DING HUIRONG v. CHINA TIMES SECURITIES LTD AND ANOTHER

CACV 112/2020
and CACV 122/2020
(Heard together)

[2021] HKCA 419

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 112 AND 122 OF 2020

(ON APPEAL FROM HCA 365/2018)

____________________

____________________

(HEARD TOGETHER)

________________________

JUDGMENT

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Hon Lam VP (giving the Judgment of the Court):

Background

1.  In April 2017, the Plaintiff used 19,112,000 shares (“the Shares”) he owned in a listed company called Billion Industrial Holdings Limited as collateral for the raising of funds.  The Shares were deposited by him into an account maintained with the 1^st Defendant. The 1^st Defendant played the role of a custodian agent pursuant to a Collateral Agency Agreement.  In return, the Plaintiff received $11,946,099 which was transferred into his account pursuant to a Funding Notice, sent to him through email on 3 June 2017, issued under a “Secured Loan and Pledge Agreement” dated June 1 2017 (“the Agreement”) between the Plaintiff as “Borrower” and Adam International Limited as “Lender”.  The sum was the first of 4 tranches to be advanced under the Agreement.  The total loan amount was stated to be US$6,400,000. 

2.  According to the calculation set out in the Funding Notice, the sum of $11,946,099 represented a loan amount of US$1,533,517:

“Funding Notice
Loan:	Secured Loan and Pledge Agreement dated June 1, 2017 between Ding Hui Rong, as Borrower, and Adam International Limited, as Lender
Total Amount:	Approximately US$6,400,000
Total Collateral:	19,112,000 pledged shares of 2299.HK
Total Tranches:	4 tranches, subject to Lender’s discretion and to prevailing market conditions
LTV%	: 50%

TRANCHE #1 FUNDING AMOUNT
Date: June 3, 2017
Tranche Shares	4,778,000	share
		Lowest VWAP over previous
Tranche Valuation Price	HKD 5.2058	25 days
Total	HKD 24,873,312
Tranche Amount (Total x LTV%)	HKD 12,436,656
Less: Origination Fee (2.00%)	(HKD 248,733)
Less: Coupon (4.00% p.a., paid up to Nov 30, 2017 in advance)	(HKD 241,824)
	________________
Net Funding of Tranche Amount (HKD)	HKD 11,946,099
	==============
Exchange Rate (as reported by Bloomberg)	HKD7.79	per US$
Net Funding of Tranche Amount (US$)	$1,533,517
	________________

The Net Funding Amount of HKD11,946,099 will be transferred to Borrower’s account at China Times with account number M810235 by June 6^th 2017.”

3.  The 2^nd Defendant’s case is that it was the party to the Agreement and that there had been a mistake in the naming of the Lender in the document.  The sum of $11,946,099 was deposited by it to the Plaintiff’s account.

4.  On the other hand, the Plaintiff’s pleaded case was that he had actually entered into another loan agreement with another entity called LC3, and had never entered into any loan agreement with the 2^nd Defendant.

5.  Notwithstanding these complications, in light of the stance adopted by the Plaintiff through his leading counsel Mr Li SC (together with Mr Lam) before us and the undertakings given on his behalf, we can proceed on the basis that the Agreement was the agreement governing the rights and obligations between the parties.  In a nutshell, the Plaintiff intimated to this Court through Mr Li that for the purposes of this action (and the appeal before us), he adopted the Agreement with the 2^nd Defendant as the counterparty to the same.

6.  The Agreement provided that the loan was to be advanced in four tranches.  The timing of the advances shall be reasonably determined at the sole discretion of the lender subject to market conditions, see Clause 2(a).  After the advancement of the first tranche, the Plaintiff did not receive the other three tranches.  Instead, on 6 July 2017, the 2^nd Defendant sent a Notice to the Plaintiff stating that an event of default under Clause 6(a)(2) of the Agreement had occurred.  Because of that, the 2^nd Defendant claimed that it had the right to exercise all rights with respect to the collateral as if it were the sole and absolute owner thereof.

7.  On 11 July 2017, an email was sent on behalf of the Plaintiff to the 1^st Defendant and a firm of lawyers representing the lender, giving notice of termination of the loan and demanding the return of 14,334,000 shares (after deducting 4,778,000 shares held as collateral for the first tranche as stipulated in the Funding Notice).

8.  On 13 July 2017, the 2^nd Defendant responded to the email of 11 July 2017 and reiterated the event of default.  It also stated that it had taken full control and possession of the Shares.

9.  The Plaintiff commenced the action by a writ of 12 February 2018.  In the Statement of Claim of 20 April 2018 he advanced various claims including causes of action based on fraud and deceit, breach of agreement and breach of duty.  The Plaintiff also advanced a claim at paragraph 51 of the Statement of Claim based on his right in equity to redeem the Shares.

The Order 14A application

10.  By a summons of 15 March 2019 (amended on 17 June 2019), the Plaintiff applied for a determination under Order 14A for the following relief:

“ 1. Pursuant to Order 14A, rule 1 of the Rules of the High Court, that as a matter of law, if the allegations of fact set out in the 1^st and 2^nd Defendant’s respective Defence dated 17 August 2018 and Defence and Counterclaim dated 20 August 2018 are assumed to be correct:

(1) The terms of the loan agreement described as between the Plaintiff and the 2^nd Defendant dated 1 June 2017, which purportedly entitle the 2^nd Defendant to forfeit the Plaintiff’s 19,112,000 shares in Billion Industrial Holdings Limited (stock code: 2299)(the “Shares”) and cash dividends in relation to such Shares, constitute an unlawful clog on the Plaintiff’s equity of redemption.

