December 2011
From the Editors
Editors:
Welcome to the 17th edition of Arbitration World, a publication from K&L Gates'
Arbitration Group. This special edition focuses on issues and recent developments
of particular relevance to those operating in the field of finance. We also include our
usual round-up of news items in international commercial arbitration and investment
treaty arbitration.
Ian Meredith
ian.meredith@klgates.com
+44.(0)20.7360.8171
Peter R. Morton
peter.morton@klgates.com
+44.(0)20.7360.8199
_________________________
We hope you find this edition of Arbitration World of interest, and we welcome any
feedback (email ian.meredith@klgates.com or peter.morton@klgates.com).
__________________________________________________________
In this issue:
 News from around the World
 World Investment Treaty Arbitration
Update
 Global Tribunal Established for
Settlement of Complex Financial
Disputes
 Dispute Resolution in Islamic
Finance
 FDIC’s and OCC’s New Rules Ban
Mandatory Pre-Dispute Arbitration
Agreements with Retail Forex
Customers
 Investment Treaty Protection for
State Defaults on Sovereign Bonds
 KPMG v. Cocchi: United States
Supreme Court Favors Arbitration
of Some But Not All Claims over
the Spectre of Piecemeal Litigation
 Should Participants in the Pensions
and Investment Management
Industry Agree to Use Arbitration?
 Arbitration under the ISDA Master
Agreement
 U.S. Courts Split on Ability to Use
Sovereign Immunity Act Exceptions
to Enforce Arbitration Awards
against Foreign Nations
 Insurance Coverage for Financial
Institutions: Common Issues in
Coverage Disputes and Selecting
Appropriate Dispute Resolution
Procedures in Policies
News from around the World
Asia
India
The controversial Supreme Court decision in Bhatia International has been referred
to a five-member constitutional bench of the Supreme Court for reconsideration. In
the Bhatia case, the Court held that the Indian Arbitration and Conciliation Act 1996
could be applied to international arbitrations seated outside India. The holding has
caused concern, particularly since being applied in Satyam Computers to permit
Indian courts to set aside foreign awards in certain cases. A 2010 proposal by the
Indian Law Ministry to amend the law having come to nothing, it is hoped in some
quarters that the effects of Bhatia will be reversed by the Supreme Court. The recent
reference (in Bharat Aluminium v. Kaiser Aluminium Technical Services Inc)
provides the Court with an opportunity. The case is expected to come before the
Court in January 2012, but a final decision may not be issued for some time after
that.
Pakistan
Pakistan has passed legislation giving permanent effect to the New York Convention.
Pakistan first ratified the Convention in 2005. Legislation enacted at that point only
gave the Convention temporary effect, and expired in 2010. Earlier this year, the
Recognition and Enforcement (Arbitration Agreements and Foreign Arbitral
Awards) Act 2011 entered into force, bringing into domestic law the key principles
of the convention including as to stays of court proceedings and limited grounds of
challenge to arbitral awards. The Act applies to awards made after 14 July 2005.
Arbitration World
Europe
England and Wales / Northern Ireland
The English Commercial Court has clarified the test
for the removal of an arbitrator and the setting aside
of an award on the grounds of justifiable doubts as
to impartiality. In A v B, a barrister acting as sole
arbitrator in a dispute between A and B was
instructed by B's solicitors to act for another client in
unrelated litigation. The arbitrator disclosed the
matter a year later when he was writing his award.
The award was in B's favour, and A applied to the
court to remove the arbitrator, under section 24 of
the Arbitration Act 1996, and to set aside the award
for serious irregularity, under section 68.
Mr. Justice Flaux applied the test of whether the
fair-minded and informed observer, having
considered the facts, would consider that there was a
real possibility that the tribunal was biased. He held
that the mere fact that the arbitrator acted for one of
the firms acting in the arbitration did not mean that
test was made out. The judge clarified that the court
had to consider the facts as they appeared at the
hearing, not at the time of the disclosure or nondisclosure.
A notable feature of the case is the reliance by the
complaining party on the IBA Guidelines on
Conflict of Interest in International Arbitration. The
judge held that not only had that party misconstrued
the relevant Guideline, but in any case those
Guidelines could not override national law.
Liechtenstein
The Principality of Liechtenstein has acceded to the
New York Convention. The Convention entered
into force for Liechtenstein on 5 October 2011,
bringing to 146 the number of states party to the
Convention.
Slovakia
Slovak courts are reported as having held that
actions for declaratory relief cannot be decided in
arbitral proceedings. Two regional Slovak courts
(whose decisions are subject to review only by the
Slovak Supreme Court) have ruled that actions for
declaratory relief as to the validity of a contract
cannot be decided by arbitration. The reasoning
behind the decisions has been described as
representative of an antipathy towards arbitration in
certain courts, in contrast with the pro-arbitration
stance of the legislature, as shown by the passing of
legislation based on the UNCITRAL Model Law.
Concern has been expressed that for the decisions to
be followed by other courts or approved by the
Supreme Court would be a retrograde step for
arbitration in Slovakia, by making recognition of
foreign arbitral awards in Slovakia more
complicated, and inviting opportunistic parties to
resort to Slovak courts to frustrate foreign arbitral
proceedings.
Oceania
Australia
In recent months, the Commercial Arbitration Bill
has progressed through the legislative process in the
legislatures in several Australian states. The Bill is
intended to modernise and reform Australian
domestic arbitration law, bringing it into line with
the UNCITRAL Model Law and creating a coherent
approach with Australia's international arbitration
statute. The Bill is expected to be passed in all
States and Territories.
The Australian Centre for International Commercial
Arbitration (ACICA) has launched revised rules,
which include a new emergency arbitrator
procedure.
Institutions
Swiss Chambers
The Swiss Chambers Court of Arbitration and
Mediation working group responsible for the
revision of the Swiss Rules is expected to conclude
its work in late 2011. The Swiss Rules were first
published in 2004. The working group revisions,
which have not yet been published, are intended to
bring the Rules in line with developments in recent
years and to apply to both domestic and
international arbitrations conducted in Switzerland.
CIArb
The Chartered Institute of Arbitrators has published
its survey on costs in international arbitration
(available at
http://www.ciarb.org/conferences/costs/012-thesurvey/). The survey ran from November 2010 to
June 2011 and was completed by lawyers and
international arbitrators. The survey contains
statistical analysis drawn from information on 254
international arbitrations between 1991 and 2010.
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The survey found that the average arbitration took
between 17 and 20 months, depending on the nature
of the dispute. Respondents to the survey reported
that of their total spend, on average 74% went on
external legal costs, 10% on experts, and 3% on
institutional or management costs.
ICC
The ICC has published the text of its 2012 Rules of
Arbitration, which will apply to ICC arbitrations
commenced after 1 January 2012, unless parties to a
dispute expressly agree to apply the 1998 Rules.
K&L Gates' Alert on the new Rules, summarising
the principal changes, is here.
LCIA
The LCIA is currently undertaking a review of its
Rules of Arbitration which have been in operation
since 1998. It is expected that details of any changes
arising from the review should be available in 2012.
_____________________________
World Investment Treaty
Arbitration Update
Lisa M. Richman (Washington, D.C.) and Sabine
Konrad (Frankfurt)
In each edition of Arbitration World, members of
K&L Gates’ Investment Treaty practice provide
updates concerning recent, significant investment
treaty arbitration news items. This edition features a
discussion of Mexico’s loss of a request for review
of a NAFTA claim against it; a number of losses by
Argentina at ICSID; a novel litigation funding
concept introduced by a claimant in a dispute against
Venezuela; claims against Turkey before the
European Court of Human Rights (“ECtHR”) and
ICSID relating to the expropriation of land; and
dismissal of NAFTA claims against Canada relating
to an alleged investment in a waste disposal plan.
Canadian Court Denies Mexico’s NAFTA
Award Challenge
On 4 October 2011, the Ontario Court of Appeal
dismissed Mexico’s request to reverse a decision of
the Ontario Superior Court of Justice which refused
to set aside a US $77 million arbitration award
against Mexico. See Mexico v. Cargill, Inc., 2011
ONCA 622. The underlying September 2009
arbitral award against Mexico for NAFTA violations
was made under the ICSID Additional Facility
Rules in favour of Cargill, an American supplier of
high fructose corn syrup (“HFCS”). See Cargill,
Inc. v. United Mexican States, ICSID Case No.
