THIRD PARTIES AND ARBITRATION AGREEMENTS, APPLICATION OF CONTRACT (RIGHTS OF THIRD PARTIES) ACT 1999

Facts
The appellants are the two managers of an investment structure, with underlying assets of EUR 200 million (the fund). The investment structure is based around an English limited partnership. The key contract underlying the dispute is the partnership deed (the contract) signed by four partners, but not the managers. One of these partners assigned its interest under the contract to the respondent (Fortress) as security for a loan. Fortress commenced English court proceedings contending that in 2011 the managers, and numerous others, acted in concert to reorganise the fund with severe adverse effects for Fortress and others.

The contract was governed by English law and contained an arbitration agreement (providing for arbitration under the ICC Rules, with an English seat). It also contained exclusion of liability and indemnity provisions specifically stated to be for the benefit of the managers against certain claims by the partners.
Proceedings by Fortress against the other partners were stayed under s9 Arbitration Act 1996 because of the arbitration agreement in the contract. The key issue before the Court of Appeal was whether the managers were also entitled to a stay of the English court proceedings against them, in favour of arbitration. The managers sought to rely on the arbitration agreement in the contract, and ultimately on the contractual exclusion in the contract as a defence to Fortress’s claim.

Rights under the 1999 Act
Section 1 of the 1999 Act provides, in summary, that a third party may enforce a term of a contract if the contract expressly provides that he may or a term purports to confer a benefit on him (unless it is clear that the parties did not intend this). That right is subject to any other relevant terms of the contract. So it is open to the contracting parties to impose limits or conditions on the third party’s right to enforce a particular term.

Where a right for a third party to enforce a term is subject to a term providing for the submission of disputes to arbitration, s8(1) provides that the third party will be treated as a party to that arbitration agreement in disputes between the third party and the promisor relating to the enforcement of a substantive right under the contract by the third party. Section 8(2) further provides that where a third party has a right to enforce an arbitration clause contained in a contract but does not fall within s8(1), the third party is treated as party to the arbitration agreement if he exercises the right to enforce the arbitration clause.

The managers argued, inter alia, that they were entitled to have the dispute arbitrated because they would be relying on the contractual exclusion clause in their defence to the claim and their right to rely on that clause was subject to a requirement that any dispute be arbitrated. The Court of Appeal disagreed.

Tomlinson LJ, giving the lead judgment, rejected the argument that in the context of the 1999 Act the arbitration clause must be read as covering any dispute with a third party arising out of or connected with the contract. Whether a right to take the benefit of an exclusion clause is subject to a term providing for arbitration is a question of construction.

There was no express language in the contract to the effect that the right to rely on the exclusion clause in a defence was subject to the arbitration clause. Tomlinson LJ held that it would be to "impute to the parties a really very far reaching intention if it is to be inferred that they positively intended to bring about the result that third parties would be bound by the outcome of arbitration proceedings which they had not themselves initiated in order to secure the benefit apparently conferred on them by the Agreement". "Very clear language" would be required to bring about a result that the right of a third party to avail himself of an exclusion clause in an agreement to which he is not party is subject to an arbitration clause in the same agreement. No such clear language could be found in the contract in question. The managers’ arguments were contrary to the consensual nature of arbitration.

Tomlinson LJ distinguished the situation where a third party brings proceedings (instead of defending a claim) to enforce a benefit conferred under a contract (such as an indemnity). In this situation Article 8(1) would operate to bind the third party to arbitration.

Toulson LJ, agreeing with Tomlinson LJ, helpfully summarised the effect of Article 8(1) – it allows a party to give a third party an enforceable substantive right, subject to a procedural condition on which the contracting party may, but need not, insist. By contrast, Article 8(2) allows for the party to give the third party an enforceable procedural right, which the third party may, but need not, exercise (since the right is unilateral). Although the contract at issue in this case could easily have contained a provision entitling the managers to insist that any claim against them by any party in connection with the agreement should be determined by arbitration, it "simply does not say so", thus Article 8(2) did not apply.

Comment
During the passage of the 1999 Act through Parliament there was some controversy as to whether it should cover arbitration agreements. The Law Commission expressed serious concern about an arbitration agreement constituting, in effect, a procedural condition on a third party’s rights to enforce a substantive promise contained in a contract in which an arbitration agreement appears.1 As Tomlinson LJ notes "... this case demonstrates that the Commission’s fears were not unfounded".

The Court of Appeal’s judgment highlights a clear difference between the operation of s8(1) and s8(2) of the 1999 Act, and also shows a reluctance to find a third party bound by an arbitration agreement for any claim made against the third party where the third party seeks to rely on some kind of limitation or exclusion of liability benefit conferred on it in the contract in which the arbitration agreement is contained. For such a claim against a third party to be subject to arbitration it seems that a very clear contractual provision would need to be added to that effect. Contract drafters will need to bear this in mind if it is intended that any disputes involving third parties should be arbitrated, in order to avoid any fragmentation of disputes between court and arbitration proceedings arising out of the same underlying contract or dispute.

Footnotes

1. Privity of Contract: Contracts for the Benefit of Third Parties, Law Com No 242 (1996), paragraphs 14.14-14.16.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.