Following nine years of fruitlessly attempting to enforce an ICC award in India against state-owned mining company, Coal India, over the supply of equipment and development of a coal mine, White Industries Australia Limited (‘White’) commenced UNCITRAL proceedings in Singapore against India under the Australia-India BIT. The claim was for failure to provide investors with an ‘effective means of asserting claims and enforcing rights’ owing to undue delay in the Indian courts. This claim was brought using the Kuwait-India BIT, whose obligations were imported via a Most Favoured Nation clause contained in the Australia-India BIT. Kuwaiti investments were allegedly treated more favourably by India than those of Australian investors as a result of this wording. In addition, White brought a claim for denial of justice, in breach of the fair and equitable treatment standard in the Australia-India BIT.

White also complained more generally of the Indian courts’ willingness to engage in the extensive and protracted review of foreign arbitral awards, contrary to their obligations under the New York Convention – a recognised issue where arbitration seated outside India involves an Indian party and the parties have not excluded Part I of the Indian Arbitration Act 1996.

The delay they alleged was both in enforcement and setting aside proceedings; enforcement proceedings brought by White in the High Court of New Delhi and set aside proceedings brought by Coal India in the High Court of Calcutta. The enforcement proceedings were eventually stayed pending a decision on the set-aside proceedings. White applied to have the set-aside application dismissed and pursued its appeal to the Indian Supreme Court where it waited for a date to be set for more than five years.

The UNCITRAL Tribunal delivered its award in November 2011, granting White the amount due under the original ICC award plus interest. Effectively, therefore, the treaty arbitration afforded White a second bite at the proverbial cherry, to recover damages in relation to its original claim.

In the context of the set-aside proceedings, the tribunal accepted White’s assertion that delays in the court system (the nine year jurisdictional claims) amounted to a breach of the obligation to provide ‘effective means to assert justice and enforce rights’, although not a ‘denial of justice’, which it considered (following Chevron-Texaco v. Ecuador) to be a more demanding standard under the BIT.

However, in the context of the enforcement proceedings, the tribunal did not accept either of these claims. Its argument was that White had not taken all measures available to prevent delay. With regard to White’s complaints about the Indian courts’ failure to adhere to their New York Convention obligations, the Tribunal was unsympathetic. It held that White should have known the attitude of the Indian judiciary towards implementing the Convention and should have been aware of India’s ‘seriously overstretched judiciary’. Such presumed knowledge meant that there could have been no legitimate expectation on White’s part that the Indian courts would comply voluntarily with its obligation to enforce. The nuances of India’s legal system were taken into account and it was decided, in context, that the time taken to process the claims was not excessive.

Therefore, the decision is something of a double-edged sword. On the one hand it provides a remedy of last resort to investors with a presence in countries such as India where judicial interference in the enforcement of arbitral awards is commonplace. In so doing, it, builds on the decisions in the cases of Saipem S.p.A v. The People’s Republic of Bangladesh (ICSID Case No ARB/05/7), and more recently Chevron Corporation (USA) and Texaco Petroleum Company (USA) v. The Republic of Ecuador (UNCITRAL arbitration): Partial Award on the Merits of 30 March 2010.), both of which upheld claims of judicial delays as amounting to an infringement of the rights of an investor.

However, it is unlikely to open the floodgates for claims relating to delays in enforcement. Several hurdles would need to be overcome in any comparable case:

First, the relevant BIT relied upon by the investor would need to include ‘effective means’ wording, or, as was the case in White v. India, a Most Favoured Nation clause capable of importing such wording into the BIT.

Second, the Tribunal in question would need to accept that an arbitral award falls within the definition of an ‘investment’ under the respective BIT, which remains a contentious issue. In White v. India, for example, the Tribunal held that the ICC award fell within the definition of ‘investment’ not as an investment per say, but as a ‘crystallisation of White’s rights and obligations’. However, there is, of course, no formal doctrine of precedent within investment arbitration so it cannot be assumed that the same conclusion would be drawn, even in like circumstances.

Third, the counter-argument raised by the UNCITRAL tribunal – that there could be no legitimate expectations in respect of enforcement in the Indian courts could apply in most similar scenarios where a court system is subject to systemic delays.

In any case, commencing a BIT arbitration is not a quick or an easy route to obtaining enforcement of a commercial award. There is, after all, the necessary pre-requisite of long delays in enforcement in the commercial arbitration award. This will be followed by an investment treaty arbitration, the average length of which is currently over three years and at a substantial cost to the investor – costs which may not be recoverable. Even then, enforcement does not happen automatically. Despite the procedures in place, notably under the ICSID framework, when States choose not to pay, the procedure can be equally protracted and fruitless.

For those investing in India, attention must be paid to the Department of Industrial Policy and Promotion’s (DIPP) recent pronouncement that India is likely to exclude investor-state arbitration clauses from its future BITs (including the BIT that it is negotiating with the EU) on the basis that ‘the state should not get drawn into private disputes’. It is not yet suggested that this might extend to the renunciation of current BITs and/or withdrawal from the ICSID convention, as per the trend in Latin America. Nonetheless this may well impose a further limitation on remedies for some investors into India.

In White v. India the foreign investor was entitled to a second bite at the cherry in order to eventually successfully enforce a commercial arbitral award. However, given the limitations – both from the point of view of applicable investment treaty frameworks and the procedural burden, this is likely to remain a remedy of last resort.

Joanne Greenaway and Luanna Schultz, Herbert Smith LLP

Conducted by QMUL’s School of International Arbitration and sponsored by White & Case LLP, the 2012 survey aims to examine whether a “harmonised international arbitration procedure is emerging, by canvassing the views of experienced arbitration practitioners from all over the world,” comments Professor Loukas Mistelis, Director of the School of International Arbitration at QMUL.

Entitled “Current and Best Practices in the Arbitral Process,” the survey is the fourth carried out by QMUL since 2006, and seeks to conduct a major investigation into arbitration practices and trends worldwide. Corporate attitudes towards arbitration, recognition and enforcement of foreign awards, and corporate choices in arbitration in key and emerging markets were past survey themes.

There are two significant differences between this survey and those done before. First, this survey concerns the arbitral process itself, rather than corporate user attitudes towards arbitration. Second, this survey reaches out to arbitration counsel and to arbitrators, in addition to inside counsel. This should provide a much broader universe of respondents, along with greater empirical evidence for what actually occurs in arbitration and what works and what does not.

The following topics will be explored in the 2012 survey:

• Arbitrator selection: The preferred methods of selecting arbitrators, experiences in interviewing potential arbitrators and expectations regarding the conduct of such interviews.
• Organising arbitral proceedings: How procedural meetings are convened, the use of the IBA Rules on the Taking of Evidence in International Arbitration, experiences and expectations regarding the role of the tribunal secretary, methods for expediting arbitration proceedings and the use of fast-track arbitration.
• Interim measures and court assistance: The frequency of interim measures applications to tribunals and courts (including security for costs applications), the level of compliance with tribunal-ordered interim measures and the power of arbitrators to order interim measures ex parte.
• Document disclosure: The frequency of document disclosure requests, the standard that applies/should apply for disclosing documents in international arbitration and how to best manage the disclosure process.
• Fact and expert witnesses: The effectiveness of fact witness statements, experiences and views on mock cross-examination of witnesses and witness conferencing, types of expert witnesses most frequently used and the preferred method of appointing expert witnesses.
• Pleadings and hearings: The number and order of delivery of written submissions, methods of expediting pleadings and hearings, duration and mode of hearings and the effectiveness of oral closing submissions and post-hearing briefs.
• Arbitral awards and costs: The frequency of partial, interim and dissenting awards, expectations regarding the length of time to issue an award and experiences and preferences regarding costs allocation.

The questionnaire for this year’s survey can be accessed at www.arbitrationonline.org/survey. Corporate counsel, private practitioners and arbitrators are encouraged to participate.

