Disputes Between Joint Enterprises Concerning Articles of Association in the Practice of Foreign Arbitration Tribunals

The History of the Matter

The process of creating joint ventures that took place at the end of the 1980s – early 1990s, still the Soviet period, was an absolutely new phenomenon in domestic external economic practice. This step, revolutionary for its time and one that introduced significant changes in the principles governing external economic activity was taken, however, within the framework of acting legal regulation and legal practice that had evolved in conditions of state monopoly in the sphere of foreign economic activity.

One of the manifestations of discrepancies between the old and the new became, in certain cases, the approach to the problem of resolution of disputes concerning the articles of association of joint ventures and the affirmation in them of conditions regarding applicable law. It should be noted that this old problem continues to create difficulties at the present time.

The period under examination also saw the emergence of not just specialized external trade associations, but also numerous new subjects of external economic activity with extremely modest experience of work in the international arena. This frequently led to the circumstance that the initiators of a joint drawing-up of articles of association were foreign firms, that suggested the inclusion of customary provisos in the text concerning the order of resolution of disputes and applicable law.

At the same time, it was not uncommon for bodies of subjects of the federation and even federal bodies to become involved in the process of setting up joint ventures. With time, this practice gave rise to a number of problems concerning state liability.

An analysis of the articles of association of those days shows that most of them approached the issue of resolution of disputes and applicable law in a fairly standard manner. As a rule, the location for examination of disputes was to be a commercial arbitration court in a third country, usually in Stockholm, Zurich, Geneva or Paris, acting in accordance with the rules of legal procedure of the arbitration tribunals of the Chambers of Commerce of those cities or the International Chamber of Trade, or ad hoc arbitration in accordance with the rules of UNSITRAL. The applicable law was indicted as the substantive law of the country where the arbitration was to take place.

At first glance, the indicated arbitration clause appears traditional, as for many years it was used by the All-Union external trade associations within the Ministry for Foreign Trade contacts of the USSR, and this maintained confidence that it had been tried and tested by time. However, accumulated experience indicates that “reference to international commercial arbitration is certainly not the only possible recourse in the emergence of disputes, including disputes directly connected to foreign investments. In the realization of complex and large investment projects and in the preparation of relevant investment agreements, it is advisable to weigh carefully all the “pros” and “cons” in selecting a location for arbitration at home or abroad, definition of the procedural rules by reference to concrete legislation or their affirmation in the arbitration clause etc.”

An analysis of conflicts between founders of joint ventures brings to light certain negative inevitabilities.

Firstly. The inclusion into the articles of association of arbitration clauses that that were formerly used by large All-Union foreign trade associations resulted in difficulties connected with the possibilities of defense of their rights by private Russian enterprises. Many of them simply lacked sufficient financial resources to conduct arbitration proceedings abroad. Objectively, the expenses incurred in the conduct of such proceedings are much greater than those borne by parties to arbitration in Russian Federation courts and frequently are excessive for still financially weak Russian enterprises.

Secondly. Arbitration clauses formulated in very general terms within articles of association gave cause for the extension of arbitration proceedings to legal relationships, which actually were of an independent legal nature. In some cases, there were problems the solution of which requires a complete idea of the legal regulation of obligations which were to be executed on the territory of the Russian Federation. However, the composition of arbitrage that, following the very idea of a tribunal nature of the examination of a dispute should be “made up” of people with special knowledge of the issues presented for examination, were all too frequently represented by attorneys without the necessary experience.

Thirdly. In some cases, problems were connected with the circumstance that the founders of a joint enterprise were state enterprises.

The structure of contractual relations and arbitration clauses

The causes of disputes can be divided into two categories. The first and sufficiently traditional one includes disputes arising from differences between the founders in matters of management of the enterprise and attempts to change the management system or influence decision-making. The second category consists of disputes arising from more complex economic and legal problems. Paradoxically, they appear in relation to enterprises in which the activity of the investors was not limited by participation in the formation of a minimal authorized capital and where production was developing quite satisfactorily. These enterprises are the realization of an ideal scheme: on one hand, foreign investment is attracted through the implementation of leading foreign technologies, experience in production, trade, services, use of the retail chain of the foreign partner etc., and on the other hand – exploitation of the production capacity and raw materials of the Russian party.

