Lau Yu also known as Jaffe Lau v. The Hongkong and Shanghai Banking Corporation Ltd

CACV 213 /2017

[2018] HKCA 744

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 213 OF 2017

(ON APPEAL FROM HCB NO 104 OF 2017)

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J U D G M E N T

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Hon Yuen JA:

1.I agree with the judgment of Kwan JA.

Hon Kwan JA:

2.This is an appeal against a bankruptcy order made by Deputy High Court Judge Le Pichon on 5 September 2017.  The judge ruled that the debtor, Lau Yu, does not have a bona fide defence to the petition presented by The Hongkong and Shanghai Banking Corporation Limited (“the Bank”), which was based on a statutory demand for the outstanding principal sum of US$41,254,067.45 with interest.

3.The crux of the matter is whether the Bank could rely on an event or a state of affairs as an event of default under a settlement agreement.  The debtor contended that the Bank could not, as such event or state of affairs was allegedly brought about by the Bank’s own failure to co-operate with the debtor.  Furthermore, the judge was in error in holding that the Bank could rely on such event as the debtor had suffered no prejudice.

Background facts

4.I will first relate the relevant background facts that are not in dispute.  Most of them are set out in the judgment at §§2 to 7 and 18.

5.The debtor was a director and the chief executive officer of a private company known as General Nice Resources (Hong Kong) Limited (“GNR”).  He also held less than 20% shares in GNR.  GNR was wound up by a court order on 5 December 2016.  It was previously a member of the General Nice Group, which is involved in mineral resources investment and trading, and real estate development.

6.From 2011, the Bank became one of the main bankers of GNR and provided facilities to GNR for its business operation.  As security for such facilities, the debtor and two other shareholders and/or directors of GNR, Cai Sui Xin and Cai Sui Rong, executed an unlimited joint and several guarantee dated 13 June 2011 in favour of the Bank (“the Guarantee”).  The guarantors agreed to pay to the Bank on demand all monies that might be owing by GNR whenever and however incurred, whether presently or in the future (cl 1 and 3.01).  The Guarantee was a “continuing security” and was “in addition to, shall not be affected by and may be enforced despite the existence of any other guarantee or security held by the Bank” (cl 4.01 and 4.03).  It further provided that the Bank “may at any time and without affecting or discharging this Guarantee or the obligations of the Guarantor … (ii) vary, exchange, abstain from perfecting or release any other security or guarantee held or to be held by the Bank as security for the Guaranteed Monies” … or (vi) do or omit to do anything which but for this provision would discharge any Guarantor from liability under this Guarantee” (cl 10 (ii) and (vi)).

7.In 2015, the Bank made demands against GNR for the repayment of outstanding facilities. GNR made various allegations against the Bank denying liability.  On 31 March 2016, GNR, the debtor and other parties (collectively “the GN Parties”) entered into a settlement agreement with the Bank to settle their disputes (“the Settlement Agreement”).  The Settlement Agreement provided that:

(1)   As at 25 January 2016, GNR owed the Bank US$42,592,324.90 with interest (“the Outstanding Amount”) and the GN Parties agreed that the Outstanding Amount was immediately due and payable. (recitals (L) and (M))

(2)   Those of the GN Parties that had provided guarantees or mortgages in favour of the Bank with respect to the liabilities owing by GNR to the Bank agreed and confirmed that their respective guarantee and mortgage extended to cover the Outstanding Amount payable by GNR to the Bank under the Settlement Agreement, and each of the GN Parties confirmed that their respective security provided to the Bank remained in full force and effect. (recitals (O) and cl 4)

(3)   The GN Parties agreed to waive all claims against the Bank arising out of or in connection with GNR’s account, the securities provided by them to secure the liabilities owed by GNR to the Bank and any of the GN Parties’ relationship, dealings or transactions with the Bank. (recitals (P) and cl 5.1)

(4)   Each of the GN Parties agreed and confirmed that they were jointly and severally liable to repay the Outstanding Amount in accordance with the terms of the Settlement Agreement, and repayment was to be made by 28 quarterly instalments between March 2016 and December 2022. (cl 2.1, 2.2 and Schedule of Repayments in Schedule 1)

