WELL KENT FINANCE LTD. AND ANOTHER v. WULFGRAM, MARGA SIGRID RENATE AND ANOTHER

HCMP 4035/1996
& HCA 13124/1996

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.4035 OF 1996 AND
ACTION NO. 13124 OF 1996
(Consolidated)

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J U D G M E N T

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1. In these consolidated proceedings the plaintiffs claim against the 1st defendant possession of a property in Cloudview Road, of which the 1st defendant is the owner, and payment of a sum of $11,396,392.26, under a second legal charge ("the legal charge") purportedly made on 23 December 1995, to secure a debt which the plaintiffs say was owed to the 2nd plaintiff and assigned, with the legal charge, to the 1st plaintiff. The 1st defendant, who is the wife of the 2nd defendant, avers that the legal charge was obtained by fraud on the part of the 2nd defendant and others, or that the mortgagee had constructive notice that she had not agreed to the legal charge and was entitled to have it set aside. The plaintiffs claim in the alternative against the 2nd defendant for breach of warranty of authority, as it was he who signed the legal charge acting under the purported authority of a power of attorney in his favour signed by his wife, the 1st defendant.

2. The 1st plaintiff is a company owned and controlled by the Guangdong branch of the China Construction Bank ("the bank") and the 2nd plaintiff is a company through which the city of Qing Yuan did business in Hong Kong and which maintained a close relationship with the bank.

3. The series of events which culminated in the signing of the power of attorney and legal charge began in late 1993 when a company called Hancheer Ltd ("Hancheer"), a trading company owned and controlled by the Qing Yuan branch of the bank, started to purchase left hand drive vehicles, for use or resale in China, from a Hong Kong company called All Have Development Ltd ("All Have"), which traded under the name of Yue Fung Motors Co., and of which the principal shareholder and director was one Chan Wai Man ("Chan"). The general manager and director of Hancheer was Mr Zhang Bing Yin, although Mr Mo Shi Liang, the manager of the International Division of the Qing Yuan branch of the bank, describes himself in his witness statement as being in charge of Hancheer. Mr Zhang was also a deputy manager of a department of the bank. The relationship and the business between the two companies and the men in charge flourished over the next year or so, in the course of which Hancheer made a number of loans to Chan's company to assist it to expand its business. Initially these were short term loans, promptly repaid, and further advances were made. Some time in 1994 the business climate began to deteriorate, and Chan started defaulting on the loans. Hancheer continued to make loans to Chan in the hope that their assistance would enable his business to recover and make it possible for him to repay the debt. By late 1995 the debt owed by Chan's company to Hancheer was about $13 million, money which had in effect come from the bank, and for the recovery of which Mr Zhang and Mr Mo were responsible.

4. The 2nd defendant came on to the scene in about August 1995 when he became acquainted with Chan through a sales representative. The 2nd defendant was also in the motor trade through his company High-Tech Motors Co. Ltd ("High-Tech"), and also dealing in, inter alia, left hand drive vehicles, and had sold one to Chan through the representative. Over the next three months he sold him altogether 7 vehicles. During this time the 2nd defendant wished to move his business from Central, and Chan offered to share the premises his company occupied in Kwun Tong. The 2nd defendant agreed and moved his office there in September 1995, where he and Chan shared an office and he paid half the rent to Chan, although their businesses were conducted separately, and the names of their companies were both displayed outside. In about November 1995 Mr Zhang and Mr Mo, who had been aware of the presence of the 2nd defendant in Chan's office, became acquainted with him when Chan introduced him as his new partner. The 2nd defendant denies that there was any partnership between them, or other business apart from Chan being a customer for the 2nd defendant's cars.

