CREDIT AGRICOLE INDOSUEZ v. SHANGHAI ERFANGJI CO. LTD. AND ANOTHER

HCA 14569/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 14569 OF 1999

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J U D G M E N T

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1. On 30 November 2001 Master Yuen, having heard an application by the plaintiff for summary judgment and determination of a point of law brought under Orders 14 rule 1 and 14A RHC, gave the defendants unconditional leave to defend. This is an appeal from that order.

History

2. The plaintiff is the Shanghai branch of a bank incorporated in France. The bank has branch offices all over the world; there is one in Hong Kong. The defendants are companies incorporated under the laws of the PRC and carry on business in Shanghai. The 1st defendant is listed on the Shanghai Stock Exchange. Its business consists of the import and export of commodities. Its major source of income is in US dollars and its major expenditure is in Deutsch marks and pounds sterling.

3. By facility letter of August 1992 the plaintiff granted banking facilities to the 1st defendant which included US$6 million for spot and forward foreign exchange dealing. It is the defendants' case that this was for the purpose of enabling the 1st defendant to hedge against the risk of foreign exchange fluctuation. It is the defendants' case that all such dealings were required to be based on actual import and export contracts and be in the currencies of those contracts; any alternative arrangement was unlawful according to the laws of the PRC. The plaintiff denies that the dealings were to be limited as aforesaid or that those entered into were unlawful.

4. In any event the plaintiff and 1st defendant engaged in foreign exchange transactions over the next few years. There came a time when the 1st defendant failed to meet the cost of two such transactions. The plaintiff granted an indulgence but the default persisted. The plaintiff settled the account and called for payment. The amount in question was not agreed. The parties sought to settle the dispute. On 13 November 1995 they entered into a document called a memorandum of understanding, which fixed the indebtedness at US$3,872,464.69, and went on to record a deadline pending the parties entering into an agreement to enable the debt to be settled over the passage of time by a series of foreign exchange transactions. Clause 3 of the memorandum stated:-

"3) In view of realizing the exchange loss through offsetting pairs of forward foreign exchange contracts, each party will check with its respective supervising authorities and experts the feasibility and the proper way of handling the scheme in its accounts."

5. The plaintiff and 1st defendant on 29 December 1995 then entered into a document called 'This Foreign Exchange Agreement', (the FX agreement) under which the 1st defendant contracted to purchase foreign exchange from the plaintiff over a period of five years at a pre-determined rate on terms more particularly set out therein. The first transaction required the 1st defendant to purchase foreign exchange at the equivalent value of the indebtedness aforesaid, the consideration therefor being not the sale of the foreign exchange but satisfaction of the debt. A condition of the FX agreement was that the 2nd defendant guarantee and indemnify the performance by the 1st defendant; to this end the plaintiff and the 2nd defendant entered into a document headed 'Guarantee' (the guarantee) on the same date. The FX agreement was expressed to be governed by and interpreted in accordance with the laws in force in Hong Kong. Clause 7.12 made this clear:-

"7.12 Governing Law and Jurisdiction

(a) This document is governed by and must be interpreted in accordance with the Laws in force in Hong Kong.

(b) Each party irrevocably and unconditionally submits to the non-exclusive jurisdiction of the courts of Hong Kong and courts hearing appeals from those courts and waives any right to object to any proceedings being brought in any of those courts."

The governing law of the guarantee (at clause 5) was expressed to be as for the FX agreement. The FX agreement provided for payment when due to be made in Shanghai or New York. The guarantee provided for payment at a place as may be reasonably required by the plaintiff.

6. The 1st defendant and plaintiff proceeded to trade in foreign exchange in compliance with the FX agreement from 20 March 1996 to 22 December 1997. But on and since 20 March 1998 the 1st defendant defaulted in meeting payments and that default continued to 21 June 1999. Treating that default as repudiation, the plaintiff accepted that and terminated the FX agreement. In terms of the default provisions it proceeded to demand from the 1st defendant under the FX agreement and the 2nd defendant under the guarantee the sums overdue, interest thereon and an amount calculated to compensate the plaintiff for prospective loss on those transactions not yet due. As at 26 July 1999 these amounts came to, respectively, US$1,320,209.76, US$17,909.09 (to that date) and US$1,263,601.34.

7. When no payment was forthcoming the plaintiff issued a writ against both defendants.

The Proceedings

8. The plaintiff's writ is dated September 1999. It sues for the amounts it calculates to be outstanding under the FX agreement and, as a consequence, the guarantee.