2. Subject to the determination of the application under paragraph 1 above, the action against both Defendants be discontinued upon the completion of the following conditions:

(1) The Plaintiff, in exercising his equity of redemption, pays the loan principal of HK$11,946,099 (as described in the Funding Notice purportedly issued by the 2^nd Defendant on 3 June 2017) with interest into Court. Such interest shall be calculated and agreed as between the Plaintiff and the 2^nd Defendant, failing which either party shall be at liberty to apply to the Court for an assessment of such quantum (the “Redemption Funds”);

(2) Subject to the Plaintiff’s payment of the Redemption Price Redemption Funds into Court, the Defendants shall deliver the Shares and Dividends to the Plaintiff within seven (7) days;

(3) Other directions as the Court deems appropriate; and

(4) Subject to the delivery of the Shares and Dividends to the Plaintiff, the Court shall release the Redemption Funds to the 2^nd Defendant.”

11.  The summons was heard by Recorder Stewart Wong SC (“the Judge”).  On 12 March 2020, the Judge held in favour of the Plaintiff that the terms of the Agreement which purportedly entitle the 2^nd Defendant to forfeit the Shares constituted an unlawful clog on the Plaintiff’s equity of redemption.

12.  The Judge however declined to grant the relief under paragraph 2.  He held at [50] of the judgment of 12 March 2020:

“ … I do not think that it is appropriate for me to make an order in the terms thereof, as the making of such an order does depend on whether the plaintiff did enter into the Adam Loan Agreement and the Adam CAA with AIIL, which remains unresolved. It is for the plaintiff to decide how to proceed with this action in the light of my ruling on §1 of the Summons (subject of course to any appeal). In all the circumstances, it is appropriate for me to adjourn §2 of the Summons sine die with liberty to restore.”

The appeals

13.  From this decision, the 1^st Defendant (as appellant in CACV 122/2020) and the 2^nd Defendant (as appellant in CACV 112/2020) appealed.

14.  Two main grounds of appeal were advanced in both appeals:

(a)  The Judge erred in entertaining the Order 14A application when the Plaintiff disputed the relevant facts and proceeded to determine the preliminary issue on assumed facts contrary to the Plaintiff’s pleadings; and

(b)  The Judge erred in characterizing the transaction as a security arrangement and in his conclusion that the terms of the Agreement constituted an unlawful clog on the equity of redemption.

Should this Order 14A application be entertained?

15.  On the first ground, subject to what we have to say below, we agree with the Judge’s analysis at [19] to [29] of his judgment in the application of the approach of Rockwin Enterprises Ltd v Shui Yee Ltd [2003] 3 HKC 174 in the present case.

16.  We have alluded to the Judge’s reason for not granting the relief under paragraph 2 of the summons.  We agree with the Judge.  The way in which Paragraph 2 was drafted is problematic.  The court cannot order the action against the Defendants to be discontinued.  As the Judge observed, it is a matter for the Plaintiff.

17.  By reason of such defect, the Judge was unable to grant any effective relief which would conclude the action.  Though the ambit of Order 14A is wide enough to cater for the final determination of an issue in an action, the extent to which such determination could resolve the action is relevant to the utility of an Order 14A application.  Whilst Order 14A can be useful if the determination of the issue can substantially cut down the costs and time for the overall resolution of the dispute, the procedure could bring about multiplication of rounds of appeal and prolong the final resolution of the action if the issue to be determined is only one of the many issues in the action.

18.  In the present context, it is highly relevant for the exercise of the discretion to entertain an Order 14A application to consider if the determination of the clog on the equity of redemption issue could substantially further the final resolution of the whole dispute.  This, as explained above, depends on the stance of the Plaintiff. 

19.  We are of the view that this aspect of the application should have been addressed before the court embarked on a determination under Order 14A.

20.  At the hearing before this Court, Mr Li gave us the intimation mentioned in paragraph 5 above.  Counsel also undertook on behalf of the Plaintiff that the Plaintiff would reflect such position in his pleadings and would exercise his right of redemption (if this Court agrees with the Judge in this respect) by paying the principal plus interest (at the rates prescribed by the Agreement) into court.  The Plaintiff would abandon the other claims against the Defendants.

21.  In light of such stance, assuming a determination of the clog on equity of redemption issue in favour of the Plaintiff, the only outstanding issue in the action would be whether there had been an event of default under the Agreement.  If there had been an event of default, the Plaintiff would have to pay interest at the default interest rate after the event of default.  Otherwise, the Plaintiff would only need to pay interest at the normal interest rate. 

22.  It is clear to us that taking this course would substantially cut down the costs and time for the overall resolution of the dispute in the action.  With the adoption of the Agreement (and the associated Promissory Note and Collateral Agency Agreement and Pledge Agreement) by the Plaintiff, the issue of equity of redemption is not at risk of being determined on a false premise.

