Lead Mile Ltd v. Sino Peak Finance Ltd and Others

HCA13870/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.13870 OF 1998

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BETWEEN

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Before : Recorder Fok, SC, in Court

Dates of Hearing : 22, 24-26, 29-30 November and 1-3 December 2004

Date of Judgment : 17 December 2004

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J U D G M E N T

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Introduction

1.For reasons explained below, the trial of this action concerned only the plaintiff’s claims against the 2^nd defendant.  It is, however, necessary to explain some of the background leading to the claims against all three defendants.

2.The action arises out of the funding arrangements between the former shareholders in a money lending business.  The business in question was operated by the 1^st defendant, Sino Peak Finance Limited, which was incorporated on 16 January 1996 with a share capital of $1 million.  The initial shareholders in the 1^st defendant were the 2^nd and 3^rd defendants who each owned 50% of its shares.  The 1^st defendant obtained a licence under the Money Lenders Ordinance on 22 May 1996.

3.Pursuant to a Shareholders Agreement dated 30 August 1996, Mr Bonidy Kung Yu Wah and three other individuals (namely Mr Leo Lok Kin Wah, Mr David Guo Jian Fong and Mr Louis Leung Wing On) agreed to acquire shares in the 1^st defendant from the 2^nd and 3^rd defendants on the terms of that agreement.  Mr Kung and the various individuals in question each held their shares in the 1^st defendant through corporate vehicles.  In the case of Mr Kung, that vehicle was the plaintiff, Lead Mile Limited, which was a company owned as to 99.99% by Mr Kung.  The 2^nd defendant and the 3^rd defendant were both also parties to that Shareholders Agreement.

4.As a result of the Shareholders Agreement, the plaintiff, the 2^nd defendant, the 3^rd defendant and the various other corporate entities owed respectively 26%, 26%, 10% and 38% of the shares in the 1^st defendant.  With funds derived from shareholders’ loans, the 1^st defendant commenced its money lending business in September 1996.

5.At a shareholders’ meeting of the 1^st defendant on 11 December 1996, the shareholders resolved to adopt a scheme for the making of further shareholders’ loans to provide additional funds for the business of the 1^st defendant called the “Call Fund Procedure”.  The Call Fund Procedure was, as its name suggests, designed to enable the 1^st defendant to call for funds proportionately from its shareholders in order to fund its business.  There was no obligation on a shareholder to provide funds in response to a call but, under the Call Fund Procedure, whenever a shareholder made a shareholders’ loan to the 1^st defendant, that shareholder would receive (i) a promissory note duly signed by the 1^st  defendant for the amount of the loan, and also (ii) post-dated cheques drawn by the 1^st defendant in favour of the shareholder to cover the principal and interest due under the promissory note.

6.On 13 January 1997, a proposal was made to the shareholders in the 1^st defendant that the Call Fund Procedure be amended so that the other shareholders should be accountable to a shareholder who made a loan to the 1^st defendant if they did not themselves provide funds pursuant to a call.  This proposal matured after discussion at a shareholders’ meeting on 18 February 1997 and, although not formally the subject of a resolution of the shareholders, appears to have resulted in the adoption of a development of the Call Fund Procedure whereby, if one shareholder made a loan in response to a call for funds, a shareholder who did not do so would be required to execute a guarantee in respect of the 1^st defendant’s liability to repay the shareholder making the loan.  The amount of the guarantee would correspond to the proportion of that particular shareholder’s shareholding in the 1^st defendant and it was stipulated that the guarantee must be given in a personal name by each shareholder or on behalf of each shareholder in the case of the corporate shareholders.

7.Despite the new Call Fund Procedure, and possibly because there was objection from Mr Leung to the guarantee arrangement, the 1^st defendant’s business did not develop as the shareholders had hoped and at a shareholder’s meeting held on 5 March 1997, it was unanimously resolved that the business should be sold.  By the end of April 1997, no purchaser for the business had been found and so, in late April 1997, a reconstruction of the 1^st defendant was proposed.  This involved a buy out of Messrs Lok, Guo and Leung who held 38% of the shares of the 1^st defendant.  Although there were aspects of the reconstruction agreement that were in dispute, it was common ground that it was agreed between the plaintiff, the 2^nd and 3^rd defendants that :

(1)     Their shareholdings in the 1^st defendant would become 50%, 40% and 10% respectively.

(2)     In addition to contributing to the extent of their respective shares of the share capital of the 1^st defendant in the sum of $1 million, the shareholders would proportionately contribute interest free shareholders’ loans totalling $2 million for operating capital.  In the plaintiff’s case, he would contribute to the increased capital in the sum of $1.5 million, part of that being his 50% of the share capital of $1 million and the remainder being an interest free loan.  (Confusingly, although the plaintiff pleaded that under the restructuring it was agreed that the share capital would be increased from $1 million to $3 million, there was no evidence that the share capital of the company was in fact increased and at a later stage the shareholders resolved to repay the $2 million interest free loans, which they could not have done if that sum was in fact share capital.)

(3)     The plaintiff would also advance a loan to the 1^st defendant of $7 million by way of shareholders’ loan for additional operating capital.  Taking into account the sums already due from the 1^st defendant to the plaintiff for previous loans and call funds, the net amount payable by the plaintiff to the 1^st defendant would be $5,395,760.

8.With effect from 1 May 1997, the shareholding structure of the 1^st defendant changed so that the shares of the three individuals who held 38% of the shares in the 1^st defendant through corporate vehicles were transferred to the plaintiff and the 2^nd defendant with the result that the shares of the 1^st defendant were thereupon held by the plaintiff, the 2^nd and 3^rd defendants as to 50%, 40% and 10% respectively.  In the case of the 2^nd defendant, his additional 14% shareholding resulted from the transfer to him of part of the shares held by Grandpot Limited, which was the company through whom Mr Lok held his shares.

9.On the same date, 1 May 1997, the plaintiff duly issued a cheque for $5,395,760 pursuant to the agreement for reconstruction of the 1^st defendant.  In return, the plaintiff received from the 1^st defendant a promissory note of the same date for $7 million, together with a series of post-dated cheques for the amount of principal and interest due on the shareholders’ loan of $7 million.  The plaintiff also received letters of guaranty signed by the 2^nd and 3^rd defendants whereby they each respectively guaranteed the payment of up to 40% and 10% respectively of the loan amount of $7 million.

10.In the period between 4 September 1997 and 15 October 1997, the plaintiff, either itself or through Mr Kung and his wife on its behalf, advanced a further aggregate sum of $4.9 million by way of eight separate shareholders’ loans.  This was to provide the 1^st defendant with further operating capital.  In respect of each of these eight loans, the 1^st defendant issued a promissory note in favour of the plaintiff and also issued post-dated cheques for the amounts of principal and interest due on those shareholders’ loans.

11.In respect of those further shareholders’ loans made by the plaintiff to the 1^st defendant, the 2^nd defendant signed Letters of Guaranty whereby he guaranteed the payment of up to 40% of the loan amounts of at least six of those eight loans, totalling $4 million, and the 3^rd defendant signed Letters of Guaranty, whereby he guaranteed the payment of up to 10% of the loan amounts of each of those eight loans, totalling $4.9 million.  Each of those Letters of Guaranty were dated the same date as the respective loan advanced by the plaintiff to the 1^st defendant.  On the evidence, there was a dispute as to whether the 2^nd defendant also in fact provided Letters of Guaranty for the other two loans advanced by the plaintiff to the 1^st defendant.  Mr Kung claimed that the 2^nd defendant had given guarantees for these two loans.  For his part, the 2^nd defendant claimed that he had not given guarantees for the loans in question because, instead of doing so, he had made two loans to the 1^st defendant in the total sum of $600,000 representing his proportionate liability to contribute to the call funds.  It was common ground that the 2^nd defendant had made these two loans and this may tend to support the 2^nd defendant’s denial that he gave guarantees for the plaintiff’s two loans in question.  However, it is ultimately not necessary to resolve this dispute as the plaintiff is not claiming on the basis of any such guarantees.

