XCHRX RE: CHAO SZE BANG FRANK (趙世彭) and EX PARTE: BRIGHT ISLANDS CORPORATION (A Creditor)

HCB 549/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

IN BANKRUPTCY NO.549 OF 2000

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D E C I S I O N

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1. This is an application by summons dated 5 July 2000 by Chao Sze Bang Frank ("Mr Chao") to strike out the bankruptcy petition presented against him by Bright Islands Corporation ("Bright Islands") on 22 February 2000.

The background facts

2. On 15 October 1997, Mr Chao executed a performance guarantee (the "Guarantee") in favour of Bright Islands in consideration of the execution by Bright Islands of (i) a Ship Sales Contract with Finex Shipping Limited ("Finex") and (ii) an Agency Agreement with Finex which Bright Islands did on 16 October 1997. The purchase price under the Ship Sales Contract was US$29,704,000. 10% (the 1st instalment) was due and payable within three business days after receipt by Bright Islands of a Refundable Guarantee under the Shipbuilding Contract referred to below. Another 10% (the 2nd instalment) was due and payable within three business days after keel laying of the first section of the Vessel. A further 10% (the 3rd instalment) was due and payable within three business days after launching of the Vessel. The balance (the 4th instalment) was due and payable on delivery of the Vessel.

3. Mr Chao "absolutely, unconditionally and irrevocably" guaranteed :

"(1) the due and punctual payment by [Finex] in accordance with the terms and provisions of the Contract of any and all sums which are now or at any time hereafter payable by [Finex] under or in respect of the Contract in accordance with terms and conditions thereof including (without limitation) all claims or moneys due and to become due to you thereunder and all claims for damages in respect of any breach by [Finex] of the Contract (the 'Contract Liabilities'); and

(2) the due and punctual performance of all obligations of [Finex] under and in respect of the Contract other than the Contract Liabilities (the 'Contract Obligations').

The Guarantee also provided that -

"If [Finex] fails to make payment of any of the Contract Liabilities when and as the same shall become due and payable I hereby covenant that I will pay to you upon demand the amount equal to any sum or sums in respect of which [Finex] shall not have made payment and will indemnify you against al losses, damages, costs or expenses suffered or incurred by you in consequence of [Finex's] failure to perform or comply with the Contract Obligations."

So the Guarantee contained a personal covenant from Mr Chao to pay certain sums.

4. The Vessel, which was the subject matter of the Ship Sales Contract, was to be built by China Shipbuilding Trading Company Limited and Dalian Shipyard (collectively "the Shipyard") which entered into a contract with Bright Islands ("the Shipbuilding Contract") on the same day as the Ship Sales Contract. The Ship Sales Contract and the Shipbuilding Contract were back to back arrangements, the contract price and terms of payment being identical. Finex's payment obligations to Bright Islands mirrored Bright Islands' payment obligations to the Shipyard. What Bright Islands stood to gain from the arrangement was a commission of US$300,000 payable by the Shipyard under a separate commission agreement. The Agency Agreement authorized Finex to supervise the construction of the Vessel. Bright Islands' role was thus purely nominal. Under clause 8 of the Agreement, the instalments payable by Finex under the Ship Sales Agreement were to be remitted directly to the bank account designated by the Shipyard. The Shipbuilding Contract was guaranteed by Nissho Iwai (which owns Bright Islands) under a guarantee executed on 28 October 1997. On 16 October 1997, Rudolf A. Oetker ("Oetker") entered into an agreement to charter the Vessel from Finex.

5. After Finex failed to pay the 2nd and 3rd instalments, a meeting was held in early September between representatives of Bright Islands and Mr Chao. Bright Islands was informed that there were negotiations for the resale of the Vessel to the Royal Bank of Scotland for US$27.55 million and that the charterer had consented to the transfer of the Vessel subject to the charter-party. A shortfall of roughly US$2 million would still arise after paying off the Kwangtung Provincial Bank which had advanced the 1st instalment and Finex would need time to settle the shortfall. Bright Islands/Nissho Iwai were requested to enter into the necessary arrangement with the Shipyard to enable Finex to repay the shortfall within a period of time. Mr Chao offered to provide security to Bright Islands/Nissho Iwai by executing a mortgage over his half interest in his late father's estate. The delivery date for the Vessel originally due on 15 September 1999 was extended by agreement to late September, although the precise date is a matter of dispute. According to Bright Islands, it was 28 September and according to Mr Chao, it was 30 September. Bright Islands was receptive to the proposal.

