A question of construction – Hong Kong court rules that arbitration clause in head contract was not incorporated into sub-contract

Hogan Lovells

The question of whether an arbitration clause has been successfully incorporated into a contract is one that has come before the courts regularly, with different jurisdictions taking different approaches to what counts as effective incorporation. Difficulties arise in particular in situations where chains of contracts collide, as in the typical construction scenario, and where the reference is to standard forms rather than individually-negotiated contracts.

In Yun Kwan Construction Engineering Ltd v Shui Tai Construction Engineering Co Ltd [2019] HKCFI 1841, the Court was asked by the defendant in an action for alleged outstanding sums under sub-contracts for an order that further proceedings in the action in relation to two of the projects be stayed for arbitration.

The defendant argued that an arbitration clause in the head contracts with the respective employers had been incorporated into the corresponding contracts between the defendant and the plaintiff.

Contractual chain

The first project concerned a residential and commercial development in the Kai Tak district. The main contractor, Konwall Construction & Engineering Co Ltd ("Konwall") had entered into a main contract with the employer for works relating to hoarding, basement excavation and lateral support, foundation and pile caps (the "Employer-Konwall Contract").

In a contract letter dated 3 October 2015 and countersigned by the defendant on 5 October 2015, Konwall then sub-contracted various works to the defendant (the "Konwall-D Contract"). Clause 7 of the letter expressly stated that a number of documents, in particular the General Conditions of Sub-Contract ("GCSC") would form part of the contract. Clause 18.1 of the GCSC provided that disputes in connection with the Sub-Contract would be referred to arbitration.

The defendant in turn sub-sub-contracted part of the works to the plaintiff by way of a contract dated 30 September 2015 ("D-P Contract 1"). Clause 10 of D-P Contract 1 provided that:

"The Principal Contractor entered into a sub-contract with Party A to sub-contract the main works to Party A (Sub-Contract). Party B understands clearly that the works of this sub-contracting agreement were [all/part] of the Main Contract and Sub-Contract, and both parties agreed to the following terms". (English translation)
 
The contractual chain in the second project, which concerned a residential development in Tuen Mun, followed a similar pattern and was analysed in like terms by the Court. Clause 2 of the relevant sub-sub-contract noted that the terms and conditions of the Standard Form of Domestic Sub-Contract (2008 Addition) published by the Hong Kong Construction Association would apply ("SFDSC").

Clause 18 of the SFDSC said that disputes would "be referred to the arbitration and final decision of a single arbitrator in accordance with and subject to the provisions of Part II of the Arbitration Ordinance…and any such reference shall be deemed to be a submission to domestic arbitration within the meaning of such Ordinance".

Legal principles

Lam J reviewed the relevant legal principles. Article 7(6) of the UNCITRAL Model Law (given effect by sections 19(1) and 19(3) of the Arbitration Ordinance, Cap 609), says that an arbitration clause referred to in a separate document may be incorporated as part of the contract. Section 19(3) provides that:
"A reference in an agreement to a written form of arbitration clause constitutes an arbitration agreement if the reference is such as to make that clause part of the agreement".
Lam J said that under Hong Kong law, there does not need to be an explicit reference to the clause itself; reference to a document containing it may be sufficient provided "the reference is such as to make that clause part of the contract".

The document referred to does not even have to be a contract between the same two parties. As Lam J put it, "It is possible under Art 7(6) to incorporate into a contract between A and B an arbitration clause, by reference to an agreement between B and C or even between X and Y or to an unsigned standard form of contract, which contains the arbitration clause".

This had been settled law in Hong Kong for the past quarter century, unlike the position in other jurisdictions, such as England where courts have often taken the view that, for incorporation of an arbitration clause into a contract between A and B by reference to an agreement between B and C or X and Y, there must be a specific reference to the arbitration clause itself, rather than simply to the contract or document containing the clause.

Untangling the chains

The question as to whether the reference was sufficient as to make the arbitration clause part of the contract, was one of construction. The task of the court was to ascertain, with no preconceived notions, the intentions of the parties when they entered into the contract by reference to the words they used.