ARB(AF)/05/2, Award of 18 September 2009. The
appellate court determined that the trial court’s
decision to uphold the arbitration award -- although
based on the “reasonableness” instead of the
“correctness” standard of review (on issues of
jurisdiction) -- was nevertheless appropriate and
therefore that its dismissal of Mexico’s argument
that the arbitral tribunal exceeded its jurisdiction
was not in error.
The claim in the arbitration related to losses
allegedly suffered by Cargill’s Mexican subsidiary
and its U.S. operations that it contended were
created or expanded specifically for production of
HFCS to be sold in Mexico. Cargill alleged that
these losses were caused by import legislation
enacted by Mexico to protect its domestic sugar
industry to the detriment of HFCS distributors such
as Cargill.
Because the arbitration was brought under the
ICSID AF Rules (as Mexico is not a member of
ICSID), it was not insulated from national law, as
an arbitration under the ICSID Rules would have
been. Instead, it was subject to review by the
national courts located at the seat of the arbitration,
Toronto. Pursuant to the UNCITRAL Model Law,
Mexico therefore filed its request for review with
the trial court.
In that request, Mexico argued that the arbitral
tribunal lacked jurisdiction under NAFTA on
grounds that it incorrectly interpreted NAFTA in
awarding compensation for “up-stream” losses (that
is, the impact on sales of HFCS manufactured at
Cargill’s U.S. facilities that it intended to distribute
through its Mexican subsidiary) instead of only
“down-stream” losses (the direct impact on the sales
of Cargill’s Mexican subsidiary in Mexico).
Mexico contended that the damages should be less
than half of the US $77 million awarded as a result
of these errors, arguing that the damages should
only be for losses incurred within Mexico under
Chapter 11 of NAFTA. In the subsequent appeal
proceedings in the Ontario Court of Appeal, the
court held that the arbitral tribunal had correctly
applied NAFTA “by reason of, or arising out of”
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language by requiring that the damages awarded
must relate to the investment and investor, but that
this did not impose a territorial limitation on the
location of Cargill’s compensable losses, as
correctly decided by the trial court. Mexico v.
Cargill, Inc., 2011 ONCA 622, at para. 22.
The court reached this decision despite the amicus
submissions of Canada and the U.S., both of which
supported Mexico’s submission that, under Article
31(3)(b) of the Vienna Convention on the Law of
Treaties, damages were intended to be limited to
those incurred in the host state—and should not
extend to other states, including the home state. The
court found significant the fact that there was no
evidence filed by the contracting state parties to
NAFTA to support this alleged intention. Id. at
paras. 76 ff.
Argentina’s String of Losses at ICSID
Continues
Following closely on the heels of the award of over
US $21 million on which we reported in the August
2011 edition of Arbitration World, there have been
recent developments in the Impregilo S.p.A. v.
Argentine Republic case and in two other cases
involving Argentina at ICSID.
Two Dissenting Opinions to Award Against
Argentina
As noted in our prior report, two dissenting opinions
were filed in the Impregilo case, one by Judge
Brower criticizing the low amount of compensation
awarded to the claimant, and the second by
Professor Stern on the majority’s application of the
BIT’s most-favored nation (“MFN”) clause to allow
the investor to invoke the terms of the US-Argentina
BIT to overcome the requirement to file local court
proceedings in the Italy-Argentina BIT. See
Impregilo S.p.A. v. Argentine Republic, ICSID Case
No. ARB/07/17, Award and Concurring and
Dissenting Opinions of Judge Charles Brower and
Professor Brigitte Stern of 21 June 2011.
Dissent Concerning MFN Clause in Case
Involving German Investor
On 24 October 2011, another dissent on the basis of
an MFN clause was issued, this time to a Decision
on Jurisdiction in the arbitration involving German
construction company Hochtief against Argentina
relating to Hochtief’s investment in a toll road and
bridge project. See Hochtief Aktiengesellschaft v.
Argentine Republic, ICSID Case No. ARB/07/31,
Separate and Dissenting Opinion of J. Christopher
Thomas of 7 October 2011.
The Germany-Argentina BIT contains an 18 month
litigation clause like the one at issue in Impregilo.
In Hochtief, the majority determined that Hochtief’s
claims can proceed to the merits phase, allowing it
to benefit from the dispute settlement mechanism in
the Argentina-Chile BIT, which does not contain a
mandatory local courts provision.
Echoing Professor Stern’s concerns in Impregilo,
Mr. Thomas argued the MFN clause could not be
used to bypass a treaty’s jurisdictional requirements.
He disagreed with the majority’s characterization of
the litigation requirement as “arbitrary,” “pointless”
and “perfunctory”, stating that “[i]t is not the place
of international tribunals to second-guess the
choices of [states] even when one can envisage
instances where such choices might lead to
inefficiency and additional cost to a would-be
claimant.” Id., at paras. 5 and 10.
Unlike the clause in the Italy-Argentina BIT in
Impregilo, the German BIT does not extend MFN
status to “all other matters.” Despite this fact, the
majority still concluded that the MFN clause applies
to dispute settlement which can be regarded as
“activity in connection with an investment.” Award
of 24 October 2011, at paras. 73-74. The majority
concluded that the investor simply was relying on
the Chilean BIT to pursue a right it already had – to
pursue arbitration – “more quickly and more
cheaply.” Id., at para. 85. As noted above, it
perceived the 18-month waiting period as a
“perfunctory and insubstantial” requirement which
would only delay the proceedings and add “no
necessary benefit.” Id., at para. 88.
Acknowledging the cases on both sides of the MFN
debate, the Hochtief majority determined that it was
required “to interpret…the specific provisions of the
particular treaties that are applicable in this case,
and not to choose between broad doctrines or
schools of thought, or to conduct a head-count of
arbitral awards taking various positions and to fall
in behind the numerical majority.” Id., at para. 58.
Like the Impregilo majority opinion, in the Hochtief
majority’s view, the right of an investor to arbitrate
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is a “substantive” right. It “is one component of the
bundles of rights and duties that make up the legal
concept of what property is.” Id., at para. 66
(emphasis in original). For that reason, it was
“nonsensical” to deny the investor the opportunity to
use the MFN clause because “the right to enforce is
an essential component of the property rights
themselves, and not a wholly distinct right.” Id., at
para. 67.
award in the Abaclat v. Argentina case in this
edition), Canadian mining company Crystallex is
using a different type of novel funding strategy to
bankroll its claims against Venezuela. The
underlying arbitration relates to a contract for the
operation of a gold mine that Crystallex values at
US $3.8 billion. See Crystallex International
Corporation v. Bolivarian Republic of Venezuela,
ICSID Case No. ARB(AF)/11/2.
The majority also held that the investor could not
pick and choose different clauses from various BITs,
however, and having decided to use the MFN clause
to apply the Chilean BIT, would need to “rely upon
the whole scheme” provided in the Chilean BIT. Id.,
at para. 98. This approach may have been in
response to Professor Stern’s concern that investors
in Impregilo were trying to take advantage of the
best provisions contained in multiple treaties.
Third-party funding by litigation funding companies
is starting to gain greater acceptance in the
investment treaty arbitration context, having
enjoyed popularity in the commercial arbitration
field for some years. Assuming it is successful,
Crystallex’s anticipated sale of securities valued at
US $120 million relating to its ICSID claims against
Venezuela appears to be the first time that such
financial instruments will be used to fund an
investment treaty arbitration. Crystallex reportedly
intends to secure up to 120,000 five-year secured
notes in the value of US $1,000 each, the recovery
on which will be tied to distribution pro rata to the
funders of between 35 to 40 per cent of a settlement
or award. Crystallex reportedly needs the funds not
only to pay for the arbitration itself, but also for
working capital and to pay off a debt of US $100
million.
