LAWS 6018 Principles of Equity & Trusts Coursework Student ID: 1155022236   Undue influence is an important equitable doctrine, the object of which is to prevent the influence of one party over the other from being abused. When the undue influence is established, the court may set aside the transaction and therefore causes commercial uncertainty. It’s important to create a just, clear and effective legal framework of undue influence to balance the interests among lender, borrower and surety. Hong Kong’s legal framework of undue influence generally follows the rules of O’Brien [1994] 1 A.C. 180 and Etridge (No.2) [2001] UKHL 44. General rules in O’Brien Prior to O’Biren, there was much uncertainty as to the rules of undue influence. O’Brien made considerable improvements on this aspect. First, O’Brien confirmed the utility of classification of undue influence. Class 1 is actual undue influence, which is highly fact-intensive. Class 2 is presumed undue influence, which is further divided into Class 2(A) and Class 2(B). In the context of charge, it is always Class 2 undue influence that causes controversy. O’Brien also pointed out that the doctrine of notice lies at the heart of equity and undue influence, as an equitable rule, should also follow the doctrine. In detail, the lender is put on inquiry if the transaction is on its face not to the financial advantage of the party making it and there is a substantial risk of wrong doing [1994] 1 A.C. 180 at 197. To satisfy the inquiry obligation, the lender needs to take steps to bring home to the surety the risk he/she is running and advised to take independent legal advice Ibid.. If the lender is put on inquiry but fails to do that, the court will hold that the lender has constructive notice of the undue influence. Reform and modification in Etridge (No.2) Etridge (No.2) is another significant case in the development of undue influence. It made clear that a three-step test is needed to establish undue influence. First, has the surety proved what is necessary to satisfy the court that the transaction was affected by undue influence [2001] UKHL 44, at [101]? At this stage, the surety needs to prove either there is an actual undue influence or the relationship between surety and borrower falls within Class 2(A). If both of them are negative, the surety should prove the relationship is within Class 2(B), the test of which is modified Ibid, at [14]: The complaint placed trust and confidence in the other party in relation to the management of the complaint’s financial affairs; and There is a transaction which calls for explanation. Second, was the lender put on inquiry? Ibid, at [101] Here, the judge tends to adopt a wider principle – a lender should be put on inquiry in every case where the relationship between the surety and the debtor is non-commercial Ibid, at [87]. Besides, the court also treats a relationship between husband and wife as special. Third, if so, did the lender take reasonable steps to satisfy itself that there was no undue influence? Ibid, at [101] Compared with O’Biren, Etridge (No.2) provided a clearer guidance for the lender to discharge its duty. This approach was basically confirmed by the Hong Kong Courts in Bank of China (Hong Kong) Ltd v Wong King Sing [2002] 1 HKLRD 358. Critical thinking on O’Brien – Etridge principles in HK It seems that O’Biren, Etridge (No.2) and a series of cases have provided a basic legal framework of undue influence. However, there are some issues remain to be interpreted. “Inexplicability” or “manifest disadvantage” The second element to raise the presumption of Class 2(B) in Etridge (No.2) can be summarized as an inexplicability test, which means that there must be a transaction not readily explicable based on the relationship of surety and borrower and therefore calls for explanation. This replaces the previous “manifest disadvantage” test [2001] UKHL 44, at [21-31]. It’s a great improvement because the old test may only be useful in “straightforward transactions such as a substantial gift or a sale at an undervalue” Ibid, at [26]. However, the new test raises new problem – it’s difficult to draw a line between “explicable” and “inexplicable”. The new test is actually comprised of two facets: first, assess the advantage of borrower and the disadvantage of surety; second, whether this transaction is inexplicable or exceed the normal range based on the relationship between the parties. The first limb is very similar with the “manifest disadvantage” test, but it’s just a necessary assessment prior to the second limb. If the court cannot provide a clearer line between explicability and inexplicability, the judge may stop at the first limb. This may revert back to the “manifest disadvantage” test although it is still labeled as “inexplicability” test. Change of bank’s duty to make inquiry Etridge (No.2) largely extended the circumstances where the bank is put on inquiry. 3.2.1 Is it fair and just? The first question after the change of law is that whether it’s fair and just to make the bank to bear such a heavy duty. I think the answer is affirmative. Granting loans and accepting guarantees are the most common business of banks and the working staffs in banks are professionally trained. On the contrary, the individual sureties generally are not well educated on this matter and have very weak bargaining power over the contract terms. Besides, the bank’s duty to inquiry is the most modest burden and is limited by the knowledge of banks. The surety alleging undue influence needs to show that the bank is aware of the non-commercial relationship and the banks don’t have to inquire every surety of his/her relationship with the borrower. This is a proper limitation of bank’s duty. 3.2.2 Application of non-commercial test “Non-commercial” is an inherently imprecise conception and it’s possible that there are more than one kind of connections existing simultaneously between the surety and borrower. This gives rise to the question that how the court can identify the relationship between the parties as commercial. Hong Kong’s position tends to separate the marital relationship from other relationships under Class 2B. For those relationships