In Malaysia, an arbitration award can be set aside if it is in breach of the “rules of natural justice” (section 37(2)(b) of the Arbitration Act 2005, or “the Act”).

The Federal Court in Pancaran Prima Sdn Bhd v Iswarabena Sdn Bhd [Civil Appeal No. 02(f)-26-03 & 27-03 / 2019 (W)] recently provided further clarification on what amounts to a breach of the rules of natural justice, especially when it involves the arbitrator relying on his own personal knowledge and expertise in the industry to decide certain matters.


Brief Facts

  • Iswarabena Sdn Bhd (“Iswarebena”) appointed Pancaran Prima Sdn Bhd (“Pancaran Prima”) as its subcontractor for the construction of certain works which formed part of the proposed Sungai Buaya Interchange and Toll Plaza.
  • Iswarabena later purported to terminate the subcontract, which led to a dispute between the parties.
  • The dispute was referred to arbitration, and by agreement of the parties, a professional engineer and chartered arbitrator was appointed as arbitrator.
  • After a full hearing, the arbitrator published his award which found that Iswarabena’s termination of the subcontract was unlawful, and ordered Iswarabena to pay the sum of approximately RM 2.3 million to Pancaran Prima comprising:
    • the cost of completed works amounting to RM1.4 million and;
    • loss of profit amounting to RM0.9 million

(“Award”)

  • Pancaran Prima applied to the High Court to enforce the Award, while Iswarabena applied to have the Award set aside and/or varied.
  • Among other things, Iswarabena alleged that the arbitrator had breached the rules of natural justice when he made a ruling about the “loss of profit”.
  • The High Court agreed with Iswarabena and found that the subcontract had been lawfully terminated:
    • Under the sub-contract, Iswarabena can terminate the agreement if the works are delayed by “more than 20% financially”.
    • The arbitrator found that the threshold of 20% financial progress delay had not been met, so Iswarabena could not lawfully terminate the agreement at that stage.
    • However, the High Court found that the arbitrator erroneously applied physical progress delay instead of financial progress delay in finding that a threshold of 20% financial progress delay had not been reached. The High Court was of the view that the actual financial progress at the time of termination was either 9% or 11.37% only, well below the threshold of 20%.
  • Therefore, the High Court set aside the Award of loss of profit. Despite holding that the subcontract had been lawfully terminated by Iswarabena, the High Court did not disturb the arbitrator’s assessment of completed works (approximately RM1.4 million).
  • On appeal, the Court of Appeal reversed the entire order of the High Court. As a consequence of this, the original finding of the arbitrator that the subcontract had been unlawfully terminated was restored.
  • In respect of the loss of profit, the Court of Appeal found that the Arbitrator had breached the rules of natural justice because the arbitrator had “invented” extraneous evidence with a factual basis that was not tendered in evidence nor submitted by the parties.
    • Among other things, the arbitrator used his personal knowledge and expertise in the industry to form a presumption that a 10-15% profit margin for “profit and attendance” was reasonable and represents what the industry considers as “a safe no risk profit margin”, when calculating Pancara Prima’s loss of profit.
  • Pancara Prima appealed to the Federal Court.

 

Federal Court’s Decision

Pancara Prima was granted leave on the following questions of law, which were answered by the Federal Court as follows:

 

Leave Question (paraphrased) Federal Court’s Decision

 

1.      Whether the threshold under Section 37 of the Act to set aside an award is “very low”?

Affirmative. The threshold requirement stipulated by section 37 of the Act to set aside an award is “very low”, relative to the threshold under section 42 of the Act.  The grounds enumerated in section 37 are exhaustive and as such the court cannot set aside an award for reasons other than those that are listed.

2.      Whether an arbitrator who is an engineer and who has knowledge of the construction industry could be in breach of the rules of natural justice by relying on such knowledge in arriving at his decision on the quantum of “loss of profit”?

Negative. An engineer who relies on his own knowledge of the construction industry is not in breach of the rules of natural justice. Section 21(3)(b) of the Act allows an arbitrator to be able to draw on his own knowledge and expertise.

