The arbitral tribunal refused to defer its award pending the conclusion of foreign court proceedings: was this a serious irregularity?24 May 2018
Section 68 of the Arbitration Act 1996 sets out a number of grounds on which a challenge may be made to an arbitration award, including (at section 68(2)(a)) a failure by the tribunal to comply with section 33. Section 33 in turn sets out the general duty of the tribunal to conduct the arbitration fairly, including by
- acting “fairly and impartially as between the parties, giving each party a reasonable opportunity of putting his case and dealing with that of his opponent” and
- adopting “procedures suitable to the circumstances of the particular case, avoiding unnecessary delay or expense, so to provide a fair means for the resolution of the matters falling to be determined“.
To succeed under section 68, a party has to show in addition that the serious irregularity “has caused or will cause substantial injustice to the applicant“. To put things in context, while such applications are not infrequently made, it has to be said that they tend to fare badly, and the success rate is not good.
The case of SCM Financial Overseas v Raga Establishment (3 May 2018) concerned a Sale and Purchase Agreement (SPA) between two Cypriot companies.
To put it very briefly: Raga sold to SCM for some US$860m its shares in a company whose principal value was that they gave an indirect majority shareholding in Ukrtelecom, a major telephone operator in Ukraine. Ukrtelecom had been privatised in 2011.
In more detail, SCM was ultimately owned by a Ukrainian company, a member of a substantial group. Raga was a subsidiary of an Austrian international financial company and owned the issued share capital in UA Telecominvest (UAT), which in turn owned the shares in ESU, which in turn owned 92.7906% of the shares in Ukrtelecom. Ukrtelecom was one of the largest fixed line telephone operators in Ukraine, having previously been in public ownership until 2011, when the State Property Fund of Ukraine (SPFU) privatised it by means of an agreement between SPFU and ESU – this agreement was subject to Ukrainian law and imposed various obligations on ESU.
Under Raga’s and SCM’s SPA, the second and third instalments totalling over US$760m had not been paid. Raga commenced the arbitration proceedings to secure payment of these instalments.
SCM’s defence was that Raga was in breach of various conditions of the privatisation agreement, which meant that the Ukrainian state would be likely to confiscate the shares in Ukrtelecom without paying compensation. This meant that it had paid a lot of money for an asset that was effectively worthless.
The upshot of these contentions was that the arbitral tribunal had to consider whether Raga (or rather, ESU, whose shares Raga owned) was in fact in breach of the privatisation agreement – the very same determination that the Ukrainian courts had to make. When the arbitration was commenced, the Ukrainian authorities had started an investigation, but there were no court proceedings in the Ukraine yet.
SCM was concerned to avoid having to pay for shares that were likely to be confiscated and applied to the tribunal to defer any award until the Ukrainian courts had decided the matter one way or the other. The tribunal declined to do so and gave directions for a hearing which concluded on 19 May 2017.
Meanwhile in Ukraine, investigations had got underway, leading to various findings and a report by SPFU on 17 February 2017 concluding that privatisation agreement should be rescinded and the shares in Ukrtelecom returned to the state. On 10 May 2017, the SPFU filed proceedings against ESU in the Ukrainian courts, claiming the termination of the privatisation agreement and the return of the Ukrtelecom shares to the state.
On 18 May 2017, SCM’s lawyers brought the Ukrainian claim to the tribunal’s attention and argued that the tribunal should defer any award until the court proceedings in Ukraine had been determined.
On 26 June 2017, the tribunal found by its award in favour of Raga, concluding that SCM had not shown any breach by Raga of the SPA. The tribunal regarded the absence of a Ukrainian court’s decision on the privatisation agreement as “significant”, especially since the tribunal did not rule out political machinations in the allegations against ESU, given that its ultimate owner had been a political ally of the ousted president, Yanukovich.
SCM challenged the award on the ground of serious irregularity, arguing that the tribunal’s decision not to defer the award led to a real risk that the Ukrtelecom shares would be confiscated without compensation, causing substantial injustice to SCM.
On 19 October 2017, the Ukrainian court decided, contrary to the tribunal’s findings, that the privatisation agreement should be rescinded and the shares should be confiscated without compensation. It also subjected ESU to a penalty of US$81.9m. The court relied heavily on the reports of the government entities, which the tribunal had been cautious about accepting because of the risk of political influence.
Finally, ESU’s appeal to the Commercial Court of Appeal in Kiev was dismissed on 12 December 2017. As at 15 May 2018, ESU’s appeal to the Supreme Court was due to be heard.
