MALAYSIA’S FEDERAL COURT SETS ASIDE DEFAULT JUDGMENT OBTAINED IN BREACH OF AN ARBITRATION AGREEMENT

In Tindak Murni Sdn Bhd v Juang Setia Sdn Bhd (Civil Application No. 03-2-11/2018(B) and Civil Application No. 02(i)-104-11/2018(B)), the Federal Court was asked to decide whether a default judgment from a Malaysian court which was obtained in breach of an arbitration agreement in the underlying contract between the parties should be set aside on the basis of the existence of the arbitration agreement.

Background

The appellant (“Tindak Murni”) entered into a building construction contract (“Contract”) with the respondent (“Juang Setia”), which contained an arbitration clause. Following a dispute over an alleged failure to make payment by Tindak Murni, Juang Setia commenced civil proceedings against Tindak Murni in the High Court in Shah Alam to claim the alleged outstanding sums.

At the High Court, Tindak Murni did not formally enter its appearance under the rules of the court, nor take immediate steps to stay the court proceedings under the section 10 of the Arbitration Act 2005 (the “Act”). As a result, on 1 March 2017, Juang Setia obtained a default judgment against Tindak Murni to pay the outstanding liquidated sums.

On 10 April 2017, Tindak Murni applied to set aside the default judgment on the basis that it had valid disputes against Juang Setia’s claims and that there exists an arbitration agreement between the parties. On 31 July 2012, the Registrar of the High Court set aside the default judgment on the basis that “there was a defence on the merits in that there were disputes and/or triable issues justifying the matter being heard on the merits”.

Upon setting aside the default judgment, Tindak Murni did not file a defence in the court proceedings, but instead applied for a stay of the court proceedings pending arbitration. Unsatisfied, Juang Setia appealed to the High Court Judge against the decision of the Registrar, and for a determination of Tindak Murni’s application to stay the court proceedings. The High Court Judge held that (1) there was, on its face, a potential defence which could be raised, which substantively justified the setting aside of the default judgment; and (2) a valid arbitration clause to which the parties had agreed to be bound. The court proceedings where therefore stayed pending referral of the dispute to arbitration.

Following the decision of the High Court Judge, Juang Setia then filed two appeals to the Court of Appeal against the (1) decision to set aside the judgment in default (“Default Judgment Appeal”); (2) the decision granting the stay of court proceedings pending arbitration (“Stay Appeal”).

Decision at the Court of Appeal

Administratively, the Court of Appeal dealt with both appeals separately (as did the High Court), and proceeded to hear and decide the Default Judgment Appeal before the Stay Appeal.

On the Default Judgment Appeal, Juang Setia argued that the relevant clauses of the Contract and applicable Malaysian law relating to interim certification was such that its claim was beyond dispute. In other words, the existence of a debt due and owing to the Contractor was undisputed. As such the contention was that there was simply no dispute that could be arbitrated. The Court of Appeal agreed that the certificates of payment were conclusive in fact, which effectively dismissed any possibility of defects in the work done. It concluded that there could not be any merits to Tindak Murni defending the claim, which meant that the High Court had wrongly set aside the default judgment. The Court of Appeal allowed the contractor’s appeal, restoring the default judgment.

As a result of the decision on the Default Judgment Appeal, the Court of Appeal allowed the Stay Appeal without addressing its merits.

Decision at the Federal Court

The Federal Court held that both appeals should have been heard together (as opposed to the sequential and isolated manner adopted by the Court of Appeal), and thereafter determine which of the two appeals should be decided first in time. It determined that section 10 of Act requires the court to first ascertain whether there is, in fact, an arbitration agreement in respect of the dispute. Section 10 of the Act reads as follows:

A court before which proceedings are brought in respect of a matter which is the subject of an arbitration agreement shall, where a party makes an application before taking any other steps in the proceedings, stay those proceedings and refer the parties to arbitration unless it finds that the agreement is null and void, inoperative or incapable of being performed.

The Federal Court observed that the Court of Appeal, having heard and decided the Default Judgment Appeal first, was left with no choice but to allow the Stay Appeal, given that it would be inconsistent with the Court of Appeal’s decision in the Default Judgment Appeal to make a subsequent finding on the merits of the Stay Appeal. In so doing, the Court of Appeal failed to recognise that the subject matter of both appeals were “inextricably intertwined”, and that an application to stay court proceedings pending arbitration is an “essential jurisdictional issue”, which a Malaysian court is bound to consider. As such, the Federal Court proceeded to hear both appeals simultaneously.

