October 1st, 2009

Continental European Legal Update: French Supreme Court Holds That Findings Made by Arbitrators are Effective Against Third Parties

Posted at 1:00 AM ET

recentlegislationDavid Lewin, Managing Director
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In a decision dated December 2, 2008, (ITM Enterprises et al v. Prodim et al), the Commercial Division of France’s Supreme Court, the Cour de cassation, ruled that, although an arbitral award is not binding on third parties and does not bar a subsequent lawsuit against them, the findings made in the award are effective against them. This ruling could impact both insurers and reinsurers.

The Case

Prodim, a hypermarket franchiser and distribution company, entered into a franchise contract and a supply contract with Sodi, a distributor. Under the franchise contract, Sodi was required to operate its business under the franchiser’s trade name “Codec.” Complaining of improper performance, Sodi terminated both contracts. As of the effective date of termination of the contracts, Sodi sold its business to a competitor of Prodim, ITM, which, a few months later, began operating the business under the trade name “Intermarch√©.”

Availing itself of the arbitration clause in the terminated contracts, Prodim initiated an arbitration proceeding against Sodi for breach of contract through the early termination of the supply and franchise contracts, and for violation of both the non-compete clause and the right of preemption granted to Prodim in the franchise contract.

Finding in favor of Prodim, the panel declared the contracts rescinded at the fault of Sodi, held that Sodi had violated Prodim’s right of preemption, and awarded damages against Sodi in an amount assessed in equity at a sum lower than the loss actually sustained. The arbitrators cited “the personality of the distributor,” probably meaning its small size.

Prodim thereupon brought an action for damages against ITM for its alleged complicity in Sodi’s breach of contract.

The court of appeals handed down a four-part opinion in favor of Prodim, finding that: (i) the arbitration award is res judicata on the issue of Sodi’s wrongful conduct, (ii) the findings made in the award are effective against third parties and hence against ITM, (iii) ITM was complicit in Sodi’s breach of contract, and (iv) because the arbitrators’ award of an amount less than actual loss was made in equity, the court could make an award against ITM for the difference.

The Cour de cassation quashed the court of appeals’ decision with respect to the affirmation constituting the fourth part of the opinion, on the ground that an arbitral award is effective against third parties even if it was rendered in equity. Damages awarded by arbitrators are presumed to compensate all losses, including those for which others (not the parties to the arbitration proceeding) are jointly and severally liable.

Issues

The case dealt with three issues:

1. Whether the franchiser’s lawsuit against its competitor was barred by the previous arbitral proceeding between the franchiser and the franchisee

For negative res judicata to apply, the lawsuit would have had to involve the same parties. But it was brought by the franchiser against its competitor, not its franchisee. Consequently, the previous arbitral award between the franchiser and the franchisee was not a bar to the franchiser’s lawsuit against its competitor.

2. Whether the findings made by the arbitrators regarding the franchisee’s wrongful conduct could be relied upon by the franchiser in its lawsuit seeking to establish its competitor’s complicity in such conduct

Generally, the positive effect of res judicata is relative, i.e., the decisions of judges or arbitrators are binding only on the parties to the proceeding.

In the present case, however, the court of appeals held that the arbitral award was effective against third parties, notwithstanding its lack of binding effect on them. The court, therefore, refrained from inquiring into the wrongfulness of the franchisee’s conduct, which had already been determined by the arbitral panel. The Cour de cassation approved the stance taken by the appellate court and upheld that the arbitrators’ findings regarding the franchisee’s conduct were authoritative in the subsequent lawsuit against the franchiser’s competitor.

This position has been criticized as a misapplication of the concept of third-party effectiveness (see P. Mayer, Rev. arb., 2009, No. 2, pp. 334 et seq.), which in substance prevents third parties from challenging a legal situation created by an arbitral or judicial decision, but does not prevent them from contesting findings made in a proceeding to which they were not parties. By basing its award against ITM on the third-party effectiveness of the arbitral tribunal’s findings, the court made the findings binding on ITM, which was not a party to the arbitration proceeding, and thereby disregarded the relative effect of res judicata.

In so doing, the court arguably violated ITM’s due-process rights by preventing ITM from contesting findings made in a proceeding in which it did not have the opportunity to be heard.

As ITM was not in a position to defend itself in the arbitration proceeding, it should not be bound by the arbitrators’ findings. Yet the appellate court and Cour de cassation decided otherwise. They seemed to take the view that it is more important to avoid inconsistency between their decisions and the arbitrators’ decisions than to deprive a party of the opportunity to challenge findings of fact made in a proceeding to which it was not a party.

3. Whether the damages awarded by the arbitrators had compensated the franchiser for all the losses sustained by it as a result of the franchisee’s breach of contract

The court of appeals held that the monetary award made by the arbitral tribunal had only partially compensated the franchiser for its losses. The Cour de cassation disagreed, holding that damages assessed by arbitrators acting as amiable compositeurs compensated all losses. Since, under joint and several liability, each co-debtor is liable for the entire loss, the aggrieved party who has recovered damages from one co-debtor cannot seek to recover damages from another co-debtor.

In the present case, the court’s holding allowed the competitor to benefit from the amiable compositeur powers conferred on the arbitrators, which allowed the arbitrators to award the franchiser damages in an amount less than its actual loss on equity principles.

Implications for Insurers and Reinsurers

The Cour de cassation ruling could adversely affect insurers and reinsurers, since it would enable findings made in an arbitration proceeding to which they were not parties to be used against them.

To take an example in the construction industry, in the event of damage at the worksite, the client could bring an arbitration proceeding against a contractor pursuant to an arbitration clause in the construction contract. For example, a finding of bad workmanship made in the arbitration proceeding could later be set up against the contractor’s insurers without their having the possibility to contest it.

In the reinsurance context, the ruling could enable an insurer to pursue against a reinsurer a finding regarding coverage between the insured and the insurer. The issue is even more acute in matters referred to arbitration, where applications to be joined to the proceeding are less readily allowed than they are in matters referred to a court.

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