CHAPTER 1: HONG KONG LEGAL SYSTEM

Readings: 1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part I. 2. Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Two

THE SYSTEM OF COMMON LAW

A. General Concept of Common Law System 1. Hong Kong legal system is based on English legal system known as common law system. 2. Common law system mainly consists of two parts:(a) case law (two branches, the common law and law of equity) (b) legislation 3. Common law system is different from the legal system of other European countries which is known as civil code. In this type of legal system, a code, or some other form of legislation, is the only source of law. The judges are required to interpret the code, but their judgments are not a source of law. This type of system operates in France, Germany and is the system being adopted in the PRC. B. Meaning of Common Law 1. The narrow meaning of "common law" (a) A set of legal rules "common" to the whole England. It was a collection of popular customs and beliefs developed over many years from various parts of England. These customs and beliefs were applied by judges as legal principles in resolving disputes in every part of England. Special courts known as the common law courts were set up to hear cases and resolve disputes. (b) Case law The common law is that which emerges from judicial decisions (i.e. case law) rather than from the legislature. In this sense, principles of equity are part of common law. (c) Common law as opposed to equity

The law formulated in one set of the courts i.e. the common law courts, and not in the others e.g. Court of Chancery, which was for equity (discussed below). 2. The broad meaning of "common law" The common law system compares with other legal system e.g. civil code system. C. Advantages and Defects of Common Law 1. Advantages One major advantage of common law is that the law is consistent, predictable and authoritative. Why? 2. Defects (a) Rigidity Judges placed too much emphasis on consistence. They decided cases on established principles in an inflexible manner irrespective of justice and fairness. (b) Limited remedy The commonest remedy in common law is damages (monetary compensation) e.g. breach of contract. In many cases common law was incapable of providing remedy e.g. breach of trust in land or undue influence on contract. D. Equity As common law was not satisfactory to justice in some aspects, there was development of another branch of law in England to address the problems that could not be redressed by common law. This branch of law is known as equity. 1. The meaning of equity (a) Wider meaning It means that which is fair and just, moral or ethical. (b) Legal meaning The branch of the law which was applied and administered by the Court of Chancery (as opposed to common law which was applied and administered by the common law courts). 2. Origin of equity The inflexibility and harshness of the common law caused injustice to some people. As a result, they petitioned to the English King directly for justice. The petitions were dealt with by Lord Chancellor - Chief Secretary of State and "Keeper of the King's Conscience".

The Chancellor was not bound by the rigid rules of the common law. His decisions were based on what he considered to be just and fair. In 15th century, the Chancellor set up his own court known as the Court of Chancery to hear the petitions. The rules applied by the Court of Chancery subsequently became a branch of the English law called equity. One of the most important remedies created by equity is the concept of trust. 3. Development of Equity Until the Judicature Act 1873, rules of equity were not enforced in common law courts. If a defendant to a common law action had an equitable defence, he had to go to the Chancery to obtain an injunction to stay the proceedings in the common law court and then start a new action in Chancery to establish his equitable rights. The basis of intervention by equity was that it was necessary on the ground of conscience. The most significant and far-reaching sphere of jurisdiction of the Chancery Court was the enforcement of the use of land. 4. Merging of Common Law and Equity The Judicature Acts of 1873 and 1875 abolished the old system of separate courts of common law or Chancery. It created the Supreme Court of Judicature with a High Court applying both principles of common law and equity. It was inevitable that a court which applied the rules of both common law and equity would face a conflict and in such event, the Supreme Court of Judicature 1873 provides that the rules of equity shall prevail.

E. Hong Kong Development 1. Before 1 July 1997 The Chinese Government formally ceded Hong Kong to Great Britain on 26 January 1841. The British introduced the English legal system to Hong Kong but Chinese customary continued to play an important role. Since the enactment of Supreme Court Ordinance in 1873, the rules of both common law and equity have been applying in Hong Kong courts. S. 3 of the Application of English Law Ordinance applies the English common law and rules of equity to Hong Kong as far as they are applicable to the circumstances of Hong Kong or its inhabitants and subject to such modifications as such circumstances require. Modelled on the English parliament, Hong Kong Legislative Council enacts its own legislation. 2. After 1 July 1997

The Basic Law (article 8) stipulates that the laws previously in force, including the common law and rules of equity shall be maintained. SOURCES OF HONG KONG LAW A. Before the 1 July 1997 1. The rules of common law and equity of England as far as they are applicable to the circumstances of Hong Kong or its inhabitants and subject to such modifications as such circumstances require. 2. Case law (decisions of Privy Council and Hong Kong courts). 3. Legislation passed by Hong Kong legislative council. 4. English Acts and Orders in Council which apply to Hong Kong. 5. Chinese law and custom. B. After 1 July 1997 1. The Basic Law 2. The laws previously in force in Hong Kong The common law, rules of equity, ordinances, subordinate legislation and customary law shall be maintained, except for any that contravene the Basic Law, and subject to any amendment by the legislature of the Hong Kong SAR (article 8 of the Basic Law). 3. Legislation passed by Hong Kong SAR legislature (article 18 of the Basic Law). 4. Case law (decisions of Court of Final Appeal of Hong Kong and Hong Kong other courts). 5. PRC national laws as listed in Annex III to the Basic Law. The National People's Congress may add or delete from the list of laws in Annex III after consulting the Basic Law Committee and the government of HKSAR (article 18 of the Basic Law).

COURTS OF LAW IN HONG KONG

A. Magistrate's Court 1. Jurisdiction Criminal court which deals with a vast number and a great variety of cases. There are in total ten Megistracies: Western; Eastern, South Kowloon, North Kowloon, San Po Kong, Kwun Tong, Tsuen Wan, Shatin, Fanling, and Tuen Mun. 2. Maximum sentence and fine

2 years' imprisonment. If a person is sentenced for two or more offences and the sentences are to run one after the other (consecutively), then a permanent magistrate can impose a maximum of three years imprisonment. HK$100,000.00 (HK$500,000.00 if specified by other Ordinance) 3. Committal proceedings Criminal cases involving indictable offences to be heard by a judge and jury in the Court of First Instance must be brought to the Magistrate's Court for committal proceedings. At these proceedings, unless the person accused elects for an automatic committal, the prosecution must show that they have sufficient evidence for the case to be heard by the Court of First Instance.

B. The District Court 1. Criminal jurisdiction The District Court has both a civil and a criminal jurisdiction and is located in Wanchai. Whether a case concerns a civil or a criminal matter, it is heard by one judge who sits alone. There is no jury in the District Court. Maximum term of sentencing is 7 years' imprisonment (murder, manslaughter and rape are tried in Court of First Instance). 2. Civil jurisdiction Claims for damages for breach of contract and torts, such as negligence, where the amount claimed is between $ 50,000 and $ 600,000 (claims in contract and tort for less than $ 50,000 are heard by the Small Claim Tribunal). Claims relating to recovery of land whose rateable value is not more than $ 240,000 Claims relating to the administration of a deceased person's estate, breach of trust, and other equitable concerns where the value of the interest is generally not greater than $ 600,000. 3. Appeal against the decision of the District Court Appeal lies to the Court of Appeal C. High Court of the Hong Kong Special Administrative Region 1. Establishment Established under the Hong Kong Reunification Ordinance to replace the previous Supreme Court of Judicature. It consists the Court of First Instance and the Court of Appeal.

2. Court of First Instance. Original jurisdiction The Court of First Instance has unlimited jurisdiction in both civil and criminal matters. It also exercises jurisdiction in shipping, bankruptcy, company winding-up, adoption, probate, and lunacy matters. Appellate jurisdiction Hears appeals from Magistrate's Courts, Labour Tribunal and Small Claims Tribunal. 3. Court of Appeal Hears appeals on all matters, both civil and criminal, from Court of First Instance, District Court and Lands Tribunal. D. The Court of Final Appeal 1. Establishment Established under the Hong Kong Court of Final Appeal Ordinance. Take over the function and jurisdiction of the Privy Council. 5 judges (1 non permanent or from other common law jurisdiction). 2. Civil Appeal As of right if involves a dispute of at least HK$1,000,000.00. At its discretion if the matter involves great general and public importance. 3. Criminal Appeal No appeal shall be admitted unless:(a) where a point of law of great and general importance is involved or (b) substantial and grave injustice has been done. 4. Limitation No jurisdiction over act of state such as defence and foreign affairs (art 19 of Basic Law).

THE CREATION OF LEGISLATION

A. Meaning of Legislation 1. The term "legislation" has two meanings

The process of making laws by the legislature; Statutory laws (Ordinances and subsidiary legislation) 2. Effect on common law Statutory laws are important sources of Hong Kong law. Whenever there is a conflict between common law (case law) and statutory law, the latter prevails. B. Creation of an ordinance 1. Bill An ordinance originates in a bill. Bills may propose new legislation, amend or repeal existing legislation. Bills are generally introduced by the policy bureaux of the Hong Kong Government. Bills are drafted by the Department of Justice. After a bill is drafted, it is presented to Chief Executive in Council for approval before it is submitted to the Legco. Next, the bill will be presented to the Legco. The bill will be published in the Government Gazette (Legal Supplement No.3) and sent to every member of the Legco. 2. Readings First reading: short title of the bill read out and the date for the second reading is fixed. Second reading: the legislative councillor in charge of the bill explains the contents of the bill. The bill's merits and defects will be debated at this stage. If the second reading is approved, a committee will be set up within the Legco to examine the bill in detail and make a report to the Legco for any amendment. Third reading: The legislative councillor in charge of the bill proposes that the bill read for the third time. If the majority of the Legco agrees, the bill is formally passed. 3. Assent The bill is finally sent to the Chief Executive for his assent. The bill becomes an ordinance when it receives the Chief Executive's assent.

INTERPRETATION OF LEGISLATION
Statutes can be difficult to understand because of their complex sentences and their use of legal terms. If there is dispute as to the meaning of an ordinance, arising from ambiguity or confusion, it is the task of a judge to give an interpretation. There are different guides a judge can apply in order to interpret a statute. A. Statutory Guides

1. Interpretation and General Clauses Ordinance. This ordinance provides definitions of words frequently used in Hong Kong legislation. B. Common Law Rules Common law has developed certain principles and guideline to assist judges to interpret legislation where the wordings are ambiguous and not clarified by the statutory guides. 1. The literal rule The judge gives the words their ordinary meaning. It is legitimate to look at a dictionary to ascertain the meaning of words which have no particular legal meaning. If words have only one literal meaning, the literal rule is that this meaning must be applied even if it appears absurd. 2. The golden rule Where the statute permits two or more literal interpretations, the court must adopt that interpretation which produces the least absurd result. 3. The mischief rule The judge looks at the mischief behind the legislation, ie what was the problem the piece of legislation was attempting to remedy? When the judge has established the mischief, he interprets the words to provide that remedy.

THE CONCEPT OF RULE OF LAW

1. The law must be certain and not arbitrary (a) Law must be published and available (b) Binding precedent (c) Limited judicial discretion in the interpretation of statute 2. Administration of justice (a) The law is paramount and not those who administer the law (b) The administration of justice is open and impartial (public can hear the case) (c) Everyone is equal before the law (d) Citizens are entitled to "due process" in terms of both substantive and procedural aspects

CLASSIFICATIONS OF LAW

A. Public and private law 1. Public law is concerned with matters that affect the government and the community as a whole. 2. Private law deals with matters relating to individuals or groups within the community e.g. law of contract, law of tort. 3. Public law can be further categorized as:(1) Criminal law. (2) Constitutional law Governs the structure, functions and organisation of the government e.g. the legislative and executive bodies, the judiciary. The Basic law is Hong Kong's constitution. (3) Administrative law Concerns with the rules by which the executive (government) deals with individual members of the community. Prevent arbitrary abuse of government power e.g. granting of licences for restaurant, mini bus. Ombudsman (Commissioner for Administrative Complaint) - deals with complaints lodged by the public against government officials who fail to observe proper standard of administrative conduct. B. Criminal and civil law 1. Criminal law Defines those acts or omissions (failure to act) which are considered deserving punishment. Criminal Proceedings are taken against those who perform such acts or omission with a view to punishing the offender, having deterrence and satisfying public feeling but not compensating the victim. Criminal proceedings are taken by the State(i.e. HKSAR), not individual. Prosecution has the burden of proof and must prove beyond reasonable doubt - benefit of doubt belongs to defendant. Guilty mind and criminal act must be proved by prosecution. 2. Civil law

Designed to provide a remedy (compensation, redress) for the loss suffered by the injured party. Civil proceedings are brought in the name of the injured party (the Plaintiff) against the wrongdoer (the Defendant). Burden of proof lies with the party seeking redress - balance of probability.

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Chapter Two: Formation of Agreement and Intention (Hong Kong Contract Law)
Readings:
1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part II.
Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Four
2.

What is a contract?
A contract is a legally enforceable agreement. To make an agreement enforceable in court it must satisfy three conditions. There must be offer and acceptance. The agreement must be supported by consideration and the parties to the agreement must show their intention to enter into a legal relationship. Therefore the basis of every contract is a concrete agreement of some basic terms.

Formation of an Agreement (Offer and Acceptance)

An agreement is the result of the mutual assent of two parties to make the bargain, a simple model of contract formation would consist of two aspects: (1) A person (offeror) communicates his definite proposal of an agreement to another person (offeree). The proposal made by the offeror is an offer, which is a manifestation of willingness to enter into a bargain. If the offeree accepts the offer, he will communicate an unconditional assent to the offer to the offeror. This is known as acceptance. Once an offer is accepted, an agreement of two consenting minds is then formed.

(2)

According to this analysis, the court held that two offers, though identical, could not make a contract. Tinn v. Hoffman & Co.1 Facts: The defendants wrote to the plaintiff offering to sell him 800 tons of iron at 69s. per ton. Without knowledge of this letter and by an amazing coincidence, the plaintiff wrote to the defendants offering to buy the same quantity at the same price. The main issue for the court was whether two identical offers, without reference to each other, could make a contract. Held: there was no contract.

(1873) 29 LT 271

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What the judge said: "When a contract is made between two parties there is a promise by one, in consideration of the promise made by the other; there are two assenting minds and there is an exchange of promises; but I do not think exchanging offers would, upon principle, be at the same thing. The promise or offer being made on each side in ignorance of the promise or offer made on the other side, neither of them can be construed as an acceptance of the other." (per Blackburn J)

The Distinction between Offer, Mere Puff and Invitation to Treat

An offer is a proposal, by word or conduct, of a willingness to enter into a legally binding contract, and which in its terms expressly or impliedly indicates that it is to become binding on the offeror as soon as it has been accepted by the person to whom it is addressed.2 Invitation to treat is a statement of intention of making a contract, but it is not an offer. It is merely an invitation addressed to the other party to invite that other party to make an offer. In most situations, if an advertisement is intended to be an offer, the person placing the advertisement could find himself in a legally difficult position. There is no limit to the number of people who may respond to the advertisement, and if their response constituted an acceptance of an offer, an unlimited number of contracts would result. Gibson v. Manchester City Council3 Facts: The plaintiff expressed his intention of buying a property from the defendant. In its reply letter the defendant stated that it may be prepared to sell the house at the price of 2,190. That reply also stated that if the plaintiff 'would like to make a formal application', he should complete the enclosed application form and return it to the defendant. The plaintiff did as required but later, the defendant declined to sell the property. Held: The reply letter, together with the application, was not an offer, but an invitation to treat. What the judge said: "[The relevant words in the letter] make it quite impossible to construe this letter as a contractual offer capable of being converted into a legally enforceable open contract.... The words 'may be prepared to sell' are fatal to this; so is the invitation 'to make formal application to buy' on the enclosed form. It is a letter setting out the financial terms on which it may be the council would be prepared to consider a sale and purchase in due course." (per Lord Diplock) In an auction sale, who is the offeror auctioneer or participants? When an auctioneer asks for bids, he is giving an invitation to treat to the participants. The bids from the floor are offers that the auctioneer could accept or reject. The auctioneer accepts a particular when he/she 'knocks the hammer down'. Carlill v. Carbolic Smoke Ball Co.4
2 3

Guest (1984:25) [1979] 1 All ER 972

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The defendant company put an advertisement on a newspaper which stated that (1) The company would pay 100 to any person who used the 'smoke ball' and still contracted influenza and (2) The company had deposited 1000 pounds with a bank for future possible claims. The plaintiff used this product and was subsequently contracted influenza. The defendant company refused to honour their promise. In court the defendant company argued that the advertisement was a mere puff. A mere puff is a promotional statement that no reasonable people would believe in its truth. The court said that it was not a mere puff that could be ignored. The court stated that the defendant had made an offer to the whole world and that they would be liable to anyone who came forward and performed the required conditions because their performance constituted acceptance of the offer. (deposit of money was an evidence showing that the advertisement was more than a mere puff in fact it was an offer.)

Advertisement or Display of Goods Offer or Invitation to Treat?

The answer is it depends. If the contract in question were bilateral in nature, its advertisement or display of goods would be regarded as an invitation to treat. Pharmaceutical Society of Great Britain v. Boots Cash Chemists (Southern) Ltd.5 Facts: The defendants' shop was operated on a self-service basis. A customer, on entering the shop, was provided with a basket, and having selected from the shelves the articles he wished to buy, the customer put them in the basket and took them to the cashier's desk at the exit where the cashier stated the total price and received payment (just as we do in a supermarket nowadays). A registered pharmacist was present at the cashier. The then English law prohibited the sale of certain drugs unless under the supervision of a registered pharmacist. The plaintiff sued the defendants for selling the prohibited drugs without the supervision of a registered pharmacist. The plaintiff's argument was that putting the goods, which were marked with prices on the shelves, was an offer. A customer's act of taking off the shelves was an acceptance. Therefore, a contract was concluded without any supervision. Held: the self-service system did not amount to an offer by the defendants, but merely to an invitation to treat. The offer was made by customers. The defendants were the offeree who could refuse to accept the offer if the registered pharmacist advised so. Accordingly, the drugs were sold under the supervision of a registered pharmacist. What the judge said: "[A]lthough goods are displayed and it is intended that customers should go and choose what they want, the contract is not completed until, the customer having indicated the articles which he needs, the shopkeeper, or someone on his behalf, accepts that offer, Then the contract is completed." (per Somervell LJ)
4 5

[1893] 1 QB 256 [1953] 1 QB 401

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If the contract were unilateral in nature, the advertisement would work as an offer. In Carlill, the defendant argued that it could make a contract with the whole world at large. The court agreed this argument but held that a party could make an offer to the whole. In point of law this advertisement is an offer to pay anybody who will perform these conditions, and the performance of the conditions is the acceptance of the offer.

Termination of Offer
After an offer is communicated to the offeree, the offer would remain open until it is accepted or it lapses. An offer may lapse in the following ways: 1. Rejection or counter-offer

When an offeree rejects an offer, the offer lapses. An offer will also lapse where the offeree makes a counter-offer. 2. Revocation

Revocation causes an offer to lapse. As in the case of offer, a revocation is ineffective until it is communicated to the offeree. The postal rule does not apply to communication of revocation. The offeror may revoke an offer even where it contains a promise not to revoke for a period of time unless consideration and contractual intention support this promise. Usually a person cannot act for another unless that person is a properly authorized agent of the latter. In Dickinson v. Dodds,6 however, the court held that what was important was that the plaintiff, as the offeree, knew or should have known as a reasonable person that the defendant no longer wished to sell him the property. The source of information was irrelevant in their judgements.

Dickinson v. Dodds Facts: D, on 10 June gave P offer to sell a house for 800. D agreed to keep the offer open until 12 June, 9am. On June 11, D sold the house to a third party. On that evening P was told of the sale by a fourth man, called Barry. Before 9am 12 June, plaintiff handed to the defendants a formal letter of acceptance. Held: P, before attempting to accept the offer, knew that D was no longer mined to sell the property to him as plainly and clearly as if D had told him in so many words that D had validly withdrawn his offer and that P's purported acceptance was too late.

In the situation of unilateral contracts, the offeror and offeree may be strangers or even they know each other, the offeree may have commenced performance without informing the offeror. Does the law allow the offeror to revoke?