The following is a typical legal structure in such instances. The Russian and foreign founders establish an enterprise on an equal share basis. The equality of the shares also predetermines the order of decision-making based on the principle of unanimity. Such an approach is quite reasonable, because when the Russian and foreign parties establish the enterprise, they have a common aim – to gain profits from its activity. However, in the course of business, the enterprise “acquires” contractual bonds, including with the founders, and this results in a broad field of possible conflicts that frequently turn into arbitration disputes. Contractual relations between founders and enterprises may arise in connection with the execution of an agreement to supply the joint venture with technology or parts, raw materials, etc. There may be the provision of management services such as, for example management of a hotel, covered by a separate contract between the foreign founder and a joint venture. On the basis of an agreement, the joint venture may hire production equipment from the Russian founder, etc. The possibility of a conflict of interests between the founders in such a situation is clear. Let us envisage the following situation. A founder is engaged in the sale of production through an offshore company on the basis of an agreement with a joint venture and is thus receiving his main profit from the business of the offshore company and not the joint venture. The commercial interest of the other founder, however, lies in ensuring a maximum profit by the joint venture and his efforts are directed towards changing the price policy of the joint venture or abrogating the agreement concerning sale of production. In order to attain his aims, he must put the relevant question to the management body of the joint venture – the board of directors. In reality, there is virtually no chance of changing anything, as the principle of unanimity is enshrined in the articles of association. The founder then begins to act through the general director, elected on his nomination, and there is a formal dispute now between the joint venture and the founder – a party to the contract. The arbitration clause in the articles of association may be as follows: “Founder-participants shall apply all efforts to resolve any differences arising in connection with the present Agreement or with the activity of the Company through amicable negotiation. If the founder-participants cannot reach agreement, the dispute shall be referred for arbitration in the city of Stockholm (Sweden) and shall be resolved exclusively by way of arbitration in accordance with the Rules of the Arbitration Institute of the Chamber of Commerce of the city of Stockholm with the exception of general court jurisdiction.

The Arbitration tribunal consists of 3 (three) persons. The official language of the arbitration hearing shall be English, however, statements and written evidence from witnesses may be submitted to the arbitration tribunal in both the Russian and English languages.

The rights and liabilities of the Founders-participants are interpreted, by the present document, in accordance with the present Agreement and the substantive law of Sweden (excluding the norms relating to conflict of laws) – with the exception that the Russian Law is determining with respect to the conditions of the present document, concerning the establishment, internal questions of production and economic activity and legal competence of the Company. The arbiters are empowered to take clarifying decisions, impose conditions and assign compensation for material loss.

The arbitration ruling explains the basis for such a decision, indicates the composition of the arbitration tribunal, the date and place of the ruling, and also the awarding of costs and expenses for the arbitration between the Founders-participants and the Company.

By the present, the founders-participants incontrovertibly decline the right to sovereign immunity which they may possess at the present time or which they may, at a future time, invoke in connection with the present Agreement, execution of their responsibilities under the present document, and also any court or arbitration ruling connected with it.

The arbitration ruling is final and binding on the Founders-participants and may be brought into execution by a competent court.

Despite the above, the Founders-participants in the dispute may undertake temporary or protective measures for the safeguarding of their rights and means for legal defense, or petition any juridical body to carry out a resolution concerning such undertaking.”

In those extreme cases where it proves impossible to settle the dispute by amicable means, and the joint venture, due to the actions of its management, virtually abrogates the contract with the founder, the latter has every right to seek the defense of his rights through a court or an arbitration tribunal.

However, this leads to a rather paradoxical situation. The investor, whose interests and rights are violated by the management of a joint venture, understands clearly that a court (tribunal) ruling, affirming the action of the agreement with the joint venture, does not guarantee due execution of the agreement in the future. The filing of a claim for compensation of losses, connected with violation of the agreement or its unilateral abrogation by the joint venture and further satisfaction of the claim shall result in the claimant’s receipt of compensation from an enterprise of which he is half-owner.

A number of cases show investors choosing another method of defending their rights: the filing of a claim for compensation of losses against the co-founder of the joint venture demanding compensation for losses sustained as a result of violation of the conditions of the articles of association and/or charter. The causes of claims cite violation of conditions of cooperation. Moreover, the arbitration clause and the clause relating to applicable law may differ from corresponding clauses, contained in the agreement between the founder and the enterprise. Let us assume that the articles of association envisage examination of disputes by the Institute of Arbitration of the Chamber of Commerce of the city of Stockholm and the application of Swedish substantive law, while the lease agreement between the enterprise and the founder contains a clause concerning examination of disputes by the ICAC of the Chamber of Commerce of the Russian Federation and the application of Russian substantive law.

