Tag Archives: Arbitration

Unenforceability of Arbitration Clauses?

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Introduction

Banks in Hungary as in many jurisdictions, prefer arbitration over litigation before ordinary courts to resolve disputes arising out of a financing transaction. Efficiency, flexibility, professionalism and protection of sensitive information are among the main reasons for this preference. However, the large number of insolvencies in recent years revealed a difficulty in enforcing arbitration clauses.

The question of enforceability of the arbitration agreement often arises from a challenge to the validity of the entire loan agreement (or at least certain parts of it) by the borrower in financial difficulties. If such or similar dispute arises, the financially distressed claimant may not be in a position to advance the relatively high costs to initiate arbitration proceedings.

The arbitration agreement may be rendered incapable of being performed

Since the beginning of the financial crisis the number of debtors unable to meet their financial obligations has increased substantially. Most of these debtors commenced negotiations with the banks to achieve grace periods and standstill arrangements or the restructuring of the loans. For various reasons (the analysis of which is outside the scope of this article), banks in Hungary were often able to fulfil these requests, and the outcome was rather termination and acceleration in most cases. Debtors often challenged the banks’ decisions on drawstop, termination or acceleration; some chose to also initiate bankruptcy or final insolvent dissolution proceedings.

Arbitration proceedings are expensive, particularly for anyone in financial difficulties. A trend of submitting claims to ordinary courts has emerged, arguing that a person should have a fundamental right and possibility to assert or defend its rights before dispute resolution bodies, irrespective of its financial condition. The legal argument of the petitions for establishing the competence and jurisdiction of ordinary courts is unenforceability: debtors claim that the arbitration agreement shall be rendered “incapable of being performed”.

Hungarian precedent declaring that an arbitration agreement with a company under liquidation is unenforceable

In response to the emerging of these cases, ordinary courts were divided on how to handle this type of case, and whether or not they could rely on an exemption granted by the Hungarian Arbitration Act allowing ordinary courts to hear a case on its merits despite a valid arbitration clause in the underlying agreement. In 2014 the Supreme Court of Hungary issued a its guidelines confirming that an arbitration agreement is not enforceable with respect to a company under liquidation, since such agreement is incapable of being performed as a result of the pending liquidation. The Supreme Court of Hungary provided the following reasoning for this view:

      i. the costs of the arbitration proceedings exceed the costs of an ordinary court case;
      ii. in arbitration matters the claimant must advance the arbitration costs in any case, and may not request the suspension of this obligation or exemption from it;
      iii. in arbitration proceedings the insolvent company’s third party creditors are not able to intervene or interplead;
      iv. arbitration proceedings are not open to the public, which is detrimental to the interests of other creditors;
      v. the arbitration proceeding is a one instance proceeding without a right to appeal or contest the award and the setting aside of an award is available only in limited circumstances;
      vi. arbitration proceedings are less effective than ordinary court proceedings.

Consequences

The need for support for financially distressed companies to enable them to obtain a fair trial (or, to that end, at least the chance of a fair trial) is understandable. However, the arguments of the Supreme Court of Hungary are not entirely convincing in establishing legitimate reasons for rendering an arbitration agreement “incapable of being performed”. Some of the reasons difficult to deny, but it is hard to see their relevance in the context of evaluating the enforceability of an arbitration agreement. For example, it is unconvincing, to say the least, that the arbitration proceedings being closed to the public and that the creditors cannot intervene prejudices the rights of the debtor company to such an extent that it raises the question of the enforceability of its valid contractual undertakings. Equally it is questionable whether non-availability of an appeal, even in theorem, should render an arbitration agreement “incapable of being performed” just because the claimant is under liquidation. Why would non-availability of appeal matter in respect of insolvent companies but not others?

