SILVERCORD LTD v. THE SWATCH GROUP (HONG KONG) LTD

HCA 268/2021
and HCA 269/2021

[2022] HKCFI 362

(Heard together)

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 268 OF 2021

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IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 269 OF 2021

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D E C I S I O N

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A.  Introduction

1.  This is the Plaintiffs’ (Ps’) application for summary judgment and striking out of the Defendant’s (D’s) counterclaim. The dispute concerns tenancy agreements between Ps and D.

2.  D’s defences are, in gist:-

(a)  frustration as a result of the 2019 Social Unrest and the COVID-19 Pandemic;

(b)  rental abatement based on the rent abatement clause;

(c)  Ps’ alleged failure to mitigate.

B.  Background

3.  The facts of the case are relatively simple and can be summarized as follows.

4.  Insofar as HCA 268/2021 is concerned (ie the tenancy at The ONE Shopping Arcade):-

(a)  The tenancy was entered into on 20 Sep 2018 for 3 years.

(b)  On 28 April 2020, D stopped conducting business.

(c)  From 1 July 2020, D started to default on payments of rent.

(d)  On 18 December 2020, D claimed that the tenancy had been frustrated from 30 Jun 2020.

(e)   On 21 Jan 2021, D returned keys.

(f)  On 25 Jan 2021, The ONE accepted D’s breach and terminated the lease.

5.  Insofar as HCA 269/2021 is concerned (ie the tenancy at Silvercord):-

(a)  The tenancy was entered into on 8 Oct 2018 for 3 years.

(b)  From 1 July 2020, D started to default on payments of rent.

(c)  On 18 Dec 2020, D claimed that the tenancy had been frustrated from 30 Jun 2020.

(d)  On 15 Jan 2021, D returned keys.

(e)  On 21 Jan 2021, Silvercord accepted D’s breach and terminated the lease.

C.  Frustration

6.  It is apt to start with the way D has presented its case on frustration.

7.  As a starting point, Mr Chan cites National Carriers v Panalpina (Northern) Limited [1981] AC 675 as the leading case on frustration, deriving from it the proposition that:-

“Frustration of a contract takes place where there supervenes an event (without default of either party, and for which the contract makes no sufficient provision) which so significantly changes the nature of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution, that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances.” [D Skel §34.2]

8.  On this basis, he submits that the Social Unrest and the Pandemic are events that “so radically and fundamentally changed the nature of the outstanding rights and/or obligations…that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances.” For this, he places particular emphasis on:

(a)  how unprecedented the double blow of Social Unrest and Pandemic were; and

(b)  the fact that these occurred one after the other in the relatively short period of the tenancy (3 years).

9.  More particularly, he relies on the doctrine of failure of common purpose [D Skel §§35, 38], the common purpose being “the Premises would be operated as luxury watch retail stores”.

10.  In support of his submission that there exists such common purpose, Mr Chan relies on:

(a)  The restriction of user clauses in both tenancy agreements, ie, that the Premises should only be used as a first class shop for the display and retail sales of Tissot watches and accessories [D Skel §38.1]. In this regard, he relies particularly on the academic commentary that the common purpose of the lease can be inferred from a restriction of use clause: Treitel, Frustration and Force Majeure (3^rd Edition) §11-014.

(b)  Mr Chan also relies on other clauses which require the Premises to be fitted out to the standard of a first class shopping and commercial centre [D Skel §38.2].

11.  Mr Chain (together with him, Mr Jiang), on the other hand, makes the following submissions.

12.  The doctrine of frustration is not to be lightly invoked, especially in lease cases. This is because the rights and obligations of the parties to a lease are very simple – provision of Premises and paying rent. It will be exceedingly rare for a contract to be frustrated on the basis of impossibility of performance [Ps Skel §21].

