SUPREME DESIGN FASHION LTD. AND ANOTHER v. MICHAEL HOPE INTERNATIONAL LTD

HCA1198/96

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.1198 OF 1996

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J U D G M E N T

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1. The Plaintiffs' case against the Defendant is that certain transactions entered into between them are struck down by the provisions of the Money Lenders Ordinance, Cap.163. The Plaintiff claims declarations as to the invalidity and unenforceability of the transactions, or alternatively for their reopening under the provisions of the Ordinance, and for the return of certain securities. The Defendant for its part counterclaims for the sums due under the transactions, which on its case are not struck at by any of the provisions of the Ordinance.

Facts not in dispute

2. Various facts are not in dispute as appears from the pleadings and from the large number of documents which have been put before the Court by agreement. Some of the evidence given by Madam Hung for the Plaintiffs and Mr Ziulkowski for the Defendant is also not disputed.

3. The 2nd Plaintiff, Madam Hung Lai Chu, is a businesswoman who operated for many years in the garment trade. At the relevant time she held directorships and major shareholdings in various companies, including the 1st Plaintiff. She was one of its two directors, and owned 9,997 of the $10,000 issued shares. Members of her family owned the other three shares.

4. The 1st and 2nd Plaintiffs were the shareholders of another Hong Kong company called Supreme International Enterprises Ltd. This company in turn was the major shareholder in Marko Development Ltd., also incorporated in Hong Kong. The latter company was one of the joint-venture partners in a company called Shanghai Marko Fashion and Toys Co. Ltd. ("Shanghai Marko"), incorporated on the Mainland.

5. Madam Hung decided in about 1992 or 1993 to diversify her business interests into real estate. On 13th September 1993, the 1st Plaintiff entered into a joint venture agreement with a Chinese company to form a company called Shanghai Xue Bao City Co. Ltd. ("Xue Bao") in Shanghai. The purpose of the joint venture was to construct and operate an "amusement city".

6. Madam Hung was married to one Patrick Kwok Siu Hong. They separated, according to Madam Hung, in about April 1993, and they divorced in 1997. However, again according to Madam Hung, they continued and still continue to have a business relationship.

7. Patrick Kwok, according to Madam Hung, is now the General Manager of Xue Bao. It appears from correspondence between the parties' solicitors that he was appointed as such in 1993 although Madam Hung says that this was nominal and he only became the General Manager in fact in the past couple of years. He was also at the relevant time a Director of Marko Development Ltd. and the Chairman of Shanghai Marko. He was neither a shareholder nor a Director of the 1st Plaintiff.

8. By a contract of employment dated 25th July 1992, Patrick Kwok was employed by the Defendant as Assistant to the Managing Director. He resigned on 1st January 1994. The Managing Director, who was employed by the Defendant by a contract dated 26th July 1992, was a Mrs Regina Richter. She was removed - in effect dismissed - on 25th February 1994. She and Kwok had previously worked together in a company called Ruggedson Co. Ltd., owned by Mrs Richter and her sister. Kwok was at one time a Director though not a shareholder of that company.

9. The Defendant company, whose name has since the issue of proceedings been changed to Salzgitter Trade Hong Kong Ltd. is the subsidiary of a German company, Preussag Handel GmbH. The Defendant was set up by, inter alia, Mr Dieter Gerhard Ziulkowski, the Defendant's witness. According to him the company was mainly in steel and technical trade and back to back garment business. When Mrs Richter was working for the Defendant, she dealt with the garment side of the business and Mr Ziulkowski with the steel and technical trade.

10. On 25th August 1993, the Defendant and Shanghai Marko entered into a "Long Term Sales Co-operation Agreement" for the sale of garments in China. The Defendant was to supply the garments and Shanghai Marko was to pay a profit of 15%.

11. On 11th September 1993, the 1st Plaintiff and the Defendant entered into what, on the face of it, is an agency agreement under which the Defendant was appointed to handle the purchase of not more than US$3,000,000 worth of building and construction equipment and materials. The Defendant was not to place orders for the equipment and materials. It was simply to open letters or credit or other documentary credits up to a total amount not exceeding US$3,000,000 on the instruction of the 1st Plaintiff, in favour of payees to be named by the 1st Plaintiff. The 1st Plaintiff for its part agreed to repay this amount, with an agency commission of 35% within 8 months after all the equipment and material had been delivered.

12. Madam Hung signed a personal guarantee in favour of the Defendant, also on 11th September 1993. She guaranteed payment of all liabilities of the 1st Plaintiff under the agency agreement.

