Z v. Y

HCMP 1771/2017

[2018] HKCFI 2342

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1771 OF 2017

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D E C I S I O N

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Background

1.On 28 August 2017, this Court granted leave to the Applicant in these proceedings to enforce in Hong Kong an arbitral award dated 27 February 2017 (“Award”) of the China Guangzhou Arbitration Commission (“Commission”). This was in the usual course of an ex parte application for leave.

2.On 22 September 2017, the Respondent applied under section 95 of the Arbitration Ordinance Cap 609 (“Ordinance”) to set aside the order granting such leave (“Order”), on the stated ground that the arbitration agreement giving rise to the Award was invalid, that the Respondent was not given proper notice or opportunity to appoint her arbitrator to the tribunal, that she was under incapacity as a party to the arbitration agreement, and that it would be contrary to public policy to enforce the Award in Hong Kong.

3.The claims made by the Applicant against the Respondent in the arbitration which led to the Award (“Arbitration”) were made on the basis of a guarantee in writing (“Guarantee”) purported to have been signed by the Respondent on 5 May 2014.  Under the Guarantee, the Respondent guaranteed the payment of a debt of RMB 10,239,325.09 (“Debt”) allegedly due to the Applicant by a company on the Mainland known as HD.  The Debt was said to be due by HD to the Applicant under 8 supply contracts entered into between July 2013 and March 2014, under which plastic raw materials were sold by the Applicant to HD (“HD Contracts”).  HD had an affiliated company on the Mainland, known as MD.  Both HD and MD were beneficially owned by the Respondent’s husband, Mr X.  During the same period of July 2013 to March 2014, MD purportedly entered into 8 supply contracts with the Applicant, under which MD purportedly supplied to the Applicant the exact amount and types of goods supplied by the Applicant to HD under the HD Contracts.  It was essentially a back-to-back arrangement, whereby MD purportedly sold and supplied raw materials to the Applicant, and the Applicant sold and supplied the same materials to HD. 

4.In summary, the Respondent’s case is that:

(1)    There was no actual sale and purchase, and no genuine transfer of goods, under the HD Contracts and MD Contracts.  They were sham arrangements to hide what was in reality loans between the Applicant and HD, and loan arrangements disguised as supply contracts contravene PRC laws and constitute the criminal offence of “fraudulent contracts” (“Illegality Ground” under section 95 (3) (b)).

(2)    HD had sustained financial difficulties in the 2^nd half of 2013, and on 3 May 2014, HD made an official announcement of its cessation of business.  The Respondent had assisted her husband to deal with the closing down of HD’s business, which entailed discussions with creditors and suppliers of HD, local government and workers.  As a result, the Respondent came under tremendous pressure and was diagnosed as suffering from severe depression, and was unable to deal with stress or anxiety.  She claims that she did not have the capacity to enter into any contractual agreement at the material time when she was asked to sign the Guarantee (“Capacity Ground” under section 95 (2) (a)).

(3)    There was no valid arbitration agreement.  The arbitration clause contained in the Guarantee was vague and uncertain, providing only that parties to the Guarantee “may” apply to the Commission for arbitration.  The Guarantee was not signed by the Applicant, and there is no evidence that the Applicant had agreed to the document, or become a party to the Guarantee and arbitration agreement (“Absence of Arbitration Agreement Ground” under section 95 (2) (b)).

(4)    The Guarantee is void and invalid both under PRC law and Hong Kong law, since the underlying transactions of the HD Contracts are illegal.  The Guarantee was only given after HD had encountered financial difficulties, and there was no valid consideration.  The Respondent further alleges that the Guarantee was obtained by inducement, duress, undue influence, misrepresentation, and/or deceit.  The Respondent was pressurized by the Applicant’s representatives into signing the Guarantee, and had further been told that the Guarantee was a mere formality, only for the Applicant’s representatives to take back for reporting to their superiors, and would not be enforced against the Respondent (“Invalid Guarantee Ground” under section 95 (3) (b)).

(5)    The Respondent had, through her lawyers, applied to the Commission to challenge the jurisdiction of the tribunal, claiming that the arbitration agreement under the Guarantee was invalid.  The Respondent claims that without first dealing with her jurisdictional challenge, 3 arbitrators were appointed to the tribunal without her participation, such that she was not given proper notice of the appointment of the arbitrator (“Proper Notice Ground” under section 95 (2) (c) (i)).

