BROAD MARK LTD v. LIN ZHEN ZHONG AND OTHERS

HCCL 2/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO. 2 OF 2012

------------------------

BETWEEN

-------------------------

-----------------------

D E C I S I O N

-----------------------

1.  This is an appeal from the decision of the learned master who set aside the default judgment entered by the plaintiff against the 1^st defendant and discharged certain prohibition orders made against the 1^st defendant. Although the Notice of Appeal issued by the plaintiff seeks an order that the order of the learned master be set aside, including the orders he made to discharge the prohibition orders in question, I am not concerned with the prohibition orders because they would have lapsed, by now, in any event.

The master’s jurisdiction

2.  I queried, at the outset, why the application to set aside had not been brought up before the judge in charge of the Commercial List.  Mr Andrew Hart (“Mr Hart”), who appeared on behalf of the plaintiff, responded that the application had been made by the 1^st defendant to set aside the default judgment, and to discharge the prohibition orders, pursuant to a practice direction issued by the Commercial Court.  Indeed, a practice direction had been issued by Reyes J, the judge then in charge of the Commercial List, on 5 October 2009, pursuant to O.72, r.2(3) of the Rules of the High Court (“RHC”), in which he directed that:

“1. Save where otherwise ordered by the Judge of the Commercial List, in actions set down in that List the following matters shall be heard or otherwise dealt with by a master:

(a) applications for entry of default judgments;

(b) applications for or pursuant to the enforcement of judgments; and

(c) assessments of damages.

2.       Practitioners are asked to comply with these directions, the object of which is to provide for the more efficient disposition of business in actions within the Commercial List.  The taking out of applications otherwise than in accordance with these directions may be reflected in costs.”

This practice direction superseded a similar but wider practice direction that had been issued by Stone J, the judge previously in charge of the Commercial List, on 17 February 1997, which stated that the matters which should be heard, or otherwise dealt with, by a master also included unopposed applications for amendments of pleadings, unopposed applications for time extensions for the filing and service of pleadings and unopposed applications for time extensions for the discovery of documents and compliance with interrogatories.  The subsequent deletion of these matters was effected upon Reyes J to enable the judge of the Commercial List to have greater control over and better case management of the proceedings.

3.  Mr Hart was clearly right when he submitted that the applications to discharge the prohibition orders were properly before the learned master.  However, I do not accept his submission that the practice direction in question empowered the master to set aside the default judgment.  Although the master is clearly empowered to deal with applications for entry of default judgments and matters relating to enforcement of judgments, all applications to set aside default judgments obtained in actions in the Commercial List, as well as all other interlocutory applications, must be made to the judge of the Commercial List.  The Commercial List has been designed to enable the judge in charge of the list to carry out effective case management from inception of proceedings; to enable close involvement in the case by the same judge with a view to achieving better interlocutory and trial management; to enable the early identification of issues so that the proceedings can be managed efficiently and unnecessary interlocutory applications avoided; and thereby avoiding delay and expense and ensuring the efficient disposal of cases.

4.  It is provided in O.72, r.2(3) that the judge shall have control of the proceedings in his particular list and that, subject to the provisions of O.72 and to any other directions of the judge, the powers of the judge in chambers (including those exercisable by the Registrar) shall, in relation to any proceedings in such action, be exercisable by the judge.  Although O.32, r.11(1) provides that the Registrar and any master shall have the power to transact all such business and exercise all such authority and jurisdiction as, under any ordinance or by these rules, may be transacted and exercised by a judge in chambers, sub-paragraph (f) thereof excepts any matter or proceeding which, by any of the rules, is required to be heard only by a judge.  Woo J, as he then was, held in Silver Sand Navigation Inc v Xiamen Shengli Economy and Trading Development Co [1996] 4 HKC 555 that the master did not have jurisdiction to grant an extension of time to file and serve a defence in respect of a Commercial List action.  It is likely that the Practice Direction issued by Stone J in 1997 was prompted by this decision.  I also find that the learned master did not have jurisdiction to set aside the default judgment entered against the 1^st defendant in this case and I treat the appeal from the decision of the learned master as an original application by the 1^st defendant to set aside the default judgment entered against him.  I have little difficult doing so since an appeal from the master to a judge in chambers takes the form of a hearing de novo before the judge in chambers.

