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BCI & BIMC Ascertainment Cases ▍How to determine the priority in repayment in respect of the loan contract in Hong Kong Law?

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Facts

It was found by the court of first instance that on May 19, 2011, the appellant Li Ye signed the “Loan Agreement” with the third party Glories Global Limited, under which Glories Global Limited agreed to lend USD 5 million to Li Ye. Article 3 regarding the “Usage Term of the Loan” stipulates that the term of the loan is “from the date of payment by the creditor to the date of repayment”; Article 4.1 regarding the “Term of the Repayment” stipulates that: “(A) According to Article 4.2, the repayment date is 18 months after the date of payment ...”; Article 5 regarding the “Term of the Loan” stipulates that: “within the loan period, (the debtor) is obliged to pay interest at a rate of 12% per annum, which should be paid on December 31 and the repayment date of each year”; Article 10 regarding the “Jurisdiction of the Court” stipulates that: “The law applicable to this contract is laws of Hong Kong, and each party to the contract agree on the non-exclusive jurisdiction of Hong Kong court. The creditor is also entitled to sue the debtor in courts in mainland China.” The Loan Agreement also set out the parties’ agreement other matters and was confirmed by Li Ye and Weng Jiyi, the director of Glories Global Limited, with their signatures therein.

On May 19, 2011, Li Ye issued the “Letter of Commitment” to the third party Glories Global Limited, in which the second point states: “When the loan becomes due, Glories Global Limited may choose to accept the transfer of the 1,051,039 shares of Global Wide Asset Management Limited, which was held by Ms. Tang Huiyin (or a BVI company in her control) on behalf of Mr. Li Ye; or choose to accept the transfer of interest that Ms. Tang held in Wide Bright Holdings Limited, which accounts for 32.84%; or choose to require Mr. Li Ye to repay and it was agreed that a loan interest at the rate of 12% per annum will be charged.” The “Letter of Commitment” also set out the parties’ agreement on other matters, which were confirmed by Mr. Li Ye with his signature. On May 24, 2011, the third party Glories Global Limited remitted USD 2.5 million to Li Ye. On the same day, the third party GOLD STAND GOAL LIMITED remitted USD 2.5 million to Li Ye.

On December 13, 2013, Li Ye repaid USD 2 million to the third party Glories Global Limited through Power Strategy Holding Limited. On December 16, 2013, Li Ye repaid USD 2 million to the third party Glories Global Limited through Power Strategy Holding Limited. On March 28, 2014, Li Ye repaid CNY 1 million to the third party Glories Global Limited. On April 21, 2014, Li Ye repaid CNY 3 million to the third party Glories Global Limited.

During the period from November 14, 2013 to August 28, 2014, Weng Jiyi negotiated with Li Ye on the repayment for several times. WeChat chat records on November 15, 2013 and December 9, 2014 supported Weng Jiyi’s claim regarding the principal of USD 5 million. On September 22, 2017, Mr. Zhang, a director of the third party GOLD STAND GOAL LIMITED, was inquired about the relevant facts in the case. Mr. Zhang confirmed that it was Glories Global Limited that entrusted GOLD STAND GOAL LIMITED to remit USD 2.5 million to Li Ye on May 24, 2011.

On April 29, 2015, the third party Glories Global Limited issued the “Notice on Assignment of Claims”, which states: “Mr. Li Ye: According to the Loan Agreement that you concluded with Glories Global Limited in May 2011, Glories Global Limited has provided you with USD 5 million loan as scheduled. After several attempts of collection, you have only repaid USD 4 million and CNY 4 million. Glories Global Limited is hereby sending you the “Notice on Assignment of Claims”, through which the claims against you (including unpaid principal, interest to this date which was calculated at the agreed rate and all other incidental) will be assigned to Mr. Weng Jiyi altogether. Upon receipt of this Notice, you are expected to make the payment with respect to the aforementioned debts to Mr. Weng Jiyi, including the principal and interests, etc.”

Weng Jiyi claimed that as the amount of repayment per installment was higher than the unpaid interest, the formula for the calculation of the principal after each repayment shall be: The principal owed in the current installment = the principal of the loan in the last installment - (amount repaid - interest owed). The formula for the calculation of the interest is: the outstanding principal in the current installment as the basic amount, on which the interest shall be calculated at the annual rate of 12%, from the day after the repayment in the last installment to the day when Li Ye pays off all the debts. Specifically, in the following three periods, namely from May 24, 2011 to December 13, 2013, from December 13, 2013 to December 16, 2013, from March 29, 2014 to April 21, 2014, the formula for the calculation of interest is: Interest = unpaid principal × monthly interest rate (1%) × number of months of arrears + unpaid principal × monthly interest rate (1%) × days of arrears ÷ 31 days. While the formula for the calculation of interest in the period, from December 17, 2013 to March 28, 2014, is: Interest = outstanding principal × annual interest rate (12%) × days of arrears ÷ 365 days.

