Security for costs is scarcely the most popular partner on the arbitration dance floor.

Derains and Schwartz note in their treatise on the ICC Rules, for example, that ICC arbitrators have ordered parties to provide security for costs, although such cases are “exceptional.” They observe that the ICC Rules do not expressly provide for security for costs, but add that “parties may apply to the Arbitral Tribunal for the same under Article 23” — a phrasing that stops short of placing the writers in the camp of those who consider that a security for costs order is indeed an interim measure covered by ICC Article 23. They further quote Swiss author Marc Veit, writing in the ASA Bulletin in 2005, that “[t]he common denominator in international arbitration practice for ordering security for costs is the requirement of a fundamental change of situation since the agreement to arbitrate was entered into which results in a clear and present danger that a future costs award would not be enforceable.”  But this describes a necessary but not sufficient condition.

The LCIA Rules (Article 25.2) and Hong Kong International Arbitration Centre Rules (Article 11.1) have little company among the major rules regimes, in providing expressly that arbitrators have the power to order security for costs.

But whether the power to grant security is stated expressly or is found by implication in general interim measures rules, the question always is under what conditions such orders shall issue.

Research into the issue readily turns up the reasons why such measures might not be ordered — that an impecunious but bona fide claimant (or counterclaimant) might be unfairly deprived of access to relief on the merits; that a financial decline of the party that might be ordered to bear costs is a normal business risk taken in agreeing to arbitrate disputes. Wendy Miles and Duncan Speller of Wilmer Hale (London), writing in the European Arbitration Review in 2007, note that security for costs “serves a valuable role in complementing cost-shifting rules and acts as a deterrent against spurious or frivolous claims.” (Article is republished on Wilmer Hale website under publications).

Tests that focus on the merits of the claim will be inherently biased against the granting of security, as arbitrators will be reluctant to pre-judge the merits or to accelerate the presentation of proofs in the fashion of US court preliminary injunction hearing. 

Tests that focus only on a “fundamental change of situation” risk turning security for costs into a form of claim-owners insurance. It is rather the reasons for the fundamental change (for the worse) that should be examined. Jean Kalicki (Arnold + Porter, Washington) is on the right path, writing that “security is more likely to be awarded where the claimant’s financial incapability appears the result of deliberate actions to shield itself from potential liability, while maintaining the upside potential of a favorable merits award. A twist on this is where the claimant’s arbitration fees and expenses are being covered by a related entity or individual who stands to gain if the claimant wins, but would not be liable to meet any award of costs that might be made against the claimant if it lost” (www.arbitralwomen.org/files/publication/0207001415156.pdf)

Business failures due to competitive conditions or economic cycles are not risks that should be addressed by orders for security; these are risks a contracting party takes in the ordinary course of doing business. Contrived business failure or financial weakness, arranged specifically to frustrate enforcement of an eventual award of costs are really at the core of what security for costs orders should address.

Such conditions are prone to exist in the domain of family-owned or closely-held enterprises, or small-to-moderate sized enterprises whose financial structure may be tied to a handful of investors who can exercise de facto control over the financial affairs of the business.  In such environments, regular financial reporting and record-keeping may be non-existent, except as necessary for the filing of tax returns, and owner-employees may have essentially unilateral ability to transfer funds among a group of companies or into individual or trust accounts of family members or investors.

How shall a Tribunal identify such a situation? Relatedly, how shall the applicant for security demonstrate the existence of such circumstances to the satisfaction of the Tribunal? Manipulation, or an environment conducive to it, are probably the critical factors.

One scenario that is probably frequently encountered is the obligor of a defaulted obligation that threatens to “self-destruct” (e.g. file for bankruptcy, or liquidate) as a means to discourage a creditor who has threatened arbitration. The same debtor also threatens a counterclaim in an amount vastly disproportionate to the contract debt — one that blames the creditor for its alleged woes — to discourage the claimant from pursuing the matter.

When the counterclaim is filed, should the claimant, now faced with far higher legal expenses than were anticipated for a straightforward non-payment claim, be entitled to security for costs? And how does the Tribunal decide this without pre-judging the counterclaim to be purely tactical and lacking substantive merit?

