It is an oft-repeated rule that only signatories to an arbitration agreement can be made party to arbitration proceedings. To this end, various jurisdictions have considered situations where an arbitration clause can be ‘extended’ to a third party, and arbitral institutions have also introduced rules to ‘join’ third parties to arbitration proceedings, subject to the consent of the parties. What steps can a third party take to safeguard its rights where parties to an arbitration do not consent to a joinder?

In Jaya Sudhir a/l Jayaram v Nautical Supreme Sdn Bhd & Ors (Federal Court Civil Appeal No. 02(i)-83-09/2018(W)), although the applicant, Jaya, was not a signatory to the shareholders’ agreement containing the arbitration clause, he nevertheless sought to enforce both contractual and beneficial rights under it. Malaysia’s Federal Court granted an anti-arbitration injunction restraining Malaysian arbitration proceedings in favour of litigation in Malaysian courts, to prevent a non-party from being left without meaningful remedy. In doing so, the Federal Court set out limited circumstances where it would allow a third party to restrain arbitration proceedings.

Background

Nautilus Tug & Towage (JVCo) was a joint venture formed to build, own and manage tug boats and provide harbour tug services in a project by a global mining company’s Malaysian subsidiary. Its initial shareholders were Nautical Supreme and Azimuth Marine. Jaya claimed that he had agreed to invest in the project based on his collateral understanding with Nautical Supreme and Azimuth Marine. Pursuant to the collateral understanding:

  • Azimuth Marine would hold 80% of the shares in the JVCo, with part of the shares being held in a trust for Jaya;
  • Jaya would be entitled to participate in the JVCo’s equity, either directly or indirectly, through Azimuth Marine’s shareholding; and
  • Nautical Supreme agreed to Jaya’s participation in the JVCo’s equity, and no further consent was required for Azimuth Marine’s divestment of any part of its shares.

Jaya subsequently requested that 10% of the JVCO’s shares held in Azimuth Marine’s name be transferred to him. After the transfer of the shares, Nautical Supreme denied the existence of the collateral understanding and commenced arbitration proceedings against Azimuth Marine and the JVCo pursuant to the arbitration clause in the shareholders’ agreement. Jaya was not a party to the shareholders’ agreement and thus not a party to the underlying arbitration clause and the arbitration proceedings.

Concurrently, Nautical Supreme commenced three separate civil suits against Azimuth Marine and the JVCo. Two of the actions sought injunctions in aid of the arbitration to maintain the status quo of the shareholdings and management of the JVCo, whereas the third action was a civil claim against Jaya for the tort of inducing a breach of contract, which was brought on the basis that Jaya was not a party to the arbitration.

Jaya commenced a claim in the High Court to enforce the collateral understanding and compel a transfer of the JVCo’s shares to him, amongst other orders. Ten months after he was made aware of the arbitration proceedings, Jaya applied for an injunction to restrain Nautical Supreme from continuing the arbitration proceedings pending the resolution of Jaya’s claim in the High Court.

High Court

The High Court allowed Jaya’s anti-arbitration injunction for the following reasons:

  • As Jaya was not a signatory to the shareholders’ agreement, he was not a party to the underlying arbitration agreement and therefore could not be made party to the arbitration proceedings.
  • Court proceedings are preferable to arbitration as no party is barred from taking part in the proceedings.

The High Court held that Malaysia’s Arbitration Act 2005 (Arbitration Act), and the case law decided under it, do not apply to non-parties to an arbitration agreement and proceedings. To this end, the High Court considered that the usual American Cyanamid test for an injunction applies, i.e. (i) whether there are serious issues to be tried; (ii) whether damages would be an adequate remedy; and (iii) whether the balance of convenience lies in favour of granting the injunction.

Court of Appeal

The Court of Appeal agreed that the provisions of the Arbitration Act do not apply to non-parties to arbitration proceedings. However, the Court of Appeal considered that, where arbitration proceedings are underway, the courts should give effect to the objectives of the Arbitration Act as a whole, i.e. to uphold party autonomy and to limit judicial interference with arbitration. In this light, the Court of Appeal considered that the correct legal test for a third party to restrain arbitration proceedings should be twofold, i.e. (i) the injunction cannot cause injustice to the claimant in the arbitration; and (ii) the continuance of the arbitration must be oppressive, vexatious, unconscionable or an abuse of process.

Applying the test, Jaya’s 10-months’ delay in seeking the injunction proved fatal to the application. The Court of Appeal also held that the prospect of concurrent proceedings and inconsistent findings between a court and tribunal is no longer a material factor to be considered in an application to restrain arbitration proceedings in light of the regime of the Arbitration Act. Therefore, the prospect of multiplicity or concurrent proceedings does not allow a court to override the parties’ agreement to arbitrate. The Court of Appeal reversed the decision of the High Court.

Federal Court

On appeal to the Federal Court, the critical issue for determination was whether a non-party to arbitration proceedings was entitled to have its proprietary claim heard first by restraining the parties to the arbitration from proceeding with the arbitration. The Federal Court disagreed with the reasoning of the Court of Appeal and reinstated the High Court’s ruling, premised on the following findings:

  • Neither the Arbitration Act, nor its legislative objectives, should apply to a party who does not fall within the scope of the legislation. Specifically, the Federal Court observed that Jaya was not a party who should be affected by the Arbitration Act by virtue of section 2, which provides that a reference to a ‘party’ under the Arbitration Act means “a party to an arbitration agreement or, in any case where an arbitration does not involve all parties to the arbitration agreement, means a party to the arbitration“.
  • It is the test identified by the High Court – and not the Court of Appeal – which applies to applications by a third party to restrain arbitration proceedings.

