Handling Second-layer Recipients in Fraud Cases – Defence Concerning Underground Banking (地下錢莊/地下钱庄)


In typical fraud cases, victims would find it difficult to trace the defrauded money because often case, the first-layer fraudsters would have dissipated fund elsewhere in a nano second, leaving their own bank balance with close to nothing. Victims therefore have to also sue the second-layer recipients to recover the lost fund. The fund transfers from the victims to the second-layer recipients, however, are not a direct one. Problem arises if the second-lawyer recipients come forth and defend the claim by arguing that they are equally innocent and their receipt of money was deriving from legitimate underlying transactions with the first-layer fraudsters.  

One of the most often cited defence by PRC second-layer recipients is that they engage service of Underground Banking (地下錢莊/地下钱庄) whereby they send money to a stranger in the PRC and in return obtain money from another stranger in Hong Kong. This explains why they would receive money from certain person not even their acquaintance as this is essentially the modus operandi of Underground Banking. It could be entirely credible that these second-layer recipients do not know the first-layer fraudsters personally (notwithstanding that they do transact with them) and that these second-layer recipients are truly irrelevant to the fraud scheme. In light of the prevalence of email and identity scam these years, such fact pattern and defence has become a common occurrence. Does that then mean that the victims’ claims against these second-layer recipients would be defeated?

As the Mainland practices foreign currency control, it is not uncommon for individuals in the Mainland to use underground banking for their outward remittance needs. While commonly used, such practice is inherently illegal under the relevant PRC administrative regulations and administrative measures on foreign exchange. Victims facing such defence raised by the second-layer recipients may therefore counter-argue in response that the use of underground banking itself constitutes an “illegality” and thus should not be given effect.

The Case Laws

OLN acted for the victim in the fraud claim Taihei Dengyo Kaisha Ltd v. Zhao Yizhe and another [2024] HKDC 222. The Plaintiff was a victim of an elaborate email scam, whereby after its funds were induced to be deposited into a fraudster’s account (first layer bank account), part of the funds were then dissipated from the first layer bank account to the second-layer recipient (i.e. 1st Defendant in the present case)). To recover the funds, the Plaintiff started a civil claim against the 1st Defendant based on the different causes of action including unjust enrichment and tracing.

In response to the Plaintiff’s unjust enrichment claim and tracing claim, the 1st Defendant raised the aforesaid defence concerning the use of Underground Banking, arguing that she received the funds due to her purchase of HKD with RMB through an exchange agent in the Mainland, and such constituted (1) defence of bona fide purchaser and (2) defence of change of position.

In the Plaintiff’s application for summary judgment against the 1st Defendant, the District Court has confirmed that in analyzing the issue of illegality, a distinction has to be made between domestic illegality and foreign illegality, and that the Court has different approach in handling the two types of illegality.

In view of the frequency of litigation in Hong Kong involving cross-border elements, especially regarding PRC law, this is a much welcome decision in confirming the Court’s readiness to grant judgment at summary stage where the defence concerns a transaction illegal under PRC law, and should discourage unmeritorious defences going to trial.

Summary Judgment

The District Court confirms that in respect of foreign illegality, the Court of Final Appeal decision in Ryder Industries Ltd v Chan Shui Woo [2015] 18 HKCFAR 544 (“Ryder”) is the highest authority in Hong Kong on how it affects the enforceability of contracts.

In respect of foreign illegality, the Court’s task is to identify which type of illegality the case falls within as follows:

  • Type 1: the contract is unenforceable under its proper law (whether chosen by the parties or otherwise)
  • Type 2: the performance of the contract requires or necessarily involves conduct which is illegal under the laws of the place where it is required to be performed
  • Type 3: the contract could have been performed in a legal manner but the real objective and intention of the parties at the time of concluding the contract necessitates them to perform by some act which is illegal by foreign law
  • Type 4: the actual performance of a contract may violate foreign laws, even though not required or initially intended, but nonetheless lead to the unenforceability of the contract before a Hong Kong court, regardless of its proper law

Following Ryder, if the transaction is identified as a Type 1, Type 2 or Type 3 case, the contract will not be given effect. If, on the other hand, it is a Type 4 case, the Court should make a judgment as to whether comity should require it to give effect to the contract or deny its enforcement by evaluating the seriousness of the illegality and the important policies which may underlie the impugned foreign law.

The Court found that as the 1st Defendant’s purchase of Hong Kong Dollars through the agent “necessarily” contravened PRC law as the very essence of the transactions was to circumvent PRC currency exchange controls, the transactions fall squarely within the Type 2 case. The Court was required to refuse enforcement of the contract, and the defence of change of position and bona fide purchaser would not therefore be available.

The Court also acknowledged that despite the issue of foreign illegality being a complicated and developing area of law, as Hong Kong case authorities have fairly established that it is illegal under PRC law to engage underground banking and there is no material dispute on the PRC law in the present case, the Court failed to see what utility can be gained for the restitution claim to go to trial.

The Court therefore granted summary judgment in favour of the Plaintiff against the 1st Defendant for the unjust enrichment claim for the amount of the sums received and a declaration that the 1st Defendant held the sums received on trust and/or constructive trust.

Key Takeaways

  • Regarding the issue of illegality, a distinction has to be made between domestic illegality and foreign illegality, as the Court would adopt different approaches regarding the enforceability of the underlying transaction.
  • Although foreign illegality remains a complicated and developing area of law, where Hong Kong case authorities have fairly established the relevant foreign illegality in issue and there is no material dispute regarding the foreign illegality in question, the Court may still be prepared to grant judgment at the summary stage.
  • Aside from a litigation standpoint, for individuals residing in Mainland who have outward remittance needs, whilst using underground banking or money exchange (地下錢莊/地下钱庄) may seem convenient, it is nonetheless an illegal practice in Mainland. More importantly, it carries the risk that there is no safeguard regarding the source of funds, and the funds received may well stem from innocent parties and be clawed back through legal proceedings.

Anna Chan, Kacy Lam and Dexter Yuen acted for the Plaintiff.

The full Judgment can be viewed here.