Annulment Request in Case Involving Italian
Investor
On 25 October 2011, the day after the Hochtief
award was rendered, ICSID registered Argentina’s
application to annul the Impregilo award, requiring
Argentina to pay Italy US $21 million plus interest.
The annulment grounds have not yet been made
public and the ad hoc committee has not yet been
constituted.
US $43 Million Award in Case Involving U.S.
Investor
Impregilo and Hochtief are not the most recent in the
string of defeats for the Argentine Republic—a US
$43 million award plus interest reportedly was
issued on 31 October 2011 against Argentina in
favor of a U.S. energy company. El Paso Energy
International Company v. The Argentine Republic,
ICSID Case No. ARB/03/15. The El Paso award is
not yet public. At issue in those proceedings is
Argentina’s alleged failure to provide fair and
equitable treatment, particularly with respect to the
impact on energy regulations as a consequence of
measures adopted by Argentina as a result of the
financial crisis in the late 1990’s and early 2000’s.
Investor Sells Securities Tied to ICSID
Award
Shortly after a tribunal in another ICSID case
sanctioned the use of mass claims to fund an ICSID
dispute (see our separate report on the August 2011
The ICSID proceedings are at a very early stage.
The tribunal was recently formed and held its first
session on 1 December 2011.
Turkey Loses Claim at the ECtHR,
Unrelated ICSID Claim Filed
The ECtHR has issued a number of decisions in
favour of claimants related to the compensation of
individuals for the taking of their land for purposes
of reclassifying it as “state forest.” See, e.g., Affaire
Tongun c. Turquie App. No. 8622/05, ECtHR,
Judgment of 27 September 2011; Affaire Malhas et
Autres c. Turquie, App. Nos. 35476/06, 28530/06,
43192/06, 43194/06, Judgment of 13 September
2011; Affaire Ali Kiliç et Autres c. Turquie, App.
No. 13178/05, Judgment of 13 September 2011.
Since 2008, over 40 judgments have been issued
condemning the Turkish government for taking
registered private property without compensation
because it was deemed to be state forest. Although
compensation has not been awarded in all of the
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cases to date, the claims apparently total over US
$15 million. All of the judgments have found
Turkey in violation of Article 1 Protocol 1 of the
Convention on Human Rights for infringement of
property rights. The Court concluded that the
Turkish Government annulled title acquired in good
faith. See, e.g., Affaire Emiroğlu c. Turquie, App.
No. 40795/05, Final Judgment 8 June 2011, at
para. 19.
Although the Court acknowledged the legitimacy
of Turkey’s right to protect the state forest for
environmental reasons, particularly given the
legality of the reclassification under Turkish law,
it has concluded that compensation must be paid.
Notwithstanding the alleged lawful nature of the
taking, the Court apparently also has concluded
that Turkey is required to pay the current value of
the land (as supported by expert reports) instead
of, for example, the price originally paid for the
land or the value at the time of the taking. See,
e.g., Affaire Ali Kiliç et Autres c. Turquie, App.
No. 13178/05, Judgment of 13 September 2011, at
paras. 30 ff.
This is not the only dispute facing the government of
Turkey related to alleged damages resulting from rezoning. On 28 October 2011, ICSID registered a
claim by a Dutch developer, Tulip Real Estate,
against the Turkish Government. See Tulip Real
Estate and Development Netherlands, B.V. v.
Republic of Turkey, ICSID Case No. ARB/11/28.
The value of the claim filed under the NetherlandsTurkey BIT has not yet been quantified, but is
estimated to be hundreds of millions of dollars. It
relates, among other things, to Turkey’s rezoning
and termination of a contract for the development of
a housing project in Istanbul, concerning which a
number of court proceedings also are pending in
Turkey. Those claims allege, among other things,
corruption by Turkish officials during the raid and
takeover of the project in June 2010.
NAFTA Win for Canada
Canada was recently successful in defending itself
against a US $350 million claim by a U.S. individual
who alleged that he invested in a project intended to
find a solution to Toronto’s waste disposal problem.
See Gallo v. Canada, PCA-UNCITRAL Arbitration
Rules. Mr. Gallo alleged that the lawyer for the
entity that had intended to use an abandoned iron
mine to store the refuse transferred the interest in
the land to him. He further contended that he was
prevented from carrying out the plan by the
Canadian government.
The tribunal determined that Mr. Gallo was unable
to prove that he was an investor in the project at the
time the Canadian government put a halt to it, given
he did not pay anything for his alleged investment.
In addition, the company registered as being
invested in the project was Canadian, and Mr. Gallo
did not request compensation at the time the
government enacted the allegedly discriminatory
legislation, unlike other companies. The award has
not yet been made public. Mr. Gallo allegedly was
ordered to pay nearly US $1 million to cover the
costs of the arbitration, but each side apparently was
ordered to pay their own legal fees and costs.
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Global Tribunal Established for
Settlement of Complex
Financial Disputes
René Gayle (London)
An expert body has recently been set up to hear
complex financial disputes, particularly those
resulting from intricate financial products such as
derivatives. The body has been named “The Panel
of Recognised International Market Experts in
Finance” (PRIME Finance).
It boasts an impressive list of over sixty finance and
dispute resolution experts, including Lord Woolf,
former Lord Chief Justice of England and Wales,
Nout Wellink, former President of the Dutch
Central Bank, Antonio Sáinz de Vicuña, General
Counsel of the European Central Bank and Judge
Stephen M. Schwebel, former Judge and President
of the International Court of Justice, and President
of the Administrative Tribunal of the World Bank,
among notable others. PRIME Finance finds its
home in the Peace Palace, situated in The Hague,
the Netherlands. There, it will be in the
recognisable company of the Permanent Court of
Arbitration and the International Court of Justice.
The eminence of its members and its palatial seat
much reflect the lofty expectations for the future of
this body.
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The plan to set up a body such as this, to deal with
complex financial issues, was conceived just over a
year ago, when some sixty delegates from a broad
spectrum of financial stakeholders from fourteen
different countries were invited to The Hague on 25
October 2010 for a roundtable. The event was
organized by the Dutch Non-Profit Organisation, the
World Legal Forum and chaired by Lord Woolf.
The objective was to have dialogue on the
possibilities of establishing some sort of “world
financial court.” The discussions led to an
overwhelming consensus that it would be beneficial
to introduce a panel of experts to resolve complex
financial matters. After a feasibility study
concluded that the body could be set up in as little as
a year, PRIME Finance was established on 29 June
2011.
For now, the focus is on judicial training and the
establishment of a specialised library. The initiative
for an international financial court appears to have
been temporarily shelved; instituting an international
court would have required significantly more time to
facilitate negotiations, government involvement and
treaty ratification. In the meantime, arbitration and
mediation services are scheduled to be launched in
January 2012 and PRIME Finance will also provide
early evaluation and advisory opinions, due to the
relative ease of set up of these services. PRIME
Finance will host an opening conference and
seminar on Dispute Resolution in Financial Markets
on 16–17 January 2012 at the Peace Palace in the
Netherlands; details can be found at
http://www.primefinancedisputes.org/index.php/e
vents/conferences.
It appears that the initiative for a focused global
tribunal on finance has been welcomed in most
quarters. Owing to the world financial crisis, the
suggestion of establishing such a body has been very
topical within legal circles since about 2008. The
recurring theme is that the sheer complexity of
modern day financial products requires expert
attention, as regular courts are presumed to lack the
expertise to properly dispose of such matters. A few
high profile cases—such as that of Bernard Madoff
and the inconsistent judgments surrounding the
bankruptcy cases of Lehman Brothers—have
encouraged those who endorse the move. The main
supporting argument is that PRIME Finance will be
able to interpret the laws of the various financial
systems in a consistent manner. Also, having these
matters dealt with by a central body may give rise to
the development of jurisprudence constante,
resulting in a more permanent and relevant body of
law. This would help, since the manner in which
courts interpret a contractual term potentially has
implications, not only for the parties involved, but
also for the wider financial market. It is expected
that the panel will keep abreast of the latest
financial developments and trends, and have a more
pragmatic approach to dealing with complex
financial cases. It is also hoped that PRIME
Finance will have the advantage of being more
centralised, expeditious, cost-efficient and
predictable than regular courts, leading to greater
stability in the global financial market. PRIME
Finance notes on its website, under a section
entitled ‘why choose us’, that “because of the
quality of our expertise, PRIME Finance will
represent the single greatest source in the world of
collective knowledge and experience of
documentation, law and market practice for
derivatives and other complex financial products…
In addition, benefitting from a variety of subsidies,
PRIME Finance expects to be less expensive than
many other alternatives.”
