Background
Decisions
Comment


The Supreme Court recently issued a ruling whereby it effectively confirmed that an arbitration clause can be challenged separately and independently of the underlying contract. While the idea that an arbitration agreement is subject to relevant provisions of contract law is by no means new, allowing challenges to arbitration agreements in state courts is likely to be inconsistent with the Kompetenz-Kompetenz principle and may have unwelcome and far-reaching consequences.

Background

In North Caucasus Power Repair Company v Interregional Distributary Network Company of North Caucasus(1) the parties entered into an engineering, procurement and construction contract relating to development of project documentation and erection of certain electric power facilities in the North Caucasus region of Russia. The agreement provided for final and binding resolution of disputes by arbitration in an arbitral institution created under the auspices of a certain non-commercial partnership in the sphere of the power industry.

At some point the contractor challenged the validity of the arbitration clause (but not the underlying contract) in the arbitrazh (state) courts, relying on three main grounds:

  • It stated that the arbitration clause provided for resolution of disputes in the arbitral institution which did not pass the test of objective impartiality. It noted that five of the 14 members of the board of the non-commercial partnership under the auspices of which the relevant arbitral institution was created were appointed by the respondent's parent companies and other companies from the respondent's group.
  • It alleged that the contract in question was a contract of adhesion, as it was concluded on the respondent's terms and the claimant was unable to change or negotiate any of these terms. According to the applicable legislation on domestic arbitration, arbitration agreements relating to disputes arising out of contracts of adhesion can be concluded only after the dispute has arisen (ie, only submission agreements would be allowed in this context).
  • It argued that the contract was effectively a public law contract since the facilities in question were to be erected in the public interest.

Decisions

The first-instance court rejected the contention that the contract was concluded in the public interest and qualified as a contract of adhesion.(2) On the contrary, the appellate court agreed with the claimant's reasoning to this effect.(3) Moreover, the appellate court somewhat surprisingly found that the agreement that the arbitration should be final and binding – excluding recourse for setting aside – was illegal, despite the clear legislative provision acknowledging the validity and enforceability of such terms. All of these errors committed by the appellate court were corrected by the cassation court, which agreed with the judgment of the first-instance court.(4)

On the merits, the first-instance court found that the arbitration clause was invalid, because it provided for resolution of disputes by arbitration in an arbitral institution that could not be considered objectively impartial. The court then referred to a number of cases heard by the Supreme Arbitrazh Court in which its position on the objective impartiality of arbitral institutions as a condition for validity of arbitration agreements was spelled out. Specifically, the court found that the board of the non-commercial partnership had approved the list of arbitrators and the provisions on arbitrator fees, and had appointed the president of the arbitral institution. On this basis, the court concluded that the board could have influenced the arbitral institution's activities; under theses circumstances, the arbitral institution could not ensure the impartiality and independence of one of the parties.

The court also noted that it was under no duty to refer parties to arbitration, since the arbitration clause was found invalid. Interestingly, this conclusion departs from earlier court practice in which the courts would refuse to hear claims relating to invalidity of arbitration clauses by virtue of the Kompetenz-Kompetenz principle.

The cassation court, having supported the first-instance court's judgment, mentioned in passim that the arbitration clause is a civil law contract and, as such, can be challenged independently of the underlying agreement. This view was fully supported by the Supreme Court, which refused to grant leave for further appeal.(5) In particular, the Supreme Court agreed with the lower court's conclusion that "an arbitration clause is a civil law contract by nature and that consequently the provisions of civil law on invalidity of contracts are applicable to it".

Comment

As with many cases of this sort, the decision leaves more questions than answers. The case concerned domestic arbitration, which is governed by a separate law (not based on the United Nations Commission on International Trade Law (UNCITRAL) Model Law) and is not subject to the New York Convention 1958. Despite this, the legal regimes and underlying principles relevant to this case do not substantially distinguish (if at all) between domestic and international arbitration in Russia, and therefore this case may potentially be relevant in the international arbitration context as well. In particular, there are at least three potential implications for international arbitration.