12.For various reasons, the business of the 1^st defendant did not prosper and the relationship between the shareholders deteriorated.  Mr Kung’s evidence was that the issue that brought matters to a head was that, at a shareholders’ meeting on 4 November 1997, the 3^rd defendant complained that the 2^nd defendant had wrongfully failed to contribute the sum of $5 million by way of further call funds following the reconstruction in May 1997 having only contributed the two loans referred to above in the total sum of $600,000.  For his part, the 2^nd defendant reacted by denying that he was liable to make this contribution of call funds and accused the 3^rd defendant and Mr Kung of granting loans without his approval.  The dispute between Mr Kung and the 3^rd defendant on the one hand and the 2^nd defendant on the other led to Mr Kung and the 3^rd defendant voting against the 2^nd defendant’s re-election as a director of the 1^st defendant at the company’s first AGM held on 5 January 1998 and electing in his stead Mr Kung’s younger sister, Ms Kung Po Shan.

13.By the end of 1997, the effect of the Asian financial crisis was beginning to be felt and the consequent fall in the property market in Hong Kong resulted in customers of the 1^st defendant being unable to repay loans and having to seek extensions of time for repayment.  This had a knock-on effect on the position between the plaintiff and the 1^st defendant.  So far as the shareholders’ loans from the plaintiff were concerned, although the post-dated cheques in respect of interest on the principal sums were duly met on presentation, all of the cheques drawn by the 1^st defendant in favour of the plaintiff for principal were dishonoured when they were presented on 4 April 1998 (as to four of the cheques) and on 8 May 1998 (as to the other five cheques).  Despite a Letter of Demand from the plaintiff to the 1^st defendant dated 9 July 1998, the 1^st defendant had, as at the date of the writ in this action, failed or refused to repay the amounts of principal of the plaintiff’s shareholders’ loans in the aggregate sum of $11.9 million.

The plaintiff’s claims in this action

Against the 1^st defendant

14.The principal amounts of its shareholders’ loans in the total sum of $11.9 million being unpaid, as described above, the plaintiff sent a letter before action to the 1^st defendant, dated 10 July 1998, demanding payment within seven days.  No payment being forthcoming, the plaintiff issued the writ in this action on 18 August 1998 claiming this sum against the 1^st defendant.  No notice of intention to defend having been given by the 1^st defendant, default judgment was entered in favour of the plaintiff on 9 November 1998 for HK$11,900,000 together with interest as claimed in the Statement of Claim.  The 1^st defendant was subsequently wound up by order of the court dated 5 July 2000 on the petition of the plaintiff.

Against the 2^nd defendant

15.As against the 2^nd defendant, the plaintiff claims on the basis of the seven Letters of Guaranty, given by the 2^nd defendant in the circumstances described above.  The claim under the guarantees is for up to 40% of the principal amounts of seven loans in the total amount of $11 million, namely $4.4 million.  When he opened the case, counsel for the plaintiff indicated that, although the pleaded amount of the plaintiff’s claim against the 2^nd defendant in the Statement of Claim was for the full extent of the liability under the guarantees in the sum of $4.4 million, after taking account of money received from the 1^st defendant between 1 May 1998 to 17 April 2000, the plaintiff’s claim against the 2^nd defendant was for 40% of $7,752,742.31, namely $3,101,096.92 (differing slightly from the plaintiff’s written Opening Submission which quantified the claim as being for 40% of $7,807,394.17, namely $3,122,957.67).

Against the 3^rd defendant

16.The plaintiff’s claim against the 3^rd defendant is similar to its claim against the 2^nd defendant.  The claim is made on the basis of the nine Letters of Guaranty given by the 3^rd defendant in respect of the shareholder’s loans made by the plaintiff to the 1^st defendant.  The Letters of Guaranty are in the same form as those given by the 2^nd defendant (as to which, see below) save that the 3^rd defendant is identified as the Guarantor and the amount of each Letter of Guaranty is 10% of each respective Loan Amount.  The 3^rd defendant was the subject of a bankruptcy order dated 1 December 1999 and the proceedings against him in this action have been stayed since that date.

The 2^nd defendant’s defences and counterclaims

Express written terms of the guarantees

17.First, the 2^nd defendant contends that on the face of the Letters of Guaranty, there were two conditions precedent to liability, namely (a) default of the 1^st defendant in paying on the due dates under the promissory notes either the principal or interest of the loans guaranteed, and (b) irrecoverability of the loan principal sums despite the taking of necessary proceedings.  The 2^nd defendant contends that the second of these conditions precedent had not been fulfilled as at the date of the writ so that no cause of action had accrued to the plaintiff under the 2^nd defendant’s Letters of Guaranty.  The 2^nd defendant also contends that the plaintiff’s claim is incurably bad, because on the plaintiff’s pleaded case the second condition precedent was not fulfilled until 5 July 2000, over 20 months after the date of the writ, so that no amendment can save the claim.

Failure to prove case/overstatement of quantum of plaintiff’s claim

18.Additionally, the 2^nd defendant submits that the plaintiff failed to come up to proof in establishing the necessary facts to succeed in its claim and that the plaintiff has, in any event, overstated the amount of the 2^nd defendant’s guarantee liability.  As part of the former argument, the 2^nd defendant contends that due to the fact that the plaintiff controlled the 1^st defendant at all material times after 6 January 1998, the plaintiff had by its misconduct or connivance caused the default on the part of the 1^st defendant so that the 2^nd defendant should not be held liable as guarantor for the 1^st defendant’s default.

The Oral Assurances

19.Next, the 2^nd defendant contends that the Letters of Guaranty were given by him in reliance upon three oral assurances, which the 2^nd defendant says were conditions precedent to each of the Letters of Guaranty, alternatively implied terms of them, alternatively constituted a contract collateral to them.

20.Those oral assurances, as pleaded by the 2^nd defendant, were to the effect that the 2^nd defendant’s risk under the Letters of Guaranty would be minimal because :

(1)     the 1^st defendant was prepared to employ the 3^rd defendant who was at that time a friend of the 2^nd defendant as its executive director on a full time basis with effect from 1 May 1997 so that the 3^rd defendant could keep a closer supervision on the business and finance of the 1^st defendant to ensure that it had the means to pay back the plaintiff (this was referred to as the First Assurance);

(2)     Mr Kung of the plaintiff would buy back all the 140,000 shares purchased by the 2^nd defendant from Grandpot Limited at the expiry of the financial year of 1997-1998 on 31 March 1998 and so much so that the extent of the 2^nd defendant’s personal guarantees would be adjusted accordingly based on the 2^nd defendant’s shareholding in the 1^st defendant after the buy-back (this was referred to as the Second Assurance); and

(3)     the 1^st defendant would implement a new policy shortly, in which prior approval of all shareholders would be required for granting of any loan of over HK$300,000 to any customer so that the 1^st defendant would be in a secured financial position at any time for repaying loans to the plaintiff (this was referred to as the Third Assurance).

21.The 2^nd defendant contends that the Second and Third Assurances were breached by the plaintiff so that (i) the plaintiff is not entitled to claim under the Letters of Guaranty because these were conditions precedent and they were not fulfilled; (ii) alternatively, the plaintiff was thereby in breach of the Letters of Guaranty so that the 2^nd defendant is entitled to rescind them; (iii) in the further alternative, the 2^nd defendant contends that the plaintiff was thereby in breach of the Letters of Guaranty or the collateral contract and that he is entitled to counterclaim for loss and damage suffered as a result.  It was common ground that the plaintiff did not buy back the 140,000 shares of the 1^st defendant from the 2^nd defendant but the alleged breach of the Third Assurance was in issue.

2nd defendant’s continual representation on the board of the 1^st defendant and participation in the loan approval procedure

22.Next, the 2^nd defendant contends that, by reason of the Third Assurance and its close connection with clauses 7 and 19 of the Shareholders Agreement, and by necessary implication, the 2^nd defendant’s continual representation on the 1^st defendant’s board of directors pursuant to clause 7 of the Shareholders Agreement and his continual and full participation in the approval and authorization of loans of over HK$300,000 to be granted by the 1^st defendant to any customer or borrower were conditions precedent to each of the Letters of Guaranty, alternatively implied terms of them, alternatively implied terms of the collateral contract.

23.Clauses 7 and 19 of the Shareholders Agreement respectively provided that :

“7.    Each of the parties (but not their assigns, successors or trustee-in-bankruptcy) is entitled to appoint or withdraw a representative as Director of the Company to be entitled for re-election from time to time.  Any further directors may be appointed or terminated at general meetings of the Company for one year period but eligible for re-election.  Other than the aforesaid, no other persons shall be admitted as a Director of the Company unless approved by the Company in general meetings.

