Hong Kong court assesses damages for breach of implied promise to honour arbitral award

The Hong Kong Court of First Instance ("CFI") has discussed the key principles relating to the assessment of damages for the breach of an implied promise to honour an arbitral award in the case of 廈門新景地集團有限公司 formerly known as 廈門市鑫新景地房地產有限公司 v Eton Properties Ltd and Others [2024] HKCFI 1291.

This decision is the latest development in the long-running dispute between Xiamen Xinjingdi Group Co Ltd ("XJ") and Eton Properties Limited and others (together "EP"), which we have covered in our previous blog posts here, here, here and here.

In earlier proceedings, the Hong Kong court found that EP had breached its implied promise to honour an arbitral award made in XJ's favour ("Award"). The court held that XJ was entitled to bring a common law action in the Hong Kong courts against EP for breach of that implied promise.

In the most recent proceedings, the CFI assessed the damages payable by EP to XJ under the common law action.

Background

XJ and EP entered an agreement to develop a piece of land in China ("Agreement"). The Agreement was governed by PRC law and contained an arbitration clause providing for CIETAC arbitration seated in the Mainland.

Under the Agreement, XJ was to pay EP for the possession of land held by a subsidiary of EP. XJ would build and sell apartment blocks on the land, and EP would then transfer their shareholding in the subsidiary to XJ. However, before the shareholding was transferred, EP purported to terminate the Agreement and its subsidiary developed the land itself.

XJ commenced arbitration and obtained the Award which ordered, amongst other things, that EP perform its obligations under the Agreement by completing the transfer of the shareholding to XJ.

Unbeknown to the tribunal and XJ, EP carried out an internal restructuring shortly after the commencement of the arbitration. According to EP, this made it impossible for EP to transfer the shareholding to XJ.

XJ commenced a common law action in the Hong Kong courts seeking damages for EP's breach of its implied promise to honour the Award. The CFI dismissed XJ's claim, but the case was appealed through the Court of Appeal to the Court of Final Appeal. The Court of Final Appeal found in XJ's favour and the claim was returned to the CFI to assess damages.

Legal Principles

The CFI discussed the legal principles which are applicable to the assessment of damages for the breach of an implied promise to honour an award:

• The implied promise, as a contractual obligation, is separate and distinct from the obligations created by the underlying agreement between the parties and under which the award was issued.
• The object of awarding damages for breach an implied promise is to put the claimant, so far as money can, in the situation it would have been in if the implied promise had been honoured. This means that damages will be assessed as if the award had been complied with. (In other words, the court found that damages should be assessed on the basis of the "expectation" measure of loss.)
• The court has flexibility in the remedial measures to be granted, such that it is able to fashion an appropriate remedy to give effect to the award. This may be wider than any remedy that could have been claimed in the arbitration itself or that would have been within the jurisdiction and powers of the arbitral tribunal to have granted.
• When considering what would have happened had the award been complied with, the court should construe the award generously, in a reasonable and commercial way, and in accordance with the expectations of commercial persons who are parties to the arbitration agreement.

Arguments on the applicable counterfactual

A key dispute between the parties in the proceeding was the correct counterfactual to be applied by the court when assessing damages.

The Award ordered, among other things, EP to "continue to perform the Agreement". However, by the time the Award was rendered in October 2006, the restructuring had occurred and, according to EP, the transfer of shares contemplated by the Agreement had become impossible. Further, by time of the Award the land had been partially developed by EP and units had been sold.

XJ's position was that damages should be assessed as at the date of the Award in October 2006, and on the basis that XJ would have received the shareholding at that time had the Award been honoured. Assessing damages on that basis would have given XJ the benefit of the development of the land and the sales of the units.

EP's position was that damages should be assessed by reference to the reasonably anticipated profits that XJ would have made if it had developed the land according to its own design and its own schedule, as contemplated under the Agreement. The Agreement did not permit XJ to use EP's design or take the benefit of EP's development work up to the time of the Award. An award of compensatory damages should not extend to the profits earned by EP through its development of the land.

Decision

The CFI, applying the principles outlined above, agreed with XJ's approach to assessing damages:

• XJ's claim for damages was not for breach of the Agreement made in 2003. The counterfactual must be as if EP had performed the Award in October 2006, and the position in which XJ would have been in October 2006.
• By the time of the Award, EP had informed the arbitral tribunal about the status of the land and the sales. The tribunal nevertheless ordered EP to "continue to perform the Agreement". The Award could only be read, sensibly and commercially, to mean the Agreement was to be performed in the context of the facts prevailing at the time of the Award.
• The Award should not be read as requiring XJ to restart development on the land (which would have meant demolishing the existing development) merely in order to allow XJ to perform what it had originally agreed to do under the Agreement. That would be unrealistic and uncommercial. To the extent that the court's approach marked a departure from the Agreement, the court had the flexibility to fashion an appropriate remedy in order to give effect to the Award.
• The relevant counterfactual was that EP would have transferred the shareholding to XJ in October 2006, to enable XJ to obtain the benefit of the development of the land. The fact that a transfer was by then impossible was irrelevant to the court's assessment of damages.

The CFI therefore ordered damages by reference to the profits earned by EP through its development of the land. This was reflective of the profits that XJ would have obtained had the shares been transferred at the time of the Award in October 2006.

Comment

This decision highlights the distinction between an action to enforce an agreement and a common law action to enforce an arbitral award arising from that agreement.

When assessing damages for breach of the implied promise to honour an award, the decision suggests that the relevant counterfactual will reflect the circumstances which prevail as at the time of the award. These circumstances may be different from the circumstances which prevailed at the time the underlying agreement was breached – and may have a significant impact on quantum.

The decision also illustrates the flexibility of the remedial measures that a court enjoys when deciding on a common law action to enforce an award. The remedies available to an arbitral tribunal when enforcing an agreement may be restricted by the claims made in the proceeding, the powers and jurisdiction conferred on it by the arbitration agreement, and applicable law. By contrast, the court has flexibility to fashion an appropriate remedy to give effect to the tribunal's award.

Most award creditors will seek to enforce their awards through the New York Convention, as if they were judgments of national courts. However, where enforcement of the award on its own terms is problematic (e.g. because the relief ordered by the tribunal is no longer feasible), a common law action for breach of the implied promise to honour the award may provide an alternative means of achieving an effective remedy.