A non-exhaustive list of considerations might be:

1. Can the debtor reliably corroborate a situation of financial distress due to business conditions?

2. Can the debtor reliably corroborate having formulated the counterclaim other than as a retaliatory measure?

3. Is the debtor’s business prone to manipulation by its owners, particularly in the ability to transfer funds to related entities or individuals?

4. Is the debtor’s claim of distress contradicted by its apparent ability to bear substantial legal expenses?

5. Does the debtor’s conduct in the arbitration indicate a strategy to promote delay and inefficiency, and to maximize the legal expenses of the claimant?

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Despite the differences among rules and statutes, which treat security for costs less than explicitly under most regimes, the question of the power of arbitral tribunals to grant security for costs is less controversial than the question of when the power should be exercised.  Experienced arbitrators should recognize situations where the claimant or counterclaimant is using tactics to run up costs for the other side while organizing its own affairs to make an anticipated eventual final award against that entity unenforceable.  This is the realm in which security for costs can be an essential tool to prevent subterfuge and promote justice in the arbitral process.

Not so long ago, there was controversy among federal courts in the United States about whether the New York Convention ousted the courts of jurisdiction to provide injunctive relief in aid of international arbitration. Just as that issue was sorted out in favor of judicial power to grant provisional relief, controversy arose over whether institutional rules conferring power on arbitrators to grant provisional relief, when adopted by parties, left courts without power to grant such parties provisional relief, or at least when viewed in light of the Federal Arbitration Act strongly suggested that courts should wield discretion against granting provisional relief.

That issue, also, has largely been sorted out in favor of judicial power, and discretion, to grant provisional measures in aid if arbitration to preserve the efficacy of the arbitral process. (See, for example, the Commentary on the applicable law in New York, posted on this site on June 22, 2010.)

But pockets of resistance have remained, notably where federal district courts have considered themselves bound to follow older, unrevisited precedents in their Circuit Courts of Appeals. The Ninth Circuit is one such jurisdiction, and, as it embraces so many important centers of international commerce — such as Los Angeles, San Francisco, Seattle, San Diego and Phoenix — the revisitation of an older precedent by that court is a development worthy of note.

Last month the Ninth Circuit reversed a Los Angeles federal district court’s refusal to grant an injunction in aid of arbitration, where the parties had a pending arbitration under the ICC Rules, but the Tribunal was not fully formed at the time of the application for relief. The Court held that the granting of such relief was fully consistent with Article 23 of the ICC Rules, which permits a party to apply to a competent judicial authority for provisional measures before the Tribunal is formed and in “appropriate circumstances” thereafter. (Toyo Tire Holdings of Americas, Inc. v. Continental Tire North America, Inc., 2010 U.S. App. LEXIS 12475 (9th Cir. June 17, 2010)).

The district judge had considered himself bound to deny the relief under a Ninth Circuit decision dating from 1999 that also involved an arbitration under the ICC Rules, and Article 23 thereof whose text was essentially the same at that time. But here the Ninth Circuit found that 1999 precedent distinguishable, as a case in which the applicant was seeking to bypass the arbitral tribunal, maintaining that it lacked power to grant the particular provisional relief sought. In the present case, in contrast, movant’s application was made expressly for the purpose of ensuring that the status quo was maintained until the Tribunal was able to act, so that any application to the Tribunal for further provisional (or permanent injunctive) relief would not be rendered ineffectual. Specifically, the Court concluded that “a district court may issue interim injunctive relief on arbitrable claims if interim relief is necessary to preserve the status quo and the meaningfulness of the arbitration process — provided, of course, that the requirements for granting injunctive relief are otherwise satisfied.”

This decision harmonizes Ninth Circuit law with the law in other Circuits where international arbitrations in the United States often take place, notably the Second (New York), Eleventh (Miami and Atlanta) and Fifth (Houston and Dallas) Circuits. 

