Law in transition

Contract enforcement Autumn 2001

Law in transition

page

1 ForewordJudge Vladlen S. Vereshchetin, International Court of Justice

2 Private participation in infrastructure projects: the selection of concessionairesNorbert Seiler, Deputy General Counsel, EBRD

7 Recent trends in secured transactions under Georgian lawVictor Kipiani, Partner, Mgaloblishvili, Kipiani, Dzidziguri

10 Building on the past: history and transition in the ‘other’ EuropeChristopher Cviic, Senior Political Counsellor, EBRD

16 Focus on contract enforcement

17 Enforcing contracts in transition countries Francis Delaey, Counsel, EBRD

23 Mitigating structural and jurisdictional risks in the enforcement of commercial contracts: the EBRD’s experienceKamen Zahariev, Senior Counsel, EBRD

27 UNCITRAL texts on international commercial arbitrationJernej Sekolec, Secretary of UNCITRAL and Chief of the International Trade Law Branch of the United Nations Office of Legal Affairs

33 Why arbitration institutions matterAdrian Winstanley, Director-General and Registrar of the London Court of International Arbitration

38 Settlement of investment disputes: the experience of ICSID in transitioncountries and elsewhereAntonio R. Parra, Deputy Secretary-General, ICSID

42 Lender beware: an overview of contractual defences Michael E. Barrack, Georges P. Racine and Anthony Alexander, Partners, McCarthy Tétrault

49 Contract enforcement in Lithuania Giedrius Stasevicius, Partner, and Giedre Valentaite, Lawyer, Lideika, Petrauskas,Valiunas and Partners

54 Legal transition developments

59 Legal transition events

General Counsel of the EBRDEmmanuel Maurice

Co-Editors-in-Chief Gerard Sanders, David Bernstein

Focus EditorFrancis Delaey

Production EditorAnila Gramshi

Contributing EditorsHsianmin Chen, Frederique Dahan, Vladimir Fedorov, Stephen Petri, Alexei Zverev

SupportRichard Bate, Mathew Chambers,Sandy Donaldson, Anthony Martin, Olivia Oddi, Jon Page, Tabitha Sutcliffe

Cover photographAndrew Molyneux

The EBRD Office of the General Counselgratefully acknowledges the generoussupport of the Government of TaipeiChina for funding the production of thisissue of Law in transition.

Law in transitionAutumn 2001

Law in transition – Foreword 1

Judge Vladlen S. Vereshchetin, International Court of Justice

In commerce, as in other spheres of humanactivity, the interaction among members ofsociety often takes the form of arrangements andagreements that are contained in or underpinnedby contracts. As commercial interaction amongmembers of society becomes more complex, sothe contracts entered into by the parties becomevery sophisticated. In this context, the need toprovide for appropriate and efficient mechanismsto enforce contractual obligations and resolveany disputes that may arise is acute. Thesedevelopments have reinforced the importance ofthe courts as forums where contracts and rightsare upheld and enforced. In addition, it has led tothe increasingly frequent use of arbitration as thepreferred method of solving disputes.

The International Court of Justice (ICJ) stands atthe judicial apex of the international legal order’seffort to settle differences among states.International organisations and financialinstitutions, such as the United Nations, WorldBank, the European Bank for Reconstructionand Development (EBRD) and others, are bothsubjects and promoters of this internationallegal order. In its agreements involving loansto or guarantees by states, the EBRD typicallyincludes arbitration clauses that name thePresident of the ICJ as the appointing authorityfor the purpose of UNCITRAL-based arbitration.

States and international institutions, such asthe EBRD, like individuals and all commercialplayers, are held accountable by society tohonour contracts that they freely enter into.Today, most commercial disputes betweenstates, and between states and non-states,are resolved by international arbitration.Indeed, an agreement to arbitrate, whetherexpressed in a stand-alone document orincorporated into something larger, is itselfa contract and one which must be enforced. Itis therefore a welcome endeavour for the EBRDto bring the issues of contract enforcement anduse of international arbitration to the attentionof the legal community in the countriesof central and eastern Europe and theCommonwealth of Independent States (CIS)through this publication. In the transitioncountries entrepreneurship, and with iteconomic development, will take permanenthold only if those countries adopt theinternational legal mechanisms and build thedomestic institutions necessary to ensure thatcontracts between parties in different statesare honoured and enforced.

The international legal order, in large partthrough the work of the United Nations, cantrumpet as one of its great successes theexistence of the New York Convention that

fosters the recognition and enforcement offoreign arbitral awards. It is a very encouragingdevelopment that most of the transitioncountries have acceded to this Convention.Slower progress has been made so far inreaching a world-wide treaty for the enforcementof judgements. The Hague Conference on PrivateInternational Law has undertaken work in thisimportant area.

This issue of Law in transition provides a numberof different perspectives and experiences on thesubject of contract enforcement, some fromwithin central and eastern Europe and the CIS,and others from outside the region where alonger experience of market economics mayprovide useful lessons. No one has a monopolyon wisdom, however. Pacta Sunt Servanda isa universal principle to which societies intransition countries have as much claim asanyone else.

The importance of efficient contractenforcement mechanisms for the international legal order The complexity of commercial transactions in today’s society has pointed to the need for buildingappropriate contract enforcement mechanisms.Through the emphasis placed on strengthening thecourts, the increasingly frequent use of arbitrationand the development of conventions on contractenforcement, the international communityendeavours to establish a sound frameworkfor conducting business.

Private participation ininfrastructure projects: theselection of concessionairesThe EBRD supports concessionarrangements in its countries of operations,and sees them as an important instrument inthe transition process. The EBRD will financeconcessionaires only if the selection processfollowed by the contracting authority satisfiesthe Bank’s core criteria of transparency,fairness, compliance with applicable lawsand regulations, and absence of fraud andcorruption. The EBRD therefore generallyexpects that contracting authorities adoptformal competitive procedures for theselection of concessionaires.

Norbert Seiler, Deputy General Counsel, EBRD*

2 Law in transition

The involvement of private sector enterprisesin the provision of infrastructure services is animportant factor in the transition from centrallyplanned economies to market economies in theEBRD’s countries of operations. The Banksupports this positive private sector involvementin infrastructure projects through loans, equityinvestments and other financial instruments.The EBRD also arranges technical assistancefor public authorities considering public-privatepartnerships and assists in legal reform effortsfor the creation of new legislative frameworksfacilitating such arrangements.

Private sector participation is desirable in awide range of infrastructure sectors, includingtelecommunications, water, natural gas andelectricity systems, and in transportinfrastructure such as roads, ports, airportsand railroads. The involvement of private sectorparties in infrastructure projects may takeseveral forms, ranging from simple servicecontracts1 to concession arrangements,whereby the private sector party becomesresponsible for the infrastructure facility for a set period of time, while the public authoritymaintains some control over the services. Insome instances, the public authority abandonsinvolvement with the infrastructure facilityaltogether, by transferring ownership of thefacility to the private sector party, which thenassumes full responsibility for its maintenance,rehabilitation, operation, management andexpansion.2

Under concession arrangements, the publicauthority (herein referred to as “contractingauthority”) leases, or otherwise transfers,infrastructure assets to a private sector operator(herein referred to as “concessionaire”) for adefined period of time. The concessionaire isthen responsible for the operation, maintenanceand expansion of the infrastructure facility andprovision of the service, including meeting therequired financing arrangements. Theconcessionaire is compensated for theseactivities, at least in part, in accordance withthe applicable tariff regime.

The detailed rights and obligations of both thecontracting authority and the concessionaire areset out in a complex web of contracts and otherlegal instruments (referred to herein as the“concession contracts”). Concession contractsoutline not only the operation of the infrastruc-ture facility by the concessionaire, but also various

other rights and obligations of the concessionaire,such as physical construction, refurbishment orexpansion of the facility, and the right to chargea price for the services rendered. The contractingauthority undertakes to maintain an adequateregulatory framework, and to adopt a tariff policyfollowing agreed criteria. Concession contractsthus seek to allocate risks and obligations to theparty best able to manage them. They includeincentives to the concessionaire for the efficientprovision of the infrastructure service, and theyprovide safeguards against undue exploitation ofmonopoly positions enjoyed by the concessionaire.

Concessions and EBRDProcurement Rules

In all its operations, the EBRD is committed totaking measures to ensure that the financing itprovides is used for the intended purpose, andwith due regard for economy and efficiency.3 TheBank’s Procurement Policies and Rules containdetailed procurement procedures to be followedby borrowers under public sector operations, inconnection with contracts for goods, works andservices that it finances.4 As for private sectoroperations, the Procurement Rules do notrequire that the EBRD’s private sector clientsfollow a prescribed procurement method, as its concerns for economy and efficiency inprocurement will generally be met throughestablished commercial practice.5 However, theEBRD will satisfy itself that in all operations withprivate sector clients, sound and cost-effectiveprocurement methods are employed, and thatcontracts awarded by them are negotiated on anon-partisan basis and are in line with marketprices.6 These principles also apply toprocurement actions by private sectorconcessionaires financed by the EBRD.

As to the selection of concessionaires bycontracting authorities, Paragraph 4.4 of theProcurement Rules states that whenever theEBRD provides or arranges for the provision of advice to a contracting authority “with theobjective of the Bank ultimately financing thesuccessful candidate”, the EBRD will requestthat the contacting authority adopt “competitivetendering procedures acceptable to the Bank”.7

The Procurement Rules do not explicitly set forthstandards for the selection process in caseswhere the EBRD does not provide advice to thecontracting authority on the selection process.However, the Bank will finance concessionairesonly if it is satisfied that the concession was

1 The private party is hired to deliverparticular services to a public authoritywhich remains responsible for theprovision of the infrastructure service.

2 For a more comprehensive discussionof the various arrangements that areavailable for private sector participationin infrastructure services, seeP. Guislain and M. Kerf, “Concessions– The Way to Privatize InfrastructureSector Monopolies”, Public Policy forthe Private Sector, the World Bank,Note No. 59 (October 1995), andJ. Brook Cowen, “The Private Sectorin Water and Sanitation – How to GetStarted”, Public Policy for the PrivateSector, the World Bank, Note No. 126(September 1997).

3 Agreement Establishing the EBRD,Article 13 (xiii).

4 Procurement Policies and Rules forprojects financed by the European Bankfor Reconstruction and Development,(hereinafter Procurement Rules),Sections 3 and 5 (August 2000).

5 Procurement Rules, Section 4.

6 See Procurement Rules, Paragraphs4.2, 4.3.

7 See Procurement Rules, Paragraph 4.4.

Law in transition 3

In all its operations, the EBRD is committed totaking measures to ensure that the financing itprovides is used for the intended purpose, andwith due regard for economy and efficiency.

awarded in a fair and transparent process thatcomplied with applicable rules and regulations,and was free from fraud and corruption. As ageneral rule, the EBRD therefore expects thatconcessionaires approaching the Bank forfinancial assistance were awarded theirconcession following formal competitiveselection procedures. This approach, whichis elaborated more fully in the section on theEBRD’s core selection criteria below, isconsistent with the general principles andconsiderations outlined in Sections 1 and2 of the Procurement Rules.

Selection of concessionaires:rationale for a specific approach

In most cases, standard procedures generallyapplicable for the procurement of goods, worksand services would not be suitable for theselection of concessionaires by contractingauthorities. These selection procedures musttake into account the specific nature ofconcessions, specifically:

■ The preparation and competition forconcession arrangements are complex andtypically demand rigorous efforts from boththe contracting authority and the privatesector tenderers. Contracting authoritiestherefore tend to invite tenders only from asmall number of private sector entities thathave demonstrated in a prequalificationprocess that they have the capacity andexperience required to carry out such projects.

■ Tender evaluation criteria may include thecharges to be paid by the end-users for theinfrastructure service, along with theconstruction and operation costs.

■ Concessions involve long-term continuingobligations on the part of the contractingauthority and the concessionaire.

■ The infrastructure facilities and services forwhich the concession is to be awarded oftenhave a natural monopoly character, such aswater supply, sanitation and energy delivery.These services are of vital importance to the population of the contracting authority,and have significant social dimensions.Concession contracts, especially those of longduration, are therefore politically sensitive andmay become vulnerable to renegotiation andabrogation, especially if the selection processis not perceived to be fair and transparent.

Recommended selection process – competition

As noted above, in accordance with Paragraph4.4 of the Procurement Rules, where the EBRDhas been involved as an adviser to thecontracting authority, it will generally financeonly concessionaires that were selected incompetitive procedures acceptable to the Bank.8

These procedures include public invitation tointerested firms, prequalification proceduresfollowing criteria previously announced in thepublic invitation, and a structured approach tothe request for proposals and their evaluation.The recommended process is similar to theprocedures set out in Section 3 of theProcurement Rules for the procurement ofgoods, works and services by the EBRD’s publicsector clients, but it involves greater flexibilityand more interaction and negotiation betweenthe parties.

This structured approach should lead to theselection of a concessionaire capable ofperforming the relevant infrastructure service in a manner consistent with the price, quality and risk-sharing objectives of the contractingauthority. The approach should also facilitatethe selection of a concessionaire within areasonable time and at a fair cost to both the contracting authority and to the firmsparticipating in the tender. Furthermore, astructured approach promotes transparencyand integrity of the selection process.

The key elements of the recommended approachinclude the following:

■ The contracting authority should appointcompetent advisers able to assist with thetechnical, legal and financial issues that arelikely to arise in the interaction with tenderers,in the structured evaluation of proposals, andin the selection of the winning firm. Advisersshould also ensure that the selection processand all communication with tenderers meethigh professional standards.

■ The contracting authority should issue a publicinvitation addressed to all firms that might beinterested in participating in the pre-selectionproceedings. This invitation should beadequately publicised in a way which isdesigned to reach as many potential tenderersas possible. The public invitation shouldcontain sufficient information to stimulate theinterest of potential tenderers, and enable

them to assess whether they are likely to bequalified for the concession.

■ The contracting authority should adopt andpublish clear and concise prequalificationcriteria that will enable the contractingauthority to identify potential tendererscapable of meeting the set performancecriteria. A large group of prequalified tendererswill increase the competitive pressure amongthe interested firms. However, in light of theconsiderable time and expense involved in theselection process for the participants and thecontracting authority, only firms standing areasonable chance of success should beinvited to submit a proposal.

■ The contracting authority should issue clearrequests for proposals to prequalifiedtenderers, setting out in detail all tenderrequirements, procedures for the submissionof proposals and evaluation criteria. Thetender documents should not be technicallyflawed or contain excessively detailedtechnical specifications.

■ The contracting authority should follow astructured approach in the evaluation ofproposals and in the negotiations with thehighest-ranking tenderer.

■ The contracting authority should publishthe fundamental terms of the concessioncontracts once final agreement has beenreached with the concessionaire.

The structured approach towards the evaluationof proposals and negotiations, referred to in the penultimate point above, typically involvesseveral successive rounds of requests forproposals and subsequent clarificationdiscussions with tenderers. The contractingauthority, with the assistance of its expertadvisers, will have to determine the followingaspects of the process:

■ the number of rounds of preliminary, subse-quent, and final proposals from tenderers;

■ the extent to which negotiations withtenderers will be permissible between rounds;

■ negotiable and non-negotiable matters at each round;

■ at which point in the process one of thetenderers may be declared preferred tenderer,with whom the contracting authority is enteringinto final negotiations, with the understandingthat it will revert to other tenderers only if the

4 Law in transition

The EBRD examines all aspects of a project toensure that the process has provided adequatesafeguards against corrupt practices.

negotiations with the preferred tenderer breakdown; and

■ detailed methodology to be applied in respectof the evaluation criteria.

The selection process generally involvesextensive interactions between the contractingauthority and tenderers. It is essential for theintegrity of the process that the contractingauthority maintains fairness and consistency in all communications with the tenderers. Finalnegotiations should therefore not touch uponmatters that previously had been identified toother tenderers as non-negotiable.

Core selection criteria

Whenever the EBRD advises contractingauthorities on the concessionaire selectionprocess, it generally recommends that theyadopt and follow a structured, competitiveapproach consistent with the principles outlined above.

However, it is not always practicable for acontracting authority to adopt structuredcompetitive selection procedures. For example,a structured selection approach may notnecessarily be appropriate when there is anurgent need to ensure immediate provision or continuity of the infrastructure service to be provided by the concessionaire. Nor would a structured process be required where only onefirm is capable of providing the required service,or where a public invitation initiating competitiveprocedures has not yielded responses fromcompetent firms.

Furthermore, the EBRD occasionally encountersfinancing requests from concessionaires thathave already been selected without the Bank’sprior involvement, and without formalcompetitive procedures meeting the criteria set out above. While the EBRD supports theprinciple that contracting authorities shouldfollow formal competitive procedures whenselecting concessionaires, it will consider suchfinancing requests in exceptional circumstances.

Whether or not the concession has beenawarded following formal competitiveprocedures, the EBRD will provide financing to the concessionaire only if it is satisfied thatthe following core criteria have been met:

1. The selection procedures were transparent,fair, and allowed for sufficient competition, evenif the contracting authority did not follow astructured approach. When assessing thesecriteria, the EBRD will determine whether thecontracting authority has ensured that thefollowing conditions have been met:

(i) The contracting authority has taken adequatesteps to identify interested and qualifiedfirms, either by advertising its intentions insuitable media or by consulting independentexpert advisers. Furthermore, it must nothave excluded potential concessionaires on the basis of arbitrary or irrelevant criteriafor the concession at hand. Contractingauthorities may, however, exclude interestedparties who fail to demonstrate that theywould be able to perform all contractualobligations to be performed by theconcessionaire in connection with the project.

(ii) The selection process was subject to publicscrutiny, in accordance with applicableadministrative procedures. Generally,concession projects should be announced tolocal elected assemblies and administrativebodies, and these bodies should be given the opportunity to review the terms of theconcession contracts and to approve theselected concessionaire. The project shouldalso be subject to public review, such as apublic consultation process, and provideadequate opportunity for non-governmentalorganisations and other interested parties tocomment on the project.

(iii) If more than one offer has been received, thevarious offers must have been evaluated in aconsistent manner on the basis of equitableand transparent evaluation criteria.

(iv) The contracting authority must certify to theEBRD that the selection process satisfied allapplicable requirements that have beenadopted for the selection.

(v) The contracting authority must publish theaward of the concession, and must discloseall salient terms of the concession contracts.

2. The EBRD will provide financing to aconcessionaire only if the selection process hasbeen free from corruption and complied with allapplicable laws and regulations. The Bankaddresses these concerns through extensivelegal due diligence. It also examines all aspectsof the project to ensure that the process has

8 In limited cases competitive proceduresdescribed in this section are notsuitable. For examples and theprocedures to be followed in suchcases, see “Core selection criteria”below.

* Norbert SeilerDeputy General CounselEuropean Bank for Reconstruction and DevelopmentOne Exchange SquareLondon EC2A 2JNTel: +44 20 7338 6000Fax: +44 20 7338 6001

The author expresses his gratitude to Jean-François Maquet, Deputy Vice-President in the EBRD’s Evaluation andOperational and Environmental SupportVice-Presidency, for his comments andsuggestions in connection with thepreparation of this article.

Law in transition 5

provided adequate safeguards against corruptpractices on the part of representatives of thecontracting authority and the concessionaire. Thisincludes a detailed review of the concessionaire’squalifications, past experience with similarprojects, reputation and business practices.

3. The EBRD will provide finance only if theterms of the concession contracts, such asprice, quality standards and allocation of risksbetween the parties, are fair, reasonable andconsistent with market practice. Considerationsin this assessment include the following:

(i) The price of the infrastructure service mustbe in line with independent cost estimatesand international benchmarks whereavailable.

(ii) Where the price for the service is set byreference to the costs incurred by theconcessionaire, the contract terms shouldprovide appropriate incentives for theconcessionaire to construct and operate the infrastructure facility economically and efficiently.

(iii) Risks and rewards associated with theconcession contract should be allocatedfairly between the contracting authority andthe concessionaire. In particular, theconcessionaire should bear all commercialrisks in respect of design, construction,financing and operation of the infrastructurefacility, in accordance with applicableindustry standards.

Even where a structured competitive processhas been followed, the terms of the concessioncontracts may not be fair and reasonable. Forexample: the requirements of the contractingauthority may not have been clearly defined; theprocess may have been flawed or manipulated;or the invitation by the contracting authority maynot have attracted enough qualified tenderers togenerate significant competitive pressure.However, it is less likely that the terms of theconcession contracts will satisfy the EBRD’sfairness requirement in cases where acompetitive process has not been followed. Insuch cases the Bank scrutinises the terms ofthe concession contracts more closely, even ifqualified independent advisers have assistedthe contracting authority in the process.

The EBRD will judge the fairness of the termsagainst international benchmarks whereavailable. In the absence of suitable benchmarks,the Bank will finance a concessionaire only if thefollowing criteria are met:

■ a structured selection process has been followed;

■ the expected financial returns to theconcessionaire seem reasonable in lightof the risk profile of the project;

■ the project is likely to yield economic benefitsto the public at large; and

■ environmental concerns associated with the project have been addressed to theEBRD’s satisfaction.

Conclusion

Concession arrangements involving privatesector enterprises in the provision ofinfrastructure services are an importantinstrument in the transition of the EBRD’scountries of operations to market economies.The Bank supports such arrangements byproviding technical assistance to contractingauthorities that are interested in implementingconcessions, and by financing the private sectorconcessionaires.

In each case, the EBRD examines whether the contracting authority has adoptedappropriate procedures for the selection of theconcessionaire, and will finance private sectorconcessionaires only if it is satisfied thatthe following core criteria have been met:

■ the process adopted by the contractingauthority in the selection of theconcessionaire was transparent and fair;

■ the process was carried out in compliancewith all applicable laws and regulations, andwas not tainted by fraud or corruption; and

■ the terms of the concession contracts meetacceptable fairness standards.

These core criteria are met and safeguardedmost effectively when contracting authoritiesadopt and follow a structured competitiveselection process, with the assistance ofcompetent advisers. As a general rule, the EBRDtherefore expects that contracting authoritiesadopt formal competitive procedures for theselection of concessionaires.

6 Law in transition

Recent trends in securedtransactions under Georgian lawThis article highlights some of the recentchanges in secured transactions andcreditors’ rights in the legislation of Georgia.It is worth noting that these changes signifymore than simple modifications of laws; theyare part of an ongoing process of increasingthe efficiency of the legal protection ofcreditors, including national andinternational financial institutions. It ishoped that this process will lead to improvedcredit facilities for domestic businesses.

Victor Kipiani, Partner, Mgaloblishvili, Kipiani, Dzidziguri*

Law in transition 7

Recent amendments to the Georgian Law ofExecution Proceedings reflect the current trends in secured transactions legislation inGeorgia. These amendments are of particularsignificance, and can be seen as a directresponse to the EBRD’s core principles for amodern secured transactions law. In substance,these core principles provide that: a) the securityright should be paramount, irrevocable andeffective, even after bankruptcy and liquidationproceedings have been opened, or in case ofenforcement of judicial and/or arbitral awards,1

which in its turn b) leads to an increasedavailability of credits on improved termsparticularly for start-up and medium-sizedbusinesses.

Georgian legislation deals extensively withsecurity rights. Those concerning thehypothecation of immovable property and thepledge of movable property are of particularinterest. The basic underlying principle is thatthe right to pledge movable property, or the rightto hypothecate immovable property, may beused as the means of securing an obligation insuch a way as to entitle a creditor to receive – inpreference to other creditors – satisfaction fromthe value of the pledged or hypothecatedproperty. As far as the pledge is concerned,parties to the pledge agreement may agree onnotarising the latter. In this type of case, thepledge takes effect from the moment of itsregistration in the Public Registry, while theactual transfer of the pledged property is notnecessary. In the case of a complete or partialfailure on the part of the pledgor to perform hisor her obligations to pay the debt, the pledgeeshall be satisfied by the sale or disposal of thepledged property. The sale of the pledgedproperty shall be carried out through publicauction and the pledgee shall be entitled toparticipate in the auction. It should be noted thatany agreement by which the ownership ofpledged property is directly transferred to thepledgee should be null and void.

Hypothecation is effective from the moment ofregistration in the Public Registry, which ismandatory under Georgian law. Registration iscarried out on a basis of notarised agreementand release of the hypothecated property isnecessarily registered in the Registry as well.Should the debtor fail or delay to fulfil his or herobligations secured by hypothecated property,the creditor is authorised to request the sale ofthe security. In this case, as in the case of

pledged property, any agreement providing directtransfer of hypothecated property from thedebtor to the creditor shall be null and void.

Considering that Georgia has been found tohave some of the most severe impedimentsto collecting collateral, the recent changes inGeorgian legislation on secured transactions are very significant.2 These impediments includebiased valuation of charged property, and thehigh dependency of local currency exchange onexports and protracted judicial proceedings. Inaddition, according to the EBRD’s RegionalSurvey of Secured Transactions, Georgia maybe found among the “minor reform” countriesin terms of securing progress in collateral lawreform.3 However, recent changes shouldcontribute significantly to the overallimprovement of this situation.

Georgian commercial banks have frequentlyfaced the same obstacle when receivingproceeds as a result of the realisation of acharged property. This took the form of anawkward mechanism provided by the Civil Codeof Georgia and the then Law on ExecutionProceedings in respect of the auction of sucha property. According to Article 306 of the CivilCode: “If during the first auction the bid is lowerthan seventy per cent of the initial sales price ofthe property as valued by the expert, the auctionshall be subject to a second auction. The lowestbid during the second auction must at leastcover the auction expenses and the creditorclaims. Should these requirements not be met,the auction would be declared not to have takenplace and the expenses thereof would be borneby the owner.” However, no answer might befound within such a legal framework to thecritical question: what happens if the propertywould not be realised, even at reduced cost,following a second auction?

In this way, the law has created the conditionsfor a deadlock through the auction process. Onone hand, a liquidator or executor fails to realisea charged property, and, on the other, a creditorfails to receive appropriate proceeds.

This legal deadlock was to some extent resolvedby the introduction of a new clause into the Lawon Execution Proceeding (Article 771), which isthe special law on regulating enforcement ofjudicial decisions on secured transactions. Thislaw states that “if the second auction also failsto sell the property, then the property may be

transferred to the creditor at the creditor’sapplication”. This legislative approach may notbe ideal, but it certainly gives to the bank, asto any creditor, an unambiguous rule as to themethod of realisation of the charged propertyin public auction.

The amendments are more categorical and clear-cut regarding the distribution of recoveredproceeds among registered creditors. Accordingto the law, the registration of any chargedproperty is carried on the Public Registry andthen by the executor right before public auction.Although the proceeds shall primarily be directedto cover auction fees, court expenses and otherexpenses in respect thereof, the remainingproceeds shall be subject to clear ranking order for fulfilment of the creditor’s claims asestablished by the Law on Execution Proceeding(Article 823). Thus, under the category “Claimsof first rank” are included “the proceeds of thesale of hypothecated and pledged property shallprimarily be used to satisfy the claims securedby hypothecation and pledge”. All other claimsmay be fulfilled only after the claims of first rankhave been met in full.

It should be noted that an auction is preceded by seizure of all the pledged property. Thisentails making an inventory of the property,prohibiting the disposal, transfer or furtherpledging of the property in any form, prohibitingthe making of a rent or lease agreement ortransferring the property for keeping, and anyother arrangements over charged property. The seized property is recorded in the Report of Property Inventory (Article 23 of theAmendments Law into the Law on ExecutionProceeding). In addition, before holding theauction, the executor ascertains which of therights recorded in the Public Registry, which arepredominantly hypothecations and pledge forsecured transactions, prevail over the claim ofthe creditor for which the execution is beingcarried out. Of equal importance for enforcementprocedures to enable prompt realisation ofthe property is the fact that “two weeks afterinitiating a seizure procedure on the movableproperty, the executor may appoint an auctionfor that property” (Article 29 of the AmendmentsLaw into the Law on Execution Proceeding),though the provision deals with immovables.

These amendments send a clear signal from the legislator that its intention is to create legalleverages for commercial banks in their lending

8 Law in transition

Recent amendments to the Georgian Law of Execution Proceedings are of particularsignificance, and can be seen as a directresponse to the EBRD’s core principles fora modern secured transactions law.

activities. From a commercial perspective,however, the amendments are flawed. Theamendments state that if the proceeds arenot enough to fully satisfy all the claims in onecategory, then these claims shall be met prorata to the amounts ascribed to each creditor.However, special norms of the Civil Codeintervene here, supplementing on the matter,providing for priority rights among the creditorsin respect of the hypothecated property, andeliminating any uncertainty on ranking createdby the Law on Execution Proceeding.

The procedure for auction of realised pledgedproperty has significant shortcomings. First, thelast bid at the first auction must not be less than70 per cent of the charged property’s value, andmust cover the value of the transitive rights andthe auction expenses (Article 74 of the Law onExecution Proceedings in conjunction with Article306 of the Civil Code). The same law providesthat “the highest bidder at the auction mustprovide a guarantee in the amount of ten per centof the bid. The executor shall make a decision on the admissibility of the guarantee. Unless the guarantee is forthwith provided, the bid shallbecome invalid” (Article 74.3 of the Law). Mostpeople who are familiar with the problem ofrealisation of collateral will agree that thiswording poses several crucial questions withoutgiving either explicit or implicit answers to them.These questions are: What kind of guaranteeshall be provided in order to be admissible for the executor? Would it be better for the purposeof clarity to define precisely “admissibleguarantees”? Why is such wide power granted tothe executor, who decides at his sole discretionwhether the guarantee is to be considered“admissible” or not? And finally, what shall beunderstood under the term “immediately” from a legal point of view? If the guarantee in theamount of 10 per cent of the bid is not provided“immediately”, a public auction shall beconsidered invalid. It is clear that ideally the law should fix a time-limit for providing such aguarantee, given that if the bidder does notprovide it “immediately”, the actual right of thecreditor for prompt realisation of the assets givenas security may be seriously undermined.Another issue is the value of the property to beascertained. Considerable loopholes still remainin the law on this issue, and as a result, furtherlegislative restructuring is necessary to meet theimportant requirement that enforcementprocedure should enable realisation of theassets given as security at market value.

Particular emphasis has to be given to Article48 of the amendments to the Law on ExecutionProceedings, since this article deals with therights and privileges of a foreign corporate orfinancial institution as party to a securedtransaction with Georgian counterparts, orwhen the charged property is located in theterritory of Georgia. In this case, a judicialdecision duly acknowledged in the territoryof Georgia, pursuant to agreements oninternational private law and interstate mutuallegal assistance, and the writ of executiondelivered by a competent court of Georgia shallbe transferred by the Ministry of Justice to theexecution bureau according to the debtor’slocation. This right to execute foreign awards,including those on collateral, is furtherreinforced by the binding force of the 1958New York Convention of Recognition andEnforcement of Foreign Arbitral Awards,as well as by the Law of Georgia on PrivateInternational Law, which reiterates that“Georgia recognises effective judicial awardsof foreign states” (Article 68.1 of the Law) and “judicial awards of foreign states shall beenforced only if subject to enforcement” and“at the motion of interested party” (Article70 of the Law).

In spite of some shortcomings, there is no doubtthat these changes described here should beviewed as a step towards further development of the existing framework of Georgian legislationon secured transactions. These changes reflecta positive trend towards the ultimate objective of harmonising the national rules with commonlyrecognised progressive norms and standards.It is hoped that these developments will leadto more intensive involvement of internationalbusiness and financial institutions in theGeorgian economy, and a further influx offoreign investment into the country.

1 www.ebrd.com/english/region/legtran/secured_trans_core.

2 H. Muent and F. Pissarides, “Impact ofcollateral practice on lending to smalland medium-sized enterprises”, Law intransition, EBRD, p.54 (Autumn 2000).This study of collateral-relatedobstacles to SME lending found thatGeorgia had the highest weightedaverage in a ranking of a numberof transition countries.

