TRAFFIC STREAM (BVI) INFRASTRUCTURE LTD v. THE JP MORGAN CHASE BANK AND OTHERS

HCA 2301/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2301 OF 2004

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J U D G M E N T

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I.  Introduction

1.   The Defendants apply to strike out Traffic Stream BVI’s claim.  The Defendants say that the claims are untenable in law. The Defendants also say that Traffic Stream BVI’s complaints have previously been decided, to the Defendants’ favour, in related litigation before the Hong Kong and United States courts.

II.  Background

2.  Traffic Stream BVI formerly owned 4 Hong Kong companies (the HK companies).  The HK companies operated toll road projects in the Mainland together with joint venture partners (the JV partners).

3.  To finance the toll road projects, Traffic Stream BVI issued US$119 million worth of 14 1/4% Secured Notes pursuant to an Indenture dated 6 May 1998.  The 1st Defendant (the Bank) was trustee under the Indenture.

4.  As security for its obligations under the Indenture and Notes, on 6 May 1998 Traffic Stream BVI executed a legal mortgage of its interest in the HK companies’ shares.

5.  Traffic Stream BVI defaulted on its obligations under the Indenture and Notes.  On 4 June 1999 the Bank obtained summary judgment from the US District Court (Southern District of New York) for the amounts due under the Indenture and Notes. 

6.  Traffic Stream BVI challenged that judgment by appeals and other applications.  But on 4 June 2003 its last application was summarily rejected by the US Court of Appeals.

7.  On 3 May 2002 the Bank exercised its right under cl. 6.2 of the mortgage to appoint the Full Wisdom, Worthing and Dawn Bright as new directors of the HK companies.  The new directors resolved on 14 May 2002 to remove Mr Wong Kwok Choi as company secretary of the HK companies.

8.  Mr Ng Hon Leung and his wife (then directors of the HK companies) refused to treat the appointment of the new directors as valid.  The Bank accordingly commenced HCA No. 1939 of 2002 (the 1st HK action) against the HK companies, Mr Ng, Mrs Ng and Mr Wong.  The Bank sought declarations that the new directors had been validly appointed and Mr Wong properly removed.

9.  The Bank obtained summary judgment in the 1st HK action from Chung J on 28 August 2003.  The judgment was upheld on appeal.

10.  Following Chung J’s judgment, the Bank caused Mr Ng and his wife to be removed as directors of the HK companies.  I note that Mr Ng, Mr Ng and Mr Wong have been (and remain) directors of Traffic Stream BVI.

11.  Just before the hearing by Chung J started on 22 May 2003, Traffic Stream BVI filed a petition for reorganisation under USC chapter 11 in the US Bankruptcy Court (Southern District of New York).  By letter and e-mail to the Bank, Traffic Stream BVI then alleged that it was a contempt of the US proceedings to proceed with the 1st HK action.

12.  The Bank having nevertheless continued with the 1st HK action, Traffic Stream BVI started contempt proceedings against the Defendants in the US Bankruptcy Court.  In its motion dated 10 June 2003 Traffic Stream BVI asserted that it was a defendant in the 1st HK action.

13.  By a Decision dated 26 September 2003 Judge Bernstein of the US Bankruptcy Court dismissed the contempt motion.

14.  The Decision noted that Traffic Stream BVI had never sought to stay the 1st HK action, but instead brought the contempt motion.  Judge Bernstein observed that, although initially claiming that it was a party to the 1st HK action, Traffic Stream BVI finally conceded that it was not.  Traffic Stream BVI also accepted that it was not the legal owner of the HK companies’ shares.

15.  The Decision further stated that Traffic Stream BVI had argued that the 1st HK action placed a clog on its equity of redemption in the HK companies’ shares.  In particular, the clog was alleged to arise because, if allowed to appoint directors onto the HK companies’ boards, the Bank would be able to interfere with the declaration of dividends by the HK companies. Without those dividends, Traffic Stream BVI could not meet its payment obligations under the Indenture and Notes.

16.  Judge Bernstein pointed out that, before the chapter 11 petition, the Bank validly acquired a legal mortgage. The Bank had thus validly:-

“exercised its rights to vote the Shares, and replaced old management with the New Directors.  As of the petition date, [Traffic Stream BVI] had neither title nor possession nor control of the Shares, and its rights were limited to redemption upon payment.”

17.  Judge Bernstein concluded:-

“The Hong Kong Action, which now appears to be complete, did not interfere with the Debtor’s limited rights.  Unlike a mortgage foreclosure proceeding, the Hong Kong plaintiffs [in the 1st HK action] did not seek to cut off or interfere with the Debtor’s equity of redemption.  Instead the lawsuit merely sought to confirm [the Bank’s] pre-petition actions and curb the interference by former management.”

III.  Discussion

18.  Traffic Stream BVI complains of 2 matters in this action:-

(1)	the appointment of the new directors and removal of Mr and Mrs Ng as directors and officers of the HK companies; and,
(2)	the ongoing negotiations between the Defendants and the JV partners for the sale of the HK companies’ interests in the toll road projects.