(1876) 2 Ch D 463. Contrast this case with Powell v. Lee (1908) 99 LT 284

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Errington v. Errington7 Facts: A father promised his son and daughter-in-law that if the couple could pay off the mortgage of his house, he would transfer the house to them. Later, the father died and the couple separated. The wife continued to pay the mortgage instalments. One question for the court, among the others, was whether the offer survived the father's death. Held: the court held that the offer remained good. What the judge said: "The father's promise was an unilateral contract a promise of the house in return for their act of paying the instalments. It could not be revoked by him once the couple entered on performance of the act, but it would cease to bind him if they left it incomplete and unperformed. If the daughter-in-law continues to pay all instalments, the couple will be entitled to have the property transferred to them as soon as the mortgage is paid off" (per Denning LJ) 3. Lapse by failure of condition

An agreement may be negotiated subject to a condition. If an offer is made subject to a condition, then the offer will lapse where the condition is not satisfied. An offer that requires acceptance within a specified time lapses when that time expires. An offer contains no time limit for acceptance lapses after a reasonable time. What is reasonable depends upon the circumstances. In Ramsgate Victoria Hotel Co. v. Montefiore,8 the defendant applied for shares in a company. The plaintiff allotted the shares to him five months later. The court held that in the circumstances it was unreasonable to expect an offer of this kind of nature to remain open for such a period of time. 4. Lapse by death/bankruptcy of a party

The death of either the offeror or offeree before acceptance generally brings the lapse of the offer. An offeree who does not know of the offeror's death should be entitled to accept the offer, unless the offer on its true construction indicates that the offer is personal to the offeror.9 An offer is in any event terminated by the death of the offeree before he accepts the offer.10

The nature of acceptance

An Acceptance is the unconditional assent to the proposed terms of the offer. It is unconditional in the sense that the offeree cannot introduce any variation to the terms of the offer by way of acceptance. The 'alleged' acceptance with new terms introduced is a counter-offer that has the effect of rejecting the original offer. Hyde v. Wrench11

7 8

[1952] 1 KB 290 [1986] LR 1 EX 109 9 Guest (1984:54) 10 Re Cheshire Banking Co. (Duff's Executor's case) (1886) 32 Ch. D. 301 11 (1840) 3 Beav. 334

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Facts: The defendant wrote to the plaintiff offering to sell a farm for 1000. The plaintiff replied that he would take it for 950. The defendant rejected the plaintiff's offer. Then the plaintiff told the defendant that he would accepted his original offer of 1,000. The defendant refused to sell the farm. The plaintiff sued the defendant for breach of contract. Held: the original offer was caused to lapse by the subsequent counter-offer. There was no contract between the parties. What the judge said: "The defendant offered to sell [his property], and if that has been at once unconditionally accepted, there would be undoubtedly a perfect binding contract; instead of that, the plaintiff made an offer of his own and he thereby rejected the offer previously made by the defendant. I think that it was not afterwards competent for him to revive the proposal of the defendant, by tendering an acceptance of it" (per Lord Langdale) Stevenson, Jacques & Co. v. McLean,12 The defendant offered to sell a quality of iron to the plaintiffs at 2 per ton. Then the plaintiffs sent a telegram asking whether there was a possibility of credit and, if so, what the best possible credit arrangements were. Meanwhile, the defendants had already sold all the iron to a third party, thinking that the telegram was a rejection of the original offer. Unfortunately for the defendants, the courts held that the telegram was simply a request for information by the plaintiffs

Communication of the offer and acceptance

An offer or acceptance is effective when it is communicated to the offeree or offeror respectively. '[A]s an ordinary rule of law, an acceptance of an offer made ought to be notified to the person who makes the offer, in order that the two minds may come together. Unless this is done, the two minds may be apart, and there is not that consensus which is necessary according to the English law - to make a contract'.13 For bilateral contracts, the acceptance is not complete unless and until it is communicated to the offeror. A contract is formed when an offeree has done something, by words or conduct, to signify his intention to accept unequivocally. Brodgen v. Metropolitan Railway Co 14 The defendant sent a draft contract to the plaintiff, requiring the plaintiff to fill in some particulars. The plaintiff filled in the blanks, signed and marked 'approved' on the draft contract and returned the same to the defendant for approval and signature. However, the defendant ignored it. Afterwards the parties did make some transactions on the basis of the draft contract. In this case the court held that there was a contract because the acceptance of the defendant could be inferred from its acts. According to the 'consensus' approach, there must be a meeting of minds of the parties before the court holds that there is a contract. Therefore a person cannot 'accept' an offer which he/she had
12 13

(1880) 5 QBD 346 Carlill v. Carbolic Smoke Ball Co. [1893] 1 QB 256 14 (1877) 2 App Cas 666

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no knowledge at the time when the alleged contract was said to have been concluded. In R. v. Clarke15, Higgins J said, "A consensus ad idem is a prime essential to the validity of a contract... The motive inducing consent may be immaterial, but the consent is vital. Without that there is no contract. How then can there be consent or assent to [an offer] of which the party has never heard? There cannot be assent without knowledge of the offer... " Higgins J further pointed out ignorance is the same thing whether it is due to never hearing of it or forgetting it after hearing. In this case Clarke was arrested on a charge of murder. He denied the charge and gave information to the police which led to the arrest of the real murderer. The police offered a reward of $1,000 to any person who provided information to the police. Clarke did see the offer beforehand but forgot it when he gave information to the police. The learned judge agreed that in normal circumstances it could be presumed that Clarke, having once seen the offer, acted on the faith of it, in reliance on it. However, in his evidence Clarke frankly admitted that he forgot the offer when he volunteered information and thus rebutted this presumption. Accordingly, Clarke was not entitled to the reward. An offeree could authorize an agent to communicate the acceptance to the offeror. Unintended communication of acceptance cannot turn an offer into a contract. In Powell v. Lee,16 the plaintiff applied for the position of headmaster of a school and the school's management resolved that the plaintiff be appointed. Without authorization, a manager of the school told the plaintiff that decision. But, a few days later, the school's management decided to appoint another candidate. The plaintiff went to the court and sued for damages. The court held that, since the school had never authorized that manager to accept the plaintiff's offer, there was no contract between the parties. Generally speaking, the court does not agree that acceptance could be objectively extracted from silence17. In Felthouse v. Bindley,18 the plaintiff offered to buy a horse from the defendant, who was his nephew. In the offer the plaintiff stated that if he heard nothing from the offeree then he would take that they had a contract. In the action for the horse the plaintiff failed for want of acceptance. The nature of unilateral contract would cause some difficulty to the requirement of communication: it is not practical to require a person, after the 'wanted' notice has come to his/her knowledge, to communicate his/her acceptance. On this issue Bowen LJ in Carlill said that notification of acceptance was required for the benefit of the person who made the offer. An offeror could dispense with this requirement if he/she thinks it desirable to do so. Therefore, if an offeror expressly or impliedly intimates in his/her offer that it will be sufficient to act on the proposal without communicating acceptance of it to him or her, performance of the condition is a sufficient acceptance.

Postal rule

15 16

(1927) 40 CLR 227 (1908) 99 LT 284 17 In Fairline Shipping Corporation v. Adamson [1975] 1 QB 180, Kerr J stated that the decision in Felthouse could be overcome if an estoppel could operate in the offeree's favour. 18 (1862) 11 CB, NS 869

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The postal rule states that where it is REASONABLE for the offeree to notify his acceptance by post, the acceptance is COMPLETED when the letter is posted. Since a contract would be concluded at the moment of posting if this rule applies, an offeror is put into a difficult position because the letter may be delayed or event lost on its way. This rule originated from the decision in Adams v. Lindsell19. In this case, the defendant posted an offer to the plaintiff on 2 September. The plaintiff did not receive the letter until 5 September because the address on the letter was wrong. On the same day the plaintiff posted the letter of acceptance and this letter reached the defendant on 9 September. However, the defendant sold the goods to a third party on 8 September. The court held that the contract was concluded on 5 September. The rule could be put in this way: where an offer is made and accepted by letters sent through the post, the contract is completed the moment the acceptance letter is posted, even though the letter is delayed or even lost in the course of post. If an offeror so desires, the postal rule could be ousted if it is stated in the offer that the formation of the contract is conditional upon the actual communication to him the acceptance. The postal rule was extended to communication by telegram 20 . Whether instantaneous communication (such as fax or telex) is within its scope of application was discussed in Entores Ltd. v. Miles Far East Corporation21 Facts: The plaintiff company in London made a telex to the defendant in Amsterdam, offering to buy goods from the defendant. This offer was accepted by telex from the defendant in Amsterdam. One question for the court was where this contract was formed. If postal rule applies, the contract would have been formed in Amsterdam. Held: the contract was concluded in London. What the judge said: "when a contract is made by post it is clear law throughout the common law countries that the acceptance is complete as soon as the letter of acceptance is put into the post box, and that is the place where the contract is made... [After delivering his argument why the postal rule did not apply to telex and telephone, Denning LJ continued: my conclusion is that the rule about instantaneous communication between the parties is different from the rule about the post. The contract is only complete when the acceptance is received by the offeror... " (per Denning LJ) In Susanto-Wing Sun Co. Ltd. v. Yung Chi Hardware Machinery Co. Ltd.22, the learned judge stated that the postal rule does not apply to communications by facsimile therefore a contract is made when and where the facsimile message indicating acceptance is received. How about communications over the internet? S.19 of the Electronic Transactions Ordinance: The time of receipt of an electronic record is determined as follows-

19 20

(1818) 1 B & Ald. 681 Brunner v. Moore [1904] 1 Ch 305 21 [1955] 2 QB 327 22 [1989] 2 HKC 504

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(a) If the addressee has designated an information system for the purpose of receiving electronic records, receipt occurs at the time when the electronic record is accepted by the designated information system; (b) If the addressee has not designated an information system, receipt occurs when the electronic record comes to the knowledge of the addressee. One important point to note is that postal rule ONLY APPLIES to acceptance by post. Communication of offer, counter-offer and revocation must follow the general rule: the message takes effect unless and until it is received. Byrne v. Van Tienhoven23 Facts: On 1st October the defendants in England sent a letter to the plaintiff in the United States offering to sell them 1000 boxes of tinplates. On 11st October, when the plaintiffs received the offer they sent out an acceptance by telegram on the same day. On 15th October the plaintiffs confirmed their acceptance by letter. On 20th October the plaintiff received a letter of revocation from the defendant which was posted on 8th October. Held: the contract was formed between them on 11st October What the judge said: "The postal rule appears to me to be inapplicable to the case of the withdrawal of an offer. In this particular case I can find no evidence of authority in fact given by the plaintiffs to the defendants to notify a withdrawal of their offer by merely posting a letter; and there is no legal principle or decision which compels me to hold that the letter of October 8 is to be treated as communicated to the plaintiff on that day or on any day before the 20th, when the letter reached them. A complete contract binding on both parties was entered into on October 11, when the plaintiff accepted the offer of the 1st, which they had no reason to suppose had been withdrawn." (per Lindley J) Another important point to remember is that postal rule is only applicable when it is reasonable to apply the rule. The rule will not apply: (1) If the express term of the offer specify that the acceptance must reach the offeror or (2) If the acceptance has been misaddressed to the offeror by the offeree. One example to demonstrate that it is reasonable to apply postal rule is where the offeror indicates to the offeree that the latter should accept the offer by post. It follows that even the offeror makes an offer by post, the postal rule will not necessarily apply if the offeree accepts the offer by post unless this is the mode of acceptance prescribed by the offeror or it is reasonable to apply to rule. Where the offer is accepted by post and the postal rule does not apply, the acceptance will only become effective when offeror receives the letter of acceptance. Significance of contractual intention

23

(1880) 5 CPD 344

19

The court may refuse to enforce a definite agreement, supported by considerations, for want of intention to enter into a legal relation. For instance, two friends may agree to exchange gifts on Christmas Eve and it may be unimaginable if one partys failure to do so would provide the other party with a cause of action. When it is clearly stated in the agreement itself whether the parties to the agreement intend it to be legally binding, the court would take the expressed intention as conclusive. Usually the court would classify agreements into two categories: (1) business agreements and (2) family or social agreements. By this dichotomy most cases fall into one or other of two categories. Either they are commercial contracts between parties at arms length, which are obviously intended to be enforceable at law unless the parties by express provision declare that they are binding in honour only, or otherwise they are social or domestic agreement which are obviously not designed to be legally binding. The test of contractual intention is an objective one: the court, guided by the 'reasonable man' approach, considers the language used by the parties (and the circumstances in which they use it) and the subject matter of the agreement and draws an inference as to the parties contractual intention.

Family or social agreements

Where one person says to another, 'We will meet at the entrance to the Victoria Park this afternoon at 4:00 p.m.; you bring the snacks and I bring the drink.' Our daily experience would tell us that neither party envisages any legal action in court if the agreement is not honoured. What each of them provides is good consideration. Presence of consideration does not necessarily evidence that of intention. Of course, the parties with close relationship can make their agreement legally binding by using clear words to that effect. Without clear evidence or express terms to the contrary, the court would presume that family members do not intend their agreement to be legally binding. The same presumption, though may be weaker in this case, also applies to agreements between friends. Balfour v. Balfour24 Facts: Mrs. Balfour followed her husband to come to England. Some time later, Mr. Balfour wanted to return to their homeland. However, on medical advice, Mrs. Balfour had to stay in England. Mr. Balfour promised to pay his wife a monthly allowance until she returned. Later they separated and the husband stopped payment. The wife wanted to sue for the unpaid allowance. Held: The agreement between them was not legally binding. What the judge said: "Arrangements made between husband and wife are arrangements in which there are mutual promises. Nevertheless they are not contracts because the parties did not intend that they should be attended by legal consequences." (per Atkin LJ)
24

[1919] 2 KB 571

20

Jones v. Padavatton25 Facts: A mother (the defendant) offered her daughter (the plaintiff) some benefits if she would give up her well-paid job in the United States and go to England to study for the Bar. The plaintiff agreed. Before the plaintiff was able to pass the Bar examination, the defendant breached the agreement. Held: The court held that the parties did not intend the agreement to be legally binding when it was made. What the judge said: "At the time when the arrangement was made, the mother and daughter were, and always had been, to use the daughter's words, 'very close'. I am satisfied that neither party at that time intended to enter into a legally binding contract ... The daughter was prepared to trust the mother to honour her promise of support, just as the mother no doubt trusted the daughter to study for the Bar with diligence, and to get through her examinations as early as she could." (per Fenton Atkinson LJ) If the words used in a family or social agreement are clear enough and/or the surrounding evidence is strong enough, the presumption of 'no intention' could be displaced. Parker v. Clark26 Facts: An elderly couple, agreed with their niece and her husband that if they would sell their house and come to look after them, the elder gentlemen would leave the young people some of his properties in his will. The young couple did as agreed and lived with the elder couple. One year later, the young couple was told that the arrangement did not work and they had to move out. Held: there was a valid contract between them What the judge said: "No doubt a proposal between relatives to share a house, and a promise to make a bequest of it, may very well amount to no more than a family arrangement of the type considered in Balfour v. Balfour, which the courts will not enforce. There is equally no doubt that the arrangement of this sort can be the subject of a binding contract... The question must, of course, depend on the intention of the parties, to be inferred from the language they use and from the circumstances in which they use it..." (per Devlin J) It is clear in Balfour and Jones that the usual position of the court is that, family arrangements are ordinarily not intended to create legal relations. But this presumption would lose force when the quality of the relation changes. In Merritt v. Merritt,27 the effect of the agreement was that, Mr. Merritt (who was about to divorce his wife) would pay a monthly allowance to Mrs. Merritt and she in turn paid the outstanding mortgage payments on the condition that the husband would transfer the house to the wife when the mortgage be paid off. The court said that the presumption in cases like Balfour did not apply to the present case when the parties were not living in amity
25 26

[1969] 2 All ER 616 [1960] 1 WLR 286 27 [1970] 2 All ER 760

21

but are separated or about to separate. In this situation the parties did not rely on honourable understandings. Moreover, the agreement between the parties in this case is in writing, a strong indication that they intended their agreement to be legally binding.

Business agreements
In markets where strangers or profit-oriented people negotiate agreements at arm's length, the objective view would be that they intend to solve their future possible disputes in court. In Albert v. Motor Insurers' Bureau,28 Lord Cross provided us with a vivid example: 'If I get into a taxi and ask the driver to drive me to Victoria Station it is extremely unlikely that either of us directs his mind to the question whether we are entering into a contract. We enter into a contract not because we form any intention to enter into one but because if our minds are directed to the point we should as reasonable people both agree that we were in fact entering into one." Therefore, unless compelled by clear words and/or strong surrounding circumstances, the court would apply the presumption of contractual intention to business agreements. Rose and Frank Co. v. Crompton Bros.29 Facts: In this case the court was asked to consider the effect of a clause on the legal validity of the commercial agreement which contained it. The clause was as follows: "Honourable Pledge Clause: This arrangement is not entered into, nor this memorandum written, as a formal or legal agreement, and shall not be subject to legal jurisdiction in the law courts of either United States or England, but it is only a definite expression they each honourably pledge themselves with the fullest confidence, based on past business with each other, that it will be carried through by each of the three parties with mutual loyalty and friendly cooperation."

Held: The clause clearly indicated that the parties did not intend the agreement to be legally enforceable. What the judge said: "It is quite possible for parties to come to an agreement by accepting a proposal with the result that the agreement concluded does not give rise to legal obligation. The reason of this is that the parties do not intend that their agreement shall give rise to legal relations. This intention may be implied from the subject matter of the agreement, but the parties may also express it. In social and family such an intention is readily implied, while in business matters the opposite results would ordinarily follow. But I can see no reason why, even in business matters, the parties should not intend to rely on each other's good faith and honour, and to exclude all idea of settling disputes by any outside intervention ... If they clearly express such an intention I can see no reason in public policy why effect should not be given to their intention." (per Scrutton LJ)

28 29

[1972] AC 301 [1923] 2 KB 261

22

Chapter Three: Consideration

Readings:

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part II.
2. Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Four

1. Consideration
Consideration is a necessary ingredient of a contract. The law does not enforce a purely gratuitous promise unless it is made in a deed. A promise not in a deed is binding only if the promisee has bought it by paying the price requested by the promisor. Consideration is the price for the promise. Consideration can usually be classified as executed and executory consideration. Executed consideration means that a contracting party has done what he is required to act and leave an outstanding liability to the other. Executory consideration, on the other hand, is a promise to act or to forbear. A valuable consideration in the eyes of the law may consist either in some right, interest, profit or benefit to one party, or some forbearance, detriment, loss or responsibility give, suffered or undertaken by the other30. This definition of consideration simply suggests that each contracting side can have benefit or suffer detriment at the same time in the formation of a contract. Combe v. Combe31 Fact: While getting divorced, a husband promised his wife a permanent annual allowance of 100. The husband never paid and after 7 years his ex-wife sued on the basis of promise. Held: There was no contract since no consideration existed.

3.2 Rules Governing the Validity of Consideration

In this section, we will introduce 4 basic legal rules which determine the sufficiency of consideration. (1) Past consideration is not a good consideration: Consideration must be present when or after a contract is concluded.32 If the benefit or detriment was given or suffered before the promise was given and was independent of the promise, the benefit or detriment is called past consideration, which does not support a promise. Roscorla v. Thomas33
30 31

Currie v. Misa (1875) 1 App Cas 554, per Lisa J. [1951] 2 KB 215; [1951] 1 All ER 767. 32 Re McArdle [1951] Ch 669, [1951] 1 All ER 905. 33 (1842) 3 QB 234; 114 ER 496.

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Fact: The plaintiff had bought a horse from the defendant who later guaranteed that the horse was sound and free from vice. But the horse was in fact vicious. The plaintiff decided to sue on that promise. Held: The plaintiffs consideration for the defendants promise was past consideration. Under the contract, the payment of 30 was for the horse without any assurance that it was sound and free from vice. The subsequent promise by the seller was not a part of that contract. It was extraneous to that contract. If the plaintiff had promised to give some more money for the sellers new promise that the horse was sound and free from vice, then that promise could have been enforced because a new contract would have come into existence, but that was no the case. There is exception to the general rule: If the promisee performed a service at the request of the promisor who subsequently promised a certain payment. This particular promise can be enforced by law if the following conditions are satisfied: (a) the act has been done at the promisors request; and (b) the parties must have understood that the act was to be rewarded; and (c) the promise of the reward must satisfy the usual requirements of a binding contract. Lampleigh v. Brathwait34 Fact: In relation to a criminal offence, the defendant asked the plaintiff to obtain a pardon for him from the King. After the plaintiff had incurred certain expenses, the defendant subsequently promised to pay him 400. The defendant, however, paid the plaintiff nothing. Held: This past consideration was a good consideration, and this was a legal contract. Re Caseys Patents, Stewart v. Casey35 Fact: The defendants, owners of a number of patent rights, after considering the work which their manager had done, promised him 1/3 share of the patents. The defendants refused to honour the promise. Held: It was an enforceable contract. What the judge said: The fact of a past service raises an implication that at the time it was rendered it was to be paid for, and it was a service which was to be paid for, when you get in a subsequent document a promise to pay, that promise may be treated as an admission which evidences or as a positive bargain which fixes the amount of that reasonable remuneration on the faith of which the service was originally rendered. (per Bowen LJ)
34 35

(1615) Hob 105. [1892] 1 Ch 104.

