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Leave No Stone Unturned: Contractual Indemnity As The Best Safeguard

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Letter To The Hong Kong Lawyer – September 2021

In “Arbitrators’ Power to Award Costs of Ancillary Court Proceedings” (Hong Kong Lawyer, June 2021), the authors maintain that an arbitral tribunal cannot award costs incurred for obtaining interim measures in ancillary court proceedings (the “Costs of ACP”) because such costs do not constitute “costs of arbitral proceedings”.

The overlooked legislation

With due respect, the analysis set out in the earlier article “Recovering in Arbitration Costs of Ancillary Court Proceedings Revisited” (Hong Kong Lawyer, April 2021) has not been fully appreciated and again section 74(3) of the Arbitration Ordinance (the “AO”) has been overlooked.

To recap, section 74(3) of the AO expressly provides that an “arbitral tribunal may …… order costs …… in respect of a request made by any of the parties for an order or direction (including an interim measure).” (emphasis added) It appears to empower the arbitral tribunal to award costs in addition to the usual costs of arbitral proceedings under section 74(1) of the AO.

Costs of arbitral proceedings

Although the concept of “costs of arbitral proceedings” has been explored in many articles in other jurisdictions, such discussion has no relevance to the interpretation of section 74(3) of the AO, a unique provision created by Hong Kong legislators without any equivalent in foreign statutes.

In any event, in the materials cited, certain circumstances under which an arbitral tribunal may award Costs of ACP in arbitration have been identified:

1. In International Arbitration Practice Guideline (2006), it is suggested that the costs of interim measures may be recoverable in arbitration if they cannot be dealt with by the local court, or the court has referred them to the arbitration tribunal for decision.

2. Similarly, Micha Bühler (2018) accepted that Costs of ACP may be recoverable as arbitration costs so long as there is no duplication in the award of costs and that the proceedings are not in breach of arbitration agreements.

3. Prof Jeffrey Waincymer (2012) went further to say that Costs of ACP may potentially be argued to be costs of the arbitration “where it is ancillary behaviour of the successful party in supporting the arbitration, such as the costs of court-ordered provisional measures”.

Doctrinally, an arbitral tribunal’s jurisdiction to award Costs of ACP should not be contingent upon certain events unless otherwise clearly specified. In our humble submission, these writings therefore tend to support, rather than reject, the proposition that an arbitral tribunal indeed has jurisdiction to award Costs of ACP. A better proposition should be that an arbitral tribunal has jurisdiction to award costs, but such jurisdiction should be extremely rarely exercised, for obvious public policy reasons that need not be repeated here.

Realistic and practical commercial solution

Whilst it might be commendable to advocate for a foreign jurisdiction to make way for Costs of ACP to be awarded by arbitral tribunal, this approach may not be realistic where such a position is contradictory to the default costs rule in the foreign jurisdiction. In any event, it may be impracticable to change the practice of each foreign jurisdiction as well.

Consistent with the cited academic writings, in particular Waincymer (2012), it is humbly submitted that a simple and practical solution is to insert a costs indemnity in the arbitration agreement, so that Costs of ACP could be expressly recovered as damages.

Acknowledgement

The authors acknowledge the research guidance by Dantes Leung (Partner of Oldham, Li & Nie) and research input from Jerry Leung (Summer Intern of Oldham, Li & Nie). Any errors, omissions and mistakes remain the sole responsibility of the authors.

Is a Gig Worker Self-employed or an Employee?

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“Gig economy” is an emerging global trend alongside technological advancement. It generally describes the economy in which people take up part-time jobs and/or engage in project-based and/or temporary freelance works via digital job-matching platforms. Gig economy has prospered in HK in recent years as the pandemic alters the job market landscape. Employers tend to downsize the portion of permanent staff and increase the number of temporary/part-time worker to allow for flexibility. The growth of gig economy is also attributed by the blooming online platforms and e-commerce industry, such as those engaging in food delivery and ride-hailing. Conventional sectors such as banking, retail and information technology have hired more gig worker to bring flexibility to their employment structures. In this article, we would look at how the employment relationship under the gig economy is governed under our present legal framework.  

