PCLL Conversion Examination June 2014 Examiner s Comments Commercial Law

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1 PCLL Conversion Examination June 2014 Examiner s Comments Commercial Law This Report sets out the Examiner s General Comments on aspects of the questions in Parts A, B and C. Part A (Sale and Acquisition of Goods) Students generally performed well on both questions in Part A. Q.1 The facts are loosely based on Godley v Perry [1960] 1.W.L.R.9. and require a detailed examination of the implied terms protecting a consumer under the Sale of Goods Ordinance (SOGO), sections 15, 16 and 17. No marks were awarded for any discussion of the Misrepresentation Ordinance as this question requires an analysis of Hong Kong s consumer protection law as set out in the Sale of Goods Ordinance. Jack comes clearly within the definition of dealing as a consumer and is therefore able to rely on the full protection of the implied terms in SOGO. The best students cross referenced dealing as a consumer with the Control of Exemption Clauses Ordinance (section 11). This provides that a seller cannot exclude liability for sections 15, 16 and 17 SOGO as against a person dealing as a consumer. In particular, this question requires a close analysis of the implied term of merchantable quality section 16(2) as this is a sale in the course of a business, the course of business - (a shop qualifies as a business) (Stevenson v Rogers [1999] QB 1028) Merchantable quality is difficult to define but students were expected to explain section 16 (2) and section 2(5). Some students failed to discuss the exceptions in section 16(2) when the implied condition as to merchantable quality does not apply. a) Defects drawn specifically to buyer s attention b) If buyer examines the goods before contract is made as regards defects examination ought to reveal c) If contract is a sale by sample and defect would have been apparent on a reasonable examination. Some students also failed to explain the effect of section 16(2) which replaces the caveat emptor principle and puts the burden on the seller. On the facts Jack examined the goggles but there was no defect apparent on 1

2 his reasonable examination in shop. In respect of Section 16(3) (fitness for purpose and reliance on seller s judgment) some students neglected to discuss whether implied terms as to fitness for purpose would apply. The best students highlighted the potential ambiguity on this point raised by the facts and noted in particular that words top quality do not go to Seller s knowledge of fitness for purpose. The best students also discussed the application of section 17(2) (a sale by sample). In Godley v Perry involving the sale of a defective catapult the court held that the sale was a sale by sample and that, since the defect was not apparent on a reasonable examination, there was a breach of the implied condition. In section 17(3) there is an implied condition that the goods shall be free from any defects, rendering them unmerchantable, which would not be apparent on reasonable examination of the sample. Wong Supplies Ltd is therefore liable to Jack (as in Godley v Perry) despite its own examination of 5 samples of the goggles before purchasing the 20 goggles from wholesaler. Some students did not fully explain the effect of section 15 (sale by description) in which there is an implied condition that the goods shall correspond with the sample of the goods and it is irrelevant if buyer selected goods himself. In conclusion, on the facts the defect is clearly not apparent and Jack is dealing as a consumer. Thus, there can be no avoidance of implied term as to merchantable quality. Q. 2 This is a more difficult question and was less popular with students than Question 1. Most students gave a comprehensive analysis of the nemo dat principle and how it interferes with the normal legitimate commercial expectations of business people. It is also a difficult question to answer in the time available. Those students who answered it are to be congratulated for demonstrating a mastery of this complex set of provisions in the Sale of Goods Ordinance and Factors Ordinance. In their answers these students demonstrated a clear understanding of how SOGO and the Factors Ordinance seek to impose rights on bona fide purchasers with legitimate expectations in opposition to the nemo dat principle. They analyzed the exceptions to nemo dat principle in SOGO and the Factors 2

3 Ordinance, with a particular emphasis on the definition and significance of a mercantile agent. Students also explained the meaning of the Latin Transferee can never get a better title than that of the transferor or, more simply, no one can give a better title than he himself possesses. The principle has been modified by the common law and now by statute. Some students failed to discuss the rationale behind the nemo dat principle under which third parties are not protected as a general rule. The best students explained that the rule serves to protect the owner of the property and to find balance between upholding the sanctity of property and giving effect to a commercial transaction. Students also referred to Lord Denning in Bishopsgate Motor Finance Corp Ltd [1949] 1KB 322 The nemo dat principle is designed to protect a man s property However commercial law seeks to protect commercial transactions the person who takes in good faith and for value without notice should get a better title. Students were expected to explain the meaning and significance of: Mercantile agent Voidable title Seller in possession Buyer in possession Some students neglected to discuss the exceptions to nemo dat in SOGO and Factors Ordinance in sufficient detail. SOGO section 23(1) estoppel on the application of estoppel - the buyer may acquire good title even if the seller does not have one provided that the owner of the goods is by his conduct precluded from denying the seller s authority to sell. Section 23(2) nothing in SOGO affects the Factors Ordinance enabling the apparent owner to dispose of the goods as though he were the true owner thereof. Section 3 Factors Ordinance Students also gave detailed explanations of the meaning of a mercantile agent definition in Factors Ordinance section 2 (authority in customary course of business to sell goods or consign them). 3