Insolvency laws set out the rules under which an administrator or liquidator of an insolvent company may challenge, terminate, rescind from or set aside agreements and contractual obligations. These rules also guarantee that no cherry-picking occurs and only entire agreements may be set aside by the liquidator. In effect, the decision of the Supreme Court of Hungary by-passes the statutorily defined (and limited number of) circumstances where this could happen; and establishes an extraordinary exemption. This, in the view of many, goes beyond the scope of the traditional function of courts to apply laws, and breaches the prohibition of court created laws.

It has to be noted that the issue discussed above and the interpretation of law in that context is not a Hungarian novelty. The exemption from being bound by an arbitration agreement on the basis that it is “incapable of being performed” has its origin in Article 8 (1) of the UNCITRAL Model Law on International Commercial Arbitration which was implemented into the Hungarian Arbitration Act. Thus, in principle, banks should be aware of the risks that there may be special circumstances when an arbitration clause cannot be enforced. However, by specifying the general term of “incapable of being performed” and applying it to all cases where a party is under financial difficulty the Hungarian Supreme may have gone too far. Pandora’s Box is now open and a company which may have no more to lose, following the acceleration of its loan, could very easily hinder enforcement or the collection of the debt by filing for an insolvency procedure and commencing a lengthy ordinary court procedure against the banks. The consequence of this is not only significant delay, but also that the claim of the bank will be registered by the liquidator as “disputed”, which makes a creditor’s position in an insolvency scenario even worse, depriving them from their fundamental creditors’ rights such as the right to vote.

To be blunt, the Supreme Court of Hungary’s decision is not a surprise in light of the traditional borrower-friendly approach of Hungarian courts. Banks and other financing entities could only hope that the tide will turn, and their interests will be taken into account with a more balanced emphasis in future decisions.

 

International Arbitration in Sport: Why The Pechstein Case Could Throw The Court Of Arbitration For Sport Into Disarray

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1    INTRODUCTION

1.1    The benefits of arbitration (as opposed to the Court system) in resolving sporting disputes have long been recognised by those concerned with the regulation and governance of sport.  The specialised expertise of sports arbitrators, the speed, confidentiality and relative cost efficiency with which arbitral panels can deliver decisions are all attractive in an industry that requires disputes to be decided quickly and at short notice .  Unsurprisingly, the overwhelming majority of sport governing bodies therefore include an agreement to arbitrate sporting disputes in their Rules as a pre-condition to participation in the sport.

1.2    Since its inception, three years after the then IOC President Juan Antonio Samaranch proposed the creation of a “supreme court of world sport”, the Court of Arbitration for Sport (CAS), has gained the trust of most sports as an independent and consistent forum for the resolution of disputes. Unsurprisingly, most sports have now adopted the CAS as the final appellate forum (save in limited circumstances) once the sports’ own internal dispute resolution procedures have been exhausted.

1.3    Against that backdrop, the ongoing proceedings concerning Ms Paula Pechstein’s dispute with the International Skating Union (ISU) in connection with the two year ban from competition imposed by the ISU Disciplinary Commission (ISUDC) in 2009 for doping offences are relevant not just to the immediate issue of CAS’ jurisdiction, but also to the wider issue of how disputes are best resolved in the modern sporting context.

2    THE PECHSTEIN PROCEEDINGS

2.1    The story began in February 2009 when blood samples were taken from Ms. Pechstein as part of the ISU’s blood testing programme  on the eve of the ISU World Allround Speed Skating Championships in Hamar.  These samples were compared with Ms. Pechstein’s apparent blood profile based on information that the ISU had gathered over a number of years from blood samples taken from her as part of its anti-doping programme.  That comparison gave rise to suspicious findings because of an abnormal increase in reticulocytes (immature red blood cells) which were potentially indicative of blood doping.

2.2    On 5 March 2009, the ISU filed a complaint with the ISUDC accusing Ms. Pechstein of blood doping offences. Following a hearing in Berne, the ISUDC found Ms. Pechstein guilty of an ‘Anti-Doping Violation’ and disqualified her from competing for two years.  Notably, this was in spite of the fact that no Prohibited Substances had ever been identified in any of Ms. Pechstein’s samples.  Her case was therefore determined on circumstantial rather than any actual evidence of doping.

