POLYSET LTD. v. PANHANDAT LTD.

CACV70/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 70 OF 2000

(ON APPEAL FROM HCMP 1840 OF 1998)

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J U D G M E N T

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Hon Rogers VP :

1. This is an appeal from a judgment of Deputy Judge Li dated 20 January 2000 following decisions which he had given on 23 November 1999 and 20 January 2000. The judge made a declaration that the plaintiff had wrongfully rescinded an agreement for sale and purchase dated 23 May 1997 in respect of a property in Cannon Street, Wanchai and that the plaintiff was in breach of the agreement in failing to complete. The second declaration made was that the defendant was entitled to forfeit and retain HK$40,250,000.00 paid by the plaintiff to the defendant under the said agreement. That declaration continued with the words "which extinguishes the damages of the defendant assessed at HK$33 million." Apart from awards of interest which the judge made, there was also an order that the defendant should repay a further sum of HK$11,534,575.34.

2. The plaintiff appeals the finding that it wrongfully rescinded (or more accurately repudiated) the agreement and in the alternative claims that the sum of $40,250,000 was a penalty and that the only sum that the plaintiff should be held liable for was an amount of $33 million which the judge had held to be the damage suffered by the defendant.

Background

3. By written agreement dated 23 May 1997, the plaintiff agreed to purchase a building known as No.2 Cannon Street which was formerly 519 Jaffe Road in Wanchai. There were a total of five shops in the building. The purchase price was HK$115,000,000.00. There were a number of unusual features about this agreement. In the first place, completion was to be delayed for slightly over 9 months. The completion date was to be 2 March 1998. The property was sold subject to existing tenancies and there were provisions in the agreement in respect of those. The vendor was required to show and give good title to the property. In that respect, the agreement was unusual because reference was made to two existing orders which had been registered against the property. These are referred to in clause 12(a) which is set out here as it is an important clause :

"Save and except the existing two orders which have been registered at the Land Registry by Memorial Nos.6436976 and 6436979 ('the said two orders') in respect of the Property and are referred to in Clause 25 hereinafter, the Vendor hereby warrants and declares that the Vendor has not received and is not aware of there being any notice or order from any Government or other competent authority or the manager or the management committee of the building of which the Property forms part requiring the Vendor to demolish or reinstate or improve any part of the Property. If it should be discovered that any notice or order for demolition or reinstatement or improvement unrelated to the subject matter of the said two orders has been issued/served before the date of completion, the costs for such demolition or reinstatement or improvement shall be solely borne by the Vendor and the Purchaser shall have the option to rescind this Agreement whereupon the said deposit and all monies paid hereunder shall be returned to the Purchaser forthwith by the Vendor in full but without any compensation interest or costs and neither party shall have any claim against the other hereon and the parties hereto shall [be][at] the costs of the Vendor enter into and cause to be registered at the Land Registry an Agreement for Cancellation."

4. Clause 25 of the agreement provides that the cost of complying with the two orders was to be borne by the purchaser, the plaintiff.

5. For convenience, it would also be convenient to set out at this juncture the provisions of clause 26 which relate to failure to perform the provisions of the contract and provide for forfeiture of the deposit should the purchaser fail to complete.

6. Clause 26(a) and (b) :

"(a) Should the Purchaser fail to observe or comply with any of the terms and conditions herein contained, the Vendor may (without tendering an Assignment to the Purchaser) forthwith determine this Agreement by giving notice of termination in writing to the Purchaser's solicitors to such effect and the Vendor shall thereupon be entitled to re-enter upon the Property and repossess the same if possession shall have been given to the Purchaser free from any right or interest of the Purchaser therein and the Vendor shall be entitled to forfeit the said deposit. Upon determination of this Agreement the Vendor may resell the Property either by public auction or by private contract or partly by one and partly by the other subject to such stipulations as the Vendor may think fit and any increase in price on resale shall belong to the Vendor. Without prejudice to the Vendor's right to recover the actual loss which may flow from the Purchaser's breach of this Agreement, on such resale any deficiency in price shall be made good and all expenses attending such resale shall be borne by the Purchaser and such deficiency and expenses shall be recoverable by the Vendor as and for liquidated damages. On the exercise of the Vendor's right to determine this Agreement as aforesaid, the Vendor shall have the right, if this Agreement shall have been registered at the Land Registry, to register at the Land Registry an instrument signed by the Vendor alone evidencing determination as aforesaid of the sale of the Property. This Clause shall not preclude or be deemed to preclude the Vendor from recovering, in addition to the liquidated damages, damages representing interest paid or lost by him by reason of the Purchaser's default and failure.

(b) For the avoidance of doubt, as it is an important commercial term and condition to this Agreement, the Purchaser hereby expressly acknowledges, agrees accepts confirms that in the light of the unusual long duration for completion, the Vendor shall be entitled to, without prejudice to the Vendor's other rights under this Agreement, forfeit the said deposit in full absolutely as agreed damages, i.e. HK$40,250,000.00 should the Purchaser fail to comply with Clause 26(a)."

