BANK OF CHINA (HONG KONG) LTD v. CHEUNG LUEN KWAN AND OTHERS

HCA 3385/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 3385 OF 2002

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J U D G M E N T

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The background

1. The plaintiff is a bank. With effect from 1 October 2001 Sin Hua Bank Limited, Hong Kong Branch, ("SHB") merged with the plaintiff by virtue of the Bank of China (Hong Kong) Limited (Merger) Ordinance, Cap. 1167 ("the Ordinance").

2. The 1st defendant ("D1") and the 2nd defendant ("D2") were customers of SHB at all material times. D1 and D2 together ran a business for the trading of leather goods in 1990. At or about the end of 1991 Hing Yip International Development Limited ("Hing Yip") took over the business that they had been running. D1 and D2 each held 50% of the shares in Hing Yip. They were also the only two directors of Hing Yip.

3. Hing Yip was a customer of SHB and was granted banking facilities by SHB. D1 and D2 as directors and shareholders of Hing Yip were required to and did provide personal guarantees to SHB as guarantors for the facilities granted to Hing Yip.

4. D1 was also a customer of SHB. He was granted a mortgage loan for the purchase of a property known as Flat C (with flat roof) 6th floor, Block 9, Park Versailles 1, No. 8 Mui Shu Hang Road, Shui Wai, Tai Po, New Territories ("D1's property) in or about November 1997.

5. D2 and his wife were also customers of SHB. They were granted a mortgage loan for the purchase of a property known as Flat B, 2nd floor, Block 11, Phase 1 and Car Parking Space No. 370 on Ground Floor, Park Versailles, Shui Wai, Tai Po, New Territories ("D2's property") in or about 1995.

6. In about early September 2000 D1 contacted Mr. Lee Sik Tim ("Mr. Lee") of SHB and told him that he intended to sell D1's property but that the sale price was not sufficient to cover the outstanding mortgage loan to SHB. In view of the fall in property values, the selling price was less than the outstanding mortgage loan and D1 was thus a "negative equity" owner.

7. D1 requested SHB to restructure the shortfall due from him to SHB after the intended sale so that he could repay the same by instalments. The anticipated shortfall was about HK$1,530,000.

8. The above facts are undisputed.

9. It is also undisputed that SHB eventually granted D1 a loan in the sum of HK$1,530,000 and that the loan would be repayable by 60 monthly instalments of HK$32,885.67.

10. By an Undertaking for repayment of loan dated 20 November 2000 D1 agreed to repay SHB the loan of HK$1,530,000 with interest by 60 equal monthly instalments of HK$32,885.67 ("the undertaking").

11. By a Deed of Guarantee also dated 20 November 2000 executed by D2, D2 provided SHB with his personal guarantee in favour of SHB whereby he agreed to pay and satisfy to SHB on demand in writing all sums of money owing by D1 to SHB to the total extent of the specified amount of HK$1,530,000 together with interest accrued ("the guarantee"). Although D2 accepts that he signed the guarantee, the circumstances under which he signed the same and was required by SHB to provide the same are disputed.

12. By virtue of section 8 of the Ordinance as from the effective date of 1 October 2001 all existing contracts, agreements, guarantees and undertakings entered into by, made with and given to SHB shall be construed and shall have effect as if the plaintiff had been a party thereto instead of SHB and the plaintiff shall have the same rights, powers and remedies for, inter alia, enforcing the right or liability of SHB as if it had at all times been a right or liability of the plaintiff.

13. Since about February 2002 D1 defaulted in making repayments due to the plaintiff.

14. Despite demands made on D1 and D2, D1 and D2 have not made payments to the plaintiff.

The claim

15. On 4 September 2002 the plaintiff instituted these proceedings against D1 as the principal debtor and D2 as the guarantor claiming the sum of HK$1,293,084 together with interest and costs.

