ENGLISH COURT ALLOWS EQUITABLE COMPENSATION FOR NON-COMPLIANCE WITH ARBITRATION CLAUSE

In Argos Pereira España SL and another v Athenian Marine Ltd [2021] EWHC 554 (Comm), the English High Court found that a third party who acquires the right to claim under a contract may be liable to pay equitable compensation if it fails to comply with the arbitration clause.

This case clarifies that (i) third party insurers or assignees who receive the benefit of a contract containing an arbitration clause must commence claims in accordance with the arbitration clause in the primary contract; (ii) parties who have had to defend proceedings brought in breach of an arbitration clause are entitled to compensation without having to apply for declaratory relief; and (iii) group companies who are on the receiving end of claims brought in breach of an arbitration agreement may be able to recover their wasted costs where there is a risk that no other remedy is available.

Background

The dispute arose out of a shipment of frozen seafood under bills of lading governed by English law and under which disputes were to be referred to ad hoc arbitration seated in London. The cargo was defective, and the consignee’s insurer (the “Insurer”) ultimately pursed a claim in arbitration against the owner of the vessel (the “Owner”) by way of subrogation.

Although the bills of lading required disputes to be submitted to arbitration, the Insurer initially brought court proceedings in Spain. The Insurer initiated the court proceedings against Lavinia Corporation (“Lavinia”), the Owner’s manager and the charterer of the vessel, on the mistaken understanding that Lavinia was the legal carrier of the cargo.

Lavinia successfully challenged the jurisdiction of the Spanish courts on the grounds that Lavinia was not the correct defendant to the action. Nonetheless, Lavinia was only awarded a fraction of its costs for the Spanish proceedings by the Spanish courts, and was left out of pocket for the rest (the “Irrecoverable Costs”).

When arbitration proceedings were eventually commenced by the Insurer, the Owner counter-claimed for the Irrecoverable Costs. The sole arbitrator ordered the Insurer to compensate the Owner for the Irrecoverable Costs incurred by Lavinia. The Insurer and consignee of the cargo brought a challenge to the arbitrator’s award under s69 Arbitration Act 1996 on the basis that there had been an error of law.

The Court was required to consider whether the arbitrator was correct in ordering the Insurer to compensate the Owner for the Irrecoverable Costs. This raised two questions:

1. Whether an assignee or subrogee of cargo claims can be held liable to pay equitable compensation to the carrier if, in breach of an equitable obligation to arbitrate those claims, the assignee brings proceedings in respect of those claims in a foreign court against a party other than the carrier?
2. If so, whether the carrier can rely on the principle of transferred loss to claim equitable compensation in respect of legal costs incurred by a third-party in defending foreign proceedings, where the carrier itself was not the defendant and did not itself suffer any such loss?

Decision

Compensation

It was common ground between the parties that a party to an arbitration agreement who sues their counterparty otherwise than in accordance with the agreement will be in breach of contract, for which damages are available. However, the Court noted that the Insurer was not a party to the arbitration agreement, and so it could not be said to have breached it by bringing the Spanish proceedings.

The arbitrator found that the Insurer owed an equitable obligation not to sue the Owner (who was party to the bill of lading) other than in accordance with the arbitration clause. The Insurer also owed an obligation not to sue non-parties (such as Lavinia) in relation to disputes that fell within the scope of the arbitration clause.

The Court proceeded to consider whether breaching this equitable obligation left the Insurer liable to pay compensation. In support of this position, the Owner argued that the Insurer had assumed a duty to compensate “irrespective of and additional to the remedies of injunction or declaration”, highlighting the risk of abuse if compensation was not available in its own right.

Noting the absence of case law precluding such an obligation, as well as its compatibility with equity and logic, the Court accepted the Owner’s submissions. Accordingly, it did not disturb the sole arbitrator’s decision to award the Irrecoverable Costs.

Transferred loss

The second question for the Court was to consider who could claim the compensation. As Lavinia was not a party to the arbitration, the Owner relied on the principle of transferred loss to claim the Irrecoverable Costs in its own name.

The Court cited the leading authority on the principle, Swynson Ltd v Lowick Rose LLP [2018] AC 313, in which the Supreme Court set out the requirements that (i) the “known object” of the transaction must be to benefit a third-party, and (ii) a breach of the duty must be likely to cause that party loss. Importantly, it can only ever apply to prevent a “legal black hole”, in which the party who has actually suffered the loss is otherwise unable to have it remedied.

The Court referred to the arbitrator’s finding that the arbitration clause was intended to benefit Lavinia, being a closely related company of the Owner, which was therefore a “known object” of its dealings, in the sense that a breach of the Insurer’s obligations “if they sued a third party such as Lavinia…would lead to harm or detriment to Lavinia”.

This left only the question of whether denying compensation to the Owner would leave Lavinia without any way to recover its loss. The Court considered whether Lavinia would be entitled to damages in lieu of an injunction. While it was doubtful whether an injunction was available in respect of the Spanish proceedings in the light of West Tankers (for a recent discussion of that case, see here), opinions differed on whether damages under s50 of the Senior Courts Act 1981 could be granted by way of substitute. Whilst admitting ”considerable uncertainty” as to the availability of the damages remedy, the Court did not consider that the arbitrator had erred on the transferrable loss point.

Accordingly, the appeal was dismissed and the arbitrator’s award was upheld, allowing the Owner to recover the Irrecoverable Costs as originally awarded by the sole arbitrator.

Comment

This case provides welcome clarity to parties who agree to arbitrate their disputes that their arbitration agreement cannot be circumvented by third parties who benefit from the contract, such as subrogees or assignees, who (i) must still comply with the contractual dispute resolution mechanism, and (ii) may be liable in damages for the pursuit of a claim in breach of an arbitration clause. Importantly, this relief is available independently and in addition to existing remedies.

This case is also a useful precedent for parties wishing to recover wasted costs incurred by group companies, who may be able to rely on the “transferred loss” principle where there is a risk that no other remedy is available.

For more information, please contact Craig Tevendale, Partner, Elizabeth Kantor, Senior Associate, Rebecca Warder, Professional Support Lawyer, or your usual Herbert Smith Freehills contact.

The authors would like to thank Louis Austin for his assistance in preparing this blog post.