Fortress Valley Recovery Fund v Blue Skye Special Opportunities Fund

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Fortress Value Recovery Fund I LLC (and others) v Blue Skye Special Opportunities Fund LLP (and others)

English Court of Appeal; Pill, Toulson, Tomlinson LJJ; [2013] EWCA Civ 367; 31 January 2013

Mark Hapgood QC and Craig Morrison (instructed by Signature Litigation LLP) for Fortress Value Recovery Fund I LLC (“Fortress”)

Ewan McQuater QC and David Quest (instructed by Slaughter and May) for Blue Skye Special Opportunities Fund LLP (“Blue Skye”)



Disputes arose in relation to the operation of an investment structure modeled upon an English limited partnership. Under the partnership agreement, the managers of the investment structure enjoyed exclusions of liability in relation to, and a right to an indemnity for, various claims. One of the partners’ assignees sued various parties, including the managers of the investment structure. The managers sought a stay in favour of arbitration, relying on the Contracts (Rights of Third Parties) Act 1999 (“Act”).

At first instance, a stay was rejected because the managers were not exerting a right of action, but relying upon a contractual defence. The Court of Appeal agreed with the result below, but not the reasoning. It rejected the plain distinction between action and defence, preferring to rest its decision on a construction of the partnership agreement in question.

(In the course of his concurring judgment, Toulson LJ delivered a clear and concise statement on the difference between Section 8(1) and 8(2) of the Act: see [42-45].)

This case note has been contributed by Justin Gan Boon Eng, LLB (Hons) (NUS), an advocate and solicitor of the Singapore Bar


Blue Skye was an investment structure formed by a Deed of Limited Partnership (“Deed”). The Deed, most relevantly:

(a) contained an English law and arbitration clause governing disputes related to the Deed between the “parties hereto”.

(b) purported to confer substantial rights upon Blue Skye’s managers.

(c) expressly provided for their involvement in Blue Skye’s operation

(d) excluded liability of, amongst others, Blue Skye’s managers to the partnership for certain types of claims, and provided that Blue Skye would indemnify its managers against such claims.

(e) allowed, amongst other things, Blue Skye’s managers to enforce their “rights or benefits under this agreement”, expressly referring to the Act.

One of the partners assigned its interest in Blue Skye to Fortress as security for a loan. Two other partners were shareholders of the assignor partner. Subsequently, Fortress, as assignee, sued Blue Skye, Blue Skye’s other partners, Blue Skye’s managers, and other related entities, alleging among other things, conspiracy and dishonest dealing, intended to take control and benefit of the assets for themselves.

Blue Skye, including its managers, sought a stay of the English Court proceedings in favour of arbitration. At first instance before Blair J, the position vis-à-vis each of the respondents was:

(a) Blue Skye – Fortress (naturally) conceded that the English Court proceedings against Blue Skye should be stayed.

(b) Blue Skye’s partners which were also shareholders of the assignor partner – Although these partners were also parties to the Deed, Fortress argued that the claim against these partners related not to their participation in the Limited Partnership, but to their role as shareholders in the assignor partner. Blair J found that the arbitration clause should be widely construed and that the English Court proceedings against these partners should be stayed, as they arose in connection with the same subject-matter.

There appears to have been no appeal in relation to Blue Skye’s partners.

(c) Blue Skye’s managers – It was conceded that the claims against Blue Skye’s managers were “broadly the same in nature” as those brought against the partners referred to in (b) above.

Blue Skye’s managers were not party to the Deed (and arbitration agreement), but argued that they could rely on the arbitration clause by virtue of the Act . Consequently, the English Court proceedings against them should be stayed.

Fortress conceded that if Blue Skye’s managers wanted to enforce the indemnity clause, Section 8(1) of the Act required the managers’ claim to be referred to arbitration. However, if the managers chose to rely on the exclusion clause, the efficacy of that reliance fell outside the scope of the arbitration clause because “it is a contractual defence, as opposed to a contractual right of action which is subject to arbitration.” Blair J agreed and refused the stay in relation to Blue Skye’s managers, explaining that:

“Whether proceedings are liable to be stayed in favour of arbitration must depend on the nature of the claim, not on the nature of an exclusion defence, because the issue has to be determined at the time the proceedings are issued… and before the taking of any step in those proceedings to answer the substantive claim.”

The Court of Appeal upheld Blair J’s decision, via different reasoning.


On Section 8(1) of the Act

Tomlinson LJ, delivering the leading judgment, explained that Blair J’s distinction between a right and defence was inconsistent with the express language of the Act, Section 1(6) of which provides that “the third party availing himself of the exclusion is the equivalent of his enforcing a term in the contract.”

Instead, whether a third party’s taking the benefit of a contractual exclusion is subject to an arbitration clause in the same contract depends on the correct construction of that contract to determine whether the third party’s right is indeed subject to an obligation to arbitrate disputes.

Studying the Deed, however, there was nothing to indicate that the parties had intended that the managers’ reliance on the exclusion clause was subject to their being bound by the arbitration clause. In fact, “very clear language” in the Deed would have been required to persuade Tomlinson LJ to decide otherwise (at [36]). In so deciding, Tomlinson LJ was concerned:

(a) that if Section 8(1) of the Act did apply to contractual defences in the present case, the managers – by relying on the exclusion clause - would automatically be considered parties to the arbitration agreement and thus be forced to submit to arbitration to which they did not consent [29]); and

(b) to avoid a situation where “…third parties would be bound by the outcome of arbitration proceedings which they had not themselves initiated in order to secure a benefit apparently conferred upon them by the Agreement” ([36]).

(c) that deciding otherwise would lead to one of two situations, both of which were undesirable ([30]):

(i) strictly speaking, only the aspect of the dispute related to the third party’s entitlement to rely on the contractual defence could be referred to arbitration, which would lead to fragmented dispute resolution.

(ii) if it were otherwise, the third party would be effectively forced to arbitrate aspects of the dispute unconnected to its contractual defence, to which the third party could not be taken to have consented.

Toulson LJ agreed generally with these views and specifically rejected the managers’ argument that (a) since it was clear that any claim by the managers for an indemnity was subject to arbitration, (b) similarly, if the managers wanted to rely on the exclusion clause, they could only do so in arbitration. After all, “It would not make sense or accord with the purpose of section 8(1)” to interpret that section as preventing a third party from relying on a contractual defence when a contracting party chose to sue him ([54]).

On Section 8(2) of the Act

Section 8(2) only applies where the third party has a contractual right to arbitrate. It was therefore argued that in the context of the Act, notwithstanding that the law and arbitration clause of the Deed referred to the “parties hereto”, the arbitration clause in the Deed would encompass any disputes with third parties arising out of or connected with the agreement.

The argument was rejected. It was inconsistent with other express words of the Deed, which defined references to “parties” as the parties to the Deed ([31]). Further, per Toulson LJ, had the parties intended the managers to have a contractual right to refer disputes to arbitration (and therefore be captured by Section 8(2) of the Act), express wording could easily have been inserted ([47]).


Separately, Tomlinson LJ noted that it was not legitimate to consider the contents of the Defence in an application for a stay under Section 9 of the Arbitration Act 1996 ([34]). This is because such an application must be made before the prospective defendant takes any step in the proceedings, including filing a Defence.