In the recent case of Stronghold Insurance Company, Inc. v Spouses Rune and Lea Stroem (“Stronghold”),[1] the Philippine Supreme Court held that a non-party to a construction agreement cannot invoke the arbitration clause therein.

This involved an agreement for the construction of a house (“Agreement”).  The Contractor, as required by the Agreement, secured a performance bond (“Bond”) from petitioner Surety.  The project was not finished on time prompting the Owner to file a complaint in court against the Contractor and the Surety.  When the case reached the Supreme Court, the Surety argued that the dispute should have been brought to arbitration under the rules of the Construction Industry Arbitration Commission (“CIAC”), in light of the arbitration clause in the Agreement.  The Supreme Court rejected this argument ruling that “contracts take effect only between the parties, their assigns and heirs” and, not being a party to the Agreement, the Surety cannot invoke the arbitration clause and the jurisdiction of the CIAC.

In the decision, the Supreme Court analyzed the earlier 2010 case of Prudential Guarantee and Assurance, Inc. v. Anscor Land, Inc. (“Prudential”)[2] – which upheld the impleading of the surety in an arbitration between the owner and the contractor in that case, and recognized that both cases involved similar factual circumstances.  The Supreme Court, however, did not apply Prudential explaining that unlike the construction agreement in Prudential, which expressly incorporated the performance bond into the contract, the Agreement in Stronghold merely referred to the Bond issued by the Surety in this case.

Although the Stronghold ruling resulted to a positive outcome for arbitration, having upheld the basic doctrine that only parties to an arbitration agreement are generally bound by it, the reasoning as to why Prudential was not applicable may nevertheless be a source of confusion. Whether or not an agreement between an owner and a contractor (which contains an arbitration agreement) “incorporates” or “refers” to a performance bond does not make the issuer of a bond a party to the arbitration agreement.  The reasoning of the Supreme Court in not applying Prudential actually appears to undermine its main ruling that an arbitration agreement does not bind non-parties.

While it is difficult to predict how the courts will subsequently apply Stronghold  in relation to Prudential, it is interesting to note that Stronghold is consistent with another recent case, Gilat Satellite Networks, Ltd. v. United Coconut Planters Bank General Insurance Co., Inc. (“Gilat”),[3] where the Supreme Court also held that “the existence of a suretyship agreement does not give the surety the right to intervene in the principal contract, nor can an arbitration clause between the buyer and the seller be invoked by a non-party such as the surety”.  Both Stronghold and Gilat suggest that the Supreme Court is moving away from, although not reversing, the 2010 case of Prudential.

In practical application, the Prudential and Stronghold cases suggest that persons entering into agreements which are ancillary to a main agreement (e.g. a performance bond) should be aware of the risk that they may be impleaded in arbitration proceedings under the main agreement (even if they are not themselves parties thereto) if said agreement contains language incorporating the said ancillary agreement.  Steps should be taken by said persons to clarify, whether in the main agreement or in the ancillary agreement, that they do not agree to be bound – if this is the case, by the arbitration clause of the main agreement.

 

By Donemark Calimon and Grace Ann Lazaro (Quisumbing Torres in the Philippines, a member firm of Baker & McKenzie International)

 

[1] G.R. No. 204689, 21 January 2015.

[2] G.R. No. 177240, 8 September 2010.

[3] G.R. No. 189563, 7 April 2014.