Immunity of states in international arbitration

Doing business with a foreign state (whether that be an independent sovereign state, a political subdivision of a foreign state or the head of a foreign state) is often attractive because of the business value and prestige that can flow from such business. However, along with the rewards, comes the risk of loss and disputes arising between the foreign state and the private party. An important issue to consider when doing business with a foreign state is the method of resolving potential disputes.

Put simply, obtaining legal recourse against a foreign state can often be difficult. International arbitration is the established method for resolving disputes between parties to international commercial agreements. The advantages of international arbitration are particularly apparent when a private party enters into a commercial agreement with a foreign state. Should a dispute arise between the parties, the advantages for the private party of having an arbitration agreement include: choice of a neutral forum, choice of independent and neutral arbitrators and the option of a well-respected institution to administer the arbitration and act as appointing authority.

If the private party is successful in the arbitration and an arbitral award is rendered in favour of a private party but the unsuccessful party fails to comply with that award, it will then need to consider which jurisdiction is most suitable to enforce the arbitral award. If enforcement of the arbitral award is sought in Australia the International Arbitration Act 1974 (Cth) (IAA) will apply with respect to the enforcement. The IAA incorporates the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) and states that a foreign award is binding on the parties to the arbitration agreement and can be enforced in the Federal Court or in the State/Territory courts. Although the IAA lists various grounds for refusing the recognition and enforcement of an arbitral award, two grounds not mentioned and which foreign states regularly rely upon during enforcement proceedings are the defences of jurisdictional immunity and immunity from execution. In Australia these defences are subject to the Foreign States Immunities Act 1985 (Cth) (FSIA).

With respect to the jurisdictional immunity defence, section 17(2) of the FSIA provides that in proceedings for the enforcement of an arbitral award, a foreign state cannot rely on jurisdictional immunity if:

• it has entered into an arbitration agreement; and
• the foreign state would not be immune in court proceedings with respect to the subject matter of the dispute.

Accordingly, for a private party to rely on section 17(2), it would be necessary to demonstrate that by reason of other provisions of Part 2 of the FSIA, the foreign state would not be immune in court proceedings with respect to the transaction or event. Probably one of the most common exceptions to immunity under the FSIA is the exception in relation to commercial transactions (section 11). It provides that a foreign state is not immune in a proceeding concerning a commercial transaction, unless there is an express agreement in writing between the parties that the state should be able to rely on its immunity. Despite section 11 of the FSIA, it is advisable for the private party to include in the arbitration agreement, a clear statement that the foreign state waives its immunity to jurisdiction. This would enable the private party to rely on section 10(5) in Part 2 of the FSIA which provides that "an agreement by a foreign [s]tate to waive its immunity under the Part has the effect to waive that immunity and the waiver may not be withdrawn except in accordance with the terms of the agreement".

The fact that a foreign state has entered into an arbitration agreement containing a clause waiving the foreign state's immunity from jurisdiction will, however, not be sufficient to prevent the foreign state from claiming as a defence that its property is immune from execution. Accordingly, a private party must ensure there is also a provision in the arbitration agreement which has the effect of waiving the foreign state's right to claim that its property is immune from execution. A final hurdle for a private party to cross is determining what foreign state's property can be executed.

The types of property belonging to a foreign state that the FSIA permits to be executed are "commercial property" and "immovable property". "Diplomatic or military property" can only be executed if the foreign state has explicitly waived its immunity to such property being executed. "Commercial property" is defined by the FSIA as "property, other than diplomatic property or military property, that is in use by the foreign State concerned substantially for commercial purposes". In practice, if a private party seeks to attach "commercial property" it is likely to encounter difficulty proving that a foreign state's property is being used by the foreign state "substantially for" commercial purposes, for example in circumstances where a private party is attempting to enforce an arbitral award by attaching a foreign State's bank account which will often have funds used for mixed purposes.

Having an arbitration agreement between the foreign state and a private party is highly recommended as it serves as a powerful tool to prevent a foreign state from relying on the jurisdictional immunity and immunity from execution defences in the FSIA. An example of a waiver clause which a private party may rely upon to prevent a foreign state from being able to claim jurisdictional immunity and/or the immunity from execution defences is:

"[State or State Entity] (both for itself and for any of its agencies or instrumentalities) hereby unconditionally and irrevocably waives any right to claim jurisdictional immunity and/or immunity from execution of its property (which includes diplomatic and military property) in a proceeding concerning the recognition as binding for any purpose or for the enforcement, of an award made pursuant to the arbitration, wherever the award was made. [State or State Entity] agrees that this waiver of immunity shall have the fullest scope permitted under the Foreign State Immunities Act 1985 (Cth) of Australia.”