NORTHEAST ELECTRIC INVESTMENT LTD AND OTHERS v. FAN YING CHAO AND OTHERS

HCA 607/2005

 IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 607 OF 2005

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J U D G M E N T

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1.  This is an application by the plaintiffs for summary judgment against the defendants for various orders including an order for rectification of the register of members of the 3rd plaintiff, orders for delivery up of documnents, books and accounts belonging to the 3rd plaintiff and declaration that the 1st and 2nd defendants were no longer shareholders of the 3rd plaintiff since July 2002.

2.  Fundamental to the plaintiffs' claim is the assertion that the 1st and 2nd plaintiffs are entitled to be registered as shareholders of the 3rd plaintiff.  This is hotly disputed by the 1st and 2nd defendants.  Indeed, they deny that the plaintiffs’ solicitors have authority to act for the 3rd plaintiff, although this is not a matter which I have been called upon to decide.  Before I delve into the parties' respective case, I would briefly set out the background.

3.  The 3rd plaintiff is a company registered under the Companies Ordinance.  It holds approximately 97.68% of the shares of Guangzhou Laureland Property Company Limited (“LPC”).  LPC is the beneficial owner of a highly valuable property in the PRC called Purple Clouds Villas.

4.  The 1st plaintiff is a subsidiary of a company known as Northeast Electrical Transmission & Transformation Machinery Manufacturing Co. Ltd., which changed its name to Northeast Electric Development Company Limited.  This company has been referred to as “NET” and I shall adopt the same abbreviation.  The shares of NET are listed in the Hong Kong Stock Exchange.  In March 2000, NET lent a sum of RMB96 million to Henan Yinji Property Co. Ltd. (“HYPC”) with LPC and the 3rd plaintiff acting as guarantors.  The loan was to be repaid by 31 December 2000.

5.  HYPC failed to make repayment by that date.  In May 2001, NET instituted proceedings at the Intermediate People’s Court of Shenyang.  That Court ruled that HYPC and the guarantors (i.e. LPC and the 3rd plaintiff) should repay RMB 46m and RMB 50m respectively before 30 December 2001.  By a further order in April 2002, the Shenyang Court ruled that LPC and the 3rd plaintiff should use certain assets, viz. six 120MW steam turbine generating units and four 200MW steam turbine generating units (“the Assets”) to set off the debt owing to NET (which had by then been reduced to the sum of RMB 90,760,000).  NET approved the set-off and disclosed the same in December 2002 as a discloseable transaction under the rules of the Hong Kong Stock Exchange.

6.  An agreement in Chinese dated 24 July 2002 (“the 24 July agreement”) made between NET as party A, the 3rd plaintiff as party B and the 1st plaintiff as party C recorded that the 3rd plaintiff agreed to transfer all its shares to the 1st plaintiff as NET's subsidiary.  Of course, the shares of and in the 3rd plaintiff do not belong to the 3rd plaintiff and it is not legally possible for the 3rd plaintiff to agree to sell shares of and in the 3rd plaintiff.  What was presumably intended was that the 1st and 2nd defendants, who were the shareholders, agreed to sell their shares in the 3rd plaintiff.  Indeed, in one version of the 24 July agreement the 1st and 2nd defendants were named as party B.  The true effect of the 24 July 2002 is a matter of controversy.  I shall briefly sketch some of its provisions.

7.  Clause 3 of the 24 July agreement provided that the transfer of shares was against the set-off of RMB 46 million loan, subject to adjustment upon valuation.  Clause 5 provided that the 3rd plaintiff (or more correctly, the 1st and 2nd defendants) may re-purchase all the shares at the consideration of RMB 46 million within a period of 12 months.

8.  Clause 4 provided that the transfer would be handled by Hong Kong lawyers engaged by NET.  Clause 6 provided that during the repurchase period, NET agreed not to transfer, charge or mortgage the shares or make changes to directors of the 3rd plaintiff.

9.  Clause 7 provided that NET agreed that it would not take part in the management of Purple Clouds Villas within the repayment period.  Clause 8 provided that party B may use the proceeds from the Purple Clouds Villas to set-off against the debt due to NET.

