The Supreme Court has held that a third party who relies on a contract containing an arbitration clause but then sues in a foreign court instead of arbitrating, is in breach of contract. The innocent party may therefore recover ordinary contractual damages. In reaching that conclusion, the Supreme Court overturned the Court of Appeal and corrected an error that had persisted in the case law for almost 30 years. The decision provides contracting parties, particularly insurers facing direct claims, with a clear monetary remedy where a third party disregards an applicable arbitration clause.

Background: Benefit and Burden

Normally, only the parties to a contract can enforce it or be bound by it. However, the law sometimes allows a third party to enforce a contract. For example, some countries allow the victim of an accident to sue the wrongdoer’s insurer directly (see paragraphs [5] and [7]).

Where a third party chooses to enforce a contract in this way, it must also accept the contract’s terms, including any arbitration clause. This is known as the “conditional benefit” or “benefit and burden” principle. As Megarry V-C put it in Tito v Waddell (No 2) [1977] Ch 106, 289, “You can’t have it both ways” or “You can’t eat your cake and have it too” (see paragraph [50]).

Until this decision, the courts had treated a third party’s obligation to arbitrate as equitable rather than contractual. That characterisation mattered because equitable compensation and common law damages are different remedies. In particular, equitable compensation is discretionary and may be subject to equitable defences, such as unreasonable delay (“laches”) or lack of “clean hands”, which do not directly apply to common law damages (see paragraph [44]).

The Facts and Procedural History

In 2002, the oil tanker Prestige was damaged in a storm and sank off the Spanish coast, causing major pollution in Spain and France. The vessel’s owners were insured by the London Steam-Ship Owners’ Mutual Insurance Association (the Club), a mutual insurer of shipowners’ liabilities. Two terms of the insurance contract were particularly significant:

• a “pay to be paid” clause, which made payment of the full amount of the member’s liability a condition precedent to its right to recovery under the insurance contracts; and
• a London arbitration clause, which required disputes to be referred to arbitration in London and for the arbitration to be subject to English law.

(see paragraph [4]).

Among the claims arising from the disaster were direct claims brought by Spain and France (the States) against the Club in the Spanish courts. In response the Club commenced the first set of London arbitrations against each State. The States did not participate. The arbitrator held that the States’ claims were, as a matter of English law, claims to enforce rights derived from the insurance contract. They therefore had to take those rights subject to the contract’s terms, including the London arbitration clause and the “pay to be paid” clause. He declared the States were bound to arbitrate their claims in London and that, because the shipowners had not first paid the insured liability, the Club was not liable to the States (see paragraphs [11] – [12]).

The States challenged those awards in the English courts, arguing, among other things that they were not bound by the arbitration clause. The Club, meanwhile, sought to enforce the awards as judgments. Hamblen J rejected the States’ challenges and permitted enforcement, holding that their direct claims were in substance contractual and that, by seeking to enforce rights under the insurance contract, the States were bound by the arbitration clause. The Court of Appeal dismissed the States’ appeals.

Notwithstanding those awards and the English court judgments upholding them, the Spanish proceedings continued. The Club was held directly liable and held that the States were entitled to recover up to around €2.355 billion (Spain) and €117 million (France), subject to the US$1 billion limit of the insurance cover (see paragraph [6]).

That led to a second set of London arbitrations. The Club sought compensation for the States’ breach of the arbitration clause (see paragraph [18]). Because an injunction cannot ordinarily be granted against a state under section 13(2)(a) of the State Immunity Act 1978, the Club could not obtain the usual anti-suit relief. The case law, at the time, treated the obligation to arbitrate as an equitable obligation, so the Club claimed, ‘equitable compensation’.

The arbitrators awarded compensation for the Club’s losses. The High Court upheld the awards, but the Court of Appeal set them aside, holding that equitable compensation was not available in the circumstances (see paragraph [37]). By the time the case reached the Supreme Court, therefore, it was already established that the States were bound to arbitrate and had breached that obligation. The central question was what monetary remedy was available for that breach.

The Decision

The Supreme Court unanimously allowed the Club’s appeal and restored the awards. Lord Leggatt and Lord Burrows gave the judgment.

The Supreme Court’s reasoning had two stages: First, it rejected the premise on which the case had previously proceeded: the States’ obligation to arbitrate was not an equitable obligation but a contractual one. It followed that the ordinary remedy for breach was common law damages. Second, the court considered and rejected the Court of Appeal’s separate reasons for concluding that monetary relief was unavailable.

The Starting Point: The Obligation Is Contractual

The Supreme Court held that the question raised by Ground 1 was “a loaded question”, because it assumed that the obligation to arbitrate arising by the operation of the conditional benefit principle was equitable (see paragraph [40]). That assumption mattered because the characterisation of the obligation determined the remedy:

• if the obligation was contractual, the ordinary remedy was common law damages;
• if it was equitable, equitable compensation might in principle be available.

The key was to identify the source and content of the States’ rights. Because the States were seeking to enforce rights derived from the insurance contract, the conditional benefit principle required them to accept the conditions attached to those rights, including the obligation to arbitrate in London.

That also determined the nature of the obligation. For the purposes of the arbitration clause, the States were treated as if they were parties to the contract. Their failure to arbitrate was therefore treated as a breach of contract, attracting the ordinary contractual remedy of damages (see paragraphs [59]–[65]). Otherwise, a third party could be placed in “a different, and potentially better, position” than an original contracting party (see paragraph [62]).

