Contracting out of proportionate liability after Tesseract
Ever since proportionate liability schemes were introduced to the Australian legal environment – reducing the liability of wrongdoers who, together with others, fail to take reasonable care causing pure economic loss or property damage – well-advised buyers of construction and engineering services have looked to obtain a strategic commercial advantage by excluding the application of proportionate liability to their contractual relationships. One method by which they have tried to do so has been to refer all disputes to arbitration, on the widespread understanding (supported by several court decisions) that proportionate liability legislation would not apply to arbitrations.
The High Court has shattered this understanding with its decision in Tesseract International Pty Ltd v Pascale Construction Pty Ltd [2024] HCA 24. Consequently, it is no longer possible for contracting parties to exclude the application of proportionate liability by merely referring all disputes arising out of a contract to arbitration.
Instead, parties wishing to exclude the application of proportionate liability need to do so explicitly, either by:
including an express provision in their contract that excludes the application of proportionate liability legislation or otherwise provides for their right, obligations and liabilities under the contract; or
including an express provision in their arbitration clause that the substantive law that governs the substance (or merits) of the dispute excludes any applicable proportionate liability legislation.
But, the first approach won’t work in jurisdictions that prevent parties from contracting out of proportionate liability, like Queensland. And it’s doubtful that the second approach will work in such jurisdictions either, for public policy reasons which I will explain in more detail below. This makes arbitration in states and territories that don’t clearly permit contracting out a much riskier proposition, compared to litigation, for providers of construction and engineering services. Arbitration practitioners won’t be happy. Nor will contracting parties that prefer arbitration to litigation for cost, speed, privacy, flexibility, or control reasons.
More broadly, the merits of proportionate liability continue to be hotly debated around the globe. While it may have decreased liability insurance premiums in some contexts, it has undoubtedly increased the complexity and cost of negligence claims and introduced uncertainty into contract risk allocation. The case for further law reform, including abandoning proportionate liability as a failed experiment, has just grown stronger.
Proportionate liability on construction projects
Construction projects involve many participants – project owners, engineers (across many disciplines), head contractors, subcontractors, suppliers, consultants, operators, certifiers, local councils and so on. When things go wrong, causing one participant to suffer loss, it is typical for the negligence of several project participants to contribute to the loss – for example, a loss suffered by the project owner due to a negligent design defect that would have been avoided had the contractor or the certifier not also been negligent in failing to spot the obvious error by the designer.
Traditionally, Australian law would have allowed the project owner in the above example to recover 100% of its loss from any one of the negligent parties (each a ‘concurrent wrongdoer’). If the project owner only pursued one of the parties, say the negligent designer because it had a significant level of professional indemnity insurance, the designer would need to seek contribution from the contractor and/or the certifier to make them liable for their share of the loss. But if contribution from another concurrent wrongdoer was not possible because it was insolvent or untraceable, the wrongdoer sued by the claimant (in our example, the designer) would bear the insolvent or untraceable wrongdoer’s share of the loss.
To reduce liability insurance premiums and the prevalence of negligence claims, all Australian states and territories reformed their negligence laws shortly after the turn of the century and, as part of the reform package, enacted legislation to replace these traditional legal rules with ‘proportionate liability’, for claims in respect of property damage or pure economic loss. Under this proportionate liability legislation, each concurrent wrongdoer’s liability is limited to the proportion of the loss that the court considers just, having regard to the extent of their respective responsibility for the loss. Liability is, therefore, distributed across all concurrent wrongdoers according to their proportionate contribution to the loss, and the claimant must sue all concurrent wrongdoers to recover its total loss. As such, the risk of insolvent or untraceable wrongdoers shifts from each wrongdoer to the claimant.
Another risk that proportionate liability creates for claimants is the risk of inconsistent findings in multiple proceedings on the extent of each concurrent wrongdoer’s liability. A claimant can avoid this risk if it can join all concurrent wrongdoers in the initial proceeding.
Contracting out
The proportionate liability reforms were, therefore, ‘good’ for concurrent wrongdoers (and their insurers) and ‘bad’ for claimants. Accordingly, project participants who are more likely to be claimants than defendants are better off excluding the application of proportionate liability by “contracting out” of it to the extent they can. Consequently, it has become common for project owners and other buyers of construction services to seek to contract out of proportionate liability schemes, and for service providers to resist such attempts.
