The Hong Kong regulators are taking actions in relation to their concerns regarding dubious loan transactions in listed companies. In mid-2023, the Securities and Futures Commission (SFC) and the Accounting and Financial Reporting Council (AFRC) published a joint statement on common regulatory concerns and provided guidance on conduct standards in relation to loans or other financial arrangements. In relation to misconduct of listed companies and directors, the April 2024 edition of the Enforcement Bulletin of the Hong Kong Stock Exchange (“HKEX“) discusses red flags commonly seen in lending arrangements of listed issuers and provides practical tips on compliance.

In recent years, the number of regulatory investigations involving loans, advances and other similar arrangements made by listed issuers has been on the rise. Some of the red flags below are often seen in various phases of the lending arrangements:-

The Bulletin also provides practical tips on how to ensure compliance in respect of three areas which are the HKEX’s focus and major concerns, namely (i) directors’ duties, (ii) internal controls and (iii) disclosure obligations:-

The Bulletin serves as an important reminder of the HKEX’s rigorous oversight on loans, advances and other similar arrangements of listed companies. Listed companies and directors are advised to ensure that appropriate internal control measures are in place and the disclosure obligations under Chapters 14 and 14A of the Listing Rules are complied with. Directors should bear in mind their obligations under the Listing Rules, including a duty to safeguard the company’s assets, and they could be asked to demonstrate proper actions have been taken in accordance with established policies and procedures by producing relevant written records. Any material failure in safeguarding the assets of the listed company and/or giving due consideration regarding commercial rationale of proposed loan transactions will likely trigger regulatory investigations and enforcement actions.

In our February 2024 update, we discussed the proposed amendments to the 2018 Hong Kong International Arbitration Centre (“HKIAC“) Administered Arbitration Rules.

This article follows up on the launch of the 2024 version of the HKIAC Rules (the “2024 Rules“), which will take effect on 1 June 2024 (unless the parties have agreed otherwise) and incorporate most of the previously discussed amendments.

The 2024 HKIAC Rules is available here.

The key amendments are summarised as follows:

1. Diversity in arbitral appointments (see Art. 9A): parties and co-arbitrators are encouraged to consider “diversity” when selecting arbitrators, but the HKIAC offers no definition or guiding principles regarding the concept of “diversity“. However, the HKIAC, in its press release, has cited its 2016 signing of the ERA Pledge as an example – the Pledge aims to increase the appointment of women arbitrators to achieve fair representation and gender parity.

2. New overarching considerations (see Art. 13.1): tribunals and parties should now consider information security and environmental impact when adopting procedures for the conduct of the arbitration. This reflects the HKIAC’s existing practices, such as its offering of “HKIAC Case Connect” since 2021, which is a secure case management platform with banking-grade encryption and continuous server monitoring, and its work on drafting the “Green Protocols” to promote sustainable arbitration.

3. Clarifications of the arbitral tribunal’s powers (see Art. 13.6, 13.9 and 13.10): the amendments clarify that the tribunal has power to determine preliminary issues and enhance the HKIAC’s role in matters that impact the integrity of the arbitral process, such as the appointment of arbitrators and revocation of an arbitrator’s mandate.

4. Enhancements to the mechanism for a single arbitration to proceed under multiple contracts (see Art. 29.2): the amendments allow the HKIAC to appoint the arbitral tribunal if it determines that the arbitration is properly commenced under Article 29, with parties deemed to have waived their rights to designate an arbitrator.

5. Time limit to declare the closure of proceedings (see Art. 31.1): the revisions now impose a fixed time limit, no later than 45 days from the last directed submissions, for the tribunal to declare the proceedings or the relevant phase of the proceedings closed.

6. Considerations for cost apportionment (see Art. 34.4): factors such as the relative success of the parties, scale and complexity of the dispute, parties’ conduct, outcome related fee structure agreements, and adverse environmental impact should be taken into account when determining whether the costs of arbitration are reasonable and how to apportion arbitration costs.

7. Enhanced information security provisions (see Art. 45A): data protection and cybersecurity are critical in international arbitration, as demonstrated by the hacking incident of the Permanent Court of Arbitration website during the China-Philippines maritime border dispute in July 2015. In light of this background, the HKIAC has taken steps to address the risk of cyberattacks such as recognising secure online repositories as valid means of communication and is now empowering the arbitral tribunal to make decisions, orders, or awards in respect of any breaches of information security measures agreed upon by the parties or directed by the tribunal.

