Citation(2006) 18 SAcLJ 473
Date01 December 2006
Published date01 December 2006

This note discusses the House of Lords decision in National Westminster Bank plc v Spectrum Plus Ltd[2005] 2 AC 680 and the Singapore High Court decision in Cheah Geok Tuan v Lie Khin Sin[2006] 1 SLR 340 in the context of when a transaction, particularly one ostensibly involving a sale and repurchase agreement, would be characterised instead as a loan. It is suggested that that lawyers giving true sale opinions to structures that have a borrowing or lending effect must now quite often qualify those opinions or at least word them more conservatively because it is a question of fact whether a transaction is viewed as a sham or pretence. Quite often, policy considerations dictate how closely a court scrutinises the surrounding circumstances, including post-contractual evidence.

I. Introduction

1 This note does not seek to revisit the fixed versus floating charge debate which was revived by the House of Lords in National Westminster Bank plc v Spectrum Plus Ltd1 (“Spectrum”) that was ably discussed by Associate Professor Dora Neo and Mr Lee Eng Beng in the September 2005 issue of the Singapore Academy of Law Journal.2 However, in

discussing the local decisions on whether a sale and repurchase agreement amounts to a loan, it is unavoidable that often involved reference is made to some of the speeches of the Law Lords there, and in particular to the questions left unanswered by that case, which sanctioned the examination of post-contractual or post-creation events to determine whether security given by a company to a bank is fixed or floating in nature. This is problematic because it has been said, for example, by Lord Reid that “it is now well settled that it is not legitimate to use as an aid in the construction of a contract anything which the parties said or did after it was made”.3 Post-contractual evidence was usually inadmissible and yet after Spectrum it appears that the reverse is now true, which is the important point made by Alan Berg in his recent article in the Journal of Business Law.4

II. Cheah Geok Tuan v Lie Khin Sin

2 The aim of this piece is more modest. Its focus is the judgment of Choo Han Teck J in Cheah Geok Tuan v Lie Khin Sin5 (“Cheah”), where the learned judge prefaces his judgment by asking: “When is an elephant a bird?”6 In so describing the issue of whether a sale and repurchase should be characterised as a loan, he reminds us of what Lord Templeman said in Street v Mountford7 when holding that a grant of “exclusive possession for a term at a rent” is a lease:8

If the agreement satisfied all the requirements of a tenancy, then the agreement produced a tenancy and the parties cannot alter the effect of the agreement by insisting that they only created a licence. The manufacture of a five-pronged implement for manual digging results in

a fork even if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade.

The imagery utilised by Choo J is, however, perhaps more nuanced than the inanimate garden tools utilised by Lord Templeman. Is an elephant considered a bird because it looks like a bird, or because it acts like one?

3 In Cheah, there was in May 2001 a purported sale of shares at $255,000 with a buyback option attached to it. The seller was to repurchase the shares at $297,750 on a stipulated date in August 2001 (which worked out to an additional sum of $15,000 per month, and this was also the rate payable for any extension of the option). The seller also had to pay stamp duties on the transfers of shares. In addition, dividends and bonus shares were to accrue to the seller. Payment for the shares was made to the seller’s husband (for use in his business), and the argument raised in court by the seller and her husband was that this was a third party loan secured on the seller’s shares.

4 The most important point to note is that this was an inter partes dispute, not involving third parties, which arose because the shares were subsequently worth more than the agreed upon redemption amount or repurchase price (which was settled by the seller’s husband and the buyers at a price of $450,000 in September 2004 because the seller and her husband had for almost three years failed to pay the required “interest” or the price for extending the option, after having done so for the first six months after the agreement had come into force). The seller claimed the shares back on the basis that it had agreed to redeem the loan. The buyers, who were father and son (the financing was arranged by the son, and the shares were also transferred into his name) claimed, on the other hand, that the shares were held on trust for an Indonesian financier that had provided the purchase money. Rejecting the last submission,9 Choo J held that the transaction was a loan with interest payable at 20% per annum as permitted by the Moneylenders Act.10 Consequently, the buyers had to deliver up the share scrips to the seller’s husband on payment of the principal plus interest.