The judgment – legal principles applicable
Males J observed that, for a challenge for serious irregularity under section 68 to succeed, it must be shown that something had gone badly wrong with the fairness of the procedure. This meant, as the judge observed, that decisions by arbitrators will be upheld regardless of whether the court thinks they are right or wrong.
The judge made a number of observations in approaching the facts of this case:
- whether the tribunal’s decision not to defer the award was an irregularity must be determined as at the date of the publication of the award
- what must be shown is unfairness by the arbitrators – not just a mistake or misunderstanding by the losing party or its lawyers
- the standards demanded of the tribunal are not unduly demanding – a party may have been given a reasonable opportunity to put its case even if there was more evidence that could have been adduced and a procedure can be fair even if it is not perfect
- the tribunal must avoid unnecessary delay – deferring an award could itself be unfair and in breach of the tribunal’s duty under section 33 of the Arbitration Act 1996
- the court will look at the reasons given by the tribunal for its decision, but the real question is whether the procedure has been fair
- it is necessary to show that the irregularity “has caused or will cause” substantial injustice – it is not enough to show that it may do, so if the injustice has not yet occurred, the court must form a view about whether it will do so
- it is not necessary to show that, but for the irregularity, the result of the arbitration would have been different – there would be a substantial injustice if the result “might well” have been different
- choosing arbitration carries with a risk of inconsistent decisions – and this is simply a risk the parties take when they opt for arbitration
Judgment – applying the principles to the facts
The tribunal explained its decision not to defer its award on the basis that waiting might result in uncertainty over a lengthy period, and that this would be contrary to the tribunal’s duty to adopt procedures which avoided unnecessary delay and expense. The tribunal also thought that, on the basis of the evidence before it, the Ukrainian court would be likely to reach the same conclusion as it did.
The tribunal was, as it turned out, wrong on both these views: the court proceedings in Ukraine were swift (albeit pending the decision of the Supreme Court) and (again, pending the Supreme Court’s decision) had come to diametrically the opposite conclusion reached by the tribunal.
The judge therefore thought that the decision of the Ukrainian court was potentially important evidence – though not conclusive, as the tribunal could still, if it wished, come to its own conclusions of law and fact.
It came down to the facts in each case – a decision not to defer an award pending further evidence would certainly be capable of being a breach of a tribunal’s duty under section 33. The relevant matters had to be assessed as at the date of the award.
As at that time, the tribunal had no evidence as to how long the Ukrainian proceedings would last and it was entitled to proceed on the basis that it had been provided with whatever relevant information was available to the parties. It was not right to impose on the tribunal the burden of asking for that information.
The possibility of the Ukrainian court reaching a different conclusion represented a prejudice to SCM but to some extent it was the sort of risk inherent in the parties having chosen arbitration. As against which, deferring the award would mean that Raga was kept out of its money for what might be a lengthy period and might make eventual enforcement of the award more difficult. This was against a background that Raga might dissipate its assets despite freezing orders and undertakings.
In the end, any tribunal has a very wide discretion as to how to proceed. The tribunal could not have been criticised if it had decided to defer the issue of its award, at least for a short while, so as to get more information about the issues and likely timescale. However, the decision the tribunal actually came to was one it was entitled to take, and so was not unfair under section 33. There was therefore no irregularity and the question of substantial injustice did not arise.
One’s immediate feeling of injustice is great in this case – SCM paid an awful lot of money for something that it did not get and, pending a decision from Ukraine’s Supreme Court, may still not get. However, the judge was right to focus on the evidence and facts as they stood as at the time of the tribunal’s award, ignoring what actually happened thereafter, what might I suppose be called “20-20 foresight” as opposed to “20-20 hindsight”.
The most important features to note in my view are as follows:
- it is up to the parties to adduce the evidence they intend to rely on before the tribunal – and the court was not prepared to impose on the tribunal the burden of teasing out the evidence as to likely delays in the Ukrainian court system
- the tribunal had a tricky task but its procedural decision was capable of being challenged under section 68, the judge commenting that to characterise the tribunal’s decision as just case management did not advance the matter
- the judge made it brutally plain that choosing arbitration carried with it the risk of inconsistent decisions – and that parties are to be taken to accept this as part of parcel of electing arbitration as their chosen dispute resolution process
- the tribunal could have come up with a range of decisions, none of which could have been held to be unfair, so it might have deferred and remained beyond successful challenge – the fact is that a tribunal has a broad discretion in coming to the decisions it does and the court will not (in general) interfere
As always, this is a general update on a specific case and is not intended as general advice applicable to other situations.