XCHRX BANK OF CHINA (HONG KONG) LTD. v. KANISHI (FAR EAST) LTD. AND ANOTHER

HCMP5045/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.5045 OF 2000

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J U D G M E N T

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The present appeal

1. The present appeal raises, principally but not exclusively, the following questions : Can a charging order absolute be granted in respect of property which is subject to a prior interest and if so, ought one be made in the present case? I will later place these questions in their proper context.

2. On 23 February 2001, Master Jones ordered the 1st and 2nd defendants to pay to the plaintiff the following sums together with interest thereon, being the liability of the defendants under two mortgages :-

(a) HK$46,377,286.73;

(b) USD$132,164.27; and

(c) JPY6,264,261.

3. In this appeal, I am concerned only with the position of the plaintiff, the 1st defendant and the claimant Po Ding Company Limited. I will refer to these parties respectively as "the Judgment Creditor", the "Judgment Debtor" and the "the Claimant".

4. On 2 April 2001, the Judgment Creditor obtained from Master Wong a charging order nisi on certain securities being 25 shares with a par value of HK$1.00 ("the Shares") in a private company named Main World Development Limited ("the Company"). These shares were, according to the documents filed by the Company in the Companies Registry, held in the name of the Judgment Debtor.

5. The charging order nisi was in the form required under RHC, Order 50, rule 1(2) and was therefore also a notice to show cause with a return date of 27 April 2001.

6. On 27 April 2001, an Affirmation from Louis Ho Chi Wai dated a day earlier was filed on behalf of the Claimant claiming that it had a prior equitable charge or mortgage on the Shares which had, on 10 April 2001, been converted into a legal charge when the Claimant became the registered legal owner of the same.

7. On 27 April 2001, Master Kwan adjourned the return date of the notice to show cause, giving leave to both the Judgment Creditor and the Claimant to file further affidavit evidence. Neither party did.

8. On 11 September 2001, after hearing argument from the Judgment Creditor and the Claimant, Master De Souza held in favour of the Claimant and discharged the charging order nisi with costs. It is from that Order that the Judgment Creditor now appeals. The main protagonists before me are the Judgment Creditor and the Claimant. Although the Defendants are represented by Mr Lau, no submissions were made on their behalf.

Background

9. The relevant facts are not really in dispute. The main controversy between the Judgment Creditor and the Claimant lies in the correct legal analysis of the facts and in those questions I have already set out above.

10. The starting point is a letter dated 1 September 2000 from the Claimant to the Judgment Debtor, in which there was confirmed an agreement ("the Loan Agreement") on the Claimant's part to extend a temporary loan of HK$2 million to the Judgment Debtor on the terms and conditions contained in the letter. The relevant term for the purposes of the present appeal is clause 1 dealing with the security for the loan. This states :

"1. As security, you [the Judgment Debtor] will pledge to us [the Claimant] 25 shares of.... [the company] representing 25% of the issued share capital of.... [the company]. Please deliver to us the share certificate together with the form of transfer duly executed." (emphasis added)

11. The 25% of the Shares represented the whole of the Judgment Debtor's interest in the Company. As far as the Claimant was concerned, it was prior to the Loan Agreement already the holder of 45% of the issued share capital in the Company.

12. On 1 September 2001, in compliance with the Loan Agreement, the Judgment Debtor delivered to the Claimant :-

(a) the share certificate for the Shares in the Judgment Debtor's name; and

(b) an Instrument of Transfer signed by the Judgment Debtor as transferor transferring the Shares to the Claimant (who was named as transferee). This document, to which I will further refer below, was undated and unsigned by the Claimant.

13. The Judgment Debtor failed to repay the said loan of $2 million. As a result, the Claimant enforced the security in the Shares by completing the blanks on the Instrument of Transfer (by inserting the date of 1 September 2000 and signing it) and having it stamped on 10 April 2001. The Claimant signed the Instrument of Transfer twice : first simply as transferee, the second under the words :

"We hereby certify that the shares as mentioned overleaf are held by us as security against facilities granted and no purchase or sale in respect of this transaction has been involved."

14. I now turn to the issues that arise from these facts.

The issues

15. The following issues arise for consideration in the present appeal :-

(a) What was the nature of the Claimant's interest in the Shares, whether (as the Judgment Creditor submits) a mere pledgee or (as the Claimant contends) an equitable mortgagee or chargee (Issue 1)?

