Hong Kong Court Refuses Recognition of Mainland Award on Public Policy Grounds

On 18 October 2018, the Hong Kong Court of First Instance (Court) in Z v Y [2018] HKCFI 2342 refused to recognise an Award of the China Guangzhou Arbitration Commission by reason of public policy. Mimmie Chan J presided and considered the several grounds raised for a set aside order under the Arbitration Ordinance.

Background

Between July 2013 and March 2014, the Applicant and a Mainland company (HD) entered into eight contracts, whereby the Applicant would supply raw plastic materials to HD (HD Contracts). During the same period, an affiliated company of HD on the Mainland (MD) entered into eight contracts with the Applicant (MD Contracts) for the supply of the same materials from MD to the Applicant. The result was a back to back arrangement where MD supplied the materials to the Applicant, who then supplied them to HD. The Respondent's husband, "Mr X", was the beneficial owner of both HD and MD.

On 5 May 2014, the Respondent signed a Guarantee for the payment of a RMB10,239,325.09 debt allegedly due to the Applicant under the HD Contacts.

The matter proceeded to arbitration administered by the Commission and, on 27 February 2017, the presiding tribunal issued the Award based on the facts above. The Applicant then applied to the Court for leave to enforce the Award in Hong Kong and this was granted on 28 August 2017.

On 22 September 2017, the Respondent applied under section 95 of the Ordinance to set aside the order on the following grounds:

1. The HD Contracts and MD Contracts were in fact loan arrangements between the Applicant as there was no sale and purchase or transfer of goods, thereby amounting to "fraudulent contracts" under PRC law (section 95(3)(b)) (Illegality Ground).
2. The Respondent did not have contractual capacity when she signed the Guarantee as she suffered from severe depression and was unable to deal with stress or anxiety (section 95(2)(a)) (Capacity Ground).
3. There was no valid arbitration agreement as:
   • the arbitration clause in the Guarantee was vague and uncertain, providing only that parties to the Guarantee 'may' apply for arbitration; and
   • the Applicant neither signed the Guarantee, nor agreed to become a party to the Guarantee and its arbitration agreement (section 95(2)(b)) (Absence of Arbitration Agreement Ground).

4. The Guarantee is void and invalid both under PRC law and Hong Kong law because:
   • the underlying transactions of the HD Contracts were illegal;
   • the Guarantee was only given after HD had encountered financial difficulties and without valid consideration;
   • the Guarantee was obtained by inducement, duress, undue influence, misrepresentation, and/or deceit; and
   • the Applicant's representatives pressured the Respondent into signing the Guarantee and told her that it was a mere formality which would not be enforced against her (section 95(3)(b)) (Invalid Guarantee Ground).

5. The Respondent was not given proper notice of the tribunal's appointment because three arbitrators were appointed to the tribunal without first dealing with her jurisdictional challenge and without her participation (section 95(2)(c)(i)) (Proper Notice Ground).

Decision

Although most of the Respondent's arguments were ultimately rejected, the Court granted the set aside application on the basis that the Tribunal had failed to deal with the serious issue of illegality in its Award and it would be contrary to public policy to allow enforcement in these circumstances. The Court addressed each of the five grounds, finding:

• the Award did not adequately address the illegality ground and it would offend notions of fairness and equality to enforce an award that may be tainted by illegality;
• the Respondent had not sufficiently demonstrated that she did not sign the Guarantee, did not know what she had signed, or that she lacked contractual capacity;
• the Respondent's evidence on duress and misrepresentation were unreliable as she i) only denied signing the Guarantee before the tribunal and never raised the issue of duress or capacity, and ii) failed to produce signature specimens requested by the tribunal without explanation;
• there was a valid arbitration agreement because, even though the arbitration agreement used the permissive term 'may', there was sufficient authority that this would be binding when one party chose to engage the clause and commence arbitration (citing Hermes One Ltd v Everbread Holdings Ltd [2016] 1 WLR 4098). The Court held that there was no evidence on PRC law to refute this position. Further, the absence of the Applicant's signature on the Guarantee and the question of validity under PRC law were not addressed in the Award;
• the Respondent was given proper notice of the arbitration but, by misunderstanding or ignorance, failed to appoint her own arbitrator within 20 days from receipt of the Commission's notice of acceptance of arbitration, pursuant to Article 94(1) of the China Guangzhou Arbitration Commission Arbitration Rules.

Accordingly, the Court set aside the Award under section 95(3)(b) of the Ordinance, on the bases that i) it would be contrary to the public policy of Hong Kong to enforce the Award when there are valid grounds to claim the Guarantee secured obligations under contracts that may be illegal, and ii) the tribunal failed to sufficiently explain why it accepted the Guarantee to be valid and legally enforceable. The Court awarded costs of the application to the Respondent.

Discussion

Yet another matter where the Court has considered public policy grounds in the context of a set aside application (see this post last month), the decision demonstrates the various grounds upon which a set aside application may be made. Hong Kong Courts will be reluctant to enforce an arbitral award where it appears the original tribunal has insufficiently addressed important issues in its award - such as illegality of contract.