This article was first published on Herbert Smith Freehills’ arbitration blog and is reproduced here with the kind permission of the authors.

In Koshigi Ltd and another company v Donna Union Foundation and another [2019] EWHC 122 (Comm) the English High Court considered an application for costs arising from discontinued proceedings under s.68 Arbitration Act 1996 to challenge two arbitral awards. The claimant in the underlying arbitration had successfully obtained two awards in its favour from the tribunal, which the respondents then sought to challenge in the English courts through two related sets of proceedings for serious irregularity under s.68, alleging bias on the part of the chairman of the tribunal. The respondents then discontinued the s.68 proceedings before they reached a hearing, asserting that the awards which they were seeking to challenge had become unenforceable.

In considering the claimant’s application for costs in relation to the discontinued proceedings, the Court decided that the liability for the costs rested with the applicants (the respondents in the arbitration) and that the costs should be assessed on an indemnity basis rather than the usual – and typically lower – standard basis. The Court’s approach, which disincentivizes the pursuit of s.68 applications without a strong substantive basis, is consistent with other attempts by the English courts to block applicants who bring weak s.68 appeals.

Background

The underlying arbitration concerned a dispute between the shareholders of a Maltese company concerning a provision of the Maltese Companies Act requiring the compulsory purchase of the claimant’s minority shareholding in certain circumstances.

Following the issue of the first award, the respondents commenced s.68 proceedings, alleging that the chairman of the tribunal breached his duty to act fairly and impartially and was biased. The claimant issued an application for security for costs in relation to this application. Shortly thereafter, the tribunal issued its second award. The respondents then issued a further s.68 challenge in relation to this award, relying on the same allegations of bias regarding the chairman.

However, within a month of issuing the second set of s.68 proceedings, the respondents discontinued both sets of s.68 proceedings, alleging that the underlying awards which they had been seeking to challenge had become unenforceable. The tribunal had ordered the purchase of the shareholding by way of a mechanism that involved the claimant transferring its shares to be held in escrow and the respondents paying the purchase price to be held in escrow. The respondents argued that as the claimant had not delivered the shares into escrow by the relevant deadline (even though the respondents had not paid the purchase price either), the mechanism had failed. They argued that the tribunal, having already delivered its awards, was now functus officio and could not be called on to substitute another mechanism. The respondents had decided to discontinue their s.68 proceedings challenging the awards on this basis.

The Court’s approach to costs 

The Court decided that the respondents should bear the costs of the discontinued s.68 proceedings and should do so on an indemnity basis.

The Court applied the test from Brookes v HSBC Bank plc [2011] EWCA Civ 354 regarding costs liability for discontinued proceedings. This set out a presumption that the defendant in the discontinued proceedings should recover their costs and that there is a burden on the claimant in those proceedings to show a good reason for departing from that position.

In this case, the respondents argued that the claimant had acted unreasonably by first pursuing the arbitration but then failing to comply with the tribunal’s deadline to deliver the shares and that the consequence was that their s.68 challenge to the awards had become redundant. The respondents contended that they had a reasonable belief that the awards were unenforceable at the time they discontinued the s.68 proceedings and that the circumstances of the claimant’s failure to deliver the shares amounted to unreasonable conduct which justified a departure from the usual rule of cost allocation for discontinued proceedings.

In response, the claimant argued that the enforceability of the awards remained in dispute and that the question of their enforceability was not to be determined in costs proceedings. There were otherwise no circumstances to justify the departure from the presumption in Brookes.

The Court agreed with the claimant. In reaching its decision, it noted that the burden on the respondents to discharge the Brookes presumption was high. It also noted that many of the respondents’ contentions relied on factual matters which were in dispute and which would have required extensive examination of the facts in order to determine them, stating that “the court cannot on a costs application embark on what would amount to a hearing of the case on the merits and on the evidence“. Engaging in any assessment of the enforceability of the awards would require the Court to conduct a de novo hearing on highly contentious matters involving extensive evidence (including on Maltese law), which was not appropriate or permissible as part of a costs application and would in any event “usurp the function of any court which ultimately has to decide enforcement proceedings“. The respondents’ alleged ‘reasonable belief’ in the unenforceability of the awards could not be relied on by the Court for these purposes.

