Ariel Ye, Paul Starr and Yang Fan, King & Wood Mallesons
This is an extract from the second edition of GAR’s The Guide to M&A Arbitration. The whole publication is available here.
Frequency of M&A disputes
Although there are no empirical studies or surveys as to the frequency of M&A disputes in the Hong Kong Special Administrative Region, we can readily testify, from our own case load, that not only are these types of disputes ever-increasing in number (representing for us about 50 percent of our Hong Kong arbitration case load), they also reflect massive rises in the value of disputes (many of which reach into the tens or hundreds of millions of dollars).
There are various reasons for this growth in frequency and value. Mainland China parties increasingly tend to arbitrate their differences, both with international counterparties and each other. A perceived slowdown in world economies fosters disputes. The first emanations of dissent on the Belt and Road Initiative are manifesting themselves in arguments over abandoned or allegedly incomplete transactions.
More and more parties are nominating Hong Kong as their forum for arbitrating disputes, with each of the three administering institutions seeing exponential growth.
To give some concrete examples, we are handling erstwhile consortia partners’ arbitrations over the implementation of an agreement providing for return of shares in the event of a failed M&A transaction (at HKIAC); a failed acquisition in Central America (at ICC Hong Kong); and alleged non-performance by a European–Hong Kong consortium (at CIETAC Hong Kong).
Form of dispute resolution
Our general perception is that it is quite common to see arbitration agreements in M&A transactions, especially those involving cross-border elements. From the M&A transactions that we have seen, it is not very common to see parties choose expert determinations or other ADR procedures to settle M&A disputes.
Grounds for M&A arbitrations
From our own Hong Kong caseload, we analyse the relative frequency of the following grounds for M&A arbitrations in Hong Kong as follows:
Fraud and failure to disclose
The Hong Kong court has never ventured to lay down, as a general proposition, what constitutes fraud. Actual fraud arises from acts and circumstances of imposition.
The elements of fraud or deceit may be summarised as follows:
- there must be a representation of fact made by words or conduct;
- the representation must be made with knowledge that it is or may be false. It must be wilfully false, or at least made in the absence of any genuine belief that it is true;
- the representation must be made with the intention that it should be acted on by the claimant, or by a class of persons that includes the claimant, in the manner that resulted in damage to the claimant;
- it must be proved that the claimant has acted on the false statement; and
Fraud, especially, had to be distinctly pleaded with the utmost particularity.
Failure to disclose
In general, the seller in an M&A transaction is under no duty to disabuse the buyer in pre-contractual negotiations of an error concerning the target, its assets or shares. Accordingly, cases involving failure to disclose in an M&A context are rare in Hong Kong.
In Aktieselskabet Dansk Skibsfinansiering v. Brothers, the Hong Kong Court of Final Appeal held that a failure to provide information is not in itself a misrepresentation. Therefore in an M&A context, the seller is not required to disclose all information regarding the target.
However, it would be wrong to suppose that a party to negotiations can always refrain from pointing out errors or otherwise engage in artful silence. A seller may be liable in the following situations.
Active misrepresentation by a half-truth
The seller in a pre-contractual statement misleadingly discloses only part of the true position: ‘the true import of what was said or written is distorted by what is left unsaid, so that even if the representation is literally true in every particular it is nevertheless misleading.’
Active misrepresentation by misleading conduct
In Spice Girls Ltd v. Aprilia World Service, it was found that deliberate steps taken by the seller to conceal from the buyer the true state of affairs can constitute misrepresentation by conduct.
Falsification known to representor before contract formed
The buyer may rescind an SPA if the seller has made an initially accurate statement but, before the contract’s formation, the seller discovers a change of situation rendering that statement misleading and the seller fails to notify the buyer of this change.
Mistake as to terms of deal: other party acquiescing
If the seller knows that the buyer is mistaken regarding the terms of the proposed transaction, the contract cannot be upheld by the seller. In such a case, the contract is void (or the buyer might also have the right to insist that the contract proceed on the buyer’s supposed version). This scenario could result in the unwinding of an M&A transaction or a rectification of the SPA.
Burden of proof
It is usually incumbent upon the plaintiff to prove what it contends.
In respect of a particular allegation, the burden lies upon the party for whom the substantiation of that particular allegation is an essential part of his case. Formulations of the incidence of the legal burden of proof are sometimes made on the basis that it rests on the party asserting the affirmative of an issue.
