CHINA UNITED HOLDINGS LTD AND ANOTHER v. JOHNSON STOKES & MASTER (A firm)

HCCL 42/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO.42 OF 2003

(formerly HCA No.1015 of 2003)

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J U D G M E N T

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Introduction

1. This is a professional negligence action brought by the plaintiffs against the defendant, a firm of solicitors in Hong Kong.

2. The application presently before the court is an Order 14A application taken out by the defendant pursuant to an amended summons dated 9 October 2003. This summons also sought a strike out under the provisions of Order 18, rule 19, but this element has been withdrawn in light of an indication given to the court during the hearing by leading counsel for the plaintiffs regarding pleading amendments which are to be made, amendments which it is now accepted preclude the striking out of the pleading even should the principal application under Order 14A prove successful.

3. The present application seeks a determination of the following points of law :

(i) Whether Asia Standard International Group Limited had an immediately enforceable indemnity claim against East Champion Ltd as at about 3 March 1999; and

(ii) Whether Paul Y-ITC Construction Holdings Ltd had an immediately enforceable indemnity claim against East Champion Ltd in about September 1999 and /or before China United Holdings Ltd executed the ITC Management Deed.

The factual background

4. As with many commercial disputes in Hong Kong, this case has its origin in the purchase of property, in this case the whole of the basement of a building in Marble Road, North Point. The purchase price was HK$470 million, and the purchaser was a company called Great Gains International Limited, a wholly-owned subsidiary of the 1st plaintiff; aptly enough, since this agreement to purchase took place at the height of the property market in May 1997, the vendor was a company called Get Rich Enterprises Limited.

5. Under the agreement for sale and purchase, HK$235 million was to be paid in cash and the balance in the issue of new ordinary shares of the 1st plaintiff. It was one of the conditions for completion under the agreement that a loan of HK$235 million was to be arranged by the vendor, to be repayable by instalments.

6. By a sub-sale agreement the purchaser, Great Gains, sub-sold all its interests in the S&P Agreement to another wholly-owned subsidiary of the 1st plaintiff, a company known as East Champion Limited, at the same consideration of HK$470 million. In order to finance the purchase, East Champion took out a term loan for HK$235 million, repayable by 60 monthly instalments, from the International Bank of Asia Ltd.

7. One of the conditions of the facility thus granted was that two companies, Asia Standard International Group Limited (which held 80% of Get Rich) and Paul Y-ITC Construction Holdings Limited (which held 20%) were to provide separate corporate guarantees of the repayment by East Champion of the sums of HK$94 million and HK$23.5 million respectively.

8. On 11 August 1997 Asia Standard executed a corporate guarantee in favour of IBA guaranteeing the repayment of the sum of HK$94 million and interest, and on the same date Paul Y-ITC executed a like guarantee to the extent of HK$23.5 million. Both guarantees were in like terms, save that they differed only in the guaranteed amount of repayment.

9. Recital (1) of each guarantee defined the loan agreement between IBA and the borrower, East Champion, as including such agreement as from time to time supplemented or amended. Recital (2) of each guarantee made it explicit that the guarantee was supplemental to the loan agreement.

10. However, these guarantees were not the end of the inter-company transactions.

11. By two counter indemnities dated 11 August 1997 each of Asia Standard and Paul Y-ITC obtained indemnification from East Champion for their respective liabilities under the guarantees each had executed in favour of the lending bank. As with the guarantees, each of the counter indemnities are in like terms.

The event of default

12. East Champion defaulted in repayment of the term loan advanced by the International Bank of Asia, and as the result the bank called on its guarantees by letter dated 29 October 1998.

13. On 29 December 1998 both Asia Standard and Paul Y-ITC settled their respective liabilities under their guarantees with IBA.

The case against the defendant

14. Against this background, the thrust of the case now mounted against the defendant firm of solicitors is that the defendant was required to advise the plaintiffs as to whether Asia Standard and Paul Y-ITC had immediately enforceable claims against East Champion, that Asia Standard and Paul Y-ITC in fact did not have such immediately enforceable claims because the counter indemnities in question were either void or were liable to be set aside by virtue of being contrary to clause 10 of the 1997 guarantees given to the bank, that the defendant, in breach of its duties, had failed to advise the plaintiffs of the 'true' position, and that in reliance upon the erroneous belief that Asia Standard and Paul Y-ITC did have immediately enforceable claims against East Champion, in 1999 the plaintiffs themselves had executed certain security documentation, pursuant to which payments were made to the corporate guarantors, and that loss was suffered thereby.

