XCHRX JAPAN LEASING (HONG KONG) LTD. v. SHUN KAI FINANCE CO. LTD.

HCMP 3604/1999
HCMP 4999/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 3604 of 1999
MISCELLANEOUS PROCEEDINGS NO. 4999 of 1999

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J U D G M E N T

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1. These 2 actions give rise to the same issues of facts and law. The parties are the same and the parties agree that the result of the two actions must be the same. Accordingly, for simplicity reason I would merely refer to the evidence filed in HCP 3604 of 1999.

2. The Plaintiff and the Defendant are both money lenders. The Plaintiff is now in creditors' voluntary liquidation. The special resolution for the winding up of the Plaintiff was passed on 29 September 1998. It is common ground that the Plaintiff is insolvent.

3. By an agreement dated 19 May 1993 (hereinafter called the "Master Loan Agreement"), the Plaintiff agreed to make available to the Defendant certain loan facilities to such extent and on such terms and conditions as shall from time to time be mutually agreed between the parties, and such agreed terms are to be found in the facility letter issued by the Plaintiff to the Defendant in respect of each of the loans. Under the arrangement as envisaged by the Master Loan Agreement, in respect of each of the loan (the "1st loan") granted by the Plaintiff to the Defendant, the Defendant would in turn lend the amount of the loan to its own customer (the "sub-borrower"). The amount so lent by the Defendant (the "2nd loan") may be larger in amount than the 1st loan. As a security for the 2nd loan, the Defendant would obtain a mortgage of landed property from the sub-borrower. As security for the 1st loan, the Defendant would give a sub-mortgage of the landed property to the Plaintiff.

4. It is plain that the parties intended that the terms of the Master Loan Agreement should govern their relationship. Clause 10 of the Master Loan Agreement provided that :

"This Loan Agreement shall be deemed to form part of and shall supplement the terms and conditions of the Sub-Mortgage. In the event of any conflict or inconsistency between the terms and conditions of the Sub-Mortgage and the terms and conditions hereof, the latter provisions shall prevail and override the former."

5. Under clause 5(a) of the Master Loan Agreement the Plaintiff agreed that subject to there being no default of repayment or in complying with the terms of the 1st loan by the Defendant, the Plaintiff authorised the Defendant as the Plaintiff's exclusive agent in demanding, suing for recovering, collecting and receiving from the borrower the monthly installments repayment in respect of the 2nd loan together with interest and all other money agreed to be paid by the sub-borrower. This clause further provided that the authorization may be revoked in respect of a particular loan transaction upon 7 working days' prior written notice if the Defendant shall make any default in repayment of the 1st loan and interest thereon or in complying with the terms of the relevant Sub-Mortgage and facility letter relating to the particular loan transaction. By clause 5(b) of the Master Loan Agreement, the Plaintiff agreed that so long as the Defendant would not make any default in punctual repayment of the 1st loan or in complying with the terms of the 1st loan, the Plaintiff shall not enforce the security under the Sub-Mortgage nor give any notice of assignment of the 2nd loan to the borrower.

6. In pursuance of the Master Loan Agreement the Defendant applied to the Plaintiff for a 10-years property sub-mortgage loan of $4.75 million. The Plaintiff agreed to grant such loan on terms set out in a facility letter dated 3 February 1997 and the Defendant also agreed to the terms of the letter. According to this letter, the loan together with interest thereon was repayable by monthly installments over a period of 10 years. The interest rate on the loan was 3.25% per annum over the one-month Hong Kong Inter Bank Offer Rate. The security for the loan was to be a sub-mortgage of the property of Units 01-3, 27th floor, Shun Fung International Building, 182 Queen's Road East, Hong Kong (hereinafter called the "property"). The loan was drawn on 14 April 1997 and accordingly, the 1st installment was due on 14 May 1997. According to the terms of the facility letter, the draw down of the loan was to be effected through Messrs Sin, Wong & Mui, solicitors.

7. By a facility letter dated 14 February 1997, the Defendant in turn agreed to lend the sum of $5.1 million to its customer Toprofit International Limited at the interest rate of 5.5% over the prime rate of the Hong Kong & Shanghai Bank. The loan and interest thereon were to be repayable by monthly installments over a period of 15 years. The security was a first legal mortgage on the property.

8. Toprofit drew on the loan on 14 April 1997 and on that day executed a mortgage of the property in favour of the Defendant. The Defendant in turn executed a sub-mortgage of the property in the Plaintiff's favour also on 14 April 1997.

