Summer Pioneer Holdings Ltd v. Hna Group (International) Co Ltd

HCA 488/2021

[2022] HKCFI 1691

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 488 OF 2021

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(By original action)

(By counterclaim)

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DECISION

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1.This is an application by Summer Pioneer Holdings Limited (“the Plaintiff”) by summons (amended on 11 November 2021) to strike out certain parts of the Defence and Counterclaim (“D & CC”), or alternatively that certain questions be determined under Order 14A or as a preliminary issue under Order 33, the net effect of which is for the Plaintiff’s claim of approximately USD 357 million be determined on a summary basis. At the conclusion of the hearing, the decision was reserved which I now give.

I. BACKGROUND

2.On 19 May 2017, Alright Investment Holdings Limited (“Alright”) (who is the 3^rd counterclaim defendant), a then wholly-owned subsidiary of HNA Education & Healthcare Co-Limited (“HNA Investor”) entered into an agreement (“the SPA”) to acquire all the shares of the Swiss Education Group Holding AG (“SEG”) for CHF 750 million.

3.A deposit totalling CHF 59,600,000 (equivalent to USD 60 million) was paid by instalments between June 2017 and February 2018 to the vendor.

4.Meanwhile, by letter dated 13 November 2017, HNA Investor engaged Summer Capital Limited (“SCL”) to act as the sole leading structurer to design and establish a financing structure for the leveraged acquisition by HNA Investor of the shares in the capital of SEG per the SPA (“the Engagement Letter”).  The Engagement Letter provided that SCL was not acting as adviser or agent of HNA Investor and has no duties to HNA Investor in relation to any transaction financing.

5.The financing arrangement is acknowledged to be complex. Although the court is not required to consider its complexities, an understanding of its overall structure is necessary.  

6.SCL utilised a fund structure it already controlled, namely, Summer Feeder Fund Limited (“Fund I”) and Summer Master Fund II Limited (“Fund II”). Fund I holds 100% of the non-voting shares in Fund II, representing the full economic benefit of the investments made by Fund II. SCL owns all the shares in each of the Funds.

7.HNA Group (International) Co Ltd (“the Defendant”) and HNA Investor are members of the HNA Group Co Limited (“HNA Holding”), the parent group entity. While the Defendant is majority owned by HNA Holding, HNA Investor is not a subsidiary of the Defendant which has no direct or indirect ownership or control over HNA Investor. Likewise, HNA Investor has no direct or indirect ownership or control over the Defendant.

8.The financing structure involved, inter alia, the following steps:

(a) on 10 April 2018, HNA Investor agreed to transfer all its shares in Alright to Fund II (“Alright share transfer”); and

(b) on 17 May 2018, Fund I, SCL and HNA Investor entered into a letter agreement (“the Side Letter”) to reflect the parties’ agreement on certain matters in relation to HNA Investor’s investment in Fund I.

9.It is the Defendant’s case, pursuant to the Side Letter, that

(a) it was intended and agreed that HNA Investor would be the only equity investor in the fund structure for the purposes of acquiring SEG and that all other financing would be raised by debt financing, including the Bonds and other debt instruments;

(b) HNA Investor would subscribe for Fund I shares representing shares in Alright for a total amount of USD 186 million (“the subscription amount”) with the Alright deposit amount treated as part of the subscription amount;

(c) HNA Investor would procure the Defendant to provide the HNA Guarantee and Indemnity (“the HNA Guarantee”);

(d) HNA Investor would be entitled to appoint 2 directors to the SEG board[1]; and

(e) HNA Investor’s investment in Fund I would be used to fund the acquisition of SEG and that HNA Investor would be entitled, proportionate to the percentage of equity shares it held in Fund I to participate in the equity investment in SEG, a beneficial interest in the issued shares of each of Alright and Jiarui Investment (Hong Kong) Co Ltd[2] (“Jiarui”) and SEG (“the anti-dilution clause”).

10.The financing structure SCL designed is depicted in the following chart:

11.Following the Side Letter,

(a)  HNA Investor was allotted USD 186 million participation shares of Fund I;

(b)  on 29 May 2018, the Defendant entered into the HNA Guarantee in favour of the Plaintiff;

(c)  Alright entered into a Convertible Bond Trust Deed (“CB Trust Deed”) on 30 May 2018 and issued convertible bonds due 2023 in the principal amount of USD 275 million (“the Bonds”) to Fund II. The Plaintiff guaranteed performance by Alright of all its obligations in respect of the Bonds (“the Pioneer Guarantee”);

(d)  also on 30 May 2018, Alright assigned all of its rights under the SPA (to acquire SEG) to Jiarui; and

(e)  completion of the Transaction[3] took place on 6 June 2018.

(A) The HNA Guarantee

12.The HNA Guarantee was made between the Defendant (as guarantor) and the Plaintiff (as beneficiary). It recited inter alia that the Plaintiff had agreed to guarantee all of the obligations of Alright arising under the Bonds on the condition that the Defendant shall provide the HNA Guarantee.