10.  The 1st and 2nd defendants executed instruments of transfer and bought and sold notes in respect of their shareholdings in the 3rd plaintiff in July 2002.  The dates on these documents were left blank.  These documents were then handed over to the plaintiffs’ solicitors together with a written resolution of the 3rd plaintiff approving the transfer.  That resolution, the date of which was also left in blank, recorded that the secretary was directed to register the transfer.

11.  As noted above, the parties disagree as to the legal effect of this arrangement.  The plaintiffs’ case is that the agreement was a sale of the shares in the 3rd plaintiff with an option to repurchase.  They say in the alternative that what was intended was a legal mortgage of the shares.  The 1st and 2nd defendants say that what was intended was only an equitable mortgage.

12.  There is, however, no dispute that as far as the debt due from the 3rd plaintiff to NET was concerned, that has been discharged in December 2002 as a result of NET's acceptance of the transfer of the Assets following on the judgment of the Shenyang court.

13.  This is not the end of story.  Although the debt which underlay the 24 July agreement has been discharged, the 1st and 2nd plaintiffs claim that they are still entitled to the shares.  To understand their case, it is necessary to mention the involvement of another company called Shenyang Suntime Power Investment Company Limited (“Suntime”).

14.  It is not in dispute that by an agreement in writing dated 16 November 2002 (“the November agreement”), Suntime agreed to sell and the 3rd plaintiff agreed to purchase 6 sets of 120MW steam turbine generating units and four sets of 200 MW steam turbine generating units at the price of RMB 80 million.  These are the Assets which were to be used to set-off the debt due to NET.  The November agreement recorded that RMB 26 million had been paid, thus leaving RMB 54 million outstanding.  Party A to the November agreement was LPC.  Party B was the 3rd plaintiff.  Party C was Suntime.  Clause 6 of the November agreement provides :

“六.   在甲乙方將甲方所有的位于廣州增城市新塘鎮南安村陳家林念如咀山的紫云山庄會員俱樂部（建築面積為：11317.58平方米）抵押給丙方，并辦理完登記手續後，丙方同意協調東北電投資有限公司將其所有的香港德奧投資有限公司的股杈全部轉給樊迎朝和樊志強；同意協調東北輸變電机械制造股份有限公司解除對香港德奧投資有限公司所擁有的廣州羅蘭德房地產有限公司的百分之九十七點六八股杈的質押。”

The certified translation of this clause reads:

“Upon Party A and Party B pledged (sic) Party A’s property of Tsz Wa Shan Zhou members' club (11317.58m² in gross area) situate at Lin Lian Ru Zui Mountain, Chan Family, Nan An Village, Sin Tang County, Tseng City, Guangzhou to Party C and after registration is completed, Party C agrees to coordinate with (the 1st plaintiff) to transfer all the shares of (the 3rd plaintiff) held by it to (the 1st and 2nd defendants); agrees to co-ordinate with (NET) for the discharge of the share charge of (the 3rd plaintiff) holding 97.68% of the shareholding of (LPC).”

Clause 7 provides:

“七.   如甲乙方違反本協議規定，沒有按時向丙方支付款項，則丙方有權提呈沈陽市中級人民法院解決，并按本協議及抵押擔保合同規定向甲乙方主張權利。”

The following is the certified translation:

“If Party A and Party B commit a breach of the terms of this Agreement, fail to pay Party C as scheduled, then Party C shall have the right to apply to Shenyang Middle People’s Court for reliefs, to exercise the rights under this Agreement and the charge and guarantee contract against Party A and Party B.”

15.  It is not in dispute that the 3rd plaintiff has not fully discharged the debt due to Suntime.

The parties’ respective cases

16.  I come now to how the respective parties formulate their cases.  The plaintiffs’ claim as pleaded is that the 1st and 2nd defendants sold the shares to the 1st and 2nd plaintiffs.  It is further pleaded that the 1st and 2nd plaintiffs purchased the shares as nominees and trustees of NET and that the beneficial interest in the shares was transferred by NET to Suntime pursuant to an oral agreement made among NET (represented by its director Qu Lin), Suntime (represented by its general manager, Wang Tao), the 3rd plaintiff (represented by the 1st and 2nd defendants), LPC (represented by the 1st and 2nd defendants) and the 1st and 2nd defendants in their personal capacities.  It is alleged that under this agreement, the 1st and 2nd defendants had an option within 12 months from 25 December 2002 to be transferred back the legal and beneficial interest in the shares in the 3rd plaintiff on condition that a mortgage of the Purple Cloud Hill Development in Guangzhou of an area of 11,317.58 m² was made in favour of Suntime as mortgagee to secure the unpaid balance of the purchase price for the Assets.

