Resolvable clash?

The Tata-Docomo case highlights the conflict between party autonomy and public policy in international commercial arbitration

Priyanka Dasgupta explains

Although international commercial arbitration is increasingly popular as a means of dispute resolution in cross-border transactions, there continue to be challenges with respect to enforceability of arbitral awards.

When a transaction involves parties of different nationalities, then in order to avoid having to approach the courts of the country of one of the parties and to ensure a level playing field, parties tend to choose a third country’s law as the governing law and arbitration as the means of dispute resolution. The principle of party autonomy, which is central to international commercial arbitration, allows parties to choose a third country’s law as the governing law. Yet this can result in conflicts with public policy in the jurisdiction where an award is sought to be enforced, which is often the home jurisdiction of one of the parties.

An ongoing dispute between Tata Sons and NTT Docomo (a subsidiary of Japan’s Nippon Telegraph and Telephone Corporation), over Docomo’s stake in Tata Teleservices, provides an opportunity to study the scope of challenge to foreign arbitral awards in India and analyse the conflict between party autonomy and public policy in international commercial arbitration.

BACKGROUND TO THE DISPUTE

In 2009, when Docomo acquired 26.5% of Tata Teleservices, Tata Sons, Docomo and Tata Teleservices entered into a shareholders’ agreement. Under the terms of the agreement, Docomo had the right to exit from Tata Teleservices, and Tata Sons had the obligation to provide an exit opportunity by either buying Docomo’s shares or arranging for another purchaser to buy the shares.

Such a sale was to be at an assured purchase price, which was either the fair price of the shares at the time of exit or 50% of the acquisition price (₹58.045 per share), whichever was higher. In 2014, Docomo decided to exercise this right to exit and as Tata Sons had failed to find another purchaser to buy the shares, it agreed to buy the shares at the assured price.

However the Reserve Bank of India (RBI) did not allow Tata Sons to do so, as the exit at assured price was in violation of the regulations under the Foreign Exchange Management Act, 1999 ( FEMA), in relation to pricing of shares, as in force on the relevant date. Following the RBI’s decision, Tata Sons offered to buy the shares at ₹23.34 per share on the basis of fair market value as laid down by the FEMA regulations.

Invoking the arbitration clause in the shareholders’ agreement, in January 2015 Docomo approached the London Court of International Arbitration (LCIA) to resolve the dispute. On 23 June this year the LCIA tribunal awarded Docomo damages of US$1.17 billion for Tata Sons’ breach of the shareholders’ agreement. Docomo has since approached Delhi High Court for enforcement of the award and Tata Sons has deposited the compensation amount before the court without prejudice to its legal rights.

CAN COURTS INTERVENE?

In light of these facts, the pertinent question is the enforceability of the award in India, the country with which the agreement has the closest nexus. Over the years, Indian courts have adopted different views on their extent of review of foreign arbitral awards (see Evolving views, page 42).

The latest position clearly distinguishes between the standard of review for enforcement of a domestic and a foreign award. This position was incorporated into the Arbitration and Conciliation Act, 1996, by way of the Arbitration and Conciliation (Amendment) Act, 2015. Section 48, which deals with enforcement of foreign awards, now clarifies the meaning of public policy and lists the following three grounds on which a foreign award can be set aside for violating public policy: (i) the making of the award was induced or affected by fraud or corruption; or (ii) it contravenes the fundamental policy of Indian law; or (iii) it is in conflict with the most basic notions of morality or justice.

Thus, unlike in the case of a challenge to a domestic arbitral award under section 34, patent illegality – as added by the court in Oil & Natural Gas Corporation Ltd v Saw Pipes Ltd (2003) – is no longer a ground to challenge or set aside a foreign award. Further, the amendment specifically clarifies that when testing whether a foreign award contravenes the fundamental policy of Indian law, the court cannot review the merits of the dispute.

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WHY THE FUSS?

A proper understanding of the law relating to foreign exchange and challenges to domestic and foreign arbitral awards is pertinent to analyse the award in the Tata-Docomo case.

