Substantive Grounds for Challenge

Introduction

For several decades, the conventional wisdom in arbitration law has been that arbitral decisions should be insulated from direct judicial review. Courts have accordingly shied away from delving into the merits or substance of arbitral awards. In recent years, this highly deferential, pro-enforcement paradigm is being increasingly tested and some courts seem to be showing a greater willingness to scrutinise arbitral awards.

This chapter looks at various avenues for challenging awards on substantive grounds. First, we explore a possible shift in judicial attitudes towards arbitration, tending to suggest that courts are taking a more active role in reviewing substantive aspects of arbitral awards. In line with that trend, we define ‘substantive grounds’ broadly to include mistakes of law or fact going to the overall substance of an arbitral decision, as opposed to only the merits of the underlying dispute, and distinguish these substantive defects from procedural or jurisdictional errors affecting only the arbitral process itself.^[2] Second, we identify existing mechanisms for appealing mistakes of law or fact directly within certain arbitration institutions or in the courts of certain jurisdictions. Third, we survey recent court decisions to assess the viability of raising mistakes of law or fact, or other serious defects such as fraud or corruption, as grounds for challenging awards in collateral judicial proceedings under national arbitration laws and the Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 (the New York Convention). Finally, we describe the sui generis investor-state arbitration regime created under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States of 1966 (the ICSID Convention) and consider the possibility of challenging ICSID awards on substantive grounds.

An evolving paradigm for challenges on substantive grounds

The current ‘enforcement friendly’ system is largely attributable to the implementation of two of the most significant legal instruments governing arbitral awards: the New York Convention and the United Nations Commission on International Trade Law (UNCITRAL) Model Law on International Commercial Arbitration of 1985.^[3] These legal developments were a boon to international commercial arbitration.^[4] That growth in cases carried over into investor-state arbitration with the ratification of the ICSID Convention and the subsequent proliferation of bilateral and multilateral investment treaties.^[5]

As explained in more detail below, this international legal framework limits the extent to which courts are able to review arbitral awards. With rare exceptions, awards are not subject to direct appeal. Thus, any relief from a defective award is likely to occur in collateral judicial proceedings either to set aside the award in a supervisory or primary jurisdiction (also known as the seat of the arbitration) or to enforce the award in secondary jurisdictions. In either situation, there are no express provisions for directly challenging an award on ‘substantive grounds’, that is to say based on a general mistake of law or fact. Instead, grounds for challenging awards are geared towards correcting mistakes in the arbitral process itself, such as serious departures from basic procedural rights or deviations from the arbitral mandate (sometimes described as jurisdictional or admissibility errors).^[6]

As this international legal regime made its way into domestic laws, many national courts began to shed any prior scepticism towards arbitration and adopted an explicitly pro-arbitration bias.^[7] Accordingly, courts have significantly limited their review of arbitral awards to facilitate faster and easier enforcement across jurisdictions. In other words, courts have acted as strict enforcers of the parties’ agreement to arbitrate and have deferred substantially to the legal and factual determinations of arbitral tribunals. Thus, under the existing legal framework, a party has little chance, if any, of successfully challenging the merits or substance of an arbitral award.

However, recent judicial decisions suggest that courts may be showing a greater willingness to flex their judicial muscle to correct excesses or abuses of arbitral power. Most notably, in 2018, the Court of Justice of the European Union (CJEU), the highest judicial authority on EU law, sent shock waves through the arbitration community when it ruled in Slovak Republic v. Achmea that EU Member States are precluded from agreeing to arbitrate disputes with investors from other EU Member States outside the EU judicial system,^[8] effectively ending investor-state arbitration in its current form within the European Union.^[9]

Achmea (a Dutch investor) brought claims against Slovakia pursuant to the arbitration provisions in a bilateral investment treaty (BIT) between the Slovak Republic and the Netherlands, both of which are EU Member States. Slovakia opposed the arbitral tribunal’s jurisdiction, arguing that, on the state’s accession to the European Union, the arbitration provision in the BIT was unenforceable under EU law.^[10] The tribunal concluded that it had jurisdiction and rendered an award in favour of Achmea. Because the arbitration was seated in Germany, Slovakia applied to set aside the award in a German court. Germany’s highest civil court, the Federal Court of Justice (BGH), referred the issue to the CJEU for a preliminary ruling. The CJEU agreed that Slovakia’s accession to the European Union precluded the state from agreeing to arbitrate disputes with investors of other EU Member States under the BIT. Accordingly, the BGH annulled the award on the grounds that no valid arbitration agreement existed between the parties under EU and German law.^[11]

Although the BGH’s reason for annulling the award (the non-existence of a valid arbitration agreement) fits within the jurisdictional grounds for setting aside awards under the existing legal framework, this narrow characterisation of the issue obscures a more fundamental aspect of the court’s decision. The court overruled the tribunal’s determination of its own jurisdiction based on a substantive legal error, namely a mistake in the interpretation and application of EU law. Thus, in a broader sense, the Achmea decision is an example of an award that was set aside on substantive grounds because the German court reversed a mistake of law in the arbitral decision itself, as opposed to correcting only a mistake in the arbitral process.

