PACIFIC FOUNDATION FINANCE LTD. v. FAIRYOUNG HOLDINGS LTD.

CACV 129/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 129 OF 1999

(ON APPEAL FROM HCA 4029 OF 1998)

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J U D G M E N T

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Mortimer V-P:

1. This is a defendant's appeal against Pang J's dismissal of its appeal against Master Bharwaney's Order 14 judgment against it for $15m plus interest.

The background

2. The defendant is a public company. Its main business is investment. John Chan was at the material times its Manager Director. Angklong Limited is the defendant's controlling shareholder. John Chan is the Director and sole beneficial shareholder of Angklong and through it he exercised control over the defendant. The plaintiff is a finance company. Angklong had a margin account with the plaintiff. On 26 January 1998 a loan agreement was made between the defendant and the plaintiff whereby the plaintiff made available to the defendant up to $25m. John Chan signed that agreement on behalf of the defendant. When the loan was signed, and in accordance of the agreement, the minutes of the defendant's board meeting attended by John Chan and his brother authorising the loan agreement were provided to the plaintiff along with the defendant's Memorandum of Association or By-laws. At the meeting, it was resolved:

"(a) It is for the commercial benefit of the Company to enter into the Loan Agreement;

(b) The Company do borrow the Facility and THAT the terms and conditions of the Loan Agreement be and are hereby approved;

(c) Any one Director of the Company be and are hereby authorised to execute on behalf of the Company to the Loan Agreement.

(d) Any one Director of the Company be and are hereby authorised to execute any further document (including, without limitation, any Notice of Drawing) and/or do such further acts for and on behalf of the Company as required by or in connection with the availability of the Facility."

It was signed by the chairman of the meeting, John Chan.

3. On the same day, by a notice of drawing, the form which was annexed to the agreement was used to draw down the loan. John Chan, acting for the defendant, gave notice that the defendant would draw down the full amount of the loan, $25m, under the agreement the next day and gave instructions that the loan was to be credited to Angklong's account with the plaintiff. Accordingly, the next day the plaintiff credited $25m to the account of Angklong with it. Later, on 12 February the defendant's account with the plaintiff was debited with that $25m. It followed that the $25m never passed through any of the defendant's accounts, but as can be seen, the last accounts of the defendant available at the time of the drawing down of this loan, showed that the defendant was indebted to Angklong in a sum of over $108m.

4. The history continues. On 4 March 1998 the defendant's shares were suspended. On the next day the plaintiff terminated the loan facility with the defendant and called in the $25m together with interest. On 14 March 1998 the plaintiff issued proceedings to recover that $25m together with interest from the defendant. On 3 August, by which time the plaintiff had commenced the Order 14 proceedings. Angklong paid the plaintiff $10m in reduction of the defendant's loan and there was a letter from the defendant's solicitor dated 15 September to the plaintiff's solicitors asking for the confirmation that in the Order 14 proceedings the plaintiff would only seek judgment for the balance, that was $15m plus interest. In these circumstances the plaintiff obtained judgment for the $15m from the defendant.

The defence

5. The defence raised by the defendant, upon which it contends it ought to have leave to defend, can be summarised briefly. It is as follows:

(1) That John Chan had no authority from the defendant company either to enter into the agreement for the defendant or to draw down the money in the way that he did.

(2) That the plaintiff had actual or constructive notice that John Chan had no authority.

The plaintiff's case

6. The plaintiff on the other hand argues that whether or not John Chan had authority to act as he did, the plaintiff company had no actual knowledge of this because it is entitled to rely upon the regularity of his acts on behalf of the company and there is nothing in the circumstances of the loan or the draw-down to put the plaintiff on enquiry. As is clear from that submission, the plaintiff relies upon the rule in Royal British Bank v Turquand [1856] 6 E&B 327. Finally, the plaintiff said that in any event by two letters, one after the $10m had been paid in reduction of the defendant's debts, and the other dated 10 March which was written by Mr Tsao who gives evidence on affidavit for the defendant in these proceedings, the defendant admitted its indebtedness in respect with the loan agreement and the draw-down.