With so many arbitral institutions having adopted rules for fast-track procedures or appointment of an emergency arbitrator, the next wave of case law development concerning provisional relief is likely to focus upon whether an agreement to arbitrate under such rules further narrows the circumstances in which judicial relief is strictly necessary to preserve the status quo. Given the strong emphasis in US provisional remedies law on proving likely success on the merits, US judges can be expected to incline against hearing applications for provisional relief absent strong evidence that an arbitrator cannot be selected on an expedited basis.

A new decision of the US Second Circuit Court of Appeals holds when a vacancy on an arbitral tribunal occurs due to resignation of an arbitrator, and the parties’ agreement does not address that situation, a district court has broad discretion under Section 5 of the Federal Arbitration Act in deciding how the arbitration shall proceed. (Insurance Co. of North America (“INA”) v. Public Service Mut. Ins. Co., No. 09-3640-cv, 2d Cir., slip opinion, June 23, 2010. The decision may be found on the Court’s website: www.ca2.uscourts.gov).

The decision affirms a ruling if the District Court that was reported upon in Arbitration Commentaries in January 2009. (You may access that Commentary by clicking on that month in the “archive”

column along the left border of this site.)

An earlier Second Circuit case had held that where a vacancy occurs due to the death of an arbitrator, and the parties have no agreement on how to fill the vacancy, the “general rule” is that absent “special circumstances,” a new panel must be formed and the arbitration commenced anew. That decision was not overruled in INA. The Court did however take note of “eroding support” for that decision, and that the “general rule” had first been stated in a case in which the Court had in fact declined to require a new panel to be appointed when one arbitrator died after the panel had rendered a partial final award.  Thus, Second Circuit law has long recognized that the potential for waste and inefficiency might in some situations outweigh the prejudice a party might suffer from having to continue an arbitration with a replacement party-appointed arbitrator. 

In INA the Court has gone further down this path. It holds that the so-called “general rule” does not apply to resignations of any kind, even those resulting from permanent incapacity of the resigning arbitrator (and thus having the same impact on the panel as would a death). In any resignation situation, therefore, no presumption will apply that an entirely new panel must be convened and the proceedings started anew.

Equally, the Court’s holding is not stated to be limited to the resignation of a party-appointed arbitrator — although the case did involve resignation of a party-appointee, and district courts might seek to read the holding as limited to that scenario.

But if courts take the Second Circuit at its words: “in dealing with vacancies resulting from resignations, the [ “general rule” applicable on death of an arbitrator] does not apply,” then district courts are now free to decide that even in case of resignation of the sole arbitrator, or the presiding arbitrator, circumstances may dictate that the reconstituted tribunal should be allowed to move forward rather than begin anew.

Indeed, if there is a broad arbitration clause, district courts may well hold that the extent to which proceedings must be repeated is an arbitrable issue to be resolved by the reconstituted tribunal. Section 5 of the FAA addresses the filling of a vacancy, but does not expressly confer power on a court to decide to what extent proceedings should be repeated. The Second Circuit’s so-called “general rule,” requiring a fresh start in case one of three arbitrators dies, is a common-law rule, not one that purports to be based on the FAA itself. 

Institutional rules governing international arbitrations, and the UNCITRAL Rules, typically confer power on the reconstituted tribunal to decide whether and to what extent proceedings should be repeated. This reflects a broad consensus among practitioners and institutions that the tribunal is in the best position to balance considerations of efficiency and fairness, and that a case-by-case approach makes the most sense.

The Second Circuit’s decision in the INA case appears to be moving American arbitration law toward conformity with the international arbitration position.

Godfather buffs will remember Johnny Fontane’s contract with the famous bandleader. Don Corleone’s most feared enforcer, Luca Brasi, held a gun to the bandleader’s head, and the Don assured him that either his brains or his signature would shortly be on the contract. The bandleader signed, and Johnny Fontane’s singing career was re-launched.

Now we know the rest of the story.

