Argyle Fund SPC Inc. (“Argyle”) is a Cayman Island Mutual Fund which went into insolvent liquidation on 26 April 2016, purportedly due to significant exposure to debt factoring via investments made through two credit advisors which each perpetrated major frauds at Argyle’s expense.
Argyle’s auditor, BDO Cayman Ltd. (“BDO Cayman”), was its statutory auditor for the audit years ending 31 December 2006 – 2014, as a result of which audits of the investments held by certain of Argyle’s classes would necessarily have had to have been properly scrutinised.
Between 2010 – 2013, Argyle and BDO Cayman entered into four separate audit engagement letters, none of which BDO Cayman’s affiliates were a party to.
In 2016, it was discovered that large sums had been misappropriated through fraudulent actions under the control of one of the credit advisors in which it had invested (and which had purportedly been audited).
First Instance – The Anti-Suit Injunction
On 21 June 2017, Argyle commenced the New York proceedings against BDO Cayman as well as BDO Trinity Limited, BDO USA LLP and Schwartz & Co LLP (the “Affiliates”) for their alleged failure, over the period of four audits during the years of 2010 to 2013, to bring to Argyle’s attention that they were, or may have been a victim to what should have been unmistakable frauds which ultimately brought about its demise. In the New York proceedings, Argyle sought compensatory damages of over US$86 million and punitive damages of not less than US$260 million.
In August of 2017, BDO Cayman filed an ex parte application in the Grand Court of the Cayman Islands for an anti-suit injunction to prevent Argyle from being permitted to continue its New York proceedings against BDO Cayman and its Affiliates. Their basis for this application relied on the engagement letters entered into by Argyle, which contained five key clauses under which Argyle was obligated to have any and all disputes arising out of an audit governed by the engagement letters determined by arbitration in the Cayman Islands and, also, solely against BDO Cayman. These clauses where namely (i) The Applicable Law Clause; (ii) Exclusive Jurisdiction Clause (iii) Dispute Resolution Clause (iv) Assignment Clause; and (v) Sole Recourse Clause.
In the first instance, Justice Parker granted the anti-suit injunction, ruling that the New York proceedings were in breach of a number of the clauses in the engagement letters, and the proper forum for Argyle to pursue any claims arising under or in relation to the Engagement Letters was by arbitration solely against BDO Cayman, notwithstanding whether a third party assisted with the audits. Justice Parker also held that BDO Cayman was solely liable for the performance of all of its Affiliates, and Argyle had agreed not to bring claims or proceedings against any Affiliates.
The Cayman Islands Court of Appeal
The Court of Appeal also looked at the same clauses relied on in the first instance and determined that the Judge had erred in his decision.
The Justices of the Court of Appeal agreed that the Sole Recourse clause was a clear covenant not to sue; however, the covenant not to sue the Affiliates was subject to a carve-out, or exception as it were, which stated that Argyle would not bring any claim against any of BDO Cayman’s Affiliates or any members of the international BDO network who assisted as supplemental service providers unless there was “any liability, claim, or proceeding founded on an allegation of fraud or wilful misconduct or other liability that cannot be excluded under the applicable laws” .
It follows that whether Argyle was free to sue the Affiliates in the New York proceedings it would have to overcome two hurdles. Firstly, whether the New York proceedings against the Affiliates were a "claim or proceeding founded on an allegation of fraud or wilful misconduct or other liability that cannot be excluded under the applicable laws?" such that they fall within the exception in the Sole Recourse Clause; and secondly, if the claims were founded on such an allegation, were the New York proceedings brought in breach of the Exclusive Jurisdiction clause?
The Court of Appeal was of the opinion that the allegations of fraud and wilful misconduct did indeed fall within the exception, thereby advancing past the first hurdle, and to answer part two of the question, they considered the observations of Mr Rabinowitz QC sitting as a Deputy Judge in Team Y & R Holdings Hong Kong Ltd v Ghossoub in which he laid out a seven step process in determining when it is appropriate for an exclusive jurisdiction clause to be enforced in relation to proceedings against persons or entities who were not a party to the contract.
In that case, Mr Rabinowitz QC set out that:
- Whether an exclusive jurisdiction clause should be understood to oblige a contractual party to bring claims in the chosen forum even against a non-contracting party, the clause must be considered as part of the whole contract; language included in other clauses may shed light on what the parties truly intended.
- The principle that the parties are likely to have intended that all disputes arising out of the relationship they have entered would be decided by the same court cannot apply with the same force when considering claims brought against non-contracting third parties. The starting position should be that “absent plain language to the contrary, the contracting parties are likely to have intended neither to benefit nor prejudice non-contracting third parties”.
- Reference to third parties’ position in other clauses, demonstrating that the parties have consciously turned their minds to them, means that the absence of any express mention of third parties in an exclusive jurisdiction clause may be an indication that the clause was not intended to affect third parties.
- If the above mentioned silence occurs, the fact that any other clause dealing with third parties shows an intention that third parties should not acquire rights as against a contracting party may be a further indication that the clause was not intended to affect third parties.
- If a particular interpretation of the clause creates a material contractual imbalance, this may lead to indicate that it was not intended to apply as such, as it is unlikely that rational contracting parties would have intended this.
- If the contract fails to identify any third parties whatsoever, this may be an indication that the clause was only intended to affect the contracting parties.
- Where contracting parties wish for a claim to be subject to the exclusive jurisdiction clause even where it is brought by or against a non-contracting party, it should be expressed, setting out said intention, and who is to be affected in unambiguous terms in the clause.
After setting out these steps in the judgment, the Court of Appeal held that the exclusive jurisdiction clause did not extend to the claims brought by Argyle against the Affiliates. If BDO Cayman intended for the clause to cover the Affiliates, express wording would have been required.
The Court of Appeal also held that, despite the Dispute Resolution clause calling for arbitration to be the appropriate method for resolution, the carve-out in the Sole Recourse Clause had the effect, intended or not, of allowing Argyle to bring any claim that fell within the carve-out in judicial rather than arbitration proceedings, as the Dispute Resolution Clause could only apply to claims brought by or against parties to the engagement letters.
What does this mean for Service Providers and Contracting Parties?
This is a very significant decision with far-reaching implications on service providers and contracting parties alike. On one hand, this decision sets the stage for companies and funds that have relied on service providers to directly take action against the entity that has actually carried out the work delegated to them by the contracting service provider, thereby widening their pool of potential defendants tenfold.
On the other hand, many have viewed this as an uncommercial decision as it is arguably an established principle in contract law that by agreeing to an exclusive jurisdiction clause, both parties to the contract are to be taken to have agreed and intended for any and all disputes arising out of the relationship entered to be decided in a single jurisdiction, and this decision goes against this principle entirely.
One thing has been made abundantly clear from this decision. As a service provider, the only certain way to ensure that all affiliates outside of the jurisdiction to whom work is delegated are protected from claims arising under a contract is to expressly limit liability in unambiguous terms to non-contracting parties in all relevant clauses – else they may find themselves in proceedings in New York regardless of an exclusive jurisdiction clause.
*Previously published in TerraLex Connections newsletter - January 2019