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Russian court of appeals interprets a pathological arbitration clause

In a case filed by Spetstehnika LLC (Russia) against Cadman Power Equipment Asset Corp. (Canada), the 20th Circuit Court of Appeals in Russia considered the enforceability of a potentially pathological arbitration clause that referred to a non-existent arbitral institution in Canada. 

The court of appeals, on 9 November 2021, refused to meddle with the parties’ arbitration agreement, emphasizing that if parties have portrayed a clear intention to settle the dispute by arbitration, then such intention must be given effect. The court further found itself an inappropriate forum to resolve the dispute on the merits in case if the arbitration agreement in fact turns inoperative or the tribunal finds it has no competence.

Despite the dispiriting trend in Russian courts, that become infamous for decisions that thwarted arbitration agreements between disputants, this particular decision might signal a shift in a policy approach that Russian courts will not intervene in international arbitrations unless they have clear authority and good cause.

Background of the underlying dispute

The dispute stemmed from the parties’ commercial relationship. In 2016, the parties entered into a contract for the supply of agricultural machinery, under the terms of which they undertook to ship the goods on a FOB basis (Ontario, Canada).

Once things have gone downhill, the buyer (Russian enterprise) filed a case before Arbitrazh court in Russia seeking damages of USD 437,449 and requested the seller (Canadian counterparty) to take back the hydraulic manure injectors and spare parts.

The contract stipulated that all contradictions between the parties must be settled in accordance with the laws of Canada. Any conflicts, disagreements or claims must be resolved before the Arbitration Court of Ontario, Canada.

The buyer filed a case before the domestic court of the first instance in Russia advancing an argument that the arbitration agreement was inoperative as it referred to a non-existing arbitral institution in Canada, and the state court should therefore have declared itself competent to hear the dispute on the merits. The court of the first instance declined to hear the case for lack of jurisdiction. Even if the claimant elects to further challenge the arbitration agreement, the court noted it should try its luck before the Canadian courts as the ones with a closer connection to the dispute.

Unraveling the pathological arbitration clause conundrum

In the appeal, the plaintiff argued that the arbitration clause addressed a non-existing body as the arbitral institution to which the parties have to present possible controversies. The appellant provided the court with a letter from the Canadian Embassy in Russia that had confirmed the non-existence of the institution in Ontario stipulated in the arbitration agreement. With reference to art. 247 of the Commercial (Arbitrazh) Procedural Code of Russia, the appellant asserted that at the stage of accepting the statement of claim the court of the first instance had no grounds to conclude that the state court in Russia could not consider the case.

The appellant argued that the state courts in Russia had the most proper jurisdiction to resolve the case at hand. To substantiate its claim, the appellant alleged that the place of performance of the obligation, which is the subject matter of the dispute, was in Bryansk, Russia. Further, Russia was closely connected to the dispute as the place of delivery and storage of the goods took place within the boundaries of Russia. Lastly, the appellant made particular reference to the fact that the defendant did not object to referring the case to the Russian courts.

The court of appeals took a different stance and found no close connection between the dispute and Russia. In its analysis, the appellate court stressed that the defendant, a foreign legal entity registered under Canadian law, did not have any branches, divisions or offices on the territory of Russia. Neither the defendant had any property or assets in Russia. Further, the place of performance of the contract was also Canada, and the parties determined the laws of Canada to govern their contractual relationship. The court upheld the decision of the lower court and refused to hear the case on the merits.

The appellate court provided further guidance noting that, when an arbitration agreement turns unenforceable, the competent court should be determined on the basis of the general rules on international jurisdiction, which is based on the notion of the closest connection of the dispute with the relevant State.

The appellate court noted that the arbitration clause in the case at hand sufficiently showed the parties’ intention to submit to arbitration in Canada applying the Canadian law and hence rejecting the appellant’s contention that the state court in Russia constituted the most proper forum for adjudicating the merits of the dispute.

The appellate court further stressed that even if the arbitration agreement in fact turns inoperative, the dispute shall be resolved before the Canadian courts, as the potentially pathological clause should be then construed as a forum selection clause, that in this case indicates the parties’ will to refer the dispute to the courts in Canada.

A cure for every ill? Judicial Interpretation of Pathological Clauses: Russian Scenario

The appellate court has undertaken a reasonable and meaningful construction of a potentially pathological arbitration agreement. The real intention of the parties to arbitrate, notwithstanding the fact that it was under a non-existent institution, has been given due recognition. The court of appeals reiterated its reticence to meddle with arbitration agreements

In fact, if the Claimant continues to endeavor to challenge the arbitration agreements across the ocean, the courts in Canada might construe the pathological clause as referring to the ADR Institute of Ontario, a well-recognized arbitral institution in the region.

Several years before, the Supreme Commercial (Arbitrazh) Court of Russia upheld another arbitration clause that, although specifying that the parties’ disputes were to be resolved pursuant to the ICC Arbitration Rules, was silent on the parties’ choice of administering institution.

At the same time, clauses in some other cases had a different fate. The analyzed case once again reminds that poorly drafted arbitration clauses may become a source of strife for the entire duration of the dispute. As such, the parties must be cautious of possible defects that might render an arbitration clause inoperative.

About the Author:

Rinat Gareev currently holds a position of case counsel at the Russian Arbitration Center. He is a US-qualified attorney (admitted in New York), holds civil and common law degrees. Prior to joining the arbitral institution, Rinat has gained experience by working and training in leading arbitral institutions (AIAC (Malaysia), KCAB (South Korea), international organizations (UNCITRAL) and commercial firms in Russia, the United Kingdom, and the USA. Through Rinat's professional and educational experience, he has developed expertise in trade law, aviation law, arbitration and cross-border dispute resolution. He has published several papers in international and local journals on issues relating to cross-border dispute resolution and also provides expert opinions on various domestic and international law-related issues.

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