MALAYSIA: HIGH COURT DECLINES TO STAY ARBITRATION PROCEEDINGS ON THE BASIS OF A NON-SIGNATORY'S ALLEGATION OF BRIBERY AND CORRUPTION UNDERLYING THE CONTRACT

In Vertex Superieur Sdn Bhd & Anor v Shell Malaysia Trading Sdn Bhd (Civil Suit No. BA-22C-5-03/2020), the Malaysian High Court refused to stay court proceedings brought in breach of an arbitration agreement on the basis that it was in the public interest that allegations by a non-signatory that an underlying contract was procured by private bribery and corruption should be tried expeditiously through court proceedings. While the case is indicative of how bribery and corruption allegations brought by a related but non-signatory party to an arbitration agreement would be treated in Malaysian courts, it highlights the need for a more sophisticated approach in dealing with these nuanced but increasingly common issues in arbitration.

Background

On 14 May 2019, Shell Malaysia Trading Sdn Bhd (SMT) entered into a Design and Build contract with Vertex Superieur Sdn Bhd (Vertex) for the construction of a petrol station in Selangor (Contract). At the same time, the two shareholders and directors of Vertex executed an irrevocable guarantee and indemnity in favour of SMT to jointly and severally indemnify SMT for any loss or damage suffered by SMT in the event of any breach of the Agreement by Vertex (Indemnity). The salient terms of the transaction are as follows:

• Under the Contract, Vertex warranted that it had not made, offered or authorised any payment to any person which could comprise a facilitation payment or violate anti-corruption laws in Malaysia. SMT was entitled to terminate the Contract by written notice if SMT held a reasonable opinion that Vertex had breached anti-corruption laws in Malaysia.
• The Contract also provided a dispute resolution clause, requiring the parties to attempt to settle any dispute arising under the Contract by way of negotiation for a period of 30 days prior to commencing arbitration. The Indemnity signed by the two shareholders, however, did not contain any arbitration clause.

On 18 February 2020, SMT issued a notice of termination to Vertex on the basis that SMT had discovered that Vertex had breached the latter's warranty under the Contract that it had not violated any anti-corruption laws in Malaysia. The notice purported to take effect immediately, and required Vertex to cease its works and deliver vacant possession of the site to SMT. Following receipt of the notice, Vertex lodged a police report on the same day, alleging that an employee of SMT had, sometime in 2017, requested for "gratification" from Vertex and a shareholder director (First Guarantor) in order to facilitate the award of the Contract to Vertex. It was understood that that SMT employee had been arrested by the Malaysian Anti-Corruption Commission prior to the termination.

Following the termination, Vertex and the First Guarantor commenced court proceedings in the Kuala Lumpur High Court, alleging that the First Guarantor had reported the request for a bribe to a number of other employees of SMT between 2017 and 2018, but there was no action taken against the employee. In response, SMT filed an application under section 10 of the Arbitration Act 2005 (Act) to stay the court proceedings brought by Vertex in breach of the arbitration agreement in the Contract, and for the First Guarantor's claim in the High Court to be stayed pending the resolution of Vertex's claim against by SMT in arbitration.

The main issues before the High Court were:

• whether Vertex and SMT were required to negotiate the subject matter of the termination notice prior to SMT's issuance of the said notice; and
• whether the court should stay the court proceedings and refer the dispute to arbitration in light of the First Guarantor's claims against SMT in the court proceedings.

For the second issue, the judge considered three options, which are:

• to stay the court proceedings and refer Vertex's claim to arbitration under section 10 of the Act, and try the First Guarantor's claim upon final disposal of the arbitration;
• to stay the court proceedings and refer Vertex's claim to arbitration under section 10 of the Act, and proceed to try the First Guarantor's claim; or
• refuse to stay Vertex's claim and proceed to try both Vertex and the First Guarantor's claims.

Decision

The judge dismissed the first issue on the basis that it was contrary to public policy for the subject matter of the termination notice (regarding the alleged breach of anti-corruption laws) to be settled by negotiation.

The judge did not refuse a stay on the basis that the arbitration agreement was null and void, inoperative or incapable of being performed. Instead, the judge exercised his discretion under Order 92 rule 4 of the Rules of Court and the inherent power of the High Court to refuse SMT's application to stay Vertex's claim and allow the dispute to be litigated, for the following reasons:

• It is in the public interest for any corruption offence which has been committed regarding the Agreement to be tried expeditiously in court in order to publicly expose any party involved in such wrongdoing and deter the public from undertaking corrupt activities.
• All the evidence of corruption (if any) adduced in the arbitration would be subject to the requirement of confidentiality and consequently, the public has no access to such evidence.
• The First Guarantor's liability under the Indemnity is independent of Vertex's claim under the Contract. The court speculated that SMT might object to the admissibility of evidence on corruption at the trial of the First Guarantor's claim.
• It is just, expeditious and economical for the court to deal with the claims given that the evidence that will be led by Vertex and the First Guarantor is likely to be the same.
• The cost of maintaining two separate arbitration and litigation proceedings would be uneconomical to Vertex and the First Guarantor.
• The exhaustion of any review of an award from the arbitral tribunal presiding over Vertex's claim against SMT, and any appeal, would delay the trial of the First Guarantor's claim.
• A stay of the proceedings in favour of arbitration might result in conflicting decisions in the arbitration and the trial of the First Guarantor's claim against SMT.
• Vertex and the First Guarantor have the right to sue SMT in the court proceedings.
• No injustice is caused to SMT by having the dispute resolved in court as it would have the right to resist Vertex's and the First Guarantor's claims, and could initiate a counterclaim against the two directors and shareholders of Vertex in the proceedings premised on the Indemnity.