Those who wish to contribute have until the end of May to complete their responses. Questionnaire responses may be followed by individual interviews for those willing to participate. The report is expected to be launched in September 2012.

By Paul Friedland and John Templeman
White & Case, LLP

The factual background to West Tankers has been widely discussed (and is summarised in paragraphs 1 to 14 of the judgment) and there is no need to do so again here. Before the Court of Appeal, West Tankers submitted that judgment be entered under s. 66(2) of the English Arbitration Act 1996 (the “Act”) against the insurers on the terms of a declaratory arbitral award. This was on the basis that such a judgment would allow West Tankers to establish the primacy of the award over any judgment by Italian courts in ongoing proceedings of the same dispute. The High Court held that “[t]he purpose of s. 66 (1) and (2) [of the Act] is to provide a means by which the victorious party in an arbitration can obtain the material benefit of the award in his favour other than by suing on it” and that “[w]here … the victorious party’s objective in obtaining an order under s. 66 (1) and (2) is to establish the primacy of a declaratory award over an inconsistent judgment, the court will have jurisdiction to make a s. 66 order because to do so will be to make a positive contribution to the securing of the material benefit of the award”.

The insurers appealed, arguing that Field J had erred in his construction of s. 66 of the Act, specifically in the meaning of the word “enforced”, and that a declaratory judgment (and in particular a negative declaratory judgment) is incapable of being “enforced” under the meaning of the section. Lord Justice Toulson, in the leading judgment, however agreed with West Tankers that a broader interpretation of the phrase ‘enforced in the same manner as a judgment to the same effect’ in s. 66 is “closer to the purpose of the Act and makes better sense in the context of the way in which arbitration works”. He rejected the insurers’ argument that in the present case the court would not be enforcing an award but only the rights determined by an award as being “an over subtle and unconvincing distinction [that] sits on shaky foundations”, emphasising that “the enforcement of any judgment or award is the enforcement of the rights which the judgment or award has established”. However, Toulson LJ emphasised that the language of s. 66 is permissive and requires the court to determine whether it is appropriate in the situation before it to enter judgment – it is not “an administrative rubber stamping exercise”.

Although Toulson LJ emphasised that the issue before the Court of Appeal “is not a question with a distinctively European flavour”, the consequences of the judgment, and more generally of the approach of the English courts, clearly are (as illustrated earlier in African Fertilisers). It remains uncertain whether the judgment falls under the arbitration exception to the Brussels Regulation 44/2001, thereby underlining the need for reform of the Regulation. As any such reform is likely to take time, there remains the real possibility that the English courts may, before any such reform, be faced with enforcement proceedings under the Regulation of an (inconsistent) judgment of the Italian courts. The questions presented by African Fertilisers remain unanswered for the time being.

Phillip Capper and Christian Blank

White & Case LLP
London

The declaratory award (on the tribunal’s jurisdiction) was made pursuant to an arbitration agreement contained in a bill of lading for the carriage of African Fertilizer’s cargo from Romania to Nigeria. The English court had given the claimant, Shipsnavo, leave to enforce the arbitration award and to enter judgment again the defendant, African Fertilizers.

The English court had previously issued an injunction restraining African Fertilizer from continuing an arbitration in Romania, as well an interim declaration that such arbitration proceedings, together with court proceedings commenced in Romania, were both in breach of the arbitration agreement.

Shipsnavo had sought an order for enforcement under s66 of the Arbitration Act 1996 because it was concerned that, should African Fertilizer be successful in its Romanian court proceedings, then it would seek to enforce that judgment under Article 34 of the Brussels Regulation 44/2001, notwithstanding the arbitration award. If Shipsnavo had already obtained an English judgment, then it could seek to resist the recognition of an irreconcilable judgment of the Romanian court.

African Fertilizers resisted the application on the ground that the English court had no jurisdiction to make such an order because the material terms of the award were in purely declaratory terms.

First, it argued that enforcement of an award of a purely declaratory nature is not possible (notwithstanding the ruling – albeit on appeal – in West Tankers). Second, it argued that a judgment entered under s66 of the 1996 Act does not constitute a judgment within the meaning of Article 34 of the Brussels Convention, relying on the ECJ case Solo Kleinmotoren v Boch.

The first limb raised questions of the distinction between “recognition” and “enforcement” in the context of New York Convention awards. African Fertilizers argued that the West Tankers decision was incorrect, that Shipsnavo really intended simply “recognition” of their award in order to defend any adverse Romanian court judgment, and enforcement was not appropriate. The court disagreed, aligning itself with the West Tankers decision and giving primacy to the party’s right to the benefit of the award. The court preferred the plain meaning of “enforce” in s66 of the Act, and cited both textbooks and case law in support of its jurisdiction to enforce a declaratory award.

The second limb was also rejected. The court distinguished the Solo Kleinmotoren decision as being a case about a court approved settlement, in which the ECJ held that a settlement agreement recorded in a court order is not a judgment for the purposes of Article 34(3). Beatson J commented that a settlement is essentially contractual, and while the “submission to arbitration is consensual, the outcome of the arbitration and contents of the award are not”. Further, there were public policy considerations. Citing Briggs on Civil Jurisdiction, Beatson J noted that an English court could not give “leave to enforce an arbitral award and then be required to recognise and enforce a foreign judgment which undermined or contradicted that arbitral award”.

However, there are public policy considerations not considered by the court. Shipsnavo’s objective in seeking to enforce the declaratory award was to pre-empt the enforcement of any irreconcilable judgment that may be given by the Romanian court. What happens if the Romanian courts do find in favour of African Fertilizers? The parties could each have irreconcilable judgments from England and Romania, arising from the same agreement.

While the pro-arbitration stance of the English courts is welcome, this approach can result in inconsistent judgments within Europe. It may be that the current proposals to reform the Brussels Regulation will go some way to temper this risk. The European Parliament’s Legal Affairs Committee (LAC) has proposed maintaining the arbitration exception to the Regulation, but with clarifications for the interface between arbitration and the courts. The first reading of the LAC’s report is reported to take place on 18 April 2012 and the process can take several years to pass through the European parliament. Are those reforms appropriate? And meanwhile, are there risks for the health of the inter-twining systems of justice that are arbitration and litigation?

As previously discussed in this blog, the Second Circuit drew criticism in 2002 by applying the forum non conveniens doctrine to dismiss an action brought by the Russian state gas company’s insurer to enforce an award not only against the Ukrainian state gas company named in the award, but also against the Ukrainian government. See Monegasque de Reassurances S.A.M. (Monde Re) v. Nak Naftogaz of Ukraine, 311 F.3d 488 (2d Cir. 2002); Charles H. Brower II, Reflection on Forum Non Conveniens: Monde Re Was Right?!?.

Contrary to general opinion in the field, this author supported the Second Circuit’s decision in Monde Re because the plaintiff did not only seek summary enforcement of the award against its counterparty to the arbitration, but also sought relief against a third-party government based on veil-piercing theories that would have raised difficult questions of foreign law, required the collection of evidence from government sources in foreign capitals, and drawn U.S. courts into a politically charged dispute about energy security in Europe. See Brower, supra.

At a high level of generality, the alignment of parties and the procedural history in Figueiredo called forth memories of Monde Re: the claimant brought an arbitration and received an award against a state-controlled program in Peru (“Water for All”), then sought enforcement in New York not only against the named counterparty, but also against the Republic of Peru based on veil-piercing arguments. Figueiredo Ferraz e Engenharia de Projecto Ltda. v. Republic of Peru, 655 F. Supp. 2d 361, 367 (S.D.N.Y. 2009). However, the similarity stops there. Contrary to the situation in Monde Re, the district court held that the veil-piercing arguments could be resolved without further collection of evidence because the Peruvian Ministry of Housing, Construction and Sanitation had itself: (1) made partial payments of sums due under the award; (2) asserted, in intra-governmental correspondence, that the Ministry of Economy and Finance had an obligation to satisfy the award; and (3) initiated proceedings to set aside the award in Peruvian courts. Id. at 371.