This creates a rather complicated legal situation. The claimant files a claim concerning violation of the articles of association with the Institute of Arbitration in Stockholm, basing the jurisdiction of this body with reference to the arbitration clause contained in the articles of association, while the substance of the violation is connected with the actions or inaction of the founder, which led to the violation of its contractual obligations by the enterprise of another agreement, containing an arbitration clause in favor of referring all disputes to the ICAC of the Chamber of Commerce. It is commonly asserted that the actions undertaken by the enterprise in the person of its general director contradict the interests of both the contracting party in the agreement, in the person of the founder-claimant and the joint venture itself, of which the claimant is also a party.

The problem of the limits of the competence of arbitration

In substance, the subject under examination in arbitration becomes the question of establishing the fact of violation of the agreement between the joint venture and the founder and the liability of the parties arising from this agreement. In fact, however, this issue is examined by other arbitration, endowed with the power to resolve a dispute only between the founders of a joint enterprise.

In practice, the process develops as follows. The claimant files his claim with an arbitration tribunal that is named in the articles of association, indicating the co-founder of the joint enterprise as the defendant.

As a rule, there are no difficulties in determining the competence of the given arbitration body to deal with the claim. The claimant states the subject of the dispute, for example – violation of the conditions of the articles of association concerning the obligations of the parties to “act exclusively in the interests of the enterprise” or to take decisions “only on a unanimous basis” or liability to compensate losses ‘in the case of non-fulfillment or inadequate fulfillment of any of the obligations, envisaged by the Articles of Association.” Further, he cites the arbitration clause in the Articles of Association, requests examination of the submitted claim and appoints an arbiter.

It should be noted at this stage that art.7 of the Rules of the Institute of Arbitration of the Chamber of Commerce of the city of Stockholm, that defines reasons for denial of institution of proceedings, is formulated in a rather general manner. The only concrete reason for refusal is the non-payment of the arbitration fee by the claimant.

Otherwise, the arbitration court has no reason to decline institution of arbitration proceedings.

The claim is conveyed to the defendant with an offer to respond to the claim and name an arbiter.

At this stage the arbitration body or, rather, its secretariat, does not seek to establish the validity of the demands in the claim, and if the defendant objects to them, including citing the arbitration body’s lack of jurisdiction concerning the disputed issues contained in the claim, the secretariat still hands the matter over to examination by the arbiters. In this case, refusal by the defendant to name an arbiter or to participate in the arbitration examination itself does not impede the beginning of the process. On the basis of p.5 of art.10 of the Rules the process may be continued if the defendant does not respond to the claim. In accordance with p.2 of art.16, the Institute may appoint an arbiter to act for the defendant, if the latter has not made his choice in the time period allowed. Non-attendance at the hearing without a reasonable excuse or non-observance of the set order of examination of the case otherwise, according to art. 28 of the Rules, does not hinder examination of the matter and execution of a decision.

Thus, the question of the arbitration’s competence concerning a dispute at the basis of which lie legal relations that have arisen due to another agreement, are examined by selected or appointed arbiters. As a result, the arbiters are faced with the dilemma, insofar as circumstances connected with the fulfillment of an agreement between the joint venture and the founder may be different by nature. In some cases they are only the result of factual events, which arbitration evaluates as evidence, in others the issue is invariably related to the need to give a legal qualification of the actions of the parties to the contract.

As a general rule, such legal questions are outside the limits of arbitration competence. Such a limiting approach arises from the content of p. “c” art. V of the New York Convention on Recognition and Execution of Foreign Arbitration Rulings which indicates that execution shall be denied if it is proved that:

“the said ruling concerns a dispute not envisaged by or not falling within the jurisdiction of the conditions of the arbitration agreement or arbitration clause in an agreement, or contains resolutions on matters beyond the limits of the arbitration agreement or arbitration clause in the agreement, with the proviso, however, that if the resolutions concerning questions embraced by the arbitration agreement or arbitration clause may be separated from those which do not come under such an agreement or clause, then that part of the arbitration decision that contains resolutions on matters embraced by the arbitration agreement or arbitration clause in the agreement, may be recognized and executed.”

The practice of foreign commercial arbitration gives a very varied picture of decisions with the problem under discussion as their foundation. In some cases arbitration, not acknowledging lack of competence to examine a case as a whole, has denied satisfaction of the part of the claim that concerns fulfillment (violation) of obligations arising from the agreements between a joint venture and third parties. In other instances, on the contrary, arbitration maintained its competence to examine questions which the defendant disputed as falling outside the bounds of the arbitration clause.