On the date of the shareholders’ agreement, the FEMA regulations stipulated that the value of shares at the time of transfer from a non-resident to a resident was to be determined by considering the price which is lower based on two independent valuations of the company – one by statutory auditors of a company and the other by a chartered accountant or by a merchant banker registered with the Securities and Exchange Board of India.

However, when the dispute arose between the parties the law had changed considerably. FEMA regulations stipulated that the fair value of shares was to be determined in accordance with any internationally accepted pricing methodology, provided the foreign investor while exiting its investment should not be entitled to an assured return, i.e. the exit should not be at a pre-determined price.

Due to this change in the law, Tata Sons could no longer buy back Docomo’s shares at the assured price and the RBI refused to grant it permission to do so. This leads to the question whether the courts in India can enforce the award which requires Tata Sons to pay US$1.17 billion as damages, in light of the fact that the FEMA regulations do not permit Tata Sons to buy the shares at the assured price. The RBI has stated that the guiding principle will be that the non-resident investor should not be guaranteed any assured exit price at the time of making an investment and should exit at a fair price computed in accordance with the FEMA regulations.

Further, as discussed above, the court under section 48 is permitted to set aside an arbitral award which contravenes the fundamental policy of Indian law. Hence it is unlikely that the award will be enforced by the Indian courts. Thus, this is a classic case in which party autonomy is in conflict with the public policy of a nation.

It can be argued that as arbitrators are exclusively at the service of parties, they may fail to take into consideration any applicable mandatory public law or public policy in order to uphold party autonomy. It is equally arguable that arbitrators are not entrusted to protect or implement the public policy of a particular country and hence they should disregard it and decide a dispute purely on its merits. Despite such arguments, a failure to have regard to mandatory public law or public policy of the jurisdiction in which the arbitral award is sought to be enforced will likely result in situations such as in the Tata-Docomo case.

PRUDENCE AND CREDIBILITY

The term “mandatory public law” often refers to non-derogable rules of law from which private parties cannot derogate while exercising their party autonomy. The problem of disregarding mandatory public law and public policy to favour party autonomy is that the arbitrator cannot guarantee that the arbitral award will be enforced by the courts of countries where it is sought to be enforced.

Irrespective of the substantive law of the contract, it would be prudent for arbitrators to consider the mandatory public laws and public policy considerations of the country with which the contract is most closely connected and where the prevailing counterparty will most likely seek to enforce the arbitral award. In addition to ensuring enforceability of the arbitral award, this will go a long way in maintaining the credibility of international commercial arbitration.

There is no real difficulty when the mandatory public laws are part of the substantive law chosen by the parties because an arbitrator is bound to apply the substantive law in its entirety. However in certain other situations as well, mandatory public laws should be taken into consideration even though these are not part of the substantive law of the contract.

OTHER JURISDICTIONS

Courts in the US and the UK have taken different views when faced with questions relating to applicability of mandatory public laws of other countries that are not part of the substantive law of the contract. In the US case of Mitsubishi Motors Corp v Soler Chrysler-Plymouth Inc (1985) the parties chose Swiss law as the substantive law of the agreement and provided that all disputes would be subject to arbitration in Japan under the rules of the Japan Commercial Arbitration Association. Further, by an exclusive choice of law clause, the agreement between the parties specifically excluded the application of mandatory rules of public law of the place of performance of the contract.

Though the agreement was valid under Swiss competition law, it was illegal under US antitrust law. When the parties approached the US Supreme Court with respect to validity of their agreement, the court observed that when parties have agreed that their inter se claims will be decided by an arbitrator, such adjudication must be in accordance with the national law which gives rise to such claims.

The vital message expressed by the court was that if a claim is being made under US antitrust laws, then irrespective of the choice of law of the parties, the arbitrator must apply US law to the merits of the dispute. Otherwise, US courts might refuse to enforce the arbitral award on grounds of public policy. However, the court failed to note that the arbitral award might be enforced in other countries even though the arbitrator may have failed to consider US antitrust law.