4 must be in possession of the goods or document of title at the time of the transaction must take place in the ordinary course of business the buyer must take the goods in good faith and without notice that he sale was made without the owner s authority Sale in market overt SOGO Section 24 Where goods are openly sold in a shop in the ordinary course of business buyer acquires good title if he buys them in good faith and without notice of any defect of title. Note also that section 24 does not apply to a shopkeeper who purchases goods form public in his own shop - see, for example, R v Tai Shing Jewellery Co [1983] 2 HKC 441. Sale under a voidable title section 27(1) SOGO Where a person having sold goods continues to be in possession of the goods or document of title. This section seeks to protect an innocent purchaser who is deceived by the seller s apparent ownership because of seller s physical possession or possession of documents of title. The buyer must act in good faith with no notice of the first sale. Buyer in possession section 27(2) This section is complex. First buyer must obtain possession of the goods or document of title. First buyer makes a delivery of goods or transfer of document of title to second buyer. Second buyer must take goods or document of title with no notice of any lien or other right of original seller of the goods. Generally students covered most of these points but some students did not manage their time well. End Part A 4

5 Part B (Personal Property) As mentioned in previous Examiner s Reports students clearly find Part B to be the most difficult and complex part of the syllabus. Q.1 This question requires students an overview of the meaning of and the significance to company of the law relating to fixed and floating charges. Students generally performed well on this question but some found it difficult to explain the legal issues under time pressure. All students discussed the advantages of a fixed charge to the Bank as secured creditor and the significance of obtaining priority over all other creditors with no need to pay preferential creditors upon appointment of receiver. However some students failed to provide sufficient detail as, for example, failing to identify the items that are intended to be caught under Clause 1 of the fixed charge, (HK$ 700,000 equipment and HK $ 400,000 book debts). Most students, however, gave a close analysis of both Clause 1 and Clause 2. The first floating charge created under Clause 2.1 is a continuing security that covers all of the other assets of the company, from time to time and both present and future of any nature wherever situated. Some students neglected to explain the significance of: Beneficial owner - legal title in the assets does not pass to the bank but interest attaches immediately Continuing security - the amount remains fully payable on all accounts irrespective of amounts paid into one particular account and the security remains in force until full amount of secured debt (HK$700,000 has been paid off). Protects bank against operation of Clayton s Case In Clause 1 of the Debenture the Bank purports to create a fixed charge as security for the loan to Cut Above [ CA ] of HK700, 000 over all of CA s plant, machinery vehicles, computers, office and other equipment and chattels and book debts. Note that clause 1 expressly excludes stock in trade and work in progress which are covered by Clause 2 of the Debenture. Students should therefore explain to CA that in practical terms the fixed charge is taken over assets that are not used in the day to day business of the company and will not be sold as part of the company s normal business / trading activity. Despite the labeling in Clause 1 of the Debenture (which purports to create a fixed 5