….

19.    Subject to the overriding authority of the Board of Directors, the executive directors shall report to the Board of Directors and shall be responsible for supervising the general management of the Company and in processing approval of loan applications and to procure compliance and observance by the Company of the Money Lender’s Ordinance and other statutory provisions.  Any decision of the executive directors shall require simply (sic) majority of the executive directors.  The granting of any loan to any proposed borrower exceeding the sum of $300,000, or to a borrower who is related to any executive director by blood, business or other caused (sic) giving rise to a conflict of interest shall be approved by the Board of Directors.”

24.The 2^nd defendant contends that various loans in excess of $300,000 were granted by the 1^st defendant before 5 January 1998 without his approval.  He also contends that, because the plaintiff voted against his re-election to the board of the 1^st defendant at its first AGM held on 5 January 1998, he was denied his right to continual representation on the board of the 1^st defendant, and further, that various loans in excess of $300,000 were granted by the 1^st defendant after 5 January 1998 without his approval.

25.As a consequence, the 2^nd defendant contends that (i) the plaintiff is not entitled to claim under the Letters of Guaranty because these matters (i.e. continual representation on the board and participation in the loan approval procedure) were conditions precedent and they were not fulfilled; (ii) alternatively, the plaintiff was thereby in breach of the Letters of Guaranty so that the 2^nd defendant is entitled to rescind them; (iii) in the further alternative, the 2^nd defendant contends that the plaintiff was thereby in breach of the Letters of Guaranty or the collateral contract and that he is entitled to counterclaim for loss and damage suffered as a result.

Breach of Undertaking

26.Finally, the 2^nd defendant contends that on 5 January 1998 in the aftermath of the first AGM of the 1^st defendant, at which the plaintiff voted against the re-election of the 2^nd defendant to the 1^st defendant’s board, he threatened to report the matter to the ICAC and the CCB and to apply to the court for the immediate liquidation of the 1^st defendant.  He contends that in response, Mr Kung of the plaintiff said that in return for the 2^nd defendant’s forbearance from reporting the matter to the authorities in question and from putting the 1^st defendant into liquidation, he would undertake (i) to suspend the 1^st defendant’s money lending operations temporarily until all outstanding loans had been recovered from customers, and (ii) to arrange for soonest repayment by the 1^st defendant of all moneys due to its shareholders.

27.By reason of the 1^st defendant’s re-financing of various loans after 5 January 1998, the 2^nd defendant contends that the plaintiff breached the undertaking and he claims loss and damage which he seeks to set off against any liability to the plaintiff on the Letters of Guaranty.

The witnesses

28.Both parties called oral evidence at the trial.  For the plaintiff, evidence was given by Mr Kung and also by a Mr Chong Sze Wai, who was employed by the 1^st defendant as a loan officer.  The 2^nd defendant gave evidence and a Ms Pang Yuk Fong, who was an accountant retained by the 2^nd defendant around the time of the second AGM of the 1^st defendant held on 1 April 1999, was also called to give evidence on his behalf.  Witness statements of each of the above witnesses were filed which I was informed by the parties had earlier been directed to stand as the respective maker’s evidence-in-chief.

29.In addition to the witness statements of the witnesses called to give oral evidence, a witness statement of the 3^rd defendant was also filed on behalf of the 2^nd defendant but he was not called to give oral evidence and the 2^nd defendant did not otherwise rely upon his statement.  The 2^nd defendant had also apparently served a subpoena on a Ms Kung Po Shan to attend at the trial to give evidence but counsel for the 2^nd defendant ultimately indicated that he did not propose to call her.

30.I shall deal below with the relevant conflicts in the evidence, to the extent necessary, when discussing the issues.

Discussion of the issues

Express written terms of the guarantees

31.Each of the letters of guaranty is in a similar form and is headed “Letter of Guaranty”.  It is addressed to the plaintiff and identifies and defines the 1^st defendant as “the said Debtor”, the plaintiff as “the said Creditor” and the 2^nd defendant as “the said Guarantor”.  Each Letter of Guaranty then sets out the monetary sum of the Loan Amount, which is defined as “the said Loan” and is cross-referred to a Promissory Note made between the Creditor and the Debtor of the same date as the Letter of Guaranty, defined as “the said Promissory Note”.

32.The Letter of Guaranty then provides as follows :

“I, [the 2^nd defendant] do hereby agree that in the event of default in payment by the said Debtor on the respective due dates under the said Promissory Note, being either principal or interest, I will guarantee that 40% of the said Loan then outstanding will be paid to the extent of not exceeding [the particular dollar amount representing 40% of the Loan Amount] if the said Loan cannot be recovered from the said Debtor despite having taken necessary proceedings.  This Guaranty shall expire and be cancelled and void unless written notice of any claim under any claim under this Guaranty is sent and received by the Guarantor at the said Guarantor’s address.”  (My emphasis)

33.Each Letter of Guaranty is dated on a date corresponding to the date of the Promissory Note evidencing the particular loan from the plaintiff to the 1^st defendant and each is signed by the 2^nd defendant as Guarantor.

34.As will be apparent, the Letters of Guaranty were not in the nature of standard form guarantees of the sort customarily used by banks and other financial institutions.  Hence, various terms that are designed for the benefit of a creditor, such as a principal debtor clause or conclusive evidence clause, are not included.  The guarantee is only for the principal amounts of the loans and not for interest. 

35.Although the evidence was not clear as to who actually drafted the Letters of Guaranty signed by the 2^nd defendant in favour of the plaintiff, it appears that the parties simply adopted the form of the earlier guarantees that had been given by the shareholders under the Call Fund Procedure in the early part of 1997.  An earlier form of guaranty provided by one of the pre-1 May 1997 shareholders, namely Mr Leo Lok Kin Wah, who held his shares in the 1^st defendant through Grandpot Limited, was identified and the operative parts are substantially in the same terms as those of the Letters of Guaranty given by the 2^nd defendant.

What were the conditions precedent to liability under the Letters of Guaranty?

36.The first question that arises is whether it is a necessary precondition to liability arising under the guarantees for the plaintiff to plead and prove that the loan amounts “cannot be recovered from the said Debtor despite having taken necessary proceedings”.  Although the plaintiff’s pleaded case appears to proceed on the basis that this is the case, and the case was opened on the basis that when the writ was issued the loans could not be recovered, counsel for the plaintiff argued in his closing submissions that the words “if the said Loan cannot be recovered from the said Debtor despite having taken necessary proceedings” do not constitute a condition precedent to liability.  He submitted that these words should be read as qualifying the words “to the extent of not exceeding [the particular dollar amount representing 40% of the Loan Amount]” and that they merely indicate that the quantum of the 2^nd defendant’s guarantee liability might be reduced in the event the plaintiff were to recover part of the loan amount from the 1^st defendant.

37.The 2^nd defendant contended that there were certainly two, and possibly three, conditions precedent to liability under the Letters of Guaranty : first, default in the payment by the 1^st defendant on the respective due dates under the relevant promissory note; second, the establishment of the fact that the loan amount could not be recovered; and (possibly) third, the taking of necessary proceedings to demonstrate that the loan amount could not be recovered.

38.The modern approach to the construction of guarantees is that they should be construed according to usual contractual principles, but cases of doubt and ambiguity are to be resolved in favour of the guarantor : see The Modern Contract of Guarantee (English Edition, 2003) paras. 5-04 and 5-05.  Thus, the usual principles by which contractual documents are construed, as summarised by Lord Hoffman in Investors Compensation Scheme Ltd v. West Bromich Building Society [1998] 1 WLR 896 at 912-913, apply.

39.In my opinion, and applying those usual principles of contractual construction, the construction of the guarantees for which the plaintiff contended is not correct.  Reading the guarantees as a whole, I consider that it is clear, simply as a matter of plain language, that there are two distinct and separate triggering events before the 2^nd defendant can be liable thereunder.  The first is “in the event of default in payment by the said Debtor on the respective due dates under the said Promissory Note” and the second is “if the said Loan cannot be recovered from the said Debtor despite having taken necessary proceedings”.  It is true that the order of the wording in the operative paragraph is odd in that the two triggering events might have been better expressed by both being placed before the words “I will guarantee …”.  However, I do not think that this eccentricity in the word order affects the position.  Both the elements are triggering events before the liability to guarantee arises.

