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Theoretical Analysis and Opinion – Can a breach of payment obligations render an arbitration agreement inoperative?

The recent Court of Appeal case of JKP Sdn Bhd v Anas Construction Sdn Bhd [2023] MLJU 240 concluded that a defaulting party’s breach of its payment obligations of advanced deposit can render an arbitration agreement inoperative. The Court opined that the defaulting party’s breach of the arbitration rules, without a qualified reason, indicates a clear and unequivocal intention not to abide by the arbitration process of resolving the disputes. Such action signifies a waiver to arbitrate the matter and abandonment of the proceedings altogether.


In contrast, the Court in the English case BDMS[1] came to a different conclusion, although it is to be noted that the facts contained therein differs from the above case.


In the case of BDMS[2], BDMS Limited (BDMS) initiated arbitration proceedings against Rafael Advanced Defence Systems (Rafael), alleging non-payment of a success fee outlined in a consultancy agreement that mandated London-seated ICC arbitration. An arbitrator was appointed, and the ICC instructed both parties to equally contribute to the advance on costs. Rafael's solicitors expressed concern over BDMS's financial capability and intended to seek security for costs, refusing to pay its share until security was in place.


Despite BDMS fulfilling its share of the advance on costs, Rafael persisted in its refusal and formally applied for security for costs against BDMS. The ICC Court repeatedly urged Rafael to fulfil its payment obligation and invited BDMS to substitute for Rafael, warning of withdrawal if payments were not received. BDMS opted not to substitute, asserting that Rafael's non-payment constituted a fundamental breach of the arbitration rules.


BDMS subsequently initiated High Court proceedings, leading to the withdrawal of the arbitration claim. Rafael sought a stay of the court proceedings under Section 9 of the Arbitration Act 1996, which mandates a stay unless the arbitration agreement is null, void, inoperative, or incapable of being performed.


The Court held that although Rafael had breached its contractual obligation, such breach was not repudiatory which would render the arbitration agreement inoperative. The Court’s reasoning can be summarized as follows;


a)      Rafael actively participated in the arbitration but contested the payment of the advance on costs, insisting on security. This refusal was not a complete rejection but rather a condition for payment;

b)     The breach did not prevent BDMS from arbitrating, as alternatives like posting a bank guarantee were available;

c)      BDMS was not substantially deprived of contract benefits, as the ICC Rules provided mechanisms to address the situation;

d)     Even if a claim was withdrawn due to a payment default, it didn't constitute repudiation, and the arbitration agreement allowed for future arbitrations on the same claim.


It's important to highlight that the judge reviewed decisions from Canada and France to confirm that a refusal or failure to pay an advance on costs might, under specific conditions, be considered repudiatory. Nevertheless, the judge ultimately concluded and noted that determining repudiation in such cases relies on the specific facts of each situation.


A crucial question then arises for discussion; when arbitration rules offer the option for the non-defaulting party to cover the deposit obligations of the defaulting party in the event of the latter’s default, would the non-defaulting party's decision not to cover the deposit obligations of the defaulting party be sufficient to render an arbitration agreement inoperative?


As the BDMS[3] case aptly observed, providing a definitive answer to this question is not straightforward, as it depends entirely on the specific facts, the arbitration agreement, and the governing rules upon which the parties intend to rely.


Given the subjective nature of facts, this analysis and opinion will delve into the theoretical implications of breaching arbitration rules concerning the payment of deposits and whether such a breach could render an arbitration agreement inoperative.


Reference will be made to Rule 14 of the AIAC Arbitration Rules 2018 (Arbitration Rules) for purposes of discussion, which has been reproduced below for ease of reference.


 “Rule 14

Deposits

In lieu of the provisions of Article 43, the following provisions shall apply:


1. After the arbitration has commenced in accordance with Rule 2, the Director shall fix a provisional advance deposit in an amount intended to cover the costs of the arbitration. Any such provisional advance deposit shall be paid by the Parties in equal shares and will be considered as a partial payment by the Parties of any deposits of costs fixed by the Director under Rule 14.

2. ….

3. In the event that any of the Parties fails to pay such deposit, the Director shall give the other Party an opportunity to make the required payment within a specified period of time. The arbitral tribunal shall not proceed with the arbitral proceedings until such provisional advance deposit is paid in full.