It is clear that hopes are high for the potential
benefits and sophistication of the service to be
offered by PRIME Finance. As for its future, the
body is now in its very nascent stages and only time
will render a true verdict on its utility.
_____________________________
Dispute Resolution in Islamic
Finance
Hussain Khan and Peter R. Morton (London)
The number of Sharia compliant products available
on the market has grown enormously over the past
few years. Many Islamic finance transactions are
governed by English law or the law of another
country, instead of Sharia law. ‘Sharia’ is a set of
moral and religious principles rather than a codified
body of laws. These types of transactions often take
place on a global level, with parties originating from
different regions in the world. Due to the diverse
backgrounds of the parties involved, the specialist
nature of the agreements and the potential variety of
legal jurisdictions in play, this is an area where
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disputes may be well suited to resolution by
arbitration.
knowledge both of Sharia and the relevant
commercial transactions.
The tendency to favour litigation
Amongst some entities working in Islamic finance
there is scepticism towards alternative forms of
dispute resolution, such as arbitration or mediation,
with litigation being the default method used to
resolve disputes. For example, certain Middle
Eastern states are reticent towards non-litigation
forms of dispute resolution since the outcome of a
series of oil concession arbitrations conducted from
the 1950s to the 1970s, in which the application of
local laws and ‘Western’ systems of law applied
instead.
Historical connection between Islam
and arbitration and the development of
international arbitration in the Islamic
world
Arbitration has a longstanding history as a form of
dispute resolution in Islamic culture, and is
specifically mentioned in the Quran at Chapter
(Surah) 4, verse 35. Arbitration under Islamic law
is known as ‘tahkim’ where parties agree to settle
their dispute by referring it to an arbitrator known as
a ‘hakam’ or ‘muhakkam’.
Whilst there has been a tendency to favour court
litigation as a means of resolving disputes in Islamic
finance, this has not been without difficulties. For
example, the English courts have at times struggled
to deal with contracts where the parties have sought
to have their dispute resolved in accordance with
Sharia or other non-national laws or principles. In
Beximco Pharmaceuticals Ltd v. Shamil Bank of
Bahrain EC [2004] EWCA Civ 19, it was held that a
contract can only have one governing law and that
parties can only agree to adopt the law of a country
as the governing law of a contract. Therefore,
according to English law, as Sharia law is a nonnational system of law, it is not capable of being the
governing law of a contract.
The recent reticence towards international
arbitration is now changing, with many Middle
Eastern countries adopting the UNCITRAL Model
Law for their arbitration laws, signing the New
York Convention, becoming contracting states to
the ICSID Convention, and establishing local
arbitration centres.
The development of international arbitration
institutions in the Islamic world presents an ideal
opportunity for international arbitration to establish
itself as the method of choice for the resolution of
Islamic finance disputes.
There may be less difficulty in electing to have a
dispute in relation to a contract decided in
accordance with Sharia law by submitting the
dispute to arbitration, rather than litigation. Taking
the position in England as an example, the English
Arbitration Act 1996 expressly permits the arbitral
tribunal to decide the dispute in accordance with the
law chosen by the parties (s46(1)(b)). So in Englishseated arbitrations the arbitral tribunal can decide the
dispute in accordance with such other considerations
as are agreed by the parties, and this could include
Sharia law.
The factors for growth in the use of arbitration
include globalisation and the increased involvement
in international finance of parties from emerging
markets. The reasons for using arbitration include
the unattractiveness of litigating in the courts of
certain jurisdictions, and the enforcement
advantages brought by the New York Convention.
Leading international arbitrators are familiar with
complex transactions, able to get to grips with
issues outside their core expertise and likely to be
much better equipped to deal with Islamic finance
disputes than judges in certain jurisdictions.
Arbitration agreements can also provide for the
parties to be able to nominate members of a tribunal
who are knowledgeable in Sharia.
Further, many commentators state that litigation is
not appropriate for the resolution of Islamic finance
disputes as judges often lack the education in
industry principles. Some would say that arbitration
is a better means of dealing with these cases, given
that arbitrators can be selected on the basis of their
Conclusion
The Quran and ‘Sunnah’ (Prophetic instructions)
repeatedly stress the importance and benefits of
settling disputes quickly and discreetly.
International arbitration is a method that can be used
to achieve this. When drafting Islamic finance
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agreements parties should consider carefully
whether arbitration may be a preferable means of
resolving the dispute to court litigation.
_____________________________
FDIC’s and OCC’s New Rules
Ban Mandatory Pre-Dispute
Arbitration Agreements with
Retail Forex Customers
Alice Y. Ahn and John L. Boos (San Francisco)
The Dodd-Frank Wall Street Reform and Consumer
Protection Act, hailed by some as “a sweeping
overhaul of the United States financial regulatory
system,” also bans mandatory pre-dispute arbitration
clauses in residential mortgages and home-equity
loans, agreements to arbitrate whistleblower claims
on securities fraud, and commodities fraud.
Mandatory pre-dispute arbitration agreements in
retail foreign exchange (“forex”) transactions were
axed as well.
Dodd-Frank amended the Commodity Exchange Act
(“CEA”) to prohibit federally regulated U.S.
financial institutions from entering into off-exchange
retail forex transactions absent a federal regulatory
agency rule or regulation permitting such
transactions. The U.S. Commodity Futures Trading
Commission (“CFTC”) set the bar for other
regulators, proposing in January of this year
regulations that implemented Dodd-Frank’s ban on
mandatory arbitration agreements while providing
specific conditions for arbitration with retail
customers. More than 9,100 comments were
received by the CFTC. In April and May, the U.S.
Department of Treasury, the Office of the
Comptroller of the Currency (“OCC”) and the
Federal Deposit Insurance Corporation (“FDIC”)
followed suit, proposing similar regulations
authorizing national banks, federal branches and
foreign banks (collectively, “national banks”) and
FDIC-supervised savings and community banks
(collectively, “state non-member banks”),
respectively, to engage in forex transactions with
their retail customers. The OCC and the FDIC final
rules became effective on July 15, 2011.
The OCC and the FDIC rules generally follow the
requirements for reporting, capital, margin, recordkeeping, risk disclosure and other consumer
protection provisions laid out by the CFTC.
Additionally, the new rules establish specific
procedures on the use of dispute resolution to
resolve claims arising from such transactions,
notably curtailing the ability of the national banks
and the state non-member banks to require
mandatory arbitration of customer disputes.
The OCC rules permit a national bank to enter into
pre-dispute arbitration agreements with a “retail
forex customer” if certain conditions are satisfied in
which the arbitration agreement must: (1) not be a
precondition of service; (2) be separately agreed if
part of a broader agreement; (3) inform customers
that they have an “opportunity to choose a person
qualified in dispute resolution to conduct the
proceeding”; and (4) contain specific language
explaining that the agreement to arbitrate must be
“voluntary”, that it may result in waiver of rights to
sue in court, and noting the difference between
claims submitted in court and arbitration.
The FDIC rules, on the other hand, create an
absolute bar on a state non-member bank entering
into pre-dispute mandatory arbitration agreements
with a “retail forex customer”.
These rules purport to respond to “concerns about
pre-dispute settlement resolution agreements” that
Congress addressed in several provisions of DoddFrank. However, due to lack of clarity in certain
definitions and aspects of the procedure, questions
remain as to how the rules will operate in practice.
For example, the application of the OCC and the
FDIC rules is complicated by the broad definition of
“retail forex customers”, which includes anyone
“not encompassed within the definition of ‘eligible
contract participant’”, as defined in the CEA. This
embraces some smaller businesses as well as
individuals with US$10 million or less in total
assets who are not using the trades to reduce risks
associated with other investments and are not
registered as futures or securities professionals.