Gig Workers’ Status in Hong Kong

While gig employment is a relatively new concept in Hong Kong, the characterization of such relationship is still determined by the conventional “employee/self-employed” dichotomy. A gig worker can be an “employee” or a “self-employed” depending on how the contract is drafted. If one is classified as employee under the law, s/he is entitled to the statutory benefits and protections under, among others, the Employment Ordinance (Cap. 57) (“EO”), the Employees’ Compensation Ordinance (Cap. 282) (“ECO”) and the Mandatory Provident Fund Schemes Ordinance (Cap. 485) (“MPFSO”). 

Therefore, the employee/self-employed distinction remains to be the starting point prior to understanding the gig worker’s legal rights in the HK employment context. The major differences between self-employed persons, fixed term employment and permanent employment under the labour protection regime in Hong Kong are summarized in the following table:-

 

 Self-employed persons Fixed Term Employment Permanent Employment

Nature

Self-employed

Employee

Employment Ordinance

Not applicable

Applicable

Employees’ Compensation Ordinance

Not Applicable

Applicable

Statutory Employee Benefit – Annual Leave

×

As of right to an employee under a continuous contract for not less than 12 months (Part 8A, EO).

Statutory Employee Benefit – Sickness allowance

×

As of right to an employee under a continuous contract for not less than 1 month (Part 7, EO).

Statutory Employee Benefit – Severance

×

As of right to an employee under a continuous contract for not less than 24 months, and is dismissed by reason of redundancy or laid off (Part 5A, EO)

Statutory Employee Benefit – Long Service Payment

×

As of right to an employee under a continuous contract for not less than 5 years:, and:

(i) is dismissed not by reason of summary dismissal due to serious misconduct, or redundancy

(ii) is certified by a registered medical practitioner as permanently unfit for the present job and has resigned on such ground

(iii) is aged 65 or above and resigned on such grounds

(iv) dies during service

(v) employment contract of a fixed term expires without being renewed (provided that the employee has not unreasonably refused an offer to renew).

 

Statutory Employee Protection – MPF

Self-employed persons are required to enrol themselves in an MPF scheme within the first 60 days of becoming self-employed.

Employer must contribute to registered scheme, and deduct from an employee’s income as contribution, unless the employee is employed for a fixed period of less than 60 days.

Termination

Depends on agreements between self-employed persons and online platforms

Termination of employment contract by notice or payment in lieu of notice by either the employer or the employee

Termination without notice by employer (i.e. summary dismissal) on the ground of the employee (i) wilfully disobeys a lawful and reasonable order, (ii) misconducts himself, (iii) is guilty of fraud or dishonesty, (iv) is habitually neglectful in his duties, or (v) on any other ground on which the employer would be entitled to terminate the contract without notice at common law.

Termination of contract without notice by employee (i.e. constructive dismissal) on the ground of (i) he reasonably fears physical danger by violence or disease, (ii) he is subjected to ill-treatment by the employer, (iii) he has been employed for not less than five years and is certified by registered medical practitioner as being permanently unfit for the type of work he is being engaged, or (iv) on any other ground on which he would be entitled to terminate the contract without notice at common law.

Termination upon expiry of fixed term contract.

 

Employees’ Compensation in the course of employment

×

Available for an employee suffering any personal injury by accident arising out of and in the course of the employment (s.5 ECO).

As shown in the table, under the current labour protection regime, many, if not all, labour rights stem from the “employee” status. Often time, businesses are attracted to contract out parts of their works to gig worker because they are generally expected to be self-employed and the businesses need not bother themselves with submission of return to the HKIRD or MPF arrangement which would otherwise be compulsory if they are in the capacity of employers. Whether the gig employment constitutes an employee/self-employed relationship is, however, not always easy to determine. 

Precedent cases, however, suggest that an “agent”, “consultant”, “freelancer” or “contractor” (however one names it) might still be deemed an “employee”. What further muddles the water is the few landmark cases by courts of other jurisdictions ruling that gig worker are indeed “employees” or “workers” who are entitled to certain labour rights. For example, The UK Supreme Court has unanimously held that Uber drivers were “workers” under UK employment legislation, thus entitled to labour rights such as national minimum wage and paid annual leave: Uber BV and others (Appellants) v Aslam and others (Respondents) [2021] UKSC 5. The Amsterdam’s Court of Appeals has ruled that riders of Deliveroo, an online food delivery platform, must be treated as employees, and a Barcelona Court in Spain has ordered a payment of 1.3 million euros in social contributions for the same reason. All these rulings were made in 2021, and they seemed to have contributed to a more gig worker’s protection in Denmark, Austria and Sweden. 

