Judicial Power to Change the Place of Arbitration?

The US Fifth Circuit Court of Appeals, acting in a long-running contract dispute between an American shipbuilder and the Republic of Venezuela, has held that the Federal Arbitration Act (“FAA”) might permit a District Court, in proper circumstances and with sufficient statement of justification, to compel arbitration at a place of arbitration other than the one established in the contract, or to deny enforcement of the arbitration clause entirely based on political conditions at the agreed place of arbitration. Northrop Grumman Ship Systems Inc. v. Ministry of Defense of the Republic of Venezuela, 2009 U. S. App. LEXIS 15260 (5th Cir. July 9, 2009).

Whereas the outcome in Northrop Grumman was to remand the question of the place of arbitration to the District Court, and whereas the District Court at an earlier stage had compelled arbitration in its own federal judicial district in State of Mississippi, some comments on the principles that should guide the District Court are in order.

The Fifth Circuit, in stating the “general principles” that should guide the District Court, curiously omitted any reference to the New York Convention or Chapter Two of the FAA. The Court referred to its holding in Nat’l Iranian Oil Co. v Ashland Oil Co., 817 F. 2d 326 (5th Cir. 1987) that “a forum selection clause establishing the situs of the arbitration must be enforced unless it conflicts with an explicit provision of the Federal Arbitration Act.” 817 F. 2d at 332.

But the Fifth Circuit in National Iranian Oil had analyzed the issue under Chapter One of the FAA because Iran was not then a party to the New York Convention. The Court in Northrop Grumman does not mention that Venezuela, even at the time of the contract, was a member state of the New York Convention. And so the Fifth Circuit here neglects to refer to the Convention and FAA Chapter Two as sources of principles governing the enforceability of the parties’ contractual choice of Caracas as the seat of arbitration.

Article II (3) of the Convention states that “(t)he court 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, shall, at the request of one of the parties, refer the parties to arbitration, unless it finds that the agreement is null and void, inoperative, or incapable of being performed. ”

The text of Article II (3) raises several issues that arise when, as in Northrop Grumman, a foreign party’s motion to compel arbitration is opposed on the basis that the agreed seat of arbitration is an unreasonable forum in view of political instability.

First, the plain meaning of Article II (3) would appear to permit a court to deny a motion to compel arbitration only if it may find that the agreement to arbitrate, and not merely the agreement on the seat of arbitration, is “null and void” or “incapable of being performed.” The answer to that question may depend on whether the agreement on the seat is viewed as separate and severable from, or completely integral to, the agreement to arbitrate. And the answer to that question cannot be ascertained until a court first decides what law is applicable to interpretation of the arbitration/forum selection clause.

The contract at issue in Northrop Grumman, between a US company and an instrumentality of Venezuelan Government, providing for arbitration in Caracas and (one may infer) application of Venezuelan law to the merits of disputes, seems an unlikely candidate for application of American contract law principles to determine the validity of the agreement to arbitrate. Yet the Fifth Circuit’s decision appears to assume that American contract law principles govern the question of whether the clause may be denied enforcement in whole or in part. Under potentially applicable transnational principles, the nearest analogs to common law doctrines of “impossibility” and “commercial impracticability” might not lead to the same conclusions as would be reached if American law were applied.

A second evident limitation on the power of a District Court is Section 206 of the FAA. That section provides: “A court having jurisdiction under this chapter may direct that arbitration be held in accordance with the agreement at any place therein provided for . . . .” The plain meaning of this provision would seem to negate the possibility of a District Court acting, in a Convention case, to compel arbitration at a place other than the agreed place, or to compel arbitration without reference to any place of arbitration if a place has been designated in the contract.

If these provisions, and the law applicable to interpret the arbitration/forum clause, lead to the conclusion that the clause must be enforced as written, is the aggrieved party without recourse? Not necessarily. If the forum clause is severable, the arbitral tribunal will have jurisdiction to interpret it. And the arbitral tribunal could hear and determine a preliminary contention that the place of arbitration designated in the contract has ceased to exist as a result of dramatically changed political conditions. If that determination is made, the agreement would stand, in its “reformed” state, as if no place of arbitration had ever been selected, and the authority competent to select a place of arbitration in the absence of agreement could select a seat.

Arbitration practitioners should watch with interest to see if the federal district court in Mississippi, on remand in the Northrop Grumman case, takes into account the relevant provisions of the Convention and Chapter Two of the FAA.