17.  The evidence as to this alleged oral agreement is to be found in the affirmation of Qu Lin and the affirmation of Wang Tao.  However, in relating this alleged agreement, the deponents only mentioned the 2nd defendant as being present as representing himself and his brother.

18.  The 1st and 2nd defendants admit signing the instruments of transfer and the bought and sold notes.  They deny that there was any sale of their shares in the 3rd plaintiff.  They aver that the instruments of transfer and bought and sold notes were executed by them by way of equitable mortgage or charge pursuant to the 24 July agreement.  Their case is that the mortgage or charge was a security for the debt in the sum of RMB 46 million due from the 3rd plaintiff to NET, and that under the 24 July Agreement, the 1st and 2nd defendants had the right to redeem their shares upon discharge of the debt due to NET.  Their case is that the Assets were transferred to NET in December 2002 and thus satisfied the debt due to NET.  Accordingly, so the 1st and 2nd defendants say, they are entitled to redeem the mortgage.  They deny the oral agreement alleged and argue that under the terms of the November agreement, the only remedy that Suntime has in the event of the failure to honour clause 6 was for Suntime to apply to Shenyang Court for relief as provided for in clause 7.

19.  The 3rd defendant’s position is different.  He is the secretary of the 3rd plaintiff and his counsel informed me that he did not take any stance on whether it is the 1st and 2nd plaintiffs or the 1st and 2nd defendants who are entitled to be on the register of members.  He denies that he is liable to the plaintiffs for damages.

The Plaintiffs’ Arguments

20.  Mr Chan for the plaintiffs submitted that it is plain from the 24 July agreement that what was intended was a sale with an option to re-purchase or a legal mortgage, and at any rate, not an equitable charge.  He relied in particular on clauses 4 and 6 of the agreement which showed that it was anticipated that the formality would be dealt with by lawyers and contended that the clauses were predicated upon the 1st and 2nd plaintiffs being constituted registered shareholders of the 3rd plaintiff.  He also relied on the fact that the resolution contained a direction to the secretary to register the transfers and that the transfers were duly stamped.  He argued that since the administrative act of registering the transfer was a matter of internal management, it was not surprising that the plaintiffs were not aware that the transfers were not registered until June 2005.  However, his argument was that it was in fact immaterial whether the mortgage was legal or equitable, it being not in dispute that the Suntime debt is still outstanding.

21.  Mr Chan submitted that the only materially disputed issue between the parties is whether it was agreed that Suntime substituted NET as the plaintiffs contend; or whether Suntime agreed to sell the generators on credit without security, so that the 1st and 2nd defendants would be entitled to the release of their shares from NET.  He contended that the defence sought to be run by the 1st and 2nd defendant is simply incredible.  He relied heavily on clause 6 of the November agreement, arguing that clause 6 only made sense against the background of the oral agreement contended for.  He submitted that no businessman would agree to the supply of goods worth RMB 80m without security.

The arguments of the 1st and 2nd defendants

22.  Mr Mak contended that there are a number of triable issues:

(1) whether the 24 July agreement involves an equitable charge of the shares of and in the 3rd plaintiff in favour of the 1st and 2nd plaintiffs to secure the repayment of the debt due to NET, subject to an equity of redemption; or whether the same was an outright transfer of the shares as alleged by the plaintiffs;

(2) whether the shares had subsequently been redeemed by the 1st and 2nd defendants transferring the Assets to set off the debt; and

(3) whether there was any oral agreement to transfer NET's rights over the shares under the November Agreement to Suntime.

23.  He also pointed out a number of inconsistencies in the plaintiffs’ case:

(1) Whilst the Re-amended Statement of Claim alleges a sale of shares, it appears to be their real case that the transaction was a mortgage.  This has not been pleaded.

(2) The 1st and 2nd plaintiffs are supposed to be the legal mortgagees of the shares, but are not pleaded as parties to the oral agreement.

(3) According to the Re-amended Statement of Claim, both the 1st and 2nd defendants were present at the time of the oral agreement; but on the evidence, only the 2nd defendant was allegedly present.