Thus, in a dispute arising from the articles of association the arbitration, in examining a claim concerning violation by the defendant of a lease agreement he concluded with a joint venture and containing an independent arbitration clause, noted:

“Although the arbiters acknowledge that in examining the dispute between the founders they are not authorized to carry out an enforceable decision concerning the relations between the parties regarding the lease agreement, they are not obliged, however, to wait until another dispute-solving body reaches a decision binding on both parties to the lease agreement, therefore the arbiters have the right to examine circumstances connected with the defendant’s fulfillment of his obligations under the lease agreement.”

In principle, practice shows that arbitration, within the framework of a dispute referred to it, may examine any facts and circumstances it may deem necessary. This also applies to obligations connected with legal relations arising from other agreements. However, unlike acts of court, facts established by arbitration do not, firstly, have any prejudiciality, and secondly – the very establishment of facts should be differentiated from a warrant to rule on the culpability of a party to the contract as such a decision can be reached only after a comprehensive examination and, unquestionably, taking into account the position of the party to the contract whose rights have, allegedly, been violated. In the case cited above, the extreme position adopted by arbitration is expressed not only in a willingness to examine disputed issues independently, without waiting for its examination by due arbitration, but also in the conclusions reached that indicate the defendant's culpability with regard to the lease agreement, the non-acknowledgement of the legality of his actions in defending his interests, and also acknowledgement of the losses sustained, as stated by the claimant, in the joint venture.

Bearing in mind that in a dispute arising from articles of association the parties may encounter diametrically opposed approaches by arbiters, greater attention should be paid to the content of arbitration clauses included both in articles of association and contracts concluded by the joint venture with one of the parties. It is essential to take into account that the traditional general form of the clause “all disputes arising from the present agreement and in connection with it…” may be subsequently interpreted differently both by the parties and the arbiters.

The problem of the exclusive jurisdiction of state courts

A special category consists of cases in which the problems of the limits of arbitration competence is connected with examination of questions to which the courts from one of the countries claim exclusive jurisdiction.

The exclusive jurisdiction over certain categories of disputes by national state courts is a fairly characteristic occurrence in any legal system. It has been noted in literature that: “in determining approach to the exclusive jurisdiction of national courts, the legislation of many countries must take into account two contradictory phenomena; a) jurisdiction must be connected with the location of the establishment of material-legal relations and b) the person must always be connected with its domicile or citizenship.

Naturally, resolution of such a complex contradiction may be found only in extremely rare cases.”

Otherwise, there will be the inevitable problem of the conflicting jurisdictions of state courts that could paralyze the institution of international commercial arbitration itself.

The Arbitration Procedural Code of the RF establishes (p. 3 and 4 art.212) the exclusive jurisdiction of arbitration courts of the RF only in respect of two categories of matters with the participation of foreign parties. Such matters concern real estate and claims against transporters, arising out of transport contracts. In the light of the issues under examination, the first category is of greater interest.

In Russian practice, it is quite common for a Russian party to introduce real estate which is his property or the rights to include that real estate into the authorized capital of a joint venture. In this case, the rights of the joint venture with regard to the property arise not pursuant to a separate contract with one of the founders, but by virtue of the articles of association. Formally, if the dispute is connected with specific conditions of the articles of association, it is subject to the arbitration clause. Thus, in the case of a dispute relating to the order of terms of transfer of the property, or a dispute generated by demands made by third parties, etc., these disputes may not be evaluated as coming only within the category indicated in pp. “c” part 1 art. V of the New York Convention.
Disputes concerning real estate located in Russia may come under the action of p.3 art. 212 of the Arbitration Procedural Code of the RF, which excludes them from the jurisdiction of arbitration tribunals. Thus, in the consideration of a dispute the subject of which concerns real estate property located in Russia by an international arbitration body abroad, there is a problem in that the possible execution of the arbitration ruling, taking into account p.p. “a” part 2 art. V of the New York Convention. According to the Convention, recognition and execution of the arbitration decision may be denied “if the competent authorities of the country in which recognition and execution of the ruling is requested, find that:

a) the object being disputed cannot be subject to arbitration under the laws of this country…”

Part 3 of art. 219 of the Arbitration Procedural Code of the RF specifies the objects relegated to the exclusive jurisdiction of RF arbitration: “Cases concerned with the recognition of rights to buildings, constructions, plots of land, confiscation of buildings, constructions, plots of land from illegal possession by others, elimination of violations of the rights of the proprietor or legal owner, if this does not involve deprivation of ownership, are examined in the place of the location of the building, construction, plot of land.”