4. Upon fixing of the fees of the arbitral tribunal and administrative costs of arbitration, the Director shall prepare an estimate of the fees and expenses of the arbitral tribunal and the administrative costs of the arbitration which the Parties shall bear in equal shares. Within 21 days of written notification by the AIAC of such estimate, each Party shall deposit its share of the estimate with the AIAC.

5. …

6. …

7. If the required deposits are not paid in full, the Director shall give the other Party an opportunity to make the required payment within a specified period of time. If such payment is not made, the arbitral tribunal may, after consultation with the Director, order the suspension or termination of the arbitral proceedings or any part thereof.

8. Notwithstanding the above, the Director shall have the discretion to determine the proportion of deposits required to be paid by the Parties.”

 

 

If one were to examine Rule 14 of the Arbitration Rules comprehensively, it is evident that Rules 14(3) and 14(7) explicitly integrate mechanisms to uphold the ongoing validity of the arbitration agreement even if a party fails or refuses to pay its required deposits. With these rules in place, the non-defaulting party would have the option and capability to provide the necessary deposits as required, ensuring the continuity and uninterrupted progression of the arbitration proceedings. The purpose of these mechanisms is clear: to preserve the sanctity of the arbitration agreement and counter any attempts by a party to extricate itself from the agreed-upon arbitration process.


On the contrary, institutional rules which only cater to mandatory payment obligations are suboptimal, potentially allowing a party to strategically violate its payment obligation and circumvent arbitration proceedings. From the standpoint of a party striving to uphold the arbitration agreement, the existence of this possibility would inherently undermine the fundamental purpose of maintaining the mutually agreed commitment to arbitrate. Consequently, many institutional rules have evolved to incorporate mechanisms equivalent to Rules 14(3) and 14(7) to address this issue, as seen in Rule 34 of the Singapore International Arbitration Centre Rules 2016 and Article 43 of the UNCITRAL Arbitration Rules 2021, among others.


It is observed that, these mechanisms, which empower the non-defaulting party to cover deposits for the defaulting party, are rooted in an ideal scenario where parties steadfastly commit to arbitration, ensuring the continuity and progression of proceedings even in the face of breaches in payment obligations. This is because, in cases where parties are genuinely dedicated to resolving disputes through arbitration, it becomes inconsequential whether one party covers deposits on behalf of the other to ensure the continuity of arbitration proceedings. After all, these costs will be awarded to the prevailing party upon the conclusion of the proceedings, regardless. Furthermore, if a party is concerned about the potential recovery of these upfront expenses, interim security measures, as provided for in the Arbitration Act, are designed to alleviate such apprehensions.


Unfortunately, real-world situations often deviate from this ideal, as parties may grow wary of shouldering the substantial upfront costs to ensure the continuity of proceedings, making them more susceptible to wavering in their commitment to arbitrate, even when they have the means to seek necessary redress and protect their financial interests. This is because, although Rules 14(3) and 14(7) provide the non-defaulting party with the option to 'remedy' the defaulting party’s breach, the exercise of this option is discretionary and lies within the non-defaulting party's discretion.


This poses a unique challenge, as the non-defaulting party's decision not to cover the deposit obligations of the defaulting party could potentially set the parties on an endless loop. This is because, even if arbitration proceedings come to a halt due to the parties' inability to make required deposit payments, the presence of a valid arbitration agreement prevents the same claim from being reintroduced in court. Notably, there are no restrictions preventing the re-initiation of the same claim in arbitration. In light of this scenario, the non-defaulting party may assert that the agreement has become inoperative since the parties are unable to progress beyond the payment obligation stage.


However, deeming the agreement inoperative under such circumstances may be considered both premature and perverse, given that the agreement can and will remain operative as long as the required upfront costs are paid. While acknowledging that the breach of the payment obligation may be caused by the defaulting party, applying the appropriate test, as laid down in the case of BDMS[4], involves questioning whether the defaulting party's breach substantially undermined the arbitration agreement to the extent that it significantly deprived the non-defaulting party of the entire benefit of the agreement. If the answer is yes, it is safe to assume that the agreement has become inoperative.


