CATHAY PORT LTD v. ZHU MING

HCA 2707/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2707 OF 2008

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BETWEEN

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RULING

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1.   This is an application by the Defendant under Order 13 rule 9 of the Rules of High Court to set aside the Final and Interlocutory Judgment entered against him on 18 March 2009. It is not disputed that the said Judgment was entered regularly. Accordingly, to set aside the said Judgment, the burden rests on the Defendant to show a meritorious defence which is not merely arguable, but one that carries a real prospect of success.

Background

2.   It is not disputed that the Defendant is and was at the material time the Director of China Group Logistics Investment Limited (“the Company”). The Plaintiff was interested in investing in the Company by subscribing for its shares. By a subscription agreement between the Plaintiff and the Company dated 22 December 2005, the Company agreed to issue and the Plaintiff agreed to subscribe for a US$10,000,000 note (“the Note”) which is exchangeable into shares in the Company. The Defendant is also a party to the subscription agreement as a guarantor guaranteeing unconditionally the performance of the agreement by the Company.

3.   Further, by Instrument in Writing dated 22 December 2005 (“the Instrument”), the Note was established for subscription and the Defendant acted as the guarantor. It is not disputed that the Plaintiff has subscribed for the Note in the value of US$10,000,000 issued by the Company.

4.   Clause 4 of the Instrument provides the payment of interest by the Company, which reads as follows: -

(A) The Note shall bear interest at the rate of 25% per annum on the principal amount of the Note outstanding from time to time in accordance with condition 4(B) below.

(B) Interest shall accrue on a daily basis from the date of issue of the Note calculated on the basis of a 365 day year on a principal sum of the Note for the time being outstanding, and shall be payable annually in arrears [my emphasis] on or before 31 December in each year (“each and interest payment date”) with the first interest payment date being 31 December 2006. Interest on any notes not for the whole of the period between any two successive interest payment dates shall be calculated on a pro rata basis. Interest on the principal sum outstanding shall cease to be payable as from the exchange date or date of the redemption (as the case may be).

(C) In the event that the whole of the principal amount of a note exchange in accordance of condition 5(A), such note holder shall be entitled the interest accrued but unpaid in respect of the whole of the principal amount up to but excluding the exchange date.

5.   Accordingly, by 31 December 2006, the Company should pay interest to the Defendant in the sum of US$2.5 million. It is not disputed that this has been paid. On 31 December 2007, another payment for US$2.5 million became due. The Company failed to pay this amount. It was only around 1 July 2008 when the Company made the payment of US$1,001,340.95.

6.   Pursuant to the guarantee provided by the Defendant under the Instrument, as from the date of default of payment of the said interest, the Defendant shall upon demand paid all sums of which default have been made. And pursuant to clause 17(H) of the Instrument, the Defendant as guarantor agrees to pay interest on such outstanding sums at the rate equal to the rate of interest paid under the Note. Accordingly, as further set out in paragraph 7 of the Statement of Claim, the balance of interest including default interest thereon payable by the Defendant as at 22 December 2008 came to US$2,025,373.56.

7.   It is not disputed that the Plaintiff demanded for payment of the said interest due. And sometime in November, there had been active negotiation between the Plaintiff and the Defendant for payment. It is indeed the request of the Defendant that he would pay US$1.5 million in the first week of December 2008 (“the 1^st Installment”) and the balance of the interest on or before the end of December 2008 (“the 2^nd Installment”). The negotiation ended up with a Deed of Forbearance To Sue dated 1 December 2008 signed by the Plaintiff with the Defendant and the Company (“the Deed of Forbearance”).

8.   It is provided by clause 2(b) of the Deed of Forbearance that if the 1^stInstallment is not fully settled on time but within 60 days of the scheduled time, a penalty interest shall be payable by the Company calculated at the rate of 12% per annum on the principle sum of the Note together with any outstanding sum payable under the Note or the Deed of Forbearance (including the 1^st and 2^nd Installments) with retrospective effect from 1 January 2007 until the date of full payment. If the 1^st Installment or the 2^nd Installment is not fully settled after expiry of 60 days from the respective payment deadlines, then an additional penalty interest at the rate of 12% per annum shall be charged on the principal sum of the Note together with any outstanding sum payable under the Note or the Deed of Forbearance from the 1^st Payment and/or the 2^nd Payment due date until payment.

10.   A Deed of Modification dated 1^st December 2008 was executed at the same time with the Deed of Forbearance. It serves the purpose of amending the Instrument to reflect the aforesaid penalty interest and additional interest. It adds nothing to the legal effect of the Deed of Forbearance.

11.   After the Deed of Forbearance was executed, the parties further agreed to add a provision, being clause 2(d), for capping the effective interest payable on the Note at 48% per annum. This forms the last amendment to the Instrument, on the provision of default interest.