3 D. Fairgrieve and M. Andenas,“Securing progress in collateral lawreform: the EBRD’s Regional Surveyof Secured Transactions Laws”, Lawin transition, p.32 (Autumn 2000).

* Victor KipianiPartner, L.L.M.Mgaloblishvili, Kipiani Dzidziguri (MKD)Tavisupleba Square No.4380007 Tbilisi GeorgiaTel: (99532) 923880, 923882Fax: (99532) 923884Email: [email protected] site: www.sanet.ge/mkd

Law in transition 9

Building on the past: history and transition in the ‘other’ Europe

In this article the author provides a personalreflection on the somewhat forgotten role that history can play to explain and guide the transition process underway in centraland eastern Europe. Both the West and thepeople and leaders of the transition countriesthemselves should look back before therecent Communist period to identify positivehistorical examples in both politics andeconomics that can serve as positiveantecedents for the difficult multipletransitions that these countries are presently undertaking. Building on positive perceptions of history can help the central and eastern European countriesovercome an overly pessimistic generalperception of their recent past to achievea successful transition.

Christopher Cviic, Senior Political Counsellor, EBRD*

Romania

Ukraine

Poland

BulgariaYugoslavia

Bosnia &Herzegovina

CroatiaSlovenia

Hungary

Slovak Republic

Czech Republic

10 Law in transition

They come, they go

European countries stretching from the Baltic to the Adriatic have undergone a profoundprocess of reform and transition over the pastdecade. The success of this process has beenconsiderable, particularly in the political sphere.Since the electoral defeat or negotiated steppingdown of the Communist regimes whichpreviously ruled the region, most states havenow passed the ‘double election’ democratictest. This test requires at least two peacefulchanges of government. What the French callalternance has now become establishedpractice. Elections now come and go withalmost monotonous regularity.

Former Communists in a new democratic, andsometimes even free-market garb, have won freeelections in a number of countries and havedeparted again, without causing political turmoil.Political progress has been heartening, but by nomeans even. There are variations in the pace ofpolitical transition, resulting in different rankingsfor individual countries in the transition leaguetable. Scores for central Europe are higher thanthose for south-eastern Europe, while those forboth central and south-eastern Europe are abovethose for the former Soviet republics (the threeBaltic states, Estonia, Latvia and Lithuania,which formed part of the Soviet Union for ashorter period, are an exception).

These variations are due to a number of factorsincluding the nature of the policy adopted in eachcountry, the quality of local leadership, and thecurrent situation in the region, in Europe and inthe international community. Surprisingly, theindividual histories of the transition countries areoften ignored when assessing these countries’progress since 1990.

In analysing transition, it is a mistake toconcentrate solely on the common startingpoint, 1989-90. Consideration of the historicalexperiences of these countries is very important.On careful reflection, it can be argued that to alarge extent, the transition countries are whatthey are today because of what went before. Inorder to understand the present better, and topredict the future more accurately, it is beneficialto take into account the individual countries’very different historical circumstances andexperiences, as well as their own perceptions oftheir past. This is not least because awarenessof past success, particularly in the relatively

recent past, may foster success in the future.1

By the same token, a sense of national failure,especially if anchored within a ‘victimhoodcomplex’, may stop or at least delay a countryfrom embarking on policies more likely to bring it success.

The argument for taking seriously the historicaldimension of countries prior to transition isreinforced by the fact that the region hassuffered from an overly pessimistic generalperception of its recent history. A closerexamination of the region’s very varied recordcasts serious doubt on the basis for thispessimism. Its history is far more complex than any simplistic interpretation wouldsuggest. Ironically, it is the negative versionthat many in central and eastern Europe haveaccepted at face value and, perhapsdemonstrating a degree of masochism, evenadopted as their own. A fresh look at centraland eastern Europe’s much criticised politicaland economic record is overdue.

Never a monolith

It is worth remembering that from the early yearsof the Cold War, almost right up to its end, thepredominant Western view about Communist-ruled Europe was that the region was monolithic.This simplistic ‘monolith’ myth was dictated bythe imperatives of Cold War propaganda. Thesole exception for the West was Yugoslavia – achip that broke off early in 1948. Yugoslavia’sbreak with Moscow raised hopes among Westernpolicy-makers that others may follow, andtherefore at least in the immediate aftermath of the break, the country received excessivepraise from the West for propaganda purposes.

Dominated by Moscow, central and easternEurope may indeed have looked like a monolithto an outside observer seduced by a certainexternal sameness imposed by Communist styleand rhetoric. However, to anybody who knew thearea from the inside, the idea that the regionwas a monolith never carried any weight. Even in the early Stalinist years after 1945, there werequite noticeable differences between and evenwithin individual countries. They arose not somuch from explicit policy differences as from apolitical pragmatism reflecting different nationaltraditions as well as contemporary realities inparticular countries.

1 There is a Hungarian word sikerélmény– which literally means ‘success-experience’. The dictionary translationis ‘real experience of achievement’. TheGerman equivalent is Erfolgserlebnis.The existence of these words suggeststhat while the often negative role ofself-perception of a national past as apsychological factor in the politics ofindividual countries such as Germanyhas been studied quite extensively,the potentially positive impact of self-perceptions of the past in economic,financial, legal and other spheres hasbeen neglected.

Law in transition 11

Poland provides a good example of theseinternal differences. Even at the height ofStalinist rule in the late 1940s and the 1950s,the existence of the Roman Catholic Church and of private agriculture offered a limited butfree space, not just for the Catholic clergy andthe farmers, but also for the rest of the citizenry.The Communist regime had some successin keeping the private farmer down and insubverting the Church from within, but in the endboth proved too strong to be brought entirelyunder Communist control. Similar instancescould be cited from other Communist countries.Of course these pockets of autonomy in what tothe outside world looked like a tightly run singlecamp were not exactly the equivalent of politicalpluralism. However, they were significant in thesense that they subsequently proved to beuseful bridgeheads from which campaigns forpolitical relaxation and ultimately fullliberalisation could be mounted.

In East Germany, the Lutheran Church, thoughless powerful than the Roman Catholic Church in Poland and despite being hemmed in from allsides by the regime, retained sufficient internalautonomy to provide a base in the late 1980s for what eventually developed into a politicalmovement challenging the regime. In somecases – in East Germany as well as inCzechoslovakia, Poland and Bulgaria – theCommunist regime itself created quasi-pluralistenclaves in the shape of a small number of so-called ‘satellite parties’. This was done purelyfor tactical reasons, chiefly to disarminternational criticism in the immediateaftermath of the Second World War. These‘parties’ played no independent role, beingstrictly supervised and directed by theCommunist Party and the Communist secretpolice. Yet, the existence of these very small,heavily controlled pockets of “autonomy”provided a valuable base for expanded politicalactivity. This was the case during the “PragueSpring” in Czechoslovakia in 1968 and in EastGermany and Bulgaria in the 1980s when,almost overnight, genuine democratic partiesgrew out of their shells. In Bulgaria, one of thosestate-sponsored organisations, the Movementfor Rights and Freedoms, deliberately created to keep the country’s Turkish minority undercontrol, is a fully-fledged democratic party today.

There was nothing unique about the existenceof those ‘pockets of autonomy’ within theapparently solid Communist monolith – it had

happened before. Nazi and Fascist Europe hadalso seemed like a terrifyingly solid monolith tothe outside world. Yet, almost right up until theend of the Second World War, there was aconsiderable variety in the amount of spaceavailable to the private citizen to breathe andsurvive. The case of the courageous and success-ful defence of Denmark’s Jews by King ChristianX during the Second World War is well known.2

View from within

Other examples could be quoted in support ofthe view that central and eastern Europe, farfrom being a monolith, was and still is a regionof great variety and complexity, whose countriesshould not simply be lumped together, as theyoften are in Western accounts even today.3

The reasons for that variety are often complexand not easy to grasp without closer analysis.Below are a few instances that, while notproviding full answers, hint at where theanswers might be sought.

Some Catholic countries, like Poland, owed theirChurch’s relative autonomy from the state to thede facto separation – never perfect and oftencompromised – from the secular state, whichwas achieved by the Roman Catholic Church inEurope during the Middle Ages. In the Orthodoxcountries on the other hand, a very different kindof tradition grew out of the old Byzantine Empire.It was that of a Church so close to the state itwas virtually an arm of it.4 Intriguingly, thoughnot by any definition a defender of pluralism perse, the Catholic Church in countries like Polandfulfilled such a role objectively in the course ofdefending itself and promoting its interests andpolicies as an institution. This was harder for the Lutheran church in the region, particularly in Germany, with its tradition of the Frommigkeit(piety) combined with deep respect for theObrigkeit (secular authority). However, theexperience of Nazi rule had helped change theGerman Protestants’ outlook, opening the wayfor them to become more politically active.

Hungary’s relative liberalism, which partiallysurvived into the Second World War period, canat least partially be explained by reference to a deeply ingrained feudal tradition of respect for the constitution and the rule of law, datingback to Hungary’s existence as an independentkingdom before 1527. That tradition was furtherdeveloped and strengthened after 1527, underthe strongly legitimist Habsburg Empire. The

Austro-Hungarian Monarchy, as the HabsburgEmpire came to be called after the Ausgleich(compromise) between Budapest and Vienna in 1867, never became a democracy, but couldclaim to have become a Rechtstaat, a stateliving under the rule of law. Not unlike in theUnited States, law in Austria-Hungary was anessential tool of governance helping to keeptogether an extremely varied and complexmultinational state. Another element of theEmpire’s cohesion supporting its legal systemwas its disciplined, well paid and, contrary towidespread misperceptions, honest andrespected bureaucracy that was open to talentand ability from all the constituent nations.

The tradition of respect for the rule of law andrules in general lingered on, to a varying degree,in Austria-Hungary’s successor-states such asAustria, Czechoslovakia, Hungary, Poland andYugoslavia. However, it was a mixed record, withmany shades of grey and some significant blackmarks. For example, in Hungary in 1919, aCommunist revolution led by Bela Kun wasfollowed by a period of severe right-wingrepression involving a wave of anti-Semitism,popularly named the ‘White Terror’. In 1920,Hungary introduced the so-called numerusclausus, a milestone in the development of anti-Semitic laws in twentieth century Europe. Theselaws limited the percentage of Jewish studentsadmitted to universities – an example of centralEuropean legalism turned to sinister uses.

No comparable national tradition of the rule oflaw had existed in those parts of south-easternEurope that, up to 1918, did not form part of the Austro-Hungarian Monarchy. Most of thatregion, better known as the Balkans, had for five centuries been under Ottoman rule. In theOttoman Empire, there was no separation of thestate from its official religion, Islam. However,Orthodox Christians and the Jews were allowed a high degree of autonomy as religiouscommunities or millets. These milletssubsequently became the framework for the new national states of the Bulgarians, theGreeks, the Romanians and the Serbs. Since the Ottomans had started modernising relativelylate, their successor states had little or no nativetradition to build on and so on becomingindependent, they were obliged to create theirpolitical and legal systems in a hurry.

Most of what was the Soviet Union until 1991was in an even worse situation. The slow


In analysing transition, it is a mistake toconcentrate solely on the common starting point, 1989-90. Consideration of the historicalexperiences of [transition] countries is very important.

emergence of the rule of law in Tsarist Russia,which unlike western and central Europe hadnever experienced feudalism with its intricateand important system of mutual legalobligations, ended abruptly with the BolshevikRevolution in 1917. Under Communism, the lawwas the handmaiden of the Communist state.

This is no place for a detailed, in-depth inquiryinto the deeper reasons for the variations in thetransition region. It might, however, be useful to draw attention to the notable difference thathas existed for some time between the region’sown historical perspective and that of outsiders,especially those from the West. This is not new.This divergence of view was apparent during theCommunist era, as I remember from my timecovering the region as a journalist. When visitingWestern journalists, academics and business-people coming from the direction of Moscow or further east arrived in an already reformingHungary or Poland in the 1970s and 1980s, they praised what they saw. The local responseto this praise would often be: ‘We do not want to be lumped together with the Soviet Union orChina; judge us, if you must, by the standards of our neighbours to the West, such as Austria,Italy, Germany or the Nordic countries and by ourown standards that we once had.’

Unwillingness to be likened to the Soviet Unioncould all too easily be dismissed, perhapsunderstandably, as a reflection of the resentmentinvariably felt by former dependencies towards theformer imperial master. To a certain extent, thiswas probably the case, but there was also adifference. Here, the resentment by the localswas much greater because the Soviet Union, the region’s imperial master between 1945 and1990, was not only disliked – as imperial rulersusually are – but was never even respected,unlike, for example, the Austrian or the GermanEmpires. Was this central and eastern Europeans’wish for Abgrenzung or distancing from the bigeastern neighbour, perceived by them to be morebackward than themselves and, therefore, in adifferent, ‘lower’ league, just another case of‘narcissism of small differences’?

Cold War distortions

Central and eastern Europeans have been rightto stress what their countries were like beforebeing placed under the harsh rule of the region’slatest imperial power. They were, and are today,even more justified in demanding to be judged

against their national historical record taken asa whole. The prevailing view of these societies isone that has been bequeathed to us by the ColdWar. This portrait reflects an unhappy amalgamof Communist and anti-Communist views of theregion. Putting it bluntly, but hopefully notinaccurately, the Communists, having taken overin 1944-45, were determined to prove that,whatever had happened before them in theregion, they had come to rescue that hotbed of nationalism, xenophobia and anti-Semitismfrom itself. Ironically, the Communists’ arguablyexaggerated and pessimistic view of pre-Communist central and eastern Europe cameto be shared by non-Communists and even anti-Communists in the West.

There was widespread acceptance on the otherside of Europe that the region had always beena failure – politically, economically and socially.Therefore, its fall, first under Nazism and thenlater under Communist rule, was understood as almost an inevitability, perhaps even apunishment visited on the region for itsinadequacies. This explains why the rejoicingover the collapse of the Berlin Wall in 1989 wasaccompanied by fears of a re-run in the ‘otherEurope’ of the nasty nationalist conflicts of the1920s and 1930s. In fact, some ‘Cold Warriors’must have secretly welcomed the existence ofthe heavy Soviet corset over the region in the1945-90 period as a protection against arecurrence of the various diseases afflictingit between 1918 and 1939.

Even a cursory examination of well known butoften overlooked facts will suffice to make thecase for the need for a new, less biased andnegative view of pre-1945 central and easternEurope. A proper framework for makingcomparisons is necessary. All too oftencontemporary works on the history of centraland eastern Europe – with honourableexceptions5 – assess the region’s admittedlypatchy record before the Second World Warfrom the standpoint of post-1945 westernEurope (taken here to include also the Nordicand South European states). Even if probablysubconscious, this attitude is not only unfairbut ahistorical.

Not so disastrous a record

The true standard of comparison is not theprosperous, peaceful and gradually integratingpost-1945 non-Communist half of Europe. It is

2 Less well known is the role Bulgaria’sKing Boris (1894-1943) played insaving his country’s Jews fromdeportation to Nazi death camps –though the Jews from parts ofYugoslavia and Greece occupied byBulgaria, at that time the Nazis’ ally,did not escape that fate. See F. Chary,The Bulgarian Jews and the FinalSolution, 1940-44 (1972).

3 There is, for example, the case ofHungary’s ‘exceptionalism’ in theSecond World War. I can add a personalrecollection from that period. As ateenager living in neighbouring Croatiaunder the quisling regime presided overby a former Mussolini-sponsoredterrorist, Ante Pavelic, I was struck bythe story a family acquaintance broughtback from Budapest in 1943. Itsounded incredible: in Budapest cafésit was possible to read English andSwiss newspapers. Years afterwards,I learned that the story was true. Theavailability of Allied and neutralnewspapers reflected a real situationdescribed in a British Foreign Officememorandum about Hungary in early1944 as follows: ‘There is muchgreater freedom of thought andexpression than elsewhere in NaziEurope, trade unions continue tofunction and the Jews are treatedhumanely.’ See E. Barker, British Policyin South-Eastern Europe, p.258 (1976).Unfortunately, in March 1944, not longafter the above Foreign Officememorandum was penned, Hitler – inorder to prevent Hungary from goingover to the Allies – ordered itsoccupation and installed in power thereFerenc Szalasi, leader of the smallFascist Arrow Cross movement, thusclearing the way for Adolf Eichmann’smass deportations of the Jews to thedeath camps, in which Hungarianmembers of the Arrow Cross movementalso took part. For a full account anda broader historical perspective, seeC. A. Macartney, October Fifteenth:a History of Modern Hungary, 1929-1945 (1956).

4 An excellent scholarly work analysingin detail both the advantages anddisadvantages of the close connectionbetween church and nation in Serbiais that of the noted Hungarian Slavist,Professor Laszlo Hadrovics. It is calledLe peuple serbs et son Eglise sous ladomination turque and was publishedby Les presses universitaires de Francein Paris in 1947. An excellent shortwork dealing with the Orthodox Churchin the post-Communist period is acollection of essays edited by P. M.Kitromilides and T. Veremis entitledThe Orthodox Church in a ChangingWorld (1998).

5 One of those honourable exceptionsthat maintains a proper sense ofbalance and never loses sight of the broader European perspective isProfessor R. J. Crampton’s excellentwork Eastern Europe in the TwentiethCentury and After (2nd ed., 1997).Three works worth mentioning thatfocus specifically on central Europeare: L. R. Johnson, Central Europe.Enemies, Neighbours, Friends (1996);P. Stark (Ed.), Mitteleuropa. History andProspects (1994), and C. Lord (Ed.),Central Europe: Core or Periphery(2000).


In the 1920s and 1930s, the tradition of the rule of law had survived and, in some countries, even developed further. However, with the Communisttake-over in 1944-45 came the systematic attempt to destroy the old legal system.

the deeply divided, crisis and conflict ridden pre-1939 Europe, which saw the rise of Fascismand Nazism before those phenomena appearedfarther east. Spain had a savage, three year longcivil war from 1936 to 1939 without parallel inthe other half of the continent at that time. Seenin this perspective, central and eastern Europe’s1918-39 record, which few would reasonablydefend as satisfactory, appears much lessdisastrous. Several of the newly-independentstates of this region, those orphans of theempires they had supplanted, had a stab atdemocratic rule. Democracy took a relativelystrong hold in Czechoslovakia, though eventhere it was not as perfect as it has sometimesbeen portrayed.

At the same time, it should not be forgotten thatduring the 1918-39 period, democracy both asan ideal and as a political system was in retreateverywhere in Europe, decried equally from theextreme left and right. Authoritarianism was very much in vogue, tempting many even inthose countries in western Europe that had notsuccumbed to Fascism and Nazism. In the widerEuropean context, the figure of MarshalPilsudski, the founder of independent Polandwho was also its stern, authoritarian ruler from1926 until his death in 1935, is not so much outof place, as it might be today. Most multipartysystems had collapsed throughout the region by the late 1930s, including that of the relativelyliberal Francophile Romania. King Carol, understrong pressure from the Fascist Iron Guard, andin order to stop it from gaining power, introduceda new constitution after a plebiscite in February1938, making the country a corporatist state.Unfortunately, this did not stop Romania’ssubsequent slide towards wartime dictatorship.The three Baltic states which had managed,despite considerable political difficulties, tosecure a degree of economic independence and viability after 1918, were annexed by theSoviet Union in 1940, under the terms of theMolotov-Ribbentrop Pact of August 1939. Untilthen, the multiparty system had survived thereas well as in Bulgaria, Hungary and Yugoslavia.In Czechoslovakia, it was only extinguished byHitler’s occupation of Bohemia and Moravia inMarch 1939, and the setting up of the quisling,one-party state in Slovakia. Poland’s semi-authoritarian political system went down withthe Polish state when it was attacked and thendivided by Hitler and Stalin in September 1939.

A fact often overlooked in discussions about the transition is that not only between but alsobefore the two world wars, central and easternEurope already had a capitalist system,functional if imperfect. Reminders of itsexistence are, among other things, the old stockexchanges in various cities of the region. Pre-1939 Czechoslovakia was one of the richestcountries in Europe, economically on par withFrance. Even Yugoslavia, one of the worstconstructed and most poorly functioning post-1918 states in the region, could boast a soundfinancial system. In the mid and late 1930s,under Yugoslavia’s brilliant Finance Minister andlater Prime Minister Milan Stojadinovic, the gold-based dinar was one of Europe’s most soundcurrencies, on par with the French franc.

One of central and eastern Europe’s successesin the period between the two world wars wasland redistribution. This extremely complex andpolitically difficult operation was implementedwith “ingenuity and good sense”.6 The objective,which was to ensure social stability and to blockthe Communists’ attempt to capture localpeasantry, was achieved. The agrarian partiesplayed an important and on the wholeconstructive role in the process, particularlyin south-eastern Europe. One of the mostsuccessful agrarian parties was the CroatianPeasant Party, founded by Stjepan Radic in1905. Radic was a student in Prague in the lastyears of the nineteenth century. He admired andlearnt from Thomas Masaryk, a Czech democratand strong legalist who founded the democraticstate in Czechoslovakia in 1918, and remainedits president until 1935. After Radic’s fatalwounding at the hands of a fellow deputy in theBelgrade National Assembly in 1928, his partywas led by Vladko Macek. Macek, a pacifist anddemocrat, was interned in Croatia by the Pavelicregime during the Second World War. He endedhis life after 1945 in exile in the West.7

Agrarian parties like Macek’s and itscounterparts in Bulgaria and other centraland eastern European states were linked toflourishing cooperative movements. Thedepression of the early 1930s dealt a severeblow to the politics and the economies ofpredominantly agrarian central and easternEurope, which resulted in a severe agriculturalslump in the region. The need to find outlets for their depressed agricultural exports droveseveral south-eastern European countries intothe arms of Nazi Germany. Unfortunately, the

economic relief provided by a revived Germaneconomy able to absorb their exports alsocompromised their political independence.8

Lost assets

Those parts of central and eastern Europe thathad been under the old empires – particularlythe German and Austrian empires – inherited astrong industrial base, a sound financial systemand vibrant commerce. Austria-Hungary alsomade significant investments in infrastructure in the second half of the nineteenth and the firstdecade of the twentieth century. Some of it hassurvived to this day in places like Bosnia, whichwas under Austro-Hungarian rule from 1878 to1918. There was modest but real industrialprogress throughout the region between 1918and the outbreak of the Second World War. Muchof the region’s industry remained untouchedduring the Second World War. As in other parts of Nazi-occupied Europe, further industrialexpansion came as a result of intensive Germaninvestment in central Europe, notably in Bohemiaand Moravia from 1939 to 1945. Hungary’sindustry also benefited from German orders on the eve of and during the Second World War.After 1945, the region suffered as a result of itsforcible inclusion into the Soviet block, which inturn resulted in its separation from mainstreamindustrial areas such as western Europe and theUnited States.

Between 1918 and 1939, a crucial role in thefurther development of central and easternEurope continued to be played by the Jews andGermans of the region. Jews and Germans wereregarded both as important economic assetsand as the area’s social cement – propelling theregion forward and holding it together after 1918despite new political divisions. Perhaps the mostsevere long-term blow to the region during andjust after the Second World War came from thealmost simultaneous forcible elimination ofthose two groups from it – though for verydifferent reasons and under very differentcircumstances. The Jews were deported toHitler’s death camps, and the Germans wereforced to leave by Hitler himself, who wantedthem in his Grossdeutsches Reich, and after1944-45, by the national governments. SomeGermans had fled with Hitler’s armies beforeactually being expelled. In Romania, the bulkof the remaining, once numerous and extremelycapable German-speaking community wasliterally sold for money by President Ceausescu’s


regime to the post-1945 Federal Republic ofGermany whose 1949 Constitution obliged it to take in ethnic Germans from anywhere. Theregion is recovering only very slowly from thisblow, as the places left vacant by the departedJews and Germans are being filled by newgenerations of locals.

An even more serious blow to the long-termfuture of the region, whose effects continue tobe acutely felt today, has been the loss of theother bond that had been holding it together: atradition of respect for the rule of law. An attemptwas made in central and eastern Europe – as inthe Soviet Union since 1917 – to liquidate theindependence of the judiciary under Communistrule. This had its political logic: to a Leninist,a judiciary independent of the Party was acontradiction in terms. The rule of law has hada long and honourable tradition in the region. It was probably the most valuable bequest fromthe old empires – particularly the Habsburgempire as the Ottoman rule over large part ofsouth-eastern Europe left no such legacy. In the1920s and 1930s, the tradition of the rule oflaw had survived and, in some countries, evendeveloped further. However, with the Communisttake-over in 1944-45 came the systematicattempt to destroy the old legal tradition.

More than half a century later, it is clear thatfortunately the attempt to displace the rule oflaw has not been completely successful. This is partly because the Communist period did notlast long enough in central and eastern Europefor the link with the old legal tradition to becompletely broken, but also partly because inthe later stages of Communist rule, the regimesin some countries like Hungary, Poland andYugoslavia became alive to the value of ‘legality’as a useful prop of the system’s stability.

The old system of the rule of law may have beenweakened but its value, even in its diminishedform, remains to remind today’s generation of what their predecessors once had, lost andpresumably can have again. It is a reminder thatnot that long ago, most of the nations of centraland eastern Europe lived under the rule of lawand were, by implication, a law-abiding people.People in the region in turn have said that thisawareness makes it easier to struggle for therule of law today. This awareness could be animportant factor in the attempt that is underway in the region to build legal transition.

Though this essay is devoted to the politicalaspects of transition, it is worth widening thescope of the argument by postulating thatmemories of past economic success must alsoact as encouragement to present efforts aimedat creating a stable and prosperous economy. In Hungary, it is a point of pride that in theimmediate aftermath of the Second World War,as western Europe was close to collapse andneeded the Marshall Plan to rescue it, theHungarian economy, without any externalassistance, was relatively quickly back on itsfeet and functioning again.

In the late 1970s or early 1980s, ProfessorJozsef Bognar, a noted reformer during theCommunist era in Hungary, told me of his dreamfor the country. His dream centred on his fellowcountrymen sitting in Budapest cafés andscanning the financial pages of their papers tocheck on their shares – instead of quarrellingabout the purity of the nation’s language andagonising about its low birth-rate and the sadfate of the Hungarians left outside the country’spresent borders. As Hungary becomes a share-owning democracy, the Professor’s dream isbeing realised. But the real point about it is that in realising it, Hungary is in some respectsreturning to its traditional social roots. By thesame token, dwelling on the nation’s pastsufferings – real or imagined – as theHungarians have done in the past can bedeeply demoralising and demobilising andthus detrimental to its future.

No nation is immune to brooding about pastwrongs done to it, but it is important to knowthat it is possible to move past this stage.9

Those still prone to such reflection – such as, in our time, the Serbs have had nothing but grieffrom it.10 They might remind themselves that atthe turn of the twentieth century they had KingPeter I. Karadjordjevic as their ruler; an honestman who translated John Stuart Mill’s essayOn Liberty into Serbian and, more importantly,during his decade on the throne preceding theFirst World War, ruled a somewhat rough-and-ready but essentially democratic polity.

Contrary to conventional wisdom, central andeastern Europe as a whole has had enoughpast successes to look back upon and drawinspiration for the future. It is important thatit does so, and learns to build on them.

6 R. J. Crampton, op. cit., p. 34.

7 For a vivid, well-documentedcontemporary account of the state ofthe peasantry and of peasant politics ineastern and central Europe betweenthe two world wars, see H. HessellTiltman, Peasant Europe (1934).

8 See P. Stark, op. cit., p. 141.

9 Elizabeth Pond, transatlantic editor ofInternationale Politik, a Berlin-basedmagazine, makes the interesting pointthat today’s young people in Poland,widely judged to be a successfultransition country, want to be neithervictims nor heroes. See The Wall StreetJournal, p. 6 (17 May 2001).

10 For a perceptive, well-documentedrecent study of the Serbs’ ‘victimhoodcomplex’ and its political implications,see B. Anzulovic, Heavenly Serbia: fromMyth to Genocide (1999).

* Christopher CviicSenior Political CounsellorEBRDOne Exchange SquareLondon EC2A 2JNTel: +44 20 7338 7832Fax: +44 20 7338 6110Email: [email protected]

Christopher Cviic was born in Croatiaand has been living in the UK since1954. He is now working as a SeniorPolitical Counsellor in the EBRD Officeof the Chief Economist, with responsi-bility for the Baltic countries and centraland south-eastern Europe. Prior tobeginning this role in 1999, he coveredthe region as a journalist, first for theBBC and then for The Economist.


Focus on contractenforcementContract enforcement is the natural corollary of the axiom“pacta sunt servanda” (agreements must be honoured).When two parties strike a bargain, there must be somemechanism to ensure that each party will stick to theterms. Without such a mechanism, the party who hasto perform first would be placed at a disadvantage forit would have no assurance that the other party wouldsubsequently honour its end of the bargain. Over thecourse of history, societies have developed a number of formal and informal enforcement mechanisms rangingfrom primitive remedies such as hostage taking, ransomdemands and reprisals in ancient times to sophisticatedlegal frameworks with court enforcement in modern times.Contract enforcement is crucial to economic exchange and hence to economic and industrial development.

The first two articles in this focus section emanate fromthe Office of the General Counsel at the EBRD. FrancisDelaey, Counsel, first examines how contract enforcementand the choice of enforcement mechanisms can influencethe economic transition process. The article points outthat, in addition to judicial contract enforcementmechanisms, economic agents rely on a wide varietyof informal mechanisms to enforce their contractualbargains. The article concludes that a policy to enhancecontract enforceability is a prerequisite for the successfulimplementation of any transition programme and that suchpolicy should focus both on judicial and informal contractenforcement mechanisms. The second article, by KamenZahariev, Senior Counsel, outlines some of the techniquesused by the EBRD to facilitate the enforcement of itsfinancing agreements. To ensure enforceability, the EBRDtypically relies on carefully drafted legal documentation,adequate governing laws and dispute settlementmechanisms, compliance monitoring techniques tomitigate the risk of spurious contractual defences, and a thorough due diligence of domestic legal requirements.The article concludes that despite the use of thesetechniques, efforts to enforce contracts are oftenseriously hampered by the weak legal and judicialframework of the EBRD’s countries of operations.

The next two articles focus on arbitration. Over the pasttwo decades, arbitration has gradually supersededlitigation as the favourite dispute resolution mechanism in international commercial contracts. Enforceability, party-control, neutrality, privacy and confidentiality, costeffectiveness and speed are often cited as the mainadvantages of arbitration. Jernej Sekolec, SecretaryGeneral of the United Nations Commission on

International Trade Law (UNCITRAL), presents an in-depthanalysis of the UNCITRAL documents that have helpedrevolutionise arbitration and conciliation. Thesedocuments can assist transition countries in creatingan attractive regime for the settlement of commercialdisputes through arbitration and conciliation. AdrianWinstanley, Director-General and Registrar of the LondonCourt of International Arbitration, then examines thecrucial role played by arbitration institutions in arbitrationproceedings and how they safeguard the advantagesassociated with arbitration.

The next article is by Antonio R. Parra, Deputy Secretary-General of the International Centre for Settlement ofInvestment Disputes (ICSID). Public-private partnershipsbetween states and international investors play a growingrole in economic development. Recognising the need tocreate an independent and impartial dispute resolutionforum for cross-border public-private partnerships, theInternational Bank for Reconstruction and Developmentsponsored the establishment of ICSID. In this article,Mr. Parra examines ICSID’s increasing role and itsevolving jurisprudence.

