CHEERBOND DEVELOPMENT LTD v. TUNG KWOK YU

CACV 238/2009

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 238 OF 2009

(ON APPEAL FROM HCA 320 OF 2008)

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BETWEEN

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J U D G M E N T

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Hon Cheung JA :

Background

1.  Madam Yan Pui Ming (‘Madam Yan’) was the registered owner of a property known as Flat B5, 11^th Floor, Block B, Yan On Building, 1 Kwong Wah Street, Kowloon, Hong Kong (‘the property’).

2.  On 28 December 2007, Madam Yan, by a provisional sale and purchase agreement, agreed to sell the property to the plaintiff for $2.8 million. Completion took place on 31 January 2008 by an assignment of the same date.

3.  Both the provisional agreement and the formal agreement dated 4 January 2008 contained an identical clause that :

‘ The parties agreed if on the date of completion, the vendor’s former husband Tung Kwok Yu does not move out of the property, it is the responsibility and undertaking of the purchaser to notify Tung Kwok Yu to vacate the property.  The vendor has nothing to do with such responsibility (The purchaser already knew that Tung Kwok Yu occupies a room in the property.)’

4.  About seven days before the completion a representative of the plaintiff Mr. Ho went to the property and met the defendant, the former husband of Madam Yan. The defendant told the representative that there was a dispute on the ownership of the property. He refused to move out of the property after completion and called the police when the plaintiff took action to enter the property by force.

5.  The plaintiff then commenced the present action against the defendant seeking vacant possession of the property. The defendant counterclaimed for a declaration that he is the beneficial owner of the property. The trial was heard by Recorder Kwok SC who gave judgment for the defendant. The plaintiff now appeals.

The defendant’s case

6.  The defendant married Madam Yan in 1975. The property was acquired in 1983 and the defendant together with Madam Yan and their family moved into the property in 1984. In 2003, Madam Yan moved out of the property and in 2005 she obtained a divorce. The defendant has been living in the property since 1984.

7.  At the time of the acquisition of the property the defendant had been operating a water and electrical works business known as ‘Kwok Ming Water and Electrical Works’ (‘Kwok Ming’) for nearly 18 years. He was the sole proprietor.

8.  The defendant’s case is that when it was decided to buy the property it was agreed between him and Madam Yan that the property would be bought in Madam Yan’s name but she would only own it in name and he would own all the rights in the property. The reason was that it was not certain if he would be profitable in his business and in the event of his business suffering a loss, the creditors would go after the property if it was registered in his name. This could be avoided if the property was in Madam Yan’s name instead. The defendant funded the acquisition of the property together with money advanced by the Bank of Communications (‘BOC’) on a mortgage of the property. The mortgage was dated 10 August 1983 (‘the 1^st mortgage’) which was executed on the same date of the assignment of the property to Madam Yan. Under the 1^st mortgage, BOC granted overdraft facilities of $200,000 and a fixed mortgage loan of $100,000 repayable by 36 monthly instalments. The defendant was the borrower under the mortgage. Together with Madam Yan he also covenanted to repay BOC the money. He repaid the money under the mortgage himself. Madam Yan was not gainfully employed. The Recorder accepted the defendant’s account of the acquisition of the property.

The principles

9.  The defendant’s case that the property was registered in the name of Madam Yan in order to avoid creditors laying hands on the property in the event he suffered loss in his business was a scheme to defraud his creditors. This together with his claim of beneficial ownership to the property bring into play the following legal principles :

1) The Court will not lend its aid to a claimant who found his cause of action upon an immoral or an illegal act : Holman v. Johnson (1775) 1 Cowp. 341, Tinsley v. Milligan [1994] 1 AC 340 and Wong Kwok Learn Baldwin & Wong Po Yee Shirley v. International Trading Co. Ltd. (‘Baldwin Wong’) (CACV 70/2009). Based on this principle alone, the defendant’s claim would be defeated.

2) Nonetheless, a claimant may enforce property rights under a contract which is illegal if he does not need to rely on the illegal contract for any purpose other than providing the basis of his claim to a property right. A classic example of the operation of this principle is the claimant’s reliance on resulting trust where he provided the consideration for the acquisition of a property and was not the named purchaser or where a voluntary transfer was involved: Tinsley and Baldwin Wong.

3) Where, however, because of the relationship between the claimant and the named purchaser, for example, the relationship of husband and wife or father and children, the presumption of advancement will come into play, the claimant must rebut this presumption first. Hence Lord Browne-Wilkinson in Tinsley at 371G-H and 375C-D stated that :

‘ Where the presumption of resulting trust applies, the plaintiff does not have to rely on the illegality. If he proves that the property is vested in the defendant alone but that the plaintiff provided part of the purchase money, or voluntarily transferred the property to the defendant, the plaintiff establishes his claim under a resulting trust unless the contrary presumption of advancement displaces the presumption of resulting trust.  Therefore, in cases where the presumption of advancement does not apply, a plaintiff can establish his equitable interest in the property without relying in any way on the underlying illegal transaction.’