The evidence

7. I turn now to the evidence and seek to summarise it. In Mr Tsao's first affidavit on behalf of the defendant, the defendant seeks to take these points:

(i) That no advance was made to the defendant. The defendant never received the money.

(ii) That the advance was made to Angklong Ltd.

(iii) That the plaintiff was aware of all this as he said in paragraph 16 on that first affidavit:

"All the loan documentation requested by the Plaintiff to be executed, namely, the Loan Agreement and the Notice of Drawing were signed by Mr Chan. All the above must have alerted the Plaintiff to the fact that Mr Chan did not, or at least may not, have the requisite authority on behalf of the Defendant to enter into the Loan Agreement."

(iv) That the board meeting, the minutes of which were provided to the plaintiff, was held without notice to the other Directors. The affidavit also raised the question whether the board minutes were supplied to the plaintiff, but that issue has been resolved.

8. By a later affidavit, Mr Tsao concedes that he was not a Director of the company at the time when the loan agreement was made. That is in an affidavit which relates to proceedings for a stay of execution. So there is no affidavit from any director of the defendant at the time of the loan agreement and the draw-down. The other affidavits of Mr Tsao on the stay of execution take the matter no further.

The rule in Turquand

9. The chief issue engaged in these proceedings, is whether the defendant has demonstrated any arguable defence on which he ought to have leave to defend having regard to the rule in Turquand's case. Its rule and its effect is conveniently set out by Slade LJ in Rolled Steel Ltd v British Steel Corpn (1986)1 Ch 246 at 283D-F where he says:

"The possible relevance of the rule in Royal British Bank v Turquand, 6E&B 327 in the present context is obvious. The following statement of the rule, taken from Halsbury's Laws of England, 2nd ed., vol. V (1932), p. 423, was approved by the House of Lords in Morris v Kanssen [1946] AC 459 (see per Lord Simonds at p. 474):

'persons contracting with a company and dealing in good faith may assume that acts within its constitution and powers have been properly and duly performed and are not bound to inquire whether acts of internal management have been regular.'"

Lord Simonds later pointed out the rationale of the rule, at p. 475:

'The wheels of business will not go smoothly round unless it may be assumed that that is in order which appears to be in order.' "

10. The Rolled Steel Ltd's case is authority for the proposition that if a party seeks to rely upon the rule in Turquand's case, it normally must be pleaded. The rule is one of mixed law and fact. So typically the rule is pleaded by way of defence when a company pleads that the acts of a director were done outside his authority or without authority. It is, therefore, only after the absence of authority has been established by the company that the other party needs to rely upon the rule. Of course, the rule is of no assistance to a party if that party has actual or constructive notice of the irregularity. The whole of the circumstances may put that party on inquiry, and if put on inquiry this may, depending upon the circumstances, amount to constructive notice. See the Rolled Steel's case.

11. The effects of the rule in Turquand's case, in Order 14 proceedings, therefore, may cause some difficulty. Normally it will be necessary for a defendant to establish an arguable case that both the acts of a director were unauthorised and that the other party had actually notice of the irregularity.

The issues considered

12. I turn now to the issues. The first issue on the affidavit, but not as I understand it, pursued by Mr Ronny Wong SC for the defendant, is whether there was any loan to the defendant and any draw-down at all. But the circumstances clearly were such that if John Chan had the necessary authority to act, he entered validly into a loan agreement, drew it down and arranged for payment into Angklong account in reduction of the defendant's debt to Angklong. There is no defence on this ground. The loan and its draw-down were valid unless of course it is demonstrated to be arguable that John Chan had no authority.

The central issue considered

13. I turn then to the real issue on the appeal which is whether the defendant company has established an arguable defence that John Chan had no authority to do that which he did. In the affidavits, this, if raised at all, is raised in a most half-hearted way without any relevant particulars. The defendant is required to "condescend upon particulars" of such a defence or, indeed, any defence. However, Mr Ronny Wong seeks to remedy this by submissions upon what must have been known to the plaintiff from (a) its knowledge of John Chan and (b) its knowledge of the defendant and particularly Angklong.