Having the formula “cases concerned with” at its disposition, part 3 art. 219 of the Arbitration Procedural Code of the RF gives the court considerable latitude in referring disputes of this category to the exclusive jurisdiction of RF arbitration courts and, accordingly, refusal to recognize and execute arbitration tribunal decisions.

Problems, connected with separate responsibility of state unitary enterprises in the Russian Federation; problems of state immunity from mandatory execution of the decisions of international commercial arbitration

The present study contains a number of articles on state immunity, as do other works. We should like to draw attention to specific aspects of this problem in the context of disputes between founders of a joint enterprise, a party of which is a Russian state unitary enterprise.

The inclusion of an arbitration clause in articles of association where a party is a state enterprise is a sufficiently widespread practice. Moreover, state enterprises are usually large structures, with adequate material means, and do not experience the inconveniences and problems encountered by small or medium commercial structures.

Confirmation of this can be found in the domestic practice of both arbitration tribunals and state courts. But foreign experience frequently demonstrates very specific approaches, that contradict Russian practice in principle. In some cases one encounters preserved stereotypes, according to which everything in Russia is under state control. The situation may be further complicated by such circumstances as the active participation by state bodies in the negotiations concerning the creation of an enterprise or the inclusion of real estate which is government property into the authorized capital of the enterprise. As a result, in the course of arbitration proceedings, one must insistently prove that the liabilities of the state and the juridical person - the subject of entrepreneurial activity, must be separately defined.

In other cases problems arise at the at the stage of execution of rulings of foreign arbitration tribunals in the courts of foreign countries which enforce the decisions. The situation develops as follows. The foreign firm files an arbitration claim against the Russian party in the joint enterprise – a state enterprise - in, for example, Stockholm. The claim, which is written in English, indicates the name of the respondent, the state body in whose system the enterprise happens to be and, possibly, the Russian Federation.

Frequently in Russian practice, in the definition of the name of the state enterprise, the nature of the relationship between the enterprise and the state body is very imprecise. Sometimes the enterprise retains the name it had in Soviet times and has such components as “administration”, “main specialized administration” etc. Bearing in mind that the arbitration process abroad is conducted in a foreign language, such as English, and all documents presented are in translation, it often happens that the unwieldy, uncommon in international practice name of a state enterprise and its relationship to a federal organ or an organ of a subject of the Federation is conveyed in distorted form. Moreover, this provides grounds for speculation that the Russian respondent is a structural sub-division of a state body.

Additional difficulties arise when the articles of association contain a so-called clause “on surrender of immunity.” Being included in an agreement between two juridical persons it is devoid of any meaning from the legal point of view. However, there have been occasions when it was applied in foreign courts, where mandatory enforcement of the decision was requested with regard to both a state enterprise and the Russian Federation with reference to an alleged surrender of legal immunity by the government.
Existing practice shows that one claim concerning independent (separate) responsibility of the state enterprise and the state can be insufficient. Two separate problems arise. One is the material and legal. The second is procedural.

Representatives of a state unitary enterprise, trying to explain the status and property of such an enterprise to a court in, say, the USA, invariably have to clarify the differences between “operational management” and “economic conduct” in the context of legal institutions. Allowing for the specifics of these institutions and the elementary difficulties of their adequate translation into English, the Russian respondent frequently risks his chances of proving his legal independence from the state or the differences in the liabilities of the enterprise based on the right of economic conduct and enterprise on the rights of operational management.

Bearing in mind that among state enterprises, participants of joint ventures, there are enterprises based on the right of economic conduct, it is worth stressing the nature and special nomination of the second type of enterprise – federal government enterprise. This nomination adequately reflects its legal character, and also the closer bond with the state, including a possible subsidiary liability of the state in accordance with part 2 art. 115 of the Civil Code of the RF.

The problem of the procedural character is linked in that according to the procedural law of some countries, including the USA, the court recognizes the legal immunity of a foreign state, but the necessary condition for this is a corresponding statement to the court, made by the representative of a foreign state.

In the matter under consideration, when the state itself was not a party to the joint venture, i.e. was not a party in private-legal relations, but was declared to the court as the respondent, it may declare its immunity with an indication that its appearance in court does not mean surrender of immunity, but is limited only by the aim of making the relevant declaration. International practice shows that this institution of a special declaration by a state has found application. As for the Russian Federation – its position in these matters is still to be defined.

A.G. Svetlanov
Source publication: Mezhdunarodnoye chastnoye pravo. Sovremennaya praktika. M. 2000. Pp. 239-252.