13.Under the HNA Guarantee, the Defendant irrevocably and unconditionally agreed to indemnify the Plaintiff immediately on demand against any liability incurred by it as guarantor under the Finance Documents (clause 2.1). Upon demand by the Plaintiff or the Bonds Trustee, the Defendant would make payment unconditionally and its obligations were unconditional (clauses 2.3 and 2.4). The guarantee was a continuing guarantee and indemnity and the Defendant would not be discharged by anything other than irrevocable and unconditional discharge of the liabilities in full (clause 3.1).

14.As I understand it, the HNA Guarantee effectively underwrote the Plaintiff’s liability (if any) under the Pioneer Guarantee given to Bondholders. It appeared that the Plaintiff’s role was purely nominal. According to the Plaintiff, its function[4] was limited to providing the Pioneer Guarantee and contracting with the Defendant under the HNA Guarantee[5].

(B) Breaches of the Side Letter

15.On 5 September 2019, 2 HNA representatives were removed from the Board of Directors of SEG and on 22 November 2019 the same representatives were also removed from the Board of Directors of SEG’s subsidiary Swiss Education Group AG.

16.On 27 November 2019, Castle Loyal Limited (“Castle Loyal”) a subsidiary of an entity called Skilled Dragon Limited (“Skill Dragon”) acquired all the shares in SEG from Jiarui. Skill Dragon then issued 49% of the shares in Castle Loyal to Jiarui.

17.It is accepted that the events mentioned in §§15-16 above occurred. It is the Defendant’s case that they constituted breaches of the provisions of the Side Letter,: see §9 (d) and (e) above.

II. THE ISSUES

18.They fall under the following main heads: (a) striking out under the court’s inherent jurisdiction; (b) implied term; (c) discharge by conduct; (d) whether discharge by conduct applies to indemnities; (e) minimum balance; and (f) the Defendant’s counterclaim. They are considered below.

19.Before turning to the issues, it would be convenient to set out the rather singular features of this application.

20.The Plaintiff’s case focuses entirely on the HNA Guarantee as a stand-alone transaction involving only the Plaintiff and the Defendant.

21.But the backdrop against which the HNA Guarantee came into existence is relevant. The Defendant highlighted the following matters:

(a)  Ms Zhang, the Plaintiff’s key witness, is a director of the Plaintiff and also a director of SCL which was a party to the Side Letter. Ms Zhang is also the sole director of Fund II and she was authorised to affirm on behalf of the other counterclaim defendants[6].

(b)  Hence, Ms Zhang bestrides 3 key entities: the Plaintiff (the party to the HNA Guarantee); Fund II (the shareholder of Alright, Jiarui and SEG); and SCL (which controls Funds I and II).

(c)  The HNA Guarantee formed part of a suite of documents designed collectively to effectuate a particular purpose.

(d)  The transactions are interrelated and were designed collectively to fund the purchase of a business and to provide for its ongoing management (“the Transaction”).

(e)  The fund structure was designed by SCL.

22.In her affirmation, Ms Zhang made it clear that whenever she refers to “we”, “us” or “our” in her affirmation, she is referring to SCL and all of the entities that it controls (“the Summer parties”).

23.I now turn to the issues.

(A) Striking out under the court’s inherent jurisdiction 

24.The Plaintiff’s application to strike out parts of the Defence (“the challenged paragraphs”) is not brought under RHC O 18, r 19 (1) (a) (“limb (a)”)[7] but (b), (c) and (d) or the court’s inherent jurisdiction. As one of the defences raised is based on an implied term, it was necessary for the Plaintiff to file an affidavit which precluded the Plaintiff from invoking limb (a)[8].

25.The question that arises is whether the Plaintiff is thereby precluded from contending that the challenged paragraphs do not raise an arguable defence.

26.Mr Toby Brown, counsel for the Plaintiff, submitted that a cause of action or defence that is reasonably arguable in the sense that it would survive an application for striking out under limb (a) could be struck out under the inherent jurisdiction of the court. He relied on 2 authorities.

27.The first authority is Koo Ming Kown v Talent Property Group Limited, HCA 2335/2016 where the defendant had relied on all 4 grounds in r 19(1) for striking out the plaintiff’s claim. Master M Wong found that the statement of claim did not disclose any reasonable cause of action and struck it out on that ground under O 18, r 19(1)(a). He went on to hold that the expression “frivolous or vexatious” includes proceedings which is an abuse of process, not capable of reasoned argument, without foundation or where it cannot possibly succeed, citing HKCP 2017[9] at §18/19/7.   

28.As the court has similar powers to strike out the statement of claim and to dismiss the action as those contained in O 18, r 19, the statement of claim was also struck out and the action dismissed under the inherent jurisdiction of the court.

29.There is a material difference between the present case and Koo Ming Kown: the plaintiff in Koo was able to rely on all four limbs of O 18, r 19 including limb (a). Here, it is accepted that the Plaintiff cannot invoke limb (a).  

30.The other authority is Yanfull Investments Limited v Datuk Ooi Kee Liang [2017] 5 HKC 42 where the Court of Appeal stated (at §40) that apart from the statutory power,

“there is also the parallel power under the inherent jurisdiction of the court to strike out pleadings which are obviously frivolous or vexatious, or are otherwise an abuse of process of the court, even in the absence of a specific application, provided that a fair opportunity to be heard has been afforded to the party affected.”

