CHINA CONSTRUCTION REALTY LTD v. SINO BUSINESS SERVICES PROPRIETARY LTD AND OTHERS

HCA 1294/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1294 OF 2005

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D E C I S I O N

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Introduction

1.  This is the application of the 5^th defendant (“the defendant”) to set aside the default judgment entered on 24 March 2006.

2.  For the purpose of this application, the defendant (a company incorporated in accordance with the laws of Samoa) accepts that the writ of summons has been served in accordance with the Rules of the High Court.

3.  Consequently, it is also accepted that the defendant bears the burden of showing a defence on the merits.  The test regarding this aspect has been variously described as showing a defence on the merits which has “a real prospect of success”, or one which “carries some degree of conviction”, or one “to which the court should pay heed”.

4.  The causes of action on which this action is based are in short:-

(a)     s. 60, Conveyancing and Property Ordinance (Cap. 219);

(b)    conspiracy to injure.

Also for the purpose of this application, the parties’ focus is centred on whether the defendant has shown a meritorious in relation to the cause of action referred to in sub-para. (a) above.

5.  The relevant parts of s. 60(1), Cap. 219 provides:-

“Subject to [subsection (3)], every disposition of property made, whether before or after the commencement of this section, with intent to defraud creditors, shall be voidable, at the instance of any person thereby prejudiced”.

S. 60(3) provides:-

“This section does not extend to any estate or interest in property disposed of for valuable consideration and in good faith or upon good consideration and in good faith to any person not having, at the time of the disposition, notice of the intent to defraud creditors”.

6.  The parties’ dispute in this application is related to whether the defendant has been able to show a meritorious defence relying on s. 60(3).

Background Facts

7.  Most of the background facts are undisputed in this application.

8.  The asset in question is in gist the land use right of a substantial piece of land in Dalian which was owned by the 4^th defendant (“the suit property”).

9.  All of the parties herein are companies.  It is unnecessary to set out the details of the respective shareholding by these companies; the net result of the tiers of shareholding was, prior to the sale of shares by the plaintiff to the 1^st defendant, the plaintiff was the ultimate owner of the suit property.

10.  The plaintiff and the 1^st defendant entered into an agreement in June 1997 for the said sale of share for the price of about AUS$46.5 million.  Save as to the initial payment of some AUS$500,000, the 1^st defendant failed to pay the said price.  Legal action was commenced in Australia seeking payment of that sum.  After protracted proceedings, judgment was entered in the plaintiff’s favour in March 2004 (“the Victorian judgment”).

11.  Before the Victorian judgment was entered, through an agreement made between the defendant and (in effect) the 1^st to 3^rd defendants in about April or May 2003 (“the Lucky Dragon Agreement”), the suit property became owned by the defendant.

Plaintiff’s Pleading Relating to S. 60(1)

12.  In the context of the background set out above, the plaintiff pleads in the statement of claim:-

“The Lucky Dragon Agreement and the transfer of the Shares by the 4th Defendant to [the defendant] … were procured by the 1^st to 3rd Defendants and entered into and effected by the 4^th Defendant with intent to defraud the Plaintiff as a creditor of the 1st Defendant” (para. 47, statement of claim).

13.  In relation to the defendant, the plaintiff avers:-

“… [the defendant] had at all material times actual or constructive notice that the Lucky Dragon Agreement was procured by the 1st to 3rd Defendants and entered into by the 4^th Defendant with the intention of defrauding or evading the 1^st and 3rd Defendants’ liabilities to the Plaintiff” (para. 50, statement of claim).

14.  The particulars given in support of the last-mentioned averment are:-

“… such notice is to be inferred from the fact that the purported sale of the Shares pursuant to the Lucky Dragon Agreement to [the defendant] was at an undervalue as mentioned in [para. 47] above and that there was no commercial justification for the terms of the Lucky Dragon Agreement” (emphasis supplied);

“[The defendant] had actual notice of the [Australian proceedings] which were referred to in the Lucky Dragon Agreement” (emphasis supplied);

“Despite being advised to obtain independent legal advice, both the 4th [Defendant and the defendant] insisted on executing the Lucky Dragon Agreement without obtaining any prior independent legal advice” (emphasis supplied).