(5)   Each of the GN Parties undertook to “ensure that the Settlement Security is entered into and registered within 30 days of the date of [the Settlement Agreement]”. Settlement Security was defined to mean “a second lien mortgage over Pepper House, a commercial property located at 146 Arthur Street, North Sydney, NSW, Australia as security for the obligations of the GN Parties under [the Settlement Agreement] in form and substance satisfactory to the Bank”. (cl 1 and 7.9)

(6)   During the Standstill Period, the Bank agreed not to enforce any of the Outstanding Amount or any security or petition for winding up or bankruptcy for the benefit of creditors of a GN Party.  Standstill Period was defined to mean the period between the date on which the Bank confirmed receipt of both the first repayment amount and “the fully executed and dated Settlement Security”, and the date on which the Bank issued a Standstill Termination Notice.  A Standstill Termination Notice meant a notice issued in consequence of a Settlement Event of Default, by which all scheduled payments under Schedule 1 were declared immediately due and payable. (cl 1, 3.1, 6.10)

(7)   Each of the events or circumstances set out in cl 6 was a Settlement Event of Default.  This included the failure to pay in full any amount on the due date and in accordance with the Settlement Agreement and any failure of any GN Party to comply with any obligation under the Settlement Agreement. (cl 6 and 6.1)

8.The Australian property to be furnished as the Settlement Security was then subject to a first mortgage in favour of the National Australian Bank (“NAB”).  It is common ground that as a matter of Australian law, the registration of a second lien mortgage requires the written consent of the first mortgagee.  Thus, the consent of the first mortgagee was a pre-requisite for registration, and, without registration, the second mortgagee would be at risk of losing priority to subsequent encumbrancers[1].

9.No Settlement Security was executed or registered within the 30‑day period stipulated in cl 7.9 of the Settlement Agreement or at all.  What happened was as summarised in §18 of the judgment:

“18. The only contemporaneous evidence available is a chain of email correspondence passing between the parties and exhibited by the [petitioner] showing the sequence of events. The following summary is extracted from that correspondence:

(i) Between 16 March 2016 (2 weeks prior to the date of the Settlement Agreement) and 8 April 2016, the Bank and its solicitors (A&O; [Allen & Overy]) sent several reminders to the GN Parties concerning their obligation to enter into and register the Settlement Security[2].

(ii) On 18 April 2016, GNR instructed Corrs its Australian solicitors to prepare a draft for a second mortgage of the Australian property and, on 22 April 2016, such a draft was provided by the GN Parties’ HK solicitors to the Bank for comment, stating that they had been instructed by their clients to inform the Bank that the first mortgagee was NAB who “usually will not consent to 2^nd mortgage charges by other financial institutions”.

(iii) On 25 April 2016, the Bank expressed surprise at this statement and enquired of GN Parties’ Hong Kong solicitors as to the status of any contact between GNR and NAB.

(iv) 4 days before the deadline, on 26 April 2016, GNR advised the Bank to the effect that the second mortgage might require the consent of the first mortgagee “which may or may not be granted”. It also disclosed that notwithstanding its best endeavours made since late March 2016, GNR had not been able to obtain NAB’s consent but GNR believed that the second mortgage “though not perfect with[out][3] the consent” could provide additional comfort.

(v) The Bank expressed surprise in its reply to GNR but agreed to instruct A&O to review the draft and to take such steps as were necessary to ‘perfect the security’.

(vi) On 28 April, the marked-up draft was returned to Corrs, A&O referencing its understanding that the mortgagor was in continued discussion with NAB concerning the latter’s consent to the second mortgage and stating that “NAB will be required to produce the certificate of title with NSW LPI for the purposes of registration ….”

(vii) On 2 May 2016, not having received any response, A&O enquired of Corrs if the latter had further comments on A&O’s mark-up, whether its terms were agreed and whether NAB’s consent had been obtained. No reply was received although by this time the 30‑day deadline had expired.

(viii) On 11 May 2016, the Bank reminded GNR that clause 2.3 of the Settlement Agreement stipulated for “perfection of the Settlement Security” and stated that a no consent from NAB consent “is not considered perfection of Settlement Security, even if the 2^nd lien documentation is finalised and signed.”