Direct review on questions of law or fact

Although the default practice is to agree to final and binding arbitration without any appellate review, parties may still be able to obtain direct review of an adverse award by agreeing to arbitrate either under the rules of an arbitral institution that provides for direct appeals within the arbitration process or under the laws of a jurisdiction that allows for direct review by a court.

For instance, the American Arbitration Association (AAA) and its international arm, the International Centre for Dispute Resolution (ICDR), provide for direct review of awards within the arbitration process pursuant to the Optional Appellate Arbitration Rules, which ‘apply a standard of review greater than that allowed by existing federal and state statutes’ in the United States.^[12] Under these rules, a new ad hoc panel of arbitrators is appointed to hear challenges to an award based on ‘(1) an error of law that is material and prejudicial; or (2) determinations of fact that are clearly erroneous’.^[13]

Similar optional appellate provisions are included in the arbitral rules of the International Institute for Conflict Prevention and Resolution (CPR) and the Judicial Arbitration and Mediation Services (JAMS). The CPR rules allow the new ad hoc appellate panel to set aside or modify an award if it ‘(i) contains material and prejudicial errors of law of such a nature that it does not rest upon any appropriate legal basis, or (ii) is based upon factual findings clearly unsupported by the record’.^[14] Under the JAMS rules, the ad hoc appellate panel ‘will apply the same standard of review that the first-level appellate court in the jurisdiction would apply to an appeal from the trial court decision’ and ‘may re-open the record’ to review any evidence that was improperly excluded by the original arbitrators or new evidence that has become ‘necessary in light of the [appellate] Panel’s interpretation of the relevant substantive law’.^[15] Other major institutions, such as the International Chamber of Commerce (ICC) and the London Court of International Arbitration (LCIA), do not provide comparable appellate procedures.

Outside the arbitration process, few jurisdictions still permit direct appeals from arbitral awards in court. One prominent example is England. The English Arbitration Act explicitly provides for direct appeals in certain specified circumstances, but only on questions of English law, and only by agreement of all the parties to the arbitral proceedings or by leave of the court.^[16] In practice, few applications make it ‘over the leave requirement which has been designed to catch all but the most meritorious appeals’.^[17] One exception is a 2019 decision by the High Court (Chancery Division) to set aside an award rendered by a sole arbitrator, finding that he had made a ‘fundamental error of law’ in interpreting the agreement by applying a subjective rather than an objective test of the parties’ intent.^[18]

Parties may contract out of this appellate review by explicitly waiving the right to appeal in the contract or by selecting arbitral rules that expressly waive any right to appeal or other forms of recourse, such as Article 35(6) of the ICC Rules and Article 26(8) of the LCIA Rules.^[19] However, a provision in an arbitration agreement that the award shall be ‘final, conclusive and binding’ has been deemed to be insufficiently clear to waive this right.^[20]

Collateral review under national arbitral laws and the New York Convention

In the absence of a direct appeal, a party may still be able to attack an award in collateral judicial proceedings in two ways. One option is to oppose enforcement of the award wherever the prevailing party tries to enforce it. The New York Convention, with more than 160 contracting states, provides the nearly universal defences against recognition and enforcement of awards.^[21] A successful defence would not extinguish the award, but would avoid enforcement in that jurisdiction and could preclude enforcement in other jurisdictions as well.^[22]

The other option is to apply to have the award set aside or annulled by a court in a primary jurisdiction. Under the New York Convention, there may be two primary jurisdictions (i.e., ‘the country in which, or under the law of which, that award was made’).^[23] The most common grounds for setting aside an award are set forth in Article 34 of the UNCITRAL Model Law, which forms the basis of arbitration laws in more than 110 jurisdictions.^[24]

If the award is properly set aside, courts in other countries or secondary jurisdictions may recognise the annulment decision and refuse to enforce the award under the New York Convention.^[25] However, nothing in the New York Convention or the UNCITRAL Model Law mandates recognition of an annulment decision.^[26] Some courts have enforced awards notwithstanding the fact that they had been annulled in a primary jurisdiction, for instance when the annulment decision is ‘repugnant to fundamental notions of what is decent and just’.^[27]

As is evident from a side-by-side comparison (see table below), the grounds for challenging an award in set-aside proceedings under the UNCITRAL Model Law and in enforcement proceedings under the New York Convention are practically identical.

