Hong Kong Court dismisses set aside application where party alleges arbitration agreement a sham

The Hong Kong Court of First Instance dismissed an application to set aside an arbitral award, rejecting claims that the underlying agreement was a sham and that enforcement of the award would be contrary to the public policy of Hong Kong. The Court did not accept that the Defendant had signed the relevant agreement as agent for another party, in order to conceal that party’s involvement in breach of his fiduciary duties. If it had, the Plaintiff was complicit, and could not be allowed to benefit financially from the arrangement.

The Court also refused to set aside on public policy grounds. Hong Kong courts construe the public policy ground narrowly. Moreover, a set aside application must clearly set out the grounds on which it is based, as must the supporting affidavit; the Court cannot consider any other grounds.

X v Jemmy Chien [2020] HKCFI 286, [2020] HKEC 356

Background

The Plaintiff applied to set aside an arbitral award on the merits dated 25 February 2019 and an award on interest and costs dated 26 June 2019. The Defendant submitted a cross application to enforce the awards.

The dispute involved a Service Agreement, which the Plaintiff alleged the Defendant had signed as agent for Mr Philip Chen, who was the principal and true party to the Service Agreement. The Plaintiff claimed the Service Agreement was a sham to conceal Mr Chen’s involvement, which amounted to a breach of his fiduciary duties to a third party under Taiwanese law. On the Plaintiff’s case, the Defendant was never intended to be a true party. Therefore, the Plaintiff argued, there was no valid arbitration agreement between the Plaintiff and the Defendant, and the award should be set aside on that basis. Moreover, enforcing the award would uphold an arrangement by which Mr Chen contravened Taiwanese law, and would therefore conflict with the public policy of Hong Kong.

Whether there was an arbitration agreement

The parties did not dispute that the Service Agreement was governed by PRC law, whereas the arbitration agreement in clause 7 of the Service Agreement was governed by Hong Kong law.

The Plaintiff relied on the fact that, before executing the Service Agreement, there had been no relationship between the Defendant and the Plaintiff or the group of companies of which it was part. The Service Agreement had been signed by the Defendant next to the words “Party B” and “Representative”. Therefore, the Plaintiff argued, the Defendant had signed as a representative of Mr Chen.

The Plaintiff also relied on the fact that the Defendant had not participated in negotiating the Service Agreement or communicating with the group and possessed little knowledge of the Service Agreement’s terms and the duties and obligations provided within it.

However, in the award on merits the arbitrator found that the Defendant was the true party to the Service Agreement and, consequently, the arbitration agreement. Under PRC law, where a party signs and seals a contract without any qualification, that party is the true party.

For completeness, the arbitrator also considered Hong Kong law to determine whether the Defendant had contracted personally, or merely as an agent for a Mr Chen. He asked:

• Was the contract qualified? Did the party sign the contract in its own name, or was it listed as an agent of another party?
• Was any party (explicitly or impliedly) held out to another party as an agent?
• Who issued invoice payments under the contract?
• Who issued requests for payments under the contract?
• To whose bank account was (any) payment transferred to and who is the party making such payments?
• Who issued the termination notice of the contract and who were the parties named in the termination notice?

Applying those questions, the arbitrator found the Service Agreement was valid.

At the hearing before the Court, the Plaintiff argued the arbitrator had erred in applying the “literal approach” of contractual interpretation under PRC law and should have instead considered the factual matrix.  The judge observed that the arbitrator had made a decision based on the evidence produced during the arbitration. The judge also noted that an arbitration agreement is always separate from any underlying contract. Therefore, fraud or illegality in the underlying Service Agreement did not render the arbitration agreement null and void, or the dispute unarbitrable.

Regardless of who was to carry out services set out in the Service Agreement, the existence, enforceability or validity of the arbitration agreement remains unaffected. The Court held clause 7 of the Service Agreement was objectively and commercially an independent arbitration agreement between the Plaintiff and the Defendant, such that any dispute arising from the Service Agreement should be arbitrated between them.

Whether enforcement would be contrary to public policy

In a set aside application, Order 73 r 5(4)(b) Hong Kong Rules of the High Court requires the originating summons to state the grounds of the application. Here, the originating summons stated that the award was in conflict with the public policy of Hong Kong.

The accompanying affidavit stated only that “if the Arbitration Agreement contained in the Service Agreement is enforceable, the Court would be enforcing a sham agreement whereby the Defendant was never meant to be the true party“, and allowing the Award to stand would be to give effect to a sham agreement.

At the hearing, the Plaintiff argued that what this actually meant was that the Service Agreement was a sham because it was the parties’ intention to hide Mr Chen’s involvement in the contract, which amounted to a breach of his fiduciary duties to the third party. If the Defendant was not intended to be a true party to the Service Agreement, it could not have been intended to give the Defendant the benefit of the arbitration agreement either.

Counsel for the Plaintiff further argued that the Service Agreement “should not be given effect if the real object and intention of the parties at the time of the contract necessitated their joining in an endeavour to perform in a foreign country (Taiwan in this case) some act which is illegal by the law of such country”.

However, the Court held that the application could only be based on the grounds set out in the originating summons. Neither the originating summons, nor the affidavit, stated that performance of the Service Agreement would involve Mr Chen committing conduct which is illegal under the laws of Taiwan. It reminded the parties that the affidavit served with the summons must set out the facts and grounds relied upon in the application to set aside “precisely and with the necessary particulars”.

The Court also observed that, if the Plaintiff’s allegations of concealing the true transactions between the Plaintiff and Mr Chen and diverting business away from the third party were true, the Service Agreement must have been made between the Plaintiff and Mr Chen in concert with the Defendant. Therefore, accepting the Plaintiff’s application to resist enforcement of the Award would be tantamount to permitting the Plaintiff to rely on its own wrongdoing to avoid payment for the services rendered to it under the Service Agreement.

The Court additionally observed that the public policy ground has always been narrowly construed by the Hong Kong courts. Refusal to enforce must be balanced against other public policy interests including upholding parties’ agreement to arbitrate their dispute, facilitating enforcement of arbitral awards, and observing obligations assumed under the New York Convention.

Comment

This case is consistent with the Hong Kong courts’ general reluctance to interfere with arbitral awards. The public policy ground, in particular, is narrowly construed and rarely accepted. Parties should think carefully before applying to set aside, or resist enforcement of, an arbitral award in Hong Kong. A failed application will incur indemnity costs.

Parties who do make such applications must also ensure they follow the procedure set out in Order 73 RHC. Specifically, it is essential that the originating summons and accompanying affidavit clearly set out the grounds on which the application is based, and the evidence in support.