On 24 July 2014, we issued a legal update on the Hong Kong Government’s proposed two-year Pilot Scheme for arbitration on land premium (the “Pilot  Scheme”). The Pilot Scheme was intended to streamline procedures for resolving land premium  disputes  with property developers by allowing a third party arbitral tribunal to rule on the appropriate amount of premium payable pursuant to applications for  lease modification and land exchange. The Pilot Scheme was officially launched by the Government pursuant to an Information Note dated 27 October 2014 (the “Information Note”) and cases that meet the criteria for referral can now adopt the expedited  procedure to help break the deadlock between the parties.

Launching the Pilot Scheme

The Pilot Scheme was originally set to launch in August 2014 following  the presentation of the proposed framework to the Legislative Council (“LegCo”). However, it was met with opposition from lawmakers  due to concerns over potential conflicts of interest arising on the part of third party arbitrators. As a result, the launch was delayed to  facilitate additional modifications to the framework to address those concerns.

The new arbitration mechanism  will serve as an alternative avenue for the Government and  developers to resolve the common disputes arising from negotiations over the amount of premium to  be paid, and we consider that it may go some way to addressing the underlying goal of increasing  land supply for housing and other purposes in Hong Kong. However, the actual effectiveness of the Pilot Scheme can only be assessed after it has been in  operation and a few arbitrations have been conducted under the procedural rules.

In this Legal Update, we will draw your attention to some key issues and provide our thoughts on a  few practical matters. The main features of the Pilot Scheme are summarised in the Appendix.

Scope of arbitration

The issues to be considered by the Arbitral Tribunal (“Tribunal”) are confined to matters that  determine the amount of land premium but questions relating to lease interpretation and/or government policy will be excluded from the  scope of arbitration. The basis for this approach is that there may be sector-wide ramifications arising from a decision on such matters and an open court would be a  better forum  to resolve the issues. This renders the Pilot Scheme inapplicable to cases where the dispute pertains to a difference of opinion on the  interpretation of a lease term and/or government policy, which nonetheless may affect the valuation of the premium. This limits the type and number of disputes  that may be referred to arbitration.

We consider that, notwithstanding the Government’s interest to set precedents for lease  interpretation and government policy in open court, by removing the exclusion, Tribunals would be more holistically empowered to arbitrate cases relating  to premium valuation and more disputes  will be able to benefit from the expedited procedures under the Pilot Scheme. However, this can  also mean that the arbitrators may need more time to consider the issues before making an award.

15% deposit and restrictions on alienation

The Government requires the developer to pay 15 percent of the Government’s latest land premium  offer as deposit, as well as to sign a Deed of Undertaking subjecting it to a restriction on alienation of the subject lot and/or on transfer of shareholding, upon agreeing  to submit to arbitration under the Pilot Scheme. These “walking away provisions” are said to help bind the developer from defaulting on its agreement to arbitrate  or failing to abide by the terms of the arbitral award.

There is a question of whether the deposit requirement is legally enforceable since it appears to  be in the form of a penalty and not a genuine pre-estimate of the loss to the Government. This is  particularly true since a majority of the sum will be paid to and held by the Government even before the determination of the actual  premium. We consider that this may be an area of contention between the parties that necessitates  further clarification.

Date of valuation

The valuation date for land premium under the Pilot Scheme will be the date on which the Tribunal  is first constituted. Under the ‘documents-only’ procedure, the Tribunal is required to issue a  final award within 10 weeks of the valuation date although the Tribunal may seek an extension of  time of up to four weeks based on exceptional circumstances. Should further time extensions be  required, the date on which each further extension is ordered will become the operative valuation  date.

This is a material issue as market values tend to fluctuate over time and the longer time passes  from the valuation date, the greater the risk that the assessment under the award will be superseded by events. Developers will be expected to commit to a valuation date  without knowing the ultimate premium figure to be awarded by the Tribunal so there is a risk that  market prices will become unfavourable between the valuation date and the date of the award. Of course, there is also  potential for market prices to increase in the interim which would be advantageous to developers.

Arbitration Agreement and Procedural Rules

The Information Note included an appendix entitled “A summary on key features of an Arbitration  Agreement”, which constitute the terms of the pro-forma Arbitration Agreement under the Pilot  Scheme. In line with usual practice, it is unlikely that the Government will agree to negotiate or  amend these standard terms. The arbitrations under the Pilot Scheme will be conducted subject to the Hong Kong Arbitration Ordinance, the IBA Guidelines on Conflicts of Interest in  International Arbitration 2004 and the Domestic Arbitration Rules 2012 of the Hong Kong  International Arbitration Centre (“HKIAC”). The application of the latter is subject to  the  modifications set out in the pro-forma Arbitration Agreement. The Government’s modifications to  these Rules are quite extensive and there may be some uncertainty as to precisely which of the other procedural rules will, by implication, be adopted.  We would therefore recommend the parties to seek professional advice before entering into the  Arbitration Agreement.

Disclosure of arbitrator’s declarations

One of the notable modifications to the framework pursuant to concerns from LegCo is the ability of  the Government to disclose the written declarations of the arbitrators. Disclosure was said, in the  original July framework paper, to “inhibit prospective arbitrators  from accepting the appointment,  hence compromising the chance of the parties concerned getting the best candidates to serve as  arbitrators” based on the feedback from stakeholder groups. Whether this will be the case remains to be seen, but arbitrators who accept appointments under this process will no doubt  be subject to close scrutiny by LegCo and the public.

Considerations before signing the Arbitration Agreement

Prior to entering into the Arbitration Agreement with the Government, developers should carefully  consider a number of issues before deciding whether arbitration under the Pilot Scheme is the best avenue for resolving the dispute at hand. Some of these include:

  • What is the scope of matters that could be included in the List of Disputes and would the  Tribunal be in a position to consider these matters subject to the limitations of the Pilot Scheme?
  • Do the issues in dispute pertain to matters that  can properly be resolved under a  “documents-only” procedure, and do the supporting documents and records suffice to inform a suitable valuation assessment in the absence of oral hearings?
  • What is the status of the market and are there external factors that could lead to significant  adverse fluctuations in market values up to the expected date of the arbitral award?
  • How will the 15% deposit and restrictions on alienation requirements affect your company’s  operations?
  • How will the HKIAC Domestic Arbitration Rules 2012 apply in the context of the arbitration?
  • Which suitable candidates meet the qualification requirements and could be nominated to the Tribunal?

Final thoughts

Upon reaching the trigger point of two appeals on land premium, either the Government or the developer is able to refer the dispute to arbitration. Furthermore, when the Lands Department  issues its Binding Basic Terms Offer letter for the lease modification transaction, an Arbitration  Agreement will also accompany the letter for the developer’s consideration of the arbitration option. We  recommended that developers should consult its professional advisors including legal and surveying  representatives in advance of this stage to seek advice on whether pursuing arbitration under the Pilot Scheme would be in their best interests. Developers who wish to use arbitration should also begin to collect the  necessary documents in anticipation of commencing the process.

Following the late October 2014 launch, we anticipate that the first few test cases to apply the  arbitration mechanism under the Pilot Scheme may arise in the near future. It will certainly be  interesting to see how the procedural rules are applied in practice and whether the Pilot Scheme will ultimately have the desired effect of unlocking land supply in Hong Kong.