CORNHILL DEVEOPMENT LTD. v. THE NEW CHINA HONG KONG FINANCE LTD.

HCMP5078/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 5078 OF 2000

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J U D G M E N T

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1. The plaintiff is a licensed money lender. It is a wholly owned subsidiary of DC Finance (Holdings) Ltd ("DC") (now known as Star East Holdings Ltd). The parent company conducted at least some of its finance business through the plaintiff. The defendant was one of the group of companies known as The New China Hong Kong Group. Other loans than that the one with which we are concerned were made by the plaintiff to members of the Group.

2. This case concerns payments made on 24 September 1997 by cheques in favour of the defendant, totalling $60,500,000. One was drawn by the plaintiff itself, for $30,500,000, one by Lucky Man Properties Ltd for $20,000,000 and one by DC for $10,000,000.

3. It is the plaintiff's case that these cheques represented a loan of $60,500,000 made by it to the defendant at interest of 2% per month, with $25,200,000 repayable within 10 days and the balance repayable 90 days from the drawdown date. Unfortunately, there is no note or memorandum in writing of the loan agreement, as required by section 18(1) of the Money Lenders Ordinance, Cap.163 ("the Ordinance").

4. In fact, the defendant paid $25,000,000 to the plaintiff on 9 November 1997. No further payment was made. The defendant went into creditors' voluntary liquidation by a resolution dated 9 March 1999. The plaintiff claimed against the liquidators for $61,250,629.40 which represented a principal sum of $35,500,000 plus interest thereon, at 2% per month up to 11 October 1999. The liquidators refused the plaintiff's proof of the claim.

5. The plaintiff accordingly seeks orders that the loan agreement is an exempted loan within the meaning of Schedule 1, Part II, paragraph 2 of the Ordinance; alternatively, that the loan agreement be enforceable notwithstanding non-compliance with Part III of the Ordinance; and an order that the decision of the joint and several liquidators be reversed.

6. The defendant denies that the loan is exempted and argues that, in any event, there is insufficient proof that the loan agreement was between the plaintiff itself and the defendant. It says that the loan is unenforceable by reason of non-compliance with section 18 of the Ordinance, and that it would not be inequitable so to hold it; therefore, the court should not exercise its discretion in favour of a declaration of enforceability under section 18(3).

Evidence

7. There is not much evidence before me and what there is somewhat confusing. On the plaintiff's side, there is a Mr Leung Man Fai, who himself knows nothing of the transaction. He produces a statement made by a Mr Eric Chan Man Hon, who says that at the relevant time he was the Chairman of DC and was involved in the transaction.

8. According to Mr Chan, he was approached on about 22 September 1997 by two representatives of the defendant. They told him that a client of theirs needed a loan of $35,500,000 to facilitate the settlement for the purchase of 55 million shares in Chung Hwa Development Holdings Ltd, and asked whether DC or the plaintiff would be interested in making the loan. Mr Chan told them that DC would be interested if the defendant would guarantee the loan on behalf of their then unnamed client.

9. The defendant then requested an increased loan for its client of $60,500,000. Ultimately, it was agreed that either DC or the plaintiff would lend this sum to the defendant for lending on to its own client. The interest was 2% per month, with $25,200,000 repayable within 10 days and the balance repayable 90 days from the drawdown date. Collateral was to be a declaration of trust in respect of the plaintiff's interest and rights in the collateral agreement to be made between it and its client, whereby the defendant was to have a charge over the shares purchased, as well as a corporate guarantee by another member of the defendant's group of companies, namely New China Hong Kong Capital Ltd.

10. Someone, presumably Mr Chan, filled in loan evaluation sheets showing that the intended lender was DC.

11. Following this agreement, the plaintiff's solicitors, Messrs Richards Butler, prepared a draft loan agreement. This showed the lender as DC, the borrower as the defendant and the defendant's customer as New Targets International Ltd ("New Targets"), and contained provision for a declaration of trust in respect of the interest of the borrower in the agreement between the borrower and the customer, and a corporate guaranteed from the defendant to DC.