(b) In any event, even if the nature of the Claimant's interest was that of an equitable mortgagee or chargee, does the Court nevertheless have the jurisdiction to make a charging order in respect of the Shares and if so, in the circumstances of the present case, ought the Court make such an order (Issue 2)?

16. In defining the issues as above, I have reworded those issues as identified by Mr Eugene Fung for the Judgment Creditor. I intend to deal with the issues in the order I have set them out, which was the order in which Mr Michael Yin for the Claimant dealt with the matter. I agree this is the more logical approach in applications such as the present.

17. However, before dealing with these specific issues, I first mention briefly the nature of the Court's jurisdiction in respect of charging orders.

The Court's jurisdiction in respect of charging orders

18. Procedurally, the making of charging orders is of course governed by RHC Order 50. Substantively, however, the starting point is to look at sections 20, 20A and 20B of the High Court Ordinance.

19. The following points are of note in relation to these provisions :

(a) In deciding whether or not to make a charging order (nisi or absolute), the Court is vested with a discretion. The Court is by statute required to take into account "all the circumstances of the case" : section 20(3). The width of this discretion is designed to enable the court to ensure that practical justice is done, balancing on the one hand the right of judgment creditors to enjoy the fruits of money judgments they have obtained by making use of all execution procedures open to them and on the other, the rights or interests (and I use these terms not necessarily in the strict proprietary sense) of other persons in connection with the relevant property. Which way the balance tilts in any given case is a matter of individual judgment in the circumstances : Roberts Petroleum Ltd v. Bernard Kenny Ltd [1983] 2 AC 192, at 212 A-B.

(b) Specifically, however, but in my view in no way cutting down on the width of the discretion, the Court is required to consider the personal circumstances of the debtor and whether any other creditor of the debtor would be likely to be "unduly" prejudiced by the making of the order : sections 20(3)(a) and (b). I emphasise the word "unduly" here.

(c) Charging orders can only be made in relation to interests held beneficially by the debtor in certain specified types of property, being land, securities and funds in court : section 20A(2).

(d) Once a charging order is made, a statutory fiction is created whereby it "shall have the like effect and shall be enforceable in the same courts and in the same manner as an equitable charge created by the debtor by writing under his hand" : section 20B(3). In other words, a charging order takes effect as an equitable charge and this interest in the relevant property will be recognised notwithstanding the winding up or bankruptcy of the debtor, providing that the charging order was made prior to the commencement of the winding up or bankruptcy : section 269 of the Companies Ordinance and section 45 of the Bankruptcy Ordinance.

(e) The term charging order "absolute" is a slight misnomer in that the Court may at any time on the application of the debtor or anyone interested in the property, make an order discharging or varying the order : section 20B(4); RHC Order 50, rule 7. This is a provision that recognises a common feature of charging orders, namely, that the relevant property may be subject to a number of competing interests each enjoying different priorities and characteristics that may not be readily apparent at the time the charging order (whether nisi or absolute) is made.

20. With these general observations in mind, I now deal with the issues that I have earlier identified.

Issue 1 : The nature of the Claimant's interest in the Shares

21. The Judgment Creditor's contention is that the security interest in the Shares arising from the Loan Agreement was a simple pledge with no proprietary interest. I should perhaps at this point just set out what is meant by a pledge here. I can find no better definition of this term (and the distinction between a pledge and a mortgage) than in the judgment of Cohen J in the Supreme Court of New South Wales (Equity Division) in Askrigg Pty Ltd v Student Guild of the Curtin University of Technology (1989) 1 ACSR 40, at p. 44 :

"A pledge is a form of security created by a contract which results in a bailment of the subject matter to the creditor which he is entitled to retain until the debt is paid. It requires actual or constructive delivery of the goods to the pledgee. This does not involve a transfer of the title and in this way it differs from a mortgage. In that case the mortgagor transfers to the mortgagee the whole of the rights to the property, retaining a right of redemption. Under a pledge the pledgee has no more than a right of possession but with a right of sale of the property upon default by the pledger. There is no right of foreclosure : see Sykes The Law of Securities, p 649; Fisher & Lightwood's Law of Mortgage, Butterworths, 10th ed, p 4."

