Rising to the top – Hong Kong Court of Appeal rules that escalation clauses compliance queries are best left to arbitrators

The dispute In C v D [2022] HKCA 729 arose from a contract between Company C and Company D in relation to the operation and development of a satellite. The dispute resolution provision contained in the Agreement stated in the event of a dispute, “the parties should attempt in good faith promptly to resolve such dispute by negotiation.”

The provision said that “either party may, by written notice to the other, have such dispute referred to the Chief Executive Officers of the Parties for resolution” and that the dispute could be referred to arbitration if the dispute could not “be resolved amicably within sixty (60) Business days of the date of a Party’s request in writing for such negotiation”.

The Court of First Instance dismissed Company C's application, and held that compliance with an "escalation clause" such as this was an issue of admissibility and did not go to the jurisdiction of the arbitral tribunal (see Hogan Lovells alert, C v D – Hong Kong court rules on compliance with pre-arbitration procedural requirements).

Issue on appeal

Company C was granted leave to appeal. In particular, it was noted that multi-tiered dispute resolution clauses are not uncommon, that it is important for Hong Kong courts to determine the appropriate approach to an application to set aside an arbitral award on the ground that certain pre-conditions described by the agreement have not been fulfilled.

The issues in dispute on appeal were as follows:

1. Whether the award should be set aside under Article 34(2)(a)(iii) of the Model Law (as implemented by section 81(1) of the Arbitration Ordinance) since the failure to comply with preconditions meant that the dispute was “not contemplated by or not falling within the terms of the submission to arbitration under Article 34(2)(a)(iii).
2. The arbitral award was not in accordance with the agreement with the parties.
3. The true construction of the relevant contractual provisions in particular, whether D was obliged to refer the disputes for determination by the companies’ respective chief executives.

The Court of Appeal decision

The Court of Appeal dismissed all three grounds of appeal, upholding the first instance judgment.

Company C argued that the distinction between jurisdiction and admissibility should not be adopted because it is not found in the text of Article 34(2)(a)(iii) itself and that the court should simply ask whether the award dealt with a dispute “not contemplated by or not falling within the terms of the submission to arbitration” as stated in the subparagraph.

Even if there were a distinction, Company C argued that its objection was “jurisdictional” in nature. In particular, Company C submitted that there was no consent and no duty to arbitrate until the occurrence of the condition.

A useful distinction

The Court of Appeal said the language used did not mean that the distinction between jurisdiction and admissibility was irrelevant. On the contrary, there was much to commend it.

In a recent English case Republic of Sierra Leone v SL Mining Ltd [2021] Bus LR 704, an arbitral award had been challenged on the ground that the three-month negotiation period as envisaged in the relevant dispute resolution clause had not yet expired by the time of the request for arbitration, and thus the arbitrators were alleged to be without jurisdiction. Sir Michael Burton held that an objection based on an alleged prematurity of a request for arbitration was a challenge to the admissibility of the claim, rather than of the jurisdiction to hear it.

The judge cited the Singapore Court of Appeal's judgment at para 77 of BBA v BAZ [2020] 2 SLR 453 which noted that:

"Jurisdiction … is commonly defined to refer to 'the power of the tribunal to hear a case', whereas admissibility refers to 'whether it is appropriate for the tribunal to hear it'… The issue here is not whether the claim is arbitrable, or whether there is another forum rather than arbitration in which it should be decided, but whether it has been presented too early. That is best decided by the arbitrators."

The English court concluded that arbitrators are in any event in the best position to decide issues relating to whether pre-conditions in the parties' agreement had been satisfied, which could only be a matter or procedure, hence a question of admissibility of the claim.

The Court of Appeal remarked that it is an "over-simplification" to say that where a reference to arbitration is subject to some preconditions, an arbitral tribunal's decision on whether the condition precedent has been fulfilled must necessarily be a jurisdictional decision, or one which would be open to review by the court under Art 34(2)(a)(iii) of the Model Law.

The true and proper question to ask was "whether it is the parties' intention (or agreement) that the question of fulfilment of the condition precedent is to be determined by the arbitral tribunal, and thus falls "within the terms of the submission to arbitration" under Art 34(2)(a)(iii)."

Given that arbitration is a consensual process, it is always open to parties to decide that any dispute on whether a pre-arbitration procedural requirement has been fulfilled should be resolved by arbitration. The answer depends on the parties' intention to be ascertained as a matter of true construction of their agreement.

In the present case, Company C's objection was merely that the reference to arbitration was premature as some pre-arbitration conditions should first be observed (as opposed to that the substantive claim advanced by Company D could never be arbitrated). In the absence of the parties' agreement to the contrary, Company C's objection went only to the admissibility of the claim. The partial award was therefore not subject to review by the court under Article 34(2)(a)(iii).

The second ground of appeal was also rejected. The Court noted that even if the term "arbitral procedure" could be extended to cover "pre-arbitration conditions precedent", the parties in this case had clearly intended the question of fulfilment of the pre-arbitration procedural requirement to be determined by arbitration. Hence, it was clear that it was not the parties' intention that non-satisfaction of the requirements would mean that arbitration was to be barred altogether.

In light of the above, the court considered it unnecessary to consider the third ground of appeal.

Conclusion

The Court of Appeal judgment in C v D is likely to be highly persuasive in other Model Law jurisdictions bearing in mind the level of the court that decided the point. The decision does not mean that escalation clauses should be regarded as unimportant. Tribunals have many tools at their disposal to ensure that they are properly respected where that is the intention of the parties.

The decision does however underline that it is for the tribunal itself to determine the issue and aligns with the trend of discouraging court involvement in a process that is meant to be quicker and more efficient than court proceedings.

Everything is a question of what the parties intended. One way of ensuring that recourse to such clauses cannot be used by a party dissatisfied at the findings of a tribunal, is to place a strict time limit on when negotiation should occur, failing which, if it does not, the precondition can be shown to have been met.

Authored by Timothy Hill, James Kwan, Nigel Sharman, and Vanessa Kwok.