Key Issues for Ascertainment

The court of first instance entrusted BCI&BIMC to ascertain the law regarding the following four issues:

1. Whether the interest agreed in the “Loan Agreement” and the “Letter of Commitment” conform to the laws and regulations of the Hong Kong Special Administrative Region (hereinafter refer to as Hong Kong)?

2. What are the rules under laws of Hong Kong regarding the sequence of repayment with respect to a loan contract, namely, whether the offsetting of the interest is followed by that of the principal, or in a reverse order?

3. Under the circumstance where the agreement is ambiguous or parties have different understandings of the agreement, what are the specific rules in Hong Kong law regarding the interests within the term of loan and the overdue interest, and the sequence of repayment, namely, whether the offsetting of the interest is followed by that of the principal, or in a reverse order.

4. Whether Weng Jiyi’s claims on the interest within the term of loan, the overdue interest and the sequence of repayment (that the offsetting of the interest is followed by that of the principal) are consistent with the laws of Hong Kong?

Outcome of ascertainment

1. Jurisdiction.

According to Article 10 of the “Loan Agreement”, the law applicable to this contract is the law of Hong Kong, and each party to the contract agree on the non-exclusive jurisdiction of Hong Kong court. When it comes to the validity of the exclusive and non-exclusive jurisdiction clauses, Dr. Geoffrey Ma Tao-li, the then Chief Justice of High Court once stated in the case Nobel Power Investment Ltd v Nissei Stomach Tokyo Co Ltd [2008] 5 HKLRD 631, paragraphs 24 -31, that the validity of the clauses on non-exclusive jurisdiction should first be interpreted. Since both parties agree to be subject to a certain jurisdiction, the parties’ autonomy should be respected. When legal proceedings commence in the designated jurisdiction, the party who applies to set aside the proceedings or raises objection to the jurisdiction shall bear heavier burden of proof, due to the reason that both parties have agreed to be subject to the jurisdiction.

When it comes to the case at hand, both parties agreed in the “Loan Agreement” that courts in Hong Kong should have non-exclusive jurisdiction, while Weng Jiyi chose to file a lawsuit in Mainland China. If Li Ye later raises objection to the jurisdiction in Hong Kong courts claiming that it is more appropriate for courts in Hong Kong to hear the case, Weng Jiyi will bear the burden to prove otherwise, as the suit brought by parties before Hong Kong courts constitutes suit “as of right”.

2. Characteristics of loan contracts under common law.

In common law, contract terms can be divided into three categories: conditions, warranties and innominate terms. In breach of conditions, the non-defaulting party may be exempted from its non-performed obligations under the contract and is entitled to claim damages caused by the breach. On the other hand, in breach of the warranties, the non-defaulting party cannot be exempted from its non-performed obligations under the contract, but is only entitled to claim damages caused by the breach.

In the case at issue, as no innominate terms can be found, it is not necessary to elaborate on them. Terms in loan contracts are discussed in Chitty on Contracts (32nd edition): When the debtor fails to repay in accordance with the terms of the contract, the creditor may sue the debtor. In common law, a creditor is not entitled to claim interest during the period from the date when the loan is due to the date the judgment is made. In most cases, if there is no contractual agreement, the creditor can only claim interest in accordance with the law. Nevertheless, since the case Sempra Metal Ltd v Commissioner of Inland Revenue [2007] UKHL 34, creditors, in case of delayed repayment by the debtor, were entitled to recover damages in accordance with the principle of contract breach under general contract law. Therefore, repayment terms in contracts constitute conditions, and the legal effect is that once in breach of the conditions, the creditor can sue the debtor. The creditor’s unfulfilled obligations under the contract would be exempted and it is entitled to claim for damages. The theoretical basis can be traced back to the provisions of English law on loan contracts. The book Halsbury’s Law of England (1st edition, 1912) states that if the creditor is not a person engaged in loan service, he/she is not obliged to meet the registration requirements under the Debtors Act 1869. In the case of loan, the existence of the debt directly constitutes a cause of action.

In short, if there exists a debt between A and B, A or B can recourse to the court for remedies. The existence of the debt directly constitutes a cause of action. In Norton v Ellam (1837) 2M&W461, Parke B mentioned on page 464 that if the parties decided to specify the period in the contract, there is no obligation to notify in law. In a loan contract, the existence of a debt constitutes a cause of action. If the creditor defaults, the debtor can recover damages if he/she is able to prove that the actual loss is caused by the creditor’s default and the damage is foreseeable.

