Andrey Panov September 11 2014 Court affirms non-arbitrability of disputes involving public element Norton Rose Fulbright | Arbitration & ADR - Russia Andrey Panov Arbitration & ADR BackgroundPublic procurement contractsLease contracts for forest plotsCommentThe presidium of the Supreme Arbitrazh Court recently published two resolutions in cases which arguably provide guidance as to the arbitrability of disputes arising from contracts with a high concentration of public elements. While both cases concern domestic – rather than international – arbitration, they touch on the public interest implications of arbitrability, the validity of arbitration agreements and public policy in general.BackgroundThe idea that public elements in disputes may affect their arbitrability is by no means new to the Russian courts. Previously, the Supreme Arbitrazh Court took a now-infamous approach to the arbitrability of real estate disputes that was later overruled by the Constitutional Court. This position was set out in Section 27 of Informational Letter 96 (December 22 2005) of the presidium of the Supreme Arbitrazh Court.(1) It was subsequently applied in 2009 in the well-known case of Kalinka Stockmann v Smolensky Passazh.(2) Nevertheless, this practice was later overturned by the Constitutional Court, which held that real estate disputes between private parties are arbitrable.(3)Moreover, in 2012 the Supreme Arbitrazh Court ruled in Aldega v Krasnozavodsk that disputes involving the exercise of public functions by local authorities are non-arbitrable.(4) The case concerned an investment agreement whereby the local authorities agreed to provide the claimant with a land plot and ensure that all relevant authorisations would be issued for the investor to erect two multi-storey blocks in Krasnozavodsk (Moscow Region). The investor requested termination of the agreement and damages, which were awarded by an arbitral tribunal. However, the local authorities did not voluntarily comply with the award and the claimant sought its enforcement in the arbitrazh courts.The lower courts refused enforcement of the award and their rulings were subsequently endorsed by the presidium of the Supreme Arbitrazh Court. The presidium ruled that the investment contract contained no civil law obligations on the part of the local authorities, since their obligations (including providing the relevant land plot, refraining from privatising and dissipating the plot, and ensuring necessary gas and electricity supply) were public law obligations and were directly linked to the exercise of public functions. Therefore, the disputes concerning the local authorities' failure to fulfil such obligations could not be referred to domestic arbitration, which can serve as a method of resolution only for private disputes.Public procurement contractsIn Major Repairs and Construction Agency at the Health Department of Moscow v ArbatStroy the Supreme Arbitrazh Court declared that public procurement disputes are non-arbitrable under Russian law.(5) The dispute concerned a contract concluded between the agency and ArbatStroy in accordance with the Federal Law on Placing Orders for the Supply of Goods, Making Works and Rendering Services for the State and Municipal Needs (94-FZ).(6) ArbatStroy undertook to carry out certain works in certain state hospitals in Moscow. The contract provided for the resolution of any resulting disputes by a domestic arbitral institution and the agency included an arbitration clause in the draft contract presented as part of the public tender.When the dispute arose, the arbitral tribunal ruled in favour of the agency and ordered ArbatStroy to pay the contractual penalty. The agency sought enforcement of the award, while ArbatStroy applied for its annulment. Although the lower courts granted the enforcement and refused to set aside the award, the Supreme Arbitrazh Court came to the opposite conclusion.Among other things, the court criticised the choice of arbitral institution, which had been established only a few months before the contract in question was concluded and whose caseload mostly related to public procurement contracts concluded by various agencies under the Health Department of Moscow. According to the presidium of the Supreme Arbitrazh Court, the agency's direct and non-transparent choice of arbitral institution ran contrary to the rules and purpose of public procurement legislation.In deciding that public procurement contracts are non-arbitrable, the presidium first considered the nature of contracts in the field of public procurement. It noted that such contracts are concluded by special public law bodies with a view to achieving certain results in the public interest and are financed out of the relevant government budgets. According to the presidium, such a high concentration of public elements means that disputes arising out of these contracts are not private in nature and therefore cannot be resolved through private means of dispute resolution (including arbitration).Further, the presidium noted that the applicable legislation provides that disputes are to be resolved by 'the courts', a term that does not include arbitral tribunals.(7) The relevant legislation provides rules governing termination as well as liability for non-performance of contracts. Since such disputes are to be resolved by the courts, arbitral tribunals have no jurisdiction over them. In addition, the public procurement legislation includes various mandatory provisions which:limit the discretion of the government body carrying out the public tender;stipulate the cases in which contracts may be concluded with the tender winner; andgovern the invalidation of the tender.Having outlined this, the presidium concluded that arbitral tribunals do not have jurisdiction to consider disputes relating to public procurement contracts or their validity.The presidium also noted that both the conclusion and performance of public procurement contracts are subject to the principles of transparency in order to combat corruption and other abuses. From this perspective, arbitration – which is based on the principles of confidentiality, procedural flexibility and relaxed rules of evidence, and where awards remain unpublished and cannot be appealed on the merits – is incompatible with the principles of the public procurement system.Finally, the presidium noted that the resolution of disputes through arbitration would lead to increased costs through applicable arbitration fees, which would be contrary to the principle of economy of budgetary funds.For these reasons, the presidium concluded that disputes arising from public procurement contracts are non-arbitrable and arbitration agreements in such contracts are null and void. The presidium further noted that resolution of such disputes by arbitral tribunals is contrary to Russian public policy.Lease contracts for forest plotsIn Ministry for the Environment and Ecology of Karelia v Forest-group the Supreme Arbitrazh Court likewise held that a dispute concerning the lease of forest plots could not be resolved through arbitration.