Under both legal regimes, the grounds for attacking an award are limited primarily to serious deviations from constitutive or procedural aspects of the arbitration, for example a failure to act within the scope of the arbitration agreement or a failure to abide by basic standards of due process. In addition, an award may be disregarded if it decides an issue that is not arbitrable (i.e., not capable of settlement by arbitration under the state’s domestic law), or if it is otherwise contrary to public policy insofar as it violates the forum’s fundamental notions of justice and morality or contravenes important national interests.^[28] Notably, neither legal regime includes express provisions for directly attacking the merits or substance of an arbitral decision, whether based on a mistake of fact or law. Despite these similarities, the odds of success may vary depending on whether an award is challenged in set-aside or enforcement proceedings because courts in different jurisdictions may apply different standards of review and may respond differently to the same award.^[29]

Arbitration laws that are not based on the UNCITRAL Model Law can be similarly or even more restrictive in leading arbitral jurisdictions. In the United States, the Federal Arbitration Act (FAA) provides the exclusive grounds for a federal court to set aside or ‘vacate’ an award:

(1) where the award was procured by corruption, fraud, or undue means;

(2) where there was evident partiality or corruption in the arbitrators, or either of them;

(3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehaviour by which the rights of any party have been prejudiced; or

(4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.^[30]

As with the UNCITRAL Model Law, the FAA does not expressly include grounds for vacating an award on the basis of general mistakes of law or fact.^[31] The same is true under Swiss and French arbitration laws.^[32] French law is even more restrictive with respect to international awards. Unlike domestic awards, which are subject to review based on French standards of morality and justice (ordre public interne), international awards – regardless of where they were rendered – are subject to a presumably narrower standard of review under internationally recognised norms (ordre public international).^[33]

In short, the only realistic way to attack an arbitral award on substantive grounds in collateral proceedings is to present a challenge within the context of the express provisions found in the New York Convention or the relevant state’s domestic arbitration law. Recent court decisions setting aside or refusing enforcement of awards illustrate this point.

Fraud, corruption and other public policy violations

A significant development affecting the enforcement of arbitral awards is the emergence of fraud and corruption as substantive grounds for challenge. In some jurisdictions, courts seem willing to relax the traditionally stringent standard for reviewing awards to revisit allegations of fraud or corruption or to consider them for the first time.

To remain within the legal framework established by the UNCITRAL Model Law and the New York Convention, courts have relied on public policy to reject awards that are tainted by fraud or corruption, not only in the arbitral process itself but also in the underlying transaction. Again, courts are free to disregard an award if they believe it violates their own state’s public policy. As a general matter, an award is contrary to public policy if it is repugnant to fundamental notions of justice or morality, or if it contravenes important national interests.^[34] Because of its inherent vagueness, the public policy defence seems to provide the greatest latitude for courts to overturn infirm awards.

For now, French courts seem to be leading the charge against fraud or corruption in international arbitration. This is especially remarkable because, in France, as explained above,^[35] international awards are only subject to review for violations of internationally recognised norms rather than purely domestic norms, and courts must normally find that the alleged public policy violation satisfies the heightened standard of being ‘flagrant, effective and concrete’.^[36]

For instance, in 2018, the Paris Court of Appeal cited public policy as a basis for vacating an ICC award because it had the effect of conferring international legal protection on an investment secured by defrauding government authorities in derogation of the ‘international consensus’ respecting every state’s right to control foreign investments within its territory.^[37] The Court ruled that it had the power to review an award ‘in law and in fact’ to determine whether it violated international public order.^[38] In 2019, the Paris Court of Appeal again invoked public policy to refuse enforcement of an award because it violated the ‘international consensus’ prohibiting bribery of public officials.^[39] The Court emphasised that it had the power to investigate all relevant facts, regardless of whether they were presented to or addressed by the arbitrators, in determining whether the underlying contract was tainted by corruption.^[40]

