Arbitration and embargo

The Supreme Court recently ruled on an interesting matter. The case dealt with the consequences of the prohibition to undertake or continue economic transactions with a sovereign State (a State under embargo), with respect to an arbitration clause stipulated in an agreement previously entered into with the embargoed State.

The Italian full text of decision no. 23893 of the Supreme Court sitting en banc of 24 November 2015 is available here.

In November 1983, an Italian company entered into an agreement with the Iraqi government, governed by French law, for the sale of five helicopters. The Italian company also issued a “guarantee in favor of the purchaser for an amount equal to the advance payments.” It is likely that such guarantee was a first demand bank guarantee. In any case, the ruling at hand clarifies that the guarantee has been issued by an Iraqi bank, couter-guaranteed by an Italian bank.

The agreement contained a rather complex arbitration clause. First of all, it provided for a mechanism for the settlement of the disputes and, in case of failure, an ICC arbitration: “any dispute shall be settled by one or more arbitrators in accordance with the rules of conciliation and arbitration of the International Chamber of Commerce of Paris. The decision of the Arbitral Tribunal shall be binding and final upon the parties.

The Iraqi government failed to pay one of the price installments, due for payment in November 1986. As a consequence, the Italian seller did not deliver the helicopters subject of the contract.

Later, in August 1990, Iraq invaded Kuwait. After that, the UN Security Council passed resolution 661 of 6 August 1990 (available here), which states that: “all States shall prevent: (…) (c) The sale or supply by their nationals or from their territories or using their flag vessels of any commodities or products, including weapons or any other military equipment, whether or not originating in their territories but not including supplies intended strictly for medical purposes, and, in humanitarian circumstances, foodstuffs, to any person or body in Iraq or Kuwait or to any person or body for the purposes of any business carried on in or operated from Iraq or Kuwait, and any activities by their nationals or in their territories which promote or are calculated to promote such sale or supply of such commodities or products” (paragraph 3) and “all States shall not make available to the Government of Iraq or to any commercial, industrial or public utility undertaking in Iraq or Kuwait, any funds or any other financial or economic resources and shall prevent their nationals and any persons within their territories from removing from their territories or otherwise making available to that Government or to any such undertaking any such funds or resources and from remitting any other funds to persons or bodies within Iraq or Kuwait, except payments exclusively for strictly medical or humanitarian purposes and, in humanitarian circumstances, foodstuffs” (paragraph 4).”

The Regulations of the European Economic Community were even stricter (due to their imperative nature). In particular, it is worth mentioning: (i) Council Regulation (EEC) no. 2340/90 of 8 August 1990 (available here); (ii)  Council Regulation (EEC) no. 2340/1990 of 29 October 1990 (available here), both preventing trade by the Community as regards Iraq and Kuwait; and (iii) Council Regulation (EEC) no. 3541/1992 of 7 December 1992 (available here), which expressly prohibits “to satisfy or to take any step to satisfy a claim made by: (a) a person or body in Iraq or acting through a person or body in Iraq; (b) any person or body acting, directly or indirectly, on behalf of or for the benefit of one or more persons or bodies in Iraq (…)” (Article 2). Under the Regulation, a claim shall be understood as “any claim, whether asserted by legal proceedings or not, made before or after the date of entry into force of this Regulation, under or in connection with a contract or transaction” (Article 1).

In light of the factual circumstances, in November 1991 the Italian seller commenced proceedings in Italy, requesting the Court to terminate the sale agreement and claiming compensation for the suffered damages. The seller also requested the Italian Court to declare the termination of the counter-guarantee issued by the Italian bank in favour of the Iraqi bank.

The Iraqi government failed to appear in Court by the first hearing, but it did so later in the proceedings. It argued that the Italian Court lacked jurisdiction on this matter (as the Iraqi government acted as a sovereign entity) and raised the “exceptio compromissi”, objecting that the jurisdiction  – if any – rests with the Arbitral Tribunal.

The Court of first instance issued an order pursuant to Article 700 of the Italian Code of Civil Procedure, preventing the Italian bank from paying the amount due under the counter-guarantee.

In November 2003, the Court of first instance ruled that the jurisdiction on the claims against the Iraqi government rests with the Arbitral Tribunal. This decision was issued after a rather complex taking of evidence, which also included two expert opinions (on the value of the helicopters and on the content of the French law governing the agreement).

However, this decision was overturned in appeal. In December 2012, the Court of Appeal ruled that the Court had jurisdiction on the matter, and accepted the claims brought against the Iraqi government.

The Iraqi government filed an appeal to the Supreme Court, claiming that the decision of the Court of Appeal was wrong.

The stipulation of an arbitration clause, and therefore the jurisdiction of the Arbitral Tribunal (maintained by the Court of first instance and denied by the Court of Appeal), was one of the grounds for appeal to the Supreme Court.

The Supreme Court confirmed the ruling of the Court of Appeal.

In a nutshell, the ruling of the Supreme Court states that the embargo resulted in the non-negotiability of the rights object of the sale agreement entered into between the Italian seller and the Iraqi government. Such embargo therefore determined the non-arbitrability of any dispute relating to that agreement.

This reasoning is enough to rule that the arbitration clause at hand is null and void and, thus, confirm the decision of the Court of Appeal.

The Supreme Court also dealt with the issue of the jurisdiction to state that the arbitration clause became null and void. The Iraqi government alleged that this jurisdiction only rests with the Arbitral Tribunal. However, this assertion is inconsistent with the principle according to which each Court has the authority to determine its own jurisdiction. As the Supreme Court ruled: "article II(3) of the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards clearly determines that the Court will decide on its own jurisdiction, regardless of the existence of an arbitration agreement. Therefore, it is on the Court – and not on the Arbitral Tribunal – to determine the jurisdiction of the Court if the arbitration agreement is null and void.” 

Moreover, the Supreme Court ruled that the partial lifting of the embargo did not imply a revival of the arbitration clause. Instead, the Court held that the embargo is “a sanction that rendered illicit and immediately inadmissible arbitration proceedings and irreversible any claim filed with the competent Court, according to the lex fori.

Nevertheless, the case did not end after that. Indeed, the Supreme Court only confirmed that the jurisdiction rests with the Italian Court. The grounds of the appeal on the merits will have to be examined by the I Civil Chamber of the Supreme Court.

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