BANK OF CHINA (HONG KONG) LTD v. THE SECRETARY FOR JUSTICE AND ANOTHER

HCMP 1820/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1820 OF 2014

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J U D G M E N T

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Introduction

1.  This is an originating summons by way of an interpleader.  The property at stake is the balance of the proceeds of sale of a property in the sum of $15,254,378.47 which was paid into court in August 2014.  The property sold was Flat B on 12^th Floor, Tower 25 (Phase IVB) Ocean Vista, Laguna Verde, No 8 Laguna Verde Avenue, Kowloon (“the property”).  The property was previously owned by one Mr Tsoi Chit Tsang (“Tsoi”).  The contest is now between the two defendants, both of whom lay claim to the entirety of the proceeds.  The 1^st defendant, as representative of the Government, claims the money in court on the strength of a restraint and charging order and a confiscation order made under the Organised and Serious Crimes Ordinance (Cap 455) (“OSCO”).  The 2^nd defendant is a licensed money lender who claims the money in court as security for a loan advanced to Tsoi on the basis of a mortgage of the property.  The issue raised is which of them has priority.  The dispute has arisen in the following way.

Factual background

2.  On 21 September 2005, Tsoi obtained a loan of $6 million from Bank of China on a mortgage of the property.  I shall refer to this as the “first mortgage”.

3.  The 2^nd defendant lent $5 million to Tsoi on the security of another mortgage of the property executed by Tsoi and dated 16 October 2008 mortgage and registered in the Land Registry on 11 November 2008.  I shall refer to this as the “second mortgage” and to the loan of $5 million as “the first loan”.

4.  On 7 January 2009 Tsoi was arrested by the police.

5.  In July 2009, the police interviewed a director, the General Manager and an account relationship executive of the 2^nd defendant, presumably in connection with the arrest of Tsoi.  In the course of the interview, they were informed that Tsoi, one of the 2^nd defendant’s customers, was involved in a case of money laundering.

6.  On 5 October 2010, Tsoi was, along with four others, charged with offences of money laundering under OSCO.  There is no evidence that the 2^nd defendant was informed of this or the progress of the criminal proceedings generally.

7.  By July 2011, Tsoi had repaid all sums outstanding under the first loan though the second mortgage was not released. On 22 July 2011, the 2^nd defendant agreed to lend another loan to Tsoi in the sum of $15 million on the security of the second mortgage.  On 25 July 2011, Tsoi received the loan proceeds of $15 million.

8.  On 3 August 2011, the Government obtained in an ex parte application a restraint and charging order pursuant to ss 15 and 16 of the OSCO in proceedings in the High Court (HCMP 1453/2011) against nine respondents including Tsoi.  The order prohibited Tsoi from removing from Hong Kong or disposing of any of his property including the property.  It was registered in the Land Registry on 4 August 2011.  The order was subsequently continued on an inter partes basis.

9.  On 16 April 2012, because of the restraint and charging order and Tsoi’s default on the first mortgage, Bank of China commenced a mortgage action (HCMP 734/2012) against him seeking, inter alia, an order for sale.  Tsoi defended those proceedings through solicitors.

10.  After the second loan was granted, Tsoi continued to pay interest on it until December 2012.  The payments made by him up to that point came to a total of $1,400,484.  Thereafter he defaulted on the second loan and did not make any further payment to the 2^nd defendant.

11.  On 22 May 2013, the 2^nd defendant instituted a mortgage action against Tsoi (HCMP 1153/2013) on the basis of the second mortgage.

12.  The trial of the criminal charges against Tsoi commenced on 15 July 2013.  He absconded in the middle of the trial which continued in his absence.  Eventually Tsoi was convicted on 31 October 2013.

13.  On 10 September 2013, Bank of China obtained judgment against Tsoi and an order for possession of the property.

14.  On 10 March 2014, a confiscation order was made in the criminal proceedings against Tsoi pursuant to ss 8, 11 and 13 of OSCO.  In making the confiscation order the court certified that Tsoi had benefited from the specified offences of which he was convicted and that the value of his proceeds of the specified offences was $231,819,846.71 and the value of the realisable property of Tsoi as of the date of the order was $33,597,064.02.  Tsoi was ordered to pay that sum to the Government.

15.  On 16 June 2014, the sale of the property (with the consent of the 1^st and 2^nd defendants) was completed.  The proceeds of sale after deducting all expenses and charges and repaying Bank of China all sums due under the first mortgage were paid into court to the credit of these proceedings on 28 August 2014 in the amount of $15,254,378.47.