The last two articles draw upon the contract enforcementexperiences of private practitioners. Michael E. Barrack,Georges P. Racine and Anthony Alexander, partners atMcCarthy Tétrault, discuss contractual defences availableunder English law. When structuring project financetransactions, financiers frequently select English law togovern financing agreements. Potentially valid reasons toprevent enforcement under English law range from denyingthe validity of the contract to implying unwritten terms. Thearticle examines these and other defences and indicateshow parties can mitigate the risk of these defences beingraised spuriously. The focus section concludes with anarticle on contract enforcement in Lithuania written byGiedrius Stasevicius, partner at Lideika, Petrauskas,Valiunas and Partners, and Giedre Valentaite, an assistantin the firm. The article provides an insight into how aforeign investor can enforce a cross-border investmentagreement in Lithuania. As in the article by KamenZahariev, this piece notes the importance of adequatelyaddressing enforcement issues as early as possibleduring the contract negotiation stage.

16 Law in transition – Focus on contract enforcement

Enforcing contracts intransition countriesFor markets to function properly, contractsmust be honoured. Development in industrialdemocracies has been attributed to a longtradition of upholding and enforcingbargains among economic agents. Thisarticle looks at how contract enforcementand the choice of enforcement mechanismscan influence the transition process.

Francis Delaey, Counsel, EBRD*

Focus on contract enforcement – Law in transition 17


Low-cost and impartial contract enforcementmechanisms are crucial to economic andindustrial development. In the eighteenthcentury, Adam Smith remarked that “theestablishment of perfect justice, of perfectliberty and of perfect equality, is the very simplesecret which most effectually secures thehighest degree of prosperity”.1 More recently,a number of studies have established a directcorrelation between the level of investment andeconomic performance in a country and theoverall level of confidence in its institutions,including the judicial system.2

The need for low-cost and impartial contractenforcement mechanisms is particularly acute in the formerly planned economies of central and eastern Europe and the Commonwealth ofIndependent States (CIS). Contract enforcementmechanisms were largely irrelevant in plannedeconomies. State-owned enterprises were highlyintegrated in an industrial network built aroundan inefficient model of production. Exchange wasdictated by central planning edicts. When theSoviet Union collapsed, supply and distributionlinks were virtually severed overnight. State-owned enterprises, which previously relied oncentral planning bureaucrats for their productionand sales activities, had to restructure from top

to bottom. New trading partners had to be found.Industrial and commercial networks inheritedfrom central planning days were dismantled andreplaced by new relationships better adapted tocope with market demands. The extent to whichformerly planned economies can successfullyreap the benefits of transition depends in nosmall measure on their ability to ensure theenforceability of bargains freely entered into by economic agents. A lack of contract enforce-ability, whether real or perceived, stifleseconomic and industrial growth.

Why contract enforcementmatters

Enforcement is central to commercial exchange,and therefore to economic and industrialdevelopment. The sixteenth century philosopherThomas Hobbes observed that “there must besome coercive power to compel men equally tothe performance of their covenants, by the terrorof some punishment greater than the benefit they expect by the breach of their covenant”.3

Good enforcement procedures enhance thepredictability of exchange, and reduce uncertaintyby restraining destructive opportunistic behaviouramong contracting parties. This, in turn, reducestransaction costs and promotes exchange.

If good enforcement procedures are lacking,economic agents will seek to minimise the riskof non-compliance by resorting to structureswhich economise on enforcement, such as spot-market transactions or vertical integration. Asdiscussed later, these structures not only inhibitthe overall volume of transactions but also affectthe economic and industrial growth of a country.

Game theorists represent a contractualrelationship as a game in which the first moverhas to decide whether to enter into a contractwithout knowing whether the second mover willperform. When contracts are generally enforced(high contract enforceability), all second moversperform because the expected cost of non-performance exceeds its potential benefits, andall first movers enter the contract comforted bythe expectation that the second movers will besufficiently deterred from breaching the bargain.As a result, more contracts are executedbetween a greater number of economic agentsand markets become more efficient. When, onthe other hand, contracts are rarely enforced(low contract enforceability), first movers will beextremely cautious. First movers will only enterinto the contract, if they know – either directlyfrom personal experience (trust) or indirectlythrough the community (reputation) – that the

The EBRD Legal Indicator Survey for 2000 questioned legalpractitioners in central and eastern Europe and the CIS onhow frequently the courts recognised and enforced a party’srights against another party. On a scale with five gradations(ranging from “never” to “almost always”) only Sloveniareceived a rating of “almost always”. In general, EU accessioncountries scored better than the other countries. In thesecountries, practitioners estimated that the frequency withwhich courts upheld a party’s rights ranged from“sometimes” to “frequently”. The fact that practitioners in

EU accession countries tend to use EU standards as abenchmark may explain their somewhat conservative ratingof “sometimes”. Courts in countries of south-east Europe“sometimes” enforced a party’s rights, except for FYRMacedonia where rights were enforced less frequently. Inthe CIS the results were more disparate. Courts in Russia,Belarus and in most of the countries of the Caucasus andCentral Asia “sometimes” enforced a party’s rights. However,rights in Armenia, Kyrgyzstan, Moldova and Ukraine were“rarely” or “never” upheld.

Local lawyers’ faith in their commercial courts: How frequently do local courts uphold legal rights?

Russian Federation

Estonia

LithuaniaLatvia

Belarus

Poland

Czech Republic UkraineSlovak Republic

SloveniaHungary

Yugoslavia

Croatia

AlbaniaFYRMacedonia

Bosnia &Herzegovina

MoldovaRomania

Georgia

Armenia Azerbaijan

Kazakhstan

Uzbekistan

Turkmenistan

Kyrgyzstan

Tajikistan

Bulgaria

Almost alwaysFrequentlySometimesRarely or never

Source: EBRD Legal Indicator Survey, 2000.

Note: Respondents were asked to score how private parties generally believe that courts will recognise andenforce their legal rights. The results of the survey are not readily verifiable and reflect the subjectiveassessment of survey respondents. Where there were discrepancies or inconsistencies in survey responses,recourse was made to the EBRD’s in-house knowledge of conditions in particular countries. Insufficient datawas received for Turkmenistan.

second mover is trustworthy. This cautionreduces the likelihood of exploitation for the firstmover and makes trustworthy second moversmore successful than others because, onaverage, they will get more contracts thanothers. Conversely, first movers will refrain fromentering into contracts with second moverswhose trustworthiness cannot be sufficientlyestablished.4

The reluctance of economic agents to deal with strangers in a low contract enforceabilityenvironment entails a significant cost. In a1997 survey,5 managers of privately ownedmanufacturing firms in Russia, Ukraine, Poland,Romania and the Slovak Republic werequestioned on whether they would abandon acurrent supplier to purchase instead from a new,previously unknown supplier offering a 10 percent lower price. The survey found that firmswho expressed doubts about the capacity of the courts to enforce contracts were reluctant to deal with new suppliers even if it meantcontinuing to deal with a more expensivesupplier. Accepting the lower-priced offer froman unknown supplier carries a risk. If the newsupplier delivers low-quality goods or fails todeliver, production may be delayed and a firm’sreputation jeopardised.

Furthermore, if the new relationship fails, thefirm will have to switch supplier and incur searchand screening costs to find another trustworthysupplier. The study found that persisting with ahigh-priced supplier because of the trust thathas developed generates inefficiencies: “[If]firms routinely reject lower-priced deals, low cost producers will find it difficult to get newcustomers and high-cost producers will not bedriven out.” In other words, when contractenforceability is poor and transactions are basedon trust, the rewards to (and incentives for) low-costs suppliers will be smaller and new entrantswill find it harder to enter the market.

The same survey examined the incidence ofcontract enforceability on trade credit. Supplierswill only offer trade credit if they believe thecustomer will (or can be made to) repay it. Of thefive countries surveyed, the study found that inRussia and Ukraine – where respondents wereleast likely to express confidence in the capacityof courts to enforce contracts – only 12 per centand 38 per cent respectively of the firmsinterviewed declared that they could settle their bills after delivery. This starkly contrastswith Poland and the Slovak Republic, whererespondents expressed greater confidence injudicial contract enforcement and where up to 84 per cent and 70 per cent respectively of thefirms interviewed received trade credit.

Fewer contracts, sub-optimal exchange, highersearch and screening costs and less tradespecific financing are not the only consequences

of poor contract enforceability. Weak contractenforcement procedures also affect industrialgrowth. When contracts are rarely enforced,suppliers are reluctant to produce goods toorder, and will instead gear their production lineto standard goods. The reason for this is that the more specialised the good, the lower itsvalue for another user, and the higher the risk for the supplier in case of non-compliance of thecounterpart. Standard goods, on the other hand,can be sold to a multitude of users and as aresult, present a lower risk in case of non-compliance. These empirical findings areconfirmed in another comparative study ofRussia, Ukraine, Poland, Romania and theSlovak Republic.6 The study found that Russiaand Ukraine, two countries with low levels ofcontract enforceability, produced substantiallyfewer specialised goods than Poland, Romaniaand the Slovak Republic, which scored better oncontract enforcement. The result is a productionprocess where less value is added.

Likewise, in a poor contract enforceabilityenvironment, producers whose productionprocess depends on the regular supply ofspecialised goods will frequently opt for verticalintegration (either by acquiring the supplier or by duplicating the supplier’s production line)rather than relying on a supplier. Verticalintegration circumvents the issue of contractenforcement and ensures timely and qualitativeperformance by hierarchical control. It alsoentails an inherent risk of sub-optimal resourceallocation and reduced product diversity.7

Economic agents also economise on enforce-ment by eschewing long-term (where the quidand the quo are continuously exchanged over a period of time) and inter-temporal contracts(where a lapse of time passes between theexchange of the quid and the quo) in favour ofspot-market transactions (where exchange of thequid and the quo is simultaneous). In contrast tolong-term contracts and inter-temporal contractswhich leave ample scope for opportunisticbehaviour, spot-market transactions are by andlarge self-enforcing because goods aresimultaneously exchanged against cashpayment. They enhance certainty by excludingthe inter-temporal element between theexchange of the quid and the quo. Sinceexchange is simultaneous, there is less scopefor opportunistic behaviour.

Like the standardisation of the product line and the vertical integration of the productionprocess, the bias for spot-market transactionshas economic implications. The fluctuatingincome stream intrinsic to spot-markettransactions is less likely to encouragemanufacturers to make long-term capitalinvestments than the steady and predictableincome stream resulting from long-termcontracts. In addition, while spot-markets are

1 A. Smith, Wealth of Nations, (TheHarvard Classics 1909-14).

2 See, for instance, D. A. Grigorian andA. Martinez, “Industrial Growth andQuality of Institutions: What Do(Transition) Economies Have to Gainfrom the Rule of Law?”, Working Paper,Private and Financial SectorDevelopment Unit, Europe and CentralAsia Region, World Bank, undated,www.worldbank.org.

3 T. Hobbes, Of man, being the first partof Leviathan, (The Harvard Classics1909-14).

4 I. Bohnet, B. Frey and S. Huck, “MoreOrder with Less Law: On ContractEnforcement, Trust and Crowding”,Kennedy School of Government atHarvard University, (July 2000),www.ksg.harvard.edu.

5 S. Johnson, J. McMillan and C.Woodruff, “Contract Enforcementin Transition”, Sloan School ofManagement at MIT, (January 1999),mitsloan.mit.edu.

6 S. Johnson, J. McMillan and C.Woodruff, “Entrepreneurs and theOrdering of Institutional Reform:Poland, the Slovak Republic, Romania,Russia and Ukraine Compared”,Economics of Transition, Vol. 8, pp. 1-36 (2000).

7 Consider, for instance, a laptopmanufacturer. For simplicity we assumethat laptops consist of a keyboardcomponent with a processor and anLCD-screen. If the quality of the LCD-screen is insufficient or its deliverybehind schedule, the laptopmanufacturer will incur sizeable losses.In an environment where contractenforceability is low, the laptopmanufacturer may be tempted toacquire the LCD-screen manufacturer.By doing so, the laptop manufacturerwould be able to control the quality andthe timely delivery of the LCD-screens.Vertical integration, however, entailsan economic cost. The laptopmanufacturer, for one, would have totie up substantial resources in theacquisition and operation of the LCD-screen manufacturing plant. Theseresources could be allocated moreefficiently elsewhere. But verticalintegration does not only affect themanufacturer. It also affects theconsumer. By developing itstechnological expertise, the LCD-screenmanufacturer could have produced LCD-screens for other applications at acheaper price.


Market-friendly laws and an independent and competent judiciary toimplement them have long been credited for fostering economic andindustrial development. On the other hand, poor laws or a weak judiciary can undercut even the most ambitious efforts to develop a modern market-oriented economy.

a good environment to trade commodities, theyare less suited to support the exchange of highlyspecialised goods, which ineluctably entail aninter-temporal element. Economies where adisproportionate number of transactions takeplace on the spot-market at the expense of long-term or inter-temporal contracts tend thereforeto be characterised by a lack of technologicalinnovations and a decreased productivity andcompetitiveness.8

Judicial contract enforcementprocedures

Market-friendly laws and an independent andcompetent judiciary to implement them havelong been credited for fostering economic andindustrial development. On the other hand, poorlaws or a weak judiciary can undercut even themost ambitious efforts to develop a modernmarket-oriented economy.9

Adequate judicial contract enforcementprocedures are crucial because they supportimpersonal (as opposed to personal) and inter-temporal (as opposed to spot-market) exchange– a conditio sine qua non for market expansionand hence economic and industrial develop-ment. In addition to enhancing economic andindustrial development, judicial contractenforcement procedures can also have strongequality-promoting effects. Powerful actors oftenhave other (informal and sometimes illegal)means of ensuring performance. As discussedbelow, the sheer size of their orders combinedwith the threat of withdrawing future business or their extensive network of contacts combinedwith the threat of a collective boycott are oftenenough to deter their counterparts from “re-defining” their contractual obligations. Lesspowerful actors cannot avail themselves (or atleast not to the same extent) of such alternativemeans and as a result are more vulnerable.Impartial and predictable contract enforcementprocedures can create a level playing field andincrease competition among economic agentsby providing a viable alternative to size orpurchasing power to enforce contractualarrangements.10

Paradoxically, despite their undeniableimportance, judicial contract enforcementprocedures only play a minor role in day-to-daybusiness transactions. Generally they constitutea measure of last resort in whose shadowcommercial relationships evolve more or less

informally. A number of studies arguei that theparties’ reliance on judicial contract enforce-ment procedures decreases over time. As therelationship progresses and trust builds up,parties tend to switch to informal means andreserve judicial contract enforcementprocedures for situations where monetarystakes are high or to signal the end of abusiness relationship. A survey of manufacturingfirms in Russia, Ukraine, Poland, Romania andthe Slovak Republic found that the importance of courts is greatest at the start of a relationshipand declines as the relationship matures.Moreover, the survey indicates that themeasured effects of courts are smaller than themeasured effects of relational contracting. Itfound, for instance, that the estimated likelihoodof granting trade credit increased by more overthe course of the first year of a relationship thanit increased if the courts become available.11

Informal contract enforcementmechanisms

Informal means of enforcement oftencomplement and sometimes supplement judicialcontract enforcement procedures in transitionand market economies alike. Relationalcontracting is the most frequently cited informalmechanism. The underlying premise is that thelong-term benefits of a business relationshipoutweigh the one-off gains brought about bybreach of contract. Or, as one scholar puts it,“the discounted present value of the earningsstream that can be realised from futuretransactions exceeds the one-time wealthincrease realisable from breaching the currentagreement.”12 This also highlights thelimitations of relational contracting as anenforcement mechanism; if the discountedpresent value of the earnings stream is lessthan the one-time wealth increase realisablefrom breaching the agreement, the relationshipis not worth preserving and the threat toterminate in case of breach will not constitutea sufficient deterrent.

Closely related to relational contracting andbased on a similar premise is reputationalcontracting. Reputational contracting is based onthe assumption that over time one’s good nameis worth more than the one-off gains resultingfrom reneging on one’s contractual obligations.Economic agents with a good reputation will inthe long run be more successful than othersbecause on average they will get more contracts

than others. Unlike relational contracting, thevalue of a particular relationship is irrelevant,because even in an insignificant relationship the breach of contract will affect the reputationof the party breaching it. Medieval judges playedan important role in facilitating trade acrossEurope by supplying information on the pastbehaviour of merchants. More recent examplesof reputation based enforcement institutionsinclude credit bureaux that record anddisseminate information on payment defaults,and trade associations who exchangeinformation about their members.13

Multilateral Punishment Systems (MPS) are anextension of reputational contracting. MPS relieson the threat of a collective boycott to detera party from reneging on its contractualundertakings. The underlying premise is that a party duped by its counterpart will informothers of its misfortune who – in solidarity withthe victim – will refuse to deal with the renegade.Medieval merchants relied on a form of MPS todeter their agents from double-crossing them.Agents did not double-cross their masters ontheir trans-Mediterranean voyages because theyanticipated a boycott by other merchants in caseof misconduct.

Economists examined whether MPS was aviable enforcement mechanism in transitioncountries such as Russia. They found thatthe threat of a future boycott only deters ifthe potential renegade is unable to postsufficient collateral at a later time for anothertransaction. If the renegade can post sufficientcollateral, economic agents will accept totransact with the renegade and the boycottcrumbles.14 More generally, because boycottsare only as strong as the coalition among theindividual members imposing them, MPS is onlyeffective when wielded by close-knit financial-industrial groups in respect of counterpartswho have only a limited number of alternativetrading partners. Lastly, MPS can also raiseanti-trust considerations, for instance, whenone of the boycotting firms is a competitorof the boycotted party.

Relational contracting, reputational contractingand MPS frequently complement judicial contractenforcement procedures and can in certain casessupplement them. This is the case, for instance,when the relative cost of judicial contractenforcement procedures makes themuneconomical as an enforcement mechanism,


or when goods have such subtle qualitycharacteristics (e.g., software programs) that it is difficult or impossible for a third party to verifythat the contract has been breached. Yet, theseinformal enforcement mechanisms suffer somesignificant drawbacks. First, relational contracting,reputational contracting and MPS can onlyfunction properly when there is repeatedinteraction and parties are able to verify the past behaviour of prospective counterparts. As a result, these mechanisms are not suited tosupport impersonal exchange. Second, the needto screen prospective trading partners alsoincreases transaction costs. Lastly, the intrinsicbias of these informal enforcement mechanismsto existing relationships generates – as discussedabove – inefficiencies by making it more difficultfor new participants to enter a market.

Does this mean that impersonal exchange isimpossible in an environment lacking judicialcontract enforcement procedures? Not quite, atleast in close-knit and well defined communities,according to some scholars. These scholarscontend that from as early as the twelfth century,Community Responsibility Systems (CRS)supported impersonal and inter-temporalexchange in medieval Europe, despite the lackof appropriate contract enforceability providedby the state. A 1997 research paper argues, “byholding all members of a community responsiblefor the default of a particular member, thecommunity is provided with the incentive toemploy its intra-community contract enforcementinstitution to ex post punish the member whodefaulted in inter-community exchange.”15 Thepaper recounts the case of an individual namedJames, who in the thirteenth century at a fair in S. Botulph, England, complained that severalmerchants of Brussels had cheated him. Afterverifying his complaint, the bailiff confiscatedwool belonging to other merchants fromBrussels who were present at the fair. Thearchives do not disclose the fate of the deceitfulmerchants. However, typically their goods wouldhave been seized to compensate the honestmerchants for their loss. The essence of CRS isthat economic agents condition their actions onsocial affiliation rather than on past behaviour. If a party defaults on its contractual obligations,its victim is avenged by the confiscation of goodsbelonging to that party’s community, who is leftto deal with the offending party as it sees fit.

CRS quickly outlived its usefulness as anenforcement mechanism in business

transactions. Due to the considerable riskof retaliation, the use of CRS was promptlyregulated. The same paper cites the exampleof a treaty signed between Pisa and Florencein 1214, which provided that if one communityrefused to compensate the other, members of the latter would be allowed 40 days to leavetown. A Florentine statute of 1325 similarlyrequired the city governor to wait one monthbetween declaring and acting upon anyconfiscation of goods under CRS. Furthermore,the practical application of CRS tended to becumbersome: CRS required not only theverification of the validity of the original claim,but also the confirmation that the renegade andthose that were actually being sued for the debtbelonged to the same community. As communitycohesion faltered over time, communityresponsibility was replaced by individual legalresponsibility and CRS largely fell into disrepute.

Relational contracting, reputational contractingand MPS are not the only informal means toensure performance, but they are by far themost common. Other informal means includethe media, traditional authorities, social norms,ostracism and private protection rackets.

Designing a contractenforceability enhancing policy

As discussed above, contract enforcementmechanisms, whether formal or informal, arecritical to commercial exchange, and hence toeconomic and industrial development. In asurvey of 27 transition countries of Asia andLatin America, a World Bank paper found that “a developed legal and regulatory framework,good enforcement and low administrativebarriers affect the industrial growth not only byincreasing the amount of investments madeavailable in the economy but also by improvingthe efficiency of resource allocation.”16 Thepaper recommends that “policy makers shoulddevote resources and efforts to reducingcorruption, eliminating bureaucratic barriers,improving contract enforcement and the legalenvironment … as an essential complementarymeasure to accompany large scale privatisation,flow of public and private investments ineducation and R&D and measures promotingForeign Direct Investment”. Put differently,designing and implementing a contractenforceability enhancing policy is a necessaryprerequisite of any transition programme.

8 See also S. Kähkönen and P. Meagher,“Contract Enforcement and EconomicPerformance”, IRIS Centre at Universityof Maryland, African Economy PolicyDiscussion Paper No. 1 (July 1998),www.iris.umd.edu.

9 A number of commentators haveargued that this is what happened inthe CIS, particularly in Ukraine andRussia. Johnson, for instance, providessurvey evidence that in these countriesinvestment is hampered not by the lackof outside finance but by the insecurecontractual environment.

10 S. Kähkönen and P. Meagher, ibid.footnote 8.

11 S. Johnson, J. McMillan and C.Woodruff, ibid. footnote 5.

12 R. E. Messick, “Judicial Reform andEconomic Development: a Survey ofthe Issues”, The World Bank ResearchObserver, Vol. 14, No. 1, pp. 117-36(1999).

13 Johnson et al. found that membershipof a trade association increased thelikelihood of switching to a new andcheaper supplier and extending tradecredit by 9 per cent and 6 per centrespectively. By comparison, they foundthat confidence in the capacity ofcourts to enforce contracts increasedthe likelihood of switching to a newsupplier and extending trade credit by6 per cent and 8 per cent respectively.

14 Y. Kossykh and A. Sarychev, “ContractEnforcement in Transition”, BostonUniversity, (November 2000),www.bu.edu.

15 A. Greif, “On the Social Foundationsand Historical Development ofInstitutions that Facilitate ImpersonalExchange: From the CommunityResponsibility System to IndividualLegal Responsibility in Pre-modernEurope”, Department of Economics atStanford University, Preliminary Paper,(June 1997), www.stanford.edu.

16 D. A. Grigorian and A. Martinez, ibid.footnote 2.

17 See for instance Ciao!com atwww.ciao.com.

18 R. E. Kranton and A. V. Swamy, “TheHazards of Piecemeal Reform: BritishCivil Courts and the Credit Market inColonial India” quoted by R. E.Messick, ibid. footnote 12.

19 R. E. Messick, ibid. footnote 12.

20 Convention on the Recognition andEnforcement of Foreign Arbitral Awards,New York, 10 June 2000.

21 For a more detailed discussion on thissubject see infra J. Sekolec, “UNCITRALtexts on international commercialarbitration”, p. 28.

* Francis DelaeyCounselEBRDOne Exchange SquareLondon EC2A 2JNTel: + 44 20 7338 7352Fax: +44 20 7338 6150Email: [email protected]


Designing an effective contract enforceabilityenhancing policy poses several challenges:

■ Due consideration should be given to thesocial, political and cultural contexts in which contracts must be enforced. Contractenforcement mechanisms do not operateindependently, but are part of a largerframework of norms and values that organisea society. CRS, for instance, was a viableenforcement mechanism in medieval Europebecause commercial exchange mainly evolvedaround corporations, and the social andeconomic cost of leaving one’s corporationwas relatively high. When corporations losttheir primordial role in commercial exchange,however, CRS was no longer practicable andfell into disuse. More recently, the ease withwhich information can be disseminatedthrough the Internet has revolutionisedreputation-based contract enforcementmechanisms. Some Internet sites providetheir users with a novel platform to exchangeopinions on a wide range of products andservices, from computers and ski resorts toinsurance and brokerage services.17 Potentialbuyers can read opinions of other users of aparticular product or service, and can rateeach opinion according to its usefulness.Registered users can also write their ownopinions and receive a modest compensationevery time their opinion is read. The moreuseful the opinion, the more it will be ratedand read and the higher the compensationfor its author. Where previously only a limitednumber of consumers could relate theirexperiences in consumer testing magazineswith a limited readership, the Internetempowers an infinite number of users to readand voice their opinions on a web site with apotentially unlimited readership. However, thebenefits of the Internet are not unmitigated.Just as the Internet facilitates the exchange ofbona fide opinions, it also increases the easewith which false or slanderous information canbe distributed. Disreputable firms can abusereputation-based web sites by either writingcomplimentary opinions of their own productsor disparaging reviews of those of theircompetitors.

■ Policy makers should also take care that theircontract enforceability enhancing policy doesnot have unintended consequences. Forinstance, with the introduction of judicialenforcement, impersonal exchange graduallybecomes more important than personal

exchange. As the volume of personalexchange reduces, the benefits of intra-community trade diminish and as a resultthe community could begin to break up. Whilethis is neither good nor bad of itself, policymakers should examine whether othercommunity benefits are lost as well and,if so, how this can be mitigated. A study ofrural credit markets in India exemplifies thepotentially adverse impact of the introductionof judicial enforcement procedures.18 Prior to their introduction, moneylenders relied on informal mechanisms to ensure loanrepayments. As a result, competition was laxand interest rates remained high, providingthe lenders with a financial cushion allowingthem to extend payment terms and otherwiseaccommodate borrowers experiencingdifficulties. The introduction of courtsincreased the competition and interest ratescame down. When the region was hit bydrought, borrowers defaulted and lenders,deprived of their financial cushion, went tocourt to foreclose on farmers’ land.Widespread social unrest followed. This doesnot mean that the introduction of judicialenforcement procedures is inappropriate(after all the increase of competition and thereduction of interest rates are importantbenefits) but merely that policy makers shouldendeavour to identify and avoid undesiredside-effects by ensuring that adequatesafeguards are in place (such as insurancecoverage for instance).

■ Policy makers should address judicial reformin conjunction with informal enforcementmechanisms. According to one study, “judicialreform projects that build upon or enhance the operation of such informal enforcementmechanisms will yield greater returns thanthose that do not. As a minimum, designers of reform projects must take the presence of these informal mechanisms into account.Otherwise ... the projects could backfire”.19

Policy makers should endeavour to maximisethe synergies between judicial and informalcontract enforcement mechanisms.Reputation based enforcement mechanismscan be reinforced, for instance, by promptlypublicising court decisions (including theidentity of the parties to the lawsuit), byassisting business communities to developsystems to share information about suppliersand customers, and by fostering the growth ofcredit reporting agencies and central company

registers. Judicial reform projects can furtherenhance contract enforceability by ensuringthat impartial and predictable judgements areissued, cases are heard within a reasonabletimeframe, and the judicial process istransparent and cost-effective. Only whenthese conditions are met, is the threat ofjudicial enforcement sufficiently credible tocurb destructive opportunistic behaviour. The overhaul of filing procedures to minimisedelays, the creation of small claims courtsand specialised commercial courts, theprofessionalisation of the bench and the bar,and the transfer of non-contentious matters(such as registration of property) toadministrative agencies to reduce casebacklogs are some of the measures that canbe implemented to achieve this goal. Policymakers in transition countries can alsoenhance contract enforceability by activelyendorsing the use of arbitration andconciliation. In this respect, policy makers will find the groundbreaking work of the UnitedNations Commission on International TradeLaw (UNCITRAL) – and in particular the 1958New York Convention20 and the UNCITRALModel Law on International Arbitration –particularly useful.21

Designing and implementing an effectivepolicy to enhance contract enforceability is along and arduous task fraught with numerousobstacles. It touches the core of society andits values. Yet transition economies have nooption but to persevere and discharge itsuccessfully, for without it, even the mostmodest transition programme is unlikelyto achieve its objectives.


Mitigating structural andjurisdictional risks in theenforcement of commercialcontracts: the EBRD’sexperienceThis article outlines some of the policies,practices and techniques that the EBRD usesto mitigate the structural and jurisdictionalrisks inherent in its investments. The EBRDhas adopted a comprehensive approachto the drafting and structuring of legaldocumentation in relation to theseinvestment activities. Despite the use of suchmitigation techniques and practices, theEBRD’s experience in enforcing commercialcontracts shows that such efforts by foreigninvestors to enforce contracts are oftenseriously hampered by the existingweaknesses of the legal and judicialenvironment in the EBRD’s countriesof operations.

Kamen Zahariev, Senior Counsel, EBRD*


The EBRD’s mandate is to foster the transitionto market economies and to promote private and entrepreneurial initiative in central andeastern Europe and the Commonwealth ofIndependent States (CIS). It does so throughoffering a wide range of investment products,from simple corporate loans to complex limitedrecourse project financings and venture capitalinvestments. Documenting contractually and, if necessary, enforcing such a wide array ofcross-border investment products in the EBRD’scountries of operations presents a significantchallenge, given the need to balance several,sometimes conflicting, requirements. Whennegotiating and structuring its legal documen-tation, the EBRD has to ensure the protection of its interests as lender and/or equity investor,and take into account the expectations and riskperceptions of the investment partners in theprojects financed by it – participating banks, co-investors and project sponsors. The Bank’sapproach to structuring and enforcing thecontracts to which it is a party is also influencedto a large extent by the current state of the legalenvironment in transition countries. Thesecountries continue to undergo rapid andextensive change, and sometimes fail to offer an acceptable degree of legal and judicialcertainty of contract enforcement.

There are a number of commercial risksassociated with medium and long-term projectfinancing and venture capital investments in thevolatile emerging markets of central and easternEurope and the CIS. The EBRD is also faced withanother two categories of legal risk: those associ-ated with the complex, multi-party, cross-borderand long-term nature of its investment products(structural risks); and those arising from therelatively underdeveloped local legal infrastructurein the jurisdictions where its investee companiesare located (jurisdictional risks).

The EBRD employs a range of policies andpractices to mitigate these risks. These include:a careful choice of the law governing itsinvestment agreements and of the mechanismsused to resolve disputes; a comprehensiveapproach to the drafting and structuring of legaldocumentation; the adoption of adequatecompliance monitoring techniques to preventthe use of unmeritorious contractual defences bydefaulting borrowers; and a careful analysis ofthe domestic legal requirements in the hostcountry to ensure local enforceability offinancing documentation.

Approach to documentation

Businesspeople and other parties sometimesquestion the length and complexity of cross-border project finance documentation. However,with the possible exception of some purelydomestic projects in advanced continentaljurisdictions, there has been no widely acceptedalternative to the approach of comprehensivelydocumenting the arrangements between theparties of complex cross-border financings so far.

Given the EBRD’s mandate to advance transitionin all of its countries of operations, the Bank isfrequently taking high risks in the markets inwhich it operates. On the other hand, as apublicly funded institution, the EBRD is alsoaccountable for ensuring that its investmentsare made with appropriate safeguards so that it observes “sound banking principles” in all its operations.