15. East Champion is an wholly owned subsidiary of the 1st plaintiff, China United, and the 2nd plaintiff, Large Investments, is also an wholly owned subsidiary of China United. The security documentation entered into by the plaintiffs into which it is said they would not have entered, had the defendant properly advised them of the true position - indemnified Asia Standard and Paul Y-ITC with regard to their liability to IBA, and led to the 1st and 2nd plaintiffs respectively paying significant sums to Asia Standard and Paul Y-ITC in satisfaction of the perceived liabilities of East Champion under the counter indemnities; it is said that these sums were not payable at all, or, at the least, were not payable at the time when such payments were made.

16. The crux of the plaintiffs' case is contained within paragraph 19 of the Statement of Claim, which pleads :

"The two Counter Indemnities were void and should have no effect, or alternatively subject to be set aside, as the provision of which to and acceptance by Asia Standard and ITC were in breach of Clause 10 of the Corporate Guarantees."

17. Thus the principal line of demarcation between the parties is that the defendant says that as a matter of law the counter indemnities were immediately enforceable, whilst the plaintiff's case depends upon a finding of law that the counter indemnities were not so enforceable.

The present application

18. Mr Gerard McCoy SC opened the defendant's Order 14A application by submitting that the question of law identified on the face of the summons, namely the immediate enforceability in each instance of the counter indemnity, was a question entirely suitable for determination without full trial of the action. He submitted that determination of the point presently at issue was solely a matter of construction of the relevant commercial documents, and that when thus construed in favour of the defendant this case falls to the ground with the demolition of the central premise within the plaintiff's case, thereby enabling the Statement of Claim to be struck out and the case dismissed. He argued that the strict criteria under Order 14A are met : see, for example, Rockwin Enterprises Ltd. v. Shui Yee Ltd [2003] 3 HKC 174, at 184; Netwell Properties Ltd v. JCG Finance Co. Ltd [2003] 4 HKC 566 (CA).

19. However Mr McCoy was constrained to modify this approach in light of the indication now given, in draft form, by Mr Sarony SC, of proposed pleading amendments by the plaintiff. These proposed amendments were produced at relatively short notice at the behest of the court, which took the view that it could not properly adjudicate upon this application unless the true 'shape' of the case was placed before it.

20. In the event, on the basis of the draft amendments it appears that the alternative case now sought to be run by the plaintiffs is that if, contrary to the primary case, there indeed was an obligation to make payment under the counter indemnities, then it is arguable that no such obligation arose to make immediate payment thereunder - the so-called 'financing costs' issue. In addition, on the face of the draft amended pleading at least, other issues are raised as to the unenforceability of the counter indemnities, namely the absence of attestation of necessary signatures and the absence of corporate seals, and the fact that the grant of the counter indemnities on 11 August 1997 was in breach of specified listing rules.

21. Notwithstanding these amendments, upon which Mr McCoy had had little opportunity to reflect since they were produced during a short adjournment in the hearing, he nevertheless persisted with the submission that this remained an appropriate case for consideration under Order 14A although it was no longer possible to argue, as had appeared to be the situation at the outset, that resolution of the Order 14A application in his client's favour would mean that a successful strike out necessarily would follow; hence his withdrawal of the Order 18, rule 19 element of the application.

22. Mr McCoy reverted to the specific terms of Order 14A rule 1(1), which reads :

"The Court may upon the application of a party or of its own motion determine any question of law or construction of any document arising in any cause or matter at any stage of the proceedings where it appears to the Court that -

(a) such question is suitable for determination without a full trial of the action; and

(b) such determination will finally determine (subject only to any possible appeal) the entire cause or matter or any claim or issue therein." (emphasis added)

23. He further referred to the judgment of Recorder Geoffrey Ma SC (as he then was) in Rockwin Enterprises, op cit., wherein the learned judge in that case analysed the requirements of Order 14A, emphasising the court's residual discretion as to whether to embark upon determination of a question under this rule, and in particular had cited with favour the English Court of Appeal decision in Korso Finance Establishment Anstalt v. John Wedge (15 February 1994, unreported) wherein the Court of Appeal had allowed the plaintiff's appeal, thereby enabling a question of construction, which was a "dominant feature" in that case, to be determined under Order 14A. The learned judge further noted that in Korso, op cit., not only was the particular agreement to be construed "at the heart of the case", but also that a further factor relevant to the court's decision was whether dealing with the question of construction sooner rather than later might assist the parties either to avoid the expense of trial or would assist them in the efficient disposal of the action.