As to the date of repayment, Chitty on Contracts (32nd edition) lists the following provisions: (1) If the repayment date is unspecified, the creditor and debtor may agree on the details of the repayment without prior notice of the loan. (2) Provided that the loan is required to be repaid, prior request or prior notice is required. It is worth mentioning that, in this case, the “Loan Agreement” signed between the original creditor Glories Global Limited and Li Ye, mentioned that six months after the date GAML is listed, the conversion right may be exercised on or before the repayment due day through effective notice. Nonetheless, the “Loan Agreement” is silent on the situation where the target company GAML fails to be listed. Therefore, this “Legal Opinion” would not further explore and discuss the relevant events of default.

3. Cap.163 Money Lenders Ordinance of Hong Kong.

To start with, not all contracts concerned with “loan” or “debit and credit” are regulated by the Money Lenders Ordinance (Cap. 163) of Hong Kong. According to Section 2 of the Money Lenders Ordinance, money lender means every person whose business (whether or not he carries on any other business) is that of making loans or who advertises or announces himself or holds himself out in any way as carrying on that business, but does not include—(a) a person specified in Part 1 of Schedule 1; or (b) as respects a loan specified in Part 2 of Schedule 1, any person who makes such loan; (Amended 69 of 1988 s.2).

Section 24 of the Cap. 163 Money Lender Ordinance provides the prohibition of excessive interest rates:

(1) Any person (whether a money lender or not) who lends or offers to lend money at an effective rate of interest which exceeds 60 per cent per annum commits an offence.

(2) No agreement for the repayment of any loan or for the payment of interest on any loan and no security given in respect of any such agreement or loan shall be enforceable in any case in which the effective rate of interest exceeds the rate specified in subsection (1).

(3) The Legislative Council may by resolution alter the rate specified in subsection (1): Provided that in relation to any agreement for the repayment of any loan or for the payment of interest on any loan which is in force at the date when such rate is so altered, the rate so specified as at the coming into force of such agreement shall continue to apply.

(4) Any person who commits an offence under this section shall be liable—(a) on summary conviction to a fine of USD 500,000 and to imprisonment for 2 years; (b) on conviction on indictment to a fine of USD 5,000,000 and to imprisonment for 10 years. (Amended 82 of 1994 s. 33)

(5) Nothing in this section shall apply to—(a) a loan specified in paragraph 12 in Part 2 of Schedule 1; or (b) as respects such loan, any person who makes such loan. (Replaced 69 of 1988 s. 20)

Exempted Loans are regulated in Part II of Schedule 1. Paragraph 12 states:

(a) A loan made to a company that has a paid up share capital of not less than $1,000,000 or an equivalent amount in any other approved currency.

(b) For the purposes of this paragraph approved currency means a currency—(i) freely convertible into Hong Kong dollars; or (ii)approved in writing by the Registrar for the purposes of this paragraph.

In the case at issue, the “Loan Agreement” does not mention the terms of interest, while in the “Letter of Commitment”, matters concerning interests are mentioned. However, there are no specific terms on the amount of interest, calculation method, repayment period and repayment methods. Therefore, subject to further documents, terms of interest in the “Letter of Commitment” are in compliance with the laws of Hong Kong.

4. Provisions on interest in the contract.

First, according to Lender Claims (1st edition, 2010, Sweet & Maxwell), a clear distinction should be made between interest compensation and interest as compensation. Generally speaking, when Li Ye borrows money from Weng Jiyi, Weng Jiyi will receive interest compensation; if Li Ye breaches the contract and result in losses, Weng Jiyi will receive interest as compensation. In Bushwall Properties v Vorte x Properties, the differences between interest compensation and interest as compensation were further elaborated. It can be concluded that the terms of interest were not specified in the “Loan Agreement” and the “Letter of Commitment”.

Under the common law system, following points related to interests are noteworthy:

(1) Both parties can specify the repayment of interest in the contract. Generally, the court will respect parties’ agreement and enforce it. The court may also infer the repayment of interest in accordance with the transaction practices of both parties. Previously, English courts ruled that interest should not be compensated without explicit or implicit terms on interest. Until recently, the House of Lords held that if the loss could be brought up and proved by one party, the loss of interest should be compensated.

(2) In the case London, Chatham & Dover Railway v SE Railway [1893] AC429 in 1893, the House of Lords held that interests are not recoverable for the delayed payment of a debt. It was not until 2007, the House of Lords reviewed and determined in the case Sempra Metals Ltd v Commissioners of Inland Revenue [2007] UKHL34 that interests were payable. In that case, the House of Lords stated that under common law, if the claimant could prove the actual loss were caused by delayed repayment, such claims would be approved.

Rules regarding interests are different in common law and equity law.

(1) Common law. Historically, interests were discouraged under common law. As mentioned above, in the case London, Chatham & Dover Railway v SE Railway [1893] AC429, the House of Lords held that interest should not be paid in delayed repayment. Therefore, provided that the parties did not explicitly reach an agreement in the contract, English courts believe that the interest on the price of the goods which sold overdue should not be paid; except for the circumstances of fraud, the debtor should not compensate the creditor for interest.