8. Determination of fees payable to arbitrators (see §5.1 of Schedule 2 and §5 of Schedule 3): the amendments grant the HKIAC the authority to review and adjust the fees and expenses of the arbitral tribunal if parties have chosen to pay based on an hourly rate. Similarly, if parties have elected to pay by reference to an ad valorem fee scale, the HKIAC is empowered to determine the amount of fees and expenses to be paid to any arbitrator.

9. Clarifications of the powers of the emergency arbitrator (“EA“) (see §10 of Schedule 4): the 2018 Rules include an emergency arbitration mechanism which enables parties to seek urgent interim relief from an emergency arbitrator prior to the establishment of the arbitral tribunal. Typically, the HKIAC appoints an EA within 24 hours of receiving an application, and the EA will make an emergency decision within 14 days. The 2024 Rules clarify that the EA has the power to issue any preliminary or interim order during this 14-day timeframe.

Overall, the 2024 revisions codify the HKIAC’s existing initiatives and clarify the powers of tribunals and the institution itself.  These changes are a targeted enhancement which underscores the HKIAC’s commitment to maintaining its preeminent position in international arbitration.

In the recent case Manulife Financial Asia Limited v Kenneth Joseph Rappold & ors [2024] HKCFI 989, the Court of First Instance (“Court”) has once again emphasised the importance of ensuring that “non-compete covenants” (“NCCs”) in employment contracts are drafted in such a way that they go no further than reasonably necessary to protect the employer’s legitimate business interests.

Background

This decision concerns an application for interim-interim injunction against Mr Rappold (who was formerly employed by Manulife Financial Asia Limited (“Manulife“), the Plaintiff, as Chief Financial officer, Asia) from joining Prudential, which Manulife argued was its key competitor, pending determination of an interlocutory application.

Mr Rappold’s employment contract contained an NCC which provided, among other things, that for a period of 12 months following a voluntary termination of his employment, Mr Rappold must not be employed in a “Similar Capacity” by a “Competitor“[1].  

The Court refused to grant an interim-interim injunction against Mr Rappold. In reaching this decision, whilst stressing that its views on the merits of Manulife’s claim should be treated as provisional in nature, the Court considered that (i) Manulife had not demonstrated that its claim to enforce the NCC had reasonably good prospect of success at trial; (ii) the balance of convenience was against the granting of such interim-interim relief.

No reasonably good prospect of success in demonstrating enforceability of NCC at trial

As a general principle, an NCC (being a form of restraint in trade) is prima facie unenforceable unless the employer can show that (i) it is reasonable in the interests of the parties and in the public interest, and (ii) it goes no wider than is reasonably necessary for the protection of the employer’s legitimate business interests.

There are three reasons contributing to the Court’s view that the NCC in this case may not be found enforceable at trial:

• First, there was no geographical limitation in the NCC (i.e. it imposed a worldwide restriction on Mr Rappold). As Mr Rappold only possessed confidential information relating to Manulife’s business in the Asia region, Manulife was unable to justify a worldwide restraint which prohibits Mr Rappold from being employed outside Asia. Despite Manulife’s attempt in performing the ‘blue pencil’ test[2], from the way the NCC was drafted the Court was unable to read-into it any geographical limitation.
• Secondly, Manulife was unable to justify why a 12-month period of restriction was necessary to protect its legitimate business interests. The Court observed that information in today’s modern business world would often cease to be confidential within a very short time. However, Manulife was unable to identify specifically the confidential information allegedly possessed by Mr Rappold, nor was evidence adduced to explain (i) the shelf life of each category of the allegedly confidential information, (ii) how such shelf life warranted a 12-month restraint, and (iii) how such confidential information materially affected Manulife’s business.
• Thirdly, the NCC lacked a “temporal backstop” and applied to all work done by Mr Rappold throughout his 5-year employment with Manulife (as opposed to work carried out more recently), and was therefore arguably wider than necessary.

Balance of convenience lies against granting an interim-interim injunction

The Court was also of the view that the balance of convenience lies against granting an interim-interim injunction for the following reasons:

• Considering Mr Rappold’s age and the competitiveness of the insurance industry, granting an interim-interim injunction would cause irreparable harm to Mr Rappold’s career prospects which could not be quantified in monetary terms;
• On the contrary, Manulife failed to demonstrate an appreciable risk of irreparable damage to its business if no interim-interim injunction was granted, considering that Mr Rappold would already be bound by the confidentiality covenant and undertaking in his employment contract;
• The Court also factored in Manulife’s delay in seeking interim injunctive relief, which had already caused disruption to Mr Rappold’s employment plans.

For the reasons above, the Court refused to grant an interim-interim injunction against Mr Rappold, which is the course that carries a “lower risk of injustice” in case the decision turns out to be wrong.

