MALAYSIAN HIGH COURT CONSIDERS THE LEGALITY OF AN UNDERLYING CONTRACT WHICH WAS THE SUBJECT OF ARBITRATION

In Calibre M&E Sdn Bhd v PT Cooline HVAC Engineering (Originating Summons Nos. WA-24C(ARB)-47-09/2017 and WA-24C(ARB)-49-10/2017), the Malaysian High Court  considered an application to set aside an arbitral award on the basis that the recognition by the tribunal of the allegedly illegal underlying contract was in conflict with the public policy of Malaysia.  Section 37 of Malaysia's Arbitration Act 2005 ("Act") (which is modelled after the Article 34 of the UNCITRAL Model Law on International Commercial Arbitration 1985 (as amended in 2006)) allows an award to be set aside on the basis that the award is in conflict with the public policy of Malaysia.

Facts

Malaysia's Registration of Contractors (Construction Industry) Regulations 1995 ("Regulations") sets out various grades of registration for contractors, which determines the value of construction works which a contractor registered under Malaysia's Construction Industry Board Act 1994 ("CIDBA") is able to carry out.  PT Cooline was registered as a Grade 3 contractor, which allowed it to carry out works to a value not exceeding RM1,000,000 (approx. US$240,555).

Calibre M&E appointed PT Cooline as its sub-contractor to undertake the supply and installation of air-conditioning ducts and related accessories for mechanical and electrical works for the construction of a public hospital in Putrajaya, Malaysia, for a lump sum of RM5,730,000 (approx. US$1,378,000).

After the works were well underway, a dispute arose as to whether the Calibre M&E wrongfully terminated the contract.  The parties agreed to ad hoc arbitration by way of a submission agreement.  The tribunal found in favour of PT Cooline and awarded it all its claims, while dismissing Calibre M&E's counterclaims.

Calibre M&E sought to set aside the award on various grounds, predominantly that the award was in breach of Malaysian public policy.  It alleged that the Tribunal "had recognised the unlawful construction works undertaken by PT Cooline, which had exceeded its grade of registration with the Construction Industry Development Board".

Decision

The High Court rejected Calibre M&E's assertions entirely.  In particular, the High Court considered that:

• breach of the Regulations is not a matter which is clearly injurious to the public good, or shocks the most basic notion of morality and justice;
• Calibre M&E cannot approbate and reprobate by willingly condoning the non-compliance during the making of the contract, but to deny its validity to escape liability; and
• the Court of Appeal in a prior Malaysian case held that the failure to comply with the Regulations does not render the contract void, illegal and unenforceable, as CIDBA already provides a penalty in the form of a fine for non-compliance. The fact that CIDBA prescribed a monetary penalty for non-compliance suggests that no illegality flows from non-compliance.

Comment

In many cases, setting aside on public policy grounds involve issues of public policy or mandatory law already considered by the arbitral tribunal.  It is unclear from the judgment whether the Tribunal had ruled on the issue of illegality which was raised in the High Court.  If the issue was already determined by the Tribunal, the question is what level of deference, if any, should a court setting aside an award accord to the tribunal's decision on issues of public policy?

• In Westacre Investments Inc v Jugoimport SDPR Holding Co Ltd [2000] QB 288, the English Court of Appeal enforced an award in which the tribunal had addressed allegations of bribery of public officials and found that the contract underlying the arbitration was not illegal.
• In Singapore, the Court of Appeal in AJU v AJT [2011] SGCA 41 found it inappropriate for a court sitting on an application to set aside an arbitral award on the basis of illegality of the underlying contract, where the tribunal already made such determination.
• In Hong Kong, the Court of First Instance in Z v Y [2018] HKCFI 2342 set aside an award in which the tribunal had insufficiently addressed important issues of illegality of the underlying contract.

If the issue of illegality was not raised in the arbitration, the question is: should a Malaysian Court allow a party to raise, issues and arguments which it could and should have raised in the arbitration in an application to set aside an award?  This practice is frowned upon in England (Dallal v Bank Mellat [1986] QB 441) and Singapore (Denmark Skibstekniske Konsulenter A/S I Likvidation v Ultrapolis 3000 Investments Ltd [2011] 4 SLR 997).

This area is relatively underdeveloped in Malaysian law as, in the past, it was not unusual for questions of illegality of the underlying award to be raised in a "rolled-up" application and hearing to set aside an award under sections 37 and 42 of the Act (the latter, being a procedure for appeal on a question of law).  In certain cases, this effectively allowed a party to resist an adverse award by arguing ex post facto that the underlying contract was illegal, or enabled a rehearing on issues of law surrounding the illegality.  Given that section 42 has since been repealed in 2018, Malaysian courts and parties should be conscious against such abusive tactics.

For further information, please contact Peter Godwin, Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur, Nicholas Hoh, Senior Associate, Daniel Chua, Associate, Rebecca Pang, Associate, or your usual Herbert Smith Freehills contact.

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.