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Are you ready for the global tax reform?

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A brief discussion on how MNCs should respond to the OECD’s new measures relating to Automatic Exchange of Information and Transfer Pricing issues

AEOI and the CRS – Enhanced tax controls on tax evasion  

We are living in a globalised world, and cross-border activities have become the norm in the last few decades. In the past, multinational corporations (MNCs) often adopt aggressive tax strategies by booking most profits in tax heavens where information sharing with foreign tax authorities is often minimal. The result is that tax authorities across the world often face difficulties in gathering sufficient offshore asset and transactional information of the tax payers to conduct tax assessments in their home jurisdiction. To unplug loopholes, the OECD has led the international effort in the implementation of Automatic Exchange of Information (AEOI) and adoption of the Common Reporting Standard (CRS).

In order for participating countries to enjoy the mutual benefits of information exchange, financial institutions (FIs) of a participating country are required to report financial information regularly to local tax authorities which is then transmitted to their overseas counterparts in exchange of similar information from other participating jurisdictions. It is noteworthy that more than 100 jurisdictions are already committed to AEOI implementation as at June 2020.

Why is this relevant to me?

Let’s assume that you are a tax resident of your home Country A and have offshore assets or income in Country B. If both countries are committed to AEOI, Country B will become duty-bound to share your financial information automatically with the tax authorities of Country A, such that the latter may track your offshore investments beyond national borders, carry out a tax avoidance investigation and enforce any non-compliance. The most typical types of information covered include tax return and financial statements, company directors/shareholders, company registration, interests, dividends, account balance or value, sales proceeds from financial assets, etc. Such new disclosure regimes have made tax evasion through non-disclosure extremely difficult, if not practically impossible, because offshore undeclared financial assets can now be targeted by a taxpayers’ country of residence.

In Hong Kong, legislative amendments were introduced into the Inland Revenue Ordinance in 2016 to enhance tax transparency and combat cross-border tax evasion. Information exchange is permitted where a bilateral agreement is concluded between the Hong Kong government and a partner jurisdiction. By the start of 2020, the number of reporting jurisdictions in Hong Kong has increased extensively to 126. FIs in Hong Kong are required by law to collect information of identified individual/corporate account holders and their financial account information for onward exchange with other jurisdictions. Furthermore, FIs in Hong Kong must require account holders to complete a self-certification form to declare their tax residence status, and any intentional or reckless false statement on residence status will constitute a criminal offence.

The AEOI regime is relatively new, which might explain why reports about defects in the CRS are not uncommon. For example, there are still many offshore jurisdictions without a public company register and the ultimate beneficial owners might remain unidentifiable. However, with increasing perfection over the CRS, the past practice of utilising offshore entities for secrecy or confidentiality purposes is deemed to be phasing out gradually.

Take-home message

Given the global enhanced tax transparency, in-house legal professionals should plan ahead with their tax advisers before implementing any cross-border transactions, especially where certain offshore financial information may be exposed and reported back to the tax authorities of the home jurisdiction. Quite often, they are no longer protected on the grounds of secrecy or client confidentiality. In addition, since the AEOI regime may take retrospective effect in some jurisdiction, companies with foreign operations are also expected to review past transactions to ensure that tax disclosure has been adequately made to avoid penalties imposed upon future investigations.

Transfer Pricing – how does it work?

As mentioned above, tax authorities often pay close attention to MNCs to ensure that their modus operandi is not structured in a way that diverts domestic profits to overseas entities. A typical tax strategy which is often subject to challenge and scrutiny is called ‘transfer pricing’ – a practice adopted by MNCs to determine pricing, often artificially, between related entities and reduce tax liability for the group as a whole. This is most common where one entity is located in high-tax rate regime and another overseas company is in a low-tax rate jurisdiction. Imagine Company A is a PRC semiconductor manufacturer and Company B is a trading company in Hong Kong set up to facilitate onward global sales. The group may manipulate intercompany pricing by suppressing product price of Company A such that part of the manufacturing profits could be shifted from the PRC to Hong Kong when they are sold to third-party end customers. The group’s profits are thus subject to a more favourable tax rate in Hong Kong. This example can be illustrated in the following diagram.

