XCHRX LARK INTERNATIONAL LTD. v. CHAN HIN FAI WILSON

1994 No. A8372

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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J U D G M E N T

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THE FACTS

1. The Third Party, Malton House Ltd. ("Malton House"), did business in China. It owed the Hong Kong Bank ("the Bank") over US$2 million. This indebtedness had been guaranteed by the Plaintiff, Lark International Ltd. ("Lark"), which had a 60% controlling interest in Malton House. However, Malton House was not able to discharge its indebtedness to the Bank because its customers in China had been slow in paying their debts to Malton House. If the Bank called in Malton House's debt, Lark would have to pay up.

2. What happened, though, was that at the request of the Defendant, Mr. Wilson Chan, Lark lent US$2 million to Malton House. That was in October 1992. Malton House could then pay off its debt to the Bank immediately. The loan agreement provided that any sums paid to Malton House by its customers were immediately to be paid to Lark to reduce the loan. However, the repayment of Malton House's loan to Lark was guaranteed by Mr. Chan, who owned the remaining 40% of the shares in Malton House. This arrangement suited Lark. Under the old arrangement, Lark was liable to pay Malton House's indebtedness to the Bank. It is true that, under the new arrangement, Lark had to pay US$2 million itself to Malton House, but Lark would be able to recoup that from Malton House if its customers paid up, or from Mr. Chan under the guarantee if they did not. However, this was an arrangement which Mr. Chan was prepared to enter into. He was confident that Malton House would in due course be paid by its customers, and he must have realised that he was now guaranteeing Malton House's repayment of its debt of US$2 million in place of Lark.

3. The loan agreement provided that, if Malton House became unable to pay its debts when due, the balance of the loan then outstanding, plus accrued interest, became due and payable to Lark immediately. In June 1994, Malton House became unable to pay its debts when it failed to pay a sum in excess of $100,000.00 which was owed to a creditor in China. Accordingly, the balance of the loan then outstanding became due and payable to Lark. Lark claimed that, with interest, the amount due and payable was the sum of US$1,409,578.20. Lark's solicitors required Mr. Chan to pay that sum to Lark. When he did not do so, Lark commenced these proceedings against him for that sum. On 27th April, Master Jones gave Lark summary judgment for that sum under Ord. 14. Mr. Chan now appeals against that judgment. He claims to have two defences to Lark's claim.

THE DEFENCE ON QUANTUM

4. Mr. Chan's first defence relates only to the amount claimed. He says that Lark has failed to credit Malton House with sums of RMB$700,000.00 and RMB$3,600,000.00, which are said by Mr. Warren Chan Q.C. for Mr. Chan, on the basis of Mr. Chan's instructions, to be equivalent in total to about US$800,000.00 at the official rate of exchange. Those sums were repaid to Lark in December 1992 and March 1993 respectively. For its part, Lark does not deny receiving those payments from Malton House. Nor does it deny failing to give Malton House credit for those payments. Instead, Lark claims that they were repayments in respect of another loan made by Lark to Malton House in February 1993 for US$500,000.00. Even if that is correct, though, Lark must have failed to give credit to Malton House for about US$300,000.00, being the difference between the amount of the loan and the amount repaid, assuming, of course, that Mr. Chan's instructions to his counsel are correct.

5. However, in my judgment, the matter goes further than that for two reasons :

(i) There is, in my view, a triable issue as to whether there was a loan of US$500,000.00 at all. Although that is asserted in an affidavit sworn by Mr. Michael Kwong, Lark's Chief Financial Officer, the documents which he produces to support it show merely that Lark paid the Bank the sum of US$500,000.00 to settle a loan for that amount which the Bank had made to Malton House. The documents do not show that Lark lent that sum to Malton House.

(ii) Even if Lark had lent the sum of US$500,000.00 to Malton House in February 1993, there is nothing, apart from Lark's "Statement of Account with Malton House", which suggests that either of the two RMB payments were appropriated by Lark to the repayment of that loan (which I assume Mr. Chan did not guarantee) as opposed to the repayment of the October 1992 loan (which Mr. Chan did guarantee). As it is, the first payment of RMB$700,000.00 is likely to have been made in respect of the October 1992 loan because the February 1993 loan had not been made at the date of payment. For all I know, discovery may reveal documents which show that Malton House made the second payment of RMB$3,600,000.00 against the October 1992 loan, or that Lark appropriated it to that loan. There is therefore a triable issue, in my view, as to which loan the two payments related.