16. On 10 October 2002 the plaintiff obtained a default judgment against D1. It was adjudged that D1 do pay the plaintiff the sum of HK$1,293,084 together with interest on the sum of HK$1,248,880,83 at the rate of 10.125% (5% over the prime rate) from 8 August 2002 to date of judgment and thereafter at judgment rate until payment and HK$1,550 fixed costs.

17. The remaining claim in this action is against D2 as guarantor.

The defence

18. D2 denies that he is liable to the plaintiff on the guarantee.

19. In D2's defence and counterclaim he alleged that :

(1) D1 and D2 were close personal friends. They had a joint business being Hing Yip. D1 and D2 both bought properties in Tai Po, drove to work in each other's cars and visited each other often particularly, during Chinese festivals. They have travelled together to the USA and the Mainland (paras. 13(a) to (c));

(2) D1 and D2 had joint personal savings accounts and foreign currency accounts with SHB in which they were both signatories and could effect transactions independently (para. 13(d)).

(3) D2 left the handling of all the financial matters of Hing Yip to D1 (para. 13 (e));

(4) SHB, through their agents Mr. Ma Kin Fai ("Mr. Ma") and Mr. Lee knew or ought to have known about the matters pleaded in para. 13 and that D1 had a specially close relationship with Mr. Ma (para. 14);

(5) the plaintiff was aware or ought to have been aware that D2 reposed trust and confidence in D1 in the management of D2's financial affairs. The guarantee was manifestly disadvantageous to D1. The plaintiff was, therefore, put on constructive notice of the risks of undue influence having been exercised by D1 on D2 in procuring D2 to act as surety for his loan (para. 16);

(6) despite the above, the plaintiff neither explained the meaning and effect of the guarantee to D2 nor pointed out the risks that D2 would be running. The plaintiff also did not ask D2 to seek independent legal advice (para. 17).

20. There is also a counterclaim seeking a declaration that the guarantee be set aside.

21. By para. 21 of the counterclaim D2 also alleged that the plaintiff wrongfully froze his accounts with the plaintiff and deprived him of using the same. By prayer 2 thereof D2 was seeking an order that he be permitted to utilize his accounts with the plaintiff. However, para. 21 and prayer 2 of the counterclaim were ordered to be struck out by consent at the pre-trial review on 11 May 2004. This was no longer an issue at the trial.

The agreed issues

22. The following are the agreed issues :

"1.	Whether a presumption of undue influence has arisen.
	(1)	Whether [D2] had placed a sufficient degree of trust and confidence in [D1] in relation to the management of [D2's] financial affairs.
	(2)	Whether [D2's] execution of the [guarantee] was not readily explicable by the relationship between [D1] and [D2].
2.	If the answer to 1 is yes, whether the Plaintiff was "put on inquiry".
	(1)	Whether the Plaintiff had knowledge of the relationship between [D1] and [D2].
	(2)	Whether the nature of the [guarantee] was such as to be apparently disadvantageous to [D2].
3.	If the answers to 1 and 2 are yes, whether the Plaintiff has taken sufficient steps to satisfy itself that [D2's] agreement had been properly obtained."

23. It is only if the answer to both sub-issues (1) and (2) of Issue 1 are yes that the Court should go on to consider Issue 2. And it is only if the answer to both Issues 1 and 2 are yes that the Court should then go on to consider Issue 3.

The applicable principles

24. D2 relies on a presumption of undue influence.

25. It is common ground that there are two classes of relationships which raise a presumption of undue influence. They have been termed as Class 2(A) and Class 2 (B) relationships.

26. The applicable principles were succinctly stated by Lord Browne-Wilkinson in Barclays Bank Plc. v. O'Brien and Another [1994] AC 180 at page 189 as follows :

“ Class 2 : Presumed undue influence

In these cases the complainant only has to show, in the first instance, that there was a relationship of trust and confidence between the complainant and the wrongdoer of such a nature that it is fair to presume that the wrongdoer abused that relationship in procuring the complainant to enter into the impugned transaction. In Class 2 cases therefore there is no need to produce evidence that actual undue influence was exerted in relation to the particular transaction impugned: once a confidential relationship has been proved, the burden then shifts to the wrongdoer to prove that the complainant entered into the impugned transaction freely, for example by showing that the complainant had independent advice. Such a confidential relationship can be established in two ways, viz.,

Class 2(A)

Certain relationships (for example solicitor and client, medical advisor and patient) as a matter of law raise the presumption that undue influence has been exercised.

