Liability of arbitration institutions: the Hungarian Supreme Court’s new approach

In one of its recent cases the Hungarian Supreme Court had to decide whether or not an arbitration institution is liable for the allegedly unlawful content of an arbitral award. The Supreme Court approached the question of liability in a new way – compared to its previous judgement in a similar case – because it reviewed the content of the arbitral award with regards to its substance. While the Supreme Court rejected the claim for damages, its new approach can be criticised. (Judgement no. Pfv.IV.20.816/2014/11.)

1. The dispute

The plaintiff of the lawsuit for damages was party to two consecutive arbitration proceedings against its contractual partner. Both proceedings concerned the shareholders’ agreement between the plaintiff and its contractual partner. The first arbitration was about the question of whether the call option right contained in the shareholders’ agreement was null and void. The arbitral award in the first arbitration declared that the option right was indeed null and void (“First Award”). Afterwards the plaintiff’s contractual partner started a new arbitration procedure against the plaintiff. In this second arbitration the main question was whether the exclusive distribution right contained in the same shareholders’ agreement was also null and void. The arbitral award in the second arbitration declared that the exclusive distribution right was in breach of the competition law provisions of the EC Treaty (“Second Award”).

The plaintiff brought a setting aside action against the Second Award, but the ordinary courts rejected the claim.

Finally, the plaintiff initiated a lawsuit for damages against three entities: (i) the institute which operates the arbitration court, (ii) the ordinary court which rejected the setting aside claim, and (iii) the Hungarian State. In its claim the plaintiff stated that the arbitration institute infringed upon a number of substantive and procedural rules, including the right to a fair trial and the principle of res judicata (the Second Award allegedly decided on the same question as the First Award). It also claimed that the court which heard the setting aside case violated directly applicable EU law rules, and that the Hungarian State is ultimately also liable for the breach of EU law by Hungarian Courts.

2. Liability of the ordinary court

While in principle courts are liable for the damage they unlawfully cause, this liability is subject to a number of limitations. One of these is that the court adjudicating the damages claim against a particular court cannot review the original judgement as to its substance. Due to the principle of res judicata, the content of a final and binding judgement is immune in a subsequent damages claim brought against the court which rendered that judgement. The Supreme Court followed this approach and rejected the claim against the court which did not set aside the Second Award.

3. Liability of the arbitration institution

Before this case, there was only one publicly available Supreme Court judgement dealing with the liability of an arbitration institution. In that case, the Supreme Court applied the rules of judicial liability and, in particular, the principle that arbitral awards cannot be reviewed as to their substance in a lawsuit for damages (case no. Pfv.III.21.148/2013/4.). In this case, however, the Supreme Court adopted a new approach. It said that the arbitration court’s (or institution’s) liability is based on a contract, thus the relevant question is whether there was a breach of contract. When answering this question the Supreme Court effectively reviewed the Second Award as to its merits. As a result, the Supreme Court established that the Second Award does not infringe upon the legal provisions indicated by the plaintiff.

4. Liability of the Hungarian State

Finally, the Supreme Court held that Hungarian State is not liable for the alleged unlawful acts of Hungarian courts. The courts have separate legal personality and they are liable for their own conduct themselves. The Supreme Court therefore rejected the plaintiff’s claim against the Hungarian State.

5. Comments

The Hungarian Arbitration Act expressly states that arbitral awards have the same legal effect as final and binding judgements of ordinary courts. The Supreme Court confirmed in previous cases that arbitral awards have res judicata effect (see our previous blog entry). The Supreme Court derived from the principle of res judicata that, in a subsequent lawsuit for damages, it is prohibited to review a final and binding ordinary court judgement as to its merits. If arbitral awards also have res judicata effect, which they do, the same principle should apply in the case of damages actions brought against the arbitration institutions. One of the advantages of arbitration is that the award is immediately enforceable, no appeal lies against it and ordinary courts have very limited grounds to review arbitral awards. This basic characteristic and advantage of arbitration would be jeopardized if the losing party could have the award fully reviewed in a damages action brought against the arbitration court.

Hungarian Supreme Court sets aside an arbitral award

In a recent judgement the Hungarian Supreme Court set aside an arbitral award on the basis that the arbitral tribunal failed to decide on the whole claim, and thereby the arbitral procedure was not in accordance with the agreement of the parties (Case no. BH 2015.167).

 When an ordinary court sets aside an arbitral award, this is always worth noting and reporting. Such cases are exceptional because the grounds for setting aside arbitral awards are limited, in most of the cases the conditions for setting aside are not fulfilled, and Hungarian courts generally follow a liberal, pro-arbitration approach. Under Hungarian law the grounds for setting aside correspond to Art. V of the New York Convention. One of these grounds is if the arbitral procedure was not in accordance with the agreement of the parties. In a recent judgement the Hungarian Supreme Court set aside a domestic arbitral award based on this ground. Since the legal basis of the domestic decision (Section 55(1)(e) of the Hungarian Arbitration Act), corresponds to Art. V(1)(d) of the New York Convention, applicable in case of recognition and enforcement of foreign arbitral awards, the case is relevant for both domestic and international arbitration.

