The Principle of Reality

In the November issue of this journal last year, the decision of the Court of Appeal in Penny’s Bay Investment Co Ltd v Director of Lands (Unreported CACV 115/2015, 19 May 2016) was discussed. The decision has now been overturned by the Court of Final Appeal, in respect of the subject valuation issue (Penny’s Bay Investment Co Ltd v Director of Lands, Unreported, FACV 1/ 2017,16 October 2017).

It will be recalled that the litigation concerns compensation for the acquisition of a sea access (or marine rights, as the subject matter has been described in the various proceedings). Compensation became payable when an authorisation for a proposal to reclaim an area at Penny’s Bay, including the sea access, was gazetted. (The date was 5 May 1995, which is also the date of valuation.) The reclamation was originally intended to provide land for the construction of two container terminals. But the container terminal project never got off the ground. Eventually the reclaimed land became part of the Disneyland site.

In an earlier decision the Court of Final Appeal had held that the measure of the compensation is the difference in the values of the adjoining land with and without the sea access (“the first CFA decision”). In all the relevant proceedings those values have been referred to as the before value and after value.

The Lands Tribunal decision

In Penny’s Bay the failed container terminal project has implications for the valuation exercise. The project would have been accompanied by a road scheme, providing vehicular access to the land. This in turn would have made possible development of the land for industrial use, as opposed to use as a shipyard or midstream site. The former use was liable to produce a larger valuation figure in respect of the land.

The specific matter, the villain of the piece, in relation to the container terminal project which has divided the parties concerns the market expectations, at the date of valuation, as to the likelihood of its implementation. Insofar as the before value was concerned, the Lands Tribunal took the view that there was a 50 percent chance that the project might not materialise, a consideration which the notional purchaser of the land in the hypothetical open market sale would take into account. The before value assessed on the basis of industrial use was reduced accordingly to reflect the uncertainty as to whether the container terminal project would be implemented.

In relation to the after value, however, the Lands Tribunal was satisfied that as at the date of valuation, it was certain that reclamation would take place, following which the Government would be sure to proceed with the construction of the container terminals. This in turn guaranteed that the land would be able to be used industrial purposes. The result was a substantial after value, with no discount being made to reflect any uncertainty as to the implementation of the container terminal project, and a corresponding diminution in the amount found to be due to the land owner for the loss of the sea access.

The decision of the Court of Appeal

The Court of Appeal disagreed with the Lands Tribunal on the question of whether the container terminal project was certain to proceed. It agreed with the Director of Lands that there was an assumption required under the first CFA decision that, at the valuation date, reclamation of the sea access had been completed. But this assumption had no valuation implication. “[T]his is only a legal assumption to give effect to the accrual of the right to lodge a claim…It does not follow that this legal assumption would affect the expectation in the hypothetical sales.” (Penny’s Bay Investment Co. Ltd v Director of Lands, Unreported, CACV 115/2015, paragraph 73.) The Lands Tribunal had found, in respect of the before value, that there was a 50 percent possibility that the container terminal project would come to pass. The Court of Appeal held that there was no basis, in finding the after value, for a different assessment as to the expectations in the market of the likelihood of the implementation of the project:

“75. … [The land] is to be valued by reference to the same prevailing market conditions (instead of market conditions at 2 different points in time, one “Before” and the other “After” the reclamation). The only difference which [the first CFA decision] postulated is that one valuation must proceed on the basis that the land has marine rights whilst the other valuation shall proceed on the basis that the land does not have any marine rights…

76. In principle, with the same prevailing market conditions, the expectation in the market on potential future use of the land should be the same. Further, since the existence and impact of such expectation is a matter of evidence, it should not be affected by the legal assumption of reclamation having taken place when in reality it has not.”

The valuation issue

The Court of Final Appeal identified as the key question for determination whether the Lands Tribunal was right to assume that, as at the date of valuation, reclamation was certain to take place. It accepted that, if the assumption was upheld, the Lands Tribunal would have been entitled to find (as it did) that the container terminal project was bound to go ahead (and that the land would accordingly be able to be used for industrial purposes).

