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Act of State doctrine applies in arbitration

 

21 June 2018

The foreign Act of State doctrine applies to arbitration just as it applies to litigation before the English courts, according to Popplewell J, in the first English law authority on the point. The dispute arose under two oil and gas Production Sharing Contracts, in which the Indian Government had refused to pay for oil and gas. The ruling will be of interest to all commercial parties who contract with foreign states: Reliance Industries Ltd and BG Exploration & Production India Ltd v Union of India [2018] EWHC 822 (Comm), 16 April 2018.

The dispute arose under two Production Sharing Contracts (the PSCs) between, inter alia, the claimants and the Government of the Union of India (the Government). In practice, the oil and gas produced from the fields covered by the PSCs was sold to Government-controlled nominees. The Government instructed the nominee purchasers to withhold payment of the amount that was due to the claimants for the oil and gas on two occasions.

Various disputes were eventually submitted to arbitration under the PSCs by the claimants, including a claim for the sums withheld by the nominees. The claimants argued that they were entitled to payment by the Government of the amounts withheld by the nominees as, under the PSCs, the Government was the principal debtor for the amounts owing for the oil and gas supplied to the nominees. The PSCs were governed by the law of India, except for the arbitration agreement, which was governed by English law.

Government tries to rely on its sovereign powers to excuse non-payment

In the arbitration, the Government submitted that the nominees were entitled to withhold the payments because they had been directed by the Government to do so, pursuant to a legislative act. It relied on two notices issued pursuant to a so-called Office Memorandum (the OM) issued by the Ministry of Petroleum and Natural Gas. While the first notice referred to the OM, the second did not. The Government maintained that the OM was an executive order passed by the Government as a legislative act, and its sovereign powers were not curtailed by the PSCs.

The OM provided that “it has been decided by the Government that in case of statutory or contractual amounts due to the Government as calculated by contractors […] are not deposited in a timely manner […] the Government of India or its nominee shall withhold payments until such time as the default is remedied by contracts”. The claimants contended that, on a true construction of its terms, the OM did not deprive them of their substantive right to payment under the PSCs or afford the Government with the power to direct the nominees to withhold payment because there were no “amounts due to the Government as calculated by contractors”. At this stage the Government did not specifically raise the Act of State doctrine.

Tribunal finds that it lacked jurisdiction

Although the Tribunal concluded that the Government was the principal debtor under the PSCs and was prima facie liable to pay the amounts owing, the majority found that the Tribunal did not have jurisdiction to determine the question of whether the Government was entitled to direct its nominees to withhold any part of the payment that was otherwise due to the claimants. The majority’s view was that the Tribunal’s jurisdiction extended only to determining the rights and obligations of the parties under the PSCs, not to the issue of whether the OM permitted the Government to expropriate substantive rights under the PSCs. The claimants appealed to the English court.

A reminder of the Act of State doctrine

The English court will recognise, and will not question, the validity or effect of a foreign state’s legislative acts (or the effect of a foreign state’s executive acts in relation to property situate within its territory) and will not adjudicate upon whether such acts are lawful.

The Government argued before the English court that the issues before the Tribunal were non-arbitrable because of this doctrine. The claimants argued that the Tribunal had jurisdiction, because: (1) the foreign Act of State principles of non-justiciability do not apply to arbitration; (2) to the extent that the Government might have had an Act of State objection, it had waived any such objection by submitting to the arbitration and in any event by failing to object promptly; and (3) the issue before the Tribunal was arbitrable (and would have been justiciable before a court) because it concerned the construction and/or applicability of the OM, rather than its validity.

Foreign Act of State doctrine applies in arbitration too

On appeal, Popplewell J held that the issues in question did in fact engage the foreign Act of State doctrine, and that therefore they were non-justiciable before the court and not arbitrable before the Tribunal. Popplewell J considered that the rationale of the Act of State doctrine derives from the concept of sovereignty, which recognises the power and right of a state to determine the property rights of those whose property is situate within its territory. He did not see any good reason why the doctrine should be any less applicable in arbitration than in litigation before an English court.

Popplewell J disagreed with the claimants that there had been a waiver or submission to the jurisdiction of the Tribunal by the Government. A state’s agreement to have contractual disputes determined by arbitration is not sufficient for it to have waived its right to object to the tribunal determining Act of State issues which might be raised in the course of any dispute under the contract.

 

Comment

This judgment raises issues concerning the interplay between English private international law rules and arbitration law. Up until now the Act of State doctrine was not thought to be relevant in an arbitration context. This decision means that now a state party seeking to avoid performance under a contract, by issuing legislation or executive orders conflicting with its obligations under the contract, may be able to invoke the Act of State doctrine in an English seated arbitration. When contracting with a state, a private party may therefore wish to provide in the contract that the state will not invoke a foreign Act of State defence to meet a claim that otherwise falls within the scope of the arbitration agreement.

Separately, a private party may also wish to include an appropriate stabilisation clause in the contract. This type of clause, which can take various forms, aims to protect a private party from any economic loss suffered as a result of legislative changes introduced subsequent to the contract. In circumstances where a state party seeks to circumvent its contractual obligations through a legislative or executive act, the private party should then be able to trigger the stabilisation clause. This would avoid the need to invoke any contractual provision that conflicts with the legislation in question, and thus avoid any potential Act of State issues as the validity of the legislation would not be challenged.

It should also be possible to limit the effect of this ruling to contracts governed by foreign substantive law. This is because, where the contract is governed by English substantive law and the obligation in question is to be performed outside of the state concerned, it would be possible to argue that any supervening illegality brought about by sovereign actions of a state party to the contract do not excuse the state’s performance of its English-law-governed contractual obligations as long as those obligations are to be performed outside of the territory of the state concerned.

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  If you wish to receive this publication, please contact Amy Edwards, amy.edwards@allenovery.com.

 

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