Class 2(B)

Even if there is no relationship falling within Class 2(A), if the complainant proves the de facto existence of a relationship under which the complainant generally reposed trust and confidence in the wrongdoer, the existence of such relationship raises the presumption of undue influence. In a Class 2(B) case therefore, in the absence of evidence disproving undue influence, the complainant will succeed in setting aside the impugned transaction merely by proof that the complainant reposed trust and confidence in the wrongdoer without having to prove that the wrongdoer exerted actual undue influence or otherwise abused such trust and confidence in relation to the particular transaction impugned."

27. The relationship between D1 and D2 did not fall under Class 2(A).

28. D2 relies on the Class 2(B) presumption. It was accepted by Mr. Au-Yeung, for D2, that the burden of proof of establishing the presumption of undue influence was on D2.

29. As was said by Lord Nicholls of Birkenhead in Royal Bank of Scotland plc. v. Etridge [2001] 3 WLR 1021 at page 1032 :

"21. As already noted, there are two prerequisites to the evidential shift in the burden of proof from the complainant to the other party. First, that the complainant reposed trust and confidence in the other party, or the other party acquired ascendancy over the complainant. Second, that the transaction is not readily explicable by the relationship of the parties."

30. And as Recorder Ma SC (as he then was) said in Bank of China (Hong Kong) Ltd. v. Wong Kin Sing [2002] 1 HKC 83 at page 96 :

"In Class 2 (B) cases, the complainant needs to do more before the presumption arises. Here, the complainant has first to show that :

(a) he placed trust and confidence in the influencer or that the influencer had acquired an ascendancy or domination over him; and

(b) the transaction cannot be readily explicable by the relationship of the parties."

31. It is abundantly clear that in order to raise the Class 2(B) presumption D2 must show :

(1) that he placed trust and confidence in D1 or that D1 had acquired an ascendancy or domination over him; and

(2) that the transaction cannot be readily explicable by the relationship between the parties.

The evidence and findings

32. I heard evidence from Mr. Lee and Mr. Lo Hon Fai ("Mr Lo") both of the plaintiff. I also heard evidence from D2. Much of the evidence was not in dispute. However, there was a serious dispute of fact as to when D2 was asked to provide the guarantee and the circumstances surrounding the execution of the same.

33. Mr Lee gave evidence that in early September 2000 D1 contacted him and told him that he intended to sell D1's property. D1 felt that property values had fallen after 1997 but would not recover soon. In view of this and the faltering economy D1 felt that it would be difficult for Hing Yip to collect payments from customers and that as a consequence he might not be able to make mortgage repayments on the mortgage loan SHB had granted to him. At that time, however, D1 was not in arrears in his mortgage repayments. D1 wanted to sell D1's property but was afraid that he might not be able to make up the difference between the purchase price and the selling price of the same. He, therefore, asked for debt restructuring.

34. Mr Lee said that he prepared a brief proposal for his superior, Mr. Ma, who proposed that as there was no property given as security for this loan to D1, D2 was required to provide his personal guarantee before the loan could be approved. Mr. Ma asked Mr. Lee to make a detailed proposal to the Head Office for their approval. This Mr. Lee did on the basis that the property would be sold for HK$4,200,000. As D1 was owing HK$5,730,000 at that time, the shortfall would be HK$1,530,000. This loan would be repayable over 5 years by 60 instalments. It was also proposed that D1's business partner, namely D2, would provide a personal guarantee.

35. Mr Lee also said that before he submitted the proposal to Head Office for approval, he called up D1 and told him that a term for the loan was that D2 should provide SHB with his guarantee to guarantee D1's payment obligations. D1 told him that would not be a problem.