7. The deposit which was recorded in clause 26(b) as being a total of HK$40,250,000.00 comprised four separate payments. These are identified in the Fourth Schedule. The first payment was a payment of HK$11,500,000.00 which was said to be as deposit and in part payment to be paid when the agreement was signed; it was to be held by the vendor's solicitors as stakeholder but could be released to the vendor upon acceptance, or deemed acceptance, of the title. The second deposit and part payment was a sum of half that amount and was to be paid on or before 2 June 1997. There is no dispute between the parties that the time for deemed acceptance of the title had passed. There were two further deposits to be paid on 3 July 1997 and 4 August 1997 respectively. Both deposits were in the sum of HK$11,500,000.00 which again were in part payment of the purchase price. These two deposits were only to be released provided that the balance of the purchase price would be sufficient to discharge the existing mortgage.

8. It is pertinent to point out that there had been a period of significant rise in value of land in Hong Kong, at least in the area in which the property was situated, immediately prior to May 1997. In a report by Mr Memfus Wong, the Managing Director of Memfus Wong Surveyors Limited, which was provided by the plaintiff, reference was made to the "JLW Price Index for Shop[s] in Causeway Bay/Wanchai" : the figure for January 1997 was 501.4 and April 1997 was 756.9. It thus showed on a straight line calculation an increase of some 51%. The Jones Lang Wootton Capital Value Index for retail properties in the "Wanchai/Causeway Bay" district appears to show a somewhat slower rate of increase but even that would apparently equate to an annualised rate of 35% over the period. Thus, whatever figures are taken, it would seem that there would have been a very significant increase in the value of the property to be sold in the period leading up to May 1997.

9. Matters, however, do not appear to have proceeded smoothly for the purchaser because on 2 March 1998, a Supplemental Agreement was entered into between the plaintiff and the defendant deferring the completion date until 2 April 1998. A further sum of HK$11,500,000.00 was to be paid as a deposit and part payment. The recital clause of the Supplemental Agreement referred to the unexpected delay in arranging the mortgage loan for the purchase of the property and the fact that the purchaser had requested the vendor to extend the completion date to enable that to be done.

10. There was evidence to suggest that the average value of comparable properties in the Wanchai/Causeway Bay district had dropped considerably since the agreement had been signed in May 1997. The capital value index of properties in the Wanchai/Causeway Bay district had apparently dropped 27% between October 1997 and April 1998. Indeed the plaintiff itself filed evidence that the value of the property on 2 April 1998 was only HK$72 million.

The Building Authority letter

11. According to the plaintiff's evidence, in late March 1998, shortly before the extended completion date for the contract, Mr Wong Hing Sun, the Project Manager of the plaintiff, instructed Mr David Tong, who was an authorised person and architect who had been consulted by the plaintiff, to check with the Building Authority as to whether any new notices or orders had been issued in respect of the property. It is said that on 28 March 1998, Mr Tong called Mr Wong and informed him that he had found a copy of a letter in the Buildings Department file relating to three items. The letter was a standard format letter in Chinese addressed to the defendant. Because of the importance of the terms of that letter, the English translation is set out below :

" Ground Floor Shop No.2 Cannon Street, Hong Kong

It is noted that certain building works have been carried out in the above premises and they comprise : (1) an iron gate installed at the half landing from the Ground Floor to the 1st Floor, (2) an iron gate installed at the Ground Floor exit of the rear staircase and (3) an opening in the wall of the Ground Floor rear staircase.

These building works contravene the provisions of the Buildings Ordinance and are therefore unauthorized. For the sake of your own interest and as a responsible owner/occupier, you should organize to carry out the removal work as soon as possible. You are also obliged to ensure that your premises are in a safe and sound condition and free from damage and unauthorized building works.

I suggest that you immediately take steps to remove the relevant unauthorized building works immediately, and reinstate the premises in accordance with the approved building plans.

Should you have any query, please contact Mr.Man (telephone No.2626 1614) or Mr.Poon (telephone no.2626 1618) for details.

	Yours faithfully,
	Building Authority
	(acting by Senior Surveyor Ma Ying Kit)
27th March 1998"

12. The plaintiff's representatives took a copy of the file copy of this letter from the Buildings Department. It was drawn to the attention of the defendant's solicitors by a letter dated 30 March 1998. The matters referred to there apparently caused the defendant little problem. The three items of work referred to in the letter were carried out and apparently completed by mid-day on 31 March.

13. The defendant chose to arrange for the work to be carried out rather than leave it to the building management despite the fact that they considered them to be in a portion of the building that was part of the common area.

14. By a letter dated 31 March 1998, the plaintiff's solicitors wrote giving formal notice that the plaintiff exercised its right to rescind the agreement of 23 May 1997.

15. By 11 am on 1 April, representatives of the Buildings Department had inspected those works and expressed their satisfaction that the matters referred to in the letter had been attended to. The plaintiff's solicitors were informed of this by a letter dated 1 April but despite this, the plaintiff still refused to complete and on 3 April, the defendant's solicitors served notice terminating the agreement and forfeiting the deposit.

16. These proceedings were commenced by originating summons on 29 April 1998. The relief sought by the plaintiff was a declaration that the plaintiff had effectively rescinded the agreement and that there should be an order for repayment of the deposits and part payments under the agreement. It might be noted at this stage that there was no claim that, in the event that the plaintiff should be found to have breached the agreement, the deposit constituted a penalty and was thereby unenforceable.

17. The proceedings were conducted without pleadings and the matter proceeded on the basis of the affidavit evidence filed together with documentary exhibits.

The issues

18. As the matters have been argued before this court, the following questions fall to be determined :

(1) Whether the plaintiff was entitled to exercise an option under clause 12(a) of the agreement to rescind the agreement.

(2) Whether the forfeiture provisions in clause 26 constituted a penalty and were unenforceable.