40.The operative part of the guarantee is that the 2^nd defendant “will guarantee that 40% of the said Loan then outstanding will be paid to the extent of not exceeding [the particular dollar amount representing 40% of the Loan Amount]”.  By the use of the phrase “then outstanding”, it is unnecessary, and does not make sense, for the words “if the said Loan cannot be recovered from the said Debtor despite having taken necessary proceedings” to be read merely as qualifying “the extent of” the guaranteed amount, as was submitted on behalf of the plaintiff.  When liability is triggered upon the happening of the two conditions precedent, the amount that is “then outstanding” is the amount for which the guarantor will be liable.  There is no further need to qualify the extent of the guaranteed amount.

41.The occurrence of the first condition precedent is relatively easy to ascertain, namely default in payment on the due dates under the relevant promissory notes.  The occurrence of the second condition may not be so clear.  What needs to be established is that the loan amount cannot be recovered from the 1^st defendant despite having taken necessary proceedings, not merely that the 1^st defendant is unwilling to pay or that enforcing payment may be difficult.  It was submitted on behalf of the 2^nd defendant that “if the said Loan cannot be recovered” meant if or when or in the event that the entire principal sum of the loan, or part of it, could not be recovered.  It was further submitted that “cannot be recovered” denoted finality and did not mean “could not yet be recovered”.  I agree with those submissions, which seem to me to be incontrovertible as a matter of plain language.  In my opinion, the additional words “despite having taken necessary proceedings” support this conclusion: it may or may not be clear whether the loan amount can be recovered and the taking of necessary proceedings will assist in demonstrating whether the required degree of irrecoverability has occurred.  In other words, the creditor may be able to show that he cannot recover the loan amount simply by reference to a state of affairs, e.g. the insolvency of the debtor without the creditor having taken any proceedings, or he may be required to exhaust his legal remedies in order to demonstrate that he cannot recover the loan amount.  This element is, in my view, a part of the second condition precedent and not an independent condition precedent to liability.

42.I conclude therefore that the plain wording of the guarantees does require the plaintiff as creditor to demonstrate that it cannot recover the loan amount from the 1^st defendant as debtor before the 2^nd defendant will be liable as guarantor.  That this may make the Letters of Guaranty less commercially valuable or delay the time when the guarantor can be pursued or place a heavy burden on the plaintiff in seeking to enforce them is simply the result of the agreement embodied in them.

Has the plaintiff established that the conditions precedent to the 2^nd defendant’s liability existed as at the date of the writ?

43.It was submitted on behalf of the 2^nd defendant that the plaintiff neither pleaded nor established that the loan amounts subject to the Letters of Guaranty could not be recovered as at the date of the writ.  To support this submission, counsel for the 2^nd defendant referred to the plaintiff’s Re-Re-Amended Consequential Reply, which pleaded the plaintiff’s case as to the occurrence of the second triggering event.  In paragraph 7 of that pleading, the plaintiff pleads the fact of the writ against the 1^st defendant, the judgment entered in default, the winding up petition and the winding up order eventually made, culminating in the pleas that “The Plaintiff’s loans to the 1^st Defendant were not recoverable despite having enforced the Judgment and taken the Winding-Up Proceedings against the 1^st Defendant” and “By reason of the matters pleaded in paragraphs 7(a) to (f) hereinabove, the 2^nd Defendant being the guarantor of the 1^st Defendant has become and is liable to pay to the Plaintiff all the outstanding sum payable by the 1^st Defendant under the Judgment to the extent of not exceeding HK$4,400,000.00 under all the Letters of Guarantees signed by him in favour of the Plaintiff”.  Moreover, the 2^nd defendant refers to the fact that the plaintiff pleads that “For the period between 1^st May 1998 and 17^th April 2000, the 1^st Defendant had paid to the Plaintiff a total sum of $6,368,274.40”.  Those sums were appropriated by the 1^st defendant to both interest and principal amounts of all the loans evidenced by the promissory notes.

44.All this, says the 2^nd defendant, demonstrates that, whether or not it was necessary to take winding up proceedings, the loan amounts could not be demonstrated to be irrecoverable until after the last of the monthly payments made between 1 May 1998 and 17 April 2000.

45.For its part, the plaintiff contends that it has demonstrated the irrecoverability of the loan amounts by reference to a number of facts.  First, the failure of the 1^st defendant to pay the loan amounts in the face of a letter of demand to the 1^st defendant dated 9 July 1998.  Second, a resolution of the 1^st defendant’s board dated 26 March 1998 resolving that the 1^st defendant “would temporarily freeze all cheques for repayment of the principal of shareholders’ loans until the resolution of the extraordinary general meeting”.  Third, a letter apparently dated 10 August 1998 from the 1^st defendant to its three shareholders referring to the writ (although this is curious, as the writ was not in fact issued until 18 August 1998) and stating that it “still cannot repay all outstanding loans up till now”.  Fourth, the fact that there was no repayment of the principal of the loan amounts after the issue of the demand letter.  I understood the fourth matter to relate to the period after the date of the demand letter and before the date of the writ, because it was otherwise inconsistent with the plaintiff’s pleaded case that sums were applied to both interest and principal sums due under the loans in the period between 1 May 1998 and 17 April 2000.

46.I am not satisfied that the plaintiff has demonstrated that, as at the date of the writ in this action (18 August 1998), the loan amounts could not be recovered as required under the guarantees :

(1)     The failure to pay in response to the letter of demand dated 9 July 1998 does not, in my opinion, satisfy the requirement that the loan amounts could not be recovered despite the taking of necessary proceedings.  All that this demonstrates is that the 1^st defendant was unwilling to pay the outstanding loan amounts to the plaintiff, not that it was unable to do so.

(2)     The resolution of 26 March 1998 is no proof that the loan amounts in question were irrecoverable.  It was unclear from the evidence whether the shareholders loans in question were the additional $2 million of capital injected by the shareholders in May 1997 and which the shareholders had resolved in their monthly meeting on 1 October 1997 would be repaid by instalments as opposed to the call funds which were the subject of the promissory notes and the guarantees.  In any event, the fact that the freeze contemplated was expressed to be temporary indicates that it was envisaged that payments of principal would resume.

(3)     It is no answer, in my opinion, for the plaintiff to say that the loan amounts could not be recovered because the 1^st defendant had not received any sums from its own debtors in the period to 18 August 1998.  The plaintiff could have commenced proceedings against the 1^st defendant and, upon obtaining judgment, sought and obtained garnishee orders against those customers of the 1^st defendant with outstanding loans.  If it had done so, the plaintiff might or might not have been able to show that the loan amounts due from the 1^st defendant could not be recovered but absent the taking of such rudimentary and obvious steps to enforce payment against the 1^st defendant before commencing this action against the 2^nd defendant, I do not consider that the plaintiff can show that the loan amounts could not be recovered as at the date of the writ.  It is to be noted in this context that Ms Pang Yuk Fong gave evidence (which I accept) that at the second AGM of the 1^st defendant on 1 April 1999 she was given a schedule of “Overdue Interest and Principal” up to 31 March 1999 by Ms Kung Po Shan which records total debts due to the 1^st defendant from its customers of $3,779,842.79 interest and $9,948,763.69 principal.

(4)     Finally, I should add that I do not think that the self-serving statement in the letter dated 10 August 1998 is sufficient to demonstrate the irrecoverability of the loan amounts as at the date of the writ.  The fact that, subsequent to the date of the writ, the 1^st defendant made recoveries of loans made by it to its customers and was thus able to repay interest and part of the principal of the loans merely emphasizes the fact that it was not the case that the loan amounts could not have been recovered at that time.

47.I therefore find that the plaintiff has not established that the conditions precedent to liability on the part of the 2^nd defendant existed as at the date of the writ.

Should the plaintiff be required to start fresh proceedings against the 2^nd defendant?

