Proportionate liability applies in Australian arbitrations

The recent judgment of the High Court of Australia (High Court) in Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24 marks a seminal shift in arbitration in Australia.

Key takeaways

• In a significant reversal of the previously widely-held understanding, proportionate liability legislation will apply in most arbitrations in most Australian states, unless the parties’ arbitration agreement expressly provides otherwise. The High Court has confirmed that parties are free to “pick and choose” the rules of law that apply in their arbitration, subject to issues of arbitrability and public policy. In principle, this permits the parties to exclude aspects of a given law or legal system, such as the proportionate liability regime. Accordingly, parties will still need to consider the relevant legislation in each jurisdiction carefully and seek advice when negotiating and drafting arbitration agreements which exclude the operation of a relevant proportional liability regime. In the case of proportionate liability the position is not yet clear, but the ability of the parties to contract out may depend on the specific provisions of the state or territory legislation in question. Queensland, for example, specifically prohibits contracting out, and Victora, South Australia and the Northern Territory do not say either way.
  
  
• Parties with existing arbitration agreements that do not expressly contract out of the proportionate liability regime will need to carefully consider their exposure to the risk that they will not be able to recover any losses in full without commencing additional proceedings against alleged third‑party concurrent wrongdoers.
  
  
• Parties negotiating arbitration agreements in the future will also need to think about whether to exclude the proportionate liability regime, and, depending on their commercial objectives and bargaining position, what measures to take to protect their position. (For example, this may be by ensuring that all potential counterparties execute compatible arbitration agreements and consent in advance to joinder.)

The High Court’s decision confirmed that the proportionate liability legislation will usually apply to arbitrations in Australia, reversing the previously widely-held understanding that it does not. It is a significant ruling which has far-reaching consequences, particularly in the construction industry where contractor and sub-contractor arrangements involving multiple counterparties are common. It also links the proper interpretation of the domestic arbitration regime to international practice as a consequence of the domestic and international regimes in Australia being based on the UNCITRAL Model Law. There are important and useful observations, relating to the three legal systems which regulate any arbitration, which may be different. Those legal systems are: (a) the law to be applied by the court supervising an arbitration; (b) the substantive law pursuant to which the dispute will be resolved; and (c) the procedural law. The High Court’s observations are likely to be useful when considering issues that arise in both international and domestic arbitration and are of general application, but are beyond the scope of this discussion.

The majority decision was delivered in three separate opinions by Gageler CJ, Gordon and Gleeson JJ, and Jagot and Beech-Jones JJ (with Edelman and Steward JJ dissenting in separate opinions). Differences in reasoning in the various judgments make it difficult to derive a single clear statement of principle. The result, however, is clear. This article extracts some key insights, which will be useful for arbitration practitioners and parties alike.

Arbitration

Arbitration is a private dispute resolution process. The parties to a contract consent in an arbitration agreement to have their disputes resolved by an agreed arbitrator (or arbitrators) pursuant to authority given to the arbitrator(s) by the parties, and in accordance with the rules of law selected by the parties. The concept of party autonomy, and the consent of the parties to this process, is central.

The consensual nature of arbitration also means that any decision of an arbitrator is binding only upon the parties to that specific arbitration agreement. As a result, third parties generally cannot be joined to the arbitration without consent and are not bound by the findings of an arbitrator. (This is unless the third party falls within one of the limited exceptions to this rule of privity, such as where it is the agent or alter ego of a signatory to the arbitration agreement, there are grounds to pierce the corporate veil, or it advances a claim or defence ‘through or under’ a party to the arbitration agreement.)

Proportionate liability

The proportionate liability legislation in Australia is broadly uniform across the Commonwealth, states and territories, subject to the notable exception of Victoria (see below). It provides defendants with a substantive defence that caps their liability at the ‘proportion’ of loss or damage for which they are held responsible. Under this regime, where there are multiple wrongdoers in respect of an apportionable claim, a plaintiff must sue each and every wrongdoer who contributed to its loss to recover the full amount of that loss.

