Legal update 5 February 2025

Hong Kong: Implied due diligence terms in share sale and purchase agreement of property holding company

Hong Kong real estate practitioners should be familiar with certain implied terms in the sale and purchase agreement of immovable property – namely terms that contracting parties and the court would readily agree should be implied, even if not expressly written out in the agreement.

But in the context of the sale and purchase agreement of shares in a property holding company, the legal position is less certain.

In a recent District Court judgment in Tang Yang v Qiu Shichang (12/12/2024, DCCJ2922/2022) [2024] HKDC 2086 (“Judgment”), the court held that reasonable satisfactory result of due diligence review is an implied term of the share sale and purchase agreement – and breaching it could entitle the innocent party to terminate the transaction.

Judgment summary

The defendant (“Vendor”) was the sole shareholder of a BVI company (“Company”) which in turn was the registered owner of a flat and parking space in Tuen Mun, New Territories. The Vendor entered into a provisional sale and purchase agreement (“Agreement”) with the plaintiff (“Purchaser”) relating to shares in the Company.

The Agreement was in a pre-printed form prepared by an estate agent and did not mention anything about due diligence review of the business, financial and legal aspects of the Company.

Shortly after the date of the Agreement, the Purchaser’s solicitors requested the Vendor’s solicitors for various documents and information of the Company for due diligence review.

The Vendor and the Purchaser did not enter into any formal agreement after the Agreement. The transaction proceeded on the basis of the Agreement.

The Vendor’s solicitors did not provide any accounting documents of the Company to the Purchaser’s solicitors until two days after the scheduled completion date. Only management accounts of the Company were provided to the Purchaser’s solicitors.

The management accounts revealed that the Company had received income from renting out the flat and parking space. Therefore, the Company ought to (a) have applied for a Business Registration Certificate, (b) have registered as a non-Hong Kong company with the Companies Registry, and (c) have prepared tax computation for submission to the Inland Revenue Department.

The Vendor and the Purchaser eventually did not complete the transaction. The Purchaser’s solicitors wrote to the Vendor’s solicitors alleging breach of the Agreement by the Vendor and demanding for refund of deposits and payment of liquidated damages.

However the Vendor’s solicitors argued that the Purchaser was in wrongful repudiation of the Agreement and the Purchaser’s deposits were forfeited.

Purchaser’s contractual right to terminate

The Purchaser’s primary case was that the Vendor was in breach of clauses 5(e) and (f) of the Agreement, namely:

(e) The Vendor warrants and undertakes to the Purchaser that on completion, the Company shall not be liable to any debt commitment, or involved in any legal proceedings or dispute in tax liability, or violate any law or any rule or regulation of any governmental body affecting any of the Company.

(f) The Vendor warrants and undertakes to the Purchaser that the Company has always been in compliance to supply all its relevant records and document to any competent authority as required by the current legislation, rule and regulation.

The Vendor conceded being in breach of clauses 5(e) and (f) of the Agreement, but argued that clause 5 was a “warranty“; and breach of it would entitle the Purchaser only to compensation (as opposed to breach of a “condition” which would give the right to terminate the Agreement).

The court ruled that the Purchaser was entitled to rely on clause 8 to terminate the Agreement.

Clause 8 reads:

8. Should the Vendor fail to complete the sale and purchase of the shares of the Company in accordance with the Agreement, the Vendor shall immediately compensate the Purchaser with a refund of the deposits together with a sum equivalent to the amount of the initial deposit as liquidated damages …

Note, however, that earlier, in Man Wing Fun Stephen and Another v Ho Ching Yee Susanna (25/02/1999, HCA3724/1997), the court examined a clause in a provisional sale and purchase agreement of immovable property which was similar to clause 8 of this present Agreement, and held that:

The word “complete” would not just include the act of the execution of the assignment and the payment of the balance of the purchase money, but may include any other act which the parties had agreed to do before to complete the sale.11

Drawing analogy from this earlier case, the court in the present case ruled that the words “complete” in clause 8 were not limited to business usually transacted on the completion date, such as signing of bought and sold notes or instrument of transfer.

It included acts the parties agreed to before completing the sale of shares of the Company.

The “warranty” or “intermediate” term

On the point whether clause 5 was a “warranty“, as contended by the Vendor, the court took a different view and ruled it was an “intermediate” term; noting that traditional categorisation of a term as “warranty” or “condition” is of reduced significance nowadays, and the court is more likely to classify a term as “intermediate“.

The remedy to breach of an “intermediate” term depends on the nature and consequences of the breach, where trivial breach may be compensated by money and fundamental breach may undermine the whole contract.22

The court accepted the Purchaser’s submission that the Vendor’s breach of clause 5 was serious and persistent for years – which undermined the entire Agreement – and ruled that the Purchaser was entitled to terminate the Agreement.