23.  In the circumstances, we hold that it is appropriate for this Court to consider the clog on the equity of redemption issue in the Order 14A context.  We reject the first ground of appeal accordingly.

Equity of redemption and clog on the equity

24.  As highlighted by the grounds of appeal in the Defendants’ two notices of appeal, the crux of the matter under the second ground of appeal is whether the Judge was correct in characterizing the transaction as a loan and security arrangement.  In our judgment, the correct legal characterization of the transaction will provide the answer with regard to the equity of redemption.  The proper legal characterization of a transaction is a question of law: see Tang Ying Loi v Tang Ying Yip (2017) 20 HKCFAR 53 at [18] and [19].

25.  Though there had been disputes on the factual background leading to the Agreement, they are no longer obstacles to the determination of the issue formulated in paragraph 1 of the summons of 15 March 2019 in light of the position of the Plaintiff and the undertakings given by Mr Li on his behalf to this Court.  There is no suggestion that the terms set out in the Agreement and the other relevant documents were sham.  Counsel’s arguments focused on the terms set out in the various documents which the Plaintiff adopted as his agreement with the 2^nd Defendant.  We can therefore proceed on the basis that the parties’ intention on the substance of the agreement was accurately reflected in the documents.

26.  As regards the approach that the courts should adopt in deciding on the true legal nature of a transaction, it is useful to refer to the judgment of Dillon LJ in Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148.  At p.161 f to 162 d, His Lordship discussed the law as follows:

“ In my judgment there is no one clear touchstone by which it can necessarily and inevitably be said that a document which is not a sham and which is expressed as an agreement for sale must necessarily, as a matter of law, amount to no more than the creation of a mortgage or charge on the property expressed to be sold. It is necessary therefore to look at the provisions in the master agreement as a whole to decide whether in substance it amounts to an agreement for the sale of goods or only to a mortgage or charge on goods and their proceeds. In doing that I would in a case such as the present apply the law as stated by Lord Herschell in McEntire v Crossley Bros Ltd [1895] AC 457 at 462–463, [1895–9] All ER Rep 829 at 831 where he said:

‘ ... I quite concede that the agreement must be regarded as a whole—its substance must be looked at. The parties cannot, by the insertion of any mere words, defeat the effect of the transaction as appearing from the whole of the agreement into which they have entered. If the words in one part of it point in one direction and the words in another part in another direction, you must look at the agreement as a whole and see what its substantial effect is. But there is no such thing, as seems to have been argued here, as looking at the substance, apart from looking at the language which the parties have used. It is only by a study of the whole of the language that the substance can be ascertained.’

In the same case Lord Watson said ([1895] AC 457 at 467, [1895–9] All ER Rep 829 at 833–834):

‘  As is usual in cases of this kind, we have heard a great deal in the course of the appellants' argument of the necessity of attending to the substance of the agreement which we have to construe.  My Lords, that is a canon of construction which is applicable to all agreements; but it must always be borne in mind that the substance of the agreement must ultimately be found in the language of the contract itself.  The duty of a Court is to examine every part of the agreement, every stipulation which it contains, and to consider their mutual bearing upon each other; but it is entirely beyond the function of a Court to discard the plain meaning of any term in the agreement unless there can be found within its four corners other language and other stipulations which necessarily deprive such term of its primary significance.’ ”

27.  Dillon LJ also referred to the judgment of Lord Wilberforce in Lloyds & Scottish Finance Ltd v Cyril Lord Carpets Sales (1979) 129 NLJ 366; [1992] BCLC 609 at 617 to highlight the need to pay close regard to the contractual framework under the agreement in ascertaining the true legal nature of a transaction.

28.  In essence, this was the approach adopted by the Judge when he concluded at [45] to [46] that the nature of the transaction in the present case was a loan and security arrangement.

29.  The Agreement contained the following provisions:

(a)  At the preamble, it is described as a “loan agreement” between a “lender” and a “borrower”;

(b)  In a recital, it recited that the borrower has requested the lender to make a “non-recourse loan” to the borrower “secured by the [Shares]”;

(c)  Another recital states that in order to induce the lender to “make the loan”, the borrower has agreed to execute and deliver to the lender “the pledge” “to pledge the Shares … to secure the prompt payment, performance and discharge in full of all of the borrower’s obligations”; and

(d)  A further recital states that “the lender is willing to make the loan contemplated here secured by the Collateral in accordance with the terms hereof”.  The pledged shares were the Collateral.  Under the definition for that expression, it was said that in respect of the Pledged Shares the lender “is granted a security interest pursuant to a Pledge Addendum”, a document which we shall examine.

30.  In the preamble and the recitals, all the terms and expressions used to describe the parties’ relationship, the nature of the transaction as well as the 2^nd Defendant’s interests in the Shares point towards a loan and security arrangement.  Since it is necessary to have regard to substance rather than form and all the provisions should be considered as a whole, we shall turn to the detailed contractual provisions governing the rights and obligations of the parties. 