In order to balance these objectives and improvethe chances for successful enforcement of itscontractual rights, the EBRD’s preferredapproach is to prepare and negotiatecomprehensive, self-contained documents ona project by project basis. The Bank incorporatesa range of safeguards in its legal documentation(for instance, security arrangements, financialratio covenants, project performanceundertakings, environmental and procurementcovenants and exit arrangements). Setting outthe commercial arrangements of the parties indetail and appending the background analysisand assumptions of the parties to legalagreements lessens the risk of the partiesentering into the transaction with differing beliefsabout what is intended. This is a distinct risk in cross-border transactions, where legal andcommercial expectations can vary extensivelybetween jurisdictions. The approach alsoimproves the chances of successful enforcementof contracts by making it easier to prove thecommercial background of the original bargainstruck by the parties. In addition, it reduces the chances of defaulting parties to invokeunmeritorious defences such as implied terms,error of fact or law, or change of circumstances.1

Choice of governing law

Typically, the recipient of EBRD funding is acompany or joint venture incorporated in one ofthe Bank’s countries of operations and its mainoperating assets are also located there.

Investment partners, whether as lenders,participants in the EBRD’s loans, or fellowshareholders, are typically from a range ofcountries. In an ideal world, the law andjurisdiction where the project assets werelocated would be a logical choice which shouldfacilitate speedy enforcement. However, inpractice, foreign investors almost invariablychoose the laws of an established foreignjurisdiction to govern their relations with localpartners. Their choice is influenced by the factthat the legal environment in the localjurisdictions is still in the process of transitionto being more market-oriented.

Ten years into the process of transition to marketeconomies, most countries of the region havedeveloped and passed the basic commerciallaws necessary for private sector development –company, commercial, foreign investment,insolvency, concessions and securedtransactions. However, few of them havesuccessfully passed the test of practicalimplementation. Successive surveys conductedby the EBRD’s Office of the General Counselthroughout the region have consistently shownthat the effectiveness of the implementation of local laws lags significantly behind itsextensiveness. In other words, notwithstandingthat basic legislation is in place, investors insome countries in the region may be confrontedwith a combination of the following:

■ Local laws remain subject to unpredictablechanges, sometimes followed by dramaticreversals, depending on politicaldevelopments.

■ Local legislation may contain “grey areas”which are not expressly addressed in thelaw, and for which there is no establishedadministrative or judicial practice. In a regionwhere legal education and thinking have beendominated for decades by administrativemethods, tight bureaucratic regulation andthe downplaying of the contractual freedomof economic players, this contributes to anuncertain legal environment and, almostinvariably, causes implementation problemsfor foreign and local investors andfinanciers alike.

■ Implementing regulations might be passedlong after the basic legislation has beenpassed, and/or might contain provisionswhich contradict the spirit of the laws theyare designed to implement.



■ Enforcement procedures are often regulatedby unreformed codes of civil procedure, whichprovide for court-led enforcement mechanismsthat are slow, expensive and leave room fordefaulting parties to drag out the process.

Under these conditions, foreign investors andfinanciers, when given a choice, frequently optfor the laws of an established foreign jurisdictionto govern their contractual relations anddisputes with their local partners. The EBRD’spractice is to have its private sector loanagreements governed by the law of anestablished jurisdiction whose laws arerecognised by participant banks as supportiveof international financiers’ interests. The mainreason for this is to mitigate the jurisdictionalrisks outlined above, as the law of a developedjurisdiction provides a high degree of legaland judicial certainty in its application andinterpretation. As such, it is also a safeguardagainst the structural risks involvedin structured finance products.

Choice of dispute settlementmechanism

In multi-party, cross-border project financings,the parties normally face the choice betweenopting to submit to the jurisdiction of local orforeign courts, or to have their disputes resolvedby arbitration (foreign or local). In many cases,this decision may have far-reaching conse-quences for the parties and the chances ofenforcing their rights. Thus, the choice ofappropriate dispute settlement mechanisms isan important tool in legal risk management.

It is the EBRD’s practice to submit disputes to ad hoc arbitration under the United NationsCommission on International Trade Law(UNCITRAL) Arbitration Rules. In addition, theEBRD reserves the right to enforce its rights in the English courts, or in any other courtshaving jurisdiction. The reasons for this policychoice are to a large extent the same as thosedetermining the choice of governing law outlinedabove. In addition, the choice of internationalarbitration as the main dispute settlementmechanism is influenced by the fact that whilemost countries of central and eastern Europeand the CIS are not parties to bilateral ormultilateral treaties on the mutual recognition ofjudgements, almost all of them have ratified the1958 New York Convention on the Recognitionand Enforcement of Arbitral Awards.

Contract enforcement, duediligence and local law

The freedom of the parties to a cross-borderfinancing to choose a foreign law to govern theircontract is not unrestricted. Using a foreign lawto govern cross-border lending agreements forprivate sector projects does not mean that thelaw of the borrower is either ignored or forcedto yield to an alien system. Many importantaspects of the project will invariably be governedby, or subject to, the laws and regulations of thehost state.

For instance, the choice of a law other than thelaw of the borrower does not in general affectproperty rights or security interests to the extentthat these are mandatorily treated under locallaw as a matter of public policy. In order to beenforceable, security arrangements must bevalid under the laws of the jurisdiction in whichthe collateral is located, and therefore securityarrangements are almost invariably governed by,and subject to, local law. Similarly, when theEBRD invests in the equity capital of a localcompany, its rights in relation to the investeecompany and its shareholders and directors are reflected in the company’s charter and otherdocuments (e.g., the subscription agreement),which are governed by the laws of the countryunder which the investee entity was formed.

Even those financing agreements which aregoverned by a foreign law (e.g., loan agree-ments, inter-creditor agreements or agreementsbetween shareholders) may ultimately have to beenforced in the local jurisdiction of the borroweror investee company (if this is where its assetsare located), and must therefore be consistentwith, and enforceable under, the laws of thecountry of operations of the investee company.

In order to ensure the enforceability of itsagreements, in the process of so-called “legaldue diligence”, the EBRD carefully evaluates thelocal legal environment affecting the investment.In particular, it will review whether:

■ the financing agreements have been dulyauthorised and executed by the relevantcounterparties and constitute valid and legallybinding obligations, enforceable in accordancewith their terms;

■ any local law or regulation has been or will beviolated by the execution of the financingagreements or by their performance;

1 For a more detailed discussion on thissubject, see infra M. E. Barrack, G. P.Racine and A. Alexander, “Lenderbeware: an overview of contractualdefences”, Law in transition, Autumn2001, p. 44

2 For a more detailed discussion onthis subject see M. E. Barrack, op. cit.,p. 44.

* Kamen ZaharievSenior CounselEBRDOne Exchange SquareLondon EC2A 2JNTel: + 44 20 7338 6907Fax: +44 20 7338 6150Email: [email protected]

Kamen Zahariev leads the CorporateRecovery and Litigation Team within the EBRD’s Office of the GeneralCounsel. The team provides specialistlegal advice and legal transactionmanagement services in relation toimpaired assets, corporate debtrestructurings and asset recovery,bankruptcy and insolvency proceedingsand related litigious matters.

■ all local law consents, licences andauthorisations have been obtained;

■ the security has been validly created in orderto be effective against third parties andenforceable against the borrower; and

■ the choice of governing law and themechanism for settlement of disputes arevalid and enforceable under the law of thecountry of operations.

Monitoring of contract conditionsafter signing

Given the complex nature of project financeagreements and the long implementation time,during the course of implementation itsometimes becomes necessary to revisit certainconditions of disbursement of the loan or towaive or amend (temporarily or permanently)certain terms of the original documentation.This is necessary to take into account changedcircumstances or new legal and commercialdevelopments which have led to a change inthe original risk perceptions of the parties.

The EBRD has a developed system of monitoringthe fulfilment of conditions of disbursement andcontract compliance. The Bank’s practice is tocarefully document any waivers or amendmentsto the original documentation. Such waivers andamendments are always made and retified inwriting, specify in detail any terms andconditions attached, and state the durationfor which they are granted. Waivers andamendments also contain appropriate clausesaimed at reserving the EBRD’s rights andremedies. This practice has an important“demonstration effect” in many countries of theregion, as it requires local borrowers to adoptadvanced accounting and management practicesin the context of implementing projects financedby the EBRD. It also protects the rights of theEBRD and mitigates the risks which mightotherwise arise at enforcement stage, suchas the risk of making it easier for defaultingborrowers to avail themselves inappropriatelyof contractual defences such as promissoryestoppel, acquiescence, waiver by conductor forbearance.2

EBRD experience and challengesfor transition countries

As a leading foreign investor in central andeastern Europe and the CIS, the EBRD hasgained considerable experience in enforcingcommercial contracts related to various aspectsof banking, capital markets and venture capital.The EBRD’s experience shows that efforts byforeign investors to enforce contracts are oftenseriously hampered by the existing deficienciesin the legal environment of the EBRD’s countriesof operations. Many of these deficiencies arecaused by the weaknesses of a judiciary whichin many countries is underfunded, lackscommercial experience and is prone to beinginfluenced by powerful local interests. Thereluctance of the courts in some countries,especially Russia and some CIS countries,to enforce validly issued international arbitralawards based on an overly expansiveinterpretation of domestic public policy isof particular concern, as is their apparentwillingness to invalidate commercial contractson highly formalistic grounds at the request oflocal parties who are unwilling or unable to fulfiltheir contractual obligations.

In its investment activities, the EBRD hasadopted a comprehensive approach to thedrafting and structuring of legal documentation,and pays particular attention to the choice ofappropriate governing law and disputesettlement mechanisms to resolve disputes.The EBRD also employs compliance monitoringtechniques aimed at preventing the use ofcontractual defences by defaulting borrowers.The EBRD also conducts a careful analysis of the domestic legal requirements in the hostcountry to ensure local enforceability of itsfinancing documentation.

For their part, transition countries can helpattract foreign investment, particularly fromcommercial sources, by improving their legalsystems so that the law and judicial attitudescollectively foster a culture that sees theenforcement of contracts freely entered into bycommercial parties. Much progress has beenmade in many countries, particularly those withEU membership aspirations. However, muchremains to be done.


UNCITRAL texts oninternational commercialarbitration The United Nations Commission onInternational Trade Law (UNCITRAL)1 haslong been at the forefront of internationalarbitration and conciliation. The 1958 NewYork Convention on the Recognition andEnforcement of Foreign Arbitral Awards, oneof the world’s most successful treaties in termsof number of ratifications, has revolutionisedarbitration and made it the most commondispute resolution mechanism ininternational transactions. This articleexplores five UNCITRAL documents thathave helped shape contemporary disputeresolution mechanisms that can be usedin transition countries.

Jernej Sekolec, Dr. jur., L.L.M, Secretary of UNCITRAL and Chief of the International Trade Law Branch of the United Nations Office of Legal Affairs*


UNCITRAL1 is a prominent organisation in thearea of arbitration and conciliation. It hasformulated contract rules, practice notes as well as legislative provisions on this topic. TheCommission is currently preparing further textsof this nature.2 The significance of UNCITRALtexts is evident when examining the ways inwhich they are utilised by parties involved inarbitration. Usually, after the parties have agreedon the substance of an international transaction,they turn their attention to a dispute settlementclause. Parties often prefer to use a standardarbitration clause and complete it with a fewadditional elements suited to the transaction –particularly the place of arbitration, the numberof arbitrators, the appointing authority and thelanguage of the proceedings. If such anarbitration agreement is to be effective and freeof risks and uncertainties, the parties mustoperate against the background of an acceptableand widely understood legislative andcontractual procedural regime.

The parties should be able to expect thefollowing from a procedural regime oninternational arbitration:

■ that the arbitration agreement entered into bythe parties will be recognised and given effectunder law;

■ that the parties may agree on a set ofarbitration rules and that the mandatory rulesof the applicable procedural regime will notpresent obstacles to the effectiveness of suchchosen rules;

■ that the law will provide a minimum set ofprocedural solutions if the parties have notagreed on a set of arbitration rules, or if theagreed rules do not provide a solution;

■ that the arbitral tribunal may, subject tocertain acceptable limits, conduct thearbitration in such manner as it considersappropriate (unconstrained by technicalitiesapplicable in national procedural systems);

■ that the courts at the place of arbitration willprovide efficient assistance (in matters suchas the appointment of or challenge to anarbitrator), if the parties have not providedthemselves with such assistance;

■ that, in the interest of the parties and thepublic interest, a court will ensure judicialsupervision when the arbitral tribunal hasoverstepped its jurisdiction or a party hasbeen treated unfairly;

■ that the winning party will be able to enforcethe award, should the defendant refuse tocomply with it.

It is for the legislative regime governingarbitration to ensure that the above expectationsof the parties are fulfilled. Such a regime isincorporated in the UNCITRAL Model Law on

International Commercial Arbitration (discussedbelow). The Model Law provides well-balancedand universally known solutions to the issueslisted above. The 1958 New York Conventionon the Recognition and Enforcement of ForeignArbitral Awards adds another layer of rulesproviding certainty and predictability regardingthe recognition of arbitration agreements andthe enforcement of foreign arbitral awards.

The parties have a wide range of arbitration rulesto choose from, due to the numerous arbitralinstitutions offering to administer arbitrationson the basis of their rules. If the parties preferarbitration without the involvement, or withlimited involvement, of an arbitral institution, theymay agree upon the applicability of the UNCITRALArbitration Rules (discussed below). These Ruleshave become so widely known and accepted thatmany arbitral institutions have modelled theirrules on them, or are offering the parties anoption to administer their case under the Rules.

1958 New York Convention onthe Recognition and Enforcementof Foreign Arbitral Awards

The main purpose of the 1958 New YorkConvention on the Recognition and Enforcementof Foreign Arbitral Awards is to establish anobligation to enforce foreign awards and limit thereasons for which a national court may refuse torecognise or enforce a foreign arbitral award. A“domestic” award, i.e. an award made in thestate in which it is to be recognised, is notcovered by the Convention.3 In addition, theConvention deals with some issues concerningthe validity of the arbitration agreement.

Without discussing the solutions of theConvention in detail, it may be said that ithas passed two important tests. First, theConvention is acceptable in different legal,political and economic systems, including thoseof most of the transition countries of central andeastern Europe and the Commonwealth ofIndependent States (CIS). Secondly, the pro-visions continue to be acceptable, even thoughthe Convention has been in existence for morethan 40 years. This is illustrated by the fact thatthe provisions on the recognition and enforce-ment of awards in the UNCITRAL Model Lawclosely follow the main provisions of theConvention, and that the solutions of theConvention have been incorporated into anumber of multilateral and bilateralinternational treaties.

There are currently 126 states party to theConvention, and the number continues to grow.The expanding membership in the New YorkConvention enables commercial entities inmember states to rely on the growing networkof the regime for recognition and enforcementof awards. There are several reasons why it

continues to be in the interest of states tojoin the Convention:

■ Participants in international trade needreasonable confidence that in case of adispute, the decision of the arbitral tribunalwill be complied with. Without this confidence,it is difficult to expand trade to non-traditionalmarkets and establish trade ties withuntested partners. In addition, export creditinsurers are likely to regard the non-paymentrisk as higher without the protection of theConvention, which adversely affects theavailability of export credit insurance.

■ The adoption of the Convention does notmean that the state forfeits its role inarbitration and is therefore compelled torecognise and enforce all foreign awards.The Convention offers a reasonable scope forrefusing to recognise an award in cases wherethere has been disregard for rules relating tojurisdiction, arbitral procedure, arbitrability,and public order of the enforcing state.

■ Parties are usually more willing to accept theplace of arbitration in a state that is a party tothe Convention because of the internationalenforceability of an award.

■ By adopting the Convention, the state providesa legal basis for enforcement of awards madein its territory in those contracting states thathave adopted the Convention with thereciprocity reservation.

■ It is usually short-sighted for a party to refuseto comply with an award since the winningparty can obtain enforcement of the award onthe basis of the Convention in a third statewhere the party in default has assets. Suchenforcement is possible for many years afterthe award has been made.

The UNCITRAL Secretariat continues toactively promote the Convention. Recentlythe Secretariat, in cooperation with theInternational Bar Association, has been payingparticular attention to the manner in which theConvention has been incorporated into the lawsof the contracting states, and may propose tothe Commission that a discussion be held onthis matter.

UNCITRAL Model Law onInternational CommercialArbitration

The Commission adopted the Model Lawin 1985, after several years of extensivepreparatory work and consultations withinterested parties. Legislation based on theModel Law has been enacted in many states.In other states, its provisions have influencedalmost all recent national revisions of arbitrationlaws. It is clear that the number of enactmentsof the Model Law will continue to grow.4


The main purpose of the Model Law is to assistlegislators when they draft or revise nationallaws on arbitration. One of the many benefits of enacting the Model Law is that the legislationbeing introduced is already widely known anduniversally acceptable. When negotiatingarbitration agreements, parties are increasinglyconscious of the need for a modern arbitrationprocedural system in the country where anarbitration might take place. If the parties arenot comfortable or are unfamiliar with theprocedural law in that country, they are likely toavoid arbitrating there, even if that country wouldbe most appropriate for other reasons.

Model legislation

The form of a model law was chosen becauseit provides flexibility to the enacting state whenit incorporates the text into the nationallegislation. A model law allows a legislator todeviate from the model if it considers that aparticular model provision is unacceptable toits legal system. By comparison, a conventionmay allow such flexibility only to a limited extent,by way of reservations, which in commercial lawconventions are typically rather restricted.

Nevertheless, in view of the reasons forundertaking the preparation of the Model Law,and in view of the practical advantages of havinga universally known and acceptable law onarbitration for a state, it is advisable not todeviate from the uniform text.

Special regime for internationalcommercial arbitration

According to Article 1(1), the Model Lawpresents a special legal regime for internationalcommercial arbitration, as opposed to domesticarbitration. Nevertheless, there is nothing in theModel Law that would not also be suitable fordomestic arbitration. Several states haveenacted it for both international and domesticarbitrations.

Territorial scope of application of the Model Law

According to Article 1 (2), the Model Law (withthe exception of specified articles) would applyonly if the place of arbitration is in the enactingstate. The Model Law does not recognise a right of parties to submit their arbitration to aprocedural legal system other than that of theplace of arbitration. However, the determinationof the place of arbitration in the state leaves thearbitral tribunal free, unless otherwise agreed by the parties, to meet at any place it considersappropriate for consultations among itsmembers, for hearing witnesses, experts or the parties, or for inspection of goods, otherproperty or documents (Article 20). Thecombined result of these provisions is that the

parties determine the procedural law governingthe arbitration (and also the competence of thecourts for interventions in the arbitration) byagreeing on the place of arbitration, even if infact the proceedings take place in anothercountry or countries. Such a concept of territorialapplication of the Model Law is also suited to theincreasing use of electronic communications ininternational arbitrations.

Autonomy of the parties

An important principle of the Model Law is thefreedom of the parties to agree on how an arbi-tration should be carried out. Typically theparties would exercise this autonomy by incor-porating into their agreement a set of arbitrationrules such as the UNCITRAL Arbitration Rules.The parties may also submit the case to anarbitral institution, which would normally proceedon the basis of its arbitration rules.

Minimum set of non-mandatory rules anddiscretion of arbitral tribunal

The parties may fail to agree on a set ofarbitration rules, or the agreed rules may notgive all the answers. For such cases, the ModelLaw contains elementary non-mandatoryprovisions, which ensure that the proceedingsmay commence and continue until the makingof the award.

Subject to the agreed rules and the Law, thearbitral tribunal may conduct the arbitrationin a manner it considers appropriate. Thiscombination of the freedom of the parties,the system of non-mandatory rules, and thediscretion of the arbitral tribunal makes itpossible to conduct an international commercialarbitration independently from local rulesgoverning the conduct of proceedings in adomestic arbitration. This approach is welcomedin international arbitrations, in which it would becumbersome if the participants, often foreignersat the place of arbitration, would have toresearch and adhere to local rules of civilprocedure or rules of evidence.

Limits to autonomy of parties and todiscretion of arbitral tribunal

The Model Law provides limits to party autonomyand the discretion of the arbitral tribunal. Thelimits, designed to prevent abuses in arbitralproceedings, are provided in the interest of theparties and also in the interest of the state,which may be expected to enforce the award if the arbitral procedure is conducted inaccordance with the principles of justice.

The general rule is contained in Article 18,according to which each party must be treatedequally and be given a full opportunity to presentits case. This general principle is implemented

and expressed in a more specific manner insome other provisions of the Model Law.

Extent of court assistance andsupervision

The state enacting the Model Law is called uponto indicate in its law the court or courts that willbe competent to perform the functions ofassistance and supervision, particularly withregard to: the appointment of arbitrators;termination of an arbitrator’s mandate as aresult of a challenge or of his or her failure orinability to act; court control over a decision ofthe arbitral tribunal on its jurisdiction; settingaside of the arbitral award; and recognitionand enforcement of the award.

Waiver of right to object

During arbitral proceedings a party or the arbitraltribunal may act in a way that is contrary to theagreed arbitration rules or the non-mandatoryprovisions of the Model Law. If a party objects,remedial action must be taken or the awardmight be called into question. If, however,nobody objects, it might be uncertain as to whatthe consequence of the deviation from the rulesis. In order to avoid any doubt, Article 4 providesthat a party who knows that any non-mandatoryprovision of the Model Law, or any requirementunder the arbitration agreement, has not beencomplied with, and yet proceeds with thearbitration without objecting without undue delay,is deemed to have waived its right to object. Thisimportant presumption produces effects not onlyduring the arbitration proceedings, but also inany recourse proceedings against the award, orin recognition and enforcement proceedings.

Arbitration agreement

Article 7, which covers the form of the arbitrationagreement and has been modelled on the 1958New York Convention, contains additionalprovisions designed to eliminate someuncertainties noted in the application of thatConvention. The additional provisions concernarbitration agreements entered into by anexchange of means of telecommunication, whichprovide a record of the agreement, or by anexchange of statements of claim and defence, in which the existence of an agreement isalleged by one party and not denied by another.In addition, Article 7 addresses the question ofarbitration clauses in general contract conditionsthat may be incorporated in a written contract byreference. Currently, the Commission ispreparing a model legislative provision designedto promote a liberalisation of the formrequirement for arbitration agreements.5


The main purpose of the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards is to establish an obligation to enforce foreign awards and limit the reasons for which a national courtmay refuse to recognise or enforce a foreign arbitral award.

Jurisdiction of arbitral tribunal

Article 16 expresses the principle that thearbitral tribunal may rule on its own jurisdiction,including any objections with respect to theexistence or validity of the arbitral agreement.

The arbitral tribunal’s decision affirming itsjurisdiction is subject to court review. If such a decision is taken as a preliminary question, a party may request court review immediately,during the arbitral proceedings. If, however, thearbitral tribunal decides to rule on its jurisdiction,together with the award on the merits of thecase, the ruling affirming the jurisdiction canbe challenged in the recourse against thearbitral award.

Recourse against award

The Model Law establishes the setting asideof an arbitral award as the exclusive means ofrecourse against the award, and unifies thegrounds on which an award may be set aside.The grounds for setting aside an award areessentially the same as the grounds for refusingrecognition and enforcement of an award underthe 1958 New York Convention.

Thus, a party objecting to the award is given achoice by the Model Law, between requestingeither its setting aside at the place where theaward was made, or opposing its enforcement.This dual system of defence against an award is reasonable in view of the difference in thenature, effects and time frames of the twomeans of defence. On the one hand, the settingaside procedure is set in motion on the initiativeof the losing party before the court of the statein which the award was made. The effect of thesetting aside of the award is universal in that theaward (as provided by Article V (1) (e) of the1958 New York Convention) cannot berecognised or enforced anywhere. According toArticle 34 (3), the time limit for an application forsetting aside is three months after the receiptof the award. On the other hand, opposition toa request for recognition and enforcement isavailable to the defendant as long as andwherever the claimant may take the initiativeto rely on the award. The effect of a successfulopposition against a request for recognition andenforcement is limited to the state in which therecognition and enforcement was sought.

UNCITRAL Arbitration Rules

The UNCITRAL Arbitration Rules were adoptedin 1976. One of the main reasons for theelaboration of the UNCITRAL Rules was toprovide modern contractual rules suitable forad hoc arbitrations, i.e., arbitrations organisedby the parties themselves without the admin-istrative assistance of an arbitral institution.Such arbitrations were often commenced withoutthe parties having agreed on the rules ofprocedure, which was a source of difficulty whenthe participants in the arbitration had differentviews on how to proceed. The existence of theUNCITRAL Rules offers the possibility of avoidingsuch difficulties in ad hoc arbitrations.

Another reason for preparing the UNCITRAL Rules was to offer a model to arbitral institutions.With the growing number of institutions that haveadopted the Rules as their single or optionalinstitutional rules, or modelled their institutionalrules on the UNCITRAL Rules, the parties have abetter opportunity to combine the benefits of anadministered arbitration with the benefits of auniversally known and acceptable set ofarbitration rules. This orientation of the UNCITRALRules to different types of arbitration is possible,in view of the fact that as regards the proceduralrole of the arbitral tribunal, there is no essentialdifference between an ad hoc arbitration and anarbitration administered by an institution.

The UNCITRAL Rules are among the mostsuccessful international trade law texts. Theyhave become universally known and are widelyregarded by merchants in different parts of theworld as being well suited to the settlement of international commercial disputes. TheUNCITRAL Rules are written in clear languageusing expressions that are recognisable indifferent legal systems. The UNCITRAL Ruleshave proven to be effective in arbitrations inwhich the participants come from states withdifferent legal or social traditions. Indeed,negotiations for the conclusion of an arbitrationagreement are often short and simple if therules agreed upon are the UNCITRAL Rules.

In view of the international standing enjoyed by the UNCITRAL Rules, it is advisable for arbitral institutions to offer to administer casesgoverned by the UNCITRAL Rules or to adopt theRules, with necessary adaptations, as the rulesof the institution.

The UNCITRAL Rules, as is the case with anycontractual rules, function against thebackground of the law applicable to the arbitralprocedure. That law will be the law in force at the place of arbitration. To the extent that law is mandatory, it will prevail over the Rules. If it is non-mandatory, the Rules will override the lawbecause the parties agree to them.

The UNCITRAL Rules generally exclude theobligation to follow the non-mandatory provisionsof law governing the conduct of the arbitralproceedings. This is expressed by Article 15 (1):

“Subject to these Rules, the arbitral tribunalmay conduct the arbitration in such manneras it considers appropriate, provided thatthe parties are treated with equality and thatat any stage of the proceedings each partyis given a full opportunity of presentinghis case.”

However, the formulation of Article 15 (1) alsoindicates the limits of the discretionary right ofthe arbitral tribunal to “conduct the arbitration insuch manner as it considers appropriate”. Thelimit is defined by the introductory phrase:“Subject to these Rules”, which means that thearbitral tribunal’s discretion does not extend toquestions that are settled in the Rules. If thetribunal considers that it would be appropriate to deviate from a provision of the Rules, it maysuggest to the parties to agree to a modificationof the Rules.

The principle of independence of the arbitralprocedure from non-mandatory law on theconduct of proceedings has a significantpractical value in international commercialarbitration. In such arbitrations, it is notuncommon that some or all participants areunfamiliar with all aspects of the law of theplace of arbitration. It is important that suchparticipants, who often do not know thelanguage of the applicable law, are notobliged to undertake extensive researchon the local law.

UNCITRAL Notes on OrganizingArbitral Proceedings

In discussing legislative and contractualarbitration regimes, it is useful to mention theUNCITRAL Notes on Organizing ArbitralProceedings, a text that is neither legislation norcontract. The aim of the Notes, adopted in 1996,


is to give arbitration practitioners an aide-mémoire, or a checklist, for organising andplanning arbitral proceedings.

In the introduction to the Notes, it is stressedthat the text is in no way binding on thearbitrators or the parties. The expression“notes” (“aide-mémoire” in French) is used inthe title in order to reflect its non-binding nature.If anyone decides to refer to the Notes, thisleaves the discretion of the arbitrators and theautonomy of the parties unfettered. The Notesare a source of ideas, and practitioners remainfree to adapt those ideas to the proceedings athand. Thus, the text may be used in the contextof any type of arbitration – an arbitrationadministered by an arbitral institution or the so-called ad hoc arbitration – and irrespective of the type of arbitration rules governing theproceedings.

Many arbitrators have developed their ownpersonal methods for organising arbitralproceedings based on their individualexperience, including personal checklists ornotes. Experienced counsel also tend to followprocedural patterns that they are used to. Some practitioners have a tendency to modeltheir actions in arbitral proceedings onprocedures and habits used in courts, whileothers tend to adopt eclectic procedural styles,depending on their own view as to whichprocedures are most effective in arbitration.

To some extent the tendency to use principlesof court procedures in arbitration is under-standable, because the ultimate purpose (a binding resolution of the dispute) and thebasic procedural principles in both types ofproceedings are the same. However, arbitrationprocedures may be shaped more freely and aretherefore better adapted to the circumstancesof the case. This flexibility of arbitral proceduresis possible because of the absence of detailedlegislative regulation of arbitration, and is oneof the reasons for the appeal of arbitration ininternational trade. Nevertheless, the inspirationthat arbitration practitioners draw from methodsused in court proceedings remains considerable.

The preferred procedural styles in internationalarbitration differ widely, and often depend on theexperience and legal backgrounds of arbitrators.This makes it advisable for the arbitral tribunal tomake sure that all participants understand howthe proceedings will be conducted, and that they

are able to prepare themselves accordingly forthe various stages of the proceedings. If theparties are surprised by the manner in which theproceedings are conducted, or are unpreparedbecause they have not received sufficientguidance from the arbitral tribunal, the quality ofthe proceedings is bound to suffer and there willbe delays and extra costs. By organising theproceedings sensibly, such difficulties may beavoided or reduced. It is in this importantorganisational and explanatory work of thearbitral tribunal that the Notes are helpful.

An important principle underlying the Notes isthat they do not seek to unify different arbitrationpractices or methods or give value judgementsabout them. The text is also not meant to be amanual on how to conduct an arbitration. TheNotes are limited to a brief list with annotationsof procedural matters that may come up duringarbitral proceedings and on which the arbitraltribunal may wish to take appropriately timeddecisions.

UNCITRAL Conciliation Rules

The consideration of the texts governingarbitration would not be complete withoutmentioning conciliation as a complementarymethod of settlement of commercial disputes.The term “conciliation” is used here broadly torefer to various proceedings in which a personassists the parties in dispute in an impartialmanner in their attempt to reach an amicablesettlement. Conciliation differs fromnegotiations between the parties in dispute,in that conciliation involves impartial assistancefrom a third party to settle the dispute. Thedifference between conciliation and arbitrationis that a conciliation ends either in a settlementof the dispute or it ends unsuccessfully;in arbitration the arbitral tribunal imposes abinding decision on the parties. In addition to“conciliation”, other terms are used in practicefor such proceedings, including “mediation” and“neutral evaluation”. These terms are often usedinterchangeably without an apparent differencein meaning.

Conciliation is increasingly used in thecommercial world, because in many circum-stances it is seen as a promising alternative toarbitration. It is cheaper, less time consuming,free of formalities and, if it ends successfullywith a settlement, the result is preferable to abinding arbitral decision.


1 UNCITRAL was established in 1966 bythe UN General Assembly to promotethe harmonisation and modernisationof the law of international trade. It isa universal organisation with 36 statemembers from diverse geographic,economic and political areas. Legaltexts elaborated by the Commissionmay take the form, for example, ofa convention, model law, modelnormative rule, recommendation to the legislators or contract parties,model contract clause or legal guide.All UNCITRAL texts and preparatorymaterials are available in the sixlanguages of the United Nations(Arabic, Chinese, English, French,Russian and Spanish). TheInternational Trade Law Branchfunctions as the substantive secretariatof the Commission.

2 The UNCITRAL Working Group onArbitration is preparing modellegislative provisions on therequirement of written form forarbitration agreements, theenforceability of interim measuresof protection ordered by an arbitraltribunal, and the settlement ofcommercial disputes byconciliation/mediation. Currentinformation on this work may beobtained for the UNCITRAL Secretariator at www.uncitral.org under “WorkingGroups” (document A/CN.9/487 ofJune 2001).