The proportionate liability legislation was introduced specifically to reverse the existing regime of solidary liability under the common law, whereby a plaintiff could recover the entirety of its loss from a single defendant. Under the common law regime, that defendant then bore the burden of seeking contribution from other wrongdoers in subsequent proceedings. At the time, this led to an increasing number of claims where defendants were selected based on their ‘deep pockets’, i.e. their capacity – or their insurers’ – to pay large awards for damages, rather than their culpability.

By introducing proportionate liability, the Commonwealth, states and territories deliberately sought to transfer the burden of pursuing concurrent wrongdoers, and the risk of non-recovery, from defendants to plaintiffs.

Background to the appeal

The underlying dispute concerned work completed by the appellant, Tesseract International Pty Ltd (Tesseract), who provided engineering consultancy services under a sub-contract to the respondent, Pascale Construction Pty Ltd (Pascale).

Pascale alleged it had suffered loss and damage as a result of Tesseract’s conduct, which Pascale alleged included breach of the sub-contract, breach of a duty of care in negligence, and misleading or deceptive conduct.

The sub-contract contained an arbitration agreement and the dispute was referred to arbitration. Neither the subcontract nor the arbitration agreement specified the law applicable to the dispute. However, the parties were ultimately in agreement that the laws of South Australia applied.

Tesseract denied liability. In the alternative, Tesseract pleaded that any damages payable should be reduced to reflect the percentage of the plaintiff’s notional damages that is ‘fair and equitable’ or ‘just’ having regard to the extent of its responsibility, in accordance with the proportionate liability provisions of Part 3 of the Law Reform (Contributory Negligence and Apportionment of Liability) Act 2001 (SA) (Law Reform Act) and their equivalent in Part VIA of the Competition and Consumer Act 2010 (Cth) (CCA).

Pascale denied the applicability of the proportionate liability legislation to the arbitration.

Tesseract applied to have the question of whether the proportionate liability provisions of the Law Reform Act and CCA applied in the arbitration determined by the court as a question of law.

The Court of Appeal of the Supreme Court of South Australia unanimously held that the proportionate liability provisions did not apply.

The Court of Appeal’s decision

Prior to the High Court’s decision, the consensus in Australia, both from a jurisprudential and academic standpoint, was that proportionate liability did not generally apply to arbitrations.

Consistent with this, the South Australian Court of Appeal held that:

• The proportionate liability regime in the Law Reform Act and CCA formed part of the substantive law of South Australia. However, this alone did not determine the question as to whether their proportionate liability provisions applied in the parties’ arbitration.
  
  
• The proportionate liability provisions in the Law Reform Act and the CCA did not apply to arbitral proceedings ‘by force of their own terms’, because neither statute expressly or impliedly indicated that they applied to arbitrations. The Court of Appeal relied on both:
  
  a) the language of the statutes, which used words like ‘court’ and ‘judgment’, and which it held were indicators that there was no legislative intention to apply the proportionate liability provisions to arbitration; and
  
  b) contextual features of the proportionate liability regime, which it considered indicated the same absence of legislative intention.
  
  In particular, the Court of Appeal noted that many of the features of proportionate liability are not ‘amenable’ to arbitration. These include the power of a court to join concurrent wrongdoers to a dispute (which power arbitrators do not have, and which counterbalances the risk to the plaintiff of incurring additional costs due to the potential need for multiple proceedings). They also include the requirement for a judgment regarding an apportionable claim to address (among other things) the proportionate liability of each wrongdoer, (which is problematic in circumstances where any third party is unlikely to have had any opportunity to participate in the arbitration).

• There is a general implied term in arbitration agreements that arbitrators can determine the dispute in accordance with the applicable substantive law that would be applied by a court of competent jurisdiction dealing with the dispute (including all rights and remedies available in a court, subject to certain exclusions). However, the ability of an arbitrator to exercise certain statutory powers depends on the capacity of those powers to be ‘moulded’ to apply to arbitration. The Court of Appeal held that, in view of the inability to join third parties and the confidential and bipartite nature of arbitration, any attempt to ‘mould’ the proportionate liability legislation to arbitration would lead to a materially different regime being applied.

In May 2023, the High Court granted Tesseract special leave to appeal the South Australian Court of Appeal’s decision.