13.  Insofar as the ground of frustration is failure of common purpose, Mr Chain pointed me to Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] L&TR 14 at §29 onwards, whereby Marcus Smith J put forward an analysis of the failure of common purpose defence. In gist, the learned Judge made the following observations:-

(a)  First, citing Treitel, he noted that the failure of common purpose defence is in essence, a mirror image of the impracticability of performance defence. For impracticability cases, it is usually the supplier who would say that, due to increase in costs, it could no longer supply; for failure of common purpose cases, it is usually the recipient who claims that the supplier’s performance is no longer of any use to the recipient for the purpose to which both parties had intended the performance to be used [§35].

(b)  Second, going through a number of cases, including Krell v Henry [1903] 2 KB 740 and Herne Bay Steam Boat Co v Hutton [1903] 2 KB 683, the learned Judge draws the line between cases where frustration would be allowed as a defence and where it would not. In gist:-

(i)  If the supervening event is to cause the price for the bargain to appear, in hindsight, too high, the contract is not frustrated.

(ii)  If however, the supervening event makes the common purpose impossible to perform (as in the Krell case, where the common purpose was held to be the provision of a room with a view of the coronation, but the view would never come to pass as the coronation was cancelled), then the contract will be frustrated.

14.  Applying these principles, Mr Chain submitted that D’s case of frustration falls on the wrong side of the line.

(a)  First, Mr Chain does not accept that the common purpose in the present case is that “the Premises would be operated as luxury watch retail stores”. In particular, Mr Chain points towards the clauses in the tenancy agreements which make it clear that no warranty is made as to the suitability of the Premises for the use or purpose to which D proposes to put them to. For example, the Silvercord tenancy agreement provides as follows:-

“[Silvercord] does not warrant that [the Silvercord Premises] or any part thereof are suitable for the user mentioned in the Fifth Schedule and/or the operation of the trade or business of [Swatch]…”

A similar clause exists for The ONE.

(b)  Second, even if arguendo there existed a common purpose in that “the Premises would be operated as luxury watch retail stores”, Mr Chain submits that this does not bring D home.

(i)  On proper analysis, there is no suggestion that this purpose is frustrated. The Premises are there and functioning; there is nothing to stop D continuing to display watches and selling them.

(ii)  As such, to bring D home, D has to argue something further, ie, the common purpose is that “the Premises would be commercially viably operated as luxury watch retail stores”. The issue of viability was repeatedly raised in D’s Skeleton [§§38.4, 72-74].

(iii)  Once this is laid bare, it is quite clear that D simply cannot make out a case of frustration. Lack of commercial viability is exactly what is not sufficient to cause frustration – instead, it smacks clearly of a bad bargain.

15.  I have considered the above arguments. My view is as follows.

16.  As per the discussion in Canary Wharf (see §13 above), this is a case which can be characterized as a failure of common purpose case – in gist, D, as the recipient of the use of the Premises, claims that the supplier’s (ie, the landlord’s) performance of providing the Premises to be no longer of any use for the common purpose of the parties, ie, to run a luxury watch retail store.

17.  If such framework of analysis is utilized, the first crucial question would be this – what would be the minimum scope of the common purpose in order for D to successfully claim frustration? Would it be:-

(a)  Mr Chan’s formulation, ie “the Premises would be operated as luxury watch retail stores”; or

(b)  Mr Chain’s formulation, ie “the Premises would be commercially viably operated as luxury watch retail stores”?

18.  In my view, Mr Chain’s formulation would be the bare minimum that D would need to establish in order to succeed in its defence of frustration. The reason is simple – there has been no suggestion that the Premises cannot be used to display and sell luxury watches as a store. It can surely be so operated. The real complaint is that it is no longer commercially viable.

19.  Once the formulation is so crystallized, the next question is this – do the facts justify a finding that the common purpose of the tenancy agreements is to run commercially viable luxury watch retail stores?

20.  The question can in fact be put another way - as a matter of contractual risk allocation, where was the risk of lack of commercial viability of the business on the Premises placed? Was it on the tenant, the landlord, or both? This is exactly the kind of approach taken by DHCJ William Wong SC in Holdwin Ltd v Prince Jewellery and Watch Co Ltd [2021] HKCFI 2735 at §§33-43.

