The Bank of East Asia, Ltd v. Yip Chi Wai and Others

[English Translation – 英譯本]

HCMP2766/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2766 OF 2005

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BETWEEN

Before: Hon To J in Court

Dates of Hearing: 22 and 23 February 2011

Date of Judgment: 31 March 2011

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JUDGMENT

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Background

1.This case concerns disputes about bank loans. The Plaintiff (hereinafter referred to as BEA) took out an originating summons against the Defendants pursuant to Order 88 of the Rules of the High Court for recovery of payment in arrears. In addition to filing their Defence, the Defendants also put forward a counterclaim. The main issues herein are the rates at which BEA charged interests and its right to charge overdue interests and compound interests. On 1June 2009, Master Levy ordered BEA to have the action begun by originating summons converted to an action by writ. BEA therefore filed its Statement of Claim on 27 June 2009 to proceed with the action.

2.BEA is engaged in banking business and the Defendants are its clients. The 1^st and 2^nd Defendants are elder brother and younger sister, serving respectively as the company secretary and director of the 3^rd Defendant, a company registered in Hong Kong. All the Defendants are unrepresented. The 1^st and 2^nd Defendants appeared in person whereas the 3^rd Defendant was, with the leave of the court, represented by the 2^nd Defendant. I shall first set out the facts not in dispute.  

3.The 1^st Defendant was engaged in commercial activities in the form of joint-stock company as early as 1994. Through the introduction by his partner, he made the acquaintance of Raymond Chow (hereinafter referred to as Mr. Chow), a Business Manager of BEA. In the same year, he opened savings, current, foreign exchange and fixed term personal account(s) with BEA. BEA also provided a series of banking services such as standby credit to Tic Tac Oro Limited, another registered company operated by him at that time. In 1997, Mr. Chow was posted to another branch and Leo Wong (hereinafter referred to as Mr. Wong) replaced Mr. Chow in handling the account(s) of the 1^st Defendant’s joint-stock company.

4.Mr. Wong made a suggestion to the 1^st Defendant: if he used his own property as security, his joint-stock company would be able to get more standby credit from BEA. So the 2^nd Defendant founded the 3^rd Defendant in April 1997 and applied for credit from BEA. Besides, the 1^st and 2^nd Defendants used the properties under their respective names as security (hereinafter referred to as “the 1^st Property’ and ‘the 2^nd Property”) to apply to BEA for personal instalment loans. The negotiation with BEA concerning the details and arrangements for all the Defendants’ loans was all handled by the 1^st Defendant.  

5.On 23 August 1997, BEA issued facility letters to the 1^st and 2^nd Defendants, offering them personal instalment loans of $915,000 and $780,000 respectively (hereinafter referred to as “1997 facility letters”). Except for the loan amounts and names of borrowers, the two letters are identical in content. The two Defendants signed the letters respectively and accepted the terms concerned.

6.On 26August 1997, the 1st and 2nd Defendants signed jointly a non-capped bond (hereinafter referred to as “the 1st Bond”), undertaking to repay the 3rd Defendant’s loan(s).

7.On 10 September 1997, the 1^st Defendant signed a legal charge/mortgage (hereinafter referred to as “1^st Mortgage”) in relation to the 1^st Property, using it as security for the loans from BEA to the 1^st and 3^rd Defendants. On the same day, the 2^nd Defendant signed a legal charge/mortgage (hereinafter referred to as “2^nd Mortgage”) in relation to the 2^nd Property, using it as security for the loans to the 2^nd and 3 Defendants from BEA. Except for the mortgagors, mortgaged properties and the borrowers, the contents of the 1^st and 2^nd mortgages are identical.

8.After the loan procedures were completed, BEA began to provide overdraft loans to the 3^rd Defendant through its current account.

9.Between September 1997 and January 2004, the borrowings and repayments concerning all the Defendants were normal. However, in January 2004, the 3^rd Defendant began to default in repaying the overdraft loans and more than a million dollars were overdrawn.

10.On 13 January 2004, BEA issued a facility letter (hereinafter referred to as “2004 facility letter”) to the 3^rd Defendant, offering 3 loans for its debt restructuring: Invoice Financing Loan, Overdraft Facility and Non-revolving Term Loan. On behalf of the 3^rd Defendant, the 2^nd Defendant signed the 2004 facility letter in acceptance of the terms for the 3 loans.

11.On 2 March 2004, the 1st Defendant signed another non-capped bond (hereinafter referred to as “the 2nd Bond”), undertaking to repay the 3rd Defendant’s loan(s).

12.However, in July 2005, the 3^rd Defendant began to default on repaying the loans as prescribed by the 2004 facility letter. Subsequently, in October and November 2005 respectively, the 1^st and 2^nd Defendants also began to default on repaying their personal instalment loans.

13.On 19December 2005, after the originating summons was taken out by BEA against the Defendants for recovery of the defaulted payments, the 1^st Defendant repaid $22,629.95 towards the principal of the personal instalment loan and $21,761.95 towards the interest, the 2^nd Defendant repaid $19,087.12 towards the principal of the personal instalment loan and $19,255.58 towards the interest and the 3^rd Defendant repaid $20,000 towards the overdraft loan.

14.The claims lodged by BEA against the Defendants are as follows:

(1)  The 1^st Defendant:

For the personal instalment loan, outstanding principal balance of $644,380.90, loan interest and overdue interest of a total of $881,241.60 as well as delivery of vacant possession of the 1^st Property;

(2)  The 2^nd Defendant:

For the personal instalment loan, outstanding principal balance of $546,226.32, loan interest and overdue interest of a total of $741,619.24 as well as delivery of vacant possession of the 2^nd Property;

(3) The 3^rd Defendant:

1.   Regarding the Invoice Financing Loan, outstanding principal balance of $563,315, loan interest and additional penalty interest of a total of $872,313.85;

2.   Regarding the Non-revolving Term Loan, outstanding principal balance of $300,000, loan interest and overdue interest of a total of $461,178.14;

3.   Outstanding amount of $1,253,953.01 for the Overdraft Facility;

and

(4) 1^st and 2^nd Defendants:

Joint and several liability to pay the amounts due from the 3^rd Defendant in (3).

Apart from the interest on the 3^rd Defendant’s Overdraft Facility, all interests were computed on the basis of simple interest, with the inclusion of overdue interests (commonly known as “penalty interests”). For the Overdraft Facility, the interests were computed on the basis of compound interest and BEA did not charge overdue interest on it.

The basis of BEA’s claims and its case

15.The basis of BEA’s claims and its case are very simple. Its claims comprise outstanding principal balance and interests, some calculated on compound basis, as well as overdue interests on some of the loans. BEA’s claims  rely on various documents signed by the Defendants: the 1997 facility letters, the 1^st Mortgage, the 2^nd Mortgage, the 1^st Bond, the 2^nd Bond and the 2004 facility letter (hereinafter referred to collectively as “facility documents”). The Defendants admit to have signed the facility documents and have no dispute on their authenticity. In addition to the interpretation of the facility documents and the presentation of its case by Mr. Lee, BEA also relies on the elucidation by its Risk Manager Mr. Leung regarding the outstanding principal balance and the basis on which the interests were worked out.