The High Court’s decision

On 7 August 2024, the High Court upheld Tesseract’s appeal by a 5:2 majority and confirmed that the proportionate liability regimes under the Law Reform Act and CCA apply to the arbitration between Tesseract and Pascale.

While the decision is confined in some ways to the arbitration agreement and statutes ultimately before the High Court, in circumstances where both the proportionate liability and domestic arbitration regimes in question are reflected in (mostly) uniform legislation across all key Australian jurisdictions, the majority’s decision is far-reaching.

The High Court’s reasoning

The High Court did not speak with one voice in deciding that the proportionate liability regime applied in the arbitration. Their Honours were, however, unanimous in concluding that the fact that the Law Reform Act and CCA included provisions relating to the involvement of third-party concurrent wrongdoers was no impediment to applying the essential features of the proportionate liability regime in an arbitration. This is notwithstanding that it would not normally be possible to join third parties to arbitral proceedings.

The Chief Justice focused on the distinction between the substantive and procedural provisions of the Law Reform Act and CCA. In Gageler CJ’s view, an arbitral tribunal is required to apply only the substantive provisions of the proportional liability regimes enshrined in those statutes. These included the ‘central provisions’ empowering a court to limit a defendant's liability. Collateral provisions, such as those requiring a defendant to notify a plaintiff of a concurrent wrongdoer, or those conferring a power on the court to join concurrent wrongdoers to proceedings, were matters of procedural law and, therefore, not applicable. His Honour held that those substantive ‘central’ provisions were capable of being applied independently of the procedural provisions, and there was nothing in their application that could render: (a) the dispute as not arbitrable; or (b) a resulting award as contrary to public policy. As such, there was no obstacle to applying those provisions in an arbitration.

Justices Gordon and Gleeson took a different path in their joint reasons but arrived at the same conclusion. Their Honours asked whether the proportionate liability provisions in the Law Reform Act and CCA could be adapted to the arbitral context without distorting them to such an extent that they could no longer be described as part of the substantive laws of South Australia.

Justices Gordon and Gleeson answered in the affirmative. Their Honours observed that the parties had accepted that the ‘key operative provisions’ of the proportionate liability regime -namely, those limiting the liability of a defendant – could be applied in an arbitration, including in the absence of any concurrent wrongdoer. As for the remaining provisions, including provisions empowering the court to compel the joinder of all wrongdoers in a single proceeding, their Honours considered that they could also be adapted or, if not, they were not ‘so integral to each of the proportionate liability laws that the operative provisions could not operate as the legislatures intended’.

In their joint reasons, Jagot and Beech-Jones JJ agreed with Gageler CJ that the proportionate liability regime could be split into substantive and procedural provisions, and that the procedural provisions relating to the involvement of third-party concurrent wrongdoers were not applicable to the substance of the dispute. However, their Honours took their analysis further, finding that ‘the manifest policy choice made by the Commonwealth and South Australian Parliaments in enacting their proportionate liability regimes was that the regimes would apply whether a plaintiff could join all potential wrongdoers as parties or not, irrespective of the forum for dispute resolution’. Their Honours also held that, in any event: (a) the relevant procedural provisions could, in fact, be given effect in an arbitration; and (b) even if they could not, that would not render the dispute non‑arbitrable or any eventual award contrary to public policy.

In dissent, Steward J considered that the proportionate liability regimes were designed for proceedings involving multiple wrongdoers. In the arbitral context, in which an arbitral tribunal cannot compel concurrent wrongdoers who are not parties to the same arbitration agreement ‘to participate in the one settled outcome’, any attempt to apply the Law Reform Act and CCA would impose on the parties ‘a dramatically different regime for proportionate liability, authorised neither by the Parliament of South Australia nor by the Parliament of the Commonwealth’.

Justice Edelman similarly considered that the procedural aspects of the Law Reform Act and CCA, which could not be applied in terms in an arbitration, were ‘inextricable’.

Justice Edelman also made the critical and striking observation that:

“… a consequence of [the High Court’s] decision may be that those parties to agreements concluded prior to this Court's decision, who may have relied upon the pre-existing legal position in Australia in not including an express exclusion of proportionate liability laws, could find themselves as parties to agreements where those rules apply.”