31.Mr Marc Corlett, counsel for the Defendant, accepts the statement in Yanfull as correct if the Plaintiff is able to establish that the defence is frivolous, vexatious or otherwise an abuse of the process of the court but that is not what the Plaintiff is seeking to do in the present case.

32.In my view, neither of the authorities relied on provides support for the Plaintiff’s proposition. The parallel inherent power is plainly exercisable where the corresponding statutory power can also be exercised. But where a party cannot invoke or rely on limb (a), absent authority (and there is none), I am not persuaded that in those circumstances the court may exercise its ‘parallel’ inherent power.

(B) Implied term

1.Whether the court should determine the existence of the implied term summarily 

33.The Plaintiff submitted that an implied term can be resolved by summary determination and cited Kenworth Engineering Limited v Airport Authority [2002] 1 HKLRD 796 as an example. In that case the court made a summary determination of whether a term should be implied in a bond. One of the reasons given by Kwan J (as she then was) in §45 was that the term is ineffective as it could not be enforced by Kenworth who was not a party to the bond. Further, the court also held that in the alternative, determination would be made under O 14 A which required a lower standard of proof.

34.A more recent example is Wu Fung Chu v Ng Pak Wing, HCA 654/2014 [2020] HKCFI 615 where (at §38) the implied condition was held to be “untenable”.

35.While those cases are examples where the court dealt with the question of an implied term on a summary basis, whether or not summary determination is appropriate in the present case would depend on whether factual issues arise that require determination.

36.Ng Chun Kong v First Star Development Limited [2007] 3 HKLRD 281 is an example of a case where it was not appropriate to decide the implied term on a summary basis. There, a factual issue arose concerning “practice and custom” in support of the implied term.  

37.The context giving rise to the implied term raised in the defence in the present case in outline is as follows.

38.It is Ms Zhang’s evidence that the acquisition and management of SEG did not involve the Plaintiff whose “function was entirely and intentionally isolated from those operational aspects of the transaction”.

39.Ms Zhang elaborates on this in Zhang 2^nd at §25. The Plaintiff was created as a separate company for the limited function of (i) providing to the holders of the convertible bonds of a guarantee of the obligations of Alright and indemnification against the consequences of any non-performance of the same; and (ii) contracting with the Defendant under the HNA Guarantee but isolated from any of the activities of the other Summer parties.

40.The financing structure was specifically designed to effectuate the Transaction (ie completing the acquisition of SEG and providing for its ongoing management). However, if the real provider of the guarantee is the Defendant, it is not readily apparent why it was necessary to interpose a new and, seemingly, nominal entity (the Plaintiff) into the equation.

41.The Defendant takes exception to this intentional isolation of the Plaintiff from the operational aspects of the Transaction. It takes the view that the actions of the Summer parties in breaching the terms of the Side Letter should be subject to scrutiny.

42.As I understand it, its case is that the Pioneer Guarantee was an integral part of the financing structure SCL devised (including the Side Letter) underpinning the Transaction. That is the focus of the implied term put forward by the Defendant.

43.§§41-42 of the D & CC read as follows:

“41. Further and/ or alternatively to the defence set out in section J above, it was an implied term of the HNA Guarantee that the Plaintiff, Summer Feeder Fund Limited, Summer Master Fund II Limited, Alright and Jiarui would not act in a manner to undermine or thwart the common intention of the parties that:

41.1. HNA Investor would be the only equity investor in respect of the purchase of SEG and that its equity participation rights under the Anti-Dilution Clause contained in the Side Letter would not be diluted in breach of that clause;

41.2. The HNA Directors (or any replacements appointed by HNA Investor) would not be removed from the boards of SEG and SEG AG or otherwise excluded from the management of those companies; and

41.3. The Plaintiff, Summer Feeder Fund Limited, Summer Master Fund II Limited, Alright and Jiarui would not cause or allow any of their respective subsidiaries or affiliates to otherwise act in breach of the terms of the Side Letter and in particular the terms pleaded at paragraphs 41.1 and 41.2 above (“Implied Term”).

42. It is necessary to imply the Implied Term to give business efficacy to the HNA Guarantee so as not to undermine or thwart the commercial intention and agreed contractual provisions in respect of the acquisition and ongoing management of SEG.”

44.Mr Corlett submitted that the court will need to assess whether there was a common intention between the various parties to what he referred to as “the broader suite of documents”. That common intention (being an integral part of the implied term and set out in §32 of the defence) is broken down into 7 elements/aspects reflected in §9 above.

45.With a view to forestalling factual disputes, the Plaintiff is prepared to accept that breaches of the Side Letter have occurred solely for the purposes of this application.

46.However, that acceptance does not resolve all the factual issues. As an example, Zhang 1^st (at §§15 and 17) takes issue with the first element (that HNA Investor would be the only equity investor in the fund structure) as a matter of fact.

47.It would follow that the existence and scope of the alleged common intention is disputed and which must first be determined at trial.

