Kluwer Law International

The judgment in the case of Mary Harvey v. Motor Insurer’s Bureau (QBD (Merc) (Manchester), Claim No: 0MA40077, 21 December 2011) just before Christmas provided another opportunity for the English courts to rule on their ability to consider appeals on a point of law.

This controversial power, retained in the UK’s Arbitration Act notwithstanding its absence from most other national legal systems, has often been criticised. Perhaps for this reason, the trend of the English courts in recent years has been increasingly to restrict its application. This latest, fully reasoned, judgment is no exception.

The Claimant, Mary Harvey, was a victim of a road traffic accident, and applied to the Motor Insurer’s Bureau (‘MIB’) for compensation for her injuries. Dissatisfied with the amount of compensation awarded, she served notice on the MIB requiring the matter to be submitted to arbitration. After an oral hearing, the arbitrator concluded that there was no evidence to infer that the driver of the vehicle that struck her was driving negligently, and concluded that the Claimant was not entitled to any compensation. She applied to the court, seeking leave to appeal under section 69 of the UK Arbitration Act on a question of law arising out of the Award.

In his judgment, Judge Hegarty QC reiterated certain features of appeals under section 69. It was clear that its provisions were ‘of a highly restrictive nature’. First, the only type of appeal that the courts can entertain is one involving a question of law arising out of an award, and that question must be one which the tribunal was asked to determine. Second, in the absence of an agreement between the parties, leave of the court is required before an appeal can be pursued, and, unless the question is one of ‘general public importance’, leave can be granted only if the decision is ‘obviously wrong’.

The court dismissed the application on the grounds that in essence this was an appeal on a question of fact, not of law. Citing the judgment of Steyn LJ in Geogas SA v. Trammo Gas Limited (The Baleares) [1993] 1 Ll Rep 215 at 228, the Judge affirmed the principle that any question as to the admissibility, relevance or weight of any evidential material was a matter solely for the arbitrator. The arbitrator’s findings of fact were ‘effectively immune from scrutiny’ by the courts, and this included not only primary facts but also any secondary findings or inferences of a factual nature.

The Judge commented further that: ‘I very much doubt if even a total absence of any evidential basis for a finding of fact can give rise to a question of law for the purposes of section 69’, though ‘it might conceivably amount to a serious irregularity under section 68(2)(a) of the Act’. A question of law might arise if, on the basis of the facts found by the tribunal, the conclusion which it reached was ‘outside the range which could properly have been arrived at by a tribunal which had properly directed itself as to the applicable law’. But it must still be possible to conclude that the error arose from a misapprehension or misapplication of law.

The case also raised questions regarding the application of the maxim res ipsa loquitor in this context, but after a full review the judge concluded that any failure to apply this maxim would not necessarily constitute an error of law, since ‘it simply refers to the way in which factual inferences may be drawn from other factual findings’.

Under English law (and virtually all other national systems) appeals are not possible from arbitral awards on questions of fact, probably even if the parties expressly so agree (Guangzhou Dockyards Co Ltd v. ENE Aegiali 1 [2010] EWHC 2826). Nevertheless, in contrast to the UNCITRAL Model Law and most other national systems, the provisions of the UK Arbitration Act are clear that there may be circumstances in which an appeal on a point of law will be available – the underlying justification focusing on the general public interest in the law being correctly applied. But this case reaffirms the very limited grounds on which an appeal on a point of law may be available. As Judge Hegarty noted, this limited right reflects ‘the increasing recognition accorded to the autonomy of the arbitral process’.

Of course, section 69 is a non-mandatory provision: in contrast to rights to challenge awards under sections 67 (lack of jurisdiction) and 68 (serious irregularity), the parties can, by agreement, opt out of it. This requires clear language, however (see, for example, Shell Egypt West Manzala GmbH v. Dana Gas Egypt Ltd [2009] EWHC 2097 (Comm)). An opt-out is also achieved where parties elect to apply institutional rules such as those of the ICC or the LCIA, whose articles 34(6) and 26.9 respectively provide for a waiver of a right to any form of recourse regarding the award, insofar as such waiver can validly be made.

As mentioned, there are few other legal systems where a right to appeal on a point of law exists, and it seems their number is diminishing. There is no express right under the US Federal Arbitration Act (‘FAA’) to appeal an arbitral award on a point of law. US courts have found in the past that awards could be set aside where there has been a ‘manifest disregard of the law’ (following the dictum in Wilko v. Swan 346 US 427 (1953)). But recent cases suggest that this may no longer be the correct position, and Awards may only be challenged on the basis of the specific categories set out in the FAA (Hall Street Associates, LLC v. Mattel, Inc 522 US 576 (2008), followed in Medicine Shoppe International, Inc v. Turner Investments, Inc  614 F3d 485 (8th Cir. 2010)). Under English law, the right to appeal on a point of law is enshrined in statute, but the circumstances in which it can be invoked are applied by the courts only on a very restrictive basis.

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It has become fashionable in recent years, each time an ICSID annulment decision is released that takes issue with the procedures or reasoning of an ICSID tribunal, for commentators to bemoan the lack of certainty, predictability and finality that this reflects in the ICSID system for adjudicating investment treaty disputes between investors and host States. Some commentators urge a return to greater use of ad hoc UNCITRAL arbitration, or arbitration before institutions other than ICSID, to avoid the perceived vagaries of the ICSID annulment process. Yet commentators often forget that these alternatives carry their own risks of uncertainty, inherent in the national court review process that can be invoked with respect to any arbitration subject to challenge and enforcement under the New York Convention. Last week’s U.S. court decision in Argentina v. BG Group (D.C. Court of Appeals, No. 1:08-cv-00485) reminds us that whatever arbitral mechanism the parties select, some risk of uncertainty is unavoidable. The debate between ICSID and alternative forums thus should not be framed as one about avoiding uncertainty and promoting finality, but rather about a more fundamental question: who decides?

Much to the surprise of many seasoned international arbitration practitioners, the D.C. Circuit vacated a US$ 185.3 million Final Award against Argentina, essentially nullifying a hard-fought, four-and-a-half year arbitration between the parties. The court vacated the Award on the basis that the “arbitral panel rendered a decision . . . without regard to the contracting parties’ agreement establishing a precondition to arbitration,” namely the clause in the Argentina-UK bilateral investment treaty (BIT) requiring claimants to submit disputes to the Argentine courts for 18 months before resorting to arbitration. In the underlying UNCITRAL arbitration, the tribunal had considered whether the dispute was admissible without having been first submitted to the Argentine courts. It ruled that such submission was not essential because it in this case it would have been an exercise in futility: the claimant could not have obtained relief anyway from the Argentine courts, given the Republic’s apparent interference with access to the courts and its punishment of all would-be local court litigants by excluding them from contract renegotiations. The tribunal concluded that in these circumstances, the 18-month provision could not “be construed as an absolute impediment to arbitration,” and therefore deemed BG Group’s arbitration claims admissible.

By contrast, the D.C. Circuit concluded that this entire analysis was misplaced, since in its view the BIT terms—which it analyzed principally by reference to U.S. domestic law on contractual intent to arbitrate, rather than under the Vienna Convention—were clearly designed to require prior recourse to the Argentine courts. The court found that the tribunal had exceeded its powers by permitting direct access to arbitration contrary to that expressed intent. Indeed, the court suggested that under U.S. case law, the tribunal should not have even engaged in an analysis of the feasibility or usefulness of prior resort to the Argentine courts, because as a threshold matter it had no proper authority under the BIT to admit such issues for substantive consideration.

