Kwok Kit Cheung, Partner, Deacons, looks at a recent case in the Court of First Instance that highlights the high thresholds relevant to obtaining leave to appeal against an arbitral award in Hong Kong.

In the recent case of MC v SC, HCCT 17/2020, a main contractor (MC) applied for leave to appeal against an arbitral award (Award) on a question of law under Section 5 of Schedule 2 to the Arbitration Ordinance (Ordinance) in an arbitration in Hong Kong between MC as the claimant and its subcontractor (SC) as respondent. The arbitrator had ruled that MC had breached the subcontract by omitting a significant part of SC’s scope of works under the subcontract and that the breach was repudiatory in nature, entitling SC to terminate the subcontract.

The court dismissed MC’s application, holding that the arbitrator’s decision was obviously made in light of his examination of the correspondence between the parties and their conduct, and that the weight to be given to primary facts was a matter for the arbitrator. The court could not conclude that the arbitrator was ‘obviously wrong’ and, even if the test of ‘open to serious doubt’ should apply, that threshold had not been attained.

Background

The arbitration was brought pursuant to an arbitration agreement in a subcontract between MC and SC for the supply and installation of external façade renovation (Subcontract Works) of a complex. MC was the main contractor engaged by the employer of the overall project (Project). SC was the specialist subcontractor nominated by the employer, and engaged by MC, to carry out the Subcontract Works, which formed part of the works under the main contract. In the course of the work, a special payment arrangement (SPA) was entered into between SC and the employer directly.

Disputes arose between MC and SC with regard to SC’s termination of the subcontract on the alleged grounds of non-payment and the omission of works from the scope of the Subcontract Works to be given to others. MC accepted SC’s termination as a wrongful repudiation of the subcontract.

The disputes in the arbitration focused on the architect’s issue (AI), on the employer’s behalf, of a variation instruction under the main contract to MC, whereby part of the Subcontract Works were omitted from the subcontract, for such omitted works to be carried out by MC. The instructions were then forwarded by MC issuing the AI to SC under GS SC 7 (1) of the subcontract. MC claimed that it expressly invited SC to question or challenge the validity of the AI pursuant to GS SC 7 (2), but SC terminated the subcontract instead on the ground of MC’s breach. Such termination was accepted by MC as SC’s repudiation of the subcontract.

Arbitrator’s decision

The arbitrator ordered two preliminary issues to be determined in the arbitration.

1. On its true construction, would the omission of a significant part of SC’s scope of works under the subcontract and contemporaneous addition of the same scope of works to MC’s work be a breach of the subcontract and/or the SPA?
2. Would any such breach as might be held to have occurred (under (1) above) be repudiatory in nature, entitling SC to terminate the subcontract?

The arbitrator ruled that the omission of a significant part of SC’s works and contemporaneous addition of such works to MC was a breach of the subcontract, which was repudiatory in nature, entitling SC to terminate the subcontract, irrespective of its compliance with all of clauses 2, 3 and 4 of the SPA.

MC’s application for leave to appeal the arbitral award

MC claimed that the arbitrator had erred in law in determining that such breach was repudiatory in nature, giving rise to SC’s right to terminate the subcontract (Question). MC claimed that the Question turned on the construction of the provisions of the standard form of special conditions of subcontract, which are commonly used in the building industry, and a decision on appeal on the Question would clarify the law for the benefit of the construction industry.

SC claimed that the Question was not of general importance and that significant amendments had since been made to the form of the conditions and contract adopted by MC and SC, and in this case the particular provisions in dispute in the arbitration were no longer of general use. In particular, the arbitrator’s determination of the Question and any appeal from it was a one-off dispute between the parties on the facts of the particular case and provisions of the subcontract between MC and SC, which was supplemented by a separate SPA, specifically agreed between the employer and SC for the Project.