12. This draft was, however, not used. According to Mr Chan, there were further discussions on 24 September between himself and the defendant's Mr Raymond Sun. These produced a further verbal agreement. According to it, the plaintiff would be the lender and the defendant would be the borrower, and the repayment provisions would be as already agreed. As security for the loan, New Targets would execute a legal charge over the shares it bought and its parent company would execute a guarantee, and, subject to the loan documents and the securities being entered into, the defendant committing to the plaintiff in writing that it was holding the rights under the loan and security documents in favour of the plaintiff, and in accordance with the plaintiff's instruction, or assigning to the plaintiff those rights, the plaintiff would not hold the defendant liable for the second part of the loan ($35,300,000), except to the extent that that part of the loan and interest thereon was repaid by New Targets to DC.

13. Mr Sun then went off to check if the defendant "really needed the loan". Then, on the same day in the late afternoon, he contacted Mr Chan, saying that the defendant needed the loan of $60,500,000 immediately to complete the settlement of the share purchase. Mr Chan said that the documentation was not yet ready. Mr Sun suggested that he send the cheque forthwith and the documents to reflect the arrangements earlier agreed between them be completed later. He stressed that :

"... by accepting the cheque the defendant would be liable for the $60,500, 000 as borrower simpliciter and the defendant had to trust that the plaintiff would enter into documentation to reflect the arrangements they had earlier agreed."

14. Accordingly, the three cheques were made out and sent to the defendant. The plaintiff tried to follow up with documentation later (though no copy documents are before the court). It sent the defendant a debit note dated 24 October for the balance of the debt and interest. Then in early November, the plaintiff received a letter from the defendant dated 24 September, in which it said in effect that the loan had not been to it but to New Targets.

15. There followed a letter from the DC's director, Ms Irene Wong, dated 6 November to the defendant, setting out her understanding of the position which was in accordance with that stated by Mr Chan, though this letter does not make it clear whether the loan agreement was ultimately agreed to be between DC and the defendant, or the plaintiff and the defendant. Then on 27 November, the defendant said that it was in custody of the Chung Hwa shares owned by New Targets and offered to deliver them to the plaintiff if requested.

16. Further correspondence followed, but I do not need to set it out, save to note that the liquidators expressed on 12 September 2000 that although they had rejected the defendant's claim as not being legally enforceable by reason of breach of the Ordinance, they would not object to the plaintiff making an application to the court for validation of that part of the loan which represented the outstanding principal.

17. On the defendant's side, there is an affirmation by one of the liquidators, Mr Wardell, filed at the last minute. From this, it appears that the shares were originally bought for New Targets by The New China Hong Kong Securities Ltd which was then an associate company of the defendant. It bought them as broker, and (under a new name) is still in possession of them as broker. By virtue of a corporate restructuring scheme, the Chung Hwa shares were exchanged for shares in a company called Star Bio-Tech. The shareholding is now worth about $400,000. It also appears that the defendant has sued New Targets (a company registered in the British Virgin Islands) for repayment of a loan balance of $35,749,865. Interest is not included because no rate was ever agreed. The liquidators expect to get a default judgment, and to execute a charging order against the shares, but that nothing else is recoverable from New Targets.

18. Mr Wardell says that, from the documents he has reviewed, there is nothing to show that the defendant ever held any security interest in the shares.

The loan

19. The defendant's argument is that although Mr Chan says that there was a loan agreement between the plaintiff and the defendant, that is not necessarily the true position. Much of the documentation and correspondence suggests that it was, or could have been, between DC and the defendant. Alternatively, since it is said that the defendant was to be "borrower simpliciter" of the funds received by it, those funds came not from the plaintiff alone but also from DC and Lucky Man Properties Ltd. It follows that there could be three distinct loans.

