Introduction
In Hong Kong, it is not uncommon that some parts of a property may have unauthorized or illegal structures or alterations. When such property is sold, it is often in the vendor’s interest to insert provisions into the sale and purchase agreement to limit the extent of its duty to show and give title to the property. In Channel Green Ltd v Huge Grand Ltd CACV 174/2013, the Defendant vendor successfully relied on a contractual provision to bar certain requisitions from the Plaintiff purchaser and forfeited the deposit paid under the sale and purchase agreement when the Plaintiff purchaser refused to complete the transaction.

Background
By a provisional sale and purchase agreement of 2 June 2011, Ms. Ho agreed to purchase from the Defendant a commercial property which was made up of 10 shops and an open forecourt at a building (the “Property”) at the price of HK$240 million. Subsequently, the Plaintiff was nominated as the purchaser in the formal sale and purchase agreement of 17 June 2011 (the “Agreement”). A total sum of HK$36 million (representing 15% of the purchase price) was paid to the Defendant as deposit (the “Deposit”).

Disputes arose between the parties on whether the Plaintiff could rely on certain features in the physical conditions of the Property to challenge the Defendant’s title to the Property. The Plaintiff raised, among others, the following requisitions in relation to breaches of the Conditions of Sale ( the “Government Lease”) and breaches of the Deed of Mutual Covenant in respect of the building in which the Property was situated (the “DMC”):-

1.         the absence of car parking spaces mandated under Special Condition 7 of the Government Lease (“SC7”) which were originally provided for in the forecourt but became occupied by the stalls;

2.         the extension of some of the shops into the area of the Property which was required by Special Condition 8 of the Government Lease (“SC8”) not to be built over; and

3.         request for documentary proof that the breaches of the DMC as identified by the incorporated owners of the building had been remedied.

The Defendant relied upon the following clause of the Agreement (“Clause 30”) as a bar to these requisitions:-

“The Property is sold on an ‘as is’ basis to the purchaser. The purchaser has inspected and understands the existing state of the Property, and the purchaser shall not raise any questions/inquiries or refuse to complete or delay completion of transaction on the ground that there are any unauthorized additions, alterations or illegal structures on the Property.”

As a result, the sale and purchase of the Property was not completed and the Defendant forfeited the Deposit pursuant to the Agreement. The Plaintiff disputed the Defendant’s right to forfeit the Deposit as it was more than 10% of the purchase price and argued that the forfeiture provision in the Agreement was a penalty. At trial, the Court found in favour of the Defendant and held that the Defendant was entitled to forfeit the Deposit.

Issues on Appeal
The Plaintiff appealed to the Court of Appeal (the “CA”). Two of the issues on appeal were:-

1.         whether the trial judge erred in construing that Clause 30 encompassed breaches of SC7, SC8 and the DMC (the “Construction Issue”); and

2.         whether the forfeiture of the Deposit was a penalty (the “Forfeiture Issue”).

The Construction Issue
The CA considered that the key question was the extent to which Clause 30 cut down the Defendant’s duty (as vendor) in giving title.

The Plaintiff raised the following arguments:-

1.         Clause 30 did not apply to problems caused to the title of the Property apart from those arising from a breach of the Buildings Ordinance. As such, breaches of SC7, SC8 and the DMC did not come within the scope of Clause 30.

2.         The phrase “illegal structure” in Clause 30 could only be interpreted as illegal structures under the Buildings Ordinance. A breach of SC7 or SC8 could be waived (perhaps upon payment of a premium) and therefore a structure so erected would not be described as an illegal structure.

On the other hand, the Defendant contended that Clause 30 could be relied upon by the Defendant to preclude requisitions (and qualified the title to be proved and given) relating to breaches arising from SC7, SC8 and also the DMC so long as they stemmed from unauthorized additions, alterations or illegal structures on the Property.

The CA did not accept the Plaintiff’s arguments and considered that illegal structure simply meant any structure erected against the law. The relevant illegality could stem from a breach of the Buildings Ordinance, the Government Lease or the DMC. The fact that a breach of the Government Lease might be addressed by a waiver from the Government did not alter the character of such a structure as an illegal structure before such waiver had been obtained. In other words, the CA agreed with the trial judge’s construction that Clause 30 not only covered breaches of the Buildings Ordinance but also that of the Government Lease and the DMC. As such, the Plaintiff’s requisitions were within the scope of Clause 30 and the Defendant was entitled to rely on Clause 30 as a bar to such requisitions.

The Forfeiture Issue
As mentioned above, the Deposit was 15% of the purchase price, which was higher than the 10% conventional amount. As such, the Court had to consider whether it was justified by exceptional circumstances. According to the Court of Final Appeal case Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234, the exceptional circumstances must relate to a true deposit’s purpose as an earnest of performance and as compensation for the vendor’s withdrawal of the property from the market pending completion and the relevant test is reasonableness at the time of contract. The relevant factors for determining whether a larger than usual deposit is justified include the length of the pre-completion period and the volatility of the market.

In the present case, the completion period was 4.5 months as compared to the usual completion period (as found by the trial judge) of 3 months for a commercial property of the nature of the Property. The CA held that the trial judge was entitled to take account of the fact that the longer the completion period, the longer the Defendant was at risk of the variations of the market and there was objective justification for a 15% deposit. The CA therefore upheld the Defendant’s forfeiture of the Deposit and dismissed the Plaintiff’s appeal.

Conclusion
This case illustrates the significance of the contractual provisions in a sale and purchase agreement in limiting a vendor’s duty to show and give good title to a property which has certain unauthorized or illegal features. From a purchaser’s perspective, it is crucial to inspect the property prior to entering into any sale and purchase agreement and to carefully consider the terms of such an agreement to ensure its interest is adequately protected. Whether you are a vendor or a purchaser in a sale and purchase of property, you should seek professional legal advice whenever there is any doubt regarding the implications of any terms of a sale and purchase agreement.

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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.