HK Courts’ Consideration

In Hong Kong, the determination of employer-employee relationship is highly fact-specific and is a matter for the courts to decide on a case-by-case basis. In the leading authority, Poon Chau Nam v Yim Siu Cheung [2007] HKCFA 19, it was decided that the existence of an employer-employee relationship is a matter of overall impression against the background of indicia of employment. The list of factors that would be considered by the courts in determining the question was explained in Tang Chau Yuet v Fu Kin Po [2011] 1 HKLRD 519. Factors include: –

  1. Alleged employer’s degree of control over the task of the alleged employee – if the alleged employee has liberty to decide how, when, where one works, he is more likely to be viewed as “self-employed” rather than “employee”;
  2. Alleged employee’s own provision of equipment; 
  3. Alleged employee’s own hiring of helpers;
  4. Alleged employee’s own bearing of financial risk and the degree of it;
  5. Alleged employee’s opportunity to profit from sound management in the performance of his task;
  6. Alleged employee’s bearing of responsibility for investment and management;
  7. Alleged employee’s role in the alleged employer’s organization;
  8. Alleged employer’s bearing of responsibility in relation to insurance and tax for the alleged employee;
  9. Alleged employee’s carrying on business in the trade in question;
  10. The parties’ own view of their relationship; and,
  11. The traditional structure of the trade or profession concerned and the practices within it.

How the Hong Kong Court would perceive the gig worker’s relationship with their principals is yet to be seen. In this regard, reference could be drawn to the UK Supreme Court decision in Uber BV where their Lordships unanimously came to the following conclusion and found that Uber drivers are “workers”, i.e. an intermediate class with basic labour protection under the UK law: –

  1. Fixed remuneration – Uber has control over the fares, as well as the sole discretion to make full or partial refunds upon complaints.
  2. Standard contractual terms – Uber drivers are required to accept Uber’s standard form of contract.
  3. Restricted driver’s choice to accept rides – Uber exercise controls over acceptance of the request by the driver by first controlling information provided to the driver, and second by monitoring the driver’s rate of acceptance and cancellation of trip requests, with penalty for high cancellation rate.
  4. Control over types of car and platform – types of car and technology integral to the service is wholly owned and controlled by Uber
  5. Restricted communication between passenger and driver – Communication is limited to the minimum necessary to prevent drivers from establishing any relationship with a passenger. 

The Uber case was highly fact-sensitive. The above factors, or some of them, may or may not be present in other online platforms and gig employment, which could lead to very different result. Nonetheless, it would be advisable for online platforms or businesses in e-commerce, or anyone intending to hire gig worker, to go over the checklist above and assess their proper relationship with the gig worker. 

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

E: anna.chan@oln-law.com
 

Thank you Helping Hand!

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We are so fortunate to be given the chance to work with low-income individuals within the elderly community.  Always a good thing when the feelings are mutual! Thank you for the “badge of honour”, Helping Hand! 

helping hand certificate of appreciation oln

Dissipation of Assets by Debtor – How Lumley v Gye Tort Can Assist Creditor

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The notorious “dissipation” cases

One of the common questions a desperate creditor would ask is whether he/she can go after the ultimate owner/the controller of the debtor company instead of the debtor itself. In most circumstances, the answer is No because:-

  1. Under the “privity of contract”, only the contracting party can be sued for breach of contract. Where there is a written contract, a party is in general bound by its terms after signing. A party is not allowed to claim that there are contracting parties other than those stated in the contract, especially when the application of The Contracts (Rights of Third Parties) Ordinance has been expressly excluded.
  2. A company is accepted in law as a separate “legal personality” which is able to act on its own, and is also able to be sued and become liable on its own. In the case of a limited liability company, a shareholder’s liability is limited to the extent of his investment in the company.
  3. Only in very exceptional circumstances (such as fraud) that the court would “lift the corporate veil”. But even in the case of fraud, the UK Supreme Court once pointed out in VTB Capital plc v. Nutritek International Corp [2013] UKSC 5 that it is wrong to treat the persons behind as contracting parties to hold them contractually liable.  

