HONG KONG COURT REMITS AWARDS TO ARBITRATOR FOLLOWING CHANGE IN LAW OF ILLEGALITY DEFENCE

The Hong Kong Court of First Instance (“CFI”) has suspended set-aside proceedings in respect of two HKIAC awards on liability and quantum and remitted the matter to the arbitrator (G v. N [2023] HKCFI 3366).

The decision centred on the arbitrator's denial of relief to the claimant due to the illegality of the underlying transaction, based on English authority which had ceased to be good law in Hong Kong only a few days before the arbitrator's decision.

Mimmie Chan J emphasised that any error of law on the issue of illegality was not subject to review, but that the court had the power and duty to consider whether the denial of relief to the claimant rendered the awards contrary to the public policy of Hong Kong "as at today".

Although the judge accepted that the claimant had a good arguable case that the awards should be set aside on that basis, she declined to express a final view.  Instead, she decided that it would be more appropriate to remit the matter to the arbitrator in order to provide him with the opportunity to resume the arbitral proceedings, consider the most recent authority and take such action as in his opinion would eliminate any grounds for setting aside the awards.

The underlying transaction

G was a shareholder in N, a British Virgin Islands (“BVI”) entity listed on the New York Stock Exchange.  G and N agreed a securities purchase agreement (“SPA”) for a “PIPE” (private investment in public equity) placement of additional shares which would increase G’s shareholding from approximately 23.9% to 43.9% in return for consideration of approximately US$147 million.  The SPA was governed by Hong Kong law and contained an HKIAC arbitration clause.

The placement gave N’s largest shareholder and its supporters sufficient votes to defeat a requisition for a shareholder meeting by IsZo Capital LP (“IZ”), an American investment fund which had lost confidence in the board of G and wished to change its composition.

The BVI decision on illegality

IZ successfully obtained a judgment from the BVI Commercial Court setting aside the placement on the basis that it was not in the interests of N, in breach of section 121 of the BVI Business Companies Act.  The BVI Court of Appeal upheld this decision in material part.

The BVI courts acknowledged that G would “in principle” be entitled to, or be expected to have, a claim to repayment of the consideration monies from N.

The arbitration

G commenced arbitration against N pursuant to the HKIAC arbitration clause in the SPA, seeking restitution of the consideration monies.  Shortly after the commencement of the arbitration, G applied to the arbitrator for, and was granted, an interim preservation order restraining N from disposing of approximately US$90 million of the consideration monies held in a Hong Kong bank account in the name of a subsidiary of N.  The CFI subsequently granted leave to enforce the interim preservation order as an order of the court.

In its defence, N argued that G should not be permitted to recover the consideration monies because the placement was illegal and in reliance on the principle of unclean hands.  N also advanced a counterclaim based on unlawful act conspiracy and dishonest assistance.

The arbitrator issued: (i) a first partial award on liability in which he applied the English case of Tinsley v. Milligan [1994] 1 AC 340 in finding that the placement was illegal and dismissing G's claims, whilst at the same time upholding N’s counterclaims; and (ii) a second partial award on quantum in which he awarded N approximately US$13 million plus interest and costs.

The effect of the awards was that N was able to both retain the US$147 million consideration paid to it by G, and to recover damages of US$13 million from G.

The change in the law

Only a few days before the handing down of the award on liability, Hong Kong law in relation to the illegality defence had changed as a result of the decision of the Hong Kong Court of Appeal in Monat Investment [2023] HKCA 479.

Previously, Hong Kong had followed the "reliance" approach set down by the House of Lords in Tinsley (the case applied by the arbitrator), pursuant to which a claimant would generally be denied a remedy if it had to rely directly on unlawful conduct to succeed.

In Monat, the Court of Appeal followed the UK Supreme Court decision in Patel v. Mirza [2016] UKSC 42 in applying the "range of factors" approach, which requires that, in deciding whether to allow or deny a claim involving an illegal act, the court should: (i) consider the underlying purpose of the prohibition which has been transgressed; (ii) conversely, consider any other relevant public policies which may be rendered ineffective or less effective by the denial of the claim; and (iii) keep in mind the possibility of overkill unless the law is applied with a due sense of proportionality.

The set-aside application

G applied to the CFI seeking the setting-aside of the awards, or alternatively the remission of the matter to the arbitrator, as well as the continuation of the effect of the preservation order granted by the arbitrator and previously recognised by the court.

The first ground for G's application (directed at the arbitrator's findings on G's claims) was that the awards were premised on an incorrect understanding of Hong Kong's public policy (the "public policy ground").  G emphasised that it was not seeking to challenge the awards on the ground of any error of law, but rather on the basis that the arbitrator's decision to deny relief to G was wholly disproportionate and had produced such a harsh and manifestly unjust result that it would be contrary to public policy to enforce the awards.

