Monday, October 7, 2013

The Enforceability of Guarantees in Contravention of Indian Foreign Exchange Law

The choice of a law to govern a contract and a court to resolve disputes arising out of it is—naturally—fundamental in many ways. One of these is that a defence otherwise available may be lost, if one law does not contain it and the conflicts rules of the forum lead to the application of that law in preference to the law that does. Another is that different jurisdictions take different views about the extent to which its courts will tolerate the enforcement of a contract that requires or involves an infringement of the laws of a foreign country. Both these features have come to light in recent years in several cases involving Indian defendants. Typically, the contract between the parties provides that disputes will be resolved by foreign-seated arbitration or by the courts of a foreign country; the respondent is ordered by that forum to pay the judgment debt and the respondent alleges that to do so would contravene RBI regulations or Indian foreign exchange law. Sometimes it is not a judgment-debt but simply a contractual one: for example, an Indian company guarantees a debt owed by another Indian company to a foreign company; the borrower defaults and the guarantee is invoked; the Indian company has reason to believe that paying the guarantee in foreign currency violates Indian foreign exchange law and sets this up as a defence before the foreign court or arbitral Tribunal.

The leading cases on this subject—Foster v Driscoll [1929] 1 KB 470 and Ralli Brothers [1920] 2 KB 287—have been revisited recently in two cases involving foreign exchange laws. The principle in Ralli Brothers is that no action lies on a contract which requires an act or omission that is unlawful in the place of performance and the principle in Foster v Driscoll is that a court will not enforce a contract the real object and intention of which is to infringe the laws of a friendly foreign State. The difference between the Ralli rule and the Foster rule is that the latter applies even if act which infringes the foreign law is not required by the contract. This, of course, is well-established and Teare J recently described it as “so well-known a principle of the English conflict of laws that it is unlikely to require prolonged legal argument.” The two cases in which it has been recently invoked are Beijing Jianlong v Golden Ocean and Deutsche Bank v Unitech.

In Golden Ocean, a Chinese company, Beijing Jianlong, executed a guarantee in favour of Golden Ocean with respect to a charterparty under which Golden Ocean chartered a vessel to a subsidiary of Beijing Jianlong. The arbitration clause provided for London arbitration and Beijing Jianlong’s contention before the Tribunal was that the arbitration clause was itself unenforceable because Chinese foreign exchange law prohibits Chinese companies from executing guarantees in favour of foreigners without the prior authorisation of the State; and that should the guarantee be invoked, funds would need to be transferred from China to pay it, which would also constitute a contravention of Chinese law. It is important to notice that the argument was not that the guarantee was void but that the arbitration clause was unenforceable, which would then prevent the Tribunal from restraining Beijing Jianlong from pursuing proceedings in China by way of an anti-suit injunction. The Tribunal rejected these arguments and the Commercial Court upheld the award. It was pointed out by counsel for Golden Ocean that a London arbitration clause cannot violate the rule in Foster when, if the Tribunal has jurisdiction and applies English law, it will be required to apply that very rule to test the validity of the guarantee. Beijing Jianlong’s response was that the Tribunal would consider the validity of the guarantee under English law (by applying Foster v Driscoll) whereas a Chinese court would simply rule that it was void notwithstanding the intentions of the parties or the applicable law. HHJ Mackie QC accepted the submissions of the respondents, holding that, once it is accepted that an arbitration clause is severable, the Foster v Driscoll rule cannot invalidate it simply because the underlying contract may be contrary to the substantive law of a foreign country: instead, it would be open to the respondent in the arbitration to set up Foster as a defence to the substantive validity of the contract before the Tribunal and the fact that the Tribunal would analyse this issue through the prism of English, rather than Chinese, law was irrelevant.

The second case is more recent and involves an Indian company which, like Beijing Jianlong, provided a guarantee of $150 million to Deutsche Bank, said to be payable in New York, under an agreement governed by English law and subject to the exclusive jurisdiction of the English courts. The validity of the guarantee is part of a more complex dispute between the parties (involving charges of interest rate rigging and product mis-selling) that is not material here. In the case before the Commercial Court, Unitech sought to resist the enforcement of the guarantee on the basis that, although the guarantee was expressed to be payable in New York, Unitech would have to transfer money from India to New York as a first step, and this first step would violate Indian law. Two points are of interest: (i) it was argued (and assumed to be true) that a New York court would not order Unitech to perform because to do so would expose it to criminal prosecution in India but performance in New York was not per se unlawful and (ii) although New York was the “place of performance” for the purpose of Ralli Brothers, it was said that the rule also applies where an act required to be done in order to perform another act required by the contract is unlawful in the place of performance of that act.

Teare J, it is submitted correctly, rejected these arguments, explaining that:

The decisions in Ralli Brothers and Kleinwort establish that the English law of conflicts excuses performance of an obligation where performance would be illegal by the law of the country where the obligation is to be performed but does not excuse performance where, although performance of the obligation is not illegal in the country where performance is to take place, steps necessary to enable a party to perform its obligation would be illegal in the country where such steps would be taken.

These cases demonstrate that the choice of forum may often be decisive of this issue, since the conflicts rules of different jurisdictions deal with infringement of foreign law differently.

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