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Effective incorporation of arbitration clauses: a reminder

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31/08/2016

Arbitration has firmly established itself as an alternative means of resolving commercial disputes, for a variety of reasons including cost, speed, confidentiality and flexibility, depending on the circumstances. It is particularly popular in relation to cross-border matters.

It may be the case that all of the terms comprising the contractual arrangement between commercial parties in relation to a given subject matter are expressly set out in a single written agreement, including a clause setting out the parties’ agreement to arbitrate any disputes arising between them in relation to that subject matter.

However, there will also be times when parties wish to incorporate into their contract the terms of a separate document – this could be the standard form of one of the parties, a previous contract between them, a contract between one of the parties and a third party, or a contract between two or more third parties. Whether or not the parties will be bound by an arbitration clause contained in that separate (secondary) document, will depend on whether the clause has been effectively incorporated into the parties’ (primary) contract.  In this regard, English law distinguishes between so-called “single-contract cases” and “two-contract cases”.

General principles

In a single-contract case, the arbitration clause is contained in a document – such as a standard form or previous contract – and that document is incorporated by reference, as a whole, into the parties’ primary contract. In order to effectively incorporate the clause, there is no need to refer to it expressly – reference to the document in which it is contained will be enough.

A more restrictive approach applies in a two-contract case, where the arbitration provision in question is contained in a contract to which only one, or neither, of the parties are party. Clear words will be required for effective incorporation, so that express reference in the primary contract to the clause itself will generally be necessary.  The reasoning behind this is that arbitration clauses are not “germane or directly relevant to” the subject matter of the primary contract, are “ancillary provisions”, and “oust the jurisdiction of the courts”.  It may not be evident that the parties intended not only to incorporate the substantive provisions of the other contract but also provisions as to the resolution of disputes between different parties, particularly if a degree of verbal manipulation is needed for the clause to work [1].

A recent practical example

The High Court recently considered these differing approaches in Barrier v Redhall Marine [2].  Redhall contracted with BAE for the construction of submarines for the Ministry of Defence.  It subcontracted parts of its function under the BAE contract to Barrier.  Barrier applied to the court for pre-action disclosure of documents in relation to the recovery of sums allegedly owed.  One of Redhall’s arguments in defence was that the parties’ subcontract incorporated an arbitration agreement.  That was significant because, if true, any court proceedings contemplated by Barrier would need to be stayed (the parties having chosen to arbitrate their disputes instead) and the court would accordingly have no jurisdiction to make an order for pre-action disclosure.

The single-contract approach: On the face of the relevant Redhall purchase order was written: “The terms overleaf must be read and strictly adhered to“.  Those standard terms included an arbitration provision.  It was not disputed that, if incorporated into the subcontract, this would put a stop to the pre-action disclosure application.  The parties’ subcontract, in turn, provided that Redhall’s “standard terms and conditions…shall be incorporated into this Agreement” and identified them by reference to the purchase order.  The judge concluded that a reasonable person reading that clause in the subcontract would have no doubt that Redhall’s standard terms (including the arbitration provision) were incorporated.  (For some reason, the purchase order copy received by Barrier had nothing written on the back of it.  This did not affect the judge’s findings, however, because Barrier could have requested a copy of the terms at any time.)

The two-contract approach: Redhall’s alternative argument was that the subcontract was effective to incorporate the arbitration clause contained in its contract with BAE. The subcontract provided that the terms of the BAE contract “shall be incorporated into this Agreement“, but it did not expressly refer to the arbitration clause.  Clear words were required and, in the judge’s view, the general words of incorporation in the subcontract were insufficiently clear to incorporate the clause.  There were also considerable difficulties in incorporating it, because significant modifications would be required and it was not easy to see how one particular part of the clause could be adapted without doing significant violence to the wording.

WM Comment

Choice of dispute resolution mechanism is a very important consideration, and commercial parties may have very good reasons for choosing one over another [3].  This case highlights the dangers associated with ineffective incorporation.  Had Redhall’s alternative argument been the only one available to it, it would have found itself subject to the court’s, rather than an arbitral tribunal’s, jurisdiction.

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[1] Habas Sinai v Sometal [2010] EWHC 29 Comm
[2] Barrier Limited v Redhall Marine Limited [2016] EWHC 381 (QB)
[3] Note that the English courts have held that the same principles apply in relation to incorporation of jurisdiction clauses.

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