Defendants’ grounds of defence and case

16.The main ground of defence of the 1st and 2nd Defendants is that, other than the facility documents, BEA has also reached a verbal agreement with them (hereinafter referred to as “verbal agreement”). According to that verbal agreement, the interest rate for their personal instalment loans was subject to fluctuation, would vary with the market and was adjustable, and that it was lower than the interest rate stated in the 1997 facility letters.     

17.The second ground of defence for the Defendants is that there is no contractual term whatsoever in the facility documents that gives BEA the right to charge compound interests and overdue interests.  

18.The Defendants allege that, in the process of handling the present proceedings, they have found many instances where BEA was wrong, unjust and in defiance of contractual spirit of the relevant terms when calculating interest. They also contend that the overcharged interests as well as the compound interests, overdue interests and banking fees charged in the absence of the contractual rights concerned have exceeded the amounts due from them. Accordingly, they deny owing BEA any money.

19.The defendants further allege that BEA has breached the verbal agreement by overcharging them $1,000,000 in interests; and, in the absence of contractual rights, has charged them compound interests, overdue interests and banking fees of $1,705,894.86. Nonetheless, no breakdown has been provided regarding the overcharged interests. They also accuse BEA of, with its overcharging of interests, causing them to misjudge their repayment ability and fail to change to another bank. They claim for overpaid interests of $2,705,894.86 as well as compensation for breach of contract (to be assessed), interests, costs and further or other relief.

20.In his Defence, the 1^st Defendant disputes that he has to pay $1,680 for fire insurance of the 1^st Property for the period between 2005 and 2009 on the ground that BEA had already deducted from his account the fire insurance fees for 2005 to 2007. BEA clarified in its Reply that it was referring to the fire insurance for 2007 to 2009. The 1^st Defendant did not respond to that in his evidence or final submission. However, as BEA has not claimed for such fire insurance fees in its Statement of Claim, I will not deal with the dispute about such insurance fees.

21.The 1^st Defendant stresses that any legal documents signed while one was being misled or under undue influence may be null and void. The 2^nd Defendant also relies on this argument. In other words, they allege that the facility documents signed when being misled or under undue influence are null and void. Nonetheless, in their Defence, they never sought to have the facility documents declared null and void on the grounds of having been misled or unduly influenced. Besides, their allegations are lacking in details. I do not intend to consider this suggestion.

22.The Defendants’ case are basically that, for all their loans, it was the 1^st Defendant who negotiated and reached agreements with Mr. Chow, Mr. Wong and their assistant KK YIP (hereinafter referred to as “Mr. Yip”) and that the 2^nd and 3^rd Defendants never took part. Details concerning those loans were arrived at through many conversations between the 1^st Defendant and Mr. Yip. According to the 1^st Defendant, Mr. Yip had explained in detail to him that the loans for the Defendants would work in the same way as that of the loans to his joint-stock company, the interests for the mortgages would be subject to fluctuation and would be adjustable, changing with the market. The undertakings from Mr. Yip became verbal agreement between them. After Mr. Yip’s reposting, Mr. Wong took charge of the Defendants’ accounts. In 2000, when he asked Mr. Wong to lower the interest rate, Mr. Wong flatly refused and suggested that he should repay all the outstanding sums and borrow from another bank instead. He stresses that, in light of the verbal agreement with Mr. Yip, the 1997 facility letters signed by the 1^st and 2^nd Defendants should be held as null and void. Further, the interests erroneously overcharged by BEA on its breach of the verbal agreement have already offset the repayments due from them.

Issues in the present proceedings

23.BEA relies on the facility documents signed by the Defendants as the basis for its claims. The Defendants admit to have signed the facility documents and have no dispute on their authenticity or the amounts of outstanding principal balance. They only dispute the rates at which BEA charged interests and its right to charge overdue interests and compound interests. Apart from these disputes, as they have signed the 1997 facility letters, 2004 facility letter, 1^st Bond and 2^nd Bond, they are in no position to dispute their liability to repay the outstanding amounts and interests. Further, on the basis of the 1^st Mortgage and 2^nd Mortgage they have signed, if BEA can prove that there are still amounts due from them, they cannot refuse to deliver up vacant possession of the 1^st Property and 2^nd Property.

24.The present proceedings involve the following issues:

(1) The basis on which the interest rate prescribed in the 1997 facility letters was arrived at between BEA and the 1st and 2nd Defendants;

(2) Whether BEA did, through Mr. Yip, reach the alleged verbal agreement with the Defendants, and the content of its terms;

(3) According to the facility documents, whether BEA has the contractual right to charge compound interests;

(4) According to the facility documents, whether BEA has the contractual right to charge overdue interests;

(5) On the above findings of fact, whether there are any amounts due to BEA by the Defendants, or whether BEA has overcharged the Defendants on interests; and

(6) The relief to the successful party.

Assessment of witnesses’ credibility

25.BEA has only called its Risk Manager Mr. Leung. His evidence is mainly about elucidating the basis of charging compound interests and overdue interests as well as calculation of the amounts due from the Defendants. Although the Defendants dispute the interest rates and the interests charged by BEA, they do not query his method of calculation. BEA’s right to charge compound interests and overdue interests is a question of law which has to be resolved in accordance with the provisions of the facility documents concerned and the legal principles of the interpretation of documents. I accept Mr. Leung’s evidence on the calculation of interests. As for the alleged verbal agreement, Mr. Leung has not provided any evidence to rebut the Defendants’ evidence.

26.The 1^st Defendant is a key witness for the defence. In the defence’s case, he is the only witness who has negotiated with Mr. Yip about the verbal agreement. His evidence is crucial and vigorously disputed. He claims that in 1997 when he had negotiation with BEA about the loans in the present case, he was only an ignorant and inexperienced 28-year-old. Nevertheless, as early as 1994, his joint-stock company already borrowed from BEA. It was also disclosed in his own evidence that in 1997, Tic Tac Oro Limited, a company operated and controlled by him, also borrowed from BEA. These indicate that when signing the facility documents, he was already a rather experienced businessman and had quite some knowledge of the procedures of borrowing from bank. In giving evidence, he acted flippantly, often evaded questions and, even for simple questions, took a long time to consider before giving his answers. I am of the view that he is not a credible witness.       

27.The 2^nd Defendant gave evidence on behalf of herself and the 3^rd Defendant. She did not have negotiation with Mr. Yip concerning the verbal agreement and had no personal knowledge of the facts in dispute in the present case. I would not attach weight to her evidence.

BEA’s refusal to call Mr. Yip as witness or provide his particulars

28.The Defendants allege that the 1^st Defendant and Mr. Yip have reached verbal agreement concerning the 1st and 2nd Defendants’ personal instalment loans and such verbal agreement has replaced the interest rates prescribed in the facility documents. BEA denies making such verbal agreement but it has failed to provide a substantive reply.