13. Pursuant to this agreement, the Defendant in November 1993 opened five letters of credit, in favour of various Hong Kong companies, to a total value of US$2,893,438, for the purchase of various equipment and materials including escalators and elevators as well as air conditioning equipment. The goods were duly shipped from Japan, the United States and Korea to Shanghai, and paid for with the letters of credit. The Defendant issued commercial invoices to the 1st Plaintiff for a total of US$2,893,438, between 1st December 1993 and 20th April 1994. The 1st Plaintiff paid to the Defendant a total of US$1,433,228.00 between 15th August and 7th December 1994, and then stopped paying.

14. Following negotiations, on 18th May 1995 the Plaintiffs and the Defendant executed a Deed of Settlement and Madam Hung executed a charge on her shares in the 1st Plaintiff in favour of the Defendant. By this deed it was agreed that the 1st Plaintiff still owed the Defendant US$2,476,645 plus interest from the agency agreement, and that the Plaintiffs had agreed to pay the Defendant US$300,000 in respect of textile goods left unsold on the termination of the "Long Term Sales Co-operation Agreement". In consideration of the Defendant's forbearance to sue, the Plaintiffs were to pay these sums, plus $70,000 as a late interest payment, by instalments up to 30th September 1997.

15. After this, the Plaintiffs paid a total of US$400,000 to the Defendant, up to December 1995. On 31st December 1995, one of the instalment cheques for HK$618,000, representing an agreed instalment of US$80,000, was dishonoured. No further payments were made and the Plaintiffs issued their Writ on 29th January 1996.

The Plaintiffs' Case

16. It is the Plaintiffs' case that :

1. The agency agreement was in fact a loan agreement. The letters of credit represented a series of loans made by the Defendant to the 1st Plaintiff at interest of 35% over 8 months.

2. The Defendant was an unlicensed money lender, therefore by s.23 of the Money lenders Ordinance the money lent is not recoverable.

3. There was no statutory note or memorandum as prescribed by s.18 of the Ordinance, therefore by s.18 the money lent is not recoverable.

4. Because the original agreement prohibited payment by instalments, it was illegal under s.22 of the Ordinance.

5. Because the sums agreed under the Deed of Settlement included an element of compound interest, that agreement is also illegal under s.22.

6. Even if the Defendant is not a money lender, the original agreement is extortionate under s.24 of the Ordinance, and should therefore be re-opened under the provisions of that section.

The Defendant's Case

17. The Defendant contends that :

1. The original agreement was not a loan, but an agency agreement.

2. While it is admitted that the Defendant did not hold a money lender's licence, and that there was no statutory note or memorandum as prescribed by s.18, it was in any event not a money lender. Therefore, the provisions of s.s.18, 22 and 23 could not apply.

3. If the Defendant was a money lender, the Court should exercise its powers under those sections to order the agreement enforceable to such extent as it considers equitable.

4. If the original agreement was a loan, it was in any event superseded by the deed of arrangements agreed in the Deed of Settlement, which were in the nature of a "roll-over". The new loan so agreed was not extortionate because the effective rate of interest over the agreed period of repayment was reasonable.

The Evidence

18. Madam Hung ga ve evidence for the Plaintiffs, and Mr Ziulkowski for the Defendant. As I have indicated, there were large numbers of agreed documents. I do not propose to rehearse the evidence here but will deal with it as necessary in dealing with the various issues. I will, however, say at this stage that Madam Hung was not a very impressive witness. She tended to be evasive. Her attempts to present herself as an ignorant victim, in view of her long and extensive business experience, do not help. Nor does her admission that she finally stopped paying what was due under the Deed of Settlement, which she had entered into with the benefit of legal advice, simply in the hope of negotiating a better deal.

19. Mr Ziulkowski made a better impression. He was quite straightforward. However he suffered from the handicap of having no personal knowledge of what went on between Madam Hung and Mrs Richter.

20. Where there is a conflict, I prefer the evidence of Mr Ziulkowski. I turn to the various issues, which I will deal with under the headings of "Illegality" and "Extortion".

Illegality

Was the agency agreement really a loan?

21. It is Madam Hung's evidence that it was. She approached Mrs Richter for a loan, and that is what she got. It was Mrs Richter who said that the loan was to be by way of letters of credit, the agreement was to be in the form of an agency agreement and the interest was to be shown as agency commission. After this, Madam Hung instructed her solicitors to draw up the agreement in this form; they sent it to Mrs Richter for approval and once it was approved it was duly signed.