(3) Whether the plaintiff was entitled to the return of the difference between $40.25 million, being the total amount of the deposits, and $33 million, being the difference in value, as found by the judge, between the property at the date of the agreement in May 1997 and the extended completion date in April 1998.

19. In realty the answer to the second question will also provide the answer to the third question.

Was the plaintiff entitled to rescind the agreement?

20. So far as this case is concerned, clause 12(a) has two significant provisions : in the first place, there is a warranty :

"... that the Vendor has not received and is not aware of there being any notice or order from any Government or other competent authority or the manager or the management committee of the building of which the Property forms part requiring the Vendor to demolish or reinstate or improve any part of the Property. ..."

There is no suggestion in this case that the defendant was in breach of this warranty. It is, however, to be contrasted with the second provision which caters for the eventuality of a notice or order being issued or served. That part of the clause reads :

"... If it should be discovered that any notice or order for demolition or reinstatement or improvement unrelated to the subject matter of the said two orders has been issued/served before the date of completion ... the Purchaser shall have the option to rescind this Agreement ..."

Although in the second provision there is no specific statement as to where the notice or order should emanate from, the structure of the clause shows that a notice or order which is discovered to have been issued or served before the completion date will only come within clause 12(a) if it emanated from any Government or other competent authority or the manager or the management committee of the building.

21. Again, whilst the word "requiring" appears only in the first provision namely that specifying a warranty, it is implicit from the use of the word "for" (which appears immediately before the words "demolition or reinstatement or improvement"), that either the notice or order must have the effect of compelling the carrying out of such an act or the failure to comply with the notice or order would of itself trigger legal consequences.

22. In my view, a notice which is merely advisory does not have any coercive force.

23. In so far as the "Government or other competent authority" has powers to issue "notices" and indeed "orders", these are contained in the Buildings Ordinance, Cap.123. In this respect, sections 24, 24B, 25, 26, 27 and 40 are all pertinent. These provisions are all designed to compel the carrying out of an act and provide penal consequences if orders are not complied with. The notices for example in sections 24B(2) and 27(2) are necessary pre-requisites to the making of an order. It may be noted that the Building Authority and the Director of Buildings have powers to issue notices which were contained in other Ordinances as well.

24. In so far as notices or orders are issued by a Building Manager or the Building Management Committee of the building, these would be governed in the normal course by the provisions of the Deed of Mutual Covenant. The effect of failure to comply with the same is a matter which would be dealt with under the Deed.

25. Turning to the letter of 27 March 1998 which has been set out above, there is in my view doubt as to whether this would even constitute a notice within the meaning of clause 12(a). The letter is neither a notice of the kind contemplated by the Buildings Ordinance nor is it a notice issued by the Building Manager or the Management Committee.

26. Looking at the terms of the letter, in so far as it constitutes a notice, it does not compel the carrying out of an act. It merely advises it. Letters of this nature are not something which are contemplated under the Buildings Ordinance whether as a specific item in their own right or even as a necessary step in the course of compelling the carrying out of an act. Failure to observe the terms of the letter in question here would carry no adverse consequences as such. In order for that to happen, steps would have to be initiated to issue a notice or order under the Ordinance.

27. After hearing argument from the plaintiff in respect of the first question, the court indicated to Mr Chang SC who appeared on behalf of the defendant that it did not need to hear further argument on this aspect of the appeal. For these reasons, it is merely noted that the defendant took further points in the skeleton argument. In the absence of argument on these points no conclusion can be arrived at and it would be more appropriate not to comment further.

Was clause 26(b) a penalty clause and unenforceable?

28. Clause 26(a) contained standard provisions for termination of the agreement should the purchaser fail to comply with the terms. In the event of default by the purchaser, the agreement provided that the vendor should be entitled to give notice of termination and amongst other things would be entitled to forfeit the deposit. Clause 26(b) does not, however, appear to be a standard clause. It refers specifically to the unusual features of the agreement and the amount of the deposit; it emphasises the forfeiture provision as being an important commercial term of the agreement and it highlights that the reason for the size of the deposit was the unusual long duration for completion. The question which arises is as to whether the provision for forfeiture of the deposit constituted a penalty and in consequence whether the plaintiff was entitled to relief against forfeiture of the deposit.

The law relating to penalties

29. Initially, the Courts of Equity and subsequently the Common Law Courts have for centuries refused to enforce penalty clauses. The Earl of Halsbury LC in the case of Clydebank Engineering and Shipbuilding Company v Don Jose Ramos Yzquierdo Y Castaneda [1905] AC 6 at page 10 described the test as to whether the agreement as to money to be paid upon breach constituted an agreed sum of damages or a penalty in terms of whether the sum was unconscionable and extravagant with reference to the particular facts and circumstances of the individual case.

30. That approach was repeated in the classic case of Dunlop Pneumatic Tyre Company Limited v New Garage and Motor Company Limited [1915] AC 79. Lord Dunedin who gave the first judgment echoed the use of the words "extravagant and unconscionable" saying that the amount was to be judged in comparison with the greatest loss that could conceivably be proved to have followed the breach: See page 87. Lord Parker at page 97 commenced his speech by stating that whether an agreed sum would constitute a penalty would depend on the circumstances of each particular case. He went on to say that it is a general consideration that if the agreed sum was in excess of any damage which "can possibly, or even probably, arise from the breach" the sum would not be regarded as being a proper pre-estimate of the damage.