5.  As such, I treat the further evidence that has been served and filed after the decision of the learned master as evidence that has been properly adduced before me, save for the 3^rd and 4^th affirmations of the 1^st defendant, which I deal with below.

These proceedings

6.  On 22 February 2012, the plaintiff issued a writ in the Commercial List against the 1^st, 2^nd and 3^rd defendants and claimed the following reliefs against them, pursuant to a Subscription and Investment Agreement in writing dated 10 February 2007, as amended by a Supplemental Deed dated 20 June 2008, and a Further Supplemental Deed dated 6 December 2008 :

(1)     the sum of US$8,944,538, or its HK$ equivalent at the time of payment, as at 21 January 2009;

(2)     interest pursuant to contract in the sum of US$13,649,078 or its HK$ equivalent at the time of payment, from 22 January 2009 to 22 February 2012; and

(3)     further interest pursuant to contract from 22 February 2012 at the rate of US$21,665.11 per day, or its HK$ equivalent at the time of payment, until judgment or earlier payment and thereafter at the judgment rate pursuant to section 48 of the High Court Ordinance.

The indorsement of claim also contained claims for costs and further or other relief.  On 20 March 2012, default judgment was entered against all 3 defendants in the sums claimed, including further interest from 23 February 2012 to 20 March 2012 at the rate of US$21,665.11, and HK$10,000 fixed costs.

7.  Bonus Earn is a company incorporated in Hong Kong and having its registered office in Gloucester Tower, Landmark, Central, which was also the office address of Hastings, a firm of solicitors.  The proceedings arose from the plaintiff’s injection of US$3m into Bonus Earn to purchase zero-coupon convertible bonds of Bonus Earn with the objective of making a capital gain through the disposal of shares obtained upon the conversion of the bonds, or the disposal of the shares through an initial public offering to be undertaken by Bonus Earn, or through a trade sale of all the shares of Bonus Earn.  The subscription of the convertible bonds was made pursuant to the Subscription and Investment Agreement dated 10 February 2007. Under that agreement, the bonds, if not converted into shares, were due on 30 June 2010.

8.  The 1^st defendant, who is based in Fujian, is an engineer and specialist in internal combustion engines.  He and his wife owned a 100% stake in Fuan Zhenzhong Electric Manufacture Co Ltd (“Fuan ZEM”), a company incorporated in China, which designed, manufactured and sold engine components and which, in turn, owned Fujian Zhenzhong Electric Manufacture Co Ltd (“Fujian ZEM”), another company incorporated in China, which was also engaged in the business of design, manufacture and sale of engine components.  The 1^st defendant and Mrs Lin transferred their 100% stake in Fuan ZEM, which owned Fujian ZEM, to Bonus Earn to enable Bonus Earn to be publicly listed.

9.  By 2008, there was a change of plan and it was decided that the 3^rd defendant (“ZAC”), a company incorporated in the Cayman Islands, would be used as the listing vehicle instead of Bonus Earn.  Accordingly, the parties who had executed the Subscription and Investment Agreement dated 10 February 2007, which included the 1^st defendant, also executed the Supplemental Deed dated 20 June 2008 by which the original convertible bonds issued under the February 2007 agreement were all converted into shares of Bonus Earn and which shares were transferred by the plaintiff to ZAC in exchange for some 39+ million shares of ZAC.  Soon thereafter, the global financial crisis occurred.  This brought about another change of plan and resulted in the parties executing the Further Supplemental Deed of 6 December 2008.  This involved a repurchase by ZAC of the 39+ million shares that had been transferred to the plaintiff in exchange for new zero-coupon convertible bonds of ZAC (“the New Bonds”) which were to become due on 30 June 2010, unless they were converted into shares of the company to be publicly listed.

