Chung Yuen Chu and Another v. Cosimo Borrelli and Others
Read the full judgment text of CACV 173/2018 on BabelCite. This Court of Appeal judgment was delivered on 4 June 2019.
1. I respectfully agree with the judgment of Yuen JA and have nothing to add.
Cites 1 case
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CACV 173/2018 [2019] HKCA 622 IN THE HIGH COURT OF THE HONG KONG SPECIAL ADMINISTRATIVE REGION COURT OF APPEAL CIVIL APPEAL NO 173 OF 2018 (ON APPEAL FROM HCMP 2093 of 2017) _______________
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_______________ J U D G M E N T _______________ Hon Lam VP: 1.I respectfully agree with the judgment of Yuen JA and have nothing to add. Hon Yuen JA: 2.This is the plaintiffs’ appeal from a Judgment of Chow J given on 24 April 2018 (“the Judgment”) in which he held on the trial of a preliminary issue that two Deeds of Share Pledges dated 1 April 2015 (“the Pledges”) under which the plaintiffs (“the Pledgors”) mortgaged[1] their shares in the 5th defendant in favour of the 3rd defendant and the 4th defendant respectively (collectively “the Pledgees”) were not irredeemable and thus not void. 3.The learned judge also ordered the Pledgors to pay the costs of the trial of the preliminary issue. Background 4.1The detailed factual background has been set out in the Judgment[2]. 4.2Essentially the Pledgors controlled a group of companies (with the 5th defendant as the ultimate holding company) which were involved in the research, development and manufacturing of high performance materials. They wished to attract investment, and two private equity funds (“the Investors”) agreed to invest more than US$60 million. The aim (expected to be achieved in around two years time[3]) was an initial public offering (“IPO”) of a company in the group called SRO Aramid (Jiangsu) Co Ltd (“the Company”). 4.3A complex restructuring scheme was undertaken for the purpose of the investment. A number of documents were executed (“the Transaction Documents”) which included an Investor Rights Agreement (“IRA”) and the Pledges. In respect of the Transaction Documents, the Pledgors’ position before the judge was that:
Mr Hollander[5] acting for the Pledgors on appeal did not resile from that position. 4.4The IRA and the Pledges dated 1 April 2015 were not the first set of documents entered into for the investment. We were not referred to these earlier documents, save that Mr Hollander emphasized that no money was owing to the Investors by the above date. The IRA 5.1The IRA was made between the “Founders” (defined as the Pledgors and the 5th defendant), the Investors[6] and the Company. 5.2It contained (amongst other things) provisions for:
- Corporate governance 6.1Section 5 is the section on Corporate Governance. 6.2At the end of this section, there is the following provision:
6.3These provisions on corporate governance, surviving after completion of the IPO until an Investor’s shareholding drops below 5% may be summarized below:
- Confidentiality obligation 7.Section 10.1 (which the Appellants emphasized both here and below[11]) sets out a “general obligation” (subject to exceptions set out in Section 10.2) that each party to the IRA should not disclose confidential information[12] to any third party, and the Founders are obliged to procure that each Group Member[13] comply with that obligation as if it were a party thereto. Section 10.3 provides that no publicity release or public announcement concerning the relationship or involvement of the parties should be made (except as required by law or an authority or the stock exchange). - Termination of the IRA 8.1Section 11 is the section on “Term and Termination” of the IRA. 8.2Section 11.1 provides that the agreement
8.3The provisions in section 11.1(c) above which survive the closing of an IPO may be summarized as follows:
8.4Section 11(2) provides that:
8.5Mr Hollander submitted that as set out above, there were three categories of obligations which survive (to different extents) the termination of the IRA. He provided a table[15] indicating the three survival periods for the provisions relevant to his submissions. I have made some minor revisions to the headings of the columns for more clarity. The Pledges 9.1As for the Pledges, the Pledgors entered into them on the same day as the IRA. As noted above, one Pledge was made in favour of the 3rd defendant and the other was made in favour of the 4th defendant. It has not been suggested that there is any substantive difference[16]. 9.2In the Pledges, the Pledgors pledged their shares in the 5th defendant to the Pledgees[17] and covenanted[18] with them to fully comply with, as principal and not merely as surety, all of the Secured Obligations, which were defined[19] to mean:
9.3The term “Obligors” was defined[20] to mean:
9.4Section 8.1 provided that the Pledgors would not transfer, etc the pledged collateral other than as permitted by the IRA, and under section 8.2, the Pledgors agreed that they would procure the Company to carry on business in the ordinary course and not to dispose of its assets except as permitted by the IRA. 10.Section 12 provided that the Pledgees may appoint receivers if (amongst other things) the security has become enforceable upon the occurrence of an event of default, defined as a default with respect to any Secured Obligation[22]. - Termination of the Pledges 11.1Section 20.2 provided:
11.2Section 20.3 provided that the Pledge shall remain in full force and effect after it takes effect till its termination. Events leading to litigation 12.1A year later, according to the Investors, various breaches of the IRA occurred[24]. This was disputed by the Pledgors. In 2017 the Investors appointed receivers[25] pursuant to Section 12 of the Pledges. 12.2The Pledgors challenged the validity of the Pledges, and an order was made on 6 November 2017 in HCMP2093/2017 that there should be determined in a trial of preliminary issues whether the Pledges[26] were null and void, or are otherwise invalid and/or ineffective, on the ground that they either (a) are irredeemable, or (b) contain provisions repugnant to the equity of redemption. Brief review 13.1Before considering the issues before the judge, it may be helpful to briefly review the historical development of the equitable right of redemption, and how the courts disposed of “clogs” or “fetters” on it. 13.2In a typical mortgage, the mortgagor was obliged under contract to repay the loan on a certain date. If he failed to do so on the contractual date, then under the common law he would have forfeited his interest in the property. 13.3However the court of equity gave him the right to redeem his property – after the expiry of the contractual date for repayment – on repayment of the loan, interest and costs. This equitable right to redeem (also called the equity of redemption) was regarded as an equitable estate which belonged to the mortgagor. 13.4Anything which hampered the mortgagor’s right to get back the property in the same state or condition as when he mortgaged it was regarded as a “clog” or “fetter” on his right to redeem, and was struck down by the court of equity. Thus, in a typical “tied house” case, a provision in the contract of mortgage which stated that even after repayment of the loan, the mortgagor/publican could only sell liquor supplied by the mortgagee/brewery for the remainder of the leasehold term meant that the property after redemption was not in the same condition as when it had been mortgaged. Accordingly the provision was regarded as a clog on the equity of redemption and was severed from the mortgage[27]. 13.5At the same time, the court of equity applied the same concept against mortgagees who attempted to devise ways of, in effect, doing away with redemption. For instance, if the contract of mortgage itself sets a redemption date to be at so distant a time as to render the equity of redemption illusory (eg if the mortgaged property is a short term of years and the contract provides that redemption can only occur shortly before its expiry), equity would also intervene to declare that postponement provision to be void[28]. 13.6This brings one to the question whether a particular term agreed between a mortgagor and a mortgagee which imposes an obligation on the mortgagor:
or alternatively,
This is how the learned editors of Cousins on the Law of Mortgages[29] put it:
Issues before the judge 14.At the hearing before the judge, it would appear that Mr Sussex was not contending that there was a clog or fetter on the equitable right to redeem[31]. His submission was that the Pledges in their entirety were irredeemable and void ab initio on the grounds that:
The judge’s Judgment 15.In his Judgment, the judge set out the relevant legal principles in admirably succinct and clear terms at §§20-24. (On appeal, Mr Hollander has not challenged those principles or the judge’s understanding of them). (i) The non-monetary, continuing obligations point 16.The judge noted that Mr Sussex did not dispute as a matter of principle that it is valid for a mortgage to secure non-monetary obligations; the challenge was to the “indefinite period” of the obligations[32]. Counsel emphasized:
