2 November 2020
Introduction
The Hong Kong Arbitration Ordinance sets out the statutory procedure for parties to apply to the Hong Kong Courts to seek enforcement of an arbitration award. However, what happens when an arbitration award is physically incapable of being performed? Does the court have the power to step in to assist the aggrieved party by making an order for other relief? This question was recently addressed by the Court of Final Appeal in the case of Xiamen Xinjingdi Group Co Ltd v Eton Properties Limited and others [2020] HKCFA 32. In particular, the judgment of the Court of Final Appeal clarifies the role of the Hong Kong Court when enforcing an arbitration award pursuant to a common law action.
Background
In July 2003, Eton Properties Limited and Eton Properties (Holdings) Limited (collectively referred to as “EP”) entered into an agreement with Xiamen Xinjingdi Group Co Ltd (” XXG “) (the “Agreement”). Pursuant to the Agreement, EP agreed to sell the right to develop a plot of land situated in Xiamen (” Land “) to XXG. At the time of the Agreement, EP warranted that they had complete control over Legend Properties (Xiamen) Company Limited (“Legend Properties”). In turn, Legend Properties had incorporated and owned a foreign-owned enterprise incorporated in the PRC, which had the right to develop and use the Land. As part of the Agreement, EP agreed to transfer all their shares in Legend Properties to a legal entity designated by XXG upon payment of the transfer price in full. This would give XXG the development and use rights to the Land.
Four months after the Agreement was entered into, EP wrote to XXG giving notice that they would not be going ahead with the Agreement. XXG did not accept the termination of the Agreement, and demanded for delivery of the Land. In the meantime, EP took steps to develop the Land themselves.
Subsequently, in August 2005, XXG commenced CIETAC arbitration proceedings against EP pursuant to the dispute resolution clause in the Agreement, and the first hearing was scheduled to take place in November 2005. A week before the hearing, a restructuring of the corporate shareholding relating to the Land took place. As part of the restructuring, Eton Properties Group Limited (“Eton BVI”), a BVI company, became the company that owned the rights to the Land, instead of EP. This meant that the promise contained in the Agreement that EP would, at completion of the development, transfer their shares in Legend Properties to XXG could not be performed. XXG was not made aware of the restructuring until sometime in January 2008.
On 27 October 2006, the arbitral tribunal made its first arbitration award (“First Award”), awarding XXG damages for breach of contract (“monetary obligation”), and also ordered that EP shall continue to perform the Agreement (“non-monetary obligations”).
Issues with the enforcement of the First Award
After the First Award was issued, XXG applied to the Hong Kong Court for leave to enforce the award pursuant to section 2GG of the Arbitration Ordinance (Cap. 341) (which has since been repealed and substituted with the Arbitration Ordinance (Cap. 609)). In October 2007, Justice A Cheung granted XXG leave to enforce the First Award (“Statutory Judgment”). However, in January 2008, EP applied to set aside the Statutory Judgment on the basis that it was impossible to perform the non-monetary obligations imposed on EP by the First Award. It was only afterreading the affirmation filed by EP in support of the setting aside application did XXG realise that a restructuring had taken place, and that EP had divested themselves of their shareholding in Legend Properties.
Upon learning about the restructuring, XXG started a fresh action in Hong Kong in May 2008 to enforce the First Award (“Common Law Action”). XXG also brought an action against Eton BVI, Legend Properties and others who were not parties to the Agreement or the arbitration as defendants for other relief.
Sometime in December 2011, XXG obtained leave to amend its pleadings to add an alternative claim for damages and/or equitable compensation in the event that the relief it had been pressing for, namely the transfer of shares in Legend Properties, was physically incapable of being performed. This article will focus on the decision of the Hong Kong Courts in relation to XXG’s alternative claim for damages and/or equitable compensation.
The decision of the Hong Kong Courts
When the matter first came before the High Court, the judge was troubled by the existence of the Statutory Judgment. While the High Court recognized that the Common Law Action was brought to enforce the implied promise to honour the First Award at common law, the judge regarded this as being “no different in specie” from, and permitting no greater latitude in terms of remedy than the statutory procedure. In other words, the High Court was of the view that the court’s role is limited to “mechanistically” converting the award into a judgment in terms of the award. In this regard, by pursuing a new claim for damages and/or equitable compensation, XXG was going beyond the scope of the First Award. More fundamentally, XXG was asking for a remedy which the arbitral tribunal was not even asked to consider. This was tantamount to subverting the integrity of the arbitral process, as the High Court would be usurping the designated dispute resolution body and imposing its own remedy under the purported guise of “enforcement”. Accordingly, the High Court held that it did not have jurisdiction to make an order in respect of XXG’s alternative claim for damages and/or equitable relief.