In the most narrow sense, the D.C. Circuit’s decision did not directly repudiate the years of fairly consistent rulings by ICSID and UNCITRAL tribunals with respect to the 18-month local court requirement under similar Argentine BITs. That is because the BG Group tribunal had not relied on the BIT’s most-favored-nation (MFN) clause, upon which prior tribunals had rested their decisions, even though BG Group did argue that point. Nonetheless, the D.C. Circuit’s analysis implicitly suggests that it also might have overturned an MFN-based decision, since by the Court’s logic, the tribunals who rendered those decisions likewise would have had no authority to bypass the BIT parties’ allegedly clear intent to require local court proceedings in all circumstances. If the decision is read in this broader way, it can be seen as impugning the core logic of many prior decisions. This would include Maffezini v. Spain (ICSID Case No. ARB/97/7, 1 September 2000), where the tribunal allowed an Argentine investor to invoke (by way of an MFN clause) the Chile-Spain BIT to avoid the domestic court prerequisite in the Argentina-Spain BIT; Siemens v. Argentina (ICSID Case No. ARB/028, Decision on Jurisdiction, 3 August 2004), where the tribunal permitted a German investor to invoke the Argentina-Chile BIT to proceed directly to arbitration; National Grid plc v. Argentina (UNCITRAL, Decision on Jurisdiction, 20 June 2006), where the tribunal permitted a British investor to invoke a more favorable term in the Argentina-US BIT to avoid 18 months of litigation in the Argentine courts; and several other cases in the same line. Until the D.C. Circuit’s opinion, the jurisprudence appeared to be converging on consensus regarding the 18-month waiting requirement, even though much controversy remained about the broader application of MFN clauses in other, less procedural, contexts.

Now, with one 17-page decision, a national court not only has completely up-ended the result in one major case, but also in the process unsettled what most observers had thought to be a progression towards certainty, predictability and finality with respect to this issue. Much can—and undoubtedly will— be written about the substance of the court’s analysis. But at heart, it serves as a reminder that some degree of uncertainty is inherent in international arbitration in any forum, so long as there is any mechanism for review and challenge of arbitral awards. This is just as true for the “alternative” routes of ad hoc UNCITRAL or non-ICSID institutional arbitration as it is for ICSID arbitration, since all non-ICSID mechanisms allow for national court challenges under the New York Convention, and national courts (once vested of the matter) may be tempted to apply their own national laws, including on core issues such as arbitrability. Arguably, the uncertainty of national court review may be even greater than that of ICSID annulment review, since most national court judges are comparatively unfamiliar with investment treaty jurisprudence and may be less concerned about contributing to the growth of consensus or emerging doctrine. The choice between the two systems, thus, should not be framed as a quest for predictability and finality, but rather as something more fundamental: a decision about which decision-makers will evaluate challenges, and what rules and standard of review they will use in deciding.

By Jean E. Kalicki and Dawn Yamane Hewett

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Following the path of the hotly debated West Tankers decision, in African Fertilizers v BD Shipsnavo, the English Commercial Court held that a declaratory award is enforceable, allowing judgment to be entered on the same terms as the arbitral award. Such an order enables a party to obtain the material benefit of the award and indicates the continuing trend of the English courts in favour of arbitration and the enforcement of arbitral awards. However, this approach does raise questions for the health of the inter-twining co-existence of the arbitration and court systems.

The declaratory award (on the tribunal’s jurisdiction) was made pursuant to an arbitration agreement contained in a bill of lading for the carriage of African Fertilizer’s cargo from Romania to Nigeria. The English court had given the claimant, Shipsnavo, leave to enforce the arbitration award and to enter judgment again the defendant, African Fertilizers.

The English court had previously issued an injunction restraining African Fertilizer from continuing an arbitration in Romania, as well an interim declaration that such arbitration proceedings, together with court proceedings commenced in Romania, were both in breach of the arbitration agreement.

Shipsnavo had sought an order for enforcement under s66 of the Arbitration Act 1996 because it was concerned that, should African Fertilizer be successful in its Romanian court proceedings, then it would seek to enforce that judgment under Article 34 of the Brussels Regulation 44/2001, notwithstanding the arbitration award. If Shipsnavo had already obtained an English judgment, then it could seek to resist the recognition of an irreconcilable judgment of the Romanian court.

African Fertilizers resisted the application on the ground that the English court had no jurisdiction to make such an order because the material terms of the award were in purely declaratory terms.

First, it argued that enforcement of an award of a purely declaratory nature is not possible (notwithstanding the ruling – albeit on appeal – in West Tankers). Second, it argued that a judgment entered under s66 of the 1996 Act does not constitute a judgment within the meaning of Article 34 of the Brussels Convention, relying on the ECJ case Solo Kleinmotoren v Boch.

The first limb raised questions of the distinction between “recognition” and “enforcement” in the context of New York Convention awards. African Fertilizers argued that the West Tankers decision was incorrect, that Shipsnavo really intended simply “recognition” of their award in order to defend any adverse Romanian court judgment, and enforcement was not appropriate. The court disagreed, aligning itself with the West Tankers decision and giving primacy to the party’s right to the benefit of the award. The court preferred the plain meaning of “enforce” in s66 of the Act, and cited both textbooks and case law in support of its jurisdiction to enforce a declaratory award.

The second limb was also rejected. The court distinguished the Solo Kleinmotoren decision as being a case about a court approved settlement, in which the ECJ held that a settlement agreement recorded in a court order is not a judgment for the purposes of Article 34(3). Beatson J commented that a settlement is essentially contractual, and while the “submission to arbitration is consensual, the outcome of the arbitration and contents of the award are not”. Further, there were public policy considerations. Citing Briggs on Civil Jurisdiction, Beatson J noted that an English court could not give “leave to enforce an arbitral award and then be required to recognise and enforce a foreign judgment which undermined or contradicted that arbitral award”.

However, there are public policy considerations not considered by the court. Shipsnavo’s objective in seeking to enforce the declaratory award was to pre-empt the enforcement of any irreconcilable judgment that may be given by the Romanian court. What happens if the Romanian courts do find in favour of African Fertilizers? The parties could each have irreconcilable judgments from England and Romania, arising from the same agreement.

While the pro-arbitration stance of the English courts is welcome, this approach can result in inconsistent judgments within Europe. It may be that the current proposals to reform the Brussels Regulation will go some way to temper this risk. The European Parliament’s Legal Affairs Committee (LAC) has proposed maintaining the arbitration exception to the Regulation, but with clarifications for the interface between arbitration and the courts. The first reading of the LAC’s report is reported to take place on 18 April 2012 and the process can take several years to pass through the European parliament. Are those reforms appropriate? And meanwhile, are there risks for the health of the inter-twining systems of justice that are arbitration and litigation?

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This is the second article in a three-part series summarising the main valuation methodologies used for the purposes of determining economic loss. In part one, I provided an overview of the market-approach methodology. I now turn to the income-based approach, focusing on the discounted cash flow (DCF) methodology.

In my previous article, I noted that a business is only worth what someone is prepared to pay for it. Under the market-approach to valuation, Company A’s worth may be informed at least in part by recent transactions in Company A itself and/ or businesses sufficiently comparable to Company A. The ability to apply usefully the market-approach ultimately depends on the availability of relevant and timely transaction data.

Whilst the market-approach provides a useful insight as to what price was paid for any given asset or business, it may be of less help if one wishes to know how the purchase price of a business was determined. Understanding the underlying value of a business, and the drivers of that value, is often central to the quantification of damages in international arbitration.

Although the purchase price of an asset can be determined by many factors, the underlying value of an asset is based on the future economic benefits that accrue to its owner. This notion is at the heart of the income-based approach to valuation. Within the overall income-based approach, one needs to distinguish between earnings methods and cash flow methods.

Earnings are analogous to the accounting profits that are generated by a company, and attributable to the ordinary shareholders. Since a company’s earnings can be heavily influenced by the specific accounting policies it adopts and applies, comparisons of earnings across different companies can sometimes be difficult. For this reason, valuers often choose to focus on a business’s actual cash flows as this avoids the distorting impact of accounting. On the other hand, where one does not have sufficient detail about the accounting treatments used, it may be easier to focus on earnings. There are a number of different valuation methodologies focusing on either cash flows or earning methods, a few of which are described very briefly in the footnote to this article.

Introduction to DCF

DCF continues to generate much discussion within the arbitration community; certainly, it is being used ever more frequently in support of claims, if anecdotal and personal experience is any guide. In my experience, however, DCF is not always properly understood by non-valuation professional and/ or is on occasions applied incorrectly. I do wonder if this explains, at least in part, why certain arbitrators are sometimes wary of making awards in respect of claims that are based on DCF valuations.