In view of the above cardinal principles, a cunning owner/controller may nominate a limited liability entity as the borrower/contracting party thus shielding oneself from personal liability. Such owners/controllers may also willfully drain the company’s financials or in more radical cases, they may even try to siphon off assets from the company to their related parties. In the latter scenario, as it is not uncommon for such controllers to have lent money to the company by way of shareholders’ loans, such controllers may even actively pursue the winding-up of the company with the ultimate goal to appoint a liquidator over whom they may exert influence.

Creditors’ options in such an unfortunate circumstance are limited. The creditor may try to obtain a Mareva injunction against the debtor company, which is, however, preventive in nature and would have no use if dissipation has already occurred. In such a situation, what has been consistently underexplored, if not overlooked, is the tort as recognised in Lumley v. Gye [1853] EWHC QB J73, or what is modernly called the tort of procuring a breach of contract. As will be seen below, this tort has been recently reinvigorated (in particular in the cases of Marex Financial Limited v. Carlos Sevilleja Garcia [2017] EWHC 918 (Comm) and Palmer Birch v. Lloyd [2018] EWHC 2316 (TCC)) to cover shareholders/ directors (and even ultimate beneficial owners and shadow directors) of a company who, through dissipation, have emptied the pocket of the company to deprive it of the means to make payments to its contractual counterpart. This may sound a bit ironic because while commercial lawyers have always tried to use the device of contract to avoid the need to establish a “duty of care” should a dispute later arise, it is tort law which comes to the rescue when no effective means is to be found in enforcing a contract. On the other hand, as will be analysed below, it cannot be overstated that a contract nonetheless plays a significant role here because the tort relies on the existence of a contract and a breach thereof (which in turn depends on the existence, breadth, legality and enforceability of a contractual clause). Viewed in this light, the existence of the Lumley v. Gye tort actually highlights the importance of the drafting technique of a commercial lawyer.

The Elements of the Lumley v. Gye Tort 

The basic elements of the Lumley v. Gye tort are that:

  1. There at least has to be a contract.
  2. There at least has to be a breach of the contract.
  3. There has to be an element of participation (which has to be more than mere prevention) on the part of the shareholder/director/controller in causing the breach of the contract.
  4. The shareholder/director/controller must also have intended to procure the breach of the contract through its participation. Impliedly, they must also have known of the existence of the contract.
  5. The plaintiff has to have suffered a loss.

Having regard to the elements of the tort, it is then not difficult to understand why such a tort can be a useful weapon in a dissipation case against the controllers of the company where a breach of contract has already occurred. By definition, such controllers are in control of the company so that it is usually hard for them to insulate themselves from the dissipation. On the other hand, being close to the affairs of the company, they cannot really deny their knowledge of the contract. As for the fifth element, the non-payment under the contract is the loss suffered.

It can be immediately observed that while the Lumley v. Gye tort seems to have “sidestepped” the doctrine of separate legal personalities, it does not deny and is actually premised on the recognition of the separate legal personalities of a company and its controllers (so that they can be properly regarded as third parties). Therefore, there is no established policy reason to exclude a claim against the controllers once the elements of the tort are satisfied. The debtor in Palmer Birch tried to argue that the whole claim was an impermissible attempt to pierce the corporate veil but such argument failed.

As can be shown in the Supreme Court case of Sevilleja v. Marex Financial Ltd [2020] UKSC 31, a claim based on the Lumley v. Gye tort is allowed even when the company is in the process of being wound up. The no reflective loss rule is no bar to such a claim. A general creditor may therefore be in a more advantageous position since he/she could have a direct claim against the controllers circumventing the problems of ranking lower than secured creditors or ranking pari passu with claims of other general creditors. 

Is there a tort of knowingly inducing or procuring the wrongful violation of a judgment debt?