1. The case

The case concerned an arbitration before the Permanent Court of Arbitration of the Money and Capital Markets. The dispute originated from a credit agreement which was terminated by the creditor. The debtor contested the termination and alleged that it suffered damages in the magnitude of HUF 13 billion plus EUR 42 million as a result of the allegedly unlawful termination. The debtor initiated arbitration proceedings against the creditor and claimed damages, however, the amount of its claim was only HUF 1.98 billion (about 7% of its alleged full loss), and it reserved its rights to claim further damages. According to the claimant its total loss consisted of four different heads of losses, it nevertheless failed to specify, despite the arbitral tribunal’s repeated requests, which heads of losses did his claim of HUF 1.98 billion cover.

2. The arbitral award

In its award the arbitral tribunal rejected the claim. In the award’s reasoning, the arbitral tribunal considered that the claim corresponded to two heads of losses the aggregate amount of which was HUF 1.92 billion. Since this amount is slightly lower than the amount claimed (HUF 1.98 billion), the arbitral tribunal ordered that the advance on arbitration costs paid for the difference (HUF 0.06 billion) shall be transferred back to the claimant.

3. The Supreme Court’s decision

The Hungarian Supreme Court set aside the arbitral award. The Supreme Court found that the arbitral award’s operative part and its reasoning were contradictory. In the operative part the award rejected the claim entirely, while it was clear from the reasoning that the award does not cover the whole claim because the tribunal did not decide on the amount of HUF 0.06 billion but rather ordered the refunding of the corresponding advance on costs. Therefore it is impossible to determine the scope of the arbitral award’s res iudicata effect. The Supreme Court referred to its previous judgement according to which the res iudicata effect of arbitral awards is a part of Hungarian public policy. According to the Procedural Rules of the Permanent Court of Arbitration of the Money and Capital Markets the arbitration is concluded with either an award or an order terminating the proceedings. Thus, the arbitral tribunal should have issued an order terminating the proceedings with respect to that part of the claim which it did not decide upon (HUF 0.06 billion). The tribunal failed to do so, consequently the arbitral procedure was not in accordance with the agreement of the parties.

The Supreme Court emphasized that it does not have the right to overrule the arbitral tribunal’s decision as to what is the amount and the legal basis of the claim. Thus, it did not investigate whether the tribunal was correct in stating that the claim covered two specific heads of losses. The Supreme Court’s only concern was that the arbitral tribunal failed to properly close the case based on its own Procedural Rules (issuing an award on the merits, issuing a termination order about the remaining part of the claim).

The Supreme Court rejected the setting aside claim based on the alleged lack of impartiality of one of the arbitrators. The claimant’s allegation was based on the fact that one of the arbitrators was member of the Arbitration Court’s Board of Directors where another board member, who did not act either as an arbitrator or counsel in the arbitration, but worked in the same law firm as the respondent’s counsel in the arbitration.

4. Comments

While it is a rare occasion when the Supreme Court sets aside an arbitral award, the court’s decision seems to be justified. The court’s approach remained within the strict limits of reviewing arbitral awards. Under Hungarian law, if the conditions for setting aside are fulfilled, the only decision the court can make is to set aside (annul) the arbitral award. This rule applies even if, as in this case, the reason for setting aside is that the arbitral tribunal failed to render an additional order. Finally, it is reassuring that the Supreme Court confirmed the ordinary courts’ prohibition to overrule the merits of the arbitral award.

The Current State and Reform of Arbitration in Hungary

Civil procedural law is currently under reform in Hungary. It is the Government’s intention to draft a new Code of Civil Procedure and also to revise the rules on arbitration. Authors of our blog participated in a roundtable discussion about the current state and possible reforms of arbitration in Hungary.

Hungary to repeal the restriction relating to arbitration in connection with so-called national assets

The Hungarian parliament repealed the controversial restriction on arbitration relating to so-called national assets. Two and a half years after the introduction of the restriction, and one and a half years after its much debated approval by the Hungarian Constitutional Court, Hungarian law will again permit arbitration in relation to contracts that relate to national assets.

Arbitration clauses in the statutes of companies

According to both the new Civil Code and the old Act on Business Associations, arbitration clauses can be stipulated for corporate law disputes both in corporate statutes and in agreements of the parties involved in a dispute. It is worth examining whether these two different types of arbitration clauses are treated differently in the Hungarian and international court practice or not.

Investment Arbitration and the EU-USA Free Trade Agreement

The adoption of the Transatlantic Trade and Investment Partnership (TTIP) treaty by the EU and the US, including its Investor to State Dispute Settlement (ISDS) mechanism, should be a significant development in investment arbitration. Since the issue of “secret courts” is one of the focal points of protests against the TTIP, to form an informed opinion it is worth taking a look at the ISDS rules of the EU- Canada Comprehensive Economic and Trade Agreement (CETA), which is likely to serve as a regulatory model of the TTIP ISDS rules.

Hungarian Supreme Court confirms Res Iudicata effect of Arbitration Awards and the public policy nature of Res Iudicata effect

In a recent decision published under BH 2015.14, the Hungarian Supreme Court confirmed that arbitral awards have a res iudicata effect and that an arbitral award disrespecting the finality of an earlier award can be annulled on the basis of the public policy clause of the Hungarian Arbitration Law. The Supreme Court also clarified the scope of such effect, and its interpretation has important implication for litigants faced with incomplete arbitral awards.