Is the finality of arbitrations now a myth for apportionable claims?

Proportionate liability now applies to the substantive law of arbitrations in Australia

The finality of arbitrations is now a myth – at least in respect of disputes involving apportionable claims where parties have not contracted out of the proportionate liability regime.

When parties to a commercial contract select arbitration as a forum for resolution of disputes, it could be expected, in the absence of clear words to the contrary, that their common intention at the time of contracting was to have any disputes finally settled in the arbitration. So much is reflected in the objects of each Commercial Arbitration Act in this country.

This long held presumption was turned on its head in the recent High Court decision in Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24 which overturned the South Australia Supreme Court of Appeal where the majority of the Court (Edelman and Steward JJ dissenting) answered “YES” to the following question:

“Does Part 3 of [the Law Reform Act] and … Part VIA of [the CCA] apply to this commercial arbitration proceeding conducted pursuant to … [the Domestic Arbitration Act]?” (Preliminary Question)

Brief facts

This case involved the design and construction of a Bunnings warehouse in Adelaide. Pascale, the builder, engaged Tesseract to provide engineering consultancy work in connection with the building works. The contract contained an arbitration clause and a dispute regarding the standard of Tesseract’s work was referred to arbitration. Pascale sought damages for breach of contract and negligence and, pursuant to s 236 of the Australian Consumer Law (ACL), for misleading or deceptive conduct in contravention of s 18 of the ACL.

Tesseract’s defence included a proportionality defence for apportionable claims under Part 3 of the Law Reform (Contributory Negligence and Apportionment of Liability) Act 2001 (SA) (Law Reform Act) and Pt VIA of the Competition and Consumer Act 2010 (Cth) (CCA) (Proportionate Liability Laws). Tesseract alleged that any liability that it was found to have owed to Pascale should be limited and apportioned to a third party, Mr Penhall, who Tesseract claimed was responsible for the loss. Mr Penhall assisted Pascale in preparing the tender for the design and construction of the warehouse. Mr Penhall, as a non-party to the contract, could not be joined to the arbitration without his consent and the consent of the parties to the contract. Pascale denied the applicability of the Proportionate Liability Laws in the arbitration and the Preliminary Question was raised in the arbitration for initial resolution by the Court of Appeal of the Supreme Court of South Australia.[1]

The Court of Appeal unanimously answered NO to the Preliminary Question, on the basis, generally, that the Proportionate Liability Laws, being substantive law in South Australia, could not be applied by the Arbitral Tribunal in the arbitration. The Court of Appeal reasoned that attempting to apply the proportionate liability regimes to arbitrations “would result in difficulties and differences not contemplated by the relevant legislatures in enacting those regimes” and as “essential features of both of the regimes … are not amenable to application in arbitration proceedings“, it would not be “appropriate to conclude that the parties intended to confer the Arbitrator with authority to apply these provisions in this changed way; or indeed that the relevant legislatures intended that the regimes they enacted might be ‘picked up’ and applied, in a materially changed way, by an implied term of an arbitration agreement.“[2]

Tesseract appealed the Court of Appeal’s decision and the dispute proceeded to the High Court for final resolution.  The High Court had to grapple with how the risk-sharing policy under the Proportionate Liability Laws (which enlarged disputes between a greater number of wrongdoers) could be applied in arbitrations in which parties expected to have their disputes finally resolved.

The Proportionate Liability Laws

The Proportionate Liability Laws, in effect, seek to spread responsibility for loss or damage in the relevant proportions according to each party’s share of their respective responsibility for causing the loss or damage. These reforming laws were enacted at the turn of this century and overturned the common law principle of solidary liability – where one wrongdoer could be held accountable for the entirety of the loss and would then be required to commence separate contribution proceedings against other concurrent wrongdoers. By the time (or before the time) separate proceedings could be commenced, other concurrent wrongdoers (perhaps with knowledge of, and in anticipation of, upcoming proceedings) would invariably be placed into administration or cease to exist entirely. This had a crippling effect on the insurance industry as premiums rose sharply to offset the cost to the industry in defending large litigious claims. The Proportionate Liability Laws were introduced to “ensure, amongst other things, that insurers could be more confident in insuring risk, as the insured risk would be confined to the loss for which the insured was responsible”. The associated procedural rules were “designed to provide the appropriate balance between the interests of plaintiffs and defendants“.[3]

The effect of the Proportionate Liability Laws is “typically not confined to a principle that limits the liability of wrongdoers. It typically also operates by way of substantive and procedural rules to distribute liability among wrongdoers, and therefore to enlarge a dispute between an applicant and a respondent into a dispute that also includes third parties”.[4]

Arbitrations

In contrast to the Proportionate Liability Laws, arbitration has been widely regarded as a “one stop shop” for commercial parties to resolve their differences by a contractual, consensual process which enables flexibility around which substantive laws, procedural law and curial law are to apply, all within the confines of a confidential tribunal hearing.