In addition, technical issues remain as to how to
implement the process of submitting claims and
selecting arbitrators, especially if one or both parties
is out of compliance with the terms of the
arbitration agreement. The OCC final rule provides
that “the customer will have the opportunity to
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choose a person qualified in dispute resolution to
conduct the proceeding;” this is implied in the FDIC
final rule. Both the OCC and the FDIC final rules
allow national banks and FDIC-supervised insured
depository institutions 10 days to provide a list of
arbitrators and the customer 45 days thereafter to
select one from the list. However, both the OCC
and the FDIC rules fail to explicitly provide for the
situation where the bank or the depository institution
is the claimant, to define “persons qualified in
dispute resolution”, or to specify in what manner a
bank could identify potential arbitrators for inclusion
on its list.
Finally, it is unclear, in the event of a failure or
delay in providing a list or appointing an arbitrator
in accordance with the parties’ agreement, what the
interplay is to be between, on the one hand, the OCC
and the FDIC rules and, on the other hand, Section 5
of the Federal Arbitration Act, which provides that
“upon application by either party to the controversy
… the court shall designate and appoint an
arbitrator.”
On the face of it, the new OCC and FDIC rules put
the future of mandatory arbitration of consumer
disputes in doubt. However, given the foregoing
uncertainties, it remains to be seen what practical
impact these rules will have on the retail customer’s
real-world ability to submit a dispute to an arbitrator
acceptable to the customer.
_____________________________
Investment Treaty Protection
for State Defaults on Sovereign
Bonds
Sabine Konrad (Frankfurt) and
Lisa M. Richman (Washington, D.C.)
An arbitral tribunal at the World Bank’s
International Centre for Settlement of Investment
Disputes (ICSID) recently concluded that it had
authority “to hear” claims of over 60,000 claimants
asserting that Argentina’s default and subsequent
debt restructuring breached protections contained in
the Argentine-Italian bilateral investment treaty
(BIT). See Abaclat et al. v. The Argentine Republic,
ICSID Case No. ARB/07/5, Decision on Jurisdiction
and Admissibility of 4 August 2011. K&L Gates’
recent alert on this case can be found here. Since the
issuance of that alert, the state-appointed arbitrator,
Egyptian professor Georges Abi-Saab, issued a
dissenting opinion and subsequently resigned from
the Tribunal. In addition, Argentina has challenged
the two remaining arbitrators.
This case stands as a significant victory for the
creditor claimants, and has implications for
investors who suffered investment losses as a result
of the global credit crunch. Importantly, the
Abaclat award suggests that investment treaty
arbitration may serve as a method to recover
damages for investment losses from nations
defaulting on their sovereign debts. It also
demonstrates that investor-state arbitration may
serve as a model for dealing with state insolvency in
an orderly fashion. Given the current financial
crises worldwide, this should provide hope for
investors who have suffered losses at the hands of
sovereigns restructuring their debt instruments.
1. How can investors protect their
rights?
(1) Absence of State Insolvency Law
In the past, creditors’ rights have been extremely
difficult to enforce. The balance of power was
against investors unless their home state intervened
to help them implement their rights. The result was
a “disorderly default” that provided only partial or
occasional redress to the investor and took the
power out of the investor’s hands. The Abaclat
decision provides comfort that investor-state
arbitration may serve as a model to deal with state
insolvency issues and thereby protect the investor’s
rights on a global level.
(2) Available Treaty Protection
Defaults arise because the state is unable to pay all
of its creditors. An investment treaty arbitration
award can confer on an investor the status of a
secured or quasi-preferred debtor, particularly over
domestic creditors who do not have the same means
of enforcement available to them.
Over 2000 bilateral and multilateral investment
treaties allow for the enforcement of claims directly
against a government in an international forum.
These treaties provide protections afforded by states
to foreign investments as well as an arbitration
mechanism that permits investors to file claims for
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compensation when the state fails to meet its
obligations under the treaty.
Treaties give investors the right to seek money
damages through arbitration against a host state in a
neutral arbitration forum. Many treaties offer the
option to arbitrate under the auspices of the ICSID.
In addition, disputes between investors and host
states under treaties are not necessarily governed by
domestic law, but instead may be governed by
international law standards. Although host states
typically honor awards against them, if necessary,
there are enforcement mechanisms which the
investor can seek to use. Enforcement of an award
under the ICSID Convention is unique given the
ability of an investor to pursue assets in any one of
the over 140 ICSID member states and the added
benefit of the political clout of the ICSID-affiliated
World Bank. Awards rendered under the ICSID
Convention are supranational and immune from
court intervention in all of those member states.
All of these factors make treaty arbitration a unique
and effective alternative to seek recovery – or a
potential bargaining tool for settlement negotiations.
(3) Treaty Arbitration in the State Insolvency
Context
As demonstrated in the Abaclat proceedings,
investment losses occasioned by state insolvency
may be resolved through investor-state arbitration.
In the future, this approach could overcome many of
the difficulties both states and state creditors faced
in the past. It provides for an orderly procedural
framework (including a phase of pre-trial
negotiations) and offers a fair and systematic trial.
Although the state party may argue that a state of
necessity serves as a basis for the damage inflicted
on the investor, this argument generally serves only
as a justification to defer payment to the investor.
Moreover, an independent tribunal rather than the
debtor state will make the determination whether a
state of necessity really exists, whether the debtor
state contributed to the state of necessity, and what
consequences its findings should have.
it would otherwise be cost-prohibitive to file an
investment treaty arbitration claim. Given the
significant increase in creditors over the last decade
as states increasingly sought financing on stock
exchanges, the importance of viable options to seek
redress is all the more important.
2. What should current investors know?
To protect investments from future problems and to
have all options available, current investors with
potential claims resulting from state insolvencies
should follow three steps:

First, investors should identify which BIT or
BITs may protect their investment. For
example, Greece, a country whose financial
difficulties have received significant attention in
the press, maintains BITs with 38 countries
throughout Europe, South America, Asia and
Africa.

Second, investors should seek guidance as to
the strength of the applicable BIT. Not all BITs
guarantee the same rights or level of protection.
Whether a BIT can be considered strong and
effective depends on a variety of factors that
must be analyzed carefully. Important features
to look for are a good “fair and equitable
treatment” clause, an “umbrella” clause and a
“most-favored nation” clause. It is also
essential that the BIT provides for a broad
definition of investment and for investor-state
arbitration.

Finally, investors should consult their lawyer
before any problems with their investments
arise. If a BIT does not provide for (optimal)
protection there may still be scope and time for
restructuring. This might allow the investor to
take advantage of a more favorable treaty.
Proper investment planning at an early stage of
a project can help to optimize the available tax
benefits and to protect investments from future
problems.
_____________________________
The mass claims aspect of the Abaclat tribunal’s
decision is of particular importance given that the
cost savings associated with such claims ensure that
the arbitration forum also may be available to
creditors whose damages are smaller and for whom
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KPMG v. Cocchi: United States
Supreme Court Favors
Arbitration of Some But Not All
Claims over the Spectre of
Piecemeal Litigation
Andrew Morrison and Molly Nixon-Graf
(New York)
The Supreme Court of the United States of America
recently acknowledged the “emphatic federal policy
in favor of arbitral dispute resolution” and held that
the public policy favoring arbitration of disputes
trumps the public policy disfavoring piecemeal and
inefficient litigation in different forums. On
November 7, 2011, the U.S. Supreme Court issued a
per curiam opinion in KPMG v. Cocchi vacating the
Fourth District Court of Appeals of Florida’s refusal
to compel arbitration after the Florida appellate court
determined that two of four claims asserted in that
action were non-arbitrable. The possibility that the
other two claims may be arbitrable precluded the
denial of a motion to compel arbitration with respect
to those claims.
The Florida Decisions
The plaintiffs are investors in limited partnerships
known as the Rye Funds, which are managed by
Tremont Group Holdings. The accounting firm
KPMG served as outside auditor for the Rye Funds.