48.On that basis, I accept the Defendant’s submission that the alleged implied term is not and cannot be suitable for summary determination.

         2. Whether there is an arguable case for an implied term as pleaded

49.The Plaintiff focused on the third of the 5 requirements for a term to be implied into a contract, namely that “it must be so obvious that it goes without saying”.

50.The Plaintiff’s principal criticism of the implied term is that it appears to impose contractual terms and obligations on the Plaintiff and other parties including SCL, Fund I and Fund II when those entities are not subsidiaries or affiliates of the Plaintiff and over which the Plaintiff has no control. As appears from the chart, the Plaintiff is a wholly-owned subsidiary of Fund II and, in terms of hierarchy, ranks at the bottom. 

51.The Plaintiff has no relationship with HNA Investor as it is not a party to the Side Letter which was entered into by HNA Investor with SCL and Fund I.

52.Mr Brown submitted that it is not evident what the Plaintiff is alleged to have done to thwart the common intention of the parties. Thwarting is not an act in itself. One can only thwart by doing something that has an effect of thwarting.

53.Those criticisms were premised on the implied term being “that the Plaintiff, Fund I, Fund II, Alright and Jiarui would not cause or allow their “subsidiaries or affiliates” to act in breach of the Side Letter[10]”. That premise appears to be incorrect.

54.The implied term is that pleaded in D & CC §41[11]:

“… it was an implied term of the HNA Guarantee that the Plaintiff, [Fund I, Fund II,] Alright and Jiarui would not act in a manner to undermine or thwart the common intention of the parties that …”

55.As part of the implied term, the Defendant alleges that the common intention of the parties was that: (a) HNA Investor would be the only equity investor and its equity would not be diluted; (b) the HNA Directors would not be removed from the boards of SEG and SEG AG; and (c) the Plaintiff and others would not cause or allow any of their respective subsidiaries or affiliates to otherwise act in breach of the terms of the Side Letter[12].

56.The Defendant reiterated that (i) the structure was specifically devised by SCL which controls all of the relevant Summer entities including the Plaintiff; (ii) the HNA Guarantee was part of a series of transactions designed to fund the acquisition of SEG with agreed contractual provisions for its ongoing management; and (iii) the Defendant was not party to any of the other contractual documents and does not otherwise stand to benefit in any way from its entry into the HNA Guarantee.

57.In those circumstances, Mr Corlett submitted that it is only reasonable and equitable to expect that the Plaintiff and the other parties would act consistently with their obligations under the transactional documents and that HNA Investor’s rights would not be thwarted to the detriment of HNA Investor and for the purpose of the HNA Guarantee, the Defendant who otherwise stood not to benefit from that guarantee.

58.It was said that without the implied term, the Plaintiff would be free to act without regard to the rights of either the Defendant or HNA Investor and without any recourse or scrutiny in respect of its conduct or that of its associated entities.

59.Further, it would be artificial in the extreme to suggest that the Plaintiff sits out on a limb in the corporate structure with no knowledge or ability to influence what its associated entities are doing when Ms Zhang through SCL controlled all the non-HNA entities appearing in the chart.

60.The legal requirements for implication of a term into a contract are summarised by Lord Hughes (with whom Lord Neuberger, Lord Clarke and Lord Carnwath agreed) in Nazir Ali v Petroleum Company of Trinidad and Tobago [2017] UKPC 2 at [7] conveniently set out in Lo Yuk Sui v Fubon Bank (Hong Kong) Limited formerly known as International Bank of Asia Limited [2019] HKCA 261 at §32:

“It is enough to reiterate that the process of implying a term into the contract must not become the re-writing of the contract in a way which the court believes to be reasonable, or which the court prefers to the agreement which the parties have negotiated.  A term is to be implied only if it is necessary to make the contract work, and this it may be if (i) it is so obvious that it goes without saying (and the parties, although they did not, ex hypothesi, apply their minds to the point, would have rounded on the notional officious bystander to say, and with one voice, “Oh, of course”) and/or (ii) it is necessary to give the contract business efficacy.  Usually the outcome of either approach will be the same.  The concept of necessity must not be watered down.  Necessity is not established by showing that the contract would be improved by the addition.  The fairness or equity of a suggested implied term is an essential but not a sufficient pre-condition for inclusion.  And if there is an express term in the contract which is inconsistent with the proposed implied term, the latter cannot, by definition, meet these tests, since the parties have demonstrated that it is not their agreement.”

61.The contract into which the implied term is to be added is the HNA Guarantee, the parties to which are the Plaintiff and the Defendant.  In his written submissions, Mr Corlett posed the following hypothetical question:

“since [the Defendant] does not otherwise benefit from the HNA Guarantee, do we all agree that at least [the Defendant] should be able to expect that we will all comply with our respective obligations under the broader suite of documents?” (emphasis added)

62.To that question Mr Corlett submitted that it is difficult to imagine why the answer would be anything other than “yes” or that anyone could have said “no, we should be free to breach our obligations, and [the Defendant] should still be liable under the [HNA Guarantee]”[13].

