The Jerusalem District Court recently handed down a judgment which could undermine the effectiveness and scope of an arbitration agreement to which the State of Israel ("State") is a party.

Under the terms of a Concession Agreement with the State, Dead Sea Works ("DSW") has spent the last five decades extracting minerals such as potassium and bromine from the Dead Sea, and paying the State royalties for them. The Concession Agreement dictates that all disputes arising from the arrangement will be resolved exclusively by arbitration.

Over the last few years the volume of the royalties due to the State increased significantly, partially due to a public debate in Israel regarding the use of national resources by private companies. Following a separate large investment made by DSW in a national project in the Dead Sea, the State agreed to maintain a fiscal "status quo" between the parties, and not to initiate any legislation which may disrupt their arrangement. 

Nevertheless the waters of the Dead Sea turned choppy. In June 2013 the Israeli Minister of Finance appointed a committee to review the State's policy on private use of national resources (the “Committee”).

Believing that the Committee’s true purpose was to revisit the issue of the State's share derived from the utilization of the Dead Sea minerals, DSW objected to the Committee’s mandate to review its fiscal arrangement with the State. The Ministry of Finance denied its objection.

Viewing the appointment of the Committee as a breach of the Concession Agreement, DSW decided to seek relief and accordingly exercised its contractual right to commence arbitration proceedings. According to the terms of the arbitration clause, in the event of a dispute, each party should appoint an arbitrator on its behalf, who would in turn should together appoint a third arbitrator.

However the State refused to appoint an arbitrator, arguing that its undertaking not to introduce new legislation and impair the fiscal status quo between the parties, did not prohibit the Committee from considering DSW's income and revenues when forming its recommendations for a revised fiscal policy.

In response, DSW filed a motion with the Jerusalem District Court (OM 49394-04-14) asking the court to appoint the second arbitrator on behalf of the State.

The court denied DSW’s motion, claiming, inter alia, that the dispute in question had not materialized, and more significantly that it would be inappropriate for the court to appoint an arbitrator to decide on the lawfulness of legislation enacted by the Israeli parliament.

Accordingly, even though the parties carefully drafted a specific arbitration clause which detailed the mechanisms by which to resolve their disputes, the court frustrated the arbitration agreement, and DSW's legitimate expectation to resolve the alleged breach through arbitration.

This court decision highlights the problems parties may encounter in trying to enforce an arbitration agreement against a sovereign state in local courts, especially in relation to matters under public debate, and involving policy concerns. As this case shows, this concern, usually raised to justify the existence of the ICSID regime and investor-state arbitration, exists in Israel, not only with respect to foreign investors but also to Israeli companies and nationals.

How can parties avoid the disastrous effects of frustrated arbitration agreements? We suggest adopting one of two solutions:

  1. appoint a neutral party, agent or institute (such as the ICC, LCIA or AAA secretariats) to appoint and observe the arbitration proceedings instead of the local courts; or
  2. draft the arbitration agreement in such a way to limit the court's discretion to refuse to appoint an arbitrator;

Otherwise you may be dragged into the muddy waters of the Dead Sea.