The judge concluded that the public interest of having the issue litigated in court far outweighed the practical effect of allowing Vertex to circumvent the arbitration agreement.

Comment

The dispute brought out nuanced issues relating to the potential extension of an arbitration agreement to non-signatories, and the potential effect of bribery allegations underlying the procurement of a contract on the validity of an arbitration agreement, the jurisdiction of a tribunal to resolve such disputes, and the admissibility of such claims to arbitration. Although none of these issues appears to have been canvassed, there are two observable trends following this judgment.

The treatment of claims of bribery and corruption which are the subject of an arbitration agreement

Allegations of bribery, fraud and corruption are not uncommon in arbitration, but the effect of such allegations on questions of validity, jurisdiction and admissibility remain undeveloped in Malaysia.  In the past, the Malaysian courts did not intervene when private bribery allegations were the subject of an arbitration agreement. In Bina Jaya Mantap Sdn Bhd v Institute of Technology Petronas Sdn Bhd (Originating Summons No. 24C-4-08/2013), the High Court, in issuing an injunction to restrain the defendant from calling on a bank guarantee in support of arbitration proceedings, acknowledged that the plaintiff's allegations of private bribery against an employee of the defendant's agent "form[ed] the subject matter of arbitration and are to be resolved by arbitration as to its merits". This approach is consistent with the approach of the English Court of Appeal in Fiona Trust & Holding Corp v Yuri Privalov & Ors [2007] EWCA Civ 20, which held that claims to rescind charterparties on the grounds of bribery fell within the scope of valid arbitration clauses contained in those charterparties.

The Malaysian High Court judge in the present case found that it was contrary to public policy for disputes involving private bribery allegations to be resolved by negotiation. However, it did not make any determination as to whether such allegations affected the validity of the arbitration agreement between Vertex and SMT or the prospective arbitral tribunal's jurisdiction over the dispute. While the judge did not go as far to suggest that such claims are not arbitrable, some of the reasons outlined by the judge arguably hint that such claims may be inadmissible before an arbitral tribunal.

The judicial treatment of arbitration agreements where non-signatories are involved in litigation

Following the decision of the Federal Court in Jaya Sudhir a/l Jayaram v Nautical Supreme Sdn Bhd & Ors (discussed here), Malaysian courts may refuse to give effect to an arbitration agreement where the interests of third parties are involved or where there is a risk of parallel proceedings and inconsistent decisions arising out of the conduct of an arbitration. Priority would ordinarily be given for the matter to be determined by the court if that would be the fairest approach to all parties taking into consideration the interests of the justice of the case.

While it is difficult to balance competing interests between upholding arbitration agreements and the rights of non-signatory third parties, the High Court judge did not appear to consider whether joinder provisions could be applied to balance the interests of all parties. Further, it is difficult to conclude whether the rights of a non-party to the transaction were actually affected, given that the First Guarantor was one of two of the shareholders and directors of Vertex, and that both directors had signed the Indemnity as part of the transaction. There is no indication that the High Court considered whether the First Guarantor should have been joined to the arbitration based on established principles of veil-piercing and the alter ego doctrine.

Finally, we note that:

• The findings on confidentiality and admissibility of evidence appear to be speculative.
• No standard of review was considered or applied to ascertain the veracity of the allegations of private bribery and corruption, given their weight in persuading the court not to give effect to the arbitration agreement.
• The assumptions held by the High Court point towards a policy of preferring litigation over arbitration where a non-signatory is involved.

When agreeing to arbitration provisions, few parties anticipate criminal misconduct as a source of dispute. However, it is not uncommon for a disputing party to raise allegations of bribery, corruption or some other wrongdoing – merited or otherwise – as a means to pressure a counterparty into settlement or circumvent an arbitration agreement. The decision of the High Court confirms the potential for circumventing an arbitration agreement on that basis.

Further, Malaysian courts do not have a track record of giving effect to arbitration agreements where non-signatories are involved in the dispute. Based on this judgment, parties are likely to face an uphill task in arguing that an agreement to arbitrate can be extended to a non-signatory third party under Malaysian law.

The decision should remind parties to consider carefully the wording of their arbitration agreements if they wish to include all relevant parties in an arbitration agreement, or to exclude certain types of claims and allegations from arbitration, whilst maintaining the efficacy of their dispute resolution procedures.

For further information, please contact Peter Godwin, Partner, Daniel Chua, 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.