24. Thus it was in this case, Mr McCoy suggested. Whilst in light of the new amendments the issue of construction presently before the court would not necessarily be dispositive of the entire action, nevertheless this remained a point which pervaded the entire case, analogous to the "dominant issue" in Korso, op cit. Accordingly resolution of the issue at this stage would have the "proportionate benefit" of focusing the minds of the parties upon what was left, assuming of course that amendments were now made in the form presently canvassed by leading counsel for the plaintiff.

25. For his part Mr Sarony SC disagreed. He cited the dictum in Netwell Properties, op cit., to the effect that few cases are sufficiently 'fact insensitive' to merit the invocation of Order 14A, and submitted that this case was not one of them. These were unusual facts, he submitted, and the case itself contained a number of factual disputes which were to be keenly contested, the most obvious of which was the scope of the defendant's retainer, in particular whether the defendant firm was asked to advise on the validity or "unusual features" of the 1997 transactions. And in any event, even if the purely legal issues were to be resolved on this Order 14A application, this would not have the effect of enabling the parties to avoid the expense of trial. Were the defined issue now to be decided in favour of the defendant, the issue of negligence would remain at large, he submitted, albeit he did accept that resolution of the point now sought to be argued might have an impact upon quantum if the defendant were to succeed upon this application. Thus, Mr Sarony's position was that the court should not now be persuaded embark upon the construction issue, which should be left to be dealt with at trial, along with everything else.

26. I have reflected upon this argument. As a matter of principle Order 14A applications are to be approached with considerable care, particularly if, as in this case, a determination of the questions posed cannot be shown to avoid the necessity for a trial. If this be the case, therefore, why should a trial judge be thus fettered by determination of an issue under this rule? Would it not clearly be more advantageous to leave all issues open, thereby enabling the trial judge to decide such issues within the framework of the trial as now anticipated to take place before him?

27. The answer to this question, it seems to me, is that in the vast majority of cases clearly this is the wisest course to adopt. However, as Mr Recorder Ma pointed out in Rockwin, op cit., at 185, in deciding whether to accede to the application the court is able to take an overall view of the matter to discern the context in which the question arises, and to form a judgment on that basis.

28. The present issue for determination, in my view, is not merely one of a variety of issues for decision, but lies at the very core of the plaintiff's case. A decision now on the questions of construction as presently posed in this application may have a signal effect on the progress of this case, not least upon whether the remaining issues the subject of the proposed amendments will be taken to trial at all. There is, moreover, a substantial difference between a claim in damages quantified by reference to the sums as paid by the plaintiffs, based upon the allegedly negligent advice (or lack of advice) asserted to have been received from the defendant, and a claim the quantum of which is restricted to a much smaller amount, as yet unquantified, in terms of the so-called 'carriage costs' which arise by reason of the argument that the payments in question were made at an unnecessarily early stage.

29. Regarded broadly, therefore, I see force in the submission that a decision at this stage on the core legal issue may for practical purposes turn out to be determinative of this case, the existence of other pleaded issues notwithstanding. Nor is it said that the questions as posed in this application involve other than an issue of pure construction. Whilst there are certainly surrounding factual disputes, the precise point at issue cannot be said to be 'fact sensitive', and Mr Sarony SC very fairly did not suggest otherwise.

30. Accordingly, in the exercise of my discretion, I have decided to accede to the application and to determine the questions as posed on the face of the application. Although there are two questions, there is but one issue arising, and to this I now turn.

The substantive argument

31. Mr McCoy submitted that for the purpose of the present construction exercise but two documents are relevant, namely the corporate guarantee and the counter indemnity, which are in like form in each instance.