21.  In my view, the answer to the question posed at §19 must be “no” – and the answer to the question posed at §20 is that the risk of lack of commercial viability rests with D. The reasons are as follows:-

(a)  The high watermark of D’s case is that there is a restriction of purpose clause, and other clauses that require D to maintain Premises to a particular standard. Such clauses, it is argued, shows that common purpose of the tenancy agreement is the running of a luxury watch retail store.

(b)  For present purposes, I am content to assume (without finding) that the clauses do show such a common purpose. However, as noted above, D needs to go further. The question is whether one can find that the true common purpose of the tenancy agreements is for something more: to run commercially viable luxury watch retail stores on the Premises.

(c)  With respect, I am unable to come to such a finding. To say that commercial viability of the business on the Premises is part of the common purpose of the tenancy agreements is another way of saying that both parties agreed to take risks over the lack thereof. Given the landlord’s wholesale lack of control over such business, it is simply difficult to see how, objectively speaking, the landlord can be taken to have agreed to bear such risks.

(d)  In an attempt to increase the nexus between the landlords and the business, D points to the fact that both tenancy agreements include turnover rent over and above a minimum basic rent – ie being the amount by which 10% of D’s monthly gross receipts exceed basic rent. On this basis, D argues that the landlords are not mere passive landlords - they are interested in the business venture on the Premises, and thus the viability of the business is also their concern.

(e)  While I can see where D is coming from, I do not agree with the inference sought to be drawn. The argument may have some mileage had there been no minimum rent, but this is not the case. The existence of a minimum rent in fact points right to the opposite – while the landlord is happy to participate in profits if the business does spectacularly well, the minimum rent draws a clear line in the sand - insofar as D’s business does not perform, the risk is placed squarely on D.

(f)  While D may lament the one-sidedness of the provision, this was what was agreed to. I am unaware of any legal doctrine in this context which suggests that, insofar as the landlord is to take the benefit of an upside, he must correspondingly bear the detriment of the downside.

22.  Based on the above analysis, in my view, D’s defence of frustration must fail. In fact, the analysis above is similar to the one conducted by DHCJ Le Pichon at Vember Lord v The Swatch Group (Hong Kong) Limited [2022] HKCFI 279 §§72-74.

23.  Finally, as a matter of completeness, I note that Mr Chan had, in both his written and oral submissions, stressed that this case is unique in that the Social Unrest and the Pandemic were lengthy events which had particular impact as the lease term was short (3 years). For this, he says, one should take note of Lord Simon’s dicta in National Carriers at 706E, 707B-D to the effect that this should be a “potent factor” to take into account in determining whether the tenancy agreements are frustrated.

(a)  In my view, such dicta is not applicable in the present case. In National Carriers, what happened was that the supervening event had in fact meant that the common purpose of using the premises as a warehouse has become temporarily impossible. The Court therefore had to evaluate the length of the temporary impossibility to determine whether the lease ought to be frustrated.

(b)  In the present case, D is unable to show that the common purpose had been frustrated at all. D’s argument on this point must therefore fail.

D.  Abatement of Rent Clauses

24.  The second issue concerns rental abatement. The ONE abatement clause provides as follows:-

“If the Premises or any part thereof are rendered unusable or inaccessible by closure order or building order issued by the Government, fire lightning explosion storm tempest flood earthquake bursting or overflowing of water tanks apparatus and pipes impact aircraft and articles dropped therefrom riot civil commotion labour disturbances and malicious damage and such other events beyond the control of the Landlord and as may be determined by the Landlord the Rent and Service Charges or a part thereof proportionate to the extent to which the Premises shall have been so rendered unusable or inaccessible shall abate and ceased to be payable from the month following the happening of the events mentioned hereinabove until the Premises shall have been again rendered fit for use and accessible…” [emphasis added]

25.  The Silvercord abatement clause provides as follows:-

“If the Premises or any part thereof are rendered unusable by an Insured Risk the Rent reserved hereby and Service Charges or a part thereof proportionate to the extent to which the Premises shall have been so rendered unusable or inaccessible shall abate and cease to be payable until the same shall have been again rendered fit for use and accessible…”