16.  As at 8 October 2014, the date of the 2^nd defendant’s affirmation filed herein, the total amount of principal and interest owed by Tsoi to the 2^nd defendant on the second loan was $22,253,074.

The issues

17.  It is common ground that a restraint and charging order under the OSCO once granted takes effect as an equitable charge and enjoys the same priority as if it were an equitable charge: s 16(8) of OSCO.  A charging order has priority from the day following the day of its registration: s 5A Land Registration Ordinance (Cap 128).  The restraint and charging order in this case therefore has priority from 5 August 2011.  If the second mortgage is a valid mortgage for a valid loan, there is no dispute that, being prior in time, it would have priority over the restraint and charging order. 

18.  In order to defeat the 2^nd defendant’s claim, Mr Michael Yin essentially took three points on behalf of the 1^st defendant:

(1) The second mortgage is unenforceable as security for the second loan because the second loan failed to comply with s 18(1) of the Money Lenders Ordinance (Cap 163).

(2) In any event, the priority enjoyed by the second mortgage does not extend to interest on the second loan because interest cannot be “tacked” under s 45 of the Conveyancing and Property Ordinance (Cap 219).

(3) The partial repayment of $1,400,484 made by Tsoi to the 2^nd defendant should be deducted from the principal owed to the 2^nd defendant so that, as a consequence of (2) above, the 2^nd defendant has priority only over the outstanding balance of the principal ie $13,599,516.

19.  In the evidence there is in addition a statement that the 1^st defendant does not accept the second loan was a bona fide commercial transaction.  Mr Yin however did not put forward a positive case in that regard, being content to leave it to the 2^nd defendant to satisfy the court that the second loan was a genuine transaction.  Nor has he sought to cross-examine the deponent of the 2^nd defendant’s affirmation.

Enforceability under the Money Lenders Ordinance

20.  S 18 of the Money Lenders Ordinance (Cap 163) provides:

“(1) No agreement for the repayment of money lent by a money lender or for the payment of interest on money so lent, and no security given to any money lender in respect of any such agreement or loan, shall be enforceable unless-

(a) within 7 days after the making of the agreement, a note or memorandum in writing of the agreement is made in accordance with subsection (2) and signed personally by the borrower, and a copy of such note or memorandum is given to the borrower at the time of signing; and

(b) there is included in or attached to such copy a summary, in such form as may be prescribed, of such provisions of this Part and Part IV as may be prescribed,

and no such agreement or security shall be enforceable if it is proved that the note or memorandum was not signed by the borrower before the money was lent or the security was given.

(2) The note or memorandum shall contain all the terms of the agreement and in particular shall set out-

(a) the name and address of the money lender;

(b) the name and address of the borrower;

(c) the name and address of the surety, if any;

(d) the amount of the principal of the loan in words and figures;

(e) the date of the making of the agreement;

(f) the date of the making of the loan;

(g) the terms of repayment of the loan;

(h) the form of security for the loan, if any;

(i) the rate of interest charged on the loan expressed as a rate per cent per annum, or the rate per cent per annum represented by the interest charged as calculated in accordance with Schedule 2; and

(j) a declaration as to the place of negotiation and completion of the agreement for the loan.

(3)     Notwithstanding subsection (1), if the court before which the enforceability of any agreement or security comes in question is satisfied that in all the circumstances it would be inequitable that any such agreement or security which does not comply with this section should be held not to be enforceable, the court may order that such agreement or security is enforceable to such extent, and subject to such modifications or exceptions, as the court considers equitable.”

21.  The 2^nd defendant and Tsoi signed a written loan agreement but it is common ground that there was no separate note or memorandum of agreement that contains all the particulars listed in s 18(2).  The issue is whether the second loan, and the second mortgage insofar as it is relied upon as security for the second loan, are therefore unenforceable as provided in s 18(1), or whether the court should, pursuant to s 18(3), order that they are enforceable notwithstanding non-compliance with s 18(1).

22.  The 2^nd defendant explained that it is a licensed money lender and that Tsoi first borrowed money from it in October 2008.  On that occasion $5 million was lent to him at the rate of 1.5% per month (an effective rate of 34.2% per annum).  Tsoi signed a loan agreement and executed the second mortgage.  At that time he also signed, and received a copy of, a document which was called memorandum of agreement and referred to s 18(1) of the Money Lenders Ordinance.  This document was a standard form previously prepared by the 2^nd defendant’s solicitors.  The 2^nd defendant used that form for the purpose of giving instructions to its solicitors to prepare the second mortgage.