32. The relevant clauses within the corporate guarantee, in each instance dated 11 August 1997, are Clauses 8 and 10 thereof, which read :

"8. The Guarantor declares that it has received no security for giving this Guarantee and agrees that should any such security be created while any Secured Indebtedness remains undischarged, any such security shall be forthwith pledged or sub-pledged to the Lender to secure the obligations of the Guarantor hereunder and shall forthwith be deposited with the Lender accordingly. The Guarantor agrees that if default is made in observing the preceding provisions of this Clause 8, any security taken in contravention and all moneys at any time received in respect thereof shall be held in trust for the Lender as security for the liability of the Guarantor to the Lender hereunder.

10. Until all the Secured Indebtedness has been paid discharged and satisfied in full (which expression shall not embrace payment of a dividend in liquidation or winding-up of less than one hundred per cent (100%) the Guarantor waives all rights of subrogation (whether statutory, arising at common law or in equity, or howsoever otherwise) and agrees not to demand or accept repayment in whole or in part of any moneys, obligations or liabilities then or thereafter due to the Guarantor from the Borrower or to demand or accept any security or lien in respect thereof or to assign the same or charge the same as security or to take any step to enforce any right against the Borrower or to claim any set-off or counterclaim against the Borrower or to claim or prove in competition with the Lender in the liquidation or winding-up of, or have the benefit of any share in any payment or composition from the Borrower or any other person or in any other guarantee or security now or hereafter held by the Lender."

33. As to the counter indemnity, in each instance of like date, Clause 1 is in the following terms :

"1. INDEMNITY

In consideration of the Guarantor entering into the Guarantee and undertaking its obligations made under the Guarantee (the 'Guarantor's Obligations'), the Company unconditionally and irrevocably agrees (1) at all times as a continuing security to keep the Guarantor fully and effectively indemnified, without any demand therefor being required, from and against all amounts paid by the Guarantor under the Guarantee and, on demand, from and against all demands, actions, claims, proceedings, losses, damages, costs, liabilities and expenses which the Guarantor may suffer or incur by reason of the issue of the Guarantee or the performance of the Guarantor's Obligations or in taking, preserving or enforcing this Indemnity or exercising any right or power under this Indemnity, (2) to supply the Guarantor promptly from time to time with such evidence as the Guarantor may require of the termination or reduction of the Guarantor's Obligations, and (3) to pay to the Guarantor on demand from time to time interest on any amount payable by the Company under this Indemnity from its due date for payment until paid in full, at the rate which is 3% per annum above the prime rate for Hong Kong dollars quoted by the Bank from time to time."

34. These proceedings are effectively founded upon the bald proposition that the counter indemnities executed by East Champion were worth nothing because they were in breach of the terms of the corporate guarantees given to the lender, IBA, by Asia Standard and Paul Y-ITC respectively. Thus, Mr McCoy submitted, although the questions of law on the face of the application are couched in terms of whether the corporate guarantors had an immediately enforceable indemnity claim, in conceptual terms the issue of law for present consideration is thus :

"Whether a primary obligor [East Champion] can refuse to satisfy a covenant to repay a surety [Asia Standard/Paul Y-ITC] on the basis that the surety has separately contractually agreed with the lender [IBA] not to demand payment from the primary obligor?

Framed in this manner, he suggested, the answer must be a resounding 'No'.

35. Mr McCoy submitted that the express terms of the two counter indemnities provided that East Champion would keep the guarantors, Asia Standard and Paul Y-ITC fully indemnified at all times, as a continuing surety, without the necessity for any demand. In turn, the effect of clause 10 of the guarantees is that the guarantors agreed with the creditor that the guarantors would not demand or accept payment from the debtor until the secured indebtedness was paid or discharged in full, whilst it was expressly contemplated by clause 8 that any security in fact received by the guarantors would be held in trust for the creditor bank - a provision, he said, which expressly contemplated that the guarantor may have taken security notwithstanding the restrictive terms of clause 10. In short, Mr McCoy argued that the contractual agreement between guarantor and creditor that the guarantor would not demand or accept payment from the debtor, or claim any set-off, before the creditor was paid in full did not affect the debtor's clear liability to indemnify the guarantors.

36. To this argument Mr Sarony SC did not, I think, differ in point of principle. He submitted that the defendant's contentions as to the effect of the standard 'non competition' clause embodied within clause 10, whereby until full repayment to the lender bank the guarantor promised a number of things, including agreeing not to take any steps to enforce any right against the borrower, was not an objectionable approach to take in 'run of the mill' cases.

