The decision comes as a surprise in the market – not least because consulting firms ordinarily limit liability to cases of gross negligence or wilful misconduct. However, the case will not only have implications for the consulting industry. The unusual publicity it has gained raises questions concerning the conduct of arbitral proceedings generally, namely, what confidentiality obligations there are for the parties to an arbitration. The topic has repeatedly been debated in this blog (see, for example, Ileana Smeureanu’s post on the situation in the Philippines) and in the arbitration community generally. Confidentiality is, in fact, said to be one of the most important advantages of arbitration as a dispute resolution mechanism.

Practical experience such as the Märklin case shows, however, that confidentiality in arbitration is not guaranteed. Notwithstanding the long debate, numerous court decisions and legislative activity, there is still no generally accepted answer to the controversial question of whether an agreement to arbitrate implies an obligation to treat the proceedings and the attendant information as confidential. In England, there is a long line of case law according to which the confidentiality of arbitral proceedings is an implied obligation of the parties to an arbitration agreement (for a recent decision see Emmott v. Michael Wilson & Partners Ltd. [2008] EWCA Civ. 184 at [81] per Collins LJ). A similar position has been adopted by legislators elsewhere (see, for example, section 18(1) of the recent Hong Kong Arbitration Ordinance 2011 which expressly forbids the parties to disclose information relating to the arbitral proceedings).

However, senior English judges have expressed doubts as to the merits of this “confidentiality by default” rule (Associated Electric and Gas Insurance Services Ltd v. European Reinsurance Co of Zurich, [2003] UKPC 11 at [20] per Lord Hobhouse), and the English approach has, in fact, met with little sympathy elsewhere. In other jurisdictions such as Australia, Sweden and the U.S., the courts have refused to recognise an “implied confidentiality obligation”. In France, some court decisions have held that there was such an obligation (Aïta v. Ojjeh, [1986] Revue de l’Arbitrage 583; Bleustein v. Société True North et Société FCB International, [2003] Revue de l’Arbitrage 189). However, the new arbitration law of 2011 now provides specifically that in international arbitration, a duty to treat information confidentially cannot be implied from an arbitration agreement (there is an implied confidentiality for domestic arbitration under art. 1464(4) of the Nouveau Code de Procédure Civile, but under art. 1506, this does not apply in international arbitration). When the ICC prepared the edition of its new 2012 Arbitration Rules, it was decided not to include a general duty of confidentiality. Under the new rules, an arbitral tribunal may make orders to enforce confidentiality obligations (art. 22(3) ICC Rules 2012), but the legal basis for such obligations must be found elsewhere, for example, in an express agreement between the parties.

Several arguments have been put forward in favour of an implied duty of confidentiality: Allegedly, confidentiality is part of the legitimate expectations of the parties to an arbitration agreement. Moreover, it is said that the private conduct of arbitral proceedings would become meaningless if the parties were at liberty to communicate freely about the arbitration. It is also feared that, without a duty of confidentiality, parties may face what is described as “trial by press release” instead of the neutral and objective dispute resolution mechanism that arbitration is expected to provide.

The latest legislative reform in France shows, however, that these arguments are far from compelling. There is little evidence that parties to an arbitration agreement actually expect that this agreement implies a confidentiality obligation. At any rate, against the background of widely diverging approaches of statutory law and case law, it is doubtful whether such expectations are legitimate. In fact, recent research from Queen Mary University suggests that for many users, confidentiality may not be that important after all (2010 International Arbitration Survey: Choices in International Arbitration, p.30). To imply a duty of confidentiality may also conflict with the principle of party autonomy, because it leads to confidentiality by default even where the parties never considered the issue at the time when the arbitration agreement was concluded. Where parties actually wish to secure confidential treatment of the proceedings, they are free to make an express agreement to that effect, and it is universally accepted that courts and arbitral tribunals will enforce such an agreement (subject to few exceptions such as legal provisions requiring the parties to make information public or requiring the public conduct of court proceedings in support of arbitration). In such circumstances, there is no need to imply an obligation of confidentiality.

A specific feature of the Märklin case suggests that there may be another argument against an implied confidentiality obligation: in fact, AlixPartners announced that it will apply to have the partial award set aside. Most recent figures suggest that about 20% of arbitral awards are not being complied with voluntarily and have to be executed. This figure is unsatisfactorily high and shows that in many instances, arbitration fails to provide a resolution of the dispute that is accepted by all parties. One way to improve this situation is to increase the degree of transparency in arbitration. Such transparency may have positive effects on the quality of arbitral awards: it would, in fact, create an additional incentive for arbitrators to conduct the proceedings in a way that stands the test of public debate, and to make persuasive and diligent decisions. In that respect, the recent legislative reform in France has much to commend itself.

At any rate, the debate on confidentiality is far from being settled. The latest trend in case law and legislation is, however, not to imply a duty of confidentiality in an agreement to arbitrate. Against that background, potential litigants will have to determine well in advance what needs they have with regard to confidentiality, and to include appropriate and express agreements in the arbitration clause, or at least in the terms of reference set up at the beginning of the arbitral proceedings. Without express agreements of that sort, confidentiality is certainly not a feature which parties should rely on when choosing arbitration as a dispute resolution mechanism.

In a recent decision issued on 7 November 2011 on a request for annulment of a partial award on jurisdiction rendered by the Court of Arbitration for Sport (“TAS”), the Swiss Supreme Court recalled and applied its previous jurisprudence on the interpretation of pathological arbitration clauses (Case 4A_246/2011).

The case arose out of a contract between a football club and an agent relating to the transfer of a player. The contract contained a dispute resolution clause which provided that “[t]he competent instance in case of a dispute concerning this Agreement is the FIFA Commission, or the UEFA Commission, which will have to decide the dispute that could arise between the club and the agent.” After a dispute arose between the parties, the agent initiated arbitral proceedings before the FIFA Players’ Status Committee, a body tasked with adjudicating disputes arising from transfers of professional football players. However, on the basis of its internal rules, the Committee declined jurisdiction on the grounds that the agent was a legal person and not a natural person. The agent therefore requested the Zurich High Court (Obergericht) to appoint an arbitrator, which it did. However, the sole arbitrator subsequently found that he did not have jurisdiction on the grounds that the parties had agreed to submit disputes to arbitration under the rules of a sports arbitral institution.