5 While it is possible that title to shares can pass back to the seller where payment has been tendered under a repurchase agreement,

perhaps even where it is not specifically enforceable,11 that difficult question did not have to be addressed as Choo J found that the buyers had only extended a loan to the seller and her husband. While not expressly discussed in the case, the parol evidence rule was not an issue as it was clear that the agreement was based on a contract that was both partly oral and partly written.12 In any case, the documentation itself contained terms that were alien to a sale and repurchase. For one, the seller had to pay stamp duties (indeed it was, on the buyers’ instructions, stamped for a much higher amount than the actual transfer value in order to avoid the scrutiny of the tax authorities) and also retained the dividends and bonus issues even though the shares were prior to repurchase registered in the buyer’s name.13 Further, the buyback price and the extra amount payable for extending the option appeared to Choo J very much like monthly interest payments, which was how the parties described it during pre-contractual negotiations.14

6 These inconsistencies were gleaned from the documentation itself, which had been labelled “a purchase of shares with a buyback option”.15 However, Choo J went on to examine other evidence, including post-contractual actions of the parties, particularly the events surrounding how the parties came to settle on the redemption amount in September 2004, which were more than three years after the contract was made. While Choo J stated that post-contractual evidence had no bearing on the nature of the agreement, thus strictly not offending the old principle that such evidence cannot be used to aid the construction of a document, he held that it indicated the state of mind of the parties concerned,16 and this buttressed the characterisation of the transaction as

a loan. Choo J concluded by saying that “[a]n elephant is a bird when it has feathers and can fly”.17

7 While both the agreement and post-contractual evidence of intention here pointed to the transaction being a loan, it is suggested that there is some profit to be gained from examining in greater detail what Staughton LJ referred to in Welsh Development Agency v Export Finance Co Ltd18 (“Exfinco”) as the internal and external routes of characterising a transaction, even if it only serves to confirm Berg’s suspicions, drawn from Spectrum, that there should be no distinction between them.19 There may be instances where the initial appearance and subsequent conduct by the parties do not match, and in those situations post-contractual evidence may do more than simply confirm the parties’ intentions at the time of contracting, particularly where the interests of third parties are involved. Where external concerns are involved, policy considerations would be relevant in determining how a transaction is characterised (such as in the case of the Rent Acts which was often at the heart of the lease/licence debate in England). Some would argue that this is tantamount to a form of (re)characterisation,20 something which Choo J did not have to deal with as Cheah was strictly a two-party case. At the end of this article, we will re-examine two older cases in Singapore where third party interests were at stake, and yet where sale and repurchase agreements were found to be such, even though arguments were raised that they were really secured loans.

III. Internal and external routes to (re)characterisation

8 The problem lies in the use of the language of form and substance. At first blush, it makes sense to say that courts should and can look at the substance of the matter.21 What, however, is this? Are we referring to the parties’ subjective intentions, or what is reflected in the documentation, or the economic function of the transaction, or a court’s objective view of their intentions as played out in their actions? In the

latter case, are we looking at it purely evidentially, as Choo J appeared to do in Cheah or do we more formally recharacterise the transaction because it is a sham or pretence? Further, in the later instance, is the transaction characterised retrospectively, or only varied for the future? As Staughton LJ said in Exfinco:22

The problem is not made any easier by the variety of language that has been used: substance, truth, reality, genuine are good words; disguise, cloak, mask, colourable device, label, form, artificial, sham, stratagems and pretence are ‘bad names’, to adopt the phrase quoted by Dixon J in Palette Shoes Pty Ltd v Krohn(1937) 58 CLR 1 at 28.

9 In Exfinco, the English Court of Appeal expressly said that it was only concerned with the four corners of the agreement, as it was not pleaded that the transaction was in any way a sham. This involved sales by Parrot, an exporter of floppy disks for computers to overseas buyers...

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