The Notion of “Material Breach” as the Ground to Terminate an Inter-State Arbitration Agreement (Compromis): A Criticism over Croatia v. Slovenia Tribunal’s Approach

Trinh Ba Duong (Geneva MIDS)[1]

Croatia v. Slovenia is an exceptionally rare case which deeply touched the matter of terminating an arbitration agreement between two states, particularly a compromis.[2] The dispute addressed in the partial award arose in the context that there was an ex parte communication between Dr. Jernej Sekolec, the arbitrator appointed by Slovenia, and H.E. Ms. Simona Drenik, an agent of Slovenia. In particular, after the hearing and the beginning of Tribunal’s deliberations, audio files and transcripts of the telephone conversations between these two individuals were published which indicated that Dr. Sekolec disclosed co-arbitrators’ preliminary views and positions during deliberations, and Dr. Sekolec received documents from Ms. Drenik to forward to other arbitrators in support of Slovenia’s arguments.

Croatia attempted to shut down the Arbitration Agreement between Croatia and Slovenia concerning the territorial and maritime dispute (“Arbitration Agreement”) by referring to Article 60(1) of the Vienna Convention on the Law of Treaties (“VCLT”), which enunciates that a ‘material breach’ in a bilateral treaty is the ground for one party to invoke the termination of the treaty. Croatia alleged that such misconducts committed by Slovenia had constituted a material breach. The Tribunal addressed this issue by analyzing the notion of material breach under Article 60(3) of the VCLT. This blog aims to explore the Tribunal’s decision before directing some criticism against its approach.

The Croatia v. Slovenia Tribunal’s approach

There are two circumstances under Article 60(3) where an action constitutes a material breach. The first one is where such action is a repudiation of the treaty, meaning that the defaulting party refuses to fulfil the treaty. This is obviously not the case here, as pointed out by the Tribunal that Slovenia not only did not refuse to fulfil the treaty obligations, which were the obligations to arbitrate, but on the contrary supported the Tribunal to continue its jurisdiction over the substantive dispute.

The second circumstance is where an action violates a provision essential to the object or purpose of the treaty. The Tribunal used the traditional method to seek the object and purpose of a treaty, which was to resort to the preamble, and determined the main object and purpose of the Arbitration Agreement being “the settlement of the maritime and territorial dispute between the Parties in accordance with the applicable rules”. The Tribunal took a further step to say if the breaches of Agreement by Slovenia did not made such object and purpose impossible to be accomplished, such breaches would not be considered material breaches.

After the files had been leaked, the Tribunal was recomposed with the replacement of 2 new arbitrators. The new Tribunal also reviewed the documents forwarded by Dr. Sekolec from Ms. Drenik, and concluded that “[t]hese documents contained no facts or arguments not already present in the written or oral pleadings”. No other breach of confidentiality in the proceedings was raised by the Parties. By taking all the remedial action, the Tribunal decided that the continuation of the proceedings was totally possible, thus dismissed the claim by Croatia that Slovenia’s actions constituted a material breach and led to the termination of the Arbitration Agreement.

Criticism over the Tribunal’s Approach

As can be drawn from the above decision, the Tribunal assessed a ‘material breach’ with regard to whether the remedial actions taken could ‘cure’ the mistakes and made the continuation of the proceedings possible. If they could, such mistakes should not be deemed material breaches. This approach should provoke some criticism.

Firstly, the idea of ‘curing’ a breach is not non-existent, but the VCLT never explicitly provides for the curability of a breach. In a very few exceptional cases, a defaulting party is given the right to cure a breach. An example can be found under Article 48(1) of the United Nations Convention on Contracts for the International Sale of Goods (“CISG”), which allows the seller to cure ‘any failure’ to perform his obligations. However, it only applies to sale of goods in a specified context with a clear expression under the law. The law cannot be assumed to provide an opportunity to cure if it does not express so.[3]