9. By clause 4(A) of the Sub-Mortgage, the Plaintiff was entitled to declare an event of default by 7 days' notice in writing to the Defendant on the happening of the following events :

(a) The Defendant making default in payment of any money payable under the terms of the facility letter.

(b) The Defendant making default in payment of any money due or claimed by the Plaintiff to be due under any of the clauses, covenants or conditions contained in the sub-mortgage or the facility letter.

(c) There shall be any breach of any of the covenants contained in the sub-mortgage or any of the terms or condition of the facility letter.

In the event of such event of default the entire amount outstanding together with interest thereon and all amounts payable under the facility letter would become immediately due and payable without any further demand or notice of any kind.

10. By clause 5(F) of the Sub-Mortgage, the Defendant covenanted with the Plaintiff that so long as any money remains owing to the Plaintiff the Defendant would not be entitled to exercise any power under the mortgage of the property or suffer or permit the leasing or accepting surrenders of leases in respect of the mortgaged property except with the prior written consent of the Plaintiff.

11. It is common ground that the Defendant had not made any repayment on 14 November 1997 and had made no further repayment since.

12. On 19 December 1997 the Defendant instructed Messrs Sin, Wong & Mui to commence proceedings against Toprofit for the payment of amounts due under the mortgage of the property and also for possession of the property. On 25 March 1998 the Defendant obtained judgment against Toprofit in the sum of $5,649,299.68 and also an order for the delivery of vacant possession of the property. It would appear that since obtaining vacant possession from Toprofit, the Defendant had also let the property and thereby became entitled to collect rent from its tenant.

13. By a letter dated 1 September 1998 the Plaintiff through its solicitors demanded the Defendant to pay the full amount outstanding under the facility letter and the sub-mortgage within 7 days and threatened that legal action would be taken if the amount was not paid within 7 days. At the same time the Plaintiff also asked the Defendant about the progress of the Defendant's proceedings against the sub-borrower. In particular the Plaintiff asked if possession of the property had been obtained. It is to be noted that there was no suggestion in the letter that the Defendant's commencement of the proceedings against the sub-borrower was in breach of the Defendant's obligation under the terms of the sub-mortgage although it is fair to point out that in the letter there was a general reservation of the Plaintiff's rights in the matter.

14. The Defendant had given no substantive response to the Plaintiff's solicitors' letter. By another letter dated 27 January 1999 the Plaintiff's solicitors referred to the fact that the Defendant had already obtained possession of the property from the sub-borrower and asked for possession of the property under the sub-mortgage.

15. There are many pieces of litigation between the Plaintiff and the Defendant. In particular in or about September 1998 the Defendant commenced High Court Action No. 13826 of 1998 against the Plaintiff. By that action, the Defendant claimed that the Plaintiff was in breach of the Master Loan Agreement in that the Plaintiff had given various notices on 22 June 1998 to the sub-borrowers of the Defendant to make repayments of the amounts they owed the Defendant to the Plaintiff instead of to the Defendant. The Defendants claimed that as a result of these wrongful acts many of the sub-borrowers had not paid the Defendant. The Defendant further claimed that the Defendant suffered loss and damage including loss of profit. This action is still pending.

16. On 21 June 1999, the liquidators of the Plaintiff commenced this action against the Defendant for possession and also for an order that the sub-mortgage may be enforced by sale. There was no claim for any monetary judgment on the amount due under the sub-mortgage.

17. The Plaintiff's case is that the Plaintiff is entitled to an order for possession and an order for sale because the Defendant had made default in 2 aspects. First there was the failure to repay the sub-mortgage installments since 14 November 1997. Secondly, the Defendant had acted in breach of clause 5(F) in trying to enforce its rights under the mortgage against Toprofit without the prior written consent of the Plaintiff. Apparently at the time when the Plaintiff commenced this action, the Plaintiff was not aware of the letting of the property by the Defendant.

18. The originating summons was heard by Master Jones who granted the Plaintiff an order for possession of the property and also an order for sale of the property. The order further provided that in the event of the Defendant's paying to the Plaintiff all moneys secured by the sub-mortgage, then the Plaintiff was to redeliver possession back to the Defendant. There was however no order or finding by Master Jones as to the amount due and owing by the Defendant. The Defendant appealed against the Master's decision.

