When Foreign Laws Collide with Local Claims: How Hong Kong Courts Now Handle Restitutionary Claims Tainted by Foreign Illegality

Written By

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Danny Leung

Partner
China

I am a partner in our Hong Kong office specialising in complex commercial litigation, arbitration, regulatory investigations and anti-money laundering laws.

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May Leung

Associate
China

I am an associate in the Hong Kong office of Bird & Bird. I have a broad civil and commercial disputes practice covering company and insolvency matters, shareholders' disputes, contractual disputes, fraud and asset recovery.

The doctrine of illegality in Hong Kong – Part 2

Introduction

In Part 1 of our three-part series on the doctrine of illegality (read here), we provided an overview of the fundamental principles of how illegality affects civil claims.  

In this second instalment, we examine the recent developments in Wong Chi Hung v Lo Wing Pun & Ors HKCA 370 (currently under appeal), where the Hong Kong Court of Appeal addressed, for the first time, how foreign illegality affects restitutionary claims.  This landmark decision has significant implications for practitioners and businesses engaged in cross-border transactions, particularly those involving jurisdictions with differing regulatory frameworks. 

Facts in Wong Chi Hung

In Wong Chi Hung, a money exchange shop in Hong Kong was sued by its customer.  Despite having paid the shop funds in RMB in Mainland China, the customer did not receive an equivalent amount in HKD in Hong Kong as agreed.

The customer pursued dual claims: breach of contract and, alternatively, unjust enrichment.  Whilst the lower court rejected the contractual claim, it allowed the restitutionary claim.

The issue on appeal

There was no appeal against the lower court’s findings that the shop was enriched at the customer’s expense, with the ‘unjust’ factor being a total failure of consideration.  It was also undisputed that the underlying agreement would be illegal under PRC law, presenting a case of foreign illegality.

The Court of Appeal faced two fundamental questions: (1) whether foreign illegality can constitute a defence to restitutionary claims, and (2) if so, what principles should govern such cases.  Notably, this was uncharted territory in Hong Kong jurisprudence, with no previous case directly on the point: see §41 of Wong Chi Hung.

The preliminary question: What is the governing law?

When restitutionary claims come before Hong Kong courts, the governing law is determined by Hong Kong’s conflict of laws rules.  The established position is that where an obligation to make restitution arises in connection with a contract, the proper law is the law applicable to that contract.

In Wong Chi Hung, it was common ground that the agreement for the money exchange was governed by Hong Kong law, applying the ‘closest and most real connection’ test.  Consequently, the unjust enrichment claim, including questions regarding the effect of illegality, shall be determined under Hong Kong law.

Foreign illegality: Potential defence to unjust enrichment claim under Hong Kong law 

Following comprehensive analysis of the lower court’s reasoning, the parties’ submissions, and relevant authorities, the Court of Appeal established that foreign illegality may indeed constitute a defence to restitutionary claims.

The Court of Appeal considered familiar principles from Ryder[1] as to the effects of foreign illegality on a contract, with public policy considerations and international comity serving as guiding factors.  However, the Court of Appeal recognised that these considerations affect contractual and restitutionary claims differently.  Crucially, the reasons for refusing to enforce contracts due to foreign illegality do not automatically preclude restitution, given the fundamental distinction between these claims: restitution seeks to restore parties to their pre-transaction positions, rather than helping them achieve fulfilment of their contract. 

The Court of Appeal clarified that allowing restitutionary claims (which arise from obligations imposed by, in this case, Hong Kong law, separate from the underlying contract) does not involve giving effect to illegal agreement under foreign law or rights derived therefrom.  Rather, the courts recognise the transaction’s ineffectiveness on the strength of the foreign law.  The Court of Appeal observed that “[c]omity, in the form of respect for the laws of another jurisdiction and restraint from facilitating their contravention, is in general not offended by permitting such a claim” (emphasis added): see §49 of Wong Chi Hung.

