Soapbox


Myths: Magna Carta (“The Great Charter”) and other myths?

In 1866 Thomas Keightley wrote of the Magna Carta [MC] that:

 It is the foundation of all the abundant liberty which we now enjoy, and no other nation can produce such a monument of genuine patriotism and tended and enlightened humanity as it presents; and that too, it should be observed, in an age which we are apt to regard and despise as rude and barbarous. For those enlightened prelates and high-minded nobles who wrested the Great Charter from a reluctant despot, were not actuated by a selfish regard to their own peculiar interests. They provided for the security of even the lowest of the people.  

An Elementary History of England at 53.

The MC protected our civil and criminal rights so that, in the words of Chapter 40: “To no one will we sell, to no one will we deny, right and justice”.

The myth? Well there are two views on that. First, many scholars "have dismissed the traditional interpretation of what the MC actually achieved as a myth" Lectures on Legal History : WJV Windeyer: (1957) at 79. This group of critics considered that the Charter was to serve ‘the dominant class” only.  Second, which version was “the real thing”?  Apparently the MC was re-copied several times without exactitude. Several versions were thereafter published with varying mirror-image terms, some of which were exact, others were not so. Tales of lost copies, plus quashing of the MC by papal rule, the deposing of “bad” King John and so on, have lead to the mystique of the MC up to this day. Whatever are perceived, or actual, defects of the MC, no one can deny that its spirit remains, and will continue to remain, as a core value of our common law thereby giving us the “rule of law” so that we can celebrate its 800th birthday. Indeed as Windeyer wrote: “We cannot lightly dismiss the greatest document in English history, the good root of title of the British constitution”, even if it was not as perfect as we theorise.

The terms of the MC were considered to have been derived from Roman and canon law. Roman law apparently in most common law schools is no longer taught. Canon law as religious law prevails in other spheres, but no longer the source of common law.

The lowest level of criticism of the MC was that it denied relief to the ‘unfree villein”. Feudalism required layers of rights to function and produce income for the overlord. An unfree villain had the use of land from his overlord, he could not leave the land without the overlord’s consent, and he was subject to certain punishments by the overlord. By and large, the missing rights can now be found in section 8 of the Hong Kong Bill of Rights Ordinance, and in parts of the Basic Law.

We seek to ensure that the rule of law is ongoing in the common law world with only a few dissenters. Without the MC what would common law be like? So whatever we may seek to establish precision in its terms, it is undeniable that without it eight hundred years of common law would have been bleak indeed.

MC allowed the natural justice and moral obligations of Equity to flourish, although the Court still maintain that morality has no place in the common law.

Happy 400th birthday also this year to Equity. The court of conscience, Chancery later that of Equity, is also celebrating a milestone this  year – namely the Earl of Oxford’s case (1615) in which the right of Chancery, to maintain its separate court from the King’s courts, and even perhaps for Equity to prevail over the common law, was upheld. Equity was said to be necessary “to correct men’s consciences against frauds, breaches of trust, wrongs and oppressions of what nature soever they be, and to soften and mollify the extremes of the law”.

The myth of the English Mortgage

The phrase “suppressio veri and suggestio falsi” was applied to the traditional form of mortgage, introduced in the twelfth century.

This traditional mortgage was identified as a conveyance plus a contract, to redeem title, by reference to its external appearance. It involved the conveyance or assignment of the legal estate of the mortgagor to the mortgagee, usually as a collateral security for a loan, with a right of defeasance to the mortgagor.

On the surface – the common lawyer would see that the mortgagee now owned the land. Common law did not trouble itself with equitable interests. Equity acknowledged the legal estate to the land in the hands of the common law, but went further to treat the defeasance right of the mortgagor as the main element for protection, and that as an equity of redemption, able to override the contractual right to redeem.