31. In the case in the Australian High Court of AMEV-UDC Finance Limited v Austin (1986) 162 CLR 170, Mason J and Wilson J gave a joint judgment in which they reviewed the history of the law relating to penalties. At page 190, they referred to what was considered to be an erosion of the principles relating to penalties. It was suggested that there might be a return to the concepts of the Clydebank and Dunlop cases: that would permit parties a greater latitude in contract to determine what their rights and liabilities would be so that an agreed sum would only be categorised as a penalty if it was out of all proportion to damage likely to be suffered as a result of breach.

32. That judgment was cited with approval by the Privy Council in the case of Philips Hong Kong Ltd. v AG of Hong Kong (1993) 61 BLR 49. At page 57, Lord Woolf quoted the passage from page 103 of the joint judgment referring to the supervisory jurisdiction which was not to rewrite contracts which had been made imprudently but to relieve against provisions which were so unconscionable or oppressive that their nature was penal rather than compensatory. The passage quoted went on to emphasize the importance of the circumstances of a particular contract. Two matters were raised. Firstly, the relationship between the agreed sum and the loss likely to be suffered. Secondly, the nature of the relationship between the parties.

33. After citing another authority from the Australian High Court, Esanda Finance Corporation Limited v Plessnig [1989] ALJ 238 and Dickson J in the Supreme Court of Canada in Elsey v J G Collins Insurance Agencies Limited (1978) 83 DLR 15 which were to the effect that an agreed sum would be regarded as a penalty if it was extravagant or unconscionable in comparison with "the greatest loss that could conceivably be proved to have followed the breach", and as referred to in the Elsey case, the court's power to give relief in respect of penalty clauses which should be confined to those cases where there is oppression, Lord Woolf said at the foot of page 58 :

"Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision."

34. In relation to contracts for the sale of land, there has been some flexibility with regard to the court's application of the rules relating to forfeiture. These are summarised in the case of Workers Trust & Merchant Bank Ltd. v Dojap Investments Limited [1993] AC 573. The Privy Council was there considering an appeal from the Court of Appeal of Jamaica where a 25% deposit had been forfeited by a bank after a sale by auction. The Court of Appeal in Jamaica had granted relief from forfeiture to the extent of 15% of the purchase price. In giving the advice of the Privy Council , Lord Browne-Wilkinson referred to the exception to the general rule as to penalties in relation to deposits on contract for the sale of land. He said at page 578 :

"Ancient law has established that the forfeiture of such a deposit (customarily 10 per cent of the contract price) does not fall within the general rule and can be validly forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract."

At page 580, he referred to the customary deposit in the United Kingdom and previously in Jamaica as being 10% and said that :

"A vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit."

The effect of this judgment was followed in the case of China Pride Investment Ltd v Silverpole Ltd [1994] 2 HKC 341.

35. In referring to special circumstances in relation to contracts for the sale of land, Lord Browne-Wilkinson was doing no more than reiterating the law as to penalties. Having acknowledged that there was special treatment of deposits in such contracts which enabled a 10% deposit to be forfeited without regard to any other consideration, it is clear that a deposit in excess of 10% could be forfeited and would not be the subject of relief if it otherwise would have been exempt from relief against forfeiture.

36. In the circumstances of this case, it seems to me that despite the high level of the deposit it was neither excessive, nor exorbitant, nor unconscionable, nor was it oppressive. As indicated above, the property market prior to the date of the agreement had risen considerably. Whatever figure is taken as being the correct rise in value of the land, even increases in the order of 30% in a few months must in the long run be considered exceptional. Whereas in times of high monetary inflation, changes in the value of land can be anticipated to be sustained, in times when monetary inflation is not an excessive feature, the value of land will no doubt depend on a number of other factors. In those circumstances, it seems to me that it is by no means unreasonable for an owner of land who had seen the price of his land rise by many times more than simple interest in a few months, to consider that that rise might not be sustainable and that the value of the land might drop to its original figure. Indeed, the volatility of the price of land in Hong Kong is a feature which has previously been the subject of judicial comment.

37. Whereas a sudden drop in the value of land within a period of 28 days, which is the normal period for completion, might not be anticipated, the contemplation of a substantial drop in a 9-month period after a sudden and extremely large rise in value is something which a reasonable land owner would almost certainly have in mind. In the circumstances of this case, it appears to me that clause 26(b) clearly shows that. Indeed, such anticipation has been proved by hindsight to have been not unreasonable. In his judgment, the judge assessed the drop in value of the land between May 1997 and April 1998 as $33 million. Whereas, of course, in considering the question as to whether the agreed sum constituted a penalty, it is the drop in value which was reasonably contemplated which should have been taken into account and not the drop in value which actually occurred, nevertheless, that latter figure does provide some indication that the vendor's approach was by no means unreasonable.

38. I should mention in passing that in considering the question of whether the clause relating to the forfeiture of the deposit was a penalty, the judge looked at the anticipated rise in value of the property as at the date of the agreement. This was not a matter which Mr Chang on behalf of the defendant sought to support and indeed, in my view, was not a relevant consideration.

39. In this respect, it is to be noted that the judge relied upon a newspaper report in May 1997 which indicated that the plaintiff expected to divide the property and re-sell it for $150 million. Quite apart from the fact that the attribution of this to the plaintiff is somewhat suspect, there was no basis in the evidence for the judge to conclude that in May 1997 the defendant contemplated that the value of the property would rise.