Against this background, tax authorities around the world have taken active steps to prevent artificial pricing manipulation through anti-avoidance legislation to combat erosion of their tax revenue. Although details in the legislation may vary from jurisdiction to jurisdiction, the common objective is to enforce an ‘arm’s length transaction’ rule that requires pricing to be based on similar transactions done between unrelated parties. We shall briefly discuss below relevant Transfer Pricing law and practice and latest update in Hong Kong.

Transfer Pricing (TP) in Hong Kong

Prior to the legislative amendment in 2018, s.20 of the Inland Revenue Ordinance (IRO) (now repealed) had long been the general provision used to deal with TP issues. Under this section, if a non-Hong Kong resident carried on business with a resident with whom he was closely connected and the operations were arranged in such a way that they resulted in the Hong Kong resident producing no Hong Kong profits or less than ordinary profits, the non-Hong Kong resident’s business would be deemed as carrying on a business in Hong Kong, and thus chargeable to Hong Kong tax. Currently, TP issues in Hong Kong are mainly curbed by s.50AAF (alongside with other anti-avoidance provisions) by empowering the Hong Kong Inland Revenue Department (HKIRD) to impose TP adjustments on income or expenses in accordance with the arm’s length principle if a transaction has been made between two associated persons which (i) differs from the one which would have been made between two independent persons and (ii) confers a potential Hong Kong tax benefits. This principle corresponds to the OECD TP Guidelines for Multinational Enterprises and Administrators (issued in July 2017) (Guidelines) and became effective from 1 April 2018 (i.e. the 2018/19 Year of Assessment). It is worth noting that the burden in proving an arm’s length transaction falls upon the taxpayer and should they fail to satisfy the HKIRD, it may make adjustment accordingly.

Mandatory Documentation – a ‘3-tiered’ approach

Master File and Local File

Despite the introduction of the new legislation, we understand that some enterprises in Hong Kong are not aware that they could be subject to the three levels of TP reporting requirements. In fact, with effect from April 2018, any Hong Kong entities engaging in related party’s transactions (RPTs) are required by the HKIRD to prepare a Master File and a Local File. They are required to disclose whether they are required to prepare any TP documentation when filing their Tax Returns. Nevertheless, an entity may be exempted from documentation requirements if at least two of the following exemption criteria are satisfied for a given accounting period:

  • Total revenue of the MNC group does not exceed $400 million;
  • Total value of assets does not exceed $300 million; and/or
  • Average number of employees does not exceed 100.

In addition, Hong Kong entities are not required to prepare the Local File if the relevant RPTs do not exceed the following amounts:

  • Transfers of properties (whether movable or immovable but excluding financial assets and intangibles) – HK$220 million;
  • Transactions in respect of financial assets – HK$110 million;
  • Transfers of intangibles – HK$110 million; and
  • Other transactions – HK$44 million.

The HKIRD has issued Departmental Interpretation and Practice Notes No.58 setting out the detailed contents required in the Master File and Local Files. For instance, the Master File must contain a high-level overview of the company group (including global business operations and TP policies) in order for the HKIRD to evaluate any significant TP risks. As for the Local File, detailed transactional TP information specific to the enterprise in each jurisdiction, including details of transactions, amounts involved and TP benchmarking analysis with respect to those transactions must be documented.

Country-by-Country Report (“CbC Report”)

MNC groups are also required to file a CbC Report where the consolidated group revenue for the preceding accounting period is at least HK$6.8 billion and the group has constituent entities or operations in two or more jurisdictions. Such report should include (among other data) aggregate tax jurisdiction-wide information relating to the global income allocation, taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE Group operates.

Guidelines on TP Benchmarking Analysis

The Guidelines have set out five TP methods to establish whether an RPT is consistent with the arm’s length principle when preparing a benchmarking study. Identification of a suitable method for TP analysis is a very technical exercise and is beyond the scope of this article. However, it is important for in-house lawyers to note that depending on the industry or business activities which taxpayers engage in, tax advisers often make use of external databases to conduct searches of financial data and to identify domestic data comparable to the RPTs and if such comparables are unavailable, then comparables from similar markets in Asia or other parts of the world will be used. In many cases, statistical concepts, such as the interquartile range, may be helpful tools in determining whether an RPT is consistent with the arm’s length principle.