(2) Equity law. In some cases, even the contract is silent or no transaction practices can be found, interests can be approved under equity law. For example, although it is not mentioned in the contract, interest is payable under mortgage loans. In addition, when the debtor bears a faithful obligation to the creditor, the creditor is entitled to obtain compensation for the interest derived from the loan.

5. The issue of the offsetting of interest and principal.

Regarding the issue of the offset of interest and principal, Chitty on Contract (32nd Edition) states that in cases where there is interest in arrears, if the creditor and the debtor did not divide the amount, unless there are contrary intentions, the interest due shall be offset initially and following by the principal of the earliest period. In the case West Bromwich Building Society v Crammer [2003] BPIR783, Lord Justice Neuberger (position at that time) mentioned the following points in the judgment: The argument put forward by the debtor is that the creditor should use the£420,000 received to offset the principal rather than the interest. According to the creditor’s argument, the law stipulates that interests should be offset first rather than the principal; or the creditor may offset part of the funds as he/she deems reasonable.

In The “Mecca” (1897) AC286, Lord Macnaghten stated in the judgment on page 293 that “It is the position of English law that when a debtor pays to a creditor, he/she can pay it as wishes, then the creditor may offset the arrearage according to the payment rules. If the debtor does not make any choice regarding offset when paying, then the creditor has the right to choose.” Lord Macnaghten then discussed how the law assumes the problem of offsetting without a specific choice. The Lord Justice Neuberger also cited paragraph 28.47 of the book Fisher and Lightwood’s Law of Mortgage (11th edition) and concluded that “if the debtor wishes to repay to offset part of the principal or interest (which is not specified), generally, the repayment should be offset from interest first and then deducted from the principal” with a similar legal effect.

In the case Potomek Construction Ltd v Zurich Securities Ltd [2004] 1 AllER (Comm) 672, the debtor was a property development company claiming compensation from the mortgagor for selling the debtor’s property at a low price. When the debtor, who had pledged his property to the creditor, failed to repay the loan, the creditor bid£400,000 at the auction catalogue. Before the auction, the debtor sold the property for£380,000. The debtor won the case. David Donaldson QC mentioned in paragraph 69 of the judgment: The judge cited Chitty on Contracts paragraph 22-067, demonstrating that if the debtors and creditors have no explicit provisions for the offset, the law stipulates that unless there are contrary intentions, the interest due shall be offset initially and following by the principal of the earliest period.

In the case at issue, the “Loan Agreement” did not regulate on how to repay the principal and the interest, moreover, Li Ye, the debtor, did not raise requirements on this problem. Therefore, under common law, interest should be offset first following by the principal. Generally speaking, the interest within the loan period claimed by Weng Jiyi should be supported unless the interest requirement violates the prohibition on excessive interest in the Money Lenders Ordinance. Hence, if Weng Jiyi is able to prove that the overdue interest is the reasonable and foreseeable compensation due to Li Ye’s default, then Weng Jiyi’s claim for overdue interest should be supported. On this basis, the claim of interests within the loan period, overdue interests and that interest due shall be offset initially and then following by the principal are in accordance with the laws of Hong Kong.

In conclusion, the four points which have been identified above could be summarized as follows:

(1) All the provisions of the “Loan Agreement” and the “Letter of Commitment” in this case that related to interest are in accordance with the laws of Hong Kong.

(2) With regard to the sequence of repayment in the loan contract under the laws of Hong Kong, unless the parties have agreed in the contract, otherwise the interest due shall be offset initially and then following by the principal of the earliest period according to English law.

(3) Under the circumstance that the agreement is ambiguous, or parties have different understandings of the agreement, the laws of Hong Kong shall be applicable regarding the loan period in the loan contract. Generally speaking, the interest within the loan period claimed by Weng Jiyi can be approved unless the interest requirement violates the prohibition on excessive interest in the Money Lenders Ordinance. According to English law, unless the parties have agreed in the contract, otherwise the due interest shall be offset initially and then following by the principal of the earliest period.

(4) In the case at issue, the interest within the loan period claimed by Weng Jiyi should be supported unless the interest requirement violates the prohibition on excessive interest in the Money Lenders Ordinance. Hence, if Weng Jiyi is able to prove that the overdue interest is the reasonable and foreseeable compensation due to Li Ye’s default, then Weng Jiyi’s claim for overdue interest should be supported. On this basis, the claim of interests within the loan period, overdue interests and that interest due shall be offset initially and then following by the principal are in accordance with the laws of Hong Kong.


Read the original: 藍海查明案例 ▍香港如何規定借款合同中的還款順序?

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