19. The Defendant's case is that in relation to the allegation that the Defendant had been in breach of clause 5(F) of the sub-mortgage, in fact the Plaintiff had given its consent for the commencement of the proceedings. Although the consent was not in writing, the Defendant's case is that there was undoubtedly the consent and in any event the Plaintiff must be estopped from relying on the failure to obtain the prior written consent. In this regard, the Defendant said that in commencing action against the sub-borrower, the Defendant in fact instructed Messrs Sin, Wong & Mui which was nominated by the Plaintiff to be the Defendant's solicitors in the action against the sub-borrower. Furthermore, it was contended that but for the co-operation of the Plaintiff the Defendant could not have succeeded in obtaining an order for possession against the sub-borrower because in order to do so, it would be necessary to produce the original of the mortgage to the Court and the mortgage was in the Plaintiff's possession. Further, as I have pointed out earlier, in the letter of 1 September 1998 declaring an event of default, no mention was made by the Plaintiff of any default in complying with the terms of the sub-mortgage by the commencement of the action. In these circumstances, I am of the view that the Defendant had made out a triable issue on whether in fact the commencement of the action was with the consent of the Plaintiff. Although the consent was not evidenced in writing, there is also a triable issue on the defence of estoppel. Accordingly before the point is resolved in the trial, I am of the view that it would be wrong to order possession or order the sale of the property on the ground that there was default in complying with the terms of the sub-mortgage in commencing proceedings against the sub-borrower.

20. Furthermore, it is plain from clause 5(F) of the sub-mortgage that the Defendant was prevented from taking of action against the sub-borrower without the written consent of the Plaintiff only if there was money remaining owing to the Plaintiff under the facility letter or under the sub-mortgage. Hence if the Plaintiff is unable to show that there was money still owing, the Defendant's acts in taking action against the sub-borrower would not be an act of default.

21. Thus the crux of the matter in this case is whether there is any triable issue on the issue of whether the Defendant is in default in payment of money to the Plaintiff. If the Plaintiff can satisfy the Court that clearly the Defendant is in default in that the Defendant is still liable to pay the Plaintiff some amount and that amount has still not been paid, then the Plaintiff would be entitled to an order for possession and also an order that the security be enforceable by sale.

22. The Plaintiff's case is that since November 1997 the Defendant has made no repayment of the monthly installments and this is not disputed by the Defendant. In this sense there is no question that the Defendant has been in default since 1997. There has not been any repayment and so the Defendant remains to be in default even up to to-date. The Plaintiff contended that even though the Defendant may have a claim against the Plaintiff for unliquidated damages in HCA No.13826 of 1998, the existence of such cross claim would not disentitle the Plaintiff from getting the relief of possession or order for sale. The Plaintiff relied on what is commonly known as the "Mobil Oil" principle, viz. that "contract and statute apart, a legal mortgagee's right to possession of the mortgaged property cannot be defeated by a cross-claim on the part of the mortgagor, even if it is both liquidated and admitted and even if it exceeds the amount of the mortgage arrears." (see Ashley Guarantee Plc v Zacaria [1993] 1 WLR 62 at 66D per Nourse LJ citing Slade LJ in National Westminster Bank Plc v Skeleton [1993] 1 WLR 72).

23. In my view, the "Mobil Oil" principle which derived its name from the decision of Nourse J. in Mobil Oil Co. Ltd. v Rawlinson (1982) 4 P & CR 221, is founded on 2 legal principles. The first principle is about the mortgagee's right to possession. The established common law principle is that the mortgagee is entitled to possession of the mortgaged property as an incident of his legal estate in land, at any time after the mortgage is executed, except insofar as his rights are limited by contract or statute (see Ashley Guarantee Plc v Zacaria supra at page 70G). The second principle is that a mortgagor cannot unilaterally appropriate the amount of a cross-claim, even if it is both liquidated and admitted, and a fortiori if it is unliquidated or not admitted, in discharge of the mortgage debt (see Mobil Oil Co. Ltd. v Rawlinson, supra at page 226).

24. In my view neither of the 2 underlying principles would apply to the present case.

25. First in relation to the mortgagee's right of possession of the mortgaged premises, the position in Hong Kong is quite different from the position in England. The sub-mortgage in the present case is by way of legal charge. Although clause 3 of the sub-mortgage was expressed in terms that the sub-mortgagor "assigns or (as the case may be) charges unto the [the sub-mortgagee] [the mortgaged property]", it is plain that the sub-mortgage could not take effect in any way other than by way of legal charge. This is because under section 44 of the Conveyancing & Property Ordinance it is clearly provided that :

"(1) After the commencement of this section, a mortgage of a legal estate, including any second or subsequent mortgage of that legal estate, may be effected at law only by a charge by deed expressed to be a legal charge." (emphasis added)

The sub-mortgage is a mortgage of the legal mortgage in favour of the Defendant. As legal mortgage is within the meaning of legal estate in the Conveyancing & Property Ordinance, plainly the sub-mortgage in this case is also a mortgage of a legal estate within the meaning of section 44(1). Thus this sub-mortgage could only take the form of a legal charge notwithstanding that words of assignment were also used in the creation of the sub-mortgage.