6. It is relevant to mention that several days later, Mr Chao was informed that Nissho Iwai had instructed their solicitors to start documentation concerning the mortgage, the fee being in the region of HK$50,000. Nissho Iwai sought confirmation that such legal fee would be borne by Mr Chao. Mr Chao replied by fax as follows :

"You may proceed with the legal documentation at the cost of no more than HK$50,000."

On the following day, Nissho Iwai sent a fax to the effect that in addition to the mortgage documents, the scheme of the transaction and documentation in relation to the guarantee also needed to be drafted and sought confirmation that such legal fee (the amount of which would be made known as soon as it was available) should also be borne by Mr Chao. There is no evidence as to whether Mr Chao was informed of and/or agreed to bear this additional legal fee.

7. The proposed transaction with the Royal Bank of Scotland fell through on 22 September 1999. Finex failed to take delivery of the Vessel on the delivery date and Oetker cancelled the charter-party. Finex defaulted on the fourth instalment which was due on the date of delivery of the Vessel and also failed to take delivery. Bright Islands gave notice of default and cancelled the Ship Sales Contract pursuant to clauses 2 and 4 of Article XI.

8. The Vessel was eventually resold by the Shipyard on 19 November 1999 for US$21.25 million less 2% commission (leaving a net sum of US$20,825,000) and the Shipyard accordingly claimed from Bright Islands and Nissho Iwai, the guarantor of the Shipbuilding Contract, the sum of US$7,065,710.86, said to be the shortfall arising on the sale of the Vessel. Nissho Iwai settled the Shipyard's claim by paying the sum of US$6 million.

9. The statutory demand served on Mr Chao is for the sum of US$6,305,772.88 made up as follows :

(i) shortfall on the sale of the Vessel	US$6,000,000.00
(ii) loss of commission	US$270,000.00
(iii) legal fees	US$35,772.88

This is the debt upon which the petition is founded.

The issue

10. Mr Chao's case is that any claim that Bright Islands has under the Guarantee is unliquidated, being an action for damages and, in any event, the debt underlying the petition is substantially disputed and to invoke the bankruptcy jurisdiction in such circumstances is an abuse of process. The issues which arise therefore are :

(1) whether Bright Islands' claim against Mr Chao under the Guarantee is for a liquidated sum; and

(2) if so, whether such sum is substantially disputed.

The shortfall

11. As noted above, the US$6 million shortfall claimed by Bright Islands was the amount paid by Nissho Iwai to the Shipyard in settlement of the Shipyard's claim against Nissho Iwai under its guarantee of Bright Islands' obligation under the Shipbuilding Contract. This liability is disputed by Mr Chao. He submitted, first, that Finex never agreed to indemnify Bright Islands/Nissho Iwai in respect of claims from the Shipyard under the Shipbuilding Contract or from Nissho Iwai under its guarantee to the Shipyard. If Finex was not so liable, Mr Chao could not be in any different position. Second, as the sale was effected by the Shipyard and not Bright Islands, clause 5(e) of the Ship Sales Contract was not engaged so that the shortfall was not one for which Mr Chao was liable.

12. Clause 5 provided as follows :

"5. SALE OF THE VESSEL

(a) In the event of cancellation or rescission of this Contract as above provided, [Bright Islands] shall have full right and power either to complete or not to complete the VESSEL as it deems fit, and to sell the VESSEL at a public or private sale on such terms and conditions as [Bright Islands] thinks fit without being answerable for any loss or damage occasioned to the [Finex] thereby. In the case of sale of the VESSEL, [Bright Islands] shall give telex or written notice to [Finex].

