STEADFAST INTERNATIONAL LTD v. TUENBO CO LTD AND OTHERS

HCA 2095/2016

[2021] HKCFI 3094

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2095 OF 2016

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DECISION

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1.  This is an appeal by the plaintiff Steadfast International Limited (“Steadfast”) from the order of Master Rebecca Lee dated 23 October 2020 granting leave to the 2^nd to 4^th and 6^th to 7^th defendants (collectively “the Tuenbo parties”) to amend their Defence and Counterclaim. At the conclusion of the hearing, the Decision was reserved which I now give.

Background

2.  Steadfast is part of the New World Group.

3.  The 1^st defendant Tuenbo Company Limited (“TCL”) (formerly known as Utaloy Company Limited), is the corporate vehicle of the Tuenbo parties (comprising individuals and entities owned by them) who, prior to 21 July 2016, together owned 94.1% of TCL’s shares.  

4.  In September 1989, TCL and Zhongguo Guangzhou Bairun Properties Company, now known as Guangzhou Bairun Real Estate Co Limited (“Bairun”) into a Cooperative Contract (“the Contract”) under which Bairun was to obtain the land-use rights over the Golden Lake Site (“the site”) return for a fixed fee from TCL, the latter being solely responsible for the development of high-class residential properties and entitled to the fruits thereof.

5.  On 27 August 1991, TCL and Bairun established a Sino-foreign joint venture company known as Guangzhou Golden Lake Residential Neighbourhood Development Company Limited (“GLRN”) as the cooperative enterprise to hold the development interest in the site.  TCL and Bairun have been the only shareholders of GLRN.  On 28 August 1992, Bairun was granted the Land Use Contract over the site which is held by GLRN.

The original contractual structure

6.  In 1992, the New World Group through Steadfast entered into a series of agreements with TCL and/or GLRN for collaboration in developing the site (“the project”) in various phases.  These proceedings arise out of the phases 1 and 2 of the project.

7.  In broad outline, the project was a joint venture between TCL and Steadfast, with TCL contributing the land use rights over the site and Steadfast providing funding (by way of loans to be secured over the shares in TCL), managing the construction of the project and sharing any profits with TCL.

8.  It was contemplated that the project would be completed as soon as possible; the units would be sold offshore (i.e. outside the mainland); the proceeds would be received by 2 offshore joint venture companies owned by TCL and Steadfast which would distribute the proceeds to TCL and Steadfast, first to repay the loans advanced by Steadfast to the offshore companies and then as profits to be shared by TCL and Steadfast.

9.  Under phase 1 of the Shareholders’ Agreement dated 23 September 1992 (“SHA 1”) between Steadfast, TCL and Holicon Holdings Limited (“Holicon”), Steadfast made an initial loan of HK $50 million and a further loan of HK $50 million to TCL as well a shareholder’s loan to Holicon (to cover construction costs called predetermined proceeds or “PDP”) being the necessary financing for developing phase 1.

10.  Steadfast’s rights and obligations were to be reflected through its control over (a) the development committee of GLRN[1]; and (b) the offshore entities, “Holicon” and “Jorvik” (defined below), on whose boards Steadfast would have a majority.

11.  §11 of SHA 1 provided for the application of the sales proceeds - repaying the shareholder’s loan with interest, taxes and duties and the balance distributable as dividends to TCL and Steadfast provided that Holicon was authorised to appropriate TCL’s share to repay initial and further loans, with TCL being liable for the shortfall for the shareholder’s loan, initial and further loans. In other words, TCL gave a profit guarantee in respect of phase 1 units. 

12.  A similar agreement was entered into for phase 2 on 30 September 1993 (“SHA 2”) save that the BVI entity involved was Jorvik International Limited (“Jorvik”) in lieu of Holicon and the only loan made was a shareholder’s loan to Jorvik but without a profit guarantee in respect of phase 2 units. SHA 1 and SHA 2 are hereafter collectively referred to as “the SHAs”.