17.The judge quoted two cases to support his holding that a mortgage was not rendered irredeemable even though it secured contingent liabilities over an indefinite period. 18.In Richards v The Commercial Bank of Australia [35], Fox J in the Supreme Court of the Australian Capital Territory apparently accepted[36] that in principle it was valid for a mortgage to secure one of the mortgagors’ contingent liabilities under guarantees he had signed for third parties. However there was no discussion of that issue as it was held that the mortgage document in that case was ambiguous. 19.1In Re Rudd & Son Ltd[37], two builders had given two mortgages to a bank. After paying off what was owing to the bank, they asked in 1981 to redeem the mortgages. The bank refused because it had provided performance bonds in connection with construction works done by the builders for two county councils. The performance bonds had been counter-indemnified by the builders, and the bank asserted that these constituted contingent liabilities of the builders/mortgagors. 19.2As events transpired, in 1982 the county councils did make calls on the bank under the performance bonds, but the issue before the court was whether the bank was entitled to refuse redemption the year before. 19.3The English Court of Appeal held that the builders/mortgagors could not redeem the mortgages in 1981 while there were contingent liabilities to the bank, without making provision for those liabilities to the satisfaction of the bank. It was irrelevant that at that time, there was no call made on the performance bonds yet. After construing the mortgage document to cover contingent liabilities which had not yet crystallised into accrued liabilities at the time when the builders/mortgagors asked to redeem the mortgages, Nicholls J (as he then was) said:
20.Relying on the above cases, the judge held that as a matter of law, a mortgage was not objectionable merely because it secured non-monetary obligations “for an uncertain (and, in that sense, indefinite) period”[38]. 21.Pausing there, it would be noted that in Rudd, there was a provision in the mortgage whereby the mortgagor could give notice to terminate the security, thereby crystallizing its obligations under the mortgage. Further it would appear from the passage in Nicholls J’s judgment emphasized above that there was a time limit within which the county councils could make calls on the bank under the performance bonds. In other words, when the mortgage was entered into, there was no definite period when the security could be redeemed – but it was certain that at some stage in the future, it could be redeemed. 22.On the facts of the present case, the judge noted that Section 20.2 of the Pledges provided that they would be terminated upon the satisfactory performance (in the judgment of the Pledgees) by each Obligor of its respective obligations under the Transaction Documents[39] and the termination thereof. 23.On the judge’s construction, the question of satisfactory performance of obligations under the IRA “must be judged as at the date of its termination”. On that basis he held that on the termination of the IRA, the Pledges would terminate under Section 20.2, and the fact that some obligations under the IRA survived the termination of the IRA did not prevent the termination of the Pledges. Hence there was no issue of irredeemability for a continuing, indefinite period[40]. (ii) The performance to satisfaction of pledgees point 24.In relation to this, the judge held that the Pledgees would not be entitled to exercise their judgment in an unreasonable or arbitrary manner, for the law imposed an implied obligation on them to act honestly and in good faith[41]. Accordingly he held that this point would not render the Pledges irredeemable either. 25.As a matter of completeness, the judge also dealt with the alternative argument[42] that some provisions were repugnant to the equity of redemption. Appeal 26.1The main ground of appeal was that in respect of issue (i), the judge erred in holding that, as a matter of principle, a mortgage could validly secure obligations which are both non-monetary and indefinitely continuing. Mr Hollander argued that the judge’s reliance on Rudd was misplaced because in that case not only was the obligation monetary, but there would come a point in time[43] when it would become known if the contingent liability would, or would not, become a present liability. In other words, the obligation “would continue for an uncertain period (but with certainty that [it] would terminate)”[44]. 26.2Mr Hollander argued that that is not the case here, where there were non-monetary obligations which survive the termination of the IRA, some without any certainty of termination at all, and (contrary to the judge’s construction of Section 20.2) the Pledges do not terminate contemporaneously with the IRA because they secure the satisfactory performance of all obligations in the IRA - including those indefinitely surviving its termination. Unlike Rudd, these obligations “continue without any certainty that they would terminate”[45]. He submitted that the most notable of these was the confidentiality obligation under Section 10 of the IRA, and that there is no case law which supports the proposition that it is valid for redemption to be dependent upon a non-monetary obligation which is potentially permanent. The right of redemption would then be rendered illusory or a “mere pretence”[46]. 27.Further, in respect of issue (ii), Mr Hollander submitted that the clause that performance must be “satisfactory in the judgment of the Pledgee” injects an element of subjectivity and quality. Even if the obligations were performed objectively, the Pledgors would have to show that the Pledgees’ judgment that they had not been performed satisfactorily was Wednesbury unreasonable. 