By:  Kenneth Y. Choy of King & Wood’s Hong Kong office and Antitrust & Competition Group

Tai Po is a traditional village located in the northeastern part of the New Territories in Hong Kong. Its historical relics, old temples, quaint fishing village and natural scenery make it a popular destination for both tourists and local residents alike.

The Hong Kong government began building up Tai Po in the late 1970’s, transforming it from a sleepy fishing community into a bustling new town of 300,000. In the last decade, the Government decided to tear down the old to make way for new facilities in the area. As part of the development, the old Tai Po Temporary Market which had housed many small cooked food stalls was replaced with a brand new complex. Stallholders who operated the cooked food stalls were vacated by the Food and Environmental Hygiene Department, the governmental agency that manages cooked food markets and relocate to the new facility.

The FEHD then decided to use an auction to allocate the new stalls and determine the rent they would charge the stallholders for the new stalls. The auction was a restricted one and only stallholders from the old market were allowed to bid. Invitations were sent to them which also stated that the reserve price of each stall was fixed at 75% of market price as determined by the relevant Government department.

Before the auction, 36 of the stallholders met and agreed that they would not bid against each other. By drawing lots, each stallholder drew a stall number for him or her to bid at the auction. The purpose was to ensure that there would only be one bidder for each stall. As agreed, each stallholder only submitted a bid for his or her assigned stall so each was the sole and winning bid at the reserved price. Subsequently, the FEHD entered into a tenancy agreement for each stall with the winning stallholder at the winning bid price.

Some time later, the FEHD learned of the collusion and 19 stallholders or their representatives were each charged with one count of common law conspiracy to defraud the FEHD. The claimed deception was that each defendant “conspired to defraud the FEHD by dishonestly pre-allotting among themselves the relevant food stalls so as not to bid against each other”. They were tried before a magistrate and all were convicted and sentenced to terms of imprisonment of 9 to 12 months.

Except for the stallholder who testified for the Government, all other defendants appealed their conviction.

The conviction was overturned by the Court of Appeal. Relying on a line of English cases that said an agreement not to bid against each other at an auction – known in England as a “knock out” agreement – is valid and enforceable, the Court of Appeal concluded that the collusion among the stallholders is not criminal. The Government disagreed and appealed to the Court of Final Appeal, Hong Kong’s highest court.

The Court of Final Appeal noted that the stated charge is one of deception, essentially claiming that the stallholders together duped the FEHD into believing that there was only one interested bidder for each stall at the auction and based on this false belief, the FEHD rented the stalls for the reserved price to the stallholders thereby suffering the loss of a potentially higher rents for the stalls which would have been gained if there was no collusion among the participants. The Government argued that the pre-allotment and agreement not to compete were a dishonest means and a false representation intended by the stallholders to deprive the FEHD of higher income.

Writing for the court, Sir Anthony Mason found three problems with the charge as stated by the Government. First, he found that the FEHD could not have been deceived as it was unaware of the pre-allotment and knock out agreement until after the auction was completed. Thus, the FEHD did not do anything different in conducting the auction. Second, there was no evidence that collusion of the stallholders induced or deceived the FEHD into believing anything. Finally, it is true that FEHD believed that only one bid was offered for each stall but that belief was the result of what actually happened at the auction and not because of any deception by the stallholders.

Sir Anthony also noted that from evidence presented at trial, single bids at the reserved price were common features of such auctions conducted by the FEHD. Of the 320 stalls auctioned by the FEHD in the second half of 2004, including the one at issue, virtually every one had only one bidder at the reserve price. This suggests that the FEHD auctioneer did not notice anything odd or unusual when there was only one bidder for each stall. In fact, as far as the auctioneer was concerned, this was the norm so he had no reason to suspect that anything afoul had happened.

Based on this review of the actual charge against the stallholders, the CFA concluded that the charge of conspiracy to defraud could not be made out because there was simply no evidence that the Government was deceived so the Government’s appeal must be dismissed.

The CFA also noted that under +English law, an agreement by potential buyers not to bid at an auction in order to keep the price down is “neither unenforceable as being contrary to public policy nor criminal”. As they are lawful, knock out agreements cannot be “dishonest” as they are legally valid and enforceable. So parties to the knock out agreements cannot be convicted of conspiracy to defraud. Under English law, “so long as traders individually or collectively were pursuing their own business interests without infringing the rights of others or intending to do them harm, that pursuit was legitimate, even if, by deliberately lowering prices, it drove others out of business”.

Should Hong Kong abandon this line of English cases? The argument for doing so is that knock out agreements are dishonest and anti-competitive and they strike at the very essence of a competitive auction. The CFA felt that given its finding that the charge of conspiracy to defraud could not be made out by the Government, this case was not the right vehicle for considering such a drastic change. Besides, the English authority that knock out agreements are beyond the reach of the law of criminal conspiracy is also ingrained in its Hong Kong counterpart so to discard the precedents would be a step too far for the court to take; it is “a matter entirely for the legislature” to decide.

Hong Kong’s legislature is already considering the issue, albeit via a competition bill introduced in July and currently bogged down in Legco’s Bills Committee for hearings. One of the bill’s key provisions prevents parties – undertakings – to enter into agreements, concerted practice or make decisions “if the object or effect of the agreement, concerted practice or decision is to prevent, restrict or distort competition in Hong Kong”. On the face of it, it would appear that knock out agreements, to the extent that they are intended to restrict and reduce competition in auctions, are prohibited conduct should the competition bill becomes law.