On this basis, the Court held that the respondents were liable to pay the costs of the s.68 proceedings.

Standard costs v indemnity costs 

The Court then had to decide whether to order costs on a standard basis or an indemnity basis, which will usually be higher.

The usual rule is that the costs of discontinued proceedings should be assessed on a standard basis. The Court noted that there must be some conduct or circumstances which “takes the case out of the norm” before an indemnity costs order can be made, although this conduct need not be exceptional.

In addressing whether there were any circumstances to take this case ‘out of the norm’, the parties focused on the strength of the substantive basis for the respondents’ s.68 challenges: the allegations of apparent bias in relation to the chairman. The respondents argued that they had had good grounds to assert bias and that the allegations of bias had not been waived during the arbitration. The claimant argued that the allegations of bias were “thoroughly bad” and had been waived by the respondents’ continued conduct of the arbitration. The respondents’ subsequent pursuit and then abandonment of the s.68 challenges on this basis (and in reliance on such serious allegations) was, on the claimant’s case, enough to take this case ‘out of the norm’ and justified an order of indemnity costs.

The Court concluded that the respondents’ case regarding bias had been very weak. The respondents’ allegations of bias concerned various professional links between the chairman and both the solicitors and QC representing the claimant as well as the chairman’s relationship with the head of the company acting as funder and adviser to the claimant – facts discovered by the respondents during the hearing in the arbitration – and the chairman’s failure to disclose certain of these facts.

The Court noted that the circumstances in this case were very unlikely to have given rise to bias in the legal sense or to have required disclosure by the chairman. The Court also noted, however, that it was not required to decide whether the allegations of bias were true. The Court was required to consider the strength of the allegations in the context of costs liability in respect of a discontinued claim, where the question was whether the circumstances give rise to some conduct which takes the case out of the norm so as to justify the award of indemnity costs.

The Court noted that the weakness of the case on bias in itself may be sufficient to justify the award of indemnity costs, but that an additional factor weighing in favour of this decision was that the respondents had discontinued the proceedings shortly before the claimant’s application for security for costs was due to be heard and that there was no doubt that such an application would have been granted.

Consequently, the Court ordered the respondents to pay the costs of the s.68 proceedings (including the costs hearing itself) on an indemnity basis, and to make an interim payment of 70% of the amount claimed.

Comment

This case demonstrates the way in which the English courts discourage the pursuit of weak s.68 challenges, using indemnity costs to disincentivize appeals with very low prospects of success. Parties considering a s.68 challenge on shaky grounds need to be aware at the outset that withdrawing their appeal, whether for tactical or other reasons, will be likely to incur costs, which may be on an indemnity basis. It is important to give careful consideration to this costs exposure before choosing to commence s.68 proceedings, particularly in light of the success rates for such challenges which show that in the recent past more than 90% of s.68 applications have failed.

The case also demonstrates the difficulties inherent in costs orders for s.68 proceedings. The court will not conduct a de novo hearing on the evidence or on the issues arising from the underlying case, even where they might be relevant to the costs allocation (in this case, questions around the enforceability of the awards and the allegations of bias in relation to the chairman). This limits the parties’ ability to rely on circumstances that involve disputed facts. It is important for a party considering a s.68 challenge to take account of these limitations from the start, even where there is a strong belief in the underlying arguments, particularly if there is any likelihood that other factors in play may lead to a need to discontinue the proceedings.

More generally, while some s.68 challenges are brought for tactical reasons, others are born out of a strong sense of grievance (whether well-founded or not) about the result. Given how difficult it is to succeed and the costs consequences for abandoning or failing in the attempt, it is vital for parties to reflect both coolly and dispassionately before embarking on a s.68 challenge.

Herbert Smith Freehills LLP – Craig TevendaleLouise Barber and Rebecca Warder