XXG appealed against the decision of the High Court, and the Court of Appeal allowed the appeal. The Court of Appeal held that under the laws of Hong Kong, there is an implied mutual promise to honour the arbitration award. Failure by any party to do so constituted a fresh cause of action which is separate and independent from an action based on breach of the underlying agreement. The Court of Appeal also held as follows:
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There is a distinction between the statutory procedure to enforce an arbitration award, and a common law action to enforce the implied promise to honour an arbitration award. Unlike cases involving the statutory procedure, the court was not limited, in a common law action, to granti relief which simply mirrors the terms of the arbitration award. Instead, the Court has jurisdiction to order damages or equitable compensation even though the arbitral tribunal did not make such an award.
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A common law action to enforce the implied promise to honour an arbitration award operated at the enforcement phase, and is distinct from any dispute falling within the arbitration clause. As such, it is not necessary to stay the common law action for enforcement in favour of arbitration.
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Even though XXG had obtained a Statutory Judgment in respect of the arbitration award, XXG had not made an informed irrevocable election since it had done so while material information concerning the restructuring had been withheld by EP. However, the inconsistent remedies of ordering continued performance of the Agreement on one hand, and damages or equitable compensation on the other, could not stand together. Thus, XXG was required to make an election accordingly.
After the decision of the Court of Appeal was handed down, XXG notified the Court of Appeal of its election. Thereafter, the Court of Appeal ordered that the Statutory Judgment be set aside and that judgment be entered in favour of XXG for damages against EP for breach of the implied promise to honour the arbitration award.
Subsequently, EP applied for and was granted leave to appeal to the Court of Final Appeal. EP’s main contention was that the Court of Appeal had erred because, in awarding XXG damages to be assessed, the Court of Appeal went beyond the relief that can properly be awarded in a common law action on the award. After considering all the arguments that were placed before the court, the Court of Final Appeal dismissed EP’s appeal. The decision of the Court of Final Appeal is summarized below:
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A common law action to enforce the award is separate and procedurally very different from the statutory procedure. An application to enforce an arbitration pursuant to the statutory procedure is made on an ex parte basis and is therefore summary in nature. On the other hand, in a common law action, a party must sue on the award and prove his case. In the latter situation, the court is not limited to entering judgment mechanistically, and is not constrained by the requirement that the judgment must be “in terms of the award”.
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The scope of the dispute resolution clause in the Agreement only covers disputes arising from the performance of the Agreement. The implied promise to honour an arbitration award is separate and distinct from the obligations created by the underlying contract. In this regard, EP’s failure to comply with the arbitration award gave rise to a fresh cause of action, and was not a dispute “arising from the performance of the Agreement”. More importantly, suing for breach of the implied promise is an aspect of enforcement, which is regulated by the enforcing court (in this case, the Hong Kong Court).
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There is a fundamental difference between proceedings at the arbitration as opposed to the enforcement phase, and the range of remedies open to the enforcing court. The split functions of the tribunal and the enforcing court resemble a relay race. The determination of the parties’ mutual rights and liabilities pursuant to the underlying agreement is a matter for the arbitrators. Once the arbitral tribunal has made an award, the tribunal no longer has a function to fulfil. At this stage, the arbitrator will hand the matter over to the court, and enforcement of that award will be a matter for the court. In a common law action on the implied promise, the enforcing court may grant relief appropriate to the award – (i) If it is a monetary award for payment within the jurisdiction, it may simply be a judgment enforcing the award as a debt; (ii) If it is a non-monetary award which has not been complied with, the court may fashion an apt remedy chosen from the full range of remedies available in an ordinary common law action.
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In making an order at the enforcement phase, the court is not usurping the function of the arbitral tribunal. Instead, the court is exercising its jurisdiction with a view to fashioning an appropriate remedy to give effect to the award, distinct from any remedy that might have been claimed in the arbitration. In this regard, it is not necessary for the relief granted by the enforcing court to be adjusted so as to achieve consistency with the terms of the arbitration award.
Conclusion
The Court of Final Appeal’s decision is welcomed as it allows justice to be served. Otherwise, a party to the arbitration can frustrate the arbitration award by taking steps to render the award physically incapable of being performed. If the aggrieved party is not able to seek alternative remedies from the enforcing court, the aggrieved party will be left with nothing but a mere paper judgment. However, when making an order for alternative relief, the court must confine itself to looking at the narrow issue of the breach of the implied promise to honour the arbitration award. The Court cannot, and must not, overstep its boundaries by considering the merits of the underlying dispute between the parties. To do otherwise would be usurping the function of the arbitral tribunal. In this regard, it will be interesting to see what factors the court will look at when assessing the quantum of damages to be awarded to XXG at the next stage of the trial.
For further information, please contact:
Keoy Soo Khim, Withersworldwide