36. Mr Lee also gave evidence that he had considered that D1 was 50% owner of Hing Yip and he viewed the accounts of D1, D2 and Hing Yip as a group. They had not been in arrears in their payment obligations and if D2 could provide a guarantee then it was reasonable to grant D1 the said loan of HK$1,530,000.

37. Mr Lee also said that the Head Office approved the proposal in or about October 2000. SHB agreed to grant the said loan to D1 which loan proceeds would be used to settle the shortfall and that the said loan would be repayable by 60 equal monthly instalments of HK$32,885.67 each. As a condition for the grant of the said loan, SHB required D2 to give a personal guarantee in favour of SHB.

38. After the Head Office had given its approval, Mr Lee and Mr. Ma had a meeting with D1 and D2 at the Panda Hotel in Tsuen Wan. Although Mr Lee did not say when this took place this must have been before 20 November 2000. At that meeting Mr. Ma informed D1 and D2 of the terms of the loan and the requirement of a personal guarantee from D2. This was the first time that D2 knew that he was required to provide his personal guarantee.

39. D2, however, denied that he was ever told about the provision of a guarantee from him for the loan to D1. He accepted that there was a meeting at the Panda Hotel with Mr Ma, Mr Lee and D1 but denies that they ever talked about D1 selling D1's property and about the requirement that he should provide a guarantee for D1's payment obligations.

40. On this dispute of fact, I much prefer the evidence of Mr. Lee to that of D2. I found Mr. Lee to be an honest, credible and reliable witness and I believe him. I do not believe D2 on these matters. He was evasive. I find that he did not tell me the truth about the matters. Where D2's evidence is at variance with Mr Lee's evidence, I much prefer Mr Lee's evidence to that of D2. I accept Mr Lee's evidence and reject D2's evidence on these matters.

41. I find that D2 was informed at the meeting at the Panda Hotel of the terms of the loan to be granted to D1 and that he was required to provide a guarantee for the payment obligations of D1 under the loan. He did not raise any objection to this. This was before 20 November 2000.

42. There is also a dispute of fact as to the circumstances of the signing of the signing of the guarantee by D2.

43. Mr Lo gave evidence that in the afternoon of 20 November 2000 he went to the offices of Hing Yip as he had been instructed by Mr. Ma to bring along the undertaking and the guarantee to be executed by D1 and D2 respectively. He first took out the undertaking for D1 to sign and after explaining the same to him D1 signed the same in his presence.

44. Mr Lo then arranged for D2 to sign the guarantee. Before D2 signed the same he explained to D2 that SHB had provided D1 with a loan of HK$1,530,000. He also told D2 about the repayment terms and the repayment amount and that SHB required that D2 should be a guarantor as a condition for the loan. He also told him that if D1 did not make repayment then SHB would be entitled to claim the same from D2. He did not explain each and every term of the guarantee to him. D2 signed the guarantee in his presence.

45. D2, however, gave evidence that on 20 November 2000 a bank officer, who must have been Mr Lo as D2 accepted, came to Hing Yip's offices in the afternoon. He himself had been out of the offices and returned at about 4 pm. After he sat down for a while D1 and Mr Lo appeared. D1 and D2 were asked to sign some documents including loan documents of Hing Yip. After D1 and D2 had signed the loan documents of Hing Yip, the bank staff said to D1 "as to this document, you don't have to look at it, you know what it is".

46. The bank staff then took out the guarantee for D2 to sign. D2's first reaction was to ask what it was. He was told that it related to the outstanding amount of D1's sale of D1's property. The bank staff said that he was a director of the company and that it was just a document to guarantee another director of the company. It was nothing much. D2 also said that no other explanation was given. D2 said that as their image with the bank was important he signed his name on the guarantee. He emphasised that when they dealt with the bank the question of their image was important. In view of the embarrassing situation that he was placed in he just signed his name.