2.3    Ms. Pechstein subsequently appealed to the CAS pursuant to Article 24 and Article 25 of the ISU Constitution and Rule 13.2.1 and 13.6 of the ISU Anti-Doping Rules. The Final Arbitral Award was published on 25 November 2009, dismissing Ms. Pechstein’s appeal on the grounds that “illicit manipulation of her own blood” remained the “only reasonable alternative source of such abnormal values”.

2.4    Many challenges to doping bans end at that point with the CAS typically being seen, as Mr. Samaranch had originally envisaged, as the ultimate arbiter of sporting disputes.   However, Ms. Pechstein went further and appealed to the Swiss Federal Tribunal on a number of grounds. On 10 February 2010, applying the test contained within Article 190(2)(a)-(e) of the Swiss Private International Law Act strictly, the Swiss Federal Tribunal dismissed the appeal.

2.5    There was then a second appeal to the Swiss Federal Tribunal in which Ms. Pechstein argued that a novel scientific method of diagnosing hereditary spherocytosis (which could explain the blood test abnormalities) had been developed that was not available to the CAS at the time of the underlying arbitration. The Swiss Federal Tribunal again rejected Ms. Pechstein’s appeal.

2.6    Dissatisfied with the CAS and Swiss Federal Tribunal’s decisions, Ms. Pechstein issued a damages claim for €4 million in her local German Regional Court in Munich (Landesgericht), alongside a complaint to the European Court of Human Rights .

2.7    On 26 February 2014, the Landesgericht  held both that it was seized of jurisdiction and that the arbitration agreement between the ISU and Ms. Pechstein was invalid, as Ms. Pechstein was forced to sign the agreement to arbitrate as a precondition of participating in her sport.  The Landesgericht considered this a breach of Article 6 of the European Convention on Human Rights.  However, despite this finding, it held that the principle of res judicata meant that the CAS Final Arbitral Award was enforceable pursuant to the New York Convention on the Recognition and Enforcement of Arbitral Awards.  The CAS award and the sanctions imposed on Ms. Pechstein, therefore, stood, despite the fact that the basis for it was, in the Landesgericht’s eyes, illegitimate.

2.8    Having now gained some traction in her efforts to prove her innocence and challenge the sanctions imposed on her, Ms. Pechstein appealed to the Higher Regional Court of Munich (Oberlandesgericht). On 15 January 2015 , overturning the decision of the Landesgericht, it held that:

(a)    The arbitration agreement between Ms. Pechstein and the ISU was invalid as it was contrary to mandatory German anti-trust law . Namely, the ISU’s insistence upon the agreement to arbitrate as a precondition of competing constituted an abuse of a dominant position.  This was on the basis that the constitution of the International Council for Arbitration in Sport (ICAS) that selected the closed list of arbitrators and also appointed the President of the Appeals Arbitration Division, who in turn was responsible for appointing the chair for each CAS panel, was contrary to German anti-trust law.  ICAS comprises 20 members, of which 12 were nominated by the International Olympic Committee, and only 1/5 were nominated with the athletes’ interests in mind;

(b)    Accordingly, the CAS decision (which was mandated by the invalid arbitration agreement) was unlawful; and

(c)    The Landesgericht was wrong to find that the principles of res judicata and the New York Convention meant that the decision of the CAS was valid. The Oberlandesgericht considered that the breach of anti-trust law was contrary to public policy , and pursuant to the exclusion contained within Article V(2)(b) of the New York Convention, the CAS decision was not binding.

2.9    To bring matters up-to-date, the current picture is that the ISU announced on 9 July 2015 that it had filed an appeal against the Oberlandesgericht’s decision to the German Federal Court of Justice (Bundesgerichtshof).  On 14 July 2015, FIFPro, the football players’ federation, announced that it will financially support Ms. Pechstein in the defence of the ISU’s appeal, which is now pending.

