Closer Scrutiny of Arbitral Awards Required If Fraud Is Alleged

Supreme Commercial Court

Parties’ use of arbitration for improper purposes has been a topic of growing concern for the Russian business community, courts and state authorities. While an extensive overhaul of the Russian arbitration law to address these concerns is underway, courts employ available procedural mechanisms to combat abuse.
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This week the Presidium of the Supreme Commercial Court will consider the instruments available to a court in the context of enforcement proceedings where a party alleges that the award results from sham arbitration. In the case before the Presidium the applicant seeks enforcement of an award against an insolvent company. One of the company’s creditors alleges that the arbitration in question was a sham and the result of a collision between the parties in order to create artificial indebtedness and dilute legitimate creditors’ claims against the company.

The panel of judges referring the case to the Presidium suggested that where a party alleges that the arbitration was a sham the court should shift the burden of proof onto the party seeking enforcement to demonstrate genuineness of the arbitration and the claim underlying it. The judges reasoned that it would be easy to discharge the burden for a party to a genuine arbitration. In contrast it would be next to impossible for a person that was not party to arbitration to positively prove that it was sham.
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Facts of the Case

In 2012 Gartic Limited submitted an application to the Moscow Region Commercial Court seeking recognition and enforcement of an ad hoc arbitration award against LLC Murmansk Multiservice Networks (“Murmansk Networks”). The arbitration concerned a licensing agreement with respect to two trademarks, and the tribunal awarded c. 1.5 bln roubles in outstanding royalties, penalties and damages to Gartic.
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The application was not opposed and in December 2012 the court issued a ruling recognizing and enforcing the award.

In late 2012 one of Murmansk Networks’ creditors submitted an application to the Murmansk Commercial Court asking the court to declare Murmansk Networks insolvent and liquidate its property. The Murmansk Commercial Court granted this application and at the end of 2013 Murmansk Networks was put into liquidation. Gartic and a number of other creditors were put onto the register of Murmansk Networks’ creditors, with Gartic relying on the Moscow Region Commercial Court order as the evidence of its claim.

In 2014 LLC ElTekhMontazh, another Murmansk Networks creditor, appealed the Moscow Region Commercial Court ruling enforcing the arbitral award. It argued that the arbitration was a sham intended to create an artificial claim against Murmansk Networks and dilute legitimate creditors’ claims against the company. The Federal Commercial Court for the Moscow Circuit dismissed the appeal, holding that ElTekhMontazh had failed to prove that the arbitration was a sham.

The Three-Judge Panel Ruling

In referring the case to the Presidium of the Supreme Commercial Court the panel criticized the Federal Commercial Court for the Moscow Circuit for placing too heavy a burden on the insolvent company’s creditor.

It explained that in the unique circumstances of insolvency the creditor may not be in position to prove that the arbitration and the underlying claim of another creditor are not genuine. Accordingly, once the creditor submitted prima facie evidence to support its objection the burden should shift onto the party seeking enforcement of the award to submit evidence confirming that both the claim and the arbitration were genuine.

The panel’s decision should be looked at in its context. Where a person who was not party to the arbitration opposes enforcement of the award and alleges that the award was rendered in a sham arbitration, use of unusual procedural instruments appears to be justified. The party seeking enforcement may indeed be requested to submit evidence relating to both the claim and arbitration. This should not however justify de novo review of the arbitral tribunal’s decision on the merits of the case.

One may query whether the reallocation of burden of proof is the appropriate remedy. In the alternative, the party objecting to the enforcement of the award could ask the court to order the other party to produce respective documents. Then using the documents produced the party could discharge the burden of proof with respect to its objections.

The full text of the three-judge panel ruling is available here (in Russian).