3 Recognition and enforcement of bothforeign and domestic awards made ininternational commercial cases arecovered by the 1985 UNCITRAL ModelLaw.

4 Legislation based on the Model Lawhas been enacted in Australia, Bahrain,Belarus, Bermuda, Bulgaria, Canada,Cyprus, Egypt, Germany, Greece,Guatemala, Hong Kong SpecialAdministrative Region of China,Hungary, India, Iran (Islamic Republicof), Ireland, Kenya, Lithuania, MacauSpecial Administrative Region of China,Madagascar, Malta, Mexico, NewZealand, Nigeria, Oman, Peru, Republicof Korea, Russia, Singapore, Sri Lanka,Tunisia, Ukraine, Zimbabwe, within theUnited Kingdom of Great Britain andNorthern Ireland: Scotland; within theUnited States of America: California,Connecticut, Oregon and Texas.

5 See supra note 3.

6 See supra note 3.

* Jernej Sekolec, Dr. jur., L.L.M,Secretary of UNCITRAL and Chief of theInternational Trade Law Branch of theUnited Nations Office of Legal AffairsSecretariat of the United NationsCommission on International Trade Law Vienna International Centre P.O. Box 500 A-1400 ViennaAustria Tel: (43-1) 26060-4061Fax: (43-1) 26060-5813Email: [email protected] site: http://www.uncitral.org

The views expressed in this article arepersonal and do not represent the officialviews of UNCITRAL.

Conciliation may be a useful method where the disagreement is partly due to a deficient or incomplete contract. In such a case, bothparties may feel that a more precise contractwould eliminate the difficulty, but at the sametime they may not be able to agree on how toamend the contract. In this case, the contractmay not yet have been breached and even if ithad been breached, the best solution for thecase often requires a future-oriented decision on the modification of the contract, in addition to any monetary damages payable as a result of the breach of the contract.

Arbitration proceedings may not be appropriatefor this type of modification of the contractbecause arbitrators tend to limit their role to the claim arising from a breach of contract.Arbitrators are reluctant to conduct discussionson future relations between the parties, even if according to the applicable law it would bepossible to empower them to assume such arole. Moreover, the applicable law may not allowthe arbitrators to determine a contract term evenif both parties wish them to do so, or theapplicable law may be unclear on the point,which may make the nature and status of suchan arbitration legally uncertain.

When conciliation seems like an appropriatemethod to deal with a dispute, a growing numberof institutions are prepared to assist in theorganisation of the process. In many instances,the rules of those institutions have beenmodelled on or influenced by the UNCITRALConciliation Rules (1980). These Rules, whichpresent a modern conciliation regime suitablefor resolving international commercial disputes,may also be agreed upon by the parties directly,particularly when they wish to organise theconciliation proceedings themselves.

An important characteristic of the ConciliationRules is contained in the provisions directing theconciliator to be independent from the parties, and to be active in the conduct of the proceedings.Such provisions emphasise the differencebetween conciliation and negotiations between theparties and their representatives, which normallytake place in connection with a dispute.

Several provisions are designed to dealwith potential apprehension that proposals,concessions, submissions of evidence, orsimilar statements by a party during aconciliation that failed, might be used againstthat party in subsequent court or arbitralproceedings.

According to Article 19, the parties and theconciliator undertake that the conciliator willnot act as an arbitrator or as a representativeor counsel of a party in any arbitral or judicialproceedings in respect of a dispute that is the subject of the conciliation proceedings.

The parties also undertake that they will notpresent the conciliator as a witness in any such proceedings.

According to Article 20, each party undertakesnot to rely on or introduce as evidence in arbitralor judicial proceedings: (a) views expressed or suggestions made by the other party inrespect of a possible settlement of the dispute;(b) admissions made by the other party in thecourse of the conciliation proceedings; (c) proposals made by the conciliator; (d) the factthat the other party had indicated its willingnessto accept a proposal for settlement made by theconciliator. The scope and effect of Article 20 isbroadened by the rule that the parties’ decisionnot to rely on this type of evidence applieswhether or not the court or arbitral proceedingsrelate to the dispute that is the subject of theconciliation proceedings.

It is of practical importance that the ConciliationRules leave the participants free to conductthe proceedings in an informal, flexible andpragmatic manner. The Rules outline onlyessential features of the proceedings andleave the parties and the conciliator free toadapt the other aspects of the proceedingsto the circumstances of the case.

The pragmatism of the UNCITRAL ConciliationRules is reflected, for example, in the provisionthat allows the conciliator to meet or commu-nicate separately with a party. It is also reflectedin the provision according to which the arbitrator,when a party gives information to the conciliatorsubject to a specific condition that it be keptconfidential, does not disclose that informationto the other party.

Conclusion

Participants in international trade arebecoming increasingly conscious of the qualityof procedural regimes for the settlement ofcommercial disputes. They are willing to engagein dispute settlement proceedings in a particularcountry only if they are confident that theapplicable regime is well suited to internationalcases, and is easily understood by theparticipants. As the transition countriesintegrate more fully into the internationaleconomy, they will need to ensure that they havecreated such a procedural regime. UNCITRALhas prepared several texts that may be used inconstructing an acceptable regime.

A well functioning system of settlement ofcommercial disputes requires legislative textssuited to the needs of international arbitration.A universally acknowledged and accepted regimeis contained in the UNCITRAL Model Law onInternational Commercial Arbitration and the1958 Convention on the Recognition andEnforcement of Foreign Arbitral Awards.

In addition to relying on legislation, it is highlyadvisable for the parties to agree on a set ofarbitration rules to increase the predictabilityof the arbitral process. The parties may chooserules of an arbitral institution, or may decide toorganise the proceedings themselves, in whichcase the UNCITRAL Arbitration Rules are anexcellent choice. These Rules are among themost successful instruments not only in the areaof arbitration, but also in the entire field of tradelaw. They have fostered good arbitrationpractices, contributed to a more uniformunderstanding of arbitral procedures and areproven to function well between parties fromdifferent legal traditions. In carrying out arbitralproceedings, irrespective of the law governingthe proceedings and regardless of the arbitrationrules chosen by the parties, the arbitrators andthe parties may wish to use the UNCITRAL Noteson Organizing Arbitral Proceedings as a checklistin preparing the arbitral process.

Increasingly, conciliation (or mediation) is usedin settling international commercial disputes.Such proceedings are likely to be more effectiveand efficient if the process is clear and the rulesare agreed upon from the outset. Such rules maybe the rules of an arbitral institution, many ofwhich have been inspired by or modelled on theUNCITRAL Conciliation Rules. If the partiesorganise the proceedings themselves, theUNCITRAL Conciliation Rules provide a useful,proven and widely acceptable text to agree upon.

Currently, the UNCITRAL Working Group onArbitration is preparing a model law on thesettlement of commercial disputes by conciliationor mediation. Another current project concernsprovisions presenting more modern and liberalsolutions regarding the requirement of writtenform for arbitration agreements. A further projectis to prepare model legislative provisions on theenforceability of interim measures of protectionordered by an arbitral tribunal.6 As a result, allcountries, including the transition countries ofcentral and eastern Europe and the CIS, will needto continue to review and improve their legalframework for promoting the settlement ofcommercial disputes.


Why arbitration institutions matterOver the last two decades arbitration hasgradually superseded litigation as thepreferred dispute resolution mechanismin international commercial contracts.Enforceability, party-control, neutrality,privacy and confidentiality, cost effectivenessand speed are often cited as the mainadvantages of arbitration. In this article,the author examines the crucial role playedby arbitration institutions in arbitrationproceedings, and how they safeguard theadvantages associated with arbitration.

Adrian Winstanley, Director-General and Registrar, London Court of International Arbitration (LCIA)*


There is little doubt that arbitration is now thefirst-choice method of binding dispute resolutionin the widest range of international commercialcontracts, having largely taken over litigation.

In a nutshell, the reason for the significantgrowth in the use of arbitration is that it offerscontracting parties the freedom to choose amethod of private dispute resolution tailoredto their particular needs. This freedom extendsto the choice of applicable law, the venue,the language, and the choice of arbitrationprocedures, whether under institutional rules,stand-alone procedures, like the UNCITRAL1

rules, or entirely ad hoc.

Parties may also choose their arbitrators, thusensuring the constitution of a tribunal withprecisely the right qualifications and experience.

This article looks at the place of the arbitrationinstitutions in the ever-more sophisticated fieldof international commercial arbitration, wheread hoc procedures may, at first sight, appear anincreasingly appealing option. The author arguesthat abandoning the administering body is atbest a false economy and at worst mayjeopardise the process itself.

Why arbitral institutions matter

As arbitration becomes the norm, so parties to commercial contracts and their legal advisersbecome more familiar with arbitral procedures,and more confident in the process. In thesecircumstances, it is sometimes asked whyparties should bother with administeredarbitration at all, when: there are effectivearbitration laws in place in the jurisdictions ofmost, if not all, of the important trading regionsof the world; when there are good stand-aloneprocedures, like the UNCITRAL rules; and whenthere is a body of highly experienced arbitrators,whose identities and qualifications may alreadybe known to parties in dispute and/or to theirlegal advisers.

Yet the major international arbitrationinstitutions, such as the International Chamberof Commerce (ICC), the American Associationof Arbitration (AAA), LCIA and the ArbitrationInstitute of the Stockholm Chamber ofCommerce, continue to see a steady growthin their casework.

Reasons why administered arbitration is morerelevant than ever are best given in the contextof the most often cited underpinnings ofinternational commercial arbitration –enforceability, party-control, neutrality, privacyand confidentiality, cost-effectiveness and speed.

Enforcement of awards

For the many parties for whom a final andbinding settlement is paramount, theenforcement argument is, perhaps, the mostpersuasive and enduring.

In the event that a losing party fails to complywith an award against it, enforcement may be considerably easier to achieve than theenforcement of a judgement of a national courtin another jurisdiction would be. In the majorityof cases, the successful party will be able torely on the provisions of the New YorkConvention,2 now ratified or acceded to bysome 120 states.

Parties wishing to have the reassurance thatan award will be enforceable must, of course,ensure that the arbitration takes place (and thatthe award is made) in a Convention State, andthat the enforcement is against assets of thelosing party which are located in anotherConvention State.

Where the institution countsThe rules of the major international arbitrationinstitutions expressly provide that any award willbe final and binding and will be complied withwithout delay. By agreeing to be bound by suchrules, the parties usually also exclude any rightof appeal on the merits to a national court whichmay have jurisdiction to hear such an appeal.

Apart from the contractual obligation imposedupon the parties by the institutional rules, it isalso often said that arbitrations conducted underthe auspices of the major institutions areregarded by parties, and by the courts, withgreater respect and confidence than ad hocarbitrations, as are awards that bear theimprimatur of the institution.3

Party control

Arbitration offers parties a great degree ofcontrol over the proceedings. It allows them toestablish, from the outset, a method of resolving

disputes which is not bound by the often rigidprocedures and timetables of the courts.

Parties may agree a wide range of proceduralmatters, including such key issues as thenumber of arbitrators and their qualifications,the venue and language of the arbitration, thetimetable, and the need – if any – for oralhearings.

Such tailor-made dispute resolution provisions(both domestic and international) have beenendorsed by the arbitration laws of manyjurisdictions (for example, by the 1996Arbitration Act in England), and are reflected inthe rules of the major arbitration institutions.

Where the institution countsThere is no reason why the use of institutionalrules, and the use of the administrative servicesof an institution, should in any way underminethe parties’ control over the process. On thecontrary, most institutional rules are drafted toprovide an extremely effective framework for theproceedings, while expressly encouraging theparties to agree on the specific steps and thetimetable themselves.4 What the institutionsdo provide, however, is a safeguard againstwrecking tactics that amount not to thelegitimate exercise of party control but ratherto an abuse of the process.

Ad hoc clauses are frequently either inadequateor overly complex. In comparison, theincorporation of institutional rules by a simplestandard clause takes care of the fundamentalsand does so without recourse to the nationalcourts. By incorporating institutional rules intotheir contract, parties have the comfort of acomprehensive and proven set of terms andconditions upon which they can rely, regardlessof the seat of the arbitration. This minimises thescope for uncertainty and the opportunity fordelaying or wrecking the process.

The incorporation of a set of established ruleswill take care of the essential steps, including:the mechanism and timeframe for theappointment of the tribunal; determiningchallenges to arbitrators; default provisions forthe seat and language of the arbitration; interimand conservatory measures; and control of thecosts of the arbitration.


This article looks at the place of the arbitrationinstitutions in the ever-more sophisticated field of international commercial arbitration, where ad hoc procedures may, at first sight, appear an increasingly appealing option.

Though the procedural law applicable at the seatof the arbitration may also provide for thesematters, it can be cumbersome, time-consumingand costly to invoke the jurisdiction of nationalcourts at every procedural impasse. Courtintervention may also jeopardise theconfidentiality of the process.

Party-nominated arbitrators

With arbitration, parties are in the position of being able to choose the judges who willdetermine their dispute.

Where they say so in their contracts, orsubsequently agree, each side may nominate anarbitrator to be one of a panel of three. Whereno institution is involved, the third and presidingarbitrator will be nominated by the parties, orby the party-nominated arbitrators.

Each side may satisfy itself that the arbitratorit nominates has the requisite experience andknowledge in the field relating to the disputewhich has arisen. An arbitrator may also benominated because of his or her knowledge ofa particular national or state law and/or of alanguage pertinent to the dispute.

Similarly, it may be expressly provided, or agreedby the parties, that arbitrators should not be ofthe same nationality as the parties, and/or thatif two are, then the chairperson will not be.

Where the institution countsDespite greater experience and understandingof the process among users, the selection ofarbitrators can lead to considerable difficultieswhere there is no institution to assist. Forexample, many parties lack detailed informationabout suitably qualified arbitrators. Theinstitutions’ information will invariably be morecomplete and comprehensive than that ofindividual parties, and institutions will frequentlybe willing to put forward a number of names forthe parties’ consideration, where the arbitrationclause provides for party nomination.

Parties may also be tempted to seek to haveappointed someone who will be, if not anadvocate for their cause, at least predisposedtowards their point of view. This flies in the faceof the principle of impartiality and theindependence of arbitrators. The rules andpractices of the major institutions minimise therisk of any such bias.

The so-called “Dutco problem” can also causeconsiderable difficulties, where multiple partiescannot be clearly divided into two sides in thedispute. Though joint claimants identifythemselves as one side in submitting a singlerequest for arbitration, joint respondents maydeny that they have commonality of interest andobject to having to nominate jointly onearbitrator. Careful drafting is required at thetransactional stage of multi-party contracts ifthis potential problem is to be avoided. Themajor institutions have sought to address thisproblem in their rules by providing that, in theevent of any such difficulty, the institution willselect all three arbitrators, without regard to aparty’s nomination.

In short, parties have an important role in theselection of arbitrators, but it is a responsibilityto be exercised with due care. Most institutionsreserve the right not to appoint a party nomineeif he or she is considered not to be suitable orimpartial or independent.

The institutions have detailed knowledge of,and ready access to, the most eminent andappropriately qualified arbitrators. The LCIA, for example, operates a database of some 600arbitrators, mediators and experts from manydifferent jurisdictions, possessing the widestrange of legal and non-legal experience andexpertise. The database is not, however, aclosed list and parties are free to nominatearbitrators who are not on the database.Similarly, the LCIA will look outside its owndatabase when necessary. In all cases, the LCIAcourt alone may appoint arbitrators, whether ornot the parties nominate the arbitrators.

Institutions also actively keep abreast ofdevelopments and individual progress within thepool of arbitrators and have tried and testedprocedures for checking conflicts and availability,and for agreeing tribunals’ fee rates.

Neutrality

Parties to international agreements may beconcerned that the national courts of the partywith which they are contracting may have aninstinctive, or even a manifest, bias towards a party of the same nationality. Whether or notsuch concerns are well founded, arbitration may be seen as offering greater neutrality thanthe courts.

1 The United Nations Commission onInternational Trade Law.

2 The 1958 New York Convention on theRecognition and Enforcement of ForeignArbitral Awards.

3 Court decisions relating to institutionalarbitrations have frequently commentedfavourably on the role of arbitralinstitutions.

4 See, for example, Article 14 of the LCIARules.


Contracts are generally expressed to begoverned by the substantive law of thejurisdiction of one of the parties. An arbitrationvenue in a third country, with which neither partyhas links and which might be considered by theother to be influential, will provide a neutralenvironment within which to resolve disputes.

Similarly, if the chosen venue is located withinthe country of one of the parties, the differentnationalities of the arbitrators may remove anyperceived bias.

Where the institution countsNeutrality can be most effectively reinforced by subscribing to the rules of an independentinternational arbitration institution whichrequires all arbitrators to sign declarations of independence and impartiality, and whichexclude any potential bias which may arise fromthe common nationality of party and arbitrator.5

In many cases there is not a balance ofknowledge, experience, expertise andsophistication in the arbitral process, either onthe part of the parties or their attorneys. Themajor institutions, not only through their rulesbut also in their ethos and modus operandi, are wholly focused on the fairness and neutralityof the arbitral proceedings. Institutional rulescan therefore act effectively to safeguard dueprocess, the quality and enforceability of awards,and the reputation of the arbitral process.

Privacy and confidentiality

Litigation in national courts is generally open to the public and to the media. In contrast,arbitral proceedings are conducted in private so that the identities of the parties and of thetribunal, and the nature of the dispute, shouldremain confidential.

This confidentiality may assist to preserve tradesecrets and, in some cases, even to re-buildcommercial relations. Due to the private andconfidential nature of arbitration, proceedingsare conducted in a less formal atmosphere thanis generally the case in the courts. This providesan environment that may be more conducive toreaching a settlement.

Where the institution countsMost institutions are well equipped to assist theparties and the tribunals to maintain these keyelements of the process. This extends from thediscretion of their case-handlers, through theobservation maintained to safeguard confident-iality, to such practical assistance as the provisionof private hearing rooms and support facilities.

The LCIA has, at Article 30 of its rules, anexpress provision that the parties and thetribunal are bound to keep the proceedings, the deliberations and all materials created for

the arbitration, confidential. This provision isunique among the major arbitration institutions.

Cost-effectiveness and speed

Despite claims to the contrary by someproponents of litigation, there is a strong casefor international arbitration as the cost-effectivealternative to litigation across differentjurisdictions, particularly when costs areconsidered within the proper framework ofcost/benefit analysis.

It may be easier to get parties of differentnationalities into a neutral arbitration venue atthe outset rather than into the national courtsof one of them. Therefore, the costs of initiatingproceedings, and of preparing the case, areless likely to be wasted than they would be incourt litigation.

Crucially, at the end of the proceedings(assuming no settlement), an award may bemore likely to be complied with or enforcedthan would be the award of the courts of onejurisdiction in the courts of another. So, thesuccessful party to arbitration is less likely toexperience the hollow victory that often besetsinternational litigation.

The issuing of a final award is most likely to bethe conclusion of the proceedings, in contrast tothe judgement of a court of first instance, fromwhich there may be several levels of appeal,each involving considerable legal costs andmaking unwelcome demands on the parties’management time.

Time is money (though undue haste may bemore costly in the long run) and the inherentflexibility and party control of arbitration enables parties and tribunals to adopt as tight a procedural timetable as they wish, with potentially substantial cost savings.

Where the institution countsAn established institution provides a professionaland cost-effective administrative service, whichan ad hoc tribunal, with or without the cooperationof the parties, frequently cannot ensure.

Ad hoc arbitrations do not run themselves. If thetask is allocated to a member of the arbitrator’sown staff, to members of the parties’ legalteams, or to the parties themselves, there willbe considerable direct and indirect cost incurred,and rarely will the job be done as well as it wouldbe by specialists.

The institutions encourage parties to adopt asexpeditious an approach as possible, and manyof the institutional rules include all that isrequired for “fast-track” procedures, which candispose of a matter in a fraction of the time thatwould be spent in litigation.

A significant number of arbitrations arecommenced with a view to forcing or crystallisingsettlement discussions, and/or to “testing thewater”. With the backing of an institution, thatobjective may be achieved more easily and lessexpensively than by taking the ad hoc route, withits associated vagaries. A request for arbitrationneed only be a brief submission, which, togetherwith the registration fee, is all that is formallyrequired by the institution to set theproceedings in motion.

While it is not the role of an institution tointerfere with the conduct of the proceedings(as agreed between the parties, directed by thetribunal or prescribed by the rules), institutionsdo have an important role in monitoring theprocess, in lending support to parties,counsel and arbitrators, and in keepingthe process moving.

Even the most experienced of arbitratorsfrequently turns to the institutions for guidanceand support. Equally, parties may be hesitant to prompt their tribunals if they feel that mattersare not proceeding quickly or smoothly enough.Institutions will do so on their behalf. A goodSecretariat will also provide a valuable soundingboard on procedural matters.

There is also anecdotal evidence that theconduct of ad hoc arbitrations in certainjurisdictions may be more likely to mimic local litigation procedures than institutionalarbitration, with all the ponderous, complex andcostly procedures that a well-run institutionalarbitration will avoid.

The rules of the major institutions seek tocombine the best of civil and common lawprocedures, and to provide a framework for fastand cost-effective dispute resolution whollyindependent of the culture and procedures ofcourt litigation.

An institution will have in place a framework ofcharges, both for its own administrative servicesand for its arbitrators, and will monitor the costsas the proceedings progress. Contracting partieswill want to consider the different chargingpolicies of the institutions when drafting theirarbitration clauses. Some institutions, like theICC, charge for their own administrative servicesand for their tribunals’ fees on an ad valorembasis, related to the sums in issue. Others, likethe LCIA, charge hourly and daily rates.

The major institutions also act as secure andindependent fundholders of sums deposited bythe parties, disbursing these funds as requiredand, at all times, accounting to the parties forsums held and disbursed.


Other services

UNCITRALUsers and their counsel should look beyond theprimary function of the arbitration institutions inadministering cases under their own rules. Forexample, a number of institutions will act asappointing authority under ad hoc procedures,such as the UNCITRAL arbitration rules, whichare frequently chosen by parties who do not wishto opt for the rules of any specific institution. The Secretary-General of the Permanent Court of Arbitration in The Hague may designate theinstitution as the appointing authority, upon theapplication of a party. Alternatively, parties mayprovide in their contract for an appointing role forthe institution.

In such cases, parties will have the benefit of:the institution’s experience in selecting themembers of the tribunal;6 an established body to decide any challenge7 to an arbitrator; and theguidelines of the institution’s schedule of fees.8

Many of the recognised international institutionswill only act as appointing authority under theUNCITRAL rules. Some will also act as admin-istrator, with all the advantages for the partiesthat have been set out earlier in this article.

Scheme-specific proceduresWhile most recognised institutional arbitrationrules are considered to be universally applicable,parties to certain major multiparty contracts orschemes may prefer to put in place contract orscheme-specific dispute resolution procedures.Again, parties will wish to consider thedesirability of an appointing and/oradministering body for such procedures.

Institutions may also be prepared to take onother tailor-made dispute-resolution services.Examples of this include: where an appointingauthority is required where there is provisionfor expert determination of a dispute; forthe appointment of an adjudicator; or forthe establishment of a standing dispute-review panel.

MediationMany of the major arbitration institutions,including ICC, AAA and LCIA, also offer otherforms of alternative dispute resolution (ADR),including mediation, and bringing to theseadditional services all the professionalismand expertise for which their arbitrationservices are renowned.

Mediation procedures may be used both byparties who are already committed to mediate,by virtue of contractual dispute resolutionprovisions, and by parties who have not providedfor mediation, but who wish to mediate theirdispute, either during the course of, or in anattempt to avoid, litigation or arbitration.

Permanent information serviceFinally, subscribing to the services of an arbitralinstitution, whether or not those services areever employed “in anger”, brings to parties andtheir legal advisers, to academics, and to thenext generation of practitioners, an invaluableand permanent source of information andassistance, be it for theoretical or forpractical purposes.

In summary, the major, internationallyrecognised institutions have an increasinglyimportant role to play, not only in providingeffective frameworks and professionaladministration for arbitration and other formsof ADR, but also in the further developmentof arbitration and ADR techniques.

5 See, for example, Articles 5.2, 5.3 and6 of the LCIA Rules, or Articles 9.1, 9.2and 9.5 of the ICC Rules.

6 See, in particular, Article 6.2(a) ofthe UNCITRAL Rules.

7 See Article 12.1(a) of the UNCITRALRules.

8 See Article 39.2 of the UNCITRALRules.

* Adrian Winstanley, Director-General and Registrar LondonCourt of International Arbitration (LCIA)The International Dispute Resolution Centre8 Breams BuildingsChancery LaneLondon EC4A 1HP Tel: +44 020 7405 8008Fax: +44 020 7405 8009Email: [email protected].

The views expressed in this articleare Adrian Winstanley’s and are notexpressed on behalf of the LCIA.


Settlement of investmentdisputes: the experience ofICSID in transition countriesand elsewhere1

Public private partnerships between states andinternational investors play a growing role ineconomic development. Yet when entering intoan agreement with a state (or a subdivision oragency of a state), international investorsmay be reluctant to submit any disputes thatarise under the agreement to the courts of thestate. Likewise, states may resist thejurisdiction of foreign courts or arbitraltribunals sitting outside of their jurisdiction.Recognising the need to create anindependent and impartial dispute resolutionforum for cross-border public privatepartnerships, the International Bank forReconstruction and Development sponsoredthe establishment of the International Centrefor Settlement of Investment Disputes (ICSID)to address these issues.2 In this article, theauthor examines ICSID’s increasing role andits evolving jurisprudence.

Antonio R. Parra, Deputy Secretary-General, ICSID*


Investment treaties and the useof arbitration

There have been tremendous increases inforeign investment since 1990, both within andoutside the countries of central and easternEurope and the Commonwealth of IndependentStates (CIS). In this period, annual global flowsof direct foreign investment alone have grownfrom around US$ 200 billion to well over US$ 1trillion.3 This growth of foreign investment flowshas been accompanied by equally spectacularincreases in the number of investment treaties.By the end of 1990, only approximately 400bilateral investment treaties (BITs) had beenconcluded worldwide. Today there are roughly2,000 BITs.4 About 170 countries have signedone or more of these treaties. Central andeastern Europe and the CIS alone account forapproximately 650 of these treaties. Over thepast decade, several regional multilateraltreaties dealing with investment have also been concluded. These notably include the North American Free Trade Agreement (NAFTA)and the Energy Charter Treaty (ECT).5

The provisions of the bilateral treaties, and theinvestment provisions of the above-mentionedmultilateral treaties, are for the most part similarin form and content.6 Under some of the BITsand the NAFTA, each state grants certain rightsof entry to investments from the other state orstates involved. Most of the treaties, however,are principally concerned only with the treatmentof investments following their admission. TheBITs and multilateral treaties lay down a numberof general standards in this respect. With fewexceptions, they declare that the host state shall accord to covered investments “fair andequitable treatment.” Virtually all of the treatiesadd that the treatment shall be “no lessfavourable” than that granted to investments of local nationals or of foreign investors notcovered by the treaty. The treaties often alsostipulate that covered investments shall enjoy“full protection and security” in the host state.

More particular matters dealt with by the BITsand multilateral treaties include expropriation.The provisions on this topic normally addressboth outright and indirect or “creeping”expropriation. A typical treaty provision on thesubject provides that covered investments “shallnot be expropriated or nationalised either directlyor indirectly through measures tantamount toexpropriation or nationalisation … except for a

public purpose; in a non-discriminatory manner;upon payment of prompt, adequate and effectivecompensation; and in accordance with dueprocess of law.” Currency transfers are anothermatter usually dealt with by the treaties. In thisrespect, most of the treaties provide that eachstate shall guarantee investors of the other stateor states the “free transfer” of their investmentsand returns. The ECT and many BITs also haveprovisions on the observance by the state ofundertakings related to covered investments. Inthese provisions, each state confirms that it will“observe any obligation” that it may haveentered into with respect to such investments.

Almost all of the investment treaties furthermoreprovide for the arbitral settlement of disputesthat might arise between a state party to thetreaty and an investor from the other, or another,state party. In the overwhelming majority of thetreaties, the provisions set forth the consent ofeach state to the submission of such disputes to one or more forms of arbitration specified inthe treaty. In the event of a dispute with thestate, the investor concerned may resort to theappropriate form of arbitration on the basis ofthe state’s consent in the treaty. In most of thetreaties, including the NAFTA and ECT, there areconsents to one or both of the forms ofarbitration administered by the ICSID. These arearbitration under the 1965 ICSID Convention andarbitration under the 1978 ICSID AdditionalFacility Rules.7

ICSID’s growing caseload

The creation of this vast network of treaties withsuch consents has had a dramatic impact on the caseload of ICSID, particularly in the last fewyears. Since 1998, ICSID has been registeringarbitration cases at the rate of one new case amonth.8 Three-quarters of the new cases havebeen brought to the Centre by investors relyingfor the consent of the host state on the investor-to-state dispute-settlement provisions of one ormore of its investment treaties. Altogether, 41cases have been submitted to arbitration underthe ICSID Convention or the ICSID AdditionalFacility Rules on this basis. In one of thesecases, the investor invoked the dispute-settlement provisions of both a BIT and the ECT.The other cases involved only one of the treaties.In eight of them, the treaty concerned was theNAFTA, and in 32 it was a BIT.

1 This article is based on a presentationmade by the author at the InternationalFederation of Commercial ArbitrationInstitutions 6th Biennial DisputeResolution Conference in Prague, 22 June 2001.

2 ICSID was established pursuant to the Convention on the Settlement ofInvestment Disputes between Statesand Nationals of Other States of 18 March 1965. On 14 October 1966,30 days after the deposit with theInternational Bank for Reconstructionand Development of the twentiethinstrument of ratification, the Conventionentered into force.

3 See World Bank, Global DevelopmentFinance: Building Coalitions for EffectiveDevelopment Finance, (2001), p. 37.

4 See UNCTAD, Bilateral InvestmentTreaties Quintupled During the 1990s,UNCTAD Press Release TAD/INF/2877(15 December 2000). See also ICSID,Bilateral Investment Treaties 1959-1996: Chronological and Country DataBibliography, Doc. ICSID/17 (30 May1997).

5 The North American Free TradeAgreement (NAFTA), 17 December 1992is reprinted in International LegalMaterials Vol. 33, p. 289 (1993).The principal provisions related toinvestment are contained in Chapter 11of the NAFTA. The Energy Charter Treaty(ECT), 17 December, 1994 is reprintedin ICSID Review – Foreign InvestmentLaw Journal, Vol. 10, p. 258 (1995). The principal provisions related toinvestment are contained in Part IIIof the ECT.

6 The texts of bilateral investment treatiesare published or forthcoming in ICSID,Investment Promotion and ProtectionTreaties (looseleaf, 1983).

7 Many BITs, as well as NAFTA and ECT,also refer to arbitration under theUNCITRAL Arbitration Rules. See NAFTA,supra note 3, Article 1120(1)(c) andECT, Article 26(4)(b). The ECT refers, inaddition, to arbitration under the Rulesof the Arbitration Institute of theStockholm Chamber of Commerce.See ECT, supra note 3, Article 26(4)(c).Some BITs also, or instead, mentionarbitration under the ICC ArbitrationRules. See, for example, Agreementon Promotion and Protection ofInvestments, Algeria – Spain, Article11(2) (23 December 1994)

8 See ICSID Cases, Internet Edition, athttp://www.worldbank.org/icsid.


The investments underlying the cases brought to ICSID under the investment treaties have included equity contributions, concessionagreements and various other contractual forms of investment in virtually all economic sectors.

