TELE-ART INC. (IN LIQUIDATION) v. BANK OF CHINA (HONG KONG) LTD

CACV 283/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 283 OF 2011

(ON APPEAL FROM HCA NO. 2443 OF 2008)

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BETWEEN

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REASONS FOR JUDGMENT

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Hon Kwan JA:

1.  This is an appeal from the decision of Barma J on 30 November 2011 in a trial of preliminary issues ([2012] 1 HKLRD 484). The judge ruled in favour of the defendant, the Bank of China (Hong Kong) Limited (“the Bank”), on all three preliminary issues. The plaintiff, Tele-Art Inc (“TAI”), appealed against the decision on the third issue only. We dismissed the appeal after the hearing and these are the reasons for judgment.

The facts

2.  The relevant facts may first be summarised as follows.

3.  By two share charges made in November 1993, TAI and its director and principal shareholder charged 700,908 and 122,727 shares respectively in Nam Tai Electronics, Inc (“Nam Tai”) to the Bank as security for the facilities granted by the Bank to TAI’s subsidiary, Tele-Art Limited (“TAL”).  TAL defaulted on its obligations to the Bank since 1996.  Between 1996 and 2007, the Bank, TAI and Nam Tai became embroiled in five sets of legal proceedings in several jurisdictions, owing to the enforcement by the Bank of its power of sale under the share charges to satisfy the indebtedness of TAL and TAI.  It was not until 5 September 2007 that the Bank was able to sell a sufficient number of the charged shares to fully pay off the indebtedness.  The unsold shares were returned to the liquidator of TAI.  The net proceeds of sale were received on 11 September 2007.

4.  On 1 November 2007, the Bank’s solicitors sent to the liquidator’s solicitors a letter setting out the Bank’s account in respect of the net proceeds of sale.  The Bank added to the principal debt and interest an item for its costs and expenses and interest, for which the Bank sought to indemnify itself from the net sale proceeds.  The costs and expenses were the Bank’s legal costs in respect of the five sets of legal proceedings mentioned earlier.  The Bank also sought to deduct from the net proceeds a provision for future costs and expenses not yet settled or incurred as some of the legal proceedings were then ongoing.

5.  TAI disputed the Bank’s entitlement to recoup from the net proceeds its costs and expenses as stated in the accounting letter and issued a writ against the Bank in these proceedings (HCA 2443 of 2008) on 27 November 2008, seeking enquiries as to what the Bank was entitled to deduct from the proceeds, a declaration that the Bank was not entitled to deduct a provision for future costs and expenses, and payment of any sums wrongly deducted.

6.  The total amount of costs and expenses and interest of the five sets of legal proceedings incurred up to 10 September 2007 amounted to HK$12,860,534,89, US$561,382.90 and £448,578.29, and further sums incurred in the period from 11 September to 20 October 2007 brought the total amount to HK$13,076,807.89, US$576,432.12 and £462,191.27.  As to the provision made for future costs and expenses, the provision made as at 11 September 2007 was HK$5,552,436.10 and US$15,049.22.  As at 20 October 2007, the provision was reduced to HK$5,336,163.10 and £104,081.52.

7.  Further costs and expenses were incurred in some of the five sets of legal proceedings after 20 October 2007, bringing the total to HK$15,241,955.07, US$611,988.56 and £475,095.77 as at 12 October 2010.  Costs were also incurred in HCA 2443 of 2008 in the amount of HK$1,823,356.10 up to 24 September 2010 (after the trial of preliminary issues).  Taking into account such further costs, the remaining provision for future costs and expenses held as at 2 February 2012 was reduced to HK$1,071,795.18 and £91,177.02.  I would agree with the Bank’s assessment that this remaining sum of about HK$1.8 million is probably unlikely to be enough to cover its anticipated costs to finalise the accounting process.

The judgment on the preliminary issues

8.  The three preliminary issues agreed by the parties for determination were in these terms:

“(1) Whether the Bank is entitled to recover from the proceeds of sale its costs and expenses incurred in any, and if so which, of the legal proceedings set out in Table C of the 1 November 2007 letter?

(2) If the Bank is so entitled, whether such costs and expenses are to be deducted on a full indemnity basis, and, if not, on what basis?

(3) Whether the Bank is entitled to set aside from the proceeds of sale a provision for its future costs and expenses?”

9.  The judge answered all three questions in favour of the Bank and made an order nisi that TAI is to pay the bank its costs of the application for the determination of preliminary issues, to be taxed on an indemnity basis.

