A U.S. Court Changes the Seat of an International Arbitration

Last month in a decision below the Mason-Dixon Line and perhaps below the radar detection devices of the international arbitration bar, a federal district court in Mississippi enforced in part a contractual agreement for ICC arbitration between a major U.S. defense contractor and the Government of Venezuela, but declined to enforce the agreement insofar as it named Caracas, Venezuela as the seat of the arbitration. Instead the Court directed the parties to reach agreement on another seat within 15 days failing which the Court would name a seat. (Northrop Grumman Ship Systems, Inc. v. Ministry of Defense of the Republic of Venezuela, 2010 U.S. Dist. LEXIS 134830 (S.D. Miss. Dec. 4, 2010)). An appeal to the Fifth Circuit has already been filed, and so Arbitration Commentaries views this as a percolating case with an importance that transcends its roots in a District not well known for international arbitration jurisprudence. 

Whether the District Court’s result comports with the New York Convention and Chapter Two of the Federal Arbitration Act requires, to begin, some textual analysis in which the district court did not engage.

Article III of the Convention provides that a court seized of an arbitrable dispute “shall refer the parties to arbitration…. unless it finds the agreement to be null and void, inoperative, or incapable of being performed.” Further, Section 206 of the FAA authorizes a federal district court to enforce the arbitration agreement by directing that arbitration “be held in accordance with the agreement at any place therein provided for….“

Neither of these provisions received attention from the court, which instead purported to apply a Supreme Court case from the early 1970s (Bremen v. The Zapata, 407 U.S. 1 (1972)), before there was hardly any New York Convention jurisprudence in the U.S., and which did not involve an agreement for international arbitration but instead an agreement between U.S. and German parties to resolve disputes in the English Commercial Court. The Bremen v. Zapata case held that the forum selection clause in an international contract should be upheld unless it would be “unreasonable” to enforce it. In a 1974 U.S. Supreme Court case not cited by the Mississippi District Court, the Court held that an agreement for international arbitration is a special case of a forum-selection clause that must be enforced “in accord with the explicit provisions of the Arbitration Act.” (Scherk v. Alberto-Culver Co., 417 U.S. 506 (1974)).

The District Court made its decision after a remand from the U.S. Fifth Circuit Court of Appeals. The Fifth Circuit had been asked to vacate a District Court order approving a settlement, and did so, on the ground that the attorney who executed the settlement for the Government of Venezuela lacked authority. (Northrop Grumman Ship Systems, Inc. v. Ministry of Defense of the Republic of Venezuela, 575 F.3d 491 (5^th Cir. 2009)). The Fifth Circuit, through dicta in the decision directing the remand, attempted to put the District Court on the right track. Stating that “the record before us is insufficient to determine whether the present conditions in Venezuela render the arbitration-clause unenforceable,” the Court remanded the case for “a proper determination of this issue.”  As if this was not enough of a hint that the “arbitration-forum clause” clause had to stand or fall as a unit, and not be severed into separate arbitration and forum clauses so as to render one enforceable but not the other, the Fifth Circuit elected to “reiterate governing principles.”  In this regard, the Court cited in particular its decision in National Iranian Oil Co. v. Ashland Oil, Inc., 817 F.2d 326, 332 (5^th Cir. 1987), for the proposition that “a forum selection clause establishing the situs of arbitration must be enforced unless it conflicts with an explicit provision of the Federal Arbitration Act.”  The Court reminded that contractual doctrines of impossibility or impracticability of performance could be, under FAA Section 2, sufficient to render the clause unenforceable, as Section 2 “grounds that exist at law or in equity for the revocation of any contract”  — provided that the party seeking revocation had no reason to foresee, at the time of contract, the conditions giving rise to the alleged impossibility of performance.

National Iranian Oil  is an intriguing and instructive case.  Iran sought to get the benefit of arbitration, and yet avoid wholesale non-enforcement of the arbitration clause and litigation in a U.S. court, by making three arguments: that fair and neutral arbitration in the contractually-agreed Teheran forum was impossible or impracticable, that the arbitration agreement and the agreement on the seat were severable and should be viewed as separate contracts, and finally, that enforcement of the arbitration agreement, for arbitration in the U. S. instead of Teheran, could be done under the New York Convention and FAA Chapter Two because the problem that Iran was not a Member State of the Convention would thereby be avoided.  Iran lost on all three points.  Most important for purposes of the Northrop Grumman-Venezuela case, the Fifth Circuit in National Iranian Oil held that the question of severability of the arbitration clause and the agreement on the seat depended on the intent of the parties as manifested, in the first instance, in the express terms of their agreement.  Based on the facts that Iran’s form contract provided expressly that Iranian law would govern the interpretation and rendition of any arbitral awards, as well as all issues of interpretation of the contract, and that the Appeal Court of Tehran was the default appointing authority, the Court concluded that this arbitration-forum clause was an integral, non-severable unit and that it had to be enforced, or not, in its entirety.

