Investors who rely on international arbitration of contract disputes with sovereign counterparties must be prepared to live with the fact that under the best of circumstances arbitration can be a lengthy process—and may have perverse results. Most investors, however, do not want to assume the risk that an award in their favor cannot be enforced or that, on account of the sovereign’s intransigence or conditions in the host country, the arbitration process will be frustrated, resulting in no award. Timely enforcement even of an ICSID award is not a sure thing.

Arbitral Award Default Coverage – If the Sovereign Fails to Honor the Award

The political risk insurance (PRI) market does offer some solutions. Investors can protect themselves by purchasing Arbitral Award Default (AAD) coverage, which offers compensation in the event that the investor is unable to obtain timely enforcement of an international arbitral award arising from a contract dispute with a sovereign. AAD coverage is sometimes called “breach of contract,” but “arbitral award default” is a more accurate designation.

Wordings, of course, vary greatly with the underwriter and with the degree of manuscripting (i.e., contract tailoring) that goes into the individual policy, but AAD coverage usually includes these fundamentals:

  • The investors (or the project company from whom they derive their interest) must receive a monetary award against the sovereign, whose obligation may be as contracting party or its guarantor. In some cases a sub‑sovereign entity may be acceptable to the underwriter.
  • The award must issue from an international arbitration panel.
  • The award must be final, binding and non-appealable. To be “final and binding,” an award must not be subject to further review by the arbitral panel that properly rendered it. The award also must not be subject to appeal to any other panel or authority. The conditions for appealing an ICSID award are very limited (even if often resorted to), but this may not be so with other forums where the courts may find rights to appeal under general conditions of international law, even if the underlying agreement pursuant to which the arbitration was initiated does not say so.
  • The award must be legally enforceable in the place where it is sought to be enforced. Most nations are party to a 1957 international treaty on reciprocal enforcement of arbitrations and arbitral awards known as the “New York Convention.”
  • The insured must make reasonable efforts to enforce the award, but be unable to do so within some defined waiting period. Such waiting periods may vary from 30 days to as much as a year. “Reasonable efforts” calls for the insured to seek enforcement in the local courts, and depending on the circumstances may also require the insured to seek enforcement elsewhere.
  • Compensation is typically limited to the insured investor’s (or lender’s) share of the award. One insurer places a “book value” limitation on compensation, which could be problematical, especially if the book value calculation is determined as of the date of the award, or the end of the waiting period, by which time the events giving rise to the arbitration might have severely degraded the value of the enterprise. It may be possible or investors to negotiate more favorable wordings.

Insurance protection equivalent to AAD might arguably be implied in an insurer’s expropriation coverage wordings that refer to deprivation of the investor’s fundamental rights, to creditors’ rights, or to the host government’s violation of international law. There is a case to be made for policy language that is broad and embracing, in order to capture things that a more precise enumeration of the circumstances of expropriation might miss. But most investors seeking AAD protection will be unwilling to assume that there is sufficient safety in such generalities, and will want explicit AAD coverage instead (or in addition).

Explicitly worded AAD coverage is sometimes embedded in the policy’s expropriation section, rather than being set out as a separate coverage. This can be a bad idea because exclusions and limitations appropriate to standard expropriation coverage may confound effective AAD coverage or confuse its meaning. And whether part of expropriation coverage or not, AAD wordings that include limiting or opaque terms such as exclusions for loss due to “financial causes” or requirements that the sovereign’s refusal to pay to be “arbitrary and discriminatory” or “a violation of international law” deserve special scrutiny.

Investors will want to know if compensation may be denied simply because the sovereign is insolvent, or because it is defaulting generally.

Denial of Justice Coverage – If the Arbitration Procedure is Thwarted

The very best AAD coverage will be of no avail if no award is issued, and investors can reasonably be concerned that a sovereign might thwart or indefinitely prolong a panel’s workings through delaying tactics or outright obstruction. A case can be made that in such event investors have protection in standard expropriation wordings that refer to denial of fundamental rights and/or to the host government’s violations of international law. But more certain and explicit protection may be available from insurers in the form of what is often called “Denial of Justice” (DOJ) coverage, which is usually offered in combination with AAD coverage. DOJ coverage is not nearly as readily available as AAD coverage, and terms and wordings vary greatly among underwriters, often emerging only after arduous negotiations.