14. The point he makes after examining the by-laws extensively can be summarised in this way. John Chan, the manager director of the company, had a personal interest in the repayment of part of the $108m debt owed by the defendant to his company, Angklong. It was his duty under the by-laws to disclose this interest. The minutes of the board meeting of 22 January 1998 authorising the loan do not disclose any declaration of interest. If no declaration of interest was made, the meeting was not quorate. A minimum quorum of two was required. Therefore, submits Mr Wong, the plaintiff had actual notice or at least constructive notice of an irregularity.

15. The difficulty facing the defendant, as I see it, is that every member of the board must have known John Chan's interest in Angklong, its controlling shareholder. There could be no reason for John Chan not to disclose this. It was a matter which, in the circumstances, would have been a pure formality. In these circumstances I would hold that the defendant has not raised any arguable defence on the affidavits upon the absence of the declaration of interest. It is also to be noted that there is no evidence from a director at the relevant time upon this matter.

16. That I believe is sufficient to resolve this appeal. But I would go further and say that on the documents provided to the plaintiff, there was nothing to put the plaintiff on inquiry upon the regularity of the transactions which took place. There was no reason, therefore, in the circumstances for the plaintiff to think that there had been no declaration of interest. There was no reason for the plaintiff to be put on inquiry by the nature of the transaction itself when the accounts of the defendant, if examined, demonstrated its indebtedness to Angklong.

The two letters

17. This leaves for consideration the two letters to which I have referred. The letter of 10 March 1998 was written by Mr Tsao for the defendant after a demand had been received from the plaintiff for the payment of the $25m and interest. Although for my part I would hesitate to hold that this letter amounted to admission of the loan. Indeed the judge hesitated to make such a finding on that matter. However, on this he said:

"There was not the remotest suggestion that the Loan Agreement was a sham nor that its validity was being challenged."

The letter is significantly inconsistent with the defendant's case on these Order 14 proceedings and on this appeal.

18. Similarly I would hesitate to hold that the letter of 15 September written by the defendant's then solicitors to the plaintiff's solicitors referring to the payment of $10m from Angklong Limited to the plaintiff in partial settlement of the plaintiff's claim was an admission. On that I find myself differing from the judge but that is the only matter upon which I differ with him.

Conclusion

19. For the reasons that I have endeavoured to set out, I would dismiss this appeal.

Rogers JA:

I agree. I only wish to add a few words of my own.

20. The Defendant Fairyoung Holdings Ltd is a Bermudan company quoted on the Hong Kong Stock Exchange. It is an investment holding company. The Annual Report for 1996 disclosed an amount due to a shareholder, namely Angklong Ltd of HK$108,630,000. The Report also showed that Mr. John Chan, a director of the Defendant company was the sole beneficial shareholder of Angklong Ltd. The loan from Mr. John Chan's company, Angklong, was said in the accounts to be unsecured and interest free with no fixed term for repayment, although it was not anticipated that repayment would be made within the coming year. That would hardly be a source of surprise. The turnover shown in the consolidated accounts for the Defendant's group was put as being HK$73,571,000 and the net profit attributable to shareholders was HK$10,482,000. Although the fixed assets were said to be HK$780,196,000 almost HK$600,000,000 of that was attributed to the value of construction in progress. There would thus have been little money to make any repayment.

21. It seems from the account between the Plaintiff and Angklong Ltd that, immediately prior to the loans in January 1998, Angklong Ltd was indebted to the Plaintiff to the amount of HK$54 million on its margin account. The only shares in the margin account were 19 million shares in the Defendant company. The value of those shares was about HK$381/4 million but it would seem that even after the credit of HK$25 million to Angklong's account with the Plaintiff, the Plaintiff still required a further deposit of HK$24,298,367.87.

22. The extent of the Plaintiff's dealing with the Defendant and its subsidiary companies does not end there. The papers show that substantial loans had been made by one of the Defendant's subsidiary companies to the Plaintiff. But these matters are not of relevance today. Indeed, whether there was any matter relating to the finances of the Defendant which requires investigation has not been explored before this Court.

