Court of First Instance clarifies test for setting aside Hong Kong awards

August 2011

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Introduction

In its recent decision in Pacific China Holdings Ltd (In Liquidation) v Grand Pacific Holdings Ltd [2011] HKCU 1249, the Hong Kong Court of First Instance exercised its discretion under Article 34(2) of the UNCITRAL Model Law on International Arbitration (UNCITRAL Model Law) to set aside a Hong Kong arbitral award on the basis that the losing party to the arbitration was unable to present its case and the arbitral procedure was not in accordance with the agreement of the parties.

This is a rare example of the Hong Kong courts setting aside an arbitral award. The Hong Kong courts have long been supportive of arbitration and, in accordance with the sentiment of Hong Kong’s arbitration legislation and the UNCITRAL Model Law, the Hong Kong courts have adopted a pro-enforcement approach. Indeed, in his judgment, Mr Justice Saunders recognised the pro-enforcement regime under the Hong Kong arbitration law and emphasised that the courts retain a narrow and limited residual discretion not to set aside an award even where a violation of Article 34(2) of the UNCITRAL Model Law is established. However, in the circumstances of this particular case, his Honour was of the view that, having regard to due process, the exercise of such discretion was not appropriate.

The Pacific China Holdings case illustrates that the desire to have cases heard expeditiously within the timetable agreed between the parties and tribunal needs to be balanced against ensuring that parties are afforded a reasonable opportunity to present their case and that the arbitration is conducted in a procedurally fair manner.

Whilst this case was decided under Hong Kong’s recently repealed Arbitration Ordinance (Cap. 341) (the Old Arbitration Ordinance), it will have a wider and ongoing application given that the replacement legislation, the Arbitration Ordinance (Cap. 609) which came into force in Hong Kong on 1 June 2011, gives effect to Article 34 of the UNCITRAL Model Law. Article 34 provides the grounds for recourse to a court for setting aside an arbitral award. The grounds are limited and exhaustive; no other grounds are entertained. One ground is inability to present a case. Another is that the procedure followed in the arbitration did not accord with the agreement of the parties. A third ground is that the award conflicts with the public policy of the jurisdiction where the supervising court is located.

The decision is under appeal.

Background and the arbitration proceedings

In November 2000 Grand Pacific Holdings Ltd (the Respondent) owned a 10.9 per cent stake of Pacific China Holdings (the Applicant). In about May 2001, an investor acquired a 40 per cent stake of the Applicant. Documents effecting the acquisition were executed, including a loan agreement (the Loan Agreement) under which the Applicant was said to be indebted to the Respondent in the sum of US$40 million regarding certain joint venture interests previously transferred to the Applicant.

The Loan Agreement was governed by New York law and provided for arbitration under the Rules of Arbitration of the International Court of Arbitration of the International Chamber of Commerce (the ICC), with Hong Kong as the seat of arbitration. Since the place of performance of the Loan Agreement was Taiwan, the Loan Agreement amounted to an “international arbitration agreement” for the purposes of the Old Arbitration Ordinance.

In February 2004, the Respondent made a demand on the Applicant to pay sums apparently due under the Loan Agreement, which the Applicant refused to pay. The Respondent filed a request for arbitration in March 2006; the Applicant filed its Answer in July 2006. The Applicant’s case was that the Loan Agreement was illegal under the law of the place of performance (Taiwan), and hence also under its governing law (New York) because the consideration in the Loan Agreement was false. Expert evidence and submissions on Taiwanese law, which related to the issue of consideration, were therefore crucial to the Applicant’s case.

A three-member tribunal (the Tribunal) was constituted in January 2007, comprising three experienced international arbitrators. A procedural timetable was agreed and issued in May 2007 (the Procedural Timetable) according to which the procedural steps from the close of pleadings to the evidential hearing were expected to take place within seven months. The arbitration was heard in two sets of hearings in December 2007 and May 2008, respectively. The award was rendered by the Tribunal on 24 August 2009 (the Award).

