MILESTONE ARBITRATION JUDGMENT FROM HONG KONG'S HIGHEST COURT BRINGS GREATER CERTAINTY FOR COMMERCIAL CONTRACTS

Herbert Smith Freehills has secured a landmark judgment from the Hong Kong Court of Final Appeal, with significant practical implications for thousands of commercial contracts.

In C v D [2023] HKCFA 16, the CFA confirmed that arbitrators, not the courts, should have the final say on whether a party has complied with an escalation clause – a common contractual mechanism pursuant to which parties agree (for example) to negotiate, or mediate, before commencing arbitration.

Previously, failure to comply with such an escalation mechanism had left arbitral awards vulnerable to challenge, on the basis that the arbitrators lacked jurisdiction to hear the case unless and until the escalation steps had been followed.  The risks of such a challenge were particularly acute in cases where the precise escalation requirements were uncertain or open to interpretation.

The CFA has now confirmed that these matters do not affect the jurisdiction of the arbitrators.  Accordingly – and absent exceptional circumstances – any such questions regarding compliance can be finally settled by the arbitrators chosen by the parties. This is a long-anticipated and hugely welcome decision, which narrows the scope for judicial intervention in the arbitral process and brings greater certainty. Furthermore, as Hong Kong adopts the UNCITRAL Model Law on arbitration, this decision will have persuasive effect in 118 other model law jurisdictions.

The team who successfully argued the case in the Court of Final Appeal give their overview and comment on the decision below.

Background

The clause at issue in C v D is a relatively standard escalation provision.  In short, the contract required that, wherever a dispute arose, the parties should first attempt to resolve matters by negotiation.  The contract went on to provide that, as part of this process, the parties "may, by written notice to the other" refer the dispute to their respective CEOs for resolution.  If the parties could not resolve the dispute amicably within 60 business days "of the date of the Party's request in writing for such negotiation", either party could refer the dispute to arbitration.

It was common ground that these provisions were mandatory – they imposed a binding obligation on the parties to try to negotiate before commencing formal proceedings. The parties disagreed, however, on whether it was necessary for the parties to refer such negotiations to their respective CEOs.  C argued that such a referral would always be required before formal proceedings could be commenced.  D argued that this part of the escalation mechanism was only optional.

A dispute arose which the parties could not resolve amicably, such that D referred the matter to arbitration.  C challenged the jurisdiction of the Tribunal on the basis that D had failed to comply properly with the escalation mechanism.  The Tribunal rejected the challenge and proceeded to rule in D's favour on the substantive merits of the case.  C therefore commenced proceedings in the Hong Kong court to set aside the arbitral awards on the basis that the Tribunal lacked jurisdiction.

Court of First Instance's decision

The Hong Kong Court of First Instance rejected the challenge, finding that C's objection did not raise a true question of jurisdiction, and that the “generally held view of international tribunals and national courts” is that non-compliance with a pre-condition to arbitration is a question of admissibility, not jurisdiction. There was no doubt that the parties had agreed ultimately to resolve their disputes by arbitration. Properly understood, C's complaint was not that the Tribunal lacked jurisdiction to hear the claim, but simply that the claim itself was not yet ripe for determination (because the pre-arbitration steps had not been followed). Such issues did not engage Art. 34 of the Model Law, and so there was no basis for the supervisory court to set aside the Tribunal's decision.

Our blog post with a detailed analysis of the first instance decision, can be found here.

Court of Appeal's decision

C obtained permission to appeal to the Court of Appeal, which ultimately agreed with the Court of First Instance.

The Court observed that the distinction between admissibility and jurisdiction “is well recognised in both case law and academic writings”, including in England & Wales, Singapore, Australia and the United States. The distinction is not drawn on the specific wording of the Arbitration Ordinance but “is a concept rooted in the nature of arbitration itself” and necessarily informs “the construction and application of [section] 81 even though the Ordinance does not in terms draw such distinction”.

A dispute which goes to the admissibility of the claim, rather than the jurisdiction of the tribunal, should therefore be regarded as a dispute “falling within the terms of the submission to arbitration” under Article 34(2)(a)(iii).

A fuller analysis of the Court of Appeal's decision can be found here.

