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?
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.
The Government's Pilot Scheme in focus
The Government's Pilot Scheme will run for an initial period of two years starting in October 2014. The arbitration mechanism will be subject to review over time and its application will be fine-tuned and broadened after the Government acquires the relevant experience. The latest features of the Pilot Scheme include:
Both the Government and the developer can refer a land premium dispute to arbitration after at least two appeals on the premium by the developer and no agreement is reached. The Government will provide a copy of its standard form Arbitration Agreement to the developer at the time of issuing its Binding Basic Terms Offer letter for the lease modification transaction. The developer can then decide whether to accept the arbitration option or let it lapse. If the parties agree to pursue arbitration, they will need to sign the Arbitration Agreement and agree a List of Disputes and a Fact Sheet (to be annexed to the Arbitration Agreement). The developer will also need to pay a 15% deposit and execute a Deed of Undertaking as to restrictions on alienation (see below).
Criteria for case prioritization
In circumstances where the land premium arbitration case load exceed the capacity of the Lands Department, the Department of Justice and the available pool of arbitrator candidates, cases will be prioritised in accordance to higher yields (i.e. gains in flat numbers or net gain in non-residential gross floor area); wider premium gaps and fewer or more straightforward issues in dispute.
Scope of arbitration
The matters to be arbitrated will be confined to the amount of premium and any disagreement on fundamental issues such as lease interpretation (e.g. interpretation of "industrial" use) and government policies must be resolved by way of civil proceedings in court.
Procedural Law and Rules
The arbitration will be conduct subject to the Arbitration Ordinance (Cap 609), the HKIAC Domestic Arbitration Rules 2012 (as modified under the Pilot Scheme) and the IBA Guidelines on Conflicts of Interest in International Arbitration 2004.
Tribunal composition and appointment
Land premium arbitrations will be decided by a Tribunal of three arbitrators to be mutually agreed and appointed by the parties. Both parties shall provide nominations for the President of the Tribunal and the co-arbitrators to be agreed by the other party. The President of the Tribunal must be a legal professional with at least 10 years post-qualification experience, while the other members should comprise of valuation professionals with at least 10 years of experience in land matters and professional valuation. Registered Professional Surveyors under the Surveyor Registration Ordinance (Cap. 417) with at least 7 years as a qualified member of a professional body of surveyors are to be preferred. HKIAC will be the Appointing Authority in the event of any disagreement.
Arbitrators will be required to make a written declaration as to their independence and impartiality, as well as being subject to an ongoing duty of disclosure for any conflicts of interest that may be relevant. Such declarations may be disclosed by the Government at its discretion. Anti-collusion provisions will also be included in the Arbitration Agreement to prohibit unauthorised discussions outside of the arbitral proceedings. Arbitrators will be deemed 'agents' in the context of Section 9 of the Prevention of Bribery Ordinance (Cap. 201) and will be liable for offences under the legislation in the event of misconduct.
Walk away provisions
To deter developers from abandoning the arbitration proceedings or defaulting on its obligations after an arbitral award is issued, they will be required to execute a Deed of Undertaking which stipulates their agreement to restrictions on alienation of the subject lot and on transfer of shareholding (if the lot is held by a company) until the execution of the relevant lease modification / land exchange. The developers must also pay the Government 15% of the premium last assessed by the Government in the event the developer purports to discontinue the arbitral proceedings or fails to execute the lease modification / land exchange at the premium assessed under the arbitral award. The 15% deposit will comprise of 10% in cash and 5% may be in the form of a performance bond to be cashed in the event of default.
Date of valuation and timeframe
The valuation date will be the date when the Tribunal is first constituted. However, to avoid the assessed land premium amount from becoming too out of date, the Arbitration Agreement provides that the arbitral award is to be issued within 10 weeks from the constitution of the Tribunal under a 'documents only' procedure (see diagram on the next page). Extensions of time may be allowed by agreement of the parties at the behest of the Tribunal, and the valuation date may be adjusted accordingly to reflect an unforeseen extension.
The Tribunal will decide on a suitable land premium amount by consensus or majority vote. The details of the arbitration will be kept confidential in view of the commercially sensitive nature of the information involved, although the Government reserves the right to disclose information to the public about concluded cases. The amount of land premium charged on the basis of the arbitral award will be disclosed through the usual registration process under the Land Registration Ordinance (Cap. 128).
Each party will be required to bear their own legal and other costs while the costs of the arbitral proceedings (i.e. the fees and expenses of the Tribunal) shall be borne by the parties in equal shares unless the Tribunal within its discretion deems a different allocation is appropriate.
An arbitral award in a land premium dispute will be subject to the same court appeal mechanism as defined in the Arbitration Ordinance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.