THE BANK OF EAST ASIA, LTD v. LABOUR BUILDINGS LTD AND OTHERS

HCMP 769/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 769 OF 2002

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JUDGMENT

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1. This is an application to vary, by way of enlargement of scope, an interim injunction issued by order of Deputy Judge Lam (as he then was), on 8 March 2002. The injunction was granted in the following terms, with the proposed variation in italic:

"The 1st Defendant Labour Buildings Limited and 2nd Defendant China States Limited be restrained and an injunction is hereby granted restraining the 1st and 2nd Defendants, whether by themselves, or by their directors, officers, employees, servants or agents or any of them or in any other way howsoever, or in whatever capacity, from further assigning, leasing, under-letting, sharing, licensing or in any way parting with possession of or making any arrangements for the sharing of the Property known as No.11 Changsha Street, Kowloon or any part thereof or taking or attempting to take any steps to do so."

The 1st and 2nd defendants oppose the variation. An amended summons, resulting in the above format for the proposed enlarged injunction was filed on the day of the hearing. Initially this further amendment was opposed, but upon it becoming apparent that the new amendment sought only to tidy typographical omissions, Mr Fung sensibly did not further pursue his opposition to the amended form.

2. The fundamental facts surrounding the litigation may be shortly stated, and are largely not in dispute. The plaintiff (the Bank), is a prominent and well-known bank in Hong Kong. The 1st defendant company (Labour Buildings), is a company that was established in 1963, with the Kuomintang, of Taiwan, holding 73.2% of the shares, and the remaining shares being held by a number of trade unions or individuals, in Hong Kong. The shares held by the Kuomintang were held by APH Hong Kong Limited (APH), which is in turn owned by APH Investment Shareholding Limited of Taiwan. It is common ground that that company is part of an investment arm of the Kuomintang. Labour Buildings has for a number of years owned a property at 11 Changsha St in Kowloon (the land).

3. In 1997 there was a derelict three-storey building on the land. At that time, the Bank wished to commence branch operations in Taiwan, and at the same time Labour Buildings wished to redevelop the land by demolishing the old building and constructing a new building on the site. In February 1997, by way of a debenture and legal charge, (the 1997 debenture), the Bank advanced a loan of HK$30 million to Labour Buildings.

4. It is clear from the papers, particularly from internal Bank documents, that a significant factor in the Bank's decision to loan was Labour Buildings' connection with the Kuomintang. That connection was important in two ways. First, the backing of the Kuomintang gave additional security to the Bank, and second, assisting Labour Buildings, and therefore, indirectly, the Kuomintang, was seen by the Bank as assisting its efforts of raising its status in Taiwan to that of a branch office.

5. Less than 10 months after the 1997 debenture was executed a supplemental advance was made increasing the advance in total to HK$50 million. At that stage the contract for the redevelopment of the land had not yet been signed. In October 1999 a second, replacement, debenture and legal charge, (the 1999 debenture), was signed. The redevelopment work proceeded and the derelict building has been replaced by an 18 storey new building on the land, (the building). It appears that the redevelopment of the land was completed in about April 2002.

6. As an additional security the Bank and Labour Buildings entered into an agreement whereby Labour Buildings assigned to the Bank any rentals it would receive from the letting of the building. In addition to the usual clauses that are contained in a debenture, the following clauses are of significance in the present proceedings. They are in both the 1997 and the 1999 debentures. Clause 14.01 (vi) and (viii) provide:

"14.01 [Labour Buildings] hereby covenants and undertakes [with the Bank] that during the Drawdown Period [as defined in clause 1.02 therein] and/or for so long as the Indebtedness or any part thereof remains outstanding the 1st defendant will not:

"(vi) pull down or remove any building, erection or structure for the time being forming part of the Property or any part thereof or any of the fixed plant, fixed machinery or any landlord's fixtures belonging to it thereon without the previous consent in writing of [the Bank] except in the ordinary course of repair and maintenance or improvement or otherwise in the course of and for the purpose of carrying out the redevelopment of the Property and will in any such case, unless the [Bank] otherwise consents in writing renew and replace the same."

