In the 2020 case of Law Ting Pong Secondary School v. Chen Wai, the Court of Appeal (Hong Kong) considered the question of how to interpret a penalty clause in the employment context. We published a summary article here. The principles established in this case have recently been applied in the case of Black Marble Securities Limited v Lee Yan Chi [2023] HKCFI 1084, which concerns the enforceability of an indemnification clause requiring a securities broker to indemnify her firm for the amounts owed by its clients (who were introduced by the broker).

Facts

Ms. Lee Yan Chi (“Ms. Lee”) was employed by Black Marble Securities Limited (“Black Marble”) as a securities broker. In addition to her monthly salary, Ms. Lee received a commission for introducing clients to Black Marble.

The parties also entered into a broker agreement (the “Broker Agreement”) by which Ms. Lee was to deal in securities on behalf of Black Marble’s clients and Black Marble would share a portion of the commission and fees charged to its clients. Clause 9(1) of the Broker Agreement further provided: “After the opening of an account with [Black Marble], if the Client fails to make payment in relation to dealing in securities or futures, service charges and interests on time, and is thereby in breach of any responsibility or rules, any loss including but not limited to those caused to [Black Marble] shall be borne by [Ms. Lee], and [Black Marble] has the absolute right to recover the loss against [Ms. Lee] or the Client severally or jointly” (the “Indemnity Provision”).

Ms. Lee contended that the parties had also entered into an oral agreement that any compensation payable by Ms. Lee under the Indemnity Provision would be paid through deduction of her wages (the “Oral Agreement”).
Ms. Lee introduced two clients to Black Marble whom each opened a margin securities trading account with Black Marble. Both clients however failed to settle their respective outstanding margin in full in violation of their respective client agreements with Black Marble. As a result, Ms. Lee executed two written undertakings in favour of Black Marble in respect of the amounts owed by the two clients (the “Undertakings”). Under the Undertakings, Ms. Lee authorised Black Marble to “freeze” her monthly and commission income until the clients’ arrears are paid. Black Marble withheld HK$329,512.18 from Ms. Lee’s salary and commission income. Following Ms. Lee’s resignation, Black Marble commenced legal proceedings against Ms. Lee and demanded that she repay a sum of HK$3,384.093.12, being the amount owed by the clients to Black Marble pursuant to the Indemnity Provision, plus interest. Ms. Lee disputed liability on the ground that the Indemnity Provision was (i) void for breach of section 32(1) of the Employment Ordinance (the “EO”) (which prohibits unlawful deduction from wages), or (ii) void for being an unenforceable penalty clause. She also counterclaimed for her salary and commission income withheld by Black Marble. Central to the parties’ dispute were (i) whether the Indemnity Provision was void for violation of section 32(1) of the EO; and/or (ii) void for being an unenforceable penalty clause.

Findings

In determining whether the Indemnity Provision was void for violation of section 32(1) of the EO, the Court first considered how the Oral Agreement was formed.

Ms. Lee submitted that the Broker Agreement formed part of her terms of employment, and the Oral Agreement supplemented the Broker Agreement. When construed together, the Indemnity Provision was void for violation of section 32(1) of the EO which prohibits unlawful deduction from wages. To counter Ms. Lee’s argument, Black Marble argued that the sum was simply “retained” by them.

The Court did not agree with Ms. Lee’s argument. Whilst the Court found that the Oral Agreement was made, it was not made as a supplement to, or as part of, the Broker Agreement. Further, the Oral Agreement was not legally binding due to a lack of consideration. As such, it was held that any argument based on section 32(1) of the EO failed because the Oral Agreement did not affect the operation of the Broker Agreement and could not render the Indemnity Provision void.

In the alternative, Ms. Lee argued that the Indemnity Provision was penal in nature.

Ms. Lee argued that (i) the Broker Agreement required a client to deposit funds and shares as required by Black Marble and this therefore amounted to a primary obligation on Ms Lee as broker to ensure clients made the necessary deposit and (iii) if the clients failed to make payment, any loss caused to Black Marble would be borne by Ms Lee. Ms. Lee argued that this amounted to a secondary obligation since it provided for the situation where the client had failed to make payment, Ms Lee would have failed to perform her primary obligation.

Applying the Law Ting Pong case, Ms. Lee argued that the secondary obligation that operated on a breach of contract and imposed a detriment on the contract breaker (i.e. Ms. Lee in the present case) was out of proportion to any legitimate interest of the innocent party (i.e. Black Marble in the present case) in the enforcement of the primary obligation.

The Court found that the Indemnity Provision could not be construed as a penalty clause, because the Broker Agreement did not impose any obligation on Ms. Lee. The clause in the Broker Agreement stated that the client was to deposit funds or shares as required by Black Marble, and it did not impose an obligation on the broker to ensure that the client did so. As such, the Court did not agree that any secondary obligation on the part of Ms. Lee was created in the event of a breach of the primary obligation (where the client failed to make payment).

Based on the above findings, the Court held that the Indemnity Provision is enforceable, and ordered Ms. Lee to repay Black Marble HK$3,384.093.12, being the outstanding amount owed by the clients with interest. It however also ordered Black Marble to give credit to the sum withheld by it pursuant to the Undertakings.

Key takeaways for employers

Employers often want to hold employees liable to financial losses caused by the employees themselves (and less often, losses caused by clients as in the present case), or require employees to repay certain expenses or bonuses if they resign within a certain period, by making deduction from their wages.

Employers should however note that the circumstances under which an employer could withhold or deduct from an employee’s wages are very limited. Deductions from an employee’s wages can only be made if it falls within the scope of and satisfies the specific conditions set out in section 32(2) of the EO.

For example, deductions from wages for recovery of a loan made by the employer to the employee could only be made with the written consent of the employee, and the total of such deductions in any one wage period shall not exceed 25% of the wages payable to the employee in respect of that wage period; whilst deductions for damages to property belonging to the employer are limited to HK$300 per instance, and the total of such deductions in any one wage period should not exceed 25% of the wages payable to the employee.

Unfortunately, the Court did not express its views as to whether Black Marble’s act of withholding of Ms. Lee’s wages and the non-payment of her full wages at the end of the wage period constituted a breach of the EO. Nevertheless, employers are reminded that any deductions from wages in contravention of section 32 of the EO and non-payment of wages when due would constitute a criminal offence. A disgruntled employee may also claim constructive dismissal against the employer for damages.

When drafting repayment or indemnity clauses in employment agreements, employers must therefore ensure that the terms are clearly drafted and do not violate section 32 of the EO. Even if such a clause does not involve deduction or withholding of wages, employers should also consider if there is any chance that the clause would be considered an unenforceable penalty clause, based on the principles laid down by the Court.

How we can help you?

We can assist you with tailoring your employment agreements based on your business needs. Please reach out to us if you wish to know more.

The full judgment of Black Marble Securities Limited v Lee Yan Chi [2023] HKCFI 1084 can be found here.