Finally, the agent initiated arbitration before the CAS. In a partial award issued on 17 March 2011, the CAS ruled that it had jurisdiction over the dispute. However, the football club appealed to the Swiss Supreme Court pursuant to Article 190(2)(b) of the Swiss Private International Law Act (“PILA”) to annul the partial award on the ground that the CAS had erroneously held that it had jurisdiction, one of only two grounds available to a party to challenge a partial award (Article 190(3) PILA).

The football club first disputed that the Parties had even agreed to exclude the jurisdiction of the State courts. However, the Supreme Court, interpreting the Parties intentions according to the principle of normative consensus (“Vertrauensprinzip”), found that this was not the case (para. 2.3.1). The Court noted that while the dispute resolution provision did not expressly mention arbitration, the use of the terms “competent instance” and “decide the dispute” could be understood in good faith to mean that any disputes would be decided by one of the two football bodies in a binding manner, to the exclusion of the State courts. According to the Court, the provision did not give rise to doubts which would warrant a restrictive interpretation of the Parties’ alleged intention to exclude the jurisdiction of the State courts.

Of greater interest, however, is the manner in which the Court addressed the football club’s arguments that the arbitration clause was defective to the degree that it was impossible to apply, or alternatively that it had been extinguished by the decision of the FIFA Commission not to accept jurisdiction.

The Court began by setting out the approach in Swiss law to pathological provisions in arbitration agreements, which it defined as provisions which are incomplete, unclear, or contradictory (para. 2.2.3). As the Court explained, as long as such provisions do not relate to essential elements of the arbitration agreement, such as the binding submission of disputes to an arbitral tribunal, they will not in and of themselves lead to its invalidity. Rather, Swiss law requires courts and tribunals to look for a solution, either through interpretation or if need be by means of completing the contract, which respects the fundamental will of the parties to submit their dispute to arbitration. In this sense, Swiss law imposes a broad approach to interpretation of pathological arbitration clauses, once the parties’ intention to exclude State courts in favour of arbitration is established.

On this basis, the Court ruled that the fact that neither institution identified in the arbitration clause could have, according to their own rules, decided on a dispute between the parties, did not necessarily entail the nullity of the entire arbitration clause. According to the Court, the CAS had properly sought to determine whether the designation of the institutions was so essential to the arbitration agreement that the parties would not have agreed to submit their disputes to arbitration had they known that those institutions could not assert jurisdiction (para. 2.3.2). It further found that the CAS’s determination that the parties would nevertheless have agreed to submit their disputes to arbitration was not based on abstract considerations but rather on concrete indications arising from the facts of the case. In particular, the CAS considered that the parties’ designation of two alternative football associations in the arbitration clause indicated that they were not attached to one particular institution, and that, above all, they wanted to submit their dispute to an arbitral tribunal which was familiar with issues surrounding transfers of professional football players.

Having established that the institutions designated by the parties did not constitute essential conditions of their arbitration agreement, the Court turned to determining whether submitting the dispute specifically to the CAS was consistent with the Parties’ intentions. In doing so, the Court sought to correct the partial nullity of the arbitration clause, to the extent possible, by means of filling in the missing elements. The test applied by the Court was to ask what the parties would hypothetically have agreed to had they been aware of the defects in their arbitration clause (para. 2.3.3). After a review of the facts, the Court concluded that the parties would have agreed to submit any disputes directly to the CAS. In reaching its decision, the Court was particularly influenced by the fact that, by designating FIFA and UEFA, both of which are based in Switzerland, the parties indicated their intention to submit their disputes to an arbitral tribunal with seat in Switzerland, and that they intended such disputes to be decided by a sports organisation which was familiar with the football transfer market. In this context, the Court took into consideration that decisions of the FIFA Players’ Status Committee on transfers of players could in fact be appealed to the CAS.

In sum, the Supreme Court’s decision in case 4A_246/2011 is a good example of the broad and flexible pro-arbitration approach which has characterised the Court’s jurisprudence on pathological arbitration clauses in cases in which the parties’ intention to arbitrate is established. Despite being faced with an arbitration clause with clear references to two institutions which could not adjudicate the parties’ dispute, the Court did not find the clause to be invalid as a whole, but rather engaged in an exercise of filling in the missing elements in order to ensure that the fundamental intention of the parties to arbitrate their dispute was upheld. It is also noteworthy that in the first step of its analysis, namely establishing the intention of the parties to submit their dispute to arbitration, the Court did not consider the absence of the words “arbitration” , “arbitral tribunal”, “arbitrator”, or similar terms in the dispute resolution clause (which it itself acknowledged in para 2.3.1), to be decisive.

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 tribunal was at pains to emphasize the interim award was final and binding under Article 32 of the UNCITRAL Rules, which means that Chevron could pursue recognition and enforcement of the award in jurisdictions around the world. It could do so offensively by seeking declaratory relief in Ecuador (or elsewhere), or defensively in response to an attempt by the Ecuador plaintiffs to seek enforcement of the Ecuador judgment. Of course, the Interim Award is only binding on Ecuador and Chevron, so it is not clear what a domestic court outside Ecuador would do with an award imposing injunctive relief on Ecuador.

Meanwhile, on Thursday the Second Circuit issued its long-awaited opinion in Chevron v. Naranjo. The Second Circuit’s crucial holding was that New York’s Uniform Foreign Money-Judgments Recognition Act precludes declaratory injunctive relief by a foreign judgment debtor. “There is … no legal basis for the injunction that Chevron seeks, and, on these facts, there will be no such basis until judgment-creditors affirmatively seek to enforce their judgment in a court governed by New York or similar law.”

The Second Circuit had little sympathy for Chevron’s attempt to pursue an antienforcement injunction, particularly given the comity concerns at stake.

