Arbitration Clause Covers Claims for Damages… But Not All

On 7 August the Federal Commercial Court for the Moscow Circuit delivered a remarkable decision clarifying the principles of arbitration clause interpretation. More specifically, the Circuit Court explained which claims for damages go with a standard arbitration clause and which do not, unless expressly mentioned in such clause. It stated that such claims may fall within the standard arbitration clause only when they are inextricably linked with the contract’s very subject matter.

This issue deserves particular attention. Russian courts may set aside an arbitral award should its subject matter fall outside of the arbitration clause. On the other hand, when a claim comes within the ambit of the clause, Russian courts would deny their jurisdiction in its regard. The bigger the damages at stake appear, the more difficult becomes the choice: where to pursue the claim, in a state court or in arbitration?

Most standard arbitration clauses today apply to any dispute arising out of or in connection with the given contract, including issues of breach, termination or invalidity thereof. Arguably, such wording leaves in a grey zone any claims for damages arising out of a delict (or tort), which have some connection with the contractual obligations of the perpetrator. The case at hand dealt exactly with such a grey area situation.

Facts of the Case

The claimant leased to the respondent a warehouse that later became seriously damaged by fire. The lease agreement contained an arbitration clause referring all disputes arising out of or in connection with the agreement to the International Commercial Arbitration Court at the Russian Chamber of Commerce and Industry. The fire allegedly started due to the lessee’s negligence: it operated a diesel forklift within the warehouse in direct violation of the fire regulations in force.

Since the lessor considered such a case to be outside the direct ambit of the lease agreement, it filed a claim for damages to the Russian state commercial courts.  The overall damages the lessor claimed exceeded 110 million Rubles (3.5 million USD). The lessee requested the first instance court to discontinue proceedings and refer the parties to arbitration. In addition, it filed a counterclaim stating that the fire was caused by a failure of the fire alarm and the lessor was liable in the amount of the lessee’s lost goods, approximately 60 million Rubles.

Both the court of first instance and the appellate court ruled in favour of the lessor and rejected the lessee’s request to refer the case to arbitration.

Decision of the Moscow Circuit Court

The Moscow Circuit confirmed the positions of the lower courts. The court held that the claim was outside the arbitration clause on the basis of two principal arguments.

First, the Circuit Court noted that even though the damages sought were caused within the leased premises, they were the result of a fire and therefore were “an accidental event… the possibility of which was not inextricably linked with the very subject-matter of the lease agreement.” Here the Circuit Court referred to the Resolution of the Presidium of the Russian Supreme Commercial Court N 12331/01 dated 24 April 2002.

In that case, the highest commercial court dealt with a claim relating to the validity of a promissory note. A well-known Russian car producer received this note from a buyer as a deposit to secure payment of the purchase price. The car sale contract between them included a standard arbitration clause, and this clause did not expressly provide that it extended to disputes concerning promissory notes. Given the lack of such reference, the court held that the dispute as to the validity of the promissory note fell outside of the ambit of the arbitration clause in the contract.

Second, the Circuit Court stressed that the respondent itself recognised the state court’s jurisdiction. Thus, it participated in the trial, which lasted over two years and, moreover, filed counterclaims for the damages that it suffered due to the fire. Moreover it also filed a lawsuit against the claimant for unjust enrichment on the same factual pattern. The Circuit Court thus emphasised that the respondent not only acquiesced to the state courts’ jurisdiction over that matter, but also actively used this jurisdiction in a parallel case. Therefore, the Court found that the defendant acted in bad faith in claiming this jurisdictional defence.

Finally, the Circuit Court found that on a policy level it was not appropriate to dismantle the results of two years of litigation caused by the alleged failure to comply with the arbitration clause.

Impact of the Decision

While assessing the impact of this decision, one may look at the date of the only judgment cited by the Moscow Circuit: the Russian Supreme Commercial Court issued its Resolution containing a holding on a comparable issue way back in the year 2002. The issue there was not even similar. The Supreme Commercial Court ruled that a standard arbitration clause does not cover disputes concerning the validity of promissory notes tendered in performance of the contract which included the clause in question. Notably, the Supreme Commercial Court did not explain this holding. This obviously put the lower courts in an ambiguous position. On the one hand they must follow the approach that not all disputes connected with a contract may fall within the arbitration clause. On the other hand, it remains unknown as to how to determine which ones do not. Most courts would then follow the approach usually described as the “I know it when I see it” test.

In 2009, however, the Moscow Circuit suggested a more or less clear test. In case A40-51596/09-68-437, it confirmed the request for recognition and enforcement of the award rendered by the SCC Arbitration Institute. By this award, the tribunal ordered a Russian party to pay a foreign architect for additional works and compensation for the infringement of its copyright.

The Moscow Circuit held that a claim for payment in respect of additional works falls within the standard arbitration clause, when the works at issue are “manifestly and closely” connected with the given contract. It implicitly found that the arbitration clause extended to the damages for a copyright infringement. The court noted that “the issues of copyright law were connected with the performance of the contract”. This wording offered a more or less clear test of manifest and close connection, which was however a bit relaxed by the court itself for the purposes of the damages arising out of a copyright infringement.

Meanwhile, the 13^th Appellate Commercial Court in St Petersburg stated in its decision dated 20 June 2013 in case A26-562/2013 that nothing prevented the claims for damages caused in connection with the lease in question from falling within the scope of a standard arbitration clause contained in such a lease agreement. The case is currently pending before the Federal Commercial Court for the North-West Circuit. Given the 2009 decision of the Moscow Circuit, this looked like a pattern opening up standard arbitration clauses to any kind of damages claims that are at least somehow connected with the given contract.

In light of this earlier case law the decision of the Moscow Circuit of 7 August represents an interesting development.  Although definitely influenced by the lessee’s alleged bad faith in raising the arbitration clause argument, the Moscow Circuit clearly intended to limit the scope of the arbitration clause only to damages closely connected with the lease agreement. In this sense, one may interpret the decision as a step back and a limiting line.

Nevertheless, the characterisation of a certain type of damages as “an accidental event… the possibility of which was not inseparably tied with the very subject-matter of the lease agreement” could still provide grounds for controversy.  Apparently, this test still contains a fair amount of “I know it when I see it” thinking, although “inseparable ties” makes it definitely more precise. In any case, it is important that, as a matter of legal certainty, the Russian courts established a border between the damages claims within a standard arbitration clause and the damages claims beyond it.  Once we have a border, we can move it.

The full text of the Circuit Court decision can be found here (in Russian).

Anton Petrov

Center for European Law