5. By this time the problem of repayment of the loan to Hancheer had become acute and Chan was being pressed hard to make some arrangement, and Mr Zhang and Mr Mo were under pressure to provide the bank with some comfort in respect of the debt. In circumstances with which I will deal in more detail shortly, the 2nd defendant agreed to arrange for his wife's property, their family home, to be used as security for the loan under a second legal charge, a first charge already being in effect to secure his own banking facilities. On 13 December 1995 the 1st defendant signed a general power of attorney in favour of her husband at the offices of a solicitor, and on 23 December 1995, on the authority if this, the 2nd defendant entered into the legal charge on her behalf in favour of the 2nd plaintiff. The same day, the 2nd plaintiff had purported to assume the benefit of the debt owed by All Have to Hancheer by discharging the debt to Hancheer by payment of $10 million, and there is evidence of a transfer of this sum to Hancheer on 30 December 1995, although no bank statements were produced to show that it was received. The transfer of the loan to the 2nd plaintiff is supported by a loan agreement between it and All Have dated 23 December 1995, and recital of the loan and the receipt thereof in the legal charge. The sum loaned is stated to be $12,973,533.00.

6. On 1 May 1996 the loan and the legal charge were assigned to the 1st plaintiff in consideration for the sum of $100.00, although for reasons which appear below, the 1st defendant did not receive any notice of that assignment, and, indeed, did not know of the legal charge, until a letter of demand from the plaintiffs' solicitors dated 14 October 1996.

7. The 1st defendant married the 2nd defendant in October 1981 and she was then, and still is, working for the Deutsche Bank. She was then a manager and is now in senior management. The 2nd defendant has always been a motor trader. It was the 1st defendant who purchased their first property, and in 1990 sold that, and with a loan of $1,400,000.00 from her employers, purchased the property the subject of these proceedings. She was then earning an average of more than $100,000.00 a month, and within a comparatively short space of time made early repayment of the loan, solely from her own earnings and assets. The 2nd defendant made no contribution towards the purchase or mortgage. As I have said, this was the family home for themselves and their two daughters.

8. Following the repayment of the original loan, the property was subject to two further charges before the one in question, in 1993, when it was used as security for banking facilities with the Bank of China for the 2nd defendant's business to the extent of $1,500,000.00, and, following its discharge on 4 November 1995, it was mortgaged to the Kincheng Banking Corporation for a similar purpose to the extent of $2,000,000.00. Both these charges the 1st defendant had consented to and had personally executed the mortgage documents. Apart from this the 1st defendant took no part in her husband's business, although she was a shareholder and director, and was sometimes required to sign company documents which needed both directors. She regarded herself as a nominee director. She had met Chan only once and never met Mr Zhang and Mr Mo.

9. The reason given to her by her husband for signing the power of attorney was that, as she was going away on 20 December for about three weeks, it was useful in case he had to act on her behalf on any matters relating to High-Tech which required two directors. She had no reason to disbelieve him as she trusted him, having in 14 years of marriage never had reason to do otherwise. She signed the power of attorney and returned it to him. However, shortly thereafter, he informed her that it needed to be signed at a solicitor's office, and he made an appointment for her with Messrs T. L. Ip & Co. She had never had any dealings with this firm and did not give them any instructions now. She went there during her lunch hour on 13 December 1995 and asked for a Mr Simon Chu whose name her husband had given her. She was shown to a room and given the paper to sign and Mr Chu took her identity card away to make a photocopy while she did so. He gave her the card back and she left, the whole visit lasting not more than five minutes. She said that there was no stamp with the name of any witness, and certainly not that of a Mr Yeung, who was not present and she has never met. She knew no more of the matters the subject of these proceedings until she received the solicitor's letter in October 1996, and had no idea that a legal charge had been executed in her name. Neither did she see the notice of assignment of the legal charge which was intercepted by her husband.

10. I have no hesitation in accepting the 1st defendant's evidence as to what transpired between her and her husband, and with the solicitors. I found her a credible and convincing witness who had no incentive to agree to mortgage her family home, for a sum in excess of its then value, to secure a debt incurred by a third party with whom she had no connection.

11. The evidence of the 2nd defendant, which I accept in so far as it concurs with and supports that of the 1st defendant, was otherwise far less convincing as to the events surrounding the execution of this charge, and, although I accept that he might have difficulty in recalling details of dates and places after this time, I am not satisfied that I have heard the whole truth about the dealings between the other parties from him or the plaintiffs' witnesses, whose evidence I will look at shortly.