“[W]hen a court in one country attempts to preclude the courts of every other nation from ever considering the effect of that foreign judgment, the comity concerns become far greater. In such an instance, the court risks disrespecting the legal system not only of the country in which the judgment was issued, but also those of other countries, who are inherently assumed insufficiently trustworthy to recognize what is asserted to be the extreme incapacity of the legal system from which it emanates. The court presuming to issue such an injunction sets itself up as the definitive international arbiter of the fairness and integrity of the world’s legal systems.”

But at the same time, the Second Circuit emphasized that it expressed “no views on the merits of the parties’ various charges and counter-charges regarding the Ecuadorian legal system and their adversaries’ conduct of this litigation, which may be addressed as relevant in other litigation before the district court or elsewhere.” It also avoided any decision with respect to the underlying RICO claims that Chevron has filed against the Ecuador plaintiffs and their lawyers, focusing simply on the improper procedural device that Chevron sought to employ to enjoin enforcement of the Lago Agrio judgment abroad.

Where does the case go from here? In Ecuador, Chevron has appealed to Ecuador’s highest court to review the case. No word yet as to whether Chevron will seek to have the arbitral tribunal’s Interim Award recognized and enforced in Ecuador. The arbitral tribunal is scheduled to hold hearings on February 11-12 to determine what steps Ecuador is taking to prevent enforcement of the Lago Agrio judgment.

As for the Ecuador plaintiffs’ efforts to enforce the judgment, there is no indication that Chevron will post an appeal bond, which means that the Ecuador plaintiffs are free to pursue enforcement anywhere in the world where Chevron has assets.

It appears that the Ecuador plaintiffs will not seek to have the judgment enforced within the United States. Ecuador Plaintiffs’ lawyer James Tyrrell stated yesterday that “The Ecuadorean plaintiffs are not coming to New York to enforce this judgment.” Given the locus of Chevron’s assets, it is not obvious why the plaintiffs have adopted this strategy, unless they have reason to believe that there is a high probability that the judgment would not be enforced.

There is, of course, the option of pursuing enforcement abroad. If the Invictus Memo is reliable, the Ecuador plaintiffs have identified twenty-seven nations where Chevron has substantial activities, including countries that are friendly with Ecuador, such as Colombia and Venezuela. That memo candidly states the ultimate end game strategy for the Ecuador plaintiffs:

“After approximately seventeen total years of litigation in the United States and Ecuador, the case against Chevron now enters its most critical, multi-faceted, and labor intensive…. With the ultimate goal of effecting and swift and favorable settlement, the strategy of the Plaintiffs’ Team will incorporate the following components: … managing the public relations impact of Chevron’s manipulation of the Cabrera narrative … [and] identifying jurisdictions globally that are most hospitable to an enforcement action.”

PMI contends that the Uruguayan regulations violate several provisions of the Switzerland-Uruguay BIT. Furthermore, PMI is arguing, inter alia, that the intellectual property rights of Abal Hermanos (PMI’s subsidiary in Uruguay) have been infringed as a consequence of the limitations imposed on the right to use its legally protected trademarks.² This is not, however, the only case where this international corporation has launched an arbitration claim against a state as a result of similar plain packaging measures.

In November 2011, Hong Kong-based Philip Morris Asia Limited (PM Asia), which owns Australian affiliate Philip Morris Limited, initiated arbitration proceedings against the Australian government over new legislation on plain packaging of cigarettes. The new Australian law imposes strict limitations on the use of registered trademarks. For instance, it requires cigarettes to be sold in generic olive green packages, without brands or logos. This legislation is expected to come into force in December 2012. ³

As in the claims of PMI against Uruguay, PM Asia is arguing, inter alia, that it has, whether as owner or licensee, rights to use registered and unregistered trademarks. PM Asia claims that the new Australian legislation infringes its intellectual property rights and diminishes the value of its trademarks. Furthermore, it contends there has been a violation of the Australia-Hong Kong BIT. ⁴

At this stage, it is important to distinguish between two different types of trademarks: non-word marks and word marks. Plain packaging of tobacco products involves the prohibition of the use of non-word marks (such as logos, colour schemes and graphics) and the limitation on the use of word marks (brand name).

Several questions arise in relation to these two arbitration claims. One of them is whether these anti-tobacco schemes contravene the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement) and the Paris Convention for the Protection of Industrial Property (Paris Convention). In particular, whether plain packaging infringes the right to use trademarks as well as affects the core function of trademarks.

There are strong arguments to suggest that the plain packaging measures adopted by Uruguay and Australia are consistent with their international obligations under the TRIPS Agreement and the Paris Convention. In this sense, it is important to point out that these measures do not impose limitations on the sale of tobacco products but on the use of trademarks related to such products.

The tobacco corporation claims that plain packaging unfairly limits its rights to use its legally protected trade mark. However, the right to use trademarks is not expressly granted by the TRIPS Agreement and the Paris Convention. Trademark owners only have the exclusive right to prevent third parties from using their trademarks without their consent. This is a negative right relating to the ‘exclusion’ of use rather than to the use per se. ⁵ Neither PMI nor PM Asia are claiming protection from an unlawful use of their trademark by a third party.

It can nonetheless be argued that the registration of a trademark provides an inherent right to use it. In this sense, under the TRIPS Agreement, WTO Members may make registrability depend on use.⁶ This argument could therefore be sustained in cases where the WTO Member in question established that the use of a trademark is a compulsory requirement for obtaining its registration.

In addition, it might be argued that plain packaging prevents consumers from distinguishing PMI´s tobacco products from others competitors, thereby affecting the core function of a trademark. ⁷ A trademark would lose its value if it creates the likelihood of confusion with other trademarks. However, the fact that the brand name can be displayed in the package raises doubts as to the strength of this argument.

The outcome of these cases will certainly set a precedent that could be adopted by future arbitral tribunals and national courts deciding disputes arising out of plain packaging schemes. Furthermore, the decisions adopted by the respective tribunals will have significant repercussions on the investment relationships between PMI and the countries in which it operates.

This ‘anti-tobacco movement’ has just begun. In fact, other countries, such as the United Kingdom, Canada and New Zealand, are considering introducing similar measures in their national laws, which will inevitably lead to an increasing wave of investment claims brought by tobacco companies against states.