(ix) Subsequently, on 20 May 2016, the Bank reached agreement with the debtor and GNR that (a) A&O be allowed to engage in discussions with NAB “in order to assist with perfecting the second lien in Australia”, and (b) GNR/the debtor to provide contact details of the relevant NAB contact to A&O and to notify NAB that A&O would be making contact by 23 May 2016.

(x) On 1 June 2016, the Bank recapped the then status which included GNR’s and the debtor’s agreement “to review all of the properties held by GNR and the debtor and provide details to the Bank by Fri 27 May 16 regarding details of valuation and any first lien and second lien details taken on each property by other parties”. The Bank made it clear that it would require alternative security acceptable to the Bank as substitute if A&O proved unsuccessful in perfecting the secondlien on the Australian property.

(xii) By 13 June 2016, NAB indicated that it might be prepared to consent but needed to consider the nature of the circumstances that gave rise to the second mortgage. The Bank therefore sought GNR’s consent (because of confidentiality provisions) to disclose the terms of the Settlement Agreement which request was refused on 23 June 2016.

(xii) Instead, GNR suggested advising NAB verbally that the Bank was supporting GNR with a long-term loan that required a second mortgage as collateral/comfort and that, for its part, GNR would separately seek NAB’s endorsement.

(xiii)   The Bank made several requests of the GN Parties for updates during the 3 subsequent weeks but no response was forthcoming.”

10.The judge made these pertinent observations from the events summarised:

“20. Several matters emerge from the summary above that call for comment:

(a) why was A&O’s mark-up to Corr’s draft provided on 28 April 2016 met with complete silence? That appears inexplicable given the then impending deadline;

(b) it remains unclear (i) whether and, if so, what the terms of the second mortgage were that had been agreed: was it the original or the marked-up version? and (ii) the date it is alleged the second mortgage should have been executed;

(c) the absence of any request made to the Bank by the debtor for execution of the second mortgage;

(d) the debtor’s allegation does not sit comfortably with the agreement of 20 May 2016 of the GN Parties (including that of the debtor’s) to accept A&O’s assistance to negotiate with NAB for consent; and

(e)   the absence [of] clear evidence of the Bank’s refusal to execute the second mortgage as such; insofar as reliance is placed on the 20 May email, it is to be noted that the subject matter being addressed was the GN Parties’ obligation to perfect the security.”

11.On 21 November 2016, the Bank issued a statutory demand to the debtor for payment of US$43,456,862.76, pursuant to the Settlement Agreement and the Guarantee.  The bankruptcy petition was presented on 6 January 2017 and amended on 7 September 2017[4].

12.After the petition was presented, the debtor discovered through the lands registration records that the Australian property had been sold to a third party for A$78 million in April 2017.  The outstanding indebtedness to the first mortgagee NAB was A$26 million.  The Australian property was beneficially owned by General Nice Development Limited, which was ultimately owned by Cai Sui Xin, Cai Sui Rong and one Tso Ming Chi, the debtor had no interest in the property whatsoever[5]. He claimed to have no knowledge as to the whereabouts of the balance of the net proceeds, which was approximately A$52 million, equivalent to US$38,243,266.18 as at the date of the statutory demand.

13.The value of the securities of the debtor then held by the Bank amounted to HK$70,191,031.78, equivalent to approximately US$8.97 million. It was contended on behalf of the debtor that the balance of the net proceeds of the Australian property would have been sufficient to discharge his indebtedness to the Bank, after taking into account the value of the securities he furnished.

Two broad issues on appeal

14.The grounds of appeal may be divided into two broad issues.  The first relates to the alleged breach of duties by the Bank.  The second relates to the alleged prejudice suffered by the debtor.

15.The focus of the oral arguments was on the first issue.  It was the debtor’s contention that the Bank was at fault in failing or refusing to execute the second lien mortgage.  If only that mortgage had been executed, the Bank would have been repaid from the proceeds of sale of the Australian property and it would not have pursued the debtor to recover the debts.