3    ANALYSIS

3.1    One of the most striking aspects of the German Court’s decisions to date has been their willingness to entertain a challenge to CAS’ jurisdiction in spite of Ms. Pechstein’s failure to raise her jurisdictional challenge at any point prior to issuing proceedings before the German Courts.  There was nothing preventing Ms Pechstein from raising a fundamental challenge to her arbitration agreement with the ISU and CAS’ jurisdiction under it at the outset of her case.  Ms. Pechstein did not do so; indeed, she willingly submitted to the jurisdiction of the CAS.

3.2    Given that under section 73 of the Arbitration Act of 1996, a jurisdictional challenge must be made as the first step before a participant takes any substantive steps in the arbitration, the position reached by the German Courts is, ostensibly, directly opposed to the position under English law.

3.3    Either way, if upheld, the German Court’s decision appears to open up the possibility of athletes ‘forum shopping’ for alternative dispute resolution mechanisms after receiving an unfavourable judgment .  It remains to be seen whether the Bundesgerichtshof will address the point.

3.4    With the Bundesgerichtshof yet to opine on this and the other issues at stake, there may yet be more twists and turns in this saga.  Whatever the ultimate outcome, it is impossible for CAS to ignore the challenges made and the various decisions of the German courts.

3.5    Whilst some commentators have played down the likely impact of the case, given the long standing jurisprudence of the CAS (and the Swiss Courts endorsement of its role), the significance of the German Court’s decisions is clearly on CAS’ radar, with it stating in a press release:

“If, like in the Pechstein/ISU case, arbitration agreements were to be considered as invalid by state courts, even when not challenged at any stage during the arbitration, then the basic principles of international arbitration would be compromised” .

3.6    It is easy to see that the Pechstein case could have wide ranging implications for sporting arbitration agreements. Specifically, regardless of the Bundesgerichtshof’s view of the merits of Ms. Pechstein’s case, if it upholds the Oberlandesgericht’s decision that it has the jurisdiction to interfere with CAS’ decision, then it both paves the way for courts in other jurisdictions to find similarly in respect of their national athletes, and opens the door to potential damages claims against CAS by athletes who have been on the receiving end of sanctions.

3.7    Furthermore, the fact that FIFPro (and other donors) have agreed to fund Ms. Pechstein’s defence of the ICU appeal suggests that there are a number of interested stakeholders in the sports industry waiting in the wings,  hoping that her challenge to CAS’ jurisdiction will succeed.

3.8    The statement published by FIFPro on 14 July 2015 that…
“Every athlete as a citizen and worker has the right to a fair process and to be judged in an independent and impartial court. The decisions of the regional courts in Germany in Claudia Pechstein’s case have confirmed that this right was not duly granted by CAS at the time of her anti-doping case.”

“FIFPro is firmly of the view that also today CAS does not provide footballers and other athletes with a structure and process that is fair to the athletes”.

…sounds as a warning to CAS that Ms. Pechstein and the German Courts are not alone in their belief that the constitution of the arbitral panels (and in this case CAS) are weighted in favour of governing bodies to the disadvantage of individual athletes.

3.9    Admittedly, the CAS has not stood still since 2009, and there have been amendments to the constitution of the ICAS and individual CAS arbitral panels.  It is only natural that modifications will be necessary to the structure and function of a body established over 30 years ago, and the authors believe that it is critical for the integrity of international sport to be able to call upon a dedicated and unified appellate body to deliver consistent decisions.  Otherwise, the spectre of a possible divergence in the application of and respect for fundamental sporting principles throughout the world arises.  Clearly, therefore, CAS’ attempts to address the concerns raised and reform itself are to be welcomed.

3.10    Like the majority of commentators, the authors therefore hope for a reformed CAS capable of serving the modern sporting context, not for its abolition.  However, the sports industry does not speak with one voice on this issue, as reflected in FIFPro’s statement that:

“Even after CAS’ structural reform, the composition of ICAS, the appointment of arbitrators and chairmen do not provide athletes with equal representation of arbitrators and independence of the tribunal. Other concerns such as procedural cost and the application of Swiss law to conflicts between EU-based parties have been criticized before .”