31.  In the body of the Agreement, there are provisions for:

(a)  Interest: see definitions for “Interest Period” (6-month period), “Interest Rate” (4% per annum and default rate of 15% per annum).  The obligation to pay interest is set out in the definition for “Obligations” which in turn refers to the obligations in the Promissory Note.  Under the Promissory Note, the Plaintiff promised to pay the principal sum and all accrued and unpaid interest on the outstanding principal.  Under clause 1 of the Promissory Note, the Plaintiff as borrower shall pay interest in advance for each Interest Period.  The liability of the borrower to pay interest is also referred to in Clause 21 of the Agreement.  As evidenced by the Funding Notice, the interest for the first Interest Period in respect of the first tranche was deducted from the sum paid to the Plaintiff;

(b)  Loan duration: the “Maturity Date” of the loan is three years following the execution of the Promissory Note.  The loan cannot be prepaid in whole or in part without the prior written consent of the holder of the Note, see Clause 2(b) and Promissory Note clause 2;

(c)  Depositing the Shares with the 1^st Defendant as Collateral by way of pledge: see definitions for “Collateral”, “Collateral Agency Agreement”, “Pledge Agreement”, “Pledge Addendum”, “Pledged Shares”.  In the definition of “Pledged Shares”, it provides that the Shares “shall be subject to a security interest granted by the borrower to the lender”.  It is confirmed in Clauses 3(a), 4(8) and 5(a) of the Agreement that the interest of the lender in the Shares is a security interest only which is to be held to secure the performance by the borrower of his obligations under the Agreement. Thus, these provisions read:

“ 3(a) Pledge. As collateral security for all of the Obligations, the Borrower hereby grants, transfers, assigns and conveys to the Lender a continuing security interest in, and pledges and grants a charge on, all currently existing and hereafter acquired or arising Collateral to secure prompt repayment of any and all Obligations and to secure prompt performance by the Borrower of his/her covenants and duties under the Note and this Agreement. The Borrower agrees that the Lender shall have the rights stated in this Agreement with respect to the Collateral in addition to all other rights which the Lender may have by law.

…

4(8) Security Interest. This Agreement, together with the Collateral Agency Agreement, creates in favour of the Lender a valid first priority security interest in the Shares Included within the Collateral, and will create a valid first priority security interest in any additional Shares added to the Collateral in the future in accordance with the terms of the Loan Documents, securing the payment and performance of the Obligations. All security interests created under the Loan Documents in the Collateral shall have been and will be duly perfected and subject to no prior encumbrances.

…

5(a)      Perfection.  The Borrower agrees to execute at any time and from time to time such documents and take whatever other actions are reasonably requested by the Lender which may be necessary or desirable to create a security interest in favour of the Lender in, and/or to perfect and continue the Lender’s security interest in, the Collateral, including without limitation execution of any collateral assignments and any documents required to be filed with governmental agencies or authorities.  The Borrower represents that his/her name and the location of his/her principal business are as indicated in the first paragraph of this Agreement.  The Borrower will notify the Lender of any intended change in his/her name or principal residence address at least 30 days prior to any such change taking effect.  This Agreement is a continuing pledge and security interest and will continue in effect until all of the Obligations are satisfied and paid in full.”

(d)  The collateral nature and the security interest of the lender over the Shares are reinforced by the terms in the Collateral Agency Agreement, Pledge Agreement and Pledge Addendum.  By way of example, Clause 2 of the Pledge Agreement reads:

“ 2. Pledge and Grant of Security Interest.

2.1 Grant. As Collateral for the Obligations, the Pledgor hereby grants, transfers, assigns and conveys to the Lender a continuing security interest in and pledge of and charge on the following shares: 19,112,000 free trading common shares of Billion Industrial Holding Limited (HK.2299)(“Pledged Shares”), which Pledged Shares shall hereinafter constitute Collateral and “Pledged Shares” under the Loan Agreement.

2.2 Brokerage Account Control. Upon execution hereof the Pledgor shall cause the Pledged Shares to be transferred to and/or maintained in the Account under a Collateral Agency Agreement (as such terms are defined in the Loan Agreement) with China Times.

2.3 Inclusion. All representations, warranties and covenants with respect to the Collateral under the Loan Agreement shall apply to the Pledged Shares as Collateral under the Loan Agreement.”

Likewise, Clause 3 of the Collateral Agency Agreement reads:

“ 3. Control. So long as the Loan is outstanding, the Customer may not withdraw, transfer, pledge or otherwise deal with any securities or cash deposited into the Account by the customer without the prior written consent of this Lender. Without limiting the foregoing, the Customer, in order to secure its obligations to Lender under the documentation for the Loan, has granted, and is hereby granting, to the Lender and the Collateral Agent, a security interest in the Account (including the Shares) and exclusive control over the Account by the Collateral Agent and the Lender. The Customer represents, warrants and covenants that there is no lien, claim or encumbrance on, or any right or interest of any third party in, the Account or Shares, and the Customer shall not grant any lien, claim or encumbrance on, or right or interest in, the Account or Shares, except for the security interest granted hereunder and in the Loan Agreement and other relevant documents to the Lender and the Collateral Agent.”