Under the doctrine of merger, upon obtaining a judgment, the contractual debt has “merged” into the judgment and the claimant can no longer rely on the original contractual debt. The question then is, whether the creditor can still rely on the Lumley v. Gye tort where the non-payment is in respect of a judgment debt deriving from a contractual debt? This is the scenario encountered by the English Court in Marex Financial, where at first instance Knowles J decided in an interlocutory application hearing that there exists a tort of knowingly inducing or procuring the wrongful violation of a judgment debt, thereby extending the application of the Lumley v. Gye tort to cover such a judgment debt. Though this case was subsequently appealed to the Supreme Court on other points, ruling on this point remains undisturbed.

The decision of Marex Financial however leaves another problem unaddressed. Given that the original Lumley v Gye tort only recognizes contractual interests as a specific asset class worthy of its protection, it remains to be seen whether the tort of knowingly inducing or procuring the wrongful violation of a judgment debt can be extended to judgment debts based on other causes of action (e.g. a monetary judgment obtained solely based on a tortious claim).

Even if the tort of knowingly inducing or procuring the wrongful violation of a judgment debt is kept within its current bounds, it still represents an outlier in the common law world because a cause of action is generally considered as completed upon the grant of the judgment so that the failure of the debtor to satisfy a judgment debt would not give rise to another cause of action, and the creditor is left with traditional enforcement actions and winding-up proceedings. By this special tort, the creditor can now launch a new claim against the shareholder/director/controller of the debtor company where the judgment debt (which has to be derived from a contractual debt) remains unsatisfied.

Comparison to other economic torts

The Lumley v Gye tort also has the following advantages when compared with other economic torts:

  1. No fraud needs to be proved as in the case of tort of deceit. It has to be borne in mind that fraud is a serious allegation and it is hard to prove fraud in a commercial context.
  2. No unlawfulness needs to be proved as in the cases of unlawful means conspiracy and unlawful interference.
  3. Unlike conspiracy, only one wrongdoer (other than the contract breaker) is enough in the Lumley v. Gye tort.

The Lumley v. Gye tort also seems to be exceptionally useful against shadow directors who are acting outside of the constitution of the company. Ironically, this may deprive them of the defence of “acting bona fide within the scope of his authority” conferred on by the company whereas such a defence is generally available to a de jure director. It is therefore not a coincidence that the main defendant in both the cases of Marex Financial and Palmer Birch is a shadow director.

On the other hand, in dissipation cases, what the claimant requires is some initial evidence that there has been dissipation of assets from the company. Such financial information is not normally available to outsiders and as the claimant cannot fish for evidence, he may have to obtain such evidence through other legal routes. Such routes may include contractual clauses which allow access to financial information (which are commonly included in commercial agreements), as well as disclosure orders ancillary to a Mareva injunction. 

Conclusion

Both the cases of Marex Financial and Palmer Birch have not been considered by the Hong Kong courts in the context of a Lumley v. Gye tort. It therefore remains to be seen whether the two cases will be followed by the Hong Kong courts, especially when the flexible use of the Lumley v. Gye tort has the effect of sidestepping many of the long-lasting common law principles as described above. However, as an experienced litigator can tell, there is often no better way to apply pressure on the other side than to sue the natural persons behind, and for this reason alone the possibility of launching a claim based on the Lumley v. Gye tort is worth exploring. 

Our firm has extensive experience in debt recovery action in HK. If you have any question regarding the topic discussed above, please contact our partner Anna Chan at anna.chan@oln-law.com or Martin Tse at martin.tse@oln-law.com for further assistance.

August 2021

Top 7 Contracts for Startup Survival in Hong Kong

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We are frequently asked by our startup clients whether or not written contracts are strictly necessary, particularly during the early stages when their business may not be much more than a great idea about a product or a service. We are aware that founders frequently jump into building their businesses without any written contracts but doing so can prove to be a costly mistake. 

Why bother with contracts at all?

Written contracts set out the rights and obligations of each party, thereby reducing uncertainties and helping to minimise the risk of disputes getting out of hand. Accordingly, embarking on a business arrangement without a signed written contract means that all of your rights and obligations are left uncertain, leaving your business in a weak position overall. 

Regarding the kinds of business arrangements that startups and founders will find themselves in, there are few absolute rules but one is that you should use a written contract whenever you intend to enter into dealings with third parties (paid/unpaid workers, vendors, customers or investors) or with other founders. Employees are a special category because employment laws in Hong Kong actually require employers to provide written employment agreements. 