Looking ahead

The consequences of the High Court’s decision that the proportionate liability regime generally applies to arbitrations in which Australian law applies will have significant and far-reaching consequences.

Below, we note some of the most pressing implications:

• If an existing arbitration agreement does not expressly exclude proportionate liability, there is a high probability that proportionate liability will apply in any arbitration commenced under that agreement. The probability that proportionate liability will apply will depend on the specific terms of the arbitration agreement. Parties should consider their existing contractual arrangements to ascertain any contracts where this may present a material risk and consider what steps they can take to mitigate that risk. This could include seeking to renegotiate existing arbitration agreements, (which may be extremely challenging absent significant commercial leverage) or attempting to put compatible arbitration agreements in place with relevant third parties to ensure they can be brought into the arbitration or arbitrations commenced separately can be consolidated.
  
  
• In terms of negotiating arbitration agreements, downstream parties will now be in a more favourable position when negotiating with upstream parties. Proportionate liability is now the default position, and it will require significant commercial incentives for a downstream party to agree to exclude proportionate liability and potentially assume liability for losses that are concurrently caused. However, downstream parties should be aware that this may make upstream parties more inclined either to abandon arbitration altogether, or to seek to impose requirements for multi-party agreements to arbitrate.
  
  
• Conversely, upstream parties are now in a less favourable position when dealing with downstream parties for the same reason: the default position is that they bear the risk of a shortfall in recovery in any multi-party dispute referred to arbitration. In negotiating with downstream parties, upstream parties will need to consider whether they can exclude the operation of the proportionate liability legislation and, if not, take other mitigating action to the extent possible. That could involve mandating multi-partite agreements with all potentially relevant third parties, or at least compatible arbitration agreements across all relevant contracts, and (for the avoidance of doubt) express consents to joinder and consolidation of arbitrations.
  
  
• One point the High Court did not address head on was the consequences of their decision for jurisdictions where the legislation is silent as to the parties’ right to contract out of the proportionate liability legislation or, like in Queensland, specifically prohibits contracting out. Parties will need to consider the relevant legislation in each jurisdiction carefully and should seek advice when negotiating and drafting arbitration agreements.
  
  
• Under the proportionate liability legislation in Victoria, a defendant may join other parties to the litigation. In that case the court will apportion liability in relation to an apportionable claim to the defendants (which includes third parties). The proportion allocated to each defendant will be the limit of its liability, thereby avoiding solidary liability which might otherwise apply. In Victoria, it is not possible to reduce the liability of the defendants in the litigation by reference to another wrongdoer who is not a party to the litigation. This means that, where the Victorian proportionate liability legislation applies, the power of an arbitrator to apportion liability is limited to the parties to the arbitration. In most cases there will only be one respondent in an arbitration, with the result that the proportional liability regime (which may be applicable) has no work to do. Therefore, differences between the scheme in Victoria and those of the other states may mean that the Tesseract decision is of limited relevance to Victoria, as the scheme’s application in Victoria will be limited by the fact that there are unlikely to be multiple respondents in the arbitration (unless conditions for consolidation or joinder are met).
  
  
• The High Court’s finding ultimately complicates the pathway to recovery for claimants in an arbitration where there are multiple wrongdoers. If a defendant invokes proportionate liability (and it either is not or cannot be excluded), the claimant will now need to pursue any concurrent wrongdoers in separate court or arbitration proceedings. Parties to agreements where there is a possibility of concurrent wrongdoers should actively consider the delay and costs associated with this approach when weighing up the strategic value of arbitration compared to litigation, and otherwise seek advice when negotiating arbitration agreements if arbitration is the preferred method of dispute settlement.
  
  
• Although Tesseract concerned a domestic arbitration, there is no reason in principle that the result would not be the same in international arbitrations where Australian law is the governing law. Given the uniformity of the international arbitration legislation in Australia with the domestic arbitration legislation, the High Court’s judgment may have similarly significant consequences for international arbitrations applying Australian law. Parties (and potential parties) to international arbitrations should therefore carefully consider their position and seek advice.