Civil Procedure — stay of action in favour of arbitration — contractual interpretation — incorporation of arbitration clause
P and John Dewey Group (“JD”) entered into a transfer agreement for the sale of a shareholding and an associated shareholder’s loan to JD (the “Transfer Agreement”). The Transfer Agreement provided for Hong Kong-seated arbitration. One day before execution of the Transfer Agreement, another entity, D, had issued a letter of surety addressed to P, in which D undertook the payment obligations of JD to P under the (then draft) Transfer Agreement (the “Letter of Surety”). The Letter of Surety did not contain an arbitration or jurisdiction clause. P and JD subsequently amended the Transfer Agreement to provide inter alia for Shanghai-seated arbitration.
When JD failed to pay part of the purchase price, P commenced litigation against D in the Hong Kong courts to recover the balance due under the Letter of Surety. P obtained a default judgment against D. D applied to (1) set aside the default judgement and (2) stay the litigation in favour of arbitration, arguing that the dispute ought to be referred to arbitration because the Letter of Surety incorporated the arbitration clause in the Transfer Agreement. The Letter of Surety referred to (but did not expressly incorporate) the Transfer Agreement repeatedly.
Under s. 20 of the Arbitration Ordinance, the court must refer a dispute to arbitration unless there is no arbitration agreement at all or the dispute is not covered by an arbitration agreement. To prevail on its application, D needed to demonstrate a prima facie case that P and D were bound by an arbitration agreement.
Even though (1) the Transfer Agreement and the Letter of Surety were between different parties and (2) the Transfer Agreement was executed after the Letter of Surety, D argued that the Letter of Surety incorporated the arbitration clause in the Transfer Agreement because inter alia P, D and JD had entered into those agreements in the context of “a single commercial relationship”. Given the close connection between the two agreements, D argued that one would expect the parties “as rational businessmen” to have agreed a common method of dispute resolution in the interests of efficiency, expediency and costs. It would, D argued, be highly undesirable from P’s perspective for disputes arising from the Transfer Agreement to be resolved in arbitration but disputes arising from the Letter of Surety to be resolved in the courts. D further argued that (1) it had been given a copy of the draft Transfer Agreement containing the arbitration clause before the execution of the Letter of Surety, and (2) the parties had envisaged a Letter of Surety when negotiating the Transfer Agreement, so the parties must have understood the arbitration clause in the Transfer Agreement to apply to the Letter of Surety.
P argued that arbitration clauses are “essentially personal to the parties which agree them”, and that clear words are needed to incorporate the terms of a contract between other parties. Mere reference in the Letter of Surety to the Transfer Agreement was not sufficient. P further argued that D’s case meant that disputes arising from the Letter of Surety would be resolved by Hong Kong arbitration, while disputes arising from the Amended Transfer Agreement would be resolved by Shanghai arbitration. P further argued that there can be no assumption of agreement on a common method of dispute resolution because the Transfer Agreement and the Letter of Surety were separate and independent.
Held, setting aside the default judgement and staying the litigation in favour of arbitration, that:
1) Both D and P had made respectable arguments, and the court was unable to definitely conclude that the Letter of Surety had not incorporated the arbitration clause in the Transfer Agreement. The court concluded that such incorporation was “arguable”. Given that D was only required to demonstrate a prima facie case that P and D were bound by an arbitration clause, D had discharged its burden.
2) While D prevailed on the application, it had only made clear its case on incorporation in counsel’s written reply submissions submitted one day before the hearing, ie, that the Letter of Surety incorporated the arbitration clause contained in the Transfer Agreement (ie, providing for a Hong Kong seat), not the clause contained in the Transfer Agreement as later amended (ie, providing for a Shanghai seat). The court ordered D to bear the costs of the application.
This was D’s application to set aside a default judgement and to stay the proceedings in favour of arbitration. The complete facts are set out in the judgment.