Commercial Court provides guidance as to the circumstances in which the enforcement of contractual rights by third parties will be subject to an arbitration agreement

The recent decision of the Commercial Court (Blair J) in Fortress Value Recovery Fund I LLC & Ors v Blue Skye Special Opportunities Fund LP & Ors [2012] EWHC 1486 (Comm) provides guidance as to the circumstances in which the enforcement of contractual provisions by third parties pursuant to the Contract (Rights of Third Parties) Act 1999 will be subject to an arbitration agreement in the relevant contract.

Blair J made obiter comments to the effect that reliance by third parties on an exclusion clause would not be subject to an arbitration agreement in the same contract.  The practical effect of this appears to be that third parties that benefit from an exclusion clause in a contract to which they are not party and that contains an arbitration clause may be sued in any forum in which the claimant can establish jurisdiction (rather than in arbitration), and must then raise their exclusion defence in that forum.  Similarly, it presumably also means that a third party that wishes pre-emptively to seek relief on the basis of an exclusion clause (such as negative declarations regarding liability) is not entitled to do so through arbitration, but must instead establish jurisdiction in another forum.

Blair J's decision follows the earlier decision of Colman J in Nisshin Shipping Co Ltd v Cleaves & Co Ltd & Ors [2003] EWHC 2602 (Comm), which involved a claim for commission by a broker under a contract to which it was not party and that referred disputes to arbitration.  In contrast to the decision in Fortress, it was held that the broker was entitled (and indeed obliged) to pursue its claim through arbitration.  Blair J distinguished the earlier decision on the basis that (inter alia) Fortress involved a contractual defence, whereas Nisshin involved a positive right of action that was required to be asserted in arbitration.

Background and statutory provisions

The Contracts (Rights of Third Parties Act) 1999 (the "Act") creates an exception to the common law doctrine of privity of contract.  Section 1 of the Act allows a third party that is identified in a contract (either expressly by name, or alternatively as a member of a class or by reference to a description) to enforce provisions of the contract in his own right where the contract expressly provides that he may, or where the provision in question purports to confer a benefit on him.

Section 1(6) of the Act expressly contemplates reliance by third parties on exclusion clauses.  It provides that "Where a term of a contract excludes or limits liability in relation to any matter references in this Act to the third party enforcing the term shall be construed as references to his availing himself of the exclusion or limitation".

Section 8 of the Act addresses the relationship between the Act and the Arbitration Act 1996 (the "Arbitration Act"), including the mandatory stay of legal proceedings in respect of matters that have been referred to arbitration pursuant to section 9 of the Arbitration Act.  Section 8 of the Act provides (in relevant part) as follows:

"1) Where—

(a) a right under section 1 to enforce a term (“the substantive term”) is subject to a term providing for the submission of disputes to arbitration (“the arbitration agreement”), and

(b) the arbitration agreement is an agreement in writing for the purposes of Part I of the Arbitration Act 1996,

the third party shall be treated for the purposes of that Act as a party to the arbitration agreement as regards disputes between himself and the promisor relating to the enforcement of the substantive term by the third party …"

Section 8 of the Act has previously been considered by the English courts, most notably in Nisshin.  As noted above, Colman J held in Nisshin that a claim by a third party broker for commission under a charterparty was subject to the arbitration agreement in that charterparty.  Accordingly, the broker was entitled (and required) to pursue its claim for commission through arbitration.  In reaching this conclusion, Colman J emphasised that the Act is based on the analogy of the assignment of a substantive right under a contract, which generally carries with it the benefit and burden of an arbitration clause in that contract.

The decision in Fortress

The relevant facts in Fortress were as follows.  The claimants, who were parties to a partnership deed, brought court proceedings in England against defendants who, although they were not parties to the partnership deed, were entitled (pursuant to the Act) to the benefit of various indemnities and an exclusion clause under its terms.  The defendants argued that, under section 8 of the Act, they should be treated as parties to the arbitration agreement, by virtue of the fact that they were entitled to enforce the indemnities and exclusion clause pursuant to section 1 of the Act.  On that basis, the defendants sought a stay of the proceedings under section 9 of the Arbitration Act.