Penalties

The HKIRD recognises the imprecise nature of TP and therefore caps the potential penalties at a level lower than for other tax offences. The penalty for non-compliance with the Rule is limited to 100 percent (as opposed to three times) of the tax undercharged. No additional tax will be imposed when the taxpayer has exercised a reasonable effort to determine the arm’s length amount. The HKIRD also takes the view that preparation of a Local File with a comparability analysis would be considered a reasonable effort in this regard, although more stringent penalties are imposed for omission or understatement of income.

Take-home message

It is not difficult for the HKIRD to identify entities who might have obligations to do TP documentation. Quite often, enterprises do not apprehend the immediate impacts of the new legislation on them simply because the HKIRD has not raised requisitions with the taxpayers yet. Many MNCs could therefore potentially be charged with non-compliance unless they fall within the statutory exemptions. It is therefore advisable to make preparations sooner rather than later because the evidential value is higher if a comparability analysis supporting TP calculation is done before (instead of after) an RPT is carried out. Given the technicality involved, it is always important to obtain proper advice from accounting and legal experts to reduce exposure to potential TP risks.

If you would like to discuss any points raised above in more detail, please do contact Anna Chan on the details below.

E: anna.chan@oln-law.com

April 2021

We Need to Talk About Your Website Terms of Use

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We know that you’re busy developing your MVP and growing your business but we need to talk about your website and specifically, your Terms of Use (sometimes referred to as Terms & Conditions or Terms of Service and abbreviated as “ToU” or “ToUs”).

We need to talk about them because the risks associated with operating a website with inadequate ToUs (or none at all) are huge. By “huge”, I mean that they could result in lawsuits or reputational loss that could bankrupt your business.

So, let’s briefly examine those risks and how to manage them. We can start by looking at the typical dangers of using your website as an extension of and/or marketing portal for your business.

What Could Possibly Go Wrong?

Firstly, in Hong Kong, websites are not legally required to have any ToUs unless they are used for collecting or using data that could be used to identify users, in which case they are required to at least contain a suitable privacy policy that satisfies our privacy laws. Failure to comply will result in heavy fines. Furthermore, if the website is intended to be used by users in other countries, it may also need to comply with privacy laws there.

Even if your website isn’t legally required to have a privacy policy, ToUs are still worth having, to avoid or minimise the impact of things that can go wrong. Businesses use various kinds of contracts to deal with third parties for the same reason.

Here are just a few examples of the kind of things that can go wrong with various kinds of websites: 

  • Digital bulletin board-type businesses normally sell advertising space, allowing users to post content on the website, usually in exchange for payment. Without appropriate protections in their ToUs, such businesses will be liable for whatever content is posted even if that content is illicit. They may also become the target of complaints and lawsuits if service interruptions prevent the bulletin board from operating after advertisers have paid to advertise. 
  • A digital payment operator like AsiaPay or Ezypay will usually have full e-commerce capabilities, allowing users to access a source of funds and arrange delivery to a designated recipient. Most will request and store only the minimum information required to complete the transaction but nevertheless that information is potentially at risk of being used for improper/illegal purposes. A rival business owner might launch a DDOS attack to disable the website or a hacker could deface the website to diminish goodwill or make a political statement. 
  • Although school websites typically store a lot of information (i.e.: about the school, its academic programs, and its faculty, etc.), they seldom feature any e-commerce capabilities. Their intended use is primarily for users to access and take note of information but again, that information may be stolen or illegally altered without being detected. 
  • A bank’s website might conceivably feature all of the above operational features as well as provide connections to third party websites offering various non-bank services or goods. Criminals often use bank websites to gain access to customer records for the purpose of later committing fraud. 

Also keep in mind that any services available on your websites might be interrupted either due to failure of a designated internet content provider (ICP) or a server or other hosting medium. Alternatively, the software responsible for conducting business on your website could malfunction, resulting in transactions that are not recorded, products not being delivered, and refunds not processed. 