9. The defendants' defence is dated December 1999. They deny liability on a number of grounds summarized as follows:-

(a) Illegality. The foreign exchange trading giving rise to the purported indebtedness settled by the parties entering into the FX agreement and guarantee was illegal under PRC law, rendering thus the FX agreement illegal under the laws of PRC and unenforceable under the laws of PRC and Hong Kong;

(b) Mistake. The 1st defendant entered into the FX agreement under a mistake of fact and/or law that the foreign exchange trading which resulted in the afore-mentioned indebtedness was legal, which mistake the plaintiff knew or ought to have known of;

(c) Plaintiff's wrongful repudiation. Upon completion of the first of the transactions to which the parties were committed under the FX agreement the plaintiff owed to the 1st defendant the sum of US$3,872,465.48. This default resulted in a wrongful repudiation. This has been accepted by the 1st defendant which thus is under no further liability under the FX agreement;

(d) Penalty. That part of the plaintiff's claim calculated to be US$1,263,601.34 being purportedly compensation for future loss constitutes a penalty rather than a genuine pre-estimate of loss and is thereby unenforceable;

(e) Set off. In the event that the 1st defendant is liable to the plaintiff in any sum under the FX agreement it claims a set off in respect of the said sum of $3,872,465.48.

10. By virtue of the above defences and/or set-off the 2nd defendant denies liability under the guarantee.

11. Next the plaintiff filed its application which gave rise to the decision from which the plaintiff now appeals. Under Order 14A RHC the plaintiff sought a determination on the following questions of law or construction:-

(a) Whether Hong Kong Law is the proper law of the FX agreement, and

(b) the guarantee; if so,

(c) whether the defences of illegality and/or mistake amount to defences in law;

(d) whether upon its construction, the plaintiff was liable under the FX agreement to pay the sum of US$3,872,465.48 to the 1st defendant;

(e) whether upon its construction the amount of future loss calculated to be $1,263,601.34 is a penalty and is unenforceable against the 1st defendant.

12. The plaintiff also applied for final judgment for the amount prayed for, pursuant to Orders 14 and 14A RHC or either of them.

13. During the course of argument I was told by Mr Y L Wong SC for the plaintiff, confirmed by Mr R Wong SC leading Mr S Wong for the defendants, that the defendants were no longer pursuing the defences which required a judicial response to the question at (d) and (e).

14. Evidence in support came from affidavits made by Didier Odin (Mr Odin) who is a senior vice president of the Regional Work Out Unit of the bank based at its branch in Hong Kong, and in opposition from one made by Mei Jianzhong (Mr Mei) who is the finance manager of the 1st defendant.

15. I come to their evidence next.

The Evidence

16. Mr Odin said spot and forward exchange dealing being dealing contemplated by the facility letter of August 1992 is permissible under the law of PRC. He described this as the purchase of one currency against the sale of another at an agreed exchange rate (foreign exchange spot rate plus foreign exchange swap rate) for delivery on a future settlement date. This contrasts with margin trading which is leveraged trading in treasury related products and required additional provisions, conditions, safeguards and special legal documentation, including a maximum net open position and acceptable collateral security.

17. The FX agreement did not provide for margin trading nor was any contemplated. It was entered into as a means of spreading over a period of years the losses that the 1st defendant had suffered during the trading engaged pursuant to the August 1992 facility letter.

18. He produced copies of records showing payment by the 1st defendant in compliance with the FX agreement to 20 March 1997. He produced a certificate in terms of the appropriate clause under the FX agreement stating the amount of $1,320,209.76 to be unpaid, with interest accruing thereon, and establishing the requisite discount rate giving rise to the additional indebtedness of $1,263,601.34.

19. He referred to those provisions of the FX agreement and guarantee which determined Hong Kong law as the proper law, and warranties by both defendants that execution of the respective documents and compliance with their terms did not contravene any law.

20. Prior to the parties proceeding application was made to the State Administration of Foreign Exchange (SAFE) for registration and approval of the 2nd defendant guaranteeing and indemnifying the 1st defendant. Copies of both the FX agreement and guarantee were sent to SAFE in support. A function of SAFE is to check that there is or will be compliance by entities within PRC with the foreign exchange regulations of the PRC. SAFE granted its approval.

21. Mr Mei said that the facility granted by the plaintiff to the 1st defendant by the August 1992 letter was a form of foreign exchange loan which required to be approved and registered by SAFE to be legal, but had not been. The foreign exchange transactions entered into which the plaintiff claims gave rise to the indebtedness of $3,872,465.48 were not as contemplated by the 1st defendant under the facility and were not authorized by it. Furthermore they were illegal under the laws of PRC, in particular because the foreign exchange spot rate had been substituted by the foreign exchange historical rate. This amounts to a disguised form of a loan to finance speculation on foreign exchange.