On the fact of it the approach of Lands Tribunal involved an inconsistency. It had found as a fact, in finding the before value, that on the date of valuation the market would consider that the chances of the container terminal project being implemented were equal. Yet in finding the after value it concluded that the implementation of the project was certain (and that the market would so assume). Its valuation of the after value involved the making of an artificial assumption, namely that, as at the date of valuation, the reclamation would definitely proceed.

In contrast, the approach of the Court of Appeal did not involve making any such assumption. No artificial assumption was made as to whether, as at the valuation date, the reclamation had been or would be carried out. The approach of the Court of Appeal “involves making no assumption which departs from reality, because it requires one to value on the basis that the Land, in terms of its physical state and its prospects, is as it was on the date of valuation without the Marine Rights…” (per Lord Neuberger, at paragraph 81) Lord Neuberger, with whom the other judges agreed, added

“It can fairly be said in this case that there is no logical reason why the assumption that the Marine Rights have been lost should require a person valuing on that assumption to search for or identify a reason why they have been lost, namely the Reclamation. Further, there is no practical reason requiring such a valuer to do so…one simply values on the basis that they have been lost.” (paragraph 83)

But in the event Lord Neuberger found that the Lands Tribunal was right to take into account the reason for the loss of the sea access, and value the land on that basis for its after value. In the circumstances of the present case, the modest departure from reality was justified. It was necessary in order to produce “a fair and reasonable result” (paragraph 88). Noting the difficulty of the issue in question, Lord Neuberger comes down on the side of the Lands Tribunal:-

“88. If one is carrying out a valuation assuming (as one must in the present case for the purposes of the after valuation) that any marine rights have been lost, it is, at the very least, not unreasonable, to consider why they have been lost, and then to take into account any valuation implications which naturally flow from that reason…

89. …given that relevant marine rights are to be treated as irretrievably lost, de facto as well as de jure, on publication of the authorisation, it can be said to be logically consistent to make the assumption that the cause of the loss, namely the reclamation, will undoubtedly proceed. Further, the assumption is a relatively mild departure from reality… A variant of the reality principle which seems to me to be applicable is that, if there is a departure from reality, it should be kept to a reasonable minimum. In this case, if a departure is appropriate, it is unnecessary to go further than assuming that the Reclamation will occur...”

Penny’s Bay gives valuable guidance to the valuer on the application of the principle of reality. Whereas circumstances of individual cases differ, in valuation for compensation the goal should always be to arrive at a fair and just result. The principle of equivalence asks of the same. In Penny’s Bay the departure from reality was limited. It allows for an assumption that, as at the date of valuation, reclamation was certain to happen. The assumption enables the valuer to take into account the benefit which, in the world without the sea access, would have accrued to the land on account of the implementation of the container terminal project. “[T]here is obvious force in the argument that, all other things being equal, if a development scheme on neighbouring property has both beneficial and detrimental effects on a person’s land, it would be wrong for that person to be able to claim compensation for the diminution in value attributable to the detrimental effect without having to take into account the increase in value attributable to the beneficial effect.” (per Lord Neuberger at paragraph 87) Strict adherence to the principle of reality would have risked over-compensating the Applicant.

It follows also that in the present context betterment is to be taken into account. In Penny’s Bay, two English authorities (Senior v The Metropolitan Railway Co (1863) 2 H & C 258 and Eagle v The Charing Cross Railway Company [1867] LR 2 CP 638) which appear to suggest otherwise were held not to support the proposition for which they are cited in a leading reference work.

Penny’s Bay has been a marathon of a litigation. The extinction of the marine rights in question happened more than twenty years ago. At the end of his judgment, Lord Neuberger pointed out that the present proceedings have been “going on for an unconscionable period” and directed the parties and their legal advisers to achieve a final outcome “as quickly and cheaply as is consistent with justice”. This observation, together with the rest of his judgment, is certain to be applauded by practitioners in Hong Kong.


Fortune Chambers, Barrister

Clemence Yeung is a practising barrister. He has authored a book on the law of unjust enrichment in Hong Kong and was a contributor to a practitioner’s volume on Hong Kong maritime law. He has presented professional seminars covering a variety of practice areas, including documentary credits, cross-border injunctions, land compensation and private international law.