, as required by the tenancy agreement, or until he has confirmation from the new landlord that there are no subsequent breaches of the agreement. Because the covenant is one which does not run with the land the Bank cannot, in terms of the tenancy agreement demand that Mediterranean pay to the Bank a deposit in terms of the appropriate provision. Neither can the Bank demand that Texway pay to the Bank the deposit held, for they have no rights to it. If there is a breach of the terms of the tenancy by Mediterranean the Bank have no rights to make any deduction form the deposit in respect of those breaches.

19. As the Bank have no rights to the deposit, there is no basis upon which Texway can hold it pending advice from the Bank as to breach of the tenancy. In this case Texway was put on clear notice that Mediterranean would be seeking a return of the deposit on the expiry of the lease and were offered an opportunity to inspect the premises to see if there were any other breaches. That opportunity was not taken and in any event there is not the slightest suggestion that Mediterranean were in any way in breach of the tenancy agreement.

20. In the Manual of the Law of Real Property the learned authors point out, at p 350, that the strictness of the rule is such that a lessee who assigns remains liable on covenants which he is powerless to perform after assigning the lease. It is equally so for a landlord who assigns. As the Bank has no right to demand payment to it of the deposit, equally Texway need not wait beyond the expiry of the lease by the efluxion of time before making a refund to Mediterranean. In so doing they are not in breach of any obligation to the Bank, even if Mediterranean were in breach of the tenancy.

21. It follows that I find that as at 28 March 2002, when the writ was issued the cause of action had arisen. It follows also that there is simply no defence to the claim and that this is an appropriate case for summary judgment under O. 14. Having regard to the findings I have made I do not need to have resort to O. 14A to conclude the matter. There will be summary judgment for the plaintiff against both defendants for the sum of $607,477.00.

Costs:

22. I am concerned that, despite the plain position of Texway, namely that it accepted that, now that it knew of the new tenancy, the deposit should be repaid, it has been necessary to argue this matter. There being no doubt at all that the refund would now be made the only real issue between the parties has been that of costs. Sensible solicitors ought to have reached a sensible agreement on costs, thus obviating the need for a half days argument by counsel and all the cost that that involves and the necessity of a judgment.

23. It was clear to the solicitors for the plaintiff, from the affidavits filed by the defendants, that the defendants' concern was the issue of vacant possession and any claim that might be made by the Bank for a breach of the terms of the tenancy agreement. Once the new tenancy agreement was made with the Bank all must have known that there were no outstanding issues preventing the repayment of the deposit. At that point a sensible agreement ought to have been reached on costs and the deposit repaid. The new tenancy, backdated to 1 March 2002, was granted on 9 July 2002. The defendants' solicitors should have been immediately informed of that fact and the issue of costs resolved by payment of costs on the writ. I am presently inclined to the view that by failing to resolve issues of cost by agreement, Mediterranean has unnecessarily forced the matter to a quite unnecessary hearing, and only after a plethora of amendment applications all involving further cost.

24. But the issue of costs and the conduct of the parties after the fact of the new tenancy agreement has not been fully canvassed before me. There may be relevant matters of which I am not aware. As presently informed however, I take the view that the hearing and further applications were unnecessary and that ought to be reflected in the final costs award.

25. There will be an order nisi that the plaintiff will have its costs on the writ but not on the applications for summary judgment or any of the other amendment applications. The hearings being in fact unnecessary, there will be no certificate for counsel.