Although the basic principles may appear simple, great care needs to be taken when constructing a DCF model to avoid nullifying its value to the arbitral process. The output of a DCF model is a single number, representing the net present value (NPV) of a project’s or business’s projected future cash flows, discounted to take into account the time value of money and the uncertainty – both upside as well as downside – over the projected future earnings. Crucially, DCF focuses on cash movements rather than accounting profits. When DCF is applied correctly, the calculated NPV can approximate to the fair market value (FMV) of a project or business since it reflects the present value of the future cash flows and hence determines a price at which a well-informed and willing vendor and purchaser could transact.

The quality and relevance of the output from a DCF model depends on the quality of the inputs e.g. the reasonableness of the growth assumptions and the discount rate. As we shall see below, far from being a purely ‘mechanical’ exercise, the derivation of a business’s value under DCF requires considerable skill and judgement.

Overview of a DCF model

In order to prepare a DCF valuation, one needs to determine inter alia the following:

• The relevant time-period – a cash flow model will comprise firstly an explicit forecast period, e.g. the first 5-10 years. An explicit forecast period may seek to capture the initial growth of a company until net cash flows stabilise. For example, the net cash flows of a start-up business might grow by 200% in the first year, 100% in the second year, 50% in the third, and decline each year until stabilising at say 3% per year after year 10. Where the duration of a project is fixed (e.g. a non-renewable 20 year concession over a mine), one would normally expect to see an explicit forecast period only. Where a project has an indefinite life, a terminal growth calculation is usually added to value the cash flows from the end of the explicit forecast period to perpetuity.
• The future cash flows themselves – central to producing a robust DCF model is the ability to produce reasonable forecasts of future cash flows. The model should include, in cash terms, all revenues, direct and indirect costs, capital expenditure, working capital movements etc. Since we are only interested in cash, it will not include non-cash (accounting) items like depreciation and amortisation.
• What is being valued – Defining what precisely is being valued is key; for example, valuers distinguish between the enterprise value of a business (being the value to both debt holders and shareholders) and the equity value (the value to equity holders only). The precise DCF approach used will depend on what is being valued.
• The discount rate – discussed below

Determining the discount rate

As noted above, the projected cash flows need to be adjusted to reflect both the time value of money (€100 today is worth more than the right to €100 for certain in a year’s time) and the uncertainty of the future cash flows; the greater the relevant uncertainty over the projected earnings, the greater the discount rate needed. Another way of looking at this is to say that the discount rate reflects the expected or required return from investors; the greater the risks to which the investor is exposed, the higher the return required.

The calculation of the discount rate will depend on what is being valued; for example, if we are interested in the enterprise value of a business, the discount rate will typically be based on the weighted average of the returns required by debt holders (cost of debt) (after taking into account the tax benefits of debt finance) and equity holders (cost of equity); this is referred to as the after-tax weighted average cost of capital.

The usual starting point in calculating both the cost of debt and the cost of equity is the use of a so-called risk-free rate of return, being the yield on a ‘risk-free’ asset such as a long-term US government bond. [NB: In some contexts it is important to consider the risks in fact associated with an investment in US government debt]

Dealing firstly with the cost of debt, in general, since they are paid ahead of shareholders, and hence are exposed to less risk, debt holders require lower returns than equity holders. In addition to the risk-free rate, a premium will typically be added to take into account the additional risk of lending to a company rather than a government; this premium will be determined by factors such as existing indebtedness, the size of the business, ability to cover interest payments from profits etc.

Whereas the calculation of the cost of debt is relatively straightforward, the calculation of the cost of equity can include many risk premia. A common method of calculating the cost of equity is known as the capital asset pricing model (CAPM). In very general terms, one builds up the cost of equity by taking account of several risk premia including:

• the equity risk premium (the additional return required by holders of stocks over bonds) multiplied by beta (a measure of the sensitivity of a given stock to the overall market);
• a country risk premium (CRP) – The assessment of a suitable discount rate for an investment in a developing market or emerging economy (e.g. countries in the former soviet union) requires the investor to consider risks in addition to those related to investments in more mature, developed economies (such as the United States or Germany). The exercise is one of assessing a risk premium over the return required on investments in more mature, stable economies; and
• a small company risk or ‘size’ premium – whilst this is debatable, some valuers add an additional premium for small companies to reflect the perceived additional risks when compared with larger, more established companies

This is a complicated area, and a detailed treatment is beyond the scope of this article, but it suffices to say that selecting an appropriate discount rate is an art rather than a science. A major part of the quantum expert’s role is to demonstrate to the arbitral tribunal, in as clear and transparent a fashion as possible, that he has considered all relevant issues and has been reasonable in the calculation of the discount rate.

Strengths and weaknesses of the DCF approach

A major attraction of the DCF approach is its inherent flexibility in that it can be applied in many different contexts; it is a commonly accepted basis for assessing the present value of a project, company or asset and can also be used to appraise investment decisions. Importantly, DCF is company or project-specific. Finally, DCF expresses future cash flows in present day terms.

On the other hand, like all valuation methods, a DCF model is only ever as good as the data used and the underlying assumptions. On occasions, it may simply not be possible to make a reasonable estimate of projected future cash flows e.g. because there is insufficient contemporary and/ or historic data; were one to plough on regardless, the output from the DCF model is unlikely to be anything other than pure speculation. In such circumstances, it may be more appropriate to use different valuation methodologies. In any event, the DCF methodology is not the only approach and, as explained in part 1 of this series, best practice requires that a valuation produced under one approach is cross-checked against valuation(s) produced under (a) different approach(es). I discussed approaches to dealing with uncertainty in an earlier article which can be accessed here.

Common mistakes made with DCF

As noted above, it is this writer’s experience that DCF is sometimes applied incorrectly, rendering the results of a model useless at best and, at worst, dangerously misleading. Whilst the below is not intended to be an exhaustive list, here are some of the more common errors to watch out for:

• Overlooking capital expenditure – a DCF valuation which assumes steady growth in annual cash flows should also take into account the capital expenditure required to generate that growth. The re-investment of cash in the business is something which can easily be overlooked, resulting in unrealistically high valuations where capital expenditure is ignored. Where a DCF model includes a terminal period, it is critical that the final year of the explicit period reflects the likely annual capital expenditure going forward
• Overly-aggressive terminal growth assumptions – for the purposes of determining the terminal value component of the DCF valuation, the assumed long-term rate of growth should not exceed the sum of inflation and real GDP growth at the most.
• Double-counting of risk – the uncertainty of future cash flows can be taken into account either by directly adjusting the cash flows in the model or through the discount rate. Normally, one should not make adjustments to both as this would constitute double-counting of the risk
• Explicit period too long – uncertainty increases over time. For this reason, the explicit period should not be excessive.
• Scenarios / sensitivity analysis – best practice requires that the use of sensitivity analysis and/ or considering various scenarios (best case, worst case, base case) showing how the valuation changes as adjustments are made to the various inputs. It is not uncommon for small changes (e.g. to the assumed growth rate) to have a major impact on the valuation. Alas, best practice is not always followed, with the result that some valuations are not accompanied by sensitivity analysis.
• Mathematical errors – as a general rule, the risk that a DCF model will contain formulaic errors, errors in referencing data etc increases in direct proportion to the complexity of the model and the number of assumptions.

Impact of the financial crisis on the application of the DCF approach

Having provided above a very high-level overview of the DCF approach, I will consider briefly what implications the financial crisis has for the use of DCF valuations in international arbitration.
In some ways, the financial crisis has arguably changed nothing at all; as a mere methodology for quantifying damages, DCF remains as applicable as it was prior to autumn 2008. The financial crisis has, however, made the application of DCF, including the calculation of an appropriate discount rate, a far more challenging exercise than it was previously, for reasons I touch upon below.

Dealing firstly with factors impacting on the estimation of future cash flows, it cannot be forgotten that the current global economic climate is characterized by tremendous volatility and uncertainty. In constructing a DCF model, the valuer needs to undertake rigorous analysis to ensure that projections of revenue growth and profitability can be justified. The now common sight of major financial institutions and other businesses with household names going insolvent demonstrates clearly we are living in a time of unprecedented change. The valuer must try to make sense of this volatility and make sensible predictions of future cash flows. This is not the same as saying, however, that such projections need always be excessively conservative. Just as the word ‘crisis’ in Chinese is translated by two symbols representing respectively ‘danger’ and ‘opportunity’, so might the DCF model take into account the reality that some businesses (particularly those well-financed and with excess cash) stand to gain from others’ demise due to reduced competition, availability of key assets at fire-sell price etc.