There are of course further questions that arise in the context. For example, does plain packaging amount to indirect expropriation? Is it possible to strike a balance between the WTO Members’ obligations under the World Health Organisation Convention on Tobacco Control (WHO FCTC) and the intellectual property rights conferred to investors such as PMI? Does plain packaging amount to an unfair and inequitable treatment under the said BITs? Such questions will be examined in upcoming blogs. For now, we open the floor for discussion and invite the readers to comment on what has been discussed in this blog.

By Martin Hunter and Javier García Olmedo

This controversial power, retained in the UK’s Arbitration Act notwithstanding its absence from most other national legal systems, has often been criticised. Perhaps for this reason, the trend of the English courts in recent years has been increasingly to restrict its application. This latest, fully reasoned, judgment is no exception.

The Claimant, Mary Harvey, was a victim of a road traffic accident, and applied to the Motor Insurer’s Bureau (‘MIB’) for compensation for her injuries. Dissatisfied with the amount of compensation awarded, she served notice on the MIB requiring the matter to be submitted to arbitration. After an oral hearing, the arbitrator concluded that there was no evidence to infer that the driver of the vehicle that struck her was driving negligently, and concluded that the Claimant was not entitled to any compensation. She applied to the court, seeking leave to appeal under section 69 of the UK Arbitration Act on a question of law arising out of the Award.

In his judgment, Judge Hegarty QC reiterated certain features of appeals under section 69. It was clear that its provisions were ‘of a highly restrictive nature’. First, the only type of appeal that the courts can entertain is one involving a question of law arising out of an award, and that question must be one which the tribunal was asked to determine. Second, in the absence of an agreement between the parties, leave of the court is required before an appeal can be pursued, and, unless the question is one of ‘general public importance’, leave can be granted only if the decision is ‘obviously wrong’.

The court dismissed the application on the grounds that in essence this was an appeal on a question of fact, not of law. Citing the judgment of Steyn LJ in Geogas SA v. Trammo Gas Limited (The Baleares) [1993] 1 Ll Rep 215 at 228, the Judge affirmed the principle that any question as to the admissibility, relevance or weight of any evidential material was a matter solely for the arbitrator. The arbitrator’s findings of fact were ‘effectively immune from scrutiny’ by the courts, and this included not only primary facts but also any secondary findings or inferences of a factual nature.

The Judge commented further that: ‘I very much doubt if even a total absence of any evidential basis for a finding of fact can give rise to a question of law for the purposes of section 69’, though ‘it might conceivably amount to a serious irregularity under section 68(2)(a) of the Act’. A question of law might arise if, on the basis of the facts found by the tribunal, the conclusion which it reached was ‘outside the range which could properly have been arrived at by a tribunal which had properly directed itself as to the applicable law’. But it must still be possible to conclude that the error arose from a misapprehension or misapplication of law.

The case also raised questions regarding the application of the maxim res ipsa loquitor in this context, but after a full review the judge concluded that any failure to apply this maxim would not necessarily constitute an error of law, since ‘it simply refers to the way in which factual inferences may be drawn from other factual findings’.

Under English law (and virtually all other national systems) appeals are not possible from arbitral awards on questions of fact, probably even if the parties expressly so agree (Guangzhou Dockyards Co Ltd v. ENE Aegiali 1 [2010] EWHC 2826). Nevertheless, in contrast to the UNCITRAL Model Law and most other national systems, the provisions of the UK Arbitration Act are clear that there may be circumstances in which an appeal on a point of law will be available – the underlying justification focusing on the general public interest in the law being correctly applied. But this case reaffirms the very limited grounds on which an appeal on a point of law may be available. As Judge Hegarty noted, this limited right reflects ‘the increasing recognition accorded to the autonomy of the arbitral process’.

Of course, section 69 is a non-mandatory provision: in contrast to rights to challenge awards under sections 67 (lack of jurisdiction) and 68 (serious irregularity), the parties can, by agreement, opt out of it. This requires clear language, however (see, for example, Shell Egypt West Manzala GmbH v. Dana Gas Egypt Ltd [2009] EWHC 2097 (Comm)). An opt-out is also achieved where parties elect to apply institutional rules such as those of the ICC or the LCIA, whose articles 34(6) and 26.9 respectively provide for a waiver of a right to any form of recourse regarding the award, insofar as such waiver can validly be made.

As mentioned, there are few other legal systems where a right to appeal on a point of law exists, and it seems their number is diminishing. There is no express right under the US Federal Arbitration Act (‘FAA’) to appeal an arbitral award on a point of law. US courts have found in the past that awards could be set aside where there has been a ‘manifest disregard of the law’ (following the dictum in Wilko v. Swan 346 US 427 (1953)). But recent cases suggest that this may no longer be the correct position, and Awards may only be challenged on the basis of the specific categories set out in the FAA (Hall Street Associates, LLC v. Mattel, Inc 522 US 576 (2008), followed in Medicine Shoppe International, Inc v. Turner Investments, Inc  614 F3d 485 (8th Cir. 2010)). Under English law, the right to appeal on a point of law is enshrined in statute, but the circumstances in which it can be invoked are applied by the courts only on a very restrictive basis.

Much to the surprise of many seasoned international arbitration practitioners, the D.C. Circuit vacated a US$ 185.3 million Final Award against Argentina, essentially nullifying a hard-fought, four-and-a-half year arbitration between the parties. The court vacated the Award on the basis that the “arbitral panel rendered a decision . . . without regard to the contracting parties’ agreement establishing a precondition to arbitration,” namely the clause in the Argentina-UK bilateral investment treaty (BIT) requiring claimants to submit disputes to the Argentine courts for 18 months before resorting to arbitration. In the underlying UNCITRAL arbitration, the tribunal had considered whether the dispute was admissible without having been first submitted to the Argentine courts. It ruled that such submission was not essential because it in this case it would have been an exercise in futility: the claimant could not have obtained relief anyway from the Argentine courts, given the Republic’s apparent interference with access to the courts and its punishment of all would-be local court litigants by excluding them from contract renegotiations. The tribunal concluded that in these circumstances, the 18-month provision could not “be construed as an absolute impediment to arbitration,” and therefore deemed BG Group’s arbitration claims admissible.