Illegality ground

5.The Respondent claims that in their ordinary course of business, HD and MD only purchased raw materials for their own use.  MD was a manufacturer of plastic kitchen utensils for export to the US and Europe, and HD was a processing factory manufacturing plastic and covers for air-conditioners, refrigerators and washing machines.  Raw materials were purchased by HD and MD for their own manufacturing and processing business, and not for selling to third parties.  The types of raw materials required and used by them were also different. 

6.The Respondent has filed evidence from the Head of Procurement of HD and MD, Mr Y, who stated in his evidence that he was at the material time responsible for the dealings of HD and MD with their suppliers in the procurement of raw materials for the factories, and he was familiar with the procurement activities and operations of both HD and MD.  Mr Y claims that during his employment with HD and MD, he had never seen purchases in such large quantities and monetary amounts of materials.  He explained that HD and MD had both been scaling and closing down their businesses since the 2^nd half of 2013, and it did not make sense for there to be purchases of such huge amounts as those under the HD Contracts and MD Contracts.  Mr Y claims that he had never heard of HD and MD spending several million RMB on procurement, as the largest procurement contract he had come across was worth RMB 500,000 only.  Mr Y further claims that as the Head of Procurement for HD and MD, he had never heard of, and had no recollection of, the Applicant as a customer or supplier of plastic raw materials during his employment with HD and MD.  He further confirmed that MD had never purchased raw materials to supply to the Applicant, and that the Applicant had never delivered any plastic raw materials to HD.  The Applicant was a telecommunications company, and not a trading company in raw plastic, whereas MD’s primary business was manufacturing, and not the sale of raw materials.  Although Mr Y signed one of the supply contracts on behalf of HD, his evidence is that he had been told by senior management to sign, as the Applicant would be able to “help ease HD’s financial difficulties”.  Mr Y further pointed out that the raw materials required by HD for manufacturing were those for the specific products it manufactured (air-conditioners, refrigerators and washing machines), and such raw materials were significantly different from those sold or required by MD.  As the production of goods and the requirement for raw materials were completely distinct and separate for HD and MD, Mr Y explained that it was inconceivable for there to be back-to-back transactions between MD’s supply to the Applicant, and the Applicant’s supply to HD, as evidenced by the HD Contracts and MD Contracts relied upon by the Applicant to support its underlying claim against HD, and its claims against the Respondent in the Arbitration.

7.The Respondent claims that in reality, no goods or materials were ever supplied by MD to the Applicant, nor by the Applicant to HD.  The purported purchase price for the materials was paid by the Applicant to MD, and used by HD and MD as working capital, under a loan arrangement.  However, the Applicant was only licensed to carry out distribution business (批發業).  It was not a licensed financial institution under the law of the Mainland, and not permitted to conduct any loan business without the approval of the People’s Bank of China.  The money lending activities of the Applicant were unlawful under the laws of the PRC, according to the Respondent’s expert on PRC law.

8.In response, the Applicant only pointed out that the issue of the alleged underlying illegality of the HD Contracts and MD Contracts had been argued by the Respondent in the Arbitration, and dismissed by the tribunal.

9.It is of course trite that the court of enforcement should not review the merits of the award.  Nor is any mistake of fact or law made by the tribunal a ground to set aside or refuse enforcement of the award.

10.Yet, on a careful review of the Award, it is unclear whether the tribunal had thoroughly considered the issues of illegality raised by the Respondent, and I have serious reservations as to the reasons given by the tribunal as to why the Respondent’s claims were dismissed.

11.The tribunal referred, on page 21 of the Award, to the Respondent’s claim that the contracts between HD and the Applicant were fictitious, and simply stated that this was denied by the Applicant, and that the Respondent was not able to produce evidence to prove her claim.  The tribunal stated that the Respondent’s assertions (as to the fictitious transactions) were inconsistent with the evidence or fact of HD’s debt being accepted by the trustee or administrator appointed for HD in its liquidation/bankruptcy.  There is no reference to the evidence which had been presented to and had been relied upon by the trustee or administrator, how such evidence established the genuine sale and supply of the raw materials, in particular, whether the debt was in fact disputed by HD, and whether the suspicious features referred to in Mr Y’s evidence had been made apparent to the trustee or administrator, when the debt was examined, and ultimately accepted.

