Key Points:

A respondent's failure to pay its share of the advance on costs and failure to play by the rules does not necessarily mean that it has given up its right to arbitration.

In arbitration proceedings, respondents may attempt to make it difficult for claimants to prosecute their claims or attempt to delay proceedings, if there are tactical advantages in doing so. In particular, where claimants are suffering from cash flow problems, respondents will sometimes delay payment of costs, including any agreed advance on costs. Alternatively, a respondent may delay payment of an advance on costs where it has concerns as to the ability of the claimant to meet any adverse costs order.

The purpose of an advance on costs is to provide security for the fees and expenses of the arbitrators and the institution, by requiring the parties to pay in advance an amount for costs at the beginning of the arbitration. This is allowed under the International Chamber of Commerce (ICC) Rules of Arbitration (ICC Rules) (1998 version).

Where the respondent to an arbitration fails to pay its share of the advance on costs, can a claimant commence court proceedings for its claim instead of arbitration? In the recent UK case BDMS Limited v Rafael Advanced Defence Systems [2014] EWHC 451 (Comm), the claimant was held not to be able to do so. The English High Court granted a stay of the court proceedings on the basis that the arbitration agreement had not been repudiated.

Following this case, claimants in arbitration proceedings in Australia should be aware that:

  • a respondent's failure to pay its share of the advance on costs and failure to play by the rules does not necessarily mean that the respondent has given up its right to arbitration; and
  • a claimant may have to finance the entire arbitration proceedings on a provisional basis and then seek an interim award against the respondent for the amount paid. This is a developing practice for claimants in similar situations governed under the ICC. Alternatively, a claimant may seek to recover its costs at the end of the arbitration by way of an order for costs in the award.

The arbitration and the advance on costs

BDMS Limited, an English company, and Rafael Advanced Defence Systems, an Israeli state-owned company, were parties to a consultancy agreement. A dispute arose in relation to sums allegedly due to BDMS from Rafael under the Agreement.

The Agreement contained a dispute resolution clause which required the parties to refer all disputes to arbitration in accordance with the ICC Rules.

Following the appointment of the sole arbitrator, the ICC fixed the advance on costs and asked each party to pay its half share.

Rafael expressed concerns about the ability of BDMS to meet any adverse costs order, and stated that it did not intend to pay the advance on costs until adequate security for costs was put in place by BDMS.

At a meeting with the Tribunal to discuss the terms of reference for the arbitration, the parties agreed that one of the issues to be determined was whether the parties should provide any advance on costs. The Tribunal directed that matter be dealt with at a preliminary hearing.

In the following weeks, the ICC asked Rafael, and subsequently BDMS, to pay Rafael's share of the advance on costs. In the absence of any payments being made by the requested date, the ICC wrote to the parties and made clear that unless Rafael's share of the advance costs was paid, BDMS's claims would be considered withdrawn.

BDMS wrote to Rafael asserting that Rafael's failure to pay its share of the advance on costs was a repudiatory breach of the ICC Rules and the arbitration agreement and purported to accept the alleged repudiation. BDMS stated that it would pursue its claim in the English High Court.

A month later, BDMS wrote to the ICC and Rafael confirming that its claim was withdrawn by operation of ICC Rules Article 30(4).

BDMS' argument: it's a condition precedent

BDMS contended that the payment of the advance on costs was a condition precedent to the arbitration taking place under Article 30 of the ICC Rules. It argued that Rafael's failure to pay its share of the advance on costs was a repudiatory breach of the arbitration agreement, as Rafael's behaviour caused the withdrawal of the arbitral proceedings, and its disputes with Rafael could not be resolved by arbitration.

It further contended that the repudiatory breach by Rafael rendered the arbitration agreement "inoperative". Accordingly, BDMS argued that a stay of the court proceedings should not be granted under section 9 of the UK Arbitration Act, under which a stay shall be granted unless the court is satisfied that the arbitration is "null and void, inoperative, or incapable of being performed". BDMS relied heavily on the decision of the Alberta Court of Appeal in Resin Systems Inc v Industrial Service & Machine Inc [2008] ABCA 104, in which a stay was refused based on similar facts to the present case.

Rafael: we haven't breached the agreement

Rafael contended that there was no breach, repudiatory or otherwise, of the arbitration agreement. The arbitration agreement was therefore not "inoperative" and Rafael argued that a mandatory stay should therefore be granted under section 9 of the UK Arbitration Act.

The English High Court: it's a breach, but it's not repudiatory

Justice Hamblen found that there was a breach by Rafael of the arbitration agreement. This was because there was an express reference to the ICC Rules in the arbitration agreement, and ICC Rules Article 30(3) provides that the advance on costs "shall be payable" in equal shares. He considered that to be a mandatory requirement that was imposed on the parties.

However, Justice Hamblen did not consider the breach to be repudiatory, in that there was no refusal to perform the arbitration agreement in an essential respect or a breach that went to the root of the arbitration agreement. In particular:

  • Rafael did not refuse to participate in the arbitration. Rafael's refusal to "play by the rules" was limited to its refusal to pay the advance on costs, and that was unless security was provided;
  • BDMS could have posted a bank guarantee or paid Rafael's share of the advance, a situation which the ICC Rules contemplate, address and provide machinery for dealing with;
  • BDMS could have sought an interim order requiring Rafael to pay its share of the advance; and
  • BDMS was not deprived of substantially the whole benefit of the contract, as the ICC Rules gave BDMS the means to prevent that occurring.

As the arbitration agreement was not made unworkable and therefore was not inoperative, Justice Hamblen granted a stay of the court proceedings.

In relation to reliance by BDMS of the Resin Systems case, Justice Hamblen accepted that the Resin Systems could be distinguished, as in that case the Alberta court did not address the question of inoperability by considering the grounds on which a contract might become ineffective in English law.

Comment

While this case was concerned with the ICC Rules, similar provisions concerning advances on costs are found in the rules of other institutions, for example, under Article 42 of the ACICA Arbitration Rules (2011).

The Commercial Arbitration Acts in force in the various States and Territories in Australia (except for the ACT) contain provisions that are similar to section 9 of the UK Arbitration Act, under which the court is required to grant a stay of proceedings and refer the parties to arbitration unless the arbitration agreement is found to be "null, void, inoperative or incapable of being performed". It remains to be seen whether the approach taken by the English High Court will be adopted in Australia.

This case identifies the issues that the parties to an arbitration are likely to need to consider when faced with a situation where the respondent fails to play by the rules and chooses to not pay its share of the advance on costs.

We have identified earlier in our discussions the key points that a claimant to an arbitration proceeding should be aware of when faced with a similar situation. This case also has implications which should be considered by a respondent to an arbitration proceeding:

  • while Rafael's breach was not found to be repudiatory, issues of repudiation are fact-dependent. As acknowledged by the judge in this case, in certain circumstances, a refusal or failure to pay advance costs may constitute repudiatory conduct. In this case, Rafael did not refuse to participate in the arbitration, but in fact actively participated in the arbitration and settled the terms of reference;
  • some commentators have warned that respondents would be mistaken to think that there is a free ticket to default on the payment of its share of the advance on costs. To be seen as "good citizens" who respect their contractual commitments should be an important objective for any party; and
  • a party runs the risk of being in the bad books of the tribunal or the judge if it disregards the contractual commitments and fails to pay its share of the advance on costs. In the Resin Systems case, the Alberta Court of Appeal described the conduct of the defendant who refused to pay its share of arbitration costs and subsequently sought that the claimant be denied access to the courts, as "audacious".