63.Mr Brown drew attention to the use of the pronoun “we” in the question posed, pointing out that any ‘discussion’ or ‘conversation’ would be between the parties to the contract. As the Plaintiff is not a party to the Side Letter, if the “we” is a reference to the other Summer parties, the problem is that they are not parties to the HNA Guarantee[14].  

64.Another aspect of the Defendant’s case[15] is that the implied term is necessary to give business efficacy to the contract. The Plaintiff submitted that the HNA Guarantee works perfectly well without the need for any further terms. The key terms are summarised in §§12-13 above. It was designed to ensure that if the Plaintiff had any liability under the Pioneer Guarantee, then it would be fully indemnified by the Defendant.

65.Mr Brown highlighted the terms used in the guarantee such as “unconditional”, “irrevocable” and noted that the guarantee should not be discharged by anything other than the irrevocable and unconditional discharge of the liability. He submitted that it is not obvious what other interpretation can be given to those words. No ambiguities have been identified and no alternative construction of the words appearing in the HNA Guarantee has been put forward for resolution at trial.

66.The Defendant submitted that the Plaintiff’s approach is based on an unstated assumption that it is only the interests of the Plaintiff that are relevant to business efficacy when the business efficacy of contractual provisions needs to be considered from the perspectives of both parties. The Plaintiff adopted a literal approach to the proper construction of the contract when the proper perspective is that of a reasonable person having the requisite knowledge.

67.Instead, the Defendant submitted that the requisite knowledge would include the fact that without the implied term the Defendant would stand to gain no corporate benefit in granting the HNA Guarantee in favour of the Plaintiff. What the implied term would do would be to subject the conduct of the Plaintiff “and its associated entities” to scrutiny. Put differently, the implied term would introduce a condition relieving the Defendant from liability in the event of a breach of the implied term.

68.As earlier noted, the HNA Guarantee is part of a complicated financing structure[16] devised by SCL to effectuate the Transaction. The documents are professionally drawn. In Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Limited [2016] AC 742 Lord Neuberger observed (at §21) that:

“… a term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed it if it had been suggested to them. Those are necessary but not sufficient grounds for including a term …”

69.In such circumstances, one has to approach the need for the implied term with a degree of circumspection.

70.The legal principles on striking out a pleading are not controversial. The court will only do so when it has been shown that it is plain and obvious that the other party’s claim is bound to fail. The court will not strike out a claim because it is weak or unlikely to succeed. The court has to be satisfied that it must be impossible for the claim to succeed before the court will strike it out.

71.Looking at the matter objectively, it is certainly arguable that a blinkered view should not be adopted in construing the HNA Guarantee.

72.Having regard to the matters set out in §§21-22 above and the fact that the HNA Guarantee is an integral part of the complex financing structure designed to accomplish the Transaction, while the Defendant’s task may not be easy, I do not consider the implied term so plainly unarguable and hopeless that it should be struck out without affording the Defendant the opportunity to make out its case at trial.

(C) Discharge by conduct

73.The defence of discharge by conduct which the Defendant advanced is a general equitable principle that the Defendant derives from Holme v Brunskill (1878) LR 3 QBD 495 and Black v Ottoman Bank (1862) 15 Moo PCC 472, 15 ER 573.

74.The Defendant formulated it as follows: “that actions taken by the one who stands to benefit from a guarantee, but which prejudice the guarantor, may discharge the guarantor from its obligations.”

75.In the Brunskill case, Cotton LJ’s statement of what he considered to be the true rule[17] was based on the rule of equity stated by Lord Loughborough in Rees v Berrington:

“It is the clearest and most evident equity not to carry on any transaction without the knowledge of him [the surety], who must necessarily, have a concern in every transaction with the principal debtor. You cannot keep him bound and transact his affairs (for they are as much his as your own) without consulting him.”

76.Cotton LJ explained that the cases as to discharge of a surety by an agreement made by the creditor to give time to the principal debtor are exemplifications of the rule stated by Lord Loughborough.

77.Ottoman Bank is authority for the proposition that the mere passive inactivity of the principal to whom a guarantee is given, or his neglect to call the principal debtor to account in reasonable time and to enforce payment against him, does not discharge the surety; there must be some positive act done to the prejudice of the surety or such degree of negligence as to imply connivance and amount to fraud.

78.The Plaintiff’s approach to those authorities is that unless the specific requirements of the Brunskill rule and Ottoman Bank are met, equity will not intervene. It was said that those cases are not merely examples of a broader rule. Rather, they are the rules where equity will step in in relation to a guarantee.

79.The Plaintiff submitted that neither of those rules can apply in the present case:

(a)  Under the Brunskill rule, where there is a variation of the obligation guaranteed without the consent of the guarantor, equity will step in and it is possible to have the guarantee discharged. In the present case, there is no allegation that the underlying contract (being the CB Trust Deed) had been varied. Nor was there an agreement between Alright and the Plaintiff to vary the CB Trust Deed or any guarantee obligations.