‘ A party to an illegality can recover by virtue of a legal or equitable property interest if, but only if, he can establish his title without relying on his own illegality.  In cases where the presumption of advancement applies, the plaintiff is faced with the presumption of gift and therefore cannot claim under a resulting trust unless and until he has rebutted that presumption of gift: for these purposes the plaintiff does have to rely on the underlying illegality and therefore fails.’

See also Tribe v. Tribe [1996] Ch 107.

4)  In situations where there is in existence an illegal scheme the only way the claimant could be able to rebut the presumption of advancement is to show that the illegal purpose has not been carried into effect.  Hence Lord Goff of Chieveley in Tinsley at page 356 stated that,

‘ In particular, an exception to the principle is to be found in cases in which the illegal purpose has not been carried into effect.’

Lord Browne-Wilkinson in Tinsley at page 374 also stated that,

‘There was originally a difference of view as to whether a transaction entered into for an illegal purpose would be enforced at law or in equity if the party had repented of his illegal purpose before it had been put into operation, i.e. the doctrine of locus poenitentiae. It was eventually recognised both at law and in equity that if the plaintiff had repented before the illegal purpose was carried through, he could recover his property: see Taylor v. Bowers, 1 Q.B.D. 291; Symes v. Hughes, L.R. 9 Eq. 475.’

5) The principle known as locus poenitentiae (which literally means a place of repentance) means the abandoning of the intention of committing the dishonesty before it has been completed. Millett LJ (as he then was) in Tribe at 124E described the principle that a person may recover the property if he can rely on resulting trust if he can do so without relying on the illegality as the ‘primary rule’. He described the locus poenitentiae principle as the ‘exception to the primary rule’ at page 133H. See also Baldwin Wong.

6) Millett LJ at 133F-134B further explained the rationale between the interplay of the primary rule and its exception (by withdrawing from the intention to commit the dishonest act) as a matter of legal policy. The former is to discourage fraud while the latter is to encourage withdrawal from a proposed fraud before it is implemented.

‘ At heart the question for decision in the present case is one of legal policy. The primary rule which precludes the court from lending its assistance to a man who founds his cause of action on an illegal or immoral act often leads to a denial of justice. The justification for this is that the rule is not a principle of justice but a principle of policy: see the much quoted statement of Lord Mansfield C.J. in Holman v. Johnson (1775) 1 Cowp. 341, 343. The doctrine of the locus poenitentiae is an exception which operates to mitigate the harshness of the primary rule. It enables the court to do justice between the parties even though, in order to do so, it must allow a plaintiff to give evidence of his own dishonest intent. But he must have withdrawn from the transaction while his dishonesty still lay in intention only. The law draws the line once the intention has been wholly or partly carried into effect.

Seen in this light the doctrine of the locus poenitentiae, although an exception to the primary rule, is not inconsistent with the policy which underlies it. It is, of course, artificial to think that anyone would be dissuaded by the primary rule from entering into a proposed fraud, if only because such a person would be unlikely to be a studious reader of the law reports or to seek advice from a lawyer whom he has taken fully into his confidence. But, if the policy which underlies the primary rule is to discourage fraud, the policy which underlies the exception must be taken to be to encourage withdrawal from a proposed fraud before it is implemented, an end which is no less desirable. And, if the former objective is of such overriding importance that the primary rule must be given effect even where it leads to a denial of justice, then in my opinion the latter objective justifies the adoption of the exception where this enables justice to be done.’

The narrow issue

10.  The narrow issue in this appeal is whether the scheme devised by the defendant to defraud his creditors in the event of his financial difficulties has been implemented or not. The Recorder found that the defendant’s business went smoothly since 1983 and no creditor of the defendant or of his business had been defrauded.

11.  In discussing this issue three matters should be observed. First, one should not confuse the ‘transaction’ with the ‘purpose’. The transaction is the acquisition of the property in the sole name of Madam Yan. The purpose is the intention to defraud the defendant’s creditors. As Nourse LJ observed in Tribe at 121H :

‘ Certainly the transaction was carried into effect by the execution and registration of the transfer. But Wright’s case, 23 C.L.R. 185 shows that that is immaterial. It is the purpose which has to be carried into effect and that would only have happened if and when a creditor or creditors of the plaintiff had been deceived by the transaction.’

12.  Second, although the cases referred to ‘withdrawal’, this is another way of saying that the purpose of defrauding creditors has not been implemented: see Tinsley per Lord Goff at page 356F-G :

‘ In particular, an exception to the principle is to be found in cases in which the illegal purpose has not been carried into effect;’

13.  Third, genuine repentance is not required and voluntary withdrawal from an illegal transaction when it has ceased to be needed is sufficient : see Millett LJ in Tribe at page 135D-F.