(8)In this case the ministry lodged domestic arbitration proceedings in accordance with a forest plot lease agreement, seeking recovery of the outstanding rental payments allegedly owed by Forest-group. The arbitral tribunal issued an award allowing only a small fraction of the ministry's claim. The ministry applied for the award to be set aside on various grounds, including the alleged non-arbitrability of the dispute. The lower courts rejected the annulment application, finding that the lease contract contained an arbitration clause and the claim for recovery of the outstanding rental payments was a civil law dispute which could be referred to arbitration.The ministry subsequently filed a revision complaint. The presidium of the Supreme Arbitrazh Court allowed the appeal and set aside the award. The presidium closely followed its own reasoning in ArbatStroy.The court noted that contracts for the lease of forest plots are to be concluded through a public tender pursuant to the Forest Code (from this perspective, such contracts resemble public procurement contracts). The presidium further pointed out that lease contracts for forest plots are concluded by special public law bodies:with a view to leasing forest plots that are state or local government property;to ensure rational and renewable use of forests in order to satisfy public needs with respect to environmental and timber resources; andwith rent payable to the state or local government budget.The court therefore held that the characteristics of these contracts include a combination of public interests with the involvement of public law bodies and budgetary funds.The presidium further noted that, given the purpose of forest plot lease contracts, they should be concluded and performed in an open and transparent manner. Therefore, the specifics of arbitration do not ensure compliance with the principles of the relevant forestry legislation.For these reasons, disputes arising from forest plot lease agreements are non-arbitrable and arbitration agreements included in such contracts are invalid. The presidium further held that resolution of such disputes by arbitral tribunals is contrary to Russian public policy.CommentWhile forest plot lease contracts in principle share common features with public procurement contracts, the key element in both ArbatStroy and Forest-group is the combination of the public interest with the involvement of public law bodies and budgetary funding in the contractual relationships. Such a combination, according to the presidium of the Supreme Arbitrazh Court, renders disputes arising from such contracts non-arbitrable. All other arguments put forth by the court were supplementary.The real reason behind these decisions may lie in the Supreme Arbitrazh Court's well-known distrust of small domestic arbitral institutions. Support for this theory is grounded in the presidium's reasoning that the specifics of arbitration (in particular, its confidentiality) make it unsuitable for disputes with such a high concentration of public interests. While these may have been the last two cases in the Supreme Arbitrazh Court's crusade against suspicious Russian arbitration institutions before its abolition (for further details please see "Will judicial reform lead to disappearance of arbitrazh courts?"), the principle underlying them – pronounced in very general terms – may have unintended consequences.Soon after the ArbatStroy decision was published, the Ministry of Justice sought to introduce a complete prohibition on arbitrating public procurement disputes in the draft legislation on arbitration law reform. Meanwhile, the Russian Chamber of Commerce and Industry has been lobbying for disputes relating to the performance of public procurement contracts to be arbitrable.Further, there are certain other categories of contract with a similarly high concentration of public interests (eg, public-private partnership contracts, concession and production sharing agreements and engineering, procurement and construction contracts in major government-funded infrastructure projects). Most – if not all – such contracts contain arbitration clauses. However, the rulings in ArbatStroy and Forest-group, and potentially the relevant legislative initiatives, may well affect their enforceability.Arguably, the Russian courts' and legislature's position on the arbitrability of (for example) corporate disputes may not be of major relevance to parties intending to enforce potential arbitral awards outside Russia. On the contrary, the arbitrability of public procurement contracts is of major importance to foreign companies, as the only likely place of award enforcement will be in Russia. At the same time, government bodies should be no less interested in arbitrating disputes with foreign parties in order to benefit from the worldwide enforceability of arbitral awards.Therefore, the legislative and case law developments in this area – particularly in the context of the ongoing arbitration law reform – should be closely monitored by all parties dealing with Russian government bodies, as well as those envisaging entering into contracts with a high concentration of public elements.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 ([email protected]). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com.Endnotes(1) Available in Russian at arbitr.ru/?id_sec=354&id_doc=643&id_src=E1BBBD99F9BCFD80BF1C9B11D2F44BEF&filename=643.pdf.(2) Moscow Circuit Federal Arbitrazh Court Case А40-85645/2009 (December 4 2009), available in Russian at kad.arbitr.ru/PdfDocument/8c9d5e85-e39b-46a9-8ba7-468eda2d8c49/A40-85645-2009_20091204_Reshenija%20i%20postanovlenija.pdf.(3) Constitutional Court Resolution 10-P (May 26 2011), available in Russian at rg.ru/2011/06/08/ksrf-dok.html.(4) Resolution 17043/11 (April 3 2012) in Case A41-29131/10, available in Russian at kad.arbitr.ru/PdfDocument/f735a754-b16d-4c5c-a4a9-0a8640c447b6/A41-29131-2010_20120403_Reshenija%20i%20postanovlenija.pdf.(5) Resolution 11535/13 (January 28 2014) in Cases A40-148581/12 and A40-160147/12, available in Russian at kad.arbitr.ru/PdfDocument/b1a6fc04-fcae-4696-ab64-b35bdbe627bd/A40-148581-2012_20140128_Reshenija%20i%20postanovlenija.pdf.(6) This law was replaced by a new public procurement law on January 1 2014.(7) Arguably, this reasoning was already rejected by the Constitutional Court in Resolution 10-P (supra note 3), albeit in the context of different legislative provisions.(8) Resolution 11059/13 (February 11 2014) in Case A26-9592/2012, available in Russian at kad.arbitr.ru/PdfDocument/4ca66f80-c811-4224-a4a7-690192199511/A26-9592-2012_20140211_Reshenija%20i%20postanovlenija.pdf.