THE HONG KONG AND SHANGHAI BANKING CORPORATION LTD v. NORMAN JOHN MARTEL

CACV 54/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO.  54 OF 2003

(ON APPEAL FROM HCA 4484 OF 2001)

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JUDGMENT

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Hon Woo V-P:

1.  I agree with the judgment of Yuen JA.

Hon Yuen JA:

2.  This is an appeal from the judgment of Deputy Judge Poon allowing the defendant’s appeal and dismissing the plaintiff’s cross-appeal against a master’s order giving summary judgment for the plaintiff on a guarantee. 

3.  The plaintiff bank ("the bank") had sought summary judgment against the defendant ("the surety"), who had guaranteed the debt of a company which was originally known as CCL Systems Far East Limited and later known as Constructional Systems Limited ("the company").

4.  The master gave summary judgment but for a sum that was inconsistent with the bank’s case. 

5.  At the hearing before the judge, neither party supported the master’s order.  The bank’s position was that it was entitled to the entire sum owed by the company, as claimed in the Statement of Claim.  The surety’s position was that he had been discharged from all liability whatsoever.

6.  At issue was the applicability of what has been called the rule in Holmes v Brunskill (1878) 3 QBD 495, i.e. that a material variation of the rights and obligations of the creditor and debtor which may be prejudicial to a surety’s interest,  occurring without the surety’s consent, discharges the surety.   The judge held that it was arguable that the rule applied, and so he gave unconditional leave to defend.

Background

7.  The surety was a director and shareholder of the company. In 1988, he together with two other persons who were also directors and shareholders had given a joint and several guarantee to the bank with a maximum liability of $5.5m. 

Facility letter

8.  In 1993, the bank and the company had discussions which culminated in a letter from the bank dated 9 June 1993 ("the facility letter").  The facilities offered comprised

-	an overdraft of $2m.;
-	an import line comprising documentary credits and import loan facilities of $8m. within which goods under the company’s control and/or trust receipts were to be of the value of $4.25m.; and
-	a corporate card facility of $90,000.

9.  In the facility letter, the bank asked the company to provide it with a new joint and several guarantee from the three directors for $6m.  A standard guarantee form was enclosed for their completion and return.      

Guarantee

10. A day later, on 10 June 1993, the three directors signed and returned the document ("the guarantee").  I shall refer to some of the terms later in this Judgment.  

11. Five years later, in 1998, the surety resigned as a director of the company but he remained a shareholder. 

12. By a letter dated 30 April 1999, the surety informed the bank that he was no longer a director of the company and asked to be released from the guarantee.  There was no written reply to this letter.  He repeated his request in a letter dated 5 June 1999.  Again there was no written reply but an officer of the bank apparently told the surety that the bank would not be in a position to reply to his request pending a review of the company’s accounts.

Revision of facilities

13. Apparently discussions then took place between the bank and the company, and on 16 June 1999, the bank revised the company’s banking facilities which were set out in a new facility letter.  One of the revisions was that the overdraft facility of $3m. was reduced to $1m., but a new loan of $2m. was granted, with the principal to be repaid in 18 fixed instalments commencing 1 month after drawdown, with a penalty for prepayments. 

14. The revision was accepted by the company.  For the purposes of the summary judgment application and appeal, it was accepted by the bank that the surety did not know of this revision and did not consent to it.  The surety consistently asserted in correspondence in August and September 1999 that he was no longer bound by the guarantee.

Withdrawal and consolidation of facilities

15. In November 1999, the bank withdrew the facilities and in February 2000, there was a consolidation of the facilities.  Again for present purposes, it is accepted by the bank that neither action was with the prior knowledge or consent of the surety.

16. In February 2001, the company was wound up.  The following month, the bank issued a demand against the surety for repayment.  No payment was forthcoming. 

Proceedings

17. In October 2001, the writ in the present action was issued.  Although a Defence was filed by the surety in November 2001, an application for summary judgment was issued by the bank in July 2002.