29.The Defendants allege that during the several pre-trial hearings, BEA refused to provide information of Mr. Yip’ identity and refused to call him for confrontation or cross-examination. It is further alleged that, in spite of Master Levy’s order to provide them with Mr. Yip’s photo(s) for identification, in a perfunctory response to it and for deliberate concealment of evidence, BEA has merely provided the photo(s) of another staff member instead of that of Mr. Yip. They suggest that I should accept their evidence about the verbal agreement. Mr. Leung, Risk Manager of BEA, explains that he has, in response to the learned Master’s request, only managed to find from BEA’s staff record an existing staff member known as KK Yip and that he has provided his photo(s) to the 1^st Defendant for identification. As the 1^st Defendant has confirmed that that staff member is not the Mr. Yip he has referred to, it would be meaningless to summon him. Mr. Lee, counsel for BEA, contends that BEA has already given effect to the learned Master’s direction and that the 1^st Defendant’s evidence about Mr. Yip and the verbal agreement was fictitious and incredible.   

30.The 1^st Defendant produced the first page of the document faxed to him by BEA on 31 May 1995. It is shown on that page the sender was Raymond Chow/KK Yip. BEA had no dispute on the document’s authenticity. The document proves clearly that Mr. Yip was not a figure invented by the 1^st Defendant. As the document dates back 16 years ago, maybe Mr. Yip has already left BEA. However, I am of the view that BEA and its counsel were insincere and perfunctory in giving effect to the learned Master’s direction and even misled the court. They should have searched the personnel records of BEA to see whether there was a staff member known as KK Yip in the period concerned, in which branch he was working or when he left BEA, rather than giving an incomplete and untruthful reply with just its existing staff KK Yip and responding to court’s direction in such a sloppy manner. On the first day of the trial, I already indicated to Mr. Lee that even though BEA regarded itself as having already given effect to the learned Master’s direction, it still had to consider providing evidence from Mr. Chow, Mr. Wong or other witnesses for giving an account of Mr. Yip’s whereabouts, or else I might possibly draw adverse inference against BEA on that issue. In the end, BEA has not provided information about Mr. Yip. It is open to me to draw adverse inference against BEA for its failure to provide information about Mr. Yip. However, it does not necessarily mean that I would therefore have to be satisfied with the 1^st Defendant’s suggestions concerning the verbal agreement. The Defendants have the burden to prove the existence of that verbal agreement and the content thereof.

Interest rate prescribed by the 1997 facility letters as well as the verbal agreement

31.The interest rate prescribed by the facility documents is the basis on which BEA claims for the interests. The Defendants take no issue at all on the authenticity of the facility documents and their signatures thereon. The verbal agreement alleged by the 1^st Defendant is only applicable to the personal instalment loans of the 1^st and 2^nd Defendants.

32.The 1997 facility letters signed by the 1^st and 2^nd Defendants specify an interest rate of 9.25% per annum and contain the following terms concerning interest rate:

“2. Interest on the loan will be charged at the rate as stated above and subject to fluctuation at our discretion. Such interest shall be calculated with the usual monthly rests.

3. The said Loan together with interest thereon at the present rate stated is to be repaid by such number of monthly instalments and for such amount per instalment as stated herein-above commencing one month after the date of advance. The Bank may at its discretion, adjust the number of monthly instalments or instalment amount if the rate of interest changes. Overdue instalment payment will be liable to a late charge.

8. The loan will be subject to the terms and conditions relating to instalment loans as contained in the Second Schedule to the Legal Charge/Mortgage.

10.   In case of inconsistency between the terms of this letter and the terms of the First Legal Charge/Mortgage (securing ALL Monies in respect of General Banking Facilities), the terms of the First Legal Charge/Mortgage (securing ALL Monies in respect of General Banking Facilities) shall prevail.”

It can be seen from these terms that the interest rate is subject to fluctuation and BEA has the discretion to adjust it. Besides, such personal instalment loans are subject to the terms and conditions contained in the Second Schedule to First Mortgage and Second Mortgage.

33.BEA’s case is that the interest rate for the personal instalment loans consists of two elements, i.e. prime rate plus 0.5% (commonly referred to as “P+0.5%”). The prime rate is subject to fluctuation because it moves up and down with the market. BEA has produced records of the prime rate and records of interests it had charged the 1^st and 2^nd Defendants since 1997, proving that the interest rate on those personal instalments was in accordance with the P + 0.5% formula. Nonetheless, BEA has not specified in the facility documents the formula by which the loan interest rate was determined.    

34.The 1^st and 2^nd Defendants’ defence is that, because of the verbal agreement reached between Mr. Yip and the 1^st Defendant, the rate of 9.25% prescribed in the 1997 facility letters is no longer binding. The terms of the alleged verbal agreement are set out in paragraph 10 of the Defence and Counterclaim as follows:

“The defence denies item 16 of the Statement of Claims:

1^st and 2^nd Defendants’ Instalment Loans

A. There is no P+0.5 contract between the defence and the Plaintiff;

B. There is only one contract which specifies that the interest is 9.25%;

C.   In addition to the contract, the Plaintiff had given an undertaking to the Defence that 9.25% was the cheapest interest rate at that time and such interest rate was subject to fluctuation and could be adjusted.”

The 1^st Defendant stressed in his evidence that Mr. Yip had given him an undertaking that the interest rate was subject to fluctuation and could be adjusted, and that the rate of 9.25% was so prescribed only because it was the cheapest interest rate at that time.

35.The 1^st Defendant’s case is that when he was negotiating for the loans and signing the facility document(s) in 1997, he knew nothing about the prime rate at all, nor did BEA staff ever mention to him the formula. Mr. Yip only told him that the rate was 9.25%, subject to fluctuation and could be adjusted. Besides, Mr. Yip also told him that it was the cheapest rate and it could be lowered if his company performed well. When cross examined by Mr. Lee, the 1^st Defendant stressed that what Mr. Yip had said to him was that the rate of 9.25% as a whole was subject to fluctuation and could be adjusted, and that it had not been specified that only the element of the prime rate thereof was subject to fluctuation.

36.Mr. Lee contends that the 1^st Defendant’s evidence is not credible. The 1^st Defendant was an experienced businessman. He was already 28 years old when he became a businessman, he should have quite some life and social experience. His joint stock company began to borrow from BEA in 1994. Besides, before he signed the facility documents, Tic Tac Oro Limited, another registered company of his, had also received loan(s) from BEA. On the facility letter from BEA to Tic Tac Oro Limited dated 14 March 1997 he produced to the court, it was already specified that the interest rate for the loan was prime rate plus 2.5%. I am of the view that the circumstances then were the same as they are now. In lending business, similar formulas for determining the interest rates are very common. It is in fact incredible that the 1^st Defendant would, as he claims, know nothing whatsoever about the prime rate.