The financial crisis has a number of potential impacts on the calculation of the discount rate. Firstly, the sovereign debt crisis and the well-publicized downgrading of US debt has called into question whether there exists a truly risk-free rate. Until recent events, bonds issued by the United States and other stable countries were widely considered the best proxy for the risk-free rate – a key component of the cost of capital – and, in many experts’ eyes, still are. With the threat of outright default in some countries and/ or destruction of the currency through monetary inflation in others, the idea of a risk-free rate can seem quaint! If the risk-free rate is not to be derived from US bond yields, however, what possible alternatives are there?

Two further factors to be considered in the calculation of the discount rate include the market-risk premium and the beta (explained above). Given high volatility, the observed premium of required equity returns over government bond yields can fluctuate significantly over short amounts of time. In a similar way, the beta of a given company in a given industry can also vary a great deal; it may be the case for example, that Company A had a beta of 1.5 on 1 January 2011 but that this subsequently increased to say 2.0 by the summer of 2012. It goes without saying that such changes are by their nature difficult to predict and yet this is precisely what the valuer is required to do.

Conclusion

In my experience, there are few circumstances in which a DCF method, properly applied, cannot be usefully adopted. On occasion, however, applying a DCF method properly can be both costly and difficult. Where such difficulties arise, if the same degree of relevance and reliability is required from the result, the issues giving rise to the difficulty and cost do not ‘go away’ simply by selecting a different method; on occasions where there is not an observable market price, all valuation methods (properly applied) – in one way or another – require one nonetheless to form a view about possible future outcomes and the uncertainty surrounding those outcomes.

Notes
Cash flow methods include Discounted Cash Flows or “DCF” (the focus on this article), and Capitalised Cash Flows, which derive a value for a company based on the company’s historical cash flows.

Earnings methods include Capitalised Earnings and Discounted future earnings. Whilst a detailed discussion of these methods is outside the scope of this article, under the capitalised earnings method, a company’s valuation is derived by dividing the expected annual maintainable earnings of the company (often based on an average of historical earnings) by the required earnings yield. This method is typically used where future earnings growth is expected to be minimal. If future earnings growth is expected to be high, the discounted future earnings method may be more appropriate. This method aims to calculate the present value of the expected future earnings of a business by using an appropriate discount rate.

A further methodology in the income-approach is the Discounted Dividends Model (DDM). Under the DDM, the value of an investor’s shares is based on the present value of the likely current and future dividends earned from those shares. DDM is typically used in the case of minority shareholdings and/ or where the relevant shareholder exercises little control.

©FTI Consulting, Inc., 2012. All rights reserved.
The views expressed in the article are held by the author and are not necessarily representative of FTI Consulting, Inc, or its other professionals. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual, entity or transaction. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation

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What makes an international arbitrator different from a national judge? All of us in the arbitration world have a pretty solid answer to this question. At what point do the distinctions between an international arbitrator and an international judge melt away? That’s a bit of a trickier question, depending on the case.

With the increase in investment law jurisprudence in recent years, we’ve become accustomed to seeing international judges sit on the same investment arbitration panels as commercial arbitrators with their own private practices. In any given arbitration, international judges serving as arbitrators are subject to the same challenge standards as their commercial arbitration peers. And they are not necessarily more immune to accusations of appointing-party bias than their commercial-world co-arbitrators.

But are there times when an international judge, sitting as an ad hoc arbitrator, should be nonetheless judged by the ethics applicable to international judges? On the wide spectrum of international dispute settlement — from private-to-private commercial arbitrations, to private-state disputes in investment arbitration, to state-to-state arbitrations, and finally, to state-to-state permanent tribunals — is there a point at which an arbitrator’s independence and impartiality standards have more in common with those of an international judge than to those of a commercial arbitrator? And if that tipping point isn’t to be found in hybrid public-private disputes like investor-state arbitrations, where is it to be found?

An arbitrator challenge decision released this month by the Permanent Court of Arbitration in the United Nations Convention on the Law of the Sea (“UNCLOS”) case between Mauritius and the United Kingdom gives one answer: the tipping point occurs with state-to-state arbitrations.

The decision concerns Mauritius’ challenge of the UK-appointed arbitrator, Sir Christopher Greenwood. Sir Greenwood currently sits as a Member of the International Court of Justice. Prior to his election to the Court, he served as a professor and a barrister, in the course of which he represented and advised both the UK and foreign governments. In the challenge decision, the remaining four members of the Tribunal, including Mauritius’ party-appointed arbitrator and three arbitrators appointed by the President of the International Tribunal for the Law of the Sea, addressed whether Judge Greenwood’s relationship to the UK Government should result in his disqualification from the dispute.

Mauritius did not argue that Judge Greenwood had advised the UK on the specific dispute before the tribunal (concerning a UK regulation regarding the Chagos Archipelago). Rather, it asserted that he has a “long-standing” and “close” working relationship with the UK Government. Mauritius was particularly concerned by the Judge’s participation in 2011 as a member of a Board to appoint the post of Legal Advisor to the British Foreign and Commonwealth Office (“FCO”). (The Legal Advisor has overall responsibility for the work of the FCO legal advisors, including their work on the Mauritius v. United Kingdom dispute.)

While Mauritius didn’t allege that Judge Greenwood was actually biased, it asserted that in light of his close relationship with the UK and his recent role in the FCO appointment, his participation on the tribunal permitted the appearance of bias or lack of independence. Mauritius argued, drawing on case law under the UNCITRAL Rules, the LCIA, ICSID, and the IBA Guidelines on Conflicts of Interest in International Arbitration, that an “appearance of bias” standard should apply to Judge Greenwood. According to Mauritius, the “appearance of bias” standard is “applicable to all arbitrations” and “there is no justification in law or policy for a different or lower standard of arbitral ethics in inter-State arbitrations, especially where the tribunal must resolve disputes that involve issues of national importance and great public interest.”

The United Kingdom, in contrast, argued the following:

Under the law and practice of these forums, “close past relationship” has never been a ground for challenging an arbitrator. In fact, according to the United Kingdom, “the law and practice applicable in inter-State arbitrations fully supports the election of judges with a close professional relationship to their own State, as shown by the record of most serving and previous ICJ and ITLOS judges, and the limited basis on which they are disqualified from sitting in particular cases.”

According to the UK, the law and practice of arbitrator challenges in international commercial and investment protection arbitrations are irrelevant. Those disputes involve “repeat arbitral appointments, whether by the same party or by the same law firm; potential for influence where arbitrators may be perceived as worrying about where their next appointment will come; [and] cross-overs, where individuals repeatedly switch between the roles of counsel and arbitrator”—in other words, a situation that the UK sees as different from Judge Greenwood’s appointment and role in the present state-to-state arbitration.

The Tribunal sided with the United Kingdom. In determining the applicable challenge standard for Judge Greenwood, the Tribunal first determined that all members composing an arbitral tribunal under Annex VII of the UNCLOS are required to maintain the highest reputation for “fairness, competence and integrity.” The Tribunal then drew on the law and practice of the International Court of Justice and the International Tribunal for the Law of the Sea. The Tribunal noted in particular the following provisions of the Statute of the International Court of Justice:

Article 16 requires that “no member of the Court may exercise any political or administrative function, or engage in any other occupation of a professional nature.” (The Tribunal noted, however, that Article 16 applies to judges only after their election to the Court, and does not disqualify those who exercised such functions before their election.)

Article 17 provides that (1) “No member of the Court may act as agent, counsel, or advocate in any case,” and that (2) “No Member of the Court may participate in the decision in any case in which he has previously taken part as agent, counsel, or advocate for one of the parties, or as a member of a national or international court, or of a commission of enquiry, or in any other capacity.”