Also contrary to the situation in Monde Re, the case did not raise questions that would have drawn U.S. courts into explosive political controversies involving two or more foreign states. Given the simplicity of the issues and the absence of political baggage, the district court exercised its discretion not to dismiss the enforcement action on forum non conveniens grounds. Id. at 374-77.

In a final contrast to Monde Re, the Second Circuit reversed the district court’s denial of forum non conveniens dismissal, based almost exclusively on Peru’s interest in applying a domestic statute that prohibits state agencies from paying more than three percent of their annual operating budgets to satisfy any particular judgment. Figueiredo, 2011 WL 6188497, at *4-*5. Many observers read the Second Circuit’s decision as an unwelcome December surprise that (1) lowers the threshold for forum non conveniens dismissals in enforcement proceedings, and (2) increases opportunities for second-guessing of district courts inclined to retain jurisdiction over enforcement proceedings.

As in Monde Re, however, observers seem to have lost sight of critical facts underlying the Second Circuit’s decision in Figueiredo. These include the facts that: (1) Peru represented the legal seat of arbitration; (2) the arbitral tribunal rendered its decsion “ex aequo et bono” and awarded the claimant more than $21 million; (3) the Ministry requested a Peruvian court to set aside the award on the grounds that Peruvian law limits recovery to the amount of the contract for international arbitrations involving a non-domestic party; (4) the Peruvian court denied set-aside because the claimant “had designated itself a Peruvian domiciliary in the agreement and the arbitration,” with the result that “the arbitration was a ‘national arbitration’ involving only domestic parties”; (5) when seeking enforcement of the award in New York, the claimant described itself as a Brazilian corporation; and (6) Peru’s appellate brief stridently argued that the claimant should be deemed a Peruvian national, given the position it had taken in the agreement, the arbitration and the set-aside proceedings. Id. at *1 (emphasis added); Brief of Peru at 57-59; Reply Brief of Peru at 29. In short, one might describe the claimant’s tactics as vexatious, cloaking itself in a Peruvian flag to secure the higher measure of damages available in “national” arbitrations, then cloaking itself in a Brazilian flag to avoid the three-percent payment cap for national arbitrations.

As one reads the appellate briefs of the parties on the topic of nationality, the claimant distinguishes between corporate domicile and nationality, whereas Peru seems to equate the two—an outcome that seems consistent both with the Peruvian court’s conclusions in the set-aside proceedings and with U.S. definitions of corporate citizenship for purposes of diversity jurisdiction. Compare Brief of Figueiredo Ferraz e Engenharia de Projecto Ltda. at 70-72, with Brief of Peru at 57-59, and Reply Brief of Peru at 29. See also Figueiredo, 2011 WL 6188497, at *1; 28 U.S.C. § 1332(c)(1) (assigning citizenship to corporations based on place of incorporation and principal place of business).

While the district court’s analysis accepted the claimant’s distinction between domicile and nationality, the Second Circuit (1) emphasized the Peruvian court’s description of the arbitration as a “‘national arbitration’ involving only domestic parties,” and (2) seemed exceedingly reluctant to allow an ostensibly Peruvian entity to use enforcement proceedings to avoid the application of Peru’s statutory cap on payments when dealing with the Peruvian government in a contract both executed and performed in Peru. Compare Figueiredo, 655 F. Supp. 2d at 372, with id., 2011 WL 6188497, at *1, *5.

Whatever the proper legal designation of the claimant’s nationality, the case reveals anomalies in the New York Convention and the Federal Arbitration Act. If one assumes that the claimant donned Peruvian nationality as a matter of law, the case clearly escapes the scope of international arbitration, inasmuch as it represents a legal relationship solely between Peruvian entities, with contractual performance solely in Peru, and conduct of the arbitration proceedings solely in Peru. Viewed from that perspective, the case represents a national arbitration that falls squarely outside the scope of most instruments on international commercial arbitration.

Going back to the early history of international instruments on the topic, the 1923 Geneva Protocol on Arbitration Clauses applies only to agreements “between parties[] subject respectively to the jurisdiction of different contracting parties.” Geneva Protocol on Arbitration Clauses, art. 1, Sept. 24, 1923, 27 L.N.T.S. 157. The 1927 Geneva Convention on the Execution of Foreign Arbitral Awards applied only to awards “made in pursuance of an agreement . . . covered by the [1923 Geneva Protocol],” meaning an agreement between parties having diverse nationalities. Geneva Convention on the Execution of Foreign Arbitral Awards, art. 1, Sept. 26, 1927, 92 L.N.T.S. 302.

Similarly, the 1961 European Convention on International Commercial Arbitration applies only to agreements and awards “arising from international trade between physical or legal persons having . . . their habitual place of residence or their seat in different Contracting States.” European Convention on International Commercial Arbitration, art. I(1)(a), Apr. 21, 1961, 484 U.N.T.S. 364.

Likewise, in the preamble to the 1975 Inter-American (Panama) Convention on International Commercial Arbitration, states parties express their desire to “conclud[e] a convention on international commercial arbitration.” Inter-American Convention on International Commercial Arbitration, pmbl., 1438 U.N.T.S 248. While none of the operative articles expressly limits that instrument’s coverage to international commercial disputes, the limitation finds confirmation in Article 3, which provides: “In the absence of an express agreement between the parties, the arbitration shall be conducted in accordance with the rules of procedure of the Inter-American Commercial Arbitration Commission [(IACAC Rules)].” It seems unlikely that states parties, such as the United States, contemplated application of the IACAC Rules to purely domestic arbitrations in which the disputing parties failed to identify a set of arbitration rules. See H.R. Rep 101-501, reprinted in 1990 U.S.C.C.A.N. 675, 676-77 (emphasizing the Panama Convention’s role in facilitating “international commerce,” “trade,” and “foreign investment”). Cf. John P. Bowman, The Panama Convention and Its Implementation Under the Federal Arbitration Act, 11 Am. Rev. Int’l Arb. 1, 37 (2000) (“Application of the Panama Convention to international commercial arbitration permeates the Convention from beginning to end.”).

Finally, and most recently, the UNCITRAL Model Law on International Commercial Arbitration applies only to “international commercial arbitration,” defined to encompass situations where: (1) the parties have their places of business in different states; (2) the arbitration is seated outside the state in which the parties have their places of business; (3) a substantial place of contractual performance lies outside the state in which the parties have their places of business; or (4) the parties have expressly agreed that the subject matter of the dispute relates to more than one country. UNCITRAL Model Law on International Commercial Arbitration, art. 1(1), (3), U.N. Doc. A/40/17/Annex I (June 21, 1985).

In other words, on one view, Figueiredo involved relationships so squarely grounded in Peru that the resulting arbitration could not possibly have qualified for coverage by almost any of the leading instruments on international commercial arbitration—except, of course, the New York Convention.

True to its official name, the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, applies to any award rendered on the territory of a foreign state (or, if the state of enforcement has adopted the reciprocity reservation, the Convention applies to any award rendered on the territory of a foreign state party). Convention on the Recognition and Enforcement of Foreign Arbitral Awards, Art. I(1), (3), June 10, 1958, 330 U.N.T.S. 38.

Unlike almost every other leading instrument, the New York Convention does not require the disputing parties to have diverse nationalities or to engage in transactions that cross national borders. While the New York Convention aims primarily “to facilitate arbitration in international commerce,” and while an early ICC prototype had referred to “international awards,” concerns about a-national awards and the difficulties of defining international commerce prompted delegates to the New York Convention’s 1958 drafting conference to reorient that instrument’s coverage towards foreign awards. Albert Jan van den Berg, The New York Arbitration Convention of 1958, at 17 (1981). As a result, the New York Convention technically applies to foreign awards grounded in a single jurisdiction. Thus, for purposes of enforcement in the United States, an award falls under the Convention even if rendered in Paris between two French wine merchants under a contact for the sale of French wine. Id.