13.  Part of the arrangements involved GLRN appointing TCL as sole sales agent of the phases 1 and 2 properties, thus enabling TCL to appoint Holican and Jorvik (which are BVI companies) to act as the overseas sole sales agent for those properties under Sole Agency Sub-Contracts between TCL, Holican/Jorvik (as appropriate) and GLRN (“the Holicon/Jorvik Sub-Contracts”).

14.  Since March 1998, GLRN has had a 12-member board, 9 of whom were appointed by TCL[2], 7 of whom were nominees of Steadfast and the remaining 2 were appointed by the Tuenbo parties.

15.  The funding provided by Steadfast was secured by 2 share charges respectively dated 23 September 1992 (“the 1^st share charge”) and 30 September 1993 (“the 2^nd share charge”) over the Tuenbo parties’ shares in TCL.

16.  The key features of the original structure are that (i) Steadfast would always have control of the project; (ii) the units once constructed or to be sold offshore by Holican/Jorvik as soon as possible; and (iii) the sale proceeds applied, inter alia, to satisfy the indebtedness secured by the share charges.

The original structure as implemented

17.  Although Holican and Jorvik were duly incorporated and the initial and further loans advanced to TCL, Steadfast did not make any shareholder’s loans (the contemplated PDPs) to Holican and Jorvik notwithstanding the fact that it controlled those entities.

18.  Rather, other entities within the New World Group made loans[3] to GLRN (which Steadfast controlled[4]); upon completion of construction which took place in several tranches[5], some units were let[6] and others sold[7] but the sales made by GLRN were all onshore rather than offshore.

19.  GLRN thus controlled the flow of funds which was all within the Mainland: according to the Tuenbo parties, GLRN made loans to New World entities in the Mainland at no interest; borrowed from such entities at a higher interest when GLRN did not need cash; incurred excessive construction costs and rental income and sale proceeds received by GLRN were not applied to pay down what was said to constitute shareholder’s loans which remained outstanding, attracting interest compounded at Hibor +2 throughout.  

20.  The Tuenbo parties also complain about the reduction of GFA since that has a direct bearing on the PDPs since a reduced area of construction must translate into lower construction costs.

21.  It will have become apparent that (i) the project took not a few years (as originally contemplated) but almost 20 years to complete; (ii) no shareholder’s loans were made to Holican and Jorvik as originally contemplated; (iii) instead of completed units being sold as soon as possible, some were let and the first sales did not take place until 2010; (iv) such sales[8] that took place were onshore rather than offshore: (iv) all rental and proceeds went to GLRN and, in breach of SHAs §11, little (if any) was applied to reduce the shareholder’s loans.

22.  Steadfast claims[9] that the net outstanding principal amounts of the shareholder’s loans are of the order of HK $845 million, exclusive of interest.

Events precipitating the present action

23.  The articles of association of GLRN contain a provision setting out its operation period. Unless extended before its expiration, GLRN would be dissolved and its assets liquidated and distributed.  As at 11 August 2016, GLRN’s operation period was due to expire on 27 August 2016. 

24.  According to Steadfast, GLRN’s value lay in both the future potential for development of certain parts of the site as well as the fact that in mid-2016 108 villas remained unsold although some had been leased out. If GLRN were to be liquidated, only a fraction of the potential value would be realised.

25.  It is Steadfast’s case that despite requests and demands, the Tuenbo parties refused to extend the operation period of GLRN and refused to hold any shareholders or directors meeting of TCL to extend it which Steadfast considered a breach of various warranties in the SHAs.

26.  On 18 May 2016, Steadfast called an event of default and reconstituted TCL’s board at the EGM on 21 July 2016.  After that date, the Tuenbo parties continued to hold themselves out as directors of TCL, precipitating the present action seeking various declaratory and injunctive reliefs concerning its exercise of powers under the share charges.

