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A recent decision of the Western Australian Court of Appeal (Paharpur v Paramount [2008] WASCA 110) highlights the need to pay careful attention to dispute clause drafting, particularly in cases where third parties are involved or ancillary agreements would unintentionally escape the dispute mechanisms agreed in a principal contract.

The dispute arose out of a contract between Paramount (WA) Ltd (Paramount) and Paharpur Cooling Towers Ltd (Paharpur) under which Paharpur agreed to design, supply, and supervise the installation of two cooling towers for an ammonia plant being constructed by Paramount for Burrup Fertilisers Pty Ltd (BFPL) in WA. Relevantly Paramount agreed to provide a bill of exchange (accepted by Paramount and BFPL) (BOE) payable to Paharpur 180 days from the date of the last shipment of equipment. When payment was not made, Paharpur commenced an action on a number of different fronts:

• against Paramount for monies owing under the contract
• against Burrup Holdings Pty Ltd and Pankaj Oswal for the same amount (as trustees of a trust which had provided a guarantee of Paramount’s obligations under the contract), and
• against Paramount and BFPL for monies owing under the bill of exchange.

Acting Master Chapmen had ordered a stay of court proceedings and determination of the matters in issue to be referred to arbitration. This commercially sensible decision, however, sits at odds with the fact that one of the parties to the BOE was neither subject to nor had later submitted to the arbitration agreement in the principal contract. The Court of Appeal was then obliged to consider whether there was, in relation to the BOE, a dispute for the purposes of the arbitration agreement which was only contained in the contract between Paramount and Paharpur. The arbitration agreement provided that Paramount, at is sole discretion:

“[S]hall determine whether the parties resolve the dispute by litigation within the jurisdiction of the courts of Western Australia or arbitration under the Commercial Arbitration Act. [Paramount] shall notify [Paharpur], by notice in writing, of its decision to refer the dispute to litigation or arbitration within 28 days of either [Paramount] or [Paharpur] electing that the dispute be determined by either litigation or arbitration.”

Relevantly “Dispute” was defined as, inter alia, a “dispute or difference between the parties….” (i.e. Paramount and Paharpur).

Reviewing the relevant authorities, the Court considered that the principle that parties intend “one stop adjudication” of the issues in dispute does not readily apply “in the same way where the dispute in question is not limited to the parties to the arbitration agreement”. Given that BFPL was not party to the contract in which the arbitration agreement was contained, the court was of the view that arbitration of the BOE issue would mean that “the dispute should be fragmented and that the liability of the party to the arbitration agreement and that of the third party respectively should be determined in different forums”. That is, an arbitral tribunal could determine Paramount’s liability under the BOE, but BFPL’s would need to be assessed by a judge.

The court did not think that the parties could have contemplated such fragmentation, and found the issue to not be one capable of settlement by arbitration. In consequence neither s 7 of the International Arbitration Act 1974 (Cth) (IAA) (requiring a stay of litigation where an arbitration agreement is pleaded) nor the similar s 53 of the Commercial Arbitration Act 1985 (WA) (CAA) could be applied. Steytler P and Newnes AJA therefore allowed the appeal, setting aside the decision of Acting Master Chapman as far as it related to the bill of exchange.

Thus the parties will arbitrate the first two issues and litigate the third - a fragmented result in spite of the efforts of the Court of Appeal, which might console itself that what it decided was legally correct, even if commercially and practically undesirable.

The decision serves as example of what can happen when an arbitration agreement fails to provide for related project documents to be brought within the same dispute resolution processes, and is a further reminder of the importance of clear drafting for any arbitration agreement. The parties’ problems could have been avoided had their clause made appropriate provision for the consolidation of different disputes, so that all disputes could have been arbitrated together, or simply if steps had been taken to bring the BOE within the original agreement to arbitrate.