Alleged breach of duties by the Bank

16.The arguments of Ms Audrey Eu, SC[6], who appeared for the debtor, may be summarized as follows:

(1)   The judge had correctly found that the debtor should be given “the benefit of the doubt” whether the Bank failed to execute the second lien mortgage and proceeded on the basis that “there is a factual dispute which can only be resolved at trial”[7]. In light of this finding, she should have held that the debtor had raised a bona fide defence to oppose the bankruptcy petition, in that the Bank’s failure or refusal to execute the second lien mortgage was a breach of (i) the non-prevention principle (Kensland Realty Ltd v Whale View Investment Ltd (2001) 4 HKCFAR 381 at §§97 to 98); (ii) the implied contractual duties to co-operate[8]; and (iii) the implied duty of good faith in the performance of contracts[9]. Since the Bank chose not to execute the second lien mortgage, it could not complain against the debtor about the lack of the second lien mortgage or the lack of registration of the same and rely on this as a ground for breach of the Settlement Agreement by the debtor to enforce any debts.

(2)   Under the Settlement Agreement, the Bank had an obligation to execute the second lien mortgage as long as the form and substance of it were satisfactory to it.  The revised draft produced by the Bank’s own lawyers must be satisfactory to the Bank in form and substance, so the Bank could not refuse to execute such document for any other reasons.

(3)   In any event, any issue of registration was irrelevant to the form and substance of the second lien mortgage.  Had the Bank executed any draft second mortgage, it would be valid and enforceable as between the parties thereto, as an unregistered mortgage can properly be described as an equitable mortgage despite the form of a Torrens system mortgage, and this equitable mortgage may be protected by lodging a caveat, which is intended to act as a statutory injunction to prevent alteration to the Torrens register until the rights of the parties have been decided in the ordinary way by a court (Fisher & Lightwood’s Law of Mortgage (3^rd Australian ed), §§4.24 to 4.28).  Hence, the lack of registration or the inability for registration was irrelevant and not a proper reason for the Bank to refuse to execute the mortgage.  And any dispute in relation to the potential difficulty to register the executed second lien mortgage should only become relevant after the Bank had executed such mortgage.

(4)   Had the Bank executed the second lien mortgage, there was evidence from the debtor that he would have been able to convince NAB to grant consent for the second mortgage to be registered, in light of his “good and long‑standing business relationships with NAB”, and the “huge buffer” of no less than A$52 million and the better priority NAB enjoyed under the first mortgage[10].

(5)   The judge was in error in rejecting the debtor’s submission as “fundamentally flawed because of the absence of prejudice caused by the alleged breach”[11]. If the debtor had made out a bona fide defence on the alleged breach of duties by the Bank, it is not necessary to show that the debtor would have suffered prejudice as a result.  The prevention principle operates automatically to bar any cause of action which is based on the consequence of the complainant’s own breach.

17.Ms Linda Chan, SC[12] submitted on behalf of the Bank that the judge did not hold there was a “factual dispute” or triable issue as to the alleged refusal of the Bank to execute the second lien mortgage.  To the contrary, the judge had held there was “absence [of] clear evidence of the Bank’s refusal to execute the second mortgage as such”[13] and did not consider there to be “precise and clear evidence of the Bank’s refusal to found the debtor’s defence”[14].  It is clear from the judge’s reasoning that she was merely making an assumption there was a factual dispute for the purpose of dealing with the debtor’s argument on the alleged prejudice.  Having come to the view that there was no “precise and clear evidence of the Bank’s refusal to found the debtor’s defence”, applying the well‑established principles for the threshold test of resisting a bankruptcy petition[15], the judge should have held that the debtor had failed to raise a bona fide dispute to the petitioning debt on substantial grounds[16].

18.In reply to this, Ms Eu submitted that the appeal court would only disturb the judge’s finding of a triable issue of fact in an exceptional case[17].

19.Having summarized all the relevant email exchanges, the judge made these pertinent observations[18] as quoted earlier: “A&O’s mark‑up to Corr’s draft provided on 28 April 2016 [was] met with complete silence”; “it remains unclear (i) whether and, if so, what the terms of the second mortgage were that had been agreed: was it the original or the marked‑up version? and (ii) the date it is alleged the second mortgage should have been executed”; there was “absence of any request made to the Bank by the debtor for execution of the second mortgage”.

20.There was no or no proper answer to any of the above observations by the judge.