Court’s ruling

The court said that whether the breach, as found by the arbitrator, was repudiatory in nature depended on the facts and conduct of the parties. It was also pertinent, it said, that the parties’ relationship was supplemented by the SPA specifically agreed between the employer and SC in relation to the Subcontract Works. Whether there was breach and whether such breach could amount to repudiation was a one-off question between the parties to this case, and of no general importance. Under Section 6(4)(c) of Schedule 2 of the Ordinance, the court said, leave to appeal is to be granted only if the arbitrator’s decision on the Question was obviously wrong on the basis of the findings of fact in the Award.

Whether a breach entitles the innocent party to treat the contract as repudiated is ‘highly fact sensitive’, the court said, and has to be decided by looking at all of the circumstances objectively from the perspective of a reasonable person in the position of the innocent party, to consider whether the contract breaker has ‘clearly shown an intention to abandon and altogether refuse to perform the contract’. This was a question of mixed law and fact, and the arbitrator’s decision had to be considered on the basis of his findings of fact made (Section 6(4)(c) of Schedule 2 of the Ordinance).

MC no longer disputed the arbitrator’s finding on SC’s breach of the subcontract. As regards the arbitrator’s finding that the breach was repudiatory, the court said that the arbitrator had considered the correspondence exchanged between MC and SC. Particularly in light of the submissions made by SC that in reality MC had been involved in the decision-making process, and both the employer and MC had made up their minds to remove the work from SC.

The arbitrator also referred to correspondence from SC to MC, in which it was highlighted that the works instructed for omission from the scope of the subcontract constituted more than 60% of the Subcontract Works, located in areas where there was significant delay on MC’s part. The arbitrator appeared to have accepted SC’s submissions, that MC’s actions leading to the issue of the AI were deliberate.

SC had also already reminded MC prior to the issue of the AI that MC’s issue of such instructions would be a breach of contract and compound other breaches that had been alleged by SC against MC, including MC’s breach of its payment obligations and the issue of various purported notices of default which were disputed.

The court said that it appeared from the Award that the arbitrator accepted SC’s submissions, that a ‘formal protest’ under GC SC 7 (2) would have been futile, since SC had already challenged the omission instruction before its issue, but to no effect. With notice that SC challenged the validity of the AI in question, MC had proceeded nevertheless to issue the AI, without itself invoking the challenge mechanism which was open to MC as well.

The arbitrator’s decision, the court said, that the breach amounted to repudiation, was obviously made in light of his examination of the correspondence and parties’ conduct, as shown in and evidenced by the correspondence placed before the arbitrator, and his conclusions made on what he regarded to be MC’s deliberate and continued breaches of the subcontract, demonstrating an intention not to be bound by the subcontract, which he was entitled to do.

The weight to be given to primary facts was a matter for the tribunal, and specific findings of fact are inherently an incomplete statement by the tribunal of fact of the impression which was made upon it by the primary evidence, and the court could not agree that the arbitrator’s decision on the Question was ‘obviously wrong’. The court said that even if the test of ‘open to serious doubt’ should apply, this threshold had not been attained.

Accordingly, leave to appeal on the Question was refused and MC was ordered to pay SC’s costs of the application on an indemnity basis.

Comment

The thresholds for obtaining leave to appeal against an arbitral award on questions of law under Section 5 of Schedule 2 of the Arbitration Ordinance are high. In order to succeed, the applicant has to satisfy the court that the arbitrator’s decision is obviously wrong. For questions of law of general importance, the threshold is lower. It only requires the applicant to show that the decision is at least open to serious doubt. Identifying and formulating the question of law of general importance to be considered by the court is therefore very important. In this regard, it should be noted that such question of law is not necessarily identical to the ultimate issue determined in the arbitration.

In the above judgment, given the question put forward by SC, it is not surprising that leave to appeal was not granted, especially since the question involved was the same as that determined by the arbitrator by way of preliminary issue, which was a mixed question of fact and law. If the issues decided by the arbitrator could have been reformulated as a pure question of law with the scope further narrowed down, the applicant may have had a better chance of success, although this may not be possible in every case.

Kwok Kit Cheung, Partner

Deacons

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