other than marital, the court needs to determine the overall connection to ascertain the nature of the relationship. Hong Kong court holds that shareholding and directorship of surety in the company which he/she guaranteed will indicate that the relationship between surety and borrower is a commercial one Wing Hang Bank Ltd v Crystal Jet International Ltd & Ors [2002] 3 HKC 279. But it remains unknown whether shareholding and directorship are exclusive categories of commercial relationship. However, if there is a marital relationship, the court holds a different view. According to Etridge (No.2), the banks will always be put on inquiry unless the wife and husband are joint lenders. Besides, even if the spouses are joint lenders, when the bank is aware that the loan is for the husband’s (or wife’s) purposes only, the bank is still put on inquiry. [2001] UKHL 44, at [48] This view was applied by Hong Kong court in Yu Tai Hing Co.Ltd. v Teresa Chueng [2002] HKCU 1018, at [15]. Therefore shareholding and directorship cannot discharge the banks’ duty to make inquiry and the court is reluctant to insert a commercial element in a marital relationship. Can this distinction be justified? A possible argument is that wife is much easier to repose trust and confidence to the husband due to the sexual and emotional ties between them. Therefore, the banks shall always be put on inquiry. However, this argument is not convincing enough if we take the close-knit relationship in a Chinese family into consideration. It’s possible to extend the application of the rules under marital relationship in the future. Reasonable steps for bank to discharge duties When the independent legal advice is indispensible Once the bank is put on inquiry, it must take reasonable steps to satisfy itself that there is no undue influence. The requirement of inquiry varies on the facts. Urging the surety to obtain an independent legal advice is the most common way used by the banks. In most cases, the banks only need to ask the surety to be independently advised. However, both O’Brien and Etridge (No.2) provide that in some special circumstances, the bank should ensure that the surety is actually independently advised. In O’Brien, the judge said “I would not exclude exceptional cases where a creditor has knowledge of further facts which render the presence of undue influence not only possible but probable” [1994] 1 A.C. 180, at 198. In Etridge (No.2), the judge said that “in exceptional cases the bank, to be safe, has to insist that the wife is separately advised” [2001] UKHL 44, at[50]. The wordings are ambiguous and worry the banks. In Credit Lyonnais v Burch [1997] 1 ALL ER 144, an employee agreed to give an unlimited guarantee over her house to the company. The English court held that the transaction was so manifestly to Miss Burch’s disadvantage that the bank should have ensured she sought independent advice. In Yie Yieh Commercial Bank Ltd v Hung Oi Wah [2009] HKEC 1775, which is a HK case, a similar situation arose but the court distinguished the Burch case on the basis that the bank was not put on inquiry. It seems that Hong Kong court needs to provide more guidance on this matter. A sentence from Bank of China (Hong Kong) Ltd v Wong King Sing may be helpful: “the type and weight of evidence needed to rebut the presumption will obviously depend on the presumption itself” [2002] 1 HKLRD 358, at[56]. This may take us back to the first step of the Etridge’s test. Will an extreme inexplicability of transaction indicate that the bank should ensure the independent advice is obtained? Is there any other ground that puts the bank on such position? The answers remain unknown. The independence of solicitors Etridge (No.2) provided very detailed guidelines for the solicitors. The judge emphasized the role of the solicitor is to act under his retainer to explain the document to the surety and the risks he/she is taking. If the solicitor considers the transaction is not in the surety’s best interest, the solicitor only needs to provide a reasoned advice. It is the surety who finally makes the decision whether to proceed [2001] UKHL 44, at [61]. In practice, the crucial question arises when a solicitor acts for the husband and wife at the same time. Can wife as a surety seek “independent” advice from the solicitor in this situation? The court tends to give an affirmative answer. However, according to the Etridge (No.2), the central idea of this reasoning is that “when accepting instructions to advise the wife, the solicitor assumes responsibilities directly to her, both at law and professionally” Ibid, at [74]. It seems that the independence of the solicitor will solely depend on the solicitor’s personal integrity of profession. There is a high risk that the solicitor might not act impartially. Besides, the current position may breach the basic idea of independence, which means that the person should be free from any taint of the relationship, or of the consideration of interest which would affect the act. I’m doubtful on the choice of the court. Conclusion Hong Kong’s position of undue influence is built on the structure of O’Brien and Etridge (No.2). A series of domestic cases make these rules more applicable under domestic situations. It is reasonable to say that the legal structure of the undue influence in Hong Kong is generally complete. Besides, throughout these cases, we can always find courts carefully balancing the interests among the relevant parties. However, there are always some issues in the practice call for further explanations. I believe that these issues will be properly discussed by the court in the future. (Word count: 1988)  Bibliography Cases Barclays Bank Plc v O’Brien and Another [1994] 1 A.C. 180 Bank of China (Hong Kong) Ltd v Wong King Sing [2002] 1 HKLRD 358 Credit Lyonnais v Burch [1997] 1 ALL ER 144 Royal Bank of Scotland v. Etridge (No.2) [2001] UKHL 44 Wing Hang Bank Ltd v Crystal Jet International Ltd & Ors [2002] 3 HKC 279 Yu Tai Hing Co.Ltd. v Teresa Chueng [2002] HKCU 1018 Yie Yieh Commercial Bank Ltd v Hung Oi Wah [2009] HKEC 1775 Student ID: 1155022236 Student ID: 1155022236 Student ID: 1155022236 Student ID: 1155022236 ? 1 3