24

(2) Consideration must move from promisee: As a general rule, a person cannot sue upon a contract unless he or she provides the whole or part of the consideration for that contract. However, where a contract is made with two or more persons jointly (joint promises), it can be enforced by all of the promises even though only one or some of them pay the whole consideration. If one of the promisees dies, the surviving promisees will be entitled to the entire benefit of the contract based on the doctrine of survivorship. Tweddle v. Atkinson36 Fact: After A and B got married, their respective fathers entered into a contract, promising that each should pay a sum of money to B, the husband, who should also have the power to sue for such sums. After the death of the fathers, B sued the executors of the father in law for the promised money. Held: B could not enforce the contract, because no consideration had moved from him. In other words, a party to a contract who gave no consideration cannot sue on the contract. (3) Considerations need not be adequate: Based on doctrine of freedom of contract, it is not the courts duty to compare the value of each contracting partys contribution to the formation of contract. Thomas v. Thomas37 Fact: A husband wished that his wife should spend her life in the their cottage, and after he died, his executors agreed so with his wife, saying that agreement was made in consideration of the husbands wishes. According to the agreement, the widow had to pay an annual rent of 1. Later, the executors refused to convey the cottage, arguing that there was no contract, because the widow had provided no sufficient consideration. Held: although the testators desire was only the motive for the agreement and a motive could not be consideration, the widows promise to pay 1 towards the ground rent and to keep the house in repair was good consideration to support the promise to convey the house to her. The promise to perform these acts had some value in the eyes of the law and the court did not have to inquire as to the adequacy of the widows promise. Forbearance to sue can amount to valuable consideration: Forbearance to sue is a real and valuable consideration in contract law even though it may be impossible to put a price in money terms on the promise not to sue someone in the courts. For example, if you promise not to sue me for breach of contract in return for me paying you $ 20,000 in cash today, this is forbearance to sue on a contract. If it later becomes clear that (a) there was no valid contract, or (b) there was a contract but you had no chance of a successful claim against me for breach of contract, the payment of $ 20,000 is still a valid contract based on offer and acceptance, intention to create legal
36 37

(1861) 1 B & S 393; 30 LJ QB 265. (1842) 2 QB 851; 114 ER 330.

25

relations, and consideration (the forbearance to sue being the valuable consideration element in this example). Alliance Bank v. Broom38 Fact: In debt to the plaintiff for 22,000, the defendants was asked to provide some security for the amount. The defendants verbally agreed to assign the documents of title to certain goods, but failed to do so. The plaintiff then sued for specific performance of the promise. The defendants argued that there was no consideration for the promise. Held: The defendants lost their case. What the judge said: It appears to me that, when the plaintiffs demanded payment of their debt, and in consequence of that application the defendant agreed to give certain security, although there was no promise on the part of the plaintiffs to abstain for any certain time from suing for the debt, the effect was, that the plaintiffs did in effect give, and the defendant received, the benefit of some degree of forbearance, no indeed, for any definite time but, at all events, some extent of forbearance (per Kindersley VC) Settlement: Since any out-of-court settlement could be a public good, compromise such as, abandonment of a claim or a defence, should be considered as good consideration in support of a promise.39 Does the consideration have to contain some economic value?: As the cases shown, consideration must have some economic value. But how could one determine the economic value say, forbearance to sue? It is therefore argued that nominal consideration is already adequate, since the main function of consideration is to show that the contracting parties have the intention to form a contract which is legally enforceable.40

(4) Consideration must be real/sufficient in the eye of law, although it does not have to be adequate. In the following, we will discuss those cases where the reality of consideration has been scrutinized. Performance of an existing duty: The law makes a distinction between 4 types of duty: (i) Public legal duty; (ii) Personal legal duty; (iii) Contractual duty owed to the promisor; and (iv) Contractual duty owed to a third party; and each of them carries different consequences. (i) Performance of public duty is not a good consideration: it seems that the reason for the law refusing to enforce such contracts is that they are contrary to public policy. Collins v. Godefroy41
38 39

(1864) 2 Dr & Sm 289; 62 ER 631. Guest, A G (1986: 91) and Ho, B (1994: 39). Callisher v. Bischoffsheim (1870) LR 5 QB 449; Miles v. New Zealand Alford Estate (1886) 32 Ch D 266. 40 Thomas v. Thomas (1842) 114 ER 330; Eastwood v. Kenyon (1940) 11 A & E 438; Re McArdle [1951] Ch 669; De La Bere v. Pearson [1908] 1 KB 280. 41 (1831) 1 B & Ad 951.

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Fact: The plaintiff was ordered to appear as a witness on behalf of the defendant in a trial. He attended the trial for 6 days. The defendant then promised to pay him for his trouble. Held: There was no contract. What the judge said: If it be a duty imposed by law upon a party regularly subpoenaed to attend from time to time to give his evidence then a promise to give him any remuneration for loss of time incurred in such attendance is a promise without consideration. We think that such a duty is imposed by law; and on consideration of the Statute of Elizabeth, and of the cases which have been decided on this subject, we are all of the opinion that a party cannot maintain an action for compensation for loss of time in attending a trial as a witness. (per Lord Tenterden CJ)42 However, there is one exception: If what a person does, or promises to do exceeds what he is required to do by law, then he is providing a good consideration.43 Glasbrook Bros v. Glamorgan County Council44 Fact: During a coal strike, the owners of the coal mine asked the police to maintain the safety of their mines and insisted on having the police billeted at the property (this exceeded the legal duty of the police). The owners also promised to pay the police for that service. Subsequently, they refuse to pay, claiming that the police were only carrying out their normal duty.. Held: The police had their case. What the judges said: ...it has always been recognised that, where individuals desire that services of a special kind which, though not within the obligations of a police authority, can most effectively be rendered by them, should be performed by members of the police force, the police authorities may...lend the services of constables for that purposes in consideration of payment. (per Viscount Cave LC) (ii) Performance of a personal legal duty can be good consideration. Although the difference between a public legal duty and a personal legal duty is rather artificial and confusing, we can still make a fine distinction by their nature: the objective of the former duty is to serve the state and the public, while the obligation of the latter is one towards a specific party. Ward v. Byham45 Fact: The father wrote to his illegitimate daughters mother, promised to pay her 1 a week if she could take good care of his child. When the mother got married, the

42 43

The decision is reversed by section 52 of the Supreme Court Ordinance but the principle remains. Harris v. Sheffield United FC [1987] 2 All ER 838; Hartley v. Ponsonby 170 ER 94. 44 [1925] AC 270. 45 [1956] 1 WLR 496.

27

father refused to pay and argued that there was no consideration for the agreement, because it was her legal duty to maintain the child. Held: The contract existed with the support of consideration. (iii) Performance of an existing contractual obligation owed to the same promisor does not constitute consideration.46 Stilk v. Myrick47 Fact: In the course of a voyage, two sailors left unlawfully the ship. The remaining sailors threatened to leave the ship as well. The captain failed to recruit new member but promised to divide the wages of the deserted sailors among the rest of the crew so as to encourage them to stay aboard. After reaching the destination, the captain refused to fulfil his promise. Held: There was no contract. What the judge said: The agreement is void for want of consideration. There was no consideration for the ulterior pay promised to the mariners who remained with the ship. Before they sailed from London they had undertaken to do all they could under all emergencies of the voyage...The deserting of a part of the crew is to be considered an emergency of the voyage as much as their death; an those who remain are bound by the terms of their original contract to exert themselves to the utmost to bring the ship in safety to her destined port (per Lord Ellenborough) The principle was thrown in doubt in Willams v. Roffey Bros & Nicholls48 and some judges even suggested that Stilk v. Myrick is only illustrating the doctrine of duress, where there was a risk that one contracting party (say, the crew in the Stilks case) forcing the other to make such a promise. Some scholars, however, claimed that the case simply set up a new principle, the extra bonus principle. Willams v. Roffey Bros & Nicholls49 Fact: The defendant, the main contractor, entered into a building contract with a developer. Under the building contract, the defendant must finish the project on time, otherwise they would be penalized. The plaintiff entered into a subcontract with the defendant. In March 1986, the plaintiff was facing a financial problem and could not probably finished the work under the subcontract. In April 1986, the defendant agreed to pay the plaintiff extra sum so as to make sure the job would be completed on time. Later, the defendant refused to pay and the plaintiff stopped working, but the work was already substantially done. The plaintiff sued for the promise of additional payment. Held: For the plaintiff.

46 47

Atlas Express v. Kafco [1989] QB 833; [1989] 1 All ER 641. (1809) 2 Camp 317. 48 [1990] 2 WLR 1153; [1990] 1 All ER 512. 49 [1991] 1 All ER 512.

28

What the judges said: (i) if A has entered into a contract with B to do work for, or to supply goods or services to, B in return for payment by B and (ii) at some stage before A has completely performed his obligations under the contract, B has reason to doubt whether A will, or will be able to complete his side of bargain and (iii) B thereupon promises A an additional payment in return for As promise to perform his contractual obligations on time and (iv) as a result of giving his promise B obtains in practice a benefit, or obviates a disbenefit, then (v) Bs promises are not given as a result of economic duress or fraud on the part of A (vi) the benefit to B is capable of being consideration for Bs promise, so that the promise will be legally binding. (per Glidewell LJ) (iv) Performance of an existing duties owed to a third party can be consideration. New Zealand Shipping v. AM Satterthwaite, The Eurymedon50 Fact: Plaintiff made an offer to defendant that if defendant would unload plaintiffs goods from a ship (which the defendant was already bound to do by a contract with a third party), the plaintiff would treat the defendant as exempt from any liability for damage to the goods. The goods were damaged by the defendant and the plaintiff sued the defendant. Held: A had provided consideration for Cs promise by unloading the goods even though he was already bound by contract with B to unload them. What the judge said:: An agreement to do an act which the promisor is under an existing obligation to a third party to do, may quite well amount to consideration and does so in the present case (per Lord Reid) No illegal consideration: Any unlawful activity or agreement to do any unlawful activity cannot be recognized as a consideration. A subjective sensibility, such as love, affection, gratitude, moral consideration, cannot constitute a consideration.51

50 51

[1975] AC 154; [1964] 1 All ER 1015. Tweddle v. Atkinson (1861) 1 B & S 393; 30 LJ QB 265.

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Chapter 4: Content of a Contract

Readings:
1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part II.
Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Four
2.

1. Introduction
After identifying the existence of all the requisite elements of a contract, it is then significant to determine the obligations of the parties to the contract. We can only do this through examining what are the terms of the contract. Every contract must contain terms. These are either written or unwritten, expressly agreed upon by the parties or understood by both parties to be implied in the contract. The terms must exist at the time the contract is made i.e. when the offer is accepted. If a term is introduced at a later stage, it will not be binding on either party unless it forms part of a new contract. It is sometimes not easy to ascertain the terms of a contract because it may involve the difficult question of how to determine whether a statement made prior to the contract is a term or representation. Another problem which has to be dealt with under this context is the classification of terms. If we categorize terms by its form of incorporation, a term can either be an express term or an implied term; or we can classify term by its relative importance, i.e. a term can be a-condition, a warranty or innominate term.

2 Representation vs. Term

During the pre-contractual negotiation, the parties may come across a lot of statements. Those statements which are part of a contract are terms. Any untruthfulness in this kind of statement will constitute a breach of contract. However, if a statement is not part of the contract, but merely induces the formation of a contract, it is a representation. When this statement turns out to be untrue, it is a case of misrepresentation. Oscar Chess v. Williams52 Fact: In 1954, the defendants mother bought a second-hand car, the registration book showed that it was first registered in 1948. In 1955, the defendant bought a new car on hire-purchase terms through the plaintiffs who took the second-hand car in part exchange. The defendant stated that the car was a 1948 model and produced the registration book. The plaintiffs sales representative, who was familiar with the car, checked the current price for a 1947 model and allowed the defendant an allowance of 290 against the price of the new car. Eight months later, it was discovered that the car was a 1939 model and the current market price was only 175. The plaintiff sued for the difference between the prices as damages, claiming that there was a breach of term.
52

[1957] 1 All ER 325.

30

Held: The statement that the car was a 1948 model was a mere representation, not a term of the contract. The buyer was a car dealer and could not have been expected to be misled by the innocent seller. The courts therefore laid down the following guidelines to help them in ascertaining whether a statement is a term or a representation: (1) Importance of statement to the injured party A statement is likely to be a term if the injured party/the plaintiff would not have entered into the contract without such a statement. Bannerman v. White53 Fact: Bannerman offered to sell hops to White. White asked if any sulphur has been used. Bannerman said No. White stated if sulphur has been used, I do not want to know the price. they then discussed the price and a contract was then made. White later repudiated the contract, claiming that the hops contained sulphur. Banner sued for the price. Banner in fact had used sulphur in the cultivation of a portion of the hops. Held: The representation that no sulphur was used was understood by the parties to be a part of the contract because the buyer would not have agreed to purchase the hops had it not been for the sellers untrue statement. The sellers guarantee that no sulphur was used was crucial to the buyers decision and the seller knew it. (2) Respective special knowledge of the parties Generally speaking, a statement made by a non-expert to an expert is usually classified as a representation. But on the other hand, a statement made by an expert to a public member would be held as a term, since the former is in a position to guarantee the truth of the statement. (3) Time The closer in time that the statement was made to the conclusion of the contract, the more likely it would be treated as a term, as the court would assume that statement as very significant. Schawel v. Reade Fact: The plaintiff would like to buy a horse, and when proceeding to inspect the horse, the defendant said: You need not look for anything: the horse is perfectly sound. If there was anything that matter with the horse I would tell you. The plaintiff therefore stopped inspecting the horse. Price for the horse was agreed a few days later and the plaintiff bought it after 3 weeks. However, the horse was totally unfit. Held: The defendants statement was a term. (4) Manner of the statement
53

(1861) 10 CB (NS) 844. See also Couchman v Hill [1947] KB 554; [1947] 1 All ER 103; Routledge v McKay [1954] 1 WLR 615; [1954] 1 All ER 855.

31

The court is more willing to treat a statement in a written contract as a term. If the contract is reduced into writing, then the oral statement, which was mentioned in the negotiation and was not included, will normally be classified as representation.

3 Express term
A. Oral Contract In case of oral contract, whether a statement is an express term is purely a question of fact and can be ascertained by adducing evidence. The express terms in an oral contract will be interpreted by assessing the intention of the parties, which could be ascertained by applying the objective rule.54 B. Written Contract If the contract has been reduced to written form, the first issue we need to decide is whether a statement is incorporated in the contract as a term. As a general rule, signature absolutely binds the party who signs the contract. When constructing the content of a written contract, parol evidence rule will also be applied. The rule states that the extrinsic evidence, which includes oral statements and other written documents (such as draft contracts and correspondences) cannot be admitted to add to, vary, or contradict the terms of the written contract.

4. Implied term
A. What is implied term? It may happen that in agreeing to the terms of a contract, parties omitted to state their intentions concerning one or more issues. The court may fill in the gap by finding and inserting in the contract the missing term on the ground of the presumed intention of the parties. Any such terms so inserted is implied terms. However, if the omission by the parties are major, then the agreement will fail for uncertainty or incompleteness since the courts understand very well that it is not their duty to make or (re)write any contract. The court rarely imply any term which is not intended by the parties. The implied term shares the same binding effect with the express term, the only differences between an express term and implied term are their way of incorporation and appearances. B. Classification of Implied Terms (a) Terms implied by the court on behalf of the parties (1) Trade usage

54

Thake v. Maurice [1986] QB 644; [1986] 1 All ER 497.

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What is the normal practice in the particular business with which the contract deals? Trade usage can fill gaps, but it cannot be superimposed if there is clear provisions (written or oral) in the contract: British Crane Hire v. Ipswich Plant Hire55 Fact: Both the plaintiffs and defendants were in the business of hiring out heavy earthmoving equipment. While engaging in a drainage work, the defendants urgently needed a dragline crane. They then called and hire one from the plaintiff. Charges were agreed but nothing was said about the conditions of the contract. After delivering the machine, the plaintiffs, according to the practice of business, sent their printed hiring form to the defendant. The printed form contained a condition, stating that the defendants were to indemnify the plaintiffs in the case that the crane was damaged. It was the custom of the trade that a hiring form would contain such a condition. The defendant refused to sign it, since at that time, the crane had already, without fault of both party, sank into marshy ground. Held: The term was incorporated into the contract by trade custom. (2) Previous dealings If the parties have done business on the same or similar terms previously, the court will assumed that they intended the same terms to apply if some of the terms are not specified. To incorporate a term this way, a continuing relationship between the parties is essential and there must be regular and sufficiently numerous dealings to constitute such a relationship. One or two transactions do not constitute a course of dealings: British Crane v. Ipswich Plant. Length of relationship is not sufficient if there is no regular or frequent dealings. Isolated or intermittent deals spread over a long period of time cannot constitute a course of dealings. Hollier v. Rambler56 Fact: There was an oral contract concerning car repair between the plaintiff and defendant. The car was damaged by fire. The defendant sought to rely on an exemption clause which stated: the company is not responsible for damage caused by fire to customers cars on the premises. At least on two previous occasions, the plaintiff signed the contract carrying such a term. Held: The exemption clause was not incorporated.

(3) Business efficacy The test investigates what is necessary to make a contract workable. If a contract cannot work without the inclusion of a particular term, the court will assume that the parties intended that term to be included. The term to be implied must be reasonable.57
55 56

[1975] QB 303. [1972] 2 QB 71; [1972] 1 All ER 399. 57 Liverpool City Council v. Irwin [1977] AC 236.

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The Moorcock58 Fact: The appellants was owners of a wharf and jetty on the river Thames (a famous tidal river). The respondent was the owner of the ship, Moorcock. Both parties agreed in November 1887 that the ship should be discharged and loaded at the wharf, knowing that at low tide, the ship would settle on the river bed. While the ship was lying moored, the tide ebbed and the ship was damaged because of the hard ground beneath the mud of the river bed. The respondent sued for the damage of the vessel. The appellants defended that there was no express term in the contract which guaranteed the safety of the anchorage. Held: In a contract between a wharf owner and ship owner, a term could be implied that the wharf owner promised the ship owner that the ground beneath the water was safe for loading and unloading of the ship. The defendant was therefore liable. (4) The officious bystander test This fictional busybody was introduced into legal judgments in 1939 as an alternative general test to the more narrow business efficacy test described above. The judge who introduced this test said: so that, if while the parties were making their bargain an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common Oh, of course. The officious bystander test is not necessarily so significant an implied term, but it is perhaps a more obvious one. A carefully written contract should avoid involvement in these legal questions after the event.

(b) Terms implied by Common Law E.g. in employment contract, there are implied terms that the employer will provide a safe system of work and that the employee will use reasonable care and skill in the performance of his duties. Landlord and tenant there is an implied term in the contract for the lease of a furnished house that the house is reasonably fit for human habitation. So that if, for example, the house is infested with bugs or the drainage is defective, the tenant can sue for damages and leave the house. (c) Terms implied by Statue The most famous example in Hong Kong is the Sale of Goods Ordinance.59 According to Section 14(l)(a), terms are implied in a sale of goods contract to guarantee that the seller has the right to sell the goods and that the goods are free from encumbrances and that buyer will enjoy quiet possession.60
58 59

(1889) 14 PD 64. Cap 26, LHK.

34

Section 15(l) states that there is an implied condition that the goods will correspond with the description.61 Section 16(2) refers to the situation where goods are sold in the course of a business, there is an implied condition that the goods shall be reasonably fit for the purpose for which they are required and an implied condition that the goods shall be of merchantable quality.62 Section 17(l) and (2) make it clear that when goods are bought according to the sample, they must be equal to sample.

5. Condition, Warranty and Innominate Term

Traditionally, terms (both express and implied) are divided into condition and warranty, with reference to their respective relative strength. This distinction is significant since it relates to the remedy available when there is a breach of term. However, since Hong Kong Fir v. Kawasaki Kisen Kaisha, 63 a new term has been invented - innominate term. A. Condition and Warranty Breach of a contractual term will entitle the innocent party to take legal action against the guilty party for breach of contract. Two remedies for breach of contract are available to the innocent party. They are: (a) Damages (monetary compensation) or; (b) The right to treat the contract as discharged because of the other partys breach of contract. Whether the innocent party entitles to claim damages or to treat the contract as discharged depends on the nature of a particular term which is in breach. Contractual terms (whether express or implied) are generally classified as either condition or warranty. According to the common law principle, which is now reproduced in section 13 of Sale of Goods Ordinance: A condition is an important term which are essential to the contract, and a breach of condition entitles the innocent party to repudiate or rescind the contract. A warranty is a less important term and if a warranty is broken, an innocent party can only sue for damages and not to treat himself as discharged from the contract. The classification, in short, relates very much to the intention of the parties. The label of a term (be it a condition or a warranty) is not conclusive. B. Innominate Term
60 61

Rowland v. Divall [1923] 2 KB 500; [1923] All ER Rep 270. Wilensko Slaski v. Fenwick & Co [1938] 3 All ER 429; Re Morre & Co and Landauer & Co [1921] 2 KB 519; Macpherson Train v. Howard Ross [1955] 1 WLR 640. 62 Wilson v Rickelt, Cockerell & Co [1954] 1 QB 598; [1954] 1 All ER 868; Wren v. Holt [1903] 1 KB 610; Ashington Piggeries v. Christopher Hill [1972] AC 441; Priest v. Last [1903] 2 KB 148. 63 [1962] 2 QB 26; [1962] 2 WLR 474; [1962] 1 All ER 474.