10.  If the New Bonds were not converted into shares, they had to be repaid on due date on 30 June 2010 pursuant to the formula set out for calculating the redemption price in the Further Supplemental Deed.   By Clause 6 of the Subscription and Investment Agreement, the 1^st defendant had guaranteed the performance of this obligation.

11.  Prior to the due date of the convertible bonds, the parties entered into a Deed of Compromise dated 9 April 2010.  The Deed of Compromise provided that, notwithstanding the formula for calculating the redemption price of the bonds under the Further Supplemental Deed, it was agreed that the New Bonds would be redeemed for a total consideration of US$11,500,001, and the parties also agreed, subject to the full and punctual performance of the parties’ obligations in the deed, to release and discharge each other from all obligations and liabilities under the February 2007 Subscription and Investment Agreement, and the Supplemental, and Further Supplemental Deeds of June 2008 and December 2008.

Real Prospect of Success

12.  I leave aside the Deed of Compromise for the moment and turn to the Further Supplemental Deed.  This stipulated, under its bond conditions, that the redemption amount of the New Bonds was to be calculated in accordance with 2 formulae therein set out and that the redemption amount shall be the higher amount as calculated by the 2 formulae.  Mr Harry Liu (“Mr Liu”), who appeared on behalf of the 1^st defendant, made the cogent submission that the 1^st of the two formulae required a calculation to be made based on the issue date of the New Bonds, a rate of return of 15% per annum, and the number of days that the bonds was outstanding counting from the issue date.  He made the valid point that the issue date of the New Bonds under the Further Supplemental Deed was 6 December 2008, and that the plaintiff had made a claim for early redemption based upon the occurrence of an event of default, i.e. the failure to make an initial public offering of the shares of ZAC.  As early redemption had been sought on 21 January 2009, and the New Bonds were outstanding only for a short period of time, the calculation based on the 1^st of the two formulae produced a sum slightly in excess of US$3,053,000, which was a far cry from the amount of US$8.9m claimed in the writ.  He also submitted that the calculation under the 2^nd formula could not be made because those calculations involved an assessment of the net asset value of the company, as reflected in the most recent accounts of the company.  However, audited accounts had not been prepared and, therefore, the formula could not be applied.  Mr Hart countered that submission by submitting that the amount claimed in the writ was based on a calculation adopting the 2^nd formula, as verified by Mr Kyle Arnold Shaw Jnr. (“Mr Shaw Jnr.”) in his affidavit sworn on 21 August 2012.  Mr Hart asserted that accounting documents were available, which enabled calculations to be made by applying the 2^nd formula, but he conceded that those accounts had not been exhibited into evidence.

13.  Absent the accounting documents to support a calculation based on the 2^nd formula and producing the sum of US$8.9m that has been claimed, I conclude that the 1^st defendant has demonstrated a real prospect of success in one of the defences he has raised, namely, that if he is adjudged liable, he is only liable to the extent of about US$3,050,000 and interest. 

14.  In addition to the claim for the principal sum, there is a very substantial claim for interest in excess of the sum of US$13m.  I have heard submissions that the effective rate of interest claimed, after taking into account the compounding effect of adding interest to the overdue amount on the last business day of every calendar month that it was outstanding, was to raise the rate of 35% per annum, which was the rate set out at Clause 8.4 of the bond conditions under the Further Supplemental Deed, to an effective rate of over 70%, a rate which was illegal by virtue of section 24 of the Money Lenders Ordinance, Cap 163. Mr Hart answered that submission by asserting that the amount claimed as interest was calculated by taking the rate of 35% per annum and that the provision regarding monthly compounding had not been followed.  However, he rightly conceded that, if a reasonable defence had been demonstrated in relation to the principal amount claimed, then it must follow that a reasonable defence would likewise be demonstrated in respect of the amount of interest claimed.  For these reasons, I am prepared to set aside the default judgment obtained against the 1^st defendant without going on to consider the further defence that had been raised which was based on the Deed of Compromise.  However, I must, nevertheless, deal with that defence as it impacts on the question of whether or not the judgment obtained by the plaintiff against the 1^st defendant was regular or irregular, and whether the judgment ought to be set aside on terms or unconditionally.