6 charge) it is the characteristics of the relationship and the terms of the charge that will define the nature of the charge and not the label attached to it by the parties. Re Spectrum [2005] UKHL 41. The best students also highlighted the significance of Illingworth v Holdsworth (1904) AC 355 and clarified that a fixed charge is a charge on the specific assets of a company such as land, buildings or plant and machinery. Once created the chargor (i.e. the company) cannot fully deal with the asset in the ordinary course of business or in any other way and the asset is paralyzed until repayment of the loan. From the secured creditor s point of view the most advantageous security to take over the company s assets is a fixed charge since the holder of a fixed charge security takes absolute priority over the floating and unsecured creditors in the event of the company being wound up. Students were also expected to discuss the distinguishing characteristic of the fixed charge and problems with Clause 2.2 the single most important characteristic of the fixed charge is that the company must obtain the consent of the fixed charge holder the bank before dealing with the asset. If the company fails to obtain the banks consent before dealing with the asset, the company is in breach of the charge agreement. In relation to book debts this is dealt with in Clause 2.2 under realization of debts. In Clause 2.2 the Bank seeks to prevent the Company from having access to its cash flow. Students were expected to explain the significance of Clause 2.2 in the context of Re Spectrum [2005] UKHL 41. In reality a business cannot operate without access to its cash flow i.e. book debts and thus clause 2.2 will become inoperable as a fixed charge. The fixed charge holder can exercise its powers of sale by appointing a receiver to sell the assets captured by the fixed charge and repay the debt out of the proceeds of the sale of those assets. A fixed charge usually seeks to include and cover within its terms: Land and buildings Fixed plant and machinery (i.e. of a permanent nature in the business) Intellectual property rights Uncalled share capital (if any) in the company Goodwill (notoriously difficult to quantify in monetary terms) and Receivables i.e. book debts Clause 1 however, is more limited in its scope because CA does not own land or IP rights on these facts. 6

7 In particular students were required to explain that a book debt of the company is any outstanding amount due to the company from a debtor upon which the company could sue for the money due. In respect of Clause 2 and the creation of a floating charge the best students discussed Yorkshire Woolcombers Association (1903) 2 Ch284. They explained that a floating charge does not attach to specific assets but floats over the general property of the company and the company can deal with the asset during the ordinary course of business without first asking for the consent of the chargee (bank). The characteristic of the floating charge is that allows the company to deal with its assets whilst providing the assets as security for a loan. The asset remains under the full control of the company before the charge crystallizes into an equitable fixed charge and typical examples of assets that are often secured by a floating charge are stock in trade, raw materials and book debts. Some students also discussed Re Bond Worth Ltd in which Slade LJ explains the genius of the floating charge as being a commercial mechanism with mutual benefits for the secured creditor and the company. In addition students were required to discuss the advantages of the floating charge for the company as being access to funding by way of charging business assets while operating business as usual. The disadvantages for the Bank are that the floating charge is postponed to later fixed charges, ranks behind preferential creditors and is subject to challenge from liquidator. Whilst the floating charge has many advantages from the company s point of view, there is no doubt that from the creditor s perspective there are several weaknesses to this form of security. Q.2 Students found this question difficult to answer in depth in the time available as it requires a technical and theoretical application of complex aspects of commercial law. Students were required to discuss Re Far East Structural Steelwork [2005] 2 HKC 18. This establishes the local HK practice for trade finance for HK companies with no bill of lading with particular problems highlighted in the Court of Appeal judgment [2010] 1 HKLRD 156. Students were also expected to discuss the use of the pledge as consensual quasi-security interest. Note that to create a valid pledge Bank must take possession of the goods which are the subject of the pledge as established in Re Hang Fung Jewellery Co Ltd [2009] HKCU Taking possession means either actual or constructive possession (i.e. holding the keys to the 7

8 warehouse or an Attornment from the ware housekeeper). Attornment means that the person on possession has acknowledged that the goods are held on behalf of the Bank as pledgee and NOT on behalf of the owner, the pledgor. Some students neglected to discuss the issues relating to a pledge of physical objects or documents of title. Items which can be pledged are either tangible (physical) goods or documents of title representing the title to the goods, money or securities. Examples of documents of title are Share Certificates and Bills of Lading. In Hong Kong the Bank will normally release the goods to customer and continue to retain its quasi- security interest by requiring customer to sign a trust receipt. Some students neglected to discuss the additional problem of the Trust receipt. Re David Allester Ltd [1922] 2 Ch 211 is the key case which established that the trust receipt is supplemental to the pledged security. The customer agrees to hold the goods, document of title and the proceeds of sale of goods on trust for the Bank. Neither a valid pledge nor a trust receipt is registerable as a charge under Companies Ordinance Cap 622. Students must also refer to the important HK case, typical of a local HK trade finance deal Re Far East Structural Steelwork [2005] 2 HKC 18. In order to protect the pledge, the bank treated a cargo receipt as a document of title. Is a cargo receipt the equivalent of a document of title? No, despite local HK trade financing practices. There had been no constructive delivery of the goods themselves to the Bank as there was no evidence that the person in physical possession had attorney to the Bank. Students should also note the Court of Appeal judgment [2010] 1 HKLRD 156 upholding the CFI judgment (Judge Yuen dissenting). Concluding Advice for Bank Some students ignored Re Hang Fung Jewellery Co Ltd [2009] HKCU 1932 in which Banks who advised to register all security interests of whatever type as a charge under Cap 622 for additional protection for this type of trade financing. End Part B 8

