JAPAN LEASING (HONG KONG) LTD. v. FULLY WELL INVESTMENT LTD.

HCMP4359/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.4359 OF 1998

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J U D G M E N T

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1. This is an appeal by the defendant from the Order of Master Kwan dated 9 October 1999 giving judgment to the plaintiff against the defendant for the repayment of three loans together with interest thereon which three loans were made by the plaintiff to the defendant.

2. Initially there was a second appeal, also from the Order of Master Kwan, by an intervener whose application to intervene in these proceedings was dismissed by the Master. During the course of the hearing, however, agreement was reached between the plaintiff and the intervener and therefore that appeal by the intervener is no longer in issue. I need therefore only concern myself with the appeal by the defendant in this matter.

3. The plaintiff's claim against the defendant was for the repayment of three loans, the first of which was made in 1992 for $4.8 million, to be repaid by monthly instalments over a seven-year period ("the first loan"); the second made in 1996 for $4 million, to be repaid by monthly instalments over 75 months ("the second loan"); and the third made in 1997 for $3.5 million, to be repaid by monthly instalments over a 12-month period ("the third loan"). The defendant having defaulted in the monthly instalment repayments in respect of the second loan and the third loan in January 1998 and in respect of the first loan in February 1998, the present action was instituted by the plaintiff by way of originating summons on 28 August 1998, a pre-action demand having been made by the plaintiff's solicitors by letter dated 20 July 1998.

4. All three loans were secured by way of a Legal Charge dated 10 December 1992 upon the property at Flat 10A and Car Parking Spaces Nos. 29 and 30 of No.3 Stubbs Road. The first loan was made on the basis of a facility letter. Each of the second loan and the third loan were made on the basis of a separate loan agreement.

5. The only defence raised by the defendant in its affirmation of opposition to the plaintiff's claim is that the plaintiff cannot enforce the Legal Charge by reason of alleged breaches of the Money Lenders Ordinance. However, by the time the hearing came before the Master, this defence was completely abandoned by the defendant and it was conceded by the defendant that they have no defence to the plaintiff's claim under the Money Lenders Ordinance. However, the defendant then took a completely new point arguing that the provision for overdue interest in respect of the second loan and the third loan (the first loan being by way of facility letter, no provision was made in that facility letter for overdue interest) is a penalty and therefore unenforceable. This new point was taken by the defendant only at the second hearing before the Master. The Master did not accede to this argument of the defendant and gave judgment as claimed by the plaintiff. This appeal now focuses on the same point as taken before the Master.

6. Before me, the defendant took three points all in respect of the overdue interest provided for in the loan agreements in relation to the second loan and the third loan. (Since the wordings of the loan agreements for both the second loan and the third loan are identical mutatis mutandis, all that I say in this judgment equally applies to both the second loan and the third loan.) The first point taken by the defendant was that the provision of overdue interest is itself a penalty and therefore unenforceable. The second point taken by the defendant is that such provision for overdue interest is too vague. The third point taken by the defendant is that upon a proper construction of the overdue interest provision, the plaintiff is only entitled to charge overdue interest on the outstanding instalments but not on the entire outstanding loan amount. I shall deal with each of these points in turn.

Penalty

7. The principle to be applied when considering whether a particular contractual provision is a penalty or not is to be found in the Privy Council decision in the case of Philips Hong Kong Ltd. v. The Attorney General of Hong Kong [1993] 1 HKLR 269. These principles can be summarised as follows :

(1) The court should not adopt an approach which would defeat the purpose of a liquidated damages clause, which is to enable contracting parties to know the extent of one's protection in the event of breach;

(2) It is normally insufficient that the provision could result in the payment of a larger sum;

(3) So long as the sum payable is not extravagant, having regard to the range of losses it could reasonably be anticipated, it should be upheld by the court;

(4) The court should only intervene if the sum payable is totally out of proportion to the possible range of losses; and

(5) The court must be careful not to set too stringent a standard and what the parties have agreed should normally be upheld. Any other approach would lead to undesirable uncertainty, especially in commercial contract.

8. These principles as formulated by the Privy Council are not in dispute between the parties. What is in dispute between them is the application of these principles to the present case.

9. Moreover, provisions for overdue interest, usually being of a higher rate than the normal interest, is perfectly acceptable in law (see Lordsvale Finance Plc v. Bank of Zambia [1996] QB 752, David Securities Pty Ltd. v. Commwealth Bank of Australia [1990] 93 ALR 271, and Citibank NA v. Nyland (CFS) Ltd. [1989] 878 F. 2d 620). These also are not disputed by the defendant.

10. The normal interest for the second loan is stated to be three-month's HIBOR plus 3.5% per annum and that for the third loan is stated to be prime plus 1.75% per annum. The overdue interest rate for both the second loan and the third loan is stated in the loan agreements to be "2% per calendar month, such interest to be calculated on the actual number of days lapsed on the basis of a 365-day year and to be compounded at monthly intervals." The defendant argues that this rate for the overdue interest is extravagant and totally out of proportion to the possible range of losses and therefore a penalty. The defendant further makes the point that the overdue interests in Lordsvale Finance Plc v. Bank of Zambia, David Securities Pty Ltd. v. Commonwealth Bank of Australia and the case of Citibank NA v. Nyland (CFS) Ltd. are only 1%, 1.5% and 4% respectively over the normal rate in each of those cases. Therefore, says the defendant, the overdue interest in respect of the second loan and the third loan, both of which equates to 24% per annum as compared with the normal interest rate in respect of the second loan and the third loan shows it to be extravagant and out of all proportions.

