TRUEARNS CO LTD v. WEALTHY FOUNTAIN HOLDINGS INC

HCA 1560/2018

[2019] HKCFI 1840

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1560 OF 2018

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D E C I S I O N

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INTROUCTION

1.  On 6 July 2018, the Plaintiff commenced this action against the Defendant for RMB387,010,874. On 17 December 2018, the Plaintiff obtained a default judgment against the defendant (“the Judgment”). The application now before me is the Defendant’s application by its summons dated 2 April 2019 (“the Summons”) for an order to set aside the Judgment, to stay this action, and the dispute between the parties herein be referred to arbitration.

2.  I would first briefly set out the factual background.

FACTUAL BACKGROUND

3.  By a shareholding and shareholder’s loan transfer agreement (股權和股東貸款轉讓協議) dated 6 January 2015 (“the Transfer Agreement”), the Plaintiff agreed to sell, and John Dewey Group Limited (“Dewey”) agreed to purchase, the Plaintiff’s entire shareholding in GCREF Investment III Limited (“the Shareholding” and “GRCEF”) and a shareholder’s loan in the sum of the USD equivalent of RMB 574,793,648 (“the Loan”), for the total consideration of RMB 1,127,046,368. GRCEF held, and still holds, 99% of the issued share capital of 徐州城置有限公司 (“the Project Company”), which in turn owns a property development project in Xuzhou, Mainland China (“the Project”).

4.  By a letter of surety (履約保函) (“the Letter of Surety”) dated 5 January 2015 addressed to the Plaintiff, the Defendant has undertaken an unconditional and irrevocable payment obligation towards the Plaintiff regarding a total sum of RMB 637,046,680.

5.  By a counter-guarantee (反擔保函) (“Counter-Guarantee”) dated 6 January 2015 addressed to the Defendant, Dewey, the Project Company, and Mr Kong Dehui (孔德輝) (“Kong”) (the ultimate beneficial owner of Dewey, and also the General Manager and person-in-charge of the Project both before and after the sale of the Shareholding and Loan), have undertaken that if the Defendant paid part or all of the secured sum pursuant to the Letter of Surety, the three counter-guarantors (namely Dewey, the Project Company and Kong) had to unconditionally repay the Defendant the sums.

6.  Subsequently, the Plaintiff and Dewey entered into an amended transfer agreement (股權和股東貸款轉讓協議之修訂協議) dated 7 April 2015 (“the Amended Transfer Agreement”).

7.  On or about 16 April 2015, the Plaintiff transferred the Shareholding and assigned the Loan to Dewey.

8.  On 27 July 2015, the Plaintiff and Dewey entered into a supplemental agreement (“the Supplemental Agreement”) to amend and supplement certain terms in the Amended Transfer Agreement.

9.  It is the Plaintiff’s case that although the Plaintiff had fulfilled all the conditions set out in the Amended Transfer Agreement, Dewey failed (and still fails) to pay part of the total purchase price owed in the sum of RMB 420,707,754. In light of Dewey’s failure to pay despite the Plaintiff’s demand, the Plaintiff through its solicitors wrote to the Defendant on or about 13 March 2018 to demand the Defendant to pay to the Plaintiff the amount of RMB 387,010,874 under the Letter of Surety.

10.  There is no dispute that the Judgment is a regular judgment. It is trite that in order to set aside a regular judgement, the defendant has to show a real prospect of success in his defence[1].

11.  The Defendant contends, inter alia, that there is an arbitration clause in the Letter of Surety and the dispute between the parties ought to be referred to arbitration. For this reason, the Judgment should be set aside, this action should be stayed and the matter should be referred to arbitration.

12.  The parties are in agreement that the stay application should be determined first. If the court is of the view that the stay application would succeed or is likely to succeed, the court would not consider the merits of the defence at all[2].

13.  When faced with a stay application made under section 20 of the Arbitration Ordinance (“the Ordinance”)[3], the court must refer the dispute to arbitration unless one or more of the following is demonstrated[4]:

(1)  There is no arbitration agreement at all;

(2)  The arbitration agreement is null and void, inoperative or incapable of being performed;

(3)  There is in fact no dispute or difference to be referred to arbitration; or

(4)  The relevant dispute is not one that is covered by the arbitration agreement.