Thus, on repayment, the mortgagor could recover the legal estate even if common law had already cancelled the mortgagor’s right to do so for failure to repay on the due date. Contrary to section 11 of the Law Amendment and Reform (Consolidation) Ordinance [“LARCO”], Equity allowed an extension of time Equity considered that any prevention of recovery – within a reasonable time, perhaps 6 months from the due date – was improper; any recovery but with an attached ‘clog’, or restrictive covenant, was improper. Further to allow the common law “right to redeem” to be extinguished merely because of delay in repayment was too harsh bearing in mind that the majority of mortgagors in early days were farmers, and the loss of the land meant the end of their livelihood. Equity, maintaining its policy of preventing a ‘penalty’ to operate,  justified its extension of time.

Looking at the transaction, at its creation, common law and equity saw different things. The truth of the equitable interest was hidden from view, and the surface was an assignment of title to the land – common with a sale. Thus common law saw a contract of sale. Possession passed to the mortgagee who could allow the mortgagor to remain by (a) a licence or (b) a lease or (c) by attornment.

Equity saw the right of the borrower to recover his land on repayment, even if that repayment was a little late. Hence to equity it was not a sale, but use of land as a security.

The common law interpretation of the transaction succumbed to the maxim “once a mortgage always a mortgage” under which the mortgage was a “security”[thus able to be discharged in appropriate circumstances] rather than a “sale with (possible) resale”. Today, we examine the “sale and resale” transaction to ascertain whether it is a sham. Is it hiding a security? Is the asset sold the only remaining asset held by the borrower who has already secured loans over all other assets? If so, then it is too late for the “purchaser” qua lender, to obtain priority, or even to become a secured creditor in priority of other creditors of the “vendor” qua borrower? The nature of the transaction is dependent on replies to two questions focusing on each party: does the purchaser have an obligation to re-sell: and does the vendor have a right to re-purchase or merely an option to do so? An obligation to re-sell looks like an equity of redemption; an option to re-purchase makes the sale transaction just that.

In Hong Kong, the traditional, legal mortgage over land has now been displaced by a hypothecation under which nothing is transferred to the lender. The effect of this form of security over land is that it is a “legal mortgage by way of legal charge by deed”; this merely creates an encumbrance against the land indicating the identity of the asset available for seizure and sale on default. Possession is given only on default. When repayment is achieved, nothing is redeemed or re-assigned: section 44(1) of the Conveyancing and Property Ordinance (Cap 219) [“CPO”]. Section 44(2) applies all incidents of a true mortgage to this charge other than that of possession until default. This represents the old maxim: “the common law looks at the form: equity looks at the substance”.

A release or satisfaction is available: sec 56. If the mortgagor/chargee sells on default, the bona fide purchaser receives good title: sec 52. Terminology alone, the security over land under the CPO is not clear and apparent. Thus there remains an aura of suppression and suggestion.

More myths and the law

The statutory or legal assignment of the benefit of a chose in action under section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Cap 23) [“LARCO”] can take the form of a transfer or a (traditional) mortgage. The assignment requires the whole of the benefit of the chose to be assigned. Where the form chosen is that of the mortgage, the right of redemption is ignored as part of that transaction. It is a legal transaction and so equitable principles are irrelevant.

By contrast, in equity assignment of the benefit of a chose in action requires consideration but nothing else. The form of this assignment is usually that of an equitable charge, ie a hypothecation. The common “benefit” being charged is that of book debts owed to a company borrower. These book debts are both present as well as future property. Equity has no problem dealing with future property. “Equity looks on that as done, that which ought to be done”. Conscience and the trust are the sine qua non of Equity.

For Equity, aliter the common law, lending money on non-existent property with a right on default to seize and sell the non-existent asset (when it comes into existence), was perfectly fine. The undertaking from the beginning registered with Equity as an obligation to repay; with luck the lender could seize and sell the named assets (although of course not yet clearly identified). On failure of the assets to materialize there still was the promise to repay which had its own personal remedy. Early derivatives must have had a lot of the same aura of “non-existence” that the proceeds of book debts (the future part) had in the late, nineteenth century.