27.  The writ was issued on 11 August 2016 with Steadfast obtaining an interim injunction on 19 August 2016 restraining the Tuenbo parties from holding themselves out as directors of TCL and obstructing TCL’s attempts to extend GLRN’s operation period. meanwhile, the outstanding indebtedness continued to attract interest at Hibor + 2.

28.  Since 19 August 2016, Steadfast has had total control over TCL and its underlying asset GLRN which holds the land use rights. The interest continues to accrue on the shareholder’s loans which Steadfast claims remain outstanding notwithstanding the completion of the project.

29.  On 8 February 2019, the Tuenbo parties commenced HCA 205/2019 against Steadfast for an account and redemption of the shares under the share charges.  After Steadfast’s application to strike out HCA 205, as suggested by the Registrar, the Tuenbo parties agreed to bring their claims in the present proceedings.  That led to their summons seeking to amend their defence and counterclaim being issued in October 2019.

30.  Steadfast objected to many of the proposed amendments.  The matter came before Master Rebecca Lee on 23 October 2020 who allowed the amendments as per the draft Amended Defence and Counterclaim (“ADC”) except for §§111, 116 and the prayer (xE) on 23 October 2020 and whose order is the subject matter of the present appeal.

31.  Steadfast seeks an order that the Tuenbo parties only have leave to amend as per the ADC without those paragraphs identified in the revised list of opposed paragraphs dated 7 August 2020 (“the List”).

This appeal

32.  These proceedings arise out of Steadfast’s exercise of its powers as chargee under the 2^nd share charge under which the chargors  (the Tuenbo parties) covenanted (a) to pay all amounts due and owing to Steadfast by TCL and all parties to whom at TCL’s request Steadfast had advanced monies under the SHAs and the subcontracts[10] and (b) to perform all obligations undertaken by TCL under the SHAs and the Jorvik Sole Agency Sub-contract[11].

33.  Steadfast’s objections set out in the List can conveniently be considered under the 4 headings below.

(1)     “New claims”

34.  Steadfast opposes the proposed amendments identified in items 2, 3, 5, 8-14 of the List on the ground that they raise new claims against Steadfast relating to:

(i)      Steadfast’s failure to apply proceeds as required by §11 of the SHAs;

(ii)     its wrongful diversion of those proceeds by procuring GLRN to benefit New World entities;

(iii)    its failure to procure GLRN to sell completed units as soon as possible after construction;

(iv)    excessive construction costs; and

(v)     the fact that but for those breaches, dividends to which TCL would have been entitled would have been substantially greater and the share charges could also have been redeemed earlier. In other words, there would have been much lower or even no debt owing to Steadfast.

35.  Those claims reflect the complaints of the Tuenbo parties outlined in §§17-21 above.

36.  Steadfast’s position is that irrespective of the merits of those claims, had they been raised as stand-alone claims now they would be time-barred as they do not engage any equitable set-off.  Rather, Steadfast considers that the Tuenbo parties are manipulating the doctrine of equitable set-off to circumvent the rules of limitation.

37.  Mr Joffe QC leading counsel for Steadfast invited attention to the 2^nd share charge which not only secured pecuniary or financial obligations of TCL but also, in particular, due performance of its obligations under the SHAs and the Jorvik Sole Agency Sub-contract including (as is Steadfast’s case[12]) ensuring that GLRN is not wound up.  He submitted that this action (whereby Steadfast seeks various declaratory and injunctive reliefs) is only concerned with Steadfast’s exercise of its powers under the share charges as chargee and that the chargors’ indebtedness is not an issue.

38.  Parenthetically, the declaration sought is that Steadfast is and was “at all material times” entitled to the security.  It therefore relates to the position not only in 2016 but also as the date of the declaration.  In that connection, the Tuenbo parties highlighted new developments since the Master’s order, namely the sale of further units in 2019 and 2020 the proceeds of which, it was said, would have been sufficient to discharge all outstanding debt. An application to re-amend the ADC to incorporate the new developments and for summary judgment on their claim for redemption is pending and will be heard in early November.

