In G v N [2023] HKCFI 3366, an arbitrator decided on illegality under Hong Kong law applying the wrong test. G sought to set aside the awards, among others, on the ground that they are in conflict with Hong Kong public policy on illegality, alternatively for the matter to be remitted to the arbitrator to give him an opportunity to eliminate the setting aside grounds.
The Court found that the awards were in conflict with Hong Kong public policy on illegality and remitted the matter to the arbitrator. This case is a rare example where the public policy ground is invoked successfully in Hong Kong.
The Honourable Madam Justice Mimmie Chan, the judge in charge of arbitration-related court proceedings who decided the case, put the crux of the case as follows:
- This case involves the interesting question of the application of public policy in a case where illegality is raised as a defence to a claim, and the extent to which the Court can intervene under Article 34 of the Model Law. This is in the context of a case where the arbitral tribunal had, in the course of reaching its decision on whether to grant or deny relief after a finding on illegality, considered the question of what the tribunal perceived to be the public policy of the relevant jurisdiction. Can it be contended that the tribunal’s decision on public policy is erroneous? If the tribunal’s decision on public policy is to be challenged, should it be characterized as an error of law, which is not subject to the Court’s review? Or is the Court entitled to set aside the award as it finds that the award is in conflict with public policy because the tribunal’s view of the public policy was erroneous?
Factual Background
G and N are BVI companies. G is a wholly owned indirect subsidiary of a Hong Kong listed company (K). N is a real estate developer and operator with business in Mainland China. It indirectly owns significant assets and shares in Mainland companies, including a subsidiary which holds the vast majority of N’s assets. At the relevant time, K was N’s largest shareholder and controlled its management and board; K held the shares through G. Another shareholder of N was a US investment fund (IZ).
In 2020, N’s management decided to make a substantial investment in the purchase of land in China, but without reference to its board of directors. IZ disagreed with the purchase and together with other shareholders, IZ proposed to call a shareholders’ meeting to consider a change of some of the directors.
N then arranged for an allotment of shares to thwart the likely outcome of a shareholders’ vote. On 5 October 2020, N and G entered into a Hong Kong law governed Securities Purchase Agreement for a private investment in public equity placement. N was to allot shares to G in exchange for “Consideration Monies”. The placement gave K and its supporters the necessary votes to defeat IZ’s requisition for a shareholders’ meeting.
In October 2020, IZ commenced proceedings in the BVI seeking a declaration that the placement to G and WR was void and should be set aside on the ground that it was in breach of section 121 of the BVI Business Companies Act as it was not in the interests of N and N’s directors had not exercised their powers for a proper purpose. On 3 Mach 2021, the BVI Court set aside the placement on the ground that it was in N’s interests, finding that the placement was executed for an improper purpose under BVI law, as four of N’s directors signed it to defeat the request for a shareholders’ meeting. The BVI Court of Appeal later confirmed the judgment.
The BVI Court also ordered a special shareholders’ meeting of N. At that meeting on 30 November 2021, a new board of management was voted in.
The arbitrator found that the placement was illegal, but denied the restitution relief to G
On 12 March 2021, G commenced HKIAC arbitration proceedings against N under the SPA, seeking restitution of the Consideration Monies. N asserted that the placement was illegal, contended that G should not be permitted to recover the Consideration Monies, and counterclaimed for costs and damages sustained in relation to the SPA and the invalidity of the placement.
The key issue in the arbitration was whether the placement was illegal and, if so, whether or not G could recover the Consideration Monies from N.
According to the reliance principle in the 1993 House of Lords decision in Tinsley,[1] a party cannot succeed in a claim where to do so, it has to rely on its own illegality. Tinsley had subsequently been widely criticised as arbitrary, unjust and disproportionate.
In 2016, the UK Supreme Court in Patel[2] departed from Tinsley, holding that the general rule was that a person who satisfied the ordinary requirements of a claim in unjust enrichment should be entitled to the return of their money and should not prima facie be debarred from recovery by reason of the fact that the consideration which had failed was an unlawful consideration. The UKSC found that the money paid by the claimant should be restituted to the defendant which would merely return the parties to their previous position before the conclusion of the illegal contract and prevent the defendant from gaining by unjust enrichment. The Court explained that the essential rationale of the illegality doctrine was that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system. In assessing whether the public interest would be harmed in that way, it is necessary (a) to consider the underlying purpose of the prohibition concerned and whether that purpose will be enhanced by denial of the claim, (b) to consider any other relevant public policy on which the denial of the claim may have an impact and (c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.
Notwithstanding, Tinsley continued to be applied in Hong Kong.