The Tribunal rejected Mauritius’ reliance on the “appearance of bias” standard and the IBA Guidelines. It explained:

The Tribunal recalls that the system of inter-State dispute settlement is based upon the consent of the Parties, and more specifically upon the rules of public international law, the sources of which are set out in Article 38(1) of the Statute of the ICJ. In the Tribunal’s view, Mauritius has not demonstrated that the rules adopted by non-governmental institutions such as the IBA have been expressly adopted by States, nor do they form part of a general practice accepted as law, nor fall within any other of the sources of international law enumerated in Article 38(1) of the Statute of the ICJ.

The Tribunal stressed that Article 287(1) of the UNCLOS permits States the option alternatively to submit their case to ITLOS, the ICJ, or arbitration under Annex VII, and that these three options comprise the States’ consent to dispute settlement under the UNCLOS. The Tribunal considered that that the States parties could not have intended to apply different conditions of independence and impartiality to an Annex VII arbitration than to a dispute adjudicated by the ICJ or ITLOS.

The Tribunal’s decision is unlikely to prove controversial. Nonetheless, it’s worth asking whether the distinctions we tend to draw between arbitrators and judges — including the incentives that may affect their behavior and the ethics that should apply to them — are obsolete in the context of state-to-state disputes.

Certainly, some technical distinctions remain between international judges and appointed ad hoc arbitrators adjudicating state-to-state disputes. Unlike an ad hoc arbitrator, the Members of the ICJ are elected by the UN General Assembly to serve 9-year terms at the Court. They generally sit on all cases, unless they have been recused or unless a smaller Chamber of the Court has been constituted for a specific case. As such, ICJ Members receive their caseload (and their pay) from the Court, rather than from the State parties appearing before them.

The Tribunal in Mauritius v. United Kingdom did not address these distinctions. It’s tempting, nonetheless, to speculate as to why this distinction may not matter. Is it, as the UK suggests, that state-to-state arbitration occurs relatively infrequently, and that arbitrators are therefore less likely to focus their careers and income streams around securing future state-to-state arbitration appointments than other kinds of arbitration? Or is it that the arbitrators appointed to state-to-state disputes are more likely to come from a tiny pool of candidates, most of whom are public international lawyers and judges, who might all be disqualified if more stringent challenge standards were applied? Or is it something even more intangible? Is it that there is inherently a diplomatic culture or sensitivity that pervades inter-State disputes and sets them apart from other forms of arbitration? (See, e.g., the “Notes to the Text” of the PCA Optional Rules for Arbitrating Disputes Between Two States state that they are based on the UNCITRAL Arbitration Rules, with certain modifications, including, inter alia, modifications “to reflect the public international law character of disputes between States, and diplomatic practice appropriate to such disputes.”)

I’m inclined to think it’s a combination of all of the above. I’d welcome readers’ thoughts on the subject.

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On December 14, the Second Circuit rendered its decision in Figueiredo Ferraz e Engenharia de Projecto Ltda. v. Republic of Peru, 2001 WL 6188497 (2d Cir. Dec. 14, 2011), which represents a significant development in the court’s jurisprudence on forum non conveniens dismissals of actions to enforce foreign arbitral awards. As explained below, the decision also reveals anomalies in the New York Convention and the Federal Arbitration Act (FAA), which take the instruments beyond the scope of international commercial arbitration and, thus, may encourage forum non conveniens dismissals in certain cases.

As previously discussed in this blog, the Second Circuit drew criticism in 2002 by applying the forum non conveniens doctrine to dismiss an action brought by the Russian state gas company’s insurer to enforce an award not only against the Ukrainian state gas company named in the award, but also against the Ukrainian government. See Monegasque de Reassurances S.A.M. (Monde Re) v. Nak Naftogaz of Ukraine, 311 F.3d 488 (2d Cir. 2002); Charles H. Brower II, Reflection on Forum Non Conveniens: Monde Re Was Right?!?.

Contrary to general opinion in the field, this author supported the Second Circuit’s decision in Monde Re because the plaintiff did not only seek summary enforcement of the award against its counterparty to the arbitration, but also sought relief against a third-party government based on veil-piercing theories that would have raised difficult questions of foreign law, required the collection of evidence from government sources in foreign capitals, and drawn U.S. courts into a politically charged dispute about energy security in Europe. See Brower, supra.

At a high level of generality, the alignment of parties and the procedural history in Figueiredo called forth memories of Monde Re: the claimant brought an arbitration and received an award against a state-controlled program in Peru (“Water for All”), then sought enforcement in New York not only against the named counterparty, but also against the Republic of Peru based on veil-piercing arguments. Figueiredo Ferraz e Engenharia de Projecto Ltda. v. Republic of Peru, 655 F. Supp. 2d 361, 367 (S.D.N.Y. 2009). However, the similarity stops there. Contrary to the situation in Monde Re, the district court held that the veil-piercing arguments could be resolved without further collection of evidence because the Peruvian Ministry of Housing, Construction and Sanitation had itself: (1) made partial payments of sums due under the award; (2) asserted, in intra-governmental correspondence, that the Ministry of Economy and Finance had an obligation to satisfy the award; and (3) initiated proceedings to set aside the award in Peruvian courts. Id. at 371.

Also contrary to the situation in Monde Re, the case did not raise questions that would have drawn U.S. courts into explosive political controversies involving two or more foreign states. Given the simplicity of the issues and the absence of political baggage, the district court exercised its discretion not to dismiss the enforcement action on forum non conveniens grounds. Id. at 374-77.

In a final contrast to Monde Re, the Second Circuit reversed the district court’s denial of forum non conveniens dismissal, based almost exclusively on Peru’s interest in applying a domestic statute that prohibits state agencies from paying more than three percent of their annual operating budgets to satisfy any particular judgment. Figueiredo, 2011 WL 6188497, at *4-*5. Many observers read the Second Circuit’s decision as an unwelcome December surprise that (1) lowers the threshold for forum non conveniens dismissals in enforcement proceedings, and (2) increases opportunities for second-guessing of district courts inclined to retain jurisdiction over enforcement proceedings.

As in Monde Re, however, observers seem to have lost sight of critical facts underlying the Second Circuit’s decision in Figueiredo. These include the facts that: (1) Peru represented the legal seat of arbitration; (2) the arbitral tribunal rendered its decsion “ex aequo et bono” and awarded the claimant more than $21 million; (3) the Ministry requested a Peruvian court to set aside the award on the grounds that Peruvian law limits recovery to the amount of the contract for international arbitrations involving a non-domestic party; (4) the Peruvian court denied set-aside because the claimant “had designated itself a Peruvian domiciliary in the agreement and the arbitration,” with the result that “the arbitration was a ‘national arbitration’ involving only domestic parties”; (5) when seeking enforcement of the award in New York, the claimant described itself as a Brazilian corporation; and (6) Peru’s appellate brief stridently argued that the claimant should be deemed a Peruvian national, given the position it had taken in the agreement, the arbitration and the set-aside proceedings. Id. at *1 (emphasis added); Brief of Peru at 57-59; Reply Brief of Peru at 29. In short, one might describe the claimant’s tactics as vexatious, cloaking itself in a Peruvian flag to secure the higher measure of damages available in “national” arbitrations, then cloaking itself in a Brazilian flag to avoid the three-percent payment cap for national arbitrations.

As one reads the appellate briefs of the parties on the topic of nationality, the claimant distinguishes between corporate domicile and nationality, whereas Peru seems to equate the two—an outcome that seems consistent both with the Peruvian court’s conclusions in the set-aside proceedings and with U.S. definitions of corporate citizenship for purposes of diversity jurisdiction. Compare Brief of Figueiredo Ferraz e Engenharia de Projecto Ltda. at 70-72, with Brief of Peru at 57-59, and Reply Brief of Peru at 29. See also Figueiredo, 2011 WL 6188497, at *1; 28 U.S.C. § 1332(c)(1) (assigning citizenship to corporations based on place of incorporation and principal place of business).

While the district court’s analysis accepted the claimant’s distinction between domicile and nationality, the Second Circuit (1) emphasized the Peruvian court’s description of the arbitration as a “‘national arbitration’ involving only domestic parties,” and (2) seemed exceedingly reluctant to allow an ostensibly Peruvian entity to use enforcement proceedings to avoid the application of Peru’s statutory cap on payments when dealing with the Peruvian government in a contract both executed and performed in Peru. Compare Figueiredo, 655 F. Supp. 2d at 372, with id., 2011 WL 6188497, at *1, *5.

