Arriving into arbitration pacts with sovereign states: What to look out for?

Arriving into arbitration pacts with sovereign states: What to look out for?

Although national law generally upholds agreements between private parties and states, care must be taken, explain Kristina Fridman and Michael Jaffe.

Private parties may encounter issues not applicable to commercial arbitration agreements exclusively between private parties when they enter into an arbitration agreement with a sovereign state.

State governments often enter into arbitration agreements but claim later that the government entity, which concluded the agreement lacked authority to do so, or it is otherwise invalid under domestic law. G. Born, International Commercial Arbitration 772 (3d ed. 2021) ('States attempt to disavow their international arbitration agreements under various national laws and constitutions restricting the ability of governments to conclude binding arbitration agreements.').

Despite the fact that many jurisdictions have abolished restrictions on a state's or a government's ability to agree to arbitration, some take a more restrictive stance. Id at 772. A notable example is the United States, which generally does not permit private parties to enter into enforceable arbitration agreements without explicit statutory authorization. See US v Shaw, 309 US 495, 500-502 (1940) (Congress alone may waive sovereign immunity by statute and consent for the US to be sued); see also 56 Fed Reg 55195, § 1(c) (3) (1991) (forbidding federal departments from entering into binding arbitration agreements).

Finnish case

District Court of Helsinki, A v Republic of Finland/Ministry of Justice of Finland, Case No. L 19/20225, Decision No. 21/41585, 31 August 2021, the Finnish courts recently addressed the authority issue. An official document was signed there by the minister of justice giving the Permanent Court of Arbitration (PCA) jurisdiction over disputes 'regarding the taxation and recovery measures against A and his companies'. Finland objected to A's request for arbitration when it was submitted to the PCA. Requested that Finland be compelled to arbitrate. The Finnish government raised several objections, including the fact that the minister of justice did not have the right of consent to arbitration, did so improperly and that the claims were not arbitral under Finnish law.

The district court noted that A had reasonable grounds to believe the minister of justice acted within his authority and 'failure to comply with preparatory procedures in a state body required by applicable regulations is not significant when evaluating whether A can trust the legitimacy of the consent.' However, the court invalidated the consent as ambiguous.

Alternative approaches

Courts and tribunals have emphasized that a state cannot invalidate an arbitration agreement based on its own domestic legislation are on the other side of the spectrum. G. Born, International Commercial Arbitration at 774-777. In order to reach this conclusion, courts and tribunals have applied one of three methods: (1) they use 'corrective factors', like reasonable reliance or estoppel, to Neutralize the issue of legal capacity; (2) by applying a different law, they render the restriction irrelevant; or (3) by treating the matter as subjective arbitrability, they find the 'substantial rule of international arbitration that requires state parties to honour their arbitration agreements' precludes reliance on national law. T. Cheng and I. Entchev, Sovereign Immunity and State Incapacity in International Arbitration, 26 S. Ac. L. J. 942, 954 (2014).

Generally, where a private party is contracting with a sovereign, it would be prudent to make sure that the sovereign party signing the contract containing the arbitration agreement has the requisite authority to agree to the waiver of sovereign immunity.

In New York, Kristina Fridman specializes in international arbitration, while Michael Jaffe is a disputes partner at Pillsbury based in Washington DC.