The ability of contracting parties to contract out of proportionate liability differs between states and territories. New South Wales, Tasmania, and Western Australia allow contracting out; Queensland precludes it, and the remaining states and territories are silent about whether it is allowed or not.
This situation has led to legal creativity in those states and territories where a simple contracting out clause would not, or might not, work. A view emerged that contracting parties could avoid proportionate liability, including in states and territories that did not allow contracting out, by referring all disputes arising from their contract to arbitration instead of the court system. This view gained widespread support among lawyers and academics, and was supported by several court decisions:
because of the language in the legislation (“court”, “plaintiff”, “defendant”, “judgment”); and
because it may not be possible for a claimant in arbitration to obtain a comprehensive liability ruling against all concurrent wrongdoers due to the inability of an arbitral tribunal, unlike a court, to join third parties to the arbitration without their consent.
The High Court’s position
Australia’s highest court has upended this view with its 5:2 decision that an arbitral tribunal determining a dispute under a contract that is governed by South Australian law must apply the substantive parts of the South Australian proportionate liability legislation. In doing so, the justices in the majority said:
the parties to the dispute had selected the law of South Australia as the law applicable to the substance (or merits) of the dispute – the “substantive law”;
the substantive law of South Australia includes Commonwealth statute law as well as South Australian statute law;
to the extent that a statute applicable to the determination of a dispute in a court in South Australia makes a legal right or liability dependent upon the making of an order of the court, the language of the statute as applied in the arbitration needs to be translated to place the arbitral tribunal in the position of the court and to place the parties to the arbitration in the position of parties to a court proceeding. Accordingly, the provisions in the South Australian proportionate liability legislation that empower a court to limit a defendant’s liability in the case of an apportionable liability are to be exercised by the arbitral tribunal to limit a respondent’s liability; and
the operation of the central provisions of the proportionate liability legislation (i.e. the provisions that limit a concurrent wrongdoer’s liability in proportion to the wrongdoer’s assessed responsibility for the harm) does not depend on all the concurrent wrongdoers being parties to one proceeding for the determination to be made as to the proportionate liability of any single concurrent wrongdoer.
The unfortunate consequence for the claimant
The majority’s decision has a significant unfortunate consequence, which resulted in two powerful dissenting judgements.
Because an arbitral tribunal can only join third parties to an arbitration with their consent, applying proportionate liability legislation to an arbitration can cause injustice or hardship for a claimant. For example, the respondent in the arbitration may have its liability limited to 50% of the claimant’s loss because the arbitral tribunal considers another concurrent wrongdoer who is not a party to the arbitration to be 50% responsible for the loss. But when the claimant subsequently sues the other concurrent wrongdoer via court proceedings, the court may decide, after hearing the other concurrent wrongdoer’s evidence, that its responsibility for the loss is less than 50% - with the end result being that the claimant cannot recover all of its loss.
If the initial proceedings are brought in a court of law, the claimant can avoid the above result by joining any persons who are alleged by the defendant to be concurrent wrongdoers to the court proceedings and, thereby, obtain a single comprehensive liability ruling against all concurrent wrongdoers. Indeed, the proportionate liability legislation encourages and facilitates the joinder of all concurrent wrongdoers by:
obliging a defendant to notify the claimant, at the earliest possible time, of the identity and alleged roles of any person who is not a party to the proceeding who could be held liable for the claimant’s loss; and
giving the court the power to order any defendant who fails to comply with the above obligation to pay the costs of any subsequent proceedings that could have been avoided if the obligation had been fulfilled.
But when the claimant has agreed to arbitrate its claims, the other alleged concurrent wrongdoers can only be joined to the arbitration if they consent. Without their consent, the claimant can only sue them via separate court proceedings and cannot mitigate the risk of inconsistent findings in the manner contemplated by proportionate liability legislation. According to the dissenting judges, the arbitral tribunal’s inability to apply an integral or key component of the proportionate liability scheme renders the scheme materially different to what was intended. As such, the dissenting justices consider the truncated and unbalanced proportionate liability scheme should only apply to an arbitration with the parties’ consent.
However, the legal position in Australia now is governed by the majority's decision, not the views of the dissenting justices.
But all’s not lost for those who wish to contract out
The parties to the contract in Tesseract did not attempt to contract out of the proportionate liability regime. Their contract did not:
include an express provision excluding the application of proportionate liability legislation; or
include a provision in the arbitration clause stating that the substantive law to be applied in the arbitration excludes any applicable proportionate liability legislation; or
otherwise attempt to prevent the arbitral tribunal from applying the proportionate liability legislation.