(b)  Equity will also step in (as in Ottoman Bank) where the beneficiary of the guarantee acts to the prejudice of the guarantor in a sufficiently clear way or where the beneficiary of the guarantee is sufficiently negligent.  In the present case, there was no positive act on the part of the Plaintiff; all that was pleaded was that it did not prevent the other Summer parties from breaching the Side Letter.

80.The court was referred to the Court of Appeal’s decision in Bank of Credit and Commerce Hong Kong Limited (in Liquidation) v Quadrutec Hotel Management & Development Limited & Ors [1996] 4 HKC 316 (“the BCC case”) where the Court of Appeal considered the test set out by Goff LJ in Bank of India v Transcontinental Commodity Merchants Limited and Patel [1983] 2 Lloyd’s Rep 298 (“the Bank of India case”).

81.Godfrey JA held (at 323 G-I):

“There is no general principle that ‘irregular’ conduct on the part of the creditor, even if prejudicial to the interests of the surety, discharges the surety: see [the Bank of India case] per Goff LJ, at p 302[18]. There are particular circumstances in which the conduct of the creditor may discharge the surety, for example, if the creditor acts in bad faith towards him; or is guilty of concealment amounting to misrepresentation; or connived at the default by the principal debtor; or varies the contract between himself and the principal debtor. These are, as Goff LJ points out, ‘certainly the most significant, and possibly the only, examples.’ (loc cit). The present case exhibits none of these circumstances. No other defence is suggested.”

82.It was submitted that as the present case does not fall within any of the examples given by Goff LJ set out above,the Defendant cannot satisfy the test set out in the Bank of India case.

83.While not doubting the correctness of the Privy Council’s decision in Ottoman Bank, in the BCC case Bokhary JA (as he then was) explained that the rejection of the proposition that merely irregular conduct on the part of the creditor discharges the surety was based on the irrefutable ground that the wording ‘irregular’ is so unspecific in that context as to be devoid of legal content.

84.As to the particular circumstances identified in the passage cited above, Bokhary JA noted that Goff LJ warned against ‘shutting the door upon any further development of the law in this field by rigidly confining the circumstances in which a surety may be discharged to the specified instances.’ He pointed out that the law could never develop if a suggested defence were summarily shut out simply because it cannot be brought within the established instances. I respectfully agree.

85.Relevantly, Bokhary JA went on to say this (at 325A-C):

“… So if it has the potential for developing into such an instance, it should be left for consideration at a full trial.

Naturally, it would be of great help in testing whether any suggested defence has such potential if one could identify a common theme running through the established instances. But I do not think that can be done. If it could be, I think Robert Goff LJ, would have done it.

The best O 14 test I can think of is this: is there in the suggested defence at least the embryo of something which goes beyond merely irregular conduct on the part of the creditor prejudicial to the interests of the surety?”

86.In view of those observations, I do not accept as correct the proposition that only conduct that comes within the established instances could discharge the guarantor. Put differently, the equitable rule on discharge is not confined to the situations that arose in Brunskill and Bank of India.

87.The Defendant’s case goes beyond ‘irregular’ conduct. Breaches of the Side Letter (if ultimately established) would undermine the contractual provisions agreed for SEG’s ongoing management and cause significant diminution of operational revenue which the Plaintiff accepts would be going into the MCR Account[19] to enable the interest payment to be met on the Bonds. That in turn could trigger demands for payment under the Pioneer Guarantee which would translate into demands under the HNA Guarantee.

88.In view of those matters and the highly unusual features and context referred to in §§21-22 above, I do not consider it could be said that the Defendant’s case on discharge by conduct is bound to fail. The Defendant should not be shut out prematurely from having its case determined.

(D) Whether discharge by conduct applies to indemnities

89.The relevant authorities cited by the parties are the following:

(1)     Marubeni Hong Kong and South China Ltd v The Mongolian Government [2004] EWHC 472 (Comm):

(a)  one of the issues was whether on a true construction of the MMOF Letter the defendant had undertaken a primary liability to the claimant “so that the [Brunskill rule] has no application”;

(b)  Cresswell J held (at §§139-140) that the instrument was a guarantee, that the defendant did not undertake a primary liability and that the Brunskill rule applied; and

(c)  if, contrary to his view, the defendant had undertaken a primary liability to the claimant, he observed (at §143) obiter that “it does not follow that the principles underlying the [Brunskill] rule have no application”.

(2)     An academic commentary[20] on the Marubeni decision:

The authors submitted that Cresswell J’s obiter view is correct in that the underlying rationale might be thought to apply just as much to a guarantee which creates a primary obligation as to one that is not. In either case, there is a triangular relationship with that guarantor undertaking to perform, or to secure the performance of, a contract between the other 2 parties.

(3)    Tullow Uganda Limited v Heritage Oil and Gas Limited & Anor [2013] EWHC 1656 (Comm) (“the Tullow case”):

(a) the defendant (citing, inter alia, the Bank of India case) submitted that there is, by analogy with the law on guarantees, a duty of good faith owed by the indemnified party, such that, in appropriate circumstances, that party can be disentitled from recovery under the indemnity by his conduct; and

(b) Burton J appeared to have rejected that submission[21], citing and expressing agreement with Scottish & Newcastle Plc v Raguz (No 3) [2007] 1 P & CR 1 at [109] on the basis that Hart J had “decisively and persuasively” rejected the applicability of any equitable doctrines arising in the law of guarantees to commercial contracts of indemnity[22].