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Application to set aside the Award

The Applicant applied to the Hong Kong Court of First Instance to exercise its discretion under Article 34(2) of the UNCITRAL Model Law to set aside the Award. There were two grounds for the application, namely inability to present a case, and arbitral procedure not in accordance with the agreement of the parties. The Applicant relied on three discrete procedural issues arising in the course of the ICC arbitration:

  1. Taiwanese law issue
    The Procedural Timetable issued in May 2007 provided, among other things, that the parties were to exchange pre-hearing submissions which the Tribunal would treat as containing each party’s best case on fact and law at the time of exchange. However, on 20 November 2007, the Tribunal gave further procedural directions that, whilst the Applicant’s pre-hearing submissions must include its full argument and best case on the Taiwanese law issue and its Taiwanese law expert’s report, the Respondent’s pre-hearing submissions needed not to deal with these matters. Instead, it allowed the Respondent to include a supplemental submission to be provided by the Respondent no later than 5pm Friday, 30 November 2007 (two days before the hearing started on 3 December 2007 and four days before the Respondent’s Taiwanese law expert was due to be called on 5 December 2007). The Tribunal considered that this gave the Applicant ample time to prepare its cross-examination. The Applicant immediately protested to the Tribunal.
  2. Joint expert meeting and report
    During the December 2007 hearing, the Tribunal adjourned the cross-examination of the Taiwanese law experts to May 2008 to enable the Taiwanese law experts time to produce a joint report. At this time, the Tribunal and the parties agreed that the parties could not seek to introduce new Taiwanese legal authorities without leave, which would not be granted unless the authorities in question were “sensational”. In April 2008, the Applicant made an application to the Tribunal for leave to rely on three additional legal authorities, which was opposed by the Respondent. The Tribunal ruled on the application, refusing to grant leave, without first considering the content or the subject matter of the new authorities.
  3. Hong Kong law issue
    The issue of Hong Kong law was raised for the first time by the Applicant in its post-hearing submissions in July 2008. In October 2008, the Tribunal sought an explanation from the Applicant as to its submissions on the Hong Kong law issue, and asked the Respondent whether, if the Applicant’s Hong Kong law argument was received by the Tribunal, the Respondent would wish to make any further submissions in addition to those already made. The Applicant provided a procedural explanation, without adding to the submissions that had been made. The Respondent made further substantive submissions on the Hong Kong law issue and cited two new cases. The Applicant sought leave to respond to the new cases cited by the Respondent on the Hong Kong law issue. The Tribunal informed the parties that it had sufficient material to decide the Hong Kong law issue and refused to grant leave to the Applicant to respond. The Applicant formally objected to the ruling because it deprived the Applicant of its ability to present its case on the Hong Kong law issue.
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Judgment

The application to set aside the Award was heard by Mr Justice Saunders in February and June 2011.

In his judgment, Mr Justice Saunders ruled that, in light of the pro-enforcement scheme of both the Old Arbitration Ordinance and the UNCITRAL Model Law, a party seeking to set aside an award under Article 34(2) of the UNCITRAL Model Law must pass a two-step test in order to satisfy the court that it should exercise its discretion in favour of setting aside.

Firstly, the party seeking to set aside the award must establish the basis for the appropriate exercise of the discretion, i.e. one or more of the grounds under Article 34(2) of the UNCITRAL Model Law. In this respect, Mr Justice Saunders commented that:

  1. as a matter of basic fairness, the denial of opportunity to make a submission in reply on a matter of law would invariably constitute a serious violation under Article 34(2) of the UNCITRAL Model Law; and
  2. basic fairness between parties to an arbitration also required that when new material was raised by the party who would normally have the last word, an opportunity must be given to the other party to respond, even if only by way of a short written submission.