10.  On the first question, he held that on the proper construction of the relevant clauses in the share charges (clauses 2.1(j), 11.6, 16.1, 24.1 and 31.1), the Bank is entitled to reimburse itself out of the net proceeds of sale the costs and charges incurred in each of the five sets of proceedings (subject to the quantification of those costs, which is to be determined in HCA 2443 of 2008 at a later stage), as they were incurred in order to enable the Bank to sell the charged shares, or in connection with the enforcement of the share charges, or in connection with the charged shares, or were a matter arising under or in consequence of the share charges, or arose out of the breach of TAI of its obligations under the share charges.  He held it was reasonable for the Bank to be involved in all these proceedings, to remove the impediments to the sale of the shares and to protect its security.

11.  For the second question, the judge held, on the proper construction of the relevant clauses (clauses 2.1 (j), 11.6 and 31.1), that the Bank is entitled to recover all of its costs incurred in the five sets of proceedings on the indemnity basis of taxation, and that the Bank had not lost its right to have its costs assessed by reference to the indemnity basis just because in some of the proceedings costs orders were made in its favour on the party and party basis.

12.  The third question, which is the subject of this appeal, was dealt with in paragraphs 57 and 58 of the judgment.  I will set out these paragraphs in full:

“57. This leaves the third preliminary question – whether the Bank is entitled to withhold an amount in respect of further costs that it may incur. As to this, Mr Thomas [leading counsel for TAI] accepted that the Bank was entitled to withhold a reasonable amount to cover its anticipated costs of these proceedings, by which the accounting process in respect of the proceeds of sale under the share charge would be carried out, as such costs would clearly fall within the terms of the share charge as costs which the Bank could add to its security. Mr Thomas said, however, that that was as far as the right to retain sums could go. Mr Jat [leading counsel for the Bank] submitted that having regard to the litigious history of the relationship between the Bank, TAI and Nam Tai, it was not unreasonable for the Bank to seek to withhold sums against the risk that future costs may be incurred.

58. In my view, the Bank is entitled to withhold, or seek to retain, monies in respect of reasonably anticipated future costs.  However, at this stage, some time now having elapsed since the last set of litigation in HCA 1619 of 2007, the shares having been sold (and insofar as they did not need to be sold, returned to TAI), there would seem to be no real basis for seeking to withhold any funds beyond a reasonable amount in respect of the anticipated future costs of these proceedings to finalise the accounting process.  Thus, while I would answer the third question in the affirmative, I do make it clear that the extent of the Bank’s right to set aside sums for its future costs and expenses is, on the basis of the evidence that I have before me, limited to this extent.”

13.  The effect of the ruling on the third question is that the Bank is entitled to make provision of a reasonable amount in respect of the anticipated future costs of the proceedings in HCA 2443 of 2008 to finalise the accounting process.  As mentioned earlier, the amount held as at 2 February 2012 was about HK$1.8 million and this is not likely to cover such anticipated costs.

14.  In the Notice of Appeal, it was contended that the judge was wrong to rely on the concession of Mr Thomas, SC as stated in paragraph 57 of the judgment when no such concession was in fact made.  Having read the parts of the transcript both sides had taken us to, I am satisfied what was recorded in the judgment was an accurate statement of the position adopted by Mr Thomas before the judge.  Mr Coleman, SC, who appeared for TAI in this appeal, accepted it is “understandable” that the judge came to the view he did.  He contended that TAI should be allowed to withdraw this statement, which is on a legal point, as it was incorrectly made and any prejudice to the Bank could be remedied by this court depriving TAI of its costs below if the appeal should succeed.

This appeal

15.  In his written submission, Mr Coleman framed the question raised on this appeal as follows:

“Is a chargee, who holds proceeds of sale of the charged property as a constructive trustee for the chargor, entitled to retain a provision for future costs in the absence of this being specifically contractually provided for, or does it have to apply for security for costs in the normal way, i.e. under section 357 of the Companies Ordinance or Order 23 of the Rules of the High Court?”

16.  I do not see the question for our determination to be of such a wide scope as framed by counsel.  The judge answered the question before him with regard to the evidence and with reference to the terms of the share charges.  Future costs for which the judge ruled provision could be made are only in respect of “reasonably anticipated future costs”, and on the evidence of this case, limited to the reasonably anticipated future costs of the proceedings to finalise the accounting process.  I do not regard his determination on the third question as a ruling on the general law on the right of a mortgagee to retain a provision for future costs out of the net proceeds of sale.