22. She says that the Defendant did no more than provide finance. Other agents did the purchasing. In fact the various documents support this.

23. There is of course no evidence from Mrs Richter. She is long gone. According to Mr Ziulkowski, she was dismissed because of this agreement; and I will deal with this further below. But Mr Ziulkowski, who says that he did not deal with the garment side of the business once Mrs Richter was employed, cannot tell us anything about the negotiations. So there is nothing to contradict what Madam Hung says on this point.

24. "Loan" is defined in s.2 of the Money lenders Ordinance, as follows :

"'loan' (貨款) 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; ..."

This is a very wide definition and it is clear that one must look at the substance of the agreement and not simply at its form.

25. Section 2 also defines interest as follows :

"'interest' (利、利息) does not include any sum lawfully agreed to be paid in accordance with this Ordinance on account of stamp duty or other similar duty, but save as aforesaid includes any amount (by whatever name called) in excess of the principal, which amount has been or is to be paid or payable in consideration of or otherwise in respect of a loan; ..."

Quite clearly the Defendant did not act as a purchasing agent. It did not order anything. It did not arrange for shipping or delivery. It used its own credit facilities to pay for goods ordered by another. It expected to get a return of 35% on that money within 8 months after the delivery of the goods.

26. It is perhaps significant that the Defendant itself seems to have regarded the money as a loan. In his letter dated 18th May 1995 to Madam Hung, in which he purported to charge late payment interest of $28,856.42, Mr Ziulkowski referred to a cheque dated 20th September 1994 as being a loan repayment. In a fax message dated 22nd June 1993 from Dr Kramer at Preussag Handel GmbH to Patrick Kwok at the Defendant, Dr Kramer referred to an agency agreement suggested by Kwok as "more a financing transaction than anything else". I will refer to this matter further below, but it is quite obvious that the agency agreement which Kwok had suggested was in substance that which was agreed between the parties in the agency agreement of 11th September 1993.

27. Looking at the agency agreement in the light of the evidence and the surrounding facts and circumstances, I am in no doubt that it was in substance an agreement for a loan and that the agency commission was in fact interest.

Was the Defendant a money lender?

28. In the Ordinance "money lender" is defined as follows :

"'money lender' (放債人) 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;..."

The question is whether the Defendant's business, or part of it, was that of making loans or whether it advertised or held itself out as carrying on that business. There is no documentary evidence of other loans, or of written advertisements within the trade. The Defendant's financial returns show considerable income from interest but the source of this income is not clear.

29. Madam Hung's evidence in her statement is that the Defendant was well known in the trade to be engaged in the business of providing finance in fashion trading. She gave examples of two German fashion traders who, according to her, had obtained finance from the Defendant. Cross-examined, she said that she had got this information about the Defendant from her husband Patrick Kwok.

30. Mr Ziulkowski's evidence is that the Defendant was not in the business of providing finance. It was a commission agent. Mrs Richter had been dismissed because she disobeyed the parent company's rules about taking on new business and Dr Kramer had been dismissed from the parent company for not supervising her properly. He said that she had taken on new business, not in the sense that commission agency work was new, but that commission agency in fields other than steel, technical trade or garments was.

31. I asked Mr Ziulkowski if the Defendant would have entered into a similar agreement to that of 11th September 1993 for garments. He said it would not. For garments, the company got orders from Germany then bought them locally. He had once been involved in a contract for steel with a Cyprus company for which a letter of credit had been opened by his customers.

Cross-examined further, he said that he would not open a letter of credit to let others buy steel. Nor would he do it for garments.

32. I have referred to correspondence between Mr Patrick Kwok and Dr Kramer in 1993 as showing that the parent company regarded the proposed transaction which was quite obviously the same as the transaction which ultimately took place, as primarily a financial transaction. It has been argued that Dr Kramer's response also shows that the Defendant was not engaged in the loan business. I think the response is rather equivocal on this point. Certainly Dr Kramer said that it was "not the kind of business that MHI (the Defendant) should pursue"; but he seems to have been more concerned about the degree of risk than anything else.