37.As a matter of fact, the issue raised by the 1^st Defendant is completely meaningless. He stressed that Mr. Yip had told him that the rate of 9.25% was as a whole subject to fluctuation and adjustable. BEA does not dispute that allegation. Specific provisions are also in place in the 1997 facility letters, First Mortgage and Second Mortgage signed by the 1^st and 2^nd Defendants as well as the Second Schedule (see paragraph 32 above). The 1^st Defendant’s case is that BEA has breached the verbal agreement and failed to lower the rate. Strangely, according to evidence not disputed by him, BEA in fact raised the rate from 9.25% to 10.75% for the two periods between November 1997 and January 1999 as well as between April 2000 and January 2001 and yet the 1^st and 2^nd Defendants made repayments and paid interests as usual without making any complaint ever. Although under cross examination, the 1^st Defendant explained that he had asked Mr. Wong to reduce the interest but he refused and even, turning hostile, suggested to him that he repay all the outstanding amounts and borrow from another bank instead. I do not believe and accept the 1^st Defendant’s evidence. During the first period mentioned above, just two months after he had signed the 1997 facility letter(s), BEA raised the interest rate. During the 15 months thereafter, Mr. Yip was probably still managing his account(s). If Mr. Yip had indeed reached a verbal agreement with the 1^st Defendant, the 1^st Defendant would definitely not have sat on his hands or made no complaint. Besides, for the majority of the periods thereafter, BEA lowered the interest rate of the loans to 5.5%. Such an adjustment matched perfectly with the decrease of the prime rate and the formula of P + 0.5%. In light of the evidence as a whole, the 1^st Defendant’s case and behaviour do not tally whereas BEA’s case is consistent with the P + 0.5% formula. When Mr. Lee put to the 1^st Defendant during his cross examination that BEA had indeed explained to him the formula and how the interest rate of 9.25% was worked out, he eventually gave an equivocal reply that he was not sure. I do not accept the 1^st Defendant’s evidence.

38.More importantly, whilst alleging that Mr. Yip only told him that the rate was 9.25%, subject to fluctuation, that it was adjustable and the cheapest, and that it could be lowered if his company performed well, the 1^st Defendant has failed to provide specific information of the undertaking, such as the formula for determining the rate. As a matter of fact, for the majority of such periods, with the lowering of the prime rate by the bank, the interest rate for the 1^st and 2^nd Defendants’ personal instalment loans was reduced to 5.5%. If Mr. Yip had indeed given the undertaking, it had already been carried out. The 1st Defendant has failed to provide details of the formula by which both parties were to determine the interest rate; there is nothing by which he can prove BEA’s breach of that verbal agreement and overcharging of interests.

39.BEA’s claims are based on the facility documents signed by the Defendants. Although BEA did not call Mr. Wong or Mr. Yip to prove its case on the negotiation of loan rates and that it is open to me to draw adverse inference against it in relation to the Defendants’ accusations against Mr. Yip, as the Defendants have not put up substantive challenge against the authenticity of the facility documents and are unable to state what formula was specified in the verbal agreement for determining the rates, BEA’s failure to call Mr. Wong and Mr. Yip or provide particulars of the latter have done no damage to its case.

40.The Defendants’ substantive positive assertion, which BEA denies, is that Mr. Yip has reached a verbal agreement with them. They have the burden to prove that such a verbal agreement was reached and the terms and conditions thereof. On this issue, the 1^st Defendant is the only witness for the Defendants. I do not accept his evidence. Considering the evidence as a whole, the 1^st Defendant’s case does not tally with his behaviour which, however, is consistent with BEA’s case. I therefore find that the interest rate for the 1^st and 2^nd Defendants’ personal instalment loans was prime rate plus 0.5%. As the prime rate fluctuated with the market, the loan interest rate was subject to fluctuation and was adjustable. The Defendants have no dispute on the prime rate during the relevant periods. For these reasons, I accept Mr. Leung’s evidence about the interest rate for the 1^st and 2^nd Defendants’ personal instalment loans, the payable interests and outstanding principal balance.

The right and legality of charging compound interests

41.Another claim of BEA at issue is the interests on the 3^rd Defendant’s Overdraft Facility. On its own volition, BEA debited on monthly basis the preceding month’s overdraft loan interest from the 3^rd Defendant’s overdraft loan (account), converted it into principal of the current month’s overdraft loan and then earned interests from it, incurring compound interests. The Defendants contend in their ground of defence that BEA had no contractual right to charge compound interests. I am of the view that, the questions of whether a lender is entitled to charge interests on a loan, at what rate and in what ways such interests, simple or compound, are to be calculated, all turn on the terms of the loan agreement reached between the borrower and lender. Such terms can be express or implied. BEA has the burden to prove the contractual terms for charging compound interests and the rate thereon.

42.Mr. Lee submits that the charging of compound interests by BEA has the backing of law and the authorisation from the Mortgages and the 2004 facility letter. To lend support to his contention, he cites the judgment of the House of Lords in Sempra Metals Ltd v Inland Revenue Commissioners and another [2008] 1 AC 561 and the judgment of the High Court of Hong Kong in Hongkong and Shanghai Banking Corp Ltd and Ling Lee Kang & Another [2001] 3 HKLRD 255.

43.Mr. Lee cites the judgment of Lord Nicholls of Birkenhead of the House of Lords in paragraph 52 of Sempra Metals Ltd:

“We live in a world where interest payments for the use of money are calculated on a compound basis. Money is not available commercially on simple interest terms. This is the daily experience of everyone, whether borrowing money on overdrafts or credit cards or mortgages or shopping around for the best rates when depositing savings with banks or building societies. If the law is to achieve a fair and just outcome when assessing financial loss it must recognise and give effect to this reality.”

On the basis of the above judgment, Mr. Lee takes the view that in the everyday life of the commercial world, interests are calculated on compound basis for overdrafts, credit cards, housing mortgages and deposits, etc. If the law is to achieve a fair and just outcome, it must give effect to this reality. 

44.Lord Nicholls of the House of Lord is profoundly authoritative and was also a non-permanent judge of the Court of Final Appeal of Hong Kong. I certainty have full respect of his judgment. Nonetheless, I shall not overlook the fact that the judgment had stemmed from the factual background of that case which involved sophisticated taxation laws of the European Union and the United Kingdom. In simple terms, the claimant company therein sought refund in respect of the interests paid on advance tax. The trial judge ruled that the claimant company was entitled to full relief and ordered the award to be computed on the basis of compound interest at market rate. The House of Lords upheld the judge’s decision and dismissed the appeal. For this reason, I am of the view that Lord Nicholls, in giving the above judgment, was only recognizing that charging compound interest was the reality in loan market; in other words, Lord Nicholls was only pointing out that calculating and charging interests on compound basis was the reality of the loan market, and it was not illegal. In that appeal case, as the claimant company had to borrow on compound interest to pay the advance tax, it was entitled to be compensated for the interest it paid on compound basis. Lord Nicholls did not set down in that case any legal principle that interests for bank loans must be calculated on compound basis.

45.Mr. Lee also cites paragraphs 30 to 32 of the judgment of Deputy Judge Longley of the Court of First Instance of the High Court in Hongkong and Shanghai Banking Corp Ltd and Ling Lee Kang & Another:

“30. Under the terms of the facility letters, the interest at the agreed rate was to become ‘payable at the end of each interest period to the debit of the borrower’s account’.

31. The second defendant appears to take no issue as to the amount of interest debited to its account but disputes the plaintiff’s right to charge interest on that interest.

32.   The express provision in the facilities letters that the interest due on the loans was ‘to the debit’ of the current account made it plain that such interest was to be treated as another advance by the plaintiff, which itself attracts interest.  This was the offer made, which the second defendant had unreservedly accepted.  …”

The judgment of Deputy Judge Longley reflects exactly the principle stated above in paragraph 41. In this cited case, it was specified in the facility letters that the interest was payable at the end of each interest period to the debit of the borrower’s account. Deputy Judge Longley found that this express provision stipulated that once the bank had debited the interest accrued from the preceding interest period to the borrower’s overdraft loan account, such interest would be treated as another loan and the bank could charge interest thereon.

