The final frontier - Hong Kong Court of Final Appeal grants leave to appeal in arbitration escalation clauses dispute

Space to negotiate?

In C v D [2021] HKCFI 1474, 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 agreement provided that the parties were to attempt in good faith promptly to resolve any disputes arising by negotiation between the parties' respective chief executive officers (CEOs) 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.

On 24 December 2018, the CEO of Company D issued a letter to the chairman of the board of directors of Company C, copied to other directors of Company C, alleging that Company C was in repudiatory breach of the agreement and with the letter meaning to serve as a "written request" for negotiation under the agreement. On 18 April 2019, Company D issued a notice referring the dispute to arbitration. In response, Company C claimed that the arbitral tribunal did not have jurisdiction because the letter had been addressed to Company D's directors but not the CEO, thus not fulfilling the condition in the agreement.

The tribunal dismissed Company C's objection and held that 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 an award in favour of Company D, ruling that the letter constituted a request for negotiation under the agreement (the partial award).

Company C sought to set aside the partial award under section 81 of the Arbitration Ordinance (Cap. 609) (Ordinance)¹ 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).

Court of Appeal

Company C was granted leave to appeal. The issues upon appeal were:

• 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 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)".
• The arbitral award was not in accordance with the agreement of the parties.
• The true construction of the relevant contractual provisions in particular, whether Company D was obliged to refer the disputes for determination by the companies' respective CEOs.

The Court of Appeal in C v D [2022] 3 HKLRD 116 (Cheung, Yuen and Chow JJA) dismissed all three grounds of appeal, citing recent English authority that it is arbitrators who are in the best position to decide issues relating to whether preconditions in the parties' agreement have been satisfied.

Whether an objection went to the jurisdiction of the tribunal rather than the admissibility of the claim ultimately depended on the agreement of the parties. It was not Company C's argument that Company D's claim could never be referred to arbitration, only that the reference to arbitration was premature in that some pre-arbitration procedural requirements had to be observed first. The issue therefore went to the admissibility of the claim rather than the jurisdiction of the tribunal.

The Court of Appeal found that disputes which went to the admissibility of the claim should be viewed as disputes "falling within the terms of the submissions to arbitration" under Article 34(2)(a)(iii) of the Model Law. Such an interpretation would in all likelihood give effect to the parties’ agreement that all disputes should be resolved by the same tribunal and further the objective under section 3 of the Ordinance to facilitate the fair and speedy resolution of disputes.

It would also tie in with practice in other major international arbitration centres (see Hogan Lovells alert Rising to the top – Hong Kong Court of Appeal rules that escalation clauses compliance queries are best left to arbitrators).

Leave to appeal

In their decision of 12 December 2022, the Court of Final Appeal (Ribeiro, Fok and Lam PJJ) have now given 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 Articles 34(2)(a)(iii) of the UNCITRAL Model Law (as incorporated into Hong Kong law under sections 81(1)(2)(a)(iii) of the Arbitration Ordinance (Cap. 609)."

The CFA said it was satisfied that this was a question of general importance and since this was the first case in which the issue had fallen to be considered by a Hong Kong court, granted leave to appeal.

The appeal is listed for hearing on 27 April 2023.

Taking it to the top

The CFA's ruling will be of great significance as it will be the highest court in a Model Law jurisdiction to consider the position. Until the position is clarified, one way of making sure that recourse to such clauses cannot be used by a party dissatisfied at the findings of a tribunal, is to place a time limit on when negotiations should take place. If they do not take place within the time limit, the precondition can be shown to have been complied with.

^{1. which gives effect to Article 34 of the UNCITRAL Model Law}

Authored by Nigel Sharman.