21.We went through with counsel some of the relevant email exchanges in the course of argument.  The Bank’s solicitors, A&O, sent a revised mark‑up copy of the draft mortgage to Corrs, the Australian lawyers of GNR, on 28 April 2016.  Corrs replied by email on the same day stating that they would “review the markup below”.  After the 30‑day period had expired and on 2 May, A&O asked Corrs to confirm “whether you had any further comments on our mark‑up of the mortgage or whether it is now agreed”.  On 10 May, the Bank wrote to GNR stating its understanding that “Corrs has not responded to A&O Sydney since approximately 29 April 2016” and requested GNR to instruct Corrs to “respond to our counsel’s queries on an urgent basis”.  The judge’s remark that the mark-up copy provided by A&O to Corrs was met with complete silence was completely accurate.

22.Ms Eu attempted to deflect the email exchanges by making two points.  First, she said the email exchanges produced might not have been complete.  Second, she submitted that the court should not just focus on the emails but should look at the entire picture and she referred to an affirmation made by one of the Bank’s officers[19] to contend that it was clear from the Bank’s own evidence that the Bank took the stance it would not execute the mortgage so long as consent from NAB was not forthcoming.

23.A similar suggestion was made to the judge that the emails produced might not be complete and was rightly rejected[20].  As for Ms Eu’s take on the affirmation evidence of the Bank, the relevant paragraphs must be read in context.  The deponent was seeking to answer what was perceived at that stage as the debtor’s “key defence”[21], namely, that the Bank had breached the Settlement Agreement by failing to “perfect and register” the Settlement Security[22].  The paragraphs in his affirmation that Ms Eu had pointed to appeared under the heading of “Debtor’s breach of the Settlement Agreement” and they focused on the failure of the GN Parties to obtain the consent of NAB for there to be registration of the mortgage, as a riposte to the debtor’s allegation that the Bank had failed to take necessary steps to “perfect and register” the mortgage.  In an earlier paragraph[23], the deponent had mentioned that the Standstill Period never came into effect, “because there had never been a “fully executed and dated” mortgage in respect of the Property”.

24.The Bank clearly took the stance that a second mortgage without the consent of NAB was unsatisfactory, but the paragraphs quoted by Ms Eu do not bear out the suggestion that the Bank was at fault for the absence of a fully executed mortgage in respect of the Australian property. The contemporaneous email exchanges, read in light of the judge’s observations (which were unanswerable), all point to the contrary, namely that the Bank was not at fault for this state of affairs.

25.The judge had stated she was prepared to give the debtor “the benefit of the doubt” and proceeded to address the debtor’s case on the basis there was a factual dispute.  If the judge had indeed held there was a factual dispute (as submitted by Ms Eu and contrary to Ms Chan’s contention), this would be an exceptional situation to warrant interference with such a finding.  As analysed above, the circumstances here are compelling.  There was clear and cogent support for the finding in the earlier part of §21 of the judgement that there was no “precise and clear evidence of the Bank’s refusal to found the debtor’s defence”.  On the finding that there was “absence [of] clear evidence of the Bank’s refusal to execute the second mortgage as such” and no “precise and clear evidence of the Bank’s refusal to found the debtor’s defence”, the judge should have gone on to hold on the facts that the debtor had failed to discharge his threshold onus of raising a bona fide dispute on substantial grounds regarding the alleged breach of duty of the Bank to preclude the Bank from enforcing the debts under the Settlement Agreement.

26.In any event, the debtor’s reliance on the prevention principle was misplaced.

27.As stated in Kensland Realty Ltd v Whale View Investment Ltd at §§94 and 95, that principle is subject to two limitations.  First, it is necessary to show the relevant party’s “wrong” involves his breach of the contract in respect of an obligation owed to the other party.  Second, it is necessary to show that the contractual rights or benefits which the party in question is seeking to assert or claim arise as a direct consequence of that party’s prior breach.  Neither limitation was satisfied in this instance.