14.  In considering whether there should be a stay in favour of arbitration, the proper test is whether there is a prima facie case that the parties are bound by an arbitration clause. The onus is on the applicant to demonstrate this. Unless the point is clear, the court should not attempt to resolve the issue and the matter should be stayed for arbitration[5].

THE STAY APPLICATION

15.  Section 19 of the Ordinance has given effect to Article 7 of the UNCITRAL Model Law. Article 7(1)(6) provides:

“The reference in a contract to any document containing an arbitration clause constitutes an arbitration agreement in writing, provided that the reference is such as to make that clause part of the contract.”

16.  Accordingly, there is an “arbitration agreement in writing” in a contract if the following 3 conditions are satisfied:

(1)  There is a reference in the contract to a document;

(2)  That document contains an arbitration clause; and

(3)  The reference is such as to make that clause part of the contract.

17.  There is no dispute that the Transfer Agreement is referred to in the Letter of Surety, and there is an arbitration clause in the Transfer Agreement, ie Clause 13.2[6]. The difference between the parties is whether the reference to the Transfer Agreement in the Letter of Surety has the effect of making the arbitration clause part of the Letter of Surety. This is a question concerning interpretation of the Letter of Surety.

18.  The principles on contractual interpretation are trite and not in dispute:

(1)  The ultimate aim of interpreting a provision in a contract, especially a commercial contract, is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant. The relevant reasonable person is one who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract[7].

(2)  The exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other. The business sense is that which businessmen, in the course of their ordinary dealings, would give the document[8].

(3)  Some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix, for example because of their informality, brevity or the absence of skilled professional assistance. Textualism and Contextualism are not conflicting paradigms. The extent to which each tool will assist the court in its task will vary according to the circumstances of the particular agreement[9].

(4)  The more unreasonable the result the more unlikely it is that the parties could have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear. On the other hand, the Court must also be alive to the possibility that one side may have agreed to something which with the benefit of hindsight may not have served his interest[10].

19.  Counsel for the parties have made thorough submissions and I am most grateful for the assistance provided by them. With respect, I am of the view that the arguments advance by each side have strength and weakness.

20.  Mr David Chen, counsel for the defendant, has put forward the following points: 

(1)  All the contractual agreements in this case concern the same acquisition, namely, the sale and purchase of the Shareholding and the Loan.

(2)  Although there were two contractual relationships which were entered into, one between the Plaintiff and Dewey as seller and purchaser under the Transfer Agreement and the other between the Plaintiff and the Defendant under the Letter of Surety, they were entered into in the context of a single commercial relationship between the Plaintiff on one side and Dewey and the Defendant on the other:

(a) The Plaintiff lay under the obligation to transfer the Shareholding and the Loan to Dewey under the Transfer Agreement;

(b) Dewey and the Defendant lay under the obligation to pay the Plaintiff under the Transfer Agreement and the Letter of Surety respectively.

(3)  Given the close connection between the Transfer Agreement and the Letter of Surety, and between the parties involved, one would expect the parties as rational businessmen to agree a common method of dispute resolution and, in the interests of efficiency, expediency and costs, for there to be a common tribunal (whether an arbitral tribunal or a court) to determine all the disputes arising out of the commercial transaction.

(4)  It would be surprising if the Transfer Agreement was to be subject to Hong Kong law and arbitration but any dispute under the Letter of Surety would be determined by some unspecified court in some unspecified jurisdiction according to some unspecified governing law.

(5)  The analysis above is fortified by the Counter-Guarantee, by which the Plaintiff, Dewey, the Project Company and Kong agreed to pay the Defendant a sum equivalent to the amount paid out by the Defendant under the Letter of Surety. While the Counter - Guarantee does not contain any dispute resolution provision, it is abundantly clear that by reason of various references to the Transfer Agreement, the Counter-Guarantee is also subject to Hong Kong law and arbitration. It would be surprising if the parties to the Counter-Guarantee (two BVI companies, one Mainland China company and one Mainland China individual), two of which were parties to the Transfer Agreement, had intended for disputes arising out of the Counter - Guarantee to be determined by some unspecified court in some unspecified jurisdiction according to some unspecified governing law.

