When “Loans” are not What They Seem – Revisiting Defence of “Sham”

In this interesting case 储惠敏 v. KWOK CHING CHING & ANOR [2024] HKCFI 1380, the plaintiff (“P”) claimed repayment of two substantial loans totaling RMB 150,000,000 (“Loans”), allegedly secured by legal charges over two Hong Kong properties (“Charges”). The defendants (“D1” and “D2”) were the borrowers / guarantors and owners of the properties.

At first sight, the case may appear to be a run-of-the-mill enforcement of loan and security. However, given the most peculiar facts of the case, the Court dismissed P’s claim for repayment of the Loans and enforcement of the charges, and allowed Ds’ counterclaim that the alleged loan agreements and security documents were a sham and void ab initio.

P’s case is to rely on the loan agreements and the Charges over the properties.

Ds’ Case relies on, among others, the following defences :-

1. The Loans and Charges were procured by duress and/or illegitimate pressure (such as threats of harassment and violence) on D1 and her domestic partner Lau Hei Wing, Stephen (劉希泳) (“Lau”) by a “consortium of individuals” including P and her associates including the mastermind Mr Qin, a Ms Mandy So, and a Mr Song. It is D1 and D2’s case that P had actual or constructive notice of the vitiating factors which rendered the documentation for the Loans and the Charges etc. voidable (the “Duress Defence”);
2. The Loans were procured by undue influence exercised by Lau over D1, for which P had or ought to have notice (the “Undue Influence Defence”);
3. The Loans were a sham in that neither parties intended that D1 would be borrowing any money from P, and D1 and D2 would be providing any security to secure the Loans (the “Sham Defence”);

DHCJ Phoebe Man found that the facts in the present case are unusual, and P failed to establish a prima facie case that the Loans and Charges were genuine. The key driving facts are as follows (§§12-13 of the Judgment) :-

1. P’s Lack of Knowledge and Interest in Seeking Repayment:
   This is most extraordinary. Most tellingly, P had not even met D1 prior to the Loans. P’s evidence in the witness box shows that she was (i) wholly unfamiliar with the loan terms, (ii) did not negotiate them with D1, and (iii) left all documentation to “lawyers”. P also did not conduct valuations of the security, and showed little interest in recovering the Loans or the properties. P’s attitude during cross-examination was described as one of “disdain”, wholly disinterested in the proceedings, and more consistent with someone who had been forced or instructed to give evidence on behalf of another person.
2. No Commercial Rationale:
   P made no effort to protect her interests, investigate the value of the security, or compare the investment with alternatives, which was inconsistent with the conduct of a genuine lender.
3. Conduct Inconsistent with Lending:
   The keys to both properties purportedly charged were immediately handed over to P without any default, and P allowed a friend to live in the properties and pay their mortgages (without seeking to recover such mortgage repayments from Ds). Also, P did not demand repayment for over two years after the Loans became due.
4. Draft Transfer Documents Prepared Without P’s Knowledge:
   There was evidence that, in 2019, the solicitors’ firm acting for P prepared certain draft transfer documents of the properties and emailed the same to Ms So (not P). Curiously, P denied having given instructions to prepare such documents. The Court noted the possibility, without finding, that someone other than P gave instructions to those solicitors to prepare the draft transfer documents.

The Judge concluded that these factors undermined P’s claim that the transactions were genuine loans and found that the arrangement was more akin to an outright transfer of the properties.

On this basis, P’s claim is dismissed.

The Court further accepted Ds’ sham defence.

The relevant legal test for finding a sham transaction is as follows (§§44-49 of the Judgment) :-

• A sham exists where the parties intended that the documents or acts would not create the legal rights or obligations they appear to create; and it was intended that the documents or acts would mislead a third party into believing such rights and obligations existed.
• The test of intention is subjective and can include reckless indifference (i.e., a party who goes along with a sham without knowing or caring what they are signing is taken as having the necessary intention).
• It is not necessary for both parties to have the same motivation, nor for both to have a common intention; reckless indifference suffices.

In addition to the above list of facts (at §§12-13 of the Judgment) which led to the conclusion that P failed to establish her prima facie case, the Court (at §§50-52) relied on the unchallenged fact that the loan monies received by D1 were immediately transferred to a third party Mr Song. The parties did not intend the documents to create genuine legal rights or obligations, but rather to create the appearance of a loan. Reckless indifference by D1 sufficed for the intention required for a sham.

P raised a pleading point that particulars of the sham were not pleaded. However, the Court found that a pleading that has alleged a transaction is a sham is sufficient in itself.

A “sham”defence was made out in this case, where the parties did not have a “common intention”.  Reckless indifference by D1 to go along with P suffices for the purpose of finding a “sham”.

A “sham”defence is more frequently found in a case where a third party (for instance, tax authority or liquidators of a company) seeks to unwind and set aside transactions which were entered into with some ulterior motive g. sham trusts to create a façade of beneficial ownership (or the lack thereof: see Midland Bank Plc v Wyatt [1997] 1 BCLC 242).   It is of interest that the present case is one of few examples where an unwilling party to a sham transaction successfully set aside the transaction on the basis of “sham”.

The full judgment can be found at this link.

Mr Vincent Chiu acted for the Defendants.