28.First, the debtor had not been able to identify any provision in the Settlement Agreement which imposed a duty on the Bank to enter into, let alone register, the Settlement Security.  Instead, the debtor had sought to rely on an implied contractual duty on the part of the Bank to co‑operate.  However, clause 7.9 expressly imposed a duty on each of the GN Parties to “ensure that the Settlement Security is entered into and registered within 30 days of the date of [the Settlement Agreement]”.  There can be no implied term to impose the same duty on the Bank, as such implied term would contradict an express term of the Settlement Agreement (BP Refinery (Westernpoint) Pty Ltd v Shire of Hastings (1978) 52 ALJR 20 at 26).

29.Second, the causation requirement was not met.  Ms Eu’s submission that the lack of consent for registering the Settlement Security only goes to priority and not the validity of the second lien mortgage ignored relevant provisions in the Settlement Agreement, namely, cl 7.9 and cl 1 which provided that the Settlement Security must be “in form and substance satisfactory to the Bank”.  As the judge had rightly held, the consent of NAB to register the Settlement Security was a prerequisite for registration.  In the absence of consent from NAB, the debtor would still not be able to show that the non‑compliance with cl 7.9 was caused by the alleged breach of the Bank.

30.I also agree with Ms Chan that, to the contrary, the prevention principle would operate to preclude the debtor from asserting rights or claiming benefits which arose as a consequence of his own breach of the obligation in cl 7.9[24].

31.Lastly, I do not think it is a fair criticism that the judge had erroneously imposed an extra requirement of prejudice on the debtor.  In dealing with the alleged prejudice, the judge was addressing the debtor’s case that the alleged breach of the Bank “prejudiced [his] interest under the Settlement Agreement”[25].

32.For all the above reasons, I reject the debtor’s submissions on the first broad issue.

Alleged prejudice suffered by the debtor

33.In light of the conclusion on the first broad issue, it is not strictly necessary to deal with the second broad issue on alleged prejudice.  I will try to deal with this succinctly for completeness, as this formed an important part of the judge’s conclusion and both parties had made detailed submissions on this.

34.The debtor’s case on prejudice was that “(a) had the second mortgage been executed, the debtor would have obtained NAB’s consent and the Settlement Agreement would have been perfected; (b) as apractical matter, the Bank would not seek payment from the debtor if the Settlement Security had been perfected; (c) therefore, had the Bank not refused to execute the second mortgage, the debtor would have been entitled to exercise his right of subrogation; and (d) as a result of the Bank’s breach, the debtor has been prejudiced.”[26]

35.The judge rejected the debtor’s contention that he had suffered prejudice as a result of the Bank’s breach for two reasons.  First, the right of subrogation does not and cannot arise unless and until the debtor has discharged the debt.  Had the Settlement Security been perfected and the debt discharged, no question of subrogation could or would arise.  There would be no question of the Bank pursuing the debtor for the same amount as the Bank would have been repaid[27]. Second, as a matter of law, the Bank as creditor had an unfettered choice as to how, and against whom, it should proceed to recover the debt to which it is entitled.  The Bank was not legally obliged to resort to available security before pursuing the debtor personally for the debt.  The presence of security provided by a third party is not a defence to an action against the debtor or a winding up petition (Re Fame Dragon International Investment Ltd,HCCW 373/2016, 20 March 2017, at §22; Re Kwok Chok Yee[2000] 2 HKC 543 at 548BtoE; Standard Chartered Bank (Hong Kong) Limited v Pak Kwan Ho,HCA 1269/2015, 26 August 2016, at §13)[28].

36.It seems to me the best that could be said for the debtor is the argument that “as apractical matter, the Bank would not seek payment from the debtor if the Settlement Security had been perfected”.  So regardless of the legal entitlement of the Bank that it could have pursued the debtor on his primary obligation to pay the Outstanding Amount pursuant to the Guarantee as well as the Settlement Agreement, and the unfettered choice of the Bank on the enforcement of the debt in the cases as cited above, “as a practical matter”, the Bank would likely have sought payment out of the proceeds of the Australian property had this security been perfected.  Had this been done, the Bank would have been repaid, and in that sense the debtor could be regarded as having suffered prejudice.  But this argument is not open to the debtor as it is premised on success of the first broad issue, which I have ruled against him.  The prevention principle would operate against the debtor.  He could not claim to have been prejudiced on the premise that he had suffered loss due to the loss of the Settlement Security, as any such “loss” was the result of his own breach in failing to discharge his obligation to comply with cl 7.9.