The written contract was nothing but an arbitration clause covering all disputes arising from the relationship. The clause also provided that disputes concerning the making or validity of the agreement would be decided by the arbitrator.  Fontane quit the band; the bandleader sued for breach of contract in a California federal court; Fontane moved to compel arbitration; the bandleader insisted that the Court should deny enforcement of the arbitration agreement based on unconscionabiliity; and Fontane replied that the clause committed that issue to the arbitrator.     

The District Court ruled for Fontane and compelled arbitration. The Ninth Circuit in a 2-1 decision reversed, and held that the allegations of unconscionability required the conclusion that the written agreement alone was not clear and unmistakable evidence that the parties had agreed to arbitrate arbitrability. The Supreme Court granted certiorari.

Fast forward from this 1945 scene in a 1972 movie, to  June 21, 2010.  On that date, the Supreme Court of the United States decided , 5-4, in Rent-a-Center, West, Inc. v. Jackson, No. 09-497, 2010 U.S. LEXIS 4981, in analogous circumstances (albeit the coercion was economic not physical) that the validity of the arbitration agreement is an arbitrable issue.     

That decision rests on a series of legal propositions that the four dissenting justices, and probably a fair number of arbitration lawyers, will find to be remarkable convolutions of arbitration jurisprudence as we knew it until two days ago:

1.       A “stand-alone” written arbitration clause, viewed apart from any other writings or oral arrangements constituting the parties’ relationship, is, for purposes of Section 2 of the FAA “a contract evidencing a transaction involving commerce.”

2.       Based on that premise, a subsidiary clause in a the stand-alone arbitration agreement, providing that arbitrability disputes are arbitrable, fits within Section 2  as “a written provision in … a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising.”

3.       The “First Options” principle, that clear and unmistakable evidence of an agreement to arbitrate arbitrability is required to make arbitrability an issue for the arbitrator rather than the court, simply does not apply when the issue presented is not whether the provision was actually agreed to, but whether the provision is legally binding under applicable state contract law.

4.       An unconscionability challenge to an arbitration clause under state law does not concern whether the arbitration clause was actually agreed to, but only whether it is legally binding, and therefore the “First Options” principle is not implicated.

5.       The severability principle of Prima Paint v. Conklin applies to a stand-alone arbitration agreement just as it does to any other contract.  Thus, if a party contends that the entire stand-alone arbitration agreement is unconscionable or otherwise invalid under a state’s general contract law, that issue must be decided by an arbitrator. Only if the state contract law challenge pertains to a particular written provision in the contract may that challenge be decided by the court.

A critique of this remarkable opinion will follow in a subsequent Commentary.  Your commentator is in transit to Toronto for a two-day visit. Pending my next post, readers should study the Jackson decision, and especially Justice Stevens’s faithful rendition of federal arbitration law in the dissenting opinion joined by Justices Breyer, Ginsburg and Sotomayor.

New York’s arbitration statute, Article 75 of the New York Civil Practice Law and Rules (“CPLR”), addresses in section 7502(c) the circumstances in which a New York court may give a provisional measure in aid of arbitration.

Section 7502(c) is a particularly significant provision of state law in the world of international arbitration, given New York’s role as host to many international commercial arbitrations. The Federal Arbitration Act includes no sections concerning provisional relief, so when interim measures are sought in a New York court under CPLR 7502(c) there is no issue of federal law pre-emption.  Several years ago CPLR 7502 (c) was amended to make it expressly applicable in arbitrations based on agreements governed by the New York Convention. The Legislature made this change to overcome a New York Court of Appeals decision, at odds with federal decision, that had held that the New York Convention’s ouster of judicial jursidiction in an arbitrable matter included an ouster of jurisdiction to give provisional measures. Finally, when a proceeding is brought in federal court to obtain provisional relief in aid of arbitration, Federal Rule of Civil Procedure 64 provides that the relief shall be available under the conditions specified in the law of the state where the federal court is sitting.

Further, while CPLR 7502 (c) has no necessary application to a request for interim measures made to an international arbitral tribunal seated in New York, parties will often cite it as a source of applicable standards.

It is therefore quite useful to know what those standards are, and on this point there has been some longstanding uncertainty that has never been resolved by New York’s highest court, the New York Court of Appeals.

