When faced with a party which refuses to pay their share of the arbitral fees, it may seem attractive to go to court claiming that the defaulting party has repudiated the arbitration clause.
Such a backdoor approach to the courts has been allowed in Canada. Until the recent case of BDMS Ltd v Rafael Advanced Defence Systems (BDMS), however, it was unclear whether there is any merit in approaching the English courts in such a situation.
In BDMS, the Commercial Court considered whether a respondent's failure to pay its share of the arbitration's 'advance on costs' was a repudiatory breach of the arbitration agreement, or rendered the arbitration agreement "inoperative", effectively giving the claimant recourse to the courts to resolve its dispute.
Unless the claimant, BDMS, could persuade the court on either ground, its attempt to unlock the door to litigation would fail. Court proceedings would be stayed under section 9 of the Arbitration Act 1996, leaving BDMS to continue and fund arbitral proceedings against the respondent, Rafael.
BDMS started an ICC arbitration claiming 'success fees' allegedly due from Rafael. The ICC Rules required the parties to make an advance payment in equal shares for the arbitrators' and the institution's costs. Despite actively participating in the arbitration, Rafael refused to pay its share of the advance on costs until BDMS provided security for costs, given its concern that BDMS would be unable to meet an adverse costs order.
BDMS alleged that such refusal was a repudiatory breach of the arbitration agreement, allowing it to pursue its claim against Rafael in the Commercial Court. BDMS took encouragement from the approach of the Canadian courts, which have taken jurisdiction in similar circumstances. Unsurprisingly, Rafael denied there was a repudiation and applied for a stay of the Commercial Court proceedings in favour of the arbitration.
The Commercial Court's Decision
The Commercial Court found that although failure to pay an advance on costs may be a breach of the arbitration agreement, there is a high threshold to be met for it to constitute a repudiatory breach rendering the arbitration agreement "inoperative", thus entitling a party to pursue its claim in a different forum.
The court had to examine what it is that a party signs up to when it agrees to arbitrate under institutional arbitration rules. It determined that an agreement to arbitrate under the rules of an institution is an agreement to comply with the mandatory rules of that institution.
However, although a failure to pay advances on costs may be a breach of the arbitration agreement, that does not make a failure to pay the advance a repudiatory breach.
In order to be characterised as repudiatory, a breach must be demonstrated through a clear and unequivocal intention not to perform obligations under the arbitration agreement in some essential respect. Alternatively, the breach must go to the root of the arbitration agreement, depriving the non-defaulting party of substantially the whole benefit of it.
The court determined that Rafael's breach was not repudiatory. In its assessment, the court emphasised that Rafael's refusal to "play by the rules" was limited to refusing to pay its share of the advance on costs.
Rafael had actively participated in settling the Terms of Reference and in exchanges regarding the scope of the preliminary issues hearing, and so the breach was not symptomatic of wider repudiatory behaviour.
It was also noted that while BDMS had no obligation to cover Rafael's share of the advance on costs, the arbitration could have continued had BDMS done so. Moreover, under ICC rules such costs could have been covered by bank guarantee.
Further, although the claim was withdrawn by the ICC for non-payment, there is no bar to bringing the same claim again. Ultimately, Rafael's breach did not deprive BDMS of its right to arbitrate.
The principles in BDMS have several implications for parties to arbitration – the first being that prematurely approaching the courts off the back of a breach of mandatory procedural rules is likely to be unsuccessful.
Indeed, such applications might result in further costs and delay, especially where institutional rules contemplate, address and provide machinery for dealing with such breaches.
With no route to the courts, a claimant in BDMS's shoes faces an unenviable choice. It can either allow the arbitral proceedings to become moribund, or it can continue the proceedings undertaking the funding burden, an unattractive prospect on a cashflow basis.
Accordingly, a claimant in this predicament may wish to cover the amount by way of bank guarantee – if the arbitral rules permit – or fund the respondent's share of the advance and then seek either an interim order compelling the respondent to pay or a partial award for reimbursement.
Although such an approach is not ideal, it does at least offer the prospect of reimbursement if the respondent is financially secure and is playing a tactical game. It also offers an opportunity to highlight the respondent's conduct to the tribunal at an early stage, although the weight that a battle-hardened tribunal may ascribe to this is limited.
If, on the other hand, the respondent is impecunious or fails to satisfy the tribunal's award, the sooner a claimant with a purely monetary claim discovers this, the better.
Implications For Funders
BDMS also has implications for third-party funding, which has in recent years become an increasing feature of international arbitration. There are currently several sources of such funding, with both commercial and treaty claims being seen as attractive investments.
However, funders should be alert to the possibility of having to pay additional advances on costs on behalf of the respondent. Respondents wise to a claimant's use of third-party funding may seek to test such funding by refusing to pay the advance on costs, taking comfort that a party is unlikely to be able to sidestep the arbitration process as a result.
While leading arbitral institutions do not currently require disclosure of third-party funding, it is a hot topic and reforms in this area could make such cynical tactics more prevalent.
Know Your Institution
The BDMS decision highlights again the care that needs to be taken in selecting an arbitral institution. Although arbitral fees are just one consideration in selecting an institution, both parties and their advisers should consider the method that each institution uses to calculate its administrative costs and the arbitrators' fees, as these vary significantly between institutions.
Some institutions, including the ICC and the Stockholm Chamber of Commerce, calculate their costs by reference to the claim amount, whereas others like the LCIA – and, albeit optional by the parties, HKIAC – base costs on hourly rates for arbitrators.
Purely from a fees standpoint, therefore, a simple claim with high value could cost significantly less at the LCIA, while parties to a complex, low-value claim might benefit from the ICC's methodology.
The calculation of advances on costs similarly varies from institution to institution. Under the ICC rules, the advance amounts to an estimate of the entire costs of the arbitral process, which is subject to adjustment during the life of the arbitration.
The LCIA, by contrast, generally only requires advance payments to cover the next stage of arbitration, which may assist claimants unable to pay the entire costs at the outset. Liability for advance on costs may also vary between institutions.
Under the LCIA rules, for example, the parties are jointly and severally liable for the advances, meaning that a failure to pay is technically a default by both parties. The ICC rules, on the other hand, invite the non-defaulting party to pay the defaulting party's advance on costs, albeit is not obliged to do so.
Ultimately, any analysis involving a refusal to pay an advance on costs should be seen in the overall context of the approach of the English courts in BDMS: the institutional rules of the arbitration; and the overall costs of arbitration, as arbitrators' fees and administrative expenses.
It should be remembered the latter element only accounts for around 20% of the total cost of arbitration, with the overwhelming majority being the parties' respective costs of legal representation.
Although there may be instances where a failure to pay an advance on costs can unlock the door to litigation, BDMS confirms the English courts' pro-arbitration credentials and reluctance to take jurisdiction before all avenues of arbitration are exhausted.
This article was first published by CDR (Commercial Dispute Resolution) magazine, May 2014