Whatever the proper legal designation of the claimant’s nationality, the case reveals anomalies in the New York Convention and the Federal Arbitration Act. If one assumes that the claimant donned Peruvian nationality as a matter of law, the case clearly escapes the scope of international arbitration, inasmuch as it represents a legal relationship solely between Peruvian entities, with contractual performance solely in Peru, and conduct of the arbitration proceedings solely in Peru. Viewed from that perspective, the case represents a national arbitration that falls squarely outside the scope of most instruments on international commercial arbitration.

Going back to the early history of international instruments on the topic, the 1923 Geneva Protocol on Arbitration Clauses applies only to agreements “between parties[] subject respectively to the jurisdiction of different contracting parties.” Geneva Protocol on Arbitration Clauses, art. 1, Sept. 24, 1923, 27 L.N.T.S. 157. The 1927 Geneva Convention on the Execution of Foreign Arbitral Awards applied only to awards “made in pursuance of an agreement . . . covered by the [1923 Geneva Protocol],” meaning an agreement between parties having diverse nationalities. Geneva Convention on the Execution of Foreign Arbitral Awards, art. 1, Sept. 26, 1927, 92 L.N.T.S. 302.

Similarly, the 1961 European Convention on International Commercial Arbitration applies only to agreements and awards “arising from international trade between physical or legal persons having . . . their habitual place of residence or their seat in different Contracting States.” European Convention on International Commercial Arbitration, art. I(1)(a), Apr. 21, 1961, 484 U.N.T.S. 364.

Likewise, in the preamble to the 1975 Inter-American (Panama) Convention on International Commercial Arbitration, states parties express their desire to “conclud[e] a convention on international commercial arbitration.” Inter-American Convention on International Commercial Arbitration, pmbl., 1438 U.N.T.S 248. While none of the operative articles expressly limits that instrument’s coverage to international commercial disputes, the limitation finds confirmation in Article 3, which provides: “In the absence of an express agreement between the parties, the arbitration shall be conducted in accordance with the rules of procedure of the Inter-American Commercial Arbitration Commission [(IACAC Rules)].” It seems unlikely that states parties, such as the United States, contemplated application of the IACAC Rules to purely domestic arbitrations in which the disputing parties failed to identify a set of arbitration rules. See H.R. Rep 101-501, reprinted in 1990 U.S.C.C.A.N. 675, 676-77 (emphasizing the Panama Convention’s role in facilitating “international commerce,” “trade,” and “foreign investment”). Cf. John P. Bowman, The Panama Convention and Its Implementation Under the Federal Arbitration Act, 11 Am. Rev. Int’l Arb. 1, 37 (2000) (“Application of the Panama Convention to international commercial arbitration permeates the Convention from beginning to end.”).

Finally, and most recently, the UNCITRAL Model Law on International Commercial Arbitration applies only to “international commercial arbitration,” defined to encompass situations where: (1) the parties have their places of business in different states; (2) the arbitration is seated outside the state in which the parties have their places of business; (3) a substantial place of contractual performance lies outside the state in which the parties have their places of business; or (4) the parties have expressly agreed that the subject matter of the dispute relates to more than one country. UNCITRAL Model Law on International Commercial Arbitration, art. 1(1), (3), U.N. Doc. A/40/17/Annex I (June 21, 1985).

In other words, on one view, Figueiredo involved relationships so squarely grounded in Peru that the resulting arbitration could not possibly have qualified for coverage by almost any of the leading instruments on international commercial arbitration—except, of course, the New York Convention.

True to its official name, the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, applies to any award rendered on the territory of a foreign state (or, if the state of enforcement has adopted the reciprocity reservation, the Convention applies to any award rendered on the territory of a foreign state party). Convention on the Recognition and Enforcement of Foreign Arbitral Awards, Art. I(1), (3), June 10, 1958, 330 U.N.T.S. 38.

Unlike almost every other leading instrument, the New York Convention does not require the disputing parties to have diverse nationalities or to engage in transactions that cross national borders. While the New York Convention aims primarily “to facilitate arbitration in international commerce,” and while an early ICC prototype had referred to “international awards,” concerns about a-national awards and the difficulties of defining international commerce prompted delegates to the New York Convention’s 1958 drafting conference to reorient that instrument’s coverage towards foreign awards. Albert Jan van den Berg, The New York Arbitration Convention of 1958, at 17 (1981). As a result, the New York Convention technically applies to foreign awards grounded in a single jurisdiction. Thus, for purposes of enforcement in the United States, an award falls under the Convention even if rendered in Paris between two French wine merchants under a contact for the sale of French wine. Id.

In his seminal work on the New York Convention, Albert Jan van den Berg described this phenomenon as a “harmless ‘side-effect’” that “scarcely occurs in practice” and had “not occurred in any of the reported cases.” Id. at 18. In addition, he opined that the New York Convention’s uniquely broad scope might prove useful in cases where the losing parties to domestic arbitrations possess substantial bank accounts in foreign jurisdictions. Id. While van den Berg’s assessment holds true as a general matter, one wonders if the “side-effect” remains so “harmless” when private parties exploit it to reach the assets of their own governments, thus draining the national treasury in violation of otherwise applicable national laws.

Confirming the potential for mischief in the circumstances just outlined, one need not search long for precedent rejecting the efforts of disgruntled national corporations to circumvent the limits of domestic redress against their own governments by invoking the machinery of international dispute settlement. Cf. Loewen Group, Inc. v. United States, ICSID Case No. ARB(AF)/98/3, Award ¶ 223 (June 26, 2003) (finding it “inconceivable” that states would negotiate treaties to provide their own citizens with international avenues for redress of regulatory disputes). This holds true even in the context of the New York Convention, where the only court to address the issue outside the Second Circuit invoked the forum non conveniens doctrine to dismiss an enforcement action brought by a foreign entity against its own government with respect to an arbitration involving public utilities and seated in the state of the disputing parties’ nationality. Termorio S.A. E.S.P. v. Electrificiadora del Atlantico S.A. E.S.P., 421 F. Supp. 2d 87, 103-04 (D.D.C. 2006).

Of course, the New York Convention’s unusually broad scope should not apply to cases that, like Figueiredo, arise under the Panama Convention. As mentioned above and recognized by some courts, the Panama Convention does not cover foreign awards involving parties, transactions, and arbitral proceedings grounded in a single foreign jurisdiction. See Energy Transport Ltd. v. M.V. San Sebastian, 348 F. Supp. 2d 186, 199 (S.D.N.Y. 2004) (“For example, if parties sought enforcement in the United States of an award rendered in Panama, involving only Panamanian citizens conducting a domestic transaction, the New York Convention would likely apply but the Inter-American Convention would not because of the award’s purely domestic character.”); Bowman, supra, at 39 (“Under the Panama Convention, . . . a foreign award rendered . . . in Uruguay, involving only Uruguayan citizens engaged in a domestic transaction, may not be enforceable.”).

However, this clear understanding of the Panama Convention’s scope reveals an anomaly in the FAA. Despite the obvious differences between the respective scopes of the Panama and New York Conventions, the United States inexplicably implemented the Panama Convention through a statutory provision that incorporates by reference most of the New York Convention’s implementing legislation. See 9 U.S.C. § 302. As a result, while the Panama Convention applies only to international commercial arbitration, the United States has extended its coverage by statute to awards grounded in a single foreign jurisdiction. Bowman, supra, at 39 n.104, 75. While “harmless” in most cases, this little-known “side-effect” could prove both unexpected and aggravating to foreign governments dealing with their own citizens in domestic transactions, on matters of public importance.

Given the United States’ relative lack of interest in localized disputes between foreign governments and their own nationals on matters of local importance, it seems wise for U.S. courts to preserve forum non conveniens dismissals as a possible antidote for the rare situations in which the New York Convention’s and the FAA’s unusually broad scope threatens to produce surprising results. Far from provoking allegations of treaty violations, such dismissals seem more likely to draw appreciation from states parties dealing with their own citizens on matters of the public interest.