CPLR 7502 (c) states in relevant part that the court “may entertain an application for an order of attachment or a preliminary injunction in connection with an arbitration. . . but only upon the ground that the award to which the applicant may be entitled may be rendered ineffectual without such provisional relief.” The statute goes on to say that the CPLR articles concerning attachment (62) and preliminary injunctions (63) “shall apply to the application… except that the sole ground for the granting of the remedy shall be as stated above.”

Before 2000, several decisions in New York’s intermediate appellate court, the Appellate Division, interpreted section 7502 (c) to mean that in the context of a preliminary injunction in aid of arbitration, the traditional equitable criteria mentioned in CPLR Article 63 — likelihood of success on the merits, irreparable harm, and a balance of hardships tipping in favor of the movant — no longer apply and that the sole test for relief is whether the eventual award might be rendered ineffectual. In the attachment context, some New York courts held that the “rendered ineffectual” standard superseded the “grounds” for attachment enumerated in CPLR 6201 —  such as removal of assets from the state, or actual or threatened actions to defraud creditors or frustrate enforcement of a judgment. Other courts went further, and held that the “rendered ineffectual” standard also supplanted the other criteria in CPLR 6212 — that a cause of action exists, probable success on the merits, and that the amount demanded from the defendant exceeds all known counterclaims.

But in 2000 the US Second Circuit Court of Appeals in SG Cowen Securities Corp. v. Messih (224 F.3d 79) interpreted 7502 (c) more restrictively. The Court held that the language “may entertain an application…but only on the ground…..” should be read to mean that the threat that an award will be “rendered ineffectual” is a necessary but not sufficient condition for obtaining relief. The Court read the reference in 7502 (c) to CPLR Articles 62 and 63 to mean that the standards for obtaining relief that those Articles specify remain applicable and that the “sole ground for the granting of the remedy” language did not prevent a court from denying relief where other statutory requirements for relief such as probable success on the merits were not satisfied. Further, the Second Circuit examined the legislative history on 7502 (c) and found that its purpose was to clarify the courts’ power to grant relief rather than to broaden the availability of relief by excusing movants from showing probable success or irreparable harm. Finally, the Second Circuit observed that due process concerns would arise if provisional remedies interfering with property could be obtained without any showing relating to the merits and even if the hardships of the measures upon the enjoined party would be far greater than those suffered by the movant absent interim relief.

For the past decade, decisions in New York state courts have mainly found the SG Cowen case to be persuasive, and have followed it, holding that traditional equitable criteria for preliminary injunctions must be satisfied, and, in the attachment context, that 7502 (c) only obviates the need to show one of the “grounds” in 6201 — but that the CPLR 6212 criteria including probable success on the merits do apply. Federal decisions in the injunction context have followed SG Cowen. In the attachment context, a federal decision earlier this year reviewed the disparate case law, took note that the narrow holding of SG Cowen concerned only preliminary injunctions not orders of attachment, and did not find it necessary to decide whether a ground for attachment such as fruad or misconduct to frustrate creditors must be shown, because the movant could not meet the minimum “rendered ineffectual” threshhold. (Shah v. Commercial Bank, 2010 U.S. Dist. LEXIS 19717 (S.D.N.Y. Mar. 4, 2010)).

Under the current state of the law in New York, parties seeking judicial interim measures in aid of international arbitration here must be prepared to make a substantial evidentiary presentation by documents, affidavits and sometimes live testimony in order to obtain relief. This may for example involve live testimony and cross-examination of experts on foreign law, where foreign law governs the merits and the merits position depends on a contested legal premise. In this context, the courts’ deference to the arbitrator on matters touching upon the merits collides with entrenched principle that preliminary relief in general is “drastic” — and is viewed as such largely because the merits have not yet been fully explored. Therefore many judges are inclined, particularly if the matter appears to have large commercial significance, to make an accelerated and intensive inquiry into the merits in connection with preliminary relief. Absent clear statutory direction or a definitive ruling from the New York Court of Appeals that interprets CPLR 7502 (c) to limit inquiry into the merits, this disposition among judges is likely to remain prevalent in the arbitration interim relief context.