In the UK, in Omnium de Traitement et de Valorisation SA v Hilmarton (1999), the court enforced an arbitral award although, on its face, the award indicated that the underlying consultancy contract violated Algerian law, i.e. the law of the place of performance. The governing law chosen by the parties was Swiss law and the arbitrator determined that, as a matter of Swiss law, the contract was not unlawful.

The English court indicated that an English arbitral tribunal, chosen by the parties and applying English law as chosen by the parties, may well have reached a different result. However, the court stopped short of further inquiry, stating that it was “not adjudicating upon the underlying contract”, but instead deciding only whether an arbitral award should be enforced in England. Thus, the English court enforced an arbitral award that was not contrary to the public policy of the governing law (Swiss) or the law at the place of the arbitration (also Swiss), even though the underlying contract was unlawful in the country of performance (Algeria).

AN EVOLVING SITUATION

At present, there is a lack of clarity as to the consequences that would follow from an arbitrator’s non-consideration of the mandatory public laws and public policy relevant to a dispute. Hence, the status of enforceability of an arbitral award in India or in any other country (especially arbitral awards passed in relation to fact situations like the Tata- Docomo case) cannot be predicted with any degree of certainty.

The arbitrators and experts in the field have proposed three different approaches to deal with this situation. One approach is for arbitrators to give effect to the trade regulations and other basic economic legislation of a state where the contract will be performed. Even if these mandatory public laws make the performance of the contract difficult or impossible, arbitrators may nevertheless consider applying them.

The second approach requires the arbitrator to apply the mandatory public laws of the prospective place of enforcement of an arbitral award, to ensure that the enforcement of the award does not violate the public policy of the country where enforcement is to be sought. This proposition is based on the assumption that the courts in a country where enforcement is sought will recognize the arbitral award by the standards of their country’s public policy. An arbitrator, therefore, should not render awards which violate the mandatory public laws integral to the public policy of the state where enforcement of the award is likely to be sought.

The third approach requires that the arbitrator apply the mandatory public laws of a state if the contract or the parties have close contact with that state and if, in view of the circumstances, application of such laws is called for.

In the context of the facts of the Tata-Docomo case, irrespective of the approach used, the arbitrators should have come to the conclusion that the FEMA regulations should be considered as a mandatory public law applicable to the case. The consideration of FEMA regulations is critical to deciding the dispute as the subject-matter of the agreement between the parties, i.e. Tata Teleservices, is situated in India. Further, it was clear from the outset of the dispute that if Docomo prevailed at the arbitration, in all likelihood it would approach the courts of India to enforce the arbitral award. Hence the arbitrators should have considered this while resolving the dispute.

BALANCE NEEDED

The principle of party autonomy recognizes the contractual counterparties’ right to choose their governing law and method of dispute resolution. However, merely choosing to resolve a dispute by arbitration does not permit the parties to override mandatory rules of public law and public policy or, in other words, any rule serving public interest. Where an award is passed without considering the relevant public policy or mandatory public law, it is likely to be unenforceable if it is against the mandatory public law of the country where it is sought to be enforced. Consequently such an award will fail to provide any redress.

In order to resolve the conflict between party autonomy and public policy, the courts should adopt a balanced approach. While blanket non-enforcement of arbitral awards on the grounds of public policy will erode confidence in arbitration as a viable alternative dispute resolution mechanism, undue deference on the part of the national courts to an arbitral award, without testing it on the touchstone of public policy may harm public interest.

Hence, it is time to evolve a globally acceptable concept of public policy, whereby the national courts will review the enforceability of an arbitral award in the light of public policy of the enforcement country as well as of the country with which the contract has the closest connection.

This approach will ultimately benefit the parties and encourage arbitrators to consider mandatory public laws and public policy of relevant jurisdictions. Further, this approach will ensure consistency in the enforcement of arbitral awards arising out of international commercial arbitration and will resolve the unpredictability of disputes as in the Tata-Docomo case.

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