So, what contracts does a startup really need and why? 

The following is our Top Seven list of all contracts that founders are likely to need during the early phases of setting up and growing their businesses:

1.    Employment contract

You will need at least one sturdy, reusable employment contract for your startup to be in compliance with Hong Kong employment laws but will also need to address confidentiality, non-solicitation, non-competition as well as several other key issues. If you intend to hire interns or other unpaid workers, you will also need a variation of an employment contract for them. For anyone who will be working for the business as a legitimate independent contractor you may also need a services agreement. You will also find that as a startup, these agreements and the business itself will probably need to incorporate a share incentive scheme of some sort to incentivise performance.

2.    Co-Founders agreement/Collaboration Agreement/Founders’ Agreement

The function of this contract is to address the contributions of the respective founders, their entitlement to shares in the business (vested over what time period) as well as set out clear contingencies in case any of the founders withdraw. These are often put into place before the business has been incorporated so frequently, founders will ask to include simple administrative rules that will govern the founders’ conduct until a formal shareholders’ agreement is put in place which then replaces the Co-Founders Agreement. 

3.    IP assignment contract

This is the next most important contract on the list partly because it often is put in place before the business has been incorporated and before any employment contracts are needed. However, the main reason is that the technology developed by the founders is, more often than not, the lynchpin of the business but until the underlying IP has been legally assigned to the business, it consists of little more than ideas in the founders’ heads. Without that crucial step of assigning the IP, no investor will invest in the business for the simple reason that the business doesn’t own its IP. The founders own it. And unless that IP is assigned to the business, what will prevent the founders from leaving the business in 5 months to set up another business? 

4.    Non-disclosure agreement (NDA)

Everyone has heard of NDAs (aka confidentiality agreements) which primarily function as a means of protecting the business from unauthorised disclosure or use of confidential information. The general rule of thumb is that, as a business, you should not allow any individual or organisation to have access to any valuable confidential information until after they have signed a properly prepared NDA. 

5.    Investment agreement/Subscription agreement

This contract, often signed together with the shareholders’ agreement, governs the relationships between the company, the founders and new investors and can take many forms depending on the investors’ intended contribution. In Hong Kong, the investment will usually center around a subscription of either preference or ordinary shares in exchange for an agreed amount of cash (i.e.: an equity investment). Occasionally, investors will offer cash in exchange for a convertible note or other debt instrument. Regardless of how the investment is structured, at a bare minimum, the underlying contract must address details such as the amount, timing and conditions for the investment, and conditions that must be met before the investors can recover their investment. Regardless of who prepares the original agreement, the company and founders need to careful about the scope of representation and warranties as well as potential indemnity/liability provisions that investors will typically insist on inserting to protect their own interests. 

6.    Website terms of use (aka terms and conditions)

Although not often thought of as a contract, these function the same way contracts do by stipulating the rights and obligations of website users and including protections geared to the business. Businesses that use their website for conducting e-commerce will also need to include legal terms of sale to govern functions such as payments, delivery and returns. Unlike the other contracts in this Top Seven list, terms of use are normally entered into as digital contracts instead of being signed in the traditional way. 

7.    Shareholders’ agreement

These are used to govern the relationship among shareholders once the business has been incorporated and, like the Investment Agreement, are usually quite detailed. Because they are so detailed and therefore costly to prepare, founders will normally wait until they start fundraising before paying to have a shareholders’ agreement prepared. The reason for that is because each investor will assert specific demands to protect their investment and these will need to be reflected in both the shareholders’ agreement and the Investment Agreement. Each new set of demands will entail changes being made to both agreements. 

How can OLN help?

With the above list in mind, we hope you can appreciate why it is foolhardy to operate a startup without written contracts. So, how do you avoid that?

Although contracts are freely available online, the quality and suitability of these vary tremendously. Without substantial prior experience dealing with contracts, you will not know which ones to use and what changes need to be made. To avoid making a costly mistake, in most instances, you should seek advice from a lawyer before negotiating, preparing or signing any significant contract. 