(4)    Brown-Forman Beverages Europe Limited v Bacardi UK Ltd [2021] EWHC 1259 (Comm):

(a) on the applicability of the Brunskill rule to indemnities as opposed to guarantees, Judge Pelling QC accepted the conclusions reached by Mr Richard Salter QC sitting as a deputy judge of the High Court in GPP Big Field LLP and another v Solar EPC Solutions SL [2018] EWHC 2866 (Comm) (“the GPP case”) at §§145-147 that:

(i) the overwhelming preponderance of view in the cases and textbooks is that the Brunskill rule does not apply to contracts of indemnity;

(ii) equitable protections apply only to contracts that are properly characterised as contracts of guarantee and do not apply to contracts of indemnity; and

(iii) there are sound policy reasons to support that conclusion and for not extending the ambit of the Brunskill rule.

(5)     O’Donovan, The Modern Contract of Guarantee, 4^th English Edn. (2020):

Although the author agrees with the conclusion in the GPP case (at §7-070), he went on to note (at §7-071) that (a) there has been no detailed account of “why the ordinality of the obligation[23] makes the critical difference”; and (b) it fails to explain a line of decisions on variations under contracts of reinsurance which endorse an approach analogous to the Brunskill rule[24].   

90.The Plaintiff relies on Tullow, Brown-Forman, Scottish & Newcastle and O’Donovan for the proposition that the equitable doctrines do not apply to indemnities while the Defendant relies on Marubeni and the academic commentary on Marubeni.

91.Pausing there, the Tullow case and Marubeni require comment: 

(1) the Tullow case:

(a)  the assistance to be derived from the Tullow case and Scottish & Newcastle (on which Tullow was based) is unclear if not doubtful. Scottish & Newcastle is a case concerning covenants to indemnify under the Landlord and Tenant legislation. On the question in what circumstances a surety may be discharged from his obligations, Hart J held (at §103) that it “turns primarily on equitable considerations”, citing Mance J in Socomex Ltd v Banque Bruxelles Lambert SA [1996] 1 Lloyd’s Rep 156 at 198; and

(b)  the basis on which Burton J reached the conclusion that he did the Tullow case at §105 (replicated in the Plaintiff’s skeleton at §58) is puzzling. Nothing that I can find in Scottish & Newcastle is to that effect[25].

(2) Marubeni:

(a)  while Cresswell J’s obiter remarks in Marubeni do not amount to a considered view of the matter and the judge did not elaborate on his reasons underpinning those remarks, he would not have expressed his reservations if he had shared the parties’ view, reflected in the formulation of the agreed issue[26] in that case, that the Brunskill rule has no application if a primary liability had been undertaken. Cresswell J obviously thought otherwise[27];

(b)  in the academic commentary supporting Cresswell J’s view, the authors considered that if anything the justification of the Brunskill rule “is heightened in the case of a primary liability instrument, given the more onerous nature of such an instrument on the part of the guarantor”; and

(c)  although the more recent case law on that subject has mostly gone the other way, the English Court of Appeal in CIMC Raffles Offshore (Singapore) PTE Ltd & Another v Schahin Holding SA [2013] EWCA Civ 644 referred not only to the obiter part of Cresswell J’s judgment in Marubeni but also the case comment mentioned in § 89 (2) above. Rix LJ considered that the inapplicability of the Brunskill rule to primary liability had not been clearly established[28].

92.It is apparent from the above that the applicability of the Brunskill rule to indemnities has yet to be authoritatively determined. The Defendant submitted that as this is an unsettled question of law, the court should be wary about resolving an unsettled question of law on a striking out application. I would respectfully agree.

93.In view of the state of the authorities, I do not consider it correct to characterise the law on this issue as “settled”, incapable of challenge or contrary argument. In those circumstances, it would not be right to deprive the Defendant of the opportunity of having the point argued and determined.

94.I therefore decline to strike out the Defendant’s discharge by conduct defence.

(E) Minimum balance

95.Alright as the bond issuer was required under the terms of the Trust Deed to maintain a Coupon Reserve Account (“CRA”) i.e. an account in the name of the Issuer with an Account Bank[29] with a Minimum Coupon Reserve Account Balance (“MCRA Balance”). For present purposes it is common ground that the amount required is USD 4.8 million. 

96.The Plaintiff’s statement of claim alleged inter alia as follows:

(a)  on or before 23 March 2021, Alright failed to maintain USD 4.8 million in respect of the Outstanding Bonds in the CRA and such failure constituted an event of default within clause 1 of Schedule 4: SOC §15

(b)  on 23 March 2021, the Security Trustee issued a notice to the Bond Trustee informing it that the MCRA Balance had not been maintained “as advised by the Account Bank …”: SOC §16

(c)  upon receipt of the Notice to Bond Trustee, the Bond Trustee issued a notice to, inter alia, the Bond Holder and the Bond Holder in turn directed the Bond Trustee to declare the principal amount of all of the Outstanding Bonds immediately due and payable, culminating in a Demand to Plaintiff for immediate payment of the same: SOC §§17-20

(d)  that resulted in the demand to the Defendant for the immediate payment to the Plaintiff and the Bond Trustee of all amounts due under the Trust Deed: SOC §21

97.Madison Pacific Trust Ltd was party to the Trust Deed in its multiple roles as “Bond Trustee”, “Security Trustee” as well as agent and registrar of the Trust Deed.