33. So on the Plaintiffs' side we have, at best, a rather vague assertion by Madam Hung that the Defendant was known for providing finance in the fashion trade. I have indicated that I did not find her a very reliable witness. I would not be disposed to rely on this kind of vague assertion even from a more reliable witness. Without something concrete to back it, it is no better than gossip. Further it is largely based, as is the story of the German borrowers, on hearsay of Patrick Kwok. This story of the German borrowers is uncontradicted, because evidence of Mr Ziulkowski on the matter was excluded as itself being hearsay. Nevertheless the story itself is still hearsay.

34. There is the matter of interest income, but in the absence of explanation it is difficult to see what conclusion can be drawn from it. Interest may be from other sources than money lending.

35. On the Defendant's side we have the clear and credible evidence of Mr Ziulkowski that the Defendant did not issue letters of credit for others in the manner of this transaction.

36. I have no doubt that this was a single transaction. It was not the normal kind of transaction which the Defendant undertook.

37. To prove that a person carries on business as a money lender, it is necessary to prove some degree of system and continuity in his money lending transactions. See Kirkwood v. Gadd [1910] AC 431. There is no reliable evidence that this Defendant engaged in any other loan transactions than this one.

38. It is argued for the Plaintiffs that because there was a series of letters of credit, there was a series of loans and this is enough to establish system and continuity. The Plaintiffs refer to the case of R. v. Morgan [1913] 11 DLR 795 in which one who made a series of loans to one borrower over a period of a year was held to be carrying on business as a money lender. I do not see that this can apply here. There was one contract. It was for a series of advances but the total was fixed and the repayment followed on one fixed event, namely delivery. Granted that later and long after all the letters of credit had been issued, the parties agreed that the repayments should fall due as from the individual deliveries, I cannot see that this makes any difference.

39. I conclude that the Defendant was not a "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."

40. It is not in the circumstances necessary for me to go on to consider whether the Defendant was "as respects a loan specified in Part 2 of Schedule 1, any person who makes such loan". The exemptions set out in the schedule would apply where some sort of business of making loans was carried on. Since there was no business of making loans, it is not necessary to consider whether the single loan made here was an exempted loan. Even if it was not exempted under the Schedule, the single loan could not make the Plaintiff a money lender.

Conclusion on Illegality

41. The Defendant was not a money lender. It follows that s.s.18, 22 and 23 of the Ordinance do not apply. The Plaintiffs cannot have the declarations they seek. However, s.25 applies to all loans, whether or not made by a money lender. So I turn to the issue of extortion.

Extortion

Which transaction may be reopened?

42. The Plaintiffs pray for all the agreements to be reopened including the collateral security agreements. The Defendant says that the second transaction, i.e. the Deed of Settlement is a "roll-over" or rescheduling of the original debt. Only it should be looked at; and it is not extortionate.

43. In support of this the Plaintiffs rely on the case of Binder v. Alachouzos [1972] 2 QB 151. In that case the defendant had compromised an action against him for debt in which he had alleged illegality under the Moneylenders Acts. The compromise agreement recited that the parties had been advised by solicitors and counsel and that the defendant admitted that the Moneylenders Acts did not apply to the transactions which were the subject of the actions. But the defendant did not pay under the compromise agreement. He was sued again. He sought to rely on the Moneylenders Acts. It was held that the compromise agreement was a bona fide compromise of the question of fact whether the original loans were unlawful money lending transactions; it was not open to the defendant to reopen the question of illegal money lending. The Court also said that the courts should enforce compromises agreed in good faith between lender and borrower.

44. It seems to me that the position is somewhat different here. There was no compromise as to the legality or otherwise of the original agreement. One side raised the question of a money lender's licence, but it was never pursued. However we are not in any event dealing with illegality, given my finding that the Defendant was not a money lender. The question now is not one of enforcing an illegal agreement subject to such modifications and exceptions as the court considers equitable, it is whether a legal agreement or agreements should be reopened on the ground of extortion.

45. Section 25(1) provides :

"(1) Subject to section 24(2), where-

(a) proceedings are taken in any court by any person (whether a money lender or not) for the recovery of any money lent or the enforcement of any agreement or security in respect of any loan; and

(b) subject to subsection (3), there is evidence which satisfies the court that the transaction is extortionate, the court may reopen the transaction so as to do justice between the parties having regard to all the circumstances, and, for that purpose, make such orders and give such directions in respect of the terms of the transaction or the rights of the parties thereunder as the court may think fit."

46. Here the proceedings referred to in paragraph (a) are the Defendant's proceedings by way of counterclaim for the sums it claims are due under the Deed of Settlement. So it seems to me that technically that is the only transaction which the court may reopen.