Deed of Compromise

15.  This deed, which is described as a Deed of Compromise and Release, was dated 9 April 2010 and was executed by the plaintiff, Bonus Earn, ZAC and the 1^st defendant, amongst others.  The 1^st defendant was a party to this deed because he had guaranteed the performance of the obligations under the previous agreements, including the obligation to pay the redemption amount of the New Bonds under the Further Supplemental Deed.  The recital to this deed included the following statements, namely, that, on 7 January 2009, the plaintiff had served notice on ZAC requiring ZAC to redeem the New Bonds; that the plaintiff and ZAC had been negotiating the redemption price since then; that the parties were desirous of terminating the Subscription and Investment Agreement; that, notwithstanding that the bond conditions provided the formula for calculating the redemption price of the New Bonds, the parties agreed that ZAC would redeem the New Bonds for a total consideration of US$11,500,001; and, further, that the parties agreed, subject to “the full and punctual performance of the parties’ obligations” contained therein, to release and discharge each other from all obligations and liabilities under the Subscription and Investment Agreement.

16.  Clause 2.1 of the deed stated that in consideration of the mutual promises contained therein, the parties thereby agreed that, subject to the terms and conditions contained in the deed:

“(c) The total consideration for the redemption of the new bonds and the purchase of sale shares will be in aggregate of US$11,500,001.00 … In the event that the Listco [i.e. ZAC] and Shareholder B [i.e. Sharp Step Group Ltd. which owned a large parcel of shares of ZAC] cannot pay the total consideration on or before 29 April 2010, the Listco and Shareholder B shall pay interest on the outstanding amount at the rate of 15% per annum calculated on the basis of the actual number of days elapsed …

…

(e) Upon the payment of the total consideration and interest thereon (if any) in accordance with Clause 2.1(c) hereof, the Subscription and Investment Agreement, the new Deed of Charge, the new bonds will be terminated, cancelled and shall cease to have any effect and the parties have further agreed that all provisions of the Subscription and Investment Agreement which are expressed to survive its termination (including, but not limited to, those clauses referred to in Clause 26.4 of the Subscription and Investment Agreement) shall be terminated, cancelled and shall cease to have any effect, and accordingly each of the parties shall be absolutely and unconditionally released from all their respective obligations and liabilities (financial or otherwise) under the said documents without any liability to any of the other parties; and

(f)      subject to the payment of the total consideration and interest thereon (if any), the subscriber shall absolutely release and discharge the security constituted under the new Deed of Charge …”

Listco was the abbreviation for ZAC in the Deed of Compromise and their solicitors was Hastings, to whom were delivered the documents listed under Clause 2.2 of the Deed, “in custody pending payment of the total consideration and interest thereon (if any) in the manner and at the time provided in this deed”.

17.  There were no provisions in the Deed of Compromise as to termination in the event that the agreed consideration of US$11,500,001 and interest thereon was not paid.  Mr Hart submitted that the Deed of Compromise was brought to an end by the conduct of the parties when Hastings returned the documents, which it held in escrow, to the plaintiff and that Hastings did so, not only on behalf of ZAC, but on behalf of all the other parties to the deed.  Mr Liu countered with the submission that, as defined in the terms of the Deed of Compromise, Hastings were only acting as solicitors for ZAC and not for any party.  The plaintiff sought to refute this argument by referring to an exchange of emails which, Mr Hart submitted, constituted evidence that Hastings were acting as solicitors for all the parties. 