"(viii) without the prior written consent of [the Bank], lease, license or in any way part with possession or making any arrangement for the sharing of the Property or any part thereof or in the interest vary in or accept the surrender in the lease or tenancy or license."

Clause 16.01(xiii) provides:

"16.01 Each of the following events shall be and Event of Default [as defined in clause 1.02 herein]:

(xiii) if the registered or the beneficial ownership (whether immediate or ultimate) of [Labour Buildings] or of [APH] at the date hereon or an invalid time hereafter changes without the prior written consent of [the Bank] and if [APH] ceases to be the registered in beneficial owner of not less than fifty one percent (51%), of the entire issued share capital of [Labour Buildings]."

7. On 13 September 2001 APH sold all of its shares in Labour Buildings to Yan Hei (Holdings) Limited (Yan Hei). It is common ground that the written consent of the Bank was not obtained to this transaction. On the face of it, it appears that there is a clear breach of clause 16.01(xiii) of the 1999 debenture.

8. On 20 October 2001 Labour Buildings entered into a lease of the entire building in favour of China States Limited (China States), which subsequently let, by way of sublease, the various floors in the building, to 3rd to 16th defendants. There is an argument between the parties as to whether or not the lease to China States, or the subsequent subleases, are in breach of clause 14.01 (viii) of the 1999 debenture.

9. The sublease to China States is at a rental of $18,000 per month for each floor, the total rental consideration for the building of $108,000 per month. The Bank contends that this is significantly below the proper monthly market rental which should be at least $324,000 for the whole building, perhaps more if an appropriate adjustment is made for the ground floor which it is contended it can fetch a higher rental. This allegation is of particular significance to the Bank having regard to its rights under the rental assignment.

10. It is common ground that since the end of October 2001 Labour Buildings has failed to make payments of either principal or interest due under the 1999 debenture. The Bank relies also upon this default.

11. There is a dispute between parties as to the precise time at which the Bank learned that APH's shares in Labour Buildings had been transferred to Yan Hei, and the time at which the Bank learned that the lease to China States had been given by Labour Buildings, and the subleases had been given by China States.

12. Labour Buildings now contend that by reason of various faulty technical steps in relation to the administration of Labour Buildings and its execution of both the 1997 and the 1999 debentures, the security documents upon which the Bank relies are void and not binding. Consequently Labour Buildings contends that the clauses upon which the Bank relies to contend that Labour Buildings is in default, are not applicable. Labour Buildings acknowledges that a sum is due, presumably on the basis of money had and obtained, but says that by reason of the invalidity of the debenture, there is no obligation on it to pay interest, and disputes the principal sum due.

13. In March 2002, having learned of the disposal of shares by APH to Yan Hei, and the lease to China States, and subsequent subleases of the building the Bank sought, and was granted, the interim injunction in terms set out in paragraph 1 above. The order was made ex parte on 8 March 2002 by the Deputy Judge, and continued by Sakhrani J on 15 March 2002.

14. The hearing before Sakhrani J, on 15 March 2002, was ostensibly an inter partes hearing, but Labour Buildings did not appear and was not represented. At that time all but one of the directors of the company had resigned and the board of directors was inquorate, and consequently incapable of taking any steps, or even instructing solicitors and counsel. That the fact was not, as it should have been, drawn to the attention of Sakhrani J. In the course of argument before me, it was said that the solicitors for the Bank did not know that fact at the time. I accept that they were unaware of that fact. But the fact that the board was inquorate was plain from the public record at the Companies Office at that time, as the resignations of the directors had been duly lodged with the Registrar of Companies. Had the Bank's solicitors undertaken an appropriate company search, as they ought, the information would have been known, and should have been communicated to the judge. I take the matter no further however, because there is no application to discharge the injunction before me.

