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Focus: Arbitration – July 2008

Going against the trend?

In brief: The Western Australian Court of Appeal recently held that an arbitration clause in a contract did not cover a related dispute between the contracting parties where the dispute also involved the liability of a third party. This arguably goes against the general trend of a broader interpretation of arbitration clauses. Senior Associate Brian Millar and Law Graduate Clara Wren look at the decision and its implications.

How does it affect you?

  • The decision is arguably against, or a refinement of, the recent trend in Australian and English courts towards a broader interpretation of the scope of arbitration clauses.
  • Parties who want the scope of their arbitration agreement to include disputes between the contracting parties that also involve the liability of a third party should (at least in respect of disputes that have a connection with Western Australia) expressly provide in their arbitration agreement that the involvement of a third party in a dispute does not affect the parties' agreement to arbitrate the dispute between themselves.
  • Given the consensual nature of arbitration, third parties cannot be required to take part in arbitral proceedings without their agreement. Where third parties may be involved in disputes between the contracting parties, the contracting parties should consider entering into agreement(s) to arbitrate with the third party, including agreeing to consolidate proceedings that are commenced if they involve similar issues.
Background

In the case of Paharpur Cooling Towers Ltd v Paramount (WA) Ltd1, the appellant (Paharpur) and the respondent (Paramount) entered into a contract for Paharpur (which operated in India) to design, supply and supervise the installation of two cooling towers for an ammonia plant being constructed by Paramount for Burrup Fertilisers Pty Ltd (BFPL) in Karratha in the north of Western Australia (the contract). Paharpur was to ship the equipment from India to Western Australia.

The contract contained a dispute resolution clause. This clause – clause 22 – provided Paramount with sole discretion to determine whether the parties resolve a 'dispute' by litigation or arbitration if the parties were unable to resolve the dispute through a stipulated process. 'Dispute' was defined within the contract as:

a dispute or difference between the parties as to the construction of the Contract or as to any matter or thing of whatsoever nature arising, whether antecedent to the Contract and relating to its formation or arising under or in connection with the Contract, including any claim at common law, in tort, under statute or for restitution based on unjust enrichment or for rectification or frustration or a dispute concerning a direction given and/or acts or failing to act by the Engineer or the Engineer's Representative or interference by the Principal or the Principal's Representative.

A year into the contract, Paramount and Paharpur agreed to amend the terms of payment. Under the amended terms, Paramount was to pay the final instalment of the contract price ($4 million plus interest) six months after Paharpur shipped the last of the equipment from India. Paramount also agreed to provide a bill of exchange for this sum accepted by Paramount and BFPL. The bill of exchange was to be payable to Paharpur 180 days from the date of shipment.

Paharpur subsequently shipped the equipment to Paramount and, after some correspondence with Paharpur, Paramount and BFPL endorsed a bill of exchange and returned it to Paharpur. However, when the bill of exchange fell due for payment, Paramount and BFPL refused to pay.

Paramount alleged that there were defects with the equipment and its design, and that the equipment had been delivered late and with some parts missing. Paramount contended that it had expressly accepted the bill of exchange on the condition that the bill would not be enforced until its claims for rectification and defects in the equipment were addressed. BFPL apparently relied on similar matters in resisting payment.

Paharpur commenced proceedings in the Supreme Court of Western Australia against Paramount for payment under the contract, and against Paramount and BFPL for payment on the bill of exchange.2

Paramount responded by serving notice on Paharpur referring all matters in issue between them to arbitration under clause 22 of the contract. It then applied to the Supreme Court for a stay of Paharpur's proceedings3, so far as they related to Paramount, pending the determination of the relevant issues by arbitration.

Paharpur accepted that its claim under the contract should go to arbitration, but contended that its claim against Paramount in respect of the bill of exchange should not. It argued that clause 22 did not apply to Paramount's failure to honour the bill of exchange when it fell due.4

Paramount was granted a stay of the entire proceedings at first instance,5 but Paharpur appealed this decision successfully to the Court of Appeal.

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Court of Appeal's decision

The Court of Appeal (President Steytler and Acting Justice of Appeal Newnes) held that the dispute in relation to the bill of exchange was not a dispute within the meaning of clause 22 of the contract.

In their Honours' view, the reference to 'a dispute or difference between the parties' in the definition of dispute was intended to apply to a dispute between the parties to the contract only; it was not intended to apply to a dispute which also involved the liability of a stranger to the contract, namely BFPL.

Underlying the Court of Appeal's construction of the clause was their Honours' opinion that:

The parties to the contract would hardly have intended that in such circumstances rather than being determined in one judicial forum, the liability of each acceptor [of the bill of exchange, ie Paramount and BFPL] would be dealt with in separate forums, one judicial and one arbitral, with all of the potential difficulties and additional costs involved.6

Accordingly, Paharpur could litigate the bill of exchange portion of its claim in the Supreme Court proceedings despite Paramount's election to arbitrate under clause 22 of the contract.

