Hong Kong court refuses to enforce mainland arbitral award in a rare decision - Talking Point Asia January 2022

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In a significant decision, a Hong Kong court has set aside an earlier ex parte court order granting leave to enforce an arbitralarbitralds award made by a PRC arbitral body in the sum of RMB 59 million (HK$72 million). The judge considered that the underlying contract was entered into without authority to advance the interests of an officer of the company rather than the interests of the company. The court observed that it would be "shocking to the conscience of the Court" to permit the award to be enforced and that the whole arbitral process had been misused.

Background

In 廣東順德展煒商貿有限公司 v Sun Fung Timber Co Ltd [2021] HKCFI 3823, the respondent, a Hong Kong company that carried on a timber retail business (the company), applied to set aside an earlier court order granting leave to the applicant (GD), a company incorporated in the mainland, to enforce an arbitral award made by the Zhanjiang Arbitration Commission for payment by the company to GD in the sum of RMB59 million with costs (the award).

The award was made in an arbitration commenced by GD against the company on the basis of the company's breach of a contract for the sale of marble by the company to GD dated 14 April 2017.

This was a family dispute - the directors of the company were a Mr. Tsang and a Mr. Lee and their wives were sisters. By late 2016, the family members were in disagreement and the company started to wind down its operations. Mr. Lee and Mr. Tsang had talks regarding a possible sale of the company's premises in Central which also served as the company's registered office address. The court acknowledged that the family nature of the dispute should be considered as part of the context and background.

As events unfolded, what appeared to be a straightforward contractual dispute turned out to involve an allegedly fraudulent scheme devised by Mr. Tsang (who owned fifty per cent of the company) in collusion with GD, to strip the company of its assets to the detriment of the other shareholder, a company known as NI which was majority owned by Mr. Lee.

Mr. Lee and NI were only made aware of the contract, the arbitration and the award in January 2018 when NI was notified by the Official Receiver of the winding-up proceedings commenced by GD against the company.

Finding of a sham / collusion

The court accepted the submission that claims of fraud must be proved by cogent evidence and that inferences of dishonesty must be found in primary facts. It also pointed out that in proving fraud or dishonesty, that when establishing a case based on inference from circumstantial evidence, "the whole is greater than the individual parts" - in other words, it does not matter if the facts on their own do not prove fraud as long as such an inference can be drawn from an accumulation of the facts.

The court considered there were many unusual features in the transaction and the terms were onerous. Some of the factors relied upon in coming to that conclusion were:

  • The contract sum was RMB 20 million, which was 62 times larger than the company's entire sales revenue in 2015.
  • The company maintained less than HK$12,000 in cash and bank balances over the years and therefore had no financial resources to purchase the massive quantity of the marble to be supplied under the contract.
  • GD's contractual obligation to pay a deposit was discharged by a mere deposit of a cheque which was never banked in or cashed.
  • The contract required the delivery of marble within 6 days of the contract, failing which a penalty of RMB 2.2 million per day would apply.

The court also noted that GD was incorporated only three months before the date of the contract and that Mr. Tsang had admitted the company's breach of contract and agreed to pay substantial sums in damages without ever informing NI or Mr. Lee.

Refusal of enforcement

The court set aside the enforcement order on the following grounds based on section 95 of the Arbitration Ordinance (Cap. 609):

  • The arbitration agreement was not valid under Hong Kong law

Section 95(2)(b) provides that a mainland award may be refused if the arbitration agreement was not valid under the law to which the parties subjected it or, in the absence of the stipulated governing law of the arbitration agreement, under the law of the mainland.

The court accepted that the contract was never authorised by the company's board and also found that Mr. Tsang, described as the de facto managing director of the company) had no actual, implied or apparent authority under Hong Kong law to enter into the contract and that he had not acted in good faith. The contract was therefore invalid and the arbitration agreement unenforceable.

  • No proper notice of the arbitral proceedings

Section 95(2)(c) provides that enforcement of a mainland award may be refused if the party against whom enforcement is sought was not given proper notice of the appointment of the arbitrator or of the arbitral proceedings, or was otherwise unable to present his case. It was clear that Mr. Lee and NI and never been given any notice of the arbitration and that the company was unable to present its case.

The court having already found that Mr. Tsang was not acting in good faith, it could not be said to have any implied or usual authority to bind the company by his conduct of the arbitration.

  • Contrary to public policy

Section 95(3)(b) allows the refusal of enforcement of a mainland award if this would be contrary to public policy. The court considered that the arbitral process had been misused, and that it would be contrary to the public policy of Hong Kong to permit enforcement .

Conclusion

It is rare for the Hong Kong courts to refuse to enforce arbitral awards. This decision serves as a reminder that the court will have no hesitation in refusing the enforcement of an arbitral award obtained by fraud or as part of a fraudulent scheme and that the enforcement of such an award will be contrary to the public policy of Hong Kong.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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