The only limits on domestic commercial arbitrations are whether the dispute is:

• “arbitrable” which goes to the jurisdiction of the Tribunal to hear and determine the dispute (for example the arbitration agreement may be inoperative or incapable of being performed); or
• whether an award may not be able to be enforced by reasons for example, of incapacity or where the recognition or enforcement of the award would be contrary to the public policy of the State.

The parties to an arbitration agreement are otherwise at liberty to agree on:

• the substantive law to be applied (for example, parties could choose the laws of Zimbabwe if they prefer);
• the procedural law (the rules within which the arbitration must be conducted, for example the ACICA[5] Rules or the Resolution Institute Rules); and
• the curial law (called the seat or place of the arbitration – which will dictate which courts will have jurisdiction for example to hear a separate question, order an interim measure or hear an application to enforce or refuse to enforce an arbitral award).

The High Court decision and the current law concerning proportionate liability defences in arbitrations

The High Court majority (5:2) allowed the appeal, ruling that the substantive law of proportionate liability in South Australia (the Law Reform Act) and the Commonwealth (CCA) applies to arbitration in South Australia. Given that all Australian states and territories have uniform domestic arbitration laws, the High Court decision permeates to all domestic arbitrations in Australia.

The dilemma faced by the High Court was articulated in Steward J’s judgment:

“In this appeal, the Court is faced with an invidious choice: does the law of proportionate liability apply in the proposed arbitration between the parties to this dispute? If South Australia’s law concerning proportionate liability applies in the proposed arbitration – and only part of that law can ever so apply – the claimant, Pascale Construction Pty Ltd (“the claimant”), may be disadvantaged. That is because if, in the proposed arbitration, it can only recover part of its claimed loss or damage against the respondent, Tesseract International Pty Ltd (“the respondent”), the claimant will then have to institute separate proceedings to try to recover the balance of its loss against the alleged concurrent wrongdoer, Mr Penhall, as identified by the respondent. Mr Penhall is a third party; he is not a party to the proposed arbitration. Nor can Mr Penhall be joined to the proposed arbitration without his consent. In contrast, if South Australia’s law concerning proportionate liability does not apply in the proposed arbitration – as found by the Court of Appeal of the Supreme Court of South Australia – then the respondent may instead be disadvantaged. That is because the claimant may be able to recover all of its loss or damage in the arbitration, leaving the respondent in separate proceedings to recover contribution – if it can – from Mr Penhall. In either case, the risk of multiple proceedings and inconsistent findings as to the extent of liability is real.”

The tenor of Pascale’s argument was that the version of proportionate liability that Tesseract sought to have applied in the arbitration was not the law of South Australia. The law of South Australia shifts the risk to the plaintiff in return for the plaintiff having the opportunity to join those other wrongdoers who have been identified or which the defendant has disclosed. Pascale argued that the inability for it to be able to join concurrent wrongdoers into the arbitration is not the law of South Australia, rather a distorted version of it.

The majority of the High Court disagreed with Pascale with three separate majority judgments which broadly identified the following reasons in answering YES, to the applicability of Proportionate Liability Laws in the arbitration:

• the joinder of third parties under the Proportionate Liability Laws was procedural law and not substantive law and the substantive law of South Australia was the law to be applied by the Arbitrator (See Gageler CJ at [61] of the judgment);
• the applicable statutes did not expressly exclude their application to arbitrations;
• applying the Proportionate Liability Laws would not result in an arbitration that was incapable of being performed or result in an award that was contrary to the public policy of South Australia;
• the ability to compel the joinder of all wrongdoers in one proceeding is not such an integral feature of the Proportionate Liability Laws, given that parties (in SA) could contract out of the regime, and the statutes expressly provided for what is to happen when there are subsequent proceedings. (see Gordon and Gleeson JJ at [127 – 138].

The dissenting judgments of Steward J and Edelman J focussed on the historical treatment of proportionate liability to arbitrations and the interpretation of the statutes and the parties implied choice to arbitrate in accordance with the substantive law of South Australia. Edelman J considered the silence of the parties in their contract as to the applicability of proportionate liability and preferred the Fiona Trust approach to interpretation of arbitration agreements, namely that the interpretation of an arbitration agreement “must be influenced by whether the parties … were likely to have intended that only some of the questions arising out of their relationship were to be submitted to arbitration and others were to be decided by national courts“.[6]

Implications for construction contracts

While the scope of this update only lightly touches upon the detailed reasons of the High Court, the default rule for construction disputes which are referred to arbitration and which involve apportionable claims means that the final allocation of responsibility for all concurrent wrongdoers will likely need the Court’s intervention which would then result in a multiplicity of proceedings.

The arbitrator (absence any consensual joinder of parties) will be required to apportion responsibility based on the arguments of only two parties – being the parties to the arbitration agreement. It is acknowledged that the arbitrator in applying express or implied procedural rules, may impact third parties (which may be the alleged concurrent wrongdoers), for example by:

• Compelling the Respondent to provide notice of other concurrent wrongdoers;
• Compelling production of documents from third parties under subpoenas; and
• Compelling the attendance of third parties at the hearing for cross-examination.