Having found a valid arbitration agreement between the parties, the Federal Court considered that the existence of a default judgment is immaterial to the parties’ right to arbitrate the dispute as long as (1) no procedural steps which can be construed as a submission to the court’s substantive jurisdiction have been taken in the court proceedings; and (2) that the arbitration agreement is not null and void, inoperative, or incapable of being performed.

Interestingly, the Federal Court starkly disapproved of Juang Setia’s attempt to circumvent the arbitration agreement by procuring a judgment of a Malaysian court and thereafter argue that the default judgment should take precedence over the breached arbitration agreement, thereby eliminating any consequence for the breach of the arbitration agreement. In doing so, Juang Setia argued that the effect of allowing the arbitration agreement to take precedence is to render the judgment of the court as a ‘subordinate’ to an arbitration agreement, which cannot be done without specific statutory legislation. The Federal Court rendered strong criticism of this argument, stating that:

if this form of legal rationale is allowed to persist … all forms of dispute resolution agreed to between parties in their contracts would be rendered ineffectual and nugatory as it would be open to one party to breach the same and effectively put an end to the agreement to resolve disputes by way of arbitration.

Comment

The case demonstrates a number of interesting trends.

First, Malaysian courts no longer consider whether a ‘dispute’ exists for the purposes of an application to stay court proceedings. The Court of Appeal took the wrong approach by making a substantive determination over whether a ‘dispute’ could properly exist. This approach echoes section 10(1) of the Act prior to its amendment in 2011. The pre-2011 provision of the Act reads:

A court before which proceedings are brought in respect of a matter which is the subject of an arbitration agreement shall, where a party makes an application before taking any other steps in the proceedings, stay those proceedings and refer the parties to arbitration unless it finds –

(a) that the agreement is null and void, inoperative or incapable of being performed; or

(b) that there is in fact no dispute between the parties with regard to the matters to be referred.

Section 10(1) of Act as it now stands makes no reference to the non-existence of a dispute as a ground for resisting an application to stay court proceedings in favour of arbitration. The Federal Court’s approach is consistent with other post-2011 cases which have dispensed with any formal or substantive review over the existence of a dispute by the courts (see TNB Fuel Services Sdn Bhd v China National Coal Group Corp [2013] 4 MLJ 857, paragraph 24; Press Metal Sarawak Sdn Bhd v Etiqa Takaful Bhd [2016] 5 MLJ 417, paragraph 33).

Second, a party seeking to circumvent an arbitration agreement may sometimes choose to obtain a default judgment from a national court, and then seek to enforce that judgment as a debt in the courts of the country where the counterparty is located or has assets. By then, depending on the jurisdiction involved, difficulties may arise under national law to properly challenge the default judgment or the validity of any enforcement proceedings arising out of the default judgment on the basis of an existing arbitration agreement between the parties. In order to avoid the risk of costly procedural complications in any national court, parties should take prompt and proactive steps to stay any court proceedings brought in breach of an arbitration agreement.

Finally, the procedural steps and substantive arguments on the merits of the payment dispute canvassed by both the Court of Appeal and the Federal Court underscores the Malaysian construction industry’s increasing need for arbitrations to address disputes in the construction industry efficiently. To this end, the Queen Mary University of London 2019 International Arbitration Survey (Driving Efficiency in International Construction Disputes) found that the top procedural feature which respondents consider to have the greatest potential to improve efficiency in international construction arbitration was the summary disposal of unmeritorious claims or defences at an early stage. The latest commercial arbitrations rules of a number of institutions, including the Hong Kong International Arbitration Centre (“HKIAC”), the International Chamber of Commerce (“ICC”), the Singapore International Arbitration Centre (“SIAC”) and the Stockholm Chamber of Commerce (“SCC”), provide summary disposition procedures, including early dismissal procedures and summary judgment procedures. It remains to be seen whether the Asian International Arbitration Centre (“AIAC”) would provide such procedures in the revised arbitration rules which it expects to introduce this year.

The judgment of the Federal Court is available in English here.

For further information, please contact Peter Godwin, Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur, 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.

Peter Godwin
Peter Godwin
Partner
+60 3-2777 51042

Daniel Chua
Daniel Chua
Associate
+60 3 2777 5101

 

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