For the reasons stated above, the Second Circuit’s decision in Figueiredo deserves more sympathetic consideration than accorded by most observers. Likewise, the forum non conveniens doctrine deserves slightly better treatment than the categorical rejection adopted by the draft Restatement on the U.S. Law of International Commercial Arbitration. By failing to leave any opening for forum non conveniens dismissals, the Restatement’s drafters run the risk that their final product will draw the same respect expressed by the majority in Figueiredo, which damned the ALI’s work by failing to mention it at all.

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On behalf of the many contributors to this blog and the good folks at Kluwer Law International, I am pleased to announce that this blog has won CPR’s 2011 award for best electronic media focused on ADR. The press release is here.

As most of you know, the CPR Institute is a nonprofit think tank and alliance of global corporations, law firms, scholars, and public institutions dedicated to the principles of commercial conflict prevention and alternative dispute resolution. The “Best Electronic Media Award” is presented annually to “a company, group, or individual that has produced exceptional electronic media that was focused on the field of Alternative Dispute Resolution.”

CPR presented the award at a wonderful dinner in New York last week as evidenced by the photo.

(Tali Finkelstein (left), Roger Alford (center), and Leslie Alford (right))

Without sounding cliché, the award recognizes the outstanding work of all of our permanent and guest contributors, and the tireless support from Kluwer Law International (with a special shout out to KLI superstars Gwen de Vries, Eleanor Taylor, Vincent Verschoor, and Raymond Blijd).

Others CPR winners include:
ADR Center in Italy for Outstanding Practical Achievement;
Roselle Wissler for Outstanding Professional Article;
Stacie Strong for Outstanding Short Article;
Michael Diamond and Nate Mealey for Outstanding Student Articles;
Douglas Noll for Outstanding Book.

Congrats to all!

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The P.R.I.M.E. Finance dispute resolution services and its Arbitration and Mediation Rules were launched at the opening conference of P.R.I.M.E. Finance in the Peace Palace in The Hague on 16 January 2012. Dutch Minister of Finance Jan-Kees de Jager officially opened P.R.I.M.E. Finance, which offers dispute resolution services in the area of complex financial products.

The P.R.I.M.E. Finance foundation (Panel of Recognized International Market Experts In Finance) was established with the aim of facilitating dispute settlement, reducing legal uncertainty and fostering stability in the global financial markets. Jeffrey Golden, visiting professor at the LSE, has been a strong advocate for founding an arbitral institute for complex financial disputes. See here. After a round table meeting with leading legal and financial experts organized by the Dutch not-for-profit organization World Legal Forum Foundation in the Peace Palace on 25 October 2010, it was decided that a world financial tribunal would be established in The Hague. See here.

The panel includes internationally renowned experts in the field of both finance as well as dispute resolution. Among the panel members are retired and sitting judges, central bankers, regulators, representatives from private practice and derivative market participants (both dealer and buy side). For the Finance experts list see here and the dispute resolution experts list see here. The composition of the panel is very diverse, in terms of gender and geographic reach (e.g. from England to Nigeria).

These experts are eligible to be appointed as arbitrator under the P.R.I.M.E. Finance Arbitration and Mediation Rules. Also, these experts are available to assist in judicial training and the development of library resources relevant to complex product and standard form financial contract disputes. P.R.I.M.E. Finance aspires to represent the greatest source in the world of collective knowledge and experience of documentation, law and market practice for derivatives and other complex financial products.

Secretary-General of P.R.I.M.E. Finance, NautaDutilh’s arbitration specialist Gerard Meijer, presented the first edition of the institute’s Arbitration Rules during the opening conference. These rules have been inspired by the 2010 UNCITRAL Arbitration Rules and have been adjusted, to tailor to the needs of arbitration in the financial markets. Input has been sought from the dispute resolution experts on the panel, including Johnny Veeder, Judge Stephen Schwebel, Albert Jan van den Berg and Jan Paulsson. The P.R.I.M.E. Finance Arbitration Rules will be published on the website of the institute on 18 January 2012. See here. The Secretary-General announced that the board will take into account feedback from users and may adopt a second edition of the rules after 6 to 12 months.

Distinctive features of the P.R.I.M.E. Finance Rules include the following. First of all, the P.R.I.M.E. Finance Rules provide for an arbitration institute that will administer the arbitral proceedings, whereas UNCITRAL Rules have been written for ad hoc arbitration. The Secretary-General of the Permanent Court of Arbitration (“PCA”) in The Hague has accepted to serve as appointing authority, if so requested by a party. Exclusively persons identified on the panel of experts will be eligible to be appointed as arbitrator, unless otherwise agreed by the parties. See article 8 P.R.I.M.E. Finance Rules. For reasons of transparency, this list of experts is public.

The P.R.I.M.E. Finance Rules oblige a candidate arbitrator pursuant to article 11 to disclose any circumstances likely to give rise to justifiable doubts as to availability (as well as impartiality and independence). This provision should contribute to an efficient and speedily arbitration process.

One of the conclusions from the market sounding process that took place before the P.R.I.M.E. Finance Rules were drafted was that market participants value a speedily resolution of these type of conflicts. The Rules have been tailored to this need by including rules on interim measures and fast track arbitration.

Article 26 of the P.R.I.M.E. Finance Rules provides that the arbitral tribunal may, at the request of a party, grant interim measures if it finds that it has prima facie jurisdiction to decide the claim. A party in need of urgent provisional measures that cannot await the constitution of the arbitral tribunal may make an application for such measures to be rendered by an emergency arbitrator in the form of an order under article 26a and the Emergency Arbitration Rules attached to the P.R.I.M.E. Finance Rules. Such order shall not bind the arbitral tribunal and shall not prejudice a final decision of the tribunal on the merits. In addition parties may make an application for provisional measures in referee arbitral proceedings, as referred to in article 1051(1) Dutch Code of Civil Procedure. It is noted that the parties should agree that the seat of arbitration is located in The Netherlands, in order to benefit from Dutch law that provides that the referee arbitral award is an arbitral award.

Another distinctive feature of the P.R.I.M.E. Finance Rules is that awards may in principle be made public with the consent of all parties. Also, P.R.I.M.E. Finance may publish an award or an order in its entirety, in anonymised form, under the condition that no party objects to such publication within one month after receipt of the award. These provisions, set out in article 34 of the P.R.I.M.E. Finance Rules, aim to support the overall goal of P.R.I.M.E. Finance, which is to create a vast body of case law in the area of complex financial products to increase legal certainty.

The fact that P.R.I.M.E. Finance has based its Arbitration Rules on the UNCITRAL Rules should form a solid basis for the arbitral proceedings under these rules. These rules have been well-tested and are widely accepted around the world. In combination with the list of internationally recognized experts, this should be a good basis for market participants to start including references to the P.R.I.M.E. Finance Rules in their contracts. At the opening conference Gay Evans, Vice Chairman of the Board and Non-Executive Chairman Europe of the International Swaps and Derivatives Association, Inc., (“ISDA”) stated that although ISDA does not officially endorse the P.R.I.M.E. Finance Arbitration Rules – nor the rules of any other arbitral institute for that matter – ISDA “highly supports” this initiative. Originally bankers were deemed to have an antipathy against arbitration (see here), but recent years have seen a marked increase in the use of arbitration in the financial sector. Last year, ISDA organised a consultation process on the use of arbitration in ISDA Master Agreements. See here. ISDA’s support may be a critical success factor for P.R.I.M.E. Finance arbitration. Should ISDA proceed with including model arbitration clauses for use in conjunction with the ISDA Master Agreement, it would be wise not to limit the model seats of arbitration to each of England and New York, as suggested in its November 2011 consultation memorandum. One of the main drivers of the establishment of P.R.I.M.E. Finance is that many counterparties in emerging countries are increasingly reluctant to accept that any dispute will be resolved in England or the United States. As a result, the Netherlands was elected as base for P.R.I.M.E. Finance, due to its neutral position in the financial markets and it renowned infrastructure for international dispute resolution. Also in view of the fact that the PCA has authorised the conduct of arbitral hearings at the Peace Palace, The Hague would be a logical choice for the seat of arbitration in such arbitration clauses.