The Issues in this Application

15.  The affidavit evidence adduced by the defendant in effect denies the averments set out in para. 13 and 14 above.  The ultimate issue in this application is therefore whether it has shown a meritorious defence in relation to those pleas.

(1)     Undervalue as Evidence of Notice

16.  The Lucky Dragon Agreement stipulated that the consideration payable by the defendant was:-

“… HK$643,592.50 …initial payment … ” (clause 3.1);

and a “Performance Payment” which was defined as:-

“… one of the following four alternatives:

(1)     [The defendant] shall be responsible for all taxes and cost in relation to the development of the Dalian Land and [the 4^th defendant] shall be entitled to 10% … of amounts received or receivable by [the defendant] for the sale of properties on the Dalian Land … within 30 days after completion … and on condition that [the defendant] receives such Payment; or

(2)     [The defendant] shall deliver not less [than] 10,000 square meters of completed commercial building … in Dalian Project to [the 4^th defendant] … ; or

(3)     [The defendant] shall give HK$50 million to [the 4^th defendant] before 31^st December 2006; or

(4)     A combination of the alternative[s] (2) and (3) above on the [basis] that the 10,000 s.q. meter[s] of completed commercial building is worth HK$50 million” (Schedule 2).

The total amount payable under the Lucky Dragon Agreement was thus in the region of HK$11.43 million.

17.  The defendant’s affirmation (deposed to by a Madam Yeung) states that a total of around RMB250 million has been injected into the development of the suit property (the suit property was dormant and virtually undeveloped at the time of the Lucky Dragon Agreement).

18.  She also deposed that the defendant had to invest about RMB50 million on consultancy and architects fees (it is unclear if that sum was part of the total sum injected into the project), and that another RMB45 million or so had to be incurred to settle existing debts and liabilities.  Thus, according to Yeung, the total amount of expenditure was about RMB295 million at the lowest and about RMB345 million at the highest.

19.  The plaintiff draws my attention to clause 5.1 of the Lucky Dragon Agreement which provides:-

“[The 4^th defendant] advised that it has no financial capability to make payments for any Liabilities …  [The defendant] has [undertaken] to make payments on behalf of [the 4^th defendant] for all liabilities in existence prior to [the] date of completion and [the defendant] shall … make deductions from the Performance Payment payable to [the 4^th defendant] … ”.

It is submitted that the defendant’s payment for settling the existing debts and liabilities could be recovered from the 4^th defendant.  But even if there is correct, the total amount of expenditure would still be around RMB245 million to RMB300 million.

20.  The plaintiff’s affidavit includes a valuation report which states that, as at June 1997, the asset held by the 4^th defendant was worth about RMB480 million.  It should be noted, however, the sale price agreed to by the plaintiff for the sale was merely AUS$46 million (equivalent to about HK$280 million or RMB296 million).

21.  I agree with the defence that the said valuation is of little assistance in this application, in view of the drastic value drop of real properties in Hong Kong and the mainland during the period of avian influenza (November 2002 to July 2003).

22.  The plaintiff also adduces evidence that, as at May 2003, the development project when (a) uncompleted was worth about RMB251 million and (b) completed was worth about RMB906 million.  But the weight which should be given to this piece of evidence for determining whether the sale by way of the Lucky Dragon Agreement was at an undervalue is also highly arguable.  This is because, as the defendant points out, the valuation did not take into account the state of the suit property (see para. 18 above) or the risk of its forfeiture by the mainland authorities.

23.  In view of the matters set out above under this sub-heading, I find that the defendant has shown a meritorious defence regarding whether the consideration given in the Lucky Dragon Agreement was at an undervalue.

24.  S. 59(1), Cap. 219 provides that:-

“No purchase, made bona fide and without fraud, of any interest in property of any kind within Hong Kong shall be opened or set aside merely on the ground of undervalue”.

25.  Although s. 59(1) expressly refers to “any interest in property … within Hong Kong”, no argument has been raised regarding its applicability to this issue.

26.  There is substance in the defendant’s further argument that, in the absence of other matters, mere undervalue does not advance the plaintiff’s case against the defendant.

(2)     Terms of Agreement as Evidence of Notice

27.  The plaintiff’s first contention under this sub-heading is in short:-

“It is … difficult to see why … the 1^st Defendant … would allow this asset to be transferred to [the defendant] for the Initial Payment of only HKD2 million and defer the balance for more than three years” (para. 39, plaintiff’s skeleton submissions, and also repeated in para. 51 thereof).