40. In considering the circumstances of the case, it appears to me that this was an exceptional case. Although it concerned the sale of retail premises, the property was being sold clearly as an investment property: there were a number of separate retail premises which were comprised within the property. The total contract amount of HK$115 million was by no means insignificant. In my view the parties must be looked upon as having entered the contract on an equal footing. Indeed, the contents and wording of the agreement showed that it was not a standard form of contract nor even was it a contract such as one for the sale of land at an auction where it might be supposed that a purchaser's power to persuade a vendor to change the terms of a contract might be limited. Here, there is no reason to suppose that the contract was other than an arm's length contract made by two parties who were, or at least had all the facilities to be, properly advised. I do not consider that this is a case where the court should step in and alter a commercial contract solemnly made between two parties nor should the court relieve one party of an obligation that was specifically and clearly emphasised to it at the time it chose quite freely to enter the contract with a view, no doubt, to profit.

41. One unsatisfactory feature of the case would appear to be that the lack of pleadings meant that the issues which would arise at the trial were not encapsulated in written form. The judge remarked at page 3 of his judgment that :

"throughout the trial, the issue of forfeiture never left the side of the parties in the court".

At least, on the face of the originating summons and the affidavits filed before the hearing, there was no indication that the plaintiff was alleging that the clause relating to the forfeiture of the deposit constituted a penalty. Indeed, the plaintiff's final affirmation referred to the market value of the property in April 1998 as being HK$72 million (that is $43 million less than the price in agreement). Whereas in the result, I consider that the defendant is entitled to rely upon this clause, I consider that there is cause for some disquiet that the defendant may not have been alerted to call all the relevant evidence in respect of what has turned out to be the most important aspect of the case.

42. At the hearing, the parties indicated that the other matters which had been raised in the Notice of Appeal and the Respondent's Notice and Cross Appeal had been resolved subject to the court's decision on the three questions which arose.

43. In the premises I consider that this appeal should be dismissed.

Hon Keith JA:

44. I agree that this appeal should be dismissed, but I add a few words of my own in deference to the well-argued submissions advanced by Sir John Swaine SC on behalf of the Plaintiff.

45. Clause 12(a) of the agreement. Clause 12(a) of the agreement gave the Plaintiff "the option to rescind" the agreement if it was

"discovered that any notice or order for demolition or reinstatement or improvement unrelated to the subject matter of the .... two orders [referred to earlier in clause 12(a)] had been issued/served before the date of completion ..."

Sir John did not suggest that the letter of 27 March 1998 constituted an order, whether for demolition or reinstatement or improvement. He contended that it constituted a notice (a) for the demolition of the unauthorised building works and (b) for the reinstatement of the building so as to conform to the approved building plans. The letter thus came within clause 12(a).

46. I construe the words "any notice or order for demolition or reinstatement or improvement" in clause 12(a) as referring to a notice or order which required the person, firm or company to whom it was addressed to demolish unauthorised building works or reinstate the building so as to confirm to the approved building plans or to improve the building. Such a construction is necessary in order to render this part of clause 12(a) consistent with the warranty given by the Defendant in the first part of clause 12(a) that the Defendant had not received, and was not aware of, any notice or order "requiring" the Defendant to demolish, reinstate or improve any parts of the building. If any notice to which the warranty related had to have required the Defendant to take action, so too would any notice to which the Plaintiff's option to rescind the agreement related.

47. Thus, the critical question is whether the letter of 27 March 1998 should be read as requiring the Defendant to demolish the unauthorised building works or to reinstate the building so as to conform to the approved building plans. I do not think that the letter can be read as containing such a requirement. It referred to the fact that unauthorised building works had been carried out, and it spoke of the desirability for those works to be removed and the building reinstated. But the language used was not the language of compulsion. Removal and reinstatement were merely "suggested", and the suggestion was made, not in the exercise of a power to require removal and reinstatement (although, of course, such a power existed), but "[f]or the sake of your own interest and as a responsible owner/occupier". In other words, the letter is to be construed, not as imposing any requirement on the Defendant, but as an attempt to achieve by voluntary means that which could have been achieved by coercive means. If the removal of the works and the reinstatement of the building were carried out, that would be the end of the matter. If they were not, it would be open to the Building Authority to serve on the Defendant an order for the demolition of the works under section 24(1) of the Buildings Ordinance (Cap. 123).

48. I do not think that any of this conflicts with the reasoning underlying R. v. Clarke [1969] 1 WLR 1109 on which Sir John placed much reliance. The ratio of that case is that language which is more consistent with a request can nevertheless constitute a requirement depending on the circumstances in which the request is made. As Geoffrey Lane J (as he then was) said at p. 1112G:

"A request in words which it is clear to the defendant is being made as of right is sufficient to amount to a requirement."

Thus, in a case where it is plain that the "request" is being made pursuant to a power to require something to be done, the request may be tantamount to a requirement. But in the present case, although the Building Authority had the power to require the works to be demolished, the language which it chose to use showed that its suggestion was not being made pursuant to that power, but to avoid the need for that power to be exercised. The need for that power to be exercised would be avoided if the Defendant voluntarily demolished the works.

49. Clause 26(b) of the agreement. Clause 26(b) of the agreement entitled the Defendant to forfeit the deposits which the Plaintiff had paid if the Plaintiff "fail[ed] to comply with clause 26(a)". This was an inelegant piece of shorthand. I construe the Defendant's entitlement to forfeit the deposits under clause 26(b) as arising if the Plaintiff failed to comply with any of the terms of the agreement and if in consequence the Defendant exercised its right under clause 26(a) to terminate the agreement.