26. The power of a mortgagee of a mortgage by way of legal charge is set out in section 44(2) :

"(2) Under a mortgage effected by a legal charge, the mortgagor and the mortgagee shall, subject to this Ordinance, have the same protection, powers and remedies (including but not limited to those relating to foreclosure and the equity of redemption but excluding the power of the mortgagee to enter into possession before any default by the mortgagor) as if the mortgage had been effected by way of assignment of the legal estate before the commencement of this section." (emphasis added)

Thus unlike the position in common law and the position in England, in Hong Kong, in a mortgage by way of legal charge the mortgagee no longer has the right to possession of the mortgaged premises as an incident of his legal estate before any default by the mortgagor. In this regard, it is notable that the words in italics quoted above are not found in Section 87(1) of the Law of Property Act 1925 which provided for the mortgage by legal charge in England.

27. Thus in the present case, the Plaintiff could not rely on the common law right of a mortgagee to possession regardless of whether the purchaser is in default or not. There is certainly no provision in the sub-mortgage to entitle the Plaintiff to take possession before default. On the contrary the provision which enables the Plaintiff to receive the debt payable by the sub-borrower and to receive the rent and profit of the property is predicated on the Defendant's being in default (see the proviso to clause 4 of the sub-mortgage).

28. In relation to the principle against the mortgagor's unilaterally appropriating any cross claim in discharge of the mortgage debt, the Defendant's answer is that that principle may well be applicable where there is no intervening insolvent winding up or bankruptcy but in the circumstances of the present case, because of the liquidation of the Plaintiff on 29 September 1998, and because the Plaintiff is insolvent, the rule enshrined in section 35 of the Bankruptcy Ordinance is applicable. The consequence is that as the present claim and the Defendant's claim in High Court Action No.13826 of 1998 are mutual dealings there is a mandatory statutory mutual set off and only the net amount after the set off is recoverable.

29. There is no dispute that section 264 of the Companies Ordinance is applicable to the winding up of the Plaintiff company. By that section, the rules relating to the proof of debts under the law of bankruptcy are made applicable to the winding up of an insolvent company. Section 35 of the Bankruptcy Ordinance in turn provides that :

"Where there have been mutual credits, mutual debts or other mutual dealings between a bankrupt against whom a bankruptcy order is made under this Ordinance and any other person proving or claiming to prove a debt under the bankruptcy order, an account shall be taken of what is due from the one party to the other in respect of such mutual dealings and the sum due from the one party shall be set off against any sum due from the other party and the balance of the account, and no more, shall be claimed or paid on either side respectively; but a person shall not be entitled under this section to claim the benefit of any set-off against the property of a bankrupt in any case where he had, at the time of giving credit to the bankrupt, notice that the petition had been presented."

30. In Stein v Blake [1996] 1 AC 243, one of the questions that the House of Lords had to decide was the effect of an intervening bankruptcy on the part of the plaintiff on a claim by a plaintiff for breach of contract and a defendant's counterclaim for misrepresentation. Prior to the commencement of the trial, the trustee in bankruptcy purported to assign to the plaintiff the right of action against the defendant. The defendant took out a summons to stay the action on the ground that the plaintiff's claim and the defendant's counterclaim fell to be dealt with by way of set off in bankruptcy and until the trustee had taken an account of the mutual set off there was nothing to assign. It was held by the House of Lords that upon the bankruptcy of the plaintiff, there was a mandatory statutory set off of the claim and the counterclaim. There would no longer be 2 choses in action, one representing the claim and one representing the counterclaim. There would only be one claim left, i.e. the claim in the amount of the net balance after the mutual set off. That amount was assignable. In the speech of Lord Hoffman he drew a distinction between a legal set off and a bankruptcy set off (see page 251B-G). A legal set off is confined to debts which at the time when the defence of set off is filed are due and payable and either liquidated or in sum capable of ascertainment without valuation or estimation. Bankruptcy set off has a much wider scope, and applies to any claim arising out of mutual credits or other mutual dealings before the bankruptcy. Lord Hoffman also pointed out that the bankruptcy set-off was mandatory and self-executing and the result must be that as of the bankruptcy date, there could only be one net balance after set off which is due and owing. It may well be that since the parties are in disagreement on the amount of the claim and counterclaim, the subject matters of the mutual dealings, it would be still necessary for the Court to adjudicate on the claim and the counterclaim. Yet this exercise would not affect the legal position that as on the date of the bankruptcy, there is only one sum due and owing. The position is clearly spelt out in the words of Lord Hoffman (at page 255F-G) :

