Arbitration
Fresh Arbitration Salad in Hong Kong
Hong Kong is a very arbitration friendly jurisdiction. Despite the high degree of autonomy given by the courts to the contracting parties to govern their dispute resolution process, the courts in Hong Kong still maintain a supervisory role
This newsletter selected and summarized four decisions of the Court of First Instance pertaining to arbitrations handed down in the first quarter of 2023. The decisions reminded the contracting parties the court approach in exercising supervising power to arbitrations in different stages of arbitration.
A dispute – a pre-requisite
Before the parties submit the matter to arbitration, there must exist a dispute between the parties. Without a dispute, an arbitral tribunal does not have the jurisdiction to rule on the “matter”. This principle is illustrated in CMB v Fund [2023] HKCFI 760.
In CMB v Fund, CMB entered into an investment agreement with Fund and Cattle, the 1st and 2nd Defendants in this action, for a company (“HC”). L was the Managing Director of HC. X was an employee of HC. C was the controlling shareholder and a director of HC. In the meantime, Fund was represented by L and Cattle was represented by X in the dealings with CMB.
CMB commenced an action in Hong Kong against L, X, C and Management (3rd Defendant of this action), for making fraudulent misrepresentations to CMB which induced CMB to enter into the investment agreement with Fund and Cattle (“High Court Action”).
After the commencement of the High Court Action, Fund, Cattle, Management, L and X commenced arbitration against CMB pursuant to the investment agreement, requesting, inter alia, CMB to withdraw the High Court Action and a declaratory relief that Fund and Cattle had no liability to CMB in the High Court Action. A single arbitrator constituted the tribunal (“Tribunal”).
In the arbitration, CMB challenged the jurisdiction of the Tribunal on the ground that L, X and Management had no contract or arbitration agreement with CMB and CMB had no dispute with Cattle and Fund.
In the final award, the Tribunal found that L, X and Management were not parties to the investment agreement, and the Tribunal had no jurisdiction to grant relief for them.
The Tribunal however found that he had jurisdiction in respect of Fund and Cattle ‘in so far as they seek declarations of non-liability as regards their own position and made a declaration of non-liability of Fund and Cattle accordingly.
CMB commenced the present proceedings to set aside the award because of the lack of jurisdiction of the Tribunal.
In S Co v B Co [2014] 6 HKC 421, it was held the Court can review the correctness of the Tribunal’s finding as to its own jurisdiction on a de novo basis under Article 34 of the Model Law (section 81 of Arbitration Ordinance (Cap 609)).
While the Tribunal referred extensively on the legal principles of declaratory relief when reaching the decision, the Court came to a view that the Tribunal had confused the question of whether he had jurisdiction in the reference and whether he should exercise his power to grant the declaratory reliefs.
Turning to the issue of jurisdiction, the Court reiterates that the right of the parties to put an arbitration agreement into effect does not arise until and unless there is a dispute between the parties to the agreement. CMB commenced the High Court Action only against L, X, C and Management and had no dispute with Fund and Cattle in the High Court Action.
Absent of any dispute between CMB, Fund and Cattle, the Court held that the Tribunal did not have jurisdiction to make the declaratory reliefs and the award was set aside.
Choice of law – contractual interpretation comes before the closest connection test
In determining the governing law of a contract containing an arbitration agreement, the Court first looks for the intention of the contracting parties by contractual interpretation. Only when such attempt is futile, the Court will objectively look for a system of law which has the closest connection to the parties.
In China Railway (Hong Kong) Holdings Limited also known as China Railways Services (Hong Kong) Limited v Chung King Holdings Company Limited [2023] HKCFI 132, the Court, adopting the UK approach, determined the choice of law of a jurisdiction clause by contractual interpretation before proceeding to the “closest connection test”.
The Plaintiff and the Defendant entered into what essentially was a loan agreement where the Plaintiff would provide HK$40M to the Defendant, so as to allow the Defendant to construct a hotel in Hong Kong (“Initial Agreement”). The Initial Agreement contained a jurisdiction clause:
“本合同實施過程中，雙方如發生經濟紛爭，應通友好協商解決，如協商不成， 則循當地法律解決”
The parties subsequently entered into numerous repayment agreements, including a repayment agreement (“Repayment Agreement”), which contained, inter alia, the following jurisdiction clause:
“本合同如有未盡事宜，有關方協商後可以補充協議方式予以補充， 并(並)具同等法律效力。本合同及有關補充協議執行期間如產生糾紛或爭議，可通過協商解決。協商未果，[P]有權向[Jinyin]所在地仲裁委員會申請仲裁或向[Jinyin]所在地人民法院起訴”
Jinyin was located at Wuhan, PRC. It had been joined as a party to provide security for the repayment by mortgaging its properties in Wuhan in favour of the Plaintiff, but Jinyin later dropped out of the picture and was no longer a party in the subsequent amendments of the contract between the Plaintiff and the Defendant.