19.  Ms Cheng (for the Defendants) characterises Traffic Stream BVI’s case as a bold claim that the Bank, having taken security for repayment of a US$119 million loan, is not entitled to realise its security despite the borrower’s default.  That (Ms Cheng suggests) would be an absurd result.

20.  Ms Cheng further says that in any event Traffic Stream BVI is estopped from litigating its claims.  That is because the substance of Traffic Stream BVI’s complaints have previously been considered and rejected in the 1st HK action and in the contempt proceedings before Judge Bernstein.

A.  Complaint against appointment and removal of directors

21.  There is no substance to this complaint.

22.  There is no dispute that Traffic Stream BVI has defaulted.  

23.  Clause 6.2 of the mortgage provides that, on Traffic Stream BVI’s default,the Bank can exercise:-

“any voting right and any powers or rights which may be exercised by the person or persons in whose name or names the [shares] are registered or who is the holder or bearer of them”.

24.  Such rights plainly include the right to appoint and remove directors and other officers of the HK companies.

25.  This reading of the mortgage is reinforced by cls.10.1(b) and 10.3(b).  By those provisions, Traffic Stream BVI irrevocably appointed the Bank as its attorney, in the event of Traffic Stream BVI’s default, to do all acts, and exercise all rights and powers, which Traffic Stream BVI could do in relation to the shares.  Such rights and powers must have encompassed the use of share voting rights to appoint or remove directors of the 4 companies.

26.  Mr Leo (for Traffic Stream BVI) submits that a distinction should be drawn between appointing some directors and replacing all directors on the boards of the HK companies.  The Bank can use its powers under the mortgage to do the former (Mr Leo submits), but not the latter.

27.  There is no warrant for imposing such a restriction on the Bank’s rights in the mortgage.  No clause in the mortgage so provides.  On the contrary, the mortgage’s express terms militate against implication of a term such as Mr Leo contends.

B.  Complaint on negotiations for sale

28.  Mr Leo says that, by selling the HK companies’ assets to the JV partners, the Defendants would be interfering with Traffic Stream BVI’s equity of redemption.

29.  Mr Leo’s argument runs: The HK companies’ interests in the toll road projects constitute their only assets.  A sale of those assets would render the HK companies’ shares worthless.  Thus, even if Traffic Stream BVI was later to redeem the HK companies’ shares, they would have no value.  Traffic Stream BVI’s equity of redemption would be rendered meaningless.

30.  There is no merit in the argument.

31.  First, as Ms Cheng points out, new directors having been validly appointed under the mortgage, they should be able to carry out the full range of directors’ activities.  That would include discussing the sale of the HK companies’ assets to third parties, including the JV partners, if they saw fit.

32.  Second, Traffic Stream BVI misunderstands the nature of an equity of redemption.

33.  Clause 8 of the mortgage confers a power to sell the HK companies’ shares on the Bank. 

34.  If the Bank sells the shares, it would need to account to Traffic Stream BVI for any surplus over the amount due to the Bank under the Indenture and Notes.  That is because Traffic Stream BVI retains the equity of redemption. 

35.  Obviously, the shares having been sold on this hypothesis, Traffic Stream BVI could no longer recover the shares from the Bank.  Nor could Traffic Stream BVI recover the underlying assets of the HK companies from the Bank.  The shares and assets would come under the control of the persons purchasing the shares from the Bank. 

36.  But there has been no interference or clog on Traffic Stream BVI’s equity of redemption.  The Bank has simply enforced its security.  As holder of the equity of redemption, Traffic Stream BVI would merely be entitled to an account from the Bank as to the proceeds from the sale of the shares.

37.  I do not see why it should make any difference that the Bank decides instead to use its powers as shareholder to cause underlying assets (instead of the HK companies’ shares) to be sold to third parties.

38.  Of course, the Bank would still have to account to Traffic Stream BVI for the proceeds from any sale of assets.  Traffic Stream BVI would be entitled to be paid any proceeds in excess of its debts to the Bank under the Indenture and Notes.  That entitlement arises from Traffic Stream BVI’s equity of redemption. 

39.  But the equity of redemption does not entitle Traffic Stream BVI to object to the Bank’s enforcement of its security rights in the shares.

40.  Mr Leo says that the Bank must first foreclose, before it can sell the HK companies’ assets.  I disagree. 

41.  Foreclosure extinguishes the equity of redemption.  The Bank may (if it wishes) apply to the Court for an order of foreclosure.  The result of foreclosure would be that the Bank becomes absolutely entitled to the proceeds from any sale of the shares or assets.  There would then be no need to account to Traffic Stream BVI, since the equity of redemption vested in the latter will have been extinguished. 

42.  But that does not make foreclosure a pre-requisite to the Bank exercising its powers under the mortgage instrument.  Foreclosure only does away with the Bank’s obligation to account to Traffic Stream BVI for the fruits of the exercise of its powers.

43.  Third, authority does not support Mr Leo.

44.  Mr Leo cites a submission in Musselwhite v Musselwhite [1962] 1 Ch 964 in his support.  Russell J summarised the submission thus (at 980):-

“Further, for the plaintiffs it was contended that guidance could be found from the position in law of a mortgagee of shares to whom the shares had been transferred and who was the registered holder thereof.  Such a mortgagee had, it was submitted, the prima facie right to decide how the votes were to be cast, subject to interference at the instance of the mortgagor in a case only of unjustifiable damage to the interests of the latter....”

