Hong Kong court refuses to enforce an arbitral award because of fraud/collusion

The facts

In which:  
NI and ST are equal shareholders in the respondent company, Sun Fung (the respondent) 
ST is an individual and one of the two directors of Sun Feng 
NI is a company whose majority shareholder is DL 
DL is the second director, along with ST, of the respondent company, Sun Fung

The respondent Sun Fung was a company incorporated in Hong Kong in 1989, and its shares were equally held by an individual, ST and by a company NI. NI’s majority shareholder and director was an individual DL, whom together with ST were the only 2 directors of the respondent. 

The respondent ran a timber retail business until August 2017. Until the disputes arose in late 2016/2017, DL had entrusted the daily operation of the business of the respondent to ST. ST’s wife and DL’s wife were sisters, and ST and his wife were the only full time employees of the respondent. 

By late 2016, the family members were already in disagreement, as to whether the respondent should enter into further financial commitments and loans from the respondent’s bankers. DL had expressed his intention to withdraw the guarantee he had given to the bank, as a result of which the respondent had not been able to obtain increased facilities  from its banks. The respondent had subsequently commenced to wind down its operations from late 2016, with talks between DL and ST of selling a property in Hong Kong, ie the retail shop of the respondent. 

On 14 April 2017, a contract was entered into by ST in the name of the respondent with the applicant, Guangdong Shunde Zhanwei Trading Co. Ltd. The contract was for the sale, by the respondent to the applicant, of a substantial amount of marble, for a significant sum of RMB20 million. The applicant, as the purchaser, had only been incorporated 3 months before the contract. The contract sum was 62 times greater than the respondent’s entire sales revenue in 2015. The contract stated that the marble was to be delivered by the respondent within 6 days of the contract, in respect of which the respondent was liable under a penalty clause in the contract, for up to RMB2.2 million for each day of delay in delivery. The respondent ultimately failed to deliver the marble on or before 20 April 2017 as per the contract.

On 15 May 2017, the applicant commenced arbitration proceedings before the Zhanjiang Arbitration Commission against the respondent. An award was issued 4 days thereafter on 19 May 2017. ST had dealt with the arbitration on behalf of the respondent and the parties were in agreement that the respondent had not complied with its obligation to deliver the goods under the contract, and was in breach. According to the award, the parties agreed that the respondent should pay damages to the applicant in the sum of RMB59 million.

The applicant then applied to wind-up Sun Fung [the respondent] based on the award. It was in the course of the winding-up proceedings that NI and DL first became aware of not only the petition, but also the contract (disclosed 15 January 2018) and the award (disclosed 8 January 2018). The winding-up proceedings were subsequently dismissed by the Hong Kong Court on the basis of a bona fide dispute over the debt.

As such, in April 2019 the respondent, as an alternative measure, applied ex parte for an order granting leave to enforce the award in Hong Kong, and in June 2019 this was granted.

In April 2020, NI applied for, and in March 2021 obtained, leave of the court to intervene in these proceedings to set aside the award. The basis of NI’s complaint was:

• that the contract made in the name of the respondent and signed by ST was not authorised, and was hence invalid
• that the contract was made by ST in collusion with the applicant in an attempt to strip the respondent of its assets, by their agreeing on an onerous contract
• ST admitting to the respondent’s breach and liability in the arbitration brought by the applicant on the contract
• ST agreeing to the award and enabling the applicant under the award to obtain the proceeds of sale of the property and other assets of the respondent via enforcement of the award
• NI claimed that the respondent had not been given proper notice of the commencement of the arbitration, nor of the award, as all relevant documents relating to the arbitration were served on the respondent at the property which had been sold in May 2017, to the knowledge of ST
• DL and NI as shareholder of the respondent only became aware of the award when the applicant commenced winding-up proceedings against the respondent in October 2017 because of the debt due to the award

The law

Mimmie Chan J heard the parties’ submissions, and decided to set aside the enforcement order by holding that the enforcement would be contrary to public policy given that the underlying contract was a sham and the arbitration agreement was not valid.

Authority of ST

The judge, with no hesitation, found that neither the applicant nor ST had an authority to sign the contract on behalf of the respondent. The fact that ST held office as a director did not confer on him any actual, implied or usual authority to enter into contracts on behalf of the respondent. Directors have power under the articles only when they act together collectively as the board.

In relation to the applicant’s reliance on ST’s implied authority as de facto managing director of the respondent to enter into the contract, any such implication of authority could only arise from the course of dealings between ST and the applicant (PEC Limited -v- Asia Golden Rice [2014] EWHC 1583 (Comm) at paras. 62 and 67). 

Having considered the totality of the evidence, the reasonable and proper inference was that when ST made the contract with the applicant and consented to the award in favour of the applicant, he was acting entirely in furtherance of his own personal interests, rather than in the interests of the respondent. On this basis, his acts could not fall within the scope of any apparent authority which ST may arguably have, to bind the respondent as alleged principal. 