22. It was in ignorance of this illegal conduct and in reliance on the trustworthiness of the plaintiff that the 1st defendant entered into the FX agreement to settle the loss claimed by the plaintiff. The 1st defendant stopped payments under the FX agreement as from 20 March 1997 on advice that the FX agreement was illegal and that it should not comply with its terms.

23. He produced a legal opinion from a law firm practising in Shanghai to the effect that the foreign exchange transactions pre 1995 and the FX agreement were illegal under the laws of the PRC. This was because:-

(a) the foreign exchange transactions pre 1995 were future contracts based on credit facilities not on foreign exchange possessed by the 1st defendant;

(b) the foreign exchange loan had not been approved or registered by SAFE;

(c) the transactions were not, in fact, connected with the 1st defendant's import or hedging requirements; they amounted to speculations;

(d) the rates where not market but historical;

(e) the FX agreement was designed to settle disputes under foreign exchange transactions which were illegal;

(f) the FX agreement provided for the plaintiff trading with the 1st defendant rather than on it behalf, contrary to its Foreign Exchange Business Permit;

(g) the exchange rate was not a market rate but an invented one.

24. The payments Mr Odin said were made by the 1st defendant under the FX agreement for the period 20 March 1996 to 22 December 1997 were in fact unilateral debits drawn by the plaintiff from the 1st defendant's account. The 1st defendant gave no confirmation as would have been the case with a true foreign exchange transaction.

25. Although the FX agreement and guarantee record that they be governed by the laws of Hong Kong, the defendants are both companies registered in Shanghai having no presence in Hong Kong. The plaintiff being the Shanghai branch of the bank likewise has no connection with Hong Kong at all. And nor do the defendants have offices in New York or any other connection with New York; at no stage was it contemplated that payment could be made in New York.

26. The FX agreement and guarantee were drawn by the plaintiff's lawyers. The defendants entered into them in the mistaken belief that they were lawful.

27. Mr Odin replied. He denied any wrong doing or illegal conduct by the plaintiff. Hong Kong was selected in good faith as being the governing law because the bank's branch in Hong Kong is the bank's Asian hub; it is an international commercial centre with internationally respected judges and lawyers, and its laws are those with which the bank is more familiar.

28. That being the evidence I now turn to consider the law.

The proper law of a contract

29. An express choice of law clause is valid and in the normal course conclusive. This is so even where the parties and the subject matter of the contract have no connection with the jurisdiction in question. The principle was conclusively dealt with by the editors of Dicey and Morris on The Conflict of Laws, thirteenth edition, at paragraphs 32-062 and 32-063:

"32-062 In England the principle ultimately became firmly entrenched. "Parties are entitled to agree what is to be the proper law of their contract...There have been from time to time suggestions that parties ought not to be so entitled, but in my view there is no doubt that they are entitled to make such an agreement, and I see no good reason why, subject it may be to some limitations, they should not be so entitled;" per Lord Wright, speaking for the Privy Council in the case of Vita Food Products Inc. v Unus Shipping Co. Ltd [1939] AC 277, at p. 299. It was a "fundamental principal of the English rule of conflict of laws that intention is the general test of what law is to apply," and an express choice of law was said to be conclusive. A minority view treated an express choice of law as merely one element pointing to the proper law, or as only prima facie evidence, or only one of the factors to be taken into account, or one, but by no means the only, matter to be taken into consideration. In Vita Food Products (supra) Lord Wright said at p. 290:- "where there is an express statement by the parties of their intention to select the law of the contract, it is difficult to see what qualifications are possible, provided the intention expressed is bona fide and legal, and provided there is no reason for avoiding the choice on the ground of public policy."

32-063 Must the chosen law have a connection with the contract? Although very frequently the chosen law has some connection with the transaction, it often happens that commercial contracts contain a choice of a law which has no connection, or no apparent connection, with the transaction. Thus, it is very common for parties to major contracts involving State-owned entities in certain countries to stipulate for a neutral law and neutral jurisdiction in order to avoid the application of the law (particularly law enacted after the date of the contract) of the State in any dispute...... Indeed, in Vita Food Products (supra), where it had been argued that a choice of English law to govern a bill of lading was not valid because the transaction contained nothing to connect it with England, Lord Wright, on appeal from Nova Scotia, said at p. 290:- "connection with English law is not as a matter of principle essential": the reason was that parties might reasonably desire that the familiar principles of English commercial law should apply, and that it was important for the security of subsequent dealings that bills of lading were capable of being taken at their face value. Many commercial transactions which seemingly have nothing to do with England are constantly not only insured, but also financed, in the City of London, and certain types of standard commercial contracts, especially maritime and insurance contracts, have been developed in English legal and commercial practice more fully than elsewhere. What Lord Wright called the "familiar principles of English commercial law" have gained a worldwide importance which may make it reasonable for parties to commercial contracts to subject their transactions to English law, although that law has nothing to do with the facts of the particular case."