11. In breach of the Deed of Forbearance, the Defendant and the Company failed to pay the 1^st Installment. As a result, this Writ has been issued by the Plaintiff against the Defendant for the said sum of US$2,025,373.56, being the outstanding interest payable for the year 2007, and the penalty interest pursuant to the Deed of Forbearance in the sum of US$2,854,022.75. (It is noted that the Plaintiff did not claim additional penalty interest in this Writ.)

The Proposed Defence

12.   Mr. Mok for the Defendant submitted that by subscribing for the Note and advancing the payment, the Plaintiff had made a loan to the Company and was at the material time a money lender. Since the Plaintiff was not registered as a money lender under the Money Lenders Ordinance at the material time, it was in breach of section 23 of the said Ordinance. Section 23 reads: -

“No money lender shall be entitled to recover in any court any money lent by him or any interest in respect thereof or to enforce any agreement made or security taken in respect of any loan made by him unless he satisfies the court by the production of his license or otherwise that at the date of the loan or the making of the agreement or the taking of the security (as the case may be) he was licensed:

Provided that if the court is satisfied that in all the circumstances it would be inequitable if a money lender who did not satisfy it that he was licensed at the relevant time was thereby not entitled to so recover such money or interest or to enforce such agreement or security, the court may order that the money lender is entitled to recover such money or interest or to enforce such agreement or security to such extent, and subject to such modifications or exceptions, as the court considers equitable.”

13.   Mr. Mok submitted that the Plaintiff is not entitled to recover the loan unless the Court in its discretion allows the Plaintiff to recover the loan or interest or any part thereof. Hence, the judgment should be set aside.

14.   The question turns on whether the Plaintiff is or was at the material time a money lender. Section 2 of the Money Lenders Ordinance provides that: -

“money lender” means every person whose business (whether or not he carries on any other business) is that of making loans or who advertises or announces himself or holds himself out in any way as carrying on that business, but does not include-

(a) a person specified in Part 1 of Schedule 1; or

(b) as respects a loan specified in Part 2 of Schedule 1, any person who makes such loan.

15.   While the Defendant alleges that the Plaintiff was at the material time a money lender, there is no evidence suggesting that the Plaintiff has carried on the business of making loans. I do not believe the intention of the Ordinance is to provide that any person who makes a loan would become a money lender.

16.   And in accordance with Schedule 2, Part 2 of the Money Lenders Ordinance, there are a number of exempted loans. Granting the exempted loans would not render a person a money lender. And sub-paragraph 5 of Part 2 reads: -

“A loan made by company or a firm or individual whose ordinary business does not primarily or mainly involved the lending of money, in ordinary causes of that business.”

17.   Plaintiff’s counsel submits that if necessary, they would rely on Schedule 2 to argue that the subscription for the Note is an exempted loan. I believe this is a complete answer to the argument that the Plaintiff is a money lender. There is no evidence to suggest that the Plaintiff carries on the business of making loans.

18.   It is the evidence of the Plaintiff that it is an investor. It would invest in a potential company for listing and during that process it makes profit. Mr. Mok makes a very ingenious suggestion. He submits that similar to the situation of the Defendant, in making such investment, the Plaintiff has to advance money to the individual companies. As such, money lending becomes part of their business.

19.   To begin with, there is no evidence in support of Mr. Mok’s submission or any information on how the Plaintiff invested in other companies. It is nothing more than Mr. Mok’s speculation as to how the Plaintiff invested in other companies. Taking all matters into consideration, notwithstanding the able submission of Mr. Mok, I am not persuaded that there is a reasonable chance to argue that the Plaintiff is a money lender. I dismiss this argument.

20.   Mr. Mok also relies on section 24 and section 25 of the Money Lenders Ordinance. It is not disputed that these two sections apply to all loan transactions, no matter if the loan is made by money lender or not. Under section 24, any loan that carries an effective interest rate of over 60% per annum is illegal. It is not recoverable without leave of the Court. And pursuant to section 25 of the Money Lenders Ordinance, the Court may re-open certain money lender transaction if the transaction is extortionate. It is provided that if the effective interest rate exceeds 48% per annum, it is deemed to be extortionate. It may also be extortionate if it requires the debtor or relatives of him to make payments which are grossly exorbitant or if otherwise grossly contravenes ordinary principles of fair-dealing. In such situation, the Court may re-open the transaction to do justice between the parties.

21.   It’s the second proposed ground of defence of the Defendant that the Plaintiff was in breach of either section 24 or section 25 of the Money Lenders Ordinance as the interest chargeable on the Notes exceeds 60% or 48% per annum. In the former case, the Plaintiff would not be entitled to enforce the loan without first obtaining leave of the Court. In the later case, the Court may re-open the loan.