Blair J rejected the defendants' application for a stay.  He did so on the basis that the defendants did not rely on either the indemnities or the exclusion clause under the partnership deed.  It followed that there were no "disputes between [a third party] and the promisor relating to the enforcement of [a] substantive term by the third party", with the result that section 8 had no application.

In addition, Blair J made a number of observations about what the position would have been had the defendants relied on the exclusion clause.  Blair J concluded that the exclusion clause fell outside the arbitration agreement, such that no stay under section 9 of the Arbitration Act would have been granted.  In reaching this conclusion, Blair J emphasised that the exclusion clause provided a contractual defence, rather than a positive right of action.  He also made the following observations:

• Whether proceedings are to be stayed pursuant to section 9 of the Arbitration Act must be determined at the time proceedings are issued, with the result that the outcome depends on the nature of the claim, not on any exclusion defence that may be raised.  In this regard, Blair J relied on the reasoning in Sebastian Holdings Inc v Deutsche Bank AG [2011] 1 Lloyd's Rep 106.  In that case, the court construed an exclusive jurisdiction clause, observing that rational businessmen could not have intended that the question whether a claim under the contract falls within the clause would depend on whether or not the counterparty raised a defence under a related contract that contained a different dispute resolution clause.
• Accordingly, the defendants would be entitled to rely on the exclusion clause regardless of the forum in which proceedings are brought against them.
• In the Nisshin case it was held that a third party was entitled to enforce a positive right of action through arbitration, by analogy to the position of the assignee of a substantive right under a contract that contains an arbitration clause.  However, Fortress is concerned with a contractual defence, such that there is no possible analogy with assignment.

Comment

The decision in Fortress provides welcome guidance on the enforcement by third parties of rights under a contract that contains an arbitration agreement.  Further, the approach taken in Fortress is a sensible one that avoids the uncertainty that would result if a dispute could move in or out of the scope of the arbitration agreement depending on whether an exclusion defence is raised (or is likely to be raised) by the defendants.  It also avoids the potential for fragmentation of disputes if issues regarding the interpretation and effect of an exclusion clause fell to be determined in arbitration, while issues of prima facie liability fell to be determined in a different forum.

It is also worth making the following, more specific observations regarding some of the reasoning in the judgment:

• Although Blair J's distinction between a contractual exclusion defence and enforcement of a term appears at first glance to be at odds with section 1(6) of the Act (extracted above), the two can be reconciled.  Section 1(6) is dealing with the question whether a third party is entitled to enforce an exclusion clause in a contract to which it is not a party.  In contrast, Blair J's distinction is made in the context of a different question, namely whether the third party's right to enforce the exclusion clause is "subject to" the arbitration clause (for the purposes of section 8 of the Act), and whether a dispute in relation to the exclusion clause is "a matter … to be referred to arbitration" (for the purposes of section 9 of the Arbitration Act).
• Given Blair J's emphasis on the distinction between a defence and a right of action, it is not entirely clear what approach would be taken where a third party that is entitled to the benefit of an exclusion clause itself commences proceedings seeking negative declarations as to liability.  However, it is suggested that the result in this scenario should be the same, on the basis that the scope of the arbitration agreement, and the application of section 9 of the Arbitration Act, should not vary depending upon which party commences proceedings and the precise procedural route by which the exclusion clause come before the court.  This approach also appears to be in line with the observations of Andrew Smith J in the recent case of Lombard North Central plc & Anor v GATX Corporation [2012] EWHC 1067 (Comm) to the effect that the availability of a stay under section 9 of the Arbitration Act depends on the nature of the claims made in the proceedings, not the way in which they are formulated.