15. Following the grant of the injunction the Bank arranged to post sealed copies of the injunction prominently on each floor of the building. Subsequently, all of the tenants have left the building. The 3rd to 16th defendants accordingly take no further part in the proceedings and may be effectively disregarded.

16. As a consequence of the sub-tenants departure, Labour Buildings' only income from the building is the rental payable by China States. Labour Buildings and China States share the same registered office, and although the evidence is not entirely clear it appears that China States was established purely to take the sublease, and that it is entirely in the control of Labour Buildings. It is arguable that China States was established as a device to avoid the consequences of the rental assignment.

17. In March 2003, with matters having progressed no further, and the parties engaged in interlocutory skirmishes in the litigation, the building remained empty, unproductive of income, and deteriorating. Without any notification to the Bank, in March 2003, Labour Buildings made application to the Home Affairs Office of the Hong Kong Government for permission to operate an hotel in the building. Then, again without any notification to the Bank, Labour Buildings began the work of converting what had formerly been an office building into an hotel. There is a dispute between parties as to when the Bank knew or ought to have known that this work was taking place, but it is unarguable that no notification was given to the Bank of Labour Buildings' intention to carry out this work. The 18 floors of the building have now been converted into two hotels, the Tatami Hotel and the Hampton Hotel. The Tatami Hotel has apparently been specifically designed with Japanese tourists in mind.

18. It is the contention of the Bank that the conversion of the office building into an hotel is in breach of clause 14.01 (vi) of the debenture. Labour Buildings say that the conversion is, on a true reading of clause 14.01 (vi), not only permitted, but authorised, and further contend that the use of the building as an hotel does not offend the injunction in its present form as, in its present form, it does not restrain the grant of a licence of a part of the premises.

19. The injunction granted is an injunction granted to enforce a negative covenant. The variation also seeks to enforce an aspect of the same negative covenant, because the clause relied upon by the Bank, clause 14.01 (viii), includes a prohibition against licensing or parting with possession or making arrangements for sharing the property. The context in which the variation by way of enlargement is sought may now be clearly seen.

20. The principle upon which the court should approach an application for an injunction to enforce a negative covenant is clearly established in Hong Kong. In Incorporated Owners of South Seas Centre, Mody Road v Great Treasure Development Ltd [1994] 1 HKC CA, Godfrey JA, after reviewing the authorities, and particularly Doherty v Allman (1878) 3 App Cas 709, stated the principle thus:

"Where a defendant is proposing to act in breach of an express negative stipulation binding upon him, he will normally be enjoined from doing so, and, save in exceptional cases, damages will not be regarded as an adequate remedy. However, the defendant may nonetheless, be able to establish special circumstances of such a nature that the hardship that the making of the order would cause him would so far outweigh the inconvenience to the plaintiff through denying the plaintiff specific relief that the court considers that its intervention would be unjust. In addition, general discretionary considerations, such as unfairness, acquiescence or delay, may make the grant of an interlocutory injunction inappropriate."

21. It will be noted however, that Godfrey JA refers to an "express negative stipulation binding upon him" (the emphasis is mine). It follows that if an arguable case can be made out that the stipulation is not binding, then the application for interlocutory relief will fall to be considered on the usual American Cyanamid v Ethicon [1975] AC 396 HL, principles, and the balance of convenience becomes important. Thus unless the Bank can satisfy me that there is no serious issue to be tried as to the validity of the debentures, I cannot apply the principle as stated in South Seas.

22. It is worthy of note that in none of the cases cited in relation to interlocutory injunctions in the context of the enforcement of a negative stipulation, was there any challenge at all to the validity of the stipulation. There were arguments as to the interpretation of the stipulation, but not as to validity. The cases cited were Doherty v Allman (supra), Lord Manners v Johnson (1875) 1 Ch D 673, Hampstead v Suburban Properties Ltd v Diomedous [1969] 1 Ch 248, Texaco Ltd v Mulberry Ltd [1972] 1 WLR 514, The Incorporated Owners of Mai On Building, Lee Kam Yee v Hedit Ltd (unreported A6529/87, Godfery J), South Seas (supra), and Top Talent Development Ltd v Top System Investments Ltd (unreported, HCA 3120/03, Reyes J).