The High Court’s decision recognises the fundamental principle of ‘party autonomy’ embodied in Australia’s arbitration legislation, including the right of the parties under to choose the “rules of law” that will apply to the substance of the dispute: the substantive law.
The reference to “rules of law” in section 28(1) of the Commercial Arbitration Acts and Article 28(1) of the Model Law (as given effect by the International Arbitration Act 1974 (Cth)) is intended to be flexible. The parties are not limited to the laws of a particular State on an ‘all-or-nothing’ basis. Instead, they can choose for specific laws of different states to apply to different parts of their agreement. They can also select the laws of a given state, except for specific provisions (such as the proportionate liability provisions).
The only limits on the substantive law of a given state applying in an arbitration are those which result from party choice, the conflict of laws rules, the arbitrability of the dispute, or the public policy of the place or “seat” of the arbitration.
So, let’s consider how the public policy of Queensland – a state that that prohibits contracting out of proportionate liability – would affect an arbitration agreement that excludes Queensland’s proportionate liability legislation from the substantive law to be applied in the arbitration, if the seat of the arbitration is Queensland (and, consequently, the curial law that supervises the arbitration is the law of Queensland).
Public policy
Public policy, as used in the Model Law, the New York Convention and many other international treaties is intended to cover fundamental notions and principles of justice, as opposed to political stances and the international policies of a state.
So, is the public policy of Queensland informed by the decision of its Parliament to institute a system of proportionate liability in respect of claims for pure economic loss or property damage arising from a breach of a duty of care?
To place downward pressure on the cost of liability insurance, the Queensland Parliament has decided that parties should be prevented from contracting out of this system of proportionate liability. I would suggest that:
the issue of whether a concurrent wrongdoer is wholly or partly liable for pure economic loss or property damage arising from a breach of a duty of care, is sufficiently fundamental to justice that this decision of the Queensland Parliament is a matter of public policy, and
an arbitral award based on rules of law that allocate liability in a manner contrary to that determined by the Queensland Parliament would conflict with the public policy of the State of Queensland and, therefore, be susceptible to being set aside under section 34(2)(b)(ii) of the Queensland’s Commercial Arbitration Act 2013 (in the case of a domestic arbitration) or Article 34(2)(b)(ii) of the Model Law (as given effect by the International Arbitration Act 1974 (Cth) (in the case of an international arbitration).
Where to from here?
The law as it now stands following the High Court’s decision is most unfortunate. Claimants who are required to bring their claim against a concurrent wrongdoer via arbitration will be exposed to the risk of inconsistent findings when they pursue their claims against the other concurrent wrongdoers to fully recover their loss.
This unfortunate situation can now only be addressed by a High Court decision overturning the Tesseract decision (which is unlikely to occur anytime soon) or by our State and Territory Parliaments enacting legislation to change the law. The dissenting justices have called for the latter.
In my view, the time has now come for our State and Territory Parliaments to abandon proportionate liability as a failed experiment. The havoc that it has wreaked on contractual risk allocation and the complexity of resolving disputed claims arising from negligence on construction projects and other situations involving multiple actors has been significant, and the evidence regarding the downward pressure it has placed on liability insurance premiums is scant.
If proportionate liability is to be retained, the legislation in those states and territories that do not allow parties to contract or, or that are silent on whether contracting out is permitted, should be amended to expressly allow contracting out. And the schemes should be completely aligned across the nation via uniform legislation, to bring an end to the lawyer’s picnic that proportionate liability has created in Australia.
In the meantime, I expect project owners and other buyers of construction and engineering services will continue to seek a commercial advantage by contracting out of proportionate liability schemes. They should:
seek to have their contracts governed by the law of New South Wales, Tasmania, or Western Australia, where this choice is legally available to them;
include an express provision in their contracts excluding the application of proportionate liability legislation;
make sure their arbitration clause provides that the substantive law to be applied in the arbitration excludes any applicable proportionate liability legislation or otherwise prevents the arbitral tribunal from applying the proportionate liability legislation; or
obtain the counterparty's consent to any arbitration under the contract being consolidated with any other arbitration that arises out of the same project to which the buyer and another alleged concurrent wrongdoer are parties.
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