Without suitable exclusions of liability set out in ToUs, the worst possible outcome won’t just be loss of confidence in your brand; your business could be sued and held liable for any losses that customers suffer due to interruptions or failures. 

However, an appropriate set of ToUs can avoid or limit the impact of all of the above risks.

How ToUs Can Protect Your Business

The primary role that ToUs play is to regulate how the website can be used and by whom. They function like the terms and conditions of a conventional written contract because they are regarded as legally enforceable contracts that you stipulate.

All websites engaged in e-commerce should contain suitable terms of sale (i.e.: addressing pricing, refunds, shipping policies, risk of loss, etc.). They should also include limited representations and warranties tailored to the business, so that potential liabilities for certain foreseeable events such as interruption/suspension of service, late delivery and/or loss of data, will be excluded. 

Websites that are merely used to project an online presence for the business (but not involved with selling goods or services) still need ToUs but the scope of protections will usually be more limited because the risks associated with operating such websites are more limited.

In other words, ToUs are essentially risk management tools: by ensuring that all necessary protections are spelt out in the ToUs, you will set clear expectations for users and hopefully avoid most disputes. And, for any disputes which you cannot unavoid, the scope of liability will be reduced because users will be legally bound by your ToUs. 

Final Comments

Online businesses need to comply with all relevant laws as well as exercise appropriate oversight over the use of their websites to ensure that the business is fully protected and not prone to embarrassing lapses that might reduce public confidence in them. 

We know that you’re busy and you might not have budgeted for any legal expenses but now that we have highlighted some of the legal risks involved with operating your website, would it be prudent to take your website ‘live’ without a properly curated set of ToUs? Would you risk waiting to install a sprinkler system in your business until after it has been destroyed by fire?

In addition to helping to limit your legal risks, a set of properly drafted ToUs can also serve as an effective “blueprint” for your business, outlining the appropriate procedures that users need to follow in order to complete their purchase or other desired functions. It tells users that you are complying with the law and best practices. 

If your website currently doesn’t have proper ToUs or if your business has scaled significantly since the ToUs were first prepared, now would be a good time to have them reviewed by a lawyer.  

We have helped develop ToUs for clients in nearly every conceivable sector and won’t over-complicate the process. We can also give you sensible advice about whether or not to incorporate a privacy policy and/or a cookies policy.

May 2021

Team Green OLN accepted the Adventure Clean Up challenge

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Saturday 24 April 2021, lawyers from OLN accepted the Adventure Clean Up challenge and spent their Saturday cleaning up Hong Kong’s beautiful trails & coastlines. Ten huge bags of litter were collected! 

Associate Ivan Lee, Team Captain of Team Green OLN, stated “Team Green OLN, a group of 10 enthusiastic and driven lawyers, were determined to challenge themselves both physically and mentally for a better and cleaner environment on Hong Kong’s beautiful trails and coastlines. We don’t just waste paper!“⁠⁠

As Adventure Clean Up explains ‘Hong Kong Island has around 80 km of coastline of which large parts are coastal cliffs. The easy accessible beach sites are getting cleaned on a regular basis by government services and community organised beach clean ups. The majority of coast and cliffs are more remote and harder to reach by the general public. Trash has been collecting in these areas for years.’  Adventure Clean Up’s mission ‘Is to raise awareness in relation to waste and coastal contamination and the personal actions we can take to reduce/minimise this in the future, doing so:
•    In a compelling, fun, adventurous way
•    Leveraging on our sporty community that loves outdoor challenges
•    Focusing on practical, experiential action to bring about sustaining change in the participants, communities involved and the audience.’ 

Adventure Clean Up purpose aligns brilliantly with OLN’s culture and commitment to ‘practical solutions, on time, no excuses!’ We love action and the outdoors, and treasure Hong Kong’s idyllic beaches and hiking trails through its lush green mountains.

OLN would like to express our appreciation to Adventure Clean Up for this meaningful opportunity and congratulate Team Green OLN!

April 2021

Team Green OLN accepted the Adventure Clean Up challenge

Crossover or Crossed over?