Why, then, had the obligation previously been regarded as equitable? The Supreme Court traced the error to The Jay Bola [1997] 2 Lloyd’s Rep 279, where the judge drew what he described as “a simple analogy” with equitable principles, although the Supreme Court thought “a complicated analogy” more accurate (see paragraph [71]). That analogy subsequently came to be treated as the legal basis of the obligation. The resulting view that the arbitration clause gave rise to an “equitable right” against the third party was in the Supreme Court’s opinion “misconceived” (see paragraph [94]).

The Court of Appeal’s remaining objections to damages

Having established that the States’ obligation was contractual and that damages were therefore available in principle, the Supreme Court turned to the four reasons given by the Court of Appeal which might nevertheless have prevented monetary relief. It rejected each of them.

1. Is the conditional benefit principle merely “defensive”?

The Court of Appeal considered that the conditional benefit principle was essentially defensive: it prevented a third party from enforcing a contractual benefit without accepting the corresponding burden but did not create a conventional cause of action against a third party (see paragraph [102]).

The Supreme Court accepted that the principle was “defensive” in one sense but rejected the consequence the Court of Appeal drew from that characterisation. The principle is defensive because the third party assumes the burden only when it chooses to claim the contractual benefit. But once it does so, it becomes subject to the relevant contractual obligation and can be sued for breaching it (see paragraphs [103] – [104]).

There was therefore “no principled basis for excluding monetary relief”. Indeed, it would be anomalous to permit an anti-suit injunction restraining the breach but deny damages, a “less intrusive remedy”, once the breach had caused loss (see paragraphs [104] and [105]).

2. Section 50 did not exclude ordinary damages.

The Court of Appeal reasoned that because section 50 of the Senior Courts Act 1981 could not provide damages in lieu of an injunction against the States, allowing compensation on another basis would circumvent the statutory restriction (see paragraph [113]).

The Supreme Court held that this conflated two distinct remedies. Section 50 provides damages in substitution for an injunction. It does not restrict an independent right to common law damages arising from breach of contract (see paragraphs [115]– [116]).

3. Causation

The Court of Appeal held that the Club’s losses were caused by the Spanish courts’ failure to give effect to the “pay to be paid” clause, rather than by the States’ breach of their obligation to arbitrate (see paragraph [117]).

The Supreme Court rejected that conclusion for two reasons:

• Substantively, the Spanish courts’ decisions were one cause of the Club’s loss, but there was no basis for treating them as the only cause (see paragraph [118]); and
• Procedurally, causation was not one of the questions of law before the court on the section 69 appeal. The Court of Appeal therefore should not have considered it (see paragraphs [122]– [123]).

4. International comity

The Court of Appeal considered that compensation could interfere with decisions by foreign courts about whether to recognise or enforce the Spanish judgments (see paragraph [125]).

The Supreme Court rejected the premise. The awards did not prevent any foreign court from recognising or enforcing the Spanish judgment. They addressed a different question: the consequences, as between the States and the Club, of obtaining that judgment in breach of the obligation to arbitrate (see paragraph [126]). In any event, the issue had not been raised in the arbitration or on appeal, so the Court of Appeal should not have considered it (see paragraph [127]).

The Outcome

That left two remedial questions.

First, it did not matter that the Club had framed its claim as one for “equitable compensation” rather than contractual damages. The substance of the claim was compensation for loss caused by breach of the obligation to arbitration. Refusing relief simply because it had the wrong legal label “would elevate form over substance” (see paragraph [145]).

Second the awards were not impermissibly granting damages for future breaches. The Supreme Court accepted that, outside section 50, monetary compensation cannot be awarded for a wrong that has not yet occurred (see paragraph [149]). But the awards did not compensate the Club for future breaches. The States’ breaches had already occurred. The awards simply required the States to pay if and when those existing breaches caused the Club loss in the future (see paragraphs [151]– [152]).

The awards were therefore restored, with minor amendments to record that the relevant obligation was contractual and to remove the word “equitable”.

The Significance of the Decision

The immediate significance of the decision is that it simplifies the law. Where the conditional benefit principle binds a third party to an arbitration clause, the obligation is treated as contractual. The ordinary contractual consequences therefore follow if the third party breaches it, including a claim for damages.

An anti-suit injunction will not always be available. The Supreme Court has now confirmed that the fact an injunction is unavailable does not, without more, prevent recovery of damages for loss caused by breach of the obligation to arbitrate.

There is also a separate procedural lesson. On an appeal under section 69 of the Arbitration Act 1996, the court is confined to questions of law properly before it. The Supreme Court’s treatment of the causation and international comity illustrates the limits on an appellate court introducing additional grounds for overturning an award.

Key Takeaways

• A third party who seeks to enforce rights under a contract may be bound by its arbitration clause, with breach treated as a breach of contract.
• The ordinary monetary remedy for that breach is common law damages, not equitable compensation.
• The conditional benefit principle is not limited to defensive remedies: it can support a monetary claim against the third party.
• The fact that an anti-suit injunction is unavailable does not itself preclude damages, including where the third party is a state.
• A conditional award may address future loss caused by an existing breach, but damages cannot be awarded for a future breach that has not yet occurred.

If you would like to discuss any of the issues raised in this article, please contact Anna Maxwell.