12.The claims made by the Respondent as to the sham transactions of supply of materials being loans in disguise are credible, and supported by the evidence of Mr Y from HD.  The allegations of such unlawful loans creating false increments in the financial records of HD and MD all raise serious consequences of illegality and possible offences under PRC law.  They should be thoroughly considered by the tribunal, and the dismissal of such claims should be adequately explained.  The reasons may be short, so long as the factual and legal basis are explained and the reasoning is expressed to enable the parties to understand how, and why, a finding is made on a material issue, and how a conclusion is reached by the tribunal (R v F [2012] 5 HKLRD 278, applied in S Co v B Co, HCCT 12/2013, 24 July 2014).  In the context of the issues raised in the Arbitration, I regret that the tribunal failed to give any adequate reason as to why it had concluded that the Respondent’s claim of illegality of the underlying Debt had not been established by the Respondent, and should be dismissed.

13.As I pointed out in A v B [2001] 3 HKC 521:

“It is fundamental to concepts of fairness, due process and justice, as recognized in Hong Kong, that key and material issues raised for determination, either by a court or the arbitral tribunal, should be considered and dealt with fairly. An award should be reasoned, to the extent of being reasonably sufficient and understandable by the parties (ie within the confines set out in R v F [2012] 5 HKLRD 278). Under Article 33 (2) of the Model Law, the award should state the reasons upon which it is based. Having carefully considered the Award, I have to agree that the parties are entitled to query whether the Limitation Defence had been considered at all by the Arbitrator, and if rejected by the Arbitrator after due consideration, why it was rejected. The process of arbitration is intended as a way of determining disputes and points at issue, and I agree with the sentiments expressed by the court in Ascot Commodities NV v Olaf International Ltd [2002] CLC 277 and in Van de Giessen Noord Shipbuilding Division BV v Intech Marine and Offshore BV [2009] 1 Lloyd’s Rep 273 that it is a serious irregularity and the denial of due process which causes substantial injustice and unfairness to the parties, if an important issue, which the parties are entitled to expect to be addressed, is not in fact addressed.”

14.The important issue of whether the underlying HD Contracts and MD Contracts were illegal and unenforceable under PRC law, so as to render the Guarantee void and unenforceable against the Respondent, is not in my view addressed in the Award with adequate reasons, and it would offend our Court’s notions of fairness and justice to enforce the Award when it might be tainted by illegality, and when a significant issue brought before the tribunal for determination has not been seen to be properly considered and determined, contrary to the parties’ legitimate and reasonable expectations.

Capacity ground

15.The Respondent has only been able to adduce evidence of her having been diagnosed with “severe depression”.  This is inadequate to support her assertion that at the time when she signed the Guarantee, she did not have the necessary mental capacity, by reason of her depression, to understand the nature of her acts and the documents she signed, or to enter into a legally binding contract.

16.In the course of the Arbitration, the Respondent denied that the signature on the Guarantee was hers, but made no claim that she lacked capacity to sign the Guarantee, or that it was signed by her under duress, as she now claims.  The Respondent seeks to excuse this inconsistency by claiming simply that she had been unable to verify whether the Guarantee produced by the Applicant during the Arbitration was in fact the piece of paper signed by her, when the Plaintiff’s representatives had come to her office and asked her to sign a guarantee for them to produce to the Applicant, for reporting purposes.

17.On the materials available, I am not satisfied that the Respondent has discharged her burden of showing, by independent, credible and reliable evidence, that the Guarantee was not signed by her, that she did not know what she had signed, or that she lacked mental capacity as a result of her alleged depression at the relevant time. 

Invalid Guarantee ground

18.As the Applicant highlighted, the Respondent had never raised the issues of duress or lack of mental capacity before the tribunal.  She only denied signing the Guarantee, but despite having been asked by the tribunal to produce specimen signatures for verification of her signature on the Guarantee, the Respondent had failed to do so, without any satisfactory explanation.  Her evidence on duress is not credible.  I am not satisfied that when she was asked by the Applicant’s representatives to sign the Guarantee, in the circumstances she described, she had no alternative choice and no true consent.

19.The Respondent’s claim of misrepresentation is related in some respects to her claim of duress.  I find all these claims to be unreliable, and consider that the Respondent’s assertion of having been misled into signing the Guarantee on the basis of or in reliance on the Applicant’s alleged representation, that the Guarantee would only be used for the representatives’ “reporting” (交差) purpose, and would not be enforced, is not credible. 