Arbitral tribunals seated in New York, intent on preserving their neutrality, may  prudently seek to avoid studying a judge’s decision on an interim measures application or the record made before the court. But the tribunal must know if provisional relief from a court has been granted, and so a tribunal mindful of New York law cannot help but infer that at least on a “first look” basis, a judge may well have found probable merit to the movant’s position on the merits.

One good solution for parties inclined toward a New York seat but not sanguine about this landscape for judicial interim measures is to use the ICDR’s emergency arbitrator process, the ICC’s pre-arbitral referee procedure, or comparable procedures provided institutionally or created specially by contract to address truly urgent requests that must be heard before the tribunal is constituted. Subject to the particulars of the applicable rules of arbitration, the emergency arbitrator selected will have considerable discretion in choosing applicable standards for provisional relief. And the emergency arbitrator is likely to be more persuadable than a New York state or federal judge to be guided by transnational arbitral norms concerning provisional measures that de-emphasize the merits and focus mainly on the extent of truly irreparable harm and the relative hardships and risks the parties bear with or without provisional relief.

Investment treaty arbitration awards rarely find their way into the US courts for review, as the ICSID Rules under which many such arbitrations occur include their own appellate process (see, in particular, Rules 50 and 52-54 of the ICSID Arbitration Rules concerning annulment proceedings). The grounds for annulment under the ICSID Rules overlap substantially with the grounds to set aside an award under Chapter 1 of the Federal Arbitration Act, and so a set aside motion following denied of an annulment application would most likely be rejected based on collateral estoppel principles.

So on the rare occasion when an investment treaty award is the subject of a vacatur or confirmation decision of a US court, the occasion deserves appropriate notice even if no significant developments in the law emerge from the case.

In that context I report upon a decision this week by a US district court judge in Washington D.C., denying the Republic of Argentina’s motion to vacate a $185 million award against the Republic and in favor of a British investor, made in an ad hoc arbitration under the UNCITRAL Rules as provided in the Argentina-United Kingdom bilateral investment treaty. (Republic of Argentina v. BG Group PLC, 2010 U.S. Dist. LEXIS 56055 (D.D.C. June 7, 2010)).

Turning no new doctrinal ground but rejecting arguments advanced by Argentina, the Court held:

1. That an award made in the US between a UK investor and a foreign State falls under the New York Convention as an award “not considered as domestic” (Convention Art. I(1)) under US law, and thus supports federal court jurisdiction under Chapter Two of the FAA. Argentina urged that the US in adopting the Convention had declined to adopt the “not considered as domestic” branch, and cited the US reciprocity reservation that it would “apply the Convention, on the basis of reciprocity, to     the recognition and enforcement of only those awards made in the territory of another Contracting State.” The Court found that the purpose of this reservation was not to limit Convention jurisdiction in US courts to awards made abroad, but only to exclude Convention jurisdiction over awards made in States not members of the Convention. Further, the Court held, whereas FAA Section 202 treats as a non-domestic Award covered by the Convention a dispute between US parties that involves some reasonable relationship with a foreogn state, it would be “nonsensical” to conclude that arbitration awards made in the US beteeen two foreign parties are excluded from Convention coverage in the US.

2. That the ICC Court of International Arbitration (the agreed-upon appointing authority) did not exceed it powers in rejecting a challenge of Arbitrator Albert Jan van den Berg. In reaching this decision, the district court focused on the parties’ agreement investing powers in the ICC Court. But curiously the district court did not address whether Section 10(a)(4) of the FAA has any applicability to decisions of an appointing authority, not the arbitral tribunal that made the award.

3. That the Tribunal based its decisions allowing derivative claims and selecting the measure of damages from plausible constructions of the BIT and  resort to principles of international law, and therefore did not exceed its powers by — in words tsken from the Supreme Court’s recent Stolt-Nielsen decision — “dispensing its own brand of industrial justice.”