28.It was not argued that the Pledges were oppressive or unconscionable. Discussion 29.1The starting point must be Section 20.2 of the Pledges which provides for the termination of the Pledges and the release of the pledged collateral. Under this clause, the Pledges shall be terminated upon the satisfactory performance (in the judgment of the Pledgees)[47] by each Obligor of its respective obligations under the IRA and the termination thereof. 29.2In my view, both satisfactory performance by each Obligor of its obligations under the IRA and the termination of the IRA must be achieved for the Pledges to terminate. With respect to the learned judge, I do not think that clause can be construed to mean that the question of satisfactory performance of the obligations under the IRA must be judged as at the date of its termination. It is not so expressly provided, and I do not think it can be so implied when there are many obligations of commercial benefit to the Investors which the parties expressly agreed should survive the termination of the IRA e.g. the closing of the IPO terminates the IRA, but the parties agreed that the corporate governance obligations survive and remain binding while the Investors still hold at least 5% of the shares in the Company. 30.Mr Hollander submitted that the various obligations (set out in the table) which (to varying extents) may continue indefinitely, render redemption “a mere pretence”. He referred to Fairclough v Swan where the mortgaged property was a leasehold of 17 years and the mortgagor was precluded from redeeming it until just a few weeks before the expiry of the lease. The House of Lords held that equity will not permit any device or contrivance being part of the mortgage transaction or contemporaneous with it to prevent or impede redemption[48]. He submitted that there is nothing the Pledgors could do unilaterally to bring about the discharge of the obligations in the IRA. 31.Taking the last point first, Mr Manzoni[49] for the 1st - 4th Respondents said there has also been a failure to satisfy monetary obligations[50], and therefore in any event, the relief sought on the preliminary issue is inappropriate. Mr Hollander said there is a dispute in this regard which is subject to arbitration, and so I say no more about it. 32.Even assuming there are only non-monetary obligations, Mr Hollander accepted that it is valid for a mortgage to secure a non-monetary obligation[51]. And he has not referred us to any cases which says that such a mortgage is valid only if the mortgagor himself can discharge the obligation[52]. 33.In my view, the real issue is whether the obligation is such that redemption of the collateral pledged to secure such obligation is rendered illusory. Looking at the nature of those obligations relied on by Mr Hollander (set out in the table), I take the view that the fact that some obligations survive the closing of the IPO[53] and some survive until the Investors’ shareholding drops below 5%[54] does not render redemption illusory. One must consider the intention of the parties in the factual matrix. As Mr Manzoni pointed out, the Investors are private equity funds, and given the definite life of funds, they would not be investing for an indefinite period. Further one can see from the factual matrix (and the parties were well aware) that the Investors were acquiring shares of the Company with the aim that the Company would achieve an IPO within a relatively short period of time, rather than holding them as a long-term investment. This is evidenced in the IRA where there were provisions not only for the Investors to demand an IPO within two years[55] but also for the Investors to put (to the Company or the Founders) for sale all their shares in the Company if an IPO has not occurred within 36 months (or 42 months)[56] of April 2015[57]. To suggest that in the present case, there was no certainty that those two categories of obligations would everterminate[58] would be to ignore these parties’ intentions and the realities of this transaction. 34.As for Mr Hollander’s 3rd “survival” column, he has referred specifically to the obligations in Sections 9.6, 9.7 and 10. 