Takeaways

This decision serves as yet another reminder that an NCC should be drafted in such a way that the geographical scope and duration of the restraint is no more than necessary to protect the employer’s legitimate business interests. Any employer seeking injunctive relief should also be reminded to act swiftly and to prevent unnecessary delay.

Hence, when drafting an NCC, it is always helpful to first identify the legitimate business interests it seeks to address, such that a reasonable geographical scope and duration can be determined for the NCC. When the reasonableness of the scope is in doubt, it is equally helpful to use language which makes it easy for the relevant part to be severed out from the rest of the clause, such that the clause may be saved by the ‘blue pencil’ test.

The full decision can be accessed here.

[1] Both “Similar Capacity” and “Competitor” were defined in the NCC, and there was no dispute that by joining Prudential as Chief Transformation Officer, Mr Rappold was employed in a “Similar Capacity” by a “Competitor”.

[2] When a court is able to sever an offending part of the clause and leave the remaining part of the clause intact, it may do so and convert an otherwise unenforceable clause into an enforceable one. This is known as the ‘blue pencil’ test. The test requires: (i) that the severance must be carried out without adding or modifying the remaining wording; the remaining terms must continue to be supported by adequate consideration; and (iii) the removal of the severed words must not affect the meaning of the remaining part so as to change the character of the contract which the parties entered into.

On 23 April 2024, the Hong Kong Court of Appeal handed down two important decisions clarifying the applicability of the approach emerged from the Court of Final Appeal’s decision in Re Guy Kwok Hung Lam [2023] HKCFA 9 (“Re Guy Lam“) to disputed petition debts subject to an arbitration clause, and arbitrable cross-claims raised by a company in a winding up proceeding.

Re Simplicity – disputed debt subject to arbitration clause

In Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 (“Re Simplicity“), the Court of Appeal held that when the debt forming the petition debt is disputed and should be referred to arbitration pursuant to an arbitration agreement, the established approach, namely that a petitioner is ordinarily entitled to a winding order if the petition debt is not subject to a bona fide dispute does not apply. Rather, the approach in Re Guy Lam should apply, meaning the petitioner and the debtor company ought to be held to their contract to refer dispute to arbitration, absent countervailing factors such as the risk of insolvency affecting third parties, and a dispute that borders on the frivolous or abuse of process.

The controversy is whether the debtor company should be required to demonstrate a bona fide dispute of the petition debt on substantial grounds notwithstanding the existence of an arbitration clause in order for a petition to be stayed or dismissed ([33]). In this regard, the Court of Appeal held that it is appropriate such controversy should be laid to rest in light of the reasoning in Re Guy Lam, as the effect of arbitration clauses on insolvency petitions is of central importance to the reasoning of the Court of Appeal and Court of Final Appeal’s judgments of Re Guy Lam ([34]).

Further, having regard to the statutory framework protective of arbitration (as evidenced by Section 20 of the Arbitration Ordinance (Cap 609) which provides for the Court to refer matter subject to an arbitration agreement to arbitration), there is an even stronger case for upholding the parties’ contractual bargain that disputes falling within the scope of an arbitration clause should be resolved by arbitration ([37]). Vice versa, it would be an anomaly that a party bound by an agreement for dispute resolution cannot expect to proceed with an ordinary action for his claim, but can resort to the more draconian measure of presenting a petition for winding up a company ([35(5)]).

Importantly, such public policy consideration of holding parties to their bargain is not the only consideration and the approach of the Court in exercising its discretion is “multi-factorial” – the “countervailing factors” mentioned in Re Guy Lam, namely (i) the risk of insolvency affecting third parties, and (ii) a dispute that borders on the frivolous or abuse of process, are simply instances the Court may exercise its discretion not to hold the parties to their agreed dispute resolution mechanism. In this way, the Court retains the flexibility to deal with cases as circumstances require ([39]).

The Third Requirement of Lasmos survives

Prior to Re Guy Lam and Re Simplicity, the approach to disputed petition debt subject to arbitration clause is set out in Re Southwest Pacific Bauxite (HK) Limited [2018] HKCFI 426 as the “Lasmos” approach: the petition should generally be dismissed where it is shown that (i) if the company disputes the debt relied on by the petitioner, (ii) the contract under which the debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt, and (iii) the company takes the steps required under the arbitration clause to commence the contractually mandated disputed resolution process ([23]). In responding to the company’s submission in this case that the petitioner took no steps to express their intention to arbitrate, the Court of Appeal held that a genuine intention to arbitrate on part of the petitioner remains to be relevant. Otherwise, petitioners could simply raise arbitration clauses as a tactical move with no genuine intention to arbitrate in stalling the winding up process ([42]). However, even if no steps at all were taken, the Court could still exercise its discretion in appropriate cases to grant a short adjournment for the debtor to commence arbitration and require an undertaking from him to proceed with arbitration with all due dispatch. If no progress is made during the adjournment, the Court could consider lifting the stay and proceed to exercise its jurisdiction on the petition debt ([42]).