First, the courts seem to have departed from their earlier practice, which was primarily based on what can be considered the negative effect of the Kompetenz-Kompetenz principle. Before, Russian parties had to resort to so-called 'Russian torpedoes' to jeopardise arbitration or at least enforcement of the future awards in Russia. They needed to find a party not bound by an arbitration clause (eg, a minority shareholder or a spouse) to challenge the underlying contract together with the arbitration clause. If the parties are now allowed to challenge the validity of the arbitration clause themselves, it may open the gates too wide, facilitating various abuses and making launching Russian torpedoes an easy option.

It also follows that the courts are allowed to treat differently the claims for invalidation of arbitration clauses and those for invalidation of underlying contracts. If in the latter case the courts are bound to refer parties to arbitration, why would they be allowed to resolve the case on the merits themselves in the former case? In the context of international arbitration, this would arguably be inconsistent with the state's obligations under the New York Convention.

Second, the judgments in the present case seem to suggest that the courts would not limit their review to the prima facie validity of the arbitration clause (as presumably should be the case if the underlying contract is challenged). Allowing full review of the validity of an agreement to arbitrate would make abusive and dilatory tactics much easier to implement and would be inconsistent with the arbitration-friendly policy underlying not only the New York Convention, but also the UNCITRAL Model Law, which forms a basis for the Russian legislation on international commercial arbitration. Specifically, Article 5 of the UNCITRAL Model Law provides that "[i]n matters governed by this Law, no court shall intervene except where so provided in this Law". Needless to say, challenging the validity of an arbitration clause before the state court is not one of those specifically stipulated situations.

Third, the full review of the validity of an arbitration clause implies that numerous grounds for its validity may be potentially relevant. It was specifically stated in the decisions in question that the same grounds for invalidity would be application to the civil law contracts and arbitration agreements. While the choice-of-law questions were not touched on by the courts in this case, there are a number of potential grounds for invalidity which presumably may be invoked, irrespective of the applicable law. These may include lack of approval of the relevant contract (and arbitration clause), which is otherwise required by Russian corporate legislation (eg, in major or interested party transactions), or lack of authority to enter into the contract or arbitration clause.

Allowing parties to an arbitration agreement to challenge it before the state courts and independently of the main contract – and affording such situations special treatment inconsistent with the Kompetenz-Kompetenz principle – may have unexpected and unpleasant implications. It will also be damaging to Russia's aim to become a popular place for international arbitration. Moreover, foreign parties may want to make sure that dispute resolution agreements are structured in order to minimise any possible impact of potential challenges to arbitration clauses in Russian courts. In particular, the non-Russian parties would need to be able to enforce arbitral awards outside Russia if needed.

At the same time, this case may – and hopefully will – remain a standalone exception from the more arbitration-friendly approach that the Russian courts have recently started to develop.

For further information on this topic please contact Andrey Panov at Norton Rose Fulbright (Central Europe) LLP by telephone (+7 499 924 5101), fax (+7 499 924 5102) or email (andrey.panov@nortonrosefulbright.com). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com.

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Endnotes

(1) Case A63-1982/2013, available (in Russian) at kad.arbitr.ru/Card/8ae7f5b8-2078-4771-954f-4fa699a97276.

(2) First-instance court judgment available (in Russian) at kad.arbitr.ru/PdfDocument/0eff2244-3187-4315-83fd-3fd71fe1fe8a/A63-1982-2013_20130619_Reshenija%20i%20postanovlenija.pdf.

(3) Appellate court judgment available (in Russian) at kad.arbitr.ru/PdfDocument/0933b141-2ade-4c35-ab33-cd518f1a4674/A63-1982-2013_20131022_Reshenija%20i%20postanovlenija.pdf.

(4) Cassation court judgment available (in Russian) at kad.arbitr.ru/PdfDocument/6871b6ad-ae72-4abd-a631-ee6051a9e778/A63-1982-2013_20140421_Postanovlenie%20kassacii.pdf.

(5) Supreme Court ruling available (in Russian) at kad.arbitr.ru/PdfDocument/15627915-2d0d-4d72-8221-b49237b1e3ea/A63-1982-2013_20141006_Opredelenie.pdf.