Associated Japanese Bank v Credit du Nord SA PDF

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Associated Japanese Bank (International) Ltd v Credit du Nord SA and another [1988] 3 All ER 902

Categories: Court: Lord(s):

BANKING AND FINANCE

QUEEN’S BENCH DIVISION (COMMERCIAL COURT) STEYN J

Hearing Date(s):

7, 8, 9, 10, 14 MARCH, 13 APRIL 1988

Guarantee – Construction – Sale and leaseback transaction with lessee’s obligations secured by guarantee – Parties to guarantee mistaken about existence of subject matter of transaction – Subject matter of lease and guarantee non-existent – Lessee failing to pay rental under lease and later adjudged bankrupt – Whether express or implied condition precedent of guarantee that subject matter of transaction existed – Whether guarantor excused from liability by non-fulfilment of condition precedent.Mistake – Mistake of fact – Common mistake – Subject matter of contract essentially and radically different from that which both parties believed to exist at time contract executed – Sale and leaseback transaction with lessee’s obligations secured by guarantee – Parties to guarantee mistaken about existence of subject matter of transaction – Subject matter of lease and guarantee non-existent – Whether guarantee void ab initio for common mistake. Under a sale and leaseback transaction the plaintiff bank purchased four specified precision engineering machines from B and then leased them back to him. B received £1,021,000 from the plaintiff bank under the transaction. As a condition of the transaction, B’s obligations under the leaseback agreement were guaranteed by the defendant bank. At all times both banks believed that the four machines existed and were in B’s possession. After B failed to keep up payments under the lease it was discovered that the machines did not in fact exist and that the transaction was a fraud perpetrated by B. The plaintiff claimed the outstanding balance due under the lease from B but he went bankrupt and the plaintiff then sued the defendant on the guarantee. The defendant refused to pay, contending, inter alia, that the guarantee was subject to an express or implied condition precedent that the machines in fact existed and therefore the guarantee was void ab initio for common mistake. Held – On its true construction the guarantee was subject to an express condition precedent that there was a lease in respect of four existing machines. Alternatively, it was reasonable to conclude that the guarantee contained an implied condition precedent that the lease related to existing machines. It followed, therefore, that since the machines did not exist the plaintiff bank’s claim failed and would be dismissed (see p 908 f to h and p 909 b c, post). The Moorcock [1886–90] All ER Rep 530 and dictum of MacKinnon LJ in Shirlaw v Southern Foundries (1926) Ltd [1939] 2 All ER 113 at 124 applied. Per curiam. A contract will be void ab initio for common mistake if a mistake by both parties to the contract renders the subject matter of the contract essentially and radically different from that which both parties believed to exist at the time the contract was executed. However, the party seeking to rely on the mistake must have had reasonable grounds for entertaining the belief on which the mistake was based (see p 910 h j and p 912 j to p 913 c, post); dicta of Lord Atkin and Lord Thankerton in Bell v Lever Bros Ltd [1931] All ER Rep 1 at 28, 36 applied dictum of Denning LJ in Solle v Butcher [1949] 2 All ER 1107 at 1119 considered. 1

Notes For common mistake as to the existence of subject matter or its essential element, see 32 Halsbury’s Laws (4th edn) paras 15–17, 20, and for cases on the subject, see 34 Digest (Reissue) 434–437, 3553– 3562. Page 903 of [1988] 3 All ER 902 Cases referred to in judgment Bell v Lever Bros Ltd [1932] AC 161, [1931] All ER Rep 1, HL. Davis Contractors Ltd v Fareham UDC [1956] 2 All ER 145, [1956] AC 696, [1956] 3 WLR 37, HL. Grist v Bailey [1966] 2 All ER 875, [1967] Ch 532, [1966] 3 WLR 618. Kennedy v Panama New Zealand and Australian Royal Mail Co Ltd (1867) LR 2 QB 580. London General Omnibus Co Ltd v Holloway [1912] 2 KB 72, [1911–13] All ER Rep 518, CA. McRae v Commonwealth Disposals Commission (1951) 84 CLR 377, Aust HC. Magee v Pennine Insurance Co Ltd [1969] 2 All ER 891, [1969] 2 QB 507, [1969] 2 WLR 1278, CA. Moorcock, The (1889) 14 PD 64, [1886–90] All ER Rep 530, CA. National Carriers Ltd v Panalpina (Northern) Ltd [1981] 1 All ER 161, [1981] AC 675, [1981] 2 WLR 45, HL. Sheikh Bros Ltd v Ochsner [1957] AC 136, [1957] 2 WLR 254, PC. Shirlaw v Southern Foundries (1926) Ltd [1939] 2 All ER 113, [1939] 2 KB 206, CA. Solle v Butcher [1949] 2 All ER 1107, [1950] 1 KB 671, CA. Taylor v Caldwell (1863) 3 B & S 826, [1861–73] All ER Rep 24, 122 ER 309. Action The plaintiffs, Associated Japanese Bank (International) Ltd (AJB), brought an action against the defendant guarantors, Crédit du Nord SA (CDN), claiming, inter alia, the sum of £901,687·66, being the outstanding balance under a sale and leaseback agreement for four micro textile compression packaging machines concluded by AJB and Mr Jack Bennett (trading as British Consolidated Engineering Co) pursuant to the terms of a written guarantee dated 29 February 1984 under which CDN had guaranteed Mr Bennett’s obligations as lessee. In the alternative AJB asserted tracing claims against CDN on the ground that various sums (£301,312·80 and £706,000) paid to CDN by Mr Bennett were part of the proceeds of the £1,012,000 purchase price paid by AJB to Mr Bennett for the four machines under a mistake of fact as to their existence. In July 1984 Mr Bennett was adjudicated bankrupt. The trustee in bankruptcy was subsequently added as a second defendant but later withdrew following settlement of the tracing claims. The facts are set out in the judgment. Michael Crystal QC and Richard Adkins for AJB. Anthony Thompson QC and Mark Barnes for CDN. Cur adv vult