50. The critical question which arises is whether clause 26(b) constituted a penalty. The courts can take judicial notice, not only of the volatility of the property market in Hong Kong, but also of the frequency with which slumps in the property market follow periods of dramatic increases in property values. The evidence before the judge was that the value of the building had increased dramatically in the few months before the Defendant agreed to sell it to the Plaintiff. Since there was to be an unduly long interval between then and the date for completion, the Defendant would naturally have wanted to provide for the possibility that (a) the Plaintiff might fail to complete the sale and (b) the value of the building might have decreased significantly in the meantime. If that happened, the Defendant would have been left with a property worth far less than what the Plaintiff had agreed to buy it for. Against that background, clause 26(b) could properly be said to represent the Defendant's attempt to protect itself against that loss.

51. Has that attempt succeeded? The modern law on penalties has been summarised by Rogers V-P (whose judgment I have read in draft). It has never been suggested that there was an inequality of bargaining power between the Plaintiff and the Defendant, and thus the critical factor, to use the language of Mason J and Wilson J in AMEV UDC Finance Ltd. v. Austin (1986) 162 CLR 170 at p. 193, was "the degree of disproportion between the stipulated sum and the loss likely to be suffered" by the Defendant. The issue was whether the stipulated sum "was out of all proportion to, or extravagant or unconscionable in comparison with, the greatest loss that could conceivably be proved to have followed from the breach": see the headnote of Esanda Finance Corporation Ltd. v. Plessnig [1989] ALJ 218. The fact that circumstances could be shown to exist in which the award of the stipulated sum could result in a larger sum than his actual loss being recovered by the injured party is not decisive. As Lord Woolf said in Philips Hong Kong Ltd. v. The Attorney General of Hong Kong [1993] 1 HKLR 269 at p. 280:

"Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision."

52. One of the issues in the case related to the anomalous treatment by the law of deposits by purchasers in contracts for the sale of land. The forfeiture of a deposit of a customary size does not fall within the general rule, and can be validly forfeited even though the amount of the deposit bears no relation to the anticipated loss to the seller flowing from the breach of contract. In Workers Trust & Merchant Bank Ltd. v. Dojap Investments Ltd. [1993] AC 573, the Privy Council held that a seller who seeks to forfeit a deposit greater than the customary size must show "special circumstances" which justify the forfeiture of that deposit. In my opinion, if "special circumstances" are found to exist, so that the forfeiture of a deposit greater than the customary size might be justified, it is still necessary for the court to consider whether the special circumstances justified the forfeiture of a deposit of the particular size stipulated in the agreement. That involves the application of the general principles relating to penalties.

53. For the reasons given by Rogers V-P, I have concluded that the deposits totalling $40.25m. paid by the Plaintiff were neither out of all proportion to, nor extravagant or unconscionable in comparison with, the greatest loss which on 23 May 1997 (when the agreement was reached) the parties could reasonably conclude the Defendant would suffer if the Plaintiff failed to complete the purchase on 2 March 1998 (when the purchase was originally due to be completed). I cannot usefully add anything further which would not amount to a repetition of his reasoning.

54. However, there is one final matter upon which I should comment. The judge thought that the loss from which the parties were seeking to protect the Defendant by clause 26(b) was not the loss which the Defendant would suffer if the Plaintiff failed to complete the purchase and if by then the value of the property had fallen. Rather it was the loss which the Defendant would suffer if, by the time the purchase was due to be completed, the value of the property had increased even more. The judge's words were:

"I am inclined to think that the loss contemplated by the parties was the loss of a higher price to the Defendant tied down by the contract for nearly one year before completion."

I cannot go along with this view of the case. In the absence of a liquidated damages clause, the Defendant's loss as a result of the Plaintiff's failure to complete the purchase would have been the difference between (a) the price which the Plaintiff had agreed to purchase the building for and (b) the value of the building at the date fixed for completion (if less than the purchase price). The Defendant's loss would have been nominal if the value of the building had increased. Indeed, not only would the Plaintiff have been unlikely to refuse to complete the purchase if the value of the building had increased, but the Defendant would have been delighted if the Plaintiff had refused to complete because it could then have sold the building for a greater price. Thus, the presence of what purported to be a liquidated damages clause in the agreement was consistent only with the loss from which the parties were seeking to protect the Defendant being the loss which it would suffer if the Plaintiff failed to complete the purchase and if by then the value of the building had fallen. To be fair, Mr Denis Chang SC for the Defendant did not seek to support the judge's view of the nature of the Defendant's loss contemplated by clause 26(b).

Hon Mayo Ag. CJHC:

55. The first issue which had to be determined on this appeal was what has been referred to as the construction issue.

56. This issue was whether the plaintiff had been justified in rescinding the contract to purchase the land pursuant to the provisions contained in Clause 12(a) of the Agreement.

