Introduction

It is a well-known fact that investors-cum-speculators are very active in the volatile property market in Hong Kong. It is common to see that professional investors participate in chain transactions in which a number of sub-sales are involved. This particular kind of transactions is usually completed by way of confirmor sale. In other words, an ultimate purchaser acquires a property indirectly from a head vendor through one or more confirmors and several agreements of sale and purchase are entered into respectively between (i) the head vendor and a confirmor; (ii) confirmors themselves (if more than one confirmor involved); and (iii) the confirmor and the ultimate purchaser. In case where the ultimate purchaser fails to complete in breach of his agreement of sale and purchase, would the ultimate purchaser be liable to compensate the immediate vendor for all losses incurred by the parties up in the chain? This issue was discussed by the Court of Final Appeal (“Court”) in the case of Richly Bright International Ltd v De Monsa Investments Ltd FACV 12/2014.

Background
A property situated in Kowloon was the subject of four agreements of sale and purchase three of which were sub-sale agreements. All the agreements provided the same completion date, i.e. on or before 17 September 2008.  The chain of transactions were summarised in Chart 1 below. The 3rd sub-sale between Richly Bright International Ltd as the confirmor-cum-vendor (“Respondent”) and De Monsa Investments Ltd as the ultimate purchaser (“Appellant”) was the subject matter of the present appeal. The Appellant failed to complete the 3rd sub-sale and after such failure, each of the other purchasers up the chain also failed to complete. Proceedings for breach of agreement were brought by the respective vendors and judgements entered against the respective purchasers.  In particular, the Court of First Instance ordered that the Respondent was entitled to:

1.         Forfeit the Appellant’s deposit in the sum of HK$13,586,400.00 (“Deposit”);

2.         Award of damages in the sum of HK$9,000,990.00, (“Additional Damages”) which represented:

a.         Loss of profit in the sum of HK$2,597,400.00 (being the difference between the Respondent’s purchase and resale prices) (“Loss of Profit”);

b.         Loss of the deposit paid by the Respondent to 823 Investment Limited in the sum of HK$19,989,990.00 (“Loss of the Respondent’s Deposit”);

c.         Giving credit to the Appellant’s deposit in the sum of HK$13,586,400.00 forfeited to the Respondent;

3.         Indemnity against the sum of $8,704,210.50 as the damages award made against 823 Investment Limited in favour of World Orient Investment Limited under the 1st Sub-sale (“Indemnity 1”);

4.         Indemnity against the sum of $8,092,339.50 as the damages award made against the Respondent in favour of 823 Investment Limited under the 2nd Sub-sale (“Indemnity 2”); and

5.         Indemnity against the sum of HK$1,399,298.00 due from the Respondent to the estate agents as liquidated damages payable under the 2nd Sub-sale (“Indemnity 3”).

These orders were upheld by the Court of Appeal.  The Appellant therefore appealed to the Court. The Court was asked to decide what should be the proper approach to determining the extent of the Appellant’s liability for such breach in relation to losses attributable to non-completion incurred up the chain of agreements; in other words, whether losses claimed by the Respondent against the Appellant were recoverable.

Legal Principle
An award of damages for contractual claim is always compensatory in nature and it aims to place the innocent party in the same position as if the agreement had been performed in accordance with its terms.  The Court referred to the landmark case of Hadley v Baxendale (1854) 9 Ex 341 for the basic principle of remoteness of damage for breach of agreement that the parties should only be liable for damages which were within their contemplation in the event of a breach when they entered into the agreement. The well-established test laid down in Hadley v Baxendale (1854) 9 Ex 341 has two limbs:

1.         losses may fairly and reasonably be considered as arising naturally according to the usual course of things from the breach; and

2.         losses may reasonably be supposed to have been in the contemplation of the parties at the time when they made the agreement as the probable result of the breach of it. (“Two Limb Test”)

Having considered the decision of the House of Lords in Trandsfield Shipping Inc v Mercator Shipping Inc (The Achilleas) [2008] UKHL 48 and the case of Koufos v C Czrnikow Ltd (Heron II) [1969] 1 AC 350, the Court decided that recoverable loss must be (i) “sufficiently likely to result from the breach of contract to make it proper to hold that the loss flowed naturally” under the first limb of the Two Limb Test; and (ii) loss of a type for which the agreement breaker could reasonably be regarded as having assumed contractual responsibility.

The question of whether the loss was sufficiently likely to result from the breach of contract on the information available to the agreement breaker when the agreement was made draws a line between results which were likely because they would happen in the great majority of cases, and results which were unlikely because they would only happen in a small minority of cases. The concept of assumption of responsibility provides a principled basis for distinguishing between losses which are or are not too remote. Whether an agreement breaker has assumed responsibility for a particular type of loss is decided by viewing the nature and object of the agreement against its commercial background. The courts should ascertain by reference to objective indicia, whether the parties should be taken to have intended that the relevant type of loss flowing from breach of the contract falls within the scope of the agreement breaker’s assumption of responsibility.

Decision
The Court held that, in reaching the conclusion that all the upstream losses claimed by the Respondent fell within the first limb of the Two Limb Test, the Court of First Instance and the Court of Appeal applied the wrong test by which they focused merely on the foreseeable possibility of the prior sub-sales and corresponding defaults in completion.  The Court then applied the correct legal principle to the present case and held that:

Deposit and Additional Damages
As decided by the Court in Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234, on the basis that the amount of the deposit paid by the Appellant was reasonable, the Respondent was able to forfeit the Deposit regardless of whether the breach had caused the Respondent any actual loss.

Regarding the Loss of the Respondent’s Deposit, the courts below erroneously ignored the fact that each sub-sale was a separate agreement. The state of the market might well provide commercial reasons for independent decisions made by upstream purchasers regarding completion or otherwise of their respective agreements.  The Court was of the view that one should not naturally assume that the upstream purchasers would be unable to finance acquisition of the property from their upstream vendors unless funded by the Appellant’s completion monies.  The Court found that the Respondent made its own decision not to complete the 2nd sub-sale, which caused the Loss of the Respondent’s Deposit. Such loss did not flow from the Appellant’s failure to complete. Therefore, the Respondent was not entitled to the Additional Damages.

Indemnities 1 to 3
Indemnities 1 to 3 were not in the parties’ reasonable contemplation and there was no basis for taking the Appellant to have assumed responsibility for such losses incurred by the upstream confirmors. The Court found that the general expectation in the Hong Kong property market was that a purchaser who breaches his contract by failing to complete loses his deposit and, if loss exceeding the amount of the deposit is incurred by the vendor, finds himself liable to damages for the balance. Such expectation did not go that far to the extent that the defaulting purchaser assumes responsibility for more remote losses involving indemnities voluntarily given by the vendor in respect of losses incurred by parties to contracts further upstream. Liabilities so incurred would have been wholly unquantifiable and unpredictable at the time the Appellant entered into the 3rd Sub-sale agreement.

Conclusion
Prior to the case of Richly Bright International Ltd v De Monsa Investments Ltd, professional investors might have assumed that an ultimate purchaser in a chain of confirmor sales has to bear all losses incurred by the parties up in the chain, including loss of profit and loss of the confirmor-cum-purchaser’s deposit. The Court took the chance to clarify that such assumption should be flawed. In case where the ultimate purchaser fails to complete, to protect his own interests, a confirmor should prepare the necessary fund to complete his own purchase so that his deposit paid to the immediate vendor will not be forfeited. If his purchaser fails to complete, he will be entitled to forfeit his purchaser’s deposit and to recover his further loss if such exceeds the deposit forfeited.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.