By contrast, the D.C. Circuit concluded that this entire analysis was misplaced, since in its view the BIT terms—which it analyzed principally by reference to U.S. domestic law on contractual intent to arbitrate, rather than under the Vienna Convention—were clearly designed to require prior recourse to the Argentine courts. The court found that the tribunal had exceeded its powers by permitting direct access to arbitration contrary to that expressed intent. Indeed, the court suggested that under U.S. case law, the tribunal should not have even engaged in an analysis of the feasibility or usefulness of prior resort to the Argentine courts, because as a threshold matter it had no proper authority under the BIT to admit such issues for substantive consideration.

In the most narrow sense, the D.C. Circuit’s decision did not directly repudiate the years of fairly consistent rulings by ICSID and UNCITRAL tribunals with respect to the 18-month local court requirement under similar Argentine BITs. That is because the BG Group tribunal had not relied on the BIT’s most-favored-nation (MFN) clause, upon which prior tribunals had rested their decisions, even though BG Group did argue that point. Nonetheless, the D.C. Circuit’s analysis implicitly suggests that it also might have overturned an MFN-based decision, since by the Court’s logic, the tribunals who rendered those decisions likewise would have had no authority to bypass the BIT parties’ allegedly clear intent to require local court proceedings in all circumstances. If the decision is read in this broader way, it can be seen as impugning the core logic of many prior decisions. This would include Maffezini v. Spain (ICSID Case No. ARB/97/7, 1 September 2000), where the tribunal allowed an Argentine investor to invoke (by way of an MFN clause) the Chile-Spain BIT to avoid the domestic court prerequisite in the Argentina-Spain BIT; Siemens v. Argentina (ICSID Case No. ARB/028, Decision on Jurisdiction, 3 August 2004), where the tribunal permitted a German investor to invoke the Argentina-Chile BIT to proceed directly to arbitration; National Grid plc v. Argentina (UNCITRAL, Decision on Jurisdiction, 20 June 2006), where the tribunal permitted a British investor to invoke a more favorable term in the Argentina-US BIT to avoid 18 months of litigation in the Argentine courts; and several other cases in the same line. Until the D.C. Circuit’s opinion, the jurisprudence appeared to be converging on consensus regarding the 18-month waiting requirement, even though much controversy remained about the broader application of MFN clauses in other, less procedural, contexts.

Now, with one 17-page decision, a national court not only has completely up-ended the result in one major case, but also in the process unsettled what most observers had thought to be a progression towards certainty, predictability and finality with respect to this issue. Much can—and undoubtedly will— be written about the substance of the court’s analysis. But at heart, it serves as a reminder that some degree of uncertainty is inherent in international arbitration in any forum, so long as there is any mechanism for review and challenge of arbitral awards. This is just as true for the “alternative” routes of ad hoc UNCITRAL or non-ICSID institutional arbitration as it is for ICSID arbitration, since all non-ICSID mechanisms allow for national court challenges under the New York Convention, and national courts (once vested of the matter) may be tempted to apply their own national laws, including on core issues such as arbitrability. Arguably, the uncertainty of national court review may be even greater than that of ICSID annulment review, since most national court judges are comparatively unfamiliar with investment treaty jurisprudence and may be less concerned about contributing to the growth of consensus or emerging doctrine. The choice between the two systems, thus, should not be framed as a quest for predictability and finality, but rather as something more fundamental: a decision about which decision-makers will evaluate challenges, and what rules and standard of review they will use in deciding.

By Jean E. Kalicki and Dawn Yamane Hewett

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?

In my previous article, I noted that a business is only worth what someone is prepared to pay for it. Under the market-approach to valuation, Company A’s worth may be informed at least in part by recent transactions in Company A itself and/ or businesses sufficiently comparable to Company A. The ability to apply usefully the market-approach ultimately depends on the availability of relevant and timely transaction data.

Whilst the market-approach provides a useful insight as to what price was paid for any given asset or business, it may be of less help if one wishes to know how the purchase price of a business was determined. Understanding the underlying value of a business, and the drivers of that value, is often central to the quantification of damages in international arbitration.

Although the purchase price of an asset can be determined by many factors, the underlying value of an asset is based on the future economic benefits that accrue to its owner. This notion is at the heart of the income-based approach to valuation. Within the overall income-based approach, one needs to distinguish between earnings methods and cash flow methods.

Earnings are analogous to the accounting profits that are generated by a company, and attributable to the ordinary shareholders. Since a company’s earnings can be heavily influenced by the specific accounting policies it adopts and applies, comparisons of earnings across different companies can sometimes be difficult. For this reason, valuers often choose to focus on a business’s actual cash flows as this avoids the distorting impact of accounting. On the other hand, where one does not have sufficient detail about the accounting treatments used, it may be easier to focus on earnings. There are a number of different valuation methodologies focusing on either cash flows or earning methods, a few of which are described very briefly in the footnote to this article.

Introduction to DCF

DCF continues to generate much discussion within the arbitration community; certainly, it is being used ever more frequently in support of claims, if anecdotal and personal experience is any guide. In my experience, however, DCF is not always properly understood by non-valuation professional and/ or is on occasions applied incorrectly. I do wonder if this explains, at least in part, why certain arbitrators are sometimes wary of making awards in respect of claims that are based on DCF valuations.

Although the basic principles may appear simple, great care needs to be taken when constructing a DCF model to avoid nullifying its value to the arbitral process. The output of a DCF model is a single number, representing the net present value (NPV) of a project’s or business’s projected future cash flows, discounted to take into account the time value of money and the uncertainty – both upside as well as downside – over the projected future earnings. Crucially, DCF focuses on cash movements rather than accounting profits. When DCF is applied correctly, the calculated NPV can approximate to the fair market value (FMV) of a project or business since it reflects the present value of the future cash flows and hence determines a price at which a well-informed and willing vendor and purchaser could transact.