(e)  Given that the lender only had a security interest, it was clearly stipulated that the Plaintiff (borrower) remained as the beneficial owner of Shares and the collateral account (Clause 3(b) of the Agreement; Clause 1 of the Collateral Agency Agreement) and was entitled to exercise the voting rights in respect of the Shares (Clause 3(f) of the Agreement).  Such positions would only be changed upon the occurrence of an event of default;

(f)  The Collateral has to be topped up when the value of the Shares falls below the Minimum Collateral Value, see definition of “Pledged Shares”, Clause 3(e) and 4(8) of the Agreement, and the failure to provide additional securities is an event of default under Clause 6(13).  See also the Pledge Addendum which imposes the same security interest over the additional securities as that imposed on the Shares under the Pledge Agreement;

(g)  Return of Collateral: Clause 3(g) of the Agreement provides for the return of the Shares to the borrower upon full payment, though it also stipulates that the obligation to return can be fulfilled by the delivery to the borrower of an equal number of the same shares;

(h)  Change in Collateral (cessation of trading of the Shares on the Stock Exchange) will lead to the automatic acceleration of the maturity of the loan and the borrower’s obligation to repay with the additional obligation to pay an additional Early Termination Fee, see Clause 9;

(i)  Events of default: see Clause 6(a) of the Agreement. Failure to pay the principal or any interest under the Note when due is an event of default under Clause 6(a)(1), and the cessation of first priority security interest is another event of default under Clause 6(a)(11); and

(j)  Remedies upon default: Clause 6(b)(1) gives the right to the lender to declare the unpaid balance to be immediately due and payable in full.  Clause 6(b)(2) provides for the lender to have the right to exercise all rights with respect to the Collateral “as if it were the sole and absolute owner thereof”.  Other remedies include the right to sell, lease, transfer or otherwise dispose of the Shares: Clause 6(b)(3); judicial suit for foreclosure: Clause 6(b)(4), which only makes sense in respect of a mortgage type of situation; transfer of the title to the Shares to the lender’s name or its designee: Clause 6(b)(5) etc.  Clause 6(b)(7) summed up the position in this manner:

“ (7) The Lender shall have all the rights and remedies of a secured creditor under the provisions of all applicable laws, including without limitation the applicable Pledge Laws, if applicable, as may be amended from time to time. In addition, the Lender shall have and may exercise any or all rights and remedies they may have available at law, in equity, or otherwise.”

32.  These substantive features in the transaction are usual features in a loan and security arrangement.  On the other hand, these provisions are inconsistent with a sale and repurchase arrangement or an arrangement under which the Plaintiff lent the Shares to the 2^nd Defendant for the duration of the Agreement.  The references to collateral interest in securing the due performance of the obligations under the Agreement, the obligation to top up security, and the Change in Collateral safeguard would not be apt if the transaction were intended to be a sale or lending of the Shares. 

33.  The obligation on the part of the Plaintiff to pay interest is a strong indication that the transaction was a loan.  Further, the events of default and the provisions for remedies are designed to protect the interest of the 2^nd Defendant as lender.  

34.  Neither Mr Maurellet SC (appearing with Mr Chiu for the 2^nd Defendant) nor Mr McLeish (appearing for the 1^st Defendant) advanced a submission that the transaction was not a loan.  Instead, they confined their arguments to disputing whether the interest of the 2^nd Defendant over the Shares is security for the loan and the applicability of the concept of the equity of redemption to this transaction.  However, counsel failed to reconcile their position with the substantive provisions in the Agreement (highlighted above) which categorically set out the security interest of the lender in respect of the Shares, and how the rights over the Shares were to be regulated in light of such security interest. 

35.  It is stipulated under Clause 3(c) of the Agreement that the responsibility to make payments is a “non-recourse obligation” of the borrower (except as otherwise provided in the Agreement) and the lender shall only look to the Shares for recourse and may not make any claim against the borrower for any deficiency.  In our judgment, when construed together with other provisions in the Agreement (which were premised on the existence of an obligation to repay the loan), there is still an obligation to repay for various purposes under the Agreement. 

36.  Thus, the Promissory Note is structured on a promise to pay the principal and interest on the part of the Plaintiff.  The obligations undertaken by the borrower under the Agreement include the obligations to repay the principal and to pay interest (see the definition of “obligations”).  The collateral interest created under the Agreement and Pledge Agreement over the Shares were to secure the due performance of all obligations including these obligations to repay and pay. 

37.  As we have seen, the non-payment of interest and principal is to be regarded as an event of default.  The rights and obligations in respect of the Collateral are differently provided in the Agreement upon event of default.  If there is no obligation to pay interest or to repay the principal, Clause 6(a)(1) and (b)(1) of the Agreement would be meaningless.  

38.  It is only upon payment of all outstanding sums that the Plaintiff would be able to have the Shares returned under Clause 3(g).

39.  Further, the non-recourse provision is limited in scope.  It does not apply to the Change in Collateral scenario by virtue of Clause 9(b)(2) and (3).

40.  As observed by Yuen JA in the course of the hearing, the non-recourse provision only restricts the manner in which the 2^nd Defendant could enforce the repayment obligation.  Notwithstanding such restriction, the obligations to repay principal and to pay interest remain the core obligations under the Agreement.  The non-recourse provision does not alter the substantial character of the transaction as a loan and security arrangement.  See Goode & Gullifer on Legal Problems of Credit and Security 6^th Edn paragraph 3-06 commenting on non-recourse loan:

“ … But the concept of non-recourse lending is well established in English law. The transaction remains a loan transaction even though the parties have agreed that the assignor is to make repayment only from an identified fund, not from his own resources. The transaction is in fact distinguishable from sale in that once the financier has recouped his advance with stipulated interest, any remaining value in the receivables belongs to the assignor.”