18. As mentioned earlier, the master gave summary judgment for the bank, but for the sum due as at November 1999, when the bank withdrew the facilities.  The judge allowed the surety’s appeal and gave unconditional leave to defend.

19. Before I deal with the issues raised on appeal, I should first indicate that no application under Order 14A had been made, and we did not understand leading counsel for the bank as suggesting that we should treat the appeal as an appeal from such an application.  All that he suggested was that if the appeal turned on an issue of law, then this court should not shirk from its duty to determine it.    

Issues

20. Essentially, the issues raised on appeal were these:-

(1)	What was the agreement or obligation which was guaranteed by the surety?
(2)	Was there a material variation in that agreement or obligation when the fixed term loan was granted in June 1999, or when the facilities were withdrawn in November 1999, or when the facilities were consolidated in February 2000?
(3)	If there was a material variation, would the rule in Holmes v Brunskill apply so as to discharge the surety from liability?
(4)	Was the rule in Holmes v Brunskill overridden by the terms of the guarantee?

Issue (1)

21. Issue (1) involves the identification of the underlying agreement which was guaranteed by the surety.  The guarantee did not expressly refer to any agreement between the company and the bank.  I do not think that the agreement is identified by the definitions of "banking facilities" and "guaranteed moneys", as leading counsel for the bank submits.  The definition of "banking facilities" was expressly for the purpose of describing the consideration for the surety giving the guarantee.  The definition of  "guaranteed moneys" was expressly for identifying the quantum for which the surety was to be liable.  Neither identified the underlying agreement which was guaranteed by the surety.

22. However it is clear from the evidence that the underlying agreement which was guaranteed by the surety was the agreement between the bank and the company set out in the facility letter of the previous day.  That is obvious from the factual context in which the guarantee came to be given – as a result of the bank’s express request in the facility letter of the previous day.  The facilities referred to in that letter were clearly the commercial purpose which the guarantee was intended to serve.  The terms of the facility letter would therefore be treated as "embodied or incorporated in the contract of guarantee" (per Phillips J in Wardens and Commonalty of the Mystery of Mercers of the City of London v New Hampshire Insurance Company unrep. 18 January 1991, reversed on other grounds [1992] 2 Lloyd’s Rep 365). 

Issue (2)

23. The second issue is whether the grant of the fixed-term loan of $2m. in June 1999 was a material variation of the underlying agreement between the bank and the company. 

24. The bank had relied on a passage in Phillips J’s judgment in the Mercers case where he held that "where ... the guarantee is given in respect of obligations arising out of a contemplated course of dealing without reference, express or implied, to any specific contract, it will be open to the creditor to vary the terms applying to the course of dealing so long as that course of dealing remains within the scope of the guarantee".  In so holding, Phillips J referred to Stewart v M’Kean (1855) 10 Exch 675. 

25. In Stewart v M’Kean, the surety agreed to "guarantee [his] brother’s intromissions as [the creditor’s] agent in Leith, to the extent of 500l. sterling".  The term "intromission" was partly legal and partly mercantile, and was said to signify dealings with stock, goods and cash of a principal coming into the hands of his agent, and to be accounted for by the agent to his principal.  The surety never asked for, nor received,  any information as to the nature of his brother’s employment or as to the manner in which the brother was to account to his principal the creditor.  Over a period of time, the practice evolved between the brother and his principal whereby the brother would issue promissory notes in favour of his principal.  This practice was not known to the surety.  When the brother failed to account to the principal for certain money, the principal sued the surety who then sought to rely on the change in the manner of account as a variation in the agreement between his brother and the creditor.

26. Alderson B. held (at 616) that the guarantee "must be construed according to its plain words without reference to extrinsic facts, for no such facts were within the defendant’s knowledge. ... No particular mode of dealing, except that he must deal as an agent, and no particular mode of accounting for cash received, is specified.  The natural conclusion is that any such dealing and any such accounting is guaranteed" (emphasis supplied). 