35

However, in many cases, it is difficult to define a particular contractual undertaking a condition or a warranty. The court is now (in the absence of express stipulation in the contract) inclined to treat every term as an innominate term, rather than the previous classification of condition or warranty. The word innominate simply means not having name, that is to say unclassified or uncategorised. An innominate term could therefore be interpreted either as bing a condition or a warranty, depending on the particular circumstances of the case. A term would be classified as an innominate term if once it is broken, the consequence can either be trivial or fundamental. Whether the innocent party has the right to terminate the contract depends on the gravity of the breach. The test is to see whether the breach of such a term could deprive the innocent party of most of the benefits which he should obtain under the contract, if so, the innocent party is entitled to rescind the contract and the breach is to be treated as a breach of condition. If the answer is no, then it is treated as a breach of a warranty. The focus therefore shifts from the intention of the parties to the effect of the actual breach. Hong Kong Fir Shipping v. Kawaski Kisen Kaisha64 Fact: The defendant agreed to hire a vessel from the plaintiff for 24 months. There was a term in the contract stating that the vessel being fitted in every way for ordinary cargo service. But it turned out that the crew were inefficient and the engine was too old, and the vessel was held up for repairs for 5 weeks. It was later found out that if the vessel had to be seaworthy again it needed to take another 15 weeks for repair. The defendant chose to repudiate the contract and the owner sued for wrongful repudiation. Held: Although there was a breach, it was not serious enough for the defendants to repudiate the contract.

Poussard V. Spiers and Pond (1875-76) LR 1 QBD 410 Fact: The plaintiff was engaged by the defendant to play the principal role in a new opera which was scheduled to open on 28 November. The plaintiff became seriously ill and it was clear she could not appear on the opening night of the opera on 28 November. The defendant engaged another signer to replace her. By 4 December, the plaintiff recovered and was prepared to take up her role in the opera, but was refused because the defendants had already appointed a replacement. The plaintiff sued them for breach of contract. Held: The defendants were entitled to terminate the contract for the plaintiffs failure to attend the first performance was a breach of condition going to the root of the matter. This was because the plaintiffs illness was of a serious nature and of uncertain duration and the plaintiff was to play a leading role in the new opera. If the defendants did not appoint another singer, it would have serious prejudiced their interest.

64

[1962] 2 AC 26.

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Chapter Five: Exemption Clause

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part II
Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Four
2.

Introduction
Exemption clauses are provisions in a contract that limit the duty of a party to a contract or that limit or exclude some or all of his liability for breach of contract or remedies therefor. The law usually does not interfere with the effectiveness of the clause, since freedom of contract is one of the most important doctrines within the liberal jurisprudence. However, in order to protect the party who is inferior in bargaining power, exemption clauses have to satisfy a number of common law controls and statutory conditions, before the law recognizes their lawful validity. Common Law Control: Incorporation Any party, who wants to rely on an exemption clause to exclude their liability must show that it has been incorporated into the contract. The rule is that a party have noticed or is justifiably supposed to have noticed the clause when they enter into a contract. (1) In the case of written contract, if it is signed by the party, the exemption clause will be treated as it has automatically been incorporated, even if party had not in fact read it65 or simply ignore its legal status66. LEstrange v. Graucob67 Fact: The buyer bought a faulty slot machine from the seller under a written contract signed by both parties. The buyer therefore brought an action against the seller. The seller then claimed that there was an exemption clause on the contract, which exempted him from holding any liability related to the faults of the machine sold. The buyer said that when she signed the contract, she did not read the term and it was in small print. Held: The exemption clause was effective. (2) If the agreement is an unsigned one (such as ticket), time becomes an important issue. The general rule is that all significant terms must be agreed at the time of the contract. It means that reasonable and sufficient notice of the existence of an exemption clause must be given by the party rely on the exemption clause to the other party before the conclusion of a contract. The question of reasonableness is dependent on the particular facts of each case. The test is therefore objective. However, special attention must be drawn to any unusual

65 66

LEstrange v. Gravcob [1934] 2 KB 394. Parker v. South Eastern Railway (1877) 2 CPD 416; Levison v. Patent Steam Carpet Cleaning [1978] QB 69. 67 [1934] 2 KB 395.

37

clause68. The onus of proof rests on the party who is seeking to rely on the clause to show that reasonable steps have been taken to bring the notice of the clause to the other party69. Parker v. South-East Railway70 Fact: The plaintiff, after he put a bag at the cloakroom of a railway station, received a ticket which stated See Back. On the back of it, there were some conditions. One of the printed conditions stated that if the customers package was lost, the railway companys liability was limited to 10. The bag was lost, and the plaintiff claimed 24. 10. The defendant relied on the exemption clause. The plaintiff admitted that although he knew that there were something on the back of the ticket, he had not read it. Held: Sufficient notice was not given. What the judge said: I think there may be cases in which a paper containing writing is delivered by one party to another in the course of a business transaction, where it would be quite reasonable that the party receiving it should assume that the writing contained in it no condition, and should put it in his pocket unread. For instance, if a person driving through a turnpike gate received a ticket upon paying the toll, he might reasonably assume that the object of the ticket was that by producing it he might be free from paying toll at some other turnpike-gate, and might put it in his pocket unread. (per Mellish LJ) Notice by display: the notice must be seen before or when the contract is entered. Olley v. Marlborough Court71 Fact: After the plaintiff and her husband checked in the hotel, they found that a notice was shown in their room, which read: The proprietors will not hold themselves responsible for articles lost or stolen, unless handed to the manageress for safe custody. Before the plaintiff left the hotel, she locked the room and deposited the key at the reception. When she came back, she found that the key was missing and some belongings were stolen. She sued the hotel for negligence. Held: The notice could not form part of the contract, since it was shown after the contract was made. Notice by receipt

The court must be satisfied that the particular document relied on as containing notice of the excluding or limiting term is in truth an integral part of the contract. It must have been intended as a contractual document and not as a mere acknowledgement of payment. Chapelton v Barry UDC.72

68

Thornton v. Shoe Lane Parking [1971] 2 QB 163; Interfoto Picture Library v. Stiletto Visual Programmes [1988] 1 All ER 348. 69 Parker v. South-East Railway (1877) 2 CPD 416. 70 (1877) 2 CPD 416. 71 [1949] 1 KB 532. 72 [1940] 1 KB 532, [1940] 1 All ER 356. See also Henson v London and North Eastern Rly Co and Coote and Warren Ltd [1946] 1 All ER 653.

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Facts: The plaintiff wished to hire two deck-chairs from the defendant council on their beach. The chairs were stacked near a notice which read . . . Hire of Chairs 2d per session of 3 hours. The plaintiff took the chairs and obtained two tickets from the attendant of the defendant, which he put in his pocket without reading. When he sat on one of the chairs, it collapsed and he was injured. He sued the defendant council, who relied on a provision printed on the tickets excluding liability for any damage arising from the hire of a chair. Held: The Court of Appeal held the defendant liable. No reasonable man would assume that the ticket was anything but a receipt for the money. The notice on the beach constituted the offer, which the plaintiff accepted when he took the chair, and the notice contained no statement limiting the liability of the defendant. The defendants had failed to satisfy the preliminary requirement of identifying the ticket as a contractual document, and it was superfluous, therefore, to ask if it contained a due announcement of any conditions. Notice by course of dealing: If there has been a course of dealings between the parties, an exemption clause may be incorporated into the contract although the attention of the parties are not specifically drawn to such a term at the time when the contract was made73. To incorporate a term this way, a continuing relationship between the parties is essential and there must be regular and sufficiently numerous dealings to constitute such a relationship.74 Hollier v. Rambler75 Fact: There was an oral contract concerning car repair between the plaintiff and defendant. The car was damaged by fire. The defendant sought to rely on an exemption clause which stated: the company is not responsible for damage caused by fire to customers cars on the premises. At least on two previous occasions, the plaintiff signed the contract carrying such a term. Held: The exemption clause was not incorporated. One or two transactions do not constitute a course of dealings: British Crane v. Ipswich Plant. Length of relationship is not sufficient if there is no regular or frequent dealings. Isolated or intermittent deals spread over a long period of time cannot constitute a course of dealings. Common Law Control: Construction After an exemption clause is proved to be incorporated into a contract, the next question is to see whether the term can be construed to cover the breach that has happened. Contra proferentem rule: Under the rule, the wording of the exemption clause will be interpreted more forcibly against the party purporting to rely on the clause76. It simply means that liability can only be excluded by clear wordings77. If there is any ambiguity, it is to be resolved against the person invoking the exemption clause.

73 74

J Spurling v. Bradshaw [1956] 1 WLR 461; [1956] 2 All ER 121; Kendal v. Lillico [1968] 2 All ER 444. McCutcheon v. David MacBrayne [1964] 1 WLR 125; [1964] 1 All ER 430; [1964] 1 Lloyds Rep 16. 75 [1972] 2 QB 71; [1972] 1 All ER 399. 76 Houghton v. Trafalgar Insurance [1954] 1 QB 247; Beck v. Szymanowski [1924] AC 43; Cannaught Restaurant v. Indoor Leisure [1994] 1 WLR 501. 77 Couchman v. Hill [1947] 1 KB 554; J Evans & Sons v. Andrea Merzario [1976] 1 WLR 1078.

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Control of Exemption Clauses Ordinance78

1. The Control of Exemption Clauses Ordinance was enacted in 1990. The ordinance does not aim at affecting the common law control of exemption clause. Therefore, common law control of exemption clause is still important. Before the enactment of the Ordinance, an exemption clause could be valid as long as it was incorporated into the contract and wording of the clause was clear enough. The Ordinance comes into play when common law control fails to invalidate the exemption clause. There are two types of remedy can be given by the Ordinance: (a) (b) 2. The exemption clause may be void; or The exemption clause may be void insofar as it cannot be shown be reasonable. Consumer contract (1) A distinction between a consumer contract and non-consumer contract is drawn by the Ordinance. The reason is that a greater protection could be provided in the case of a consumer contract. In a consumer contract, one party must deal as a consumer. The burden of proof is on the party relying on the exemption clause who wants to show that another party does not deal as consumer. To qualify as a person dealing as a consumer, a party must establish the following: (i) It has neither made a contract nor held itself out as making one in the course of a business (e.g. by asking for a trade discount for the company on the goods or products purchased); The other party does make the contract in the course of a business; and Where the contract is one of sale of goods, the goods must be of a type ordinarily supplied for private use or consumption.

(ii) (iii)

When do exemption clauses become ineffective? When they exempt liability for death or personal injuries

A person cannot, by reference to any contract term or by a notice given to persons generally or to particular persons, exclude or restrict business liability for death or personal injury resulting from negligence79. Personal injury includes a disease and impairment of physical or mental condition. In the CECO, negligence refers to the breach of an express or implied contractual obligation to take reasonable care in the performance of a contract, the breach of a common law duty to take reasonable care, and the breach of a common law duty of care imposed by the Occupiers Liability Ordinance.80
78 79

Cap 71 LHK. . Section 7(1). 80 . Cap 314; CECO, s2(1).

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When the seller breaches his or her implied undertakings under the SOGO

Liability for breach of obligations arising from section 14 of the SOGO (i.e. sellers implied undertaking as to tile) cannot be restricted or excluded by any contract term.81 As against a person dealing as consumer, liability for breach of the obligations arising from sections 15, 16 or 17 of the SOGO (i.e. the sellers implied undertakings as to conformity of goods with description, or sample, or as to their quality or fitness for a particular purpose) cannot be excluded or restricted by reference to any contract term. 82 Customs brokers Co Ltd v. United Dominions Trust Led [1988] 1 WLR 321 Fact: The plaintiffs company was engaged in the business of freight-forwarding and shipping. It entered into a sales agreement with the defendant, a finance company, to purchase a car for the personal and business use of one of its directors, but the car was defective. The plaintiff sued the defendant for breach of an implied term that the car must be fit for the purpose. The defendant sought to rely on an exemption clause which excluded any warranty or condition as to fitness for the purpose. The issue was whether the plaintiff was treated as a consumer. Held: The Plaintiff was dealing as a consumer in the transaction since it did not make the contract in the course of a business. Section 6(2) of the Unfair Contract Act could, therefore, apply in this case. According to the section 14(3) of the SOGO, there was to be implied into the contract of sale a condition that the car was reasonably fit for the purpose of purchase. By virtue of section 6(2), the defendant could not exclude such an implied term. When exemption clauses do not comply with the requirement of reasonableness

The question of reasonableness is decided by applying an objective test. Section 3 of the CECO states that to determine whether a clause is fair and reasonable, the court must take into account all the circumstances which the parties knew, or should have known at the time of making the contract. The party seeking to rely on the exemption clause has the burden to prove that it satisfies the test of reasonableness.83 Section 3 and Schedule 2 of the CECO set out a number of factors to be considered for determining the question of reasonableness.84 These include: The language of the clause and the language ability of the injured party85; The resources of the person invoking the clauses and the availability of insurance86;

81 82

. CECO, s 11(1). . CECO, s 11(2). 83 . CECO, s 3(6). 84 . Although it is only stated that the criteria in Schedule 2 are applicable for the purposes of sections 11(3) and 12(3) and (4), they are often regarded as being of general application. See Flamar Interocean Ltd v. Denmac Ltd [1990] Llyods Rep. 438-439. D.K.Stivastava (General Editor) Business Law in Hong Kong p. 165 Sweet & Maxell Asia 2002. 85 Section 3(4). 86 Section 3(5).

41

A number of factors must be specially taken into account in the case of sale or supply of goods87: (i) (ii) The relative bargaining power of the parties; Whether the customer is induced to agree with the clause in question or alternative contract which does not conclude the availability of such terms; Whether the customer knew or should reasonably know the existence and extent of the clause, with reference to the custom of trade and course of dealings; If the application of the clause is contingent upon a condition, whether it is practicable to comply with the condition at the time when the contract is formed; The relative bargaining power of the parties; Whether the customer is induced to agree with the clause in question or alternative contract which does not conclude the availability of such terms; Whether the customer knew or should reasonably know the existence and extent of the clause, with reference to the custom of trade and course of dealings; If the application of the clause is contingent upon a condition, whether it is practicable to comply with the condition at the time when the contract is formed; Whether the goods were manufactured, processed or adapted to the special order of the customers.

(iii)

(iv)

(v) (vi)

(vii)

(viii)

(ix)

87

Section 3(2) and Sch 2.

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Chapter Six: Discharge of Contract

Readings: 1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part II. 2. Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Four

Introduction
A contract is discharged when no further rights and obligations exist under it. A contract may be discharged by performance, agreement, acceptance of breach, or frustration. (i) (ii) (iii) (iv) If each party does as he or she promised, then the contract is discharged by performance. If the parties are in agreement not to perform, then this may amount to a discharge by agreement. Breach of contract, if serious enough, may allow the party not in breach to treat the contract as discharged. A contract will be automatically determined on the occurrence of a frustrating event.

A. Discharge by Performance 1. When both parties have performed their obligations under the contract, all rights and liabilities come to an end. 2. In order to demand performance from the other party, a contracting party must have fully performed, or be ready and willing to do so. 3. The general rule is that a party is not discharged from liability and cannot demand performance from the other party unless his or her performance is precise and exact. Cutter v Powell (1795) 6 Term Rep 320 Fact: A seaman was employed to work on a voyage commencing 2 August 1793. He was expressly promised 30 guineas, provided that he proceeded and continued his duty as second mate on the ship from Jemaica to Liverpool. The seaman could not complete the entire journey as he died on 30 September 1793. The seamans wife claimed wages for the period he had worked on the ship. Held: Since the seaman did not work for the full period of the voyage, as required by the contract, his widow could not claim any wages at all. The contract in question was an entire contract. The intention of the defendant was to pay the seaman only after the completion of the whole voyage. Whereas the common rate of wages for seamen was 4 per month, the defendant promised to pay the seaman 30 guineas (about 31.5) for the two-month voyage. If there had not been a contract to pay this higher sum, all that the

43

seaman could have recovered on a quantum meruit for the voyage would have been 8 only. The seaman was going to receive the larger sum only if the whole duty was performed, and nothing unless the whole of that duty was performed.

On the other hand, in some situations, a party does not lose the entire benefit under the contract for failure to perform its entire obligations. The party is paid for what it has done. Hoenig v. Isaacs [1952] 2 AII ER 176 Fact: The plaintiff agreed to decorate and furnish the defendants flat for 750. The plaintiffs work was defective in some respects. A wardrobe required replacing and a bookshelf required to be remade. Held: Since the plaintiff had performed the contract in other respects (i.e. substantially performed the contract), he was entitled to 750, less the cost of putting right the defects. Whether a contract has been substantially performed or not is a question of fact. It is determined by having regard to the object of the contract, the nature of the defect and the relative cost necessary to remedy the defect. Bolton v. Mahadeva [1972] 1 WLR 1009 Fact: The plaintiff had installed heating system at the defendants home for 560. However, the system gave out offensive fumes and did not heat the house properly. The remedial work would have costed 174.50. Held: If a central heating system when installed is such that it does not heat the house adequately and is such, further, that fumes are given out, so as to making living rooms uncomfortable, and if the putting right of these defects is not something which can be done by some slight amendment of the system, the I think that the contract is not substantially performed. [Cairns L. J.] B. Discharge by Agreement Parties may make a fresh agreement which may (a) Discharge the contract (b) Discharge it and replace it with a new contract (c) Merely vary terms of the original contract without discharge. C. Discharge by Breach A contract is broken by failure to perform some or all of the obligations created by it. Although all breaches entitle the innocent party to seek remedies, only the breach of a condition or an innominate term with serious consequences entitles such party to treat the contract as discharged. Repudiation

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A party repudiates by showing an intention no longer to be bound by the contract. Such repudiation may by express or implied. Anticipatory breach

Here, a party repudiates before the due date for performance. The innocent party has a choice: (i) Do nothing, and wait for the time fixed for performance. In this case, it is as though the repudiation never happened, and the first party may change his mind and perform, or performance might be excused by a frustrating event. In such a case, it is probably that the innocent party has no duty to mitigate his or her loss until the date fixed for performance, and damages will be assessed at that time; Accept the repudiation and seek a remedy immediately, without waiting for the date fixed for performance.

(ii)

Hochster v. De La Tour (1853) 2 E & B 678 Fact: The defendant agreed to employ the plaintiff from 1 June, but on 11 May informed the plaintiff that it would not employ him from that date. The plaintiff sued the defendant, although the time for performance had not yet arrived. Held: The plaintiff was entitled to claim damages and he did not have to wait until 1 June to bring his action. C. Discharge by Frustration After a contract is made, the circumstances surrounding the contract may undergo changes that have not been expected by the parties. As a result of the changes, the performance of the contract may become impossible or impracticable. The principle of frustration of contract addresses this situation. When a frustrating event occurs, the contract is discharged so that the parties no longer have to perform their duties under the contract anymore. But exactly what constitutes frustration and what are the consequences of frustration? These questions are discussed in this chapter. 1. The principle of frustration As a general rule, the parties, after they enter into a valid contract, are bound to perform their obligations under the contract. It is no excuse for a party to refuse to perform the contract simply because he has miscalculated the cost and benefit of the contract. However, in the famous case of Taylor v. Caldwell, the court recognised that performance of a contract could be excused if the performance had become impossible due to the demise of a person or thing that is the condition for the performance. Taylor v. Caldwell Fact: The defendants agreed to let the plaintiffs use the Surey Gardens and Music Hall on four days for the purpose of giving a series of grand concerts; and the plaintiff agreed to pay 100 for each day. After the making of the agreement, and before the first the day on which a concert was to be given, the Hall was destroyed by fire. The destruction was without the fault of either party,

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and as a result of the destruction, the concerts could not be given as intended. The plaintiffs claimed expenses incurred in preparation for a series of concerts at the Music Hall. Held: The plaintiffs claim failed because the contract was frustrated by the destruction of the Hall and both parties were excused from liability for performing the contract.