The applicable principles, grounded on public policy considerations and international comity, are summarised as follows: 

  • In general, a plaintiff who has paid money to a defendant pursuant to a contract which the latter has not performed and which has been rendered ineffective due to foreign illegality is entitled to restitution. 
  • This general rule is fortified if the foreign law itself provides for restitution in such a case.  The fact that the foreign law makes no provision for restitution does not mean that the Hong Kong courts should not order restitution. 
  • There may be exceptions if the underlying agreement involves egregious foreign illegality, where comity and public policy demand refusal of assistance to the plaintiff.  More specifically, the Court of Appeal remarked that it “may be debated” whether the Hong Kong courts should allow a plaintiff to recover the money paid under an aborted transaction for the commission of a heinous crime in the foreign jurisdiction (such as murder) or an agreement to support insurrections and hostilities against a foreign government.
  • Where the foreign law would be stultified by allowing a restitutionary claim or such a claim is expressly or by clear implication barred under the foreign law, and there is no countervailing Hong Kong public policy reason not to give effect to the foreign law, there may be a defence to the claim in restitution.  The burden is on the party relying on the defence. 

On the facts of the case as decided by the lower court, the Court of Appeal found no comity or public policy reasons to deny restitution, particularly given the lower court’s finding that restitution would also be available under PRC law.  The shop’s appeal was accordingly dismissed.

What was left open?

Was the lower court correct in rejecting the customer’s breach of contract claim?

Notably, whilst the customer did not cross-appeal the rejection of the contractual claim, the Court of Appeal discussed but ultimately reserved its opinion on the validity of such claim (as it was not the subject of the appeal): see §§27-32 of Wong Chi Hung

The Court of Appeal observed that what remained to be performed under the Hong Kong law contract was the payment of HKD by the unauthorised money exchanger to its customer in Hong Kong, which was not illegal or impossible in Hong Kong.  At common law, a prohibition under the law of another jurisdiction was generally not an excuse for not performing in Hong Kong a payment obligation governed by Hong Kong law.  The Court further noted that whilst Ralli Brothers v Compania Naviera Sota y Aznar [1920] 2 KB 287 (the foundation of the second Ryder principle) had been frequently cited, it was rarely applied in commercial decisions to discharge contractual performance, either because performance was not found to be illegal or performance was not required at the place of the illegality. 

This suggests potential scope for arguing that the second Ryder principle may not render similar contracts unenforceable due to foreign illegality.  This consideration should inform analysis of related authorities, such as She Ching Yan v Cai Yunxiang [2023] HKCFI 592 (referenced in Wong Chi Hung).  We will explore this further in Part 3 of this series.

Unenforceable vs void contract: the ‘no-subversion principle’

Another issue which was not before the Court of Appeal was whether the ‘no-subversion principle’ applies to prevent restitutionary claims arising from contracts that are unenforceable (but not void) due to foreign illegality.

The ‘no-subversion principle’ prevents restitutionary remedies where their effect would be to subvert parties’ agreements in valid contracts.  The money exchange shop argued, citing Chitty on Contracts, that under the second Ryder principle, the contract remained valid though unenforceable, thereby barring the unjust enrichment claim.

The lower court rejected this argument.  Despite this being a novel issue (as observed by the trial judge), leave to appeal on this ground was refused because Chitty on Contracts (the shop’s authority) stated that restitutionary claims remained permissible upon proof of total failure of consideration, even where contracts were unenforceable but valid — and the trial judge had found total failure of consideration on the facts.

Commentary

This landmark decision represents a significant development in the doctrine of illegality in Hong Kong.  As noted above, the judgment remains under appeal to the Court of Final Appeal.  We will continue monitoring developments and provide timely updates.  The final appellate decision would hopefully establish the definitive legal framework for practitioners and businesses engaged in international transactions.

In the next and final instalment of this series, we are going to look at the doctrine of illegality from another perspective, and examine how illegality affects the defence to restitutionary claims (such as the defence of bona fide purchaser for value and change of position).

 

[1]Ryder Industries Ltd v Chan Shui Woo (2015) 18 HKCFAR 544, which was discussed in Part 1 of this series.

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