47. On this dispute of fact, I much prefer the evidence of Mr Lo to that of D2 where their evidence is at variance with one another. I found Mr Lo to be a truthful, credible and reliable witness. I believe him and accept his evidence. I do not believe D2 on these matters. I find that he was not telling me the truth on these matters and I do not accept his evidence of the same.

48. I find that on 20 November 2000 D2 already knew that he was required to provide a guarantee for the loan to D1. He already knew of the terms of the loan and the repayment terms and that he was required to provide a guarantee to SHB for D1's payment obligations. He knew all this because he had been informed of the same by Mr. Ma at the meeting at the Panda Hotel prior to 20 November 2000. He was obviously prepared to provide the guarantee as he did not raise any objection.

49. I find that Mr Lo did explain the effect of the guarantee to him by telling him of the terms of the loan to D1 and the repayment terms and by telling him that it was a guarantee to SHB for D1's repayment of the said loan granted to D1. Lo did not explain the detailed terms of each and every term of the guarantee. However, nothing turns on that on the agreed issues between the parties.

50. It was D2's evidence that Mr. Ma had looked after all the accounts of Hing Yip as well as the personal and joint accounts of D1 and D2. D2 also believed that Mr. Ma knew of the close personal relationship between D1 and D2.

51. I accept part of D2's evidence. I accept D2's evidence that he and D1 were close personal friends and also business partners. D2's evidence was that he knew D1 since 1985. They ran a business together of trading in leather goods. Hing Yip was established in 1991 to take over their business. They developed a close personal relationship. They both bought properties in Tai Po and lived there. They drove to work in each other's cars and visited each other often particularly, during Chinese festivals. They have also taken business trips together to the USA and to the Mainland from time to time. On the documentary evidence, D1 and D2 had joint accounts which included savings accounts and foreign exchange account. They also had a securities account. The securities and foreign exchange accounts were for their joint investments. The documentary evidence also shows that for one of the joint accounts, any one of their signatures was sufficient to operate the account.

52. D2 explained that he left all the business in Hong Kong in the hands of D1. There seems to have been a division of responsibilities, namely D2 was responsible for purchasing and production in the Mainland and that was why he was not often in Hong Kong. D1 was responsible for the business in Hong Kong. D1 was also the general manager and was in charge of all the affairs in Hong Kong including the financial matters of Hing Yip which were entrusted to D1. D2 said that the joint savings account he had with D1 was in relation to the commercial activities which D1 and D2 undertook which was not necessarily Hing Yip's activities. He accepted that it was a sensible division of responsibilities of Hing Yip that D2 should handle the business matter in the Mainland whist D1 handled the financial matters of Hing Yip. I also accept this evidence of D2.

53. On the evidence I accept that D2 did entrust D1 with the financial affairs of Hing Yip. D2 did also operate joint accounts with D1 and did entrust him to operate the same as D1 was in Hong Kong and D2 was often in the Mainland. These were for joint investments. However, it is significant and important to observe that D2 did not entrust D1 with all of his financial affairs. In cross-examination, he accepted that for his own financial affairs in respect of his own family he did not entrust the same to D1. This is important, in my view, as it demonstrates that this case is a far cry from the cases where one entrusts a close friend or a confidant with all of his financial affairs or everyday needs.

54. I would refer to the helpful observations of Le Pichon JA in Li Sau Ying v. Bank of China (Hong Kong) Limited and another (Civil Appeal No. 309 of 2002, 11 April 2003) at para. 32 where she said :

"Trust and confidence are not to be extrapolated from what, with hindsight, turned out to be improvident or ill-advised transactions. That was the gist of Sir John Salmond's observations in Brusewitz. What the plaintiff must do is to prove the circumstances of the relation between the parties as would establish a relation of superiority on the one side and inferiority on the other. In a very loose and general sense, one 'trusts' one's friends. But that does not mean that the friend is necessarily in a position of influence or dominance. That has to be established by evidence. If, for example, he had, in the relationship, acquired the role of 'confidant' or adviser or had been entrusted with the management of the former's financial affairs or everyday needs, that may well be sufficient. But that was not the case here"

55. The reference to Sir John Salmond's observations in Brusewitz is a reference to what Sir John Salmond said in Brusewitz v Brown (1922) 42 NZLR 1106 at pages 1109-1110 :

"... The Law is general leaves every man at liberty to make such bargains as he pleases, and to dispose of his own property as he chooses. However improvident, unreasonable or unjust such bargains or dispositions may be, they are binding on every party to them unless he can prove affirmatively the existence of one of the recognised invalidating circumstances, such as ... undue influence."