Law Merchant is to thank for the share certificate, the Bill of Exchange and other assets, choses in action, but which were capable of being elevated to receive, in certain situations, protection as if the underlying asset was a chose in possession. These documents could be pledged even though the pledge itself is a possessory security. In such a case, the absence of tangibility is irrelevant. This became the same concept in relation to “future property” for the equitable charge. Furthermore, unlawful interference with the document could give rise to an action in conversion or detinue; again there was a possessory core to the relief for relief here resulted from unlawful interference with possession. Justification for this rests with trade, custom and usage of merchants: see now cases such as MCC Proceeds Inc v Lehman Brothers International (Europe)  [1998] 4 All ER 675, CA; and Silver Stone Ltd & Anor v Lau Kwong Ching James & Ors [2007] 4 HKC 77, CA.

The mythical or mysterious “unconscionability”

A consideration of unconscionability has been with Equity since time immemorial – or more correctly since the Chancellor, and later the Court of Chancery and still later the Court of Equity, began to grant relief against the harshness of the common law. If the role of the Chancellor, and then of his court needed explanation, it came in the Earl of Oxford’s Case in 1615 when the rightful role of the inherent nature of “equity” was confirmed and its place in the “common law” of England set to continue without attack.

Equity has traversed a narrow path tiled with discretion and maxims. Today path has become a great avenue mirroring the ambience and exuberance of the Great Trunk Road of Kipling’s Kim.

One of the areas of modern innovation by Equity to relieve against unconscionability has been in quasi-contract, the common law’s answer to unfair situations. These cover “common money counts” such as quantum meruit, quantum valebat, money paid under mistake, and so on. The rigidity of recovery meant that the common law, especially in quantum valebat and quantum meruit, required the presence of an implied, but never an express, promise to pay where there was a defective contract (eg: no price mentioned) or even no contract (money paid under mistake). Without that, no recovery was possible.

Equity took a different line with the common money counts and looked to overturn them by metamorphosing “quasi-contract”, via equity’s remedy of unjust enrichment, into restitution to off-set unconscionability or the harshness of the common law’s quasi-contract: Pavey & Matthews Pty Ltd v Paul (1987) 69 ALR 385, HCtA. This case was one of the first in the new development: see later examples such as Sempra Metals v IRC [2007] 4 All ER 657, HL: Goss v Chilcott [1997] 2 All ER 110, PC. See also the extensions into areas such as “knowing receipt of trust property”: Akal Holdings (In Liq) v Kasikornbank PCL [2011] 1 HKC 357, CFA.

Unconscionability is usually the trigger for restitution. But commencement of the action requires a nominate, equitable, remedy. The resulting restitution has various aliases, fact situations, legal or equitable wrongs, and results. In Kasikornbank, for example, “knowing receipt of trust property’ (from Barnes v Addy  (1874) through to Royal Brunei Airlines v Tan (1996)) was relieved as equitable compensation. Failure of the bank to do due diligence resulted in it being ordered to repay the value of the shares deposited as security, plus compound interest. In AG v Blake [2001] HL common law damages were disguised as “an account of profits”, commonly the remedy against a defaulting trustee. The identity of the monetary relief in this decision was dissembled into “common law damages” even though no loss had been suffered. The restitution through account of profits was the “consideration for hypothetical waiver” of existing rights, even though no fiduciary relationship existed.

Is the equitable relief of the past now merely a memory? Is it now mythical?  Is discretion now merely an ephemeral, vague background for expansive restitution? Trusts are fully at home in the commercial world. Common law limitations are often (expressly in legislation, or by analogy) the same as equity’s laches.

The Privy Council decision in AG v Reid  formerly doubted in England has now been endorsed; thus no longer is a bribe taken by an employee to remain a debt due to his employer. Instead, following the Privy Council in Reid, the bribe is held on a constructive trust for the employer: FHR European Ventures v Cedar Capital [2014] SC.

To end

A quote from Cardoza in [1923] (Growth of the Law: Yale LS)

Adherence to precedent is once a steadying force, the guarantee, as it            seems, of stability and certainty. …. An avalanche of decisions by tribunals great and small is producing a situation where citation of precedents is tending to count for less and appeal to an informing principle is tending to count for more.

Myths. They are throughout the law. Without them the law would be less just, and less protective of those needing protection.

So back to the MC. Without it, would we have had the law we have today?



