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18 January 2022

A new approach to the public policy defence in Ukraine

Source: GAR

Olexander Droug, Tatyana Slipachuk and Alina Danyleiko of Sayenko Kharenko in Kyiv say a recent pair of judgments show a volte-face by the Ukrainian Supreme Court in its approach to public policy as a defence to enforcement of arbitral awards.

In a judgment published in December 2021, the Ukrainian Supreme Court refused to enforce the final award of a Stockholm Chamber of Commerce tribunal against a state-owned company, Odessa Port Plant (OPP), on the basis that it would violate the public policy of Ukraine. It followed a June judgment in which the court declined to enforce a partial award in the same arbitration for the same reasons.

OPP, which is located in Ukraine’s Odesa region, is 99.57 per cent owned by the Ukrainian state. The shares are held and managed by the State Property Fund of Ukraine, which is a privatisation agency. In 2004, the Ukrainian government designated OPP as a company of “strategic importance to the economy and security of the State”.

Nevertheless, starting from the mid-2000s, the Ukrainian government announced numerous privatisation tenders in respect of OPP, none of which was successful. The latest attempt of the State Property Fund to sell shares in OPP began in 2018 when OPP was once again placed on the list of companies subject to privatisation.

In 2013, OPP entered a contract for purchase of natural gas from Cypriot company Ostchem Holding, part of Dmitry Firtash’s Group DF.

After OPP defaulted on payment under the contract, Ostchem commenced an SCC arbitration, in the course of which OPP acknowledged its debt under the contract. The arbitration led to two awards in 2016:

  • a partial award by consent in which OPP was ordered to pay Ostchem more than US$193 million as the undisputed outstanding principal debt and nearly US$58 million as the undisputed accrued fine and
  • a final award in which OPP was ordered to pay Ostchem interest on the amounts in the partial award as from 12 June 2016 until full payment; along with nearly €1 million in legal and arbitration costs, plus statutory default

Ostchem first applied for enforcement of the partial award in Ukraine in 2016. Following several rounds of litigation, in June this year, the Ukrainian Supreme Court refused to enforce the partial award on public policy grounds. On 25 November, the Supreme Court found itself bound by res judicata as a result of the June judgment and refused to enforce the final award on the same grounds.

The Supreme Court’s reasoning

There are several layers to the Supreme Court’s reasoning which are all ultimately tied to the breach of public policy of Ukraine.

The court summarised its approach to the public policy in the Ostchem case as follows: “[the] public policy reservation is a mechanism which secures priority of state interests over private interests, and thereby protects public policy of the state from any negative impacts; this reservation does not allow enforcement in the territory of the state of such an arbitral award, as a result of enforcement of which actions will be taken, that are prohibited by law and that cause harm to sovereignty or security of the state, are incompatible with the principles of economic, political and legal systems of the state.”

The priority of state interests over private interests is one of the principal threads in both the June and November judgments.

As an initial step, the Supreme Court made a general reference to the status of OPP as a company of “strategic importance to the economy and security of the State”. The court then observed that OPP was engaged in production of ammonia, urea and other chemical products, and therefore was a business operating high-risk facilities posing explosion and fire hazards. Under Ukrainian law, OPP must ensure the protection of the population and the environment from any accidents. Accordingly, the court concluded that enforcement of the SCC awards against OPP’s assets would lead to “impossibility to maintain OPP in a manner, which is safe for its proper operation” and would create a threat of technological and environmental disaster in the Odessa region, where OPP is located. Therefore, in the court’s view, enforcement of the Ostchem awards would breach Ukrainian public policy due to the need to protect the country’s ecological security.

Further, the court noted that the recently launched privatisation of OPP is still pending. According to Ukraine’s privatisation law, the sale of state- owned assets in a privatisation process aims to increase the country’s economic growth, stabilise the economy, develop competition and attract foreign investment. Based on these provisions, the court concluded in its June judgment that since enforcement of the partial award may create a danger that OPP would stop functioning and be placed into bankruptcy, this would prevent or at least materially complicate the realisation of the economic goals of privatisation. Therefore, in the court’s view, enforcement would breach Ukrainian public policy due to the need to protect the country’s economic security.

Notably, the November judgement dealing with enforcement of the final award does not expressly refer to the privatisation-related considerations of Ukraine’s public policy adopted in the June judgement. Nevertheless, the court made a general reference to the res judicata effect of the June judgment.

Lastly, the Supreme Court pointed out that Ostchem apparently had significant debts under other unrelated contracts with Russia’s Gazprombank, which is currently subject to Ukrainian sanctions. Accordingly, in the court’s view, funds collected by Ostchem under the awards potentially could be used to pay its debts to the sanctioned bank. The court made this conclusion in the context of national security and violation of public policy.