9 Part C (Consumer law) Q.1 The facts are loosely based on Shum Kit Ching v Caesar Beauty Centre Ltd [2003] 3 HKCC 245. The case is one of the few HK cases applying the Unconscionable Contracts Ordinance (Cap 458). It established clearly that to find an unconscionable bargain within UCO requires actual or constructive knowledge. The court in Shum Kit Ching interpreted the UCO as requiring that unless it could be shown that the defendant had actual or constructive knowledge of the weakness of the claimant and had taken advantage of her weakness, the contract could not be said to be unconscionable and could not be set aside. Anne can argue that she is easily persuaded by anyone putting pressure on her and was so excited by gifts that she did not, and could not have, understood clause 30. Would these fall within UCO? Only if these weaknesses were known to Fit Girls Ltd. This can be either the actual knowledge or constructive knowledge that a person should have reasonably possessed. The question of whether she is suffering from weakness is essentially objective. The fact that Anne used 2 credit cards to pay for the membership might have alerted the Manager that she has a poor credit limit and might be suffering from certain weakness. Some students neglected to explain section 5 UCO. If the court finds any part of a consumer contract unconscionable in circumstances relating to the contract at time the contract was made section 5 UCO gives court jurisdiction to refuse to enforce the contract / enforce part of contract / revise or alter the contract so as to avoid the unconscionable result. Some students also failed to discuss section 6 UCO and the issues relating to Unconscionability. In this question students were particularly expected to summarize section 6 UCO and note that the Court will take into account section 6 a) (the relative strengths of bargaining positions) and section 6 d) (undue influence or undue pressure). Following the Hong Kong case of Shum, Anne has a good chance of successfully arguing that clause 30 of the Gold Card Agreement should be set aside on the grounds of Unconscionability. She must show evidence that Anne did not clearly understand the terms of the contract and had reservations in deciding to enter into the contract. She must also show that the FG had not actually directed itself to all the pertinent evidence in considering whether Anne actually knew or understood the terms of the contract that she had 9

10 entered into. Q.2 Not many students attempted this question but the majority of those who did achieved high marks. Students were required to explain the meaning of an accessory contract as defined in Mercers Co v New Hampshire. They also explained that modern guarantees have replaced the terms Promisor with Guarantor and Another person with Debtor. Modern guarantees still use the term Promisee for the Bank. In this definition the contract of guarantee is defined as a secondary contract and is only enforceable against the Guarantor if the Debtor defaults. Students should explain that in this somewhat the old fashioned language the words Debt, default, miscarriage of another person mean that the Guarantor: agrees to become liable for the sum of money owed by the Debtor, debt also agrees to be responsible for any breach of contract, default also agrees to be liable for breach of any legal duties such as a tort, miscarriage Students explained that in modern law of guarantees we use an indemnity clause. They contrasted a pure guarantee of the type described as an accessory contract with the standard modern Hong Kong indemnity clause and language used in contracts of guarantee. They explained that a Bank will use an indemnity clause by to ensure that Guarantor assumes primary liability for the Debt. There is no requirement for the bank to seek to recover the debt from the Debtor before claiming under indemnity from surety. Thus, under a contract of indemnity, the surety is liable if Debtor breaches any term of the contract and the surety is required to pay the Bank immediately with the right to claim from Debtor after all debts to Bank have been settled by Surety. Students who achieved top marks noted that modern commercial contracts of guarantees between guarantors are framed as contracts of indemnity and involve, for example a continuing guarantee and indemnity clause over all amounts due to the Promisee Bank wherever situated and will not be limited to one account. Some students also noted that no duty of good faith between Debtor and Guarantor and that there is no duty on Bank to disclose Debtor s financial details. 10

11 Students also noted that the same common law issues apply in both a contract of guarantee and a contract of indemnity. The Banks therefore ensure that the contract of guarantee will always have a clause waiving the guarantor s common law right to cancel the contract if there is a: material variation in the terms of the loan agreement between Bank and Debtor The Bank will also waive guarantor s right of subrogation and right of set off (equitable right ) Finally the best students also explained that even in a rigorously drafted contract of guarantee and indemnity in 21 st century Hong Kong the Bank may still be faced with claims that the contract of guarantee and indemnity must be avoided because of vitiating factors. End Part C 11