Hence, this contention is about the seller’s (that is, the other defendants’) willingness to accept apparently unfavourable payment terms.

28.  The second contention is that:-

“It is incredible that a foreign prospective purchaser dealing at arms’ length in respect of a project of such massive scale … would agree to accept those liabilities and encumbrances … when forfeiture of the Dalian Land was presented as a clear and present danger at the time … ” (para. 47, plaintiff’s skeleton submissions).

This contention is thus about the buyer’s (that is, the defendant’s) willingness to accept an apparently undue risk.

29.  The third contention is based on clause 8.3 of the Lucky Dragon Agreement which states:-

“… [the defendant] has not undertaken any due diligence investigation in relation to [the 4^th defendant and other companies involved in the development project] due to the lack of complete records”.

Similar to the second contention, this is also about the buyer’s willingness to accept risk.

30.  I do not find these contentions to carry a lot of weight in this application.  The fact that there were some terms in an agreement more favourable to one contracting party and other terms which were favourable to the other is more consistent with the transaction being one reached at arm’s length.  That risks have apparently been undertaken by the defendant in exchange for a price which (according to the plaintiff) was lower than the market price is also consistent with the well-known commercial notion that risky businesses usually reap a higher return.

31.  I therefore find that a meritorious defence has been shown regarding this aspect.

(3)     Actual Notice of the Australian Proceedings

32.  Before the Lucky Dragon Agreement was entered into in about April or May 2003, the 1^st defendant’s holding company (“SSI”) sold the shares in the 1^st defendant to a Central Business Asia Ltd. (“CBA”) in February 2003 (“the 2003 Share Sale Agreement”).  It is the plaintiff’s case the 2003 Share Sale Agreement was part of the fraudulent scheme to deprive it of the asset in Dalian.

33.  The plaintiff argues that:-

“The Lucky Dragon Agreement substantially copies [the 2003 Share Sale Agreement] … in form and substance”.

I understand that to refer to the similarities in the layout and wordings of the two documents.

34.  The word “Proceedings” in the 2003 Share Sale Agreement has been defined to mean the Australian proceedings.  That word appeared in “Schedule 2 – Warranties” therein:-

“9.1   Other than the Proceedings, there is:

(a) no material Claim threatened or pending against the Company; or

(b) as far as the Vendor is aware, no material fact, matter or circumstance will give rise to any Claim against the Company.

9.2    Other than the Proceedings, there are no material unsatisfied or outstanding judgments, orders or awards the Company.

9.3    Other than the Proceedings, the Company is not currently involved in any other material legal proceedings”.

35.  On the other hand, the word “Proceedings” has not been defined in the Lucky Dragon Agreement.  That word appeared in clauses 4.2(i) [delivery by the seller of documents related to the Proceedings], 6.1 [assistance to be provided by the seller in relation to the Proceedings], 6.2 [the seller was not to enter into agreement in relation to the Proceedings] and 6.4 [conduct of Proceedings before and after completion of the Lucky Dragon Agreement].

36.  Further to the above, the plaintiff says there was no reason why the word “Proceedings” has to be used in the Lucky Dragon Agreement when the term “Legal Action” (which was defined therein) should adequately serve the same purpose.

37.  I agree with the defence that it is highly arguable whether the above matters are sufficient to show actual notice on the defendant’s part.

38.  In relation to the similarities in layout and wording, there is no evidence adduced in this application to show that the defendant was aware of them.  There is also no evidence in this application the “substantial copying” (if in fact there was copying) was done by the defendant.

39.  The defence also points out that the context in which the word “Proceedings” was used in the Lucky Dragon Agreement shows that it was intended the “Proceedings” were to be taken over by the defendant after the completion of the Lucky Dragon Agreement.  It is not part of the plaintiff’s case the Lucky Dragon Agreement intended the Australian proceedings were to be taken over by the defendant.  Hence, it is at least arguable the “Proceedings” referred to those in the mainland.