These rules of procedure may be utilised by a Claimant to better inform itself as to the likelihood of success in commencing separate contribution proceedings against those parties.

However, an arbitral award, while able to be recognised and enforced as a judgment of the court (and thus act as a ceiling in subsequent proceedings for recovery), has no bearing at all, in terms of precedent value or otherwise, on any subsequent decision of a court. The risk of fragmented proceedings with “inconsistent findings as to the extent of liability is real”.[7] As Beech J observed in Curtin University of Technology v Woods Bagot Pty Ltd [2012] WASC 449 at [86]:

“The court would not be bound by, or even influenced by, the arbitrator’s findings on the conduct and responsibility of those other concurrent wrongdoers. Consequently, the claimant would face the risk of a conflicting judgment from a court in the subsequent proceedings.”

In addition to the observation above, any insolvency risk in chasing third parties in separate proceedings is allocated to the Claimant. While this shift in insolvency risk allocation was a fundamental pillar of the Proportionate Liability Laws, this does not translate as easily to a Claimant who has agreed to have its dispute resolved privately in arbitration.

We have collectively referred to the risk of multiplicity of proceedings, conflicting judgments and pursuing insolvent third parties as the “Tesseract Risk” which is now allocated to the Claimant under the default rule in commercial arbitration law in Australia.

As construction projects often have a multiplicity of parties from various disciplines – typically the owner/principal, an architect, engineer, builder and subcontractors – the Tesseract Risk presents a significant issue for parties in construction contracts wishing to resolve their disputes by arbitration.

Some ways to address the Tesseract Risk in construction projects, are to:

1. Consider expressly contracting out of the Proportionate Liability Laws, in those states where this is permitted. If there a is a project in Queensland (where contracting out is not permitted), consider whether to draft the arbitration agreement (or dispute resolution clause) such that the substantive law of another jurisdiction applies, where contracting out is permitted (eg NSW or WA);
2. Consider a clause in the Head Contract which makes it an obligation for the Contractor to enter into any subcontracts with the same arbitration clause;
3. Consider whether to have a “linked disputes” provision which links any downstream claim (subcontractor claim) to an upstream claim (head contractor claim) based on the same or substantially similar issues.
4. If the contract and the arbitration agreement has already been executed, consider whether to:
   • Amend the contract such that the parties agree to litigate the dispute rather than to commence the arbitration (which will enable joinder of parties and cross-claims);
   • Negotiate with other alleged concurrent wrongdoers to consent to be joined to the arbitration – cost consequences and confidentiality might be compelling reasons for those parties to consent to join the arbitration.

The position in Victoria

Interestingly in Victoria, the proportionate liability regime is calibrated slightly differently. Section 24AI(3) of the Wrongs Act provides:

“In apportioning responsibility between defendants in the proceeding the court must not have regard to the comparative responsibility of any person who is not a party to the proceeding unless the person is not a party to the proceeding because the person is dead or, if the person is a corporation, the corporation has been wound-up”.

Applying the current law to arbitrations in Victoria, where it is not possible to reduce the liability of the defendants in litigation by reference to another party that is not a party to the proceeding, the Tesseract Risk would seem to transfer from the Claimant to the Respondent. This is because the arbitrator would be bound to apply s 24AI(3) of the Wrongs Act above (on the assumption that this section is a substantive rather than procedural law) and in so doing, could only take into account the parties to the proceeding – aside from those parties who are dead (individuals) or have been wound up (corporations). Notably, Edelman J in his dissenting judgement seemed to imply that contracting out of the regime is possible in jurisdictions where the legislation is silent on the ability to do so, such as in Victoria.

For example, in Victoria, if the defendant named two other concurrent wrongdoers, one that was wound up and the other still operating, then the arbitrator (applying the Wrongs Act) would apportion between the defendant and the wound-up entity only and the defendant would then need to commence a separate contribution proceeding against the operating entity. The Tesseract Risk would seem to be reversed to the Respondent for arbitrations in Victoria.

Our disputes group published a recent article on this case which can be viewed here.

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Authored by:
Matthew Taylor, Partner
Ahmad Ali, Lawyer

[1] As permitted under s 27J of the Commercial Arbitration Act 2011 (SA).

[2] Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24; Jagot and Beech-Jones JJ at [289] referring to Tesseract International Pty Ltd v Pascale Construction Pty Ltd (2022) 140 SASR 395 at 451 [200, 206 and 202].

[3] Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24 per Jagot and Becch-Jones JJ at [313] citing Australia, House of Representatives, Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum at 31.

[4] Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24; Edelman J at [145].

[5] Australian Centre for International Commercial Arbitration.

[6] Fiona Trust & Holding Corporation v Privalov [2007] 4 All ER 951 at 957; Lord Hoffman at [7].

[7] Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24; Steward J at [228].