In determining the governing law of an arbitration clause, the starting point at common law is that the contracting parties are free to choose the system of law which is to govern the contract, subject to public policy. The choice of governing law can be either express or implied from other terms of the contract and the surrounding circumstances. Determining whether the parties have agreed on a choice of law to govern their contract is in every case a question of interpretation.
In the event that a choice of law cannot be identified by interpreting the contract, the contract will be governed by the system of law with which it has its closest and most real connection.
Insofar as the closest connection test applies, the law of the chosen seat of arbitration will likely apply. The Court adopted the reasoning in Enka Insaat ve Sanayi AS v OOO “Insurance Company Chubb” [2020] 1 WLR 4117.
In Enka, where the parties have not agreed what law is to govern their contract, it is reasonable to start from an assumption that all the terms of the contract, including an arbitration clause, are governed by the same system of law. Where, however, the parties have selected a place for the arbitration of disputes, there is authority for, as a general rule, regarding the law with which the arbitration agreement is most closely connected as the law of the seat of arbitration.
The Court, however, makes a reservation that the above approach (for an arbitration clause) may not apply in full force to jurisdiction clauses.
When considering the jurisdiction clauses in both the Initial Agreement and the Repayment Agreement, the Court held that only the Initial Agreement contained a choice of law clause. The Initial Agreement and the Repayment Agreement formed one debt agreement which the Plaintiff now sues. Applying Enka, the Court first looked for the parties’ intention and interpreted the contract. Given the whole context of the Initial Agreement, the reference to “當地法律” should refer to Hong Kong laws.
The Defendant argued that, since the Initial Agreement contains provision of security in Shanghai, “當地法律” meant the law applicable to the issue at hand (which may vary depending on the issue). The Court took the view that, unless there were good reasons to conclude otherwise, all terms in the contract are governed by the same law, to avoid inconsistency and uncertainty.
When considering the wordings in the jurisdiction clause in the Repayment Agreement, the Court would be slow to interpret that the parties had changed their minds unless such intention arose by clear implication from the surrounding facts.
The Court held that the jurisdictional clause in the Repayment Agreement was governed by Hong Kong law.
Implied promise to honour the award – a distinct cause of action
The successful party to the arbitration is entitled to enforce the award in courts. The cause of action in common law roots from the mutual implied promise between the parties to the arbitration to honour the arbitration award. This cause of action is distinct from the dispute being arbitrated.
Xu Hongbiao v Oasis Investment Group Limited [2023] HKCFI 860 concerns, inter alia, an application to set aside the order granting the Defendants’ leave to serve the counterclaim out of jurisdiction.
The Plaintiff and the Defendants had a dispute over property development projects in China. The dispute was submitted to arbitration. The tribunal issued the awards in late 2018 (“Award”). In the Award, the Tribunal ordered, inter alia, the Plaintiff and the Defendants to execute various contracts for sale of company shares and property with each other.
The parties had further disputes regarding the performance and enforcement of the Awards, leading to the present action. The Plaintiff commenced proceedings against the Defendants for breach of implied promise to comply with the Award. The 1st – 4th Defendants counterclaimed the Plaintiff and the 5th Defendant for their non-cooperation to comply with the Award. The 1st – 4th Defendants (referred to as “Defendants” hereinbelow)had obtained leave to serve their counterclaim out of the jurisdiction.
While agreeing the proper authority for leave to serve out of jurisdiction was Dynasty Line Ltd v Sukamto Sia [2009] 4 HKLRD 454, the Plaintiff argued that the Defendants failed to show a serious issue to be tried in their counterclaim. If the Plaintiff’s argument succeeds, the Defendants will necessarily fail when the “good arguable case” threshold (a higher threshold) is applied for the service-out application.
The Plaintiff submitted that the counterclaim disclosed no reasonable cause of action and therefore no serious issue to be tried because the Defendant misconceived the implied duty to comply with the arbitral award as a matter of law.
The Court summarized the nature of implied promise to honour an arbitral award in common law as laid down in Court of Appeal in Xiamen Xinjingdi Goup v Eton Properties Ltd [2016] 2 HKLRD 1106 and Court of Final Appeal in Xiamen Xinjingdi Goup v Eton Properties Ltd (2020) 23 HKCFAR 348.