35.In relation to Sections 9.6 and 9.7[59], I note that section 11.1 provides that they survive the closing of an IPO, but they are not included in the proviso in Section 11.2[60] (which provides that if the Agreement is terminated under Section 11.1, the Agreement shall become null and void and of no further force and effect). It seems to me that objectively reading all these clauses together, what the parties intended was that Sections 9.6 and 9.7 survive only the closing of an IPO which otherwise would have terminated the Investors’ rights under the agreement to these reports. One can envisage, after the closing of the IPO, the IRA with some clauses (those which do not survive) struck out on the document, and these Sections (which do survive) remaining on the document. For the latter, the IRA remains a live agreement. However if that agreement is then terminated under the Section 11.1 (a) limb, i.e. by reason of the Investors ceasing to hold any shares of the Company, Sections 9.6 and 9.7 would be similarly struck out as these sections are not included in the proviso to Section 11.2, the proviso being then the only parts of the IRA still alive. It seems to me that this construction does not do violence to the language of either Sections 11.1 and 11.2, and it is fortified by the fact that one cannot see why the parties would have intended that persons (the Investors) who have no further interest in the Company should still enjoy the right to be given reports on the latter’s environmental performance or conditions for employees, etc. 36.1That leaves Section 10 (confidentiality and restrictions on announcements). Unlike Sections 9.6 and 9.7, this has been included in Section 11.2 as an obligation which continues to bind even if the IRA is terminated pursuant to Section 11.1. As the Pledges would not be terminated until satisfactory performance of this obligation (even if the IRA is terminated), Mr Hollander submitted the “perpetual” nature of this obligation would in effect render the Pledges incapable of redemption. On this submission, the analysis would be that this provision is a condition that is repugnant even to the contractual right to redeem the mortgage[61] and may be regarded in substance as a clog on the equity of redemption[62]. 36.2However it is necessary to look at the substance (and not the form) and consider the real nature of the bargain[63]. The shares in the 5th defendant were pledged by the Pledgors in consideration of the Investors’ investment, the express aim of both parties being an IPO within two years, with a backstop date of 42 months. During this period of the Investors’ interest in the Company, they demanded profit guarantees, IPO preparations, corporate governance standards etc. To ensure the performance of these demands which were clearly for the commercial benefit of the Investors, the Pledgors provided their shares in the 5th defendant as security. That was the nature of the bargain. 36.3In light of this, applying the approach discussed at §13.6 above, it seems to me it could not have been the intention of the parties that the keeping of confidentiality, a passive requirement of “perpetual” duration, would be part of the obligations which were intended to be secured by the Pledges (in the same way as say, the provision of profit guarantees for certain years or making proper preparations for the IPO). In my view, this Section of the IRA does not touch the mortgage relationship and stands outside the equitable principles protecting the right to redeem. 37.In any event, if I am wrong in the above view, the appropriate remedy would be to strike down the reference to Section 10 in Section 11.2 as a repugnant condition to the contractual right to redeem[64]. This would be the more appropriate remedy, rather than to hold, on the preliminary issue, that the Pledges are void in their entirety[65]. In Knightsbridge Estates Trust Ltd v Byrne[66], the English Court of Appeal said that equity is concerned to see two things – one that the essential requirements of a mortgage transaction are observed, and the other, that oppressive or unconscionable terms[67] are not enforced, such as not to lead to inequitable results especially in a situation where a bargain has been entered into by business people negotiating at arms’ length[68]. 38.I now come to Mr Hollander’s submission on issue (ii), which is the complaint regarding the requirement of satisfactory performance “in the judgment of the Pledgees”. In this regard, I respectfully agree with the judge that on the principles of law set out in Tadjudin,it would not be lawful for the Pledgees to judge performance in bad faith, or in a capricious or arbitrary manner. 39.Mr Hollander’s submission is that even then, the Pledgors would need to show that the Pledgees’ judgment fell below the standard of “Wednesbury unreasonableness” before they could redeem the pledged collateral. I do not think it is helpful to import standards from other areas of the law. The standard of performance required is that set out in the agreement. Any dispute as to whether it had been reached could be resolved by a court applying the Tadjudin principles. Consequently I do not think one would need to resort to Mr Manzoni’s submission that, if necessary, the words referring to the Pledgees’ judgment could be struck out. Order 40.For the reasons set out above, I would dismiss the appeal with costs to the 1st to 4th defendants. I thank counsel for their assistance. Hon Chu JA: 41.For the reasons given by Yuen JA, I agree that the appeal should be dismissed with costs to the 1st to 4th defendants.