“[The Tenant covenants:] To keep the Portions of the Building insured…against loss or damage by fire, lightning, explosion, storm, tempest, flood, earthquake, bursting or overflowing of water tanks apparatus and pipes impact aircraft and articles dropped therefrom riot, civil commotion, labour disturbances and malicious damage and such other risks as may be determined by the Landlord (each of which risks being referred to in this agreement as “an Insured Risk”)…” [emphasis added]

26.  Mr Chan’s argument is that the Pandemic is an event which falls under these clauses, being “such other events beyond the control of the Landlord” or “such other risks”.

27.  While in both cases the determination of whether there had been such events and/or risks is to be conducted by the landlord, it is trite that contractual discretions must be exercised in good faith: Braganza v BP Shipping Ltd [2015] 1 WLR 1661. On this basis, Mr Chan argues that the landlord’s non-determination is neither here nor there.

28.  Mr Chan also emphasizes that many of the other cases whereby the Pandemic was ruled as not falling within the rent abatement clause concerned clauses which used the terms “destroy or damage”, and thus tying such to physical damage. The clauses in contention herein, he argues, is less restrictive.

29.  Further, while in the recent case of Vember Lord the Pandemic was also ruled as not falling with the rent abatement clause despite such having no reference to the terms “destroy” or “damage”, the case can be distinguished for the following reasons:-

(a)  DHCJ Le Pichon made it clear that she did so not because of her holding that the clause only ties in with physical damage [§39].

(b)  Instead, her Ladyship’s rationale is that, based on her interpretation of the clause, it does not cover pure economic loss. The reason given was that the clause in question provided that the extent of rebatement is to be determined by the landlord. If the clause was intended to apply to pure economic loss, it would be difficult to see how the landlord would be in a position to determine such, since the landlord is not in possession of the relevant facts and information [§§42- 46].

(c)  In the present case, the clauses do not contain a similar provision.

30.  Finally, he places reliance on the judgment of H. Au-Yeung J in Star Win Enterprises Ltd v The One Property Ltd [2021] HKDC 922, which deals with the rent abatement clause for The ONE (which is one of the two clauses in dispute herein). In that case, the tenant sought to determine the scope of the rent abatement clause by way of an O 14A application. This was dismissed by the learned Judge on the basis that contractual interpretation requires contextual evidence which was not before him, and the matter is thus not suitable for summary determination. On such basis, Mr Chan contends that I should similarly not deal with the issue summarily.

31.  Mr Chain’s argument, on the other hand, is that:-

(a)  Abatement clauses are in effect force majeure clauses, and must be strictly construed: Goldlion Properties Ltd v Regent National Enterprises Ltd (2009) 12 HKCFAR 512 at §6.

(b)  Adopting such an approach, it cannot be said that the Premises had become “unusable” or “inaccessible”.

(c)  First, the Social Unrest is simply irrelevant, since the abatement period is said to begin in July 2020.

(d)  Second, Mr Chan’s argument, in effect, is to say that the Premises had become “unusable” or “inaccessible” because the parties contemplated that the Premises would benefit from significant numbers of international customers and customers from Mainland China, but their entry into Hong Kong had been thwarted by the Pandemic. However, such an interpretation is simply too wide, and does too much violence to the literal meaning of the words.

(e)  Finally, Mr Chain relies heavily on the alternative reasoning of DHCJ William Wong SC (as he then was) in Holdwin. Therein, his Lordship first concluded that the clause therein concerned only physical damage and thus the Pandemic could not fall thereunder [§51]. However, he went on to say that the Pandemic would in any event not render the Premises unfit for commercial use or inaccessible, as:-

(i)  “The Premises remained in use and was fully accessible to customers and patrons (including even tourists and overseas visitors who were willing to undergo the requisite quarantine in Hong Kong)…” [§56]

(ii)  “The availability of tourists and overseas visitors in Hong Kong is wholly irrelevant to the question of whether or not the Premises was fit for commercial use …” [§57(2)]

32.  I have considered the above arguments. My view is as follows.

33.  First, while I note that in Star Win it was said that interpretation of a rent abatement clause may not be susceptible to summary determination, that was against the conclusion of the Court that, in that case, “there is hardly any evidence before the court on such factual matrix” [§23], rather than any objection as a matter of principle. In the present case, the parties had filed lengthy affirmations and there is no real dispute over the facts as to the formation of the tenancy agreements. I am of the view that I have sufficient materials as to the relevant factual background.