17.  Viewed on this basis, as a matter of contractual entitlement, the Bank is entitled to deduct from the net proceeds its costs which may be incurred in the accounting process, which arose from its exercise of the power of sale, by virtue of clauses 2.1(j) and 11.6.  TAI’s former counsel was right to accept before the judge that “such costs would clearly fall within the terms of the share charge as costs which the Bank could add to its security.”  Mr Coleman did not dispute that the Bank could deduct such costs of accounting from the net proceeds if they had been incurred when the accounting exercise took place, but he contended that the Bank has no right to retain a provision for such costs in advance of their being actually incurred, for two main reasons.  Firstly, there is no direct authority in support of such right.  Secondly, the right of a trustee to a lien to retain part of the trust fund to cover his contingent liabilities does not apply to a mortgagee as a constructive trustee.

18.  As a matter of first principle, I can see no valid reason why the Bank should be deprived of its security interest merely because of the timing of the accounting exercise, and be forced to incur further costs to seek security for costs under section 357 of the Companies Ordinance or Order 23 of the Rules of the High Court.  In my view, TAI’s former counsel was right to accept that the Bank has a right to retain anticipated costs of the proceedings to finalise the accounting exercise.

19.  If authority is needed for this, support could be found in the decision of the Privy Council in Bank of New South Wales v O’Connor (1889) 14 App Cas 273 at 283, and the decision of the Supreme Court of New South Wales in Project Research Pty Ltd v Permanent Trustee of Australia Ltd (1990) 5 BPR 11,225.  The former was an action for redemption and the Privy Council approved the practice, where a proper tender had been made by the mortgagor and refused by the mortgagee, to make an order giving the mortgagor liberty to pay into court a stated sum sufficient to cover the amount of principal and interest “and the probable costs of the [redemption] suit”, and upon this payment into court the mortgagee would be required to deliver up the title deeds.  In the latter case, Hodgson J referred to the Privy Council decision and affirmed the right of a mortgagee to have the costs of a redemption suit (including the taking of accounts) taken out of the security, unless he is guilty of misconduct, so it was open to the mortgagee to require the payment, in addition to the principal and interest, of a reasonable sum to cover the anticipated costs of the proceedings in which the dispute of the payout figure was to be resolved.  Hodgson J was of the view that the position is no different where the mortgagee held surplus proceeds on the exercise of a power of sale and the mortgagor sought an account, although he was not aware of any direct authority in support.  In this situation, the mortgagee would be entitled to retain money out of the surplus proceeds as security for the costs of the proceedings in the nature of accounts.

20.  The case of Ginelle Pty Ltd v Singh, another decision of the Supreme Court of New South Wales cited by Mr Coleman, distinguished Project Research Pty Ltd in para [82] on the basis that the provision to be made for costs in Ginelle Pty Ltd was in respect of litigation not concerned with the mortgagee’s conduct in allocating the proceeds of sale and whether it had acted reasonably in doing so.  The litigation would go to whether the mortgage was ever enforceable and the mortgagee could have no expectation it would be entitled to its costs of that litigation regardless of the outcome.  I do not think this decision has detracted from the reasoning in Project Research Pty Ltd.

21.  This would be sufficient to dispose of the present appeal.

22.  It is not strictly necessary to deal with Mr Coleman’s other submission that the principle that a trustee under an express trust has a right to a lien and to retain part of the trust fund to cover his contingent liabilities (X v A [2000] 1 All ER 490 at 493g to 494b; Law Debenture Trust Corporation plc v Concord Trust & Ors [2007] EWHC 1380 (Ch), paras [49ix] and [71]) should have no application to a mortgagee holding surplus proceeds on trust for the mortgagor as a constructive trustee.

23.  In answer to Mr Coleman that there are no authorities in support of the proposition that the above principle applies to a constructive trustee, Mr Jat, SC referred us to Rowley v Ginnever [1897] 2 Ch 503, cited in Snell’s Equity (32^nd ed) para 7-034 and Lewin on Trusts (18^th ed) para 21-28.  This is not strictly necessary for my decision in this appeal, but I would agree with the authorities cited by Mr Jat.  I do not read these authorities as importing a requirement that there must be a pre-existing fiduciary duty before a constructive trustee is allowed a lien for the costs and expenses incurred by him, as submitted by Mr Coleman.

24.  For the above reasons, we have dismissed this appeal with costs to the Bank on an indemnity basis, as the judge had ruled on the proper construction of the share charges that the Bank is entitled to recover its costs on this higher basis.

Hon Lam JA:

25.  I agree.

Hon Au J:

26.  I agree.