27. Parke B. also held (at 617) that "if the course of dealing is left to the option of the plaintiffs, entirely or within certain limits, the variation of the course of dealing, entirely or within those limits, is allowed by the contract itself, and the surety cannot complain of a variation which he has himself agreed to by the original contract" (emphasis supplied).  

28. In the present case, the bank sought to argue that the grant of the fixed-term loan of $2m. in June 1999 was simply part of a contemplated course of dealings - viz. the grant of banking facilities.  However in my view, it is at least arguable that the course of dealings contemplated were the actual range of business and financing activities specified in the facility letter.  A fixed-term loan was not mentioned and there was no other evidence at this stage that a fixed-term loan was nevertheless within the contemplation of the parties.  In my view it is at least arguable that the guarantee, although a single agreement, was an agreement to guarantee the company’s liabilities to the bank arising from the range of business and financing activities specified in the facility letter, and since it did not include other financing activities not referred to in it, the grant of a fixed-term loan was therefore a material variation.

29. The bank relied on the definition of "guaranteed moneys" which included "all moneys ... owing by the [company]".  In my view, that was a description of the quantum for which the surety would be liable within the scope of his liability as demarcated by the underlying agreement.  The case of Re: Bankrupt Estate of Murphy, Donnelly v Commonwealth Bank of Australia Ltd (1996) 140 ALR 46 does not assist.  There was no discussion as to whether there was a specific underlying agreement for which the mortgage was executed as security.

30. The bank also relied on clause 4.01 under which it was agreed that the guarantee was a continuing security.  In my view, that does not assist either.  That simply dealt with the "shelf-life" of the security, which is clearly different from the identity of the underlying agreement that the surety had agreed to guarantee. 

Issue (3)

31. In the circumstances discussed above, the rule in Holmes v Brunskill would apply. The variation in the underlying agreement by the company undertaking a fixed-term loan was a substantial one and it could not be said to be clearly for the benefit of the surety.  The nature of a fixed-term loan is obviously different from that of an overdraft.  And the risk undertaken by the surety of the company defaulting is undertaken for a possibly longer term, prepayments being subject to penalties.

32. It seems fairly clear that the material variation in June 1999 was made without the consent of the surety.  He had by then resigned as a director and there was no evidence that he was aware of the grant of the fixed-term loan until after it had been made.  Accordingly, all the elements for the application of the rule in Holmes v Brunskill were present.

33. That being the case, it is not necessary for present purposes to consider the effect of the withdrawal or consolidation of facilities in November 1999 and February 2000 respectively.  

Issue (4)

34. In respect of this issue, the bank submitted that the rule in Holmes v Brunskill did not apply because it had been overridden by clause 9 of the guarantee which read:

"	9.	Guarantor as Principal Debtor
	The liability of the Guarantor under this Guarantee shall not be discharged or otherwise affected by reason of the Bank entering into any agreement or arrangement with the Customer or any other person or by reason of any legal limitation, disability or incapacity or any other act, omission or circumstance which, but for this provision, would discharge the Guarantor to any extent.  Any Guaranteed Moneys which may not be recoverable from the Customer for any such reason shall be recoverable by the Bank from the Guarantor as principal debtor by way of indemnity, on demand, together with Default Interest thereon in accordance with Clause 2.03".

35. The first point to note is that the heading is "Guarantor as Principal Debtor".  Reading the clause as a whole, I consider it is arguable that this clause applies only where the customer has been released (in whole or in part) from liability - whether by way of agreement, arrangement, legal limitation, disability, incapacity or other act, omission or circumstance.  The effect of the clause then is that even though the customer is released (in whole or in part) from liability, the surety is not, and any moneys not recoverable from the customer remains recoverable from the surety as principal debtor, hence the heading. 

36. So construed, the clause does not override the application of the rule in Holmes v Brunskill in the present case.  Here the company has not been released from a liability which the bank seeks to recover from the surety as principal debtor.

Order

37. By reason of the matters discussed above, I would dismiss the appeal from the judge’s order with an order nisi that the costs follow the event, i.e. that the appellant bear the respondent’s costs.