Is an arbitration clause in a subcontract effective against the investor? | In Principle

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Is an arbitration clause in a subcontract effective against the investor?

The investor and the general contractor are jointly and severally liable for the subcontractors’ fees. However, this does not automatically mean that the provisions of the agreement between the subcontractor and the general contractor will apply directly to the investor. A particular provision is an arbitration clause determining the method for pursuing claims. If the general contractor and the subcontractor have agreed to arbitration, can the subcontractor pursue the investor in arbitration as well, or must the subcontractor file suit in state court?

An arbitration clause is an agreement submitting resolution of a dispute between the contracting parties to an arbitration court. As a rule, only the parties to the agreement are bound by it and must respect its provisions. But this rule is not absolute, as the case law and legal doctrine admit the possibility of extended effectiveness of an arbitration clause against other persons. Exceptions apply in particular to legal succession, where one entity succeeds to the rights and obligations of another entity (e.g. in the case of assignment of a claim or assumption of an obligation). The rationale for this position is that the parties’ rights and obligations are preserved despite the change in the identity of the parties. The agreement, including the arbitration clause, should remain binding without interruption or variation, despite the change of parties.

The joint and several liability of the investor and the general contractor for the subcontractor’s fee means that the subcontractor may sue for payment:

  • Only the investor
  • Only the general contractor, or
  • The investor and the general contractor jointly.

If an arbitration clause is included in the subcontract between the general contractor and the subcontractor, what should a subcontractor do if it intends to sue both defendants at the same time? Can it do so jointly in arbitration, or must it initiate two separate proceedings: one in arbitration against the general contractor, and the other in state court against the investor?

Investor not bound by the subcontract

The existence of the investor’s joint and several liability does not mean that the investor assumes the rights and obligations arising from the subcontract. The investor’s liability is limited to payment of the subcontractor’s fee.

In the current state of law, the investor does not even need to know the contents of the subcontract to be deemed jointly and severally liable; it suffices to provide the investor with a detailed scope of construction work foreseen for a specific subcontractor, or to indicate the scope of specific subcontractors’ works in the main contract prior to commencement of construction works.

The investor will also not be bound by the subcontract if, in the main agreement, the investor makes its consent to a particular subcontractor conditional on submission and acceptance of the general contractor’s agreement with the subcontractor.

It is also accepted that the investor’s liability consists of a type of liability for someone else’s debt (the general contractor’s debt towards the subcontractor). Therefore, the investor cannot be treated in any way as the general contractor’s legal successor. Moreover, the liability of the investor and the general contractor arises from two different legal bases (statute and a civil contract).

Due to these differences, it cannot be concluded that an arbitration clause in the subcontract is binding on the investor. This position is also consistent with the wording of Art. 1161 §1 of the Civil Procedure Code, according to which the submission of a dispute to arbitration requires an agreement between the parties identifying the subject matter of the dispute or the legal relationship from which the dispute arose or may arise.

This is not altered by the rule that, as a joint and several obligor, the investor is entitled to raise defences against the subcontractor arising from the subcontract, e.g. termination of liability, expiration of the statute of limitations, or improper performance of the construction works by the subcontractor (Civil Code Art. 375 §1).

Usually two proceedings are needed

Wishing to pursue both defendants, a subcontractor bound by an arbitration clause in the subcontract should initiate two separate proceedings (one in arbitration against the general contractor, the other in state court against the investor). The substantive liability of the investor cannot be extended to a procedural method of pursuing claims established by the general contractor and the subcontractor.

However, it will not be necessary to file two separate cases if the parties reach an agreement, e.g. the investor agrees to participate in arbitration or the general contractor does not object to joint consideration of the cases by the state court.

The separation of proceedings against the investor and the general contractor will mean higher costs of initiating a case for the subcontractor, which will have to pay two filing fees. The subcontractor will not recover them from the respondents if it loses. If the subcontractor wins both cases, both the investor and the general contractor will bear the costs. The costs incurred by the investor may be subject to a further recourse claim against the general contractor. Therefore, ultimately (depending on the outcome of the case), it may happen that either the general contractor or the subcontractor will bear double legal costs. Also, two trials can mean increased evidentiary costs, for example when a separate expert opinion is required for each proceeding.

Separate proceedings will most often mean a handicap for the investor, which, because it is not directly involved in the relations between the general contractor and the subcontractor, will naturally not have as much knowledge of the case as the general contractor. The support of a second respondent who knows the case well and has access to the full documentation most often helps the investor in its defence.

However, two proceedings may be beneficial if the general contractor does not want to admit to the investor the circumstances it raises against the subcontractor. This will be the case for example if there are defects in the works. It often happens that if the investor raises such problems, in relation to the investor the general contractor disputes them, but in relation to the subcontractor responsible for the problematic works, the general contractor takes the same stance as the investor. In such cases, separate proceedings will allow the general contractor to defend itself freely. As often happens in court disputes with subcontractors in which the investors are involved, general contractors are afraid to discuss irregularities in subcontractors’ work in order not to harm analogous, separate cases against the investor.

Agata Jóźwiak, attorney-at-law, Dispute Resolution & Arbitration practice, Wardyński & Partners