23. I am satisfied that there are serious questions to be tried as to the validity of the debenture. A significant number of matters in relation to the circumstances in which both the 1997 and the 1999 debentures were executed are both pleaded in the defence, and set forth in the affidavits for the defendants, upon which it is plain that an argument can be mounted, and is to be mounted, that the security documents upon which the Bank relies are not binding. It is sufficient to say that these are dealt with, as to the 1997 debenture, in paragraphs 8 - 26 of the Defence and Counterclaim, and as to the 1999 debenture, in paragraphs 31 - 36 pf the Defence and Counterclaim. The allegations and averments in those paragraphs are sufficiently supported by the evidence on affidavit from a director of Labour Buildings to raise a serious question to be tried.

24. The existence of an argument sufficient to raise a serious question to be tried in relation to the debenture is, by itself, enough to take the case out of the type of cases to be dealt with under the principle in South Seas, and into the usual case for an interlocutory injunction, to be dealt with under American Cyanamid. It is clear that in these circumstances I should not attempt to resolve any disputed question of fact on which the claims of either party may ultimately depend, or any difficult questions of law which call for details argument and mature consideration. Equally I should not attempt to reach the "preliminary conclusion" referred to in South Seas by Godfrey JA.

25. As well as the issues as to the validity of the debenture there are serious issues to be tried in respect of the alleged breaches of negative stipulations.

26. The Bank relies upon two acts by Labour Buildings. First the Bank says that the act of converting the building from an office block into an hotel is contrary to clause 14.01 (vi). Labour Buildings contend that the conversion is a "redevelopment of the property" which it says is plainly permitted by clause 14.01 (vi). Mr Whitehead says to this that the expression "redevelopment" in clause 14.01 (vi), must be read in the context of the events surrounding the making of the loan and the demolition of the derelict building previously on the land, and the construction of the new building. That demolition and the subsequent rebuilding, he says, is "the redevelopment" contemplated by the debenture. He says that it was never intended, and plainly so, that "a redevelopment" of the new building from an office building into an hotel would be permitted by the clause. This is, at first sight, a compelling argument.

27. Mr Fung points however to the definition of provisions of the 1999 debenture and refers to clause 1.02, in which the expression "development" is defined to mean:

"the commercial development having a total gross floor area of approximately 2430.339 square metres erected in accordance with the Plans on and to form part of the Property."

The document does not contain in the definition of the expression "redevelopment", which it is argued, must mean something other than the "development". The matter is by no means plain.

28. The second matter relied upon by the Bank is the fact that the use of the building as an hotel will involve the letting of rooms in the hotel to guests. This, says the Bank, is an act of "licensing" or "parting with possession", which is prohibited, without consent, by clause 14.01 (viii) of the 1999 debenture. Mr. Whitehead relies on Lam Man Yuen v Lucky Apartments [1964] HKLR 689, in which the Full Court held that the occupants of rooms in a boarding house, that was run on virtually the same basis as an hotel, were the licensees, and not the tenants of the owner. Mr. Fung says that the provision in the debenture was intended to refer to a licensing of the property, or part thereof, for a significant period of time, but nevertheless not amounting to a "lease" in law. While the argument for Labour Buildings in this respect is not as strong, there is a serious issue to be tried, and the argument would, at least, be strong enough to resist an O. 14 application.

29. Having determined that there are serious questions to be tried, I have next to consider the balance of convenience to determine whether or not the injunction should be enlarged as sought by the Bank.