Can Equity trump the abolition of Turquand’s Case

_DSC9456

Before 1997, company law in Hong Kong, applied the “indoor management rule”. This rule was explained in Royal British Bank v Turquand (1856). It provided that, in considering contracts effected by or on behalf of a company, so that persons contracting with a company and dealing in good faith may assume that acts within the constitution and powers have been properly and duly performed and are not bound to inquire whether acts of internal management have been regular. [Morris v Kanssen [1946, HL]        

Threads of the rule include questions of

i.               the validity of the contract under the general law, and in line with the constitutional documents of the company;

ii.              the manner of execution of the contract; this is now a matter for sections 127 and 128 of the Companies Ordinance ((Cap 622) which provide that a seal is voluntary, and that compliance with either of these sections will enable the company to effect a deed without a seal;

iii.            the authority of the party representing the company, that is the purported ‘agent’ and his authority, or lack of authority; and

iv.             the equitable consequences of having constructive notice.  

By and large, Turquand’s case concerned (a) the objects and purposes of the company, and (b) agency. But there have been swings in court identifying the dominant focus of the rule: from the law of principal and agent – through estoppel – to protection for innocent outsiders from having to investigate internal management to ascertain the authority of the company representative.

Until 1997, Turquand’s case acted as a good defence to the outsider, who had acted in good faith and who was not “put on inquiry”, or was not suspicious about the validity of the transaction.  Freed from necessary investigation of documents filed in the Companies registry, the outsider was not held bound by constructive notice in Equity and thus he could retain the asset or property received under the contract. The defence eliminated possible equitable intervention. 

Where the transaction was improper, the company had to take action against the purported agent. Alternatively, a member could pursue a statutory derivative action on behalf of the company.

Amendment to the then current Companies Ordinance (Cap 32) in 1997 resulted in the insertion of sections 5A to 5C. Section 5A altered traditional law by providing that a company could now do anything a natural person could do, and so there was no need for objects and purposes of the company to be noted in the constitutional documents, up till then more usually in the Memorandum of Association. The memorandum itself was also considered unnecessary.  Although listing powers of the company became irrelevant, yet still the question of constructive notice lingered even though section 5C repealed the traditional principle that constructive notice came from the failure to search the Companies registry:. Section 5C abolished constructive notice.  Section 5B provided that anything done contrary to the existing powers in the constitutional documents would not, of itself, invalidate a transaction. It looked as if that was the end of Turquand.

But Equity and constructive notice hovered around company transactions. An outsider who knew the transactions was not valid, for example because the party representing the company was not its agent, would be unable in Equity to rely on the transaction and was to be treated as a constructive trustee for the company. A suspicion that something was “not quite right” was equivalent to constructive notice if no inquiry was made; the concept of ‘wilful blindness’, or ‘turing a blind eye’, is equitable “language” for failure to investigate when required to do so. It is used in other areas of the law, such as land contracts. Wilful blindness is not peculiar to any specific area of the law. in the Turquand’s situation, it would mean the outsider was acting unconscionable in taking an interest adverse to a prior interest holder known to the later party at the time that party contracted: Tulk v Moxhay (1842). The consequences of willful blindness vary with the type of situation: for example in Akai Holdings Ltd (In Liq) v Kasikornbank PCL [2011] the Court of Final Appeal referred to irrationality in failure to do due diligence on the facts of that case; illustrating thereby the concept of ‘knowing receipt of trust property” (Royal Brunei Airlines v Tan [1995], PC) relied through equitable compensation.

The Companies Ordinance (Cap 622), with effect from 03 March 2014, has now totally abandoned Turquand’s case, introducing in lieu thereof “statutory assumptions”. Section 117 introduces these:  namely         

i.               the outsider is presumed to have acted in good faith unless this is rebutted on proof to the contrary; and

ii.              the outsider is not regarded as acting in bad faith only because he knew the act was ultra vires the powers of the company. This means the outsider does not have to inquire into any possible limitations on the powers of the company, nor on the power of the Directors to bind the compan or to authorize others to do so.

