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The Hong Kong Court of First Instance Narrowly Construes the Arbitration Ordinance in Relation to Domestic Arbitrations and the Application of Schedule 2

In A v D [2016] CFI 1014/216 the Honourable Mimmie Chan J dismissed as “totally without merit” proceedings to set aside the decision of an arbitral tribunal and counterclaim on the alleged grounds of serious irregularity under section 4 of Schedule 2 of the Arbitration Ordinance, Cap. 609 (“the 2011 Ordinance“), imposing significant cost sanctions on the applicants.

Background

The Claimants and the Respondent were equity partners of a firm pursuant to terms set out in a letter dated 11 May 2007 (the “Agreement“). In accordance with the Agreement the Respondent gave notice of his intention to retire with effect from 15 November 2009 after which his equity was assigned back to the Claimants. Disputes subsequently arose as to the amounts due from the Respondent for outstanding loans and tax owed (i.e. the Claimants’ claim) as well as his entitlement to drawings and profit (i.e. the Respondent’s counterclaim); as a result of which the matter was referred to arbitration in May 2011 in accordance with the Agreement.

The Arbitration and Proceedings to Set Aside

The arbitral tribunal ruled that the Respondent was entitled to his share of the firm’s profits and drawings only up until the effective date of his retirement (the “Ruling“). The arbitral tribunal subsequently dismissed the Claimants’ application to strike out the Respondent’s counterclaim, awarding the costs of that application against the Claimants (the “Decision and Costs Order“). The Claimants then made the present application to the Hong Kong Court of First Instance (the “Court“) to set aside the Decision and Costs Order on the grounds of an alleged serious irregularity under section 4 of Schedule 2 of the 2011 Arbitration Ordinance.  This section contains provisions pursuant to the former domestic arbitration regime, including appeals on questions of law, consolidation, and challenging an award on the basis of serious irregularity. The Respondent in turn sought a declaration that the Court had no jurisdiction in respect of the setting aside proceedings and for the action to be dismissed.

Reasoning

The Domestic Arbitration Issue

Depending upon whether an arbitration is domestic or international, different rules apply. Under the 2011 Ordinance, by operation of section 99, the provisions of Schedule 2 only apply if the parties opt in expressly for its operation. However, in the case of arbitration agreements providing that the arbitration is a domestic arbitration, by virtue of s.100 of the 2011 Ordinance, Schedule 2 applies automatically without the need for an express opt-in. In A v D there was no dispute between the parties that their partnership agreement made no such express provision. Nevertheless, the Claimants sought to argue that because the parties were Hong Kong residents and had a place of business in Hong Kong, they had subscribed to the domestic arbitration provisions under Schedule 2 without an express opt-in being necessary.

The Court rejected this argument, noting that if the intention had been for s.100 to automatically apply Schedule 2 to arbitrations between two Hong Kong entities after the 2011 Ordinance came into effect then this would have been expressly stated in its wording; moreover, the basis on which the Claimants tried to argue that the arbitration was domestic was too simple. Therefore, in view of the fact that Schedule 2 did not apply to the arbitration, Chan J held as a corollary there was no basis on which to apply the ground of irregularity to set aside the Tribunal’s decision under s.4 of Schedule 2.

Procedural Irregularity

In any event, Chan J held that the Decision and Costs Order in no way amounted to a reversal or reinterpretation of the Ruling and thus did not give rise to a procedural irregularity.

Orders

For the above reasons Chan J dismissed the application to set aside the Decision and Costs Order as “totally without merit” and awarded further costs to the Respondent on an indemnity basis, which is more generous than the most frequent party-party costs that courts tend to award as the applicants can recover all ‘reasonable’ legal expenses as opposed to just those that are strictly ‘necessary’ for conducting the arbitration.

Comments

The distinction between domestic and international arbitration in the former Arbitration Ordinance was regarded as unnecessary and problematic. It sometimes gave rise to disputes regarding the appropriate governing regime in particular cases. A significant difference between the two regimes was that the domestic regime provided the Hong Kong courts with additional powers to intervene in and assist with the arbitration process that were not available under the international regime. This included appeals on questions of law with leave of the court, consolidation of proceedings, challenging an award on the basis of serious irregularities and determination of a preliminary point of law.

By contrast, the international regime, as based on the UNCITRAL Model Law, followed the principle that the Hong Kong courts should support, but not interfere with, the arbitral process. The 2011 Ordinance, with an aim to simplify and streamline the administration and process of arbitration in Hong Kong, harmonises both domestic and international arbitration proceedings under a single unified framework. The UNCITRAL Model Law (as amended in 2006) now applies to all arbitrations commenced in Hong Kong. This new framework increases efficiency as well as provides greater certainty and consistency for both domestic and foreign parties to arbitration.

The case reiterates the narrow approach taken by the Hong Kong courts and Chan J to interpreting the 2011 Ordinance.  Parties want finality and minimal interference by the courts.  Accordingly, we do not see parties expressly adopting Schedule 2 of the 2011 Arbitration Ordinance in their arbitration agreements.
Schedule 2 is used widely in the construction industry and automatically applies to an arbitration agreement entered into at any time within a period of 6 years after the commencement of the 2011 Ordinance (i.e. before 31 May 2017) which provides that arbitration under the agreement is a “domestic” arbitration. After 31 May 2017, if the parties want appeals on questions of law and the other provisions contained in Schedule 2, they must expressly provide for it.  Use of the words “domestic arbitration” is not enough.  Finally, when making any application to set aside an award or order of an arbitral tribunal due to procedural irregularity under s.4 of Schedule 2 of the 2011 Ordinance, the applicant must state precisely the relevant ground on which it relies and provide affidavit evidence or the application will be rejected as an abuse of process.