37. In this instance, however, he suggested the documents provided to the defendant solicitors ought "to have triggered alarm bells". In this context Mr Sarony referred to the terms of Recitals (1) and (2) within the corporate guarantees, noting that Recital (1) defined the Loan Agreement as including "such Agreement as from time to time supplemented or amended", whilst Recital (2) provided :

"It is a condition of the Agreement that the Guarantor shall execute a guarantee in respect of the obligations of the Borrower under the Agreement, and this Guarantee is accordingly supplemental to the Agreement;" (emphasis added)

38. Bluntly stated, his proposition was that, as a matter of construction, the combined effect of Recitals (1) and (2), and the respective (and very specific) use of the words "supplemented" and "supplemental to", served to incorporate the terms of the Guarantees into the Loan Agreement, thus making the Guarantees and the Loan Agreement a single tripartite agreement between the borrower, East Champion, the lending bank, IBA, and the respective guarantors, Asia Standard and Paul Y-ITC. As a result, he said, the plaintiffs were contractually entitled to rely upon the terms of clause 10 of the corporate guarantees.

39. In response, Mr McCoy argued that the obligation of the guarantor to the creditor was a private obligation to which the debtor was not privy. In this instance, he said, the obligation on the part of the guarantors was made solely for the benefit of the creditor, the lending bank, and not for the benefit of the debtor, East Champion, and thus there could be no exception on that basis to the doctrine of privity. Mr McCoy submitted that the two Recitals to the 1997 corporate guarantees, which refer to a separate Loan Agreement, could not have had the effect of incorporating the terms of the 1997 Guarantees into the Loan Agreement or otherwise rendering the borrower privy to the contracts of guarantee. He suggested that the word "supplemental" in Recital (2) to the 1997 Guarantees was clearly intended to mean 'further to' or 'pursuant to' or 'in accordance with'.

40. I agree. I am unable to share Mr Sarony's enthusiasm for the analytical position he has adopted. Clause 10 of the 1997 Guarantees is a standard guarantee clause within the specific document governing the separate relationship between guarantor and lender, whilst the guarantor's right to an indemnity is so integral a part of the separately indentifiable (and separately documented) bargain between debtor and surety that in principle a court would be resistant to find that it had been given up by what, in effect, is a side wind should Mr Sarony be correct in his ingenious argument as to the effect of the words 'supplemented' and 'supplemental' as they appear in the Recitals to the guarantees.

41. In short, as a pure matter of construction I do not consider that Recitals (1) and (2) have, or can have, the effect of 'shoe-horning' the terms of the Guarantee into the Loan Agreement, thereby creating a single tripartite agreement and establishing a direct contractual nexus between borrower, lender and the respective guarantors, and thus enabling the borrower, or its successors in title, to invoke against the guarantors the provisions of clause 10.

42. This proposition is not susceptible to greater elaboration. The separate agreements connote and confer separate and distinct contractual rights and obligations. Absent express contractual provision to the contrary, standard priority agreements do not avoid immediate rights under indemnities; in this instance the counter indemnities as are in place between debtor and guarantors could have been drawn expressly to include the obligations the plaintiffs now wish to import into the existing debtor/ surety relationship, but demonstrably this has not occurred. I can understand why the plaintiffs wish to make the argument as now advanced, and thus seek to achieve the 'protection' of the provisions of clause 10. In my judgment, however, this argument is fundamentally unsound and must fail.

43. It follows from the foregoing, therefore, that the court has determined in the affirmative the points of law set out on the face of the summons (as recited in paragraph 3 above), and has concluded that as a matter of construction of the relevant documents that Asia Standard International Group Limited and Paul Y-ITC had immediately enforceable indemnity claims against East Champion Limited as at the dates so specified.

44. It follows that the plaintiffs' primary pleaded case against the defendant is based upon the false premise that East Champion had no liability either to Asia Standard or to Paul Y-ITC at the relevant times. Accordingly, in so far as is necessary the court further holds that the Counter Indemnities were not void and of no effect by reason of the matters pleaded in paragraph 19 of the Statement of Claim.

Order

45. I should be assisted if counsel would settle the Order consequent upon this judgment.

46. I make an order nisi that the costs of this application, including the costs of the consequential application to strike out, are to be to the defendant, to be taxed if not agreed.