(b) In the event of the sale of the VESSEL in its completed state, the proceeds of sale received by [Bright Islands] shall be applied firstly to payment of all expenses attending such sale and otherwise incurred by [Bright Islands] as a result of [Finex's] default, and then to payment of all unpaid instalments and/or unpaid balance of the Contract Price and interest on such instalment at the interest rate as specified in the relevant provisions set out above from the respective due dates thereof to the date of application.

(c) ...

(d) In either of the above events of sale, if the proceed of sale exceeds the total of the amounts to which such proceeds are to be applied as aforesaid, [Bright Islands] shall promptly pay the excesses to [Finex] without interest, provided, however that the amount of each payment to [Finex] shall in no event exceed the total amount of instalments already paid by [Finex] and the costs of [Finex's] supplies, if any.

(e) If the proceed of sale are insufficient to pay such total amounts payable as aforesaid, [Finex] shall promptly pay the deficiency to [Bright Islands] upon request."

13. Whether or not the sum of US$6 million represented the deficiency between the amounts payable by Finex under the Ship Sales Contract and the sale proceeds of the Vessel requires a closer scrutiny of the basis of the claim of US$7 million odd made by the Shipyard against Nissho Iwai which was settled for US$6 million. It would appear that the US$7 million figure was arrived at by subtracting the net proceeds of US$20,825,000 from a claim totalling US$27,790,710 made up of the following :

	Item	Amount (US$)
1.	unpaid 2nd instalment	2,970,400
2.	unpaid 3rd instalment	2,970,400
3.	unpaid 4th instalment	20,792,800
4.	interest on 2nd and 3rd instalments (up to 28/9/99)	456,790
5.	extra cost in building	100,000
6.	interest on unpaid contract price (28/9/99 to 14/12/99)	391,920
7.	maintenance (including insurance)	94,000
8.	quay fees	9,400
9.	dry docking	55,000
10.	fees for functional sea trial	50,000
		27,890,710

14. Under the terms of the Ship Sales Contract, Finex's obligation to pay the 2nd, 3rd and 4th instalments is clear. Its default in failing to make these payments is also clear. In addition, under clause 3 of Article XI, Finex was also under an obligation to pay interest at the rates and for the period set out in paragraph (a) of that clause. The amount of interest is plainly ascertainable, being only a question of computation in accordance with clause 3(a). On the facts of the present case, I have no doubt that the amount of the unpaid instalments as well as interest under clause 3(a) up until 28 September 1999, i.e. items 1 to 4 inclusive listed above, are liquidated sums. However, that is not the case with items 5, 7 to 9 (inclusive) above. Whilst they may well be recoverable by Bright Islands under clause 3(b) pursuant to which Finex was under an obligation to "pay all costs, charges and expenses incurred" by Bright Islands, the amount due (if any) under those items is unliquidated and must first be established through obtaining the appropriate judgment or award.

15. Counsel for Mr Chao submitted that Bright Islands' claim against Mr Chao can only be one in damages and that no liquidated sum is due unless and until Bright Islands sues Mr Chao for damages and obtains a judgment in its favour. He referred to Moschi v. Lep Air Services Ltd [1973] AC 331 where the House of Lords had to consider the effect of a provision under which A personally guaranteed the performance by B of its obligation to make certain payments. The issue is stated in the speech of Lord Diplock (at 347 G) in the following terms :

"...whether a contractual promise by the guarantor to guarantee to the creditor that the debtor would perform his own obligations to the creditor to pay a sum of money to him was itself classified as giving rise to an obligation on the part of the guarantor to pay that sum of money to the creditor if the debtor did not do so, or as an obligation to see to it that the debtor did perform his own obligations to the creditor."

Lord Diplock held that the legal nature of the obligation of the guarantor was not an obligation himself to pay a sum of money to the creditor but an obligation to see to it that another person, the debtor, does something and that the creditor's remedy for the guarantor's failure to perform it lies in damages for breach of contract only. Lord Reid agreed. Where A undertook that the principal debtor B would carry out his contract so that if B failed to act as required by his contract, he not only broke his own contract but also put the guarantor A in breach of his contract of guarantee. In such a case,

"... the creditor can sue the guarantor, not for the unpaid instalment but for damages. His contract being that the principal debtor would carry out the principal contract, the damages payable by the guarantor must then be the loss suffered by the creditor due to the principal debtor having failed to do what the guarantor undertook that he would do.

