Entering into contracts with states or state owned enterprises can give rise to significant risks. A key risk is the state counterparty enacting legislation that impacts directly on the contractual relationship to the detriment of the non-state party. This is of particular importance for those engaged in energy or other large infrastructure projects in emerging markets and developing economies where this issue is a more commonly encountered problem.
In its recent decision in Reliance Industries Ltd. v Union of India , the English Commercial Court confirmed, for the first time, that the foreign act of state doctrine (which in essence provides that a court will not question the validity or effect of a foreign state's legislative acts) applies not just to litigation in the English courts, but also to English-seated arbitrations.
The decision highlights the importance of parties who are contracting with states deciding whether disputes are to be resolved by court proceedings or arbitration, and ensuring that they are protected if the state takes unilateral legislative action by including, for example, a carefully drafted stabilisation clause or making sure that they benefit from any available investment treaty protection.
In 1994, the Claimants (two Indian oil and gas companies), along with an Indian Government-owned company (collectively, the Contractors), and the Defendant (the Indian Government) entered into two long-term production-sharing contracts (PSCs) relating to oil and gas fields off the west coast of India.
Both the Contractors and the Government sold their respective shares of the oil and gas produced from those fields to two Government-controlled companies. In 2003, the Indian Ministry of Petroleum and Natural Gas issued an office memorandum (OM) providing that, if the Contractors did not make payments to the Government as required by the PSCs or other applicable law, the Government (or its nominees) must withhold payments from the Contractors until payment was made. Each of the Government-controlled companies withheld one payment to the Contractors pursuant to the OM.
In 2010, the Claimants commenced arbitration against the Government in London under the arbitration clause in the PSCs in relation to various disputes between them. The arbitration is ongoing, but the Tribunal has made five awards to date, including a 2016 partial award on the merits. This award was the subject of the challenges before the Commercial Court.
The Claimants made nine challenges to the award pursuant to sections 67 (substantive jurisdiction), 68 (serious irregularity) and 69 (appeal on a point of law) of the Arbitration Act 1996.
One of the Claimants' nine challenges (referred to as the "Withholdings Claim") concerned the withholding of payments to the Contractors under the OM. In the arbitration, the Government argued that the OM was an executive order passed by the Government as a legislative act and that the Government's sovereign powers (including legislative action) were not limited by the PSCs. Therefore, the withholding was required by applicable law.
The Tribunal found that, notwithstanding that the Government was the principal debtor under the PSCs and was on the face of it liable to make payment, the Tribunal did not have jurisdiction to decide whether the Government was entitled to make withholdings under the OM. The Tribunal's jurisdiction was limited to questions under the PSCs and did not extend to whether the government could expropriate substantive rights through legislation (such as the OM).
The foreign act of state doctrine
The foreign act of state doctrine is an established Anglo-American jurisprudential principle that means a court will not inquire into the legality of acts of a foreign state, in particular:
- legislative acts of a foreign state; and
- executive acts of a foreign state concerning property in its territory.
The Claimants challenged the Tribunal's finding on jurisdiction in the Commercial Court, including on the basis that the foreign act of state doctrine does not apply in arbitration.
The Court's decision
Popplewell J dismissed the Claimants' challenge on this issue, holding that the Tribunal was correct to find that it lacked jurisdiction. The Withholding Claim could only be resolved in favour of the Claimants by arbitrating issues that could not be ruled on by an English court because of the foreign act of state doctrine. There was no reason why this principle should be any less applicable in arbitration.
The judge first considered whether the issues in the Withholding Claim engaged the foreign act of state doctrine such that they would be non-justiciable in an English court. He held that the Claimants' submissions were a direct challenge to the validity of a sovereign legislative act of a foreign state in relation to property in its own territory, so the doctrine was engaged.
Second, the judge considered whether there should be any difference between the application of the principle in the English courts and in English-seated tribunals. He concluded that there was no good reason why the act of state doctrine should not apply in arbitration. While an English-seated tribunal, unlike an English court, is not an organ of the state, both are required to give effect to "a general principle of English private international law which recognises the sovereignty of nations within recognised spheres".
Confirmation that the act of state doctrine applies in English-seated arbitrations is a helpful clarification, particularly given that previous case law suggested it did not. However, for energy and natural resources companies contracting with foreign states and state entities, it raises the concerning risk of obligations becoming unenforceable if the state passes legislation affecting contractual performance, which neither a court nor an arbitral tribunal will adjudicate on.
There are various options for companies to protect themselves against this risk. One is for contracts to include a comprehensive stabilisation clause, which would protect against any economic loss arising from legislative change (enabling a company to bring a claim under that clause rather than any provision that directly conflicts with the relevant legislation or executive act). A second option is to include a specific clause in which the state expressly agrees not to invoke the foreign act of state doctrine in defence to any claims otherwise falling within the arbitration agreement. Third, the transaction could be structured so that relevant investment treaties apply, which could allow the company to bring claims for expropriation or unfair and inequitable treatment in appropriate circumstances.