(4) Further, on the pleadings, the 3rd plaintiff and LPC are parties to the oral agreement, but the evidence of the witnesses (Mr Wang Tao of Suntime and Mr Qu Lin of NET) made no mention of either of them as parties.

24.  As to the question of whether the mortgage was legal or equitable, Mr Mak relied on the fact that the dates of the instrument of transfer, the bought and sold note as well as the resolution were all left blank.  He argued that since the plaintiffs always retained the original copy of the instrument of transfer, they must be aware all along that the share transfers had not been registered, for section 66 of the Companies Ordinance makes it mandatory for a company not to register a transfer unless a proper instrument of transfer has been delivered to the company.  He also referred to the interim result of NET as at August 2002 which referred to the arrangement as a “charge”, and not as a transfer of ownership.

25.  As for clause 6 of the November agreement, Mr Mak’s submission was that what was recorded was only a promise to make certain landed property available as security, rather than the shares.  He submitted that the November agreement did not refer to any transfer of beneficial interest in the shares and indeed provided by clause 7 the remedy to the failure on the part of the parties to procure the mortgage.  He argued that in the circumstances the denial of the allegation of the oral agreement is far from incredible.

Discussion

26.  When a party applies for summary judgment, the statement of claim must be complete and good in itself.  Any defect or omission cannot be corrected or supplemented by affidavit.  If the defect is one of substance, the application for summary judgment will be dismissed: Hong Kong Civil Procedure para. 14/1/5.

27.  The claim as pleaded is that the agreement was for the sale and purchase of the shares.  With the background which is not now in dispute, it is apparent that the transfer of shares was likely to have been effected as a form of security.  Mr Chan argued that a legal mortgage involved a transfer of ownership and that the greater (transfer by way of sale) includes the lesser (transfer by way of mortgage).  In either event, the plaintiffs are entitled to be registered.  I cannot accept that submission.  A sale is fundamentally different in nature from a mortgage although both may involve a transfer of the legal title.  It is not a situation of the greater includes the lesser as Mr Chan contended.  Even if there is only an issue of fact as to whether the transaction was one of sale or one of mortgage, summary judgment ought not be given especially when the debt in respect of which the mortgage was created has been discharged.  There are other discrepancies between the case as now presented and that which has been pleaded in what is now the 3rd (re-amended) version of the Statement of claim.  In my view, it would not be appropriate for the Court to give summary judgment when the pleading does not correctly reflect the nature of the case as revealed in evidence.

28.  The case of the plaintiffs is unusual to say the least.  It is the plaintiffs’ case that the 1st and 2nd plaintiffs are holding the shares as trustees for NET.  The evidence shows that 1st and 2nd plaintiffs obtained the transfer of the shares as legal or equitable mortgagees of the shares as security for a debt due to NET.  That debt has been discharged.  Prima facie, if the debt which underlies a mortgage has been discharged, the mortgagee should be entitled to redeem the mortgage and resist any attempt by the mortgagee to enforce the rights under the mortgage.  Nevertheless, the plaintiffs seek to hold on to the rights as mortgagees as security of some other debt.  The plaintiffs’ allegations both in pleading and in evidence as to the oral agreement only relate to the beneficial interest of the shares.  They do not appear to me to touch on the legal interest of the shares.  In these circumstances, even if one were to accept the veracity of the oral agreement, it seems to me at least arguable that the 1st and 2nd plaintiffs cannot hold on to (or obtain) the legal title to the shares.

29.  There are also other triable issues.  The question of whether the true nature of the 24 July agreement was a sale with an option to re-purchase, a legal mortgage or an equitable mortgage or charge is, in my view, an issue which ought to go to trial.  Whether the alleged oral agreement exists, and if so, who are the parties to that agreement, and what are the terms of that agreement are, in my view, also triable issues.

Conclusion

30.  For these reasons, I am not satisfied that this is a case for summary judgment.  The summons for summary judgment was issued after the Defence has been filed.  In that Defence, the 1st and 2nd defendants have denied that the transaction was a sale, and maintained the case that the transfers of shares were executed by way of equitable mortgage pursuant to the 24 July agreement.  In my view, the appropriate order is that the plaintiffs’ summons should be dismissed.  As to costs, I make an order nisi that the defendants do have the costs of this summons, to be taxed if not agreed.