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Comparison with general trend

The Court of Appeal's decision is arguably against the general trend of recent Australian and English authorities, which has been towards a broad or 'liberal' interpretation of the scope of arbitration clauses.7

This trend has been based, in part, on the reasoning that parties who have agreed to include an arbitration clause in their agreement are likely to have intended that all possible disputes from their transaction should be resolved by that means. A narrow construction of the scope of an arbitration clause can result in claims under the contract being arbitrated, while other related claims not considered to fall within the scope of the clause (for example, statutory claims) have to be litigated. A liberal approach to construction is adopted because it is presumed that the parties, as sensible commercial operators, did not intend the inconvenience of having disputes between them split between different tribunals.8

In its reasons for the decision, the Court of Appeal noted the suggestions in the authorities that a liberal construction should be taken to an arbitration clause in a contract.9 However, their Honours pointed out that the task of the courts is to ascertain the intention of the parties as expressed in their agreement. They emphasised that the liberal approach results from the courts' reflection of the likely intention of the parties, not from considerations of public policy.10

Further, their Honours indicated that the presumed preference of the parties for 'one stop adjudication' does not necessarily operate in favour of a broad construction of an arbitration clause where the dispute in question is not limited to the parties to the arbitration agreement.11

On the contrary, the Court of Appeal used the presumed intention of the parties to reason against the operation of the arbitration clause to the bill of exchange dispute. In doing so, their Honours outlined the following opinion of general application:

where a party to an arbitration agreement makes the same claim against both the other party to the arbitration agreement and a person who is not a party to the arbitration agreement – with the result that, so far as it involves the latter, the dispute cannot be referred to arbitration – it will generally be ... difficult to ascribe to the parties to the arbitration agreement an intention that in such an event the dispute should be fragmented and that the liability of the party to the arbitration agreement and that of the third party respectively should be determined in different forums

Whether or not the parties intended such an outcome will necessarily turn on the facts of each case, but in our view it is not readily to be inferred.12

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Implications of the decision

The Court of Appeal's decision is surprising given the general trend of the authorities towards a broader approach to the construction of the scope of arbitration clauses. The extent, if any, to which this decision signals a movement away from or a refinement of the liberal approach by West Australian courts remains to be seen.

In the meantime, if contracting parties wish to avoid an outcome in line with the Court of Appeal's decision, they should draft their arbitration clause to clearly indicate that the involvement of a third party in a possible dispute between them is not intended to affect the application of the clause to that dispute.

Footnotes
  1. [2008] WASCA 110.
  2. Paharpur's proceedings also included a claim for payment under a guarantee from two other parties who had guaranteed Paramount's obligations under the contract.
  3. Under section 7 of the International Arbitration Act (Cth), section 53(1) of the Commercial Arbitration Act 1985 (WA) or the inherent jurisdiction of the court.
  4. It submitted that the bill of exchange was a 'stand alone' contract between the three parties and was not the subject of the arbitration agreement in the contract. It said that it could not have been the intention of the parties that clause 22 would apply to a dispute involving a person who was not a party to the contract and who therefore was not bound by the arbitration clause.
  5. Acting Master Chapman concluded that clause 22 of the contract was sufficiently wide to encompass the claim in respect of the bill of exchange and ordered that the proceedings be stayed in their entirety.
  6. Paharpur Cooling Towers Ltd v Paramount (WA) Ltd [2008] WASCA 110 at [45].
  7. Most notably in Australia, the Full Court of the Federal Court in Comandate Marine Corp v Pan Australian Shipping Pty Ltd (2006) 157 FCR 45 held that an international arbitration clause will be given a 'liberal construction and content' if the wording of the clause is 'capable of broad and flexible meaning'.
  8. See, for example, Francis Travel Marketing Pty Ltd v Virgin Atlantic Airways Ltd (1996) 39 NSWLR 160 at 165 per Chief Justice Gleeson; Comandate Marine Corp v Pan Australia Shipping Pty Ltd (2006) 157 FCR 45; Fiona Trust & Holding Corporation v Privalov [2007] 4 All ER 951.
  9. Paharpur Cooling Towers Ltd v Paramount (WA) Ltd [2008] WASCA 110 at [34].
  10. Paharpur Cooling Towers Ltd v Paramount (WA) Ltd [2008] WASCA 110 at [34]-[36].
  11. Paharpur Cooling Towers Ltd v Paramount (WA) Ltd [2008] WASCA 110 at [42].
  12. Paharpur Cooling Towers Ltd v Paramount (WA) Ltd [2008] WASCA 110 at [43]-[44].

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