40.  In relation to the last-mentioned point, Annexure A, Lucky Dragon Agreement contained documents showing the claims which have been made against the suit property by the mainland authorities.  Those documents included court order, notices of re-possession of the property, and tax demand documents.  The following appeared in some of those documents:-

“Please be advised … if you disagree with our seal-up (detention) decision, you may … request a higher-level tax authority to reconsider the case, or you may directly file it with a people’s court for legal proceedings … ”;

“[You] have the right to state and appeal …

In case you are eligible for the right of hearing and request hearing, you should present your written proposal to this tax office … ”;

“In case of disagreement with the tax office, … you may request legal institutions for reconsideration of the case … ”.

41.  In view of the above, the defendant has shown a meritorious defence in relation to this issue.

(4)     Lack of Legal Advice as Evidence of Notice

42.  This issue arises from the a letter addressed to the solicitors who witnessed the execution of the Lucky Dragon Agreement.  The letter recorded that the solicitors had advised the 4^th defendant and the defendant to seek independent legal advice regarding the Lucky Dragon Agreement.

43.  I do not consider this letter is so significant as to prevent the defendant from establishing a meritorious defence in this application.

Substantial Prejudice to the Plaintiff

44.  The plaintiff further claims it will suffer substantial prejudice if the default judgment is set aside:-

“It has been nearly 3 years since the [Victorian judgment was ] delivered, this sum remains wholly unsatisfied.  Like D1, D3-4 are companies with no real assets in the wake of the Lucky Dragon Agreement and seeking recourse from them would be futile.

…. the Dalian Project itself is in the course of being completed and it is not disputed that all 200 units of Phase 1 has already been sold” (para. 57 and 58, plaintiff’s skeleton submissions).

45.  The prejudice put forth by the plaintiff is essentially the risk that the fruits of the default judgment may be lost if the judgment is set aside unconditionally now.

46.  Having concluded that the defendant has established a meritorious defence regarding whether the Lucky Dragon Agreement falls within s. 60(3), Cap. 219, I do not find this aspect (whether on its own or together with other factors favourable to the plaintiff) is such as to warrant either not setting aside the default judgment, or setting it aside only upon condition.

Other Matters

47.  The plaintiff also put forth other matters not specifically raised in either its affidavit evidence or skeleton submissions as evidence of constructive notice.  In short, the plaintiff criticises the defendant for failing to adduce evidence regarding the following:-

(1)     the person(s) in control of the defendant;

(2)     the owner(s) of the defendant;

(3)     the person(s) in charge of the defendant’s operation;

(4)     the source of the defendant’s funds;

(5)     the person(s) involved in the negotiation of the Lucky Dragon Agreement;

(6)     whether the defendant has made enquiries about the encumbrances and liabilities relating to the suit property.

48.  The plaintiff argues that these matters are relevant to whether the defendant should be fixed with notice.  Although no authorities have been cited in support, the argument must have been based on the principle that:-

“[a person can be fixed with notice] … where [he] has, whether deliberately or carelessly, abstained from making those inquiries that a prudent [person] would have made” (Snell’s Equity (2005) 31^st Ed., para. 4-33, where the principle was referred to in the context of a bona fide purchaser).

49.  I disagree with the argument.  First, as the defendant contends, it should only be required in this application to show a meritorious defence in relation to the plaintiff’s pleaded case.  Secondly, as a matter of procedural fairness, the defendant should be entitled to know the case it has to meet.  The law does not require it to conduct a roving expedition in order to show a defence.

50.  The plaintiff also relies on the proximity in time between various steps taken in relation to the Lucky Dragon Agreement and those taken in the Australian proceedings.  But the time proximity does not necessarily mean the defendant was a party to the fraud; it could also be the result of the other defendants pressing for the conclusion of the Lucky Dragon Agreement while they were delaying the progress of the Australian proceedings.

51.  It is common ground that, in deciding whether to set aside a regular judgment, the court should consider all relevant circumstances including the reason for the default, the length of the delay in filing a defence, the reason for and length of the delay in making the application to set aside and the defendant’s conduct.  For the avoidance of doubt, I have also considered the whole circumstance relevant to this application.

Conclusion

52.  The judgment is set aside unconditionally.  The parties may be able to agree to directions for the future conduct of this action.  In case of disagreement, there will be liberty to apply for such purpose (I leave it to them to decide whether such a hearing should be heard together with, or independently of, the arguments on costs (see below)).

Costs

53.  The parties expressly ask for that matter to be reserved to enable further submissions to be made.  Accordingly, no decision will be made thereon at present.