20. While it seems pretty clear that, at the early stages, it was contemplated that DC should be the lender, it was no doubt open to DC to make the plaintiff or any other associated company the lender. It is no doubt common enough for a company which needs funds at short notice to get them from an associated company or companies. I cannot think of any good reason for having three separate loans by three separate companies, nor has any been suggested, and there is therefore no good reason to think that the parties contemplated that there would be three lenders rather than one.

21. The plaintiff argues that the defendant has all along accepted Mr Chan's version of events as factually correct. This appears from their solicitors' letter dated 13 October 2000. The defendant argues that the solicitors modified this in their letter of 21 February 2001, in which they said that the liquidators were not in a position to agree facts and that they had no evidence to gainsay Mr Chan's version of events.

22. The plaintiff has to prove what it avers on the balance of probabilities. Ultimately, there is no evidence to gainsay the statement of Mr Chan, which was prepared in support of the plaintiff's claim in the liquidation. There are the contemporaneous documents which suggest uncertainty as to who was the lender, and if the criminal burden of proof applied, the uncertainty might be sufficient to raise a reasonable doubt that DC, rather than the plaintiff, was to be the lender, though it has to be said that the defendant never took this point in correspondence before or after the liquidation. Indeed the point never came up until counsel thought of it.

23. I am satisfied on the balance of probabilities that the plaintiff was the lender. As to who was the borrower, while the defendant originally took the position that it was New Targets, that cannot be right because the plaintiff has sued New Targets for its unpaid loan. I am satisfied that the defendant was the borrower.

24. As to the terms of the loan, Mr Chan says that :

"... Mr Raymond Sun suggested that Cornhill simply send NCHKF the cheque for $60,500,000 that day and that the documentation to reflect the arrangements in paragraph 10 be entered into later."

Paragraph 10 of the statement contains in detail the terms of the loan, as I have paraphrased them above.

25. Again, there is nothing to contradict Mr Chan. The defendant argues that the agreement Mr Chan and Mr Sun reached, before the cheques were sent off, does not include any contractual provision for interest. I do not see that that can be right. The agreement, according to Mr Chan, referred to the arrangements made earlier that day. Those arrangements provided for a loan for three months, with $25,200,000 repayable after 10 days, and interest payable on the balance at 2% per month. If I accept what Mr Chan says about the parties, it seems to me that I have to accept what he says about the terms.

26. Quite obviously, what was intended was that the money would be paid forthwith, and the parties would deal with the documentation later to incorporate the terms, both as to repayment and security which had already been agreed. It was not the case that a new agreement, independent of those terms, was reached.

The liquidators' position

27. The plaintiff says that the liquidators have already adjudicated the claim in the plaintiff's favour for the principal sum by their letter of 12 September 2000, in which they indicated that they had no objection to the plaintiff seeking a validation from the court in respect of it, and they cannot go back on this. The short answer is that the liquidators in that letter clearly rejected the whole claim, for both principal and interest, on the ground that the loan was unenforceable. That is what the letter says before it makes any suggestion of application for validation. There is further correspondence which makes the liquidators' position quite clear.

Exempted loan

28. Schedule 1 to the Ordinance provides :

"2. A loan made to a company secured by a mortgage, charge, lien or other encumbrance -

(a) registered, or to be registered, under the Companies Ordinance (Cap 32); or

(b) which would, in the case of a company referred to in paragraph (b) or (c) of the definition of "company" in section 2(1), be able to be registered under that Ordinance if that company were a company referred to in paragraph (a) of that definition."

It is agreed that subparagraph (a) is the relevant one here.

