Pakistan Supreme Court declares a contract – and the arbitration clause within that contract – void on public policy grounds

In a decision earlier this year the Pakistan Supreme Court declared that a joint venture agreement between a local development authority and BHP for the exploration of minerals was void on a number of public policy grounds. A subsequent novation of the agreement was also found to be void. Of particular interest to readers of this blog is that this decision included a finding that the arbitration clause in the agreement was also void, notwithstanding previous overtures from the Pakistani courts that it recognises the separability of an arbitration agreement.

Background

In January 1993, the Chagai Hills Exploration Joint Venture Agreement was signed between the Balochistan Development Authority (BDA) and BHP Minerals Intermediate Exploration Inc (a US Company) (BHP) for the exploration of minerals in the Reko Diq area in Pakistan (the CHEJVA). The applicable law of the CHEJVA was Pakistani law which was expressed to also include "principles of international law". The CHEJVA also provided that disputes would be resolved by ICSID arbitration seated in London. In 2000, an Addendum was signed between the two parties to the CHEJVA plus the Governor of Balochistan for and on behalf of the Province of Balochistan. In 2006, the parties to the Addendum entered into a novation agreement with Tethyan Copper Company Limited (TCC) (an Australian company) whereby the parties agreed to novate BHP's rights and obligations in the CHEJVA to TCC (the Novation Agreement).

In 2006, a number of individuals petitioned the High Court of Balochistan and challenged the legality of the CHEJVA based on various allegations, including: (a) the CHEJVA was executed contrary to the provisions of relevant statutes; (b) the parties had failed to register the CHEJVA properly; and (c) that various "relaxations" in local legislation by the Government of Balochistan and set out in the CHEJVA and the Addendum were illegal. The petition was dismissed by the High Court, but permission to appeal to the Supreme Court was granted and an appeal duly launched.

In the proceedings before the Supreme Court, TCC argued that that the allegations made about the CHEJVA and the relaxations of the local statutes were directed against BHP and not against TCC, which was not even in existence at the relevant time. In any event, the invalidity of the CHEJVA under the law should have no effect on the validity of the Novation Agreement. TCC asserted that the effect of a novation of contract is not to transfer a right or liability under the original contract, but to extinguish the contract altogether such that the effect of the Novation Agreement was to extinguish the previous contract and to replace it with the terms of the new agreement in its entirety through the mutual consent of the parties. Accordingly, TCC sought (amongst other things) specific performance of the CHEJVA and asked for the grant of particular mining leases in the Reko Diq area.

However, after TCC had articulated its claim before the Supreme Court and made a number of interim applications (but before any final judgment from the Supreme Court), TCC also filed ICC and ICSID arbitration proceedings against the Government of Pakistan. The ICC claim was commenced pursuant to the arbitration agreement in the CHEJVA¹ and the ICSID arbitration proceedings were brought pursuant to the Australia-Pakistan bilateral investment treaty (BIT).² Effectively, TCC sought the same relief before both arbitration tribunals that it claimed before the Supreme Court. On 7 December 2012 (i.e. before giving its detailed judgment), the Supreme Court directed the Government of Pakistan to request the respective ICC and ICSID tribunals not to take any steps until the matter had been disposed of by the Supreme Court. Requests were sent, but neither tribunal agreed and the arbitrations continued (Pakistan challenged the jurisdiction in both tribunals; as at the date of the Supreme Court judgment – and, indeed, the date of this blog - neither challenge had been determined). However, the ICSID Tribunal did write to the Supreme Court to inform the Supreme Court that the tribunal was unable to stop the proceedings (it is not clear from the Supreme Court judgment whether the ICC tribunal responded).

Decision of the Supreme Court

In a detailed judgment on 7 January 2013, the Supreme Court upheld most of the claims of the individual petitioners and concluded that the CHEJVA was void and illegal on a number of public policy grounds. It followed, therefore, that because the CHEJVA itself was void, all subsequent agreements connected to the CHEJVA, including the Addendum and the Novation Agreement were also void. As regards TCC's arguments that such illegality did not affect the Novation Agreement, the Supreme Court stated that a necessary element for the execution of a valid novation is the validity of the original agreement that is to be substituted. Where an agreement is void, all subsequent alterations, variations or novations based upon such agreement will also be invalid. Further, a collateral illegal contract or an earlier illegal contract would still remain illegal in spite of a novation.