23.  At the time of the first loan, which was shortly after the collapse of Lehman Brothers, the estimated value of the property was not high.  Thereafter Tsoi by and large kept up with the repayment schedule as a result of which he was viewed by the 2^nd defendant as a reliable customer.  By July 2011, Tsoi had repaid all sums outstanding under the first loan.  Instead of obtaining the release of the second mortgage, however, Tsoi applied to the 2^nd defendant for another loan of $15 million. The 2^nd defendant approved it because of Tsoi’s satisfactory record on the first loan and the property had significantly appreciated in value since 2008.

24.  The 2^nd defendant explained that, because the second mortgage had not been discharged, they asked their solicitors whether a fresh mortgage need be prepared.  The reply they obtained was that it was not, as the second mortgage was an “all monies” mortgage.  As a result the 2^nd defendant omitted to prepare a memorandum of agreement similar to that prepared for the first loan.  The only document signed by Tsoi for the second loan was the written loan agreement itself.  That document set out certain particulars required by s 18(2) (including those mentioned in s 18(2)(a), (b), (d), (e), (g), (h) and (j)).  What it fails to specify are the particulars in s 18(2)(f) and (i), namely, the date of the making of the loan and the effective annual rate of interest.  As to the former, there could have been no real doubt because the 2^nd defendant’s cheque given to Tsoi was dated 25 July 2011 and cleared on the same date.  As to the latter, the monthly flat rate of 1.5% was set out in the document.

25.  Mr Yin submitted that the aim of s 18(1) is to penalise and render unenforceable any money lending transaction which fails to comply with the requirements of s 18(1) and (2).  He submitted that s 18(3) was enacted to give the court the power to do justice as between the immediate parties to the money lending transaction, and that it should not be applied to a case such as the present where the contest is between the money lender and a stranger to the loan.  Further, he submitted that the onus is on the 2^nd defendant to satisfy the court that “in all the circumstances it would be inequitable” that the second loan and second mortgage should be held to be unenforceable and that the 2^nd defendant has failed to do so.

26.  For the 2^nd defendant, Mr Albert Yau argued that the omission to include in the document all the particulars mentioned in s 18(2) was a technical and minor failure.  The monthly interest rate was specified in the loan agreement and was the same as the first loan, ie 1.5% per month.  The annual effective rate was omitted but it should be the same as that specified in the memorandum for the first loan, ie 34.2%.  He argued that Tsoi could not possibly have suffered any prejudice from the omission.

27.  In my judgment, the 2^nd defendant has passed the hurdle for showing that the second loan was a genuine commercial transaction.  It is no part of Mr Yin’s argument that the 2^nd defendant was complicit in any wrongdoing of Tsoi.  It is true that the second loan was advanced only days before the restraint and charging order, but there is nothing to suggest that Tsoi somehow got wind of the impending ex parte application and managed to steal the march with the 2^nd defendant’s help.  There is no evidence that after the 2^nd defendant was interviewed by the police in July 2009, it was kept informed and updated about any further progress in the criminal matter.  The 2^nd defendant has put forward a credible explanation for the omission of a compliant memorandum of agreement.  The omission itself is not suspicious because it did not facilitate or expedite the transaction in any way.

28.  It is clear to me that the power to grant relief under s 18(3) is available to the lender vis-à-vis a third party.  The language of s 18(3)[1] is wide.  The provision is engaged whenever the enforceability of any agreement or security comes into question before a court.  Just as s 18(1) renders unenforceable any loan agreement or security, s 18(3) confers a power on the court to order that such agreement or security is enforceable notwithstanding s 18(1).  The unenforceability and relief from it is not confined to the effect of the agreement or security as between the immediate parties.  Indeed, so far as security is concerned, it seems to me the question of enforceability would be relevant primarily as between the lender and third parties, rather than as between him and the borrower.

29.  The power to give relief may be exercised if in all the circumstances it would be inequitable that the agreement or security in question should be held unenforceable. In Emperor Finance Ltd v La Belle Fashions Ltd (2003) 6 HKCFAR 402 at §119, Ribeiro PJ stated:

“In exercising its discretion the court should examine the breach or breaches in question, their consequences for the parties to the transactions and any other circumstances which may make it inequitable to hold the agreements unenforceable.”