46.Mr. Lee claims that the terms of the 2004 facility letter were similar to those examined in Ling Lee Kang & Another. After repeated perusal in detail, I cannot find similar terms. The 2004 facility letter only set out for the Invoice Financing Loan, Overdraft Facility and Non-revolving Term Loan the terms concerning the loan amounts, interest rates and securities, etc. Besides, I am unable to find in other facility documents terms that are similar to those in the cited case.

47.Mr. Lee further submits that, as the 2004 facility letter prescribes that the Overdraft Facility was secured by the Mortgages, and the 3rd Defendant was the borrower in the two Mortgages, the terms on default interest in the Mortgages would therefore apply. I must point out that there is no such stipulation in the 2004 facility letter. However, in view of the terms of the Mortgages, I agree that the relationship between the Defendants and BEA in respect of the loans was also regulated by the terms of the Mortgages. Nonetheless, the terms on default interest in the Mortgages, set out in the Second Schedule thereto, have nothing to do with compound interest at all. Paragraph 1 of the schedule specifies that the schedule only applies to personal instalment loans:

“The following special terms and conditions apply to any instalment loan (“the Loan”) granted by the Lender to the Borrower under the terms of any facility letter, as amended from time to time.”

For these reasons, I am of the view that BEA is in no position to invoke the default interest terms in the Mortgages to charge compound interest on the 3^rd Defendant’s Overdraft Facility.

48.I am unable to find in the facility documents any express terms that authorize BEA to charge compound interest on the 3rd Defendant’s Overdraft Facility. However, as expressed by Lord Nicholls, charging compound interest is the reality in the loan market. Living in Hong Kong, a world financial centre, I can naturally experience this reality. I also note that the charging by banks of compound interests on overdraft facility on monthly basis is also a reality in Hong Kong’s loan market. This reality reflects the usage of the banking industry. Banks with prudent approach would, as in Hongkong and Shanghai Banking Corp Ltd and Ling Lee Kang & Another, include in their overdraft facility contracts an express provision about their right to charge compound interest. However, some banks rely on such usage in the banking industry, introduced into loan contracts with clients by way of implied terms the right to charge compound interest.

49.The usage of charging compound interest in the banking industry dates back to the 18^th century in the United Kingdom. In National Bank of Greece SA v Pinios Shipping Co (No. 1) [1990] 1 AC 637, Lord Goff of Chieveley of the House of Lords analysed in detail the history of the introduction of this implied term. Under the usury laws of 1714, lending of money with an interest exceeding 5% per annum was not permitted. Even if the lender and borrower had signed a loan contract providing for the charging of compound interest, it would still be illegal if the actual interest per annum was in excess of 5%. Such laws were not accepted by the banking industry genuinely engaged in loan business. In Ex parte Bevan (1803) 9 Ves. Jun. 223 at 224, Lord Chancellor Eldon circumvented this difficulty by holding that if, notwithstanding that it was a one-year loan contract, the lender agreed with the borrower to settle accounts at the end of six months, and agreed to forbear for six months upon those terms, it would be legal to charge compound interest through such a series of contractual means. On this basis, in Lord Clancarty v. Latouche (1810) 1 Ball & B. 420, Lord Manners made a presumption in law that if there was acquiescence by a customer in his banker's capitalising interest at annual rests, the court could then presume an agreement between them that, at the end of every year, the interest then due should become principal in the following year and carry interest, i.e. compound interest. Despite the subsequent repeal of the usury laws in 1854, the above practice of banks continued. Although it has since been permissible to enter into legal and binding contracts that provide for compound interest, given the fact that such a practice of banks is long established, lenders and borrowers have very often relied on the practice instead. 

50.Initially after the repeal of the usury laws, in litigations involving the charging of compound interests, courts tended to look for evidence of  acquiescence by the customer in the banker's capitalising of the interest. However, as customer’s acquiescence was only a fictional presumption, it was indeed not very satisfactory. Not long after that, however, such practice of banks became recognised as their usage. The first such case was the Scottish case of Reddie v. Williamson (1863) 1 Macp. 228. On page 236 of the judgment, Lord Justice-Clerk Inglis stated the following:

“The parties must of course have had in view that this account-current would be kept in the way, in which bankers always keep such accounts, balancing the account at the end of the year; and, in the event of the interest accruing during the past year not being otherwise paid or provided for, placing the amount of such interest as the last item to the debit of the account, and accumulating such interest along with the principal sum due on the account, and bringing down the balance thus ascertained, consisting partly of principal, and partly of interest, to the new account for the ensuing year, and placing the accumulated balance as the first article of debit in that new account. Where an account is kept in this way consistently throughout its whole course, the interest thus accumulated with principal, at the end of each year not only becomes principal, but never thereafter ceases to be dealt with as principal.

…

The privilege of a banker to balance the account at the end of the year, and accumulate the interest with the principal, is founded on this plain ground of equity, that the interest ought then to be paid, and, because it is not paid, the debtor becomes thenceforth debtor in the amount as a principal sum itself bearing interest.”

The court recognised that the lender and the borrower acknowledged that the bank would handle the borrower’s account in the practice of charging compound interest, that is, placing the interest accrued by the end of the year, which was ought to be paid and unpaid, to the debit of the account for the ensuing year, accumulating such interest along with the principal sum due as the new principal for the ensuing year, and then earning interest thereon. If the lender and borrower keep the account in this way consistently throughout its whole course, the interest accrued in the preceding year and due to be paid would become principal in the ensuing year and interest would be earned therefrom. This usage of the banking industry is based on equity. The key business of banks is to earn interests from loans made. If a borrower fails to pay interest as scheduled, the bank will be deprived of the interest it ought to be paid which it could in turn lend to another borrower as principal and earn interest therefrom. On these premises, it is entirely fair for banks to capitalise the interest accrued by the end of the year, which ought to be paid but was unpaid.

51.In 1898, the aforesaid way of keeping accounts was accepted by the House of Lords as the usage of the banking industry. In Parr's Banking Co. Ltd. v. Yates [1898] 2 Q.B. 460, Lord Justice Rigby of the Court of Appeal regarded this way of keeping accounts as the practice between banks and their customers. He considered it necessary to presume that the understanding shared between them at the time of opening an account for overdraft facility was that the money deposited by the customer in the account was meant for repaying the principal and interest due, and the outstanding principal and interest accrued at the end of each half-year period would become the principal in the next half-year period. On page 466 and 467, Rigby LJ said:

“Such a mode of making out the account is so far usual that I do not think the customer, or a guarantor of the customer, could object to it. I think one must assume that the understanding of all parties was that the account would be kept as between the person guaranteed and the bank on the usual principle with regard to such accounts - that is to say, by treating moneys paid in from time to time by the customer as a deduction from the general amount due from the customer in respect of the loan and interest thereon, and at the end of each half-year carrying over the debit balance to the next half-year as principal.”

