“Illegality” in Performance of Contracts in the Mainland and Governed by Hong Kong law

Jason Carmichael, Smyth & Co in association with RPC

This issue was considered in Ryder Industries Ltd v Chan Shui Woo [2015] HKEC 2683, FACV 12 and 13 of 2015; a judgment of the Court of Final Appeal (“CFA”) arising out of two consolidated actions and due to be formally reported. The issue is one that will be familiar to many lawyers and parties dealing with contracts subject to Hong Kong law but requiring some performance in the Mainland (a common scenario).

The CFA’s judgment considers the defence of illegality in the context of the plaintiff’s claim to sums alleged to be outstanding from the defendants pursuant to certain commercial agreements between two Hong Kong companies and governed by Hong Kong law. The defendants resisted payment on the basis of a number of grounds of alleged illegality under PRC law arising out of performance of the agreements; for example, the manner in which some materials under the agreements had been imported into the Mainland was alleged to have violated certain PRC laws.

In the lower courts the defence to the plaintiff’s claim failed. The first instance court found that (among other things) responsibility for any illegality was shared between the parties and, in any event, it would be disproportionate to dismiss the plaintiff’s claim (particularly, where the alleged illegality did not taint the claim). Based on similar reasoning, the Court of Appeal affirmed the first instance decision.

The CFA dismissed both appeals. In a unanimous judgment, the CFA arrived at the same result but for different reasons. The CFA held that the issue of illegality did not fall to be decided solely as if it was a matter of illegality according to Hong Kong law; rather, it fell to be decided in the context of the performance of the agreements in the Mainland and, therefore, according to established rules of the conflict of laws. According to the CFA judgment, these principles of international comity applied not just as between separate countries but also as between distinct legal jurisdictions (such as the Mainland and Hong Kong).

While disapproving of a “proportionality test” in this context, the CFA considered that it was too wide a proposition to suggest that every breach of foreign law resulting from the performance of an agreement would render it unenforceable. Indeed, the CFA noted that (among other things) the first instance court had found that the alleged breaches of PRC law were not serious, did not involve conduct which could be described as “iniquitous”, had not resulted in criminal proceedings on the Mainland and appeared to be more in the nature of “administrative” contraventions.

The CFA’s judgment puts the test for deciding whether the performance of an agreement is unenforceable because of contraventions of foreign law on a firmer footing, as a matter of principle, compared with the “proportionality test” applied by the lower courts. In practice, this might suggest a more flexible approach depending on the seriousness of the foreign illegality and the facts of a case. Furthermore, the outcome in Ryder Industries Ltd v Chan Shui Woo represents what many commercial parties will regard as common sense (given, for example, the vagaries of doing business in some jurisdictions)*.

* The judgment is also a good illustration of the value in having non-permanent judges from overseas common law jurisdictions appointed to the CFA, particularly for cases in respect of which they have undoubted expertise – s.5(3) of the Court of Final Appeal Ordinance (Cap.484). In Ryder Industries Ltd v Chan Shui Woo, the judgment of the CFA is written by Lord Collins NPJ.