48.It was submitted on behalf of the plaintiff that, even if the 2^nd defendant’s liability as a guarantor had not accrued at the date of the writ, his liability did accrue at the latest on 5 July 2000 when the 1^st defendant was wound up.  It was submitted that the plaintiff should not be driven away from the court and required to start another action.  The principle that the court should strive to avoid a multiplicity of legal proceedings was prayed in aid in support of this submission.  In my view, this is not a good reason to permit the plaintiff to succeed upon a claim which, as I have found above, had not accrued as at the date of the writ.

49.Counsel for the plaintiff relied upon the case of Lipers Enterprise Co. Ltd v. Realine Technology Ltd, HCA4214/2003, 7 May 2004, unrep., as support for the proposition that the court could, in a situation like the present, cater for the prematurity of the plaintiff’s action by depriving it of interest and costs for the period before the accrual of the cause of action.

50.In Lipers, Deputy Judge Jat, SC, declined to allow an appeal by a defendant against an Order 14 judgment on the ground that the plaintiff, by issuing its writ in November 2003, had prematurely sued on certain dishonoured cheques in breach of an agreement not to sue until 31 March 2004 whilst the parties continued to negotiate a settlement of their dispute.  At paragraph 6 of the judgment, the learned Deputy Judge said :

“In my judgment it would be wrong to drive the plaintiff from this court and force them to start another action.  Now that the time given to the defendant has already expired, what I think could be suitably done in those circumstances is simply to vary the judgment of the Learned Master so that the interest on the sum claimed would be 1% above the US dollar prime rate from the date of dishonour to, say, 1 June 2004, and the judgment rate would not kick in until after the date.  That would suitably compensate the defendant for any loss of interest caused by what may otherwise be considered a premature action.  I do not see any reason why this court should allow the defendant leave to defend the action on the basis that there was an agreement for forbearance to sue until 31 March when, by now, even if such an agreement were established, the plaintiff is definitely entitled to pursue its claim.  So I see nothing in the forbearance to sue point.”

51.In the present case, counsel for the plaintiff placed reliance on this passage in support of his submission that, even if the loan amounts were not shown to have been irrecoverable as at the date of the writ, they clearly were by the date of the winding up order in respect of the 1^st defendant.  He therefore submitted that the plaintiff’s claim should not be defeated by reason of its prematurity and that any injustice to the 2^nd defendant could be compensated by awarding interest and costs only from the date of the winding up order.

52.I do not agree with this submission.  In my judgment, the failure to satisfy a condition precedent to liability under a guarantee means that the cause of action is incomplete and the action stands to be dismissed.  Lipers was a case concerning an alleged agreement to forbear to sue and is therefore clearly distinguishable from the present case, which involves the failure to satisfy a condition precedent to liability.

Is it possible to save the plaintiff’s claim by way of amendment?

53.The plaintiff also submitted that the accrual of the plaintiff’s cause of action against the 2^nd defendant was pleaded in the Reply and that any defect in the Statement of Claim could be cured by amendment.  Reliance was placed on the decision in Woo Suk King v. Lam Lee Yuet Ha Lilian [1995] 3 HKC 701 at 707H-708G and the wide power of amendment referred to in paragraph 20/8/11 of Hong Kong Civil Procedure (2004 Ed.).  Counsel for the plaintiff also referred to and relied upon two English decisions, namely Maridive & Oil Services (SAE) & Anor v. CNA Insurance Co. (Europe) Ltd [2002] 2 Lloyd’s Rep. 9 and Beecham Group plc & Anor v. Norton Healthcare Ltd & Ors [1997] FSR 81 at 93, to support the proposition that the rule against allowing amendments to a claim to plead a subsequently arising claim was one of practice, not law, and could be departed from when the justice of the case required.

54.In my judgment, those cases do not assist the plaintiff.  Those cases permit the addition of an additional cause of action after the date of the writ but do not permit an amendment to cure a defective claim by the addition of a plea of a necessary factual averment that could not be pleaded as at the date of the writ.

55.Woo Suk King v. Lam Lee Yuet Ha Lilian was a case in which it was sought to amend a statement of claim in an action for slander by adding a plea of a further re-publication of the slander after the date of the writ.  Waung J permitted this amendment, holding that the practice prohibiting the addition of a post-writ cause of action could not be regarded as either the law or the law which he should apply (p.708F).  However, it is noteworthy that, in allowing the amendment in question, he emphasised inter alia that it (i) was not to cure any defect in the original writ, (ii) was merely adding a new complaint which could not have been made earlier when the writ was first issued and (iii) was adding a complaint which was not inconsistent with what was in the original writ (p.706A-B).  Waung J referred to the old authorities said to give rise to the inflexible rule that a post-writ cause of action would not be allowed and observed that :

“… the rationale of this practice is on the basis that when good title to sue was not shown by the original bill, that defective cause of action cannot be improved upon by facts subsequent to the original bill.  This is a far cry [from] adding a totally new cause of action not for the purpose of curing a possible defective cause of action.” (p.707F)

56.Nor, in my opinion, does Maridive v. CNA assist the plaintiff.  That case supports the distinction between an amendment to introduce an additional claim arising post-writ on the one hand, which may be allowed, and an amendment to plead a fact arising post-writ in order to cure a defect in the original claim, which will not be allowed.  In para.20 of his judgment, Mance LJ referred to Roban Jig & Tool Co. Ltd and Elkadart Ltd v. Taylor [1979] 1 FSR 130 in which, as Mance LJ noted :

“Lord Justice Bridge recognized that –

… those departures in practice from the absolute rigour of the rule that a plaintiff cannot recover on a cause of action which accrued only after the writ was issued were the daily practice of the Court.

But he went on to say that nothing –

… could possibly lead to the conclusion that it was appropriate to allow a plaintiff to amend so as to introduce a fact giving him a cause of action when at the time when the writ was issued he had no cause of action at all.”

57.Similarly, I do not think that Beecham Group plc v. Norton Healthcare Ltd assists the plaintiff.  There, Beecham had an existing cause of action for patent infringement.  They were seeking to add to that claim by amendment to include a claim for breach of confidence, albeit that the element of knowledge relevant to that cause of action only arose after the issue of the original proceedings.  As conveniently summarised in the headnote :

“(5)  Leave to amend a writ to add a cause of action not in existence at the time of issue of that writ could be granted provided that (i) the cause of action in the original writ was valid at the time of issue, and (ii) the new cause of action was valid at the application for leave to amend.”  (My emphasis)

Both of these conditions need to exist before leave to amend may be granted.

58.The rule against allowing an amendment to plead a post-writ fact in order to cure a defective plea is clearly supported by the decision of the Court of Appeal in Wing Siu Co. Ltd v. Goldquest International Ltd [2003] 2 HKC 64.  The headnote of the report neatly summarises the position as follows :

“It could not be said that the original rule in Eshelby v Federated European Bank had disappeared.  A distinction should be drawn between a case where the amendment was to allow a real dispute in the case to be determined and one which introduced into the action a cause of action which could be said to be incurably bad because it did not exist at the date of the original claim.  Where courts had been disposed to permit the pleading of subsequent events, it would be made on the basis that the amendment was to clarify why a claim could be made based on a cause of action which existed at the date of the issue of the writ.  It did not go so far as permitting, in the face of opposition, an amendment which would introduce into a writ a cause of action which simply did not exist at the date of issue of the writ.”

59.Therefore, in my judgment, the plaintiff cannot save its claim against the 2^nd defendant by amendment because the cause of action simply did not exist at the date of the issue of the writ.

Failure to prove case/overstatement of quantum of plaintiff’s claim

60.In light of my conclusions above, the plaintiff’s claim falls to be dismissed.  It is therefore strictly unnecessary for me to deal with the 2^nd defendants’ further submissions in defence of the plaintiff’s claim that (i) the plaintiff’s evidence as to the irrecoverability of the loan amounts was so deficient that there was no case for the 2^nd defendant to answer, or that (ii) there was an overstatement of the plaintiff’s claim against the 2^nd defendant.  However, in case I am later held to be wrong in my conclusions above, I propose to set out briefly the conclusions I would have reached on these further arguments.

Failure to prove case

61.It was submitted on behalf of the 2^nd defendant that the plaintiff simply failed to come up to proof that the loan amounts guaranteed were irrecoverable.  It was said this was so even if one took the date of the winding up order as the date on which the irrecoverability was alleged to have crystallised.