In my view, the appellant's contract is of the latter type. He 'personally guaranteed the performance' by the company 'of its obligation to make the payments at the rate of ￡6,000 per week.' The rest of the clause does not alter that obligation. So he was in breach of his contract as soon as the company fell into arrears with its payment of the instalments. The guarantor, the appellant, then became liable to the creditor, the respondents, in damages...."

See per Lord Reid at 345 B-D.

16. Into which category does the Guarantee fall? True it is that Mr Chao guaranteed Finex's performance of its obligations including the due and punctual payment of sums payable by Finex under the Ship Sales Contract and agreed, inter alia, to indemnify Bright Islands against all losses etc. in consequence of Finex's failure to perform or comply with the contract obligations which undoubtedly fall into the second category identified in Moschi v. Lep Air Services Ltd. However, the Guarantee also contained a covenant by Mr Chao that if Finex failed to make payment of any of the Contract Liabilities (and pausing here this must extend to the unpaid instalments and ascertainable interest), he would pay Bright Islands upon demand the amount equal to any sum or sums in respect of which Finex should not have made payment. So, unlike the provision in Moschi v. Lep Air Services Ltd, the Guarantee contained Mr Chao's personal covenant to pay Bright Islands sums that are liquidated. Moschi v. Lep Air Services Ltd is thus distinguishable and does not assist Mr Chao.

17. I now turn to consider whether or not on the facts there is any liquidated sum for which Mr Chao is liable under the Guarantee. Counsel for Mr Chao has taken the somewhat technical point that clause 5(e) of the Guarantee was not triggered because the sale was by the Shipyard and not Bright Islands. This technical point is a distraction, the real question being whether any liquidated sum was due under the Guarantee.

18. Counsel for Mr Chao submitted that there is a substantial dispute on the facts as to whether the sale by the Shipyard was at an undervalue and/or whether Finex was prevented from reselling the Vessel. Mr Chao adduced evidence as to the value of the Vessel. There is a valuation report prepared by Macpherson Marine Ltd ("MML") to the effect that as of middle to late September 1999, as a new building resale with the time charter to Oetker, the Vessel had a market value in the region of US$27.5 million to US$28 million and as of the middle of December 1998, on a charter free basis, the Vessel had a market value in the region of US$23 million. There is an accompanying report which explained that the intended sale to the Royal Bank of Scotland did not go through due to a technicality. It also dealt with the confidential negotiations conducted with a number of prospective buyers for the Vessel as from June 1999. Had the Royal Bank of Scotland transaction gone through, the Vessel would have been sold for US$27.5 million. But other firm, albeit slightly lower, offers were also identified in the report. There followed MML's account of its understanding of events which took place as from the middle of September 1999. In brief, there are allegations to the effect that Nissho Iwai had caused conflicting information to be released onto the market at that time. Brokers and owners with whom MML had been conducting private discussions had been receiving messages from Nissho Iwai saying that interested buyers should not work with MML and should switch instead to Nissho Iwai. In short, there were allegations that Bright Islands/Nissho Iwai had sabotaged Finex's attempt to resell the Vessel in September 1999. In this connection, it should be borne in mind the Bright Islands is a wholly owned subsidiary of Nissho Iwai.

19. The Vessel was not sold until mid-November 1999. According to Mr Chao's expert, between September and December 1999, the value of the Vessel declined sharply. As at mid-December 1999, the Vessel had declined from US$27.5 million to US$28 million to only US$23 million. Mr Chao's expert did not opine on the market value of the Vessel as at 19 November 1999 but it is reasonable to infer from the reports adduced that the value would have been somewhere between the valuations as at September and December. I will first proceed on the assumption that the value as at mid-November was the same as that prevailing in mid-December for reasons which will become apparent. On that assumption, the amount due and owing under the personal covenant to pay the Guarantee would comprise the three unpaid instalments, interest on the 2nd and 3rd instalments up to 28 September 1999, as well as interest payable up until the date the Vessel was resold (say another US$250,000 or so) which total some US$27.45 million.