41.  Apart from the non-recourse provision, the Defendants relied on the following features of this transaction to contend that there is no equity of redemption:

(a)  The right of the 2^nd Defendant as lender to make “Portfolio Protection Arrangements” before the occurrence of any event of default: the last part of Clause 3(d) refers to “the absolute right” of the lender to effect such arrangements.  Clause 1(bb) of the Agreement defines “Portfolio Protection Arrangements” as “any arrangements or transactions effectuated to mitigate the risk of loss of principal, assets or securities values, including without limitation effecting a pledge, encumbrance, hypothecation and/or loan of or on securities”; and

(b)  The entitlement of the 2^nd Defendant to return an equal number of shares as the total number of Pledged Shares as opposed to the original Shares under Clause 3(g).

42.  For the reasons given below, in our judgment, these features did not negate the existence of the equity of redemption when the other provisions of the Agreement highlighted above clearly pointed to the 2^nd Defendant’s interest in the Shares as Collateral being to secure the performance by the Plaintiff of his obligations. 

43.  Regarding the Portfolio Protection Arrangements, it is noteworthy that such arrangements could only be effected for the purpose of “mitigating the risk of loss of principal, assets or securities values”.  In other words, the lender’s right to enter into such arrangements is to preserve the value of the Collateral, and the purpose of the lender having the Collateral as spelt out in the other clauses (as we have seen) was to provide security for due performance of the borrower’s obligations.  The right to effect Portfolio Protection Arrangements could not and should be construed as expanding beyond the security interest to give an option to the lender to extinguish the equity of redemption by outright disposal of the Shares.  

44.  Further, the true nature of Portfolio Protection Arrangements should be considered against the context of the whole agreement. Clause 3(d) stipulated that the lender “shall not Transfer any Pledged Shares prior to an Event of Default”.  In the definition for “Transfer” at Clause 1(ee) of the Agreement, Portfolio Protection Arrangements were not included. Whilst Clause 3(d) explicitly reserved the lender’s right to effect Portfolio Protection Arrangements, it is plain that such Portfolio Protection Arrangements cannot include outright sale of the Shares to other parties because this would be inconsistent with the voting right retained by the Plaintiff prior to the occurrence of any event of default under Clause 3(f). Thus, the examples set out in the definition for Portfolio Protection Arrangements in Clause 1(bb): pledge, encumbrance, hypothecation and/or loan of or on securities are all in the nature of the creation of further security interest over the Shares short of outright sale or disposal of the same. 

45.  Construing the Agreement as a coherent whole, in light of the other clauses in it highlighted above, though these instances were given as non-exhaustive examples in Clause 1(bb) (“including without limitation”), we are able to reach the clear conclusion that the arrangements or transactions mitigating the risk of loss or principal, assets or securities values by way of Portfolio Protection Arrangements could not include any arrangement destroying the equity of redemption over the Shares.   

46.  Clause 3(g) only provides for the manner in which the Shares are to be returned.  It does not per se give the lender the power to sell the Shares prior to any event of default.  In this connection, we agree with the Judge’s observations at [46(8) and (9)] of the judgment:

“ (8) In answer to Mr Maurellet’s submission that AIIL did not have to return exactly the same shares, Mr Li also refers to the nature of the CCASS holding system, and the following passage in the judgment of Yuen J (as she then was) in Re CA Pacific Finance Ltd [1999] 2 HKLRD 1 at 18D-F:

‘In our case, however, the subject matter is shares. It is well established that shares are simply bundles of intangible rights against the company which had issued them. Share certificates are not valuable property in themselves – they are just evidence of the true property, which are the proportionate interests of the shareholders in the ownership of the company.

One pari passu share is exactly the same as another. This was recognised in Solloway v McLaughlin [1938] AC 247 where the Privy Council held that the broker need only have retained an equivalent quantity of stock in its possession, and in the more recent cases of Hunter v Moss [1993] 1 WLR 934 (Ch), [1994] 1 WLR 452 (CA) and Re Harvard Securities Ltd (in liquidation) [1997] 2 BCLC 369. Therefore, each share certificate with HKSCC’s depositary evidences the same bundle of rights, and each bundle of rights can satisfy the client’s proprietary interest as any other.’

(9) With respect, I agree. What was required under Clause 3(g) of AIIL was strictly a “return” (meaning, as I explained above, the restoration to the plaintiff free from encumbrance) of a bundle of rights represented by 19,112,000 shares in Billion Industrial to the plaintiff upon repayment, whether it was evidenced by the same certificate or otherwise. Each bundle of rights, as held under the CCASS in the account of the broker in question, is exactly the same as the other, and thus, notwithstanding the wording of Clause 3(g), it did require AIIL, via CCASS, to return the same subject matter to the plaintiff upon repayment.”[1]

47.  Hence, on the proper reading of the Agreement as a whole, there is no provision conferring upon the 2^nd Defendant the right to negate the equity of redemption over the Shares by way of free disposal of them prior to the occurrence of any event of default.