The Rye Funds invested with Bernard Madoff and
allegedly lost millions of dollars as a result of his
infamous scheme to defraud.
The plaintiff investors took issue with KPMG’s
audits, which did not discover the fraud, and
asserted four claims against KPMG: negligent
misrepresentation, violation of the Florida Deceptive
and Unfair Trade Practices Act (FDUTPA),
professional malpractice, and aiding and abetting a
breach of fiduciary duty. KPMG moved to compel
arbitration based on its engagement agreement with
the Rye Funds. Plaintiffs obviously were not
signatories to KPMG’s engagement agreement, and,
accordingly, had not agreed to arbitrate their claims
against KPMG. To support its motion to compel
arbitration, KPMG argued that plaintiffs’ claims
against KPMG are derivative (being asserted on
behalf of the Rye Funds) and, accordingly, arose
from KPMG’s services performed under its
agreement with the Rye Funds. The trial court
denied KPMG’s motion. The Florida appellate
court found that two of the claims against KPMG—
negligent misrepresentation and violation of the
FDUTPA—were not derivative but, rather, direct
claims. Accordingly, the Florida appellate court
affirmed the denial of KPMG’s motion to compel
arbitration without analyzing whether the remaining
two claims against KPMG were derivative in nature
and, accordingly, arbitrable.
The Supreme Court Decision
KPMG petitioned the Supreme Court for a writ of
certiorari, arguing that the Florida appellate court’s
failure to address whether all the claims were
arbitrable before denying KPMG’s motion to
compel was in conflict with the FAA and the
Supreme Court’s decisions interpreting the Act.
The Court agreed, pointing to its 1985 opinion in
Dean Witter Reynolds, Inc. v. Byrd, which held that
the primary purpose of the FAA was to ensure
enforcement of arbitration agreements and that the
expedited resolution of disputes was only a potential
benefit. The bifurcation of proceedings, which
results in piecemeal litigation in some cases, does
not, therefore, allow a court to refuse to enforce an
arbitration agreement. Therefore, the Supreme
Court remanded the action to determine the
arbitrability of the remaining claims.
Accordingly, the existence of some non-arbitrable
claims is not dispositive on a motion to compel
arbitration. In KPMG, the Supreme Court
effectively requires lower courts to explicitly render
a determination on the arbitrability of every claim
presented before denying a motion to compel
arbitration.
As KPMG’s petition to the Supreme Court noted,
the FAA is unusual in that it creates substantive
federal law to remedy a perceived hostility in state
courts toward arbitration agreements but does not
confer federal jurisdiction. When state courts refuse
to apply the FAA, only the Supreme Court can
provide redress. The Supreme Court rarely grants a
writ of certiorari to enforce settled law, but this per
curiam opinion indicates that the justices are willing
to police the lower courts in applying the FAA and
its interpreting precedents. The KPMG decision
will reassure contracting parties that the federal
policy favoring the enforcement of arbitration
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agreements will be respected by the judiciary in both
state and federal courts.
_____________________________
Should Participants in the
Pensions and Investment
Management Industry Agree to
Use Arbitration?
Thomas Ross (London)
It is widely acknowledged that trustees of pension
schemes are reluctant to pursue litigation. There is a
common, natural concern or reticence about going to
court, with the possible adverse costs and publicity
involved. Unfortunately, however, given the events
of the past three years, there will be a number of
potential claims which will have to be considered by
pension funds, ranging from possible FSMA section
90 or section 90A claims through to claims for
negligent performance/breach of contract or breach
of mandate. Many claims will involve very large
sums. The number of claims may also be fuelled by
the increasing number of litigation funders, both
U.S.-based and English, making risk-free (at least in
terms of adverse cost risk) litigation a possibility for
the pension funds.
In view of this, it is perhaps surprising that greater
consideration does not appear to have been given, in
this sector, to agreeing to arbitration rather than the
more traditional provision for English governing law
and English courts.
Arbitration offers two particular advantages over
traditional litigation: confidentiality and wide
international enforcement under the New York
Convention. The first would likely be welcomed by
all parties in this sector; the second becomes ever
more relevant to a pension fund as the potential
claimant.
Confidentiality
Arbitration proceedings, between private parties at
least, are generally confidential. English law has
long recognised the confidentiality of arbitration.
Parties to arbitration and the tribunal itself are under
implied duties to maintain the confidentiality of the
hearing, documents generated and disclosed during
the arbitral proceedings and the award. Perhaps
surprisingly, the legal basis of this confidentiality,
under English law, remains unclear. It has been
analysed (by the Court of Appeal in Ali Shipping) as
an implied term of the arbitration agreement, but
this approach has been criticised by the Privy
Council (in Associated Electric & Gas Insurance
Services Ltd v. European Reinsurance Company of
Zurich (Bermuda) [2003] UKPC 11) and the Court
of Appeal in Emmott v. Michael Wilson & Partners
Ltd [2008] EWCA Civ 184, where Lawrence
Collins LJ said: “The implied term is really a rule of
substantive law masquerading as an implied term.”
What is clear, however, is that an English court will
protect the confidentiality of arbitration
proceedings, particularly in circumstances where
this is agreed by the parties involved.
Where the parties agree to arbitration in a
jurisdiction other than England, some care may need
to be taken to preserve confidentiality. The
approach of the courts may be governed by the
proper law of the arbitration agreement; however,
there may also be statutory provisions that apply as
part of the law of the seat of the arbitration.
Provided some care is taken in drafting, private
parties should be able to ensure that confidentiality
is protected in any arbitration.
Enforcement
The New York Convention requires courts of
contracting states to give effect to an agreement to
arbitrate and recognise and enforce awards made in
other states. Contracting states may enter certain
reservations, including the “reciprocity reservation”
(where applicability is limited to awards made in
other Convention states) and the “commercial
reservation” (where applicability is limited to
awards relating to commercial matters) and there
are some limited grounds upon which enforcement
may be refused.
There are at present 146 signatory states to the New
York Convention. This wide potential for
enforcement across such a large number of
jurisdictions might be a significant advantage for
pension funds, particularly in a globalised and
geographically diverse sector such as that of finance
and investment management.
The future
For largely historic reasons, the pensions and
investment management industry has, to date,
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largely eschewed arbitration in favour of traditional
litigation. It will be interesting to see whether, in the
current financial environment and given the
advantages of arbitration, this will continue.
_____________________________
Arbitration under the ISDA
Master Agreement
Jonathan Lawrence and Jamie Olsen (London)
The use of arbitration in the financial sector has
increased in recent years. This article reviews recent
trends toward the use of arbitration clauses,
specifically in the context of the Master Agreement
produced by The International Swaps and
Derivatives Association (ISDA).
ISDA and the ISDA Master Agreement
ISDA was founded in 1985 with the aim of making
the over-the-counter (OTC) derivatives markets safe
and efficient, partly through the development of
standard documentation. It now has over 800
members (including banks, asset managers and
energy and commodity firms) from over 55
countries.
ISDA first produced the Master Agreement in 1987
as a globally standardised document to try to ensure
market-wide legal certainty and risk reduction in the
hedging market, including through netting and
collateralisation.
The appeal of arbitration
Current market trends indicate that the inclusion of
arbitration clauses in financial contracts (including
derivatives transactions) is on the increase, having
previously lagged behind other sectors. This is said
to be due to globalisation and the increased
involvement of parties from emerging markets in
international finance. Also, the clearing rules of
many of the world's clearing houses provide for
disputes to be resolved by arbitration.
In that context, ISDA has started to consider more
carefully the inclusion of arbitration clauses in its
standard forms. By a memorandum dated 10
November 2011, available at
http://www2.isda.org/functional-areas/publicpolicy/financial-law-reform, ISDA has requested
members' views on questions surrounding the
drafting of arbitration clauses, the availability of
appropriately qualified arbitrators and developing
jurisprudence via arbitral awards.
A main attraction of arbitration for the finance
sector (particularly for those involved in
international transactions) is that it benefits from the
cross-border enforcement regime for arbitration
awards underpinned by the New York Convention.