29. There is no written mortgage, charge, lien or other encumbrance securing the loan from the plaintiff to the defendant and no evidence of any securing the loan from the defendant to New Targets. At best, there is an assertion by the defendant that it was "in custody of" the Chung Hwa shares owned by New Targets. The plaintiff says that this is enough to constitute an equitable charge. Though such a charge on shares is normally constituted by delivery of the share certificates with the transferee's name left blank, an equitable mortgage can also be created by the mortgagor agreeing expressly to create a legal mortgage of the shares. Such an agreement was made between Mr Sun of the defendant and Mr Chan of the plaintiff. The defendant took possession of the shares, subject to the equitable charge in favour of the plaintiff and could have registered the charge under the Companies Ordinance, Cap.32.

30. This is all very well, but there is no evidence that the defendant as distinct from its associated company ever had possession of the shares or that New Targets agreed with the defendant that a legal charge would be executed. That agreement on its own would no doubt have set up an equitable mortgage from New Targets to the defendant, and might have made the loan from the defendant to New Targets an exempted one. Until defendant had at least an equitable mortgage, there was nothing which it could use as security for the loan from the plaintiff and nothing which it could register.

31. I find that the loan was not an exempted loan.

Validation

32. The loan agreement does not comply with section 18(1) of the Ordinance. The question now is whether it would be inequitable to hold it unenforceable.

33. The authorities, to which I have been referred, do not assist much. However, I note that in Orakpo v. Manson Investments [1978] AC 95 at 101, Lord Diplock described the equivalent English statutes as being :

"... designed to protect unsophisticated borrowers from being overreached by unscrupulous moneylenders."

On the matters to be taken into account by the court in exercising its discretions, in Adams & Anor v. Paul's Properties Ltd [1965] NZLR 171, Woodhouse J said at p.171 :

"I think that the circumstances to be taken into account should include such matters as the relative status of the parties, the nature and extent of the default, the way in which it arose, the implications for the borrower, the attitude of the lender, and the general appearance of the contract throughout."

This was cited with approval by Mayo J (as he then was) in Brother's Company (a firm) v. Ah Puk Transportation [1986] HKLR 821.

34. Here, as I have found, the parties agreed on a loan with documentation to follow it. Although the mind boggles at the thought of anyone handing over so large a sum without providing for proper security, all set out in a written memorandum, section 18(1) in fact allows the note or memorandum of the loan agreement to be made within seven days after the making of the agreement.

35. This was not a case of a licensed loanshark lending money at crippling, if legal rates of interest to an ordinary person. It was a financial transaction between two companies, both of which, it appears, are money lenders. They were on an equal footing. The borrower does not need protection.

36. According to Mr Chan, he, on several occasions, contacted Mr Sun to ask the defendant to proceed with the formal documentation but received no response. Whether or not the defendant was to prepare the loan agreement - the previous one had been prepared by the plaintiff's solicitors - it was for the defendant to arrange the legal charge by New Targets and the guarantee by its parent company. The plaintiff could do neither of those things. So it appears that the default was on the part of the defendant. It is difficult to see how equity could be on the defendant's side here because it is relying on its own default which caused the non-compliance with section 18.

37. The defendant got the money, and itself lent money to New Targets. It now says that it has not had any benefit. That may be so but it could have had if it had agreed a suitable rate of interest with New Targets. Again the mind boggles. The defendant, as well as the plaintiff, took no thought for its own protection. This sounds like negligence to me. I do not see how the defendant can rely on it.

38. The defendant also relies on the fact that it is in liquidation. It is said that admission of the plaintiff to proof in respect of its claim would be to the detriment of the general body of creditors. No doubt that is so but it would not be a good reason for not admitting a valid debt to proof. I do not see that it can be a good reason not to admit to prove a debt which should otherwise be validated as it seems to me this one should.

39. For the above reasons, I find that it would be inequitable to hold the agreement unenforceable. I therefore order that it be enforceable in full, including for interest at 2% per month to the date of winding up, i.e. 25 January 1999. The liquidators' decision will be reversed and the total of principal and interest to 25 January 1999 is to be admitted to proof. Costs be to the plaintiff against the joint and several liquidators, to be taxed if not agreed.