In an interesting decision, the Court of Final Appeal, Hong Kong elaborated the “mistake” concept in a contract.
The case involved Kowloon Development Finance Limited (“Kowloon“) and Pendex Industries Limited (“Pendex“). Kowloon advanced USD 20 Million (“Loans“) to Pendex between 1997 and 2002 through facility letters. The Loans were secured by personal guarantees and charge over a property, and were to be repaid through monthly instalments which were fixed by Kowloon in consultation with Pendex.
In 2003, Pendex defaulted in repayment of the Loans. The terms of repayment were then renegotiated by Kolwoon and Pendex and they finally reached an agreement on the discharge of the arrears and monthly instalments which would be payable in 2004. This agreement was embodied in a Tomlin order made on 8 January 2004 (“First Order“). The First Order provided for the modality of repayment of arrears upto December 2003, which were required to be paid by December 2004. The relevant paragraphs of the First Order are as follows:
“1. All the Defendants do pay the Plaintiff the sums of money upon signing this summons as follows:-
(i) HK$340,000.00 being part of the outstanding loan and interests accurred [sic];
(ii) HK$28,000.00 being the agreed legal costs and disbursements incurred by the Plaintiff …
(iii) HK$ 9,600.00 being the outstanding insurance premium of the Property.
2. All the Defendants do pay the Plaintiff 12 monthly mortgage instalments commencing on 21st January 2004 by 24 post dated cheques and presented the same to the Plaintiff upon signing of this summons as follows:-
[There followed a table of sums for which the cheques were to be payable. For the first six months the monthly payments were to be HK$170,000 and for the second six months $190,000, making a total of $2,160,000 during the year.]
3. All the Defendants do pay the Plaintiff interests on the outstanding loan in the sum of HK$21,591,264.12 at the rate of 10 per cent per annum from the date of arrears up to 18th December 2003 and at the rate of 8 percent per annum thereafter;…
6. This arrangement will be commenced from the date of this Summons till 21st December 2004. If all the Defendants do pay the plaintiff the total sum of HK$2,537,600.00 [being the sum total of the amounts payable by the end of 2004] during the aforesaid period, the Plaintiff will review the amount of repayment of Mortgage instalments annually thereafter;”
The First Order also stated that other actions related to the Loans be stayed until the arrears upto December 2003 were paid. Meaning that post December 2004 the repayment mechanism would revert to the original method of annual review by Kowloon. Here, the Kowloon solicitors argued that the following ‘paragraph 7’ be inserted in the First Order, however, this was challenged by the Pendex solicitors and was eventually not added:
“7. If all the Defendants do not comply with any term of the aforesaid arrangements during any time of the aforesaid period, the Plaintiff shall be at liberty to restore this action and all the legal costs and disbursements arising therefrom shall be borne by the Defendant on an indemnity basis.”
Further negotiation tool place between Kowloon and Pendex after October 2004 to agree to the monthly instalments to be paid in 2005. This resulted in another Tomlin Order (“Second Order“) being made, the operative paragraphs of which are as follows:
“1. The Defendants do pay to the Plaintiff HK$9,600.00 being the Fire Insurance Premium of the property …
2. The Defendants do pay the Plaintiff HK$325,000.00 in 12 equal monthly instalments, by way of 12 post-dated cheques commencing from 21 January 2005;
3. Notwithstanding the order of Master Lung dated 8th January 2004, all further proceedings in this action be stayed, save that the Plaintiff be at liberty to apply for the purposes of carrying into effect of this Order; and
4. The Defendants do pay the Plaintiff HK$8,000.00 as the costs of this application.”
In terms of the Second Order, Pendex issued post-dated cheques but some of these cheques were dishonoured. Therefore, Kowloon issued summons, seeking (a) amendment of the Second Order, for insertion of the aforesaid ‘paragraph 7’; (b) giving Kowloon the liberty to execute the unpaid balance of the 2005 instalments; or (c) setting aside the First Order.
In December 2005 Kowloon issued a letter to Pendex, demanding repayment of the full capital and interest outstanding. To this letter, Pendex responded stating that in its view, the effect of the Second Order order was that payment of the 2005 instalments discharged the whole debt and accordingly Pendex asked for the mortgage to be released.