As with other questions of contractual construction, this involved examining the wording of the documents against the relevant background to identify what a reasonable man would have understood the parties to mean, citing Building Authority v Appeal Tribunal (Buildings) (ENM Holdings Ltd) [2018] 21 HKCFAR 194.

The Court said it was clear that the "Sub-Contract" referred to in D-P Contract 1 meant the contract between the defendant and its head contractor, and the "Main Contract" meant the Employer-Konwall Contract. Lam J said the wording of the relevant sentence in the clause meant that it was the works under the D-P contract that were incorporated into the Employer-Konwall Contract and the Konwall-D Contract, not the D-P Contract 1 itself.

The clause made no reference to the "terms and conditions" of the Employer-Konwall Contract or the Konwall-D Contract, and did not in any way state that either of the contracts applied to the relationship between the plaintiff and the defendant, or that the D-P Contract 1 was "back to back" with or was to be performed "in accordance with" the Konwall-D Contract.

Intention of the parties

Lam J commented that it was not in dispute that until the point of disclosure in these proceedings, the plaintiff had never been given a copy of the Konwall-D Contract, let alone the Employer-Konwall Contract.

It was also hard to see (if the reference was sufficient for incorporation), why only the terms of the Konwall-D Contract were incorporated (as argued by the plaintiff) and not also the terms of the Employer-Konwall Contract, which was also referred to in that sentence.

Similarly, it was difficult to see how it could have been the intention of the plaintiff and the defendant to incorporate both sets of contracts, when the plaintiff had not even disclosed in the proceedings the Employer-Konwall Contract. It was therefore not known whether the two upstream contracts contained dispute resolution clauses that conflicted with each other.

As such, Lam J accepted the defendant's submission that the reference to the Employer-Konwall Contract and the Konwall-D Contract in the clause was "intended to mean that the specifications, standards and requirements relating to the works as specified in those contracts should be followed by the plaintiff in executing the works, being part of the works required under those contracts, and not to incorporate every clause (including the arbitration clause) into the D-P Contract 1".

Lam cited a passage from a leading textbook as applied by Reyes J in Sunbond Engineering Ltd v Konwall Construction & Engineering Co Ltd (unrep. HCCT 15/2003) that:
"As a matter of first principle and in the light of the usual real-life intentions of sub-contracting parties, doubtful or ambiguous references to main contract documents or terms are much more likely to be aimed at the technical descriptions of the sub-contract work to be found in the drawings, specifications or bills of quantities of the main contract rather than at the contractual or legal provisions in the main contract documentation…".

Lam J found the same reasoning applied to the contracts in the second project under consideration.

The Court therefore concluded that the arbitration provisions relied upon by the defendant had not been incorporated into the contracts between the plaintiff and the defendant.

To incorporate or not to incorporate

The incorporation of a term by reference is a frequent occurrence in construction contracts as it is in other types of contracts such as reinsurance contracts, charterparties and bills of lading.

Particular care is required in cases involving multiple contracts (often forming a chain), as here, as the Courts will be asked to determine the intentions of the parties if the drafting is unclear, particularly where one of the parties is seeking to oust the jurisdiction of the court in favour of arbitration. This is particularly important in cross-border contracts, given the differences in approach taken by the English and Hong Kong courts.

Search for certainty

The English Court of Appeal construction case Aughton Ltd (formerly Aughton Group Ltd) v MF Kent Services Ltd [1991] 57 BLR1, pointed to a difference of approach even within the English judiciary as to whether general words are sufficient for effective incorporation, with Sir John Megaw stating that the arbitration clause should be referred to expressly while Ralph Gibson LJ took the orthodox Hong Kong approach that reference to the contract or standard form document would suffice, an approach that is more in line with the provisions of the UNCITRAL Model Law.

The rationale of the courts in England as to why an express reference is needed has not always been clear, with some judges reasoning that there are some instances in which the stricter approach is called for. A bill of lading, for example, might incorporate the terms of a charterparty, but a person who had negotiated the bill in another jurisdiction might have no means of knowing what those terms were, and whether there was an arbitration clause.

As ever, parties seeking to rely on arbitration should use clear words of incorporation to avoid the potential for future disputes in a multi-party scenario.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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