The quality and relevance of the output from a DCF model depends on the quality of the inputs e.g. the reasonableness of the growth assumptions and the discount rate. As we shall see below, far from being a purely ‘mechanical’ exercise, the derivation of a business’s value under DCF requires considerable skill and judgement.

Overview of a DCF model

In order to prepare a DCF valuation, one needs to determine inter alia the following:

• The relevant time-period – a cash flow model will comprise firstly an explicit forecast period, e.g. the first 5-10 years. An explicit forecast period may seek to capture the initial growth of a company until net cash flows stabilise. For example, the net cash flows of a start-up business might grow by 200% in the first year, 100% in the second year, 50% in the third, and decline each year until stabilising at say 3% per year after year 10. Where the duration of a project is fixed (e.g. a non-renewable 20 year concession over a mine), one would normally expect to see an explicit forecast period only. Where a project has an indefinite life, a terminal growth calculation is usually added to value the cash flows from the end of the explicit forecast period to perpetuity.
• The future cash flows themselves – central to producing a robust DCF model is the ability to produce reasonable forecasts of future cash flows. The model should include, in cash terms, all revenues, direct and indirect costs, capital expenditure, working capital movements etc. Since we are only interested in cash, it will not include non-cash (accounting) items like depreciation and amortisation.
• What is being valued – Defining what precisely is being valued is key; for example, valuers distinguish between the enterprise value of a business (being the value to both debt holders and shareholders) and the equity value (the value to equity holders only). The precise DCF approach used will depend on what is being valued.
• The discount rate – discussed below

Determining the discount rate

As noted above, the projected cash flows need to be adjusted to reflect both the time value of money (€100 today is worth more than the right to €100 for certain in a year’s time) and the uncertainty of the future cash flows; the greater the relevant uncertainty over the projected earnings, the greater the discount rate needed. Another way of looking at this is to say that the discount rate reflects the expected or required return from investors; the greater the risks to which the investor is exposed, the higher the return required.

The calculation of the discount rate will depend on what is being valued; for example, if we are interested in the enterprise value of a business, the discount rate will typically be based on the weighted average of the returns required by debt holders (cost of debt) (after taking into account the tax benefits of debt finance) and equity holders (cost of equity); this is referred to as the after-tax weighted average cost of capital.

The usual starting point in calculating both the cost of debt and the cost of equity is the use of a so-called risk-free rate of return, being the yield on a ‘risk-free’ asset such as a long-term US government bond. [NB: In some contexts it is important to consider the risks in fact associated with an investment in US government debt]

Dealing firstly with the cost of debt, in general, since they are paid ahead of shareholders, and hence are exposed to less risk, debt holders require lower returns than equity holders. In addition to the risk-free rate, a premium will typically be added to take into account the additional risk of lending to a company rather than a government; this premium will be determined by factors such as existing indebtedness, the size of the business, ability to cover interest payments from profits etc.

Whereas the calculation of the cost of debt is relatively straightforward, the calculation of the cost of equity can include many risk premia. A common method of calculating the cost of equity is known as the capital asset pricing model (CAPM). In very general terms, one builds up the cost of equity by taking account of several risk premia including:

• the equity risk premium (the additional return required by holders of stocks over bonds) multiplied by beta (a measure of the sensitivity of a given stock to the overall market);
• a country risk premium (CRP) – The assessment of a suitable discount rate for an investment in a developing market or emerging economy (e.g. countries in the former soviet union) requires the investor to consider risks in addition to those related to investments in more mature, developed economies (such as the United States or Germany). The exercise is one of assessing a risk premium over the return required on investments in more mature, stable economies; and
• a small company risk or ‘size’ premium – whilst this is debatable, some valuers add an additional premium for small companies to reflect the perceived additional risks when compared with larger, more established companies

This is a complicated area, and a detailed treatment is beyond the scope of this article, but it suffices to say that selecting an appropriate discount rate is an art rather than a science. A major part of the quantum expert’s role is to demonstrate to the arbitral tribunal, in as clear and transparent a fashion as possible, that he has considered all relevant issues and has been reasonable in the calculation of the discount rate.

Strengths and weaknesses of the DCF approach

A major attraction of the DCF approach is its inherent flexibility in that it can be applied in many different contexts; it is a commonly accepted basis for assessing the present value of a project, company or asset and can also be used to appraise investment decisions. Importantly, DCF is company or project-specific. Finally, DCF expresses future cash flows in present day terms.

On the other hand, like all valuation methods, a DCF model is only ever as good as the data used and the underlying assumptions. On occasions, it may simply not be possible to make a reasonable estimate of projected future cash flows e.g. because there is insufficient contemporary and/ or historic data; were one to plough on regardless, the output from the DCF model is unlikely to be anything other than pure speculation. In such circumstances, it may be more appropriate to use different valuation methodologies. In any event, the DCF methodology is not the only approach and, as explained in part 1 of this series, best practice requires that a valuation produced under one approach is cross-checked against valuation(s) produced under (a) different approach(es). I discussed approaches to dealing with uncertainty in an earlier article which can be accessed here.

Common mistakes made with DCF

As noted above, it is this writer’s experience that DCF is sometimes applied incorrectly, rendering the results of a model useless at best and, at worst, dangerously misleading. Whilst the below is not intended to be an exhaustive list, here are some of the more common errors to watch out for:

• Overlooking capital expenditure – a DCF valuation which assumes steady growth in annual cash flows should also take into account the capital expenditure required to generate that growth. The re-investment of cash in the business is something which can easily be overlooked, resulting in unrealistically high valuations where capital expenditure is ignored. Where a DCF model includes a terminal period, it is critical that the final year of the explicit period reflects the likely annual capital expenditure going forward
• Overly-aggressive terminal growth assumptions – for the purposes of determining the terminal value component of the DCF valuation, the assumed long-term rate of growth should not exceed the sum of inflation and real GDP growth at the most.
• Double-counting of risk – the uncertainty of future cash flows can be taken into account either by directly adjusting the cash flows in the model or through the discount rate. Normally, one should not make adjustments to both as this would constitute double-counting of the risk
• Explicit period too long – uncertainty increases over time. For this reason, the explicit period should not be excessive.
• Scenarios / sensitivity analysis – best practice requires that the use of sensitivity analysis and/ or considering various scenarios (best case, worst case, base case) showing how the valuation changes as adjustments are made to the various inputs. It is not uncommon for small changes (e.g. to the assumed growth rate) to have a major impact on the valuation. Alas, best practice is not always followed, with the result that some valuations are not accompanied by sensitivity analysis.
• Mathematical errors – as a general rule, the risk that a DCF model will contain formulaic errors, errors in referencing data etc increases in direct proportion to the complexity of the model and the number of assumptions.