In his seminal work on the New York Convention, Albert Jan van den Berg described this phenomenon as a “harmless ‘side-effect’” that “scarcely occurs in practice” and had “not occurred in any of the reported cases.” Id. at 18. In addition, he opined that the New York Convention’s uniquely broad scope might prove useful in cases where the losing parties to domestic arbitrations possess substantial bank accounts in foreign jurisdictions. Id. While van den Berg’s assessment holds true as a general matter, one wonders if the “side-effect” remains so “harmless” when private parties exploit it to reach the assets of their own governments, thus draining the national treasury in violation of otherwise applicable national laws.

Confirming the potential for mischief in the circumstances just outlined, one need not search long for precedent rejecting the efforts of disgruntled national corporations to circumvent the limits of domestic redress against their own governments by invoking the machinery of international dispute settlement. Cf. Loewen Group, Inc. v. United States, ICSID Case No. ARB(AF)/98/3, Award ¶ 223 (June 26, 2003) (finding it “inconceivable” that states would negotiate treaties to provide their own citizens with international avenues for redress of regulatory disputes). This holds true even in the context of the New York Convention, where the only court to address the issue outside the Second Circuit invoked the forum non conveniens doctrine to dismiss an enforcement action brought by a foreign entity against its own government with respect to an arbitration involving public utilities and seated in the state of the disputing parties’ nationality. Termorio S.A. E.S.P. v. Electrificiadora del Atlantico S.A. E.S.P., 421 F. Supp. 2d 87, 103-04 (D.D.C. 2006).

Of course, the New York Convention’s unusually broad scope should not apply to cases that, like Figueiredo, arise under the Panama Convention. As mentioned above and recognized by some courts, the Panama Convention does not cover foreign awards involving parties, transactions, and arbitral proceedings grounded in a single foreign jurisdiction. See Energy Transport Ltd. v. M.V. San Sebastian, 348 F. Supp. 2d 186, 199 (S.D.N.Y. 2004) (“For example, if parties sought enforcement in the United States of an award rendered in Panama, involving only Panamanian citizens conducting a domestic transaction, the New York Convention would likely apply but the Inter-American Convention would not because of the award’s purely domestic character.”); Bowman, supra, at 39 (“Under the Panama Convention, . . . a foreign award rendered . . . in Uruguay, involving only Uruguayan citizens engaged in a domestic transaction, may not be enforceable.”).

However, this clear understanding of the Panama Convention’s scope reveals an anomaly in the FAA. Despite the obvious differences between the respective scopes of the Panama and New York Conventions, the United States inexplicably implemented the Panama Convention through a statutory provision that incorporates by reference most of the New York Convention’s implementing legislation. See 9 U.S.C. § 302. As a result, while the Panama Convention applies only to international commercial arbitration, the United States has extended its coverage by statute to awards grounded in a single foreign jurisdiction. Bowman, supra, at 39 n.104, 75. While “harmless” in most cases, this little-known “side-effect” could prove both unexpected and aggravating to foreign governments dealing with their own citizens in domestic transactions, on matters of public importance.

Given the United States’ relative lack of interest in localized disputes between foreign governments and their own nationals on matters of local importance, it seems wise for U.S. courts to preserve forum non conveniens dismissals as a possible antidote for the rare situations in which the New York Convention’s and the FAA’s unusually broad scope threatens to produce surprising results. Far from provoking allegations of treaty violations, such dismissals seem more likely to draw appreciation from states parties dealing with their own citizens on matters of the public interest.

For the reasons stated above, the Second Circuit’s decision in Figueiredo deserves more sympathetic consideration than accorded by most observers. Likewise, the forum non conveniens doctrine deserves slightly better treatment than the categorical rejection adopted by the draft Restatement on the U.S. Law of International Commercial Arbitration. By failing to leave any opening for forum non conveniens dismissals, the Restatement’s drafters run the risk that their final product will draw the same respect expressed by the majority in Figueiredo, which damned the ALI’s work by failing to mention it at all.

The CA in Keeneye reversed the much-discussed decision of the Hong Kong Court of First Instance (“CFI“) to refuse enforcement of a PRC arbitral award on grounds of public policy. The CFI had held that the conduct of an arbitration in which one of the arbitrators and the General Secretary of the Xian Arbitration Commission acted as mediators (a so-called “arb-med” procedure) was tainted by apprehended bias. The CFI therefore refused enforcement of the award on the basis that it would be against the public policy of Hong Kong, pursuant to section 40E(3) of Hong Kong’s old Arbitration Ordinance (Cap. 341) (which was then in force, but has since been superseded by section 95 of the new Arbitration Ordinance, Cap. 609).

The CA allowed Gao and Xie’s appeal against the CFI decision, and approved the enforcement of the award in Hong Kong on two principal grounds.

First, Keeneye had failed to raise any objection to the “arb-med” procedure during the arbitration itself, and had therefore waived its right to do so in the enforcement proceedings. This decision was underpinned by the governing arbitral rules (the Xian Arbitration Commission Arbitration Rules), which specifically provided for waiver of the right to object in such circumstances. (Similar rules on waiver exist in many institutional rules, including Article 28.1 of the HKIAC Administered Arbitration Rules, Article 39 of the new ICC Rules (which came into effect on 1 January this year), and Article 36.1 of the SIAC Rules.) On this point, the CA also emphasised the principle that a party may not keep a complaint about impropriety or bias “up his sleeve” for potential use at a later stage.

Secondly, the “arb-med” procedure adopted in the arbitration did not disclose apprehended bias giving rise to an issue of public policy in any event. This part of the CA’s decision may come as a surprise to some, given the striking factual circumstances in this case. These included the facts that (i) the mediation took place in the form of a private meeting over dinner at the Xian Shangri-la Hotel, (ii) the mediation was not held in the presence of both parties, and (iii) the mediators appeared to make a settlement proposal on their own initiative. However, in reaching its conclusion that there was no apprehended bias, the CA indicated that due consideration should be given to how mediation is typically conducted in the jurisdiction of the seat (here, the PRC). In this regard, the CA placed considerable weight upon the fact that the local court in Xian (which had supervisory jurisdiction over the arbitration) had refused an application to set aside the award – citing with approval English authority that such circumstances will be a “very strong policy consideration” for the court to take into account in deciding whether or not to enforce an award.

According to the CA, the test for determining what is contrary to public policy in Hong Kong is whether the relevant matter is contrary to “fundamental conceptions of morality and justice” in Hong Kong. Thus, if the procedure is acceptable practice in the jurisdiction in which it took place, it will not be in breach of public policy in Hong Kong unless it was so serious as to be contrary to fundamental conceptions of morality and justice.

Although this “when in Rome” approach might seem slightly troubling at first sight, the conclusion of the CA appears to be the right one. In particular, when a party consents to arbitration in a particular jurisdiction, it agrees to be bound by the rules and procedures of that seat. Whilst there is a public policy ceiling on adopted procedures beyond which the enforcing courts will be unwilling to cross, this outer limit will be narrowly construed in practice. For those engaging in “arb-med” procedures in the PRC (where practices often differ significantly from those in Hong Kong and other jurisdictions), the Keeneye judgment may provide some comfort that the mediation procedure will not in itself threaten the enforceability of any award in Hong Kong on the basis of public policy.

The CA’s recent judgment is likely to generate much (further) discussion about the development of arb-med in Hong Kong. Whilst the judgment acknowledges that arbitrators can act as mediators in the course of arbitration proceedings (a practice which is recognised expressly in section 33 of Hong Kong’s new Arbitration Ordinance, Cap. 609), the acceptable boundaries of that role in Hong Kong are far from clear. Moreover, the concept as a whole can be rather alien to common law lawyers.