States in all major regions of the world havebeen parties to these ICSID proceedingsinitiated under investment treaties. The activityhas, however, been higher in some regions thanin others. Two-fifths of the investment treatycases have had Latin American countries asrespondents. The next largest group of statesparties to the cases have been countries incentral and eastern Europe or the CIS. Of the32 BIT disputes, seven involved a country fromcentral and eastern Europe or the CIS. It mightbe noted that, while it was not a BIT case, inTradex Hellas S. A. v. Albania, the EBRD hostedthe hearing on the merits in the first ICSIDarbitration proceeding to involve one of theEBRD’s countries of operations. In late 1998,the EBRD provided the facilities for the hearingat its premises in London. Although it was notitself in any way connected with the dispute orits formal resolution, the EBRD indicated at thetime that it wished to support ICSID in this wayin order to signal to the EBRD’s recipientcountries its encouragement of internationalarbitration as an appropriate method ofresolving cross-border disputes.

In the majority of the cases, the home states of the investors (that is, the other parties to thetreaties concerned) have been members of theOrganisation for Economic Cooperation andDevelopment. Reflecting the great number andreciprocal nature of the investment treaties,however, the claimant investors have alsoincluded nationals of developing and transitioncountries, and the respondent states have alsoincluded industrial countries.

The investments underlying the cases brought to ICSID under the investment treaties haveincluded equity contributions, concessionagreements and various other contractual formsof investment in virtually all economic sectors.In many of the cases, the investments have beenin newly privatised utilities. The disputes oftenhave related to measures of sub-nationalentities, such as provinces, for which theinvestor seeks to hold the state responsible.In some of the cases, the disputes have beenprecipitated by ostensibly environmental or otherregulatory measures. The complaints of theinvestors in three of the cases, including twoof the NAFTA cases, have been directed atdecisions of courts in the host state. Two of theother cases have concerned losses occasionedby civil strife in the host state.

In all of the cases submitted to ICSID pursuantto the investor-to-state dispute-settlementprovisions of investment treaties, the investorshave alleged violations by their host states of the substantive provisions of the treaties, eventhough most of the treaties also allow claims tobe made on other grounds. The investors have in each case invoked one or more of the generaltreatment provisions of the treaties – theprovisions calling for “full protection andsecurity” and treatment that is “fair andequitable” and “no less favourable” than thatgranted to investors of other nationalities. Theprotection of the treaties against measurestantamount to expropriation have also beenrelied upon by the claimant investors in most of the cases. In some of the cases, the investorshave, in addition, cited in support of their claimsthe provisions of the treaties on the “observanceof undertakings”. The amounts in dispute in thecases have totalled some US$ 4 billion.

ICSID’s evolving jurisprudence

Of the 41 arbitration proceedings that have sofar been initiated under the ICSID Convention orAdditional Facility Rules on the basis of consentsin investment treaties, nine have beenconcluded with settlements agreed by theparties. In two further cases, the tribunalsrendered awards declining jurisdiction over thedisputes. There were awards on the merits inan additional eight of the cases. One of theseawards has, however, been partially set asideand annulment proceedings under the ICSIDConvention are pending in respect of two moreof the awards on the merits.9 The claims of theinvestors were completely dismissed by one ofthe five remaining awards on the merits. The fourothers granted the claimants compensationaveraging 10 per cent of the amounts claimed.

The five above-mentioned remaining awards onthe merits have all been published.10 Althoughnone of these awards pertains to countries incentral and eastern Europe or the CIS, they havehelped to elucidate some of the substantivestandards of treatment contained in theinvestment treaties, including those concludedby central and eastern European and CIScountries. The first of these awards wasrendered in June 1990, in Asian AgriculturalProducts Limited v. Sri Lanka. This was the firstcase brought to ICSID under a BIT. The awarddealt with the standard of “full protection andsecurity” set forth in the BIT. This was equated

by the award with the standard of “duediligence” of customary international law. Theaward rejected the argument of the claimant thatthe “full protection and security” provision of thetreaty instead imposed on the host state strict or absolute liability for harm suffered by coveredinvestments. In addition, the tribunal in theAsian Agricultural Products case declined togrant compensation in respect of future profits of the investment enterprise as it had neverbeen an ongoing concern “enjoying a proven‘future profitability’”.

The second of the five above-mentioned awardson the merits was made in February 1997 inAmerican Manufacturing & Trading, Inc. v.Democratic Republic of the Congo, an arbitrationalso initiated under a BIT. The BIT in thatparticular case provided for “protection andsecurity … not less than that recognised byinternational law”. In its award, the tribunalreaffirmed that the relevant standard ofinternational law was one of “vigilance and care”on the part of the host state. The third awardwas rendered in March 1998 in Fedax N.V. v.Venezuela, which was another BIT case. In anapparent reference to the “observance ofundertakings” provisions that the BIT contained,the award remarked that the state had, underthe BIT, “to honour the specific paymentsestablished in the promissory notes” concerned.The fourth award was the November 1999 awardin Robert Azinian and Others v. Mexico. This wasthe first award on the merits made in a NAFTAinvestor-to-state arbitration. It rejected anexpropriation claim based on the invalidation of a contract by an administrative act upheld by competent local courts in circumstances notinvolving a denial of justice or bad faith. The fifthaward was made in November 2000, in anotherBIT case, Emilio Augustín Maffezini v. Spain. Theaward in that case held that the “fair andequitable” treatment standard of the BIT hadbeen violated by a lack of transparency in theimposition of certain charges on the investor.

Proceedings are pending in 22 further casessubmitted to ICSID under investment treaties. Six of these further cases have been initiatedunder the NAFTA and 16 under BITs (with the ECTalso being relied upon in one of the latter cases).In due course, therefore, there should be aconsiderably larger ICSID jurisprudence on thesubstantive provisions of the investment treaties.


Conclusion

Several prominent non-governmentalorganisations have questioned the wisdom of the investor-to-state dispute-settlementprovisions of the investment treaties. They haveexpressed the concern that the provisions maybe too readily deployed to undermine measurestaken for such purposes as protecting theenvironment and public health. But it may betoo soon to draw such conclusions. As indicatedabove, only a few of the cases have beendefinitively disposed of, and most of themare still pending.

The investor-to-state arbitral process has alsobeen criticised for lacking transparency in thatwritten and oral phases of proceedings takeplace away from the public eye, without theopportunity for concerned citizens to makesubmissions to the tribunals. Arbitrationproceedings under the ICSID Convention andAdditional Facility, however, receive publicitythrough the Centre’s case registers, newsletterand annual reports. The Centre publishes theawards as soon as it obtains the requiredconsent of the parties for such publication.11

There appears, moreover, to be no instance ofan investor-to-state arbitral tribunal holding thatit cannot entertain “friends of the court” briefs.On the contrary, it appears that the tribunals may already have the authority to receive suchbriefs.12 A further opening of the process, toallow for example for public hearings, may bedone with the consent of the parties. In one caserecently administered by ICSID there were, withthe consent of the parties, hearings open to thepublic and simultaneous postings on the ICSIDweb site of filings by the parties.13 Generalauthorisations for such further openness mightbe incorporated into future investment treaties.

Countries have meanwhile continued to concludenumerous BITs containing the usual investor-to-state dispute-settlement provisions. Accordingto the United Nations Conference on Trade andDevelopment, 130 BITs were concluded in 1999alone.14 ICSID’s caseload has also continuedto grow rapidly. In view of the still expandingnetwork of investment treaties throughout theworld, including in central and eastern Europeand the CIS, this trend in the caseload is likelyto be with us for some time.


9 See United Mexican States v. MetalcladCorporation, Supreme Court of BritishColumbia, Reasons for Judgment, 2 May2001, 2001 British Columbia SupremeCourt Reporter, p. 664, partially settingaside the award of the Arbitral Tribunal inMetalclad Corporation v. United MexicanStates (Case No. ARB(AF)/97/ 1). Theaward in that case, a NAFTA Chapter 11proceeding, was rendered under theICSID Additional Facility Rules. Awardsrendered in ICSID Convention proceed-ings are not subject to any appeal or toany other remedy except those providedfor in the Convention itself. In contrast,awards rendered in ICSID AdditionalFacility proceedings may be set aside by competent national courts at thedesignated place of arbitration. See alsoICSID Cases, supra note 6, for informationon the ICSID Convention annulmentproceedings referred to in the text andinitiated in Wena Hotels Limited v. ArabRepublic of Egypt (Case No. ARB/98/4)and in Compañía de Aguas del AconquijaS.A. and Vivendi Universal v. ArgentineRepublic (Case No. ARB/97/3).

10 References for these and otherpublished awards in ICSID cases areprovided on ICSID’s web site http://www.worldbank.org/icsid. See ICSIDCases, supra note 6. The texts of mostof these awards are available on-line onthe web site of the Centre or have beenpublished or are forthcoming in the ICSIDReview – Foreign Investment Law Journal.

11 Article 48(5) of the ICSID Conventionprovides that the Centre shall not publishawards made pursuant to the Conventionwithout the consent of the partiesconcerned.

12 See Methanex Corporation v. UnitedStates of America, Decision of theTribunal on Petitions from Third Personsto Intervene as “Amici Curiae”, 15January 2001, at http://www.naftaclaims.com. The Tribunal in thisNAFTA Investment Chapter proceeding,conducted under the UNCITRALArbitration Rules, held that it had“the power to accept amicus writtensubmissions from the Petitioners”.This decision was rendered in regard topetitions for amicus curiae status in thisarbitration submitted by four NGOs.

13 The reference is to the Southern BluefinTuna Case (Australia and New Zealand v.Japan). In that case, an arbitrationinstituted under Annex VII of the UnitedNations Convention on the Law of theSea, the parties and the arbitral tribunalagreed to entrust the administration ofthe proceeding to ICSID, and to openthe proceeding to the public in the waysmentioned in the text. The case showedthat ICSID has the administrativecapabilities to handle proceedings opento the public if parties decide to do thisin investor-to-State cases (even thoughthe Southern Bluefin Tuna Case was aState-to-State proceeding). For furtherdetails on the Southern Bluefin TunaCase, see the full record of the proceed-ing at http://www.worldbank.org/icsid.

14 See UNCTAD, World InvestmentReport 2000, p. 8.

* Antonio R. ParraDeputy-Secretary GeneralICSIDThe World Bank GroupWashington D.C. 20433, USATel: +1 202 477 1234Fax: +1 202 477 6391Email: [email protected]

Lender beware: an overviewof contractual defencesA party attempting to enforce the terms of awritten document in complex commercialtransactions may be prevented from relyingon what it considers to be the literal meaningof the words of the contract. Denying thevalidity of the contract, seeking a non-literalinterpretation, implying unwritten terms,relying on the conduct of the opposing party,or the existence of an extraneous event,are all potentially valid reasons to preventenforcement. This article briefly canvassesthe relevant considerations to each of thesedefences under English law.

Michael E. Barrack, Georges P. Racine and Anthony Alexander, Partners, McCarthy Tétrault*


Parties who seek to enforce the strict terms of written contracts will often be faced with abewildering array of defences and manoeuvresunder English law. The very existence of abinding contract may be denied. The plain wordsof the contract may be construed against theirapparent meaning. Terms may be implied intothe contract. Unplanned events may disrupt thebargain. The behaviour of the parties maychange the terms of the deal. This article willexamine a number of legal principles whichmay arise in the context of attempts to enforcecommercial contracts under English law.

The incentives to avoid the written words of acontract may be more acute in the internationalcontext. Each of the contracting parties maybring a unique language, legal and economicbackground to the bargain. In matters suchas project finance, the arrangements will bereduced to a series of interrelated, complexand creative contracts. These documents oftenreflect the English language, law and economicsystem. The diverse backgrounds of thecontracting parties may cause them to interpretthe same documents differently. Those involvedin creating international financial contracts,performing the bargains contemplated by them,and ultimately attempting to enforce thosebargains under English law, risk being subject toconstraints which are not apparent from a simplereading of the contractual documents.

In the context of commercial contracts,including financing contracts, the relationshipbetween the parties is consensual. Partiesallocate economic risk and attempt to embodythat risk allocation in a written contract. If therelationship breaks down, courts or arbitratorsmust first determine what bargain existedbetween the parties. Having determined theextent of the original bargain, it is necessary to determine whether any behaviour subsequentto the formation of the contract alters theparties’ rights. Only then is a court in a positionto assess the remedies which are available toaddress the effects of the breakdown.

At each stage of this analysis, English law allowsthe court to move beyond the literal meaning ofthe words of the contract. Those words will beinterpreted against the background of thecontract. Words may not be given their ordinarymeaning. Terms may be implied into the contractto give effect to what the court finds was thetrue bargain. Events may occur after the

formation of the contract which affect thebargain. These events may involve the conductof the parties or completely extraneous events.

Despite the existence of these mechanisms tomove beyond the literal words of the contract,the process is one of determining the realbargain between the parties. Courts will respectconsensual commercial arrangements whenapplying English law. Parties will be held to whatis found to be their contractual undertakings.

The contract is not binding

One of the common tactics for avoiding theenforcement of a contract is to suggest that thecontract was not validly executed. Unsophisti-cated parties may argue that they were unawareof the nature of the document when it wasentered into. The English law doctrine governingsuch defences is “non est factum”.

The defence of non est factum requires acontracting party to argue that it has executedthe written document under a fundamentalmisapprehension as to the nature of thedocument. In such circumstances, the partypleads that the mistakenly executed documentis “not its deed”, and is therefore void.

A party relying on non est factum must satisfy atwo-stage test: first, it must be demonstrated thatthe party took reasonable care to find out at leastthe general effect of the document before signing;and, secondly, the party must further prove thatthere is a radical difference between what wassigned and what the party thought was signed.

In the leading English authority in this particulararea,1 each member of the House of Lordscontributed certain key principles governingwhen the defence of non est factum is and is not available. Thus, it is clear that there must be a radical or fundamental difference betweenwhat was signed, and what was believed to havebeen signed (per Lord Reid); the difference mustgo to the substance of the whole considerationor to the root of the matter (per Lord Hodson);the difference must be such that the documentsigned is entirely or fundamentally different fromthat which it was thought to be, so that it wasnever the signatory’s intention to execute thedocument (per Viscount Dilhorne); and thetransaction must be essentially different insubstance or in kind from the transactionintended (per Lord Wilberforce).

1 Saunders v. Anglia Building Society,(1971) A.C. 1004.


Given the broad discretion of the courts to import commercialreasonableness into the interpretation of contracts, it should be anticipatedthat defaulting parties may attempt to avoid liability by suggesting that thewords of the contract should not be given their literal meaning. Insteadcreative interpretations based on the “matrix of fact” against which thebargain was struck may be put forward.

The House went on to state that the plea cannotbe available to anyone who was content to signwithout attempting to determine (at least) thegeneral effect of the document. Nor is itavailable to a person whose mistake was really a mistake as to the legal effect of the document,whether that was his or her mistake or that of hisor her adviser. In all cases, the burden of proofrests on the signing party who now seeks toescape the consequences of the contract.

Generally, in commercial financing transactions,all of the parties will be well aware of the natureof the contractual documents which they areexecuting, and will be informed of their effect by professional advisers. In the context ofinternational project finance, the bargain will be made up of a series of individual but relatedcontracts between a foreign sponsor, a domesticentity and a lender or lenders (often including aninternational financial institution). If one of theseparties, in the event of a dispute, is able toconvince the adjudicator under English law that,despite taking care, it did not comprehend oneof the documents which it signed, there is a riskthat this entire document may be unenforceableagainst that party. The danger will be heightenedif the party seeking to enforce the document wasaware, prior to the signing of the documentation,that the other party was uncertain as to thenature of the document.

In international transactions this concern isparticularly relevant and should be addressedwhen dealing with counterparties who lackexperience in Western financing practices,or where parties are asked to sign, in English,documents which they have only been able toreview through inadequate translations and/orwithout the assistance of experienced legalcounsel (who in turn can review the agreementsin English). In such cases, it is prudent to ensureall parties’ proper understanding of thecontractual terms, legal representation byexperienced legal counsel, as well as theaccuracy of translations presented. In addition,competent independent legal advice and plainlanguage expression in documentation may besupplemented by correspondence from eachparty explaining in brief terms the nature andeffect of each of the contractual documents.While such correspondence may not be used tointerpret the contract, it will be very useful inavoiding a later plea of non est factum.

Determining the bargain fromthe words of the contract

Under English law, if a dispute arises over theperformance of a contract, the initial task is todetermine whether the contract expressly dealswith the issue. Modern courts have dispensedwith much of the formalism involved incontractual interpretation. It has been noted that“[a]lmost all the intellectual baggage of ‘legal’interpretation has been discarded” , withthe result that the way in which contractualdocuments are interpreted by judges has beenassimilated “to the common sense principles bywhich any serious utterance would be interpretedin ordinary life”.2

The House of Lords has set out five principlesto be utilised in the construction of a contract.These principles may be summarised as follows:

1. Interpretation is the ascertainment of themeaning which the document would convey toa reasonable person having all the backgroundknowledge which would reasonably have beenavailable to the parties in the situation inwhich they were at the time of the contract.

2. The matrix of fact which the court will look toin interpreting the contract includes absolutelyanything which would have affected the way in which the language of the document wouldhave been understood by a reasonable personsubject to the following exception.

3. The law excludes from the admissible back-ground the previous negotiations of the partiesand their declarations of subjective intent.

4. The meaning which a document would conveyto a reasonable person is not the same thingas the meaning of its words. The meaningof words is a matter of dictionaries andgrammars; the meaning of the document iswhat the parties using those words againstthe relevant background would reasonablyhave been understood to mean. Thebackground may not merely enable thereasonable person to choose betweenthe possible meanings of words which areambiguous but even to conclude that theparties must, for whatever reason, haveused the wrong words or syntax.

5. The “rule” that words should be given their“natural and ordinary meaning” reflects thecommon sense proposition that we do noteasily accept that people have made linguistic

mistakes, particularly in formal documents.On the other hand, if one would neverthelessconclude from the background that somethingmust have gone wrong with the language, thelaw does not require judges to attribute to theparties an intention which they plainly couldnot have. If detailed somatic and syntacticalanalysis of words in a commercial contract is going to lead to a conclusion that floutsbusiness common sense, it must be made to yield to business common sense.3

Given the broad discretion of the courts to importcommercial reasonableness into the interpretationof contracts, it should be anticipated thatdefaulting parties may attempt to avoid liabilityby suggesting that the words of the contractshould not be given their literal meaning. Insteadcreative interpretations based on the “matrix offact” against which the bargain was struck maybe put forward. This factual background will bemore complex in the case of contracts involvingparties from diverse political, social and legalbackgrounds. In this context the factualassumptions of one party may be unexpressedor misunderstood. This kind of misunderstandingmay occur in the context of financial covenantcompliance. In that context, parties may havedifferent understandings with respect to theapplicability of customary terms which may beundefined, particularly where the referencedaccounting principles are not specified. Anotherinstance where this may typically occur is wherethe scope of a project is loosely defined, leavingroom for differing interpretations.

To assist in the interpretation of the contract,care must be taken to use the simplest andmost direct language possible, especially whensetting out the conduct expected of each party. If the background analysis and assumptionswhich underlie the bargain have been appendedto the documents as schedules, then it is aneasier task to prove to an adjudicator thecommercial realities which the parties facedwhen entering into the contract. These analyticaldocuments remove the ability of defaultingparties to insist that they were unaware of, orhad a different understanding of, the “matrix offact” which lay behind the words of the contact.

Once the court has completed the task ofinterpreting the contract, it will make a factualdetermination of the obligations of each of theparties. In most cases, the obligations found willbe exactly those set out in the literal words of


the contract.4 In all cases, the court will holdparties to the commercial bargains they haveentered into.

Implying terms into the writtencontract

English law recognises that the entire bargainbetween the parties cannot be embodied in theformal written contract between them. If theparties do not expressly provide for a matterwithin the contract, the court may imply a term.

Implied terms fall into two categories: termswhich are implied by law; and terms which maybe implied by the wording of the contract in thesurrounding circumstances in an attempt toreflect the intention of the parties.5

Courts have recognised that, when the words of a contract are insufficient to provide businessefficacy, it is necessary either to imply a term or interpret the existing terms on a commerciallyreasonable basis. On these grounds, Englishcourts may imply a term to reflect the intentionof the parties: (a) where a term is necessary togive business efficacy to the contract; and (b)where a term represents the obvious (butunexpressed) intention of the parties.6

In one leading case, the court described theappropriate approach in the following manner:7

“The tools available to a Court in this exerciseof reluctance to accept that the parties havecontracted to do the impossible are those ofconstruction of the express terms used by theparties and of implying a term which qualifies,but does not contradict, the express terms.In many, and perhaps most, cases it may bedebatable whether the Court is giving thewords a ‘commercial construction’ or whetherit is implying a qualifying term and I cannotthink that it matters. What does matter is thatin its struggle to make common sense prevail,the Court cannot say that the parties agreedupon something, however sensible, when theirchosen words show clearly that they agreedthe exact opposite.”

Despite the broad statements of the circum-stances in which English courts will imply termsinto a contract to provide business efficacy orwhere the omission is obvious, it is not enoughthat a term simply be reasonable, unless it isone which would be agreed to by both parties.8

Accordingly the courts have been reluctant toimply terms, holding that the general presump-tion is that the parties have expressed everymaterial term which they intended should governtheir agreement.9

Therefore, at a minimum, implied terms mustbe capable of being formulated with clarityand precision.10

Commercial contracts which are to beperformed in emerging economic markets may be subject to a series of risks which arenot dealt with in more conventional contracts.When such instruments are expressed assubject to English law, it is important that allforeseeable risks be dealt with explicitly. Thisavoids the danger that a court will imply termson the basis of traditional concepts of businessefficacy or obvious inference. The danger isthat a term which gives business efficacy in afully developed economy may not be applicablein a region facing a developing politicalenvironment. Similarly, terms which may beobvious in a settled economy may make lesscommercial sense in a region undergoingeconomic change. If parties seek to avoidthe performance of their obligations on thebasis of implying terms into contracts, it maybe necessary to develop a complete factualrecord to avoid the inference that such termsare warranted in the circumstances.

English law will not countenance the rewritingof contracts to reflect parties’ desire to alter thebargain in light of changed circumstances. Theimportant factual context is that which existedat the outset. True obligations will not be variedby the implication of terms. These will onlybe clarified.11

Conduct of the parties alteringthe bargain

A party who has successfully negotiated forcertain protective rights, and who has ensuredthat such rights are expressly enshrined in thecontract itself, must be conscious of the dangerthat certain forms of subsequent conduct mayundermine the value and efficacy of thesecarefully drafted provisions.

More particularly, it must always be borne in mindthat certain forms of action or inaction by onecontracting party may be viewed as a concessionor acknowledgement that that party does not

2 Investors Compensation Scheme Ltd. v.West Bromwich Building Society, (1998)1 W.L.R. 896 (H.L.) at 912.

3 Investors Compensation Scheme Ltd. v.West Bromwich Building Society, (1998)1 W.L.R. 896 (H.L.).

4 Lewison, The Interpretation of Contracts,p. 85-118 (2nd ed., 1997).

5 Shell UK Ltd. v. Lostock Garage Ltd.,(1976) 1 W.L.R. 1187 (C.A.), per LordDenning M.R.

6 “The Moorcock” (1889), 14 P.D. 64at 68; Shirlaw v. Southern Foundries,(1939) 2 K.B. 206 at 207; The Manifest Lipowky, (1989) 2 Lloyd’sRep. 138 at 143.

7 Eurico SpA v. Philip Brothers (“TheEpaphus”), (1987) 2 Lloyd’s Rep. 215,per Sir John Donaldson M.R. at 219.

8 Liverpool City Council v. Irwin, (1977)A.C. 239 at 266.

9 Luxor (Estbourne) Limited. v. Cooper,(1941) A.C. 108 at 137.

10 Shell UK Ltd. v. Lostock Garage Ltd.,(1976) 1 W.L.R. 1187 (C.A.) at 1197.

11 “The Moorcock” (1889), 14 P.D. 64 at 68.

12 Hughes v. Metropolitan Ry. (1877),2 App.Cas. 439, per Lord Cairns, L.C.at 448.

13 Charles Rickards LD v. Oppenheim,(1950) K.B. 616, per Denning L.J.at 623.

14 Tufton v. Dilmun, (1992) 1 Lloyd’sRep. 71.

15 Enrico Furst & Co. v. W.E. Fischer Ltd.,(1960) Lloyd’s Rep. 340, per Diplock J.at 349-350, quoting Birmingham andDistrict Land Company v. London andNorth Western Railway Company (1888),40 Ch.D. 268 at 286.

16 China-Pacific SA v. The Food Corp. ofIndia, (1980) 2 Lloyd’s Rep. 213, perMegaw L.J. at 223.

17 Spiro v. Lintern, (1973) 1 W.L.R. 1002(C.A.), per Buckley L.J. at 1010.

18 Hughes v. Metropolitan Ry. (1877), 2 App.Cas. 439; and Ogilvy v. Hope-Davies, (1976) 1 All E.R. 683 (Ch.D.).


intend to rely upon, or to enforce, the strict legalrights granted to it by the contract. The seminalEnglish case in this area of law provides a usefulsummary of the relevant principles:12

“...[I]f parties who have entered into definiteand distinct terms involving certain legalresults -- certain penalties or legal forfeiture --afterwards by their own act or with their ownconsent enter upon a course of negotiationwhich has the effect of leading one of theparties to suppose that the strict rights arisingunder the contract will not be enforced, or willbe kept in suspense, or held in abeyance, theperson who otherwise might have enforcedthose rights will not be allowed to enforcethem where it would be inequitable havingregard to the dealings which have thus takenplace between the parties.”

The legal doctrines whereby English lawrecognises this form of de facto contractualvariation go by various names, including“promissory estoppel”, “waiver”, and“forbearance”.13 A closely related legal andequitable doctrine having a similar effect isusually described as “acquiescence”.

These concepts are each multi-faceted, andcan take a variety of forms depending on the specific circumstances in which the twocontracting parties find themselves. Forexample, the doctrines of waiver and estoppelmay be triggered by a party’s conduct either (i) before, or (ii) after, the other party hasbreached the terms of their written agreement.In the first instance, the conduct or words ofParty “A” may be sufficient to convince Party“B” that Party “A” will not require Party “B” to strictly observe all of its obligations underthe contract. In this context, the doctrine ofwaiver may preclude a finding that Party “B”has actually committed a breach, given thatParty “A” has effectively granted Party “B”permission to act in a certain way.14 In thesecond situation where these doctrines maycome into play, Party “B” may already havebreached the express terms of the contract,but some words or conduct of Party “A” maybe found to constitute a promise that Party“A” will not exercise the contractual rightsand remedies, flowing from the existenceof the breach, which Party “A” wouldotherwise possess.15

Setting aside these variables, certain principlesare common to virtually all situations wherewaiver or promissory estoppel come into play.First and foremost, there must exist legalrelations between the parties. Obviously, thiscriterion will be met when the parties haveentered into a binding contractual relationship.

Secondly, there must be some form of promise,representation or conduct which indicates that

the beneficiary of a contractual right does notintend to strictly enforce it. Although it is oftenstated that this promise, representation orconduct must be “precise”, “clear” and“unequivocal”,16 this does not mean that thepromise needs to be express. Indeed, althoughthe cases speak of “promises”, “promisors”,and “promisees”, it is important to bear in mindthat the message in question – i.e., the messagethat the “promisor” will not insist on strictenforcement of his rights against the “promisee”– can be conveyed by words, or by silence (atleast in situations where a duty to speakexists),17 or even by a course of conduct.18

Similarly, depending on the context, it may bethat a combination of express words andmeaningful silences (even in the absence of aduty to speak) may create a sufficiently clearrepresentation that it can form the basis ofa waiver or promissory estoppel.19

In this context, the doctrine of “acquiesence”provides an example of waiver through silence orinaction. Acquiescence – which may, arguably, becharacterised as either a sub-category of waiveror as a separate but parallel estoppel doctrine –applies where a party, having a legal right,stands by without objection and watches anotherparty deal with property in a manner inconsistentwith that right. In such circumstances, the failureto object in a timely manner precludes the firstparty from afterwards complaining about theviolation of its rights.20

Third, the party who has received the “promise”must have acted upon it in some manner,generally by altering its position in reliance onthe promise. There is no requirement that thisreliance must have been prejudicial to thepromisee, although the demonstration of such“detrimental reliance” will significantly strength-en the promisee’s argument that the promisorshould be bound by his representation orconduct. The key question addressed by a courtassessing the legal impact of the promisor’sconduct is whether it would be “inequitable” or “unfair” in all of the circumstances to permitthe promisor to strictly enforce its legal rightsagainst the promisee.21 Obviously, anassessment of what is or is not “inequitable” isa highly fact-specific question. It has beensuggested that a key consideration in decidingwhether or not the promisor should be bound byhis representation is the ease (or difficulty)attending efforts by the promisee to return to itspre-representation position.22

The legal effect of a waiver or estoppel issimilarly influenced by the facts of a specificcase. As a general rule, the triggering of thesedoctrines has the effect of suspending or holdingin abeyance the relevant contractual rights orobligations, rather than cancelling them entirely.Only in extreme situations – where the conductor words of one party makes it inequitable for

that party to ever again insist on the strictapplication of its legal rights – will the protectiveprovisions of the contract be permanently lost tothe promisor.23 More commonly, the party whoserepresentations or conduct has led the otherparty to believe that the contractual terms willnot be strictly enforced will be permitted, uponreasonable notice to the promisee, to retractthe original representation and reassert therequirement that the promisee fulfil allobligations and face all penalties under theoriginal contract. As a general rule, the givingof adequate notice that the promisor now insistson strict adherence to the terms of the contractwill satisfy the requirement that such insistencenot be inequitable to the promisee.24

Issues of waiver and estoppel are particularlyrelevant to international financial institutionshaving a broader range of objectives than thoseof purely commercial lenders. Faced with anadverse development in respect of a project,international financial institutions may exercisegreater restraint in enforcing or otherwise exer-cising their remedies. It is, however, particularlyimportant that such action (or inaction) bepursued with extreme caution. The presence ofgeneral non-waiver language in the agreementswill not provide a complete answer if a clearindulgence has been granted to a party and ithas relied on this indulgence to its detriment.

If the response to changed circumstances isto forebear in the performance of contractualobligations, then the conditions on which theforbearance is granted must be made explicit.The exact contractual obligations which arebeing excused should be clearly identified andthe length of time of the waiver set out. If theduration of the exemption is not known, amechanism for giving notice that performancewill be required should be specified and agreedto in writing.

English law seeks to promote certainty incommercial dealings. The parties obtain thebenefit of this certainty by reducing theircontracts to writing.25 The court will attempt, asfar as possible, to ensure that the expectationsof the parties are also met when a circumstancearises which calls for forbearance. The value ofpredictability in commercial dealings is notdiminished when an indulgence is granted.

Of equal importance is the need to monitor and reassess the waiver or forbearance granted. Where a time-limited waiver of certaingovernmental registrations or regulatoryapprovals has been granted, it is critical toensure that the absence of such registrationor regulatory approval is not prejudicial tothe waiving party’s rights. Similarly, where anextension is granted regarding compliance witha contractual term (e.g., achievement of projectcompletion), and no step has been taken by the


extending party for some time after expiry ofsuch extension period, the waiver which wasinitially intended to be time-limited may beconstrued as an indefinite one.

Dealing with events whichprevent performance of thecontract

The enforceability of contractual terms can beaffected, not only by the conduct of the partiesthemselves, but also by intervening eventsbeyond the control of either party. The principleof English law relevant in such circumstancesis the doctrine of “frustration”.