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Crossover is a peculiar Hongkie term to describe “collaboration” merchandises co-designed, manufactured and marketed by two established brands only for a particular season and in a limited number of production rendering such items rare, iconic and sought after in the market, such as a Supreme x Louis Vuitton Monogram Box Logo Hoodie (Farfetch market value at HKD83,758), or a Gucci x The North Face Print Jacket (Stock X market value at HKD47,900). Supportive fans of these brands are so willing to spend on these limited edition items to acquire them as collectibles or maybe even works of art.  

Speaking of works of art, artists’ works are mostly original designs from scratch whilst some artists are good at creating works based on the iconic and basic items from reputable brands (such as a Hermes Kelly or Birkin bag or a pair of plain Converse sneakers) to enhance the overall appearances of such items in very artistic manners. In most cases brand owners do not intervene or object to such works which in a way pay tribute to the brand’s status and reputation. In the US, it is a legal rationale that gives artists the ability to express their own ideas and profit from their own creativity after customized art work has been infused into the items. Such items are almost equivalent to works of art in the global art culture that brand owners generally have to bear with. What could happen if an artist has crossed the line and infused a controversial idea into a re-made product?

In early April 2021, Nike filed a law suit in the United States against MSCHF Product Studios Inc. (“MSCHF”) after its launch of a pair of modified Nike Air Max 97 black color sneakers named the “Satan Shoes” designed in collaboration with Rapper Lil Nas X priced at USD1,018 in a limited number of 666 pairs which had been sold out in just an hour. Nike is not happy because the shoes are designed in a “satanic-theme” with the midsoles of the sneakers injected with red ink and a drop of human blood (which allegedly came from one of the designers’ team of 6 guys). Whilst these sneakers are originally authentic, the customizations are not authorized or endorsed by Nike. In the Internet space, there were calls to boycott Nike for promoting Satanism! Nike reacted quickly by filing a court action based on trade mark dilution to seek both preliminary and permanent injunctions and damages plus the destruction of the shoes. The parties had settled the case just few days before they were to appear before the Judge. MSCHF had to recall the Satan Shoes voluntarily and offer a buy back of the Jesus Shoes released by MSCHF in 2019 in a total number of 24 pairs of Nike Air Max 97 white color sneakers injected with a drop of holy water extracted from River Jordan.    

To all respectable artists and designers: we love your creativity but please do not cross that line when you create a piece based on an item originated from another brand owner! 

April 2021

Can a Payee’s Money be Frozen if Payor Uses Underground Banking without Payee’s Knowledge?

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Prior to 2020, transfers of money into Hong Kong through the underground banking system were not “questioned”. Contracts involving such transfers, whilst illegal under PRC law, were enforceable. All that changed due to a trilogy of cases decided by HK’s High Court, with the jury still out on the question of whether the defence of bona fide purchaser for value without notice remains available to passive recipients who played no part in the fraud or underground banking and who could not have suspected that the money originated from such acts. 

The Law Prior to 12 October 2017

As late as 2017, our Court of First Instance in BR CAT International Co Ltd v Hong Kong Proof Import and Export Trading Co Ltd (HCA 1023 of 2014, 22 September 2017) found money originating from a fraudulent act and subsequently transferred through underground banking “legal” in HK as long as the recipient had no actual or constructive knowledge/notice of the fraud or the underground banking.  

The factual circumstances of the case are similar to those of most underground banking cases:

  • A foreign plaintiff (Saudi Arabian company) was duped by an online fraudster into transferring USD1.4 million to bank accounts located in HK belonging to the first layer of recipients.  
  • One of the first layer recipients then transferred a part of that sum, USD323,000, to the account of D8 located in HK.  
  • Separately, D7 needed to convert RMB sitting in its Shenzhen account into USD and transfer it to HK.  D7 sought D8’s help. D8 asked D7 to transfer the money to D8’s accounts in Shenzhen and Fujian. 
  • Rather than actually converting D7’s RMB and wiring it to HK, D8 simply used the USD received from the defrauded plaintiff and sitting in D8’s account in HK, and transferred it onwards to D7.
  • In other words, D8 collected RMB in the PRC but instead of using the same money to do the conversion and transfer to HK, D8 used the sum already sitting in its account which would have remained with the plaintiff but for the fraud.

