Hong Kong court: escalation clause disputes for arbitrators to resolve

The decision by the Court of First Instance in Hong Kong confirms that, in a contract containing an arbitration clause, it is for the arbitrator to determine compliance with contractual conditions precedent to arbitration, according to international arbitration expert Dr Dean Lewis of Pinsent Masons, the law firm behind Out-Law.

Hong Kong’s arbitration ordinance incorporates the UNCITRAL Model Law on International Commercial Arbitration, so the decision will be of relevance to other Model Law jurisdictions, he said. The court, in its judgment, noted that the same approach had previously been taken in Singapore, another Model Law jurisdiction.

“This case is of great relevance to the energy and infrastructure sectors where multi-tier dispute resolution provisions are the norm,” Lewis said. “It confirms that issues concerning whether a dispute has been properly referred to the engineer or whether contractually required negotiation or mediation has been adequately engaged, before an arbitration is commenced, are not matters impacting on the jurisdiction of the tribunal.”

“This does not mean that such contractual precursors to arbitration do not need to be complied with – only that the tribunal is the sole arbiter of whether they have been complied with, not the courts,” he said.

Two satellite operators, referred to in the court judgment as Company C and Company D, entered into an agreement to develop and build a satellite together. The agreement contained a dispute resolution clause requiring the parties to first “attempt in good faith promptly to resolve” any dispute between them by way of negotiation, having first made the request in writing. The dispute should only be referred to arbitration if it cannot be resolved amicably by negotiation within 50 business days of the party’s written request.

Following an apparent material default under the contract on the part of Company C, Company D wrote to Company C’s board of directors requesting it cease and desist the default. Company D said in its letter that it was “willing to refer the dispute to the parties’ respective senior management teams” for negotiation in line with the contract. Company C, through its lawyers, wrote to Company D in response, requesting that it direct further correspondence to the lawyers or Company C’s chief executive, as direct communication with the board was “neither appropriate nor productive”.

On 18 April 2019, having not entered into any further correspondence, Company D issued a notice referring the dispute to arbitration. In its response, Company C claimed that the tribunal did not have jurisdiction to hear the dispute because Company D had not formally requested negotiation. The tribunal issued its award in April 2020, finding that Company D’s letter met the conditions of the dispute resolution clause. It also found Company C in breach of the agreement, and liable for damages to be determined at a later date.

Before the court, Company C continued to argue that Company D had not complied with the wording of the dispute resolution clause. More fundamentally, however, Company D argued that the question of whether the condition precedent had been fulfilled was one of ‘admissibility’ rather than ‘jurisdiction’, and that therefore the courts should not interfere with the tribunal’s decision on this point.

The court agreed, citing a number of court decisions from the UK, Singapore and the US, as well as academic texts on the distinction between the admissibility of a claim and the jurisdiction of the arbitral tribunal.

“[I]t appears that the generally held view of international tribunals and national courts is that non-compliance with procedural pre-arbitration conditions such as a requirement to engage in prior negotiations goes to the admissibility of the claim rather than the tribunal’s jurisdiction,” the court said in its judgment.

“These academic works and international authorities demonstrate that the distinction between jurisdiction and admissibility is not one only to be drawn on the specific wording of the written law of a particular jurisdiction, but is a concept rooted in the nature of arbitration itself … Although the [Hong Kong Arbitration Ordinance] does not in terms draw a distinction between jurisdiction and admissibility, it may in my view be properly relied upon to inform the construction and application of section 81,” it said.

This being the case, it was not for the court to decide whether the condition had actually been met, the judge said.