XCHRX FORTUNE RETAIL HOLDINGS LTD. v. RICH OIL TRADING LTD. AND ANOTHER

HCA22007/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 22007 OF 1998

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J U D G M E N T

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1. By its Writ issued on 23 December 1998, the Plaintiff sues the 1st Defendant for a debt in the principal sum of HK$4.5 million, plus interest. The debt is said to arise under an Amended Reseller and Loan Agreement ("the Loan Agreement") dated 18 February 1997. The 2nd Defendant is sued as guarantor of the 1st Defendant's obligations under the Loan Agreement.

2. The Plaintiff applies today for summary judgment against both Defendants.

3. The claim is supported by the Affidavit of Louisa Ho Yuk King, sworn on 14 May 1999, which goes into considerable detail regarding the background to the loan transaction. She explains that various prior dealings led to the parties concluding an agreement dated 6 January 1996 ("the Original Agreement"), which was subsequently amended to become the Loan Agreement of 18 February 1997, the subject-matter of this Action.

4. The Original Agreement recited that the two Defendants were, on the same date, entering into an oil supply contract with a Chinese company (referred to there and in this Judgment as "the PRC Co") of which the 2nd Defendant is the legal representative and managing director. By that oil supply contract, the PRC Co, which was to operate a petrol filling and service station being constructed in Zhaoqing, had granted to the 1st Defendant the exclusive right to supply it with petroleum products and to direct its management.

5. The 1st Defendant was to provide the PRC Co with certain equipment and facilities for use in the service station's operations, and the object of the Original Agreement was for the Plaintiff to lend to the 1st Defendant a maximum of $4 million to be used for procuring such equipment and facilities. The Original Agreement also stated that the sum of HK$2,166,500 had already been paid by the Plaintiff to the 1st Defendant for such purpose and that the balance of the facility was available. It furthermore contained an undertaking by the 1st Defendant that it would itself buy petroleum products exclusively from the Plaintiff on stated terms.

6. The loan was repayable by 10 annual instalments, each payable on the last day of each calendar year, the first repayment being due on 31 December 1996. However, it was agreed that if a certain target for sales was reached during a particular year, the instalment for that year would be waived.

7. Ms Ho explains that further drawings were made on the facility granted by the Plaintiff, inter alia, in the form of payments, made at the Defendants' request, to the interior decorators and builders for work done in the construction of the service station in question. The station commenced operations in January 1996. It is alleged that the total amount of credit extended by the Plaintiff to the 1st Defendant was by then in the sum of HK$4,847,742.45.

8. The Plaintiff originally owned 51% of the shares in the 1st Defendant. However, on 24 December 1996, those shares were transferred to the 2nd Defendant's son Chan Man Lung and to a BVI company called Totteridge. Thereafter, the parties entered into a series of agreements on 18 February 1997, including the Loan Agreement and Deed of Guarantee which are the subject-matter of this Action and which replace the Original Agreement.

9. The Loan Agreement in its present form includes the 2nd Defendant as a party, reciting that his participation was required by the Plaintiff since he had become the beneficial owner of the 1st Defendant. It provides that "the maximum aggregate principal amount available for borrowing" by the 1st Defendant is $4.5 million to be used exclusively for procuring the service station's facilities and equipment listed in a schedule. However, despite its provisions setting out certain machinery for drawing down loan amounts, it states that the 1st Defendant acknowledges that $4.5 million had "already been paid by (the Plaintiff) to (the 1st Defendant) prior to the date hereof for the procurement of the Facilities." The Loan Agreement also contains undertakings from the 2nd Defendant to execute the Deed of Guarantee.

10. The Loan is now stated to be repayable by 9 annual instalments in accordance with the Repayment Schedule which is set out in Schedule 2 to the agreement. This Schedule, together with Clause 4(A), somewhat curiously, specifies that the first repayment, in the sum of $600,000 was due at the end of December 1996, that is, a month and a half before the date of the Loan Agreement. Moreover, by Clause 5, the parties mutually acknowledge that the 1st Defendant "completed the procurement of the relevant Facilities on 31 March 1996". The second instalment, also in the sum of $600,000, is shown in the Schedule to be due at the end of December 1997.

11. Ms Ho deposes to the Defendants' failure to pay either of the first two installments. Consequently, the Plaintiff made demands for payment and declared the whole of the loan due (in accordance provisions permitting acceleration of repayment on default).

12. The 2nd Defendant has made an Affirmation resisting the Order 14 application. He says that having previously entered into investment arrangements with the Plaintiff concerning petrol filling stations in Shunde in Guangdong, he was approached by one Philip So, apparently a member of the Plaintiff's management, with a plan which resulted in the Original Agreement and the Loan Agreement.

13. The plan was aimed at enabling the Plaintiff to invest in the petrol station being constructed in Zhaoqing and to engage in selling its petroleum products through that outlet, benefiting from the licence held by the PRC Co, and so avoiding having itself to go through the complicated approval procedures required by the authorities there.

14. The alleged plan involved the Plaintiff ostensibly entering into the loan and supply agreements with the Defendants while in reality, the monies purportedly advanced to the 1st Defendant under the loan documents were in fact investments made by the Plaintiff in the service station project, the express understanding with the Defendants being that repayment of the purported loans would never be required. The financial benefit of this arrangement to the Defendants was payment of $0.10 for each litre of petroleum products sold.