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At its session of 15 November 2011, the International Council of Arbitration for Sports (ICAS) amended Article 14 of the Statutes of the bodies working for the settlement of Sport-related Disputes (Article S14) and abandoned the old regime which provided that with regard to the list of CAS arbitrators, the ICAS had to respect a specific distribution, namely 1/5th of the arbitrators selected from among the persons proposed by the International Olympic Committee (IOC), chosen from within its membership or from outside; 1/5th of the arbitrators selected from among the persons proposed by the International Federations for the Summer and Winter Olympics (IFs), chosen from within their membership or outside; 1/5th of the arbitrators selected from among the persons proposed by the National Olympic Committees (NOCs), chosen from within their membership or outside; 1/5th of the arbitrators chosen, after appropriate consultation, with a view to safeguarding the interests of the athletes; and 1/5th of the arbitrators chosen from among persons independent of the bodies responsible for proposing arbitrators, in conformity with this Article.

Under the new Article S14 which came into effect on 1 January 2012, the ICAS is free to call upon personalities with full legal training, recognized competence with regard to sports law and/or international arbitration, a good knowledge of sport in general, and a good command of at least one CAS working language, whose names and qualifications are brought to the attention of the ICAS, including by the IOC, the IFs and the NOCs. This is the major amendment of the January 2012 revision and is to be welcomed as it further enhances the already existing independence of CAS arbitrators.

Other significant modifications relate to the Consultation Proceedings and to consolidation. The special provisions applicable to Consultation Proceedings (Articles 60 – 62 of the Procedural Rules of the CAS), pursuant to which the above-named organizations and associations could request advisory opinions from the CAS, were indeed abandoned. Moreover a new subsection of Article 39 of the Procedural Rules now provides for the possibility to consolidate two arbitration proceedings.

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The recent decision in Spyridon Roussalis v. Romania (ICSID Case No. ARB/06/1) is prompting renewed debate over whether ICSID arbitration, now the leading mechanism for investors to pursue treaty-based claims against host States, may also be used by those States to assert related counterclaims against the investors, allowing all such claims to be settled in a single forum. At issue are certain fundamental questions about the relationship between the ICSID Convention and investment treaties as an extrinsic source of consent to arbitrate.

Article 46 of the ICSID Convention expressly requires a tribunal, if requested by a party, to determine “counterclaims arising directly out of the subject-matter of the dispute”— unless the parties have agreed otherwise, and provided as a threshold matter that such claims “are within the scope of the consent of the parties and are otherwise within the jurisdiction of the Centre.” Yet few parties have made these requests. Even fewer parties have succeeded.

When consent to ICSID arbitration is founded on a contract rather than a treaty, few threshold jurisdictional issues arise in connection with State counterclaims, because contractual dispute resolution provisions are generally bilateral, allowing either party to the contract to assert claims for breach of the contract’s terms. In such cases, ICSID tribunals have not hesitated to hear State counterclaims. In Atlantic Triton v. Guinea (ICSID Case No. ARB/84/1), the respondent’s ability to bring its own claim for breach of contract worked against it on the merits; in rejecting the counterclaim, the tribunal stated that “it must be underscored that if Guinea itself considered Atlantic Triton responsible for the significant damages it claims to have suffered, it is surprising that Guinea did not take the initiative and institute arbitration proceedings following the rescission of the management Agreement but waited until Atlantic Triton filed its request for arbitration before making its claims” (¶ 4.2). In another case against Guinea where jurisdiction was also contract-based, Maritime International Nominees Establishment v. Guinea (ICSID Case No. ARB/84/4), the tribunal not only exercised jurisdiction over Guinea’s counterclaim, but also upheld it, awarding Guinea damages resulting from the claimant’s initiation of AAA proceedings in violation of the parties’ agreement to resolve their disputes through ICSID jurisdiction.

With respect to treaty-based arbitrations, some tribunals have entertained respondent counterclaims but rejected them on the merits. In Alex Genin, Eastern Credit Limited, Inc. and A.S. Baltoil v. Estonia (ICSID Case No. ARB/99/2), for example, without expressly addressing the issue of jurisdiction, the tribunal found that Estonia’s counterclaim was belied by contradictory evidence in the record. Other tribunals have cited a respondent’s failure to substantiate its counterclaim. This was the case in Gustav F. W. Hamester GmbH & Co. KG v. Republic of Ghana (ICSID Case No. ARB/07/24), where respondent Ghana, after presenting a counterclaim in the relief section of its counter-memorial, failed to make any further arguments in favor of either jurisdiction or a decision on the merits. The tribunal highlighted that “the BIT recognises that the State party may be ‘aggrieved’ and ‘shall have the right to refer the dispute to’ arbitration,” but it ultimately held that “in the absence of any submissions on the nature of the Respondent’s counterclaim under the BIT, the Tribunal is unable to analyse whether it is capable, in accordance with Article 46 of the Convention, of falling within the parties’ scope of consent” (¶¶ 354–55).

By contrast, the recently-decided Roussalis case squarely presented the question of jurisdiction over treaty-based counterclaims by a respondent State. The majority of the tribunal held that the BIT in question contained no consent for the submission of respondent State counterclaims.

Primarily a dispute about a dispute, the case in Roussalis centered around the alleged breach by the claimant of a share purchase agreement, and, in response, the pursuit by Romanian authorities of various domestic remedies. Claiming that Romania’s actions constituted “a series of malicious and unjustifiable acts” (¶ 10), the claimant initiated proceedings before ICSID, under the Greece-Romania BIT. Romania, for its part, submitted a counterclaim alleging that the claimant had breached its obligations under the share purchase agreement. It agreed to suspend any domestic proceedings making similar claims during the pendency of the ICSID arbitration.

After considering — and rejecting — each of the claimant’s treaty claims, the tribunal proceeded to determine whether it had jurisdiction over Romania’s counterclaim. Consistent with the decisions on counterclaims under the UNCITRAL Rules (see, e.g., Saluka v. Czech Republic), the tribunal noted that “[b]eing the party asserting that the Tribunal has jurisdiction to hear and determine the counterclaims which it seeks to bring before the Tribunal, the Respondent carries the burden of establishing that jurisdiction exists” (¶ 860). The threshold issue, according to the tribunal, was one of consent. Romania had argued that, because the ICSID Convention permits counterclaims — and the BIT did not expressly preclude them — by selecting ICSID as the forum to resolve the dispute, the claimant implicitly had consented to the submission of counterclaims.

A majority of the tribunal rejected this interpretation. The tribunal found that consent “must be determined in the first place by reference to the dispute resolution clause contained in the BIT. The investor’s consent to the BIT’s arbitration clause can only exist in relation to counterclaims if such counterclaims come within the consent of the host State as expressed in the BIT” (¶ 866).

To this end, the tribunal noted that Article 9 of the BIT provided that “Disputes between an investor of a Contracting Party and the other Contracting Party concerning an obligation of the latter under this Agreement, in relation to an investment of the former shall, if possible, be settled . . . If such disputes cannot be settled . . . the investor concerned may submit the dispute . . . to international arbitration” (emphasis added). The majority found that this language “undoubtedly limit[s] jurisdiction to claims brought by investors about obligations of the host State. Accordingly, the BIT does not provide for counterclaims to be introduced by the host state in relation to obligation of the investor. The meaning of the ‘dispute’ is the issue of compliance by the State with the BIT” (¶ 869).

In dissent, Professor Michael Reisman stated that “when the States Parties to a BIT contingently consent, inter alia, to ICSID jurisdiction, the consent component of Article 36 of the Washington Convention is ipso facto imported into any ICSID arbitration which an investor then elects to pursue.” Though Professor Reisman stated he understood “the line of [the majority’s analysis,” he also stated that it produced “an ironic, if not absurd, outcome,” in that the State was directed “to pursue its claims in its own courts where the very investor who had sought a forum outside the state apparatus is now constrained to become the defendant.”

As Professor Reisman noted, the majority’s decision in Roussalis marks the first time that jurisdiction over counterclaims has been rejected based on an absence of consent. It remains to be seen whether different tribunals, interpreting different and perhaps less narrow treaty language, will follow suit. At the very least, Roussalis has re-sparked the counterclaim debate among commentators. The case and the issue of State counterclaims more generally will be the subject of the first-ever OGEMID Mini-Seminar — a virtual panel intended to facilitate debate among members of the arbitration community — next week.

By Jean E. Kalicki and Mallory Silberman

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