The plaintiff’s contention

14.  Mr. Ambrose Ho S.C. (together with Mr. George Lam) who did not appear below, advanced a very fine argument for the plaintiff that the illegal purpose was implemented when the 1^st mortgage and another mortgage in respect of the property were entered into. The 1^st mortgage was discharged in 1988. In 2003, Madam Yan mortgaged the property again (‘the 2^nd mortgage’) in favour of BOC in order to obtain a loan for her son and his spouse to purchase a property of their own. The son and his spouse were the borrowers in that mortgage. The defendant approved of the mortgage.

15.  Mr. Ho argued that under this arrangement the bank could have been defrauded because it did not know Madam Yan was not the real beneficial owner and the defendant could have asserted a claim against the bank to be the beneficial owner of the property. While his claim might not necessarily succeed if the bank was able to prove it was a bona fide purchaser for value without notice, nonetheless, the bank might have to incur expenses and engage in litigation in order to defeat the defendant’s claim. Mr. Ho, however, accepted that his argument may not be applied with the same force to the 1^st mortgage where the defendant had given a personal covenant to BOC to repay the money advanced.

Collier v. Collier

16.  An example of where the illegal scheme had been implemented is Collier v. Collier [2002] BPIR 1057. The father was the owner of two properties. In 1986 when he thought he would be in financial difficulties because of litigation with a creditor called Bass Charrington he granted his daughter the leases of the properties with an option to purchase the freehold. The financial difficulties, however, did not materialize and in 1989 the father mortgaged the properties without telling the mortgagees about the option. Further financial difficulties of the father arose and in 1994 the mortgagees appointed receivers. In 1996 and 1997 respectively the daughter exercised the option and acquired the freehold of the properties with a substantial part of the purchase money being provided by the father. The mortgagees were deceived because as a result of the daughter’s acquisition of the freehold they were only able to receive from the father the option moneys instead of being able to look to the actual value of the leases to meet the father’s unpaid indebtedness over and above the amount of the option moneys. The father and daughter later fell out and the father asserted that the properties were held by the daughter on trust for him. The father failed to overcome the presumption of advancement to the daughter.

17.  The English Court of Appeal held

1)     the presumption of advancement applied to the transfer by the father to the daughter of the leasehold and freehold in the properties.

2)     the father could only defeat the presumption if he could rely on locus poenitentiae.

3)     there was no withdrawal before the illegal purpose had been performed as the father directed the daughter to exercise the options to acquire the freehold.

4)     as a result the father’s claim was defeated.

18.  Mance LJ held that the transfer of the properties to the daughter was not merely to defeat the claim of Bass Charrington but of creditors generally. He held at [86] that

‘The intention of the leases and ancillary agreements was to keep them out of the reach of creditors. The purpose must be viewed in those general terms. Bass Charrington could not be foiled, unless all creditors were. Further, the father can have had nothing particular against Bass Charrington; his only interest in them was as creditors.’

19.  He further rejected the argument that the aim to deceive creditors was to be treated as having expired because the leases remained in the daughter’s name long after the father’s financial difficulties in the mid 1980 were over. He held that :

‘ [109] ......If parties put in place machinery for fraud, leave it in place and then so strikingly use it for the purpose of committing (in the event successfully) the same kind of fraud, it would be artificial to treat them as ever having withdrawn from the original scheme. At most any illegal scheme was held in suspension. Not surprisingly perhaps, we were shown no case precisely parallel to the present, but dicta in the cases speaking of withdrawal ‘before the illegal purpose has been wholly or partly carried into effect’ (cf eg Tribe v Tribe at 134 per Millett LJ) must also be read in context, rather than transposed too literally to a special situation like the present.’

‘ [111] The interests of innocent third parties at whom an illegal agreement was aimed are therefore in my judgment a legitimate consideration. ...... But, however generous an attitude is taken to the exception, I do not think that it can sensibly cover a situation where creditors have been successfully deceived over a number of years, by being misled into accepting and treating the proceeds of the exercise of the options as the father’s only interest in the properties. This is so, even though their rights to pursue the father for his outstanding indebtedness remained (so far as appears) unaffected after 1996-97.’

My view

20.  I do not regard the entering of the 1^st or 2^nd mortgage as an implementation of the illegal scheme. The 1^st mortgage was needed to put the ‘transaction’ in place, namely, to allow Madam Yan to acquire the property in her name. The bank was not deceived as the 1^st mortgage was discharged in 1988 by full payment.