Secondly, where a violation under Article 34(2) of the UNCITRAL Model Law is established, the party seeking to set aside the award must satisfy the court that it cannot be said that if the violation had not occurred the result of the arbitration could not have been different (i.e. that there is a possibility that the violation could have made a difference to the result). In this respect, Mr Justice Saunders provided further guidance:

  1. although a court retained a narrow and limited residual discretion not to set aside an award even where a violation of Article 34(2) of the UNCITRAL Model Law is established, it is only if it is beyond any doubt that the decision could have been the same that a court would be allowed to override a violation. If the court cannot exclude the possibility - a real as opposed to a remote possibility that cannot be sensibly ignored - that the result might be different, then it will not be beyond any doubt that the decision would have remained the same;
  2. whether or not the result could have been different, is a determination which must be made, not by examining the merits of the award, but by examining the nature of the violation and the potential consequences that flow from the violation. It is the quality of the violation that must be examined rather than the materiality and the effect on the outcome of the arbitration; and
  3. in assessing whether it can exclude such a possibility, the court will take into account the type of violation, the nature of the violation and the result of the award.

Mr Justice Saunders applied the above two-step test when considering the three discrete procedural matters relied upon by the Applicant in its setting aside application and held that:

  1. Taiwanese law issue
    The effect of the directions of 20 November 2007 was that the Respondent would have the Applicant's best case on the Taiwanese law issue for ten days prior to being required themselves to file their best case on that issue. This change in the Procedural Timetable was not a change with which both parties agreed, and the Tribunal did not respond to the protest made by the Applicant to these directions. That was a particular advantage to the Respondent, when it would be filing its pre-hearing submissions on the Taiwanese law issue, on a Friday afternoon, with the hearing due to begin on the following Monday morning. Thus, the Respondent had ten days to peruse the Applicant's submissions and prepare to meet the Applicant's "best case" submissions at the December 2007 hearing, when the Applicant had only two calendar days and zero working days to peruse and prepare on the basis of Respondent's evidence and submissions on this issue.
  2. Joint expert meeting and report
    The Tribunal did not consider or review the additional legal authorities the Applicant wished to rely upon. Thus, there was no basis upon which the Tribunal could say whether or not those authorities came within the category of "sensational authorities" which it had indicated would be allowed.
  3. Hong Kong law issue
    Once the Tribunal had invited the Respondent to respond to the Applicant's Hong Kong law submissions, the Tribunal was bound to give the Applicant the opportunity to reply on those matters of law. The Tribunal’s refusal to grant leave to the Applicant to do so should also be viewed in the light of the fact that although the Respondent submitted two new authorities, which were duly received and considered by the Tribunal, the Tribunal had refused to allow the Applicant to submit new authorities on the Taiwanese law issue.

Mr Justice Saunders held that the above procedural matters amounted to violations of Article 34(2) of the UNCITRAL Model Law which meant that the Applicant was unable to present its case and that the arbitral procedure was not in accordance with the agreement of the parties. As Mr Justice Saunders was unable to say that, had there been no such violations, the result of the ICC arbitration could not have been different, His Honour exercised his discretion under Article 34(2) of the UNCITRAL Model Law to set aside the Award.

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Conclusion

In Pacific China Holdings, Mr Justice Saunders applied the two-step test that needs to be satisfied by a party seeking to set aside an award (which mirrors the approach of Hong Kong courts when exercising their discretion to refuse enforcement of arbitration awards). The conclusion was, in the circumstances of this particular case, that it was appropriate to set aside the award on the basis of procedural irregularities. Notwithstanding this decision, the pro-enforcement approach to arbitration awards that has long been adopted by the Hong Kong courts has not changed. Pacific China Holdings is a rare example of the Hong Kong courts exercising discretion to set aside an arbitral award on the basis of procedural irregularities and should not serve to undermine the pro-enforcement stance of the Hong Kong courts. Rather, this case illustrates the need to balance the desire to have cases heard expeditiously against the need to afford parties a reasonable opportunity to be heard in order to ensure that arbitrations are conducted in a procedurally fair manner.

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