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13 April 1988. The following judgments were delivered. STEYN J. Throughout the law of contract two themes regularly recur: respect for the sanctity of contract and the need to give effect to the reasonable expectations of honest men. Usually, these themes work in the same direction. Occasionally, they point to opposite solutions. The law regarding common mistake going to the root of a contract is a case where tension arises between the two themes. That is illustrated by the circumstances of this extraordinary case. In broad but necessarily imprecise terms the shape of this case is as follows. In February 1984 Mr Jack Bennett concluded a sale and leaseback transaction with Associated Japanese Bank (International) Ltd (AJB) in respect of four machines which were described by serial numbers. In other words, Mr Bennett sold the machines to AJB, and AJB then leased the machines to Mr Bennett. AJB had been unwilling to enter into the transaction unless the lessee’s obligations were guaranteed by an acceptable guarantor. Crédit du Nord SA Page 904 of [1988] 3 All ER 902 (CDN) proved to be an acceptable guarantor, and for a guarantee fee CDN guaranteed the obligations of the lessee under the lease agreement. AJB paid a sum in excess of £1m to Mr Bennett. Out of the proceeds of the sale Mr Bennett paid the first quarterly rental. But in May 1984 he was arrested. The second quarterly rental was never paid and it was subsequently discovered that the machines which were the subject matter of the sale and lease did not exist. Mr Bennett had committed a fraud on both AJB and CDN. Pursuant to the terms of the lease, AJB claimed the total outstanding balance from Mr Bennett. In July 1984 Mr Bennett was adjudged bankrupt. AJB sued CDN on the guarantee. In the alternative, AJB asserted proprietary or tracing claims against CDN on the grounds that various sums paid to CDN by Mr Bennett were part of the proceeds of the purchase price paid by AJB to Mr Bennett. The trustee in bankruptcy was given leave to be added as a second defendant and appeared by counsel at the trial. On the fourth day of the hearing the parties arrived at a settlement of the proprietary or tracing claims. Counsel for the trustee accordingly withdrew. The central remaining question to be resolved is whether AJB is entitled under the guarantee to judgment in the sum of £1,012,000 together with interest. The principal issues to which most of counsel’s submissions were directed related to the questions (a) whether the guarantor was excused from liability by the non-fulfilment of an express or implied condition precedent of the guarantee, viz the existence of the machines, or (b) whether the guarantee was void ab initio by reason of a common mistake affecting the guarantee, viz the existence of the machines. THE COMMERCIAL BACKGROUND Before I turn to the sequence of events which led to the present dispute, a brief sketch of the commercial background should be given. The principal transaction was a sale and leaseback of equipment. That is a transaction whereby a person who owns equipment raises money by selling the equipment to another for cash and leases it back for a fixed term. It is to be distinguished from a direct lease where the lessor buys the equipment from a third party and leases it to the user, the lessee, for a fixed term. In 1984 both forms of equipment leasing offered fiscal advantages. The advantage to the lessor was that the lessor could claim 100% first year capital allowance or 25% writing down allowance against the equipment, enabling the lessor to defer payment of corporation tax. The saving to the lessor from the delay in payment of corporation tax could be reflected in the rental payment charged to the lessee. The lessee could thus obtain finance for the acquisition and use of the equipment at a lower interest rate than if the lessee had to borrow the money to buy the machines outright and repay it over the period of the lease. THE STORY OF THE NON-EXISTENT MACHINES