3.11    Whilst the decision of the Bundesgerichtshof is eagerly awaited by those operating in the sports sector, it appears that the legal challenges to CAS’s right to act as ‘the supreme court of world sport’ are unlikely to subside even if the Bundesgerichtshof overturns the Oberlandesgericht.

CJEU potentially opens the back door to court ordered anti-suit injunctions in the EU

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Gazprom OAO [2015] Judgment in EUCJEU C-536/13

The ability of the English courts to restrain court proceedings in another Member State in breach of an arbitration agreement was curtailed, following the infamous decision of the Court of Justice of the European Union (CJEU) in Allianz SpA (formerly Riunione Adriatica di Sicurtà SpA) v West Tankers Inc, (The Front Comor) (Case C-185/07). Earlier this year, there were hopeful signs that this decision might be reviewed following the referral to the CJEU by the Lithuanian Supreme Court of similar questions arising in a dispute between Gazprom OAO and Lithuania. The CJEU[1]’s decision in that case was issued on 13 May 2015 and while it has declined to revisit The Front Comor, the CJEU has potentially opened up the back-door to court ordered, intra-EU anti-suit injunctions.

In the West Tankers case, the CJEU found that it was incompatible with the Brussels Regulation 44/2001 (the original Brussels Regulation) for a court of a Member State to restrain a person from commencing or continuing proceedings before the courts of another Member State on the ground that the proceedings would be in breach of an arbitration agreement, in circumstances where the proceedings brought in the other Member State were within the scope of the Brussels Regulation. This decision meant that an anti-suit injunction could not be granted to restrain proceedings within the scope of the original Brussels Regulation brought in another EU Member State in breach of an arbitration clause.

Since – and in part because of – the decision in West Tankers, the original Brussels Regulation has been replaced by Brussels Regulation 1215/2012 (the recast Brussels Regulation), which has applied since 10 January 2015.

It is against this background that a dispute arose between Gazprom OAO and Lithuania concerning the running of Lithuania’s main natural gas provider, in which both parties were shareholders. The Lithuanian Ministry of Energy initiated court proceedings in Lithuania. Gazprom subsequently commenced arbitration under the rules of the Arbitration Institute of the Stockholm Chamber of Commerce (SCC) in Sweden. Gazprom argued that the Ministry’s claims were in breach of an arbitration agreement contained in the shareholders’ agreement to which they were both parties. The tribunal in the SCC arbitration issued an award ordering Lithuania to withdraw certain of its court claims (subsequently referred to by the Lithuanian court as an anti-suit injunction), which Gazprom then sought to have recognised and enforced in the Lithuanian Court of Appeal. The court refused and Gazprom appealed to the Supreme Court of Lithuania, where Lithuania argued that, in light of West Tankers, the anti-suit injunction issued by the arbitral tribunal was contrary to the original Brussels Regulation.

The Supreme Court of Lithuania referred the matter to the CJEU, asking whether the court of a Member State could refuse to recognise and enforce an award containing an arbitral anti-suit injunction as being incompatible with the original Brussels Regulation.

Advocate General opines that West Tankers should be reconsidered

On 4 December 2014, Advocate-General Wathelet concluded that the original Brussels Regulation must be interpreted as not requiring the court of a Member State to refuse to recognise such an award (the conclusion); and (b) suggested, in the context of a discussion of the recast Brussels Regulation, that it is was possible that the CJEU might reconsider the approach taken in West Tankers, both in relation to the original and the recast Brussels Regulation (the suggestion).

The decision of the CJEU

The CJEU declined to follow the Advocate-General’s suggestion and has therefore avoided revisiting its earlier decision in West Tankers. Although it referred to West Tankers, the CJEU limited itself to considering the specific questions posed by the Lithuanian court. In this respect, the CJEU agreed with the Advocate General’s conclusion that the Brussels Regulation must be interpreted such that a Member State court is not required to refuse to recognise or enforce an arbitral award containing an anti-suit injunction.