22.   On the said provision for interest payment in the Instrument, the interest to be charged is 25% per annum. That does not come close to the statutory effective rate of 48% per annum.

23.   What Mr. Mok seeks to argue is paragraph 7(B) of the Instrument, which provides that the Plaintiff may demand the Company to redeem the outstanding note and on such demand, the Company, and hence the Defendant as the guarantor, is liable to pay the aggregate of : -

(1) The principal amount outstanding under the Note.

(2) All interest accrued but unpaid in respect of the Note pursuant to condition for up to and including the date of the redemption notice; and

(3) An additional amount that would result in the note holder receiving a compound interest of 25% to be received by such note holder under condition 4(A) on the aggregate principal amount outstanding under the Note calculated from the date of issue of the Note up to and including the actual dates of payment (“sub-clause (3)”).

24.   The Defendant exhibited the calculation from an accountant to submit that the effective rate of interest, according to this calculation would exceed 48% and in some years exceed 60%. Before I look at the expert opinion, I reminded myself of the judgment of Madam Justice Le Pichon in the case Kwok Ying Lung v Ko Chi Hung and others CACV 635/2000 and CACV 142/2001 when Her Ladyship ruled that the calculation of effective interest is clearly one of statutory interpretation that is not a matter for expert evidence. Experts have no role to perform in such a situation. Her Ladyship further stated that in assessing the effective rate of interest, it is not necessary to refer to Schedule 2 in all situations: -

“So where an actual rate is specified in the Note or memorandum, the schedule has no application. The calculations in the schedule are only relevant to produce a deemed rate only where the total sum of interest is not capable of being expressed in terms of the actual rate percentage per annum, for example, where loan was repayable by a number of installments, its installments comprising principal as well as interest.”

25.   Mr. Mok does not argue against the able ruling of her Ladyship. He only seeks to adopt the calculation by the accountant as his understanding and calculation of clause 7(B). Mr. Mok submits that on redemption, the Company has to repay the principal, which is a fair term. The Company has to pay all interest accrued but unpaid. This would reflect proviso of clause 4(A) that the Company would be liable for 25% interest per annum on the value of the Note for the whole period of time. What the tricky part is sub-clause (3) which provides that an additional amount has to be paid. Mr. Mok submits that it provides for an additional amount of 25% compound interest on the principal from the date of issue of the Note up to the date of actual payment. This would make the interest payable under the Note on redemption to become 25% simple interest plus 25% compound interest. It must exceed 48% and likely to exceed 60%. And even if it just exceeds 48%, then it would be a meritorious defence as the Defendant would have a ground to re-open the loan.

26.   Mr. Wou, counsel for the Plaintiff responds by commenting that sub-clause (3) does not ask for an additional 25% compound interest. The clause merely provides that “an additional amount that would result in the note holder receiving a compound interest rate of 25% to be received by note holder under condition 4(A) …”

27.   Mr. Wou submits that the joint effect of clause 4(A), (B) and (C) is that, the Company is ultimately liable to pay 25% compound interest per annum for the value of the Note. It is liable at the end of each year to pay simple interest. If it has honoured its obligation at each year-end, it has discharged most of its duty in paying interest. The difference between compound interest and simple interest is the additional sum that the Plaintiff could receive under sub-clause (3).

28.   I agree with the submission of Mr. Wou. It is obvious that this is not an additional sum equal to 25% compound interest for the whole period when the Note is outstanding. It only covers the difference between simple interest and compound interest which the Plaintiff is entitled to receive.

29.   Compound interest is not a complicated concept. It only means that interest is reckoned not only on the principle but also on the accumulated unpaid interest (The New Short Oxford English Dictionary). And sub-clause (3) refers to interest received under clause 4(A). And if we look at clause 4(A), there is no provision for compound interest.

30.   Reading the plain wording of clause 7(B) with clause 4 (A), and if the Company has paid all interest at the end of each year, there is no outstanding interest for accruing further interest, and I would have thought that there is no further payment required. I need not rule on this point but there is sufficient material before me to reject the argument that sub-clause (3) requires an additional payment of another 25% compound interest.

31.   Pausing here, the above discussion is on the original wordings of the Instrument. I shall also look at the Instrument together with the provision of the Deed of Forbearance dated 1^st December 2008. As discussed above, for future default, the Company would be liable to pay, over the 25% interest per annum, a penalty interest of 12% per annum for default below 60 days, and for over 60 days, another additional penalty interest of 12% per annum. It is simple calculation that in the worst situation, the Company could be liable to pay 49% per annum.