Whether the contract was a sham/collusion

The judge noted that it was true that allegations of fraud and collusion were serious, and had to be established by cogent evidence. The judge also accepted the applicant’s argument that inferences of dishonesty must be found in primary facts. However, the judge took the view that the court did not lose sight of the fact that direct evidence of fraud was relatively rare, and that fraudsters would be skilled at hiding their tracks (see Dadourian Group International Inc and ors -v- Paul Francis Simms, Jack Dadourian, Helga Dadourian [2009] EWCA Civ 169, per Arden LJ; also see Civil Fraud: Law Practice and Procedure, at para.34-072). 

Despite the fact that NI/DL had claimed from the start that the contract was a sham, entered into through the collusion of ST and the applicant, the applicant had only given extremely limited evidence to refute the allegation, apart from a bare denial. From the judge’s perspective, the terms of the transaction cast serious doubt on the genuineness of the deal between ST and the applicant. The below were some of the factors taken into account by the judge to reach the conclusion:

• The supply of the marble under the contract was of a value of 62 times the respondent’s entire sales revenue for 2015.
• The applicant’s payment under the contract should have been secured, it was simply incredible that the contract could have provided that the applicant’s deposit of a cheque, without clearance, would be deemed sufficient security or guarantee of payment.
• Bearing in mind that the cash and bank balances accrued over the years by the respondent was only HK$12,000, the respondent did not have the financial resources to purchase the massive quantity of marble from any supplier which ST might have located for the contract.
• The contract provided for delivery of the marble to be made within only 6 days, and for a daily penalty of RMB2.2 million to be payable by the respondent if delivery should be delayed. 

Aside from the above, the judge was also of the view that the timing of the contract, in the interim when the shareholders of the respondent had begun discussions and were contemplating winding down operations (before dividing the assets or business), and the extraordinary terms of the contract, had to be considered in conjunction with events which took place after the conclusion of the contract, and which led to the making of the award of RMB59 million in favour of the applicant, and the steps taken by the applicant by way of enforcement of the award. From a holistic consideration of all the circumstantial materials and on the entirety of the evidence adduced, including the timing of the contract, its terms, and the respondent’s usual business pattern and financial situation at the time of the contract, the judge concluded that it was more probable that the applicant was a party to ST’s plan to orchestrate an award whereby the respondent would be made liable for a debt under the contract, which was part of the scheme to enable ST to enforce the debt by winding-up and other recovery proceedings, and otherwise to enable ST and the applicant to receive valuable assets of the respondent, and to avoid ST’s need to share such assets with NI should the respondent be dissolved in the usual way.

In conclusion, the judge decided to set aside the enforcement order based on s.95 of the Arbitration Ordinance (Cap. 609), on the following grounds:

• No valid arbitration agreement: given that the contract was entered into by ST without any authority of the respondent, such that the respondent was not a party to the contract at all, the respondent was never a party to the arbitration agreement contained in the contract (see Fiona Trust Corp -v- Privalov [2005] 1 Lloyd’s Rep.192, per Lord Hoffman, at para.17).
• No proper notice of the arbitration: under s.95 of the Arbitration Ordinance, a ground of refusal of enforcement of an arbitral award was that the party was not given ‘proper notice’ of the arbitral proceedings, nor was able to present its case. If ST had no authority to act on behalf of the respondent in his conduct of the arbitration, there was no other evidence, nor claim, that DL, NI or anyone else from the respondent had been notified of the commencement of the arbitration, or of the claims made by the applicant in the arbitration, to be given the opportunity to present the respondent’s case in opposition to the claims made in the arbitration. Thus, the judge accepted that the respondent had not been given proper notice of the arbitration, and was unable to present its case.
• Contrary to public policy: the judge considered that it would indeed be shocking to the conscience of the court to permit the applicant to enforce the award, which she found was procured by ST in collusion with the applicant. The arbitral process and the award had been misused by ST with the assistance of the applicant, and it would be contrary to the public policy of Hong Kong to permit enforcement of such an award.

Comments

Hong Kong is widely recognised as a pro-arbitration jurisdiction, so it is very rare for the Hong Kong court refusing to enforce an arbitral award, especially on the basis of violation of public policy. 

As the judge highlighted in her judgment, allegations of fraud and collusion are serious, thus cogent evidence has to be provided to substantiate such allegations. In this regard, we can see the judge conducted a thorough scrutiny of the relevant evidence, and scrutinised those unusual features in the transaction, and came to the conclusion that the underlying contract was a sham and the enforcement must be refused. This shows that if an arbitral award is obtained by fraud or collusion, the Hong Kong court will have no hesitation to refuse the enforcement of the award where such enforcement would be contrary to the public policy of Hong Kong.

This case also demonstrates that if fraud and/or collusion (and/or corruption) are relied upon as substantial grounds for challenging the award, or resisting the enforcement of such an award, the Hong Kong court is willing to deviate from the traditionally stringent standard for reviewing the award, but to revisit the substantive evidence to examine the allegations of fraud or collusion, even if such evidence is adduced by a party for the first time. The Hong Kong court will review the arbitral process, the underlying transaction between the parties, as well as the subsequent actions taken by the relevant parties after the award is published.