The principle of frustration was also applied in a series of so-called 'coronation cases', which arose from the unexpected cancellation in 1902 of the British King's coronation procession. In the coronation cases, the contracts could still be performed in fact. But since the contracts were made on the assumption that the coronation procession was to take place, the court found that the contracts were frustrated because the foundation of those contracts had ceased to exist. Krell v. Henry Fact: On June 20, 1902 the defendant agreed in writing to pay 75 for the entire use of the rooms on the two days of June 26 and 27 to view the coronation procession. He paid 25 then and agreed to pay 50 on June 24. The procession did not take place owing to the serious illness of the King and the defendant declined to pay the 50. The plaintiff sued for that sum. Held: The plaintiffs claim failed, because the contract had been frustrated and the plaintiff could not enforce the obligation of the defendant to pay the agreed sum under the contract. What the judge said: 'The English law applies the principle of Taylor v. Caldwell not only to cases where the performance of the contract becomes impossible by the cessation of existence of the thing which is the subject-matter of the contract, but also to cases where the event which renders the contract incapable of performance is the cessation or non-existence of an express condition or state of things going to the root of the contract, and essential to its performance.' (per Vaughan Williams LJ). If a person takes a taxi to go to a stadium to watch a football match and, upon arriving at the stadium, is informed that the match has been cancelled, can the person refuse to pay the taxi fare on the ground that the 'foundation' or 'basis' of his taxi ride to the stadium has failed? Of course not. This emphasis on 'special qualification' for the transaction is important and was used to deny the application of frustration in some other seemingly similar cases. Heme Bay Steam Boat Company v. Hutton Fact: The defendant wished to charter a steam boat to take paying passengers to see a royal naval review. The contract said the ship was 'for the purpose of viewing the naval review'. The defendant f paid the 50 deposit. On June 25, 1902, an official announcement cancelling the review was published. The plaintiffs sued for the balance of 200. Held: The contract was not frustrated as 'the happening of the naval review was not the foundation of the contract' .The plaintiffs could recover the 200 less the profits they had made by the use of the ship on the two days in question.

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What the judge said: 'The ship (as a ship) had nothing particular to do with the review or the fleet except as a convenient carrier of passengers to see it; and other ships suitable for carrying passengers would have done equally as well.' (per Romer LJ) 2. The application of the principle The principle of frustration may be applied where a contract becomes impossible to perform because of changes in the circumstances that destroyed the fundamental assumption upon which the contract was made such as the loss of the subject matter or the death of the person to perform the contract, or if the performance has become illegal due to changes in the law. But whether frustration may be applied in a particular case is latch often difficult to determine. In many cases involving commercial contracts, the court has not been sympathetic to the claim of frustration simply because the performance of contract has been rendered more expensive or burdensome by unexpected changes of circumstances. Davis Contractors Ltd. v. Fareham Urban District Counci1 Fact: In June 1946, the contractors entered into a contract with council to build 78 houses for the sum of 97,425 within a period of eight months. Owing to unexpected circumstances and without the fault of either party, there was a serious shortage of skilled labour and of building materials and the work took 22 months to complete. The contractors contended that the contract was frustrated by reason of the long delay, and that they were entitled to a sum in excess of the contract price on the basis of the actual value of their work. Held: The contract was not frustrated and the contractors were not entitled to more money than what was agreed to under the contract. What the judge said: 'So perhaps it would be simpler to say at the outset that frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. But, even so, it is not hardship or convenience or material loss itself which calls the principle of frustration into play. There must be as well such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for.' (per Lord Radcliffe) In regard to long-term contracts, in particular, the courts are likely to conclude that the parties have assumed the risks that would in the future make their performance less beneficial. National Carriers Ltd. v .Panalpina (Northern) Ltd. Fact: Appellants leased a warehouse from respondents for a term of 10 years from 1974. In May 1979, the local authority closed the street that gave the only access to the warehouse because of the dangerous condition of a nearby building. It was contemplated that the closure would last for a year or a little longer. The closure prevented the appellants from using the premises for the only purpose contemplated, that is, as a warehouse. They stopped paying rents, claiming that the lease was frustrated. Held: The lease was not frustrated, and the appellants were liable to pay the rents.

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What the judge said: 'It is my understanding of the law that the purchaser of land, whether for a freehold or a leasehold interest, takes the risk that it may be or may turn out to be less suitable or quite unsuitable for the purpose he has in mind, unless the vendor or lessor has taken on himself by warranty or otherwise some liability in that event. ...Under the bargain between lessor and lessee the land for the term has passed from the lessor to the lessee, with all its advantages and disadvantages.' (per Lord Russell of Killowen) If a contract may be performed in more than one ways and the contract does not require to be performed in a particular way, the fact that a particular mode of performing the contract has become impossible cannot frustrate the contract and release the parties from their obligations. Blackburn Bobbin Co. Ltd. v .T. W .Allen & Sons Ltd.8 Fact: Early in 1914, the defendants, who were English timber merchants, agreed to sell to the plaintiffs a quantity of Finland timber. Prior to the war the invariable practice was to load the timber into vessels at ports of Finland for direct sea carriage to English ports, and English timber merchants did not hold stocks of Finnish timber. But the plaintiffs did not know these facts. As soon as war broke out, imports of timber from Finland stopped at once. The defendants alleged that the contract was dissolved by the outbreak of war . Held: The contract was not frustrated and the defendants were liable for not being able to deliver Finnish timber. What the judge said: 'The sellers in this case agreed to deliver the timber free on rail at Hull, and it was no concern of the buyers as to how the sellers intended to get the timber there. I can see no reason for saying-and to free the defendants from liability that would have to be said-that the continuance of the normal mode of shipping the timber from Finland was a matter which both parties contemplated as necessary for the fulfilment of the contract.' (per Pickford LJ) A contract would never be frustrated if the frustrating event was caused by the party who claims the contract is frustrated. Likewise, if the frustrating event was contemplated by the parties when making the contract and the contract contains provisions addressing the consequence of the event, those contract provisions should apply and the contract is not frustrated. Ocean Tramp Tankers Corporation v .V ..O.Soveracht. The Eugenia Fact: During the negotiation for the charterparty , both parties realised the possibility that the Suez Canal, which the ship would pass through, might be closed; but the parties were unable to agree on any provision to meet this contingency. The vessel, having sailed from Genoa, via Odessa, arrived at Port Said at a time when it was a 'dangerous zone' (which the ship was not permitted to enter under the 'war clause' in the charterparty) and became trapped in the canal. The charterers alleged that the charter was frustrated whilst the owners treated the charterers' conduct as a repudiation. Held: The charterparty contract was not frustrated, because the incident was caused by the fault of the charterers and because the charterparty contained a clause dealing with the danger. What the judge said: 'One thing that is obvious is that the charterers cannot rely on the fact that the Eugenia was trapped n the canal; for that was their own fault. They were in breach of the war clause in entering it. They cannot rely on a self-induced frustration.' 'To see if the doctrine applies you have first to construe the contract and see whether the parties have themselves provided for

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the situation that has arisen. If they have provided for it, the contract must govern. There is no frustration. If they have not provided for it, then you have to compare the new situation with the situation for which they did provide. Then you must see how different it is. The fact that it has become more onerous or more expensive for one party than he thought is not sufficient to bring about a frustration. It must be more than merely more onerous or more expensive. It must be positively unjust to hold the parties bound.' (per Lord Denning MR) 3. The Effect of Frustration Traditionally, common law of contract considered frustration to have the effect of releasing the parties from further performance of the obligations only. That is to say, when a frustrating event occurs, all the contractual obligations that should be performed after the date of frustration will not have to be performed. But all the obligations that should have been performed before the date of frustration are not affected by frustration. In other words, for such a 'prior obligation', if performance is already made the performance is valid and nothing should be restored or returned; if performance has not been made, the obligation is still binding and may be enforced.

Fibrosa Spolka Akcvina v. Fairbaim Lawson Combe Barbour Ltd.12 Fact: The respondents, an English company, agreed on July 12, 1939 to sell machinery to the appellants, a Polish company, for 4,800 of which one-third was to be paid with the order. Delivery was to be made, within three or four months of the settlement of final details at Gdynia, Poland, only 1,000 was in fact paid with the order. War broke out and Gdynia was occupied by the Germans. The appellants sued for the return of the 1,000. Held: The appellants' claim succeeded, although the contract was admittedly frustrated, because the consideration for the payment of I,OOO had totally failed.

The provisions of the Ordinance are subject to the terms of the contract (s.17(3)). If the contract contains terms dealing with the effect of frustration that are inconsistent with the relevant provisions of the Ordinance, the contract terms shall prevail. The provisions of the Ordinance are also subject to the severability of the contract (s.17( 4)). That is to say, if part of the contract may be properly severed from the remainder of the contract, and if that part has been performed, then the rules of frustration only apply to the remainder of the contract. That severed part, being performed, is not frustrated. S.16(2) prescribes the basic rules on the effect of frustration. They can be summarised into the following points: Money that is paid before frustration is recoverable. This accords with the Fibrosa J.udgment based on the principle of failure of consideration. Money payable before frustration ceases to be payable. That is to say, if party A is required by the contract to pay party B an amount of money at a time before frustration, but A somehow has not paid it when frustration occurs, then A does not have to pay that money anymore. But if the payee incurred expenses before frustration in the performance of the contract, he may retain or recover the whole or part of the money. With this provision, the court may decide on a fair and equitable division of the loss between the parties. Depending on the circumstances,

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the payee may now keep ('retain'), in whole or in part, the money that has been paid to him. Or he may claim ('recover'), in whole or in part, the amount of money that the other party was required to pay before the frustration occurred but has not paid. The money that the payee may retain or recover should, at any rate, not exceed the amount of his actual expense. S.16(3) adopts an approach similar to s.16(2) in regard to the situation where one party, instead of paying money, confers a non-monetary benefit (such as delivery of goods or supply of service) on the other party. If a party gives such a valuable benefit to the other party in the performance of the contract before the frustration occurs, he may recover a just sum not exceeding the value of the benefit. How much sum is 'just' depends on the circumstances of each case.

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Chapter Seven: Tort of Negligence Duty of Care

Reading:

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part IV.
2.

Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Nine 1. Introduction What is tort? Tort means a civil wrong. Tortious liability arises from the breach of a duty primarily fixed by law. This duty is towards persons generally and its breach is redressible by an action for unliquidated damages. A tort is different from a crime. When a person commits a crime, he or she is punished and sent to prison. A victim of crime does not usually get damages from the criminal. Tort, on the other hand, is a civil wrong. It gives the victim the right to sue the wrongdoer for damages. Tort law is more concerned with compensating the victim rather than punishing the wrongdoer. Principal source of the law of torts is the common law (i.e. cases developed by the courts), as opposed to the statute law. 2. Tort and contract Contract law is concerned with agreements or promises between contracting parties and the parties determine the contractual duties. Under a contract, the contractual duties are owned to other contracting party only, not to the whole world. Liability in tort is not based on any pre-existing relationship. Tortious duties are imposed by law and are generally owned to all persons. Whosoever commits a breach of duty in tort is liable. Sometimes, a wrong act could give rise to both liability in tort as well as liability for breach of contract. For example, where you employ a surgeon to operate upon you and that surgeon has done his work carelessly and left a pair of scissors in your stomach, you can sue him either for breach of contract or in the tort of negligence. The object of an award of damages for breach of contract as if the contract had been performed. The object of an award of damages for breach of tort duty as if the tort had not been committed. 3. General characteristics of tort of negligence

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Negligence in law means a failure to do some act which a reasonable man in the circumstances would do, or the doing of some act which a reasonable man in the circumstances would not do; and if that failure or the doing of that act results in injury, then there is a cause of action. Negligence can also be defined as the breach of a legal duty to take care which results in damage, undesired by the defendant, to the plaintiff. Tort of negligence has 3 elements which the plaintiff must prove: That the defendant owned him a duty of care; That the defendant was in breach of that duty; and That as a result the breach, the defendant caused the plaintiff some legally recognized damages (i.e. damage which is not too remote).

4. Duty of care Liability would only arise if that person is under a legal duty to take care. This duty is used mainly as a control mechanism for determining whether law of negligence can apply in a particular situation. Defendants motive is generally irrelevant in deciding whether he has been negligent or not. Duty in Law development of the rules The very first question is very trial on negligence is whether the defendant owes a legal duty of care to the plaintiff. Prior to Donoghue v. Stevenson, there was no generally recognized, universal test to determine whether a duty of care was owned in any particular situation. Donoghue v Stevenson [1932] Fact: Mrs. Donoghue went to a caf with a friend who ordered her a ginger bee float. Mrs. Donoghue drank some and when her friend poured the remainder out of the opaque bottle, a decomposed snail appeared. Mrs. Donoghue was taken ill, poisoned by the drink or sickened by the thought of it or both. Since she did not buy the drink herself, Mrs. Donogue tried to sue the manufacturer in tort instead of contract. Held: The manufacturer was liable. A person who for gain engages in the business of manufacturing articles of food and drink intended for consumption by members of the public in the form in which he issues them is under a duty to take care in the manufacture of these articles. The decision was based on Lord Atkins neighbour principle: You must take reasonable care to avoid acts or omissions which you can reasonably foresee would be likely to injure your neighbour.

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Who is my neighbour? Persons who are so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when I am directing my mind to the acts or omissions which are being called in question. 5. Foreseeability of harm The plaintiff must establish that he or she belongs to a class of persons who are likely to be affected by the defendants negligent act or omission. The duty is to avoid causing to the particular plaintiff damages of a particular kind. Palsgraf v. Long Island Rail Road 248 NY 339 (1928) Fact: While a person was running to catch a train, he was negligently pushed by an employee of the defendant railway company. He was carrying a package containing fireworks, which dropped and exploded. The shock waves caused a metal scale on the other side of the platform to tumble, injuring the plaintiff who was waiting for a train. Held: To impose liability on the defendant, it was not enough to prove that its negligence caused injury to the plaintiff. It was also necessary to prove that it was foreseeable that its negligence would cause injury to the plaintiff. The defendant owned no duty of care to the plaintiff as his injury was not foreseeable. 6. Proximity Lord Atkins speech in Donoghue v Stevenson stressed not only the requirement of foreseeability of harm, but also a close and direct relationship of proximity. Foreseeability does not of itself and automatically, lead to a duty of care. Otherwise, there would be liability in negligence on the part of one who sees another about to walk over a cliff with head in the air, and forbears to shout a warning.88 A person may see a neighbours child drowning in the Victoria Harbour, but his or her failure to rescuer the child will not make him or her liable in negligence because there is no relationship of proximity between that person and the child. However, there will be proximity in such a case if that person is a school teacher and the drowning child in under his or her control. Yurm Kun yu & Others v. Attorney General [1987] HKLR 1154 Fact: The plaintiffs deposited substantial sums of money with a deposit-taking company registered under the Deposit-taking Companies Ordinance. The deposit-taking company were into liquidation and as a result, the plaintiffs lost their deposits. The Commissioner of Deposit-taking Companies had various regulatory powers over the registration and deregistration of this deposit-taking company. The plaintiffs brought an action against the

88

. Per Lord Keigh of Kinkel, Yuen Kun Teu & Others v. Attorney General [1987] 2 HKC 25, at 32.

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Attorney General representing the Commissioner. They contended that the Commissioner was negligent since (1) He knew or ought to have known that the affairs of the company were being conducted fraudulently, speculatively and to the detriment of its depositors; (2) He failed to exercise his powers under the ordinance so as to secure that the company complied with the obligations and restrictions imposed on it; and (3) He should either never have registered the company or have revoked its registration before the plaintiffs made their respective deposits with it in order to save them from the effects of the companys eventual liquidation. Held: (1) It was reasonable foreseeable by the Commissioner that, if an uncreditworthy company were placed on or allowed to remain on the register, depositors would be at risk of losing money. However, foreseeability of harm did not of itself and automatically lead to a duty of care. There must also be proximity. (2). At the time the depositors chose to deposit their money with the deposit taking company in question, there was no relationship between the depositors and the Commissioner. There was also no special relationship between the Commissioner and the deposit-taking company. Therefore, there was no proximity between the depositors and the Commissioner. 7. Fairness, justice and reasonableness Not only foreseeability of harm and proximity but also the elements of fairness, justice and reasonableness are to be examined by the court to determine the existence of a duty of care. Even if foreseeability and proximity are established, the plaintiff may still not succeed if the court thinks that it is not fair, just and reasonable to impose a duty on the defendant. White v Jones (1995) 2 AC 207 The defendants were solicitors. They were instructed by the plaintiffs father, aged 78, to draw up a will giving the plaintiffs 9,000 each. The solicitors delayed in carrying out the fathers instruction. After a month, the father again asked the solicitors to draw up the will and again the solicitors failed to do so. The father died without executing the will. The plaintiffs had no remedy against the estate of their father so they sued the solicitors. Held: it was fair, just and reasonable that the defendants should be liable to the intended beneficiaries, otherwise there would be no sanction in respect of a solicitors breach of his or her professional duties. If the defendants were not held to be liable, they would go scot-free, which could not be right. 8. Conclusion 1. In many negligence situations, a duty of care will be established simply where there is reasonable foreseeability of harm e.g. road traffic accidents causing physical injury. 1. In other situations the court may require additional factors indicating a closer type of relationship. The type of harm suffered, the status of the plaintiff or the defendant, the

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nature of defendants conduct may be important factors in deciding the degree of proximity required establishing a duty of care.

Duty of Care: Pure Economic Loss Caused by A Negligent Act

Reading:

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part IV.
Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Nine
2.

Introduction 1 What is a Pure Economic Loss? A pure economic loss is one which is not related to or results from any physical injury to a person or damage to property. A pure economic loss may be caused by a negligent act or by a negligent statement. While pure economic losses arising from a negligent act cannot be recovered, provided that there is a duty of care owed by the maker of the statement to the claimant. 2. Pure economic losses arising from loss of profit or loss of earnings It is well settled that when a defendant by his or her negligent act causes physical injury to the person or damage to property of another, economic losses including loss of business or loss of profit or loss of earnings are recoverable. On the other hand, when such losses are not consequent upon any personal injury or damage to property, they are not recoverable. Where a ship negligently collides with another ship and the other ship is sunk, the owner of the ship can recover damages for the loss or damage to the ship and business profits. However, the workers on the ship who lose their jobs cannot recover their economic losses. They do not arise from physical injury to workers or damage to their property. Financial losses resulting from losing a job are purely economic. Weller & Co v. Foot & Mouth Disease Research Institute [1966] 1 QB 569 Fact: A serious foot and month disease virus had escaped from the laboratories of the defendant institute and infected some of the cattle in the neighbourhood. The cattle markets were closed. The plaintiff, a company which auctioned cattle, suffered considerably financial losses as a result of not being able to hold any cattle auctions. The plaintiff company commenced action against the defendant institute. It was assumed that the plaintiffs losses were foreseeable and the escape of the virus was caused by the defendants negligence. Held: A foreseeable economic loss to the plaintiff did not automatically impose on the defendant a duty to take care to avoid that loss. The defendant was not liable in negligence because its duty to take care to avoid the escape of the virus was owed to the cattle owners only. As the plaintiff was not the owner of the cattle, no such duty was owed to it. Since its losses did not arise from any injury or damage to its property, they were pure economic losses which could not be recovered.

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Spartan Steel v Martin [1972] 3 AII ER 557 Fact: Defendant was a highway contractor. It the course of digging a road, the defendant negligently damaged a power cable and interrupted the supply of electricity to the plaintiffs factory. When the power was cut, the molten metal in plaintiffs furnace was damaged. Plaintiff claimed for: Physical damage to the metal ( 368) and Loss of profit ( 1,767) from production during the absence of the electricity power (14 hours)

Held: The plaintiff should recover for the physical damage to the one melt ( 368) but not for the loss of profit ( 1,767) because that was a pure economic loss independent of physical damage to any melt. If claims for pure economic loss were permitted for the consequence of cutting of electricity, there would be no end of claims. Some might be genuine, but many might be inflated, or even false. A machine might not have been in use any way; but it would be easy to put it down to the cut in supply. It would be well-nigh impossible to check the claims. (per Lord Denning).

3. Pure economic losses arising from a defective product In the absence of a contractual relationship between the plaintiff and the defendant, the cost of repairing a defect in a chattel negligently manufactured by the defendant cannot be recovered in negligence because such costs are purely economic. For example, where the manufacturer of a car sells the car to another person, and you buy the car second-hand and subsequently find the car useless and dangerous to drive, your loss is pure economic loss. It is not recoverable in tort. As you do not buy the car directly from the manufacturer, you also do not have any claim against the manufacturer in contract. Sunface International Ltd & Others v. Meco Engineering Ltd [1990] 2 HKLR 193 Fact: The plaintiffs were owners and occupiers of several houses. The fifth defendant was responsible for the installation and testing of the electrical circuits and related works at the houses. There was no contractual relationship between the plaintiffs and the fifth defendant. The fifth defendant was negligent in his work in that the electrical installations were defective. The plaintiffs claimed the costs of demolition, repair and restoration of the electrical circuits and an amount for alternative accommodation during the period of replacing the system. No personal injury or property damage had been caused by the defective circuits although the houses were rendered defective. The defendant argued that the plaintiffs claim was for pure economic loss. Held: it was not possible to recover damages in tort for rectifying a defect itself or for costs incurred in remedying defects in order to avert damage or danger. Such losses were purely economic losses. The costs incurred in rectifying defective electrical installations, therefore, were not recoverable. 4. Pure economic losses arising from a defective building The courts apply a similar approach in dealing with building cases where a person incurs pure economic loss due to a building being defective or useless.