As regards the arbitration clause, the Supreme Court noted that the law of Pakistan was the law applicable to the agreement and that therefore the Pakistani courts are the appropriate forum to decide the legality of the CHEJVA. In this regard, the Supreme Court made three key points:

1. Article 2(3) of the New York Convention - which is incorporated into Pakistan’s domestic law - provides that: "the court of a contracting state, when seized of an action in a matter in respect of which the parties have made an agreement within the meaning of this article shall, at the request of one of the parties, refer the parties to arbitration, unless it finds that the said agreement is null and void, inoperative or incapable of being performed" (emphasis added). On this basis, a local court seized of an action is entitled to determine whether an arbitration agreement is null and void, inoperative or incapable of being performed – and the Supreme Court did just that.
2. During the course of the Supreme Court proceedings allegations of corruption were raised. Article 34 of the UN Convention Against Corruption 2003 provides that where third parties have acquired rights in good faith that: "each state party shall take measures, in accordance with the fundamental principles of its domestic law, to address consequences of corruption". Article 34 further states that state parties may consider corruption related factors in legal proceedings to annul or rescind a contract. Accordingly, this provided an additional basis under international law for the Supreme Court to decide upon the CHEJVA and its related documents.
3. The parties challenging the legality of the CHEJVA (i.e. the parties that commenced the petition before the Pakistani courts) were not parties to the CHEJVA and therefore not parties to any arbitration agreement. Accordingly, it was for the courts – and not an arbitral tribunal – to decide on the legality of the arbitration agreement contained within the CHEJVA.

Finally, in relation to the ICSID arbitration, the Supreme Court noted that the protections offered to investors under the Australia-Pakistan BIT were expressed to be "in accordance with [each side's] laws and investment policies applicable from time to time". Thus, the Australia-Pakistan BIT requires that investments must be made in accordance with the law of Pakistan and where investments are not made in accordance with the law the investor is not entitled to any protection under the BIT. The Supreme Court referred to a number of previous decisions from investment treaty tribunals to support this position.³

Comment

The "separability doctrine" provides that an international arbitration agreement is almost invariably treated as presumptively separable or autonomous from the underlying contract in which it is found. The separability doctrine has also been endorsed previously by the courts in Pakistan.⁴

The decision of the Supreme Court did not refer to the separability doctrine directly, but at first glance a decision to declare a contract invalid notwithstanding an arbitration clause would appear to go against the doctrine. However, the factual matrix of this case was very particular and the Supreme Court appeared to place particular emphasis on the fact that there were allegations of corruption and that the parties petitioning the court for a declaration that the agreement was void and illegal were not parties to the agreement itself. Moreover, the separability doctrine is not absolute, and it is acknowledged that there are circumstances where the invalidity, illegality, or termination of the parties' underlying contract may affect the validity or effectiveness of the arbitration clause; while not considered by the Supreme Court directly, it is arguable that such circumstances existed in this case.

The Supreme Court also appeared influenced by TCC's overall conduct. In particular, it noted that TCC had not been forthcoming before the court and stated that TCC's decision to invoke the jurisdiction of the ICC and ICSID while the Supreme Court was fully seized of matters relating to the CHEJVA and other matters sought to prejudice the determination of the legality of the CHEJVA. It also asserted that TCC had not been entirely accurate in its representations to the ICC and ICSID tribunals as to the series of events leading to certain interim applications before the Supreme Court.

Overall, the decision is a reminder for investors to be aware of the potential limitations of arbitration clauses in the event their underlying contract is deemed to be void or illegal. That said, the ICC and ICSID arbitrations are also still on-going and therefore it is possible that this Chagai Hills/Reko Diq saga may produce further awards and decisions for arbitration practitioners to consider in due course.⁵

For further information, please contact Nicholas Peacock, Partner, London or Mike McClure, Senior Associate, Dubai or your usual Herbert Smith Freehills contact.

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¹ The ICC claim against the Government of Pakistan was brought against the Government of Balochistan which was deemed to be a party to the CHEJVA by virtue of the Addendum

² Tethyan Copper Company Pty Limited v. Islamic Republic of Pakistan (ICSID Case No. ARB/12/1)

³ World Duty Free v. Kenya (ICSID Case No ARB/00/7); Tokios Tokelės v. Ukraine (ICSID Case No ARB/02/18); Inceysa v. El Salvador (ICSID Case No ARB/03/26)

⁴ Hitachi Ltd v Rupali Polyester 1998 SCMR 1618 

⁵ We understand that TCC has withdrawn its claim for specific performance in both arbitrations and is now pursuing a claim solely for monetary damages (see TCC press release dated 8 May 2013); the ICC hearing is scheduled for June 2014 and the ICSID hearing is scheduled for mid-2014 (see Second Quarter 2013 Report for Barrick Gold Corporation, who operate a joint venture with TCC); as far as we are aware, Pakistan's jurisdiction challenge has not been determined in either arbitration