20. As to the sale at an undervalue point, no shortfall would arise if the market value of the Vessel at that date was at its mid to late September value. A shortfall of the order of US$4.45 million (for which, prima facie, Mr Chao would be liable) would arise on the basis of the sale occurring in mid-November 1999 at its mid-December value. It would of course be commensurately less if the Vessel had a greater value in mid-November. On this scenario, Mr Chao's case is perhaps best put as follows. Although the Bank of Scotland transaction did not materialize (and it is common ground that Bright Islands/Nissho Iwai had nothing to do with that sale falling through), there were other potential purchasers with whom a deal could have been concluded at market value but for Bright Islands/Nissho Iwai sabotaging any resale at that time. As at September 1999, the liquidated amount outstanding stood at around US$27.2 million whilst the valuations by MML were of US$27.5 million to US$28 million. But for Bright Islands'/Nissho Iwai's interference, Mr Chao would have been able to resell the Vessel at market value in late September 1999 and would have realized US$27.5 million to US$28 million which, it is to be noted, would have been more than sufficient to discharge the liquidated claims of Bright Islands. No shortfall would thus have arisen.

21. Counsel for Bright Islands commented adversely on the valuations. When the potential sale at US$27.5 million failed to materialize, the next firm offer was only at US$26.5 million. He questioned whether there was any basis concluding that the Vessel was worth US$27.5 million, let alone the higher valuation at US$28 million. As noted above, the Bank of Scotland transaction which fell through because of a term unrelated to the purchase price. But for this technical problem, the Vessel would have been sold for US$27.5 million and that is at least some evidence of the Vessel's value as at late September. Of course, it would be a matter for Mr Chao to establish at trial that the Vessel could have been sold to someone else at that price. But it would be wrong for the court to make a finding at this stage that the maximum that could have been realised was limited to the value of the next highest firm offer. Indeed, on the same reasoning, it would be wrong for the court to make any finding of fact as to the value of the Vessel as at 19 November 1999 based simply on the two valuations adduced by Bright Islands of between US$20.75 million and US$21.25 million. Since the Vessel's value is very much in issue, that must be a matter for determination at trial.

22. For those reasons, I am unable to conclude that a shortfall is bound to arise. That being so, the ineluctable conclusion must be that the debt is substantially disputed.

Loss of commission and legal costs

23. It must follow from the analysis above that the lost commission and legal costs claimed are also substantially disputed. If Bright Islands did sabotage the resale of the Vessel in September as alleged, the loss may not be recoverable. In any event, subject to the $50,000 hereafter mentioned, Mr Chao's obligation would only arise under the indemnity part of the Guarantee and that must first be established as due through an action for damages.

24. As to legal costs, the amount claimed is US$35,772.88 or approximately HK$279,000. The general point made above is that the claim is unliquidated. However, arising out of the early September meeting between the parties was the agreement as to the legal costs of the proposed mortgage not exceeding HK$50,000. There is evidence that Bright Islands has incurred and discharged that amount of legal costs. Despite the clear terms of his fax dated 9 September 1999, capping the fee at HK$50,000, Mr Chao sought to add a gloss in his second affidavit to the effect that his agreement was "on the understanding that I would only be responsible for such legal costs if the mortgage did go through". Whether or not that was his understanding, nowhere is it alleged that it was the 'mutual understanding' of the parties. Moreover such an allegation would not be consistent with the clear terms of his fax. I have to conclude that the gloss was plainly an afterthought. In my judgment, he is plainly liable for this sum.

Conclusion

25. In view of the above, I am prepared to strike out the petition but only on condition that the sum of HK$50,000 is paid within 7 days of the date of this judgment.

26. The Petition should be restored for hearing on 3 October 2000 for dismissal or further directions (as the case may be).