62.In the context of this submission, the 2^nd defendant further contended that the 1^st defendant was at all material times after 6 January 1998 controlled by the plaintiff by reason of the fact that (i) as from the first AGM of the company on 5 January 1998, the 2^nd defendant had not been re-elected to the board of directors and instead, Mr Kung had caused his younger sister, Ms Kung Po Shan, to be elected and also (ii) the 3^rd defendant resigned as a director and executive director of the company on 6 January 1998.  In light of this control of the 1^st defendant by the plaintiff, the 2^nd defendant maintained that any irrecoverability of the loan amounts was the result of the plaintiff’s misconduct or connivance in causing the default in repayment of those loan amounts and that therefore the 2^nd defendant should not be liable as guarantor.

63.It is the case that, as from 6 January 1998 when the 3^rd defendant resigned, the plaintiff effectively controlled the 1^st defendant’s board.  At the first AGM of the 1^st defendant, Mr Kung on behalf of the plaintiff and the 3^rd defendant voted against the re-election of the 2^nd defendant as a director of the company.  The 2^nd defendant then did not offer himself for election as an executive director.  As a result of Ms Kung Po Shan’s election, that left the plaintiff, Ms Kung Po Shan and the 3^rd defendant as directors.  On the following day, 6 January 1998, the 3^rd defendant resigned as both a director and executive director of the 1^st defendant.  On 20 May 1998, the plaintiff resigned as a director and was replaced by TKL Nominees Limited, a corporate services provider engaged by Mr Kung.

64.Subject to the quantum argument dealt with below, I would have rejected the submission that the plaintiff failed to prove the irrecoverability of the loan amounts for the following reasons in summary :

(1)     I was not satisfied that the 1^st defendant’s default was the result of the plaintiff’s misconduct or connivance.  Counsel for the 2^nd defendant accepted that the burden of establishing this contention lay on his client.  Notwithstanding the fact that I find that the 1^st defendant’s board was at all material times after 6 January 1998 effectively controlled by the plaintiff, I do not consider that there is any or any sufficient evidence upon which I should find that the plaintiff was guilty of misconduct or connivance in causing the 1^st defendant’s default in repayment of the loan amounts.

(2)     On the contrary, I accept Mr Kung’s evidence that the 1^st defendant’s financial difficulties flowed from the nature of its business.  It was the nature of the 1^st defendant’s business of making loans to customers by way of second mortgage finance that was the cause of its difficulties and led to its commercial demise.  When the property market in Hong Kong fell dramatically as a result of the Asian financial crisis commencing in the latter part of 1997, the knock-on effect was that 1^st defendant’s customers were unable to repay their loans.  It was this that resulted in the failure of the 1^st defendant to earn profits and to recover monies it had lent to its customers in order to be able to repay its indebtedness to the plaintiff.

(3)     Although the plaintiff might have presented clearer evidence of the 1^st defendant’s insolvency, and I have not overlooked the 2^nd defendant’s complaint that the audited accounts for the 1^st defendant for the year ended 31 March 1998 were not produced by the plaintiff, there was evidence that the 1^st defendant was effectively insolvent when wound up.  The winding up order was the subject of a hearsay notice filed on behalf of the plaintiff and the Statement of Affairs in respect of the 1^st defendant was the subject of a hearsay notice filed on behalf of the 2^nd defendant.  The latter document showed that as at the date of the winding up order, the 1^st defendant had assets of only $1,623.99.  There was no evidence that there were any other assets available to repay the outstanding loan amounts.

Quantum of plaintiff’s claim

65.The 2^nd defendant’s submission on quantum was based on the way in which the 1^st defendant had appropriated payments to offset the indebtedness due from it to the plaintiff in the period from 1 May 1998 to 17 April 2000.  As I have noted above, during that period a sum of $6,368,274.40 was applied by the 1^st defendant in reduction of the indebtedness due from it to the plaintiff.  The plaintiff’s pleaded case shows that of this sum, $3,247,257.69 was apportioned to repayment of loan principals and $3,121,015.71 was apportioned to payment of ongoing loan interest.

66.Counsel for the 2^nd defendant submitted that as the promissory notes were silent as to which of the plaintiff and 1^st defendant had the right to appropriate payments, the common law rule applied so that 1^st defendant had the primary right of appropriation.  For the common law rule, counsel for the 2^nd defendant relied on the dictum in the speech of Lord Shaw of Dunfermline in Deeley v. Lloyds Bank Limited [1912] AC 756 at 783-784 :

“According to the law of England, the person paying the money has the primary right to say to what account it shall be appropriated; the creditor, if the debtor makes no appropriation, has the right to appropriate; and if neither of them exercises the right, then one can look on the matter as a matter of account and see how the creditor has dealt with the payment, in order to ascertain how he did in fact appropriate it.  And if there is nothing more than this, that there is a current account kept by the creditor, or a particular account kept by the creditor, and he carries the money to that particular account, then the Court concludes that the appropriation has been made; and having been made, it is made once for all, and it does not lie in the mouth of the creditor afterwards to seek to vary that appropriation.”

67.The 2^nd defendant contends that he was prevented from asserting a right to cause the 1^st defendant to appropriate the whole sum of $6,368,274.40 to repayment of principal rather than partly to interest and partly to principal.  Hence, the 2^nd defendant argued that the principal of the loan amounts in the total sum of $11 million should be reduced by $6,368,274.40 resulting in an outstanding amount of $4,631,725.60.  The 2^nd defendant’s 40% guarantee liability would therefore be $1,852,690.24.

68.I would have rejected this argument as well.  It is not clear that, as a 40% shareholder in the 1^st defendant, the 2^nd defendant would have been able to influence the way in which the company appropriated payments as between loan principals and interest.  Furthermore, the 2^nd defendant has not shown that, if the repayments had all been appropriated to loan principals rather than interest, this would not simply have led to the 1^st defendant being wound up at an earlier date with the consequence that it might not have recovered as much of its own loans from its own customers, thereby leaving a larger shortfall in its indebtedness to the plaintiff.

The Oral Assurances, Unauthorised Loans and Breach of Undertaking

69.Although the plaintiff’s claim stands to be dismissed for the reasons given above, it is necessary to deal with the other defences that were relied upon by the 2^nd defendant, namely those based on the alleged oral assurances, unauthorised loans and breach of undertaking, because these matters were also relied upon by the 2^nd defendant by way of counterclaim.

The Oral Assurances

70.The defences based on the oral assurances raise the following subsidiary issues :

(1)	Were the oral assurances given as a matter of fact?  This is a pure question of fact.
(2)	If they were given did they constitute conditions precedent to liability under the guarantees, or implied terms of the guarantees or merely contracts collateral to the guarantees?
(3)	Was there a breach of the Third Assurance (it being common ground that the Second Assurance, if it was given, was not complied with)?
(4)	What, if any, loss flowed from such breach?

Were the Oral Assurances given as a matter of fact?

71.This issue turns on a conflict of evidence.  Mr Kung, for his part, flatly denied having given the oral assurances.

72.It was the 2^nd defendant’s evidence and case that the restructuring of the 1^st defendant was the result of Mr Kung wanting to expand the money lending business of the 1^st defendant more aggressively than his friends Messrs Lok, Guo and Leung and, in the face of their resistance to such expansion, Mr Kung turned to the 2^nd defendant to assist him to become the major shareholder of the 1^st defendant.  The 2^nd defendant maintained that Mr Kung was responsible for persuading the other three individuals to sell their shares but was embarrassed about taking up all of his friends’ shares in the company.  Consequently, the 2^nd defendant claimed, Mr Kung asked him to take up 14% of Mr Lok’s shares to avoid that embarrassment.  It was the 2^nd defendant’s evidence that he was holding those 140,000 shares in the 1^st defendant on behalf of Mr Kung.

73.The 2^nd defendant maintained that a total of four oral assurances were given to him by Mr Kung, namely the three oral assurances set out above and the assurance that the plaintiff “would not demand for any repayment of the loan advanced to the 1^st defendant when the 1^st defendant was not in a sound financial position”.  In his evidence, the 2^nd defendant said Mr Kung gave these promises in different places and at different times between December 1996 and April 1997.  He could not remember the order in which they were given, nor whether they were given one by one over a period of time.