39.  Steadfast considers TCL’s refusal to extend GLRN’s expiration period an event of default in breach of an implied term that GLRN will remain a valid and subsisting legal entity and/or in breach of the implied term to preserve the value of the security, namely the worth of GLRN which is reflective of the value of the charged TCL shares. 

40.  Mr Bernard Man SC, leading counsel for the Tuenbo parties, submitted that a security cannot be enforced if there is no outstanding secured liability, citing Goode and Gullifer on Legal Problems of Credit and Security 6^th edition at §2-08.  In exercising its rights under the 2^nd share charge, Steadfast must also assert that there is outstanding indebtedness still being secured, that being a “critical building block” of Steadfast’s cause of action.

41.  The key issue between their respective positions is whether outstanding indebtedness is a necessary element in the enforcement of the 2^nd share charge. If indebtedness is an issue, prima facie, the so-called “new claims” would be relevant since they go to establishing a lesser amount due or no amount due at all.

42.  In his oral submissions, Mr Joffe accepted that the amount of existing indebtedness is not wholly irrelevant although the precise amount does not matter.  As noted in §22 above, Steadfast quantified[13] the outstanding shareholder’s loans at approximately HK$845 million.

43.  In so far as Steadfast’s claim is based on a breach of warranty that the Tuenbo parties would not cause the value of the charged TCL shares to deteriorate or diminish or otherwise impair the value of its underlying asset, namely GLRN, it is because the worth of GLRN is reflective of the value of the charged TCL shares. GLRN’s continued existence is said to be of crucial importance and its cash assets of approximately HK $170 million as at 30 December 2015 were insufficient to repay the shareholder’s loans and interest[14]. 

44.  Mr Man submitted that the legitimate interest of the secured creditor is to secure the payment of money.  While there may be obligations to keep the property charged intact, such obligations can only be ancillary to principal purpose which must be to secure the payment of money.  Once the money secured has been repaid, enforcement of ancillary obligations serves no useful purpose and cannot be an end in itself.

45.  On the supposition that had Steadfast not been in breach of its obligations, nothing would be owed under the share charge, logically it must follow that the warranty designed to preserve the value of the security becomes irrelevant.

46.  Schedule 5 the ADC sets out calculations[15] that illustrate amounts due to TCL if phases 1 and 2 units had been sold by August 2016 and the proceeds applied to pay down the shareholder’s loans[16]  and assuming that the PDPs (representing the construction costs) have been provided by Steadfast in the reduced amount pleaded in §24M[17], by 18 May 2016, TCL would have been entitled to $297 million.

47.  The defence pleaded there is that but for Steadfast’s breaches, a positive sum would have been payable to TCL which must mean that the shareholder’s loans would have been extinguished.

48.  As to the material adverse change complaint, it was submitted that its purpose is also to preserve the value of the security.  If nothing is owed, no material adverse change in the position of the secured creditor can possibly arise.

49.  The Tuenbo parties submitted that Steadfast is not entitled to rely on alleged liabilities incurred by reason of its own wrongdoing to inflate the amounts secured under the 2^nd share charge and/or justify the enforcement of the security. In other words, a party cannot take advantage of its own wrong: see Kensland Realty Limited v Whale View Investment Limited & Another (2001) 4 HKCFAR 381 at §§91-100.

50.  The “new claims” or the breaches the Tuenbo parties allege all go to quantum (the contention being that but for the breaches, less or no debt is owed), and constitute a defence to Steadfast’s claim by operation of the prevention principle.

51.  When so analysed, it is clear that indebtedness must be an element of Steadfast’s cause of action.  I do not accept Steadfast’s submission that the sole issue raised in the action is the Tuenbo parties’ failure to apply for an extension of GLRN’s operation period.