34.  Second, it is not seriously disputed that the Pandemic is not one of the events expressly listed in the clauses, and D has to rely on the catch-all phrases of “such other events beyond the control of the Landlord” or “such other risks”.

35.  In this regard, insofar as The ONE’s abatement clause is concerned, the reasoning of DHCJ Le Pichon in Vember Lord at §§48-52, citing the case of Tandrin Aviation Holdings Limited v Aero Toy Store LLC [2010] EWHC 40 (Comm), is apposite. In gist, the Pandemic cannot be said to be an event that is only beyond the control of the landlord – it was equally beyond the control of the tenant. The wording thus clearly shows that the Pandemic is not the kind of event that is contemplated under the rent abatement clause.

36.  Third, insofar as both abatement clauses are concerned, I agree with DHCJ Le Pichon’s dicta in Vember Lord that although an abatement clause may not refer expressly to “destroy” or “damage”, “…a common thread running through the entire provision is that the triggering event is something that affects the premises themselves, impinging on their use and/or accessibility” [§55]. This is apparent if one considers the expressly listed events, which all relate to inaccessibility or destruction/damage of the premises. For example:-

(a)  closure order or building order relate to inaccessibility;

(b)  fire, lightning, explosion, storm, tempest, flood, earthquake, bursting or overflowing of water tanks, apparatus, and pipes, and malicious damage relates to destruction/damage of the premises;

(c)  riot, civil commotion, and labour disturbances potentially relates to both inaccessibility and destruction/damage of the premises.

37.  Applying the ejusdem generis principle, the phrases “such other events beyond the control of the Landlord” and “such other risks” should be types of risks which are tied in with the inaccessibility or destruction/damage of the premises. In contradistinction, it would not include pure economic risks divorced from inaccessibility or destruction/damage of the premises, such as the Pandemic.

38.  Fourth, while Mr Chan is entirely correct to point out that, in the present case, the clauses do not provide for the landlord to determine the extent of abatement and thus a complete parallel cannot be drawn with DHCJ Le Pichon’s analysis in Vember Lord, the fact that both clauses provide that the extent of abatement depends on “the extent to which the Premises shall have been so rendered unusable or inaccessible” is not irrelevant.

39.  Such drafting, in and of itself, militates against the clause applying to risks which are purely economic. Afterall, if pure economic loss were covered under the clause, how is one to determine the economic denominator against which the extent is to be measured? Is one to take such as the sales, the revenue, the profits, or the footfall? Once divorced from issues which affect the premises, the uncertainties of the assessment mounts exponentially. It is inherently unattractive to construe what is in effect a force majeure clause in such a way.

40.  I am therefore not satisfied that the Pandemic is a relevant event/risk which falls under the rent abatement clauses.

E.  Mitigation

41.  The final issue I have to determine concerns the defence of mitigation. In the present case, it is not disputed that a significant portion of the sum claimed relate to damages in relation to the loss of rent after the Premises had been delivered up, and where the respective landlords claim that they had been unable to rent out the premises despite efforts.

42.  In this regard, Mr Chan relies heavily on the case of Wing Siu v Goldquest International Ltd (No.2) [2002] 4 HKC 420, where Ma J (as he then was) had this to say:-

“Whether or not in the circumstances the Plaintiff had acted reasonably is not something that is easily decided on a summary basis. Reasonableness is a matter of degree and in the absence of cross-examination or full discovery, this is not often capable of determination at the Order 14 stage. In other words, the very concept of reasonableness invariably gives rise to arguments that should only be resolved at trial…” [§29(2)]

43.  Mr Chain, on the other hand, notes that:-

(a)  the duty to mitigate is not onerous – the plaintiff is only required to do what he does in the ordinary course of business;

(b)  the burden is squarely on D to show lack of mitigation, and D’s evidence in this regard consists mainly of bare assertions. For example, insofar as the allegation is that the lease out rates were too high or too low, no evidence had been put forward from surveyors to sustain such.

