ABOUT TDM
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Local Court Intervention in International Arbitration
Investors in energy projects should not rely on international arbitration to insulate themselves from unpredictable judicial systems. Recent rulings by local courts in Indonesia, Pakistan and India demonstrate the limits of arbitration, particularly in matters involving economic upheaval, political instability and allegations of corruption. In such circumstances, local project participants and government agencies have employed local court orders to delay or block international arbitration proceedings in favor of judicial review of claims that the project contracts were invalid or unenforceable. Such orders have been issued with respect to the Himpurna and Patuha projects in Indonesia sponsored by Mid-American Holdings, the Karaha Bodas project in Indonesia sponsored by FPL and Caithness Energy, the Paiton project in Indonesia developed by Edison Mission Energy, Mitsui and GE, the HubCo project in Pakistan, and the Dabhol project in India sponsored by Enron.
In order to persuade local courts to intervene in these disputes despite clauses in the applicable concession contracts specifying arbitration as the exclusive dispute resolution forum, State-owned enterprises and public authorities have raised a number of claims, including assertions that local regulators have exclusive regulatory jurisdiction (Dabhol); that changes in local law override the project contracts (Himpurna/Patuha, Karaha Bodas, Paiton, Dabhol); that force majeure events override contractual allocations of risk (Himpurna/Patuha, Karaha Bodas, Paiton); that the project contracts violated local law at inception (Himpurna/Patuha, Karaha Bodas, Paiton, Dabhol, HubCo); and that the project contracts were procured by means of fraud or corruption (Himpurna/Patuha, Karaha Bodas, Paiton, Dabhol, HubCo). The local claimants in the court proceedings can argue that judges are not required to defer to arbitrators in addressing the impact of such claims on disputes covered by arbitration clauses, and instead may order the arbitrators to defer to prior judicial review of the claims.
These arguments are legitimate legal positions, regularly considered in U.S., U.K. and Western European courts. The strength of these arguments is reinforced if the law chosen in the concession contract is the law of the host State (Paiton, Himpurna/Patuha, Karaha Bodas). By selecting local law to govern the transactions, the parties have arguably assumed the risks of changes in local law and broader local interpretations of force majeure protections. Organizing the project company under local law also subjects the enterprise to local companies law. That body of law often imposes regulatory, tax, environmental, health & safety and other prudential requirements that can be abused by the host State to assert mandatory jurisdiction over related disputes. In addition, selecting the host State as the seat of the arbitral proceedings further strengthens these claims. The international treaty governing enforcement of international arbitration awards recognizes the ability of a local court to set aside or suspend an arbitration award that was made "in," or "under the law of," that country. It is therefore preferable to select a country other than the host State as the seat of the arbitration, in order to limit the impact of a local court decision annulling the final arbitration award when that award is to be enforced in the courts of other countries.
Even if the project company is established in an offshore jurisdiction, the chosen governing law is not the law of the host State and the arbitration is sited outside the host State, the hard assets and many valuable contract rights of an energy project can nevertheless be "held hostage" to compliance with a local court order blocking arbitration. For example, an Indonesian court imposed fines of US$1 million per day for violations of its order seeking to halt arbitration of the Himpurna/Patuha project disputes. That same Indonesian court ordered daily fines of US$500,000 for breach of a similar injunction covering the Karaha Bodas arbitration, as well as a US$600 million penalty for violation of an anti-arbitration injunction relating to the Paiton project. If enforced, those fines would swallow the value of the project facilities. Similarly, confirmation by the Pakistani Supreme Court of an anti-arbitration injunction brought arbitral proceedings in London over the HubCo project to an abrupt end; especially since the project company's securities were listed on Pakistani stock exchanges.
For these reasons, international investors are not likely to ignore local court orders blocking arbitration unless several conditions have been satisfied.
- Most importantly, significant recoverable assets must exist outside the host State (e.g., political risk insurance or accounts payable by offshore obligors).
- The investors must be prepared to walk away from local assets like the project facilities.
- The arbitrators must be protected against the impact of local court orders by sitting in a neutral location and residing in countries other than the host State.
International project participants may deplore the unpredictable actions of local courts. Still, those courts are employing widely supported legal doctrines as a basis for their interventions. While careful decisions about the terms of concession contract may reduce the force of the legal arguments, the presence within the host State of project facilities assures that local court intervention cannot be completely neutralized. A more detailed discussion of the arbitration proceedings and court orders described in this Note is found at Kantor, The Limitations of Arbitration, Journal of Structured and Project Finance (Fall 2002), and Kantor, International Project Finance and Arbitration with Public Sector Entities: When is Arbitrability a Fiction?, 24 Fordham Int. L.J. 1122 (April 2001).