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Murphy v Brentwood District Council [1991] 1 AC 398 The plaintiff had bought a house built and sold by ABC Homes. The house was built on a concrete raft foundation. The design of the raft had been approved by the defendant, Brentwood District Council, on the recommendation of independent consulting engineers. Ten years later, cracks started appearing in the internal walls of the house. Since the plaintiff could not afford remedial work, he sold the house at the low price of 35,000. The plaintiff sued the defendant for financial losses caused due to its negligence in approving the design of the foundations. Held: The defendant was not liable. What the plaintiff had was only a defective house which was a bad bargain. Unless and until actual physical damage had occurred, the cost of making the house sage or any diminution in value was purely economic loss which was irrecoverable in tort. 5. Conclusion What then is the present state of the law regarding recovery for pure economic loss? Likely that courts will require a high degree of proximity; this will only be established in exceptional cases and perhaps only where there is some reliance by the plaintiff on the defendant. In Spartan Steel, the parties were complete strangers, in Muirhead, they were not: they were in the relationship of consumer and manufacturer. As Donoghue v. Stevenson laid down, that is a special relationship, but when it comes to liability for purely economic loss, is not special enough. In great majority of cases Spartan Steel will continue to represent the law. Courts will be particularly reluctant to recognise a duty of care in tort where the parties are already in a contractual relationship.

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Chapter Eight: Economic Loss (Negligent Statement)

Readings 1.An Introduction to Hong Kong Business Law, Vanessa Stott, Third Edition, Longman, Chapter 15 Aspects of the Tort of Negligence
2.

Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter Nine

A. Introduction 1. Consider the number of different ways in which liability may arise in respect of words: Defamation -words affecting personal reputation. Injurious falsehood -malicious statements affecting business reputation.

2. We are mainly concerned here with negligent statements causing economic loss (the rule in Hedley Byrne Heller). 2. Where negligence is basis of liability, courts have been more willing to recognise that plaintiff has cause of action if physical harm is suffered: eg doctor wrongly prescribes drugs; mechanic wrongly tells you that your car is safe to drive. 4. For policy reasons, courts are reluctant to impose tortious liability for negligent statements because: 'Words have wings'; Fear of imposing 'liability in an indeterminate amount for an indeterminate time to an indeterminate class' (per Cardozo C.J., Ultramares v Touche (1931))

5. Liability was recognised where D 'knowingly or recklessly' made a false statement which resulted in economic loss to P: this was the tort of deceit (fraud). But in order to be liable for deceit the statement must have been made 'knowingly or recklessly'. Carelessness (negligence) was not enough to found liability. Deny v Peek (1889)

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Fact: The directors of a transport company, which run their trams by animal power, truly believed that the government would permit them to run the trains by steam power, and therefore issued a prospectus saying that the company had got the right to run steam trains. The purchaser, relying on that prospectus, took up the shares of the company. The government however, refused the application of the company, which was wound up afterwards. The purchaser sued in tort for deceit Held: The directors were not guilty of deceit because they truly believed that the approval of the government was forthcoming. They did not have the intention to defraud. Consider the position of fraudulent misrepresentation. Any difficulties? Any better remedies? Development of Law Old position: Candler v. Crane Christmas & Co (1951) l Fact: Plaintiff wanted to see the accounts of a company before deciding to invest in it. Defendants were the company's accountants. The company told the defendants to prepare the accounts for inspection by the plaintiff. At the company's request, the defendants showed the completed accounts' to the plaintiff and discussed the same with the plaintiff, and even allowed the plaintiff to take copy of the accounts. The accounts were carelessly prepared and gave a wholly misleading picture. The plaintiff relied on the accounts and suffered huge loss. The plaintiff sued the defendants. The Court of Appeal reconsidered liability for negligent misstatement but rejected the plaintiff's claim by majority (Denning L.J. dissented). The court held: Neighbour principle in Donoghue v. Stevenson has no application because there was no personal injury or damage to property. In the absence of contract or, an action for negligent misstatement cannot be maintained when there was no fraud Note the 'strong' dissent from Denning L.J: A general duty of care applied to professional persons such as accountants, surveyors, valuers, whose profession was to examine books, accounts, and to make reports on which other people relied in ordinary course of business. Accountants could be liable for negligent preparation of accounts to any third person to whom the accountants showed the accounts, so that the third party would rely on the accounts to invest money or take some other action. However, accountants should not be liable to strangers about whom they had never been informed, and to whom the client showed the accounts without their knowledge or consent.

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2. Current position: Hedley Byrne v Heller 1963 Fact: the plaintiff, a firm of advertising agent, booked advertising time on television channels, on behalf of a customer, Easipower Ltd. The plaintiff had paid the advertising fee to the television station for Easipower before they could get reimbursement from Easipower. Becoming doubtful of the financial position of Easipower, the plaintiff asked their bankers to obtain a credit report from the defendants, the banker of Easipower. The defendants in their report stated that Easipower was a "trustworthy" company. The report also contained a disclaimer to the effect that the defendants would not be responsible for the contents of the report. The plaintiff relied on the report but Easipower went to liquidation within three months after the report. Plaintiff suffered financial loss and sued the defendants. Court at first instance held the defendants were negligent but they did not owe duty of care to the plaintiff. The Court of Appeal held that the defendant owed no duty of care to the plaintiff. Therefore, it was unnecessary to consider whether the defendant were negligent or not. The House of Lords held: Lord Denning's dissenting judgment in Candler's case represented the correct legal position. A duty of care to any third party could arise from negligent misstatements causing financial ( economic) loss. The defendants owed a duty of care to the plaintiff and the defendants were in breach of this duty. However, the defendants could escape liability because they could rely on the disclaimer. Note in this case: (a) Defendant did not give the advice directly to the plaintiff but rather intermediary (the plaintiff's bank). (b) Defendant did not know the plaintiff's identity. However the House of Lords was satisfied that the defendant knew, or ought reasonable to have known that the advice was being sought on behalf of someone doing business with the defendants client and would be relied on by that person. But note that the test for determining whether a duty actually exits in a particular situation is a restricted one. It only arises where there is a special relationship between the plaintiff and the defendant. What are the requirements of the 'special relationship'? Not clearly defined by the court but seems to require the following elements:

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(a) Plaintiff relies on defendant's skill & judgment; (b) Defendant knows, or ought reasonably to know, that plaintiff is relying on him. (c) In all the circumstances it is reasonable for plaintiff to rely on defendant. This has also been described as a voluntary assumption of responsibility by defendant to plaintiff for the accuracy of his advice. If defendant knows that his skill or judgment is being relied on, he could have 3 courses of action: (1) Keep silent and decline to give any advice; or (2) Give advice with clear qualifications that he accepts no responsibility; or (3) Simply give advice without any qualifications. If he chooses to adopt the last course he must be held to have accepted some responsibility for his answer being given carefully. 3. In what situations does the rule apply? The circumstance under which the statement was made may be important: eg was it made in a 'business' context or merely on a 'social' or 'informal' occasion? There should be a serious/formal/business type of relationship, as opposed to a casual, informal one. Other important considerations concern the range or class of P does liability extend: what degree of proximity must exist between plaintiff and defendant? What is defendant's purpose in giving the advice? 4. Further development: Caparo Industries v Dickman (1990) Fact: The defendant, a firm of public accountants, prepared auditor's report for a Public Listed Company under statutory requirement. The report was negligently prepared and the report was circulated shareholders of the company. The plaintiff, a shareholder of the company, relying on the report, made a further purchase of the shares of the company. Consequently, the plaintiff suffered loss. The defendant had no knowledge of the plaintiff's purchase. There were two preliminary issues: whether the defendant owed the plaintiff any duty of care (a) as potential investor in the company; or (b) as an existing shareholder of the company. The Court of Appeal held that a duty was owed to existing shareholders but not to prospective investors.

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The House of Lords held that an accountant doing a' statutory' company audit did not owe a duty to members of the public considering investment in the company nor even to existing shareholders who rely on the accounts to purchase more shares. To hold the defendant liable, the following conditions must also be satisfied: (a) Defendant must be fully aware of the nature of the transaction which the plaintiff had in contemplation; (b) Defendant must know that the advice or information would be communicated to the plaintiff (c) Defendant must know that plaintiff would rely on his advice or information in deciding whether or not to engage in the transaction in contemplation. The situation was entirely different where a statement was put into general circulation and might foreseeably be relied on by strangers for any purpose which the maker of the statement had no specific reason to anticipate. The court also considered the purpose of defendant' s statement was significant. Defendant made the statement in order to satisfy the company' s statutory duty under the Companies Act, rather than to give advice to potential investors in the company.

C Conclusion 1. Close proximity between the maker of the statement and the person relying on it is clearly required. 2. The court is unlikely to extend liability beyond the existing clearly-established categories. 3. Where the plaintiff relies on the statement and afterwards enters into a contract with defendant he may have a statutory remedy under the Misrepresentation Ordinance.

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Chapter Nine: Sole Proprietorship (Traders),

Partnership and Corporate Personality

(Hong Kong Company Law)

Reading: 1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part V.
Business Law in Hong Kong, D.K. Srivastava (General Editor), Sweet & Maxwell Asia, Chapter 7
2.

1. Sole proprietorship
In a sole proprietorship, the sole trader is his own boss. He alone contributes his resources (including capital and skill) to the business and takes all the profits. He can run his business without any restriction provided the business is not illegal. However, there is no limit to his liability for the debts of the business. In the event that there are insufficient funds in the business to repay all the debts, the sole trader must sell his personal property to settle the debts of the business. If his personal assets are insufficient to settle all the debts of the business, he may be put into bankruptcy. To form a sole proprietorship, an application must be made to the Business Registration Office for a business registration certificate within one month of the commencement of the business. A sole proprietorship will be dissolved automatically on the death or bankruptcy of the sole trader.

3. Partnership
A. Definition A partnership is defined as the relation which subsists between persons carrying on a business in common with a view to making a profit. Hence, non-profit making clubs or associations are not partnerships. To determine whether there is a partnership or not, section 4 of the Partnership Ordinance should be referred to. It specifies that joint tenancy, tenancy in common, joint property, common property, or part-ownership does not of itself create a partnership as to anything so held or owned. B. Formation of partnership A partnership is formed by a contract (i.e. the partnership agreement which specifies the profitsharing ratios, the duties of the partners and arrangements on dissolution of the partnership) which may be made orally, in writing or by deed. If there is no partnership agreement, the provisions of the Partnership Ordinance apply. In the case of a limited partnership, the Limited Partnership Ordinance applies. C. Number of partners

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In a partnership, there should be at least two persons. A partnership should not have more than 20 partners unless it is a partnership of solicitors, accountants, stockbrokers, or any other professions, vocations, and businesses approved by the Governor in-Council. E.g. Johnson, Stokes & Masters ( a firm pf solicitors) and Ernst & Young ( a firm of accountants). Otherwise, it must be registered as a company under the Company Ordinance. D. Relations among partners Section 7 of the Partnership Ordinance provides that every partner is an agent of the firm and his other partners for the purposes of the partnership business. The acts of a partner will bind the firm and his partners provided he does the act in the ordinary course of the partnerships business. However, section 7 will not apply under the following circumstances: The partner so acting performs the act not in the ordinary course of business of the partnership business; or The partner so acting has in fact no authority to act for the firm in the particular matter; or The person with whom he is dealing with knows that he has no authority, or does not know or believe him to be a partner.

There are no restrictions on the way the partnership can run its business provided the business is not illegal and not prohibited by the partnership agreement. The partnership business should be carried on by or on behalf of all the partners. It is not necessary that all partners must take an active role in the management of the business. However, the partners who run the business must be doing so as agents for the other partners so that they can bind the others. E. Liabilities of Partners Partners (other than limited partners) are jointly and severally liable for the debts and the torts committed by the firm. Example: Chan and Wong formed a partnership and agreed to share profits equally. If the partnership business is unable to settle its debts, Chan and Wong must share the loss equally and settle the debts from their personal properties. However, if Chan declares bankrupt and becomes unable to pay his share of the loss, Wong (whether he likes it or not) must pay all the debts of the partnership business from his personal property. Partners in a general partnership are jointly and severally liable, without any limitation, for all the debts and obligations of the partnership. However, it is possible to register a limited partnership under the Limited Partnership Ordinance, under which the liability of one or more of the partners is limited to a sum which they have contributed to the firm. However, there must be at least one partner (the general partner) whose liabilities are unlimited. The partner whose liability is limited (the sleeping/dormant partner) may not take part in the management of the firm. F. Liability for Torts

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Section 12 of the Partnership Ordinance provides that a partnership is liable for a partners torts e.g. negligence, trespass under the following circumstances: The tort was committed in the ordinary course of the partnerships business, or The other partners authorized the tort.

Partners are jointly and severally liable for the wrongful acts or omission of any partner. Moreover, section 5 of the Civil Liability Ordinance provides that in an action for damages, if judgement is obtained but the damages is still not fully paid and some other persons are jointly liable for the damages, the injured party may bring an action against those other persons. Consequently, the injured party may bring an action against other partners in case the partner who committed the tort fails to pay the damages in full. G. Legal Actions by and against Partnerships Unlike a company registered under the Companies Ordinance, a partnership does not have a separate legal entity. However, partners may sue or be sued in the name of the firm of which they were partners at the time when the cause of action accrued. If partners are sued in the name of a firm, the writ may be served on any one or more of the partners, or on any person having the control or management of the partnership business. Moreover, a copy of the writ should be sent by ordinary post to the principal place of business of the partnership. H. Formation and Dissolution of Partnership A partnership is formed by a contract which may be made orally, in writing or by deed. There is no need to register a partnership with the Company Registry unless the following forms of partnership are to be formed: Limited partnerships; or Partnerships which consist of more than 20 partners formed for the purposes of carrying on any business for profit (except a partnership of solicitors, accountants etc.) Within one month of the commencement of the business, a partnership must obtain a business registration certificate from the Business Registration Office.

A partnership will be dissolved: On the occurrence of the events specified in the partnership agreement e.g. by notice to the other partners of an intention to dissolve the partnership, on the expiration of the term fixed for the duration of the partnership; On the death or bankruptcy of any partner unless otherwise specified in the partnership agreement; By court e.g. a deadlock in the management or discords between partners.

3. Corporate Personality
A company is a legal entity distinct from its members. It has legal personality and is often described as an artificial person or a body corporate. The consequences of creating such a

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body were clarified by the House of Lords [UK] in the celebrated case concerning Mr. Salomon, his family and a company which they had formed.

Salomon v Salomon [1897] A.C. 22 Facts: A Mr. Salomon had carried on boot-making business for several years. He called himself a leather merchant. In 1892 he formed a registered limited liability company: Salomon & Co. Ltd. He was the majority shareholder with 20001 in shares at one pound each; the other six shareholders [all members of his family] had one share each. The managing director of Salomon & Co Ltd was Mr. Salomon. The company purchased the boot-making business from Mr. Salomon. But it only had 20,007 pounds, and the price of the boot-making business was 39,000 pounds. The company borrowed the difference [i.e. 39,000 pounds less 20,0007] by entering into loan agreements; in particular, Mr. Salomon lent the company 10,000 pounds, by way of a secured debenture and this gives such a secured creditor a right to be paid before other [unsecured] creditors in the event of the company going into liquidation. Not long after it was formed, the company was liquidated after a depression. Its liabilities were 18,000 pounds [including the 10,000 pounds owned to Mr. Salomon] whilst its assets were only 6,000 pounds. This amount was paid to Mr. Salomon and the remaining creditors received nothing. These unsecured creditors claimed that to all intents and purposes Mr. Salomon was the company and so he could not owe money to himself. Held: Mr. Salomon and Solomon & Co Ltd were two separate and distinct persons. Salomon was entitled to be paid before the unsecured creditors, as the company was duly registered and was a separated legal entity. Salomon was able to contract with and be a secured creditor of the company. There was no evidence that Mr. Salomon had behaved fraudulently. Had he done so, the case would have been decided differently. Furthermore, having formed a company and sold property to it, such property belongs to the company and not to its members or creditors.

Macaura v Northern Assurance Ltd. [1925] A.C. 619 HL Facts: Macaura, owner of the Killymoon estate in county Tyrone, sold the whole of the timber on the estate to a company, Irish Canadian Sawmills Ltd, in consideration of the allotment to him of 42,000 fully paid 1 pound/shares. All the companys shares were held by Macaura and his nominees, and he was also an unsecured creditor of the company for 19,000 pounds. Subsequent to the sale, he purchased insurance policies in his own name with the insurance respondent company and others, covering the timber against fire. Two weeks later, almost all of the timber was destroyed in a fire. A claim brought by Macaura on the polices was disallowed. Held: Macaura had no insurable interest in the timber, as he and the company were separate legal entities. Hs claim was disallowed because the timber was owned by the company. Lord Sumner said: Macaura owned almost all the shares in the company and the company owned him a good deal of money, but neither as creditor nor as shareholder could he insure the companys assets.

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Lee v Lees Air Farming [1961] AC 12 Facts: Lee formed a company and held 2,999 of the 3,000 shares. He was appointed sole director under the Articles of Association and was employed as a salaried chief pilot. He was later killed in an air crash. His wife tried to claim compensation under the Workers Compensation Act for the death of her husband, claiming that he was an employee. Held: The lower courts held that Lee could not be a worker when he was in effect also the employer. The Privy Council held that there was a valid contract of service between Lee and the company, and so Mrs Lee was entitled to compensation. Thus, it is well established that a company is a persona at law; it is an artificial person with a separate legal personality and it can make contracts, take legal action, be sued, and own property as a natural person. It can also commit crimes and torts. In addition, and because the company is a separate legal body, it will continue to exist despite a change of owners [members]. It is said to have perpetual succession: it will continue to exist until it is finally wound up and dissolved, and it is not affected by either the death or the bankruptcy of its members.

Summary of Corporate Personality

1. A company is regarded in law as a person separate and distinct from its members. It makes no difference to this rule that one member owns all or substantially all the shares. Salomon v Salomon [1897] AC 22 [House of Lords]. 2. A company has the capacity to enter into contracts with other parties with the normal rights and liabilities of a contracting party. A company may make a valid and effective contract with one of its members. It is possible for a person to be at the same time wholly in control of a company [as its principal shareholder and sole director] and an employee of that company. Lee v Lees Air Farming Ltd [1960]3 ALL Er 420 3. A company has legal capacity to hold property. Property owned by the company belongs to the company itself and not to its members or creditors. A shareholder, even one who effectively owns all the shares in the company. Macaura v Northern assurance Co. Ltd. [1925] AC 619 HL 4. A company enjoys perpetual succession. Its existence is not affected by the death, bankruptcy or mental disorder of its members. 5. A company has the capacity to take legal proceedings in its own name.

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6. The liability of the company is distinct from the liability of the members of the company.

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Chapter Ten: Business Vehicles & Lifting the Corporate Veil

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part V.
2.

Hong Kong Company Law, Vanessa Stott, Tenth Edition Longman, Chapter 1

1. Private Companies:
Private companies are devised for the small business and are intended for situations where the members are also the managers of the company. The companies formed by Salomon, Macaura, and Lee are typical in this respect. A private company is defined by s29[1] as a company which by its articles [see Chapter 3.2] A] Restricts the right to transfer its shares; and B] Limits the number of members to 50, not including employees of the company and former employees who were members of the company whilst employed and who have continued to be members; and C] Prohibits any invitation to the public to subscribe for any shares or debentures in the company. For the purpose of this section, two or more persons holding one share jointly are treated as one member [s 29(2)]. Restriction on the right to transfer shares: May take the form that any member who wishes to sell his shares must first offer them for sale to the existing members of the company [known as a emptive clause] or that the directors have an absolute discretion to refuse to register a transfer of shares. The main advantage of private companies: They need not file accounts with their annual return [s109(3)], that means they can keep their financial information private and are relatively cheaper to maintain, as their shareholders have power to waive compliance with certain requirements as to accounts: s141D. While all companies are required to lodge with the Registrar an annual return, which is available for public inspection, exempt private companies need not file accounts with their annual return: s 109 (3). They may redeem or buy back its shares out of capital if so authorized by their articles: s491 They do not need to issue a statement in lieu of a prospectus before allotting shares or debentures: s43(3). Their members may approve loans to directors: s 157H(3)(b).

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Its directors may be elected on a single resolution rather than each director subject to a number of exceptions, they may waive compliance with certain requirements

Conversion of a private company to a public company If a private company alters its articles in such a way that they no longer comply with s29, it is required to deliver to the Registrar, within 14 days from the alteration, either a prospectus or a statement in lieu of a prospectus. The form of and particulars to be specified in the statement in lieu of a prospectus in these circumstances are set out in Schedule 2 [s30(1)]. It includes the share capital of the company; preliminary expenses of the company; the directors; vendors of property; material contracts and dividend.

2. Public Companies
If a companys articles fail to satisfy the requirements of s29, it is a public company, although term public company is not actually used in or defined by the ordinance.