In deciding that D7 was entitled to keep the converted money which came from proceeds of crime, Madam Justice Bebe Chu decided that the conversion and transfer out of money from the PRC via the underground banking system, though possibly illegal in the PRC, did not render the transaction between D7 and D8 void because D7 had no constructive or actual knowledge about the fraud, i.e. D7 got to keep her money. She stated:

Although the transactions through the “underground banking system” may be considered illegal under the Mainland law, in the present case, there was no reason for Yau to believe that the USD323,000 transfer arranged by D8 to be deposited into D7’s HSBC Account designated by him, would come from a fraudster, or any illicit or improper source, nor was there any evidence to indicate that there was anything obvious or untoward in D8 in transferring the amount to him. There was no sufficient evidence to show that a reasonable person in Yau’s position would have appreciated that the transfer arranged by D8 with whom he had had money exchange transactions in the past was probably fraudulent or improper, or a person in Yau’s position would have made inquiries or sought advice which would have revealed the probability of impropriety.

In other words, Madam Justice Chu did not consider the underground banking feature as a poison pill for D7’s claim and simply considered the question of whether the recipient had knowledge of the fraud in actual terms (she knew) or constructively (as a reasonable person, she should have known, or at least there were sufficient suspicious circumstances that should have caused her to make further inquiries as to the origin of the money).  

The New Approach 

Case No.1 – The High Court first deviated from Madam Justice Chu’s approach in DBS Bank (Hong Kong) Limited v Tian Wen Quan (HCA 3228 of 2016, 12 October 2017). In that case, Mr Justice Anthony Chan had to decide whether to discharge the plaintiff’s injunction to restrain the recipient defendant from dealing with the money in question. The cause of action was in monies had and received. Mr Justice Anthony Chan discharged the injunction because he found that the merits of the case at the interlocutory stage were tilted in favour of the recipient defendant. That said, Mr Justice Chan made a comment in obiter that if the money was received as part of an underground money exchange transaction to circumvent the foreign currency exchange control of the PRC, the recipient defendant’s bona fide purchaser for value without notice defence would fail. Again, Mr Justice Chan did not have to decide this point within the injunction context.

Case No.2 – In Grupo Arbulu S.L. v City Apex Holdings Ltd [2018] HKCFI 1351 (15 June 2018), the cause of action was in knowing receipt. Deputy High Court Judge Keith Yeung, SC ruled that since the underground banking transaction was illegal under PRC law, the defence of bona fide purchaser for value without notice would not be available. A key fact considered by the Court was the defendant’s active participation in the underground banking, namely, it personally engaged a PRC currency exchange agent to convert the money in its HK bank account (which originated from proceeds of fraud) into RMB, then transferred it to the PRC bank account of an aircraft leasing company to settle rental payments owing by itself.  

What would be the result if the defendant had just been a passive recipient?  

Case No.3 – Deputy High Court Judge Blair went even further in DBS Bank (Hong Kong) Limited v Pan Jing [2020] 4 HKC 395 (24 January 2020). He explicitly stated that HK Courts will not enforce a currency exchange contract that is contrary to PRC exchange controls, and that the defendant cannot be considered to have provided any value for the property if it was transferred pursuant to a transaction considered to be illegal under PRC law. In other words, Justice Blair appears to be saying that the defence of bona fide purchaser for value without notice is not at all available in enforcing contracts/transactions where underground banking has been used. Justice Blair further held that the defence of change of position would also not be available in such circumstances due to public policy reasons:

It is correct that the facts are different, in that the defendants in those cases were the parties that received and distributed the stolen funds in the course of a business, whereas the defendant in this case received the funds as the final leg of the exchange transaction. But otherwise, the cases are indistinguishable, because the courts refused to allow a change of position defence where the relevant acts were illegal, as they are in this case. The defendant’s submissions fail for the same reasons that ruled out the bona fide purchaser defence, namely that it is not necessary for the bank to show that the defendant knew of the fraud because the money was transferred pursuant to a transaction that was itself illegal, and the evidence does not support the proposition that the defendant did not know how the exchange would be effected. I conclude that the court should follow the decisions in Barros Mattos and Arrow ECS Norway v Yang Trading. 