Despite the Fifth Circuit’s guidance and specific reference to National Iranian Oil, the District Court’s decision last month avoided entirely the question of integration versus severability of the arbitration agreement, on the one hand, and the choice of Caracas as the seat, on the other. It simply found that arbitration in Caracas is no longer reasonable in view of the deterioration of diplomatic relations between the U.S. and Venezuela and the record of pro-Government bias in the Venezuelan legal system established by Northrop Grumman’s expert evidence. The Court ordered arbitration, ordered the parties to submit an agreement on another place of arbitration within 15 days, failing which the Court would select a new seat of arbitration.  According to the docket, no agreement on a seat has been submitted nor has any order designating a seat been made. Instead, a Notice of Appeal has been filed by the Government of Venezuela. 

The FAA, Section 16, makes an order denying a motion to compel arbitration under the Convention and Chapter Two immediately appealable, and conversely prohibits an immediate appeal from an order under Chapter Two directing arbitration unless the District Court certifies a controlling question of law for immediate appeal (which this Court has not done). One wonders how Section 16 applies to an order that granted in part Venezuela’s motion to compel arbitration by directing arbitration in a place other than the place stated in the agreement.  Seemingly, the issue of severability or integration is jurisdictional, as well as potentially dispositive of the merits: If the arbitration clause is fully integrated, the District Court order effectively denied Venezuela’s motion to compel arbitration in Caracas, and should be appealable.  If the arbitration agreement and agreement on the seat are severable, Venezuela’s motion to compel arbitration has been granted, and the decision setting aside the agreement on the seat might be regarded as interlocutory.   But this issue should bring the Fifth Circuit back to the text of Section 206 of the FAA.   In a Convention case, the District Court’s power is to compel arbitration “in accordance with the agreement at any place therein provided for.”  The text of Section 206 strongly suggests that the purported “partial granting” of a motion seeking that relief, by ordering arbitration at a place not provided for in the agreement, should be regarded as a denial of the motion to compel, and further that this was an order the District Court was without power to make.  

Arbitration law watchers will be watching for the Fifth Circuit’s next decision in the Northrop Grumman- Venezuela case.  Even assuming the District Court had solid grounds for concluding that the legal and political environment in Venezuela are unfavorable for arbitration, the Fifth Circuit may hesitate to accept this as a basis to discard entirely the arbitration clause, because the consequence is to expose both parties to concurrent litigations in the courts of the United States and Venezuela. Perhaps one of the parties will point out to the Fifth Circuit that in an ICC arbitration there are steps available that might mitigate the impact of the hostile environment, notably that the Tribunal may conduct its hearings and proceedings and deliberations in another location even though the juridical seat of the arbitration remains in Venezuela (ICC Rules 14(2) and 14(3)). The Fifth Circuit might also consider the prospects for enforceability of the Award and execution of the resulting judgment in States other than Venezuela, even if the Venezuelan courts purported to set aside the award. Further, the appellate court may wish to consider the possibility that the U.S. Claimant might obtain from the Tribunal an order for security, and the court may take into account the statements of the Government of Venezuela as to its prospective willingness to comply with such an order should one be entered. Each of these factors should impact an analysis of whether enforcement of the arbitration clause for arbitration with a seat in Caracas is “impossible” or “impracticable.”    

Finally, I present a war story, one I have often told.  More than ten years ago I was counsel an ICC arbitration against the Government of Serbia for an American claimant whose property, allegedly, had been expropriated by the Milosevic regime after the Serbian Government had assumed ownership of my client’s private Yugoslav joint venture partner.  By virtue of this assumption of contract rights, the U.S. party found itself in privity with the Serbian Government in a contract that provided for ICC arbitration with a seat in Belgrade.  Belgrade in 2000 was the scene of NATO shelling, drive-by political assassinations, manipulated elections, abuses of political dissidents, and an intimidated and regime-controlled judiciary – a scenario quite different from the one that prevailed when my client signed the contract in 1990.

Claimant asked the ICC Court to conclude that the agreement on the seat of arbitration had ceased to exist (under the civil law principle rebus sic stantibus), such that the ICC Court, in accordance with ICC Rule 14(1), could fill the void by selecting a seat. The Court referred the factual and contract interpretation issues to the Tribunal for decision, hearings were held, extensive evidence was presented. Before the Tribunal issued an award, Milosevic was ousted from power in a popular coup, and was replaced by a new and purportedly more democratic regime.  The Partial Award took into account the regime change, and concluded that the agreement on the seat of arbitration remained intact.

Could Northrop Grumman follow the same course at this stage and take the issue of the seat of arbitration to the ICC Court? One would think so.  Perhaps in view of the latest appeal filed by Venezuela, this is a course of action that will receive serious consideration.