48.  If there is no equity of redemption, the 2^nd Defendant could rely on Clause 6(b)(3) and 6(d), after an event of default, to retain all the sale proceeds of the Shares.  These clauses read:

“ (3) The Lender shall have the right (but not the obligation) to assign, sell, lease, transfer or otherwise dispose of and deliver any and all of the Collateral, at a public or private sale or otherwise (including without limitation selling any and all Shares on any public exchange or market), for cash or on credit or for future delivery, at such time or times and at such place or places, as the Lender may deem commercially reasonable, all without right of redemption of the Borrower, which is hereby expressly waived. Upon each such sale, lease, assignment or other transfer of the Collateral, the Lender may purchase all or any part of the Collateral being sold, free from and discharged of all trusts, claims, right of redemption and equities of the Borrower, which are hereby waived and released.

…

(d) Sale of Collateral. The Borrower agrees that any sale of the Pledged Shares on any public exchange or market by the Lender following any Event of Default hereunder shall constitute a commercially reasonable sale, and the Borrower shall not take any position or make any claim to the contrary.  To the extent the Lender has sold any Pledged Shares after an Event of Default, the Lender shall have the right to retain any and all proceeds of such sale, offset such amount of proceeds from any amounts remaining due from the Borrower, and retain any proceeds received in excess of such amounts due without any obligation to remit any proceeds whatsoever to the Borrower.”

49.  However, if the true nature of the transaction is a loan and security arrangement (as we conclude that it is), the court will safeguard the equity of redemption, and contractual provisions defeating or clogging the exercise of the equitable right to redeem (which by its nature is to be exercised after an event of default) would not be effective according to well-established principles discussed by the Judge at [37] to [39] of the judgment. 

50.  As the principle is not disputed by Mr Maurellet and Mr McLeish, we only need to explain it briefly.  Equity looked to the substance of a transaction and regarded the rights and obligations of the parties as being governed by the maxim “once a mortgage always a mortgage”.  The concepts of equity of redemption and clog on the equity of redemption were developed to ameliorate the strict adherence to the terms of the contract which precluded a mortgagor from exercising his equitable right as mortgagor.  The underlying philosophy is that a mortgagee’s security interest in the mortgaged property should be confined to the repayment of the loan and interest.  If a mortgagor is ready, willing and able to repay in full to redeem his property, he should be allowed to do so. 

51.  On the other hand, a mortgagee does not have to be subject to the equity of redemption forever.  He can either apply for an order of foreclosure or an order for sale (as envisaged by Clause 6(b)(4) of the Agreement).  The difference between foreclosure and sale is that in the case of a sale, the mortgagee has to account for the sale proceeds and the mortgagee is entitled to any excess over and above the repayment of outstanding principal and interest and the legal costs and conveyancing expenses.  The same applies to a sale pursuant to an exercise of a mortgagee’s power of sale under the loan and security agreement.

52.  In Cousins, The Law of Mortgage, 4^th Edn, paragraph 29-07, the principle was succinctly stated as follows:

“ … This means that once a contract is seen to be a mortgage no provision in the contract will be valid if it is inconsistent with the right of the mortgagor to recover his security on discharging his obligations. Provisions offending against the maxim may either touch the terms of redemption thereby rendering the right to redeem illusory or they may touch only the equitable right to redeem after the passing of the contract date hampering the exercise of the right. Provisions of the latter kind are termed ‘clogs’ on the equity of redemption.”

53.  Whilst it is not objectionable to have a provision in the mortgage contract for a power of sale in the event of default, the exercise of such power cannot destroy the equitable interest of a mortgagor in the surplus in the proceeds of sale over the outstanding principal and interests: Cousins, The Law of Mortgage, 4^th Edn, paragraphs 25-64 and 25-65.  The mortgagee has a duty to account to the mortgagor for such surplus and holds the same as trustee for the mortgagor. 

54.  Hence, insofar as Clauses 6(b)(3) and 6(d) purport to extinguish the right of the Plaintiff in the surplus, they in effect purport to extinguish his equitable interest in the Shares.  As such, the provisions for waiver of equity of redemption in Clause 6(b)(3) and the exoneration from the obligation to account for the excess in the proceeds of sale after discharge of the principal and interests were invalidated by the equity of redemption. 

55.  Counsel for the Defendants submitted that the intervention of the equity of redemption in the present transaction would reconstruct the contractual bargain such that the 2^nd Defendant has nothing to gain but everything to lose.  The Plaintiff can always rely on the equity of redemption to opt for redemption of the Shares at the most opportune moment in light of the fluctuations in the market, or decide not to redeem if the Share prices go down.

56.  With respect, the submissions on upsetting the contractual bargain could not be valid once it is accepted (as we do) that loan and security arrangement is the proper legal characterization of the transaction: i.e. the advances or intended advances under the Agreement by the lender were loans, and the arrangement concerning the Shares is Collateral to secure the 2^nd Defendant’s interests in the loans.  As the Plaintiff could only redeem with full repayment of the principal and interest (including interest at default rates if there had been default), there is no basis for suggesting that the 2^nd Defendant would lose out in the event of redemption.  And in the event of share prices going down, the 2^nd Defendant is entitled to demand a top up under Clause 3(e): see paragraph 31(f) above.