3. Listed Companies
A listed company is one whose shares or debentures are traded in the Hong Kong Stock Exchange. It must therefore also be a public company. The basic requirements which have to be met as a prerequisite to listing shares or debentures are as follows: The company must be duly incorporated and conform with the law in its place of incorporation and with its memorandum and articles. A company must not be private one within the meaning of s29. The company and its business must, in the opinion of the Exchange, be suitable for listing. A new applicant must have an adequate trading record under substantially the same management. This will normally mean that it must have a trading record of not less than three financial years during which the profit attributable to shareholders must in the most recent year be at least $20 million and in the two preceding years a total of at least $30 million. The Exchange may, however, accept a shorter period and/or waive the profit requirement in the following cases: 1. Natural resource exploration companies 2. Newly formed project companies [eg. A company formed to construct a major infrastructure project] 3. Exceptional circumstances where the company has a trading record of at least two financial years. [For more details, please see, Vanessa Statt Hong Kong Company Law p. 20 Langman 1998.]

4. Limited and Unlimited Companies

In practice, we refer to a limited liability company; in fact, the liability of the company itself is always unlimited, and every asset of the company will be used to pay the companys debts. It is

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the liability of the company members which may be limited. Section 4[2] provides that a company may be either: Limited by shares, or Limited by guarantee, or Without limited liability A. Limited by shares A company may be registered as limited by shares. The nominal value of a share is a fixed sum, whereas the price at which the share is issued is determined by its market value. Shareholders may therefore agree to pay the company more than the nominal value of the share. Shares are usually paid for in full when they are issued, in which case, even if the company is wound up and is unable to pay its debts, the members are not liable to pay those debts; their liability is limited to the nominal value of the shares, and this has already been contributed. B. Limited by guarantee A company may be registered as limited by guarantee. That is a company which may simply take a promise from each member to contribute a fixed amount if necessary to pay the companys debts when it is wound up. When this happens those who are members at the time are required to contribute towards the payment of the companys debts and liabilities and the costs of winding up in accordance with the guarantee. The amount guaranteed will be whatever sum is stated in the memorandum. A guarantee company without a share capital cannot have any contributed capital [until it is wound up] and this is usually considered inappropriate for a business enterprise. Accordingly, guarantee companies are usually formed only to undertake charitable objects or to carry on some non-commercial undertaking. Only a very small proportion of registered companies are guarantee companies. C. Without limited liability If a company is registered as unlimited, its members will be personally liable for the debts of the company without limit. The personal liability of members of this type of company is the reason why not many of them exist. They are sometimes formed by those who wish to keep the companys accounts away from the public gaze. In addition, there are advantages in having separate corporate status and perpetual succession even though these are not accompanied by limited liability. Unlimited companies must be private companies since a public company is by definition a company limited by shares. [or guarantee with a share capital]. If a company is registered as unlimited, its members will be personally liable for the debts of the company without limit. Unlimited companies may be formed with or without a share capital. If the company is trading and intending to distribute profits, shares are a useful method of measuring each members interest in the company. If an unlimited liability company with a share capital goes into liquidation, the members will be liable to pay whatever price they agreed for their shares; if this amount is not adequate to satisfy the debts and liabilities of the company together with the costs of winding up, the members must contribute ratably according to their shareholding. Where there is no share capital, the members contribute equally until all the debts and liabilities of the company plus the costs of winding up are paid.

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5. Lifting the Corporate Veil

In the last lecture, we learned that the company has a separate legal personality. Since a company is viewed as a separate legal entity from its members, does it mean that the members will NEVER be liable for what the company does? The fact that the separate corporate personality of a company prevents outsides from taking action against its members has held to its comparison with a veil. However, the courts will not allow the separate legal entity principle, firmly established in Salomons case and upheld many times since, to be used where it might be unjust, and they will in exceptional circumstances lift the corporate veil and look at the membership of the company. We consider here some examples of lifting the corporate veil

A. National Emergency
In time of peace, the character of individual shareholders will not affect the character of a company. However, the times of war, it is illegal to trade with the enemy. The court may list the veil of incorporation so as to impute to a company the same nationality as its members. Daimler Co. Ltd v Continental Tyre and Rubber Co. Ltd (1916) 2 AC 307 Facts: the Continental Tyre and Rubber Co. Ltd (CTI) was a company incorporated in England. Its majority shareholders and directors were German residents. The Secretary, who held only one share, was a British resident and a British subject. Held: It was held that in times of war, the court may lift the corporate veil of a company and look at the nationality of its members and directors to determine if a company is to be classified as an enemy. If the persons in control of the companys affairs are residents in an enemy country, then the company (even though it was not formed under the law of an enemy country) may be classified as an enemy. In that case, persons dealing with the company is trading with an enemy. CTI (even though it was registered in England) was therefore being classified as an enemy as its majority shareholders and directors were residents of an enemy country.

B. Where the company is formed principally for fraudulent purpose or as a sham to evade existing liability or to defeat the law
Gilford Motor Co v Horne [1933] UK Facts: Horne had been employed as managing director of Gilford and had covenanted not to solicit customers of the company after leaving its employment. He set up a company in which his wife and an employee were the sole shareholders, to solicit customers of his former employer. Held: Horne and the company, as his agent and under his direction, had committed breaches of the covenant, and an injunction was granted against both of them. Lord Harnworth MR: I am

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quite satisfied that this company was formed as a device, a strategem, in order to mask the effective carrying on of a business of Horne. China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] COS chartered a ship to a company called Mitrans Maritime Panama SA [MMP], to carry cargo from China to North Korea. A dispute between COS and MMP was referred to arbitration. The arbitrators awarded that MMP pay COS more than US$ 150,000. MMP failed to pay and COS claimed that MS were liable to pay because MS controlled MMP and MMP acted as a faade for MS to evade their legal obligations to COS. The Court of Appeal held that it was MMP who had chartered the ship and that the claim against MS should be struck out. MS had not evaded their legal obligations, they had simply used a corporate structure to avoid incurring obligations. The court is not entitled to lift the corporate veil merely because the corporate structure has been used to ensure that certain liabilities fall on another company within the group. HKSAR v Leung Yat Ming [1999] 2 HKLRD 402 The Chinese University, Ls employer, offered a rent allowance to him on condition that the proposed accommodation was not owned by the employee, his spouse or relatives and that neither the employee, his spouse or relatives had any financial interest in the property. Ls husband purchased a shelf company which was owned through nominee shareholders and directors. An apartment was purchased in the name of the company and L claimed a rent allowance from the Chinese University. When she left the Universitys employment, her husband claimed a rent allowance from the Hong Kong University. They were both convicted under the Prevention of Bribery Ordinance (Cap 201). On appeal they argued that they had not acted illegally and the corporate veil should not be lifted. The Court of Appeal held that where the justice of the case required, it was permissible to go behind the corporate veil, particularly where it was a cloak for deception.

C. Statutory Provisions
(I) Criminal acts: When a company commits an offence under any ordinance, and it is proved that the offence was committed with the consent or connivance of an officer concerned in the management of the company, then he will be guilty of the same offence. [s. 101 E of the Criminal Procedure Ordinance [Cap. 221]

R v MG Mirchandani [1977] HKLR 523 The company was charged under the Obscene Publications Ordinance with having acted as agents for the distribution of allegedly obscene magazines. The companys officers were charged with consenting or conniving in the offences. It was held that the word consented or connived covered a situation where the officers had deliberately shut their eyes to an obvious means of knowledge. Their convictions were upheld.

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(II)

Failure to observe formalities/statutory requirements: If a company carries on business without having at least two members and does so for more than six months, a person who is a member of the company and knows that it is carrying on business with only one member is liable to pay the debts of the company contracted during the period [s31]. The liability is joint and several with the company: the member and the company are each liability for the total amount of the debt, but the member is entitled to be indemnified by the company. A sole member may escape this personal liability by petitioning for company to be wound up by the court under s 177(1) on the ground that the member has fallen below the statutory minimum. (in practice, this situation may be avoided by having one share registered in some other person, who is either a genuine member or simply a nominee.)

(III)

Fraudulent Trading s. 275: If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose, the court, on the application of the Official Receiver, or the liquidator or any creditor or contributory of the company, may, if it thinks proper to do so, declare that any person who were knowingly parties to the carrying on of the business with such fraudulent intent are personally liable, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct.

Re W C Leitch Ltd [1932] 2 Ch. 71 The court clarified the meaning of carrying on business with intent to defraud. Maugham J said: If a company continues to carry on business when there is to the knowledge of the directors no reasonable prospect of the creditors receiving payment of their debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud The sunshine test: In Re White & Osmond [parkstone Ltd] [1960] Chd unreported, Buckley said: [T]here is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them get over the bad time. Wheelock Marden and Co Ltd v Akieselskabet Dansk Skibsfinansiering [1990] 2 HKC 148, Facts: A creditor of WM Ltd, which had been placed in voluntary liquidation, sought relief under s 275. WM Ltd, despite having been insolvent for two and a half years, incurred two loans at a time of adverse conditions in the shipping market when financial advisers confirmed WM Ltds difficulties and drew attention as to whether it was trading fraudulently. The companys general manager and directors argued that there was no cause of action. Held: In order to succeed on the claim for fraudulent trading, the creditor had to show that the defendants made decision that were not in the interest in the company while knowing that it was insolvent and that it would be unable to pay its debts when they fell due or that it had no prospect of paying the debts. Further, that a director was fraudulent if he took a risk in using the assets,

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which risk no director could honestly believe to be taken in the interested of the company and which was to the prejudice of the rights of others. The court concluded that P had established a cause of action.

(IV)

Misdescription of company: Where the company fails to pay the holder of a bill of exchange, promissory note, cheque, or order for goods or money, any officer of the company or person who signed or authorized the signing of that document on behalf of the company will be personally liable if the companys name is not mentioned in the documents in legible characters. [s.93(5)]

CF Bills of Exchange Ordinance s.26: Where a person signs a bill of exchange as drawer, indorser or acceptor and adds words indicating that he signs as agent but does not mention the name of the principal then the agent has personal liability. This applies to persons signing a bill on behalf of a company without specifying the companys name. Cheung Yiu-wing v Blooming Textiles [1975] HKLR 388 Two cheques bore the name of a company and the signatures of two directors. The cheques were dishonoured. It was held that although the companys name was printed on the cheque, the directors were personally liable because they had failed to indicate sufficiently that they were signing for or on behalf of the company. This case was distinguished, however, in Kwok Wing v Maytex Trading Co [1977] HKLR 149, in which eight cheques were drawn in favour of Maytex in payment for goods which they had supplied. Each cheque had the name of Texfarm Garments Factory Limited and the number of the companys bank account printed on the face of it, was signed by Kwok Wing, and surrounding his signature was the impression of a rubber stamp with the words Texfarm Garments Factory Limited above the signature and the word director below the signature. It was held that the position and qualified manner in which Kwok Wing placed his signature on the cheque showed that the signature was to authenticate the impression of the companys stamp, that the impression and the signature together formed the composite signature of the company, and that the liability under s26 does not apply where a person affixes his signature as part of the composite signature of the company.

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Lecture Eleven: Promoters and Pre-incorporation Contracts

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part V.
2.

Hong Kong Company Law, Vanessa Stott, Tenth Edition Longman, Chapter 2

Lets start from the beginning. A company must have a name, a memorandum and articles of associationPerhaps it might even need an office in order to get it off the groundBut can a company get these things without the help of people? Who are the people who get a company started? What are their rights, duties and liabilities? 1. Promoters The term promotion refers to the process of forming a company and setting it going, and includes taking the necessary steps to register the company under the Companies Ordinance, raising share and loan capital, and acquiring the business or property which the company is formed to control. The term promoter includes a wide range of persons. The question of who is a promoter has not been precisely defined by either the courts or the Ordinance. In Twycross v Grant [1877] 2 CPD 469 Cockburn CJ described a promoter as one who undertakes to form a company with reference to a given project, and to set it going, and who undertakes the necessary steps to accomplish that purpose. The term promoter is wide and covers any person who arranges for someone to be a director, to place shares, to negotiate preliminary agreements, or to prepare a prospectus. The term also includes a person who helps to arrange for an existing company to raise capital from the public. However, persons acting in a purely professional or ministerial capacity on behalf of promoters, such as lawyers or accountants, are not themselves promoters. [s40(5)]. 2. Pre-incorporation Contracts A company cannot enter into a contract before it is incorporated because it does not exist as a legal person. The promoters will, however, want to enter into contracts before the company is registered to enable it to begin its business operations as soon as possible after incorporation. Such contracts are known as pre-incorporation contracts. Common Law position The common law attempted to distinguish whether it was intended that the contract should be with the company [in which case, the company being non-existent, there would be no contract at all] or directly with the person who was acting in relation to the company [in which case that person would be liable on the contract].

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Before a company has been incorporated it does not exist and therefore lacks capacity to enter into a contract. An agent cannot contract on behalf of principal who is not in existence. Therefore a preliminary contract made on behalf of a company that has not been incorporated yet is not binding on the company when the company is formed even if the company takes the benefit of the contract. Conversely, a company cannot enforce contracts made in its name before incorporation or sue for damages for breach of such a contact once it is incorporated. Further, a company cannot simply ratify a contract purportedly made on its behalf before it was incorporated so as to make the contract valid, as it did not have contractual capacity when the contract was entered into. Kelner v Baxter [1866] LR 2 CP 174 Facts: the Gravesend Royal A lexandra Hotel Company Ltd was being formed to buy a hotel from K. All concerned knew that the company had not been formed, and a written contract was made on behalf of the proposed company by A,B and for the purpose of 900 pounds worth of wine from K. The company was formed, and the wine was handed over to it and consumed. But before payment was made the company went into liquidation. Held: A, B, and C were personally liable on the contract, the no ratification could release them from their liability. Erle C.J said at p. 183 where a contract is signed by one who professes to be signing as agent but who has no principal existing at the time, and the contract would be altogether inoperative unless binding on the person who signed it, he is bound thereby; and a stranger cannot by a subsequent ratification relieve him from that responsibility. In Kelner v Baxter the court found that it was intended that A, B and C should contract personally. See the Newborne case below where the intention was that the future company should contract: Newborne v Sensolid [GB] Ltd [1954] 1 QB 45 Facts: Tinned ham was sold to S. Ltd. The contract was we have this day sold to you [signed] Leopold Newborne [London] Ltd. The signature was typed and underneath was written Leopold Newborne. The market price of ham fell and S. Ltd refused to take delivery. When an action was brought it was found that Leopold Newborne [London] Ltd. had not been incorporated at the time of the contract and Leopold Newborne tried to enforce the contract in his own name. Held: neither Leopold Newborne [London] Limited. Nor Leopold Newborne could enforce the contract. It was not a case of an agent undertaking to do certain things himself as agent for somebody else. It was a contract in which a company purported to sell. Leopold Newborne did not purported to contract as principal or agent the contract purported to be made by Leopold Newborne [London] Ltd., on whose behalf it was signed by a future director. This company was not in existence and the signature on that document and indeed, the document itself is a complete nullity.
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Note: The above case may be decided differently in Hong Kong today in the light of C.O. s32A.

In Newborne case, it was the promoter who attempted to enforce the agreement but the position appears to be the same if the other party attempted to enforce the contract: Re English and Colonial Produce Co Ltd [1906] 2 Ch 435 CA On the instructions of persons who afterwards become directors of the company, solicitors prepared the memorandum and articles of association of the company, and paid the registration fees. It was held that the company was not liable to pay the solicitors There is no binding authority for the proposition., because it has taken the benefit of work done under a contract entered into before the formation of the company, can be made liable in equity under that contract per Vaughan William L.J. p.442 Note: Table A art 82 empowers the directors to pay all expenses incurred in promoting and registering the company. Natal Land and Colonization Co. V Pauline Colliery and Development Syndicate [1904] AC 120 Facts: prior to incorporation the P Company contracted to take an option to lease land belonging to Mrs de Carrey if it was coal bearing. After incorporation, the company entered on the land and made trial borings. The land was found to be coal bearing and the P company asked for a lease. Mrs de Carrey had transferred her interest in the Property to the N company and they would not grant a lease. The P company sued at first instance for specific perform. Held: P company could not enforce the option because Its own conduct in merely boring did not unequivocally evidence an intention to take a lease Even if it had, it was merely an offer, and there was no evidence of acceptance either by Mrs de Carrey or the N company.

Tinevelly Sugar Refining Co Ltd v Mirrlees, Watson & Yaryan Co Ltd [1849] 21 R 1009 Facts: A promoter, acting on behalf of a future company, T Co., entered into a contract with M Co. for the supply by the latter of certain machinery for a refinery. When T Co. was registered it alleged that the machinery supplied was defective.

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Held: T Co. could not sue M Co. for damages. Note: Hong Kong statutory law is quite different from the common law because of s32A.

S32A Pre-incorporation contracts [Company Ordinance] 1] Where a contract purports to have been made in the name or on behalf of a company at a time when the company has not been incorporateda] subject to subsection (2) and any express agreement to the contrary, the contract shall have effect as a contract entered into by the person purporting to act for the company or as agent for it, and he shall be personally liable on and entitled to enforce the contract accordingly. b] the company may, after incorporation, ratify the contract to the same extent as if it had already been incorporated at that time and as if the contract had been entered into on its behalf by an agent acting without its authority. 2] Where a contract is ratified by virtue of this section, the person who purported to act for or on behalf of the company in making the contract shall not thereafter be under any greater liability than he would have been if he had entered into the contract on behalf of the company as an agent acting without its authority and after its incorporation.

Under subsection (1)(a), unless there is an agreement to the contrary or ratification under subsection (1)(b), in circumstances like those in Newbornes case there will be a contract between the individual who acts for the company and the other party involved. Subsection 1(b) overturns the common law principle in Kelner v Baxter and empowers a company to ratify contracts entered into on its behalf before its incorporation.

According to s32A(1), where a contract purports to be made by or on behalf of a company at a time when the company has not been incorporated, the contract is binding on the person purporting to act for the company; thus a promoter is both personally liable and entitled to enforce such a contract. Phonogram Ltd v Lane [1981] UK QB 938 Facts: A pop group was going to be launched under the name of Cheap Mean and Nasty. A company called Fragile Management Ltd was going to be formed to manage them. In pre-incorporation negotiations, Phonogram Ltd agreed to provide finance and the first installment of 600o pounds was paid. The finance contract was

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signed by Mr Lane for and on behalf of Fragile Management Ltd, which was never incorporated. Held: Mr. Lane was liable under the equivalent of s32A(1)(a). The court considered that signing the contract as an agent or as in the Newborne case does not amount to an agreement to the contrary so as to avoid personal liability. Lord Denning considered that only a clear exclusion of personal liability would suffice. An express agreement simply to exclude the promoters liability is not practical because it would mean there would be no enforceable contract at all. A more practicable provision would be for the promoters to be released from liability on the contract if the company, after it has been incorporated, enters into a second contract with the other party on the same terms as the pre-incorporation contract, i.e. when there is a novation In that event, the old contract is discharged and replaced by the new one. Note: Novation refers to the substitution of a new contract for an existing one, between the same or different parties. In this context, the substitution is between the third party and the newly incorporated company.

Rights and Liabilities under Pre-incorporation Contracts Common Law Is Promoter Liable? Upon Is Ratification Incorporation, Is possible? Company Liable/Can Company Enforce? No No

Pre-incorporation Contract entered into by Promoter as agent on behalf of Company Pre-Incorporation Contract entered into in the name of the Company

Yes

No: Contract is void

No: Contract is void

No

Legislation: Section 32A Is Promoter Upon Liable? Incorporation, Company Liable/Can Is Ratification Is Possible?

