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MEALEY’S™

International Arbitration Report Madrid Update: Invoking A Set-Off-Defense May Jeopardize The Effectiveness Of An Arbitration Clause

by Calvin A. Hamilton and Luis Capiel

HAMILTON Madrid, Spain

A commentary article reprinted from the October 2010 issue of Mealey’s International Arbitration Report


Vol. 25, #10 October 2010

MEALEY’S International Arbitration Report

Commentary Madrid Update: Invoking A Set-Off-Defense May Jeopardize The Effectiveness Of An Arbitration Clause By Calvin A. Hamilton And Luis Capiel

[Editor’s Note: Calvin A. Hamilton is founding partner with the firm HAMILTON, Madrid, and heads the arbitration department. He is admitted to the New York and the Madrid Bar. Luis Capiel is an associate with the firm and is admitted to the Madrid and the Munich Bar. Copyright 2010 by Calvin A. Hamilton and Luis Capiel. Replies to this commentary are welcome.] ‘‘Like the theorem of Pierre de Fermat, the problem of set-off defenses in arbitration has so far resisted all attempts to resolve it once and for all.’’1 This month’s commentary examines a judgment rendered by the Madrid High Court on July 26, 2010,2 in appellate proceedings, in which the High Court had occasion to shed some light on the relationship between the set-off defense and arbitration. As we shall see the High Court was not extremely successful at doing so. The Defendant (and Appellant), Demoliciones Te´nicas S.A., acted as a contractor in two building works. It commissioned the Plaintiff (and Appellee), Incys de Climatizacio´n S.A., as a subcontractor to perform certain works on both building sites, by virtue of two different contracts. One of the contracts (‘‘contract A’’) contained an arbitration clause. It provided for a 5 % withholding on all invoices, to be paid a year after the work was finished. Further, the Plaintiff undertook to comply with all occupational health and safety regulations and to be liable for any sanctions or fines imposed on the Defendant for the lack of health and safety measures.

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The other contract (‘‘contract B’’) did not include an arbitration clause. An accident on the site during the execution of contract A led to the death of an employee of a subcontractor of the Plaintiff. As a result, the Defendant was imposed a fine of 27,025.30 euros for the breach of occupational health and safety rules. The Defendant considered the clause in contract A in which the Plaintiff undertook to answer for sanctions or fines imposed on the Defendant to be applicable to the 27,025.30 euros fine and thus refused to release the 24,742.60 euros withheld by virtue of the withholding clause. In addition it refused payment of four invoices accruing from contract B and amounting to a total of 5,020.14 euros. Hereupon, the Plaintiff sued before the ordinary Madrid courts for payment of 29,762.74 euros, made up of the amount withheld by virtue of the withholding clause in contract A (24,742.60 euros) and the sum of the four unpaid invoices deriving from contract B (5,020.14 euros). The Defendant moved to stay proceedings and compel arbitration, to which the Plaintiff opposed by arguing that the arbitration clause only affected contract A, whereas the withholding by the Defendant justifying the suit also included amounts not merely deriving from contract A but also from contract B. The Court of First Instance rejected the Defendant’s motion, and went on to decide on the merits, rejecting the set-off defense3 raised by the Defendant and


MEALEY’S International Arbitration Report

accepting the Plaintiff’s argument that the fine imposed on the Defendant was not a result of a breach by the Plaintiff of occupational health and safety rules but of the Defendant’s own responsibility. The Defendant appealed this decision before the Madrid High Court, adducing the lack of jurisdiction of the ordinary courts by virtue of the arbitration clause and further arguments on the merits, of less interest for the purpose of this commentary. The High Court confirmed the decision of the Court of First Instance dismissing the exception of arbitration. It described the extrajudicial position of the Defendant of refusal to release not only the amounts withheld pursuant to contract A but also the amounts due by virtue of contract B, and went on to explain:4 ‘‘It is precisely this attitude of mingling both contracts on account of the alleged breach in one of them, which gave rise to the suit filed for the amounts withheld as well as for the outstanding invoices [. . .] Thus the consolidation of actions derives directly from the attitude displayed by the Defendant itself [. . .].’’ The standard problematic situation before the ordinary courts is that in which a plaintiff sues based on a claim not submitted to arbitration and the Defendant raises the set-off defense based on a counterclaim subject to an arbitration agreement. The problem posed in these circumstances is whether the ordinary court has jurisdiction to assess this counterclaim, and if not, what its course of action should be. The case at bar partially fits into this standard constellation. The lower of the two main claims (amounting to 5,020.14 euros) was not covered by an arbitration agreement, whereas the counterclaim on which the Defendant based its set-off defense indeed was. It is clear that the Defendant’s exception of arbitration could not be successful as far as the claim for the lower of the two amounts was concerned, since it was not submitted to arbitration. However, the case is different insofar as the larger claim (amounting to 24,742.60 euros) is concerned. For the moment, we shall ignore the extrajudicial actions and ‘‘attitudes’’ displayed by the Defendant before the suit was filed, to which the High Court seems to attach some importance. The larger claim was covered by an arbitration agreement, as was the counterclaim on