In 2020, the Paris Court of Appeal set aside two ICC awards rendered in favour of a French construction company against Libya, finding fraudulent collusion between the French company and a public official in the procurement of the underlying contract. It bears noting that corruption had not been alleged during the arbitration even though the facts relied on before the Court were available at the time.^[41] Still, the Court found that enforcing an award infected with corruption would be contrary to international public policy.^[42] Because of the difficulty of proving actual corruption through direct evidence, French courts have developed a circumstantial evidence standard based on ‘serious, precise and consistent indicia’ (faisceau d’indices) of fraud or corruption.^[43]

The Hague Court of Appeal adopted a similar approach in a 2019 case, in which it refused to enforce an award because of ‘strong indications’ of corruption during the procurement of the underlying contract.^[44] The Court ruled that it had the power to assess independently whether the contract had been procured through corruption based on evidence that had been dismissed by the tribunal on procedural grounds, as well as facts that occurred after the award was rendered.^[45] It held that the general premise that an enforcement proceeding is not to be treated as a disguised appeal should not prevent compliance with a fundamental rule of law, such as the prohibition against corruption.^[46]

This ‘red flags’ methodology seems to have originated with the concept of ‘warning signs’ under the US Foreign Corrupt Practices Act.^[47] It also mirrors the ‘badges of fraud’ analysis developed in the common law tradition, an approach that US courts continue to use in various contexts.^[48] Despite these links to US law, it remains to be seen whether US courts will follow a similar approach. Although the US Court of Appeals for the District of Columbia Circuit has made clear that the ‘ “fundamental equitable principle” preventing courts from being made parties to fraud or other criminal acts’ applies with equal force under the New York Convention’s public policy exception and extends to awards tainted by fraud in the underlying contract,^[49] the US Court of Appeals for the Second Circuit in New York has suggested that fraud in the underlying contract is ‘a matter to be determined exclusively by the arbitrators’.^[50] Regardless, some courts seem to be coalescing around a three-part test for determining whether an award should be set aside or vacated based on fraud:

• the fraud could not have been discovered before or during the arbitration;
• there is a material connection between the fraud and an issue decided in the arbitration; and
• proof of fraud by ‘clear and convincing evidence’.^[51]

Substantive errors as excesses or abuses of arbitral power

Even though it is not expressly included in the FAA, US courts have recognised the doctrine of ‘manifest disregard of the law’ as a proper basis for vacating awards, including international awards rendered in the United States.^[52] The US Supreme Court has explained that ‘manifest disregard of the law’, as opposed to general errors of law, may be a proper basis for review under one of the FAA’s express provisions, such as when the arbitrators are guilty of misconduct or exceed their powers.^[53] As a general rule, this doctrine applies when two criteria are met: ‘(1) the arbitrators knew of a governing legal principle yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case’.^[54]

Although this defence rarely succeeds, in 2019, the US Court of Appeals for the Ninth Circuit affirmed a lower court’s decision to vacate an international award rendered in the United States under the FAA because the arbitrators’ decision was ‘completely irrational’ and in ‘manifest disregard of the law’.^[55] In that case, a US government contractor, ECC, awarded subcontracts to a local company, Aspic, for two construction projects in Afghanistan pursuant to ECC’s prime contract with the US Army Corps of Engineers. Under the terms of the subcontracts, Aspic were obliged to comply with US regulations applicable to ECC as a government contractor, the Federal Acquisition Regulations (FAR), including provisions relating to termination of contracts and settlement procedures.

Eventually, the Army Corps of Engineers terminated the prime contract and ECC accordingly cancelled the subcontracts. Aspic claimed that it was owed certain expenses and termination costs, but ECC refused to pay, in part because Aspic had failed to properly present its settlement costs as required by the relevant FAR provisions. Aspic filed for arbitration pursuant to the subcontracts, and the sole arbitrator issued an award in favour of Aspic for more than US$1 million on the basis that it would be unreasonable and unjust to hold a local Afghan company to the same strict standards as a US contractor.^[56] A federal district court in California vacated the award and the court of appeals affirmed. The latter reasoned that the arbitrator erred as a matter of law and thereby exceeded its authority in concluding that Aspic need not comply with the FAR provisions.^[57]

Similarly, in France, in 2019, the Paris Court of Appeal partially set aside an award on the grounds that the arbitral tribunal exceeded its mandate by erroneously awarding damages for claims that the tribunal itself had concluded to be outside its temporal jurisdiction.^[58] A Canadian gold mining company, Rusoro, had acquired interests in certain mining projects in Venezuela between 2006 and 2008. In 2009, Venezuela enacted various measures restricting exports of gold and regulating foreign exchange. In 2011, Venezuela nationalised the gold mining sector. Rusoro submitted a request for arbitration, claiming that Venezuela had breached its obligations under the Canada–Venezuela BIT by enacting restrictive measures in 2009 and expropriating Rusoro’s gold mining interests in 2011.