(6)  Indeed, from the Plaintiff’s perspective, it would be highly undesirable if disputes arising from the Transfer Agreement were resolved in arbitration but disputes arising from the Letter of Surety were resolved in a court, which may or may not be the same court as the one which has jurisdiction over the disputes arising from the Counter - Guarantee. Not only would the Plaintiff be compelled to incur substantial additional costs in pursuing or defending two (or potentially three) sets of parallel proceedings in what might be three different jurisdictions, there is also a risk of inconsistent factual findings and issue estoppel that might prejudice the Plaintiff.

(7)  The same analysis applies to Dewey, who was a party to the Transfer Agreement and the Counter-Guarantee, and the Defendant, who was a party to the Letter of Surety and the Counter-Guarantee. It would be highly desirable for Dewey and the Defendant to resolve their respective disputes in the same tribunal applying the same law.

(8)  The Transfer Agreement was negotiated against the background of the envisaged Letter of Surety, and was finally concluded (on 6 January 2015) when the Letter of Surety (signed on 5 January 2015) was already in place. It must be intended that all the parties involved in the acquisition, namely, the Plaintiff, Dewey and the Defendant, would be subject to the same dispute resolution mechanism.

(9)  The Defendant was given a copy of the draft Transfer Agreement before it entered into the Letter of Surety. The Defendant therefore knew that the payment obligation which it guaranteed arose from a contract that was governed by Hong Kong law and was subject to an arbitration clause.

(10)  Compared with the Transfer Agreement, the Letter of Surety is patently more informal, less detailed and appears to be prepared without any professional assistance. It is therefore not surprising that the parties did not see the necessity to expressly spell out the dispute resolution mechanism, believing instead that the mechanism provided for in the Transfer Agreement would apply to the Letter of Surety.

(11)  The Plaintiff never communicated to the Defendant that it intended for the Letter of Surety to be governed by a dispute resolution mechanism different from that set out in the Transfer Agreement.

(12)  In the circumstances, a reasonable person would have understood the Plaintiff and the Defendant to have intended for the governing law of and dispute resolution mechanism in the Transfer Agreement to apply to the Letter of Surety (and the Counter - Guarantee). This accords with business common sense. Were it otherwise, the Plaintiff might be exposed to the substantial expense and inconvenience of litigating in different courts across three different jurisdictions applying different laws in respect of disputes arising from the same transaction. This is an eminently uncommercial result that no reasonable businessman would desire. Clear words would have to be used in the Letter of Surety to produce this result.

21.  These are forceful submissions. However, as pointed out by Mr Richard Khaw SC (leading Ms Queenie Lau), counsel for the Plaintiff, the arbitration clause in the Transfer Agreement is different from the arbitration clause in the Amended Transfer Agreement – the former specifies the arbitration to be held in Hong Kong, while the latter requires the arbitration to be held in Shanghai. In reply to this, Mr Chen submits that the arbitration clause incorporated into the Letter of Surety is the arbitration clause in the Transfer Agreement. That being the case, if Mr Chen is right, the disputes arising from the Amended Transfer Agreement would be resolved by arbitration in Shanghai, while the disputes under the Letter of Surety would be resolved by arbitration in Hong Kong. That means the businessmen involved have no intention that all the disputes concerning the acquisition of the Shareholding and the Loan be resolved by one single tribunal. This has certainly weakened Mr Chen’s arguments.

22.  Mr Khaw SC submits that:

(1)  Whether there has been incorporation of any arbitration clause in a contract is a matter of construction.

(2)  When the incorporation relied on concerns terms of a contract made between different parties (even if one of them is a party to the contract in suit), in order for there to be incorporation, it would need to be clear that parties intended to incorporate the arbitration clause (and not only the substantive provisions of the other contract). Further, as arbitration clauses are “essentially personal to the parties which agree them”, and oust the jurisdiction of the courts, clear words of incorporation are required[11].