Vol. 25, #10 October 2010

which the Defendant’s set-off defense was based. The question here was therefore not whether the Court had jurisdiction regarding the counterclaim but whether it had jurisdiction regarding the main claim which was covered by the arbitration clause. As for this question (jurisdiction regarding the main claim) the material defenses raised by the Defendant (such as the set-off defense) are irrelevant, since the former has logical priority over the latter. But even assuming that the set-off defense raised by the Defendant could have an effect on the decision of jurisdiction over the main claim, in the present case the counterclaim was governed by the very same contract and arbitration clause. Again, ignoring the extrajudicial actions and ‘‘attitudes’’ displayed by the Defendant before the suit was filed, the only basis for the High Court to assert jurisdiction over the larger main claim covered by the arbitration agreement seems to be the fact that it was included in the same suit as another claim not submitted to arbitration. Evidently, this cannot be sufficient basis for disregarding an arbitration agreement. If that were sufficient basis, a claimant could rid itself of the obligations resulting of an arbitration agreement, merely by adding a second claim (however insignificant!). It is difficult to ascertain the exact reasoning of the High Court since its explanations are not very systematic. The gist of the decision seems to be though, that the Court found that the ‘‘attitudes’’ displayed by the Defendant before the suit was filed, somehow rendered the arbitration clause ineffective. This might be construed as a waiver. However it appears to be more likely that the Court understood that by extending its refusal to pay from contract A to contract B the Defendant itself had indissolubly merged the claims derived from both contracts, hence removing the complete issue from the scope of the arbitration agreement. This latter reasoning is not short of astonishing! The High Court itself pointed out that ‘‘it cannot be obviated that the issue on debate comes down to the discussion of the consequences of the sanctions which were imposed on the Defendant for breach of the occupational health and safety rules in the accident suffered by an employer of a subcontractor of the Plaintiff.’’ The fact that this issue was clearly covered by an arbitration agreement makes it hard to understand why the High Court did not partially accept the exception of arbitration (in as far as the higher claim of 24,742.60 Euros was concerned) but allowed the lesser claim to ‘‘attract’’

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MEALEY’S International Arbitration Report

Vol. 25, #10 October 2010

the higher claim as well as the counterclaim towards the ordinary courts.

2.

Sentencia de la Audiencia Provincial de Madrid (Seccio´n 11a) n8 551/2010 de 26 de julio de 2010.

3.

The decision does not actually explicitly mention set-off (compensacio´n), but substantially this is what the Defendant invoked and the Court of First Instance decided on.

4.

Translations by the authors.

Endnotes 1.

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Alexis Mourre, The Set-off Paradox in International Arbitration, 24 Arbitration International 387, 387 (2008).

n


Š Copyright 2001 Mealey Publications. All rights reserved. Reproduction strictly prohibited without written permission.


Arbitration and the Fisc: NAFTA’s ‘Tax Veto’ by William W. (Rusty) Park Professor of Law at Boston University Vice President, London Court of International Arbitration Arbitrator, Claims Resolution Tribunal for Dormant Accounts in Switzerland

A case of note reprinted from the May 2001 issue of Mealey's International Arbitration Report.

© Copyright 2001 Mealey Publications. All rights reserved. Reproduction strictly prohibited without written permission.


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MEALEY’S ™ A commentary article reprinted from the October 2010 issue of Mealey’s International Arbitration Report by Calvin A. Hamilton and...

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