In April 2006, Kowloon commenced new proceedings at the High Court, claiming among other things, to have the Second Order rectified, substantially to make it clear that the remaining debt had not been discharged and that the aforesaid orders ought to be rectified on the grounds of mutual, or alternatively unilateral mistake.
Explaining the legal requirements of mutual and unilateral mistakes, the learned Judge explained as follows.
Mutual or common mistakes: in the case of mutual or common mistake, the mistake is about whether a written document correctly reflects what the parties had, on an objective assessment, agreed it should contain. Citing precedents, the learned judge stated that rectification for common mistake has been described as “a branch of the doctrine of specific performance”, meaning, if parties have agreed to execute a document in certain terms and by mistake it contains different terms, the court can specifically perform the prior agreement by rectifying the document. Further that, in deciding what the parties have agreed, the common law adopts its usual objective stance, looking at what a reasonable observer would have understood the parties to mean and not concerning itself with their un-communicated states of mind.
Unilateral mistakes: unilateral mistake, on the other hand, is very much concerned with the subjective states of mind of the parties. If the contract contains a provision which one party knows that the other party thinks is not there, or knows that the other party is mistaken about its meaning, the court may, as a matter of discretion, either refuse to allow him to enforce the contract as it would ordinarily be construed or go further and rectify the written agreement to give effect to what the mistaken party thought had been agreed.
Explaining the difference between mutual or common mistakes and unilateral mistakes, the learned judge cited the case of Rose v Pim. In this case, the plaintiff was a London merchant who placed a written order for Moroccan horsebeans in the belief that his Egyptian buyer would accept them under the description “feveroles”. He had discussed this with the seller, another London merchant who was of the same opinion. But the parties were mistaken. In Egypt, horsebeans and feveroles are different. The Court of Appeal refused to rectify the order by substituting “feveroles” for “horsebeans” because the document did not differ from what, to all outward appearances, the parties had agreed. They had agreed on a sale of horsebeans and the order document said “horsebeans”. On the other hand, if the seller knew that the buyer mistakenly thought that it was a term of the contract that horsebeans could be sold as feveroles, a court might have thought he had contracted in bad faith and that the order should be rectified on the ground of unilateral mistake. In the judgement of this case, Lord Denning observes stated that “if you can predicate with certainty what their contract was, and that it is, by common mistake, wrongly expressed in the document, then you rectify the document; but nothing less will suffice”.
Coming back to the present case, the learned judge then took into consideration, the proceedings at the lower courts. To decide the case, the lower courts relied on evidence submitted by witnesses Ms. Monica Wai (“Ms Wai“) and Cindy Yu (“Ms Yu“) for Kowloong and Mr. Chan for Pendex. Ms. Yu was was part of the negotiations that took place between Kowloong and Pendex, that resulted in the aforesaid orders. Ms Yu’s evidence was that there was never any question of the entire debt being discharged by the payments in 2005. Ms. Yu stated that the object of the discussions was to agree upon an amount for instalment payments which would enable the entire advances to be repaid within a time acceptable to Kowloong. The discussions which preceded the Second Order order began with Ms Yu telephoning Mr Chan and saying that the monthly payments would have to be substantially increased if the advances were to be repaid within a reasonable time. Mr Chan offered HK $210,000 a month for the first 6 months of 2005 and HK $230,000 for the second. After obtaining a valuation of the mortgaged property, Ms Yu calculated that if repayments were made at the rate offered by Mr Chan, it would take nearly 8 years for the debt to be reduced even to the value of the mortgaged property. She reported this to Ms Wai, who took decisions on behalf of Kowloong, said it was unacceptable and that the instalments should be in an amount sufficient to repay the debt within 5 years. This worked out at HK $325,000 a month. Ms. Yu reported these calculations to Mr Chan, who said he had no option but to agree.
Agreeing with the judgement passed by the lower courts that “it seems likely that it was a common mistake” the learner Judge dismissed the appeal. The learned Judge recorded that that Mr. Chan always knew that it was never the intention of KDFL to release its debt and that it was misconduct on his part to use the form of the Tomlin order (assuming it admitted of such a construction) to support a claim that they had done so.