23. From the above, it is clear that because information as to Angklong's loan to the Defendant was contained in the accounts everybody, particularly the directors of the Defendant, must be taken to have been aware of this.

24. On the face of the matter, the Defendant company owed Angklong a considerable amount of money. There is no reason to suppose that Angklong would be prepared to allow that amount of money to be outstanding indefinitely, particularly as it was interest free.

25. The fact that the Defendant company obtained one or more loans in January 1998 is not a matter which can be said to have been against its interest. One may assume that if Angklong's loan to the Defendant were to be partially retired, it was in Angklong's interest and therefore in Mr. John Chan's interest. But as far as the Defendant is concerned, there would be no misfeasance in the Defendant obtaining a new loan to pay off an old loan. If Mr. John Chan were to be a member of the board when the board resolution approving the new loan were made, he would have to declare his interest in the transaction, but that is all.

26. Given the state of the Defendant's finances in January 1998, the obtaining of new loans in addition to those already owed to Angklong Ltd might have been considered questionable, but there would have been nothing surprising in the obtaining of one loan to pay off another.

27. The rule in the Royal British Bank v. British Turquand as expounded by Lord Simmonds has already been stated by the Vice-President.

28. Of course, if someone has actual knowledge of an irregularity or is put on enquiry as to whether there has been an irregularity, he cannot rely on the rule. This is trite law, but if authority is needed, it can be found in the judgment of Slade, L.J. with whom all other members of the Court agreed in Rolled Steel Ltd v British Steel Corporation [1986] 1 Ch. 246; see pages 284-5. As was said in that passage, a plea relying upon the rule in British Turquand is a plea of mixed fact and law.

29. The intent to use the loan to pay off part of the debt to Angklong Ltd is not disclosed in the relevant Board minute. Given the state of the Defendant's finances it would have been, as I have said, questionable if the new loan had been used for any other purpose.

30. The interest of Mr. John Chan was also not shown in the Board minute as having been declared. It was nowhere stated in the evidence that Mr. John Chan did not disclose his interest. Moreover, given the 1996 Annual Report of the Defendant, it is, as I have already said, clear that the other directors of the Defendant would have known of Mr. Chan's interest. Indeed, given the size of those loans in relation to the Defendant company, it must have been a central feature in the company's finances. There was thus no reason for Mr. Chan not to have disclosed his interest. As far as that is concerned, the Plaintiff was, in my view, on the contrary, entitled to assume that the interest had been declared.

31. Of course, it is no answer to say that a director's interest should have been known if he did not disclose it at a relevant meeting. But in this case, it has not been averred that Mr. Chan did not disclose his interest. If it were necessary to go further, there was nothing on the face of what has been shown so far to have put the Plaintiff on notice or enquiry as to whether Mr. Chan's publicly declared interest had been disclosed at the meeting.

32. One minor point is that it was said that Mr. Cary Cheung Nga tak, a director did not receive notice of the relevant meeting. That however, does not establish that he was not given due notice. Since it is the Defendant company itself which is making this suggestion, it is incumbent on them to show by its internal records as to what notices were or were not given.

33. Finally, I would merely mention that because considerable reliance had been made upon the Rolled Steel Ltd v. British Steel Corporation case, the facts in that case were very different. There, the relevant guarantee which gave the director the interest was not even known to that director's father. That was a finding of fact by the Judge. It was also a finding of fact by the Judge that there had been no declaration of interest. Moreover, the transaction in question concerned the disposal of that particular company's assets for the benefit of some other company and not for the benefit of the company disposing of its assets. As one of the letters which had been referred to by the Judge in his judgment clearly showed, all involved in the transaction there well knew that it would have been ultra vires the company and have constituted a misfeasance by the directors. The relevant point to be derived from the case is the matter of principle, to which I have referred, namely the passage at pages 284-5 of the report.

34. In those circumstances, I also would dismiss this appeal.