11. The plaintiff, on the other hand, submits firstly, both parties are commercial entities and the business of both involves money lending. They have entered into these loan agreements voluntarily. Secondly, the plaintiff says 24% per annum for overdue interest in Hong Kong is not extravagant when one takes into account that the Money Lenders Ordinance provides that 48% per annum for interest to be extortionate and 60% per annum is illegal. Thirdly, the plaintiff makes the point that since the normal rate of interest in respect of the second loan and the third loan is dependant on the HIBOR rate and prime rate which is not fixed but fluctuates with time, it would be futile to provide for an overdue interest rate which may turn out to be even less than the normal rate of interest. Viewed from that light, again the 24% per annum is not an extravagant rate of interest in Hong Kong.

12. Having heard arguments from both sides, I prefer and accept the arguments submitted by the plaintiff. Indeed at one stage during arguments, the defendant was driven to the submission that the overdue interest rate added onto the normal interest rate would bring such interest rate very close to 48% and therefore extortionate under the Money Lenders Ordinance. However, it can be seen from the Order of Master Kwan and from the plaintiff's claim that the plaintiff has never claimed for both the normal interest rate and the overdue interest rate at the same time. It was one or the other. In my view, it is important that what the parties have agreed should normally be upheld. There should only be a departure from that if the defendant could show that what was agreed was extravagant. Whether or not such overdue interest rate was extravagant must be looked at in the conditions prevalent in Hong Kong. It is not to be determined by what is prevalent in other jurisdictions.

13. For these reasons, I am not persuaded that the rate stated in the loan agreements for the overdue interest to be a penalty and therefore unenforceable.

Provision too vague and proper construction

14. The other two points raised by the defendant as to the provision being too vague and the proper construction can and should be dealt with together as they are interlinked.

15. There is no dispute that the defendant was in default under the loan agreement in January 1998. Clause 7 provides that in the event of such default, the lender may by written notice sent to the borrower at its registered office or at its last known address (i) immediately terminate its commitment hereunder and/or (ii) declare the entire amount or all outstanding balance of the loan to be forthwith due and payable whereupon the loan, together with accrued interest thereon shall become immediately due and payable.

16. Clause 2(a) of the loan agreement provides for the manner in which the loan is to be repaid in accordance with the repayment terms as specified in the schedule. It is clear from its wording that this provision applies to a regular situation where there is no default.

17. Clause 2(b) on the other hand makes provision for where there is default and provides as follows :

"(b) If any of the said instalments or any part thereof shall be unpaid after the date on which it ought to be paid as aforesaid or if the Borrower shall be in default or an event of default shall occur the Borrower shall pay to the Lender on demand such part of the Loan together with interest due as shall for the time being be unpaid and all other moneys payable hereunder provided that without prejudice to the rights powers and remedies of the Lender hereunder the Lender shall be entitled to charge and the Borrower shall pay to the Lender interest at the interest rate as specified in the said scheduled on any of the said monthly instalments which is not paid punctually as aforesaid from the date on which the said instalment should have been paid until the same is actually paid and received by the Lender."

Both the normal interest rate as well as the overdue interest rate are provided for in the schedule to the loan agreement.

18. Clause 2 of the loan agreement could have been better drafted. A distinction should have been spelt out in the body of clause 2 of the loan agreement as to when the normal rate of interest and when the overdue interest rate were to apply, since both the normal rate of interest and the overdue interest were specified in the schedule. This was not done. However, despite such criticism of clause 2 of the loan agreement, it must be clear that the 'interest' referred to in clause 2(a) relates to the normal rate of interest since clause 2(a) deals with the regular situation where there is no default. I therefore take the view that the only possible application for the overdue interest is to be read as being the interest referred to in clause 2(b) of the loan agreement. That could be the only intention of the parties in entering this loan agreement. Read in this light it would not only give business efficacy to the loan agreement, without which the agreement is ineffective. In my view, it is plainly reasonable and equitable. Moreover, it is so obvious that the officious by-stander would say "it goes without saying".

19. Once clause 2(b) is read in this light, there is nothing vague about what has been agreed between the parties. It is also clear from the words "the borrower shall pay to the lender on demand such part of the loan together with interest due as shall for the time being be unpaid", (my underlining) that the overdue interest is applicable to such part of the loan as may be outstanding.

20. The argument put forward by the defendant centers around the words under the proviso in clause 2(b) which reads "and the borrower shall pay the lender interest at the interest rate as specified in the said schedule on any of the said monthly instalments which is not paid punctually". These words do not confine the payment of interest to only the said monthly instalments which is not paid punctually. The proviso in clause 2(b) was necessary with these words because under clause 7 the lender may by written notice call in the entire amount of the outstanding balance of the loan. However, it was not incumbent upon the lender to do so. If the lender did not call in the entire amount of the outstanding balance upon default, that would be a good reason why such a provision has to be included as it was in the proviso to clause 2(b), making provision for the payment of overdue interest on any of the outstanding monthly instalments. Furthermore, the words relied upon by the defendant is in the proviso in clause 2(b). That proviso is expressly stated to be "without prejudice to the rights powers and remedies of the Lender hereunder".

21. For the reasons stated above, I have come to the conclusion that there is no merits in the defendant's appeal from the Order of Master Kwan. Accordingly, this appeal by the defendant is dismissed with costs. Insofar as the Order of Master Kwan appealed from is concerned, subject to the variations to that Order which I have already dealt with arising from the appeal by the intervener, the rest of that Order of Master Kwan is affirmed.