On 6 April 2023, the arbitrator issued his first partial award. Although the arbitrator found that the placement was illegal, he applied Tinsley and denied G’s restitution claim. He also held G liable for damages to N. He concluded that he was required to apply Tinsley as the Court of Final Appeal had not yet considered whether Patel should be followed in Hong Kong.
However, on 31 March 2023, only 6 days before the partial award was issued, the Court of Appeal held in Monat[3] that Patel rather than Tinsley represented Hong Kong law on illegality. Relevantly, Yuen JA noted in his judgment that it would be surprising if the common law as expounded by the highest authority in the United Kingdom, which the Court of Final Appeal had said should be accorded the greatest respect, was not to be regarded as the common law in Hong Kong simply because there might or might not happen to be a case involving the point being processed through the Hong Kong courts, which might or might not happen to reach the CFA. When such a case reached the CFA, it would be free to follow Patel or not, in accordance with the stare decisis rule, but until the CFA pronounced on it, the Hong Kong courts should not regard themselves as being “hide-bound” to adhere to an old common law rule.
On 28 July 2023, the arbitrator issued a second partial award in which he quantified the damages to be paid by G to N.
The court found that it could review the arbitrator’s decision to deny relief to G
On 20 April 2023, G applied to the Court of First Instance to set aside the first award and on 4 August 2023, G applied to set aside the second award.
G recognized that it could not challenge the awards on findings of fact or law, and on the ground that the arbitrator had erred in law in applying Tinsley or that Tinsley had ceased to be good law. G therefore framed the setting aside grounds on the basis of public policy and that the awards were premised on an incorrect understanding and application of Hong Kong’s public policy.
N argued that G’s application was a disguised attack against the factual and legal findings which were within the arbitrator’s exclusive powers and jurisdiction. N relied on the Privy Council decision in Betamax[4] that the decision on fact and law is a decision for the tribunal, and if the tribunal holds that a contract is illegal, its decision will be final (in the absence of fraud, a breach of natural justice or any other vitiating factor).
The court found it was entitled to review the arbitrator’s decision to deny relief to G:
- The court had the power and duty to consider whether the awards were contrary to Hong Kong public policy at the time of review, and whether the arbitrator considered public policy in accordance with the guidelines in Patel, now recognized to be applicable in Hong Kong on the question of illegality.
- If the arbitrator did not follow these guidelines, then the court might reach a different conclusion when applying them to decide whether the awards should be set aside as being in conflict with public policy.
- G did not seek to challenge the arbitrator’s finding on the facts. Rather, G’s complaint was that it had been deprived of a very substantial sum (in the region of USD 125 million) and the arbitrator’s conclusion to deny relief to G by virtue of the breach of the BVI Act 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.
- While Betamax made it clear that it is not open for the courts to review the tribunal’s application of the law to the facts to ascertain if there was any illegality in law, it made it also clear that the question of public policy was to be determined by the courts.
- Where a contention that an award is contrary to public policy is raised, the court was bound to consider and decide it, applying the authorities which define the narrow scope of such a claim.
- The arbitrator acknowledged that the strict application of the illegality doctrine would inevitably lead to injustice and the unjust enrichment of N, but he concluded it was defensible on the basis that it was not a principle of justice. He also acknowledged that Patel took a less strict approach and gave the court a degree of discretion, but he did not apply the approach in Patel on the basis that it was not part of Hong Kong law.
- The court considered that it would be manifestly unjust and against Hong Kong public policy to enforce the awards, whether by reason of disproportionality between the purpose of the BVI Act and the effect of denying relief, or as a result of weighing the different public policies or interests involved in the spheres of unjust enrichment and illegality.
- The court may be compelled to set aside the awards notwithstanding that the arbitrator had decided on matters engaging public interest when he made his awards because he had not considered the matters highlighted to be important in Patel, before determining whether relief should be denied to G.
- It was sufficient that the outcome could or might have been different had the arbitrator considered the relevant matters under the Patel approach.
However, the court decided not to pronounce its view on whether the awards are contrary to public policy. The court considered it more appropriate to suspend the setting aside proceedings for 3 months and to remit the matter to the arbitrator so that he has the opportunity to take such action as in his opinion will eliminate the setting aside grounds. This will allow him to consider Monat (and therefore Patel) and whether his decision as reflected in the awards would be affected in any way.
[1] Tinsley v Milligan [1994] 1 AC 340.
[2] Patel v Mirza [2016] UKSC 42.
[3] Monat Investment Ltd (滿利投資有限公司) v All Person(s) in Occupation of Part of No 16 Ma Po Tsuen [2023] HKCA 479.
[4] Betamax v State Trading Corp [2021] UKPC 14.
