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How Resort to US Courts—with US Discovery—Can Backfire on a US Party to an International Arbitration

Summer 2010
International Disputes Quarterly
Christopher R. Seppälä, Elizabeth Oger-Gross

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When faced with an international business dispute, most lawyers are inclined, instinctively, to resort to the procedures of their own legal system. This is natural and understandable, especially if a lawyer is familiar only with the courts and procedures of that jurisdiction. But this can be a fatal mistake when an international arbitration arises, as the case below illustrates.

The Background

Our client, a non-US land developer, contracted with a US-based contractor for certain construction works. Their contract provided for ICC arbitration in Paris.

Thereafter, our client terminated the contract because the contractor's work was defective. While the contract (and its arbitration clause) was between only our client and the contractor, our client had noticed that the contractor's parent had become increasingly involved in the contract's performance. Our client was also concerned about the contractor's solvency.

Accordingly, our client wanted to find a way to bring the US parent company into the arbitration it intended to bring against the contractor. To do so, we needed to argue that the US parent company was bound by the contract's arbitration clause. One of our legal arguments to that end was that the contractor's corporate veil should be pierced because of the parent's disregard for the contractor's corporate form.

Consequently, when our client began an ICC arbitration, it named the contractor and the contractor's US parent company as respondents. Yet, in doing so, our client was aware only of certain external signs of disregard of the corporate form—but not of the circumstances that caused them. While this information was obviously known by the contractor and its parent, the limited discovery generally available in an ICC arbitration (often based on the IBA Rules, as discussed below) did not seem likely to lead to disclosure of this information.

Arbitration Standards of Discovery

The 1999 IBA Rules on the Taking of Evidence on International Arbitration—which the tribunal chose to apply in this case—provide that internal documents of one's opponent are required to be produced only if they are either an identified document or a "narrow and specific… category" of documents that is "reasonably believed to exist". In addition, any request must contain a description of how the requested documents are "relevant and material to the outcome of the case".¹ The IBA Rules provide for more limited discovery than in common law jurisdictions but for more expansive discovery than in the civil law world. Neither depositions nor interrogatories are provided for under the IBA Rules.

In this case, our client would have had considerable difficulty crafting requests that would lead to evidence to support piercing the corporate veil and yet meet the IBA standard, since our client would not have been in a position to describe any "narrow and specific" category of documents that it "reasonably believed to exist" and that would be "relevant and material to the outcome of the case"—for example, board resolutions showing a transfer of corporate assets of the subsidiary or other actions in disregard of its corporate veil, since our client had no evidence that such actions had occurred. It would, therefore, have been particularly difficult to demonstrate to the arbitrators' satisfaction that the case was an appropriate one in which to pierce the corporate veil—a notoriously difficult standard under practically all systems of law.

Extensive US Discovery

But then the contractor's parent applied to a US District Court to enjoin the Paris-based ICC arbitration, arguing that it was not bound by the arbitration clause. Part of the District Court's inquiry into whether to grant the parent company's motion for a preliminary injunction included an inquiry into its probable success on the merits, which in turn involved an inquiry into whether the corporate veil would likely be pierced.

Therefore, our client became entitled to discovery under the US Federal Rules of Civil Procedure on whether the corporate veil of the contractor could be pierced and the parent company brought into the ICC arbitration in Paris. This enabled it to conduct far more extensive discovery than would normally have been available in an ICC arbitration. Our client obtained almost 300,000 pages of documents from the contractor's parent, was able to conduct depositions of the parent's executives and received responses to its written interrogatories.

Through this process, our client obtained substantial evidence that the parent had wholly disregarded the contractor's corporate form, justifying the piercing of its corporate veil. Among other things, our client learned that, after our client had informed the contractor that there was a serious defect in its work, the parent had stripped the contractor of its valuable assets, as evidenced, for example, by a board resolution approving the transfer of the contractor's assets to another subsidiary of the parent. Practically all of the contractor's employees, assets and contracts, other than our client's contract, had been transferred to that subsidiary, leaving the contractor an empty shell. This information would almost certainly never have become available to our client under the more limited document disclosure provided for by the IBA Rules.

The Award

While the US District Court dismissed the parent company's case for lack of jurisdiction over our client, we were able to use the information that we had acquired in the ongoing arbitration.

Based on this information, the ICC arbitral tribunal decided, unanimously, to pierce the corporate veil and hold the parent company bound by the arbitration clause in the contract, leading the parent company to settle the case. Our client would not have been able to marshal the evidence necessary for establishing the arbitral tribunal's jurisdiction over the parent company had the parent company not sought an injunction from the US courts and thus, opened the door to US discovery.

Conclusion

In connection with this international arbitration, the parent company and its US-based lawyers resorted to US courts presumably because this is what they were most familiar with, and because they thought that this would be a favorable forum for a US company. However, had they been more familiar with international arbitration and foreign rules of civil procedure, they would almost certainly not have begun a US court action that exposed their client to US discovery and thus, to the disclosure of information that would cause the US parent to be bound to arbitrate.

Consequently, when involved in an international arbitration, it is vital that a party's lawyers have a good command of international arbitration practice and ideally, of the general rules of civil procedure applicable in other countries as well. If they have this knowledge, they will be better able to advance their client's case and avoid resort to their own national court system when this would potentially be to their disadvantage.

1 - See International Bar Association, IBA Rules on the Taking of Evidence in International Commercial Arbitration (June 1,1999), Rules 3(3)(a) and (b). The revised Rules, adopted by the IBA Council on May 29, 2010, do not change this standard as regards paper documents. See International Bar Association, IBA Rules on the Taking of Evidence in International Arbitration (May 29, 2010), Rules 3(3)(a) and 3(3)(b), available at http://www.ibanet.org/Document/Default.aspx?DocumentUid=68336C49-4106-46BF-A1C6-A8F0880444DC.

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