A successful party can enforce an arbitral award either by a statutory process or by common law action. The implied promise to honour an arbitral award exists as a contractual obligation separate and distinct from the obligation created by the underlying contract. It is a new and independent cause of action. The essential elements for the cause of action are that (i) there was a submission; (ii) that the arbitration was conducted in pursuance of the submission; and (iii) that the award is a valid award. Ribeiro PJ further clarified that once the final award is made, the arbitrator’s mandate is exhausted. If the award is not complied with, a fresh cause of action arises, which lies within the enforcing court’s jurisdiction and is not within the power of the tribunal.
For the reasons above, the Court rejected the Plaintiff’s argument and held that the Defendants did have a cause of action to enforce the award in common law.
The Plaintiff further argued that the “losing party” did not have locus standi to bring a claim to enforce the Awards at common law. The Court disagreed with the Plaintiff that only the “successful party” had in law the locus standi to enforce the award because the nature of implied promise was mutual. Also, the cases and textbooks discussing the nature of the implied duty did not expressly mention that the “losing party” had no locus standi to enforce the award.
The Court further rejected other grounds raised by the Plaintiff and dismissed the Plaintiff’s Summons.
Refusal to enforce an award – egregious mistake
The Court’s power to enforce an arbitration award is an emblem of Court’s supervisory role in arbitration. Such power is only exercisable when there is a serious procedural impropriety which shocks the Court’s conscience to allow the award to stand and to permit its enforcement.
In Canudilo International Company Limited (“CIC”) v Wu Chi Keung [2023] HKCFI 700, CIC entered into two sales contracts with Apennine Holdings Limited (“Apennine”). The Respondents are the guarantors of the sales contracts. Disputes arose between CIC and Apennine with respect to the sales contracts. CIC commenced arbitration against Apennine and the Respondents. The Tribunal was consisted of one arbitrator. The parties first appointed the 1st Arbitrator (“1st Arbitrator”).
In the arbitration, Apennine did not take part in the defence because, owing to disagreement between controller and shareholders, Apennine did not engage legal representatives to represent the company independently. The 1st Arbitrator, finding in favour of CIC in the Interim Final Award, ruled that Apennine was liable to CIC under the sales contracts. However, the 1st Arbitrator made clear that the arbitration between CIC and the Respondents would continue and the 1st Arbitrator did not consider the dispute between CIC and the Respondents in the Interim Final Award.
The 1st Arbitrator subsequently resigned and a 2nd Arbitrator was appointed.
In view of the fact that the Interim Final Award had been issued, the 2nd Arbitrator stated that he would only consider the dispute between CIC and the Respondents. Having found that the sales contracts also binding to the Respondents, the 2nd Arbitrator concluded that he was bound by the Interim Final Award and the Respondents were liable to CIC.
The Respondents resisted the enforcement of the award before the Court.
While the Court found that the 2nd Arbitrator did not provide sufficiently detailed reason in the award, a poorly reasoned award and a failure to give adequate reasons for the award are not grounds to set aside or refuse enforcement of an award. In reliance of A v R [2009] 3 HKLRD 389, the Court was of the view that, by choosing arbitration, the parties must be deemed to have undertaken the risk that an arbitrator might get matters wrong in his decision.
The Court looked only at the structural integrity of the arbitral process, stepping in when there was an error so egregious that it would be shocking the conscience of the court to allow the award to stand and to permit its enforcement.
The Court found that the 2nd Arbitrator did not apply his own independent mind pursuant to the mandate given to him under the arbitration agreement to decide the dispute between the parties. It is particularly crucial that the 1st Arbitrator expressly stated in the Interim Final Award that it was not necessary for him to decide on the dispute between CIC and the Respondents, but the 2nd Arbitrator ruled, in the Final Award, that the Respondents should have made their case before the Interim Final Award.
The Court came to a view that the 2nd Arbitrator failed to consider and decide the Respondent’s defence in an impartial and independent manner. The 2nd Arbitrator failed to give the Respondents a reasonable opportunity to present their case on the binding effect of the Interim Final Award by assuming they were already so bound. Such deprivation of opportunity was contrary to the Court’s basic notions of justice and requirements for a fair hearing to enforce the Final Award.
The Court concluded that the procedural impropriety was so egregious that the award should be set aside and the Respondents were entitled to the reasonable and fair opportunity to present their case to the fact-finding tribunal and to have their defence properly and fairly determined.