57. The Clause reads:

"12.(a) Save and except the existing two orders which have been registered at the Land Registry by Memorial Nos. 6436976 and 6436979 ('the said two orders') in respect of the Property and are referred to in Clause 25 hereinafter, the Vendor hereby warrants and declares that the Vendor has not received and is not aware of there being any notice or order from any Government or other competent authority or the manager or the management committee of the building of which the Property forms part requiring the Vendor to demolish or reinstate or improve any part of the Property. If it should be discovered that any notice or order for demolition or reinstatement or improvement unrelated to the subject matter of the said two orders has been issued/served before the date of completion, the costs for such demolition or reinstatement or improvement shall be solely borne by the Vendor and the Purchaser shall have the option to rescind this Agreement whereupon the said deposit and all monies paid hereunder shall be returned to the Purchaser forthwith by the Vendor in full but without any compensation interest or costs and neither party shall have any claim against the other hereon and the parties hereto shall be the costs of the Vendor enter into and cause to be registered at the Land Registry an Agreement for Cancellation."

58. The letter which was sent by the Buildings Department to the defendant was in this form:

"BD	Buildings Department	YOUR REF來函檔號:
	屋 宇 署	OUR REF本署檔號:	BD 7/2488/54/N01
		FAX 圖文傳真:	2524 3291
		TEL 電話:	2625 1614

_______________________________________________________

Panhandat Limited
12/F., V. Heun Buildings,
No. 138 Queen's Road Central,
Hong Kong.

Owner/Occupant,

Dear Sir/Madam,

Ground Floor Shop No. 2 Cannon Street, Hong Kong

It is noted that certain building works have been carried out in the above premises and they comprise: (1) an iron gate installed at the half landing from the Ground Floor to the 1st Floor, (2) an iron gate installed at the Ground Floor exit of the rear staircase and (3) an opening in the wall of the Ground Floor rear staircase.

These building works contravene the provisions of the Buildings Ordinance and are therefore unauthorized. For the sake of your own interest and as a responsible owner/occupier, you should organize to carry out the removal work as soon as possible. You are also obliged to ensure that your premises are in a safe and sound condition and free from damage and unauthorized building works.

I suggest that you immediately take steps to remove the relevant unauthorized building works immediately, and reinstate the premises in accordance with the approved building plans.

Should you have any query, please contact Mr. Man (telephone No. 2626 1614) or Mr. Poon (telephone no. 2626 1618) for details.

	Yours faithfully,
	Building Authority
	(acting by Senior Building Surveyor Ma Ying Kit)

27th March, 1998"

59. Sir John Swaine SC submitted that this letter constituted a "notice" or "order" which required the defendant to demolish or reinstate part of the suit premises. He placed considerable reliance upon R v Clarke [1969] 2 All ER 1008 in support of this proposition.

60. It is necessary to consider the form of the Buildings Department's letter carefully.

61. The first point to be noted is that the letter does not invoke the statutory provisions contained in the Buildings Ordinance. Sir John argued that if the requirements set out in the letter were not complied with enforcement action would undoubtedly ensue. I am by no means convinced that this necessarily would have been the case.

62. It would seem to me that on the evidence which was before the trial Judge it was much more likely that the purpose which was served by the letter was to inform the recipient of the letter that the Buildings Department was aware of the contraventions which were alleged. It invited it to take necessary remedial measures thus obviating the necessity of putting in motion the formal procedures to ensure compliance with statutory requirements.

63. The situation can readily be distinguished from the situation which obtained in R v Clarke. There the issue was whether the polite language used by a police officer when demanding a sample from a motorist suspected of drunk driving was such that the motorist was entitled to refuse to provide the sample. What was clear in that case was that the police officer was performing his duty and that the only concern was whether he had made himself sufficiently clear to the motorist.

64. In the instant case the letter was perfectly clear. The only question was whether it amounted to a notice requiring the defendant to take the action referred to in it.

65. It is perhaps relevant to add that the contraventions referred to were remedied within a very short period at a minimal cost.

66. I have no doubt that the Judge was right in concluding that the provisions contained in Clause 12(a) were not triggered by the letter.

67. The notice did not have the force of law notwithstanding the fact that the Authority did have the power to require that there be compliance.

68. The second issue on this appeal was whether the defendant had been entitled to forfeit the deposit of $40,250,000 which amounted to 35% of the purchase price of the property.

69. Sir John's main contention was that on the evidence which was before the Judge it had not been open to him to in effect find that there had been sufficient special circumstances such as to enable him to conclude that these moneys were a deposit which could be forfeited by the defendant. He argued that the moneys amounted to a penalty and that all that the defendant was entitled to was damages which had been proved which in the present case had been assessed at $33 million.

70. Sir John placed reliance upon the passage at p. 580 from the speech of Lord Browne-Wilkinson in Workers Trust and Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573:

"However although their Lordships are satisfied that the practice of a limited class of vendors cannot determine the reasonableness of a deposit, it is more difficult to define what the test should be. Since a true deposit may take effect as a penalty, albeit one permitted by law, it is hard to draw a line between a reasonable, permissible amount of penalty and an unreasonable, impermissible penalty. In their Lordships' view the correct approach is to start from the position that, without logic but by long continued usage both in the United Kingdom and formerly in Jamaica, the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit."

71. Mr Denis Chang SC submitted that although the burden of proof lay upon the plaintiff to show that there were no special circumstances there was in fact such evidence. He referred to Clause 26(b) of the Agreement which was couched in these terms:

"26.(b) For the avoidance of doubt, as it is an important commercial term and condition to this Agreement, the Purchaser hereby expressly acknowledges, agrees accepts confirms that in the light of the unusual long duration for completion, the Vendor shall be entitled to, without prejudice to the Vendor's other rights under this Agreement, forfeit the said deposit in full absolutely as agreed damages, i.e. HK$40,250,000.00 should the Purchaser fail to comply with Clause 26(a)."