If you only require a few contracts at a time and some occasional legal advice, the most cost-effective option available in Hong Kong is to subscribe to OLN Online. OLN Online offers a huge library of contract templates for Hong Kong startups (including all of the ones listed above), as well as the basic advice you will need to get started, and is available through two subscription plans. 

If you need more hands-on assistance with your contracts, we recommend that you contact one of us at OLN. We have decades of experience advising founders and investors about emerging businesses and can provide all of the advice you will need for your contracts and other arrangements. 

If you have any questions regarding your contract needs or other legal issues, feel free to contact Cermain Cheung (cermain.cheung@oln-law.com) for advice.

August 2021

The Risks of Breaking a Hong Kong Employment Contract Before It Commences

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Prelude

It is not at all surprising in Hong Kong for job applicants to back out of the already accepted job offer and accept a better job offer with a more competitive remuneration package. In practice, usually the innocent employer would save themselves the hassle of chasing after the defaulting recruits and simply find a substitute from the job market, especially for those junior or middle-level positions. However, this may not always be the case and the recent judgment handed down by the Court of Appeal in the Hong Kong case Law Ting Pong Secondary School v Chen Wai Wah [2021] HKCA 873 demonstrated clearly that not honouring a signed employment contract may come with a price even before commencement of the employment. 

Overview of the case facts

The case of Law Ting Pong Secondary School started off at the Hong Kong Labour Tribunal and was argued all the way up to the Court of Appeal. 

In gist, this case concerned a teacher who was offered employment by a local secondary school. On 17 July 2017, this teacher was given (a) an Offer of Appointment; (b) the Conditions of Service for Teachers; and (c) a Letter of Acceptance in respect of his then potential employment with the school. The teacher signed and returned the Conditions of Service and the Letter of Acceptance to the school on the same day. The Letter of Acceptance stated that:- 

“I accept the appointment offered in your letter dated 17th July 2017 in accordance with the attached Conditions of Service for Teachers in Law Ting Pong Secondary School.

I also understand that once I accept this contract, the conditions of the new contract will come to [sic] immediate effect e.g. I need to give three months’ notice to terminate my employment with the school.

I confirm that I have read and understood all the above conditions and hereby agree to abide by them.”

The Conditions of Service stated that the period of employment would be “from 1st September 2017 to 31st August 2018”. Under the Conditions of Service, the teacher was required to give the school three months’ notice in writing, or payment in lieu of notice, or a combination of both in order to terminate the employment contract “in order to terminate my [i.e. his] employment with the school” [Emphasis Added] (the “Termination Provisions”). In August 2017 the teacher backed out of the contract. The school then claimed against the teacher for payment in lieu of notice pursuant to the Termination Provisions. 

The school succeeded at the Labour Tribunal and was awarded damages in the sum of HK$139,593 (equivalent to 3 months’ payment in lieu of notice). 

The teacher subsequently appealed against such decision and the same was overturned by the Court of First Instance. The Court of First Instance held that the Letter of Acceptance did not form part of the specified terms offered by the school to the teacher, as, inter alia, the Conditions of Service did not make any reference to the Letter of Acceptance. Accordingly, the employment should be read as only starting on 1 September 2017 in accordance with the terms of the Conditions of Service, and hence the teacher was not liable to make any payment in lieu as his employment had not commenced at the time when he back out of the employment contract.

Thereafter, the school further appealed against the decision of the Court of First Instance and the Court of Appeal restored the decision of the Labour Tribunal. The judgment of the Court of Appeal can be summarised as follows:-

