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Article: September 2014 International Arbitration Update

September 01, 2014
Business Litigation Reports

Avoiding Litigation in the Host State’s Courts in Investor-State Disputes After the Urbaser and Teinver Decisions. Previously, foreign investors whose investments have been damaged by governmental measures of the host country, such as changing tax or currency laws, other regulatory changes or forced liquidation, were required by some bilateral investment treaties (“BITs”) to pursue court litigation in the host country before they could bring investment treaty arbitrations. To get around this requirement, foreign investors relied on the “Most Favored Nation” (“MFN”) clause of BITs to argue that they need not observe the rule requiring them to pursue domestic court litigation first because other BITs did not contain that requirement. However, while some tribunals accepted the MFN workaround, other tribunals rejected it. Now, as a result of two recent ICSID decisions—Urbaser S.A. and Consorcio de Aguas Bilbao Bizkaia Ur Partzuergoa v. Argentine Republic (“Urbaser”), ICSID Case No. ARB 07/26, Decision on Jurisdiction (19 December 2012) and Teinver S.A., Transportes de Cercanias S.A. and Autobuses Urbanos del Sur S.A. v. Argentine Republic (“Teinver”), ICSID Case No. ARB/09/1, Decision on Jurisdiction (21 December 2012)—foreign investors may have another workaround to the domestic litigation requirement that avoids the MFN controversy.

At issue in both Urbaser and Teinver was whether a foreign investor was required to pursue domestic litigation before the foreign investor could file a request for international arbitration under the Argentina-Spain BIT. Article X(3) of the Argentina-Spain BIT states that a “dispute may be submitted to an international arbitral tribunal…when no decision has been reached on the substance 18 months after the judicial proceeding” in the host state began (“domestic litigation requirement”). By its plain meaning, Article X(3) requires a foreign investor to submit to the local courts of the host state for at least a period of 18 months before the foreign investor may pursue international arbitration.

Foreign investors have tried to get around the domestic litigation requirement by relying on the MFN clause in the Argentina-Spain BIT. The MFN clause states: “[i]n all matters governed by this Agreement, such treatment shall be no less favorable than that accorded by each Party to investments made in its territory by investors of a third country.” Prior to Urbaser and Teinver, the five tribunals asked to decide, under the Argentina-Spain BIT, whether a foreign investor must submit its dispute to the local courts of the host state for a period of 18 months before pursuing arbitration concluded that a foreign investor did not by relying on the MFN clause to bypass the domestic litigation requirement. See Emilio Agustín Maffezini v. Spain, ICSID Case No. ARB/97/7, Decision of the Tribunal on Objections to Jurisdiction (25 January 2000); Gas Natural SDG, S.A. v. Argentine Republic, ICSID Case No. ARB/03/10, Decision on Jurisdiction (17 June 2005); Suez, Sociedad General de Aguas de Barcelona S.A., and InterAguas Servicios Integrales del Agua S.A. v. Argentine Republic, ICSID Case No. ARB/03/17, Decision on Jurisdiction (16 May 2006); Suez, Sociedad General de Aguas de Barcelona S.A., and Vivendi Universal S.A. v. Argentine Republic, ICSID Case No. ARB/03/19, Decision on Jurisdiction (3 August 2006); and Telefónica S.A. v. Argentine Republic, ICSID Case No. ARB/03/20, Decision of the Tribunal on Objections to Jurisdiction (25 May 2006).

Nonetheless, the international community remains divided on this issue as some tribunals have rejected the MFN argument and refused to set aside the domestic litigation requirement. Even concerning BITs with similar wording, tribunals have reached different results. In Vladimir Berschader and Moise Berschader v. The Russian Federation, the Belgium/Luxembourg-Soviet Union BIT was at issue, which contained “all matters” language similar to the Argentina-Spain BIT. SCC Case No. 080/2004, Award (21 April 2006). However, the Berschader tribunal found that the “all matters covered by the present treaty” cannot be interpreted “literally” because the MFN clause could not be applied to several of the matters covered by the BIT.

Now, however, Urbaser and Teinver may provide another workaround that avoids the MFN controversy.

In Urbaser, the claimants were the holder of a concession for the provision of drinking water supply and sewage services in Argentina. The claimants submitted a request for arbitration alleging that the impact of the emergency legislation enacted during Argentina’s economic and financial crisis violated the Argentina-Spain BIT. The tribunal side-stepped the question of whether the MFN clause applies to the jurisdictional provisions of the Argentina-Spain BIT by shifting the analysis to whether the domestic litigation requirement was inapplicable because the local courts of Argentina were unlikely to be able to issue a decision on the merits within the applicable time limit. The Urbaser tribunal reasoned that a host state cannot insist on an investor resorting to domestic courts if the host state is not able to offer courts capable of handling such disputes that may reasonably contemplate an adjudication on the substance of the dispute within 18 months. Accordingly, the claimants were permitted to proceed with arbitration.