Volte-face in approach to public policy

In the Ostchem case, the Supreme Court has significantly deviated from its previous position in respect of application of public policy as a defence to enforcement of arbitral awards in Ukraine.

For the first time, the court concluded that enforcement of an arbitral award against a Ukrainian company of “strategic importance to the economy and security of the State” operating high-risk facilities violates Ukrainian public policy. In the past, the Ukrainian courts, including the Supreme Court, regularly enforced arbitral awards against Ukrainian debtors listed as strategic companies and dismissed arguments by the debtors that they operated high-risk facilities.

Notably, just in November 2021, the Supreme Court (with the same presiding judge) reached a completely opposite conclusion in   a case featuring another company of “strategic importance to the economy and security of the State”, LLC Poninkivska Paper Factory. In that case, the Supreme Court found that “the fact that [Ukrainian debtor] which is of strategic importance to the economy and security of the State and operates high-risk facilities […] does not indicate that recognition and enforcement of the award [against it] would violate public policy of Ukraine”.

Similarly, in late 2020, State Enterprise Ukrtransamiak, which was also a strategic company operating high-risk facilities, argued before the Supreme Court that it was under an obligation to take measures aimed at ensuring prevention of accidents (ecological catastrophe) and, therefore, enforcement of an arbitral award against it would block its operation and make it impossible to maintain the necessary safety measures. The Supreme Court rejected these arguments as “pure conjecture”.

One can assume that such radical change of approach in the Ostchem case might be due to the fact that the sum awarded to Ostchem in the partial award (in total, more than US$250 million) exceeds OPP’s net assets. However, this does not explain why the Supreme Court refused to enforce the final award (which is miniscule in value as compared to the partial award) on the same grounds.

Second, the Supreme Court’s finding that public policy prevents enforcement of awards against assets of companies that are on the Ukraine’s privatisation list is totally new and has rarely been invoked by Ukrainian debtors in the past. It appears that any Ukrainian award debtor that is on Ukraine’s privatisation list may now plead the public policy defence, arguing that enforcement of an award may impede the process of its privatisation. There are currently at least 50 large companies included on Ukraine’s privatisation list and it is quite easy for the Ukrainian government to add new companies to this list. OPP was added to this list in 2018, after the Ostchem awards had been rendered and the enforcement proceedings in Ukraine were already under way.

Third, Ukraine’s highest court has also expanded the understanding of the scope of public policy in the context of national security. As noted above, the court essentially found a violation of Ukraine’s public policy because there was a hypothetical possibility that funds collected during enforcement may be used by Ostchem to make payments to Gazprombank. The latter had no contractual relations with OPP and was neither a party to the SCC arbitration between Ostchem and OPP, nor a party to the Ukrainian enforcement proceedings.

The Supreme Court has previously started its analysis with whether an award creditor is subject to Ukrainian sanctions. If this was not the case, the court regularly dismissed arguments of Ukrainian debtors that enforcement of awards in favour of Russian creditors in itself would violate public policy of Ukraine simply because Russia has status of an aggressor state under Ukrainian law. In the recent case involving Russian entity Autovaz, the Supreme Court noted that the award dealt with contractual commercial relations of the parties, and hence its enforcement would not violate Ukraine’s public policy.

As the second step in the analysis, the Supreme Court would previously consider whether a Ukrainian debtor was a company from the Ukrainian military-defence sector of “strategic importance to the economy and security of the State”. This was important due to the new article 81(2) of the Law of Ukraine On International Private Law that was added in 2018 and expressly prohibits enforcement of foreign judgments and arbitral awards against this type of company in favour of companies from an aggressor state.

The Supreme Court has previously combined the above two requirements and refused to enforce awards in favour of Russian companies due to a public policy violation only if: the Russian award creditor was itself subject to Ukrainian sanctions; and the Ukrainian debtor was a company from the Ukrainian military-defence sector of “strategic importance to the economy and security of the State”. Neither of these conditions was met in the Ostchem case.

Accordingly, the Supreme Court dramatically deviated from its previous approach and applied a much wider public policy test, extending it also to enforcement of awards that may even indirectly benefit Russian companies subject to Ukrainian sanctions; as well as abandoning a requirement that a Ukrainian debtor should be a company from the Ukrainian military-defence sector.

In conclusion, the Supreme Court made a significant shift from the established mindset of the Ukrainian courts as regards the public policy defence. While the Supreme Court acknowledged that refusing to enforce an award on public policy grounds is an “exceptional measure”, it also made a reservation that the content of “public policy” shall be determined by courts depending on the facts in each particular case. Accordingly, it is yet to be seen how the Ukrainian court practice will evolve following the Ostchem decisions.

The authors’ law firm Sayenko Kharenko advised Ostchem on the initial enforcement of the partial award between 2016 and 2018 but were not involved in the latest proceedings.

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