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The story starts with Mr Jack Bennett, a professional engineer, who had by 1984 become the sole proprietor of British Engineering Co (BEC), British Consolidated Engineering Co (BCEC) and British Precision Engineering Industries (BPEI). BEC, BCEC and BPEI were trading names for Mr Bennett. In early 1984 Mr Bennett made contact with National Leasing and Finance Co (National Leasing), a firm of lease brokers. He dealt with Mr Mark Kulesza, the marketing manager. He wanted to raise money. In early February 1984 Mr Kulesza approached AJB and CDN, trying to interest the former in concluding a sale and leaseback in respect of four specific machines and the latter in acting as guarantor for reward of the lessee’s obligations. AJB is a Japanese-owned institution which carries on banking business in the City of London. Its business includes leasing equipment. CDN is a French bank with a London branch. Initially, it had been suggested to AJB that BEC would be the lessee, and BPEI the guarantor. That was unacceptable to AJB. Mr Kulesza tried to interest CDN in acting as guarantor. On 15 February a meeting took place between Mr Bennett, Mr Kulesza and two Londonbased employees of CDN, viz Mr David Brown (the credit manager) and Ms Jennifer Broadley Page 905 of [1988] 3 All ER 902 (a credit officer). At that stage CDN was asked to guarantee the obligations of BEC under a five-year equipment lease for the lease of four textile compression packaging machines. The limit of the guarantee was to be £1,058,894. The guarantee fee was to be 1% quarterly paid in advance. During the meeting the CDN representatives probed Mr Bennett’s background, and they were impressed with Mr Bennett’s financial standing and his asserted proven ability to obtain government contracts. Subsequently, CDN obtained satisfactory status reports on Mr Bennett and BEC from a branch of Midland Bank plc. Mr Brown and Ms Broadley reported to Mr Bernard Lengrand, the general manager of the London branch of CDN. Mr Lengrand was in principle in favour of the transaction. On 24 February a further meeting took place between Mr Bennett and CDN employees. Mr Bennett signed a personal counter-guarantee in blank in favour of CDN he agreed to open a current account with CDN and agreed to deposit £250,000 with CDN. At this stage CDN was unaware of the identify of the proposed lessor. On 27 February Mr Kulesza phoned Mr Kirosha Kobayashi, the assistant general manager in AJB’s loan department. BCEC (as opposed to BEC) was now put forward as the seller and lessee of the equipment. That was not a point of any great materiality. Mr Kulesza said that CDN would be prepared to guarantee the lessee’s obligations. AJB had spare ‘capacity’, and therefore a commercial incentive to conclude the transaction. AJB viewed CDN as a most acceptable guarantor. On 27 February Mr Kulesza wrote to AJB enclosing, inter alia, documents described as lease documentation, guarantee wording, guarantee structure and accounts of CDN. On the same day Mr Kulesza wrote to CDN enclosing documents described as guarantee proposal, guarantee structure and lease document. The documentation so forwarded to AJB and CDN respectively identified the subject matter of the lease as four specific machines, which were identified by serial numbers. Subject to minor drafting points, the transaction was acceptable to AJB and CDN, the latter having obtained the necessary authority from its Paris head office. Pausing there in the chronology, the position is that both AJB and CDN were proceeding on the basis that Mr Bennett was an honest and substantial businessman. AJB had relied on what it was told by National Leasing. No AJB employees ever met Mr Bennett until the completion of the transaction. CDN, on the other hand, relied both on what it was told by National Leasing and on the impressions gathered in meetings with Mr Bennett. On the basis of the oral evidence of Mr Brown and Ms Broadley, which I accept, it is clear that at no stage until after the eventual completion of the transaction did CDN know that the proposed transaction was to be a sale and leaseback, and CDN had no reason to infer it. But both parties assumed that the machines existed. On 29 February, at the offices of National Leasing, the transaction was completed. The meeting was attended by, inter alios, Mr Bennett, Mr Kobayashi of AJB and Mr Kulesza of National Leasing. No 4

employee of CDN was present. The sale agreement and the lease were executed. On behalf of CDN, Mr Kulesza handed over the signed guarantee. AJB then handed over to Mr Bennett a cheque for £1,012,000 payable to BCEC. The transaction consisted of three separate agreements. The first was the agreement whereby BCEC sold the four machines to AJB for a total price of £880,000 together with any applicable value added tax payable thereon. Under that agreement BCEC warranted that the machines were new and unused. The second agreement was the lease. It identified AJB as the owner and lessor of the machines. BCEC was the lessee of the goods. The term of the lease was five years, and rental was payable in quarterly instalments. The following provisions of the lease are relevant to an understanding of the present dispute:

‘Termination 10.1 The Lessor shall be entitled to terminate this Lease on the expiry of thirty days notice, in writing to the Lessee only upon the occurrence of any of the following events and notwithstanding any subsequent acceptance of rent: (a) If the Lessee fails to pay any rental, interest or other sum due hereunder within seven days of the due Page 906 of [1988] 3 All ER 902 date, fourteen days of the due date if the Schedule states that there is to be a Sub-Lessee (b) if the Lessee shall make default in the performance or observance of any terms and conditions hereof (all of which provisions shall for all purposes be regarded as fundamental conditions of this Agreement) 10.2 On the termination of this Lease by the Lessor:—(a) the Lessor or its agents may without notice repossess the Goods and may for that purpose enter upon any land or buildings on which the Goods are located and the Lessee shall be responsible for all damage which may be caused by any severance or removal of the Goods provided that reasonable care shall be taken by the Lessor or its agents (b) the Lessee shall then be liable for the payment to the Lessor forthwith on demand of: (i) any sums due from the Lessee to the Lessor under this Lease Agreement at the date of such termination whether by way of unpaid rent or arising from any breach of the obligations of the Lessee under this Lease prior to such date together with any investment or regional development grants (on a grossed up basis, if necessary, to maintain the after tax return of the Owner) which the Lessor or the Owner is required to repay as a result of such termination (ii) the cost of all repairs to the Goods to render it in good working order and condition (iii) all costs and expenses of the Lessor in repossessing and remarketing the Goods howsoever occasioned (iv) as agreed compensation for loss of profit an amount equal to the entire amount of the unpaid rent in respect of the Goods for the unexpired balance of the Primary Period hereunder discounted at the rate of 5% per annum on such unpaid rent in respect of the early payment thereof.’ The foregoing provisions must be read with para 8 of the schedule. It reads as follows: ‘Refund The Lessor will appoint the Lessee agent to dispose of the goods to a third party. At such a time, the Lessor shall refund to the Lessee 971/2% of the Net Sale proceeds of the sale of the goods.’ That brings me to the third agreement, the guarantee. It is addressed to AJB. The following provisions are material: ‘We, Credit du Nord, whose place of business in the UK is at 10 Old Jewry, London EC2R 8DU in consideration of your leasing 4 Textile Compression Packaging Machines to British Consolidated Engineering Company whose registered office is at PO Box 168, London NW5 1TJ (hereinafter called “the Lessee”) pursuant to Leasing Contract dated 29th February 1984 Reference no. … (hereinafter 5

called “the Agreement”) hereby unconditionally guarantee to and agree with you as follows:—1. For the duration of the Primary Period (as such expression is defined in the Leasing Contract referred to above) we hereby guarantee that if for any reason the Lessee shall make any default in paying any lease rental or any other sum that becomes due to you thereunder we will pay the amount thereof to you forthwith upon demand in writing … 11. As a separate and independent stipulation we agree that any sums mentioned in Clause (1) hereof which may not be recoverable on the footing of a guarantee whether by reason of any legal limitation disability or incapacity on or of the Lessee or any other fact or circumstance and whether known to you or not shall nevertheless be recoverable from us as sole or principal debtor in respect thereof and shall be paid by us on demand.’ The truth was, of course, that there were no machines. The lessee, BCEC, repudiated the lease, and AJB called on CDN to pay under the guarantee. THE WITNESSES This is a case in which the documents tell their own story. A few interstices were filled by the oral testimony of three witnesses: (a) Mr Gerald Birch, the assistant manager of the loan department of AJB in 1984 (b) Mr Brown and Ms Broadley, of the London branch of CDN. Page 907 of [1988] 3 All ER 902 To the extent to which they testified to matters of fact which were within their personal knowledge, I accept the evidence of all these three witnesses. Statements made under the Civil Evidence Act 1968 by Mr Kobayashi (the assistant general manager of AJB) and Mr Lengrand (the London manager of CDN) were placed before me but these statements were largely uncontroversial. In addition, and by agreement, there were placed before me three experts’ reports, viz the reports of Mr N A Roberts, Mr A E Stern and Mr W T Hender. By agreement none of these experts were called, but I was informed that by agreement their reports constituted evidence in the case which I was asked to assess in the light of counsel’s submissions. In a civil case that was, of course, a perfectly proper course to adopt. And it had the merit of avoiding the rehearsal of the very same arguments on several occasions during the same trial. One ...