18.  Mr Liu also submitted that if the Deed of Compromise remained in force, then, having regard to the provisions in the deed allowing further time for payment after 29 April 2010 and payment of interest on the outstanding amount at the rate of 15% per annum, and in the absence of any stipulation as to any final date of payment, the plaintiff ought to have given notice to make payment within a reasonable time and, thereafter, terminated the deed absent payment by such time.  The plaintiff did not do so and its email of 27 January 2011, stating that the plaintiff “will take all actions available under the 2007 Subscription and Investment Agreement”, was insufficient to terminate the Deed of Compromise.  So long as the Deed of Compromise remained valid, the plaintiff could not bring action under the Subscription and Investment Agreement, and, in particular, the Further Supplemental Deed, and could not, therefore, claim against the 1^st defendant to honour the guarantee he had given that was contained in Clause 6 of the Subscription and Investment Agreement.  Further, the 1^st defendant could not be sued on the Deed of Compromise, as the obligation to pay the sum of US$11.5m, and interest, vested in ZAC and Sharp Step Group Ltd., and not in the 1^st defendant.  Nor had the 1^st defendant guaranteed the performance of the obligations contained in the Deed of Compromise.

19.  I find that the 1^st defendant has demonstrated a real prospect of success in defending the plaintiff’s claims on the ground that these claims were not sustainable on the ground that the Deed of Compromise remained valid until brought to an end by a notice to pay the amounts outstanding within a reasonable time, and a consequent failure to do so, and that, whilst it remained valid, the 1^st defendant could not be sued on his guarantee contained in the Subscription and Investment Agreement.  Although I do not make a final adjudication of this ground of defence, the success or failure of which would depend also on the evidence of the email and other communications between Mr Shaw Jnr. and the 1^st defendant and of the authority of Hastings, I am prepared to set aside the default judgment on this ground, as well as on the other grounds I have dealt with above. 

Setting aside judgement on terms or unconditionally

20.  However, the fact remains that the plaintiff has been out of pocket in the sum of US$3m for a considerable period of time, without any real prospect of payment by ZAC and which payment had been guaranteed by the 1^st defendant.  In addition, Mr Hart made the cogent submission to me that, if the only sum outstanding was US$3m and interest accruing on that sum, the 1^st defendant and the other parties to the deed would not have agreed to compromise the claim by paying some US$11.5m.  The continuing liability to pay interest under the Deed of Compromise would increase this amount to about US$15m today.  These matters are clearly relevant to the exercise of the court’s discretion to impose conditions, particularly if the judgment being set aside was a regular one.

Was it a regular judgment?

21.  The plaintiff relied on Clause 31.3 of the Subscription and Investment Agreement to serve the writ on the 1^st defendant, amongst others, at the registered address of Bonus Earn which was the same address as the address of Hastings.  Clause 31.3 stipulated that the 1^st defendant and the other parties identified “hereby appoints [Bonus Earn] … as his/its agent for service of process on its behalf in respect of any proceedings in Hong Kong and agrees that any such proceedings may be commenced by service on such agent.”  It was further provided by Clause 26.4 of the Subscription and Investment Agreement that, amongst other clauses, Clause 31.3 “shall continue in full force and effect notwithstanding the termination of this Agreement”.  I accept the submission of Mr Hart that this provision remained valid and that service pursuant to this provision was good service notwithstanding that the payment conditions under the Subscription and Investment Agreement, and in particular, under the Further Supplemental Deed, were suspended by the Deed of Compromise insofar as and for so long as the latter remained valid.  Although Clause 2.1 of the Deed of Compromise expressly stated that all the provisions of the Subscription and Investment Agreement including those clauses referred to in Clause 26.4 of that agreement (which included Clause 31.3 on the agreed mode of service) shall be terminated, cancelled and shall cease to have any effect, there is no reason or basis to construe Clause 2.1(e) of the Deed of Compromise as effecting a termination or cancellation of the agreed service provision before the payment of the sum of US$11.5m and interest thereon. 

22.  Was service in this case effected in accordance with Clause 31.3 of the Subscription and Investment Agreement?  Mr Liu relied on O.10, r.3 RHC to submit that, in order for the plaintiff to prove that the writ had been regularly served, the writ must have been “served in accordance with the contract” and, in particular, “served on the defendant, or on such other person on his behalf as may be specified in the contract, in such manner, or at such place … as may be so specified”.  Clause 31.3 stipulated that the 1^st defendantand the other parties identified “hereby appoints [Bonus Earn] whose registered address is at the [the Landmark address] as his/its agent to accept service of process on its behalf in respect of any proceedings in Hong Kong and agrees that any such proceedings may be commenced by service on such agent.”  I find that the proceedings were properly served, by service on Bonus Earn, a Hong Kong company, being the person specified in the contract to be served on behalf of the 1^st defendant, and by service at its registered address, being the place of service specified in the contract.  I do not accept the submissions of Mr Liu that Clause 31.3 stipulated, or is to be construed to mean, that service must be made personally on an officer of Bonus Earn.

