For an investor, winning an arbitration award against a sovereign depends not just on the strength of the investor’s case, but also on the choice of forum and on specific terms of the agreement to arbitrate. Investors and their attorneys focus on these matters with a view to creating the best prospects for prevailing. They may also want to consider Denial of Justice coverage from PRI underwriters to protect themselves in the event that a sovereign thwarts the arbitration process itself. But winning an award does not mean getting paid. While most sovereigns, not wanting to jeopardize their reputation for honoring treaty and other obligations, do comply with the awards, there have been some notable recent examples of sovereign resistance to meet award payment obligations promptly, if at all.
Arbitration Award Default (AAD) coverage, which offers compensation when a final and binding award against the sovereign is not honored, could also fill an important gap. (Readers may wish to see a more detailed discussion of AAD coverage in the October 2005 edition of this Newsletter, which is on our website.) Even so, after compensation under an AAD policy is paid, the policyholder will need to work with its insurer in continuing efforts to recover from the sovereign, in pursuit of its own retained interest in the award and as required by the terms of its AAD coverage.
The enforcement process: the ICSID scenario
“Enforcement” is often casually used to describe the process of obtaining legal recognition (or confirmation) of the award by turning it into money judgment, and then securing payment by way of seizing assets of the sovereign debtor either at the seat of arbitration or in other jurisdictions (the latter is referred to as execution).
The World Bank’s International Center for Settlement of Investment Disputes (ICSID) serves as an arbitration forum for investor-state disputes arising under bilateral investment treaties and free trade agreements. If the investor brings an arbitral claim under the ICSID Convention, the resulting ICSID award is considered to be the equivalent of a final judgment of a contracting state’s court (subject only to annulment procedures under the ICSID Convention) and is to be automatically recognized by the contracting states. Execution of an ICSID award, however, is not automatic and is a matter to be decided under the laws of the state where execution is sought. Argentina’s determined efforts to resist enforcement of ICSID awards demonstrate how difficult this phase of the enforcement process can be. Another concern regarding ICSID is whether states such as Bolivia and Ecuador, which have withdrawn from the ICSID Convention, will honor treaty obligations that survive their date of withdrawal.
Enforcement of commercial arbitration awards: The New York Convention
Arbitral awards against sovereigns issued by non-ICSID commercial arbitration panels (e.g., under UNCITRAL rules) are not automatically recognized as they are subject to judicial confirmation in the jurisdiction where enforcement is sought. The likelihood that such awards will be enforced is greatly enhanced if the country in which the arbitration takes place is a member of the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”) or similar regional conventions such as the Inter-American Convention on International Commercial Arbitration (the “Panama Convention”) and the European Convention on International Commercial Arbitration. The New York Convention (of which the U.S. and about 140 other nations are signatories) requires recognition of valid arbitration agreements and resulting awards by the signatory states, subject to certain narrow and expressly articulated exceptions. When the award has been confirmed and transformed into a local court judgment in the country where enforcement is sought, it provides the prevailing party with the right to execute on the judgment.
The New York Convention covers awards rendered in a New York Convention signatory state and its application does not depend on the nationality of the parties. The procedure for recognition and execution of New York Convention awards is governed by national arbitration laws. For example, in the U.S., the New York Convention is codified in the Federal Arbitration Act, which provides for recognition and enforcement of foreign arbitral awards as well as awards made in the U.S. relating to arbitrations between foreign parties (or having some other reasonable relation with a foreign state) and involving legal relationships deemed commercial under U.S. law. The confirmation proceedings are based on a petition to confirm and can be brought within three years of issuance of the award. The U.S. and a number of other countries apply the New York Convention on the basis of reciprocity, recognizing and enforcing only those awards rendered in the territory of another signatory state.
The ability to initiate enforcement proceedings in various jurisdictions under the New York Convention matters greatly because any attachable assets of the sovereign may be in jurisdictions other than the country of the arbitration. While most countries are supportive of international arbitration and provide for expeditious adjudication of enforcement proceedings, award confirmation and subsequent execution efforts against a sovereign, which has a number of avenues to resist enforcement, can prove to be long, tedious and expensive.
Defenses to confirmation of an award under the New York Convention
A party resisting enforcement of a New York Convention award can attempt to vacate the award at the seat of arbitration or in other countries, or otherwise object when the prevailing party seeks to confirm the award. The New York Convention provides several substantive grounds on which recognition may be refused, and the party contesting the award bears the burden of proving that at least one of them applies. These grounds include, among other things, deficiencies in the underlying arbitration process, a violation of domestic public policy or a finding that the laws of the enforcing jurisdiction do not allow the dispute to be settled by arbitration. U.S. courts construe these exceptions narrowly to encourage the recognition and enforcement of arbitral awards.
The New York Convention further provides that recognition and enforcement may be refused or the enforcement proceedings may be adjourned if the award has been set aside or suspended by the courts at the seat of arbitration. These provisions allow, but do not require, the enforcing court to refuse enforcement or suspend the proceedings pending a challenge of the award in the supervisory court. The New York Convention also gives the enforcing party a right to request that the sovereign post security while its challenge is pending elsewhere.