Impact of the financial crisis on the application of the DCF approach

Having provided above a very high-level overview of the DCF approach, I will consider briefly what implications the financial crisis has for the use of DCF valuations in international arbitration.
In some ways, the financial crisis has arguably changed nothing at all; as a mere methodology for quantifying damages, DCF remains as applicable as it was prior to autumn 2008. The financial crisis has, however, made the application of DCF, including the calculation of an appropriate discount rate, a far more challenging exercise than it was previously, for reasons I touch upon below.

Dealing firstly with factors impacting on the estimation of future cash flows, it cannot be forgotten that the current global economic climate is characterized by tremendous volatility and uncertainty. In constructing a DCF model, the valuer needs to undertake rigorous analysis to ensure that projections of revenue growth and profitability can be justified. The now common sight of major financial institutions and other businesses with household names going insolvent demonstrates clearly we are living in a time of unprecedented change. The valuer must try to make sense of this volatility and make sensible predictions of future cash flows. This is not the same as saying, however, that such projections need always be excessively conservative. Just as the word ‘crisis’ in Chinese is translated by two symbols representing respectively ‘danger’ and ‘opportunity’, so might the DCF model take into account the reality that some businesses (particularly those well-financed and with excess cash) stand to gain from others’ demise due to reduced competition, availability of key assets at fire-sell price etc.

The financial crisis has a number of potential impacts on the calculation of the discount rate. Firstly, the sovereign debt crisis and the well-publicized downgrading of US debt has called into question whether there exists a truly risk-free rate. Until recent events, bonds issued by the United States and other stable countries were widely considered the best proxy for the risk-free rate – a key component of the cost of capital – and, in many experts’ eyes, still are. With the threat of outright default in some countries and/ or destruction of the currency through monetary inflation in others, the idea of a risk-free rate can seem quaint! If the risk-free rate is not to be derived from US bond yields, however, what possible alternatives are there?

Two further factors to be considered in the calculation of the discount rate include the market-risk premium and the beta (explained above). Given high volatility, the observed premium of required equity returns over government bond yields can fluctuate significantly over short amounts of time. In a similar way, the beta of a given company in a given industry can also vary a great deal; it may be the case for example, that Company A had a beta of 1.5 on 1 January 2011 but that this subsequently increased to say 2.0 by the summer of 2012. It goes without saying that such changes are by their nature difficult to predict and yet this is precisely what the valuer is required to do.

Conclusion

In my experience, there are few circumstances in which a DCF method, properly applied, cannot be usefully adopted. On occasion, however, applying a DCF method properly can be both costly and difficult. Where such difficulties arise, if the same degree of relevance and reliability is required from the result, the issues giving rise to the difficulty and cost do not ‘go away’ simply by selecting a different method; on occasions where there is not an observable market price, all valuation methods (properly applied) – in one way or another – require one nonetheless to form a view about possible future outcomes and the uncertainty surrounding those outcomes.

Notes
Cash flow methods include Discounted Cash Flows or “DCF” (the focus on this article), and Capitalised Cash Flows, which derive a value for a company based on the company’s historical cash flows.

Earnings methods include Capitalised Earnings and Discounted future earnings. Whilst a detailed discussion of these methods is outside the scope of this article, under the capitalised earnings method, a company’s valuation is derived by dividing the expected annual maintainable earnings of the company (often based on an average of historical earnings) by the required earnings yield. This method is typically used where future earnings growth is expected to be minimal. If future earnings growth is expected to be high, the discounted future earnings method may be more appropriate. This method aims to calculate the present value of the expected future earnings of a business by using an appropriate discount rate.

A further methodology in the income-approach is the Discounted Dividends Model (DDM). Under the DDM, the value of an investor’s shares is based on the present value of the likely current and future dividends earned from those shares. DDM is typically used in the case of minority shareholdings and/ or where the relevant shareholder exercises little control.

©FTI Consulting, Inc., 2012. All rights reserved.
The views expressed in the article are held by the author and are not necessarily representative of FTI Consulting, Inc, or its other professionals. 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

With the increase in investment law jurisprudence in recent years, we’ve become accustomed to seeing international judges sit on the same investment arbitration panels as commercial arbitrators with their own private practices. In any given arbitration, international judges serving as arbitrators are subject to the same challenge standards as their commercial arbitration peers. And they are not necessarily more immune to accusations of appointing-party bias than their commercial-world co-arbitrators.

But are there times when an international judge, sitting as an ad hoc arbitrator, should be nonetheless judged by the ethics applicable to international judges? On the wide spectrum of international dispute settlement — from private-to-private commercial arbitrations, to private-state disputes in investment arbitration, to state-to-state arbitrations, and finally, to state-to-state permanent tribunals — is there a point at which an arbitrator’s independence and impartiality standards have more in common with those of an international judge than to those of a commercial arbitrator? And if that tipping point isn’t to be found in hybrid public-private disputes like investor-state arbitrations, where is it to be found?

An arbitrator challenge decision released this month by the Permanent Court of Arbitration in the United Nations Convention on the Law of the Sea (“UNCLOS”) case between Mauritius and the United Kingdom gives one answer: the tipping point occurs with state-to-state arbitrations.

The decision concerns Mauritius’ challenge of the UK-appointed arbitrator, Sir Christopher Greenwood. Sir Greenwood currently sits as a Member of the International Court of Justice. Prior to his election to the Court, he served as a professor and a barrister, in the course of which he represented and advised both the UK and foreign governments. In the challenge decision, the remaining four members of the Tribunal, including Mauritius’ party-appointed arbitrator and three arbitrators appointed by the President of the International Tribunal for the Law of the Sea, addressed whether Judge Greenwood’s relationship to the UK Government should result in his disqualification from the dispute.