3.      Whether an arbitrator who is well acquainted with matters of evidence relating to the construction industry could be in breach of the rules of natural justice by relying on such matters of evidence?

Negative. An arbitrator relying on his own knowledge and expertise on matters of evidence relating to an industry in which he is well acquainted with will not amount to a breach of natural justice.

4.      Whether an arbitrator who applies his own knowledge and expertise in the construction industry to a fact in issue can be in breach of the rules of natural justice?

Negative. The concept of a breach of natural justice does not extend to the arbitrator applying his own knowledge and expertise on an issue where the parties have led evidence on and which forms one of the very issues which the arbitrator has to deal with, especially when the knowledge of the arbitrator has an impact on the quality of evidence required for evaluation by the arbitrator.

5.      Whether the decision of an arbitrator on the value of completed works is a question of law?

Negative. The decision of the arbitrator in making an award of what constitutes the value of completed works, and the basis on which such an assessment is to be made, does not constitute a question of law arising out of the award.

 

The bulk of the appeal relates to the extent in which an arbitrator can rely on his own knowledge and expertise in coming to a decision, and whether this would be a breach of natural justice.  Section 21(3)(b) of the Act was key to this issue, as it expressly confers power on the arbitral tribunal to “draw on its own knowledge and expertise”.

Iswarabena argued that it was not their case that the arbitrator cannot draw on his own knowledge and expertise, as they conceded that the arbitrator is empowered to do so. Iswarabena’s dissatisfaction was that the arbitrator had breached the rules of natural justice when he based his loss of profit ruling on extraneous evidence (ie: the norms in the construction industry) that was not tendered and submitted by the parties.

The Federal Court held that the arbitrator here was not a lay person. The arbitrator was a professional engineer and a chartered arbitrator. The arbitrator had the requisite special knowledge and expertise to entitle him to make the pronouncement that “in the Malaysian construction industry, it is almost a norm when asked to indicate a ‘profit and attendance’ for having to manage a nominated subcontractor, most contractors would include a margin of 10-15%”.

The norm that the arbitrator was speaking of related to general facts, which form part of the general body of knowledge within his area of expertise. The arbitrator was therefore competent to draw on his own knowledge and expertise on the existence of the 10-15% no profit risk norm in the Malaysian construction industry, without giving parties the opportunity of answering it and showing that his view was wrong.

The argument that there must be actual evidence of the 10-15% no risk profit margin produced before the arbitral tribunal could draw on its own knowledge and expertise would defeat the purpose of Section 21 of the Act. Unless it can be shown that the arbitrator’s own knowledge and expertise on any fact in issue is plainly and unarguably wrong, the Court must be very slow to interfere with his findings.


Commentary

One of the attractive features of arbitration is that parties can at the outset, agree on certain requirements for the appointment of this arbitrator, and this includes among other things, requiring that the arbitrator be a subject matter expert of the contract in question.

Logically, an arbitrator who is appointed for his special knowledge, skill or expertise, should be entitled to draw those sources for the purpose of determining the dispute, and he should not need to tell parties that he is intending to do so. This is reflected in Section 21(3)(b) of the Act.

There are still boundaries to which an arbitrator can rely on his special knowledge and expertise. So long as the arbitrator’s reasoning is reasonably foreseeable and there is no significant surprise to the litigants, the fact that the arbitrator has drawn from his own area of expertise is unlikely to amount to a breach of natural justice.

This is consistent with the Courts’ principle of minimal interference with arbitral awards as enshrined by Section 8 of the Act. In addition, this approach will preserve the autonomy of parties in selecting how their dispute was to be resolved, and will avoid devaluation of the arbitration agreement.

***

This article was written by Donovan Cheah. Donovan is an Advocate and Solicitor of the High Court of Malaya. He is a Fellow at the Singapore Institute of Arbitrators, the Malaysian Institute of Arbitrators, and the Asian Institute of Alternative Dispute Resolution. He is also a registered foreign lawyer with the Singapore International Commercial Court. 

Donovan & Ho is a law firm in Malaysia. Our practice areas include employment law, dispute resolution, tax advisory and corporate advisory.  Have a question? Please contact us.

 

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