However, using the aforementioned Arbitration Rules as an example, it is challenging to perceive how the non-defaulting party could have experienced such deprivation as a result of the defaulting party’s breach, given that they had the means, as outlined in Rules 14(3) and 14(7), to front the necessary deposits to sustain the continuity and progression of proceedings under the governing rules. Moreover, any concerns about frontloading these deposits and its subsequent recovery, can be addressed through necessary redress, as provided for under the Arbitration Act. It is worth reiterating that this is, of course, a theoretical assessment not tied to any specific facts.


There’s of course a flip side argument to this view; one could argue that such a principle may incentivize parties to neglect their payment obligations, exploiting the goodwill of the paying party and potentially causing the latter to finance the entire arbitration process. More disconcertingly, this principle may also be manipulated by a party that, while purporting to demonstrate commitment to arbitration, strategically breaches payment obligations, exploiting Rules 14(3) and 14(7) to its advantage.


A potential solution to curb this abuse may be found within Rule 14(8) of the Arbitration Rules, which could offer mechanisms to address and prevent the strategic manipulation of payment obligations in arbitration proceedings.


Rule 14(8) grants the Director explicit authority and discretion to determine the allocation of deposits that each party must contribute, aligning with the provisions of section 44(1)(a)(i) of the Arbitration Act. Therefore, even if a party declines to fulfil its fee obligation, the Director retains the power to mandate payment on that specific party; otherwise, the agreement may be terminated. In such a scenario, where a specific obligation is established under the rules for a defaulting party to meet its payment obligation, and it persists in non-compliance, could the agreement be considered inoperative?


In theory, it should be considered so.


The defaulting party's persistent refusal to pay, despite the clear and express obligation created under the rules, signifies a waiver of its right to arbitrate the matter. Consequently, the party cannot argue that its failure to pay has not rendered the arbitration agreement inoperative, as all mechanisms to sustain the arbitration as per the rules have been exhausted. This determination, of course, would depend on the institutional rules in place and whether they include necessary safeguards, such as Rule 14(8), for mandatory payment obligations.


As such, although the defaulting party retains the tactical option to decline payment of their allocated advanced deposits, this action may not be viewed favourably by the tribunal, potentially leading to the issuance of a mandatory order for payment. It is unsurprising that the Arbitration Rules have incorporated protective measures, such as these, to prevent potential abuses or strategic manoeuvres designed to cause delays in the arbitration proceedings. Once Rule 14(8) is invoked, the situation becomes clear-cut, offering minimal leeway for the defaulting party to gain an advantage from its breach of the rules.


In conclusion, while parties possess the autonomy to explicitly determine the mandatory obligation of equal sharing of costs and expenses in arbitration, the efficacy of such private agreements comes under scrutiny when a party neglects or refuses to fulfil its financial obligations. From the perspective of a party committed to maintaining the arbitration agreement, these arrangements can become impractical, causing easy stalling of proceedings, and potentially leading to such an agreement becoming inoperative. Hence, institutional rules are carefully crafted to cater to parties committed to preserving the arbitration process, ensuring its uninterrupted continuity and progression. With the mechanisms in Rules 14(3) and 14(7) in place, a party devoted to maintaining the agreement may even go so far as to cover the deposit obligations of the opposing party to forestall any disruption to the arbitration proceedings.


However, these rules are not tailored for parties that exhibit indecisiveness regarding their commitment to arbitrate or those primarily seeking dispute resolution without a clear preference for arbitration or court proceedings. This dichotomy often results in challenges, as such parties are unwilling to pay upfront deposits or, where necessary, cover the expenses of the opposing party, leading to dilemmas like the one witnessed in the case of JKP v Anas. One might ponder the rationale behind these parties' initial enthusiasm for embracing arbitration—an intriguing inquiry, to say the least.

 

Suren Rajah

Messrs Rajah Chambers

 

The legal article provided above is intended for informational purposes only. The content represents the personal opinions of the author and should not be considered as legal advice. Readers are strongly encouraged to seek the advice of qualified legal professionals regarding their specific legal concerns or issues. No solicitor-client relationship is established by the consumption of this information, and the author disclaims any responsibility for any actions taken based on the contents of the article.

 

 

 

 


[1] BDMS Ltd v Rafael Advanced Defence Systems [2014] EWHC 451 (Comm)

[2] Ibid

[3] BDMS Ltd v Rafael Advanced Defence Systems [2014] EWHC 451 (Comm)

[4] BDMS Ltd v Rafael Advanced Defence Systems [2014] EWHC 451 (Comm)

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