Hong Kong Court refuses to recognise arbitral award on public policy ground

17 December 2018, Construction, by Kwok Kit Cheung,

In the recent case of Z v Y [2018] HKCFI 2342, Hong Kong’s Court of First Instance (CFI) held that recognition of an arbitral award (Award) of the China Guangzhou Arbitration Commission (Commission) should be refused under section 95 (3) (b) of the Arbitration Ordinance (Cap 609) because it would be contrary to public policy to enforce the Award in Hong Kong, when there were valid grounds to claim that the guarantee (on which the claim in the arbitration was based) secured obligations under contracts tainted by illegality. It held that the arbitral tribunal had failed to give adequate reasons as to why it accepted the guarantee to be valid and legally enforceable. The tribunal’s failure to explain adequately why it upheld the validity of the guarantee also cast doubt, the Court said, on its acceptance of the existence of a valid and binding arbitration agreement in the guarantee.

Background 

The CFI granted the Applicant leave to enforce the Award in Hong Kong. The Respondent then applied, under section 95 of the Arbitration Ordinance (Cap 609) to set aside the order granting such leave on the grounds that:

(1)     the guarantee was void and invalid under both PRC and Hong Kong law for illegality;

(2)     there was no arbitration agreement;

(3)     she was not given proper notice or opportunity to appoint her arbitrator to the tribunal;

(4)     she was under incapacity as a party to the arbitration agreement;

Court’s Decision

The Court allowed the Respondent’s application and held as follows.

Illegality ground

The Applicant’s claims against the Respondent in the arbitration were made on the basis of a guarantee under which the Respondent guaranteed payment of a debt allegedly due to the Applicant by a Mainland company (HD).The debt was said to be due by HD to the Applicant under supply contracts. The Respondent’s case was that there were sham arrangements and loan arrangements disguised as supply contracts, which contravened PRC laws and constituted the criminal offence of “fraudulent contracts” and that the guarantee was void and invalid under both PRC and Hong Kong law.

The Court said that on a careful review of the Award it was unclear whether the tribunal had thoroughly considered the issues of illegality raised by the Respondent, such that the Court had serious reservations as to the reasons given by the tribunal as to why the Respondent’s claims were dismissed. The Respondent’s claims as to sham transactions were credible and supported by evidence, the Court said, and should be thoroughly considered by the tribunal, and the dismissal of such claims adequately explained. The reasons may be short, the Court said, as long as the factual and legal basis were explained and the reasoning expressed, to enable the parties to understand how, and why, a finding was made on a material issue, and how a conclusion was reached by the tribunal. 

The Court said that the tribunal had failed to give any adequate reason as to why it had concluded that the Respondent’s claim of illegality of the underlying debt had not been established. The important issue of whether the underlying debt was illegal and unenforceable under PRC law, so as to render the guarantee void and unenforceable against the Respondent, was not addressed in the Award with adequate reasons, and it would offend the Court’s notions of fairness and justice to enforce the Award when it might be tainted by illegality, and when a significant issue brought before the tribunal for determination had not been seen to be properly considered and determined, contrary to the parties’ legitimate and reasonable expectations.

No arbitration agreement ground

The Respondent claimed that there was no binding arbitration agreement since the arbitration clause in the guarantee was vague and uncertain, providing only that parties “may” apply to the Commission for arbitration. The Court rejected this argument. It said that the word “may” conferred on the parties the option of submitting the dispute to binding arbitration and that if a party chose to exercise such option, the other party would be bound to accept the reference.  There was no evidence on PRC law to suggest that the contrary should be the position.

The Respondent also claimed that the guarantee was not signed by the Applicant, and there was no evidence that the Applicant had agreed to the document, or become a party to the guarantee and arbitration agreement. The Court said that under Hong Kong law it was arguable that the guarantee and arbitration agreement was not concluded in law, such as to render the Applicant a party to the guarantee and arbitration agreement. The guarantee was expressed to be governed by PRC law. However, the question of the validity of the guarantee under PRC law was not addressed in the Award and no reason was given to support the tribunal’s finding that there was a valid guarantee under PRC law, apart from the fact that it was signed by the Respondent as a person with legal capacity and that it did not contravene any law and should be enforced. This was distinct, the Court said, from whether the Applicant had become a party to the agreement evidenced by the guarantee.

No proper notice ground

This Court rejected the Respondent’s claim that she was not given proper notice of the appointment of arbitrators. If there was a valid arbitration agreement, the parties had agreed to submit to arbitration by the Commission and to be bound by the China Guangzhou Arbitration Commission Arbitration Rules (Rules), the Court said. Pursuant to those Rules, the Commission had delivered to the Respondent the notice of arbitration, a copy of the Rules and list of arbitrators. Under Rule 94 (1), a party to the arbitration has to appoint its arbitrator within 20 days from its receipt of the Commission’s notice of acceptance of the arbitration. The Applicant appointed its arbitrator to the panel, but the Respondent failed to make her appointment, whereupon the Commission proceeded, in accordance with Rule 94 (2), to appoint the arbitrator for her as well as the 3rd arbitrator. The Commission later notified the Respondent that the substance of her jurisdiction challenge would be dealt with by the tribunal, and the tribunal decided to deal with that in the Award - all as permitted under the Rules. The Respondent’s failure to comply with the Rules in appointing her choice of arbitrator, whether by virtue of her own ignorance or misunderstanding of the Rules, or as a result of the conscious decision of herself or her legal advisers, was no ground, the Court said, to complain of the Commission’s appointment of arbitrators in accordance with its powers under the Rules.

Incapacity ground 

The Respondent had only been able to adduce evidence of having been diagnosed with “severe depression”, which was inadequate, the Court said, to support her assertion that at the time she signed the guarantee, she did not have the necessary mental capacity to understand the nature of her acts and documents she signed, or to enter into a legally binding contract. She had not discharged her burden of showing that the guarantee was not signed by her, that she did not know what she had signed, or that she lacked mental capacity as a result of her alleged depression at the relevant time. 

Comment 

Enforcement of PRC arbitration awards may only be refused on the exhaustive grounds listed in section 95 of the Arbitration Ordinance. 

Under section 95(3)(b), enforcement of a Mainland award may be refused if it would be contrary to public policy to enforce the award. “Contrary to public policy” means something so “shocking to the court’s conscience” or “offensive to our notions of justice and morality” or, in terms of an arbitration process, conduct on the part of a tribunal that is “serious, even egregious”; this is said to be a stringent test to be sparingly applied. This judgment shows that where arbitral awards are based on contracts where illegality is alleged, the Hong Kong Court will expect the tribunal to have given adequate reasons for finding no such illegality, before allowing the arbitral award to be enforced in Hong Kong.