This tension was resolved by the Court of Appeal in Hong Kong, which earlier this week held that “any dispute about escalation clauses should be resolved by the arbitrators chosen by the parties, not the courts. In other words, the arbitration tribunal’s findings on this issue will be final and binding and cannot be used as a basis to challenge the award”.

Simon Chapman QC, HSF Asia head of disputes, said that “today’s [7 June] ruling is the highest authority on this point in any model law jurisdiction, so commercial parties around the world can have confidence that their arbitration agreements will be upheld, even if there are questions about compliance with contractual pre-conditions”.

Partner at HSF Leon Chung stated that “the approach of the Hong Kong Court of Appeal is consistent with the approach which Australian courts and tribunals have taken to construing contracts, namely that the aim is to give effect to the objective, common intention of the parties and unless a contrary intention is indicated, a court or tribunal is entitled to approach the task of giving a commercial contract a businesslike interpretation on the assumption that the parties intended to produce a commercial result”.

He continued that “the NSW Court of Appeal has applied that approach recently in the context of a dispute escalation clause and emphasised that the process is not to be overlaid by assumptions or presumptions”.

According to a brief by HSF, the judgment found that “it will be for the arbitrators to determine whether the clause has been complied with and, if not, what the consequences of that should be.

“The tribunal still retains jurisdiction to hear the dispute, and so any award cannot subsequently be challenged before the courts on this point. This brings much greater certainty (and finality) to the process, and should avoid costly and protracted litigation.”

HSF also found that the enforceability of the escalation clauses remains intact. HSF noted that “arbitral tribunals can take many different steps to ensure that escalation clauses are respected. They can, for example, decline to hear a dispute until the parties have complied with the contract. They can adjourn proceedings to allow negotiation or mediation to take place.  

VIEW ALL

“They can impose cost sanctions on the party that has breached the escalation provision. Or they can proceed to hear the dispute regardless, on the basis that compliance with the clause was likely to be futile.” 

The firm continued: “The key point is that, now, these are questions for the arbitrators alone to decide, and whatever decision they make should not lead to further review by the courts.”

HSF remarked that there might be exceptions to the rule. HSF stated that “although today’s ruling will apply to the vast majority of escalation clauses, the Court of Appeal made clear that in each case the question is to be answered by ascertaining the intention of the parties. There may be extreme circumstances where the contract makes clear that failure to follow the escalation mechanism will have jurisdictional consequences.” 

The firm concluded that “for example, a contract could in theory stipulate that, before any dispute is to be referred to arbitration, the parties must negotiate in good faith for a period of 30 days, and that any subsequent arbitral tribunal will lack jurisdiction to hear the case unless these provisions are strictly met. Such drafting is exceptionally rare, however, and would not be recommended (indeed, it would create a recipe for precisely the sort of costly litigation that today’s Court of Appeal ruling is designed to prevent).”