(3)  Mere reference to the Transfer Agreement in the preamble of the Letter of Surety is not sufficient reference to incorporate the arbitration clause in the Letter of Surety. It is untenable that the Defendant makes reference to the Counter-Guarantee to support the argument for incorporation when the Counter - Guarantee simply contains no arbitration agreement at all.

(4)  There is no substance in the Defendant’s complaint that the Plaintiff did not communicate to the Defendant the Plaintiff’s intention for a different dispute resolution mechanism to govern the Letter of Surety. It is inconceivable as to why and how the Plaintiff should be under such a duty to inform in the first place.

(5)  The submission concerning “business common sense” and an assumption that one would “expect the parties as rational businessmen to agree a common method of dispute resolution” is incorrect. Given the separate and independent nature of the Letter of Surety being an indemnity, there is no basis to assume that the parties expected any common method of dispute resolution.

23.  These are also forceful submissions. However, with respect, I am of the view that there is also weakness in Mr Khaw SC’s submissions.

(1)  The Plaintiff’s position is that the Letter of Surety is governed by Hong Kong law, as evidenced by the fact that no foreign law is pleaded in the Statement of Claim. Matters of foreign law must be specifically pleaded where foreign law is applicable[12].

(2)  There is no express jurisdiction clause in the Letter of Surety.

(3)  By merely looking at the contents of the Letter of Surety, it is difficult to see the connection between this contract and Hong Kong. The Plaintiff, the Defendant, and Dewey are all BVI companies. The obligation guaranteed in the Letter of Surety is not an obligation which must be performed in Hong Kong.

(4)  The Transfer Agreement is not only mentioned in the preamble, but is repeatedly mentioned in the Letter of Surety.

(5)  There is no dispute that the Letter of Surety is governed by Hong Kong law.

(6)  It is at least reasonably arguable that the Letter of Surety is governed by Hong Kong law because the Letter of Surety has close connection with the Transfer Agreement, and the Transfer Agreement is governed by Hong Kong law by virtue of Clause 13.1 of the same. Applying business common sense, the parties to the Letter of Surety must have intended that Clause 13.1 of the Transfer Agreement be incorporated into the Letter of Surety.

(7)  Both Clause 13.1 and Clause 13.2 of the Transfer Agreement concern dispute resolution. It would be unreasonable to say that the parties to the Letter of Surety only intended to incorporate Clause 13.1 but not Clause 13.2 of the Transfer Agreement into the Letter of Surety.

24.  In my view, both Mr Chen and Mr Khaw SC have put forward respectable arguments. While I cannot definitely say that the arbitration clause in the Transfer Agreement has been incorporated into the Letter of Surety, at the same time I cannot definitely say the otherwise. My conclusion is that it is arguable that there is such incorporation. If Clause 13.2 of the Transfer Agreement has been incorporated into the Letter of Surety, the dispute between the Plaintiff and the Defendant would be covered by this clause. I am satisfied that the Defendant has demonstrated a prima facie case that there is an arbitration clause in the Letter of Surety.

25.  Accordingly, I have to make an order to stay this action in favour of arbitration. That being the case, the Judgment must also be set aside.

26.  After arriving at this conclusion, it would not be necessary for me to go into the merits of the defence put forward by the Defendant. Since the dispute between the parties may be resolved by arbitration at a later time, the merits of the defence should be considered by the arbitral tribunal.

DISPOSISITON

27.  I make the following order:

(1)  the Judgment be set aside; and

(2)  This action be stayed and the dispute between the parties be referred to arbitration.

28.  As to the costs of the Summons, I bear in mind that the Judgment is a regular judgment. Although I have ruled in favour of the Defendant on the issue of incorporation, the Defendant has only made clear its position in Mr Chen’s written reply submissions provided to the Court yesterday, i.e. the arbitration clause which has been incorporated into the Letter of Surety is the one in the Transfer Agreement, not the one in the Amended Transfer Agreement. By yesterday, almost all the costs in relation to the Summons have been incurred by the parties. In these circumstances, I am of the view that costs of the Summons (including all costs reserved) should be borne by the Defendant. There be a certificate for 2 counsel for the hearing today. The said costs be summarily assessed at HK$850,000.

29.  Lastly, it remains for me to thank all counsel for the very helpful assistance rendered to the court.