30. The first matter is the failure of Labour Buildings to comply with the terms of clause 16.01 (xiii), requiring the consent of the Bank, before any disposal of shares in Labour Buildings by APH. The Bank say that because their consent was neither sought nor given, they are forced to deal with people that they did not contract with, and do not wish to deal with. In the context of this case, where the evidence plainly establishes the importance of the involvement of the Kuomintang, this is a significant complaint. Yan Hei must have known of the requirement to obtain consent, for the debenture forms part of the public record, yet they elected to undertake the transaction without obtaining that consent. They cannot now complain if the Bank are not willing to be cooperative. This matter weighs in favour of the Bank.

31. Mr Whitehead contended that the conversion of the building into an hotel has deprived the Bank from the opportunity, when it comes to exercise its powers under the security, of selling individual commercial office building floors, the course that is not open to the Bank once the building is converted into an hotel. It is argued that it will be much easier for the Bank to sell individual floors rather than be confined to having to sell one or both of the hotels that have been constructed in the building. While this may be correct, it was not, in fact, a matter of concern to the Bank, for it was not raised at all by the affidavits filed by the Bank. The concern raised by the Bank's witness was the erosion of the value of the property as a security. Labour Buildings say that they have spent some HK$6 million on the conversion of the building into an hotel. Evidence has been produced before me to show that Labour Buildings is in the course of entering into proper arrangements with the Ramada Hotel Group to manage the hotels that are being established in the building. Labour Buildings have put before me a professional expert valuation opinion that the value of the building, as an hotel, will be in the order of $85 million. This is significantly in excess of the amount advanced by Bank. That value would in all probability be enhanced by the involvement of the internationally reputable Ramada Hotel Group in the administration of the proposed hotels.

32. In my view, there is not a sufficient risk of diminution in value, or any real or justifiable concern on the part of the Bank of such a risk, that this matter ought to weigh in the consideration of the balance of convenience.

33. Next, Labour Buildings say that it would be wrong to leave the building unused, and render the expenditure they have incurred of some HK$6 million virtually wasted. Were there no challenge to the validity of the security documents, and were the alleged breaches of the negative stipulations contained in security documents so clear that, and if the court were approaching the matter on the basis of the South Seas principles, it may well be arguable by the Bank that the hardship imposed upon Labour Buildings in making the order would not outweigh the inconvenience to the Bank through denying the Bank interlocutory relief.

34. But I am bound to say that my first reaction to the practical circumstances of this case was that irrespective of the legal merits of either party, it seemed quite wrong that a substantial commercial building should be allowed to lie unoccupied, unproductive of income, and deteriorating. Notwithstanding the matters raised by the Bank, it seems to me plainly in the best interests of both parties that the building should be occupied, producing income, and properly maintained. While the court will be slow to assist a wrongdoer, and it may be argued that Labour Buildings, in acting arbitrarily in the manner they have, are wrongdoers, nevertheless I think that the court should also be slow to allow a building to lie empty, unproductive and deteriorating, especially when it cannot be said that any real harm is suffered by the plaintiff by allowing it to be used. In this respect the balance of convenience weighs heavily in favour of Labour Buildings.

35. The final matter to be considered is delay. It is now over two years since the injunction was granted. It was strongly argued by Mr. Fung that the delay on the part of the Bank in bringing this matter to a conclusion is such that it would be wrong to enlarge the injunction. While a review of the chronology demonstrates that the Bank may have not pursued the matter with all desirable diligence, it hardly lies in the mouth of a defendant who has been subjected to two "unless orders", one of which has resulted in a judgement striking out a significant area of the defence, to complain about delay. It has always been in the hands of the defendants to move to discharge the injunction for delay and they have elected not to take that step. In the context of the balance of convenience in this case the delay is a neutral factor.

36. I should add, for the sake of completeness, that an argument signalled in the Bank's affidavits to the effect that there was a risk that an hotel in Mongkok might be used for immoral purposes was, sensibly, not pursued by Mr. Whitehead.