In Teinver, the claimants alleged that the government of Argentina violated the Argentina-Spain BIT by unlawfully re-nationalizing and taking other measures regarding the claimants’ investments in two Argentine airlines. In Teinver, proceedings had been instituted in the local courts of Argentina before the claimants filed for arbitration. Like Urbaser, the Teinver tribunal did not base its decision on the MFN controversy. The tribunal reasoned that “18 months have subsequently passed, and the local suit remains pending. As such, the core objective of this requirement, to give local courts the opportunity to consider the disputed measures, has been met.” Accordingly, the claimants survived the respondents’ jurisdictional objections.

Because the Urbaser and Teinver tribunals’ approaches to the domestic litigation requirement could influence future tribunals, investors considering bringing investor state arbitrations should examine whether the host state’s courts could reasonably resolve their disputes within the time frame that BITs may require for pursuing domestic litigation before deciding whether or not they actually need to incur the time and expense of litigation. Host states should be aware that if their courts are unable to address the claims of foreign investors within the time frames prescribed in the domestic litigation provisions of BITs, investors may be able to circumvent the domestic litigation requirement and proceed directly to investor-state arbitration.

Arbitration Award Set Aside—Carr v. Gallaway Cook Allan [2014] NZSC 75. The cornerstone of arbitration is the parties’ agreement to confer jurisdiction upon an arbitral tribunal. Trouble can arise, however, where this agreement is based on incorrect assumptions as to available procedural rights. A recent New Zealand decision held that a specific agreement to arbitrate, which was conditional on procedural rights that were in fact unavailable as a matter of law, was invalid. The decision demonstrates the serious consequences which may result from a defective agreement to arbitrate: despite both parties having agreed to the arbitration clause, and having conducted the arbitration without complaint, the New Zealand Supreme Court exercised its discretion to set aside the resulting arbitral award. The decision is a lesson in the importance of considering domestic arbitration statutes when drafting arbitration agreements. It also highlights an issue worth re-checking whenever an adverse arbitral award is delivered.

In Carr v. Gallaway Cook Allan [2014] NZSC 75, a decision of New Zealand’s Supreme Court (its highest court of appeal), Mr. Carr sued his former law firm, Gallaway Cook Allan, alleging that its negligence had caused a property transaction to fail. Mr. Carr and the firm agreed to submit the dispute to arbitration, pursuant to an arbitration agreement that gave the parties the right to appeal on “questions of law and fact.” It is not clear from the judgment whether this was a specifically-negotiated agreement or a standard form. Both parties participated fully in the arbitration, and following a hearing, the arbitrator rendered a partial award in favor of the firm.

Mr. Carr sought to appeal the arbitral award to a domestic court on questions of fact. Only then, however, did the parties learn that the New Zealand Arbitration Act 1996 (the Act) restricts judicial review of arbitral awards to questions of law.

Armed with the knowledge that he had agreed to an arbitration on the assumption of unavailable appeal rights, Mr. Carr changed tack, contending that the award should be set aside because the parties’ agreement was invalid. This argument found favor at first instance, but was overturned by the intermediate appellate court. That court adopted a “pro enforcement” interpretation of the Act, finding that that the words “and fact” could be severed from the arbitration agreement.

Mr. Carr appealed to New Zealand’s highest court, which by a 4:1 majority held that the agreement to arbitrate was invalid, and then exercised its discretion to set aside the arbitral award. The majority interpreted the right to appeal on questions of fact as being fundamental to the arbitration agreement. As such, the fact that this appeal right was not permitted by law meant that the intention to arbitrate was vitiated.

On the question of whether the unavailable appeal right could be severed from the arbitration agreement, the majority considered three United States decisions, Kyocera Corp v. Prudential-Bache Trade Services, Inc 341 F 3d 987 (9th Cir 2003); Hall Street Associates, LLC v. Mattel, Inc., 113 Fed Appx 272 (9th Cir 2004) and Hall Street Associates, LLC v. Mattel, Inc 552 US 576 (2008). The majority noted that these decisions indicate that United States federal law does not permit parties to expand the review of arbitral awards beyond the grounds provided by statute. In those decisions, the expanded review rights were severed from the agreement. However, the majority held that the decisions do not establish any principle requiring severance, but instead are merely examples of where severance was appropriate. In this case, because the right to appeal was fundamental, its severance would have impermissibly changed the substance of what had been agreed. The majority went on to hold that the invalidity of the arbitration agreement was such a fundamental defect that it was proper for the award to be set aside. In dissent, Justice Arnold focused on the proper construction of the court’s power under the Act to set aside an award, and held that that power should not be exercised.

This decision serves as another reminder of the importance of careful drafting in arbitration agreements. Often the focus in drafting is on capturing the parties’ intention and providing a clear procedure for the invoking of arbitration. This decision shows that, even where the parties are agreed on a matter and such matter is clearly captured in the document, factors such as domestic law, and specifically statutory arbitration frameworks, may render the agreement to arbitrate void. Clearly, these factors are worth re-checking any time an adverse arbitral award is delivered. The outcome of the decision reaffirms the parties’ agreement as the foundation of arbitration, illustrating that a defect therein can have dire consequences for the arbitration built upon it. The invalidity of an agreement to arbitrate, discovered after the parties have gone through the time and cost of arbitration and received an award, can render the whole process worthless, even where there has been no adverse finding in respect of the award itself.