Once the claimant shows that the statement is false for the purpose of a claim under Section 3, Misrepresentation Ordinance, the burden of proof is on the representor to show it had reasonable grounds for making the statement.
There are no specific legal requirements as to pooling of knowledge of sellers with management or target representatives in Hong Kong. The Securities and Futures Commission’s Codes on Takeovers and Mergers and Share Repurchases for public listed companies and Chapter 19 of the HKEx Listing Rules are silent on such issues.
All remedies available under the general Hong Kong contract law are generally available to a successful claimant in an M&A arbitration in Hong Kong, such as action for debt, damages, interest, specific performance, injunction, restitutionary claims, and declarations.
Section 3(1) of the Misrepresentation Ordinance provides a statutory head of tortious damages. There are at least two main reasons for the claimant to prefer this provision as the potential source of compensation for a pre-contractual misrepresentation (in the absence of a collateral warranty): (1) damages are recoverable for all the consequences of the representation, even if not reasonably foreseeable, subject only to a defence of mitigation; (2) once the representation is shown to have been inaccurate, the defendant bears the burden of showing reasonable grounds for continuing to believe, until formation, the accuracy of the statement.
Damages under this provision are classified as tortious. Sir Donald Nicholls V-C in Gran Gelato Ltd v. Richliff Ltd made helpful observations on the nature of liability under this provision:
[I]n short, liability . . . is essentially founded on negligence, in the sense that the defendant, the representor, did not have reasonable grounds to believe that the facts represented were true. . . . Stated broadly, the measure of damages payable under [Section 2(1) of the English Misrepresentation Act (1967), the mirror provision of Section 3(1) of the Hong Kong Misrepresentation Ordinance (Cap 284)] is that sum of money which will place the plaintiff in the position he would have been in if the representation had not been made.
Furthermore, the courts give effect to the so-called ‘fiction of fraud’ contained in Section 3(1). The English Court of Appeal held that this dispenses with the general remoteness test applicable to negligence claims in tort (the ‘reasonable foreseeability’ formulation of a remoteness test). Instead the representee can recover loss under Section 3(1), however unforeseeable that loss might be, provided this is causally related to the misrepresentation, in other words, provided ‘the chain of causation’ has not been broken. This led Rix J in Avon Insurance v. Swire Fraser to describe the mirror provision in the English legislation as a ‘mighty weapon’. But, earlier, Lords Browne-Wilkinson and Steyn, in Smith New Court Securities v. Scrimgeour Vickers, expressed doubt concerning the Royscot case on this point.
In Yam Seng v. International Trade Corp Leggatt J said that he did not consider that the Royscot case’s interpretation of the statute was correct, but he acknowledged that it is binding English Court of Appeal authority on the need to pattern such damages as though fraud had been established.
Measure of damages
Under Hong Kong law, the main aim of compensatory damages is to place the promisee in the position it would have been in if the contract had been properly performed. This is the so-called ‘expectation’ or ‘loss of bargain’ measure.
What if, in response to a tortious misrepresentation claim, including one under Section 3 of the Misrepresentation Ordinance, the defendant contends that the claimant’s loss is in fact lower than that claimed, or even zero, because if the claimant had placed its money elsewhere those funds would have disappeared down a drain? In Yam Seng v. International Trade Corp Leggatt J held that defendants’ discharge of this onus of proof will be an uphill struggle because they must show ‘with a reasonable degree of certainty . . . both the fact that the claimant would probably have suffered a loss from entering into an alternative transaction and the amount of that loss’.
Special substantive issues
For special substantive issues, such as employees, transfer of liabilities, landlords, competition law issues, stamp duty, consent by third parties, as well as relevant issues under Hong Kong Company Ordinance and Listing Rules and Takeovers Code the reader is directed to Alex Que and Rhoda Yung, Negotiated M&A Guide for Hong Kong (2017).
Special procedural issues
The Hong Kong Arbitration Ordinance adopts the Model Law on International Commercial Arbitration of the United Nations Commission on International Trade Law.
Parties to M&A transactions may choose to opt in Section 2 of the Schedule 2 of the Hong Kong Arbitration Ordinance so as to benefit from the court’s power for consolidation of arbitration.
Furthermore, the Hong Kong International Arbitration Centre’s Administered Arbitration Rules (2013) provide for joinder of additional parties in Article 27 and consolidation of arbitrations in Article 28.
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