15. The Defendants' defence is therefore fundamentally that the Loan Agreement and Guarantee are sham documents aimed at evading regulatory requirements on the mainland and that the funds purportedly lent to the 1st Defendant in truth remained the Plaintiff's investment funds which were applied in accordance with the Plaintiff's instructions and not borrowed or guaranteed by the Defendants.

16. In her 2nd Affidavit, Ms Louisa Ho points out that the scheme being alleged by the 2nd Defendant is unlawful under mainland law. She says that in substance, the 2nd Defendant is alleging that he participated in a fraud against the mainland authorities by naming his company, Yiu Kee, as the sole investor in the PRC Co whereas he was facilitating capital investment by the Plaintiff as an undisclosed second investor.

17. The central dispute between the parties is therefore whether, as the Plaintiff contends, the Loan Agreement and Guarantee are documents which operate as they purport to on their face, giving rise to the liability alleged or, as the Defendants contend, that these documents are a sham and merely provide a facade concealing the real underlying transaction which involves no loan but merely the channelling of the Plaintiff's investment into the petrol station.

18. In the present Order 14 context, I have to decide whether what I shall call "the facade argument" raises a triable issue or whether, as Mr Michael Winckless, who appears for the Plaintiff, suggests, that argument is wholly incredible so as to justify summary judgment in his client's favour.

19. Mr Kent Yee, who appears for the Defendants, argues that the evidence filed shows that the defence has genuine substance and raises issues of fact which make it essential to go to trial. I will not deal with all his points but will illustrate his argument with a selection of them.

20. First, he relies on the fact that on 25 January 1995, an Investment Proposal was prepared by the Plaintiff's contract staff:-

* indicating that Zhaoqing was "one of the fastest growing markets in Guangdong and ....... a critical base for (the Plaintiff) to tap the oil market in Guangdong western region" as well as "a strategic addition to (the Plaintiff's) retail portfolio";

* referring to a 20 year retail gas station project and its anticipated internal rate of return based on an initial investment of HK$5 million; and

* proposing that the Plaintiff "is to finance the project through a reseller loan agreement" with a company called Yiu Kee, which is owned by the 2nd Defendant and participates as 50% joint venturer in the PRC Co.

21. Secondly, Mr. Yee points out that $2 million of the $4.5 million presently being claimed by the Plaintiff was provided prior to the signing of the Original Agreement and indeed, was disbursed by the Plaintiff to Pacific Fame, another company owned by the 2nd Defendant, without any security and without the proposed loan agreement covering that amount even being signed. Mr Yee argues that no genuine arm's length loan would have been provided in this way.

22. Thirdly, he points to various provisions in the Original Agreement which give the Plaintiff such complete rights over the service station's management and operations that such provisions are more consistent with the sums provided by the Plaintiff being an investment rather than a loan. Thus, he points out that the Original Agreement made it clear that the money ostensibly lent to the 1st Defendant can only be used to pay for the service station and its equipment. Furthermore, the Defendants cede to the Plaintiff, not merely the exclusive right to supply the service station with the Plaintiff's petroleum products, but the right to direct the management of the PRC company (which would own the filling station in which the Defendants, through Yiu Kee, owned rights to as joint venturer). The Defendants are also required to procure that the station operates using the Plaintiff's trademarks. It is hard to see the borrower getting any commercial benefit from the alleged loan.

23. Fourthly, he points out that under the Original Agreement, the Plaintiff ostensibly made an unsecured loan of $4 million to a company with no assets, the 1st Defendant being merely a HK$1,000 company. The shareholders were the Plaintiff themselves and Totteridge, a BVI company. It is again submitted that a genuine loan would not have been made in such circumstances.

24. Finally, Mr. Yee submits that there is no commercial logic to the Plaintiff stating the loan amount as $4.5 million in the Loan Agreement when some $4.85 million had in fact been advanced, contending that this supports the facade argument and the absence of a true lender-borrower relationship.

25. In his submissions, Mr Winckless pointed to many features of the evidence which he contended, indicate the incredible quality of the facade argument. He asks for instance, what possible reason there could be for amendments to be made to the loan documentation and for the addition of the 2nd Defendant's personal guarantee in February 1997 if the first lot of agreements were a sham. He submits that there can have been no reason for going to such lengths to replace a perfectly good sham with a sham in an amended form, especially when it was not clear who was meant to be deceived by the documentation prepared.

26. He also argued, for example, that the Plaintiff did not need to evade regulations or would not be averse to seeking licences since they already had four licences for operating petrol stations in the same province, namely, Guangdong.

27. Clearly, Mr Winckless raises points of some force which call for explanation which the Defendants may or may not be able to provide. However, I am quite unable to accede to his submission that the arguments raised on the Defendants' behalf, summarised above, are so obviously lacking in substance that I should deprive the Defendants of their right to a trial. In my judgment, whether or not the agreements are a sham and/or constitute an attempt to defraud the regulatory authorities on the mainland cannot be determined by a trial on the affidavits. In the circumstances, I hold that the Defendants are to be given unconditional leave to defend.