12. I accept his evidence that he met Mr Zhang through Chan and that he knew through conversations with them of the indebtedness of Chan's company to Hancheer, however, how he came to agree to help by providing security is less clear. He had known Chan for less than four months and Mr Zhang and Mr Mo for far less than that. He had no interest in Chan's company, apart from doing some business with him and hoping to do more. Indeed, he said that his own business had not been good and he had a stock of vehicles that he wished to dispose of. If Chan's business improved there was a possibility that he would take some of them. The situation therefore was that the company of an acquaintance owed what by any standards must be regarded as a very large sum of money, and which he said he considered a financial mess, for which he could not possibly have any liability, but in respect of which he was prepared to deceive his wife and put at risk their main asset and their family home. I also accept that Mr Zhang and Mr Mo, whether from Chan or the 2nd defendant, knew that his wife owned the property, and that it was where they lived. He says that he only acted on the assurance of Mr Zhang that the security would never be called in and that he would give him a letter to that effect. This letter was never provided, either at the signing of the charge or later. He says that Mr Zhang further indicated that if security was forthcoming, another loan could be made to Chan in April or May of $4 million to $5 million, which would enable him to buy more of the 2nd defendant's vehicles. I have to say that I find this evidence unconvincing. The 2nd defendant had been a businessman for many years and I find it improbable that he would be so na?ve as to risk so much for the reasons he has put forward. I consider it more likely that there were more business arrangements between himself, Chan, Mr Zhang and Mr Mo, and a closer relationship between them, than I have been told about by the 2nd defendant or the plaintiff's witnesses. However it is clear that his wife was not a party to this, and did not know of what transpired in her name under the power of attorney.

13. The plaintiff's witnesses were Mr Zhang and Mr Mo, the only ones who appear to have had direct dealings with these matters, despite the fact that neither of them claim to represent either of the plaintiffs, and all the relevant documents were signed on behalf of the 2nd plaintiff by a Mr Wu Shao Zhang, who the 2nd defendant never met, and who has not given evidence. Neither have I heard any evidence from Chan, who may or may not now be in Hong Kong.

14. Mr Zhang and Mr Mo both confirmed that the debt had already been incurred by the time they were introduced to the 2nd defendant, but they thought he was Chan's partner, although in their witness statements they say he was introduced by Chan as his new partner, so it is unlikely that they believed that he had been part of incurring the debt. They said that it was the 2nd defendant who offered the property as security, and that they knew it was in his wife's name and that they lived there, although they said that they did not know that it had not been bought with the 2nd defendant's money. However, it is clear from their evidence that the question of the willingness of the 2nd defendant's wife to the transaction was discussed, and that Mr Zhang at least, who seems to have been the one handling this transaction, had a query on whether she agreed. His solution to this seems to have been to rely on the 2nd defendant, the relationship of husband and wife, and to ensure that the documents were executed in proper form by a solicitor. He made no attempt to obtain the approval direct from the 1st defendant, in spite of his admitted misgivings, giving as his excuse that he knew she was sometimes away, although he did not ask when. Indeed his doubts were such that he was taken by Chan to see a Mr Chu from a solicitor's firm, although it is not clear whether it was the same Mr Chu who later dealt with the power of attorney, in a strange meeting in a car, which he said in evidence took at least an hour, but in his statement only consisted of two questions and answers between Chan and Chu. The first of these was whether a legal charge could be prepared if the 2nd defendant was not the owner of the property, to which the surprising answer was that it could, provided that a power of attorney was obtained from the owner. There is no suggestion that the owner could be asked to attend and execute the documents, which one would expect if she was willing. The only explanation for this is that Chan and Zhang knew that the 1st defendant did not, or possibly would not, consent to the arrangement, and that it would have to be done by way of a power of attorney obtained by her husband.