I would have followed the result of these decisions even if (as some commentators consider) the judge in Barros Mattos put the test too high in suggesting that if the recipient’s actions in changing position are treated as illegal, the court will more or less automatically refuse to contemplate a change position defence. Whether or not this is correct, in my view, the result is justified on the basis of public policy considerations regarding breach of exchange control regulations (see Virgo, cited above, at p 693), which apply equally, if not more so, in the present case.

Again, the defendant in the above case was an active participant in the foreign currency exchange. Would the Court have decided differently had the defendant been a mere passive recipient?  

Case No.4 – Tti Global Resources v Hongkong Myphone Technology Co Ltd [2021] HKCFI 306 (10 February 2021) involved an appeal of a decision to dismiss the plaintiff’s summary judgment application against D2 and D4, both of whom actively engaged in underground foreign currency exchange and received proceeds of fraud in the course of those exchange transactions. In the same vein as Deputy High Court Judge Blair in the Pan Jing case, Justice To allowed the appeal and entered judgment against D2 and D4 on the basis that the transactions were illegal as a matter of PRC law and in any event, D2 and D4, being active participants, could not be considered to be acting with bona fides.  

The position of a passive recipient of funds – relevant point in time for requisite knowledge

The above cases beg the question: where funds came through underground banking in contravention of PRC law, if the recipient merely played a passive role with no evidence that he knew of the source of funds or the manner in which the funds arrived, or ought to have so known based on suspicious circumstances, is the defence of bona fide purchaser for value without notice available? 

It was this exact question that was faced by the High Court in Lesnina H. D.O.O. v Wave Shipping et all (HCA 154/2020). On 25 March 2021, Deputy High Court Judge Dawes, SC heard the plaintiff’s application for summary judgment. Judgment has been reserved. The facts were as follows: The plaintiff was defrauded into transferring EUR1,879,726 from its Croatian bank account to D1’s HSBC account in HK. Upon receipt, D1 converted EUR1,875,461.68 into USD2,077,399.16 and transferred part of that sum, USD320,000, to D8’s HSBC account in HK. At around the same time, D8 received a similar amount of money in its HSBC account from an unrelated 3rd party to whom D8 supplied healthcare products. Simply put, D8 was a proper business that had zero knowledge of the fraud and no connections with the fraudster or D1. It appeared that the 3rd party might have instructed D1 to pay D8, although it was quite clear that money owed to D8 by the third party did not originate from money defrauded from the plaintiff.  

Plaintiff’s Counsel argued that in a case of knowing receipt, the relevant point in time in assessing whether a recipient had the requisite knowledge was at the time of transfer and subsequent to that, for example, when D8 received the Writ of Summons. D8’s Counsel disagreed and relied on Lewin on Trusts, 20th edition (para 42-083) for the principle that a defendant’s knowledge must be assessed at the time of receipt of money (para 42-083, Lewin on Trusts), rather than afterwards which is strictly speaking “after-acquired knowledge”. Alternatively, the relevant point in time for knowledge should be at the time consideration is given by the recipient of money.

It remains a live question whether all transactions involving underground banking are categorically unenforceable, regardless of bona fides. Underground banking appears to be a fact of life in business in the current economic environment. If you are a victim or know a victim of fraud or underground banking, or wish to avoid being deprived of funds duly owed in the normal course of business, please feel free to speak to our disputes partner, Eunice Chiu.

Eunice Chiu
+852 2186 1885
Partner, Dispute Resolution
Oldham, Li & Nie (OLN)

20 April 2021

Justice Delayed is Justice Denied

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This ‘Letter to the Hong Kong Lawyer’ by Gordon Oldham was originally published in April 2021. Please click here for the original article. 

According to the recent Financial Times article ominously titled ‘Companies consider writing Hong Kong out of legal contracts,’ multinationals are reviewing whether or not to exclude Hong Kong from their legal contracts over anxieties around Beijing’s expanding influence on the territory’s rule of law. International media commentary like this is fuelling increasingly negative perceptions of Hong Kong’s legal system.