It is suggested that parties and counsel should keep an open mind to the possibility of adopting arb-med in the light of the pivotal role such procedures have played in the settlement of disputes in other jurisdictions. That said, for a number of reasons (including the fact that arbitrator-mediators are compelled by Hong Kong’s arbitration legislation to disclose to all parties any confidential but materially relevant information they learned during private caucus sessions), it is likely that arb-med procedures in Hong Kong will favour an evaluative, rather than a facilitative, approach (with appropriate waivers from the parties). Such an approach would avoid the risk of any subsequent complaint about ex parte communications between a party and the arbitrator-mediator – as was featured in Keeneye.

It remains to be seen which direction the development of arb-med in Hong Kong will take. In the meantime, the Keeneye judgment serves as a powerful reminder to parties to raise any objections they may have to the arbitral procedure promptly. Failure to do so may result in a waiver of the right to object at a later date, including in the context of enforcement proceedings.

Justin D’Agostino, Martin Wallace and Ula Cartwright-Finch

While iura novit curia is not widely addressed in investment treaty arbitration jurisprudence, several arbitral tribunals and ICSID annulment committees appear to have accepted that they can render awards based on authorities other than those pleaded by the parties. The 2002 decision of the ad hoc annulment committee in Compagñia de Aguas del Aconquija S.A. and Vivendi Universal v. Argentine Republic, ICSID Case No. ARB/97/3, is typical of these decisions in its summary analysis. The Vivendi committee explained that while the reasoning adopted by the underlying tribunal “came as a surprise to the parties, or at least to some of them . . . this would by no means be unprecedented in judicial decision-making” and was not a basis for annulment. The language in Vivendi was quoted and applied by the ad hoc annulment committee in Helnan International Hotels A/S v. Arab Republic of Egypt, ICSID Case No. ARB/05/19, one of the four annulment decisions published during the summer of 2010. As another example, in Wena Hotels Ltd. v. Arab Republic of Egypt, ICSID Case No. ARB/98/4, the tribunal exercised its assumed iura novit curia power in utilizing compound interest to calculate damages, despite the fact that neither party argued for compound interest.

Three important limitations on an investment treaty arbitral tribunal’s iura novit curia power have been identified by ICSID ad hoc annulment committees. First, according to the annulment committee in MINE v. Republic of Guinea, ICSID Case No. ARB/84/4, an ICSID tribunal cannot apply legal authorities outside the law applicable to the dispute. Second, and similarly, the annulment committee in Klöckner v. Cameroon, ICSID Case No. ARB/81/2, recognized that an ICSID tribunal cannot, “by formulating its own theory and argument . . . go[] beyond the ‘legal framework’ established by the Claimant and the Respondent,” for example by deciding the case “on the basis of tort while the pleas of the parties were based on contract.”

Finally, in 2006, the ad hoc annulment committee in Mr. Patrick Mitchell v. Democratic Republic of Congo, ICSID Case No. ARB/99/7, held that while tribunals may have iura novit curia powers, they are not required to exercise them. The Mitchell annulment committee wrote that a tribunal “is not, strictly speaking, subject to any obligation to apply a rule of law that has not been adduced; this is but an option….” A similar delineation was recognized by the tribunal in CME Czech Republic B.V. v. Czech Republic, which was heard under the UNCITRAL rules. In CME, the tribunal made clear that it was not “bound to research, find and apply national law which has not been argued or referred to by the parties and has not been identified by the parties and the Tribunal to be essential to the Tribunal’s decision.”

The 2010 annulment decision in Enron Creditors Recovery Corporation and Ponderosa Assets L.P. v. Republic of Argentina, ICSID Case No. ARB/01/3, seems to have derogated from the rule announced in Mitchell, implying (if not clearly stating) a iura novit curia obligation on investment treaty arbitration tribunals. Curiously, the Enron annulment committee paid lip service to the iura novit curia rule announced in Mitchell, writing that “a Tribunal is . . . certainly not required to address arguments that have not been put by the parties.” Nonetheless, the Enron ad hoc committee proceeded to annul the underlying arbitral decision on the ground that the tribunal failed to apply the applicable law, faulting the tribunal for overlooking arguments and facts that were not raised by the parties.

To the extent the Enron annulment committee believed that iura novit curia is not merely a power but an obligation on the tribunal, such a view would not be unprecedented. Judge Lagergren, in his 1979 decision in BP Exploration Co (Libya) Ltd. v. The Government of the Libyan Arab Republic, 53 ILR 297 (1979), a case arising under a concession contract, found that – at least in the context of a sovereign respondent’s default – an arbitrator is “both entitled and compelled to undertake an independent examination of the legal issues deemed relevant by it, and to engage in considerable legal research going beyond the confines of the materials relied upon by the Claimant” (emphasis added).

The Enron decision may also reflect the approach of the ICJ decisions cited in 2009 by the ICSID ad hoc annulment committee in RSM Production Corporation v. Grenada, ICSID Case No. ARB/05/14. In determining that an ICSID annulment committee has iura novit curia powers, the RSM committee relied on the ICJ decisions in Fisheries Jurisdiction and Military and Paramilitary Activities in and against Nicaragua. These ICJ decisions assume that iura novit curia is not only a power held by the ICJ, but an obligation on the court. In Fisheries Jurisdiction, the ICJ wrote that “ [t]he Court . . . as an international judicial organ, is deemed to take judicial notice of international law, and is therefore required . . . to consider on its own initiative all rules of international law which may be relevant to the settlement of the dispute.” In the Nicaragua case, the ICJ cited to the 1927 PCIJ decision in S.S. Lotus in holding that it was “bound” to apply iura novit curia in order to determine whether it had jurisdiction in the absence of an appearance by the respondent State.

While citing these strongly-worded ICJ decisions, the RSM ad hoc committee did not expressly address whether iura novit curia is a power or an obligation of investment treaty arbitration tribunals. Jan Paulsson, in his article on the generation of legal norms in investment treaty arbitration, attempts to connect the dots by citing to Article 38 of the ICJ Statute and Fisheries Jurisdiction to support his argument that tribunals have a iura novit curia obligation. As Paulsson explains, “a tribunal in an investment dispute cannot content itself with inept pleadings, and simply uphold the least implausible of the two.” J. Paulsson, International Arbitration and the Generation of Legal Norms: Treaty Arbitration and International Law, ICCA Congress Series No. 13 (Kluwer, 2007), at 879.

Before concluding, it is worth noting the effect local rules and practices may have on iura novit curia in non-ICSID investment treaty arbitration. For example, in Bogdanov v. Moldova, SCC Case 93/2004, an investment treaty claim heard under the Stockholm Chamber of Commerce rules, the sole arbitrator found that she “remains free, within the borders of the applicable law . . . to give the legal qualifications and determine the legal consequences that it deems appropriate, even if they were not pleaded by the parties.” Applying Swedish arbitral practice, the Bogdanov arbitrator wrote that if iura novit curia is exercised, the parties should be invited to comment on the new legal authorities, lest the parties be “surprise[d] by the consideration of legal issues that were not taken into consideration in the proceedings.” While this “no surprise” rule was not part of the iura novit curia principle stated by the Vivendi annulment committee, it is consistent with with recent decisions of several European courts in the context of commercial arbitration, as well as with the recommendations of the International Law Association in its 2008 paper, Ascertaining the Contents of the Applicable Law in International Commercial Arbitration.

Unfortunately, the investment treaty arbitral decisions expressly or implicitly addressing iura novit curia deal with the issue cursorily, providing little analysis and scant support. The textual basis for an investment treaty arbitral tribunal to exercise iura novit curia powers remains unclear. To this author’s knowledge, it is not specifically provided for in any bilateral investment treaty, although arguably it may fall under the ex aequo et bono or similar provisions included in some treaties. There is no express provision for iura novit curia in the ICSID rules (as opposed to, for example, the LCIA rules). Furthermore, scholarship sheds little light on the basis for iura novit curia in the specific context of investment treaty arbitration. As recently as 2007, Paulsson described iura novit curia in investment treaty arbitration as a “fundamental issue . . . not yet to have been considered in the depth it obviously deserves.” It is fair to conclude that a theoretical or legal framework for an investment treaty arbitral tribunal’s exercise of iura novit curia powers remains undeveloped. Certainly whether those assumed powers rise to the level of obligation is an unresolved question.