The signatories to the Convention include
developing countries such as India, Brazil, Saudi
Arabia and China, where there would potentially be
enforcement problems for judgments obtained in the
English or New York courts (the two choices of
governing law in the 2002 ISDA Master
Agreement).
Increasingly, many derivatives transactions involve
parties from emerging jurisdictions where there are
potential difficulties with enforcement, delay, lack
of consistency in decision making or even a
perception of bias. While international arbitrators'
experience of derivatives contracts may be limited,
the leading arbitrators may well be familiar with
complex transactions and able to get to grips with
issues outside their core expertise. Parties may have
the option of nominating an arbitrator with
derivatives expertise, and the experience of the
leading arbitrators will no doubt increase as more
derivatives disputes are arbitrated. Since
counterparties are increasingly reluctant to accept
English or New York court jurisdiction, arbitration
is an attractive and acceptable alternative.
The inclusion of arbitration clauses is encouraged
by the fact that the infrastructure for arbitration in
emerging jurisdictions is already in place.
Arbitration centres are established in China
(CIETAC, established 1956), India (the Indian
Council of Arbitration, established 1965) and
Russia (ICAC, established 1932), and many more
have recently been established in emerging markets.
Issues with arbitration
The use of arbitration is not without its challenges.
Defective and poorly drafted arbitration clauses are
encountered surprisingly often, and cause delay and
additional costs, or even a ruling that the clause is
invalid, frustrating the process entirely. It is
therefore important to have advice during the
documentation stage on the robustness of the
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relevant arbitration regime and the drafting of a
suitable arbitration clause.
The private nature of arbitration restricts the ability
to circulate the award more widely to inform and
guide the market, especially in the context of
document standardisation and certainty that ISDA
exists to promote. This problem could be mitigated
by specific drafting permitting an award to be nonconfidential. This may be desirable for a party
which feels there is an important point of principle
on which it wishes to obtain a clear ruling to rely on
in other disputes. Yet such drafting remains
uncommon in derivatives contracts.
The ISDA/IIFM Tahawwut Master
Agreement
On 1 March 2010, ISDA and the International
Islamic Financial Market (IIFM) jointly published
the ISDA/IFFM Tahawwut Master Agreement for
hedging Islamic finance transactions. The
agreement is based on the conventional form of the
2002 Master Agreement in many respects.
However, it is structured to provide for disputes to
be litigated in the English or New York courts or to
be arbitrated, at the option of the parties. If
arbitration is chosen, the suggestion is that the seat
will be either London or New York depending on
the choice of governing law, and the application of
the ICC arbitration rules is proposed unless
otherwise specified by the parties.
There are many advantages to using arbitration for
Islamic finance transactions, as such transactions
also often involve counterparties from different
jurisdictions and arbitration allows the parties to
choose a suitable person (such as a Sharia scholar) to
hear the dispute. Given the presence of enforcement
difficulties discussed above in certain jurisdictions
in the Middle East, there can be advantages in using
arbitration to resolve Sharia-related derivatives
disputes (click here to see the separate article on the
use of arbitration in Islamic finance in this edition of
Arbitration World).
It is interesting to note that ISDA, when drafting the
ISDA/IIFM Master Agreement, updated the
template of the 2002 Master Agreement to provide
the option of choosing litigation or arbitration.
Arbitration also has its advantages for conventional
OTC derivative transactions, and parties may in
future choose to amend the Master Agreement to
include the form of arbitration clause in the
ISDA/IIFM Master Agreement.
The authors acknowledge the arbitration memorandum written by
Peter Werner, a Senior Director at ISDA, in prompting their interest
in this issue.
_____________________________
U.S. Courts Split on Ability to
Use Sovereign Immunity Act
Exceptions to Enforce
Arbitration Awards against
Foreign Nations
Josh Leavitt and Sangmee Lee (Chicago)
In an important decision for parties who seek to
enforce international arbitration awards and court
judgments against sovereign nations with assets in
the United States, a United States federal appeals
court has upheld civil sanctions against a foreign
nation under the U.S. Foreign Sovereign Immunities
Act.
The decision follows years of efforts by FG
Hemisphere Associates, LLC (“Hemisphere”),
whose predecessor in interest financed construction
of an electric power transmission facility for the
Democratic Republic of Congo (“DRC”), to collect
default remedies from the DRC under the credit
agreement. Hemisphere obtained two arbitration
awards against the DRC.
In 2004, Hemisphere brought suit in the District
Court for the District of Columbia under a provision
of the Foreign Sovereign Immunities Act (“FSIA”),
28 U.S.C. § 1604, permitting a plaintiff to confirm
an arbitration award secured against a foreign
sovereign. Hemisphere obtained two default
judgments in those proceedings, sought to execute
the judgments and sought discovery of the DRC's
assets under § 1610, which provides that if a
judgment is based on an arbitration award, a
plaintiff may only execute that judgment on “[t]he
property in the United States of the foreign state . . .
used for a commercial activity in the United States.”
28 U.S.C. § 1610(a)(6). Although foreign states are
generally immune from the jurisdiction of the U.S.
courts, the FSIA contains several exceptions,
including allowing a plaintiff to bring suit against a
sovereign nation to confirm an award pursuant to an
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agreement to arbitrate. 28 U.S.C. § 1605(a)(6). The
DRC neither contested jurisdiction nor the merits of
the arbitration awards.
On March 19, 2009, the District Court issued an
order for sanctions against DRC for “woefully”
failing to comply with court-ordered discovery. FG
Hemisphere Assoc., LLC v. Democratic Republic of
Congo, 603 F. Supp. 2d 1 (D.D.C. 2009). The
sanctions imposed included a $5,000 per week fine,
doubling every four weeks until reaching a
maximum of US$80,000 per week until the DRC
satisfied its discovery obligations. After the DRC
finally participated in the proceedings, the District
Court denied the DRC's motion to vacate the
contempt order, and the DRC appealed the contempt
order before the D.C. Circuit.
On March 15, 2011, the United States Court of
Appeals for the District of Columbia Circuit upheld
discovery sanctions against the DRC. FG
Hemisphere Assoc., LLC v. Democratic Republic of
Congo, 10-7040, 10-7046, 2011 WL 871174, 2011
U.S. App. LEXIS 5012 (D.C. Cir. Mar. 15, 2011).
At issue on appeal was whether the District Court
could sanction the DRC for failing to respond to a
court-ordered discovery under the FSIA. The
United States, apparently seeking to protect foreign
policy concerns, filed an amicus brief, supporting
the DRC's position. The DRC and the United States
argued that such contempt sanctions are unavailable
under the FSIA, as there is no provision that
explicitly permits a plaintiff to execute on a
sovereign's assets to enforce a contempt order. The
United States also cited principles of equity, comity
and foreign relations concerns.
The D.C. Circuit affirmed the District Court, stating
that FSIA does “not abrogate a court's inherent
power to impose contempt sanctions on a foreign
sovereign” and, therefore, the District Court had not
abused its discretion when it sanctioned the DRC.
The Court of Appeals distinguished a Fifth Circuit
Court of Appeals decision, which interpreted the
FSIA as prohibiting the attachment and execution of
monetary sanctions against foreign sovereigns. AfCap Inc. v. Republic of Congo, 462 F.3d 417 (5th
Cir. 2006). The Seventh Circuit viewed the Fifth
Circuit's logic as conflating the power to impose a
contempt sanction with the authority to enforce a
contempt sanction (which was not at issue in this
case). The D.C. Circuit reasoned that the Fifth
Circuit case was unpersuasive in this case, as that
court had not sought to distinguish the two issues.
The D.C. Circuit joined the Seventh Circuit Court of
Appeals in recognizing that there is “not a smidgen
of indication” in the text and the legislative history
of the FSIA that shows that Congress intended to
have FSIA limit a federal court's inherent contempt
power. See Autotech Techs. v. Integral Research &
Dev., 499 F.3d 737, 744 (7th Cir. 2007).