Nevertheless, as the company in this case did not file any evidence in opposition to the petition and did not comply with the condition for an extension of time to do so, the Court of Appeal dismissed the company’s appeal and ruled that the petitioner is entitled to a winding up order ([43]).

Re Shandong Chenming – The treatment of cross-claims

Further to our previous articles[1], the petitioner in Re Shandong Chenming Papers Holdings Limited [2024] HKCA 352 (“Re Shandong Chenming“) appealed the Court of First Instance’s stay of the petition to wind up the company pending determination of an arbitration between the parties. Following Re Simplicity, the principal question here is whether the approach in Re Guy Lam should also be applied where a company has raised a cross-claim against the petitioner which is arbitrated pursuant to an arbitration agreement between the parties. The petitioner submitted that the Court should assess the cross-claim in the ordinary case without an arbitration clause, the test being whether there is a genuine cross-claim based on substantial grounds.

To begin with, the petitioner submitted that there are two questions arising in a petition, the first being the threshold question of whether the petitioner has standing to present his petition. If the petitioner has standing, the second question is whether the company is insolvent and should be wound up. Within this framework, the petitioner posited that Re Guy Lam only concerned with the prior question of standing and the question of cross-claims falls under the second question, which is to be considered with a range of other matters in determining the insolvency of the company. Further, the petitioner argued that since the reason underlying the principle in Re Guy Lam is that the petitioner should be held to his bargain, that principle does not apply to cross-claim which is instead asserted by the company ([24]).

Contrary to the petitioner’s submissions, the Court of Appeal held that while it is true that the dispute over the petition debt is described in Re Guy Lam as a “threshold” question, it is relevant to note that the reasoning in that case is grounded in the wider context of the Court’s discretion to decline jurisdiction and it will be too narrow to read Re Guy Lam to confine its rationale to the question of standing to petition ([37]-[38]). Rather, the Court considers the overall relationship between the parties to see whether the petitioner is a net creditor having an interest to wind up the debtor company ([40], [42])). In this process the Court does not ignore the company’s cross-claims against the petitioner, and indeed regard them as “practically equivalent to disputes of the debt” where reverse cross-claims by the petitioner against the company could also be relevant ([39]). Therefore, where the cross-claim is subject to an arbitration clause, the forum agreement between the parties is likely to be relevant to the exercise of the Court’s discretion – for the Court to enter into the merits of the cross-claim would be against the parties’ agreement ([42]-[43]).

Moreover, the Court of Appeal held that while it is true that it will be the debtor company who has drawn the cross-claim to the Court’s attention, it is not the company seeking the Court’s determination of his cross-claim but the petitioner who is asking the Court to reject the cross-claim as a ground of opposition to the petition. For these reasons the petitioner is making a distinction without a difference and thus the appeal was dismissed ([45]).

Takeaways

The two Court of Appeal decisions put the controversy and debates sparked from First Instance’s decisions to rest and confirmed that Re Guy Lam applies equally to disputed petition debt and cross-claim subject to an arbitration clause.

Further, as the Court of Appeal made clear in Re Shandong Chenming, extending the Re Guy Lam approach to cross-claims would not create a “debt dodger’s charter” as the debtor company would have to show a valid exclusive forum agreement between the parties that governed the cross-claim to rely on the approach. In this light parties who have agreed to refer their disputes to arbitration should proceed with arbitration to resolve any issues before commencing winding up proceedings, so as to avoid wasted time and costs as the Courts will probably hold parties to their contractual bargain and stay or dismiss petitions, save for exceptional circumstances

[1] Articles published on 28 June 2022, 25 August 2023, and 15 November 2023

In collaboration with Essar Insurance Services Limited, Managers of the Professional Indemnity Scheme (“PIS”), we have recently published an article on “Solicitor’s Undertaking” in the Hong Kong Lawyer Journal to highlight risk management issues learnt from the handling of PIS claims.  It can be accessed here .

This article delves into common scenarios in which solicitor’s undertakings are given, emphasises the importance of honouring these undertakings, and sheds light on the potential consequences of breaching them.

An RME bulletin on the same topic has also been published, which can be accessed here.

Should you have any enquiries or require assistance regarding this topic or professional negligence / indemnity generally, please do not hesitate to contact us.