52.In 1918, in Yourell v. Hibernian Bank Ltd. [1918] A.C. 372, the House of Lords even confirmed the legality of this usage of the banking industry. This usage had by then a history of more than two centuries. Lord Atkinson said on page 385:

“Interest was calculated from day to day on the mortgagor's overdraft on his current account. On the balancing of this account each half-year the amount of this interest was entered on the debit side of the account, a balance was then struck, and interest was charged during the next half-year upon that balance. The bank, by taking the account with these half-yearly rests, secured for itself the benefit of compound interest. This is a usual and perfectly legitimate mode of dealing between banker and customer.”

53.Since then, a number of similar cases have been decided by courts in the United Kingdom. Some judges still attached weight to identifying customers’ acquiescence to handling their overdraft facilities in the mode concerned. However, in Inland Revenue Commissioners v. Holder [1931] 2 K.B. 81, Lord Justice Romer emphasized that the relationships between banks and customers were not regulated by special agreement between them but by the usual method of keeping accounts between banks and customers prevailing in the banking industry. Romer LJ said on page 98:

“It is to be observed that the relations between the company and the bank were regulated, not by any special agreement, but by the ordinary usage prevailing between bankers and their customers as to the method of keeping accounts. In accordance with this usage the balance of principal and interest was struck at the end of each half-year and the aggregate sum was introduced as the first item in the subsequent half-yearly account and interest calculated upon it.”

54.In 1938, the status of this practice of the banking industry as its usage was firmly established by Lord Atkinson of the House of Lords in Paton v. Inland Revenue Commissioners [1938] A.C. 341. Finally, in Inland Revenue Commissioners v. Oswald [1945] A.C. 360 at 379, Lord Porter elucidated that in Paton v. Inland Revenue Commissioners, the term under which capitalisation of interest took place was a term constituted by the custom of banks, and Lord Simonds referred to it as the practice of the banking industry. This usage has by now a history of three centuries and its status as the usage of banks is beyond question. In the cases mentioned above, the interests were calculated on half-yearly rests. In today’s commercialised society of rapid development, half-yearly rests are no longer suitable. Nowadays, it is prevalent to have monthly rests for interests on overdraft facility. The interest accrued every month ought to be paid and unpaid, together with the principal sum due, are carried forward to the ensuing month as its new principal and interest will be charged thereon.

55.In the present case, the 3^rd Defendant opened an account with BEA in June 1997 for overdraft facility. Since September 1997, when the account began to have a negative monthly balance, BEA debited on monthly basis the interest on the sum due for the month to the overdraft (account). Combining that month’s accrued interest with the outstanding loan to form the total amount due for the month, BEA then brought it forward as the loan principal of the ensuing month and then charged interest thereon.BEA had been issuing a monthly statement to the 3^rd Defendant every month and, until the filing of the Defence in July 2009, the Defendants had never disputed on BEA’s method of handling the overdraft facilities and charging compound interest as such. It shows that they knew and acknowledged BEA’s method of handling the overdraft facilities concerned. The banking industry’s usage of charging compound interest on overdraft facilities had become an implied term in the contract between the 3rd Defendant and BEA concerning the overdraft facilities. BEA had the contractual right to charge compound interest on such facilities. The 3rd Defendant takes no issue on Mr. Leung’s computation of the compound interest. I accept Mr. Leung’s evidence about the outstanding loan concerning the overdraft facilities to the 3^rd Defendant.

The right and legality of charging compound interest

56.Another BEA’s claim in issue is the overdue interest. The present proceedings involve five loans: two personal instalment loans to the 1^st and 2^nd Defendants respectively, an Invoice Financing Loan to the 3^rd Defendant, an Overdraft Facility to the 3^rd Defendant and a Non-revolving Term Loan to the 3^rd Defendant. Except for the 3^rd Defendant’s overdraft facility, BEA has charged overdue interests on the 4 other loans. On the two personal instalment loans to the 1^st and 2^nd Defendants and the Invoice Financing Loan to the 3^rd Defendant, BEA charged overdue interest of 5% per annum. On the Non-revolving Term Loan to the 3^rd Defendant, BEA charged interest at, per annum, best lending rate plus 1.5%, plus the addition of 5% overdue interest. The Defendants contend in their ground of defence that BEA has no contractual right to charge overdue interests. In addition to that, I also have to consider the legality of such overdue interests.

57.According to Mr. Leung’s evidence, the 1997 facility letters and 2004 facility letter have already set out in detail the right to charge overdue interests. It is also pointed out specifically in his witness statement dated 15 January 2010 that, prior to the signing of the facility letters by the Defendants, BEA had provided them with a document entitled “Scale of Charges” in which the methods of computing the overdue interests for the Invoice Financing Loan, Non-revolving Term Loan and personal instalment loans were set out in detail. It is on the basis of that Scale of Charges that BEA charged such overdue interests.

58.I shall first of all consider the justifications for charging overdue interests on the basis of that Scale of Charges. The content of this document, known in full as “Scale of Charges on Bills Transaction”, is entirely about the charges concerning Invoice Financing Loan and has nothing to do with the charges on other loans. Paragraph 40 therein prescribes that:

“Finance charges

Interest will be charged in respect of amounts outstanding in relation to all import and export bills transactions requiring our financing, and in respect of all loans and advances at our prevailing interest rate, which is subject to fluctuation from time to time. A minimum of 10 days transit period will be applied on export bills transactions with proceeds credited to customers in same currency of the bills and/or converted into HKD at T/T rate. Unless special arrangement has been made, accrued interest on outstanding import bills financed, import invoice financing loans, export loan and export invoice financing loans will be settled on the 15^th day of each calendar month or the first banking day subsequent to the 15^th day if it is not a banking day.

Additional penalty interest will charged on overdue items at the following rates:

Transaction Type	1st month	2nd month and above
Import bills/loan/invoice Financing Loan	+5%	+5%
Export bills	nil*	+3%

*  For sight bill only. For usance bill, penalty interest will be charged 2 weeks after maturity date.”

The passage above stipulates that, for overdue import invoice financing loans, for the 1^st month, 2^nd month and thereafter, additional penalty interest would be charged at 5% per annum. This Scale of Charges is only applicable to the 3^rd Defendant’s Invoice Financing Loan. BEA could charge the 3^rd Defendant additional penalty interest at 5% per annum when its import invoice financing loan becomes overdue. However, this scale is not applicable to the 1^st and 2^nd Defendants’ personal instalment loans or the 3^rd Defendant’s Non-revolving Term Loan.

59.The 1997 facility letters and First and Second Mortgages are facility documents relevant to the 1st and 2nd Defendants’ personal instalment loans. Clause 3 of the 1997 facility letter(s), as cited in paragraph 32 above, stipulates that the borrower is liable to pay “late charge” for overdue instalment payment. However, the amount and method of calculation therefor are not specified.

60.BEA charged interest on the 3^rd Defendant’s Non-revolving Term Loan at best lending rate plus 1.5%; and the rate for overdue interest was best lending rate plus 1.5%, with the addition of 5%. The 2004 facility letter and First and Second Mortgages are facility documents relevant to the Non-revolving Term Loan. The terms in the 2004 facility letter concerning the Non-revolving Term Loan are as follows:

“(c) Term Loan Limit 450,000

- This term loan is available to you on a non-revolving basis for settlement of all O/D and T/R excess amount and is to be repaid by 36 monthly instalments of HK$12,500.- each plus interest commencing 1 month after drawdown.

