State involvement in commercial arbitration: where is the line drawn?
The involvement of state bodies and companies in international commercial arbitration remains a pressing issue not only in Ukraine, but also far beyond its borders. The temptation to question either the validity or operation of arbitration agreements concluded by state-owned entities brings before the courts and international arbitration tribunals a variety of factual patterns and legal arguments. A recent case against PJSC Ukraine International Airlines (UIA), in which the state prosecutor’s office attempted to bypass an arbitration agreement and challenge before the Ukrainian courts the commercial contract signed by the state-owned company, is yet another example of such practices and worthy of consideration.
Article 2 of the Commercial Procedure Code provides that the commercial courts of Ukraine shall commence proceedings at the request of the state prosecutor acting in the interests of the state. In such cases, the state prosecutor must define in the statement of case which state interests have been violated and justify the need to protect them.
The interests of the state must be clearly stipulated and justified by the state prosecutor.
The state prosecutor shall commence an action only in the interests of the state, and not those of its enterprises, institutions or companies, regardless of their subordination or form of ownership.
In May 2014 the Kiev City Commercial Court commenced an action against UIA at the request of the Kiev Oblast Office of the State Prosecutor, which was allegedly acting in the interests of the Ministry of Infrastructure (the first claimant) and a state enterprise, Boryspil International Airport (the second claimant). The state prosecutor requested the court to declare void certain provisions of the addendum and the additional agreement to the Standard Ground Handling Agreement (SGHA) concluded between the airport and UIA in January 2004, with subsequent amendments. Among other things, the contractual provisions in question governed:
- the price of UIA aircraft stationing at the airport;
- the calculation of airport duties and the airport’s undertaking not to increase such duties within the SGHA term; and
- the SGHA validity period and the procedure for its amendment and termination.
The state prosecutor claimed that since the airport belonged to the state sector, the disputable contractual provisions would likely aggravate its position on the market, including by making it impossible for the airport to comply with national programmes.
The SGHA contained an arbitration clause whereby all disputes arising from the agreement or in connection with it were subject to arbitration in Zurich, Switzerland. Therefore, in accordance with Article II(3) of the New York Convention as well as Ukrainian law, the respondent raised jurisdictional objections and requested the court to terminate the proceedings and refer the parties to arbitration.
Article II(3) of the New York Convention provides that the courts of a contracting state – when seized of an action in a matter in respect of which the parties have made an agreement within the meaning of this article, and at the request of one of the parties – must refer the parties to arbitration, unless the court finds that the agreement in question is null and void, inoperative or incapable of being performed.
The state prosecutor insisted that its and the ministry’s involvement in the proceedings (ie, as non-signatories to the arbitration agreement) made the arbitration clause inoperative. The state prosecutor further argued that the arbitration clause contained in the SGHA violated Article 1(2) of the Law on International Commercial Arbitration, – which effectively prescribes that only disputes containing a foreign element can be referred to arbitration – and put the airport at a disadvantage in comparison to the respondent, due to significant arbitration fees of the Swiss arbitrators which the airport would have to pay if the parties were referred to arbitration.
Having considered the parties’ submissions, on June 26 2014 the Kiev City Commercial Court terminated the proceedings and referred the parties to arbitration. The court found that the state prosecutor had no standing to sue UIA, based on the following grounds:
- A state-owned commercial company is free to conduct its operational commercial activities and is thus independent in choosing its counterparties, concluding agreements and agreeing their terms.
- By law, the risks associated with a state-owned commercial company’s commercial activities are to be borne by the company, not the state. Therefore, even if the interests of the state-owned company are violated or the risk thereof arises, this does not necessarily mean that the interests of the state have been violated or are at risk.
- The fact that the airport belonged to the state sector and the probability that the disputable contractual provisions would aggravate its position on the market (including by making it impossible for the airport to comply with national programmes) were insufficient factors to conclude that the provisions violated or created a risk of violation of the interests of the state.
- The absence of any connection between the SGHA and the fulfilment of public demands, as well as the absence of any claims in the interests of the public authority (the ministry), gave the court no grounds to disregard the arbitration clause.
The court found that in concluding the arbitration agreement, the parties had not violated Article 1(2) of the Law on International Commercial Arbitration, since the respondent was a company with foreign investments. The court also dismissed the state prosecutor’s allegations of unequal conditions in the arbitration clause, stating that in the event of arbitration, both parties would have incurred arbitration fees and expenses.
The court’s judgment was subsequently upheld by the High Commercial Court.
Although the existence of an arbitration agreement prevents resolution of the dispute by the commercial courts, Ukrainian commercial procedure provides that where a party files the respective application with the court, the court is obliged to clarify the circumstances connected to the validity of the arbitration agreement or its becoming inoperative or incapable of performance in the course of the trial conducted in the manner prescribed by law. Therefore, in similar cases the court will accept the claim for consideration, hear the parties and then decide whether it has jurisdiction to proceed with judgment on the merits or terminate the proceedings and refer the parties to arbitration.
In the case at hand, the courts conducted a detailed analysis of the state prosecutor’s standing to sue UIA under the SGHA. Each disputed contractual provision was considered against respective Ukrainian laws and regulations and the defence lawyers proved that, contrary to the position of the state representative, the agreements concluded by the parties in the SGHA complied with the law and did not limit the state authorities in the exercise of their powers (ie, there had been no violation or risk of violation of state interests).
The approach taken by the courts in this case is welcome and should serve as another guideline for lawyers dealing with similar cases in order to prevent unreasonable attempts of the state to interfere with ordinary business activities.
Authors: Andrey Astapov, Anna Kombikova