This principle recognises that certain changesin circumstance may “frustrate” a contractby making it impossible, or fundamentallyimpracticable, for the parties to fulfil theiroriginal bargain. The Court of Appeal has recentlyenumerated five principles which explicate the fundamental character of the doctrine:26

“1. The doctrine of frustration was evolved tomitigate the rigour of the common law’sinsistence on literal performance of absolutepromises. The object of the doctrine was togive effect to the demands of justice, toachieve a just and reasonable result, to dowhat is reasonable and fair, as an expedientto escape from injustice where such wouldresult from enforcement of a contract in itsliteral terms after a significant change incircumstances.

2. Since the effect of frustration is to kill thecontract and discharge the parties fromfurther liability under it, the doctrine is not to be lightly invoked, must be kept within verynarrow limits and ought not to be extended.

3. Frustration brings the contract to an endforthwith, without more and automatically.

4. The essence of frustration is that it shouldnot be due to the act or election of the partyseeking to rely on it. A frustrating event mustbe some outside event or extraneous changeof situation.

5. A frustrating event must take place withoutblame or fault on either side of the partyseeking to rely on it.”

Traditional examples of frustrating events haveincluded: (i) the physical destruction of thesubject matter of the contract;27 (ii) theeradication of the commercial basis for theundertaking28 (although not the mere fact thatthe venture turns out to be a commercialdisaster for one party);29 and (iii) the occurrenceof a radical change in the nature of (but notmerely the expense or onerousness of) oneparty’s obligation under the agreement.30

In an important decision, the House of Lords has set out specific guidelines to be followed by a court asked to find that the doctrine offrustration should release one party from itsobligations under the contract.31 First, the courtshould seek to delineate the precise nature ofthe parties’ obligations, as they existed whenthe contract was negotiated and executed. Thisis an exercise in contractual interpretation,involving a review of the nature and substance of the parties’ bargain, read in light of thecontext in which the contract was created.Secondly, the court should look to the allegedlyfrustrating event, in order to determine how thissupervening change in circumstances hasaltered the original obligations agreed to by theparties. Finally, the court is required to comparethe obligations faced by the objecting party, bothbefore and after the occurrence of the allegedlyfrustrating event. This will permit the court –utilising an objective eye – to determine whetherthere has been a fundamental or radicalalteration in the obligations agreed to andundertaken by the parties ab initio. Only if theanswer is affirmative will the doctrine offrustration apply.

The applicability of the doctrine will generally beprecluded if the intervening event was itself thesubject of an express provision in the contract.In such circumstances, it is self-evident that the allegedly “frustrating” event cannot becharacterised as something “radically different”from the circumstances contemplated by theparties at the time of contracting. It is thuspossible for the parties to contractually exclude(or limit) the availability of the common lawdoctrine of frustration by expressly identifyingpotential supervening developments, andaddressing the parties’ ongoing obligationsshould such events occur.32

In the same way that the contracting partiescan expressly provide that the agreement willcontinue unmodified despite the occurrence ofcertain future events (thus ousting the commonlaw doctrine of frustration), it is also possible for the parties to make explicit provision forthose supervening changes of circumstanceswhich will permit one or both parties to avoid ormodify their obligations under the contract. Suchprovisions are generally described as “forcemajeure clauses”.33

In contrast to certain civilian systems, there isno common law force majeure doctrine in Englishlaw. The applicability or non-applicability of forcemajeure principles is therefore a matter for theparties to decide between themselves at thetime of contract formation. If the agreementcontains no force majeure clause, the principlewill have no relevance and the common lawdoctrine of frustration will instead be applicable.In addition to determining whether to includea clause of this sort, the parties also enjoy

19 The “Chemical Venture”, (1993) Lloyd’sRep. 508, per Gatehouse J. at 521.

20 Duke of Leeds v. Earl of Amhurst, (1846)2 Ph. 117, per Lord Cottenham, L.C. at123; and Chitty on Contracts, para. 29-139 (28th ed., 1999).

21 Hughes v. Metroplitan Ry (1877) 2 App.Cas. 439, per Lord Cairns, L.C. at 448;and “The Post Chaser”, (1981) 2 Lloyd’sRep. 695, per Goff J. at 701.

22 Chitty on Contracts, para. 3-090 (28thed. 1999).

23 Toepfer v. Warinco AG, (1978) 2 Lloyd’sRep. 569, per Brandon J. at 576.

24 Panoutsos v. Raymond Hadley Corp.of New York, (1917) 2 K.B. 473, perViscount Reading C.J.; Chitty onContracts, para. 3-091 (28th ed., 1999);and Toepfer v. Warinco AG, (1978) 2Lloyd’s Rep. 569, per Brandon J. at 576.

25 I.R.C. v. Raphael, (1935) A.C. 96 (H.L.);and President of India v. Jebsens (U.K.)Ltd., (1991) 1 Lloyd’s Rep. 1 (H.L.).

26 Lauritzen A.S. v. Wijsmuller B.V. (“TheSuper Servant Two”), (1990) 1 Lloyd’sRep. 1, per Bingham L.J. at 8.

27 Taylor v. Caldwell, (1863) 3 B&S 826,esp. at 839.

28 Jackson v. Union Marine Insurance Co.Ltd., (1874) L.R. 10 C.P. 125.

29 Larringa & Co. Ltd. v. Societe Franco-Americaine des Phosphates de Medulla,Paris, (1923) 39 T.L.R. 316 (H.L.), perLord Atkinson at 322.

30 Davis Contractors Ltd. v. Fareham U.D.C.,(1956) A.C. 696, per Lord Radcliffe at729; and National Carriers Ltd. v.Panalpina (Northern) Ltd., (1981) A.C.675, per Lord Simon at 700.

31 Davis Contractors Ltd. v. Fareham U.D.C.,(1956) A.C. 696, per Lord Reid at 720-721 and per Lord Radcliffe at 729.

32 Joseph Constantine Steamship Line Ltd.v. Imperial Smelting Corp. Ltd., (1942)A.C. 154, per Viscount Simonds at 163;“The Eugenia”, (1964) 2 Q.B. 226 (C.A.),per Lord Denning M.R. at 239; “The Evia”(No.2), (1981) 2 Lloyd’s Rep. 613, perGoff J. at 616; and Paal Wilson & Co. v.Partenreederei Hannah Blumenthal,(1983) 1 A.C. 854, per Lord Brandonat 909.

33 See generally, Chitty on Contracts, para.14-126 (28th ed., 1999).

34 Channel Island Ferries Ltd. v. Sealink U.K.Ltd., (1988) 1 Lloyd’s Rep. 323 at 327.

35 “The Playa Larga”, (1983) 2 Lloyd’s Rep.171.

* Michael E. Barrack, Georges P. Racineand Anthony AlexanderMcCarthy Tétrault, Barristers and SolicitorsPountney Hill House6 Laurence Pountney HillLondon EC4R 0BLTel: +44 20 7618 2888Fax: +44 20 7618 2880Email: [email protected],[email protected],[email protected].

The comments in this article arise out ofthe experiences of members of McCarthyTétrault in representing the EBRD. In thecourse of that representation, the opinions of Charles Marquand and John Jarvis Q.C.were presented by the opposing parties asforeign law opinions. Assistance has beenprovided to the listed authors by Brian Kelsalland Ella Plotkin of McCarthy Tétrault.


considerable discretion in tailoring the contentsof such a provision to their unique requirements– i.e., it is open to the parties to determinewhich supervening events will and will not triggerthe force majeure clause, and also to decidewhat precise effect the occurrence of suchevents will have on the ongoing agreement.The onus of demonstrating that the necessaryoccurrences have arisen lies on the partyseeking to rely on the force majeure clauseto excuse its continued performance.34

Both types of clause described above – i.e.,those seeking to oust the doctrine offrustration and those defining the application of force majeure – have a similar goal. Bothcategories of provision seek to exclude ormodify the application of the doctrine offrustration should certain, specifiedcircumstances arise in the future. As a generalrule, the courts will strictly construe anycontractual provision (whether a force majeureclause or otherwise) which seeks to oust theavailability of the doctrine of frustration.35

In emerging markets, circumstances giving riseto frustration are more likely to occur. Therefore,in order to avoid a defence of frustration it isprudent to expressly address in the contractthose potential causes of frustration which willrelieve or, conversely, will not relieve, a partyfrom its obligations. In the context of a financingtransaction, it is more often the borrower’sconcern to include a specific force majeureclause identifying those circumstances whichrelieve the borrower from its obligations. In theabsence of such explicit force majeure clauses,a borrower, or another obligor, may nonethelessargue the doctrine of frustration as a basis fornon-performance. This is an instance whereinternational financial institutions are betterprotected than ordinary commercial lenders.Among the causes of frustration likely to beinvoked by borrowers in the emerging economicand legal environments are events against whichinternational financial institutions are protectedas a result of their preferred creditor status (forinstance, payment moratoriums, absence ofhard currency reserves, etc.). In a purelycommercial context, however, where a lender or another party wishes to protect itself from thefrustration defence being brought forth by acounterparty, those circumstances should beexpressly addressed in the contract.

Conclusion

Creating, per forming, and ultimately enforcing,complex commercial financing contracts inthe context of emerging economies presentsunique challenges. Against a volatilebackground, bargains are reduced to staticwritten documents. The challenge is to ensurethat these documents anticipate and reflect thedynamic nature of the relationship. English lawprides itself on its ability to provide a highdegree of certainty that, once commercialbargains are struck, they can be relied upon.If a party fails to per form legally bindingobligations, English courts will provide aremedy for any breach.English law has alsodeveloped a number of principles whichrecognise that the literal words of contractualdocuments may not reflect the full bargainbetween the parties. These principles will onlybe invoked in an attempt to give effect to thetrue intentions of the parties. The potentialapplication of these legal doctrines is a matterof which parties should be cognisant, bothwhile negotiating the contract itself and duringthe life of the resulting agreement. At all stagesof the contractual relationship, it is open to aparty to alter its behaviour so as to ensure thatthe agreement is enforced on its original terms,while minimising the likelihood that these legaldefences will be successfully raised.


Contract enforcement in LithuaniaIf a counterparty defaults on a contract inLithuania, there are some interim steps to betaken before the foreign investor can obtainthe desired performance under the contract.With little possibility to undertake legallycoercive measures, the investor must turnto the competent forum or arbitral panelto obtain a decision on the matter, whichafterwards must be executed. Making thesesteps successful is a primary concern, evenat the early stages of negotiations betweenthe parties.

Giedrius Stasevicius, Partner, and Giedre Valentaite, Lawyer, Lideika, Petrauskas, Valiunas and Partners*


The Lithuanian Supreme Court has, for the first time, introduced doctrinescharacteristic of the Anglo-Saxon tradition, such as the forum nonconveniens. There is no practice in applying this doctrine and only the future will indicate whether its introduction into the Lithuanian legal system,which is based on the civil law tradition, was justified and will be efficient.

An increasing number of people andenterprises from different countries face thenecessity to enforce contracts in Lithuania.This increase is due to two main factors. Afterregaining its independence in 1990, theformerly closed Lithuanian economy changeddramatically and opened up to the rest of theworld. Most significantly, Lithuania became aparticipant in the international global economy.

If the defaulting party to a contract is aresident of Lithuania, or has assets there,then whatever dispute resolution mechanismthe plaintiff chooses, he or she might faceenforcement in Lithuania. This should beborne in mind when drafting the contract, thedispute resolution and governing law clauses.

Lithuanian conflict of law rules in respect ofcontract enforcement, which should guide theforeign party in its decisions, are scarce andhave been substantially supplemented by thecourts. On 21 December 2000, the Senate ofthe Lithuanian Supreme Court approved theDigest of the Court Practice in Applying Conflictof Law Rules and the Resolution No. 28 On theCourt Practice in Applying Conflict of Law Rulesto be followed by the lower courts. This hasmade Lithuanian conflict of law rules moretransparent, consistent and easier to follow.

From a contract enforcement perspective,there are generally three scenarios inLithuania. The foreign plaintiff may lodge:

■ a civil suit in a Lithuanian court;

■ a civil suit in a foreign court;

■ an application for arbitration.

Self-help remedies in enforcing privatecontracts are currently prohibited byLithuanian law, except in very limitedinstances.1 These remedies are not a viablesolution for the foreign party seeking contractenforcement in Lithuania. The new Civil Codeof the Republic of Lithuania2 provides for self-help remedies, such as the possibility on thepart of the non-defaulting party to suspend theperformance of its obligations under thecontract or retain the defaulting party’s assetsin its possession until the defaulting partyperforms its obligations.

These three scenarios are examined below,with particular attention given to the practicalissues of special interest for the foreignparties to the contract.

Contract enforcement inLithuanian courts

Despite such obvious drawbacks for foreignparties as the need to engage local counseland to pay translation costs and travelexpenses, this dispute resolution mechanismmight be attractive because there is no needfor separate recognition proceedings. In somecases this might be the only way of contractenforcement available for the plaintiff. This is the case, for instance, for contractsregarding real estate situated in Lithuania.Lithuanian law provides for the exclusivejurisdiction of Lithuanian courts of law indisputes regarding ownership rights or theuse of real estate situated in Lithuania.3

Since almost all jurisdictions have a similarconflict of law rule, there is a high likelihoodthat a foreign court would decline jurisdictionand the plaintiff’s only option would be toapply to Lithuanian courts.

Jurisdiction

A court shall accept the claim only if it has jurisdiction over the particular dispute.According to the Code of Civil Procedure,4

jurisdictional rules of international treaties orconventions prevail over those of national law.However, so far Lithuania is not a party to the Brussels or the Lugano Conventions.5

Therefore, the only international sources ofjurisdictional rules are multilateral conventionson the unification of some conflict of lawrules,6 and Bilateral Treaties on Mutual LegalAssistance in Civil and Family Cases.7

When a relevant bilateral treaty has beenconcluded, its provisions prevail over thenational ones. When a multilateral conventionstipulates conflict of law rules, those rules are to be applied, except if the conventionprovides for the opposite. If there are no rulesprovided for in the convention or bilateraltreaty, general national conflict of law rulesapply.8 To sum up these rules, Lithuaniancourts shall accept jurisdiction over a civil suitarising out of a contractual relationship if:

■ the defendant has his or her place ofresidence or its seat in Lithuania;

■ the defendant is a foreign legal person buthas a branch in Lithuania and the dispute is related to the activities of the branch;

■ the place of contract performance is in Lithuania;

■ the object of the dispute is real estatesituated in Lithuania.

The parties to the contract may also choosethe jurisdiction. However, their autonomy is not absolute.9 In order to be accepted andenforced by Lithuanian courts, jurisdictionclauses cannot infringe on the exclusivejurisdiction of the courts of Lithuania. Theclause must be definite to be capable ofenforcement and the forum chosen must havea connection to the case (it might be the placeof residence of one of the parties, the placewhere the object of dispute or all evidence issituated, etc.). Lithuanian courts shall alsoagree to hear a case if the defendant does notobject to the jurisdiction, and if such a hearingdoes not infringe upon the exclusive jurisdictionof the courts of any of the parties’ state.

In addition to the aforementioned generalconflict of law rules, the Supreme Court hassuggested to the lower courts to take intoconsideration the following factors beforeassuming jurisdiction:

■ Whether the decision in the particular caseshall have to be recognised and enforced inthe foreign state. If it shall, and Lithuania hasno Bilateral Treaty on Mutual Legal Assistancein Civil and Family Cases with the state ofprospective recognition and enforcement, thecourt is directed to find out whether the courtsof the state of the defendant’s residence orseat have jurisdiction over the dispute, and to decline jurisdiction if the result of suchinquiry is positive (except for the cases ofexclusive jurisdiction).

■ Whether the court of the state where thedecision will have to be recognised andenforced has an exclusive jurisdiction over thedispute. If it does, the Lithuanian court shoulddecline jurisdiction as well, because thedecision of a Lithuanian court would not berecognised and enforced in the foreign state.

■ The place of residence or seat of the partiesand the place of the evidence. If the plaintiffand most of the evidence are in a state whichhas no Bilateral Treaty on Mutual Legal


Assistance in Civil and Family Cases withLithuania, the courts are instructed to declinejurisdiction and to suggest to the plaintiff to suein the court of the place of residence or seat ofthe defendant and the place of the evidence.

The aforementioned instructions are intendedto achieve economy of process and aim toavoid situations where a case is heard and adecision is rendered in Lithuania, but it is notrecognised and enforced in the foreign forum.With this decision, the Lithuanian SupremeCourt has, for the first time, introduceddoctrines characteristic of the Anglo-Saxontradition, such as the forum non conveniens.There is no practice in applying this doctrineand only the future will indicate whether itsintroduction into the Lithuanian legal system,which is based on the civil law tradition, wasjustified and will be efficient.

Proceedings

Litigation in Lithuania is a time-consumingenterprise. The hearing in most of the cases is oral and held publicly in Lithuanian (foreignparties are entitled to participate through aninterpreter). Both parties are summoned toparticipate in the hearing, and it is common to postpone the hearing if a party, witness or attorney is not present.

However, in 1998 the Parliament introduced10

a novel type of proceedings for casesregarding monetary claims arising out of the contractual obligations based on writtenevidence. The judge in such summaryproceedings upon accepting the claim sends a written notice to the defendant. Thedefendant is given a 14 days’ grace period for the performance. If the defendant does not perform and does not raise objections, the judge issues a court order, which may besubject to forced execution. If the defendantraises objections to the claim, and suchobjections are reasonable and supported bythe evidence, the judge returns the claim tothe plaintiff directing him or her to sue underthe general rules.

Summary proceedings are a time-saving typeof litigation. However, the plaintiff who has notperformed his or her own obligation may notresort to it.11 It also may not be used when theplace of residence or seat of the defendant arenot known. The other important restriction is

to be found in Part 3 of Article 256-1 of theCode of Civil Procedure, which states that ifthe debtor is a foreign national, the normsregarding the issuance of the court order inthe summary proceedings may be applied onlyon the basis of international treaty orconvention or private contract.

Lithuanian law follows the civil law tradition togive preference to specific performance, andthe court would usually grant damages (if any)in addition to and not instead of the specificperformance.12 Only if the specificperformance were not feasible or practicalwould the court grant only damages.

The decision of the lower court might bechallenged in two ways:

■ Appeal. Challenge is open if the lower courtdecision has not yet entered into force. Thistype of proceedings is a hearing de novo,although a rather limited one. The appellantis prohibited from raising new claims, newevidence is admitted only if it could not besubmitted in the initial proceedings or theneed to submit it arose later.13

■ Cassation. This type of review is limited tothe issues of law construction and applicationand basically serves public interest ofuniformity in the construction and applicationof law. Fact-finding conclusions of the lowercourts are never reviewed. Only the SupremeCourt of Lithuania has jurisdiction over thiskind of case.

Recognition and enforcementof foreign judgements

Judgements are a national phenomenon – amanifestation of state power. In order to haveeffect outside national borders, the judgementhas to be recognised by the foreign state.Therefore, the party wishing to enforce aforeign judgement in Lithuania must apply to the Appellate Court of the Republic ofLithuania14 and submit the followingdocuments:

■ application for the recognition;

■ judgement or its copy with the certification(in practice it is usually a court certification)of the entry into force and executability;

1 Currently self-help in the contractuallegal relationships is limited to the rightto effect the performance on thecounterparty’s account – see Articles226, 262, 306 of the current CivilCode of the Republic of Lithuania(dated 7 July 1964). Moreover, exceptfor the lease contracts where thelessee is entitled to withdraw theamounts spent to effect performance,the compensation for the effecting ofperformance is to be pursued throughthe court.

2 No. VIII-1864, enacted on 18 July2000, entered into force on 1 July2001.

3 Articles 478-1 and 139 of the Code ofCivil Procedure (dated 7 July 1964).

4 Adopted on 7 July 1964.

5 The 17 September 1968 BrusselsConvention on the Jurisdiction andEnforcement of Judgements in Civiland Commercial Matters and the 16 September 1988 LuganoConvention on the Jurisdiction andEnforcement of Judgements in Civil and Commercial Matters.

6 For example, 1956 Geneva CMRConvention, 1929 Warsaw Convention,1980 Bern Convention.

7 Lithuania has signed such treaties withthe following states: Latvia, Estonia,Russia, Belarus, Poland, Moldova,Ukraine, Kazakhstan, Uzbekistan.

8 Article 478-1 of the Code of CivilProcedure of the Republic of Lithuania(dated 7 July 1964).

9 The limits have been set by the courtpractice, see item 5.2 of the 21December 2000 Supreme Court Digestof the Court Practice in Applying thePrivate International Law and item 15of the 21 December 2000 SupremeCourt Resolution No. 28 On the CourtPractice in Applying the PrivateInternational Law.

10 Law No. VIII-959, dated 10 December1998.

11 Item 1 of part 2 of Article 256-1 of theCode of Civil Procedure.

12 Article 30 of the Civil Code providesthat the payment of the damages anddefault interest does not free thedebtor from specific performance.

13 Articles 323 and 325 of the Code of Civil Procedure.

14 Article 481 of the Code of CivilProcedure.


■ evidence on the due summons of thedefendant and due representation of the partyof limited capacity;

■ official translations of application and alldocuments.

The recognition cases are heard in publichearings. Since the debtor is entitled toparticipate and raise defences, he or she mustbe duly summoned. However, if a duly notifieddefendant does not participate in theproceedings, this does not prevent the hearing.

Recognition under internationalagreements

According to Article 481 of the Code of CivilProcedure, foreign judgements are recognisedand enforced according to the rules set byinternational conventions or treaties and thelaws of Lithuania. As Lithuania is not a partyto the Brussels or Lugano Conventions, thegrounds for non-recognition are provided for in the Bilateral Treaties on Mutual LegalAssistance in the Civil and Family Cases. In general, these bilateral treaties concludedby Lithuania usually provide for the followinggrounds for non-recognition:

■ the defendant or the applicant in therecognition proceedings was not duly notifiedabout the hearing of the case or the dueprocess of law has been infringed;

■ if there is a judgement of the national courtrendered in the same dispute between thesame parties and it has entered into force;

■ if there is a suit commenced in the court ofLithuania in the same dispute between thesame parties;

■ according to international treaty or convention,or Lithuanian laws, if there are no relevantinternational legal norms, Lithuanian courtshave an exclusive jurisdiction over theparticular dispute.

Some international treaties provide for specificgrounds of non-recognition. For example,Article 54 item 5 of the Bilateral Treatyconcluded with Poland provides for suchgrounds as the existence of the recognised orexecuted decision of the competent institutionof the third state in the same dispute.

The court examines the existence of the saidgrounds ex officio, i.e., on its own initiative,even if no party relies on them. As the shortpresentation of the grounds for the non-recognition shows, the court dealing with therecognition case does not review thesubstance of the foreign judgement. However,there are some exceptions to this rule. Forexample, Article 54 item 6 of the BilateralTreaty with Poland provides for such groundsof non-recognition as infringement of theconflict of law rules provided for in the Treaty.

Recognition of a foreign judgement ifthere is no international convention or treaty

As mentioned above, international treaties onlegal assistance are not numerous. There isno special legislation on the recognition andenforcement of foreign judgements. This gaphas been filled by court practice. In November2000,15 the case of the recognition of a Dutchjudgement was brought before the LithuanianAppellate Court. The court held that, althoughLithuania has no Bilateral Treaty on the MutualLegal Assistance with the Netherlands, thejudgement should be recognised, taking intoconsideration foreign practice, the purposeof conflict of law rules and the principles ofinternational cooperation. Private parties arenot to blame for the inability of their states toconclude international conventions or treaties.Denial of recognition solely on these groundswould deprive the parties of justice and would provoke retaliatory non-recognition ofLithuanian judgements in foreign states. Thisposition was approved by the Supreme Court,to be followed later by the lower courts.16

The grounds for the non-recognition were foundby analogy in the international practice andexisting international conventions and treaties.The court may deny recognition of thejudgement rendered in the state that has norelevant international treaty with Lithuania if:

■ the recognition and enforcement would becontrary to the public order;

■ exclusive jurisdiction of the Lithuanian courtshas been infringed;

■ the defendant has not been duly notified of the place and time of the hearing;

■ a judgement of the Lithuanian court has beenrendered regarding the identical claim;

■ Lithuanian conflict of law rules requiringapplication of Lithuanian instead of foreignlaw have been infringed;

■ the foreign judgement is not final and hasnot entered into force yet;

■ the courts of the state where the judgementto be recognised has been rendered refuserecognition of the judgements of Lithuaniancourts of law.

The same grounds must be applied when an international treaty17 provides for therecognition and enforcement of foreignjudgements and is silent on the issue of the grounds on which the recognition may be denied.

Recognition and enforcementof foreign arbitral awards

Until very recently, Lithuanian attorneys firmlyrecommended to foreign investors to choosearbitration as the best dispute resolutionmechanism, and to include an arbitrationclause in their contracts with Lithuaniancounterparties. Although the above-mentionedcourt practice has clarified the issues ofrecognition and enforcement of foreignjudgements, a foreign creditor, who has anarbitration award to be enforced in Lithuania,may feel much more comfortable. The mainreason for that is the fact that since 17January 1995, Lithuania is a party to the 1958New York Convention on the Recognition andEnforcement of Foreign Arbitral Awards. Inaddition to this convention, the recognition offoreign arbitral awards is also subject to theCode of Civil Procedure and of the Law onCommercial Arbitration.18

Before the New York Convention is applied in the recognition proceedings, the courtascertains:

■ whether it is an arbitral award that is soughtto be recognised. It should be noted that theterm “arbitration” may have differentmeanings. In the Soviet tradition the termused to denote a specialised court of law.Following this tradition, some post sovietstates19 still have a type of courts of lawcalled “courts of arbitration”. Despite theirname, the New York Convention does notapply to the recognition and enforcementof their decisions.


■ whether it is a foreign arbitral award. Thedefinition of a foreign arbitral award is to befound in Part 1 of Article 1 of the New YorkConvention. According to the Convention, onlyan award rendered outside Lithuania is aforeign arbitral award. It should be also notedthat Lithuania applies the Convention inrespect of arbitral awards rendered in non-member states solely on the basis ofreciprocity. It should be noted that there havebeen instances20 when Lithuanian courts haveapplied the New York Convention and haverecognised an arbitral award rendered in theproceedings under the ICC Rules ofArbitration, despite the fact that the placeof arbitration was Vilnius, Lithuania.

The applicant wishing to recognise and enforcea foreign arbitral award in Lithuania has tosubmit to the Appellate Court the followingdocuments:

■ an application for the recognition;

■ original or copy of the award translated into Lithuanian;

■ original or copy of the arbitration agreementtranslated into Lithuanian.

The proceedings are identical to therecognition of the foreign judgement. Thedebtor is summoned to the public hearing ofthe case. However, his or her absence doesnot prevent the hearing (if the evidence of duenotification is present).

The debtor may object to the recognition by presenting evidence to prove the grounds of the non-recognition provided for in Article 5of the New York Convention. The provisions of Article 5, as well as of the wholeConvention, should be construed uniformly by the courts of different members, in order to achieve its uniform application throughoutthe world. Therefore, the Supreme Court hasspecifically directed Lithuanian courts to takedue regard of the practice of foreign courtsand legal doctrine.

It should be noted that the incapacity21 ofthe Lithuanian counterparty to the arbitrationagreement is ascertained under the rules of Lithuanian law, including Article 11 of theLaw on Commercial Arbitration. This Articleprovides that the state and municipalenterprises and organisations have no

capacity to agree on arbitration without priorconsent of their incorporator. This provisionshould be borne in mind by the foreign investorintending to have an arbitration clauseincluded in the contract concluded with the Lithuanian state enterprise. If the priorconsent were not obtained, the arbitral awardwould not be recognised and enforced inLithuania.

Non-arbitrability of the dispute22 is defined inthe same Article 11 of the Law on CommercialArbitration. Disputes related to competition,patents, trademarks, insolvency and consumercontracts are not arbitrable. Therefore, foreignarbitral awards rendered in such disputescannot be recognised or enforced.

The Supreme Court has directed the courtstowards a more liberal approach inestablishing the existence of the grounds for non-recognition. For example, even if thedebtor proves the circumstances provided for in Part 1 of Article 6 of the New YorkConvention, the court should not automaticallyrefuse recognition. It must be established thatthe violation of the standards of due processhas been substantial enough. Moreover, thepublic order23 is not to be construed broadlyas every imperative national norm. This termshould denote only the imperative standardsaccepted internationally.

15 20 November 2000 decision in the civilcase No. 2T-96/2000.

16 Article 7.1.4 of the 21 December 2000Digest of the Court Practice in Applyingthe Private International Law adoptedby the Senate of the Supreme Court of the Republic of Lithuania.

17 For example, CMR or COTIF Convention.

18 No. I-1274, dated 2 April 1996.

19 For example, Russia.

20 16 December 1999 Ruling of the Courtof Appeals in the civil case No. 2A-139/1999.

21 Article 5.1.a. of the 1958 New YorkConvention.

22 Article 5.2.a. of the 1958 New YorkConvention.

23 Article 5.2.b. of the 1958 New YorkConvention.

* Giedrius StaseviciusGiedre ValentaiteLideika, Petrauskas, Valiunasand PartnersLabdariu 5, LT-2001 VilniusLithuaniaTel: +370 2 68 18 88Fax: +370 2 22 55 91


Legal transitiondevelopments

Legal developments

Secured transactions

In February 2001 the electronic registry forthe registration of charges, provided for bythe Law on Securing Charges of 1999, becameoperative. Under this law, transactions creatinga “securing charge” that were effected beforethe registry entered into force on 26 January2001 had to be registered within 90 days afterthis date in order to be treated as completedsecuring charges for priority purposes. Therehave already been a considerable number of registrations and the office of the ChiefRegistrar appears to make every effort toensure the efficient operation of the registry.However, it is difficult to evaluate itsfunctioning at this early stage.

Legal developments

Energy law

In March 2001 the Armenian President signedthe Law On Energy, which was passed by theNational Assembly earlier that month. The Lawregulates the energy sector, which is definedas including electric and thermal powergeneration, transportation and distribution,as well as natural gas transportation anddistribution. The Law governs the relationshipsbetween the state, the enterprises involved inthe energy sector and consumers. It providesfor the creation of the Energy RegulatoryCommission, a state authority charged withthe regulation of the energy sector. TheCommission is authorised to set tariffs forelectrical, thermal energy and natural gas, toissue licences to the operators of the energysector, and to define the rules encouraging thecreation of the infrastructure for the energy

market. The Law On Energy is a further steptowards the successful implementation of theprivatisation of the national grid, which hasbeen postponed twice due to the lack of bids.

Legal developments

Tax code

On 1 January 2001 the new Tax Code cameinto force. It is the first attempt at codificationof tax legislation and introduces significantchanges into the tax system. The Code laysout new principles of taxation and modifiesmethods of calculating and paying specifictaxes. The Tax Code defines three types oftaxes: state taxes, taxes of the autonomousrepublic, and local (municipal) taxes. Statetaxes include: (i) personal income tax,(ii) corporate (profits) tax, (iii) value added tax,(iv) excise tax, (v) assets tax on legal entities,(vi) land tax on legal entities, (vii) transit tax,(viii) mineral resources tax, and (ix) simplifiedtax. The foregoing taxes, except for the transittax, are also considered to be taxes of theautonomous republic of Nakhchevan. Municipaltaxes include: (i) corporate (profits) tax onenterprises owned by municipalities, (ii) assetstax on individuals, (iii) land tax on individuals,and (iv) mineral resources tax on constructionmaterials of local importance. The Tax Codeprohibits the imposition of any taxes otherthan those specified in the Code.