57.  In effect, counsel’s submissions were that in making the loan under the Agreement, the interest payable under the same and repayment of the principal were not the only benefits that the lender was entitled to derive from the transaction.  It is implicit in their submissions that the ability to sell the Shares upon an event of default without accounting back to the Plaintiff for the proceeds of sale should be the additional benefit that the 2^nd Defendant was entitled to obtain under the Agreement.  In substance, the necessary implication of such submissions is that upon an event of default the Shares shall become the properties of the 2^nd Defendant.   

58.  Such a position is contrary to the law against the clog on the equity of redemption.  As stated at paragraph 29-11 of Cousins, The Law of Mortgage, 4^th Edn:

“ Similarly, a mortgagee cannot by a stipulation in the mortgage contract obtain for himself an option on the property mortgaged. A contract cannot at once be a mortgage and a conditional sale even if the transaction is not oppressive.”

59.  Further, we do not accept that the position of the 2^nd Defendant is as precarious as counsel depicted in view of the following features in the Agreement:

(a)  The lender has a broad discretion in making advances in tranches, see Clause 2(a).  As a matter of fact, in the present case the 2^nd Defendant did not make further advances after the first tranche but exercised control over all the Shares and purported to exercise its right under Clause 6(b)(3) and (d) over all the Shares (instead of confining to the 4,778,000 shares held as collateral for the first tranche as stipulated in the Funding Notice);

(b)  The Agreement provided that the loan could not be repaid prior to its maturity, see Clause 2(b) of the Agreement and Clause 2 of the Promissory Note.  Thus, the 2^nd Defendant had a contractual right to retain control over the Shares as security for 3 years;

(c)  When the Collateral Value (defined as the lowest of several references values in Clause 1(e) and therefore already with some built-in margin for the protection of the lender) falls below the Minimum Collateral Value (defined in Clause 1(t) as 154% of the principal amount of the loan then outstanding), the Plaintiff was obliged to provide top-up security under Clause 3(e) to cause the Collateral Value to exceed 100% of the Target Collateral Value which is defined as 200% of the amount of outstanding loan;

(d)  As mentioned above, the non-recourse provision does not apply in cases where the Shares ceased trading in the Stock Exchange;

(e)  The 2^nd Defendant had exclusive control over the operation of the custodian account under Clause 3 of the Collateral Agency Agreement; and

(f)  The 2^nd Defendant can exercise the contractual power of sale upon default or seek an order for foreclosure to pre-empt the Plaintiff from seeking to redeem at most opportune moment taking advantage of fluctuations in the market.     

60.  Mr Maurellet and Mr McLeish relied on some authorities and discussions in the context of transactions of other characters to contend that the equity of redemption could not exist: Beconwood Securities Pty v ANZ Banking Group (2008) 246 ALR 361; Pearson v Lehman Brothers Finance SA [2010] EWHC 2914 (Ch); Goode & Gullifer on Legal Problems of Credit and Security paragraph 3-07; Beale, Bridge, Gullifer & Lomnicka, The Law of Security and Title-based Financing paragraph 4.30.  These transactions are however substantially and materially different in nature: sale and repurchase; sale and lease-back; stock lending.  Since those transactions are not of loan and security by nature, it is not surprising that the equitable doctrine pertaining to security arrangement is inapplicable.      

61.  With respect, we do not find it necessary to discuss the equity of redemption in the context of these other kinds of transactions.  The Judge had referred to some differences between the present transaction and the stock lending arrangement in Beconwood Securities Pty v ANZ Banking Group, supra.  As noted above, the discussion in Goode & Gullifer on non-recourse loan is distinct from their discussion on these transactions of other characters.

62.  In our judgment, the crucial issue in this appeal is the correct legal characterisation of this particular transaction.  For reasons already canvassed, it is clear to us that the transaction is a loan and security arrangement.  Once we reach such conclusion, the legal consequences discussed above follow.

63.  In Silver Universe Investments Ltd v China Times Securities Ltd [2021] HKCA 105, this Court (Lam V-P and Yuen JA) refused to grant leave to appeal to a plaintiff who sought interim payments against the defendants under what appeared to be a similar transaction as the Agreement.  That decision was made in light of the grounds of the application advanced below and before this Court as set out in that judgment.  As can be gleaned from that judgment, the focus in that case was rather different: the plaintiff in that case did not aver that it was ready, willing and able to redeem.  Instead, counsel for that plaintiff ran before this Court a claim for damages on the basis of acceptance of repudiation premised on the alleged wrongful disposal of the shares.  This Court held that there were arguable issues in those regards. 

64.  In the present appeals, we have the benefit of more in-depth submissions on the transaction in question and on the equity of redemption.  We do not find anything in that decision to cast doubt on our analysis in this judgment. 

Disposition

65.  We have come to the conclusion that the Judge arrived at the correct conclusion and therefore the appeals fall to be dismissed.  We shall also make an order nisi that the 1^st Defendant shall pay the Plaintiff’s costs in CACV 122/2020 and the 2^nd Defendant shall pay the Plaintiff’s costs in CACV 112/2020.  There will be certificate for 2 counsel.  Such costs are to be taxed on party and party basis if not agreed. 

66.  For the sake of the record, we would direct the Plaintiff to lodge with the Court within 7 days a written undertaking setting out those undertakings given on his behalf by his counsel orally at the hearing.  The Court shall withhold the sealing of the order in these appeals pending compliance with such direction.

67.  Last but not least, we thank counsel for their assistance in these appeals.