The D.C. Circuit itself recognized that the statutory
scheme reflects a distinction between the power to
issue the discovery order and the power to enforce it
and that enforcing such an award “could prove
problematic.” The Court further notes that, under
certain circumstances, such an order would not be
upheld, due to the principles of comity or the
concern of opening the door to possible reciprocal
treatment of the U.S. in foreign courts. While the
Court may consider “sensitive diplomatic
considerations . . . if reasonably and specifically
explained,” the Court remarked that the U.S. did not
put forth a valid explanation of how that may be the
case in this matter.
Accordingly, anyone seeking to obtain and enforce
awards and judgments in the United States against
sovereign nations should consider carefully the split
on these issues that exists at the U.S. Federal
appellate court level. There is language in the cases
that those seeking to enforce awards and those
defending such enforcement attempts might each
seek to exploit. But, as the Seventh Circuit's recent
opinion teaches, in understanding these cases, future
courts may well pay keen attention to the nuanced
views of these prior cases, the distinctions made in
the underlying legislation itself and even the stated
foreign policy concerns of an intervening United
States government.
This case is part of broader attempts by Hemisphere
to enforce a claim of over US$100 million against
the DRC, including through court proceedings in
Hong Kong and in Jersey both of which have
attracted considerable comment. Part of the interest
in the Jersey proceedings stems from the fact that in
2010 the United Kingdom Parliament passed
legislation to restrict the ability of so called “vulture
funds” to sue heavily indebted, poor countries in
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powers which can have considerable costs
ramifications for financial institutions. The
classic example of this is the FSA's power
under Section 166 of the Financial Services and
Markets Act 2000 (“FSMA”) to require a
financial institution to appoint and pay for a
skilled person (such as one of the principal
accountancy firms) to investigate and provide a
thematic review on any information, documents
or regulatory returns concerning the financial
institution which the FSA may reasonably
require. The financial burden of the costs of the
skilled person falls on the financial institution,
even though the report is for the benefit of the
FSA. Professional Indemnity and Directors &
Officers liability insurance policies taken out by
financial institutions have tended not to keep
pace with such developments in terms of
regulatory powers, which creates difficulties in
recovering such costs from insurers. Another
problem encountered has been the ability to
recover the company’s costs in producing
documents where a warning notice is served on
a board director under Section 126 of FSMA.
As the company is likely to hold the bulk of the
documents responsive to such a notice, again a
substantial costs burden will probably fall on
the company, which may be uninsured in
respect of such costs as the proceedings are
directed towards the personal conduct of the
directors and not the company.
UK courts, a favorite jurisdiction. However, the Act
does not apply to UK Crown Dependencies and
Overseas Territories such as Jersey, Guernsey, the
British Virgin Islands and Cayman islands, a
loophole which Hemisphere has been able to exploit.
_____________________________
Insurance Coverage for
Financial Institutions:
Common Issues in Coverage
Disputes and Selecting
Appropriate Dispute Resolution
Procedures in Policies
Frank Thompson (London)
The turmoil in global financial markets since 2008
has resulted in a sharp increase in the number of
claims against financial institutions and
professionals working in the financial sector.
Claims have emerged from a number of sources disgruntled shareholders, including those who have
invested in capital raisings undertaken by a number
of institutions, as well as investors and their
representatives who have suffered losses particularly
in relation to Ponzi schemes such as Madoff and
Stanford. This comes at a time when regulators in
the U.S., Europe and Asia have increased their focus
on financial institutions, with a number of high
profile regulatory investigations involving various
financial institutions and their senior management,
in addition to mandated schemes for the assessment
and redress of consumer complaints concerning a
variety of financial products such as endowment
mortgages and payment protection insurance.
This increase in claims and regulatory activity has
meant that many financial institutions have had to
put their insurance programme to the test, in some
cases for the first time in several years. Some clear
deficiencies have been revealed in insurance policy
wordings through this process, while grey areas
around the availability of coverage have also
emerged. Key areas where there have been disputes
or protracted negotiations between financial
institutions and their insurers over the availability of
coverage have included:

Regulatory investigations – The FSA in the
UK has exercised a number of wide-ranging

The dangers of policy excesses – The decision
of the English High Court in Standard Life
Assurance Company Ltd. v. Oak Dedicated &
Ors [2008] EWHC 222 is a salutary lesson to
financial institutions on the importance of
paying due care and attention to their insurance
policy wordings. The case concerned the
ability of Standard Life to access its
professional indemnity insurance cover to
obtain indemnity against mass consumer claims
for the mis-selling of endowment mortgages.
The Standard Life policy imposed a multimillion pound sterling policy excess which was
stated in the wording to apply on both a per
claim and a per claimant basis. The Court
decided that the policy language was clear in
that the excess was to be applied to all claims
by each individual, even though that plainly
was not the intention of Standard Life or the
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insurers when the policy was purchased. The
result was that Standard Life could not
aggregate, and therefore effectively had no
insurance cover, for mis-selling claims made by
over 97,000 individuals where the total quantum
of the claims was in excess of £150 million.
The Standard Life case is a clear warning that
the English Courts may enforce the plain
meaning of policy wordings even if the
consequences of the wording are obviously
unintended.

North American exposures – Insurance
policies written in the insurance market in
London and other European locations typically
contain restrictions in terms of coverage
available for claims brought in the United States
and Canada or under the laws of those
jurisdictions. For example, it is common to find
that such insurance policies do not provide
coverage for claims brought under the
provisions of the US Securities Act 1933 and/or
the Securities Exchange Act 1934 unless the
cause of action otherwise arises under the
common law applicable to the relevant state(s).
The 1933 and 1934 Acts are the principal
statutes used by the Securities and Exchange
Commission to initiate proceedings and are
often cited by claimants asserting restitutionary
and other remedies arising out of the Madoff
situation in particular. A number of coverage
disputes have emerged between financial
institutions and their insurers as to whether such
exclusionary language applies. This can
involve complex issues of US law being
considered in the context of English
proceedings. As a general observation,
policyholders in the financial sector are well
advised to consider if they are exposed to the
long arm jurisdiction of the U.S. courts, and to
model their insurance policy wordings
accordingly.
Consider carefully appropriate dispute
resolution provisions for your policies
A key lesson from the disputes which have arisen
over the recent times is that financial institutions
should give careful consideration to appropriate
dispute resolution procedures when placing or
renewing their insurance policies. This is an aspect
of the policy wordings which is often not considered
in any real depth.
Litigation and arbitration each have their advantages
and disadvantages as a means of resolving disputes
between financial institutions and their insurers. The
pros and cons of each process should be weighed
carefully in selecting the appropriate dispute
resolution process for a particular organisation.
Experience suggests that the insurance market
would prefer not to litigate coverage disputes, as
this means that disputes with policyholders are aired
in public, which can harm the reputation of insurers.
Insurers also tend to be wary of legal precedents
established by court decisions on policy wordings.
However, arbitration may equally be more suitable
for a policyholder who may wish to keep any
dispute with its insurers confidential. An arbitration
clause may be a better choice for policyholders
exposed to U.S. risk given the flexibility in making
appointments to the panel of arbitrators. This
flexibility can be useful where an insurance
coverage dispute involves matters of U.S. law, as it
is possible to select a member of the panel with
knowledge of the relevant U.S. laws in issue. It is
also possible to opt for arbitration as a means to
decide particular coverage issues only, with disputes
on other aspects of coverage to be resolved through
the Courts. Where arbitration is selected to resolve
policy disputes generally or specific issues only,
consideration also needs to be given to choice of
seat of the arbitration (this will dictate, amongst
other matters, the national law which governs the
procedure adopted for the arbitration—there are
now a number of “seats” recognised internationally)
and other matters such as the number of panel
members and how they are to be selected.
Financial institutions should explore with their
insurance brokers and legal advisors dispute
resolution mechanisms appropriate for the particular
risks they are exposed to when arranging insurance
policies. Arbitration should be one of the menu of
options considered. It is also crucial to check that
the same dispute resolution provisions apply
uniformly across insurance programmes—it is
surprising how common it is to find a mis-match in
dispute resolution clauses between different excess
layers of insurance covering the same risk which
can create considerable difficulties and unnecessary
costs in the event a coverage dispute does arise.
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