Russian SCC to Rule on Tribunal’s Powers to Apply Public Law Rules

The case deals with the tribunal’s ability to void on the basis of an alleged breach of a public law requirement.  A panel of Supreme Commercial Court judges decided this week to refer the matter to the Presidium.

The panel relied on a number of grounds justifying setting aside an award applying such rules. In particular, the judges noted that the whole dispute appears to be a sham staged to avoid the seller facing fines and customs duties payment.

More importantly, the panel stated that a dispute concerning the invalidity of a transaction due to breach of public law rules (customs rules in this case) does not in principle fall within the jurisdiction of arbitral tribunals.

Facts of the Case 

LLC VSK imported certain meat-processing equipment as its founder’s contribution to the charter capital. As such the equipment benefited from a conditional customs duties exemption. Pursuant to the applicable rules LLC VSK was required to pay the entire amount of the duties before it could sell the imported goods.

In 2012 the customs authorities discovered that LLC VSK had in fact sold the goods without paying the duties and commenced administrative proceedings. Shortly after these proceedings began LLC VSK entered into an arbitration agreement with the buyer of the equipment providing that all the disputes should be submitted to a local arbitral institution. A month later an arbitral tribunal issued an award invalidating the sales contract due to the breach of the customs law restriction on the disposal of property.

Apparently LLC VSK then sought to challenge the customs authorities’ actions claiming that the sale had never taken place as the arbitral tribunal had voided the contract. In the meantime the customs authorities applied to have the award set aside on public policy grounds. In the latter case, the first instance court decided to set the award aside, but the cassation court reversed this decision.

SCC Panel: Sham Dispute and Arbitrability Issues

A three-judge panel of the Supreme Commercial Court opined that the arbitral award should be set aside and referred the case to the full Presidium. In doing so it relied on two alternative grounds.

First, the facts of the case suggest that there was in fact no genuine dispute between the parties and the purpose of the arbitral proceedings was for the seller to avoid customs penalties. The Supreme Commercial Court had previously found arbitral awards resulting from sham disputes with improper purpose which violate Russian public policy.
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In this respect, the panel’s decision follows the established case law and the case hinges on its assessment of the facts.

Second, the panel noted that a dispute concerning the invalidation of a contract due to infringement of public law rules is not arbitrable. According to the judges the seller’s failure to comply with the relevant customs rules should not result in the contract’s invalidation, but rather lead to imposition of administrative penalties.
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The arbitral tribunal lacks the power to impose such penalties. Hence it lacked the competence to consider the dispute.

Possible Effects of the Supreme Commercial Court’s Position

Courts and arbitral tribunals in numerous countries have faced the issue of arbitrability of claims and defences based on public law rules. Examples include the illegality of contract provisions contrary to competition law rules and contracts procured by corruption. In most cases they confirmed the arbitrability of these matters. A contrary approach leads to unattractive results. Either of two cases should be pursued simultaneously: one concerning the enforcement of a contract before an arbitral tribunal, and the other concerning the validity of the contract before a state court. In the alternative, one of the parties may frustrate the entire arbitration by invoking a public law based defence.

Russian law warrants a similar approach. All civil law disputes are arbitrable. A dispute over the validity of a commercial contract between the parties thereto remains a civil law dispute even if public law rules are implicated. The lack of a res judicata effect of the resulting award for third parties protects the interests of the state authorities which may have independent standing to challenge the contract.