In general, however, explicit DOJ coverage typically includes these elements:

  • The sovereign refuses to cooperate in the initiation of the arbitration process, in spite of the insured’s diligent efforts to get it underway.
  • Or, in spite of the insured’s diligent pursuit of the process, the sovereign, through action or inaction, thwarts its completion.
  • Or, as a result of conditions in the country not extant when the policy was issued, pursuit of the process is rendered futile, impracticable, or hazardous.
  • And such circumstances exist for some stipulated period of time, often required to be “continuous.”

It takes little imagination to see that lurking in these simple concepts are a host of thorny issues and drafting challenges for investors and underwriters. Here are just a few:

  • How does one allocate responsibility between the investor (or project company) and the sovereign for delays? Arbitrations are commonly replete with disputes between the parties over evidentiary and procedural matters, and it may be difficult to pin the responsibility for delay on one party alone.
  • How is the distinction made between deliberate efforts to thwart the procedure and the actions that litigators routinely engage in to harass and discourage their opponents?
  • What constitutes an act of the sovereign? Are actions of its courts included? What if a private party uses the sovereign’s courts to thwart the process?
  • What if the sovereign’s delaying tactics are episodic and cumulative, rather than occurring continuously over a prolonged period?
  • What kinds of conditions in the country that render the process fruitless are included? Must they be the result of deliberate acts of the sovereign? If essential local witnesses are prevented from appearing because of a civil war, or an epidemic, should that be the basis of a claim?
  • Given the sluggish pace of international arbitration to begin with, what is an appropriate “waiting period” during which the process is thwarted, before a claim can be made?
  • What compensation should be paid? The amount claimed in arbitration? The project’s book value or (as the case may be) the lender’s outstanding balance? If book value, calculated as of what date?

Merely getting agreement between investor and underwriter on what they intend DOJ coverage to do can be difficult. Worse, the best efforts of underwriters, investors, and their advisors to capture DOJ coverage intentions in policy language will invariably still leave room for interpretation.

Given these problems it is no wonder that underwriters approach DOJ coverage so warily. Another reason for caution is uncertainty of salvage for the insurer. Even salvage from AAD coverage claims payments is problematic, since the reason claims are paid in the first place is that the sovereign has already refused to pay, and may simply be unable to do so. Now the insurer in a salvage position may fall among a pool of creditors whose debts the sovereign wants to reschedule, perhaps with a haircut.

If getting the sovereign to make good on a non‑honoring default or arbitration award that it is legally obligated to pay is no sure thing, recovery from the sovereign is likely to be far more difficult when the origin of the “obligation” is a third‑party insurance policy payment. For this reason, private insurers may be especially keen to offer the coverage in cooperation with, or with reinsurance from, some powerful public sector underwriter that can exercise treaty rights and national or multilateral clout to achieve a recovery.

Narrowing the Scope for Interpretation

Earnest efforts to overcome the daunting problems of negotiating and drafting DOJ coverage produce wordings that, however exhaustive, still call for interpretation in the light of real events. So it may be worth exploring DOJ wordings that rely less on abstraction and more on objective and impartial factors. If such factors were present and other policy conditions were satisfied, the investor would be compensated but still be obligated to exercise all reasonable efforts on behalf of the insuring party who succeeds to its interests. If the process eventually did produce an award in the insured’s favor the underwriter would be the first to benefit.

It is probably not feasible or desirable to trigger DOJ compensation exclusively on the basis of mechanical tests or proxy conditions, but it should be possible and beneficial to all parties to develop factual and measurable standards that narrow the scope for interpretation. At the sacrifice of some opportunities for discretion and judgment in the claims process, underwriters and investors might both enjoy greater confidence in the insurance product and leave less scope for vagaries in its interpretation by arbitrators. ■