20.The illegality of the underlying HD Contracts and MD Contracts, affecting the validity and enforceability of the Guarantee, has been dealt with in the preceding paragraphs.

Absence of arbitration agreement ground

21.Apart from the illegality and hence unenforceability of the underlying contracts, the Respondent claims that there was no binding arbitration agreement since the arbitration clause was uncertain and not mandatory.  I reject this claim. 

22.Although the arbitration clause is expressed in permissive terms, in that it provides that any party “may” apply to the Commission for arbitration of any dispute relating to the Guarantee, there are authorities to the effect that this confers on the parties the option of submitting the dispute to binding arbitration, and that if a party should choose to exercise such an option, either by commencing arbitration or applying for a stay of the litigation commenced, the other party would be bound to accept the reference (Hermes One Ltd v Everbread Holdings Ltd [2016] 1 WLR 4098).  There is no evidence on PRC law to suggest that the contrary should be the position. 

23.The Respondent also argued that the Guarantee was not signed by the Applicant.  It was only produced to the Respondent for signature, and she had never received a copy of the Guarantee signed by the Applicant, nor ever been informed that the Guarantee had been accepted by the Applicant.  If her signature of the Guarantee constituted an offer, the Applicant’s acceptance of the contract evidenced by the Guarantee had never been communicated to her.  The Respondent’s expert on PRC law stated that both parties should accept and intend to be bound by the Guarantee.

24.I accept that under Hong Kong law, it is arguable that the Guarantee, and the arbitration agreement contained therein, was not concluded in law such as to render the Applicant a party to the Guarantee and the arbitration agreement.  The Guarantee is expressed to be governed by PRC law.  However, the question of the validity of the Guarantee under PRC law,  as a contract which both the Applicant and the Respondent had agreed to accept as a contract creating rights and liabilities of the Applicant and the Respondent, was not addressed in the Award, and no reason was given to support the tribunal’s finding that there was a valid Guarantee under PRC law, apart from the fact that it was signed by the Respondent as a person with legal capacity, and that it did not contravene any law and should be enforced.  This is distinct from whether the Applicant had become a party to the agreement evidenced by the Guarantee.

Proper notice ground

25.I reject the Respondent’s claim that she was not given proper notice of the appointment of arbitrators.

26.If there was a valid arbitration agreement, the parties had agreed to submit to arbitration by the Commission, and to be bound by its rules, namely the China Guangzhou Arbitration Commission Arbitration Rules (“Rules”). Pursuant to Rules 49 and 93, the Commission had delivered to the Respondent the notice of arbitration, a copy of the Rules and a list of arbitrators.  Under Rule 94 (1), a party to the Arbitration has to appoint its arbitrator within 20 days from its receipt of the Commission’s notice of acceptance of the arbitration. The Applicant appointed its arbitrator to the panel, but the Respondent failed to make her appointment, whereupon the Commission proceeded, in accordance with Rule 94 (2), to appoint the arbitrator for her as well as the 3^rd arbitrator. The Commission later notified the Respondent that the substance of her jurisdiction challenge would be dealt with by the tribunal, and the tribunal decided to deal with that in the Award - all as permitted under the Rules. 

27.The Respondent’s failure to comply with the Rules in appointing her choice of arbitrator, whether by virtue of her own ignorance or misunderstanding of the Rules, or as a result of the conscious decision of herself or her legal advisers, is no ground to complain of the Commission’s appointment of the arbitrators in accordance with its powers under the Rules.

Conclusion

28.By reason of the foregoing matters, I come to the conclusion that recognition of the Award should be refused under section 95 (3) (b) of the Ordinance, as it would be contrary to the public policy of Hong Kong to enforce the Award, when there are valid grounds to claim that the Guarantee was to secure the obligations under the HD Contracts and MD Contracts which are tainted by illegality, but the tribunal had failed to give adequate reasons as to why it accepted the Guarantee to be valid and legally enforceable.  The tribunal’s failure to explain adequately why it upheld the validity of the Guarantee also casts doubts on its acceptance of the existence of a valid and binding arbitration agreement between the Applicant and the Respondent.

29.The costs of and incidental to the application to set aside the Order granting leave to enforce the Award in Hong Kong should be paid by the Applicant to the Respondent, with certificate for 2 Counsel.

Mr Johnny Ma, instructed by Lo & Lo, for the applicant

Mr Edward Chan, SC and Ms Kate Poon, instructed by Baker & McKenzie, for the respondent