74.When it was put to him in cross-examination that Mr Kung had not given the oral assurances, the 2^nd defendant gave a lengthy explanation of his thinking when entering into the liabilities under the guarantees.  He explained that, because of the capital structure and projected income of the 1^st defendant, he considered that it was only if the 1^st defendant had bad debts of 40% or more that his liability under the guarantees might arise.  He said that the most important thing was that all the loans were secured by properties.

75.Counsel for the 2^nd defendant emphasised the importance of the Second Assurance in closing submissions when he observed that but for the buy back assurance there would not have been the other assurances.  He explained that his rationale for saying this was because the 2^nd defendant was anxious about his increased risk in giving the guarantees as to 40% of the loan amounts.

76.For the following reasons, I find that none of the oral assurances relied upon by the 2^nd defendant were given :

(1)     The 2^nd defendant was extremely vague in his evidence as to when and in what circumstances they were given.  If they were as important to him in his decision to sign the Letters of Guaranty as he maintained, I would have expected him to be much clearer in his recollection and definite in his evidence.

(2)     The explanation that Mr Kung asked the 2^nd defendant to hold 14% of the shares in the 1^st defendant to save Mr Kung from the embarrassment of taking up all of the shares of his friends was most improbable.  The shareholders had unanimously agreed to sell the 1^st defendant’s business at the shareholders’ meeting in March 1997 and had agreed upon a price at the shareholders’ meeting on 23 April 1997.  I do not think that it is realistic to think that Mr Kung would be embarrassed to take up all his friends’ shares in those circumstances.  His friends were perfectly content to sell their shares and had agreed a price for the 1^st defendant’s business.  The identity of the purchaser would, in those circumstances, have been a matter of indifference to them.

(3)     The restructuring involved Mr Kung taking up all the shares of Mr Guo and Mr Leung but only part of the shares of Mr Lok.  If there was embarrassment, as the 2^nd defendant suggested, it does not make sense that some part of Mr Guo’s and Mr Leung’s shares would not also have been transferred to the 2^nd defendant to avoid giving the impression that Mr Kung was taking up such a large proportion of his friends’ shares.

(4)     The 2^nd defendant’s insistence that he was only holding the 14% of the shares on behalf of Mr Kung is simply not credible.  As a result of the restructuring he was treated as having paid a sum towards share capital, which included the nominal share price of $140,000 for those shares, for his entire 40% shareholding.  There is no reason why, if he was merely to hold the shares nominally to avoid embarrassment to Mr Kung, he would have to pay for them.  Mr Lok would have been none the wiser if Mr Kung provided the funds on behalf of the 2^nd defendant.

(5)     If the 2^nd defendant was only nominally holding 14% of the shares in the 1^st defendant on behalf of Mr Kung, there is no reason why he should have needed to provide Letters of Guaranty for 40% of the loan amounts advanced by the plaintiff by way of call funds.  The Letters of Guaranty could simply have been restricted to 26%, which, according to the 2^nd defendant, would have been a true reflection of his real shareholding in the 1^st defendant.

(6)     The “fax proposal” and “Net-Pay Schedule” which led to, and evidenced the terms of, the restructuring agreement between the plaintiff, the 2^nd defendant and the 3^rd defendant shows the 2^nd defendant taking up 40% of the shares of the 1^st defendant without any indication the new shares would be held on behalf of Mr Kung.  The 2^nd defendant denied being the maker of those documents.  Mr Kung’s evidence was that these documents were discussed with the 2^nd defendant and the 3^rd defendant before the latter faxed them to him.  Given his familiarity with their contents, it seems unlikely that the 2^nd defendant was not at least partly the author of those documents.

(7)     The restructuring agreement also involved the employment by the 1^st defendant of a management company, East Peak Properties Mortgage Limited (“East Peak”).  The “fax proposal” set out details of the management fee that would be payable to East Peak.  The 2^nd defendant insisted that this was a company set up at the instigation of Mr Kung in case he could not persuade his friends to sell their shares in the 1^st defendant, in which event it was Mr Kung’s plan to transfer the money lending business to East Peak.  However, that company was owned by the 2^nd and 3^rd defendants as to 40% each and a Mr Fong Chi Wing as to 20%.  In the circumstances, I do not believe the 2^nd defendant’s evidence that the restructuring of the 1^st defendant and the establishment of East Peak was solely the idea of Mr Kung, as he maintained, or that he was not responsible for the contents of the documents evidencing the terms of the restructuring.  This further supports the conclusion that the 2^nd defendant was fully intending to take up 40% of the shares of the 1^st defendant, without any buy-back arrangement as alleged.

(8)     The 2^nd defendant claimed to be a cautious and careful person in relation to his decision to give the guarantees.  If so, it is strange that he signed each of the seven Letters of Guaranty without requiring any written note to record that they were being given by him in reliance on the assurances.

(9)     The 2^nd defendant made no request to Mr Kung to buy back 14% of his shares in the 1^st defendant at the end of the financial year on 31 March 1998. 

(10)    The assurances were only pleaded for the first time by way of re-re-amendment in 2003.

(11)    There is no contemporaneous document to support the existence of the particularly important Second Assurance, relating to the alleged promise to buy back the 14% of the shares in the 1^st defendant that the 2^nd defendant acquired at the time of the restructuring :

(a)      Whilst the First Assurance is reflected in the fact of the appointment of the 3^rd defendant as an executive director with effect from 1 May 1997 pursuant to the shareholders’ resolution at a meeting on 9 May 1997, I do not think that this provides any support for the giving of the oral assurances as a whole, nor the giving of the First Assurance as an inducement to the 2^nd defendant to give the guarantees.  Prior to 1 May 1997 the three executive directors of the company were the plaintiff, the 2^nd defendant and Mr Louis Leung Wing On.  As the latter was selling his shares and withdrawing from the company, the appointment of the 3^rd defendant as an executive director was a natural step for the shareholders of the 1^st defendant to take.

(b)     Likewise, the fact that the Third Assurance is reflected in a shareholders’ resolution at the same meeting on 9 May 1997 does not mean that this oral assurance was given as an inducement to the 2^nd defendant to give the guarantees.  On the contrary, the fact that there is nothing in the documentation to indicate that the loan approval policy has anything to do with the Letters of Guaranty indicates, in my judgment, that the resolution concerning the loan approval policy was not related to the giving of the guarantees.

(12)    I am sceptical of the asserted purpose of the new loan approval policy, which the 2^nd defendant contended was to ensure that the 1^st defendant would be able to repay the plaintiff’s loans.  It is questionable how the policy could ensure the 1^st defendant’s ability to repay the plaintiff.  The commercial risk remained that the 1^st defendant’s customers might default, regardless of the new loan approval policy, and this default might in turn affect the 1^st defendant’s ability to repay the plaintiff.  Whilst scepticism as to the efficacy of the Third Assurance in achieving its stated purpose does not rule out the possibility that the assurance might have been given, it does seem to me to undermine the 2^nd defendant’s evidence that he only gave the guarantees in reliance upon this alleged oral assurance.

(13)    Overall, I was not impressed with the 2^nd defendant as a witness.  He was prone to argue his case when giving evidence and even in his examination in chief had to be reminded by his own counsel to restrain this tendency.  In respect of the oral assurances, I had little hesitation in preferring the evidence of Mr Kung.

77.In light of my finding of fact that the oral assurances were not given, it is unnecessary to consider their contractual effect, or whether there was any breach of the Third Assurance or any resulting loss and damage. 

Unauthorised Loans

78.As a result of my finding of fact that the Third Assurance was not given, it is not necessary to consider whether the 2^nd defendant’s continual representation on the board of the 1^st defendant and his participation in the loan approval procedure was a condition precedent or implied condition of the guarantees given by the 2^nd defendant in favour of the plaintiff.  However, it remains necessary to consider the allegation that the plaintiff caused unauthorised loans to be granted as this forms part of the 2^nd defendant’s counterclaim.  In this context, the relevant loans were those referred to by the parties as the “pre-5 January 1998 loans” and the “post-5 January 1998 loans”.

79.At a shareholders’ meeting on 9 May 1997, the plaintiff, the 2^nd and 3^rd defendants passed the following resolution :

“All of the directors/shareholders agreed that starting from this day, loans under $300,000 only require the approval of two directors/shareholders for them to be considered valid and officially approved.  However, loans over $300,000 require the approval of all directors/shareholders for them to be considered valid and officially approved.”