Implied terms

The Purchaser’s alternative case was that the Vendor was in breach of the following terms implied into the Agreement (“Implied Terms”):

(a) Within a reasonable time before the completion date, the Defendant (as vendor) should provide the Plaintiff (as purchaser) with the necessary information and/or documents required for the purposes of financial due diligence to ensure that the compliance of the warranties in clause 5 of the Agreement; and

(b) The parties shall only proceed to completion after the Plaintiff communicated to the Defendant its reasonable satisfaction with the result of due diligence.

While it was not necessary to decide on the Implied Terms to dispose of the case, the court proceeded to consider whether the Agreement contained the Implied Terms.

The court set out these applicable legal principles for a term to be implied into a contract:

(a) It must be reasonable and equitable;

(b) It must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;

(c) It must be so obvious that “it goes without saying”;

(d) It must be capable of clear expression;

(e) It must not contradict any express term of the contract.33

The Purchaser argued that the Implied Terms were necessary to effect the parties’ reasonable contemplation that certain scope/extent of due diligence exercise has to be carried out within a reasonable time – to enable the Purchaser to ascertain the business, financial and legal aspects of the Company, and the Vendor’s representation in clauses 5(e) and (f) of the Agreement – before proceeding to completion.

The Vendor referred to another case of High Route Ltd v Wong Chung Kai (12/01/2024, HCA320/2019) [2024] HKCFI 75 to support his argument that there were no Implied Terms in the Agreement. In that case,

  1. The vendor and purchaser entered into a provisional sale and purchase agreement of the shares in a property holding company.
  2. The parties only started to negotiate the scope and extent of the due diligence exercise in the draft formal agreement, which suggested that when the provisional agreement was signed, the scope and extent of the due diligence exercise had to be further negotiated.
  3. The transaction fell through because the purchaser was not satisfied with the due diligence investigation on the company.
  4. The purchaser argued that there were implied terms in the provisional agreement to the effect that the purchaser was entitled to carry out due diligence investigation on the business, financial and legal aspects of the company, and completion was conditional upon the purchaser having completed its due diligence investigation on all aspects of the company and was satisfied with the results thereof.
  5. The implied terms were rejected by the court for a number of reasons, including that the implied terms were too wide and not subject to any reasonableness test; whether due diligence was satisfied was to be decided subjectively by the purchaser alone; and no time limit as to when due diligence was completed.

The court considered that High Route was distinguishable because the facts differed from the present case:

  • [T]he Implied Terms proposed by the [Purchaser] are subject to the test of reasonableness in that the completion is subject to the [Purchaser’s] reasonable satisfaction with the result of due diligence.44 The Purchaser must act reasonably and could not walk away from the transaction by simply alleging dissatisfaction with the due diligence.
  • The Vendor and Purchaser “had no difficulty in understanding the scope and extent of the due diligence since the beginning.55 There was no objection from the Vendor’s solicitors when the Purchaser’s solicitors requested documents and information of the Company for due diligence review.
  • There was also no objection from the Vendor’s solicitors when the Purchaser’s solicitors wrote to them in email that the Purchaser was ready and willing to proceed with the sale and purchase subject to satisfactory due diligence.

Accordingly, the court ruled that the Agreement contained the Implied Terms; that the Implied Terms were “intermediate” terms; that the Vendor’s breach of the Implied Terms was so fundamental that it undermined the whole Agreement; and that the Purchaser was entitled to terminate the Agreement.

Conclusion

The Judgment illustrates that in the context of sale and purchase of shares in a property holding company, it is possible that the court would fill in the missing terms on due diligence review if the provisional sale and purchase agreement is silent on this point.

However, as the diverse results that the Judgment and the case of High Route show, whether the terms would be implied depends on several factors.

These include the reasonableness of the terms to be implied; the express provisions of the provisional agreement; and the conduct of the parties and their respective solicitors during the transaction.

To avoid potential dispute, it is advisable to state expressly in the provisional agreement what the parties contemplate regarding due diligence review – and seek professional advice at early stage of the transaction.

Remarks/Footnotes
  1. Paragraph 32 of the judgment of Man Wing Fun Stephen and Another v. Ho Ching Yee Susanna (25/02/1999, HCA3724/1997).
  2. Paragraph 57 of the Judgment.
  3. Paragraph 64 of the Judgment. These 5 conditions were adopted by Bokhary PJ in Kensland Realty Ltd. v. Whale View Investment Ltd. and Another (10/12/2001, FACV10/2001) (2001) 4 HKCFAR 381, [2002] 1 HKLRD 87; and supplemented by 6 comments of Lord Neuberger in Marks and Spencer pls v BNP Paribas Securities Service Trust Co (Jersey) Ltd [2016] AC 742.
  4. Paragraph 74 of the Judgment.
  5. Paragraph 74 of the Judgment.
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