In reaching this decision, the CJEU confirmed that arbitration is outside the scope of the original Brussels Regulation because the Regulation governs only conflicts of jurisdiction between courts of the Member States. The CJEU took the view that there was no such conflict in this case and no question of infringement of trust by the interference of the court of one Member State in the jurisdiction of the court of another Member State (the only court involved was the Lithuanian court).   The arbitral award did not deny the party restrained from obtaining judicial protection because, in any proceedings for recognition and enforcement of the arbitral award, that party could contest recognition and enforcement and the Lithuanian court would have to determine, on the basis of national procedural law and international law, whether or not the award should be recognised and enforced.

The CJEU therefore concluded that the original Brussels Regulation did not “preclud[e] a court of a Member State from recognising and enforcing, or from refusing to recognise and enforce, an arbitral award prohibiting a party from bringing certain claims before a court of that Member State, since that regulation does not govern recognition and enforcement, in a Member State, of an arbitral award issued by an arbitral tribunal in another Member State”.

Comment

The original Brussels Regulation is widely considered to have been a successful European instrument. However, there were concerns including in relation to the arbitration exception whose application in practice resulted in ambiguity about the boundaries between the jurisdiction of Member State courts to act in support of arbitration in accordance with national law and their jurisdiction to act under the Brussels Regulation.

The CJEU sought to address this ambiguity in the West Tankers case. Unfortunately, this decision has had the no doubt unintended but unfortunate consequence of opening the door for parties to act abusively by bringing substantive proceedings within the scope of the Brussels Regulation in the courts of the Member State most likely to find the arbitration clause invalid (so-called “Italian torpedo” tactics), and rendering the party wishing to uphold the arbitration agreement and other Member State courts, including the courts of the seat of the arbitration, powerless to prevent this. It also means that the courts of those other Member States will subsequently have to enforce any judgment on the merits given by the Member State court that heard the substantive claim in breach of the arbitration clause.

Recital 12 of the recast Brussels Regulation seeks to address this concern as it makes clear that the ruling by a court of one Member State on the effectiveness of an arbitration agreement is not subject to the rules of recognition and enforcement laid down in the recast Brussels Regulation. Following the Opinion of Advocate General Wathelet in Gazprom OAO in particular in respect of the recast Brussels Regulation, it was hoped that the CJEU might strengthen the effect of Recital 12 and revisit the approach taken in The Front Comor. The CJEU has not done so.

While this might, at first glance, appear unsatisfactory for users of arbitration keen to quell the tide of the abusive Italian torpedo, the decision warrants closer review. The CJEU concluded that the original Brussels Regulation “does not govern recognition and enforcement, in a Member State, of an arbitral award issued by an arbitral tribunal in another Member State”. This at least suggests that the decision in Gazprom should be the same where the courts of more than one Member State are involved in the analysis. In other words, it is at least open to debate following this decision whether a party to an arbitration seated in one Member State could now obtain an arbitral award restraining a counterparty from continuing proceedings in another Member State which could then be recognised by the courts at the seat, effectively obtaining a court-ordered anti-suit injunction by the back door and circumventing the limitation imposed by West Tankers.

Alternatively and possibly avoiding the inevitable risks involved in recognition and enforcement proceedings (and the question whether such an injunction could ever be issued as an award), a party may seek the arbitral injunction in the form of a peremptory order. If the arbitration were London seated, at least, that order could then be enforced by court order under section 42 of the Arbitration Act 1996. In either case, the party concerned would then have the benefit of a court order preventing their arbitral counter-party from pursuing proceedings in breach of the arbitration agreement in the court of another Member State with equivalent effect to a standard court-issued anti-suit injunction.

 

[1] The Court of Justice of the European Union was formerly known as the European Court of Justice (ECJ).