In its judgment, the Federal Court opined that where the dispute in the arbitration affects a non-party, priority should be given for the dispute to be litigated in court. The Federal Court espoused a ‘fairness’ test, in which:

the primary consideration on whether to grant the injunction to restrain the arbitration proceedings where the rights of a non-party thereto are involved is what would be the fairest approach to all parties. It must not result in any party suffering a severe disadvantage and for the ends of justice to be met, the benefits must outweigh the advantage.

The Federal Court also made clear its preference for litigation over arbitration where the rights of non-parties are involved, and set out the following guidelines:

  • A court may decline to give effect to an arbitration agreement where there is a risk of parallel proceedings and inconsistent decisions arising.
  • Where there are competing claims in court and arbitration proceedings, and not all parties are before both forums, court proceedings should take precedence.
  • In the case of non-parties, the judicial policy of avoiding parallel proceedings, the risk of inconsistent findings and inconvenience to third parties, triumphs over the policy of upholding arbitration agreements.

Notably, the court considered that the advantage of having litigation take priority over arbitration was “obvious“; litigation “would enable all material parties to be included” whereas a non-party’s claim “would not be ventilated at the arbitration proceedings“. To this end, the Federal Court identified the following situations where priority should be given for the matter to be litigated in court with the non-party:

  • Where a proprietary right is being arbitrated and litigated by signatories and non-signatories to the arbitration, and there exists a risk that the non-party would “be left out in the cold and [have] his rights affected“.
  • Where an injunction would prevent conflicting results arising from the two parallel proceedings.
  • Where, if the arbitration is to proceed followed by a third party’s court action, the issues argued in the arbitration would have to be reargued in litigation in the context of the non-party’s claim.
  • That any arbitral award given would necessarily involve the proprietary rights that were the subject matter of the parallel court action, which impacts the appellant’s proprietary claim.
  • That the issues in the arbitration and this suit overlapped, thus if the appellant succeeded in this suit and the first respondent also succeeded in the arbitration proceedings, the second and third respondents would have great difficulty in complying, once the arbitral award was enforced through a High Court.

Comments

The difficult issues faced by the Federal Court could have been avoided by careful drafting or, in its absence, well-planned steps in litigation or arbitration. It is worth being conscious of the different approaches that have been considered in different jurisdictions to some of the difficult issues faced by the Federal Court.

As a start, of interest is the fact that in his claim, Jaya sought to restrain Nautical Supreme from continuing any arbitration which affected his rights to the transfer of shares in the JVCo by Azimuth Marine without his participation in such arbitration.

In Singapore, the High Court considered that a non-signatory could be joined to an arbitration, with the consent of all the parties to the arbitration, but left undecided whether there exists any power under Singapore’s International Arbitration Act for a court to make such order in the absence of consent (see here). In England, the Court of Appeal opined that parties can and ought to include in their arbitration agreements the procedural right for third parties to insist on claims against them in connection with a contract being brought in arbitration (see here).

Should third parties to a contract be entitled to insist on its performance, without being bound by its dispute resolution clause? In Hong Kong, a non-party to a contract containing an arbitration clause who sought to enforce a contractual right under that agreement was held to be bound by any conditions integral to the exercise of the right, which includes the agreement to arbitrate (see here).

Notably, while Nautical Supreme conceded that any award in the arbitration proceedings would not bind Jaya, it was unable to confirm to the Federal Court whether the award would affect Jaya’s substantive claim in the Malaysian court. Nor could Nautical Supreme reconcile the possibility of the effect of any eventual registration of the award on Jaya’s court proceedings whilst it remained ongoing. For example, in France, the Cour de Cassation confirmed that the French Code of Civil Procedure allows a non-party to French domestic arbitration proceedings to – under certain conditions – challenge the resulting award by a specific procedure called third party opposition (tierce opposition) if the award has indirect legal consequences on the non-party. This is especially useful where a non-party is prevented from participating in the arbitration proceedings and is generally left with no action against the arbitral award which could have serious consequences for it (see here). If a claimant foresees the possibility of tierce opposition, it may be well advised to join the third party in question (if it can) into the arbitration proceedings, to avoid the inconvenient outcome of potentially having to litigate the same matter twice.

The decision of the Federal Court demonstrates that third parties can disrupt arbitration proceedings whenever their rights are potentially affected. However, the Federal Court did not definitively determine whether arbitration clauses can, in certain circumstances, bind third parties in Malaysia. This serves as an important reminder that parties should consider the complex issues created by multi-party and multi-contract scenarios when drafting their agreements to avoid multiplicity of proceedings and ensure that potential disputes could be dealt with in an efficient way in arbitration.

Parties should remember that dispute resolution clauses should not be considered as “boiler plate” clauses or reviewed in isolation, but should be water tight in all circumstances in which a dispute may arise in connection with the contract, especially in the context of drafting agreements which purport to confer a benefit on non-signatories, particularly if it is intended that third parties exercising rights under the contract should also be bound by the arbitration clauses.

 

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, or your usual Herbert Smith Freehills contact.

 

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.

 

Peter Godwin
Peter Godwin
Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur
+60 32 777 5104
Daniel Chua
Daniel Chua
Associate, Kuala Lumpur
+60 32 777 5101
Nicholas Hoh
Nicholas Hoh
Senior Associate, Kuala Lumpur
+60 32 777 5106

 

 

 


Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a foreign law practice in Singapore. Where advice on Singapore law is required, we will refer the matter to and work with licensed Singapore law practices where necessary.