98.The Plaintiff did not exhibit any bank statement evidencing a shortfall in Zhang 1^st.

99.The Defendant put the Plaintiff to strict proof that the minimum coupon amount was not maintained as at 23 March 2021.

100.On 6 May 2021, the Defendant sought discovery of the “advice” from the Account Bank to the Security Trustee pleaded in SOC §16. It took no fewer than 4 rounds of correspondence before the Plaintiff’s solicitors acknowledged 7 weeks later, on 24 June 2021, that in fact no document establishing a shortfall in the MCRA Balance exists.

101.The Defendant’s case is that (a) there is no evidence that Alright failed to maintain the balance required in respect of the Outstanding Bonds; (b) there is no evidence that the Account Bank advised the Security Trustee that the MCRA Balance had not been maintained; and (c) accordingly, the Plaintiff was not entitled to make any demand under the HNA Guarantee.

102.Exhibited to the 2^nd affirmation of the Plaintiff’s solicitor dated 25 March 2022 is an unsigned 2^nd affirmation of Ms Zhang exhibiting a copy of a bank statement dated 31 March 2021 from DBS Bank to Alright showing a balance of USD 10,691.85.

103.In its written skeleton, the Plaintiff submitted that the Defendant “must be able to ascertain the balance of the [CRA] and similarly must have known that [the] required balance was not maintained”. But that submission cannot be correct.

104.Since the Alright share transfer (which was part of the financing structure designed by SCL) of 10 April 2018[30], SCL rather than HNA Investor has been the owner of all the Alright shares. Thus, the bank statement, while addressed to Alright, was sent “c/o Summer Capital Management Ltd”.

105.Although the Plaintiff was glibly dismissive of the Defendant’s persistence in pressing for discovery of the “advice” as to how the Bond Trustee came to know that the balance was not sufficient, it was ultimately acknowledged that as a matter of fact there is no evidence as to how it gained that knowledge notwithstanding its pleaded case.

106.While acknowledging that the Summer parties would therefore be cognizant of what is in the Alright account, the Plaintiff sought to refocus attention to the ‘real’ question which is whether at the relevant date there was or there was not enough money in the account, deploying the ‘light switch’ analogy. That question was said to be conclusively answered by Zhang 2^nd. If so, one might rhetorically ask how is one to account for the Plaintiff’s recalcitrance in furnishing that piece of information?

107.The Defendant highlighted the unsatisfactory aspects of the evidence being a bank statement attached to an unsworn affirmation. It does not demonstrate or explain how the shortfall occurred given that in normal circumstances this account would have been topped up from operational revenue. The Plaintiff has not explained how it has satisfied the requirements of demonstrating that there was an event of default including what is pleaded in SOC §16.

108.As regards the ‘topping up’ aspect, that appears to be common ground. Mr Brown accepted that after completion of the SEG acquisition, the money to pay for the Bonds was supposed to come from its operations with operational revenue going into the MCR Account to enable the interest payment to be met on the Bonds.

109.If that is the case, while the parties did not consider it necessary to explain the funding process to the court, the assumed breaches of the Side Letter including the dilution of Alright’s interest in Jiarui (and thus also of SEG) would at the very least account for a corresponding diminution in operational income.

110.There was no ostensible reason for the Plaintiff’s evasiveness regarding the discovery sought by the Defendant. All it required was a straightforward answer. Instead, it was dragged out for 7 weeks. Even then, no explanation was given as to why there was a shortfall. Suffice it to say that the whole episode causes considerable unease.

111.For the Plaintiff to obtain summary judgment, it must prove its case including the matters pleaded in SOC §16.

(F) Counterclaim

112.Given the conclusions I have reached on the Plaintiff’s application to strike out both the implied term defence and the discharge by conduct defence, I see no basis for severance of the Counterclaim when it is based on the same facts as the defence.

III. CONCLUSION AND ORDER

113.For all the reasons set out above, the Plaintiff’s summons is dismissed. Costs will follow the event.

114.There is to be an order nisi of costs in favour of the Defendant, with certificate for counsel, such costs to be summarily assessed and payable forthwith.

115.The Defendant is directed to lodge its statement of costs within 7 days of this Decision, the Plaintiff its objections within 14 days thereafter and the Defendant its reply (if any) within 7 days thereafter.

116.Summary assessment will take place in Chambers.

Mr Toby Brown, instructed by Dorsey & Whitney, for the plaintiff (by original action) and the 1^st – 4^th defendants (by counterclaim)

Mr Marc Corlett, instructed by Ashurst Hong Kong, for the defendant (by original action) and the plaintiff (by counterclaim)