22. The Claimant's position was quite the opposite : the security arrangements under the Loan Agreement amounted to an equitable mortgage in favour of it.

23. In my view, the arrangements clearly point to the existence of an equitable mortgage.

24. First, although I fully accept the obvious proposition that whether or not a pledge exists is of course a matter of ascertaining the intention of the parties (see : Sewell v. Burdick (1884) 10 App Cas 74, at 97), the deposit of share certificates as well as of instruments of transfer are strongly indicative of the intention to create an equitable mortgage : France v. Clark (1884) 26 Ch.D 257; London and Midland Bank v. Mitchell [1899] 2 Ch 161; Harrold v. Plenty [1901] 2 Ch 314, at 316; Stubbs v. Slater [1910] 1 Ch 632; Coote's Law of Mortgages (9th edition) at p. 311.

25. Secondly, in ascertaining the intention of the parties as to the true nature of the transaction, it is important to bear in mind the purpose behind the transaction. The Shares were part of the security for the loan extended to the Judgment Debtor. Shares are choses in action and not choses in possession. It is therefore not possible, as Mr Fung rightly accepted, to create a pledge of shares as one would pledge either choses in possession (i.e. physical objects) or certain types of choses in action which by custom are equivalent to the objects they represent (such as bills of lading which represent cargoes or bills of exchange which are treated as cash) : see Harrold v. Plenty at p. 316. The depositing of share certificates or instruments of transfer cannot therefore constitute a pledge of the underlying shares. All that is pledged here are pieces of paper : see EG Tan & Co. v. Chase Manhattan Bank NA [1991] 3 MLJ 301, at p. 307 (High Court of Singapore).

26. Of course, if the parties truly intended a pledge of pieces of paper, the Court is bound to give effect to such an intention, but unless the facts compel such an analysis, a court would I think find it exceedingly difficult to arrive at such a result when the commercial purpose of the transaction is to provide security. Not many lenders, I perceive, would take the security of a mere pledge of pieces of paper having a dubious commercial value rather than the security of an equitable mortgage of the shares which would almost without question provide security to the extent of the shares themselves. I do not say that a pledge of pieces of paper is valueless, but there must be doubts as to just how much they would be worth. In commercial life, lenders want certainty and security, not the contrary.

27. In the present case, although the Agreement uses the word "pledge" in relation to the Shares, I am of the view that in context, what was clearly meant was the creation of an equitable mortgage by the depositing of the share certificate and instrument of transfer. The whole purpose of the transaction, I have already mentioned, was the provision of security for a loan.

28. Finally in this context, it should be remembered that the Instrument of Transfer specifically names the Claimant as the transferee thereby further indicating the intention of the parties that the Claimant was to have an interest in the Shares, as an equitable mortgagee would have. If a mere pledge was intended, which would not confer any proprietary interest in the Shares on the Claimant, the name of the transferee would probably have been left blank. Certainly, it is unlikely that the Claimant's name would be inserted as transferee. I would just also observe that where pledges are involved, the pledgee has the right to sell but has no right to acquire the goods himself by foreclosure : Carter v. Wade (1877) 4 Ch D 605, at p. 606.

29. Accordingly, in my judgment, the nature of the Claimant's interest in the Shares was that of an equitable mortgagee. But does it follow from that conclusion that the charging order nisi should not be made absolute?

Issue 2 : Can a charging order absolute be granted in respect of property which is subject to a prior interest and if so, ought one be made in the present case?

30. This was Mr Fung's primary case : that even if the Claimant is to be treated as an equitable mortgagee, the Court should nevertheless make absolute the charging order.

31. I agree the Court has jurisdiction to make a charging order absolute even where there exist prior interests in the relevant property. Nothing in the High Court Ordinance or in the Rules prevents this.

32. Indeed, I would say there is some support for this in section 20B(3) whereby a charging order takes effect as an equitable charge. This presupposes (at the very least does not preclude) the possibility of competing interests, equitable or otherwise, in the property.

33. Further support also lies in Mr Fung's submission, with which I agree, that the discretion vested in the Court is unfettered. I have already referred to section 20(3)(b) whereby the Court is required to consider whether any other creditor of the debtor would likely be "unduly" prejudiced by the making of the order. Again, this presupposes the possibility of creditors which may have an existing interest in the relevant property.