  1. The Offer of Appointment, the Letter of Acceptance and the Conditions of Service were given to the teacher together when the school’s offer of employment was made, thus the terms of all the three documents were accepted as a “package deal”. Accordingly, it must be plain and reasonably understood by the teacher, that the school was offering (and only ready to offer) employment on the basis set out in all the three documents. It follows that the Letter of Acceptance formed part of the contract between the school and the teacher, thus should be taken into consideration for adjudication of the matter. 
  2. A reasonable person shall take the Letter of Acceptance to mean that the terms of the employment contract would come into immediate effect such that the teacher would have to give 3 months’ notice to terminate the same. This shall be obvious as the notice requirement under the Termination Provision was specifically used as an example of the terms of the employment contract taking immediate effect.
  3. Further, the fact that the period of employment would start from 1 September 2017 only meant that the teacher’s performance of teaching duties was to commence on a future date. In general, a valid contract had legal effects, for example, as to repudiatory or anticipatory breach, and was enforceable immediately when it was made, irrespective of the time of performance. Hence, although performance of teaching duties would commence on a future date (i.e. 1 September 2017), as from 17 July 2017 (i.e. the date of signing the contract) both parties were both legally bound to perform their obligations under the contract.
  4. In response to the defendant teacher’s argument that the amount required to terminate the employment contract under the Termination Provision was wholly disproportionate to the monetary loss that the school might suffer and any legitimate interests of the school (thus is a penalty clause and unenforceable), the Court ruled that a clause could only be a penalty if it operated upon a breach of contract (i.e. a liquidated damages clause). The payment of a sum in lieu of notice under the Termination Provisions was a contractually agreed method of lawful termination of the employment contract; it was not in the nature of damages for breach of contract. It was therefore a primary obligation to pay rather than a secondary obligation arising upon the breach of a primary obligation of performance, thus not a penalty clause.
  5. The Court further completed the analysis by commenting that the Termination Provisions would still be enforceable even if the same was a liquidated damages clause. On this issue, the Court of Appeal clarified the test to determine whether a clause was a penalty clause was, whether the relevant clause was out of all proportion to the innocent party’s legitimate interest in enforcing the contract; and that the innocent party could have a legitimate interest in the performance of the contract or some appropriate alternative to performance that goes beyond compensation. In applying the test, the Court shall first identify the legitimate interest of the innocent party that is being protected by the clause, then move on to assess whether the clause is out of all proportion to such legitimate interest by considering the circumstances in which the contract was made. 
  6. Accordingly, the teacher was ordered to, inter alia, pay to the school HK$139,593, being payment in lieu of 3 months’ notice.
Takeaways

The case of Law Ting Pong Secondary School suggests that once the employment contract is signed, the agreed notice under its termination provision has to be observed, even before the commencement of the employment.

However, it is arguable that Law Ting Pong Secondary School turns on its specific facts that the employer school has made it explicit on the Letter of Acceptance that the conditions of the employment contract came to immediate effect upon execution and the notice requirement under the Termination Provision was specifically used as an example for illustrating the same. 

Further, it is also not certain as to what the Court’s decision would be if any probation period is provided for in respect of the relevant employment. It seems the Court did not pay any regard to Section 6(3A) of the Employment Ordinance (Cap.57) when reaching its decision in Law Ting Pong Secondary School, which provides that:-

“Where in any contract of employment, whether in writing or oral, it has been expressly agreed that the employment is on probation and the contract makes provision for the length of notice required for its termination such contract may be terminated —
(a) notwithstanding the length of notice provided for in the contract, by either party at any time during the first month of such employment without notice or payment in lieu;

(b) by either party at any time after the first month of such employment by giving to the other party notice of the agreed period, but not less than 7 days.”

In light of the Court of Appeal’s decisions in Law Ting Pong Secondary School, it seems the legal position in such scenario could possibly be, albeit awkward, (a) the employee will be required to give notice equals to such length as stated in the employment contract if he chooses to back out of the contract; and (b) no notice is required if he chooses to terminate his employment in the first month of his probation by operation of Section 6(3A) of the Employment Ordinance (which kicks in following the commencement of the employment).

How can OLN help?

As can be seen, it would be advisable for employers to clearly and expressly document in its employment contract the notice period and/or the termination mechanism if the employee fails to show up on the commencement date of employment as agreed. The degree of clarity required in this regard can be very demanding. 

We have practical experience in helping employers with the drafting and review of employment-related documentation to ensure the same complies with the employment law regime in Hong Kong and latest development on the same, so as to protect employers’ interest.
 
On the other hand, we also assist, from time to time, employees on the review of employment-related documentation and advise employees on any potential legal consequences arising from their employment contracts.

If you have any question regarding the topic discussed or other employment issues, please contact our Partner Mr. Victor Ng at victor.ng@oln-law.com or our associate Ms. Barbara Kwong at barbara.kwong@oln-law.com for further assistance.

July 2021

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.