30.  In Strong Offer Investment Ltd (in liquidation) v Nyeu Ting Chuang (2007) 10 HKCFAR 529, Chan PJ stated:

“19. … [T]he statute is not intended to stifle genuine money-lending transactions or to let the money lender lose all the money he has lent out and all the security he has because of a failure to comply with all such requirements, however trivial or unintentional the breach may be. Hence, where it is not inequitable to do so, the court would enforce the loan agreement with suitable variations, modifications and exceptions. This is the discretion given to the court by s.18(3).

20.    In resolving any dispute between the money lender and the borrower, therefore, there should be no pre-conceptions either in favour of or against the money lender or the borrower.  The statute has sought to strike a fair balance between the two parties.  In applying the provisions of s.18, the court has to bear in mind, among other things, the parties’ respective rights and obligations under the statute as well as the agreement made by them.  See Ribeiro PJ in Celestial Finance Ltd v Yu Man Hon & others (2004) 7 HKCFAR 450 at para. 21.”

31.  Likewise, in the exercise of the discretion whether or not to relieve certain security from the consequence of unenforceability, the court is not pre-disposed towards any outcome.  In the present case, as I have concluded, the 2^nd defendant made an arm’s length loan to Tsoi.  It advanced actual funds to Tsoi in the sum of $15 million.  The breaches of s 18(1) and (2), identified above, were on the evidence not intentional but inadvertent.  They were also of a minor nature as there was in fact a written agreement signed by Tsoi setting out most of the particulars required.  Interest was to accrue at a monthly flat rate and it appears that Tsoi had had no difficulty at all in knowing what he had to pay. Moreover the rate was the same as that for the first loan, ie 1.5% per month, which Tsoi knew from the memorandum for the previous loan to be equivalent to 34.20% per annum.  The omissions are hardly likely to have prejudiced Tsoi.  If Tsoi were before the court and to argue that the second loan was unenforceable because of non-compliance with s 18(1), there is no doubt in my mind that the argument would be rejected.  Does it make a difference here because it is a third party, the 1^st defendant, who is contending for unenforceability?  In my view it does not.  There is no suggestion that the omissions concerned have in any way prejudiced the 1^st defendant or any other subsequent incumbrancer.  No one placed any reliance at the time on the absence of a compliant memorandum. What it really comes down to is whether the 2^nd defendant should be punished for the non-compliance by being deprived of priority in its security for a $15 million loan and thus all prospects of recovering any outstanding part of the second loan.  In my view that would be an extreme and wholly disproportionate penalty.  In all the circumstances it would, in my judgment, be inequitable that the second loan and second mortgage should be held to be unenforceable to any extent.

Priority of interest on the second loan

32.  The second argument of Mr Yin is based on the proposition that interest accrued on the second loan after the registration of the restraint and charging order can only rank prior to it if “tacking” is available to such interest under s 45 of the Conveyancing and Property Ordinance.

33.  S 45 of the Conveyancing and Property Ordinance (Cap 219) provides:

“(1) A mortgagee under prior mortgage may make a further advance or re-advance to rank in the same priority over a subsequent mortgage as the original advance under that prior mortgage-

(a) if the subsequent mortgagee so consents; or

(b) where the further advance or re-advance does not exceed, with any other outstanding advance or re-advance, the specified maximum amount secured under that prior mortgage; or

(c) where that prior mortgage is in favour of an authorized institution (as defined in the Banking Ordinance (Cap 155)) and is expressed to secure all money which may, from time to time, be owing to the prior mortgagee,

and paragraphs (b) and (c) shall have effect whether or not the prior mortgagee had notice of the subsequent mortgage at the time when the further advance or re-advance was made by the prior mortgagee.

(2) The priority to which a prior mortgagee is entitled under subsection (1) shall extend, in addition to the amount secured under the prior mortgage, to interest on that amount and to all costs, charges and expenses secured under the mortgage.

(3) Subject to subsection (1), the right to tack in relation to land is abrogated:

Provided that nothing in this section shall affect any priority acquired before the commencement of this section.”

34.  Under the second mortgage the charge was given as security for the “Secured Indebtedness”, a term defined to include all sums from time to time advanced by the 2^nd defendant to Tsoi and all interest thereon.  Mr Yin does not dispute that the second mortgage on its terms extends to all monies advanced and interest accrued thereon.  But he argued that tacking at common law was abolished by s 45(3) and the 2^nd defendant does not qualify for tacking under s 45(1).  As a result it cannot claim the same priority for interest accrued on the second loan.