37. The evidence before me establishes that Labour Buildings has injected a substantial financial investment into the building in excess of HK$6 million. The evidence establishes that the proposed hotel business is to be operated professionally under the oversight of the reputable international hotel chain. Such a course of action will preserve the conditions of the building and may well result in a substantial enhancement of the value of the property. By an open letter, dated 24 May 2004, Labour Buildings offered terms in an effort, as they saw it, to provide safeguards to protect the Bank's interests as mortgagee of the property. In the course of the hearing I commended that letter to the Bank, but the bank maintained its position rejecting the offer. Mr Fung has not withdrawn the offer and I am satisfied that the terms offered ought to play in the balance of convenience in favour of Labour Buildings in dealing with this matter.

38. For the foregoing reasons, I am satisfied that the balance of convenience favours not extending or enlarging the interim injunction as sought, but that the injunction should be varied by the addition of the following terms, (these are the terms offered by Labour Buildings), as new paragraphs :

"4. The 1st and/or 2nd defendants, (collectively "the Defendants"), will not be restrained or in any way prohibited from operating a hotel business at the Property, whether under the name of "Tatami-Hampton Hotel" or any other name ("the Business"), and doing all such acts and executing all such documents as are necessary and/or incidental thereto.

5. Upon the Plaintiff giving the usual cross-undertaking, as to damages, the Defendants jointly and severely undertake to the Court that the Defendants, whether by themselves, or by their directors, officers, employees, servants or agents or any of them, will not allow any person(s) to stay in any room of the Property, whether as hotel guest(s) or lodger(s) or in whatever capacity, for any period of more than 28 days.

6. The Business will be professionally operated and managed under the franchise to be granted by Ramada International, and the accounts in relation to the Business will be audited annually by Messrs. Deloittes Touche Tohmatsu or a comparable accounting firm

7. Prior to the commencement of the Business, the Defendants will cause to be opened a designated interest bearing account with a designated bank other than the Plaintiff ("the Account") in the name of Messrs. David W.T. Chan &. Co.

8. After commencement of the Business and until determination of the Action herein the Defendants:

(i) will deposit or cause to be deposited into the Account, on the 15th day of each calendar month (and if the 15th day falls on a public holiday or Sunday, the next working day), 25% of the net profits generated from the Business during the previous calendar month, to be held by Messrs. David W.T. Chan & Co. as stakeholder;

(ii) will cause to be set aside and retained the remaining 75% of such net profit as the working capital for the Business."

39. Leave to apply has already been reserved and is again reserved.

40. The usual order as to costs would be simply costs in the cause. Here however Labour Buildings have succeeded in resisting the Bank's application to enlarge the injunction, and have succeeded in terms of an open offer. China States has taken no formal role and all that needs to be said for them was said by labour Buildings. In those circumstances I am of the view that the proper costs order should be 1st defendants costs in the cause.

41. Although the injunction was issued over two years ago no application was made by the defendants to discharge the injunction. At the first hearing of the Bank's summons to vary the injunction, on 27 February 2004, Reyes J expressly asked counsel for the Bank whether the Bank took the view that the injunction was sufficient in its ambit to restrain Labour Buildings from carrying on a hotel business in the building or alternatively if the injunction did not prohibit the redevelopment and hotel business and needed to be enlarged. Counsel for the Bank elected to proceed with the summons for variation. At the same hearing counsel for Labour Buildings indicated an intention to apply for discharge of the injunction. An appropriate summons was filed on 10 May 2004, but by the letter dated 24 May 2004 the Bank was informed that that summons would be withdrawn.

42. The Bank now seek their costs on that summons. I am satisfied that as the issue raised by that summons was the discharge of the whole injunction, the Bank is entitled to its costs on that summons, up to 24 May 2004. There will be an order that the Bank shall have its costs on that summons to 24 May 2004, to be taxed on a party and party basis if not agreed.

43. The costs orders will be orders nisi, to be made absolute in the absence of an application within 14 days.