It was common ground that this resolution had the effect of varying the loan approval procedure contained in clause 19 of the Shareholders Agreement.

80.Mr Kung’s evidence was that this resolution was intended only to apply to new loans and not to the re-financing of an existing loan, whether by way of extending an original loan or increasing the amount of the loan.

81.The 2^nd defendant’s case was that (i) prior to 5 January 1998, the 1^st defendant granted two new loans and re-financed two loans each in excess of $300,000 without his approval, and (ii) after 5 January 1998 the 1^st defendant re-financed nine loans in excess of $300,000 without his approval.

82.To support its case that the pre-5 January 1998 loans were not unauthorised, the plaintiff called Mr Chong Sze Wai, who was employed as a loan officer by the 1^st defendant between June 1997 and April 1998.  He explained that in respect of the pre-5 January 1997 loans (other than the re-financing of the loan to Wang Tien Yueh), and also a further loan of $2 million, he faxed the loan application forms to the 2^nd defendant and followed up by telephoning him to ask whether the application forms should be sent to him for signature.  The 2^nd defendant’s response was in each case, according to Mr Chong, to the following effect, “No problem for the loan application, I will add my signature some time later”.  In respect of these loans, Mr Chong explained that he prepared written reports in Chinese in early December 1997 to record the fact of the 2^nd defendant’s oral approval of the loans.  Mr Kung’s evidence was that the loan to Wang Tien Yueh was a case of re-financing and therefore did not require approval.  The preparation of the Chinese reports by Mr Chong was apparently done as a result of the 2^nd defendant having queried the approval of the $2 million loan as reflected in unsigned minutes of the shareholders’ meeting on 27 November 1997.  Mr Chong explained that he had prepared reports on the instructions of the 3^rd defendant for each of the loan applications which the 2^nd defendant had not signed.  The 2^nd defendant gave evidence that he queried all five loans at that meeting and did not accept the accuracy of the unsigned minutes.

83.There were aspects of Mr Chong’s Chinese reports that were unclear and he was cross-examined at some length on variances between his witness statement and the Chinese reports.  However, at the end of the day, I was satisfied that Mr Chong was a truthful witness.  I therefore accept his evidence that he did fax to the 2^nd defendant the loan application forms in respect of the pre-5 January 1998 loans.  I find that the 2^nd defendant did orally approve those loans as reflected in Mr Chong’s Chinese reports.  I think there was some force in the point made by counsel for the plaintiff that the 2^nd defendant’s complaint about the $2 million loan recorded in the minutes of the 27 November 1997 shareholders’ meeting was somewhat hollow in light of the minutes of the 19 August 1997 meeting, which he signed to confirm his attendance, and which recorded the making of that loan.  It is also telling that the alleged complaints about the pre-5 January 1998 loans came in the aftermath of the 2^nd defendant having fallen out with the plaintiff and the 3^rd defendant at the shareholders’ meeting on 4 November 1997 when the 3^rd defendant pressed the 2^nd defendant to make contributions to the 1^st defendant by way of call funds (an obligation which the 2^nd defendant disputed).

84.It was common ground that the 2^nd defendant was not asked for his approval in relation to the re-financing of the loan to Wang Tien Yueh, one of the pre-5 January 1998 loans, and all of the post-5 January 1998 loans.  However, after 5 January 1998, the 2^nd defendant was neither a director nor executive director of the 1^st defendant and so the resolution of 9 May 1997 could be complied with even in the absence of his approval.

85.Most significantly, there was no evidence adduced by the 2^nd defendant as to the loss and damage that flowed from any breach of the loan approval procedure.  Even if some or all of the pre-5 January 1998 loans and the post-5 January 1998 were granted otherwise than in accordance with that loan approval procedure, the 2^nd defendant’s counterclaim in this regard must fail for lack of proof of any resulting loss and damage.  It is relevant to note, in this context, that in his closing submissions counsel for the 2^nd defendant acknowledged that he could advance no argument as to the measure of any loss flowing from a breach of the Third Assurance.

Breach of Undertaking

86.The first issue in respect of the 2^nd defendant’s allegation of breach of undertaking is whether Mr Kung gave the alleged undertaking on 5 January 1998.  This is again a contest between his evidence and that of the 2^nd defendant.

87.Mr Kung denies having given any such undertaking.  His evidence was that, in any event, the 1^st defendant did in fact cease conducting any new business and simply concentrated on collecting in old loans.  This involved extending existing loans but no new loans were granted.

88.For his part, the 2^nd defendant maintains that the undertaking was given by Mr Kung after the conclusion of the AGM on 5 January 1998 in response to his threat to report the manner in which the 1^st defendant’s business was being conducted to the ICAC and the CCB and that he would seek the revocation of the 1^st defendant’s money lending licence and the liquidation of the company.  He says that Mr Kung responded that the company’s liquidation would not be to the advantage of any of the shareholders and said that if the 2^nd defendant agreed not to seek its liquidation, he would cause it to cease all business until all the 1^st defendant’s debtors had paid off their debts. 

89.The 2^nd defendant wrote to the 1^st defendant on 19 February 1998 referring to an undertaking given by Mr Kung on 5 January 1998 that the company would “temporarily cease its lending business until the money lent was fully recovered from the customers to whom the money had been advanced”.  I do not see any reason to doubt what this letter, which was written very shortly after the AGM, records about the undertaking and to the extent recorded I find that this was what Mr Kung promised the 2^nd defendant.

90.However, I do not consider that the evidence establishes any breach of this undertaking :

(1)     The 2^nd defendant’s case appears to be that new loans were in fact granted after 5 January 1998.  To support this case, the 2^nd defendant called his accountant Ms Yvonne Pang Yuk Fong, who accompanied him to the 2^nd AGM of the 1^st defendant on 1 April 1999 as his representative.  She testified that on 17 March 1999 she called Ms Kung Po Shan to ask for an updated schedule of outstanding loans and in return received a document entitled “Overdue Interest and Principal” up to 24 February 1999.  At the 1 April 1999 AGM, she received an updated version of that document with the same heading but updated to 31 March 1999.  Ms Pang was a straightforward witness and I accept her evidence, but these schedules do not prove that the 1^st defendant engaged in new business as opposed to seeking the recovery of existing loans.  The fact that this might have involved extending overdue loans in return for the payment of interest does not, in my opinion, constitute new lending business in breach of the undertaking.

(2)     The 2^nd defendant also referred to the schedule of debts due to the 1^st defendant in the Statement of Affairs filed in connection with the 1^st defendant’s winding up.  On its face that schedule appears to indicate that debts were contracted after 5 January 1998.  However, a review of those debts with dates after 5 January 1998 reveals that the customers and loans were existing customers and loans as shown on a List of Clients dated up to 31 October 1997.  In the circumstances, the Statement of Affairs does not, in my view, assist the 2^nd defendant to demonstrate a breach of the undertaking.

91.In any event, I can discern no loss and damage arising from the alleged breach of the undertaking.  The 2^nd defendant’s pleaded case was that by reason of irrecoverable debts incurred by the 1^st defendant, there was a corresponding reduction of its ability to repay loan principal sums to the plaintiff and so an increase in his liability as a guarantor.  However, there was no evidence of any loss or damage said to flow from any breach of the undertaking.  When I raised this with counsel for the 2^nd defendant during his closing submissions, he was candid enough to say that he could not put his finger on what loss flowed from the breach of undertaking.

Conclusions

92.In light of the findings I have made above and my conclusions on the issues, I dismiss the plaintiff’s claim and also the 2^nd defendant’s counterclaim.

93.On the question of costs, the 2^nd defendant having succeeded in defending the plaintiff’s claim is entitled to an order for his costs.  However, I do not think that he should have all his costs.  The 2^nd defendant’s counterclaim, which I have dismissed, was dependent on a number of discrete points that were also relied upon in defence and which occupied a substantial part of the time at trial.  Having considered the matter in the round, I consider that the equitable result would be to order that the 2^nd defendant should have two-thirds of his costs of the action, to be taxed if not agreed, and I make an order nisi to this effect.

Mr Lawrence Yip, instructed by Messrs Kevin Kong & Co., for the Plaintiff

Mr Denis Gordon Yu, instructed by Messrs Fred Kan & Co., for the 2nd Defendant