The author, David M. Bigge, is an Attorney-Adviser in the United States Department of State, Office of the Legal Adviser, Office of International Claims and Investment Disputes (L/CID). The views in this article are expressed by the author solely in his personal capacity and do not necessarily represent those of the U.S. Government.

My suspicion is that expert witnesses could do much more to assist the arbitration community in their dealings with the important issue of quantum. Without wishing to make sweeping generalisations, I do wonder whether some arbitrators’ relative lack of familiarity with different approaches to measuring damages might be at least a partial explanation for the following:

• The existence of relatively few awards which explain in any real detail arbitrators’ reasoning for preferring one valuation approach over another and hence their eventual award for damages.
• The perception that arbitrators ‘split the baby’ i.e. issuing an award for damages that is somewhere in the middle of two experts’ valuations, despite said valuations having been produced using entirely different methodologies and/ or assumptions.

In a similar vein, whilst many lawyers I have met say they understand (for example) discounted cash flows (DCF), it is not always clear to me that their knowledge of this methodology extends beyond the pure mechanics of the calculation. What is also needed when analysing a DCF calculation is a proper awareness of the importance and role of assumptions and the various sensitivities in a DCF calculation.

Given the above, I thought it might be helpful to produce a short series of blog postings covering the rudiments of the most common valuation methodologies. Each post will explain the basic mechanics of the valuation approach, its applicability to different situations and its strengths and weaknesses. Finally, I will explain how the ongoing financial and economic crisis may impact a valuation performed under the particular valuation approach being considered.

Introduction

Forensic accountants and other valuation professionals are frequently involved in the arbitral process to assist disputing parties and tribunals quantify economic loss as a result of a given breach or act. In order to determine the amount of economic loss (e.g. suffered by a business), an expert will often need to perform two different valuations: a counterfactual (or ‘but for’) valuation and an ‘actual’ valuation’ where the difference between the two represents the loss. There are many different methodologies for valuing a business, with the following being the most common approaches:

• Market-based approach (e.g. comparable transactions)
• Income-based approach (e.g. DCF)
• Asset-based approaches (e.g. adjusted net book value)

This article will focus on the market approach; subsequent articles will discuss the DCF and asset-based approaches.

Overview of the market approach

Underpinning the market-based approach is the basic principle that a business is only worth what somebody is prepared to pay for it. For this reason, when attempting to value a given business (let’s call it Company A) in the context of a dispute, an expert may firstly look at the value of any past transactions in Company A itself. Recent past transactions in Company A may be the best available evidence of the value of Company A, although the details of such transactions would need to be studied carefully before arriving at such a conclusion. It is not uncommon, however, that the expert will find few, if any, recent transactions in Company A; any transactions that he does find may not have been made at arm’s length (hence failing one of the tests in the definition of fair market value – see below) or else made in the distant past (and hence not reflecting current information).

In lieu of (or in addition to) using own-company transaction data, the expert will research recent transactions in businesses he deems to be similar to Company A. The premise supporting this approach is that if Company A is similar to Company B, and Company B has a value of X (assuming that we know the value of Company B), it is reasonable to assume that Company A’s value can be determined by reference to X. In this example, X might refer to any of Company B’s share price, the transaction price for the sale of the entire business, total enterprise value (value of both shareholders’ equity and debt) or equity value (the value attributable to shareholders) among other values.

The first step then for the expert who wishes to value Company A using comparable transactions is to identify businesses which are similar to Company A in that they have share common characteristics. Characteristics that are commonly taken into account include:

• Industry/ business sector
• Size of organisation (number of employees, turnover, geographical spread)
• Product mix
• Financial structure (e.g. mix of debt/ equity)
• Geography
• Maturity of the business i.e. does Company A have stable/ predictable revenues or is it a young fast-growth company?
• Profit margins

It will be appreciated that, in reality, no two businesses are exactly alike in all respects. Whilst an expert may successfully identify a business (Company B) which provides a close match to Company A, there will often be important differences between the businesses. The expert will need to take these differences into account when performing his valuation.

Putting aside for the time being the above practical considerations, assuming that the expert does find a reasonably close match, he will then seek to use the (known) valuation of Company B to inform his valuation of Company A. Today, the expert benefits from being able to access a wealth of publically available information from a variety of sources. By accessing a suitable database (e.g. Bloomberg), the expert can obtain and use details of Company B’s key financial metrics. He may discover, for example, that the enterprise value of Company B is a multiple of 10 times EBITDA (Earnings Before Interest Tax Depreciation and Amortisation). To conclude this simplistic example, the expert may decide that Companies A and B are so similar that the former should also be valued on a multiple of 10 times EBITDA. Alternatively, he might observe that Company B was recently sold for a price X and conclude that this price should inform the value of Company A.

In some industries, key drivers of value are used as relative valuation multiples, for example:

• value per customer or subscriber (telecoms, financial services, internet businesses)
• value per square foot (retail)
• revenue per available room (RevPar) (hotel industry)
• value per unit of proven reserves (mining companies, oil companies)
• value per unit of sales (value per bottle in the champagne industry in France, daily milk bottle sales in dairy industry)

As variants on the above, the study of comparable businesses may also be relevant in the following circumstances:

• selection of an appropriate discount rate for the purposes of the income (DCF) approach – discussed in the next posting. If Companies A and B are similar (e.g. large mobile phone companies operating in a given country), the discount rate for Company A at a certain date may be a sensible proxy for that of Company B on a slightly different date, although again care needs to be taken to ensure one is truly comparing like with like; and

• understanding how a business might have performed (but for a breach) by reference to the trading performance of a similar business in the same time period.

That then is the (over) simplified overview of the market/ comparables approach. I set out below some of the key strengths and weaknesses of this methodology.

Strengths and weaknesses of the comparables approach.

By way of an opening comment, it should be recognized that the market/ comparable businesses approach is generally accepted within the professional valuation community and is widely used. If properly prepared, an independent valuation which is supported by reference to real-life transactions in comparable companies demands to be taken seriously and may be difficult to criticize.

A further strength of this methodology is that the expert can access a huge amount of data in his search for a comparable company. By way of illustration, when searching recently for a particular type of manufacturing company in Eastern Europe, a database returned over 30 possible results, showing all the financial and accounting data I could possibly need and more besides.

One obvious reason why the market approach is often used in arbitration for the purposes of calculating damages is that, on the face of it, the approach itself seems entirely straight-forward and reasonable. From personal experience, it is often easier to explain to lawyers than DCF!

On a cynical view, however, in preparing its claim, a party might rely on this approach precisely because it knows it is conceptually simple and can usually be understood more easily by the lay person than a claim which is based on a complicated DCF model. As we shall see in the next article, however, the DCF approach is widely used and generally accepted in the professional valuation community. Becoming even more cynical, it can be observed that M&A transactions often reflect a heavy ‘control premium’ that might not arise in valuations produced under other methodologies. Put simply, the market approach can sometimes give higher values (and thus work in the claimant’s favour) than either the income or asset based approaches, although this does also depend on prevailing market sentiment.

What then are the flaws of using what seems to be an approach grounded in common sense and straight-forward logic?

Firstly, there exist relatively few truly comparable companies. Even assuming one is able to find a similar company in terms of size, product, geography, capital structure etc, any differences in other factors (e.g. the actual profit margins earned and/ or the profit growth rates) can mortally wound the comparison or else require complicated adjustments to be made to the valuation to create an artificial comparability.