30. As to whether there is mala fides in the choice of laws requires the presumption of freedom of choice to be upset. But where there is no connection at all with the transaction the fact that the choice is designed to avoid the application of another law may be evidence that the choice is not bona fide: see Dicey and Morris, eleventh edition, p. 1176.

31. Applying these principles to the facts of this case clauses 7.12 of the FX agreement and 5 of the guarantee are unequivocal as to choice of law. So, expressly so stated, it seems the intentions of the parties cannot be doubted. There remains however the question as to whether the intention is bona fide and legal, or whether there is on the ground of public policy a good reason for avoiding the choice.

32. It is the defendants' case that the plaintiff exercised mala fides in proposing that the proper law of the FX agreement and guarantee should be Hong Kong when there was no connection between the parties or the performance of the contract and Hong Kong, in order to protect from loss through illegality the profits made in the transactions which preceded and gave rise to the FX agreement. Further it is their case that the transactions which were envisaged and then undertaken in the FX agreement were illegal and thus unenforceable also.

33. The plaintiff's response is found in Mr Odin's second affidavit already summarized: that the bank's branch office at Hong Kong deals with problems that emerge from foreign exchange transactions undertaken in East Asia: that it is comfortable with and can rely on judicial process resulting from Hong Kong's rule of law.

The Appeal

34. It is clear from the authority of Vita Foods (supra) that the burden of upsetting on the grounds of mala fides the presumption that the proper law of a contract between parties is that which together they choose is a heavy one.

35. Can the defendants discharge this burden, to the extent of showing cause, on the merits, that they have a good arguable case to upset this presumption?

36. In considering that proposition, I pay heed to the following:-

1) The FX agreement and guarantee are not contracts founded in a vacuum. They derived from the outcome of trading in foreign exchange between the local branch of an international bank (the plaintiff) and a locally listed company in Shanghai (the 1st defendant) which trading was undertaken in Shanghai, spanning August 1992 until 1995;

2) the trading included forward exchange trading at the foreign exchange spot rate plus foreign exchange swap rate;

3) on occasion when movements in currencies held were adverse to the 1st defendant's position the parties entered into a reverse contract not at the then spot rate but at the old or historic rate. This amounted to rolling over the original contract;

4) on the evidence adduced such trading is illegal under PRC law because it is tantamount to hiding foreign exchange trading losses and amounts to a bank financing speculation in foreign exchange;

5) the FX agreement was entered into for the sole purpose of satisfying the accumulated debt due by the 1st defendant to the plaintiff;

6) the exchange rate stipulated was not a market rate but an invented one;

7) on the face of it such trading is also illegal under PRC law;

8) the plaintiff is the branch of an international bank whose South East Asian hub is its branch in Hong Kong. Apart from that it has no connection with Hong Kong. The defendants have no connection at all;

9) the plaintiff has not, so far, sought to challenge the content of the legal opinion exhibited in Mr Mei's affidavit, upon which the defendants rely;

10) the plaintiff being the branch of an international bank operating worldwide would be alive to the limits within which it may legally trade in Shanghai;

11) the guarantee was prepared and executed in tandum with the FX agreement. The governing law was expressed to be the same. The proper law of the FX agreement is that of the guarantee as well;

12) that the guarantee is registered by SAFE does not of itself necessarily amount to State approval.

37. I do not doubt there is much in the documents and in the history and in other evidence that supports the plaintiff's case as to the proper law, and its claims. But it is not necessary to rehearse these because this is not a trial of the issues. Having regard to the twelve points itemized, I am satisfied that the answer to the question posed above is "yes", the defendants have shown cause that there is a good defence to the plaintiff's case that the proper law of the FX agreement and guarantee is Hong Kong law. That deals with (a) and (b) of the plaintiff's application; (c) thus goes away.

38. It follows that I agree with Master Yuen's findings and must dismiss the appeal; I order accordingly. Costs (nisi at first instance) are to the defendants, taxed if not agreed.