Court of Appeal rules that difficulty in proving locus does not render arbitration agreement incapable of being performed

In Chu Kong v Lau Wing Yan & Ors, CACV 105/2018, the 4^th Defendant appealed against the Court of First Instance’s order, refusing its application to stay the action against it pending arbitration, pursuant to section 20(1) of the Arbitration Ordinance (Cap 609). The Court of Appeal allowed the appeal and stayed the proceedings in favour of arbitration. The Court of Appeal held that whether the Plaintiff had locus to bring arbitration proceedings derivatively on the company’s behalf was a matter falling within the disputesbetween the parties covered by the arbitration agreement and the fact that the Plaintiff might have difficulty on locus would not render the arbitration agreement incapable of being performed. 

Background 

The action was a multiple derivative action brought by the Plaintiff on behalf of a company, the 7^th Defendant. The company entered into a Bareboat Charter with the 4^th Defendant agreeing to buy its vessel. Clause 30(a) of the contract contained an arbitration clause stipulating that “any dispute arising out of or in connection with this Contract shall be referred to arbitration in London in accordance with the Arbitration Act 1996”.

Subsequently, the company’s sole director (the 3^rd Defendant), on behalf of the Company, entered into a supplemental agreement with the 2^nd and 4^th Defendants, whereby the 2^nd Defendant substituted the company as the buyer of the vessel (the Supplemental Agreement).Clause 4 of the Supplemental Agreement expressly incorporated the arbitration clause of the contract, rendering it applicable to the Supplemental Agreement “as if [it] were set out in full”.

The Plaintiff, as ultimate owner and indirect shareholder of 40% of the Company, commenced this multiple derivative action on the company’s behalf. It alleged that the 3^rd Defendant had breached her fiduciary duties and duties of fidelity and good faith owed to the company by causing the company to enter into the Supplemental Agreement and that the Plaintiff had no prior knowledge of the Supplemental Agreement, had never consented to it and that the 1^st and 2^nd Defendants were complicit with the 3^rd Defendant in the misappropriation of the company’s assets.. The Plaintiff sought a declaration against both the 2^nd and 4^th Defendants that the Supplemental Agreement was void and unenforceable. 

Court of First Instance decision

The Court of First instance refused to stay the action against the 4^th Defendant on the following grounds:

(1)    there was no substantive dispute between the Plaintiff/the Company and the 4th Defendant because the 4^th Defendant was joined essentially as a nominal defendant; and 

(2)    it was impermissible for the Plaintiff to commence arbitration proceedings against the 4^th Defendant derivatively on behalf of the company.

Court of Appeal decision 

The Court of Appeal referred to the relevant provisions of Cap 609, namely section 20(1) of the Arbitration Ordinance, which adopts Article 8 of the UNCITRAL Model Law, and which states that: 

“A court before which an action is brought in a matter which is the subject of an arbitration agreement shall … refer the parties to arbitration unless it finds that the agreement is null and void, inoperative or incapable of being performed.”

The requirement to stay an action for arbitration under section 20(1), as the Court of Appeal said, is mandatory.

The Court of Appeal referred to how the court approaches a stay application under section 20(1) of Cap 609, namely by asking four questions:

(1)    Is the arbitration clause an arbitration agreement?

(2)    Is the arbitration agreement null and void, inoperative or incapable of being performed?

(3)    Is there in reality a dispute or difference between the parties?

(4)    Is the dispute or difference between the parties within the ambit of the arbitration agreement?

Here, there was no dispute that the arbitration clause incorporated into the Supplemental Agreement was an arbitration agreement, that it was valid and operative and that the validity of the Supplemental Agreement fell within its ambit. The issues in dispute were whether there was a substantive dispute between the Plaintiff/the Company and the 4^th Defendant and whether the arbitration agreement incorporated into the Supplemental Agreement was incapable of being performed.  

The Court of Appeal allowed the appeal, and ordered that the Plaintiff’s action against the 4^th Defendant be stayed pending arbitration, as it found as follows:-

• In determining if the declaration sought against the 4^th Defendant should be granted on the basis that the Supplemental Agreement was void and unenforceable vis-a-vis the 4^th Defendant, fact sensitive questions regarding the actual/ apparent authority of the Company’s sole directoras well as the 4^th Defendant’s knowledge of it could only be resolved with evidence from all protagonists. The 4^th Defendant was not therefore a nominal party, and the disputes between the Plaintiff/ the Company and 4^th Defendant were real and substantive.

• The Plaintiff argued that as the law in Hong Kong currently stood, he could not commence an arbitration derivatively on the Company’s behalf and the 4^th Defendant would take issue with the Plaintiff’s locus if he were to do so. Arbitration, the Plaintiff argued, was not therefore a viable option to resolve the parties’ dispute. However, under s.20(1) of Cap 609, the court must stay the action unless it finds the arbitration agreement to be void, inoperative and incapable of being performed.  If, after the action against the 4^th Defendant was stayed, the Plaintiff were to commence arbitration against the 4^th Defendant on the Company’s behalf, concurrently with the present action and the 4^th Defendant were to raise the question of the Plaintiff’s locus in bringing the arbitration derivatively on behalf of the Company, then this issue would eminently be a matter falling within the disputes between the parties covered by the arbitration agreement. 

• The fact that the Plaintiff might have difficulty on the locus issue would not render the arbitration agreement incorporated into the Supplemental Agreement incapable of being performed. 

Comments 

The Court of Appeal’s decision is not surprising. Taking issue on the locus of the Plaintiff can be regarded as a challenge on the competence of the arbitral tribunal under section 34 of the Arbitration Ordinance. Section 34(1) provides that the arbitral tribunal may rule on its own jurisdiction, including any objections with respect to the existence or validity of the arbitration agreement.

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Joseph Chung

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