A second difficulty is that historical transaction values may not reflect current values and, as we know, market sentiment can change quickly. The M&A market in spring 2007 (i.e. prior to the onset of the financial crisis) was completely different to that in the fall of 2008 i.e. post Lehman collapse.
The following is a non-exhaustive list of other potential weaknesses/ drawbacks:

• Given the (sometimes) large population of notionally comparable businesses, it may be tempting for a party to ‘cherry-pick’ the businesses that support a pre-determined valuation; an experienced expert charged with rebutting a claim should be able to identify the existence of such bias by getting to the same overall population
• A deep understanding of the relevant industry/ sector may be required in order to decide which businesses truly are comparable
• Particular care needs to be taken when dealing with businesses with little history and/ or high growth
• The assumptions underpinning valuations based on comparable companies can be far less transparent than is generally the case in say a DCF valuation.
• The approach may not be possible in the case of start-up ventures
• Important intangible differences between otherwise comparable companies tend to be glossed over, such as brands, management styles, culture etc.

Impact of the financial crisis on the application of the market-based approach

Whilst the market-based approach continues to be as relevant today as it ever was, in this writer’s view, additional caution is warranted now when researching past transactions to ensure one is truly comparing like with like. The global financial and economic crisis does not look like it will dissipate in a hurry and hence its impact of valuation needs to be taken seriously. A sensible starting point for this discussion is the International Glossary of Business Valuation Terms’ definition of Fair Market Value, which is:

“the price, expressed in terms of cash equivalents, at which the property would change hands between a hypothetical willing and able buyer and hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market when neither is under the compulsion to buy or sell and when both have reasonable knowledge of the relevant facts” [emphasis added]

In conducting a review of market transactions for the purposes of identifying comparable business valuations, the absence of one or more of the above highlighted factors in a given transaction may render the transaction data useless, for the reasons explained below.

Hypothetical willing and able buyer – As is well-known, in the immediate aftermath of the Lehman’s collapse in 2008 and ensuing credit crunch, the M&A market collapsed. Whilst there has been a slight pick-up in the volume of deals since 2008, the global M&A market remains well below levels seen in spring 2007, the high watermark. An obvious implication of the depressed market is that there remains a continued lack of buyer appetite (and greater aversion to risk?) and hence numbers of buyers. Current restrictions on credit do not help. Of relevance here is the importance of geography; to pose a rhetorical question, are lending conditions in Spain – one of the countries most badly affected by the crisis – the same as in say France? If lending conditions are different, this may limit the comparability of French and Spanish businesses in a way that may not have been the case pre-crisis; both countries are, after all, members of the euro zone.

Open and unrestricted market – to what extent can pricing data, obtained from market transactions, be trusted to reflect underlying supply & demand factors, given that governments now regularly intervene in that market? By its very nature, government intervention generally makes markets less transparent and open. To use an extreme example, is the fair market value of a (toxic) derivative instrument truly its face-value simply because a government agency intervenes and purchases it for this price?

Neither is under the Compulsion to buy or sell – In reality, many transaction values since the beginning of the financial crisis may represent “fire sales”, where a vendor may have been under the compulsion to sell an asset or business and may have done so for less than it would have been able to sell it for under different circumstances. In a similar vein, due to heightened volatility, the market may not reflect “long term” view / “value-in-use”

Conclusion

It should be recalled that the market approach is only one of several possible valuation methodologies. Best practice requires that, where practicable, a valuer should seek to apply more than one valuation method, if only to cross-check the results of the different calculations in reaching a final view on value. Thus, the market approach might be used to support a valuation produced using DCF or vice-versa.
In the next article, I will discuss the DCF methodology.

©FTI Consulting, Inc., 2011. All rights reserved.
The views expressed in the article are held by the author and are not necessarily representative of FTI Consulting, Inc. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual, entity or transaction. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation

1. A control premium is the excess price a buyer is willing to pay over the current market value of publicly traded shares.

The writer would like to acknowledge the respective contributions of Andrew Flower and Greig Taylor of FTI Consulting (New York) in the writing of this article.

The background is as follows:

To build a golf course in Moscow, a Russian company (the “Russian Borrower”) had borrowed 22 million Swedish Crowns from a Swedish bank (the “Swedish Bank”) under a loan agreement entered into on 24 January 1990 (the “Loan Agreement”). The Loan Agreement included an arbitration clause providing for arbitration under the Arbitration Rules of the Arbitration Institute of the Stockholm Chamber of Commerce (“SCC”).

On 19 December 2008 the Swedish bank requested arbitration against the Russian Borrower seeking repayment of a certain capital amount under the Loan Agreement. The Russian Borrower rejected the claim and argued, inter alia, that the Loan Agreement violated then mandatory currency regulations in the former Soviet Union and that the dispute was therefore not arbitrable.

The SCC decided that the seat of the arbitration proceedings should be Stockholm.

The sole arbitrator held in the award, inter alia, that the Russian Borrower had not proved that the Loan Agreement violated then mandatory currency regulations in the former Soviet Union or in Russia and the Russian Borrower was ordered to pay a certain capital amount with interest thereon and compensation for costs.

The Russian Borrower turned to the Svea Court of Appeal and requested, inter alia, a declaration that the award was invalid on the basis that the award included the review of an issue which is regulated in mandatory currency regulations. Hence, the Russian Borrower argued that the issue was not arbitrable and the award should therefore be declared invalid. In the alternative the Russian Borrower requested annulment of the award on the basis that the arbitration agreement was not valid and binding as it violated mandatory currency regulations.

The Russian Borrower argued as follows: Rigorous currency regulations were in force in the beginning of the 1990s, both in Sweden and in the Soviet Union. Import or export of currency without authorization from the proper authorities was not allowed. Nor was the reduction of a loan amount or granting a respite for payment. In Sweden this followed from the Exchange Control Act (Sw: valutalagen (1939:350)) and the Exchange Control Regulation (Sw: valutaförordningen (1959:264)). The provisions were sanctioned by penalty and any currency could be forfeited. Since the Loan Agreement violated these provisions the Loan Agreement was invalid.

Further, the parties could not before or after a dispute had arisen “heal” the invalidity of the Loan Agreement. It was not amenable to settlement. Hence, issues arising out of the Loan Agreement were not arbitrable and no dispute under the arbitration clause could be referred to arbitration. This in turn meant that the arbitration agreement was invalid. The relevant point in time for assessing whether an issue is arbitrable is when the arbitration agreement is entered into.

The Swedish Bank disputed that the award was invalid or that it should be annulled. The issue tried in the award – whether the Russian Borrower had a payment liability under the Loan Agreement – is arbitrable. Further, the question whether an arbitration agreement is valid and binding has to be tried separately. The arbitration agreement is valid and binding under Swedish law which is the governing law of the arbitration agreement. Even though the main agreement may be invalid (which the Swedish Bank disputed) this does not mean that the arbitration agreement is invalid. The currency regulations are of no relevance for the validity of the arbitration agreement.

The Svea Court of Appeal held as follows:

Since the arbitration proceedings had been held in Stockholm it was clear that the arbitration agreement was governed by Swedish law. The question whether the dispute was arbitrable was therefore to be tried under Swedish law and under the Arbitration Act only disputes in respect of which the parties may reach a settlement may be referred to arbitration.

An arbitral award is invalid if it includes the determination of an issue which, in accordance with Swedish law, may not be decided by arbitrators (lack of arbitrability). However, the fact that there is mandatory legislation in a certain area of the law does not automatically mean that disputes in this area are not arbitrable. With respect to international disputes which involve foreign legislation it has to be decided on a case-by-case basis whether the foreign law is such that a voluntary settlement of the dispute before a Swedish court would not be accepted. With regard to economical-political regulations in a foreign state there is often no reason why the mandatory provisions should affect the possibility to settle in Sweden and, hence, the arbitrability under Swedish law. This view is in accordance with an international trend to accept that an international dispute may be settled by arbitration although a corresponding national dispute would not be arbitrable.