The outsider is thus able to enforce the transaction unless

(a) there is proof of his failure to act in good faith; or

(b) he clearly acts fraudulently within the definition of fraud under the common law.

“Good faith”, a difficult concept to define, in effect means that if the outsider was not at fault, morally or legally, and had acted ‘honestly”, in dealing with the purported representative of the company, then he is entitled to treat the representative as the agent of the company empowered to enter into the transaction so that Equity had no role to play in the transaction strengthened further by the abolition of ‘bad faith’ of a party with notice or knowledge of defects in the transaction. To rebut the presumption of good faith would probably require the company to clearly show that the outsider dealt fraudulently, or perhaps that he recklessly ignored the possibility that the representative was not in fact an agent of the company: on which see the Kasikornbank case.

Members (and creditors) of the company – acting with knowledge and speed – may bring proceedings to restrain by injunctive relief the director or representative from carrying out an ultra vires act; members may also take subsequent action against the director on behalf of the company under a statutory derivative action: see generally sections 723 to 738 of Cap 622.

Further section 120 re-iterates the earlier abolition of constructive notice of anything disclosed in the Articles or in a return or resolution kept by the Registrar of Companies.

So the result is: the outsider acts in good faith, or more correctly, the company cannot prove that he does not. He was suspicious of the transactions. He did not make inquiries. Yet he may retain the property obtained in the transaction. The Companies Ordinance considers his knowledge irrelevant because of his statutory immunity from the usual consequences of taking with notice.

As company law principles that is the end of the story. The outsider is protected.

But should it be the end of the story?

Should the outsider retain the assets obtained under the transaction? Equity considers he should not. His behaviour because of his failure to investigate suspicions is unconscionable; this is akin to, or even amounts to, equitable fraud. So what can happen?

The skill of Equity comes to the fore. By ignoring the embargo on action under company law produced by the statutory assumptions, and re-classifying the behaviour of the outside party, a court of equity can see its way clear to assisting the victim of the unconscionable behaviour, namely, the beneficiary of a constructive trust, that is the company. There are several and varied possibilities for relief. The language becomes that of trust law and ‘knowing receipt’ of trust property. Since the expansion of equitable relief and the operation of the concept of the ‘trustee de son tort’, re-classification from company to trust law expands relief possibilities.

Why should a member or members of the company have to resort to the artificial statutory derivative action against the defaulting director or ’agent’? Recovery of the assets is a more equitable remedy for the company. Other choices of relief include the constructive trust, equitable compensation, account of profits and tracing.

Restitution could also be available but for one prevailing rule which would seem to exclude restitution

Where allowing restitution would subvert a contractual (or statutory) regime whereby risks have been allocated in a particular manner, restitution will be excluded as a matter of principle. [Yew Sang Hong Lid v Hong Kong Housing Authority [2008] CA, per Reyes J at paragraph 32].

Even without restitution there is abundant relief in Equity for the trustee de son tort receiving and retaining property knowing it belongs to the company.

Time will tell whether Equity will trump section 117.

Implied Good Faith

_DSC9456

The law will not imply an obligation of good faith into a contract. If the parties want each other to act in good faith, and so in excess of the usual contractual obligation of performing their stated obligations, then they must say so in the contract. On default of this, the court will not intervene in a commercial contract to do the drafting for them by inserting a good faith obligation: see Hospital Products Ltd v United States Surgical Corpn (1984) 156 CLR 41, HCtA.  However, for certain contracts the law makes an exception and does imply an obligation of good faith – such as employment, and partnership contracts, or where one party is subject to a fiduciary obligation.

A general amelioration of the strictness of the “no implied good faith” rule is now appearing in a variety of situations. For international documents of payment, such as the Letter of Credit and the Performance Bond, there seems to be a change on the way.  Some courts and commentators indicate that this would be totally improper as the ‘autonomy” principle associated with these documents is such that only the narrowest grounds exist for refusal to honour the obligation of payment.

Significantly this development is more noticeable in certain Asian jurisdictions that follow on from similar footprints in Australia and New Zealand in past years.