When parallel proceedings arise, investors or insurers should be prepared to deal with protracted litigation in multiple jurisdictions involving various challenges. For example, a sovereign attempting to modify, set aside or vacate an award in a foreign forum can also request injunctive relief to prevent the prevailing party from proceeding with its enforcement actions in other countries. The enforcing courts will need to weigh the rights of the parties and international comity considerations when deciding whether they should give deference to such parallel proceedings.
The effect of annulment measures
A sovereign may ultimately succeed in having the award annulled in its own courts. Can a prevailing party still enforce the award in other jurisdictions? This depends on whether the annulment was made in the country of the seat of arbitration or elsewhere.
The jurisdiction of a court at the seat of arbitration and all other courts to annul an award under the New York Convention was examined by a U.S. federal court in a dispute that arose out of contracts for the construction and operation of an electrical power plant in Indonesia between Indonesian state-owned Pertamina and Karaha Bodas Co. (“KBC”). A tribunal seated in Switzerland awarded KBC over US $260 million. Pertamina applied to the Swiss court for an annulment of the award but failed, so it secured an annulment in an Indonesian court. Relying on the Indonesian court’s annulment, Pertamina sought to resist confirmation of the award in the U.S. The U.S. federal court concluded that under the New York Convention only a court with “primary jurisdiction” (a court of the country in which, or under the arbitration laws of which, the award was made) may annul an award, which in that case was the Swiss court. All other signatory states to the New York Convention have “secondary jurisdiction” and can only decide whether the award is to be enforced in that country. Accordingly, as a court of secondary jurisdiction, the Indonesian court’s annulment was viewed as ineffective, and the U.S. court confirmed KBC’s award.
Under certain circumstances an award annulled by a court in a primary jurisdiction may still be enforced in other New York Convention states. For example, a U.S. federal court confirmed the award rendered in Egypt against the Republic of Egypt and in favor of Chromalloy, a U.S. company, that had been annulled by the Egyptian Court of Appeal. The court held in that case that the Egyptian court’s judgment violated U.S. policy favoring arbitration by ignoring the language in the parties’ agreement prohibiting appeal of an arbitral award. Other decisions have since followed, suggesting that U.S. courts will not always confirm awards vacated in the country of origin, except in exceptional circumstances (as the D.C. Circuit reiterated in TermoRio) when the foreign annulment judgment is “repugnant to fundamental notions of what is decent and just in the State where enforcement is sought.”
Much attention will now be focused on the enforcement proceedings recently initiated in the U.S. District Court for the Southern District of New York by Yukos Capital S.a.r.l, a former Luxembourg affiliate of Yukos. That affiliate is seeking to enforce four separate arbitration awards amounting to approximately US $420 million that were issued in Moscow in its favor and against Yuganskneftegaz, a predecessor of OJSC Oil Company Rosneft, a Russian state-controlled corporation that took over Yukos’ production assets. All four awards were annulled by Russian courts. Earlier this year, however, the same awards were confirmed in the Netherlands where the Dutch court determined that the Russian judiciary was not independent and impartial when it came to Yukos and held that upholding a Russian court judgment vacating the awards in such circumstances would be contrary to Dutch public policy. That ruling is in line with Chromalloy. It will be interesting to see if the U.S. court takes a similar view.
Outside the U.S., the treatment of awards issued by commercial arbitration panels varies from country to country, depending on the country’s own laws, whether it has acceded to the New York Convention or similar treaties, and on the interpretation of the matter at hand. Suffice it to say, issues may arise. Even sovereigns who are parties to the New York Convention could raise objections to recognition and enforcement beyond those enumerated in the convention, especially if the arbitration took place in their own country. As the New York Convention allows a court at the seat of arbitration to apply its domestic arbitral law when faced with a petition to vacate an award, most investors will resist agreeing to have arbitrations proceed in the project host country, or under its laws, where “hometown justice” may prevail.
Dealing with sovereign immunity defenses
The prevailing party in the arbitration is also likely to face challenges in any local forum in connection with claims of sovereign immunity relating to the recognition and execution of arbitral awards. Immunity from execution is distinct from immunity from suit and therefore waiver of immunity from suit (either by virtue of ratification of the relevant convention or express waiver of such immunity in the underlying contract giving rise to the arbitration) does not imply a waiver of sovereign immunity from execution. To ensure that a judgment entered on an arbitral award (or an ICSID award) can be executed, contracts with sovereign parties should include a separate clause providing for waiver of sovereign immunity from execution of any arbitral award (or a related judgment) rendered pursuant to an arbitration agreement among the parties.