47. If I am wrong on this, it is in any event a matter of fact that the second transaction in effect reopened the first and superseded it. The relationship of the parties is now governed by the second transaction. It follows that there is no need for me to decide whether the first transaction was extortionate.

Was the second transaction extortionate?

48. Section 25 provides :

"(2) For the purposes of this section, a transaction is extortionate if-

(a) it requires the debtor or a relative of his to make payments (whether unconditionally or on certain contingencies) which are grossly exorbitant; or

(b) it otherwise grossly contravenes ordinary principles of fair-dealing."

Under subsection 3, a loan with interest of over 48% per annum is presumed to be extortionate. It is necessary to look first at the effective annual interest rate of the second transaction.

49. Clearly the starting point of the calculation of the principal sum in the Deed of Settlement was the total advanced by way of the letters of credit plus 35%, less what had been paid up to December 1994. There was a further addition of US$70,000 by way of late payment interest. But the effect of the Deed was to give the Plaintiffs further time to pay, without charging any more interest. The interest rate applicable would be the annualized rate over the total period agreed.

Counsel for the Defendant calculates the effect of the Deed of Settlement thus :

A:	Amounts paid under the 11/9/93 agreement	1,433,228
B:	Amount further payable under the Deed of Settlement (2,476,645 + 70,000)	2,546,645
C.	Total amount to be paid (A+B)	3,979,873
D.	Amount of L/C "principal"	2,893,438
E.	Amount of "interest" payable (C-D)	1,086,435
F.	Interest as total percentage of principal (E+D)	37.54%

Annual Rate of interest

(20/4/94 to 30/9/77) = 40.33 months

(37.54/40.33 x 12) = 11.17%.

50. This seems to me to be a sensible approach. I accept that this was the effective annual rate of interest under the second transaction. It was well below the rate at which extortion is presumed.

51. Returning to s.25(2), it cannot be said that the payments which the Plaintiffs agreed to make were grossly exorbitant. In fact they got a breathing space, provided by paying US$80,000 per month in the beginning. Only at the end, by which time it was hoped that they would be showing a profit, would they have to make large payments. Further, it cannot be said that the transaction grossly contravened ordinary principles of fair-dealing. One has to remember that the playing-field was level in that both sides were dealing through solicitors.

52. I must still have regard to evidence of the matters set out in s.s.4, 5 and 6 in deciding whether there was extortion.

53. While there is no actual evidence of the prevailing bank rate at the particular time, it seems to me that I may take judicial notice that it would have been around 8% as put forward by Defence Counsel. The 2nd Plaintiff said that she was able to get finance from banks at prime rate plus 1.25 to 2.5%.

54. The 2nd Plaintiff was of full age and there is no suggestion that she was not in good health. She had plenty of experience and business capacity. Granted that she and the 1st Plaintiff were under financial pressure, it is quite clear that she got them into that situation in the first place. How she came to be in financial straits in 1993, except by entering into the joint venture under which she contracted to contribute US$3,800,000, has never been explained.

55. The original loan had no real security; only a personal guarantee. The second transaction provided for a mortgage of shares in the 1st Plaintiff. There is nothing in the evidence to suggest that that was a security of any great value.

56. I conclude that the second transaction, insofar as it related to the rescheduling of the first transaction, was in no way extortionate.

57. The second transaction included $300,000 which was an agreed figure in compromise of a dispute between the Defendant and Shanghai Marko. It had nothing to do with the 1st Plaintiff's debt though it concerned Madam Hung because of her major shareholding in Shanghai Marko. It was included as part of the consideration for the Defendant's forbearance to sue. It was a compromised figure achieved after negotiation through solicitors. There was no question of interest on it. It is difficult to see how the question of extortion could arise in respect of it.

58. I conclude finally that the second transaction was in no way extortionate.

59. As I have indicated above, the Plaintiffs' claims for declarations must fail. So must the claim for re-opening of the transactions. The Defendant is entitled to be paid the sum outstanding under the second transaction.

60. The Plaintiffs' claims are dismissed. There will be judgment for the Defendant on the counterclaim in the sum of US$2,446,645 or its equivalent in Hong Kong dollars.

61. Since the above calculations depend on payment of the full sum by 30th September 1997, it seems proper that interest on the judgment debt should run from the next day. Interest is therefore awarded at the prime rate plus 1% from 1st October 1997 to the date of judgment and thereafter at the judgment rate.

62. Costs nisi of the action and the counterclaim be to the Defendant, to be taxed if not agreed.