Mr Charles Hollander and Mr Vincent Lung, instructed by Paul KC Chan & Partners, for the Plaintiffs Mr Charles Manzoni SC and Mr Keith Lam, instructed by King & Wood Mallesons, for the 1st to 4th Respondent The 5th Defendant, unrepresented, absent Annex IRA Obligations (as per Appellant’s submissions)
[1] It is common ground that the pledges were actually mortgages, as pledges are confined to physical assets. [2] Judgment, §§3-16. [3] See Investor Rights Agreement, Section 6.3(b). [4] Judgment, §7 quoting §5(3)(iii) of the Skeleton Submissions of the plaintiffs’ leading counsel Mr Charles Sussex SC. [5] With Mr Vincent Lung. [6] The 3[rd] defendant’s investment was made through a special purpose vehicle (“SPV”) called Scenery Sharp Investment Ltd. [7] IRA, Section 3. [8] IRA, Section 5. [9] IRA, Section 8. [10] IRA, Section 10. [11] See discussion at §§36-37 below. [12] As defined in that section. [13] Defined to mean the Company and its subsidiaries. [14] §6.2, ie the corporate governance provisions which only expire when an Investor’s share drops below 5%. [15] Annexed to this Judgment. [16] There are differences to reflect the fact that the 4[th] defendant had entered into a Share Subscription Agreement and Loan Agreement, whereas the 3[rd] defendant had entered into a Convertible Bond Agreement but that is not material to this appeal. [17] Pledge, Section 2.1. [18] Pledge, Section 3.1. [19] Pledge, Section 1.8. [20] Pledge, Section 1.6. [21] The Obligors are all parties to the IRA, save for SPV but it has not been submitted that SPV had any relevant obligations. [22] Pledge, Section 7.1. [23] Which I construe to mean the termination of the Transaction Documents which, in our case, is restricted to the IRA. [24] Judgment, §14. [25] The 1[st] and 2[nd] defendants. [26] In their entirety. [27] Noakes & Co Ltd v Rice [1902] AC 24, 29. [28] James Fairclough v Swan Brewery Co Ltd [1912] AC 565, 570. [29] 4[th] ed. §29-30, p.630. [30] G&C Kreglinger v New Patagonia Meat and Cold Storage Co Ltd [1914] AC 25. [31] Judgment, §27. [32] Judgment, §32. [33] IRA, Section 10. [34] Judgment, §38. [35] (1971) FLR 95. [36] At p.99. [37] (1986) 2 BCC 98, 955. [38][ ] Judgment, §§33-37. [39] The Pledgors were content to restrict this to the IRA: Judgment, §7. [40] Judgment, §40. [41] Tadjudin Sunny v Bank of America, NA CACV12/2015, 20 May 2016, [2016] HKCU 1193. [42] Abandoned at trial: Judgment, §27. [43] Which could be initiated by the mortgagors themselves by giving 3 months notice to terminate the mortgage, or (apparently) by effluxion of time of the performance bonds. [44] Notice of Appeal, Ground 1(1). [45] Notice of Appeal, Ground 1(1). [46] Fairclough v Swan, 570. [47] This part will be discussed later in this Judgment. [48] At p.570. [49] With Mr Keith Lam. [50] Skeleton Argument for the 1[st] to 4[th] defendants, §8.1. [51] Skeleton Argument of the Plaintiffs, §36. [52] This argument does not appear to have been raised before the judge. [53] The 1[st] “survival” column. [54] The 2[nd] “survival” column. [55] IRA, Section 6.3(b). [56] Depending on the reviewing process of the China Securities Regulatory Commission. [57] IRA, Section 8.5 (a) and (b). [58] cf. Uncertainty as to when the events leading to the cessation of these obligations would occur. [59] The supply of environment reports and adherence to safe working conditions etc. [60] “If this Agreement is terminated pursuant to Section 11.1, this Agreement shall become null and void and of no further force and effect, except that ...”. [61] Santley v Wilde [1899] 2 Ch 474, 475 (“If I give a mortgage on a condition that I shall not redeem, that is a repugnant condition”). [62] Cousins §29-07, p.614. [63] Cousins §29-32, p.632; Kreglinger, pp.36-7, 39, 42. [64] Kreglinger, p.51. [65] Notice of Appeal, order applied for in §2. [66] [1938] 1 Ch 441, 457-8. [67] Not argued in our case. [68] See also Citicorp Investment Bank (Singapore) Ltd v Wee Ah Kee [1997] 2 SLR(R) 1, §41. |
Cases cited in this judgment