The Supreme Court of New Zealand recently held in Carr v Gallaway that an arbitration agreement was invalid because it attempted to confer on the court a jurisdiction that did not exist under the Arbitration Act 1996 (NZ). The question was posed: when will a court decide to sever unenforceable wording in an arbitration agreement in order to render the agreement enforceable? This article summarises the decision of the Supreme Court of New Zealand and considers what implications the decision has in Australia.
What does this decision mean for you?
Parties must ensure that their arbitration agreements are carefully drafted and do not create additional rights of appeal to a court which are not prescribed by statute.
Importantly, a court is unlikely to save an arbitration agreement by severing invalid words where such wording is crucial to the parties' agreement to arbitrate.
Relevance of the decision in Australia
Ewan Robert Carr and Brookside v Gallaway Cook Allan  NZSC 75 concerned a domestic arbitration in New Zealand. In New Zealand, domestic arbitrations are governed by the Arbitration Act1996 (NZ) (New Zealand Act) which is based on the UNCITRAL Model Law (Model Law).The general rules of arbitration under Schedule 1 of the New Zealand Act apply to domestic arbitrations. In addition, Schedule 2 of the New Zealand Act sets out a number of 'opt in' provisions which parties can agree to apply in their arbitration agreements.
Relevant to the decision in question was clause 5 of Schedule 2 of the New Zealand Act. This optional provision provides that any party may appeal an arbitral award to the High Court of New Zealand questions of law (in addition to the traditional grounds of appeal contained in section 34 of the Model Law).
In Australia, domestic arbitrations are governed by uniform acts enacted in each of the states and territories (Uniform Acts). Like the regime in New Zealand, Australia's Uniform Acts are based on the Model Law and contain similar 'opt in' provisions dealing with the appeal of an arbitral award on questions of law. Section 34A of the Uniform Acts is analogous to clause 5 of Schedule 2 of the New Zealand Act.
Given the similarities between the legislation in Australia and New Zealand, Carr v Gallaway is likely to be relevant when considering how an Australian court may interpret the right of appeal in section 34A of the Uniform Acts and in construing changes agreed by parties to jurisdiction created by statutory instruments.
The arbitration related to a dispute between a party and its solicitors, who were alleged to have acted professionally negligent during the settlement of a commercial transaction which caused the transaction to fail.
The parties agreed to arbitrate the dispute. An express term of the arbitration agreement was that an arbitral award would be final and binding, subject to the parties having a right of appeal to the High Court on questions of law and fact.
Central to the decision was how the parties had worded their amendment to clause 5 of Schedule 2 of the New Zealand Act. The relevant provision in the arbitration agreement is replicated below:
"1.2 The parties undertake to carry out any award without delay subject only to such rights they may possess under Articles 33 and 34 of the First Schedule to the Arbitration Act 1996 (judicial review), and clause 5 of the Second Schedule (appeals subject to leave) but amended so as to apply to 'questions of law and fact' (emphasis added)."
As discussed above, a party's right to appeal an arbitral award pursuant to clause 5 of Schedule 2 of the New Zealand Act is limited to questions of law. Despite this, the parties "purported to amend this provision by extending the right of appeal to questions of fact as well as questions of law". The arbitrator delivered an award in favour of the solicitors, which was subject to three separate appeals.
The High Court found that the arbitration agreement was invalid as a whole because clause 1.2 granted the parties a right of appeal to a court that was not prescribed by statute. There is no provision in the New Zealand Act that provides any basis for a right of appeal against an arbitral award on a question of fact. As stated by Arnold J, "parties cannot by private agreement confer on the High Court a jurisdiction which, by statute, it does not have".
Ultimately, the High Court held that "contracting parties cannot, by agreement, create such a right of appeal to a court where no statutory authority exists" and accordingly, the words "but amended so as to apply to 'questions of law and fact' (emphasis added)" were ineffective. For the reasons set out below, the High Court held that the ineffective words were incapable of being severed and the award was set aside.
However, the New Zealand Court of Appeal took a different approach and chose to sever the ineffective part of clause 1.2 thereby giving the remainder of the arbitration agreement effect and refusing to set aside the award. This decision was then appealed to the Supreme Court.
Court's ability to sever unenforceable wording to render arbitration agreement enforceable
The reasons for the High Court and Court of Appeal's decisions are set out below.
In the first appeal, the High Court held that the words "and fact" could not be severed from clause 1.2 on the basis that the right to appeal on questions of fact was so crucial to the parties entering the arbitration agreement that severance would be difficult to justify. The High Court reasoned that the parties' italicisation of "questions of law and fact" and the parenthetical reference to "emphasis added" clearly evidenced the importance to the parties of a factual right of appeal, so much so, that the parties would not have entered into the contract without it. This rendered the arbitration agreement invalid and subject to an order for setting aside the award.
In contrast, in the second appeal, the Court of Appeal held that severing the offending phrase would not alter the nature and character of the arbitration agreement and would allow the Court of Appeal to give effect to the contractual relationship. Accordingly, the Court of Appeal held that the arbitration agreement was valid and therefore was not subject to grounds for setting aside the award.
Ultimately, the Supreme Court agreed with the High Court's decision, finding that the ability for the parties to appeal on questions of law and fact went to the heart of the parties' arbitration agreement and was so material and important a promise that it could not be severed. Accordingly, the Supreme Court held that the arbitration agreement was invalid and therefore it was able to set aside the award under the New Zealand Act. Further, the Supreme Court determined that the meaning of "arbitration agreement" under the New Zealand Act is not limited to the words referring or submitting a dispute to arbitration, but also includes any procedural steps in the agreement to be followed by the parties.
Carr v Gallaway demonstrates that a Court may not save an arbitration agreement by severing invalid words contained in the agreement, where those words are crucial to the parties' agreement to arbitrate. By extension, the decision suggests that a court may sever invalid wording in order to give effect to an arbitration agreement where the invalid wording is not crucial to the parties' agreement to arbitrate.
Accordingly, despite strong policy supporting the use of arbitration as a means of dispute resolution, parties must take care when drafting arbitration agreements to ensure that the arbitration agreement is not later invalidated. Specifically, as in the present case, parties cannot attempt to create for themselves additional rights of appeal not prescribed by statute. Where ineffective wording is so crucial to the arbitration agreement that it can be said the parties would not have entered into the arbitration agreement without it, such wording will not be capable of being severed and there is a risk the entire arbitration agreement will be invalid.