Key issues before the Court of Final Appeal

The CFA granted C permission to appeal on the basis that this was the first case in which a Hong Kong court had been asked to consider this issue, which was therefore one of general or public importance.

C advanced its appeal on two grounds. First, the requirement to refer the dispute to the CEOs was a condition precedent to arbitration, and as it had not been fulfilled, there was no valid reference to arbitration. Therefore, the award could be set aside under Art. 34(2)(a)(iii) as it “deal[t] with a dispute not contemplated by or falling within the terms of the submission to arbitration”.

Second, C submitted that the distinction between admissibility and jurisdiction was irrelevant as this did not reflect the text of Art. 34(2)(a)(iii). In any event, even if the distinction existed, the objection was jurisdictional in nature. D was therefore wrong to suggest that the Court was not empowered to set aside the award.

Court of Final Appeal's decision

The Court of Final Appeal unanimously dismissed the appeal with costs on an indemnity basis.

On the first ground, the Court dismissed C's condition precedent argument, which Mr Justice Ribeiro PJ described as "untenable".

The Court did not accept the position that an objection concerning non-compliance with a pre-arbitration condition would necessarily justify judicial interference.  The Court held that an objection under this ground is to be limited to objections that the arbitral reference or the content of the award went beyond what was agreed to be referred to arbitration, thus negating the consent to the tribunal's jurisdiction.  Meanwhile, the objection, in the present case, which was that the claim had allegedly been prematurely referred to arbitration, was plainly different.  The objection was not a denial of consent to the tribunal's authority, and such disagreement over the compliance with an escalation clause fell firmly within the parties' contemplation and intended submission to arbitration.

On the second ground, the majority of the Court endorsed the recognition of the distinction between admissibility and jurisdiction even though this is not reflected in the text of Art. 34(2)(a)(iii).  Mr Gummow NPJ, on the other hand, considered it unnecessary to rely on the distinction where, upon a proper construction of the statute and the parties' intention, it was clear that C's challenge did not fall within the scope of Art. 34(2)(a)(iii).

Nevertheless, the Court considered the distinction a useful principle to distinguish matters that are reviewable by the supervisory court from those that are not.  Consistent with the views of the lower courts, the CFA took note of the fact that the distinction has been widely recognised in several other jurisdictions, including England & Wales, Singapore and New South Wales, as well as in leading academic texts.  In particular, the Court warned that rejection of the distinction would place Hong Kong at variance with other jurisdictions, which – like Hong Kong – promote international arbitration and limit the extent of court intervention in the arbitral process.

On the distinction itself, the Court agreed with the lower courts that the effect of a pre-condition to arbitration should depend on the parties' intentions.  Ultimately, the two concepts are labels, and the consequence of a particular challenge hinges on its substance.

Chief Justice Cheung reminded that the jurisdiction of an arbitral tribunal is essentially agreement-based, and therefore matters of jurisdiction and admissibility should be left for the parties to decide under the principle of freedom of contract.  In other words, there should be no precise definition of "jurisdiction", save that the true meaning of this word depends on the parties' agreement each time, reflecting their consent to arbitration.

Unlike the Court of Appeal, the CFA was prepared to go one step further and adopt a presumption that pre-arbitration conditions should be considered as matters of admissibility.  Thus, to override the presumption, parties must expressly and unequivocally convey a contrary intention.

Comment

This decision was eagerly anticipated by arbitration practitioners and provides welcome clarity on a subject of great practical significance.  As Hong Kong is a Model Law jurisdiction, the case is likely to have far-reaching significance across the 118 jurisdictions with arbitration legislation based on the Model Law, and indeed beyond.

The decision offers assurance to commercial parties that their arbitration agreements will be upheld, with the scope for judicial intervention now greatly reduced.  In fact, the Court of Final Appeal has made it very clear that parties must unequivocally express a contrary intention should they wish matters of compliance with pre-conditions to arbitration to be subject to judicial review.  Otherwise, the presumption against such intervention now applies.

These guidelines further underscore Hong Kong's reputation as a pro-arbitration jurisdiction, where the courts will be slow to interfere with decisions of arbitrators absent compelling circumstances.  The decision also places Hong Kong firmly in line with international arbitration hubs, such as England & Wales and Singapore.