15. I am satisfied on this evidence that Mr Zhang was not convinced that the 1st defendant agreed to the transaction, and that she probably did not know of it, and that he made no effort to satisfy himself that she did consent. Rather the opposite; he went along with a scheme to avoid having to ask her to consent. The fact of the 2nd defendant executing the charge on the authority of a power of attorney must alone have been enough to put him on notice that there was at least a doubt about her consent, but he clearly believed that, as long as the documents were prepared and executed by a solicitor, then they were unassailable.

16. There are, as I have said, many matters in the dealings between these parties which are not clear on any view of the evidence I have heard, and I am sure that I have not heard all the truth from any of the witnesses except the 1st defendant. The circumstances of the loan itself and its transfer to the 1st plaintiff is a case in point. The plaintiff's witnesses say that the debt was transferred to the 1st plaintiff, by the latter discharging it by payment of $10 million to Hancheer and obtaining a new loan agreement with All Have. Yet I am told by them that in early 1996, months after this arrangement, part of the debt or interest was discharged by the transfer to Hancheer of four vehicles by All Have. This makes no sense if there had been a genuine discharge and new loan. Neither has it been explained why the loan agreement and charge was assigned to the 1st plaintiff for a nominal sum of $100.00. While I am not prepared to go as far as to say that the whole sequence of events was a sham, there is patently more to this than I have been told, and I am satisfied that the plaintiffs' witnesses, and through them the plaintiffs, were well aware that these transactions would not stand close examination, and that the involvement of the 1st defendant was probably without her knowledge or consent. As Mr Chan for the 1st defendant has pointed out, the legal charge on the face of it contains false statements of fact in that no-one has suggested that the 1st defendant requested the 2nd plaintiff to make the loan, as it states, nor that she admitted receipt of the loan. Neither has it been suggested that she was asked to provide insurance, as the document requires, nor pay the costs of its preparation, which was also stated to be her responsibility.

17. I therefore come to the inevitable conclusion that the 1st defendant was induced, by the trust and confidence that she placed in her husband, to sign the power of attorney on the understanding that it was solely for the purpose of administration of High-Tech, and that she did not know of, and certainly did not consent to, her property being used as security for any debt other than the existing banking facilities of High-Tech secured by the first charge. I further find that, the knowledge of Mr Zhang and Mr Mo that there was at least a doubt as to whether she agreed to the arrangement constituted constructive notice to the plaintiffs, as Mr Zhang admitted that everything he knew was passed to the mortgagee, the 2nd plaintiff, and in any event it is clear that, as no representative of the 2nd plaintiff took part in these negotiations, he and Mr Mo must have been acting as their agents.

18. In considering the law in situations such as this I begin with the principles enunciated by Lord Browne-Wilkinson in Barclays Bank Plc. v. O'Brien & anor [1994] 1 A.C. 180, where, at page 195, he says this:

"A wife who has been induced to stand as a surety for her husband's debts by his undue influence, misrepresentation or some other legal wrong has an equity as against him to set aside that transaction. Under the ordinary principles of equity, her right to set aside that transaction will be enforceable against third parties (e.g. against a creditor) if either the husband was acting as the third party's agent or the third party had actual or constructive notice of the facts giving rise to her equity. Although there may be cases where, without artificiality, it can properly be held that the husband was acting as the agent of the creditor in procuring the wife to stand as surety, such cases will be of very rare occurrence."

19. I have to say at this point that I am satisfied that, on a balance of probabilities, this is one of those cases. The circumstances surrounding the execution of this charge make it more likely than not that the 2nd defendant was acting in concert with Chan, Mr Zhang and Mr Mo to obtain the security they sought. This is more likely to be so bearing in mind that the debt was not even the 2nd defendant's. One matter on which the witnesses are all agreed is that the debt was incurred by Chan's company in which the 2nd defendant, on the face of it, has no interest, the only suggested connection being that he had become Chan's "new" partner, and in any event it was incurred before he came on to the scene.