THE DEFENCE ON LIABILITY

6. Mr. Chan's second defence is more fundamental. He claims that Malton House received sums totalling about HK$13 million from its customers in China between late 1992 and the middle of 1993. That is said to be the equivalent of about US$1.68 million. That claim is not disputed by Lark. What is disputed is what Malton House did with the money. It certainly did not repay all the money to Lark, because Lark's "Statement of Account with Malton House" shows that Malton House has repaid only about HK$6.5 million to Lark. Indeed, there is no evidence before me that these repayments represented the payments made to Malton House by its customers. On the face of it, therefore, Malton House was in breach of its obligation in the loan agreement to pay to Lark sums paid by its customers immediately on their receipt, though the extent of that breach depends on what proportion of the HK$6.5 million repaid to Lark represented payments to Malton House by its customers.

7. However, what is also important for present purposes is what Malton House did with the payments it received from its customers which it did not repay to Lark. That is disputed. Mr. Chan claims that Malton House used the money for its other business ventures. Lark says that it did not. However, since there is no evidence from Lark as to what the money was used for (if it was not used for Malton House's other business ventures), there is, in my view, a triable issue as to whether it was used by Malton House for its other business ventures. In those circumstances, it is arguable that Lark, by virtue of its controlling interest in Malton House, connived at Malton House's breach of its obligations under the loan agreement. It is arguable that it did so by permitting Malton House to use the money which the loan agreement had required Malton House to repay to Lark to further its other business ventures. That would have been to the detriment of Mr. Chan, who would have been left having to honour the guarantee if those business ventures failed and Malton House was unable to repay the balance of the loan when it matured in October 1994. In other words, Mr. Chan would have been left to honour the guarantee, which would otherwise have been discharged if Malton House had used the money which it had received from its customers to repay off the loan in the first place.

8. On these facts, Mr. Chan may well have a defence in law. That is because in Bank of India v. Trans Continental Commodity Merchants Ltd. [1983] 2 Lloyd's Rep. 298, the Court of Appeal in England held that a surety may be discharged from liability under a guarantee if the creditor connives at the default of the principal debtor. Since it is arguable that Lark connived at the default of Malton House, it is arguable that in those circumstances Mr. Chan should be discharged from his liability under the guarantee.

9. Two points are taken by Mr. Russell Coleman for Lark. First, if there was connivance between Lark and Malton House in Malton House's default, Mr. Chan himself was a party to that connivance in his capacity as managing director of Malton House at the time and as a significant shareholder in Malton House. However, whether Mr. Chan was a party to that connivance - merely on the basis of his connection with Malton House which was going to benefit from the indulgence which Lark gave to Malton House - is, in my view, an arguable issue of fact. After all, Lark had the controlling interest in Malton House, and it did not need Mr. Chan's participation in the connivance to enable it to grant Malton House an indulgence in relation to the repayment of the loan.

10. Secondly, Mr. Coleman relies on clauses 3 and 4 of the guarantee. In clause 3, Mr. Chan agreed "to remain primarily liable to [Lark] for the obligations of [Malton House] under the Loan Agreement". Mr. Coleman claims that, on a proper construction of this clause, its effect is that, even if Malton House's default was due to connivance between Lark and Malton House, Mr. Chan remained primarily liable for the debt. That, he says, is especially so when one remembers that clause 3(a) provided that Mr. Chan's primary liability was not to be affected by any indulgence given by Lark to Malton House. I see the force of that argument, but I must remember that contracts of guarantee, especially ones drawn up by the creditor as the evidence suggests happened in this case, must be construed strictly in favour of the guarantor. It would be unlikely, to put it at its lowest, for a guarantor to agree to remain liable for the principal debtor's debt when the debt remains outstanding as a result of connivance between the creditor and the principal debtor to which the guarantor was not a party. Indeed, none of the seven examples given in clause 3(a) of the guarantee of circumstances which would not affect Mr. Chan's liability relate directly to unfair or oppressive conduct on the part of Lark.

11. In clause 4 of the guarantee, Mr. Chan agreed that "any sum expressed to be payable by [Malton House] under the Loan Agreement but which is for any reason not recoverable from [Mr. Chan] on the basis of a guarantee shall nevertheless be recoverable from [Mr. Chan as] if [he] was the sole principal debtor". I do not overlook the words "for any reason". However, in Smith v. South Wales Switch Gear Co. Ltd. [1978] 1 W.L.R. 165, the supplier was absolved from liability under the indemnity which it had given, even though the supplier had agreed to indemnify the purchaser against any "liability, loss, claim or proceedings whatsoever". The House of Lords was not prepared to construe the indemnity, despite the presence of the word "whatsoever", as relating to liability arising out of the negligence of the purchaser's workforce. Like the House of Lords, I do not regard the presence of the words "for any reason" as necessarily excluding all the reasons for which the debt might not be recoverable from Mr. Chan. I conclude, therefore, that it is arguable that, properly construed, clauses 3 and 4 of the guarantee did not render Mr. Chan liable under the guarantee if Malton House's default was due to connivance between Lark and Malton House.

CONCLUSION

12. For these reasons, this appeal must be allowed, the order of Master Jones of 27th April must be set aside, and I give Mr. Chan unconditional leave to defend the action.