Arbitration tiered preconditions – who decides if they have been complied with?

The ruling of the Hong Kong High Court on the case of C v D [2021] HKCFI 1474 demonstrates that arbitration agreements will be upheld even where there are questions around pre-conditions to arbitration.

Many standard contracts contain contractual language which contain pre-arbitration requirements to negotiate in good faith, and/or carry out mediation and/or an adjudication before proceeding to formal arbitration. These are often called ‘tiered escalation requirements’. A failure to comply with the pre-arbitration requirements may leave any arbitral decisions vulnerable to challenge in the courts.

In the case of C v D, the Hong Kong High Court confirmed that this approach is wrong, and that questions around the tiered escalation requirements are for arbitrators themselves to resolve, not the courts.

This case is of great relevance in contracts where tiered escalation requirements are the norm. It addresses disputes where the parties must consider whether the issue has been properly referred to a third-party certifier. As well as considering whether contractually required negotiation or mediation has been adequately engaged prior to the commencement of an arbitration. The courts confirmed that these are not matters impacting on the jurisdiction of the tribunal.

THE CASE

This was a dispute between Company C which is an owner and operator of satellites and Company D which is a developer and builder of satellites.

According to the contract, parties should “attempt in good faith promptly to resolve such dispute by negotiation”. If a dispute cannot be resolved then “either party may, by written notice to the other, have such dispute referred to the chief executive officers of the parties for resolution”. If the parties could not resolve the dispute amicably within 60 business days “of the date of a Party’s request in writing for such negotiation“, they could refer the matter to arbitration in Hong Kong at the Hong Kong International Arbitration Centre (HKIAC) and the UNICITRAL Arbitration Rules (the Rules) shall apply.

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’. Therefore the courts should not interfere with the tribunal’s decision on this point.

However, the arbitration proceeded, and the tribunal ruled that Company C had breached the contract and dismissed Company C's objection to its jurisdiction. Company C filed a declaration with the High Court arguing that the ruling should be set aside because it was made without jurisdiction.

In Company C’s application it relied upon Section 81 of the Arbitration Ordinance (Cap 609) (the Ordinance), which incorporates Article 34 of the UNCITRAL Model Law and in particular, Section 81(2)(a)(iii) which provides that an arbitral award may be set aside if “the award deals with a dispute not contemplated by or falling within the terms of the submission to arbitration” and Section 81(2)(a)(iv) that provides that an award can be set aside where “the arbitral procedural was not in accordance with the agreement of the parties”.

The Court found that a pre-condition to arbitration is a question of ‘admissibility’ and not jurisdiction and therefore was an issue for which the tribunal could decide.

The Court recognised that Section 81 of the Ordinance does not distinguish between admissibility and jurisdiction, but it considered that the concept is deeply rooted in arbitration and may be relied upon to inform the construction and applicability of Section 81. The Court also took a narrow view when questioning any jurisdictional issues under Section 81.

The Court did not consider whether the pre-conditions were met and if a condition precedent was found to have been waived or not. It was considered that this was also an issue that could be decided by the tribunal as an issue of admissibility rather than jurisdiction which meant “the arbitral tribunal has jurisdiction and may deal with the question as it sees fit.”

The Court rejected Company C’s argument on the basis that Section 3(1) of the Ordinance was to “facilitate the fair and speedy resolution of disputes by arbitration without unnecessary expense.” They also said that questions on the compatibility of the Basic Law should not be examined on a piecemeal basis.

For these reasons, the appeal was dismissed by the Court who ruled that Company C was liable for the costs of compensation.

The case also provides good legal authorities by 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.

In its judgement, the court said that “the generally held view of international tribunals and national courts is that noncompliance with procedural prearbitration conditions such as a requirement to engage in prior negotiations goes to admissibility of the claim rather than the tribunals jurisdiction.”

WHAT CAN WE LEARN FROM THE RULING

This decision is important for all contracts which contain tiered escalation requirements. Although it is most relevant to construction contracts where there are pre-arbitration procedures or pre-conditions that need to be satisfied before starting arbitration. Whilst this case was only addressing the issue of “negotiating in good faith” it will no doubt be considered when looking at compliance with all pre-arbitration procedural requirements.

It, therefore, provides reassurance that if all the preconditions to arbitration are not complied with, and if there is a dispute, then it will be a matter for the arbitral tribunal, rather than the courts, to decide.

This does not mean that the parties do not need to comply with pre-arbitration escalation requirements nor that these requirements are not conditions precedent but only that it goes to admissibility, meaning that dealing with the issue will remain within the ambit of the arbitral tribunal, not the courts.

Legal Director, Pinsent Masons