23.  Further, there is no provision in Clause 31.3 to the effect that the appointed agent must “accept service of process” in the sense that he must communicate his acknowledgement, or agreement, that service has been properly effected.  Clause 31.3 provided that the 1^st defendant and the other parties identified:

“hereby appoints [Bonus Earn] whose registered office is at [the Landmark address], as his/its agent to accept service of process on its behalf in respect of any proceedings in Hong Kong and agrees that any such proceedings may be commenced by service on such agent. If such appointment ceases to be effective for any reason, the relevant parties shall immediately appoint a further person in Hong Kong to accept service of process on its behalf and, failing such appointment within 21 days, the other party shall be entitled to appoint such a person by notice to the former party. Nothing contained herein shall affect the right to [serve in any other manner permitted by law]”.

By executing the Subscription and Investment Agreement, the 1^st defendant, and the other parties identified, appointed Bonus Earn as their agent to accept service of process on their behalf.  Service on Bonus Earn at its registered address was the agreed mode of service under Clause 31.3. No further agreement or acknowledgement was required from Bonus Earn to make good that service.

24.  However, even a regular judgment obtained consequent upon proper service of process is liable to be set aside unconditionally if it is established that the defendant did not receive notice of the commencement of proceedings and, for that reason, did not take any steps to defend them.  As Godfrey JA said in Fok Chun Hung v Lo Yuk Shi [1995] 1 HKLR 420 at p.423, line 40:

“… as Denning LJ pointed out ... it is a fundamental principle in our law that no one is to be made liable by any order of any tribunal unless he has been given fair notice of the proceedings to enable him to appear and defend them. The common law has always been very careful to see that the defendant is fully apprised of the proceedings before it makes any order against him.”

Setting aside judgment unconditionally

25.  However, I need not deal with the issue of whether or not the 1^st defendant had notice of the writ, as I am prepared to set aside the default judgment unconditionally on the grounds that the 1^st defendant has established a defence on the merits with some degree of conviction.  In the course of oral argument, I had considered whether or not I should impose a condition for payment into court of the sum of US$3m as a condition for defending these proceedings.  However, I find myself unable to impose such a condition, given the defence that has been raised, namely, that the payment obligations were suspended by reason of the continuing validity of the Deed of Compromise and that the plaintiff could only proceed against the 1^st defendant by bringing the Deed of Compromise to an end.  Whilst I am not making any final adjudication on this defence that has been raised, I am persuaded that it has sufficient merit such that it would be injudicious of me to impose conditions before setting aside the default judgment, even if I were satisfied that the default judgment was regular (which I am), and that the 1^st defendant had actual notice of the commencement of proceedings (on which issue I have not made any determination).

26.  For these reasons, I set aside the default judgment against the 1^st defendant without imposing any conditions. 

3^rd and 4^th affirmations of the 1^st defendant

27.  I have been able to reach this conclusion without having to resort to the notarised 3^rd and 4^th affirmations of the 1^st defendant, which were served pursuant to my leave to do so, on 12 September 2012.  As I have not had any regard to the contents of these two notarised affirmations made by the 1^st defendant in the presence of a notary public in Macau, I do not grant leave to the plaintiff’s solicitors to adduce and rely on the 2^nd affidavit of Mr Shaw Jnr. sworn on 20 September 2012.

Costs

28.  I make the following costs orders nisi.  As the prohibition orders were rightly set aside by the learned master, I do not disturb the order of costs made below.  I order the costs of the proceedings before me to be paid by the plaintiff to the 1^st defendant in any event, to be taxed if not agreed.