34. While the Court may refuse to make absolute a charging order nisi on the ground that unsecured creditors may be prejudiced (see for example cases in which the judgment debtor is in the process of being wound up or about to be : Roberts Petroleum Ltd v. Bernard Kenny Ltd [1983] 2 AC 192), it does not in my view follow that just because a creditor is secured (for example an equitable mortgagee), this is somehow an automatic bar to a charging order being made. To be fair, I do not think that Mr Yin was really suggesting this to be the case.

35. The cases also show consistently that charging orders can co-exist with prior equitable interests. The rule is that charging orders take effect subject to prior mortgages, whether legal or equitable : Whitworth v Gaugain (1846) 1 Ph 728; Chung Khiaw Bank Ltd v. United Overseas Bank Ltd [1970] AC 767, at 747; Halsbury's Laws of England Vol. 32 (4th ediiton reissue) at paragraphs 446 and 492.

36. Mr Yin did, however, submit that as an equitable mortgagee, the Claimant was in the best position to have vested in it the legal estate : see Coote's Law of Mortgages (9th edition) at pp. 1239-1243. This occurred on or about 10 April 2001 when the Instrument of Transfer was filled in and stamped. Thus, so the argument ran, the Claimant became the legal as well as equitable owner and the Judgment Debtor's interest in the Shares was only in the equity of redemption. It was contended that an equity of redemption was not a beneficial interest in the Shares such as could be made the subject matter of a charging order and besides, the Judgment Creditor had not applied for a charging order on the equity of redemption.

37. In my view, where the interest of a judgment debtor is in the equity of redemption, this is sufficient to enable a charging order to be made on the relevant property. The requirement in section 20A(1) is that the judgment debtor should have "an interest ...... beneficially" in the assets referred to in section 20A(2). The equity of redemption is an interest held beneficially by a judgment debtor in the relevant property. As to the nature of an equity of redemption see, for example, Halsbury's Laws of England Vol 32 (4th edition reissue) at paragraphs 503-504. I would perhaps just observe that if it were somehow a bar to a charging order that the only interest of a judgment debtor was an equity of redemption, some of the cases referred to in paragraph 35 above might not have been decided the way they were.

38. I would also add it makes no difference that the legal estate in the property has vested in the mortgagee : the mortgagor (the Judgment Debtor) still has the equity of redemption. However, insofar as it does make a difference in the present case that the legal estate in the Shares has passed to the Claimant, the provisions of RHC Order 50, rule 5(1) will apply so as not to give the Claimant an unfair advantage.

39. I am therefore of the view that there is no bar to the making of a charging order even if there exist prior interests in the relevant property and the interest of the judgment debtor therein is only in the equity of redemption. In such a situation, it is also right that the charging order is made against the relevant property itself because once redeemed, it then becomes vested (or revested) in the judgment debtor.

40. Accordingly, there being jurisdiction to make a charging order absolute even where there exist prior equitable interests in the property, ought the charging order be made absolute in the present case?

41. Here, the Court, in the continuing exercise of its discretion, must carry out the balancing exercise between competing interests (a matter to which I have already alluded). Mr Yin makes the following points :-

(a) Prejudice would be caused to the Claimant if the charging order were made absolute.

(b) The Court should not act in vain because if the value of the Shares did not exceed the amount of the indebtedness owed properly to the Claimant, there would be no point in making the charging order absolute.

42. As to prejudice, no specific evidence of this appears in the affidavit evidence served by the Claimant. Certainly, the Claimant's interest as equitable mortgagee in the Shares will have priority over the interest that the Judgment Creditor would have in them in the event a charging order absolute is made. It will be remembered that the Judgment Creditor's interest would be that of an equitable chargee : section 20B(3) and therefore subject to prior equities.

43. Mr Yin also submits there would be prejudice in that if, for example, the Claimant wished to sell the Shares to enforce its security, any potential buyer would insist on being satisfied that the Judgment Creditor's interests were taken into account, so that this would somehow be an additional burden on the Claimant. Doubtless the Claimant would, if a charging order exists, have to take into account the interests of the Judgment Creditor but this does not constitute in my view undue prejudice for the purposes of section 20(3)(b). In any event, this is but a consequence of a second charge or mortgage being created on the Shares, which is something that the Claimant probably could not have prevented anyway.