The relevant point in time for assessing whether the dispute in question is arbitrable is when the Loan Agreement was entered into, i.e. on 24 January 1990. At that time the parties should be able to foresee the consequences of any lack of arbitrability.

When the Loan Agreement was entered into, Sweden as well as the Soviet Union had mandatory currency regulations. The Swedish Exchange Control Act and Exchange Control Regulation included restrictions on the import and export of foreign currency and securities. The same applied to the purchase and sale of foreign currency and foreign claims. However, there were no restrictions for a Swedish legal entity to enter into a loan agreement whereby a foreign legal entity became indebted. The currency regulations were not aimed at disallowing a creditor-debtor relation as such; but concerned the making of payments cross the borders.

The parties’ claim and debt under the Loan Agreement could not be deemed subject to mandatory legislation in such way that this undertaking was not amenable to settlement. Hence, the parties could reach a settlement regarding this. The issue tried in the award was the debt undertaking; not how any payment should be made. The dispute was thus arbitrable.

Since the mandatory currency regulations did not mean that a non-arbitrable issue was tried in the award the arbitration agreement was valid and binding. This is regardless of whether said currency regulations may entail that parts of the Loan Agreement were invalid.

The ruling of the Svea Court of Appeal seems quite arbitration friendly and is in line with the international trend to maximize the scope of application of an arbitration agreement. The restrictions in the previous currency control regulations in Sweden were narrowly interpreted and the doctrine of separability was firmly adhered to. The currency regulations in the former Soviet Union were not analyzed at all by the Court of Appeal. However, the Court of Appeal seemed convinced that the issue in dispute – whether there is a payment liability under a loan agreement – was not subject to any mandatory currency regulations. Further, the Court of Appeal did not expressly address whether the Swedish law test for arbitrability – that the dispute must be amenable to settlement – should be determined under Swedish substantive law or the lex causae. It has been suggested in Swedish legal doctrine that the question whether the parties are capable of settling the dispute should normally be assessed under the law governing the main contract. If the governing law is foreign law the outcome of that test under foreign law is decisive for the question of arbitrability. In this case it is unclear whether lex causae was Swedish law or any foreign law. The reason why this was not dealt with by the Court of Appeal might be that it had no relevance here as the previous currency regulations, both in Sweden and Russia, did not prohibit debt undertakings per se.

Leave to appeal was granted by the Court of Appeal² and the Russian Borrower has appealed the judgment to the Supreme Court.

This issue has come to particular prominence in Hong Kong recently following judgments in the cases of Democratic Republic of the Congo v. FG Hemisphere Associates FACV Nos. 5, 6 & 7 of 2010 and Intraline Resources SDN BHD v. The Owners of the Ship or Vessel “Ha Tian Long” HCAJ 59 of 2008, holding that both sovereign immunity and crown immunity are absolute in this jurisdiction. Immunity will be relevant where a contract provides for dispute resolution by the Hong Kong courts or the counterparty has assets located in Hong Kong. The upshot is that if the counterparty is a State entity, it will be able to invoke its immunity to resist the assumption of jurisdiction over it by the Hong Kong courts, including enforcement proceedings in Hong Kong against its assets, regardless of whether the transaction or assets in question are sovereign or commercial in nature. (There is some good news –immunity will not operate as a bar to arbitration seated in Hong Kong, and is unlikely to affect the supervisory jurisdiction of the Hong Kong courts over arbitral proceedings.)

One of the consequences of an absolute (as opposed to a restrictive) doctrine of sovereign immunity, particularly in light of the restrictive rules on waiver of immunity which now apply in Hong Kong, is that the status of a contractual counterparty assumes central importance in determining whether or not it will be entitled to invoke immunity. Because absolute immunity makes no exception for purely commercial transactions or assets, the key question in determining whether immunity applies in a given case will be whether or not a particular entity is, or is not, a State or a State entity. Identifying the sovereign or the crown becomes paramount.

So which entities will be accorded sovereign or crown status in Hong Kong? The question to be asked is whether the entity is an “arm or alter ego”, or “part and parcel”, of the State, such that it should be identified with the State like a government department. In answering this question, the legal tests which will be applied in the cases of sovereign immunity and crown immunity are different, although in practice the results will often be the same. In order to apply the right test, the applicable immunity must first be identified. Sovereign immunity will apply where the counterparty is a foreign (i.e. non-PRC) State or State entity, whereas crown immunity will apply where the counterparty is the PRC State or a PRC State entity. Crown immunity is therefore most likely to be relevant to typical China-related contracts and transactions, although there may of course be exceptions.

In the case of sovereign immunity, the key factors in determining whether an entity is entitled to immunity are likely to be the function of the entity and the nature of the activities which it carries out (i.e. a “functional” test), although other factors may be taken into account. Where the entity carries out activities of a sovereign or governmental nature, it will be entitled to immunity, but where it carries out ordinary commercial trading activities, sovereign immunity is unlikely to apply. The control test (discussed next) may also be relevant, but is unlikely to be determinative.

In the case of crown immunity, control, rather than function and activities, will be the benchmark for the attribution of crown immunity (i.e. a “control” test). Crucially, whether the crown has control over the entity will depend upon whether the entity is able to exercise independent powers of its own. The control required is therefore of a “ministerial” nature rather than mere ownership giving rise to voting control – the relevant question is whether or not the entity concerned is controlled by, or must act on the direction of, a minister of State or a government department. This approach to control is also likely to apply where control is a factor taken into account in determining whether an entity is entitled to sovereign immunity.

What are the results when these tests are applied to SOEs? Whilst each case must be treated on its own facts, it seems that where an SOE is purely engaged in activities of an ordinary commercial trading nature and is not subject to significant direction by a government minister or department, it will be unlikely to be entitled to immunity, even where it is majority or wholly-owned by a State. On the other hand, where an entity is engaged in activities of a governmental or public nature, potentially under the direction or oversight of a government department, it is much more likely to be entitled to immunity. It therefore appears that many, or even most, SOEs will not be entitled to sovereign or crown immunity in Hong Kong (a question for another day is whether the analysis would be different, at least under the functional test for sovereign immunity, in the case of a sovereign wealth fund, which could be argued to carry out functions of an inherently sovereign or governmental character directed towards public aims).

It would of course be prudent for businesses and their advisors to bear the tests above in mind at the pre-contractual stage when considering transacting with entities which might be entitled to immunity. Should a dispute arise in which one party attempts to invoke sovereign immunity in Hong Kong, however, it will ultimately be the Central People’s Government that has the final say on whether an entity is entitled to immunity. This is because Article 19(3) of Hong Kong’s Basic Law provides that the courts of Hong Kong shall have no jurisdiction in relation to acts of state such as defence and foreign affairs, which includes the decision as to whether or not to recognise an entity as a foreign sovereign. In such cases, the courts must obtain a binding certificate from the Chief Executive of the Hong Kong SAR, who will in turn obtain a certifying document from the CPG before issuing the certificate. There is clearly, therefore, potential for disputes as to the application of sovereign immunity to assume a political dimension.

There is no equivalent procedure in relation to crown immunity, and the decision remains that of the Hong Kong court (although the Court of First Instance in the Intraline case indicated that it would favour a procedure for certification by the CPG). In practice, it is likely that the courts will consider carefully any representations which they receive from the CPG in relation to the status of a PRC entity, albeit they will not be obliged to follow them.

Despite the very understandable concerns of the business community about the impact of absolute sovereign and crown immunity in Hong Kong when contracting with SOEs, the application of the legal tests for immunity should offer comfort that in many cases, immunity will not be applicable (provided, in the case of sovereign immunity, that any rulings by the CPG accord with the legal principles which would be applied by the courts). Obviously, even where an entity will not be entitled to immunity, it cannot be prevented from incurring the trouble and expense of taking the point, and that possibility, as well as the broader risk that immunity might apply, should be priced into the overall risk evaluation at the outset of a transaction.

Justin D’Agostino and Martin Wallace, Herbert Smith