52.  Steadfast submitted that for Kensland to apply, there has to be a causal element to link the new claims with all exercise by Steadfast of its rights as chargee which is lacking in the present case.  But the Tuenbo parties are not seeking to enforce any rights: Steadfast’s breaches are raised by way of a defence to the debt said to be owing to Steadfast, contending that less or no debt is owed.  In my view, the Kensland defence is a defence open to the Tuenbo parties to run.

53.  The Tuenbo parties also run an equitable set-off defence.  It is common ground that:

(i)      the expiry of a limitation period bars a party from obtaining a remedy, but does not extinguish that party’s right: see McGhee, Limitation Periods, 8^th ed., §§2.038-2.042.

(ii)     a defendant to an action may rely on a right (the enforcement of which would be time-barred) to set up an equitable set-off as a defence to a plaintiff’s claim: see Derham on The Law of Set-Off, 4^th ed., §§4.51 to 4.54.

(iii)    where a party raises an equitable set-off that arises out of the same transaction as the plaintiff’s claim, such an equitable set-off (operating merely as a defence) is not subject to time bar: The Brede [1974] QB 233, 247D-249A[18].

54.  Steadfast submitted that the complaint as to Steadfast’s failure to apply the proceeds of lettings and sales would require Steadfast to revisit events as far back as 1996 for lettings and 2011 for sales which is prejudicial.   However, there is no evidence of prejudice before the court.

55.  The Tuenbo parties submitted that Steadfast, as the secured creditor, is the accounting party and must come forward with the amount it says it is owed.

56.  If, as it is my view, that indebtedness is an element of Steadfast’s cause of action, the breaches alleged are raised by way of defence.

57.  In so far as it was submitted[19] that the Tuenbo parties do not ask the court to “take into account” their complaints in computing what is owed to Steadfast (or in doing justice), the basis of that submission is not apparent.  The Tuenbo parties’ defence is that but for the wrongs Steadfast committed, no outstanding debt would have existed in 2016 or any such debt would be of an amount that the Tuenbo parties could have afforded to pay and, on that basis, Steadfast could not have been in a position to enforce the 2^nd share charge.  Such a defence is not subject to time bar[20].

58.  Steadfast referred to the general rule that the mortgagor is not entitled to bring the mortgagee before the court except for the purpose of redemption.  It was submitted that as no tender has been made, no viable action can be brought simply on the “new claims”.

59.  Inglis v Commonwealth Trading Bank of Australia (1971) 126 CLR 161 (which was cited) concerned an application by the mortgagors for an interim injunction to restrain the mortgagee from exercising its rights. In that case, the mortgagors did not deny the existence of the underlying mortgage debt but denied that anything was owing to the mortgagee because of their cross claims (which had nothing to do with the mortgage debt) and consequently any debt that did exist was more than counterbalanced by the damages to which the mortgagors claimed to be entitled under their cross-claims.

60.  That decision is of little assistance in the context of a defence to the mortgage debt itself based on Kensland and/or equitable set-off.

61.  It follows from what is set out above that I do not consider that Steadfast’s objections to the “new claims” are valid.

(2)     Implied terms

62.  As regards items 6 and 7 of the List, item 6 concerns §22 of the ADC which pleads that the SHAs contain the implied terms to the effect that Steadfast (i) shall manage the project using its best endeavours, in good faith and/or with reasonable care and skill and (ii) shall use its best endeavours and act in good faith and with reasonable care in dealing with and applying the proceeds from the sale of the properties in the project to reduce the outstanding debts due by TCL under the SHAs as soon as practicable.  Item 7 is consequential to and stands or falls with item 6.

63.  Steadfast submitted that not only do they fall foul of the Kensland[21] test, they are also inconsistent with other averments in the ADC.

64.  The Tuenbo parties submitted that in 1992, what was contemplated was that Holican and Jorvik (controlled by Steadfast) would be the recipients of the proceeds.  If they were no longer to be the recipients but some other entity also controlled by Steadfast, the court would give effect to that intention.