45.  In Musselwhite, Russell J considered the position of a mortgagee exercising share voting rights.  Quoting Swinfen Eady MR in Siemens Bros. & Co. Ltd. v Burns [1918] 2 Ch 324, Russell LJ concluded (at 983) that mortgagees “are entitled to exercise their voting rights as in their judgment they may deem best, irrespective of any directions of the [mortgagor] as to the way in which their votes are to be recorded”.

46.  Certainly, if there is a genuine clog on the equity of redemption, equity will zealously protect the mortgagor’s interest.  But that does not mean that the Court can interfere with a legitimate exercise of a mortgagee’s powers, whether the power to vote arising from mortgaged shares or any other power.

47.  As far as I can see, there is no “unjustifiable damage” to Traffic Stream BVI’s interest.  Indeed, as Ms Cheng notes, nothing prevents Traffic Stream BVI from tendering the balance of monies due to the Bank and regaining control of the shares and the HK companies upon extinction of Traffic Stream BVI’s debt to the Bank.

C.  Estoppel by Hong Kong and US proceedings

48.  The discussion in Sections III.A and B above is enough to dispose of Traffic Stream BVI’s case.  Traffic Stream BVI’s complaints are simply bad in law.  Strictly, it is unnecessary to determine whether Traffic Stream BVI is also estopped by previous litigation.

49.  Nonetheless, in deference to counsel’s argument, I venture a few observations on estoppel.

50.  First, in my view, the validity or otherwise of the Bank’s power to appoint or remove new directors or officers was considered in substance by Judge Bernstein.  He held against Traffic Stream BVI. 

51.  Traffic Stream BVI is seeking to re-litigate essentially the same issue here.  I do not think that it can do so, in light of Judge Bernstein’s Decision.  Foreign judgments can give rise to issue estoppel.  See, for example, The Sennar (No.2) [1985] 1 WLR 490, at 499A-C.

52.  Second, I arrive at a similar conclusion in relation to the complaint against disposal of the HK companies’ assets.  That is alleged by Traffic Stream BVI to affect its equity of redemption.

53.  But Judge Bernstein considered whether there was a clog on Traffic Stream BVI’s equity both in general and in particular.  As a matter of general principle, Judge Bernstein rejected any notion that, by taking control of the HK companies and their activities through the new directors, the Bank was interfering with Traffic Stream BVI’s equity.  He also rejected the specific instance advanced by Traffic Stream BVI of the Bank possibly clogging the equity of redemption through interference with the declaration of dividends.

54.  I therefore do not think that Traffic Stream BVI can now raise other specific instances of potential clogs on its equity of redemption.  It is too late.  The issue of clogs on the equity of redemption was conclusively determined by Judge Bernstein.

55.  Third, Traffic Stream BVI was not a party to the 1st HK action.  Nonetheless, a person’s privies may be estopped by previous court proceedings.  Traffic Stream BVI was certainly a privy of the parties to the 1st HK action.

56.  Before Judge Bernstein, the Defendants argued that Traffic Stream BVI was not a party to the 1st HK action and for that reason at least its contempt motion should be denied.  Eventually, Traffic Stream BVI conceded that it was not a party to the 1st HK action.

57.  In light of the Defendants’ stance in the US Bankruptcy Court, I doubt that it would be right to treat Traffic Stream BVI as estopped by the 1st HK action. 

58.  The Defendants cannot blow hot and cold.  Previously, they maintained before the US Court that Traffic Stream BVI was not privy to the 1st HK action.  Now they argue that Traffic Stream BVI was nonetheless bound as a privy of the parties sued in the 1st HK action.

59.  Accordingly, I would have been reluctant to treat the 1st HK action as giving rise to an issue estoppel against Traffic Stream BVI.

60.  If I were wrong on that, I would only have found that the 1st HK action estopped Traffic Stream BVI on the issue of the appointment or removal of directors and officers.

61.  Ms Cheng argues that, if Traffic Stream BVI really believed that underlying assets could not be sold without jeopardising its equity of redemption, it ought to have intervened to say as much in the 1st HK action.  This proposition relies on well-known Yat Tung Co. v Dao Heng Bank [1975] AC 581 principles.

62.  But I am not sure that the sale of the assets was squarely in issue in the 1st HK action.  In other words, the focus in the 1st HK action was on whether the new directors had been validly appointed, not on what the new directors could or could not do on the assumption that they had been validly appointed.

63.  The gist of my observations is that I would have found issue estoppel on the basis of the US Bankruptcy Court hearing, but not the 1st HK action.  In light of that finding, I would also have held the present action to be an abuse of process.

IV.  Conclusion

64.  For the foregoing reasons, Traffic Stream BVI’s claim is frivolous and vexatious.  The claim is an abuse of process.  The claim is struck out in its entirety.  Traffic Stream BVI’s action is dismissed.

65.  I shall now hear counsel on costs.