32.   Mr. Wou refers me to clause 2(d) of the Deed of Forbearance, (which I set out above, is the late amendment to the Instrument). It provides that if the interest charged on the Note exceeding an effective interest rate of over 48% per annum, it would be capped at that rate. Accordingly, any interest charged by the Plaintiff under the Note would not exceed the statutory limit and accordingly, it would not be extortionate. I agree. The provision of the Note on default interest as being modified by the Deed of Forbearance provides a protection to the Company and the Defendant against interest rate higher than 48%.

33.   I am sure Mr. Mok would argue, though he did not, at the moment when the Deed was signed without the capping provision, it was extortionate. Nevertheless, it has been superceded by subsequence event and which must be a genuine settlement of the parties after taking into consideration of the Money Lenders Ordinance. It is well established in cases which there were genuine consideration of a compromise, such compromise shall be recognized and enforce by the Court. (Binder v Allachouzos [1927] 2 QB 151). And it is the agreement that the Court is being asked to enforce that the Court may re-open (per Deputy High Court Judge Muttrie in HCA 1198/1996). Hence, I need not consider the Deed of Forbearance without the capping provision for today’s purpose.

34.   And after the modification, the interest is capped at 48% per annum. I do not see any room to argue that the Instrument as modified by the Deed of Forbearance is deemed to be extortionate.

35.   Mr. Mok has also addressed me on the claims by the Defendant that he had to enter into the Deed of Forbearance in a rush and he had no legal advice. I note that this is a business transaction which starts with an Instrument which the Defendant is the guarantor. There is evidence to suggest that he is assisted by solicitors at all time. And he stated in his affirmation that if he did not do what the Plaintiff wanted at the time, legal action would have been issued against him as threatened and his other investments and business ventures would as a result be severely affected. And as mentioned herein before, the Defendant and/or his agents made various proposals on asking for time. In the commercial world, what is the value of a day to a businessman vary from business to business. It is consideration given and the Court does not normally look into the sufficiency of consideration. It is clear that the Defendant entered into the Deed for commercial reason.

36.   There is no sufficient material to support the argument that the Note is extortionate on other grounds. I conclude that there is no merit in the suggested defence that the Note was extortionate and the amount claimed thereunder, being paragraph 1 of the default judgment should be uphold.

37.   The more difficult consideration is on the claim for penalty interest. It is clear that the penalty interest is not provided in the original Instrument. And according to the Statement of Claim, the basis of the claim is from the provision of the Deed of Forbearance. Mr. Mok argues that the Deed provides for time to repay the said interest in the amount of about US$2M. But the amount that has to be paid for penalty interest would be about $2.8M (excluding additional penalty interest which has not been claimed in this action). This would clearly be exceeding 60% per annum, and is illegal. There is much force in this submission.

38.   In answering, Mr. Wou submits that the Deed of Forbearance is not a loan, but a Deed of Settlement. Section 2 of the Money Lenders Ordinance provides that: -

“loan” (貸款) includes advance, discount, money paid for or on account of or on behalf of or at the request of any person, or the forbearance to require payment of money owing on any account whatsoever, and every agreement (whatever its terms or form may be) which is in substance or effect a loan of money, and also an agreement to secure the repayment of any such loan, and “lend”(貸出) and “lender” (貸款人) shall be construed accordingly;

39.   Mr. Mok submitted that the Deed of Forbearance is a loan because it is a forbearance to require payment of money owing by the Defendant to the Plaintiff.

40.   I believe the section is drafted in an all embracing manner to cover all situations that a loan might be dressed up. Whether a transaction is a loan would be determined by “the overall nature of the transaction rather than taking any of the words contained in the definition individually and out of their context. In other words, what was required was to consider in overall terms what it was that the parties to the transaction were attempting to achieve and then decide whether the transaction was a "loan" according to the definition.” (Talcott Factors Ltd. v. G. Seifert Pty. Ltd. [1964] NSWR 1205).

41.   Iaccept that a settlement may not be a loan. But the Deed of Forbearance provides for extension of time to pay the outstanding interest for 2007. It provides for penalty interest for breach of compliance of the Deed of Forbearance. I put it no higher that it is a meritorious defence that the Deed is a loan and the interest payable under the Deed is illegal.

42.   But the claim under the Instrument, being paragraph 1 of the judgment, and the claim under the Deed of Forbearance, being paragraph 2 of the judgment are clearly severable and based on different contracts.

43.   I conclude that the judgment dated 18 March 2009 do stand, save that the judgment for penalty interest in the sum of US$2,854,022.75 be set aside and the Defendant has unconditional leave to defend. Leave be granted to the Defendant to file a Defence within 21 days from handing down of this judgment.

44.   I further order that there be an order nisi that the Plaintiff do have costs of this application with certificate for Counsel, to be taxed if not agreed, such order to become absolute within 14 days from handing down.