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Company Enforce? Pre-Incorporation Yes, unless Yes, if contract is Yes Contract entered express agreement ratified into by Promoter to the contrary as agent on behalf of Company Pre-Incorporation Yes, unless Yes, if contract is Yes Contract entered express agreement ratified into in the name of to the contrary the Company

3. Promoters and Their Duties A promoter stands in a fiduciary position to the company he is promoting even before it comes into existence. He may however make a profit so long as he has disclosed to the company all material facts concerning his interest. Otherwise the contract is voidable at the companys option. For example, a promoter buys land for $ 1 million on behalf of a company, which he is in the process of setting up, he may sell that land to the company, when formed, for $ 1.2 million and keep the profit provided he has disclosed it to the company. If the company has been established with a board of directors who are completely independent of the promoter, they may give the consent. But if the board is in any way under the influence of the promoter, he must obtain the consent of the persons who provide the company with its initial share capital. Accordingly, the promoters obligations are heavier where he is also a director as he will have the fiduciary duties of a director. 3.1. Remedies for breach of duty A] Where the promoter has, e.g. sold his own property to the company, the company may rescind the contract and recover the money paid. Erlanger v New Sombrero Phosphate Co [1878] 3 App Cas 1218 [pc] A syndicate, headed by E, purchased the lease of an island in the West Indies said to contain valuable mines of phosphates for 55,000 pounds. The syndicate then formed a company, and its directors included puppets of E. A contract was made between X, a nominee of the syndicate and the company for its purchase at 110,000. The directors without inquiry ratified the contract. Proceedings were brought to recover the purchase price and to have the contract rescinded. It was held that as there had been no disclosure by the promoters of the profit they were making, the company was entitled to rescind the contract and recover the purchase money from E and other members of the syndicate. B] The company may compel the promoter to account for any profit he has made

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Gluckstein v Barnes [1900] AC 240 Intending to buy property and to form a company and resell the property to the company or another purchaser, a syndicate of four persons bought charges on the property at a discount. They afterwards bought the property for 140,000 pounds formed a company of which they were the first directors and resold the property to for 180,000 pounds. As a result of this, they made a profit of 40,000 pounds on the property and one of 20,000 pounds on the charges which were paid off in full with the 140,000 pounds received for the property. A prospectus was issued, disclosing the profit of 40,000 pounds but not that of 20,000 pounds. It appears that rescission had become impossible. It was held that the 20,000 pounds was a secret profit made by the syndicate as promoters of the company and they were bound to pay it to the company. C] The company may sue the promoter for damages for breach of his fiduciary duty. Re Leeds and Hanley Theatres of Varieties Ltd [1902] 2 Ch 809 The F Co. contracted to purchase two music halls for 24,000 pounds and had the property conveyed to its nominee, R. The F Co. then promoted the T Co. and agreed to sell the music halls to it for 75,000 pounds and directed R to convey them. The board of directors of T Co. was not an independent board. The T company issued to the public a prospectus, giving R as the vendor and not disclosing the interest of F Co or the profit it was making. It was held that the prospectus should have disclosed that F Co. was the real vendor and the amount of profit it was making. For breach of their fiduciary duty to those invited to take shares the promoters were liable in damages to the company and the measure of damages was the promoters profit. Other possible remedies could include damages for fraud or negligent misrepresentation. If a promoter makes a secret profit out of the promotion of the company otherwise than by selling his property to it he must account for that profit. 4. Termination of a promoters duties A promoters duties do not come to an end on the incorporation of the company; they continue until the company has acquired the property or business which it was formed to manage, raised its initial share capital, and the board of directors has taken over the management of the companys affairs from the promoters.

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Chapter Twelve: Directors and Directors Duties

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part V.
2.

Hong Kong Company Law, Vanessa Stott, Tenth Edition Longman, Chapter 10

In the last lecture, we learned that the power of management is usually conferred on the board of directors. Directors therefore have tremendous power. How should they exercise these powers? What duties do they have? 1. A company must have Directors
Section 153 every company to have at least 2 directors; s2 definition: directors includes any person occupying the position of director by whatever name called Therefore, the term includes de facto directors. Section 158(1) Every company shall keep in the English or Chinese language a register of its directors and secretaries. Section 158(10)(a) a person in accordance with whose directions or instructions the directors of a company are accustomed to act shall be deemed to be a director and officer of the company.

Corporate Affairs Commission v Drysdale [1978] 141 CLR 236

Facts: Drysdale was appointed as a director to fill a casual vacancy on the board. The articles provided that such a director could only hold office until the next annual general meeting at which he was permitted to stand for re-election. Drysdales retirement or reelection was not considered at the general meeting. Therefore, under the articles, he was no longer a director of the company. But he continued to participate in the management of the company as if he were a director. The High court of Australia held that he was deemed to be a director and therefore subject to various fiduciary and statutory duties of directors. Held: A company is required to keep a register of directors and secretaries under s158. This register is open for inspection by members and any other person: s158[7]. A return in the prescribed form must be sent to the Registrar.

2. What are the Care and Skill expected of Directors?

If directors of a company are negligent in their performance, they will be liable for the damage caused.

Dorchester Finance Co. Ltd. V Stebbing [1989] BCLC 498

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Facts: A money-lending company had three directors, S, P, and H. S worked full time for the company, while P and H paid very little attention to the company and rarely visited its premises. P and H signed blank cheques at Ss request with which S made loans which were irrecoverable. No board meeting were held. Held: S, P and H were negligent and liable to make good the companys losses. Foster J laid some stress on the fact that the two-executive directors were experienced in accountancy, but added that the duties of a director whether executive or not are the same.

Re City Equitable Fire Ins Co. Ltd [1925] Ch 407

The company lost over 1 million pounds, due partly to the failure of certain investments but mainly to the frauds of the chairman of the directors. The liquidator sought to make the other directors liable for the losses on the ground of negligence. The action failed because the articles provided that the directors were exempt from liability unless caused by their own wilful negligent or default

In the course of deciding the case, Romer J laid down three propositions which summarise a directors duty of care
1] A director need not, in the performance of his duties, exhibit a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. Thus, in an action where it is claimed that a director acted negligently, his conduct is judged against that of the reasonable man with his (directors) qualifications and experience. If the director is qualified as an accountant, lawyer, engineer, or otherwise, his conduct will be judged in comparison with that of the relevant profession, but where the director is unqualified, the standard of competence may be very low. 2] A director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings, and at meetings, of any committee of the board upon which he happens to be placed. He is not, however, bound to attend all such meetings, though he ought to attend whenever in the circumstances he is reasonably able to do so. 3] In respect of all duties that, having regard to the exigencies of business and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

Daniels v Anderson [1995] 16 ACSR 607

Facts: A series of currency transactions were carried out by the managers of AWA Ltd. The transactions resulted in substantial losses which AWAs auditors [D] failed to detect. AWA sued the auditors who, in turn claimed that the companys own management was

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contributory negligent in failing to convey the auditors concerns over the foreign exchange operations to the board of directors. Held: the omissions by the board of directors in allowing a grossly negligent management to perservere with the foreign exchange operations in an entirely unsatisfactory manner were causes of the loss suffered by AWA. The auditors were held liable for 66.6 per cent of AWAs losses. Clarke and Sheller JJA observed at 664: The responsibilities of directors require that they take reasonable steps to place themselves in a position to guide and monitor the management of the company.

3. Directors Fiduciary Duties

At common law directors owe their company fiduciary duties of acting in good faith and exercising skill and care. The fiduciary duties of directors of a company require them to act bona fide in the best interests of the company as a whole. The word fiduciary refers to trust and confidence. A fiduciary is a person who agrees, or undertakes, to act for, or on behalf of, another person in the exercise of a power or discretion, which will affect the interest of that other person in a legal or practical sense. Are there duties owned to members? Whilst directors must act bona fide in the interests of the shareholders, this does not mean that they owe duties to particular shareholders.

Percival v Wright [10902] 2 Ch 421

Facts: Shareholders of the company approached the directors desiring to sell their shares and two of the directors and the chairman agreed to buy, but did not disclose to the sellers that the board was negotiating a takeover bid by an outsider at well above the price they had agreed to pay for the shares. The sellers claimed that the directors stood in a fiduciary relationship towards them as shareholders and that the transfers were therefore voidable for non-disclosure. Held: there was no fiduciary relationship between the directors and the shareholders individually. There was no question of unfair dealing.

Per Swinfen Eady J:

The contrary view would place directors in a most invidious position, as they could not buy or sell shares without disclosing negotiations, a premature disclosure of which might well be against the best interests of the company. I am of opinion that directors are not in that position. However, in exceptional circumstances directors may place themselves in some other fiduciary relationship with members, e.g. as their agent, in which case they may be liable on that basis:

Allen v Hyatt [1914] 30 TLR 444 P.C.

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Facts: Directors of a company found a potential buyer for all shares. They obtained from the companys other shareholders options to purchase their shares by representing that this would facilitate the sale to the potential buyer. In fact the price at which directors exercised their options was lower than the price they had agreed with the purchaser, and the directors made a handsome profit. Held: the directors were the agents of the shareholders for the purpose of selling their shares, and so owned the profit to their principals, the shareholders.

4. What are the Fiduciary Duties?

A] Duty to act fona fide for the benefit of the company. This duty governs the exercise of every power which the directors possess by virtue of the memorandum and articles, and requires a director to act honestly and in good faith.

Re Smith & Fawcett Ltd [1924] Ch 304

Facts: The articles gave the directors an absolute and uncontrolled discretion to refuse to register any transfer of shares. The two directors, who were the only shareholders, each held 4,001 shares. When one of the directors, F died , the other, S would only register Fs son as a shareholder of 2,001 shares if he would sell the other 2,000 to S. Held: there was no evidence to show that the directors power was not exercised in the companys interest. Lord Gree MR said: They must exercise their discretion bona fide in what they consider - not what the court may consider to be in the interests of the company, and not for any collateral purposes. The duty to act bona fide in the interest of the company is a subject duty. There is no breach where the directors act in what they honestly believe to be in the interest of the company. The courts are generally reluctant to override the business judgement of directors. Directors are presumed to have acted bona fide for the benefit of their company and those persons alleging a breach of duty bear the burden of proving that this is in fact not the case.

Bishopgate Investment Management Ltd v Maxwell [No.2] [1994] 1 All ER 261

Facts: BIM brought an action against M, a director of the company, for breach of his fiduciary duty in signing various stock transfers whereby shares held by the company as trustee were transferred to another company, the M Co, for no consideration. The companys articles required two signatures for a transfer but this requirement was ignored. M was also a director of the M Co. The transfers were not authorized by the board of directors and M made no inquiry about the transactions. The trial judge ordered M to pay damages to the company. Held: M was in breach of his duty because he gave away company assets for no consideration to a company of which he was a director.

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Hoffman LJ siad: If a director chooses to participate in the management of the company and exercise powers on its behalf, he owes a duty to act bona fide in the interests of the company. He must exercise the power solely for the purpose for which it was conferred. To exercise the power for another purpose is a breach of his fiduciary duty

B] Duty to exercise powers for proper purposes, i.e. the directors must not take into account irrelevant, extraneous, or collateral factors. Howard Smith v Ampol Petroleum Ltd [PC 1974] AC 821
Facts: Two shareholders, holding 55 per cent of the shares in a company, announced that they would jointly reject any offer from a particular intending takeover bidder, or from any other source. The board of directors then allotted new shares to the intending bidder. Although the company did not need new capital at the time, the directors primary purpose in making this allotment was to reduce the proportionate shareholding of the two majority shareholders to less than 50 per cent and thus enable the bidder to make an effective bid. The share issue was challenged by one of the majority shareholders. Held: although the allotment was within the boards powers, it had acted with an improper purpose, and the issue of shares to the bidder should be set aside. Lord Wilberforce said:. it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority or creating a new majority which did not previously exist.

C] A director must not allow his duty to the company and personal interests conflict. He must not be in a position of conflict of interests. A contract in which he has a personal interest adverse to that of the company is voidable by the company, and any profits made by the director may be recovered by the company unless such contract is authorised by the companys articles or the conflict is disclosed to the shareholders and the resulting contract sanctioned by them. Aberdeen Railway Co v Blaikie Brose [1854] 1 Macq H. L. 461
Facts: A railway company entered into a contract with a partnership for the supply of a large quantity of iron seats. The company sought to avoid the contract on several grounds, including that at the time the contract was entered into, one of the partners was a director of the company. Held: the company could avoid the contract even though its terms were perfectly fair. Lord Cranworth said: The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such an agent has duties to discharge of a fiduciary character towards his principal, and it is a rule of universal application that

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no one having such duties to discharge shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of those whom he is bound to protect. So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into.

Boston Deep Sea Fishing Co v Ansell [1888] 39 ChD 339

Facts: Ansell was the managing director of BDSF Co. He engaged in 2 transactions: Arranged with a ship builder to build a vessel for BDSF Cos fishing fleet. Ansell failed to disclose a commission paid to him by the shipbuilder; Contracted with an ice supplying company to supply ice for BDSF Cos shipping fleet. Ansell was a member of the ice supplying company which paid him a bonus as a member introducing business to it.

Held: Ansells personal interests conflicted with his fiduciary duty to BDSF Co. and the company was able to claim both the commmision and the bonus.

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Chapter Thirteen: Protection of Outsiders

1. Hong Kong Business Law, Anne Carver, Fifth Edition, Longman, Part V.
2.

Hong Kong Company Law, Vanessa Stott, Tenth Edition Longman, Chapter 11

When an outsider deals with a company, he must do so through its agents. Will contracts made through these agents bind the company? 1. A Companys Contract with Outsiders
S32: A contract which if made between private persons would be by law required to be in writing and under seal, may be made on behalf of the company in writing under the common seal of the company; A contact which is required to be in writing may be signed by any person acting under the authority of the company; and an oral contract may be made on the companys behalf by any person acting under its express or implied authority. S93[1][b]: Every company shall have as its common seal a metallic seal on which it shall have its name engraven in legible characters. As a general rule, a company is bound by an instrument under its seal unless it can be shown that it was used fraudulently or there was some illegality. But this general rule applies only if the use of the seal is in accordance with the companys articles, or is otherwise authorized: Woo Turhan v Tauwan Fuji Trading [HK] Ltd [1995] 2 HKC 481 A contract which, if made between individuals, is required to be in writing may be signed on the companys behalf by any person acting under its authority. Contracts which require no formalities may be made orally on the companys behalf by any person acting under its authority. The validity of a companys contracts may therefore be affected by such matters as Whether the directors have been properly appointed, Whether those who are purportedly acting as directors have authority to do so, Whether a general meeting or board meeting has been properly convened [e.g. proper quorum? Proper notice? Proper voting?] Whether a resolution has been passed by the board of directors if such resolution is required for proper authority, etc.

Question: Can a company deny liability on a contract with an outsider on the ground of some irregularity in the companys procedures, or a lack of authority or appointment on the part of those persons purportedly acting on the companys behalf? Despite an irregularity or lack of authority on the part of the officials of a company, the outsider may be able to claim that this contract with the company is valid by relying on the rule in Turquards case or by application of the agency doctrine of apparent authority.

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2. The Rule in Turguands Case Royal British Bank v Turguand [1856] 6 E&B 327; 119 ER 886 Facts: The companys constitution empowered the board of directors to borrow money if they are authorized to do so by a resolution of the general meeting of the shareholders. The company borrowed money from a bank on the authority of two directors who authenticated the companys common seal, but there was no authority given by the general meeting. The company refused to repay the loan and argued that the bank had constructive notice of the constitution and should have been aware of the lack of authority. Held: even if the company in general meeting had in fact passed no resolution, the company was still bound to the bank. An outsider need not enquire into whether such a resolution had in fact been passed, because the passing of the resolution was a matter internal to the company. The rule protects an outsider dealing with a company bona fide and without notice of the fact that the companys internal management requirements have not been followed. He is not required to investigate to ensure that all internal regulations have been complied with. Unless there are facts that put him on inquiry, he is entitled to assume that all matters of internal management and procedure required by the articles have been complied with. Hence, the rule is also referred to as the indoor management rule. 3. Limitations A, Where the doctrine of constructive notice applies A copy of a special resolution must be filed with the Registrar [s117]. Hence, if a transaction requires the sanction of a special resolution, under the old law [i.e. for transactions before 10 February 1997], the outsider was deemed to know that the resolution has not been passed even if he did not actually know. Further, if a borrowing transaction exceeded the limit stated in the companys articles, the transaction was only binding up to the limit. Irvine v Union Bank of Australia [1877] 2 App Cas 366 [pc] Facts: The directors of a company borrowed 15,000 pounds on a mortgage of its assets to the bank. The companys articles provided that the directors had the power to borrow on security of the companys property any sum not exceeding half of the paid capital of the company. The paid-up capital of the company was 17,000 pounds. Held: the bank could only recover 8,500 pounds. However, under the Companies [Amendment] Ordinance 1997, the doctrine of constructive notice is abolished. B, Where the person seeking to rely on the rule is not an outsider. Where the person contracting with the company is in a position to know that internal regulations have not been observed because he is not an outsider, the protection offered by the rule in Turquands case may not apply.

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Howard v Patent Ivory Manufacturing Co. [1888]38 ChD 156 Facts: The articles empowered the directors to borrow up to 1,000 pounds on behalf of the company without the consent of the general meeting and to borrow further money with such consent. The directors themselves lent 3,500 pounds to the company without such consent. Held: the debenture was only valid to the extent of 1,000 pounds. C, Where the outsider is put on inquiry or has notice of an irregularity When there is unusual circumstances that ought to arouse the suspicion of the outsider, the rule may not apply. These irregularities may include the possible absence of a quorum, the absence of notice of a meeting and lack of ratification, non-disclosure of interests of directors, and abuse of power by the directors. European Asian Bank v Reicar Investment Ltd [1988] 1 HKLR 45 Facts: The Bank brought proceedings to recover a loan secured by certain charges. D argued that there were issues which needed to be decided by the court because there was sufficient evidence to put the Bank on enquiry as to possible irregularities in relation to the conduct of the business including the possible absence of a quorum, the invalidity of the meeting authorising the security, the absence of notice and ratification, non- disclosure of interests of directors, and abuse of power by the directors. Held: summary judgement should be set aside and the action proceed to court. D, Where the authority is forged Hua Rong Finance Ltd v Mega Capital Enterprises Ltd [1998] Facts: By way of mortgage agreement, made two loans to MCE secured by a charge on MCEs property. HRF obtained a resolution of the board of directors MCE, purported signed by all three directors, authorising the companys seal to be affixed to the mortgage and for one of the directors, X, to sign the mortgage. MCE defaulted on the loan and HRF demanded repayment and possession of the property. The other two directors denied they had ever signed any resolution authorising the loan. Held: the forged document was a nullity, and therefore the rule in Turguands case could not apply. Since MCEs articles required the authority of the directors or a committee of directors before its seal could be affixed, X, being a single director, did not have any authority, either actual or apparent, to do so. 4. The Doctrine of Apparent Authority A, Actual Authority In Freeman & Lockyer v Buckhurst Park Properties [Mangal] Ltd [1964] 2 QB 480 Diplock LJ said: An actual authority is a legal relationship between principal and agent created by a consensual agreement to which they alone are parties. Its scope is to be ascertained by

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applying ordinary principles of construction of contracts, including any proper implications from the express words used, the usage of the trade, or the course of business between the parties. An agent who enters into a contract on the principals behalf binds the principal to the outsider, if the agent acts within the scope of his actual authority, whether express or implied. For example, an agent who is appointed to manage a business has the express actual authority to do what the agent expressly authorizes him to do, as well as implied actual authority to do all those acts which a manager in such a position should do. B, Apparent or Ostensible Authority However, from the point of view of the outsider, it is quite rare for him to know whether an agent has actual authority and the extent of that authority. Usually, all he relies on is the appearance of authority. Depending on the circumstances, the extent of an agents apparent authority may be the same as the agents actual authority, or it may exceed the scope of the agents actual authority. In some cases a person may have apparent authority even though he has not been given actual authority at all. Apparent authority arises when [1] The principal represents or holds out to the outsider that the agent has the requisite authority to do certain acts on the principals behalf; and [2] The outsider relies on the principals representation to enter into the contract with the agent who is purportedly acting on the principals behalf.

A company is bound by the acts of its agent if they are within his apparent, or ostensible authority even if he lacks actual authority. If an agents apparent authority can be established it creates an agency by estoppel. This means that as between principal and outsider, the principal is prevented or estopped from denying that the agent had authority. The representation of the agents authority must be made by the principal to the outsider. A principal is not liable merely on the representations of the agent. The principal may expressly make the representation to the outsider. However, it is more usual for the representation to arise by the principals conduct, as when the principal permits the agent to occupy a particular position, in which case the principal represents or holds out that the agent has the customary authority of a person in such a position. Where a dispute arises regarding the authority of a companys officer or agent, the outsider must establish two things: a] a holding out, or representation by the company that a person is an officer or agent b] that the particular power exercised by the person so held out is within the scope of the powers customarily exercised or performed by an officer or agent of the kind concerned. Freeman & Locky v Buckhurst Park Properties (Mangal) Ltd (1964) UK

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Kapoor, Hoon formed a company to develop a property. They each held half the shares issued. Kapoor, Hoon and two other people comprised the board of directors. The quorum of the board was four but at all material times, Hoon was overseas. Although the articles conferred a power on the board to appoint a managing director, and Kapoor contracted on behalf of the company with a firm of architects for their services. The company refused to pay the architects on the ground that the company was not bound by the contract as Kapoor had no authority.

The court held that the company had held out that Kapoor was its managing director and was therefore bound by his actions. He had apparent authority to employ the architects, as this was within the customary authority of a managing director. The architects, as outsiders had relied on the apparent authority of the managing director, and did not have to examine the companys articles or inquire whether the managing director had been properly appointed. However, if the outsider knows that the contract is not one which the director would normally be authorised to enter into on behalf of the company, his claim will fail. Houghton & Co v Nothard, Lowe and Wills Ltd (1928) UK Facts: A director purported to make an agreement, on behalf of the company, under which an outsider was to sell on commission all the fruit imported by the company and to retain the proceeds as security for the repayment of a loan to another company. The director had no actual authority to commit the company to such a contract. Held: the company was not bound. The agreement was so unusual as to put the outsider on inquiry to ascertain whether the director had authority.

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