Does the failure by a party to pay costs in an arbitration amount to a material breach of the arbitration agreement?

by Mavin Thillainathan ~ 7 November 2018

Does the failure by a party to pay costs in an arbitration amount to a material breach of the arbitration agreement?

The Fundamentals

Article 40 of the United Nations Commission on International Trade Law (UNCITRAL) Arbitration Rules defines the term “costs” in an arbitration to include the fees of the arbitral tribunal, legal costs and the fees and expenses of the appointing authority.

This commentary is targeted at exploring the effect of a failure by a party to pay the fees and expenses of an arbitral tribunal and that of the appointing authority. Whilst it is commonplace that in most jurisdictions including Malaysia, the said fees and expenses are borne by the parties in equal shares,[1] oftentimes issues arise as to whether an arbitration agreement remains valid when either or both parties are unable to meet the associated costs involved.

Under the UNCITRAL Arbitration Rules and the Asian International Arbitration Centre (AIAC) Arbitration Rules, the arbitrator’s fees and AIAC’s administrative expenses are determined based on the sums in issue. Importantly, for the purpose of calculating the amount in dispute, the value of any counterclaim lodged by the Respondent will be considered by the appointing authority.[2] As a result of this, parties may at times be faced with differing amounts of deposits to be paid corresponding to the value of their respect claim and counterclaim. This in turn may lead to one party claiming that it has been unfairly prejudiced at the outset without having the matter heard on its merits.

Arbitration agreements are generally governed by traditional principles of contract law. Accordingly, if one party breaches a material term of an agreement, the other party ought to be relieved of its obligations under the agreement.

Position of Arbitration in the U.S.

In the 2017 New Jersey Supreme Court decision of Tahisha Roach v. BM Motoring, LLC[3], the plaintiffs had signed agreements when they purchased used cars from BM Motoring. The agreements provided for resolution of disputes through arbitration in accordance with the rules of the American Arbitration Association (AAA). When a dispute crystallized, the plaintiffs filed separate demands for arbitration with the AAA. Despite repeated requests by the AAA, BM did not advance the filing fees that the arbitration agreement obligated it to pay or otherwise respond to the claim.

When the plaintiffs ultimately filed a suit in court, the defendants moved to dismiss the action in favour of arbitration. In opposing the challenge, the plaintiffs alleged that the defendants had materially breached the arbitration agreement by failing to pay filing and arbitration fees, and consequently had waived their right to arbitration.

In a majority decision, the Court held that the primary focus of an arbitration clause is to compel both parties to arbitrate claims. Accordingly, the failure to pay fees in order to facilitate the arbitration worked to materially frustrate and deprive the other party of the benefit of their bargain and thus the Court concluded that the failure to advance fees did constitute the material breach of the arbitration agreement. Consequently, such a breach barred the defendants from later compelling arbitration and thus enabled the plaintiffs to have the action determined in Court.

It is noteworthy that the New Jersey Supreme Court however, did not establish an ‘umbrella rule’ for all cases in that a failure to pay costs will amount to a repudiatory breach of the arbitration agreement. Rather, at the end of the opinion the Court stated that these determinations are to made on a case by case basis taking into consideration the course of conduct of the parties and the language of the arbitration agreements.

The U.K. Side of Things

The position in the United Kingdom is somewhat different. In the 2014 case of BDMS Limited v Rafael Advanced Defence Systems[4] , the English Commercial Court considered whether the Respondent’s failure to pay its share of the advance on costs in an ICC arbitration amounted to a repudiatory breach of the arbitration agreement entitling the Claimant to pursue its claim in court. In the particular circumstances, the judge considered that whilst a failure to pay constituted a breach of the arbitration agreement, such a breach was not repudiatory. Accordingly, the court granted a mandatory stay of the court proceedings in favour of arbitration. In this particular case, the Court was influenced by the fact that the defendant had not completely refused to participate in the arbitral proceedings. Instead, the defendant's refusal to pay its share of the cost was conditional on the providing providing security for costs. There was a genuine concern on the particular set of facts about the ability of the claimant to meet any adverse costs order.

What about Malaysia?

In Malaysia, it appears that this issue has not been tested before the courts. Be that as it may, the general position is that a claimant will need carefully to consider its options where a respondent refuses to pay the preliminary deposit. Such options will need to be weighed against the risk of creating further delay in the arbitration proceedings and/or incurring further costs. Often, as is provided in the AIAC Arbitration Rules, a claimant will simply pay the respondent's share and then seek to recover that amount at the close of the arbitration.

The author is presently involved in opposing an application to set aside an arbitration award in the High Court of Malaya. One of the principal grounds raised in the said application under Section 37 of the Arbitration Act 2005 is that the termination of the Respondent’s counterclaim (due to a non-payment of fees and expenses) by the Tribunal was in breach of the rules of natural justice. The Respondent contends that the Tribunal has a duty to hear the said counterclaim and reserve the issue of costs and expenses at the close of the arbitration. This is notwithstanding the AIAC Arbitration Rules expressly providing for the suspension or termination or proceedings by reason of a non-payment of fees by a party. The High Court has yet to date, yet to make a determination on this matter.

[1] Section 44, Arbitration Act 2005
[2] Article 40, UNCITRAL Arbitration Rules; Rules 13 & 14 AIAC Arbitration Rules
[3] Tahisha Roach and Emelia Jackson Plaintiffs – Appellants v BM Motoring LLC and Federal Auto Brokers Inc Defendants - Respondents
[4] BDMS Limited v Rafael Advanced Defence Systems [2014] EWHC 451 (Comm)