21.  Likewise the 2^nd mortgage was used to borrow money rather than to prevent creditors from laying their hands on the property. The bank was entitled to enforce the mortgage if Madam Yan and her son and daughter-in-law defaulted on it. This did not happen. The mortgage was likewise discharged after one year of its execution by repayment in 2004. The bank was not deceived.

22.  I do not wish to go into the too refined issue raised in Collier of whether the illegal scheme was suspended when the 2^nd mortgage was created. The Defendant was not cross-examined on whether he would have asserted his beneficial interest if there was default on the 2^nd mortgage. Whether the 2^nd mortgage could potentially be used to deceive the bank in the situation suggested by Mr. Ho, namely, the defendant staking a claim against the bank as the beneficial owner of the property, must be considered in the light of what had actually happened (i.e. the bank was in fact not deceived). This must be so, even if, for the purpose of argument, one ought to give a wider ambit to the meaning of creditor as not merely creditors of the defendant’s business but also creditors in general such as a bank who had lent money on the mortgaged property. It is clear from Collier that the decisive factor which caused the Court to hold that the illegal scheme had been implemented was that the mortgagees were actually deceived by the daughter’s exercise of the option to acquire the freehold. In other words, the illegal purpose had actually been implemented. This is not the case here.

23.  Millett LJ in Tribe at 135 B-C after his majestic review of cases on locus poenitentiae stated that :

‘ It is impossible to reconcile all the authorities on the circumstances in which a party to an illegal contract is permitted to withdraw from it. Atone time he was allowed to withdraw so long as the contract had not been completely performed; but later it was held that recovery was barred once it had been partly performed: see Kearley v. Thomson(1890) 24 O.B.D. 742.’

He had earlier at 134G referred to the transferor withdrawing from the transaction before the illegal purpose has been wholly or partly carried into effect.

24.  As Professor Beatson pointed out in his article, ‘Repudiation of Illegal Purpose as a Ground for Restitution’ (1975) 91 L.Q.R. 254 (cited by Millett LJ in Tribe)

‘ much of the authority suggests that the bar to recovery depends upon the substantiality of performance rather than the achievement of the illegal purpose.’

25.  In my view merely entering into the 2^nd mortgage cannot be said to constitute substantial performance of the illegal purpose. This is how I would further address the point made by Mr. Ho.

26.  In my view the defendant can rely on locus poenitentiae and adduce evidence on the circumstances of the acquisition of the property in order to defeat the presumption of advancement.

27.  Ms Queenie Lau, counsel for the defendant, had referred to the case of Q v. Q [2009] 1 FLR 935. In my view the case does not carry the matter further.

Rebutting the presumption of advancement

28.  In deciding whether the presumption of advancement has been rebutted, I bear in mind the caution given by Millett LJ in Tribe at 134-135 :o.

‘ (6) The only way in which a man can protect his property from his creditors is by divesting himself of all beneficial interest in it. Evidence that he transferred the property in order to protect it from his creditors, therefore, does nothing by itself to rebut the presumption of advancement; it reinforces it. To rebut the presumption it is necessary to show that he intended to retain a beneficial interest and conceal it from his creditors.

(7) The court should not conclude that this was his intention without compelling circumstantial evidence to this effect. The identity of the transferee and the circumstances in which the transfer was made would be highly relevant. It is unlikely that the court would reach such a conclusion where the transfer was made in the absence of an imminent and perceived threat from known creditors.’

29.  In this case the defendant has always been living in the property. According to his evidence, which was accepted by the Recorder, Madam Yan had offered to pay him $1.2 million when she told him that she had sold the property. This was said nearly three years after their divorce in 2005. This clearly can be treated, in the absence of other evidence, as recognition by Madam Yan of the defendant’s beneficial interest in the property notwithstanding that the property was registered in her sole name.

30.  In my view there was ample evidence for the Recorder to find that the presumption of advancement had been rebutted.

Resulting trust

31.  Following from the defeat of this presumption, the defendant can rely on resulting trust to assert his claim to the property. No argument was raised by the plaintiff on the extent of the defendant’s entitlement.

Interest of the plaintiff

32.  It is true that the defendant has not asserted in writing any interest to the property since its acquisition but he has been living there all the time. The plaintiff was aware of his presence when it entered into the agreement to buy the property. The special term in the agreements must have given the plaintiff notice of the presence of the defendant in the property. The Recorder found that the plaintiff only approached the defendant after the agreements had already been entered into between it and Madam Yan. Clearly in the light of the decision of Wong Chim Ying v. Cheng Kam-wing [1991] 2 HKLR 253 it was for the plaintiff to ascertain the interest of the defendant in the property. I do not see any interest of the plaintiff being prejudiced if it chose not to make the necessary inquiry.

Conclusion

33.  Accordingly the appeal is dismissed with a provisional costs order for the defendant.

Hon Yuen JA :

34.  I agree.

Hon Kwan JA :

35.  I agree.