Claims of immunity from recognition of an award
In the U.S., federal courts have the power to confirm arbitral awards, but to exercise that power they must establish jurisdiction over the matter and the defendant. In order to establish jurisdiction, it must be determined that the sovereign is not entitled to immunity from legal action in the matter in the U.S. and that proper service of process on the sovereign defendant was made pursuant to the U.S. Foreign Sovereign Immunities Act (“FSIA”). The FSIA provides the basis for obtaining jurisdiction over a sovereign in U.S. courts. It states that a foreign state and its agencies and instrumentalities are immune from the jurisdiction of U.S. courts unless one of the exceptions in the act applies. Typically, if a sovereign has consented to the arbitration and the arbitration occurred in the U.S., or if the arbitration award is governed by a treaty or other international agreement such as the New York or Panama Conventions calling for enforcement in the U.S., the federal courts will accept jurisdiction. For example, in a case involving a Canadian contractor who filed a petition in the U.S. to confirm arbitration awards against the Republic of Trinidad and Tobago, the U.S. federal court held that where a sovereign defendant was a party to the New York Convention, its agreement to arbitrate in a New York Convention signatory state implied a waiver of its immunity from jurisdiction in a proceeding to confirm the resulting awards in other signatory states. Even without such an explicit or implicit waiver of immunity by the sovereign, U.S. courts may exercise jurisdiction if the matter arbitrated was related to the sovereign’s commercial activity carried on, or that causes a direct effect, in the U.S.
Claims of immunity from execution of an award
Once the award has been confirmed (or if it is a final ICSID award), and if timely payment is not forthcoming, the next step is to seek attachment of sovereign assets to satisfy the outstanding liability. The difficulty with this step is not only that the sovereign may find ways to shield its assets, but also that most jurisdictions consider sovereign property immune from attachment, subject only to certain exceptions. The ICSID Convention, for instance, provides that its terms should not “be construed as derogating from the law in force in any Contracting State relating to immunity of that State or of any foreign State from execution.” This allows a recalcitrant sovereign to assert immunity defenses permissible under the laws of the country where the execution is sought. Exceptions to sovereign immunity vary depending on the jurisdiction. In many countries, execution is only possible against sovereign assets that are used for commercial purposes. Thus, investors need to determine the purpose of the property they are seeking to seize, although in certain jurisdictions the property’s origin may also be an important consideration.
Attachment of a foreign sovereign’s property in the U.S. is governed by the FSIA, which provides that when a foreign state is not protected by sovereign immunity, “the foreign state shall be liable in the same manner and to the same extent as a private individual under like circumstances.” But under the FSIA the property of a foreign state in the U.S. is considered immune from execution unless the property is used for “commercial activity” and certain other exceptions, including waivers of immunity from execution and situations where “the judgment is based on an order confirming an arbitral award rendered against the foreign state,” apply.
Where there is no express waiver of immunity from execution, immunity is normally accorded to central bank’s accounts held for its own account. In addition, each country’s courts will have their own notions of the circumstances under which so-called “mixed purpose” sovereign assets (i.e., those used for both commercial and public purposes) can be attached. In a case that arose out of an ICSID arbitration, the claimant attempted to attach bank accounts of the Embassy of Liberia in Washington DC. The federal court held that even though a sovereign’s embassy accounts were used in part to fund its commercial activities, such accounts were nevertheless immune from attachment under the Vienna Convention on Diplomatic Relations and the FSIA. Generally, assets of diplomatic and consular missions are immune from execution.
In summary, if a sovereign chooses to resist enforcement of an arbitral award, it may have a number of ways to do so, subjecting the process to lengthy delays. In negotiating an arbitration provision with a sovereign, attention should be given not just to the prospect of winning the arbitration, but also to receiving timely payment.
Gauging how readily the award may be honored or enforced
Although not a full menu of things investors and underwriters need to look at in determining the prospects for enforcement of an award, here are some important considerations in drafting arbitration agreements and deciding on strategies for seeking recognition and execution of arbitral awards:
• Obtaining protection under international treaties such as ICSID Convention, New York Convention or similar treaties providing for recognition and enforcement of arbitral awards
• Drafting clear and unambiguous arbitration clauses that would include, among other things:
− Clear choice of substantive and procedural laws to govern the arbitration
− Selection of the seat of the arbitration in a neutral New York Convention country (when dealing with non-ICSID arbitration)
− Express waivers of any and all sovereign immunity from suit and execution by the sovereign party and review of local law where enforcement may be sought to determine whether such waivers are enforceable
− Parties’ agreement to consider arbitral awards as final and binding and not subject to appeal
− Provisions authorizing courts in any jurisdiction to enter judgment on the award
− Parties’ agreement for award of costs, attorneys’ fees, interest and the currency for payment of the award to prevent post-award litigation of these matters
• Ensuring that the sovereign party has clear legal capacity and proper authorizations to enter into a commercial agreement
• Identifying countries where the sovereign has assets against which the award can be enforced
• Reviewing relevant treaties by which the sovereign party is legally bound as well as domestic laws in the host country that may impinge on enforcement of an award
• Understanding the behavior of the host country with respect to previous awards and as to international obligations generally
These matters also deserve the AAD underwriter’s attention both as to the prospect of a claim arising and the likelihood of recovery if it is paid to the insured. A wise investor should consider consulting with its prospective AAD underwriter before it settles on the terms of an arbitration provision in an investment agreement with a sovereign. The underwriter may be a source of good advice, and may help to assure that the arbitration provision meshes well with the coverage that the investor hopes to arrange. ■