The second ground for G's application (directed at the arbitrator's findings on N's counterclaim) was that the awards contained decisions on matters beyond the scope of the submission to arbitration, and that the procedure was not in accordance with the parties' agreement (the "lack of authority ground").  G relied in this regard on a clause of the arbitration agreement which provided that the arbitrators "shall have no authority to award consequential, special or punitive damages", contending that this constituted a limitation on the tribunal's authority (and not merely on the available remedies).  Since N's counterclaim sought "consequential, special or punitive damages", G contended that the tribunal therefore had no authority to make an award in favour of N.

Decision of the CFI

The court's decision to remit the award on the basis of the public policy ground reflected the following reasoning:

1. The question of illegality involves two distinct stages. The first is to decide whether there is any illegality in law, based upon an application of the law to the tribunal's factual findings.  The second is to determine the consequences of any illegality found.
2. The Privy Council had made clear in Betamax v. State Trading Corp [2021] UKPC 14 that although the first stage was not open to review by the court, at the second stage, it was for the court to determine whether the consequences and effect of any illegality were such as to render an award in conflict with the public policy of the supervisory court.
3. Betamax was "highly persuasive" as an authority, because it was a decision of the Privy Council on the meaning of "public policy" in the context of the UNCITRAL Model Law, and the legislative provision which it considered was the equivalent of section 81 of the Hong Kong Arbitration Ordinance and Article 34(2)(b)(ii) of the UNCITRAL Model Law (which provides for applications to set aside awards on the ground of public policy).
4. The court was therefore entitled to review the decision of the arbitrator to deny relief, notwithstanding the "valid objections" and "sound arguments" advanced by N with regard to the finality of arbitral awards and the court's lack of power in relation to errors of law.
5. It was not against the spirit or principles of the New York Convention or the Hong Kong Arbitration Ordinance to do so. As explained in Betamax, the finality of the award was not affected when the role of the court was simply to decide whether there was any conflict between public policy and the award.
6. The arbitrator had acknowledged that (i) the strict application of the reliance test under Tinsley would inevitably lead to injustice and the unjust enrichment of N, and (ii) Patel took a less strict approach and gave the court a degree of discretion, but the arbitrator had nevertheless understood himself to be bound to follow Tinsley (which, as noted above, had been the law in Hong Kong until the Hong Kong Court of Appeal decision in Monat a matter of days before the arbitrator’s decision).
7. Adopting the "range of factors" approach in Patel, the court might be compelled to set aside the awards if it considered that it would be manifestly unjust and against the public policy of Hong Kong to uphold them.  In this regard, the court indicated (in the context of its decision to continue the interim preservation order, discussed below) that it considered G to have a good arguable case for the setting aside of the awards on the ground of public policy.
8. Instead of pronouncing a final view on whether the awards were contrary to public policy and should be set aside, the more appropriate action would be to suspend the setting aside proceedings for an initial period of three months and remit the matter to the arbitrator to enable him to resume the arbitral proceedings and consider whether his decision would be affected by Monat.

The court also granted the continuation of the asset preservation order in the interim of the suspension of the setting aside proceedings.

The court dismissed G's lack of authority ground, on the basis that:

1. This ground as advanced before the court amounted in substance to a claim that the arbitrator had no jurisdiction.  However, G had not challenged the jurisdiction of the arbitrator in the arbitration (contrary to the requirements of Article 16 of the UNCITRAL Model Law), and was therefore estopped from asserting such a claim now.
2. G had expressly stated in the arbitration that its argument on the contractual limitation was not a jurisdictional challenge.  Considered in light of the decision of the Court of Final Appeal in C v. D [2023] HKCFA 16 (see our previous blog here), G's argument in the arbitration was a challenge to admissibility (i.e. that there was a limitation on the claims which could be properly advanced in the arbitration), not a challenge to jurisdiction, and the court therefore had no power to review the arbitrator's ruling.

Comment

Set-aside applications before the Hong Kong courts are generally resolved by either upholding the award or setting it aside (with the majority being upheld).  Remission of the matter to the tribunal pursuant to section 81(4) of the Arbitration Ordinance is a useful additional tool which the court can deploy (albeit only if requested by the applicant) in appropriate cases to provide the tribunal with an opportunity to cure potential defects in the award.

Although remission of awards is relatively rare, this decision follows another recent Hong Kong court decision on a challenge to a CIETAC award rendered in the Mainland PRC, in which the equivalent concept of "re-arbitration" under PRC law was discussed (see G v. X and Others [2023] HKCFI 3316 and our blog on that case here).

The significance of the decision in G v. N in terms of the scope for court intervention in arbitration should not be overstated.  Although decisions by arbitrators on legal questions which are (or go to) matters of public policy may be susceptible to challenge, the vast majority of substantive legal questions decided by arbitrators will not fall into this category and therefore will not be subject to review by the courts.

The general position remains that challenges on errors of law are not permitted in Hong Kong unless the parties have expressly "opted-in" to them (see our previous blog here for details of the opt-in regime).

Taking a step back, the decision underlines the internationalism and strong common law pedigree of Hong Kong law and the legal framework for arbitration in Hong Kong, as illustrated by the alignment of the illegality defence with English law through the Court of Appeal's decision in Monat, and the CFI's reliance in the present case on the “highly persuasive” Privy Council decision in Betamax.