"The cross-claims must obviously be considered separately for the purpose of ascertaining the balance. For that purpose they are treated as if they continued to exist. So, for example, the liquidator or trustee will commence an action in which he pleads a claim for money due under a contract and the defendant will counterclaim for damages under the same or a different contract. This may suggest that the respective claims actually do continue to exist until the court has decided the amounts to which each party is entitled and ascertained the balance due one way or the other in accordance with section 323. But the litigation is merely part of the process of retrospective calculation, from which it will appear that form the date of bankruptcy, the only chose in action which continue to exist as an assignable item of property was the claim to a net balance."

31. Thus the position is that once there is the intervening insolvent liquidation of the Plaintiff, as on the date of the winding up of the Plaintiff on 29 September 1998, the position between the Plaintiff and the Defendant is that there could only be one sum either due by the Plaintiff to the Defendant or vice versa in the net amount of the balance of the Plaintiff's claims (not just in this action but also in other actions or causes of action) and the Defendant's counterclaim under HCA No.13826 of 1998. It is not a question of the Defendant's right as the sub-mortgagor to appropriate its claim in HCA No.13826 of 1998 to satisfy the Plaintiff's claim for money owing under the sub-mortgage. It is a matter of mandatory self-executing set-off.

32. The Plaintiff sought to avoid the difficulty by arguing that in fact although there was mutual dealings in this case, there could be no mutual set-off in bankruptcy in this case. The Plaintiff contended that since the Plaintiff currently only claimed against the Defendant for possession and order for sale, the Plaintiff's claim is not pecuniary claim and there could not be a mutual set off of the Plaintiff's non pecuniary claim against the Defendant's pecuniary claim in HCA No.13826 of 1998. In this respect the Plaintiff relied on the decision of the Court of Appeal in The Eberle's Hotels and Restaurant Company Ltd. (1887) 18 QBD 459.

33. I do not think that the Plaintiff is right in the contention that there could be no mutual set off in the present case. While no doubt that there could not be a mutual set off between the right to get possession and the Defendant's claim in HCA No.13826 of 1998, what the Defendant seeks to persuade me is that insofar as the Defendant's liability to pay the Plaintiff under the sub-mortgage is concerned, the amount due under the mortgage must be set off against the claim in the Defendant's action. The set off will affect the question of the pecuniary sum due one way or the other. It will also be decisive on the issue as to whether the Defendant could be said to be in default in failing to pay the Plaintiff the amount due.

34. As only one sum could be due and owing either by the Plaintiff to the Defendant or vice versa since 29 September 1998, it could not be said that the Defendant must be in default until the Defendant's claim in HCA No.13826 of 1998 has been decided. The Plaintiff has not sought to persuade me that the Defendant's claim in HCA No.13826 of 1998 is merely a sham and I must assume that that action is bona fide brought and the Defendant has some prospect of success. The consequence is that the Plaintiff has not satisfied me that the Defendant is clearly in default and accordingly I am of the view that this is not a case where judgment should be entered against the Defendant for possession or for an order of sale at this stage.

35. I will therefore allow the appeal and set aside the Master Jones' Order of 1 September 2000 in both actions before me. On the first hearing of the originating summons if the Court is not satisfied that the dispute could be determined at this stage, the normal course is for the Court to give directions. However, as the parties had not addressed me on what directions they wanted me to give, I think the best course is for me to give no direction at this stage leaving the parties to apply for directions before a master. It may well be that in the light of my decision, the parties may like to have these 2 actions stayed pending the determination of HCA No.13826 of 1998.

36. On the question of costs, I will make an order nisi that the Defendant is to have the costs of this appeal. As to the costs before the master, since I have directed that the parties should go back to the master for direction, the last hearing before Master Jones was thus also wasted. In the circumstances, I will also make an order nisi that the Plaintiff is also to pay the Defendant's costs for the hearing before Master Jones. This will apply to both actions before me.