A Letter of Credit is payable to the beneficiary of the Letter when he (a) delivers the documents listed in the contract for the sale of the goods, in good time in accordance with the terms of that contract, (2) the documents comply with the requirements, and (3) there is no actual fraud on his part. A Performance Bond is payable when presented; it is uncommonly subject to conditions; unless the beneficiary is guilty of actual fraud, payment must be made.

In both of these cases, proof of fraud  - on the part of the beneficiary - is virtually impossible within the usual time-frame for which payment is required. The relevant fraud is usual “actual fraud”.  This probably means that the actions of the beneficiary have all the hallmarks of fraud, and that fraud exists, rather than that it is merely suspected. Further, international trade requires certainty. Any suggestion, that a payment obligation could be scrutinsed by a court to determine whether or not the payee acted conscionably, would hamper international trade.

The fear of losing, or the need to comply as others expect, can cause the loss of business. The new Companies Ordinance (Cap 622), amendments to the Trustee Ordinance, and to the Perpetuities and Accumulations Ordinance, and constant up-grading of the Securities and Futures Ordinance are designed to enhance our status as a global market place, and financial centre. Allowing the vagaries of “conscience” to intervene in transactions, which hithertofore we considered sacrosanct and immutable, could create nervousness in the global marketplace.

The reputation of the bank is at risk if it refuses to pay; the protection gained by adherence to the principles of international trade is also at risk. These principles require speedy payment, without argument  except within the terms of non-compliance with the tendering of listed documents and the absence of fraud. The UCP 600 demands timely payment. The bank can be on safer grounds for refusal to pay, where there is a discrepancy in the agreed terms for payment.

But the bank must ensure it is not a fault in refusing. If the beneficiary knows he has no right to payment – the so-called “abusive calling – the bank can advise its customer to seek an injunction to prevent the bank payment. If one only had time!

If the customer can point to payment not in conformity of its mandate to the bank, loss must fall on the bank. To counter this the bank will usually have obtained a counter-indemnity from its customer, thereby having a primary right to payment regardless of the surrounding circumstances. Thus it is really the customer who needs some protection.

Can that protection come from the imposition of “good faith”?

The Australian courts in considering these and similar documents have the benefit of the Trade Practices Act 1974 (as amended) with the reference to unconscionability entitling court intervention:  see sections 51AA and 51AC. The Unconscionable Contracts Ordinance follows the guidelines in section 51AC in determining whether clauses in a contract are unconscionable. However, the ordinance applies only to consumer transactions. The TPA is boarder allowing commercial parties to seek relief; see Olex Focas v Skodaexport [1998] VSC 380.

In Singapore also unconscionability can be a trigger to relief protecting non-payment of a Performance Bond. In BS Mount Sophie Pte Ltd v Join-Aim Pte Ltd [2012] SGCA 12 unconscionability was considered in a “nuanced way” to prevent abusive calling of a construction Performance Bond. The Court of Appeal required a balance between the nature of the Performance Bond [treated as cash for many years] and unconscionability. So a strong prima facie case is required. Obviously something a bank cannot judge on presentation of the Letter of Credit or Performance Bond where time is almost “of the essence”. To unconscionability is added “good faith”; and see HSBC v Toshin [2012] SGCA 48.

In Yam Seng Pte Ltd v International Trade Corporation (2013) All ER (D) 227, the Court (QB) in considering behaviour on the part of one party which caused the other to terminate the contract, said that

In refusing to recognize any such obligation of good faith, this jurisdiction would appear to be swimming against the tide.

I doubt that English law has reached the stage … where it is ready to recognize a requirement of good faith as a duty implied by law, even as a default rule, into all commercial contracts. Nevertheless, there seems to me to be no difficulty, following the established methodology of English law for the implication of terms in fact, in implying such a duty in any ordinary commercial contract based on the presumed intention of the parties”.

These cases are not alone.

What will the future bring in relation to good faith, and the autonomy principle?

But – see also those following a strict interpretation of what the earlier authorities decided – not what “new law” may expect: se eg Toomey v Eagle Star Insurance Co Ltd [1994] 1 Lloyd’s Law rep 516.


© Sihombing Law Mentors 2014