37.Much has been said about subrogation in the submissions but I do not think subrogation would have arisen in this instance.  First, for the reason given by the judge, subrogation cannot arise unless and until the debtor has discharged the debt and there was no payment of the debt.  Second, the legal and beneficial owners of the Settlement Security would be able to stand in the shoes of the Bank and to enjoy all the rights that the Bank had against GNR had the debt been paid off from the proceeds of the Australian property.  But the debtor was in an entirely different position, he had no interest in this security.  On first principles, equity would not intervene to assist him because he had not performed the obligation guaranteed.

38.Ms Eu took issue with the judge’s statement that “the right of subrogation does not and cannot arise unless and until the debtor has discharged the debt”.  She contended that had the Bank executed the draft mortgage, the debtor would be “immediately entitled to a right of subrogation” over the Australian property, and that such right is “not inchoate but complete”.  In support of this contention, she relied on the following extracts with particular emphasis on the parts as italicised below:

“The surety’s right to be subrogated to all the creditor’s rights in respect of the guaranteed debt is traditionally said to arise at the moment he has paid in full all that he must pay to the creditor under the guarantee, unless he has waived the right. In fact, the strict position is that the rights of the surety to the benefit of a security given by the principal arise when the guarantee is entered into, rather than upon payment or performance of the guaranteed obligation. Thus the creditor owes an obligation to the surety to deal with securities in a reasonable and prudent manner, and may discharge the surety if he does not. Pending payment or performance, the surety can (following a demand by the creditor) have the securities marshalled in his favour. However, the surety’s right to enforce the right of subrogation by calling upon the creditor to transfer or assign to him the security to which he has become entitled does not arise until the surety has paid or performed the obligation guaranteed.” (Andrews & Millett: Law of Guarantees (7^th ed) at §11-018)

“A surety is entitled to the benefit of every security which the creditor has against the principal debtor, the whole or any part of whose debt he has discharged. This right is not merely inchoate until the surety is called upon to pay, but is complete throughout. The creditor is bound to hold and preserve the securities for the benefit of the surety so that on payment of the debt he may receive them unimpaired, whether the surety was or was not aware of the existence of the securities and although they were taken by the creditor after the contract of suretyship.” (Fisher & Lightwood’s Law of Mortgage (14^th ed) at §50.9)

39.I do not agree with Ms Eu that the italicised parts of the above extracts support her contention.  The statements italicised were made in the context of the discussion of a creditor’s duty to deal with the securities in a reasonable and prudent manner until the debt is discharged. The parts italicised in Andrews & Millett are followed by this sentence: “However, the surety’s right to enforce the right of subrogation by calling upon the creditor to transfer or assign to him the security to which he has become entitled does not arise until the surety has paid or performed the obligation guaranteed.”  The other sentence quoted in Fisher & Lightwood stated that the right is not merely inchoate “until the surety is called upon to pay”.

40.Without performing the obligation guaranteed, the surety is not entitled to stand in the shoes of the creditor by way of subrogation, see Andrews & Millett at §11-017.

41.As the right to subrogation did not arise as the debtor had not performed the guaranteed obligation, it is not necessary to deal with Ms Eu’s further submission that to exclude the right to subrogation, the guarantee must be explicit and a “principal debtor clause” or a provision stating that the guarantee is in addition to other securities held by the creditor is insufficient to oust or postpone the surety’s rights of subrogation.

Conclusion and costs

42.As there is no merit to any of the grounds of appeal, I would dismiss the debtor’s appeal.

43.We have heard submissions on costs.  There is no reason why costs should not follow the event.  The judge had awarded costs to the Bank on an indemnity basis in light of the express agreement in cl 2.3 of the Settlement Agreement.  I would do likewise and order the debtor to pay the Bank’s costs of this appeal on an indemnity basis, with a certificate for two counsel.

Hon Barma JA:

44.I agree with the judgment of Kwan JA.

Ms Audrey Eu SC and Mr Isaac C K Chan, instructed by Tsang, Chan & Wong, for the Debtor (Appellant)

Ms Linda Chan SC and Mr Michael Lok Hui Yin, instructed by Allen & Overy, for the Petitioner (Respondent)