Cottonex Anstalt v Patriot Spinning Mills

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DMC/Arbn/14/04

England

Cottonex Anstalt v Patriot Spinning Mills Ltd [2014] EWHC 236 (Comm)

English High Court: Hamblen J.: 14 February 2014

Charles Kimmins QC, instructed by Holman Fenwick Willan, for the claimant seller, Cottonex

Philippa Hopkins, instructed by Watson Farley, for the respondent buyer, Patriot Spinning Mills

SALE AND PURCHASE: WHETHER CONTRACT INCORPORATED ALL TERMS OF THE BY-LAWS AND RULES OF THE INTERNATIONAL COTTON ASSOCIATION OR ONLY THE ARBITRATION PROVISIONS: GUIDANCE ON THE INTERPRETATION OF CONTRACTS ON APPEAL FROM AN ARBITRAL TRIBUNAL WITH EXPERIENCE OF THE RELEVANT TRADE

Summary

In this case, the Court determined that the Appeal Tribunal of the International Cotton Association had erred in its interpretation of a contract and gave guidance on the principles to be followed in considering an appeal on a point of law from a tribunal with experience of the particular trade.

This note is based on a note of the case prepared by Jason Robinson, a barrister at Stone Chambers, Gray’s Inn, London, United Kingdom

Background

The issue to be determined in the arbitration was whether a contract for sale of 600 mt of cotton by the Claimant to the Respondent (“the Contract”) incorporated all the International Cotton Association’s (“ICA”) Bylaws and Rules, or only its Arbitration Bylaws, where Clause 5 of the Contract provided that:

“5. Claims and controversial matters, that may occur in connection with the execution of the following contract, are to be solved by the representatives of the Buyer and Seller, having full power to act. All disputes relating to this contract will be resolved through Arbitration in accordance with the Bylaws of the International Cotton Association Limited. This agreement incorporates the Bylaws which set out the Association’s Arbitration procedure.”

The ICA’s Bylaws and Rules are set out in four sections. Sections 1, 3 and 4 contain the Bylaws whilst Section 2 contains the substantive rules which govern a contract, if incorporated. Section 3 sets out the Arbitration Bylaws. The Claimant contended Clause 5 only incorporated the ICA’s Arbitration Bylaws (Section 3) whilst the Respondent’s position was that the entirety of the ICA’s Bylaws and Rules was incorporated.

The relevance of this was that if the entirety of the ICA’s Bylaws and Rules were incorporated, the “invoicing back” provisions in Rules 225 and 226 would have stipulated a contractual method of closing out the Contract, based on the market price at the date of closure, regardless of which party was in breach.

Both parties alleged the other was in breach of Contract, but the Respondent argued that, irrespective of breach, it was entitled to rely on Rules 225 and 226 of the ICA’s Bylaws and Rules and claim payment from the Claimant under the invoicing back clauses. In this regard, the Respondent had invoiced the Claimant some USD720,745.

The dispute was determined in the first place by the Technical Appeal Committee of the ICA (“TAC”), which decided that the entirety of the ICA’s Bylaws and Rules were incorporated and it reasoned as follows (see paragraphs 14–15 of Mr Justice Hamblen’s judgment):

The first step was to consider whether Bylaw 201 applied, which at the time provided that:

“Subject to Bylaws 302 and 318, the following clauses will apply to every contract made under our Bylaws and Rules, or containing words to similar effect:

• The contract will incorporate the Bylaws and Rules of The International Cotton Association Limited as they were when the contract was agreed.

• If any contract has not been or will not be performed, it will not be as cancelled. It will be closed by being invoiced back to the seller under our Rules in force at the date of the contract.

• All disputes relating to the contract will be resolved through arbitration in accordance with the Bylaws of The International Cotton Association Limited.

• This agreement incorporates the Bylaws which set out the Association’s arbitration procedure …” „„

As Clause 5 of the Contract copied the third bullet-point above, the Contract was one which was made under the ICA’s Bylaws and Rules. Bylaw 102 provided that it was impermissible to contract out of Bylaw 201. Bylaw 201 had the effect of incorporating the bullet-points therein into the Contract and, since once of those bullet-points provided for invoicing back, the Contract had incorporated the invoicing-back rules.

Issues on the Appeal

The question of law for which the Claimant was given permission to appeal was whether Clause 5 of the Contract incorporated the entirety of the ICA’s Bylaws and Rules and, in particular, the invoicing back provisions in Rules 225 and 226.

The Respondent accepted that the TAC had erred in taking the Bylaws and Rules as the starting point in determining whether or not they were incorporated into the contract. The correct starting point was the wording used in Clause 5 of the Contract.

The position adopted by the Respondent is set out below (see paragraph 69 of Mr Justice Hamblen’s judgment).

• The reference in Clause 5 of the Contract to “Bylaws” in the sentence “[t]his agreement incorporates the Bylaws which set out the Association’s Arbitration procedure”, was merely short-hand for the ICA’s Bylaws and Rules as a whole.

• The ICA’s Bylaws and Rules are contained in a single rule book and had the parties intended to incorporate only one part of those Rules (i.e. Section 3 on Arbitration), they would have said so in clear terms.

• The Bylaws and Rules are interlinked and do not merit a separate definition in the rule book.

• Without the Rules, the Bylaws are only a framework and the rule book does not appear to contemplate the possibility of a contract being made subject to the Bylaws and not the Rules.