A hypothetical question is, even if the VCLT expressly allowed curability, should the defaulting party be given the right to cure a material breach? From the author’s view, curing breach should be made as an exception rather than a widely accepted practice, especially when it comes to curing a material breach. There has been a lot of debate around whether a fundamental breach should leave a room to be cured under the CISG. Despite the provision under Article 48(1), Article 49 (1) gives the buyer the right to avoid the contract in case of a fundamental breach committed by the seller. It leads to the question whether the seller’s right to cure or the buyer’s right to avoid the contract prevails when a fundamental breach occurs. This would solve the similar puzzle in Croatia v. Slovenia, whether Slovenia’s ability to cure the breach should prevail over Croatia’s right to terminate the Arbitration Agreement under Article 60(1). Some authors have applied a strict interpretation on the CISG that the seller’s offer to cure a fundamental breach cannot stop the buyer from avoiding the contract. However, the buyer shall have the right to choose if he accepts the offer to cure by the seller or declare the avoidance of the contract. Likewise in Croatia v. Slovenia, Croatia’s right to terminate the Arbitration Agreement should not be restricted by the curability, unless Croatia found it more convenient and was willing to accept the cure and continue the proceedings, which was not the case in fact.

Secondly, the notion of ‘curing’ breach per se has problems as some breaches simply cannot be cured. To draw an analogy, when you break an egg, you simply cannot un-break it. The egg here can be associated with either the integrity of arbitral process or the confidence of Croatia in such process. Croatia clearly stated that it ‘cannot further continue the process [of the present arbitration] in good faith’, because the ‘entire arbitral process’ was compromised by the Slovenia’s wrongdoings. Curing such breach just by replacing two out of five arbitrators is impossible. The Croatia’s confidence in arbitration, which brought it entering into the arbitration agreement, is the broken egg that cannot be unbroken.

Croatia’s statement on the loss of confidence is absolutely reasonable. Dr. Sekolec divulged the co-arbitrators’ views, including the views of Judge Guillaume, who was not replaced after the recomposition of the Tribunal. Nothing ensured that Ms. Drenik did not retell such information to other individuals of Slovenian side, or as broadly spoken by Croatia, “no reasonable person would conclude that the actions that have occurred may not have influenced other actors in the arbitration process”.

There are those who uphold the Tribunal’s approach since the erroneous actions by Slovenian side only occurred after the oral hearing and Slovenia’s impropriety could not have done anything to influence the Tribunal’s decision after its recomposition. However, a threat to arbitral process like ex parte communication should not be easily cured and tolerated. Otherwise a party would be willing to take the risk to backslide, knowing that it will not receive any severe punishment in case of getting caught again.

The Tribunal may have looked at the preamble of the Arbitration Agreement as if treating a normal ‘object and purpose’ test which it would have done with other treaties. However, arbitration agreements should be separate from the rest as they also possess unique jurisdictional features by establishing the jurisdiction of an arbitral tribunal. Such jurisdiction is built upon the consent of parties, and parties choose arbitration because of their confidence in the integrity of arbitral process. The Tribunal clearly overlooked the importance of preserving of the integrity of arbitral process and the parties’ confidence in such integrity.

Conclusion

The Tribunal in Croatia v. Slovenia should be criticized for looking at the issue of termination of an inter-state arbitration agreement in an unconvincingly weird angle. The ‘curability’ of a material breach has never been widely accepted in the absence of a clear expression of the law allowing a material breach to be cured. Attempting to fix Slovenia’s catastrophic mistakes with a half-hearted solution, not only did the Tribunal create a bad precedent of unacceptable tolerance to ex parte communication – a considerable threat to arbitration, it also failed to fulfil one of the most important duties – preserving the integrity of the arbitral process.



[1] This blog post is developed upon author’s research at Geneva MIDS. My unlimited gratitude goes to Dr. Brian McGarry for his kind guidance, yet noteworthily everything written herein is author’s own view and taken full responsibility by the author.

[2] In the Matter of an Arbitration under the Arbitration Agreement between the Government of the Republic of Croatia and the Government of the Republic of Slovenia, PCA Case No. 2012–04, Partial Award, 30 June 2016.

[3] Robert A. Feldman and Raymond T. Nimmer, Drafting Effective Contracts: A Practitioner’s Guide (Aspen Law & Business), Section 5.09

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