44.  I have reviewed the evidence put forward by both sides. In my view, this is not a case where the issue of mitigation is clear cut. On the one hand, the loss of rent claims cover quite a long period (up to 10 months), which cannot be described as ‘normal’ for prime retail premises; on the other hand, as borne out by Mr Chan’s lengthy expositions as to the dire status of the retail industry in support of D’s frustration arguments, the relevant period can hardly be described as ‘normal’.

45.  I am therefore not minded to give summary judgment on quantum insofar as they relate to unliquidated damages, eg, loss of rent and fees payable.

F.  Penalty Clause

46.  Finally, insofar as HCA 268/2021 is concerned, D argues that one component claimed, ie, liquidated damages at HK$1,000 for each day D failed to keep its premises open for business, should be disallowed on the basis that such clause was a penalty clause.

47.  In determining whether a clause is a penalty clause, both parties are content to apply the test set out in Cavendish Holding BV v Makdessi [2016] AC 1172.

48.  The only real point in dispute is whether it could be said that the sum is a penalty which is out of all proportion to the legitimate interest of the innocent party in the enforcement of the primary obligation.

49.  D’s argument, in gist, is that one cannot summarily determine such, as no evidence had been put forward to support P’s assertion on oath that other shopping malls in Hong Kong include similar liquidated damages clauses.

50.  Viewing matters in the round, I do not accept D’s argument.

51.  As pointed out by Mr Chain, there is clearly an interest on the part of The ONE to upkeep the shopping mall’s goodwill and reputation as a first class shopping and commercial centre. Such damages are intrinsically difficult to quantify, and the use of liquidated damages is thereby understandable.

52.  On this basis, and applying a common sense view, I find it difficult to characterize liquidated damages of HK$1,000 per day as being out of all proportion to The ONE’s legitimate interest, bearing in mind that monthly rental of the premises is over HK$300,000 per month. Whether other malls do the same is of limited, if any, value to the question at hand.

G.  Disposition

53.  I therefore grant summary judgment on liability in both cases.

54.  Insofar as quantum is concerned:-

(a)  I grant summary judgment on the liquidated sums claimed with interest;

(b)  the unliquidated damages are to be assessed.

55.  Further, the parties are ad idem that:-

(a)  insofar as HCA 268/2021 is concerned, insofar as I find against D on the frustration issue, the counterclaim should be struck out. I order accordingly;

(b)  insofar as HCA 269/2021 is concerned, even if I find against D on the frustration issue, as the rental deposit exceeds the liquidated sum granted in summary judgment, there is a theoretical possibility that D will be able to make net recovery under its counterclaim (ie, if the finally assessed unliquidated damages is lower than HK$101,912.33). Rather than leaving the counterclaim hanging, the parties agree that this can be replaced by Silvercord’s undertaking that it will refund to D the balance should the finally assessed unliquidated damages be lower than HK$101,912.33. I accept such proposal offered by the parties.

56.  Given that the exact form of order and the exact amount of interest is to be worked out, I ask that Ps do try to work with D to agree to a form, failing which any issues should be referred to me for determination.

57.  As to costs, Ps are generally the successful party, save that they had not succeeded in persuading me in relation to the mitigation issue. Bearing in mind that the tenancy agreements contain an indemnity clause, I would make an order nisi that:-

(a)  Costs of the Actions be to Ps on an indemnity basis, to be taxed if not agreed;

(b)  Ps shall have 80% of the costs of the summary judgment applications on an indemnity basis, with certificate for counsel, to be taxed if not agreed.

58.  Finally, I thank Counsel for the useful assistance they had rendered.