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Enforceability Of Indemnity Clause in favour of Employer
28 November 2023

It is not uncommon to find an indemnity clause inserted in an employment contract whereby the employee is required to indemnify the employer in certain situations e.g. loss caused to the employer by clients introduced by the employee.

In a Hong Kong High Court case of Black Marble Securities Limited v Lee Yan Chi [2023] HKCFI 1084, the Court examined the enforceability of an indemnity clause requiring a security broker (the Defendant employee) to compensate her employer (the Plaintiff employer) for losses owed by clients introduced by the Defendant to the Plaintiff.

The Defendant (the “Employee”) was employed by the Plaintiff (the “Employer”) as a securities broker. The parties signed two employment agreements with the same terms (except for the monthly salary of the Employee) (jointly referred as the “Employment Agreements”). According to the Employment Agreements, the Employee would receive from the Employer (1) a fixed monthly salary; and (2) commission for introducing clients to the Employer.

The Employee and the Employer also signed a broker cooperation agreement (the “Broker Agreement”) which stipulated that the Employee was to deal in securities on behalf of clients of the Employer. Clause 9(1) of the Broker Agreement also stated that “…. if the Client (introduced by the Employee) fails to make payment in relation to dealing in securities on time, and is thereby in breach of any responsibility or rules, any loss including but not limited to those caused to (the Employer) shall be borne by (the Employee) and (the Employer) has the absolute right to recover the loss against (the Employee) or the client severally or jointly.” (“Indemnity Clause”).

In around July 2016, two clients introduced by the Employee failed to settle the outstanding margins in their accounts with the Employer in breach of their client agreements with the Employer. The Employee signed two undertakings agreeing for the Employer to freeze her salary and commission until the arrears owed by her clients were fully repaid (the “Undertakings”). The Employer then withheld up to HK$329,512.

Court’s Findings
The Employer relying on the Indemnity Clause then sued the Employee for the outstanding amount owed by her clients with interests. In her defence, the Employee argued that there was an oral agreement between the parties that any sum payable under the Indemnity Clause would be paid through deduction of the Employee’s wages (the “Oral Agreement”). The Employee further argued that the Oral Agreement supplemented the Broker Agreement which violated S.32(1) of the Employment Ordinance (Cap.57) (“EO”) and would render the Indemnity Clause void. S.32(1) of EO provides that no deductions shall be made by an employer from the wages of his employee or from any sum due to the employee unless it falls within the exceptions in the EO. The exceptions do not apply in this case.

Whether the Indemnity Clause was void for violation of S.32(1) of the EO

The Court found that the Oral Agreement was made on a separate occasion shortly after the Broker Agreement was executed and it was not a supplement to, or as part of, the Broker Agreement. Also, the Oral Agreement lacked consideration and therefore was not a binding agreement with any effect. As such, the Oral Agreement would not affect the operation of the Broker Agreement and could not render the Indemnity Clause void under s32(1) of EO.

The Court also made a separate note that the Employer’s withholding of the Employee’s salary and commission pursuant to the Undertakings was itself problematic.

Whether the Indemnity Clause was a penalty clause

Counsel for the Employee submitted an alternative argument that the Indemnity Clause was penal in nature, and was a secondary obligation that imposes a detriment on the “contract-breaker” that is out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. This argument was made on the basis that the Broker Agreement already imposed a primary obligation on the Employee to ensure the compliance of her clients with the Employer’s deposit requirements. As such, requiring the Employee to compensate the Employer of the loss caused by her clients created a secondary obligation and imposed a detriment on the Employee that was out of proportion to the legitimate interest of the Employer under the primary obligation.

The Court found that the Broker Agreement did not impose any obligation on the Employee but simply stated that the client was to deposit funds or shares as required by the Employer. Accordingly, no secondary obligation had been created and the Indemnity Clause could not be construed as a penalty.

The Court held that the Indemnity Clause was enforceable and the Employee was to repay the Employer the outstanding amount owed by her clients with interest. The Employer was ordered to give credit to the sum withheld by it pursuant to the Undertakings.

It is common that employers wish to be protected and/or compensated from losses caused by their employees. Employers should keep in mind the limited scope under which they can withhold or deduct employees’ wages and to hold them liable for financial losses to the employer. Compensation can only be charged if it satisfies the conditions stipulated in S.32(2) of the EO. Any contravention of S.32 of the EO or withholding of wages when they are due constitutes an offence and employers may also face civil claims from their employees.

As regards indemnity clause, it is also important for employers to be cautious and use clear language in drafting to prevent the indemnity clause from being considered as an unenforceable penalty clause.

If you have any questions about the above eNews or need advice regarding or drafting any employment issues in Hong Kong or China, experienced employment lawyers in our firm will be happy to assist you.

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