Mauritius did not argue that Judge Greenwood had advised the UK on the specific dispute before the tribunal (concerning a UK regulation regarding the Chagos Archipelago). Rather, it asserted that he has a “long-standing” and “close” working relationship with the UK Government. Mauritius was particularly concerned by the Judge’s participation in 2011 as a member of a Board to appoint the post of Legal Advisor to the British Foreign and Commonwealth Office (“FCO”). (The Legal Advisor has overall responsibility for the work of the FCO legal advisors, including their work on the Mauritius v. United Kingdom dispute.)

While Mauritius didn’t allege that Judge Greenwood was actually biased, it asserted that in light of his close relationship with the UK and his recent role in the FCO appointment, his participation on the tribunal permitted the appearance of bias or lack of independence. Mauritius argued, drawing on case law under the UNCITRAL Rules, the LCIA, ICSID, and the IBA Guidelines on Conflicts of Interest in International Arbitration, that an “appearance of bias” standard should apply to Judge Greenwood. According to Mauritius, the “appearance of bias” standard is “applicable to all arbitrations” and “there is no justification in law or policy for a different or lower standard of arbitral ethics in inter-State arbitrations, especially where the tribunal must resolve disputes that involve issues of national importance and great public interest.”

The United Kingdom, in contrast, argued the following:

Under the law and practice of these forums, “close past relationship” has never been a ground for challenging an arbitrator. In fact, according to the United Kingdom, “the law and practice applicable in inter-State arbitrations fully supports the election of judges with a close professional relationship to their own State, as shown by the record of most serving and previous ICJ and ITLOS judges, and the limited basis on which they are disqualified from sitting in particular cases.”

According to the UK, the law and practice of arbitrator challenges in international commercial and investment protection arbitrations are irrelevant. Those disputes involve “repeat arbitral appointments, whether by the same party or by the same law firm; potential for influence where arbitrators may be perceived as worrying about where their next appointment will come; [and] cross-overs, where individuals repeatedly switch between the roles of counsel and arbitrator”—in other words, a situation that the UK sees as different from Judge Greenwood’s appointment and role in the present state-to-state arbitration.

The Tribunal sided with the United Kingdom. In determining the applicable challenge standard for Judge Greenwood, the Tribunal first determined that all members composing an arbitral tribunal under Annex VII of the UNCLOS are required to maintain the highest reputation for “fairness, competence and integrity.” The Tribunal then drew on the law and practice of the International Court of Justice and the International Tribunal for the Law of the Sea. The Tribunal noted in particular the following provisions of the Statute of the International Court of Justice:

Article 16 requires that “no member of the Court may exercise any political or administrative function, or engage in any other occupation of a professional nature.” (The Tribunal noted, however, that Article 16 applies to judges only after their election to the Court, and does not disqualify those who exercised such functions before their election.)

Article 17 provides that (1) “No member of the Court may act as agent, counsel, or advocate in any case,” and that (2) “No Member of the Court may participate in the decision in any case in which he has previously taken part as agent, counsel, or advocate for one of the parties, or as a member of a national or international court, or of a commission of enquiry, or in any other capacity.”

The Tribunal rejected Mauritius’ reliance on the “appearance of bias” standard and the IBA Guidelines. It explained:

The Tribunal recalls that the system of inter-State dispute settlement is based upon the consent of the Parties, and more specifically upon the rules of public international law, the sources of which are set out in Article 38(1) of the Statute of the ICJ. In the Tribunal’s view, Mauritius has not demonstrated that the rules adopted by non-governmental institutions such as the IBA have been expressly adopted by States, nor do they form part of a general practice accepted as law, nor fall within any other of the sources of international law enumerated in Article 38(1) of the Statute of the ICJ.

The Tribunal stressed that Article 287(1) of the UNCLOS permits States the option alternatively to submit their case to ITLOS, the ICJ, or arbitration under Annex VII, and that these three options comprise the States’ consent to dispute settlement under the UNCLOS. The Tribunal considered that that the States parties could not have intended to apply different conditions of independence and impartiality to an Annex VII arbitration than to a dispute adjudicated by the ICJ or ITLOS.

The Tribunal’s decision is unlikely to prove controversial. Nonetheless, it’s worth asking whether the distinctions we tend to draw between arbitrators and judges — including the incentives that may affect their behavior and the ethics that should apply to them — are obsolete in the context of state-to-state disputes.

Certainly, some technical distinctions remain between international judges and appointed ad hoc arbitrators adjudicating state-to-state disputes. Unlike an ad hoc arbitrator, the Members of the ICJ are elected by the UN General Assembly to serve 9-year terms at the Court. They generally sit on all cases, unless they have been recused or unless a smaller Chamber of the Court has been constituted for a specific case. As such, ICJ Members receive their caseload (and their pay) from the Court, rather than from the State parties appearing before them.

The Tribunal in Mauritius v. United Kingdom did not address these distinctions. It’s tempting, nonetheless, to speculate as to why this distinction may not matter. Is it, as the UK suggests, that state-to-state arbitration occurs relatively infrequently, and that arbitrators are therefore less likely to focus their careers and income streams around securing future state-to-state arbitration appointments than other kinds of arbitration? Or is it that the arbitrators appointed to state-to-state disputes are more likely to come from a tiny pool of candidates, most of whom are public international lawyers and judges, who might all be disqualified if more stringent challenge standards were applied? Or is it something even more intangible? Is it that there is inherently a diplomatic culture or sensitivity that pervades inter-State disputes and sets them apart from other forms of arbitration? (See, e.g., the “Notes to the Text” of the PCA Optional Rules for Arbitrating Disputes Between Two States state that they are based on the UNCITRAL Arbitration Rules, with certain modifications, including, inter alia, modifications “to reflect the public international law character of disputes between States, and diplomatic practice appropriate to such disputes.”)

I’m inclined to think it’s a combination of all of the above. I’d welcome readers’ thoughts on the subject.