The arbitral tribunal found that the claims based on the 2009 measures were time-barred under the BIT. Nevertheless, it awarded Rusoro US$967 million plus interest in compensation for the alleged expropriation based on the value of the company’s shares in 2008, without taking into account the decrease in value caused by the restrictive measures imposed in 2009. The Paris Court of Appeal reviewed the relevant elements of law and of fact and concluded that it was an error to award damages for losses that were caused by measures that fell outside the tribunal’s mandate.^[59]

Substantive review under the ICSID Convention

An entirely different regime applies to awards rendered under the ICSID Convention, which creates a ‘self-contained’ arbitration system for investor-state disputes separate and apart from the regime created under the New York Convention and the UNCITRAL Model Law.^[60] The ICSID Convention provides the exclusive mechanism for annulling an award within the ICSID system itself. An ad hoc committee composed of three ICSID-appointed arbitrators considers the annulment application.

Article 52 of the ICSID Convention sets forth the exclusive grounds for annulling an ICSID award:

• the tribunal was not properly constituted;
• the tribunal has manifestly exceeded its powers;
• there was corruption on the part of a member of the tribunal;
• there has been a serious departure from a fundamental rule of procedure; or
• the award has failed to state the reasons on which it is based.

As with the UNCITRAL Model Law, these provisions relate primarily to the integrity of the arbitration process and do not expressly include errors in the substance of the arbitral decision. Nevertheless, ad hoc committees have annulled awards for serious mistakes of law under an excess of powers rubric, for instance when the arbitral tribunal failed to apply the proper law, or its misinterpretation or misapplication of the law was ‘so gross or egregious as substantially to amount to failure to apply the proper law’.^[61]

One example is Venezuela’s success in having an ICSID award partially annulled for failure to apply the proper law in calculating damages.^[62] The arbitrators awarded certain subsidiaries of ExxonMobil approximately US$1.6 billion in compensation for various claims, including for an expropriation under the Netherlands–Venezuela BIT. The ad hoc committee reviewed the award and found that the tribunal had disregarded the terms agreed by the parties for computing damages and instead had applied general principles of international law.^[63] The ad hoc committee disagreed with the tribunal’s decision on the applicable law and ‘the way in which the Tribunal put that decision into effect’.^[64] It concluded that the tribunal had exceeded its powers and, accordingly, annulled the relevant portion of the award, which amounted to a reduction of more than US$1.4 billion.^[65]

Unless an award is annulled in accordance with the ICSID Convention, each contracting state is required to enforce it as if it were a final judgment of its domestic courts.^[66] The New York Convention’s grounds for resisting enforcement do not apply. Thus, challenging ICSID awards in court is even more difficult because, in theory, they are not subject to judicial review on any grounds. Nevertheless, the saga involving intra-EU investor-state arbitration has shown that ICSID awards may be susceptible to judicial oversight as well. In February 2019, a Swedish court refused to enforce an ICSID award because, in effect, it directed Romania, an EU Member State, to grant impermissible subsidies, or state aid, to investors of another EU Member State in violation of EU law. The court recognised that the ICSID Convention called for recognition and enforcement of the award as if it were a final judgment of a Swedish court, but reasoned that a Swedish court judgment that violated EU law would also be unenforceable.^[67]

In the United States, the notion that ICSID awards are automatically enforceable against foreign states has been rejected. Under the federal statute implementing the ICSID Convention, ICSID awards must be enforced in federal court as if they were final judgments of a court of a constituent state.^[68] For many years, federal district courts in New York believed this provision permitted the use of state court procedures to convert ICSID awards into federal judgments in summary proceedings without notice to the award debtor. In 2017, however, the US Court of Appeals for the Second Circuit put an end to that decades-old practice and ruled that proceedings to enforce ICSID awards against a foreign state are subject to the procedural and substantive requirements of the US law on foreign sovereign immunity, including its service of process, venue and jurisdictional immunity provisions.^[69]

Conclusion

Mounting a successful challenge against an arbitration award on substantive grounds is not easy, but it is not impossible. Courts across jurisdictions, including in so-called ‘arbitration friendly’ jurisdictions, have shown that they will not blindly enforce awards containing egregious mistakes of law or other serious defects. Indeed, recent court decisions seem to suggest that, in light of a growing suspicion of arbitration within many communities, some courts may be rediscovering their scepticism about unfettered arbitral power and reasserting their own power to scrutinise awards more closely.

Notes