Interest Rate : the Bank’s Best Lending Rate + 1.5% or HIBOR + 1.5% whichever the higher is applicable.

(f) Additional Charges

-  Additional interest will be charged on all overdue import and export bills/loans transactions as according to our Scale of Charges on Bills Transactions and is subject to change from time to time.”

BEA invoked paragraph (c) to charge interest on the Non-revolving Term Loan. Although additional charges are mentioned in paragraph (f), it is stipulated with clarity therein that additional charges are applicable to overdue import and export bills/loans. Additional charges are therefore not applicable to Non-revolving Term Loan. Moreover, in the 2004 facility letter, there is no mention at all of the overdue interest the 3^rd Defendant would be liable to pay or the formula for determining the rate thereof for overdue repayment of the Non-revolving Term Loan.

61.Mr. Lee cites the interpretation in paragraph 3 of the First and Second Mortgages concerning interest as well as Second Schedule to the Mortgages to justify the charging of overdue interests. In paragraph 3.12, there is an express term concerning interest:

“Interest on the principal sums advanced and all other moneys payable hereunder at the rate as shall be applicable under the terms of the facilities granted by the Lender to the Borrower or at such other rate as may from time to time be determined by the Lender in its absolute discretion which determination shall be conclusive and binding on the Borrower and the Mortgagor. Such interest shall be calculated with the usual monthly rests or on such other basis as may from time to time be stipulated by the Lender in any facility letter or written notification of change covering the secured sum or covering any term or provision in the Second Schedule under this Legal Charge/Mortgage.”

In my view, this paragraph is only providing for the charging of interest on the rate stipulated in the facility letter or so amended by BEA, as well as prescribing that the interest shall be calculated with monthly rests or on the basis stipulated by the facility letter or in accordance with the Second Schedule. There is no mention whatsoever in this paragraph of the rate of the overdue interest or the method by which such rate would be determined.

62.The Second Schedule sets out the express terms for default interest, specifying the basis of charging default interest on failure to repay personal instalment loan. The terms are as follows:  

“The following special terms and conditions apply to any instalment loan (“the Loan”) granted by the Lender to the Borrower under the terms of any facility letter, as amended from time to time.  …

…

Default Interest:

In respect of any sums due to the Lender from the Borrower which are not paid on due date, interest will be payable forthwith on such sum at such rate or rates as the Lender shall from time to time determine, such interest shall, at the absolute discretion of the Lender, be compounded at monthly intervals or calculated on the actual number of days elapsed from the date on which the same should have been paid to the date of payment.”

The first sentence of the Second Schedule prescribes that the schedule applies to personal instalment loans including Non-revolving Term Loans. However, it is not applicable to the 3^rd Defendant’s Invoice Financing Loan or Overdraft Facility. Defaults include breaching one’s obligation to make timeous repayments. The stipulations on default interest therefore also apply to overdue interest. The passage cited above provides that BEA has the right to charge overdue interest and amend the rate thereof, and has the absolute discretion to decide whether the interest is to be charged on simple or compound basis. Nevertheless, the rate for default interest and the method for determining the rate are not specified in the Second Schedule.

63.According to the facility documents, BEA has indeed the contractual right to charge overdue interests on the 1^st and 2^nd Defendants’ personal instalment loans, the 3^rd Defendant’s Invoice Financing Loan and Non-revolving Term Loan. However, except for the 3^rd Defendant’s Invoice Financing Loan, BEA is unable to prove from the facility documents that it was entitled to charge overdue interest at the rate concerned. Borrowing from the Scale of Charges applicable to the 3^rd Defendant’s Invoice Financing Loan, BEA charged overdue interests on the 1^st and 2^nd Defendants’ personal instalment loans at 5% per annum and charged overdue interest on the 3^rd Defendant’s Non-revolving Term Loan at, per annum, best lending rate plus 1.5% with the addition of 5%. It had no contractual basis whatsoever in so doing. In my view, BEA can only prove by paragraph 40 of the Scale of Charges that it has the contractual right to charge overdue interest at 5% per annum on the 3^rd Defendant’s Invoice Financing Loan. I believe BEA does have other documents to support its charging of the other overdue interests. It has, however, possibly because of ill preparation, failed to provide them to the court and therefore failed to prove its case.   

64.Regarding the legality of charging overdue interests, on the principle of freedom of contract, it is open to contracting parties to make prior agreement on the compensation to be made by the party in breach. To a certain extent, however, parties’ freedom to contract is also limited by certain legal principles. In general, if the agreed compensation is a genuine pre-estimate for compensating the other party for the loss incurred by a breach, such terms of contract shall be valid. Nonetheless, if the agreed compensation is in fact a security or penalty for compelling a party to fulfil its contractual obligations, such terms of contract shall be void and unenforceable. The question of whether it is a legal and genuine pre-estimate compensation or a penalty clause is a matter of construction of the contract. On this question, in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, the House of Lords cited the following principles of construction:

(1) The agreed compensation will be held to be penalty if it is extravagant and unconscionable in amount in comparison with the greatest loss the other party could suffer;

(2) The agreed compensation will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid; and

(3) There is a presumption that the compensation is penalty when a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage.

Apparently, the second principle of construction above is applicable to the clause of additional penalty interest in paragraph 40 of the Scale of Charges. The 3^rd Defendant’s contractual obligation was to make repayments on schedule, and its failure to do so would deprive BEA of the opportunity to make use of that sum of money. Being engaged in lending business, the greatest loss BEA could suffer therefrom, which could be quantified, was only the loss of the interests from lending out the money. If the 3^rd Defendant were to, on top of interests for the loans, pay additional penalty interests, that could be regarded as penalty and not genuine pre-estimate for compensating BEA for the loss incurred by the 3^rd Defendant’s overdue repayment. In addition to the second principle of construction, the court would also have to consider the first principle, namely, whether the agreed compensation is extravagant and unconscionable, as well as parties’ freedom to contract.

65.Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd is a House of Lords’ case from the early 20^th century. In early 1993, the same question was put before the Privy Council in an appeal case originating from Hong Kong. On pages 279 to 280 of Philips Hong Kong Limited And The Attorney General of Hong Kong [1993] 1 HKLR 269, Lord Woolf gave the following judgment:

“Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision. The use in argument of unlikely illustrations should therefore not assist a party to defect a provision as to liquidated damages. As the Law Commission stated in Working Paper No. 61 (page 30):

‘The fact that in certain circumstances a party to a contract might derive a benefit in excess of his loss does not … outweigh the very definite practical advantages of the present rule upholding a genuine estimate, formed at the time the contract was made of the probable loss.’

A difficulty can arise where the range of possible loss is broad. Where it should be obvious that, in relation to part of the range, the liquidated damages are totally out of proportion to certain of the losses which may be incurred, the failure to make special provision for those losses may result in the “liquidated damages” not being recoverable. (See the decision of the Court of Appeal on very special facts in Ariston SRL v. Charly Records Ltd. (1990) The Independent, 13^th April 1990). However, the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld. Any other approach will lead to undesirable uncertainty especially in commercial contracts.”