56. In my judgment the evidence shows clearly that D2 did not repose trust and confidence in D1 in relation to the management of D2's financial affairs. They were business partners and also close personal friends. They also invested jointly and D2 entrusted the financial affairs of Hing Yip to D1. He also entrusted D1 with the operation of the joint accounts where they had their joint investments. However, what is important, is that he did not leave all of his financial affairs in the hands of D2.

Issue 1(1)

57. As to Issue 1 (1) I find that D2 did not place a sufficient degree of trust and confidence in D1 in relation to the management of D2's financial affairs.

Issue 1(2)

58. As to Issue 1(2), D2's execution of the guarantee is, in my judgment, readily explicable by the relationship between D1 and D2. They were both business partners each holding 50% of the shares in Hing Yip. They had also both given their personal guarantees for the facilities granted by the bank to Hing Yip. It was never suggested in the pleadings nor in evidence that D2 exerted any influence on him to sign the guarantee. It is significant that D2 signed the guarantee not because of anything D1 said to him but, as he said in evidence, because he thought that it was important to their image. He was obviously concerned about their image with SHB and this led him to sign the guarantee. Mr. Lee also said, and I accept, that from the bank's point of view, if D1 were to be unable to pay his debts and were declared bankrupt the bank could even reduce the credit limit of Hing Yip or even call in the loans extended to Hing Yip.

59. It seems to me, and I so find, that the execution of the guarantee was readily explicable by reason of the fact that D1 and D2 were business partners who were also close personal friends. The business of Hing Yip had a division of responsibilities with D1 being responsible for all financial affairs of Hing Yip and for getting business for Hing Yip whilst D2 was responsible for purchasing and production in the Mainland. D2 had already executed a personal guarantee for Hing Yip's liabilities to the bank. Also, D2 and his wife had also re-mortgaged their own property to secure Hing Yip's liabilities. If Hing Yip were to become unable to pay its debts it is highly likely that the bank would seek to enforce D2's personal guarantee in respect of Hing Yip's liabilities to SHB. The financial interests of D1 and D2 were obviously related. In my judgment it was also in D2's financial interest to try and ensure that D1 was able to pay his debts. In the circumstances, in my judgment the execution of the guarantee was readily explicable by the relationship between D1 and D2.

60. Issue 1(2) is also resolved in favour of the plaintiff.

61. The answers to both sub issues (1) and (2) of Issue 1 are no.

62. It is unnecessary in the circumstances to deal with the other issues.

Conclusion

63. There is a conclusive evidence clause in the guarantee as by clause 8(a) of the guarantee it is provided, inter alia, that any judgment recovered by the bank against D1 in respect of his indebtedness to the bank shall be binding and conclusive against D2.

64. The plaintiff obtained judgment against D1 on 10 October 2002 for the sum of HK$1,293,084 together with interest on the sum of HK$1,248,880.83 at the rate of 10.125% (5% over the prime rate) from 8 August 2002 to date of judgment and thereafter at judgment rate until payment and HK$1,550 fixed costs.

65. The plaintiff is entitled to judgment as claimed against D2. I give judgment to the plaintiff against D2 for the sum of HK$1,248,880.83 together with interest on the sum of HK$1,248,880.83 at the rate of 10.125% per annum (5% per annum over the prime rate), subject to fluctuation, from 8 August 2002 until 10 October 2002 and thereafter at judgment rate until payment. The counterclaim is dismissed.

66. I also make an order nisi that D2 should pay the plaintiff its costs of the action and of the counterclaim.