72. He argued that what was necessary was to read this Clause in conjunction with the inherent surrounding circumstances. There could be no doubt that at the time when the contract had been entered into in May 1977 the real estate market in Hong Kong had been in a highly volatile phase. Property prices had increased by 35% over the last year.

73. It would not have been unreasonable for the defendant to seek to protect himself from a possible market correction having regard to the unusually lengthy period of time before the purchaser was required to complete the transaction.

74. In this connection the defendant's representative had given evidence before the Judge and he had not been subjected to any cross-examination on what had been contemplated by the parties when Clause 26(b) had been agreed. Indeed as this action had proceeded as an Originating Summons there had been no pleadings and Mr Chang argued that he had been taken unawares on this point.

75. Be that as it may Clause 26(b) does refer to the unusually long period of time and the fact that the deposit should be regarded as "agreed damages".

76. The question which then has to be considered is whether this in the context of the inherent surrounding circumstances could be considered as being in the nature of a penalty.

77. Lord Woolf considered this question at some length in his speech in Philips Hong Kong Ltd v AG of Hong Kong (1993) 61 BLR 49. At p. 57 he said:

"... It was however considered by the High Court of Australia in AMEV UDC Finance Ltd v Austin (1986) 162 CLR 170, a case to which reference is made, not for its treatment of that subject but for the general approach which was adopted as to what should be the approach of the court to alleged penalties. It was a case in which a finance company tried unsuccessfully to rely on general equitable principles relating to relief against penalties as against guarantors of a hirer when the finance company had determined a hiring agreement. Mason and Wilson JJ in a joint judgment, having admirably surveyed the decisions as to penalties decided both in this country and in other Commonwealth countries, referred to the advantages of allowing the parties to contracts greater latitude to determine for themselves the consequences of breaches or the termination of their contracts, and then went on to say (page 193):

'But equity and the common law have long maintained a supervisory jurisdiction, not to rewrite contracts imprudently made, but to relieve against provisions which are so unconscionable or oppressive that their nature is penal rather than compensatory. The test to be applied in drawing that distinction is one of degree and will depend on a number of circumstances, including (1) the degree of disproportion between the stipulated sum and the loss likely to be suffered by the plaintiff, a factor relevant to the oppressiveness of the term to the defendant, and (2) the nature of the relationship between the contracting parties, a factor relevant to the unconscionability of the plaintiff's conduct in seeking to enforce the term. The courts should not, however, be too ready to find the requisite degree of disproportion lest they impinge on the parties' freedom to settle for themselves the rights and liabilities following a breach of contract. The doctrine of penalties answers, in situations of the present kind, an important aspect of the criticism often levelled against unqualified freedom of contract, namely the possible inequality of bargaining power. In this way the courts strike a balance between the competing interests of freedom of contract and protection of weak contracting parties: see generally Atiyah, The Rise and Fall of Freedom of Contract (1979), especially Chapter 22.'

It should not be assumed that, in this passage of their judgment, Mason and Wilson JJ were setting out some broader discretionary approach than that indicated as being appropriate by Lord Dunedin. On the contrary, earlier in their judgment they had noted that the 'Dunlop approach' had been eroded by recent decisions and they stated that there was much to be said for the view that the courts should return to that approach. This is confirmed by the later decision of the Australian High Court in Esanda Finance Corporation Ltd v Plessnig [1989] ALJ 238. In that case, it should be noted that, according to the headnote, the first holding was that, as 'it had not been shown that the amount claimed ... was out of all proportion to, or extravagant or unconscionable in comparison with, the greatest loss that could conceivably be proved to have followed from the breach, a basic test for the existence of a penalty had not been satisfied'. Wilson J, in giving the first judgment with Toohey J, cited, with implicit approval, the view of Dickson J in the Supreme Court of Canada in Elsey v J G Collins Insurance Agencies Ltd (1978) 83 DLR at page 15 where he said:

'It is now evident that the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no place where there is no oppression.'

Such views are in accord with those expressed by Lord Justice Diplock in Robophone Facilities Ltd v Blank [1966] 1 WLR 1428. He said (at page 1447) that the 'court should not be astute to descry a "penalty clause"'. These statements assist by making it clear that the court should not adopt an approach to provisions as to liquidated damages which could, as indicated earlier, defeat their purpose.

Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision."

78. I do not have any difficulty in reconciling these observations with the views expressed by Lord Brown-Wilkinson in Workers Trust and indeed the Law Lord was also one of the Judge's sitting in the Privy Council in Philips Hong Kong Ltd.

79. In Workers Trust the court left open wide scope for considering the broader implications of traditional deposits when it stated that where there were special circumstances amounts greater than 10% might be forfeited.

80. It seems to me that where parties have deliberately concluded an Agreement such as it contained in Clause 26(b) this is exactly the sort of situation which would come within the "special circumstances" which were being envisaged.

81. This is particularly the case in the context of the highly volatile nature of the Hong Kong property market at the time in question and the protracted period of time for the completion of the transaction.

82. Having regard to the principles outlined by Lord Woolf. I am of the view that the defendant was entitled to forfeit all of the deposit which was payable under the Agreement. This being the case in my opinion the appeal should also be dismissed on this second issue.

83. The appeal will therefore be dismissed. There will be an order nisi that the costs of the appeal will be to the respondents.