• This construction of Clause 5 of the Contract made the most business common sense because (see paragraph 71 of Mr Justice Hamblen’s judgment) it would be odd for the parties to have incorporated the arbitration provisions of the ICA’s Bylaws and Rules, and to submit to the jurisdiction of trade arbitrators, without wishing also to incorporate the substantive provisions which those arbitrators ordinarily apply to disputes referred to them

• The Contract would lack sufficient detail if the entirety of the ICA’s Bylaws and Rules were not incorporated because it would not, for example, contain provisions as to how sampling is to be carried out, or how quality is to be assessed, or as to the terms of any insurance.

The Commercial Court’s decision

Mr Justice Hamblen rejected the Respondent’s arguments regarding incorporation and business common sense, finding that the TAC had made an error of law in its award.

As to incorporation, the judge was satisfied that the wording of Clause 5 made clear that only the Arbitration Bylaws were intended to be incorporated (see paragraph 70). In circumstances where the ICA’s rule book differentiated between Bylaws and Rules, and there was nothing in that rule book to prevent parties opting into the Arbitration Bylaws without simultaneously incorporating the Rules, the Contract was “perfectly workable on the basis that only the Arbitration Bylaws apply” (see paragraph 70). Further, it would be unusual for Clause 5, as an arbitration clause, to incorporate a set of rules containing “governing substantive obligations” (see paragraph 64).

As to business common sense, Mr Justice Hamblen accepted that it makes good sense, in principle, for an arbitral tribunal to apply its own substantive rules, but held that this did not prevent parties from electing not to adopt those rules so as to simply benefit from the tribunal’s trade experience (see paragraph 72). There was no particular need for the tribunal to apply the ICA’s substantive Rules and although the Contract would have had more content if those Rules had been incorporated, the Contract was perfectly workable without them (see paragraph 73).

Further, even if the Respondent’s interpretation made more commercial sense, Mr Justice Hamblen held that the difference was “marginal and it is not sufficient to mean that it would be appropriate to prefer that interpretation given that there is little, if any, ambiguity about the words used” (see paragraph 74).

Accordingly, the invoicing back provisions in Rules 225 and 226 were not incorporated into the Contract and the matter was remitted to the TAC to consider how to address a number of new arguments raised in the Respondent’s Notice, which were not raised before the first-tier tribunal.

Approach to issues of construction on an arbitration appeal - Questions of law, mixed fact and law and arbitral expertise

Mr Justice Hamblen made some helpful obiter comments summarising the correct approach to considering issues of construction on an arbitration appeal, particularly where the arbitral tribunal is composed of members with experience of the relevant trade (see paragraphs 43-58).

Questions of contractual construction, such as the proper construction of Clause 5 in this case, are correctly characterised as questions of law (paragraphs 43-45). Even if the factual matrix in which a contract is concluded is relevant to its construction as a whole, the meaning of words in a contract is plainly a question of law (paragraph 49).

Where the relevant question is genuinely a mixed question of fact and law, courts will only interfere with the conclusion reached if the appellant discharges a heavy burden of persuasion, namely that no reasonable person applying the correct legal test could have reached that conclusion (paragraph 47; see The Sylvia [2010] 2 Lloyd’s Rep 81). If a tribunal with relevant commercial or trade experience makes a decision on an issue of construction, which is a question of law, and that experience assisted the tribunal in determining that question of law, the court will accord some deference to the decision on that question (paragraph 50).

However, the degree of deference accorded will, of course, depend on the circumstances of the case and the extent to which the or trade experience actually assists in understanding the relevant factual background. Since an issue of construction is ultimately a question of law, the tribunal’s decision is either right or wrong as a matter of law, regardless of the extent to which trade experience was employed (paragraph 51).

Mr Justice Hamblen also commented on the oft-quoted maxim in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 that, where a contractual term is open to more than one interpretation, the construction which is most consistent with business common sense should be preferred. In his view, this maxim can be oversimplified by parties who assume that the construction of any given clause which accords most with business common sense is now always to be preferred (paragraph 54). The correct approach is firstly to identify whether the contractual words in question have more than one potential meaning. If not, the words must be applied literally. If so, the court is not required to give effect to the interpretation which accords with business common sense, but is entitled to do so as long as it can be readily ascertained (see paragraphs 55-56).

Where there are arguments either way as to which interpretation accords most closely with business common sense, courts should be wary to favour one over another because business common sense is not an overriding principle of contractual construction and, as Mr Justice Briggs noted in Jackson v Dear [2012] EWHC 2060 at paragraph 40, the parties should not be subjected to “the individual judge’s own notions of what might have been the sensible solution to the parties’ conundrum”.

Comment

The question of law on which permission to appeal was granted in Cottonex was straightforwardly dealt with by the Commercial Court. The TAC simply erred in its approach to construction as it failed to look first at the words of the Contract.

The real point of interest in Cottonex is the guidance set out in Mr Justice Hamblen’s judgment as to how issues of contractual construction on appeals on a point of law under s.69 of the Arbitration Act 1996 should be approached, particularly where matters of ‘business common sense’ are said to be relevant to that endeavour and due deference ought to be afforded to the trade expertise of the tribunal.

Parties to an appeal from an arbitration award should be mindful of the nature of the question on which permission to appeal has been granted. Whilst certain matters of fact might always be relevant to the proper construction of a contract, that does not necessarily mean that all questions of construction on which permission to appeal has been granted are mixed questions of fact and law on appeal.

Parties should also be mindful of arguing, as a matter of course, that their construction of the relevant clause accords most closely with business common sense. Business common sense is not an overriding criterion of interpretation and will only be relevant where the words have more than one potential meaning, and it is clear to the court which interpretation is to be preferred