65.  In Arnold v Britton [2015] AC 1619 at §22 Lord Neuberger stated that when an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract, if it is clear what the parties would have intended, the court will give effect to that intention.

66.  Steadfast had control over Holican and Jorvik in 1992 but the proceeds went to another entity that Steadfast also controlled. It was submitted that in those circumstances Steadfast must apply the same care and skill in whatever rights they had in the new entity to ensure that the original contractual understanding that the proceeds would have to be reasonably applied, to pay down the indebtedness as soon as possible and that the sales would take place expeditiously and reasonably.

67.  An alternative approach is to view the implied terms as arising at the time the variations came into place.

68.  I consider the point arguable. Accordingly, the proposed amendment introducing the implied terms is not objectionable.

(3)     Taking an account on the basis of wilful default

69.  Steadfast objects to items 14[22], 16, 17, 19 to 21 which seek an account on the basis of wilful default (that the effect of Steadfast’s wrongful acts should not be ignored). The objection is based on section 4 (2) of the Limitation Ordinance (“LO”).

70.  As Lord Millet explained in Libertarian Investments Limited v Hall (2013) 16 HKCFAR 681 at §§167, 168 and 170 an account is not a remedy for wrong and in making the order the court is not granting a remedy for wrong but enforcing performance of an obligation. It is the first step in a process which enables the plaintiff to identify and quantify any deficit in the trust fund and seek the appropriate means by which it may be made good. Once the plaintiff has been provided with an account he can falsify and surcharge by asking for the account to be taken on the basis of wilful default.

71.  Mr Joffe submitted that an account taken on the basis of wilful default is not a mechanical exercise to identify and quantify a trust fund. Rather it is a remedy and response to the finding of breach or default by the accounting party.  The underlying breaches must be proved and in substance they are based upon new facts sought to be introduced long past the limitation period.  Since that does not fall within any exception, section 4 (2) of the LO must apply.

72.  If a claim for an account is based on a pure equitable right, no limitation period applies: see Liu Hsiao Cheng v Wong Shu Wai [2018] 1 HKLRD 1087 at §33.

73.  Mr Man submitted that the taking of an account on a wilful default basis means that the exercise is done on the assumption that the trustee had performed his duty and obtained a relevant benefit for the trust: Libertarian at §170.  On that basis, the nature of the accounting exercise is no different from the taking of an account simpliciter since both exercises merely seek to identify and quantify the trust fund.  Limitation periods ought not apply to the taking of an account on the basis of wilful default itself either.

74.  It was emphasised that the Tuenbo parties are merely seeking to identify and quantify their true liabilities to Steadfast so that they can pay and redeem the TCL shares.  There is no claim for consequential payment by Steadfast after the taking account on the basis of wilful default.

75.  I am inclined to agree with the analysis put forward by the Tuenbo parties. They should not be precluded from seeking an account on the basis of wilful default at this stage.

(4)     Irrelevant averments

76.  Items 1 and 4 relate to averments in §§7 (1) and 18 (8) of the ADC which Steadfast opposes on the basis that they would tend to prejudice, embarrass or delay the fair trial of the action. The averments concern TCL’s contributions to GLRN in terms of assets and time, and sums of money prior to Steadfast’s involvement in the project.

77.  The averments provide particulars to TCL’s original allegation made in §18 (8) that it had contributed resources to GLRN. Their relevance is to show that the Tuenbo parties had invested a great deal into the project by securing at their own expense a valuable land use right. In sharing that right with Steadfast who would have control of the project, they reposed trust and confidence in Steadfast who accordingly owe fiduciary duties to the Tuenbo parties.

78.  I do not accept Steadfast’s submission that they are irrelevant to any issue in dispute. They form an integral part of the backdrop to the project.

Conclusion

79.  For the reasons set out above, this appeal is dismissed. There is to be an order nisi of costs in favour of the Tuenbo parties with certificate for 2 counsel, such costs to be summarily assessed and payable forthwith.  Directions will be given separately for summary assessment.