35.  With respect, in my opinion this argument is erroneous. Tacking is an equitable doctrine with two forms: tabula in naufragio and tacking of further advances.  The former is not relevant here.  Tacking of further advances describes the right of a mortgagee to add later advances to earlier advances so as to obtain priority over an intervening incumbrancer.  Interest on the second loan is however not further advances.  It is money that Tsoi as borrower was obliged to pay as a result of the second loan, not a duty arising from the further advance of new funds to Tsoi.  That obligation, like the covenant to pay the principal, was secured by the second mortgage.  It was part and parcel of the mortgage debt.  Indeed, so inherent is the obligation to pay interest a part of the security that a charge would carry interest even though there were no words allowing interest in the charge itself: Farquhar v Morris (1797) 7 Term Rep 124; Ezekial v Orakpo [1997] 1 WLR 340, 346.  A prior mortgagee does not obtain priority for his claim for interest by tacking, because there is nothing to tack.  He has priority because his claim for interest is part of the original obligation secured by the mortgage.  Thus, for example, in Law v Glenn (1867) 2 Ch App 634, a prior mortgagee was recognised as being entitled to have interest on the mortgage debt taken into consideration upon the taking of account, even for interest accrued after notice of a subsequent incumbrance, though he might not be entitled to rely on a subsequent deed increasing the rate of interest in derogation of the rights of the intervening mortgagees.

36.  The case of West v Williams [1899] 1 Ch 132 decided that the doctrine in Hopkinson v Rolt (1861) 9 HLC 514 that, after notice of a subsequent incumbrance, a first mortgagee cannot, as against that incumbrancer, tack to his debt further advances made by him to the mortgagor, applies also to further advances that the mortgagee had covenanted to make.  In my opinion this case does not assist the 1^st defendant. The case was decided on the basis that no charge arises for a further advance until it is actually made, and a mortgagee cannot obtain a charge on property which is no longer the mortgagor’s to charge and which the mortgagee knows is no longer the property of the mortgagor (p 146, per Chitty LJ).  Lindley MR put it in much the same way when he said (at p 143):

“When a man mortgages his property he is still free to deal with his equity of redemption in it, or, in other words, with the property itself subject to the mortgage. If he creates a second mortgage he cannot afterwards honestly suppress it, and create another mortgage subject only to the first. … Even if the first mortgagee has agreed to make further advances on the property mortgaged to him, the mortgagor is under no obligation to take further advances from him and from no one else …”

The position is different with interest.  The charge for it has always existed from the outset.  The amount secured is augmented by the accrual of interest every day (insofar as it remains unpaid), but no new charge is created for any new loan.  Tsoi’s equity of redemption was from the beginning subject to the repayment of not only the principal advanced but also interest accrued on it remaining unpaid.  The 1^st defendant as a subsequent equitable chargee cannot claim a greater interest than Tsoi had.

37.  Nor does s 45(2) assist the 1^st defendant.  That sub-section appears to extend the same priority, where tacking applies, to interest on the amount secured under the mortgage without distinguishing between interest on the original advance and interest on the further advance.  But that does not mean, in my view, that interest on the original advance has priority only if tacking is available pursuant to s 45(1). The priority enjoyed by the interest on the original advance does not, in my view, arise from s 45(1) and (2).

38.  Accordingly, I reject the 1^st defendant’s argument that the 2^nd defendant’s claim for interest after 5 August 2011 ranks after the restraint and charging order.

Effect of repayment of $1,400,484

39.  In light of the above, the 2^nd defendant has a prior claim for repayment of principal and interest which in aggregate exceeds the amount of money in court.  It is therefore strictly unnecessary to decide the 1^st defendant’s third point.  In any event the loan agreement stipulated that the instalments paid by Tsoi were to be appropriated to repayment of interest before principal.  So I have some difficulty with the 1^st defendant’s argument that the repayments totalling $1,400,484 made by Tsoi between February and December 2012 should all be taken to have reduced the principal owed to the 2^nd defendant.  It is however unnecessary to decide this matter.

Conclusion

40.  For the above reasons, I conclude that the second mortgage is enforceable by the 2^nd defendant, and that its claim for both principal and interest on the second loan as secured by the second mortgage ranks prior to the charge arising from the restraint and charging order in favour of the 1^st defendant.  There will therefore be an order that the money paid into court together with interest accrued thereon be paid out to the 2^nd defendant, and an order nisi that the 1^st defendant do pay the costs of the 2^nd defendant of these proceedings.