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Hong Kong court considers validity of agreement to arbitrate in the PRC under ICC Rules
Practical Law UK Legal Update Case Report 7-508-0516 (Approx. 4 pages)
Hong Kong court considers validity of agreement to arbitrate in the PRC under ICC Rules
by Practical Law
| Published on 01 Sep 2011 • China, Hong Kong - PRC, International |
Peter Yuen (Partner), Freshfields Bruckhaus Deringer
In a recent decision, the Hong Kong Court of First Instance stayed a Hong Kong court proceeding in favour of arbitration in Shanghai under the rules of the International Chamber of Commerce (ICC).
Facts
German company, Klöckner Pentaplast Gmbh & Co Kg (Klöckner), had entered into various contracts with Advance Technology (H.K.) Company Limited (Advance Technology) for the sale of plastic cards and films for use in making card products over the course of several years. On 12 October 2010, Klöckner commenced a claim in the Hong Kong courts against Advance Technology, to recover approximately US$1 million for goods supplied.
In response, Advance Technology applied for a stay of proceedings on the grounds that the dispute should be submitted to arbitration in Shanghai, China. Advance Technology relied on a Memorandum of Understanding (MoU) entered into in August 2006 between Klöckner and Advance Technology.
Under the MoU, the governing law was German law and any dispute relating to the MoU would be "submitted to an arbitral tribunal comprising of three (3) arbitrators and the arbitration venue shall be in Shanghai, China". The MoU further stated that the "arbitration proceedings shall be held in accordance with the arbitration rules of the International Chamber of Commerce ("ICC")".
Klöckner advanced two arguments against the stay of proceedings. First, Klöckner argued that the dispute relating to the cost of goods sold was outside the scope of the arbitration clause in the MoU. Second, Klöckner argued that if the arbitration clause applied, it was governed by PRC law and under that law, it would be invalid for failing to properly designate an arbitration institution to hear the matter.
Decision
The court held that the dispute fell within the scope of the arbitration clause in the MoU because the claim for monies owed and any counterclaim by Advance Technology would rightly be described as arising out of, or under, the umbrella of a formal distributorship agreement. The court relied on the leading English decision of Fiona Trust and accepted that "it is illogical to think that businessmen entering into a distributorship agreement, containing an arbitration provision, would have intended that a question of quality of goods would not be determined by the same tribunal that would determine complaints of the breach of the MoU".
The court then turned to Klöckner's second argument that the arbitration clause was governed by PRC law and was null and void for failing to properly designate an arbitration institution to hear the dispute. A key question before the court was what law governed the validity of the arbitration agreement.
Governing law
The court held that in determining the governing law, several factors were relevant. The first was that the MoU stated that "all of the obligations contained herein shall be governed in its entirety by the laws of the Federal Republic of Germany". The court took the view that the phrases "all of the obligations" and "in its entirety" clearly encompassed the entire contract, including the arbitration clause. Secondly, the arbitration clause required that one of the three arbitrators be admitted to practice law in Germany. This requirement is consistent with the intention that the governing law would be German law and not PRC law. Finally, the statements regarding governing law and the arbitration clause were contained under the same heading "Governing Law and Jurisdiction". Together, these considerations led the court to hold that the validity of the arbitration agreement was subject to German law. Under German law, there was no dispute that the arbitration agreement was valid.
Validity of the arbitration agreement
The court also considered the validity of the arbitration agreement, if their conclusion that the governing law was German law was incorrect and PRC law was the applicable law. Saunders J stated that if the applicable law was PRC law, then the failure to specify an arbitration institution would render the clause null and void unless the institution could be determined through the agreed arbitration rules. Additionally, the court concluded that based on the PRC authorities placed before it, the mere reference to the arbitration rules of the ICC was insufficient to amount to a designation of the arbitration institution. Accordingly, if PRC law applied, then the arbitration agreement would have been invalid and the stay would have been refused.
Nonetheless, as a result of the court's holding that German law applied, the arbitration agreement was upheld and the stay was granted.
Comment
This case raises two interesting questions.
The first question is what law governs the arbitration agreement. On one view, this will ordinarily be the same law as the proper law of the contract. This is on the basis that an arbitration clause is contained in a contract, so the choice of law rules that determine which law governs the rest of the contract should be the same rules for determining which law governs the arbitration clause itself. A second view, however, is that the law of the place of arbitration should be the law governing the arbitration agreement. This view has found favour in some recent English authorities.
In Klöckner, this question was unfortunately not fully addressed, as the court seemed to assume that the validity of the arbitration agreement is determined by the lex arbitri. With respect, this assumption is difficult to reconcile with the authorities, and it is disappointing that the clear distinction between the law governing the arbitration agreement and the lex arbitri was not recognised by the court. The former deals with issues such as the validity of the arbitration agreement, whereas the latter covers issues such as the arbitration procedure. As a result, the question of the law governing the arbitration agreement remains open for future determination by a Hong Kong court.
The second question is whether a clause providing for ICC arbitration in the PRC is valid. There is support for the view that an agreement to arbitrate in the PRC under a foreign arbitral institution such as the ICC is invalid. However, the court did not squarely address this issue. Instead, it focused on the question of whether, under PRC law, mere reference to the ICC rules without an express designation of the ICC International Court of Arbitration was sufficient to constitute a valid arbitration clause. On the evidence before the court, it was held that the answer was no. Therefore, the court did not consider the separate question of whether a clause providing for ICC arbitration in China is valid (for further discussion on this issue, see Legal update, First reported case of China ICC award being enforced in China).