Hong Kong Court of Final Appeal confirms escalation clauses not subject to review by courts

Disputes arose from a cooperation agreement entered into between Company C, a Hong Kong company and Company D, a Thai company, for the development and building of a satellite. The dispute resolution clause of the agreement provided that the parties were to attempt in good faith promptly to resolve any disputes arising.

The clause stated that either party may refer the dispute to the parties' respective chief executive officers (CEOs) for negotiation and that if that a dispute could not be resolved amicably within 60 business days, it was to be referred to arbitration in Hong Kong (Escalation Clause).

Company C claimed that the arbitral tribunal did not have jurisdiction because Company D had only referred the dispute to Company C's directors but not the CEO, thus not fulfilling the pre-arbitration condition in the agreement.

The tribunal dismissed Company C's objection and found that the pre-arbitration condition had been satisfied as the relevant clause only made it mandatory that the parties should attempt in good faith to resolve any disputes by negotiation, but the reference of disputes to the respective CEOs was optional. The tribunal issued a partial award in favour of Company D.

Company C sought to set aside the partial award under section 81 of the Arbitration Ordinance (Cap. 609) (Ordinance) on the ground that the partial award concerned a dispute "not contemplated by or not falling within the terms of the submission to arbitration" under Article 34(2)(a)(iii) of the Model Law.

The Court of First Instance dismissed Company C's application and held that compliance with an "escalation clause" was an issue of admissibility and did not go to the jurisdiction of the tribunal (see Hogan Lovells alert C v D – Hong Kong court rules on compliance with pre-arbitration procedural requirements). The Court of Appeal upheld the decision of the Court of First Instance (see Hogan Lovells alert Rising to the top – Hong Kong Court of Appeal rules that escalation clauses compliance queries are best left to arbitrators).

Issue on appeal

The Court of Final Appeal has granted Company C leave to appeal on the question "Is an arbitral tribunal's determination on whether a pre-arbitration condition precedent in an arbitration agreement that the parties thereto should first attempt to resolve their dispute by a specified mechanism has been fulfilled subject to recourse to the Court under Article 34(2)(a)(iii) of the UNCITRAL Model Law (as incorporated into Hong Kong law under section 81(1)(2)(a)(iii) of the Arbitration Ordinance (Cap. 609) (AO)." (See Hogan Lovells alert The final frontier - Hong Kong Court of Final Appeal grants leave to appeal in arbitration escalation clauses dispute)

Decision

The Court of Final Appeal dismissed the appeal by Company C.

Under Article 34(2)(a)(iii) of the Model Law, as incorporated under section 81(1)(2)(a)(iii) of the AO, an arbitral award may be set aside by the court only if "the award deals with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or contains decisions on matters beyond the scope of the submission to arbitration".

Company C argued that in the Escalation Clause, the requirement to refer the dispute to the CEOs was a condition precedent to arbitration. Company D's failure to comply with such pre-arbitration condition negated Company C's consent to arbitration and deprived the tribunal of jurisdiction. If it were a jurisdictional matter, then the courts could review the Tribunal's decision de novo. 

The Court of Final Appeal disagreed. On proper construction of the Escalation Clause, the dispute on whether the pre-arbitration condition had been complied with and whether Company C was in material default were intended by both parties to be dealt with "exclusively and finally by the tribunal" and fell "within the terms of the submission to arbitration". Such a decision was to be determined exclusively by the Tribunal and could not be set aside by courts under section 81(1)(2)(a)(iii) of the AO. That is concerned with the merits of the dispute.    

A majority of the Court of Final Appeal further upheld the distinction between a challenge to an arbitral tribunal's jurisdiction and a challenge to the admissibility of a particular claim. With reference to authorities in England, Singapore and New South Wales, the Court of Final Appeal adopted this distinction to construe when judicial intervention in an arbitral process was permissible. "Jurisdiction" refers to the authority of the tribunal to deal with the arbitration such as the absence of consent to arbitrate, while "admissibility" refers to whether a claim can be heard by the tribunal e.g. the claim is defective due to non-compliance with statutory limitation periods.

The Court of Final Appeal upheld that courts have the discretion to set aside a tribunal's decision over the arbitral tribunal's jurisdiction, but not a tribunal's decision over the admissibility of a claim. In the present case, whether the pre-arbitration condition had been fulfilled is a matter of admissibility, rather than jurisdiction.

In a minority judgment, the Honourable Mr. Justice Gummow NPJ disagreed with adopting the distinction between "jurisdiction" and "admissibility". He contended that there had been many decisions of courts on applying Article 34(2)(a)(iii) of the Model Law without taking into account the distinction between "jurisdiction" and "admissibility". Whether the courts could review the Tribunal's award depended on the proper construction of the parties’ agreement and the provisions of the Arbitration Ordinance adopting Article 34 of the Model Law. If none of the grounds for setting aside applied, then judicial recourse to a court is not permitted. 

Significance

The Court of Final Appeal's decision confirms the position that unless stated otherwise in the arbitration clause, the court cannot set aside an arbitral award on the basis of the tribunal's decision on compliance with pre-arbitration conditions. This ruling also confirms Hong Kong's importance in developing arbitration jurisprudence – it is the first by the highest court in a Model Law jurisdiction to confirm the position, thereby limiting intervention from courts over the arbitral process.  

Hong Kong's courts are arbitration friendly and will not review the merits of the dispute, in this case, compliance with a pre-arbitration condition to arbitrate. The court applied the principle in Fiona Trust & Holding Corp v Privalov [2007] 4 All ER 951 that the parties, as rational business persons, intended that one forum – the tribunal, and not in addition the courts – shall determine whether a precondition to arbitrate has been fulfilled, in the absence of express contrary language. No such contrary language was included in the clause in question. 

The Court of Final Appeal recognised that the parties could agree on how their disputes should be resolved, which includes agreement on expanding the scope of curial review of the tribunal's decisions, such as compliance with pre-arbitration conditions. It recognised the importance of the parties' agreement to arbitrate and the availability of judicial recourse is ultimately dependent upon the proper construction of the parties' agreement.

Parties should take care in drafting their multi-tiered dispute resolution provisions. If the parties intend that the Tribunal should not have jurisdiction to arbitrate if agreements to negotiate have not been complied with, then they should expressly specify this in their clause.

Authored by James Kwan, Nigel Sharman, and Serena Chan.