As this is a Privy Council case regarding an appeal from Hong Kong, it is of even stronger authority and binding effect in Hong Kong. Although Lord Woolf also cited the second principle of construction from Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd, he attached more weight to the freedom of contract and contracting parties’ respective bargaining powers. He took the view that, unless parties’ bargaining powers were profoundly unequal, it would be insufficient to establish that a provision is objectionably penal by solely identifying one which involved compensating the injured party by a sum larger than the loss incurred. Even in situations as such, so long as the agreed compensation is not extravagant in light of all the circumstances of the breach, it can still be regarded as a genuine pre-estimate to compensate for the loss.

66.The same stance was adopted by the Scottish Law Commission in the Report on Penalty Clauses published on 18 May 1999. Paragraphs 3.2 and 3.8 of the report read:

“3.2 … The policy aim is to respect the parties’ freedom to contract for the payment of agreed sums, or for equivalent sanctions, in specified circumstances and to restrict judicial intervention to cases where the penalty is so excessive, or so exorbitant and unreasonable, that it would be unconscionable to permit it to be exacted. …

3.8      … we have come down in favour of the term ‘manifestly excessive’ which is used in the Council of Europe’s recommendation on this subject. It helps to give the impression that the court should not examine agreed sanctions too closely. The excessive nature of the penalty should be immediately obvious to anyone considering it. It should be manifest and not a matter of nice calculation.  Unless the specified penalty is manifestly excessive, it should be enforceable.”

Paragraph 3.2 mirrors the status in today’s commercialised society. In certain circumstances involving agreed compensation, it is acceptable to use penalty clauses to ensure that a contracting party will perform its contractual obligations. At present, the public policy is to respect parties’ freedom to contract, allow them to make the agreed compensation in specific circumstances and restrict judicial intervention to cases where the penalty is excessive, exorbitant and unreasonable. Further, paragraph 3.8 puts in place a high threshold for judicial intervention that unless the penalty is manifestly excessive, it should be enforced.

67.Although BEA is engaged in lending business, it does have the legitimate expectation that a borrower will make repayments timeously so that it can plan its lending strategy and business, including whether it should extend the borrower’s credit facility, revise the line of credit or even terminate such facility. If the borrower fails to repay on schedule, the bank will not be able to manage its business with effectiveness and planning. For these reasons, as far as a bank is concerned, laying down penalty clauses with a borrower to ensure that the latter would make timeous repayments is a reasonable and necessary safeguard. According to paragraph 40 of the Scale of Charges, concerning the 3^rd Defendant’s Invoice Financing Loan, BEA was only charging penalty at 5% per annum. From any perspective in today’s commercialised society and loan market, this penalty cannot be regarded as outrageous, exorbitant and unreasonable. In my view, the penalty clauses should be enforced. In fact, concerning other loans, the overdue interests sought by BEA in its claims cannot be regarded as outrageous, exorbitant and unreasonable either, the problem is only that it has failed to establish the basis for such penalties.

Conclusion

68.The Defendants take no issue on the outstanding principals of the various loans from BEA or the computation by Mr. Leung for the interests thereon. They only dispute the interest rates as well as the contractual right and legality concerning the charging of compound interests and overdue interests by BEA. On the basis of the analyses and findings stated above, I allow BEA’s claims for the following items: the outstanding principal balance of all the loans to the Defendants, interests on the 1^st and 2^nd Defendants’ personal instalment loans accrued up to 27 June 2009, interests and overdue interests on the 3^rd Defendant’s Invoice Financing Loan accrued up to 27 June 2009, interests on the 3^rd Defendant’s Non-revolving Term Loan accrued up to 27 June 2009 and the principal and interest on the 3^rd Defendant’s Overdraft Facility. I dismiss BEA’s claims for overdue interests on the 1^st and 2^nd Defendants’ personal instalment loans as well as the claim for overdue interest on the 3^rd Defendant’s Non-revolving Term Loan.

69.The Defendants allege that, as BEA has, in breach of the verbal agreement between them and Mr. Yip, charged them excessive interests, and also charged them compound interests and overdue interests in the absence of such contractual rights, the interests they have overpaid are sufficient to cover the repayments sought. They even counterclaim for the overpaid difference. Nonetheless, the Defendants have not provided calculations or data to support their counterclaim. Besides, in light of the findings stated above, their defence and counterclaim are entirely devoid of merits. I dismiss their counterclaim.

70.I give judgment to some of the Plaintiff’s claims. In addition to repaying the debts they owe the Plaintiff, the 1^st and 2^nd Defendants shall be, in accordance with the undertaking in the 1^st Bond and 2^nd Bond, jointly and severally liable to repay the 3^rd Defendant’s debts. Besides, as they have signed the 1^st and 2^nd Mortgages, for satisfaction of debts, they also have to deliver to the Plaintiff vacant possession of the 1^st Property and 2^nd Property which were used as security.

71.I give judgment to the Plaintiff’s claims and make the following orders:

(1) The 1^st Defendant shall pay the Plaintiff $644,380.90 as the outstanding principal balance of his personal instalment loan, $158,666.10 as the interests accrued up to 27 June 2009 and the interests accrued thereafter;

(2) The 1^st Defendant shall, for satisfaction of debt, deliver to the Plaintiff vacant possession of the property used as security in the 1^st Mortgage, located at Flat 4 on 29/F and the roof of Block C, Hilton Plaza, 3-9 Shatin Centre Street, Shatin;

(3) The 2^nd Defendant shall pay the Plaintiff $546,226.32 as the outstanding principal balance of her personal instalment loan, $131,700.22 as the interests accrued up to 27 June 2009 and the interests accrued thereafter;

(4) The 2^nd Defendant shall, for satisfaction of debt, deliver to the Plaintiff vacant possession of the property used as security in the 2^nd Mortgage, located at Flat 4 on 28/F of Block A, Hilton Plaza, 3-9 Shatin Centre Street, Shatin;

(5) The Defendants shall, jointly or severally, pay the Plaintiff:

1.  $563,315 as the outstanding principal balance of the 3^rd Defendant’s Invoice Financing Loan, $308,998.85 as the interests and overdue interests accrued up to 27 June 2009, and the interests accrued thereafter;

2.  $300,000 as the outstanding principal balance of the 3^rd Defendant’s Non-revolving Term Loan, $26,466.18 as the interests accrued up to 27 June 2009, and the interests accrued thereafter;

3.  $1,253,953.01 as the outstanding amount for the 3^rd Defendant’s Overdraft Facility, as well as the interest accrued since 27 June 2009;

In respect of the above orders, interests subsequently accrued shall be paid and shall be calculated by way of accruing on the outstanding principal balance concerned at the judgment rate from 28 June 2009 until full payment.

72.Further, the Defendants shall jointly or severally pay the Plaintiff’s costs. Such cost shall be assessed on indemnity basis, to be taxed if not agreed.

73.I dismiss the Defendants’ counterclaim against the Plaintiff.

The Plaintiff: represented by Mr. Tony Li, instructed by T.S. Tong & Co.

The 1^st Defendant: appearing in person, not legally represented.

The 2^nd Defendant: appearing in person, not legally represented.

The 3^rd Defendant, represented by the 2^nd Defendant, not legally represented.

Translated by the Judgment Translation Unit of the Judiciary and approved by Mr. P. Y. Lo, Barrister-at-law.