Legal developments

Electronic signatures law

On 22 March 2001 the Bulgarian Parliamentpassed a new Law on Electronic Documentsand Electronic Signatures. After the CzechRepublic, Bulgaria is the second country

in central and eastern Europe to regulateelectronic document signatures. The lawdefines an electronic signature as any pieceof information, coordinated between the authorand the addressee, which discloses the identityof the author, confirms his or her consent tothe electronic statement and protects thecontent of the statement from later changes.It further defines the terms “improved” and“universal” electronic signatures. The universalelectronic signature has the legal effect of amanual signature. The Law authorises theCouncil of Ministers to specify the state bodiesthat are under an obligation to acceptdocuments signed by means of a universalelectronic signature. Under the Law, anelectronic signature will not be valid for certaindocuments of legal significance, such assecurities, consignment notes, or fordocuments or transactions requiring a qualifiedwritten form. The Law will come into effect sixmonths after its promulgation in the OfficialGazette, and is expected to boost electroniccommerce in the country.

Legal developments

Foreign exchange law

On 10 April 2001 amendments to the Law onForeign Exchange System, Foreign ExchangeOperations and Gold Transactions entered intoforce. The amendments partially liberate theforeign exchange market in Croatia. Thesemodifications allow domestic persons to acquireforeign exchange devices by: (i) purchasing onthe foreign exchange market in order to effectthe payment of goods and services abroad andother capital transactions permissible by law,as well as in order to deposit on foreigncurrency accounts; (ii) legal operations withforeign persons which relate to the export ofgoods and services or other legal operations;

Croatia

Bulgaria

Azerbaijan

Armenia

Albania


(iii) other legal operations in Croatia specificallydetermined by law; and (iv) inheritance. Theamendments also refer to the approvalprocedures of foreign currency loans in Croatia,the settlement procedures of the obligationsthrough cessation and the assignment of set-offs.

Legal developments

Corporate governance code

In early 2001 the Czech Securities Commissionfinalised a Code of Corporate Governance.According to the Commission, the Code ismodelled on the OECD Principles of CorporateGovernance. The Code emphasisestransparency and responsibility, and aimsto introduce best governance practice tocompanies in the Czech Republic.

Commercial code

On 1 January 2001 various amendments tothe Commercial Code entered into force. Thechanges significantly improve the protection ofminority shareholders’ rights by strengtheningthe rules concerning mandatory offers andnotification requirements when shareholdersreach prescribed thresholds. The amendmentsalso introduce other provisions designed toprotect shareholders’ rights.

Execution code

On 1 May 2001 a new Law on Court Executorsand Execution Activities (Execution Code)entered into force. However, key provisionsrelating to the execution of decisions and tothe executors’ activities will not enter into force until 1 September 2001. Each newlyappointed executor will be different fromexisting court executors, who act under theCivil Procedure Code and are court employees.The new executors are appointed by theMinister of Justice and, under the newExecution Code, are now allowed to performexecutions under less formal procedures thanthose performed under the Civil ProcedureCode. Consequently, it is expected that futureexecutions performed by newly appointedexecutors will be less time consuming thantraditional Civil Procedure executions.

Legal developments

Financial markets legislation

On 9 June 2001 the Estonian Parliamentpassed legislation that merges the supervisorybodies for securities, banking and insuranceinto a single entity, the Financial SupervisoryAuthority (FSA). It is likely that the FSA will beconstituted in the second half of the year so

that it is fully functional by 1 January 2002.The FSA attempts to unify three related areasunder one authority. Banking, insuranceand securities, were previously monitoredby various departments under the Ministryof Finance and the Central Bank. The newFSA will be independent of both state entities,while its managing board will consist of theMinister of Finance (as Chairman) and othermembers from the Ministry of Finance andthe Central Bank.

The FSA will supervise all financial marketsand efficiency will be gained through thegrouping of similar operations under oneauthority. Although there is no explicit EUlegislation setting out the standard of suchauthorities, it is thought the FSA addressesany concerns the EU might have had in thisarea, and ideally will result in complianceshould the EU mandate such authorities. The FSA will also oversee all listings of publiccompanies, as well as the Central Registry ofSecurities, in which all shares (including bothprivate and public companies) will need to beregistered within the next two years. TheCentral Registry of Securities was recentlycreated and will eventually assist in thestrengthening of pledges of shares.

Legal developments

Privatisation law

On 27 June 2001 the Serbian Parliamentadopted a new Privatisation Law. The 1997 Law on Ownership, which was based on aninsider privatisation model where up to 60 per cent of the capital of a company wastransferred to workers and pensioners in theform of shares, was frozen while the new lawwas developed. With the assistance of theEBRD, the Serbian Ministry of Economy andPrivatisation prepared the new Privatisation Law which creates three methods for privatisingcompanies, which are: (1) competitive tenderingprocess; (2) auction; and (3) out-of-courtrestructuring processes. The EBRD and theWorld Bank are now assisting the Ministry todevelop key implementing regulations so thatthe new Law can become effective as quicklyas possible.

Legal reform projects

Secured transactions

The EBRD is undertaking a legal reform projecton secured transactions law in FR Yugoslavia.The Yugoslav Federal Law on Contracts andTorts contains basic provisions on pledge, butthese do not enable more sophisticated typesof security to be taken over a variety of assetclasses. Moreover, third parties have very fewmeans to assess a potential debtor’s existing

security over its property, as public records donot exist. Additionally, enforcement of securityand recovery of collateral is not generallyviewed as efficient in practice. The generalobjective of the project would be to equip FR Yugoslavia with a modern legal frameworkon secured transactions and appropriateimplementing institutions (for example, pledgeregistry) that will support sophisticated credittransactions. The framework and institutionswould closely follow the EBRD Core Principleson Secured Transactions.

Legal developments

Enterprise law

In June 2001 the Georgian Parliamentapproved the second reading of the new draftEnterprise Law. This law limits the number oftax inspections of companies that can takeplace in any one year, and thus constrains thepotential for corruption. Under Articles 2 and5 of the draft Law, only the Tax Inspectorate isallowed to carry out tax audits at companiesonce a year. All other organisations, such asInterior Ministry departments, will be requiredto obtain a court warrant before making anykind of tax-related inspection. The proposalsform part of an anti-corruption drive that waslaunched last year by the President of Georgia,after the International Monetary Fund warnedGeorgia that future lending would depend onthe country’s efforts to stamp out corruption.Most of the draft Enterprise Law’s articles,which include further anti-corruptionmeasures, have been approved by parliament.At the time this issue went to print, parliamentwas expected to hold the final reading ofArticles 2 and 5 of the draft EnterpriseLaw in the near future.

Legal developments

Banking law

On 19 June 2001 the Hungarian Parliamentpassed a new law on the National Bank ofHungary (MNB). The law defines the mainte-nance of price stability as the primary goal ofthe MNB. The new law dissolves the CentralBank’s supervisory board and transfers thecontrol function to the State Accounting Office.According to the new Law, the MonetaryCouncil takes over the tasks of the CentralBank Council from July 2001. The MonetaryCouncil is composed of seven to nine experts,in addition to the President and DeputyPresidents of the National Bank.

Hungary

Georgia

Federal Republic of Yugoslavia

Estonia

Czech Republic


Take-over legislation

In June 2001 the parliament passedamendments to the existing Securities Lawrelating to take-over rules aiming to enhanceprotections of minority shareholders. Theamendments set stricter rules on reportingrequirements, public offers, and the waypublic offer prices are determined. They alsoimpose stricter penalties for violations of thereporting rules.

Telecommunications law

In June 2001, Hungary passed a newTelecommunications Law, which will take effect from 23 December 2001. The new lawregulates three main areas. First, it providesfor asymmetric local loop unbundling. FromJanuary 2002 the national operator, Matav,will be obliged to unbundle the local loop tosmaller players, but will itself be barred fromexpanding in concession areas of other localtelecommunications operators. Secondly, itbrings the mobile portion of calls from fixed to mobile networks under regulatory control.Thirdly, the new Law stipulates thattelecommunications providers must sharerevenues from dial-up internet calls withInternet Service Providers, although the detailsof these regulations have yet to be worked out.

Bankruptcy law

Recently the Hungarian Parliament approvedamendments to the Bankruptcy Law that willcome into effect on 1 September 2001. The amendments aim to improve a securedlender’s position in liquidation proceedingsin Hungary. Under the current law, securedclaims are paid pro rata only after liquidationexpenses, including the liquidator’s fees, havebeen paid. Any remaining proceedings are thendistributed pro rata to the unsecured creditors.The new amendments will improve the positionof secured lenders in the order of settlement.If a secured lender’s claim was created atleast one year prior to the commencement of the liquidation proceeding, then half of theproceeds of the sale of the property subject tothe claim will be reserved for the satisfactionthereof. Only then will the other half of theproceeds be shared according to the statutoryorder of payment. Another significant changewill be the elimination of the so-called “sixmonth” rule, pursuant to which mortgagesregistered with the Land Registry less than six months prior to the commencement of liquidation proceedings are treated asunsecured in the statutory order of payment.

Currency regulations

On 16 June 2001 new currency regulationsentered into force. These regulations lift mostrestrictions on current and capital operations in Hungarian forint or foreign currency, and

allow for the forint to become fully convertible.According to the regulations, residentbusinesses may hold forint accounts abroadand initiate foreign currency purchases fromsuch accounts. Resident businesses or privateindividuals are no longer obliged to transfer anyof their foreign currency earnings or incomefrom abroad to Hungary. Non-residents are freeto hold forint accounts and transfer money fromtheir domestic forint accounts abroad withoutthe obligation to report to the authorities.


Assistance with drafting a newsecurities law

At the request of the Ministry of Finance,the EBRD is undertaking a project to assistHungary in reforming its securities marketlegislation by adopting a new comprehensiveSecurities and Investment Services Law. Thisproject aims to bring the principal parts of theHungarian securities market legislation into line with international standards and soundpractices of other markets, while meeting theEU accession requirements.

Legal developments

Law on transfer pricing

On 5 January 2001 a new Law On GovernmentControl Over the Use of Transfer Pricing wasapproved. The new Law establishes anauthorised governmental body that will monitorinternational transactions and related domestictransactions. The Law aims to prevent taxevasion through the use of transfer pricing.

Currency legislation

On 30 January 2001 amendments to the Law on Currency Regulation were adopted. The amendments include the introduction of a 120 day maximum time period, by whichforeign currency must be received in paymentfor the export of goods and services. If aresident exporter does not receive suchcurrency from the non-resident within 120days, it must obtain a special licence fromthe National Bank of Kazakhstan.

Language law enforcement

On 7 February 2001 a new State Programmeon the Operation and Development ofLanguages for 2001-2010 was passed byPresidential Decree. This programme evidencesa trend towards increased enforcement of theLaw on Languages of 7 July 1997, requiring,among other things, mandatory use of theKazakh language in corporate agreementsand related correspondence.


Telecommunications reform project

On 30 June 2001 the EBRD completed thefirst two phases of its telecommunicationsregulatory reform project. Working with theMinistry of Transport and Communications and Kazakhtelecom, the EBRD and itsconsultants prepared draft laws on thetelecommunications sector and on the creationof a universal service fund, and providedpricing models to establish the real cost oftelecommunications services.

Legal developments

Land reform

In January 2001 a new Law on theManagement of Farmland came into effect,lifting the restrictions on the disposal of plotsof farmland by farmers. The new Law coversthe rights of the landowner to lease, exchange,buy, sell, mortgage and inherit land. Theabsence of such a law, and of generalmechanisms regulating legal relations inthe field of management of farmland, hada detrimental effect on internal migration,on the efficient use of farmland and on thedevelopment of the agricultural sector andeconomy of Kyrgyzstan as a whole.

Law on judicial activities

In March 2001 a law on the status of thejudges was adopted. The new law sets outprinciples of supervision for the judges. Inaddition, it provides for financial support, as well as state and social protection forjudges and for members of their families.

Legal developments

Commercial law

Recently, the Latvian Parliament approved the Law on Commerce. This comprehensive law sets in place a cohesive revamped body of jurisprudence, applicable to the rights andrelations of persons engaged in all aspectsof commerce and trade. The new Law replacesa series of laws currently governing differentforms of business (for example, Joint StockCompanies Law, Limited Liability CompaniesLaw, etc.). The new Law specifies generalprovisions applicable to all forms of businessactivity and sets out specific provisions thatare unique to each form of business. It isanticipated that, pending the adoption offurther legislation, there will be some tensionsbetween the new Law and the existinginsolvency regime. At the time this issue went

Latvia

Kyrgyzstan

Kazakhstan


to press, the parliament was still debatingwhether to delay the effective date of the newcommercial law until January 2002.

Taxation legislation

On 20 April 2001 amendments to the Law onFiscal Year Reviews became effective. Underthe new provisions, a company’s annual reportmust be reviewed by a sworn auditor orauditing company if the company’s indicatorsexceed two of the criteria set forth in the newlaw: a total balance exceeding LVL 100,000; a net turnover of LVL 200,000; and an averageof at least 25 employees over the course ofone fiscal year.

Legal developments

World Bank’s global insolvencyprinciples

On 10 April 2001 the Executive Directors of the World Bank approved the “Principles andGuidelines for Effective Insolvency and CreditorRights Systems”, and authorised its use for aseries of pilot country assessments over thecoming year. The World Bank developed theprinciples with the assistance of internationalfinancial institutions, including the EBRD,leading insolvency organisations andinternational insolvency experts. The Principlespaper emphasises contextual, integratedsolutions, and the policy choices involved indeveloping those solutions. The Principles relyon a fundamental premise: sustainable marketdevelopment requires access to affordablecredit and capital investment that can occur only in an environment that enables parties to manage the insolvency risk associated withcredit relationships. There are 35 core principlesidentified and addressed in the Principles. Thesecore principles distil international best practicein the design of insolvency and creditor rightsmechanisms, and will be used to benchmark thestrengths and weaknesses of existing systems.Notably, the Principles allow flexibility fordomestic policy choices and the manner ofapplication takes into account the comparativedomestic laws and institutions.


CIS model securities law

Since 1997, the EBRD has been involved in aseries of projects aimed at the harmonisation ofthe laws of the Commonwealth of IndependentStates (CIS) member states, co-sponsored bythe Dutch and German governments. The EBRDhas provided in-house expertise on thedevelopment of CIS model Mortgage andCompany laws. The Bank is now sponsoring atechnical assistance project to develop model

CIS securities legislation. The Drafting Grouphas now combined its drafts “On SecuritiesCirculation” and “On Capital Markets” into onedraft model law. Comments and suggestions onthis draft model law were received from variousCIS countries and western experts, and themodel law was discussed at open hearings ofthe CIS Inter-Parliamentary Assembly on 20–21June in St Petersburg where issuers, investorsand professional market participants from CIScountries and IFI representatives provided theirviews. The draft model law is expected to beconsidered and approved at the Novembersession of the CIS Inter-Parliamentary Assembly.

Legal developments

Banking law

On 17 March 2001 the Russian Parliamentapproved three bills to amend Russia’sbanking legislation. The amendments aim toestablish a sound banking system in Russia by preventing the flow of capital out of bankson the verge of bankruptcy, and by protectinginvestors’ and depositors’ rights at the earlystages when financial troubles of such financialinstitutions are recognised. The amendmentsare expected to significantly simplify theprocedures for liquidating or revoking thelicences of troubled banks.

Currency regulations

On 4 June 2001 the Russian President signed a law amending the Law “On CurrencyRegulation and Currency Controls”. The newamendments permit the carrying out of a rangeof operations that in the past were notpossible in principle. The law expands therange of operations that do not require aspecial permit from the Central Bank. Forinstance, any payments made by residentsoutside Russia for construction, insurance andreinsurance can be made without Central Bankpermission. In addition, Russian citizens arenow allowed to freely transfer abroad foreigncurrency worth up to US$ 75,000 for thepurchase of securities.


Corporate governance ratings

This legal technical assistance project initiated in September 2000, and expected to be completed within 18 months, aims to assist the Institute of Corporate Law and Corporate Governance to develop themethodology for a corporate governance ratingsystem, and apply it to a number of companiesin Russia. This system would ultimately providean indication of those Russian companiesapplying best international practice ofgovernance. The rating system will also create

an incentive for companies to apply goodgovernance standards in order to increase their attractiveness for potential investors. The ratings information will be made availableto subscribers to the system.

The web site of the Institute of Corporate Lawand Governance (ICLG) was launched in March2001, with the results of the assessments of 25 companies. By September 2001, at theend of Phase I of the project, 30 companiesare to be assessed. It is expected that a totalof 50-70 companies will be assessed byspring 2002.

Corporate governance code

The EBRD sponsors a project that aimsto assist the Russian Federal Commissionon the Securities Market (FCSM) to developa Corporate Governance Code, to beaccompanied by an explanatory commentarythat would be used as a central reference forissuers of securities. The proposed Code willbe based on the OECD Principles of CorporateGovernance and will provide guidance forimproved corporate bylaws and operatingprocedures. The Code will be developed andapproved by the FCSM and its application isexpected to be discretionary. However, theFCSM will require Russian companies todisclose the degree of compliance with theCode’s provisions, and justify any lack ofcompliance. It is hoped that the Code, broadlypublicised and accessible (through theassistance of other organisations), willultimately serve as an important tool forthe assessment of Russian companies’compliance with best international practicesof governance.

The EBRD project was started on 21-22 May2001 with the first meeting of the WorkingGroup. The international law firm of CoudertBrothers and a consortium of other advisorshave been selected to assist the FCSM.

Legal developments

Commercial code

The Slovak Government has completeda significant amount of work on variousamendments to the Commercial Code. Thedraft amendments are designed to significantlyimprove minority shareholders’ protection,incorporate the OECD principles of CorporateGovernance, and further approximate Slovakcommercial law with the laws of the EuropeanUnion. At the time this issue went to print,the third reading and approval of the latestproposed amendments in the parliament wereexpected during the course of summer 2001.

Slovak Republic

Russia

Regional


Constitutional law

On 23 February 2001 the parliament adoptedsignificant amendments to the SlovakConstitution. The amendments provide forthe reform of public administration and thepassage of legislation on regional elections.Amendments address parliamentary immunity,allowing for the prosecution of deputies afterthe expiry of their term and, in cases whereparliament does not lift their immunity incriminal charges, the amendments allow forcivil action by private parties against them.The amendments increase the number ofConstitutional Court justices from 10 to 13,and also increase their term from 7 to 12years. In addition, they establish the JudicialCouncil as a body with authority to proposenominations and removal of judges, andpropose candidates for the chair and vice chair of the Supreme Court (who are, in turn,nominated by the President). The JudicialCouncil is composed of 18 members and ischaired by the head of the Supreme Court;eight members will be justices elected byjudges, three members will be elected byparliament, three members will be nominatedby the president, and three by the government.Articles regulating the competence of theSupreme Auditing Office were alsosubstantially amended, and its powers overbudgetary spending were strengthened andmore clearly defined.

Money laundering legislation

On 1 January 2001 a new Law on Protectionagainst Legalising Income from Criminal Activitiesentered into force. The Law is designed to helpcontrol and prevent money laundering. Amongother measures, it requires so called “liableentities” (for example, banks, post offices,auditors, tax advisors, insurance companies,etc.) to notify the financial police of anytransactions that might involve money laundering.The Law also bans anonymous deposits.

On 7 May 2001, the Slovak Republic ratifiedthe Council of Europe Convention on Money Laundering, which will take effect on 1 September 2001. The Conventioncomplements the recently adopted moneylaundering legislation.

Legal developments

Law on mutual investment funds

On 24 April 2001 a new Law “On Institutionsof Mutual Investments” entered into force. The new Law establishes comprehensive rulesfor setting up, operating and liquidating mutualinvestment funds and asset managementcompanies in Ukraine. Under the Law,investment funds are designed to pool

investors’ monetary funds for the purposesof deriving profits from investing in securities,corporate rights and real estate.

Judicial reforms

In June 2001 the parliament approved an initialpackage of judicial reforms, which wereexpected to be signed into law by the presidentduring July 2001. The Constitution required anoverall reform of the judicial branch by 28 June2001. Passage of this initial package will playan important part in the reform process, whichis expected to include a new civil procedure,criminal procedure and administrativeprocedure codes. Under this initial package of reforms, an additional level of courts will be introduced, and all arbitration (commercial)courts are to be liquidated. In lieu of thecommercial courts, courts of appeal andspecialised courts are to be created.

Civil code

In June 2001 the parliament approved the first three volumes of the draft Civil Code –“General Concepts”, “Personal Property Rightsof Natural Persons”, and “Right of Ownershipand Other Rights”. The draft Civil Code isexpected to include eight volumes, specifyingpersonal property rights of natural persons andregulating property law, contracts, family lawand inheritance law. A separate chapter willdeal with copyright law, industrial ownershiplaw and trademarks. It is unlikely that the fullCode will be adopted before the end of 2001.

Competition law

On 11 January 2001 the parliament enacteda new Law on Protection of EconomicCompetition. The Law defines and sets forththe principal features of anti-competitiveconcerted actions of business entities, abuseof monopoly position on the market, andrestrictive and discriminatory activity bybusiness entities and their associations.

Legal developments

Energy sector reforms

Uzbekistan is set to launch more energy sectorreforms that will privatise and liberalise thedomestic electricity industry. The reforms willinvolve the abolition of the Energy Industry andElectrification Ministry, and the privatisation of a number of state-owned companies. Theintention is to replace the Ministry by an openjoint-stock company, Uzbekenergo. Anelectricity regulator, the State Agency forSupervision in the Electricity Industry, wouldalso be set up. The proposed reforms shouldencourage investment in the electricity sector.

Uzbekistan

Ukraine

Legal Transition Team

David Bernstein Chief Counsel/Team Leader

Craig Averch Counsel (CorporateRecovery Team),Bankruptcy

Hsianmin Chen Counsel, Financialmarket regulation/Corporate governance

Frederique Dahan Counsel, SecuredTransactions Project

Alexei Zverev Counsel, Concessions/Russia legal reform

Anila Gramshi Associate, Financialmarket regulation


Legal transitionevents

Meetings of IOSCO’s Committee onthe Implementation of “Objectivesand Principles of SecuritiesRegulations”, London and Stockholm

The International Organization for SecuritiesCommissions’ (IOSCO) Committee on theImplementation of “Objectives and Principles ofSecurities Regulations” held meetings in Londonon 5 March and in Stockholm on 23 June 2001respectively. The meetings were organised todiscuss, among other topics, whether and howIOSCO’s “Objectives and Principles of SecuritiesRegulations” need to be updated. The meetingsalso considered issues relating to theCommittee’s collaboration with internationalfinancial institutions (IFIs), in particular withregard to the financial sector assessment workconducted by IFIs in various countries.

Concessions Roundtable, EBRDAnnual Meeting, London

On 22 April 2001 the EBRD sponsored a legalroundtable on Building the Legal Environment forPublic Private Partnerships at its Annual Meeting.The roundtable was moderated by the GeneralCounsel of the EBRD, Participants includedEmmanuel Maurice. Dr Jernej Sekolec, theSecretary of the United Nations Commission on International Trade Law, Blanka Primec, State Under-Secretary for the Public ProcurementDepartment of Slovenia, Christopher Clement-Davies, partner at Vinsons & Elkins in London,and Walid Labadi, Senior Counsel at the EBRD.Discussions at the roundtable focused oninternational and institutional efforts to build alegal environment conducive to public privatepartnerships, and on the issues of concern forfinanciers and developers in concession-basedprojects. Dr Sekolec outlined efforts undertakenby UNCITRAL to increase awareness of issuesrelating to the development of public privatepartnerships, and in particular the developmentof the UNCITRAL Legislative Guide on Privately

Financed Infrastructure Projects. Ms Primecdiscussed legal issues related to thedevelopment of public private partnerships inSlovenia. Mr. Labadi focused on issues ofconcern to lenders in assessing the bankabilityof concession agreements, while Mr. Clement-Davies outlined ten key issues that arise in thecontext of negotiating concession agreements.

Annual Conference of the YugoslavAssociation of Commercial Lawyers,Vrnjacka Banja

On 23-25 May 2001 the Annual Conference of the Yugoslav Association of Commercial Lawyerstook place in Vrnjacka Banja, FR Yugoslavia. The general theme of the Conference was theharmonisation of Yugoslav law with EuropeanUnion law. Frederique Dahan, Counsel at theEBRD, made a presentation to the general sessionof the Conference, which focused on: (i) theimportance of secured transactions and theEBRD’s “core principles”, (ii) the progressthroughout the region since 1992, (iii) the stepsneeded for further legal reform, including a focuson implementation and judicial enforcement, and(iv) legal reform in FR Yugoslavia itself.

OECD Second Eurasia CorporateGovernance Roundtable, Tbilisi

On 7-8 June 2001 the OECD organised the secondEurasia corporate governance roundtable in Tbilisi,Georgia. The roundtable was a well-attended eventthat brought together representatives ofbusinesses, international financial institutions andacademics throughout the region. The roundtablefocused on transparency and disclosure issues.Participants discussed some of the key disclosureissues that affect their business and shared theirexperience on the ways to improve corporategovernance practices in their respective sectorsand countries. EBRD Counsel Alexei Zverev madea presentation describing the EBRD’s efforts toimprove corporate governance through its

investment operation and technical assistance.Materials from the roundtable can be found onthe OECD web site – (http://www.oecd.org.)

OECD, Fourth Russian CorporateGovernance Roundtable, Moscow

On 20-22 June 2001 the OECD, the RussianFederal Securities Commission and the SupremeArbitrazh Court co-hosted a corporate governanceroundtable focusing on the responsibilities of theboard of directors and the role of stakeholders.Participants discussed the role and responsibilityof boards in OECD countries, the situation inRussia (including a presentation by Boris Fedorov,member of the Boards of Gazprom OAO, RAO UESand Sberbank) and possibilities for improving thetraining and qualifications of board members.During the second day, discussion centred on therole of stakeholder relations between companiesand such groups as employees and creditors. Theroundtable was supported by USAID and theGlobal Corporate Governance Forum.

On 22 June the roundtable core participants groupmet to discuss the most recent version of theWhite Paper on Corporate Governance in Russia.Debate centred on the chapter on transparencyand disclosure. The White Paper is expected to befinalised during the first quarter of 2002, and willserve as a blueprint for corporate governanceimprovements in Russia, with recommendationsfor action by both the Russian Government andthe private sector.

UNCITRAL 34th Session, Vienna

Between 23 June and 13 July 2001, UNCITRALheld its 34th session. In response to requests at the 33rd session held last year, this year’ssession considered, among other things, thepossibility for UNCITRAL to resume its earlier work on the area of security interests law. Themain themes discussed at the session were the reasons for using secured lending, therelationship between insolvency law and the law


on security rights, the issues pertaining to thedevelopment of model legislative solutions onsecurity rights in general and the drafting of asset-specific model legislation. The session alsodiscussed more specifically issues relating tomodel legislation.

UNCITRAL Workshop on PrivatelyFinanced Infrastructure Projects,Vienna

On 2-4 July 2001, UNCITRAL held a workshopto follow-up on the successful launch of the PFI Legislative Guide. The workshop gathered agroup of practitioners and officials from variouscountries to discuss the use of the PFI Guidelinesin assisting countries to implement concession-type arrangements. A separate session wasdevoted to bringing together international financialinstitutions and countries where the PFI frameworkhas not yet been developed to discuss thepossibilities for assistance to reform suchframeworks. EBRD Counsel Alexei Zverevshared the EBRD’s experience as a lenderto concessionaires and as a legal technicalassistance provider to its countries of operationsto improve their concession frameworks.

World Bank Second GlobalConference on Law and Justice:“Empowerment, Security andOpportunity through Law and Justice”St. Petersburg

On 8-11 July 2001 the World Bank and theRussian Government hosted the second GlobalConference on Law and Justice. The Conferencewas designed to explore a variety of legal reformareas including: (i) building political will to supportlegal and judicial reform; (ii) elements of aneffective judiciary; (iii) using law to advance the poor; and (iv) legal reform and post-conflictcountries. The Conference was addressed byDmitri Kozak, Deputy Chief, President’sAdminstration who read a statement of welcome

from President Vladimir Putin, World BankPresident James Wolfensohn and Hernando de Soto, President, Institute for Liberty andDemocracy, Peru. Presentations were made byjudges and justices representing the Supreme orConstitutional Courts of Bolivia, Brazil, Colombia,East Caribbean, England and Wales, Germany,People’s Republic of China, Russia, Sierra Leone,South Africa, and the United States. EBRD Chiefcounsel David Bernstein discussed the evaluationof the EBRD Legal Transition Programme as partof the panel looking at mechanisms for evaluatinglegal and judicial reform assistance. TheConference concluded with a special sessionamong IFIs and other legal reform donors onimproving the coordination of legal technicalassistance. Additional seminars focusing onEurope and Central Asia, legal aid and judges tookplace on 12 July 2001.

UNCITRAL Insolvency Law WorkingGroup Meeting, New York

UNCITRAL hosted a working group meetingbringing together experts on internationalinsolvency law from IFIs, internationalorganisations, academia and the private sector in New York from 23 July to 3 August 2001. During the meeting the experts considered thedevelopment of a detailed and comprehensiveLegislative Guide on Insolvency Law. The purposeof the Guide will be to assist in the development of efficient and effective legal frameworks forinsolvency. Currently, UNCITRAL has identified 14areas on which to focus its efforts and resources.To help the contributors, UNCITRAL prepared a“model format” that responses should follow,building towards “model outlines” for each of the14 targeted areas. The Guide is intended to havea more pragmatic and practical focus than therecently completed and approved “matrix” ofprinciples produced by the World Bank.

EBRD Roundtable on South East Europe, Bucharest

In May 2002 the EBRD will host a legal roundtable during the Bank’s AnnualMeeting in Bucharest. The roundtable will consider critical legal issuesaffecting south-eastern Europe, a subject which will also be the focus sectionof the Spring 2002 issue of Law in transition. Participants will be announcedcloser to the time on the Bank’s web site at www.ebrd.com. However, it isexpected that they will be drawn from the EBRD, government officials from the region responsible for developing and implementing legislation, andrepresentatives from the local and international legal community and legalinternational organisations.


The European Bank for Reconstruction and Development (EBRD) is an international institution

whose members comprise 60 countries, the European Community and the European Investment Bank.

The EBRD operates in the countries of central and eastern Europe and the Commonwealth

of Independent States committed to multiparty democracy, pluralism, and market economies.

The EBRD’s countries of operations are: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina,

Bulgaria, Croatia, Czech Republic, Estonia, FR Yugoslavia, FYR Macedonia, Georgia, Hungary,

Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Poland, Romania, Russian Federation,

Slovak Republic, Slovenia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.

The EBRD works through the Legal Transition Programme, which is administered by the Office

of the General Counsel, to improve the legal environment of the countries in which the EBRD

operates. The purpose of the Legal Transition Programme is to foster interest in, and help to define,

legal reform throughout the region. The EBRD supports this goal by providing or mobilising technical

assistance for specific legal assistance projects which are requested or supported by governments

of the region. Legal reform activities focus on the development of the legal rules, institutions and

culture on which a vibrant market-oriented economy depends.

Law in transition is a publication of the Office of the General Counsel of the EBRD. It is published twice a year and is available in English and Russian. The editors welcome ideas, contributions and letters, butassume no responsibility regarding them. Submissions should be sent to David Bernstein, Office of the General Counsel, EBRD, One Exchange Square, London EC2A 2JN, United Kingdom; or [email protected]

The contents of Law in transition are copyrighted and reflect the opinions of the individual authors and do notnecessarily reflect the views of the authors’ employers, law firms, the editors, the EBRD’s Office of the GeneralCounsel or the EBRD generally. Nothing in the articles should be taken as legal advice.

© European Bank for Reconstruction and Development, Autumn 2001.

All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means,including photocopying and recording, without the written permission of the copyright holder. Such written permissionmust also be obtained before any part of this publication is stored in a retrieval system of any nature.

European Bank for Reconstruction and DevelopmentOne Exchange SquareLondon EC2A 2JNUnited KingdomTel: +44 20 7338 6000Fax: +44 20 7338 6100http://www.ebrd.com

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