20. Lord Browne-Wilkinson goes on:

"The key to the problem is to identify the circumstances in which the creditor will be taken to have had notice of the wife's equity to set aside the transaction.

The doctrine of notice lies at the heart of equity. Given that there are two innocent parties, each enjoying rights, the earlier right prevails against the later right if the acquirer of the later right knows of the earlier right (actual notice) or would have discovered it had he taken proper steps (constructive notice). In particular, if the party asserting that he takes free of the earlier rights of another knows of certain facts which put him on enquiry as to the possible existence of the rights of that other and he fails to make inquiry or take such other steps as are reasonable to verify whether such earlier right does or does not exist, he will have constructive notice of the earlier right and take subject to it. Therefore where a wife has agreed to stand surety for her husband's debts as a result of undue influence or misrepresentation, the creditor will take subject to the wife's equity to set aside the transaction if the circumstances are such as to put the creditor on inquiry as to the circumstances in which she agreed to stand surety."

21. A fortiori when the wife has not agreed at all that her property should be used as security, but has been induced by misrepresentation to sign another document which she does not know will be used to effect that transaction, and when the debt is not even that of her husband, but a third party. Were it not for the fact that I find that the plaintiffs had actual notice that it was possible, if not likely, that the wife had not positively agreed to the arrangement, the fact that the transaction could not possibly be to her financial advantage, and indeed, was grossly to her disadvantage, and there was at the very least a substantial risk that the husband had committed a legal or equitable wrong in procuring her to give him apparent authority to charge her property, I must find that the 2nd plaintiff, as original chargee, was put on inquiry and took no reasonable, or indeed any, steps to satisfy themselves that her agreement had been properly obtained. There was no inquiry as to whether she was in Hong Kong, no request to speak to her personally, and no other attempt to ensure her agreement beyond securing the power of attorney.

22. I accordingly have no hesitation in finding that this is a case where the second legal charge must be set aside as against the plaintiffs, their claim against her dismissed, and orders made in terms of her counterclaim. These will be for a declaration that the power of attorney and the second legal charge are void and of no legal effect, for delivery up of these documents for cancellation, and an order that registration of the legal charge in the Land Registry be vacated. There will be liberty to apply in respect of any consequential directions or orders.

23. The claim against the 2nd defendant is a different matter. This is on the basis that he represented and warranted to the 2nd plaintiff that he was authorised by the 1st defendant to charge the property to secure repayment of the debt and to execute it on her behalf, and that the 2nd plaintiff entered into the transaction and advanced the loan on the faith of such representations and warranties. There is no doubt that he made such representations and warranties, and that at least Mr Zhang and Mr Mo thought that they could rely on them. But did they, as agents of the 2nd plaintiff, only make the loan and enter into the charge, on the strength of those representations and warranties? I am far from satisfied that they did. This was not done for the purpose of a new loan. It was an existing debt for which they felt responsible, and were seeking a way to give comfort to the bank, which was in effect the principal creditor as the owner of Hancheer. The introduction of the 2nd plaintiff was only made necessary because of the advice they no doubt received about the difficulties that may arise in establishing consideration for a new agreement in respect of an existing debt. The 2nd plaintiff was accordingly put in as a nominee. I am far from satisfied that the $10 million apparently transferred from Hancheer to the 2nd plaintiff was an arms length transaction in the absence of any further evidence than the credit note, and the fact that the loan was within a comparatively short space of time assigned back to the bank, by way of its other company, the 1st plaintiff, for a nominal sum, demonstrates clearly the transparent fiction of the whole arrangement.

24. From my findings above it is likely that the 2nd plaintiff knew, through Mr Zhang and Mr Mo, that there were serious concerns about the validity of the charge in the absence of positive agreement by the 1st defendant, and I cannot therefore, in all the circumstances, be satisfied that it was the representations and warranties alone of the 2nd defendant which caused them to enter into the transaction.

25. The plaintiff's claim against the 2nd defendant must also therefore fail.

26. There will be an order nisi for costs to be taxed in favour of both defendants against the plaintiffs.