44. It should also be borne in mind that afterall the Claimant is only a creditor and a mortgagee of the Shares. As the Instrument of Transfer makes clear, the Shares are held only as security for the indebtedness owed to the Claimant. Once that indebtedness is satisfied, the Claimant has no further interest in the Shares. Thus, if the Shares are worth in excess of the indebtedness owed by the Judgment Debtor to the Claimant, it would be fundamentally wrong in principle in my view in the absence of exceptional circumstances, to deny the Judgment Creditor the right to a charging order on the Shares.

45. As stated above, there is no prejudice to the Claimant since its interest in the Shares has priority over the Judgment Creditor's interest, but there is real prejudice to the Judgment Creditor if a charging order were not made if the Shares are worth more than the debt owed to the Claimant. I agree with Mr Fung it is not enough merely to say that if the Shares were to be sold and there is an excess after the Claimant has been paid in full, this money will then be repaid to the Judgment Debtor and the Judgment Creditor can at that stage take any necessary action. Mr Fung asked rhetorically, how is the Judgment Creditor to be in a position to know when all this takes place so that it can take action expeditiously? There is much force in this argument.

46. I see no reason why in the present case the Judgment Creditor should not be allowed to take the benefit of a charging order even if its effect is that of creating a second mortgage or charge. Mr Yin says that such a mortgage or charge is not like a normal second mortgage or charge in that the Judgment Creditor's interest would only be in having the Shares sold and that it would somehow not be possible for the Judgment Creditor to pay off the Claimant. I do not agree. The result of a charging order would be that the Judgment Creditor becomes an equitable chargee, together with all rights and obligations that that status entails. I see no reason why it could not pay off the Claimant and thereby effectively become the first mortgagee or chargee. Certainly I can see no undue prejudice to the Claimant by the creation of a second mortgage or charge.

47. There is unfortunately no evidence before me as to the value of the Shares. If there had been evidence that their value was less than the indebtedness owed to the Claimant, there would obviously be no point in making a charging order absolute. On the other hand, if their value was in excess of the indebtedness, it would be unfair on the Judgment Creditor not to make a charging order. Both sides criticise each other for the lack of evidence here. It is a little unfair to criticise the Judgment Creditor since it would have been somewhat difficult for it to obtain such evidence : I have already referred to the fact that the Company is a private company. The Claimant on the other hand, being as I have said even before the creation of the equitable mortgage the holder of 45% of the issued share capital of the Company, could and should have produced such evidence. Even the production of audited accounts would have assisted. I note that Mr Ho, who made an affirmation on behalf of the Claimant, is a director of the company.

48. The paucity of evidence prevents me from drawing any useful inferences as to the value of the Shares but, ultimately however, I am of the view that this should not be held against the Judgment Creditor. If the value of the Shares is really less than the indebtedness owed to the Claimant, no prejudice is caused to the Claimant by a charging order being made owing to the priority of its equitable charge. On the other hand, if the value of the Shares exceeds the indebtedness, the Claimant is still not prejudiced for the same reason. I do not agree, in the circumstances, that the Court would be acting in vain in granting a charging order absolute in the present case.

49. In future, where competing interests in property are involved in applications for charging orders, it will often be important for there to be evidence as to value.

Conclusion

50. In my judgment, in the circumstances and for the reasons given above, I am of the view that a charging order absolute should be made in relation to the Shares. Accordingly, it is ordered that :

(a) the appeal be allowed;

(b) the Order of Master De Souza dated 11 September 2001 be set aside; and

(c) The charging order on securities : notice to show cause dated 2 April 2001 be made absolute and that the costs of the application for the charging order nisi dated 2 April 2001 be to the plaintiff as against the 1st defendant, such costs to be added to the judgment debt.

51. As to the costs of and occasioned by the hearing before Master De Souza and the costs of the present appeal, I make an order nisi that the Claimant shall bear the plaintiff's costs, such costs to be taxed if not agreed. I make no order as far as the defendants' costs are concerned.

52. It only remains for me to thank counsel for their assistance.