In response, I suggest that now more than ever is the time for us, the local legal community, to come together and focus on fixing our actual, real-world problem. That is our broken court system.

Our courts resemble an inspiring but vintage Rolls Royce which still very much leads with ‘the Flying Lady’- the Rule of Law, but unfortunately, the seats are threadbare, the paintwork faded, the engine requires replacing and the electronics are non-existent.

This current state of affairs has nothing to do with our excellent Judges. Our Judiciary continues to deliver above and beyond and they have the full support of Hong Kong’s legal practitioners. The problems with our court systems are operational. The system exudes a delegation of responsibility mindset, a blanket resistance to all matters digital, an all-the-time-in-the-world attitude coupled with inefficiencies which viewed from a modern corporate setting are laughable – having someone sit and wait three hours for a piece of paper to be chopped is lamentable in this day and age. On top of this, there is insufficient numbers of support staff members, as well as Judges, and limited focus on how to help the Hong Kong public.

We legal practitioners know how embarrassing it is to say to a client that they have a great case but it will probably be 18 months before it is heard. A recent survey of 69 jurisdictions around the world, carried out by OLN, showed that overall, Hong Kong not only ranks in the top five for the most expensive court proceedings but also in the top 20% for the length of time it takes to actually get to court. We are expensive and slow.

On top of all this, those of us in the Hong Kong legal community know our local courts have been chronically ill-equipped to cope with Covid-19, especially compared to Singapore and other jurisdictions. The very jurisdictions that are looking to profit from the negative perceptions pronounced by the Financial Times.

However, we cannot simply blame the backlogs on Covid-19 or the judiciaries’ techno-phobia. These operational problems run deeper and point to a more ingrained malaise. It is, in fact, our collective acceptance that enables this antiquated and dysfunctional system to exist and persist. We have to actively be part of the change instead of tolerating it as some endearing, antiquated throwback together with horsehair wigs. As practitioners, we all laugh at the story of Jarndyce and Jarndyce, described so perceptively by Dickens, but in Hong Kong, those days still exist.

However, given the Hong Kong legal community lives in the increasingly competitive and globalised twenty first century, not in Charles Dickens’ times, we urgently need to take on a solution-minded commitment to revamp our courts and double down on our efforts to undertake the repairs necessary to renovate the infrastructure of our legal system, from top to bottom. Consider the following:

  • Compulsory annual legal technology CPD: this has been introduced years ago in certain US states. Solicitors do not need to learn to code, but let’s stopped being frightened by terms such as legal design, robotic process automation and natural language processing.
  • Ask our Law Society to establish collaboration with third parties/digital designers and lawyers: We should focus on how we want the courts to look with processes that lead to a user-friendly and above all faster and more efficient system.
  • Online/video trials: Permit trials to be conducted online and in person, as we have seen in other jurisdictions.
  • Digitalization of transcripts: Judges – please put down your pens – and allow the parties to have a written transcript produced at the end of every day. There are voice recognition programs and transcription technologies that can help.
  • More Funding: There should be more financial resources available for the courts to shorten the waiting time for court hearings. These could fund for example:
    • more judges on the panel
    • transcribers to take notes and other clerks to handle note taking instead of the judge doing his/her own during trials
    • non-practicing lawyers to help write judgements to free up time for the Judges to review the draft instead of writing his/her own judgement
    • a restructuring of the legal department with more people, more KPIs, more commitment to service, and the delivery of a fast, reliable, efficient court service

In response to the Financial Times article, Teresa Cheng wrote ‘We continuously strive to meet market demands to ensure Hong Kong remains one of the world’s leading international legal hubs [….] for dispute resolution services.” However, the reality of cases taking 18 months to get to court does not make Hong Kong a leading global hub for dispute resolution services.

Now is the time for our legal community to come together and take action. We need to refocus and rebuild the Hong Kong court system, installing a modern, forward-thinking approach that serves the local community. That is if we want to continue to be proud of a Hong Kong legal system that stands head and shoulders above its international rivals.