Arbitrating disputes involving allegations of corruption: Considerations and strategies for counsel and clients

How arbitrations involving corruption allegations arise

A commercial party whose contract has been terminated or who has had performance withheld on the grounds of corruption, and who considers such action to be wrongful, may seek recourse by commencing arbitration under the dispute provisions in the contract. Similarly, in an investor-state context, an investor may allege that it has suffered discrimination, expropriation or another violation of an applicable investment treaty where the state party’s action or inaction harms an investor or investment. In its response, the state party may allege that the investor’s claim is inadmissible as the investment was initially obtained through corruption of a state official.

The potential for mismatch between regulatory and contractual requirements

An example of corrupt activity that can give rise to criminal prosecution is the bribery of public officials. It is axiomatic amongst the anti-corruption bar that nearly all prosecutions for bribery of foreign public officials will involve an agent, local partner or other intermediary (“agents”). There are many reasons for this: in some cases, only a local will know who to bribe and how. Agents who are paid a success fee or commission may be incentivized to pay bribes to local officials if they believe the financial upside outweighs the risk to them personally (particularly if domestic laws are perceived to be lax). Under current anti- corruption regimes, a similar incentive rarely applies to large global companies who face penalties in the millions, or even billions, for involvement in such activities. However, companies can be at risk of prosecution for the actions taken by the local agents with whom they have contracted.

Most sophisticated companies now have detailed anti-corruption warranties and representations in their agency contract templates to address this risk and enable the company to take steps under the contract where allegations of corruption arise. However, difficulties may arise in many scenarios. For example, (i) where corrupt acts are alleged to have taken place prior to the agency contract being updated to reflect modern anti-corruption legislation, (ii) where there is no written contract with the agent or (iii) where the law of the contract or the law governing an arbitration following termination of the contract is different from the law of the jurisdiction where the company faced potential criminal or regulatory liability.

In such cases, there can be a mismatch between what a company is required to do under criminal law and applicable regulations and what it is permitted to do under the law and terms of the contract with the agent. By way of example, while still allowed under US law, facilitation payments were made illegal under Canadian law in 2017 and under the UK Bribery Act 2010. Facilitation payments, colloquially known as “grease” payments, are typically aimed at expediting an otherwise routine administrative process (such as customs or port clearances, to use two common examples). One can readily imagine a scenario where a Canadian company hires a US agent under a contract governed by US law to perform work in some third country. The agent may make small facilitation payments to prevent work required by the contract from being unduly delayed by bureaucratic red tape. In this scenario, the agent’s conduct may be excusable under the law of the contract and its home jurisdiction, but if the Canadian company, after learning that a facilitation payment has been made, does not take steps to stop further payments to the agent, it could face prosecution in Canada. If the contract with the agent does not address this situation, it creates a difficult situation for the company and the potential for a dispute.

Similarly, there can be a disparity between criminal and commercial obligations where criminal law or regulation requires a company to take steps on the mere suspicion of corrupt activities, and whether it is in the company’s best interests to do so. At this stage of an internal anti-corruption investigation, the priority and focus will rarely be the same as in any subsequent commercial arbitration dealing with the termination of a contract following the investigation. In an internal anti-corruption investigation, the focus is on limiting a client’s exposure to criminal and civil liability for corrupt activities, particularly as penalties for companies can be large. The client will want to establish whether the threshold imposed by applicable criminal laws and regulations has been met, either triggering liability on the part of the client or requiring the client to take active steps, such as terminating the agent, to avoid facing criminal or regulatory penalties. Corruption by an agent may also attract liability for the client. Many anti- corruption regimes impose criminal or other forms of liability where continued payments are made in the face of early warning signals indicative of the agent engaging in corruption. If corrupt activities are suspected, counsel will want to distance their client as much as possible from the activity. What is permitted by the law and within the terms of the contract with the agent at this stage (where there is no conviction or direct evidence of bribery) may be of secondary consideration if the amounts at stake are comparably smaller.

We can see examples of this in Canadian law. In Canada’s Criminal Code, liability may be imposed on a company as an accessory if a court concludes they have been willfully blind to the prospect of bribery by an agent.

A similar mismatch can occur where certain conduct is proscribed by the criminal law or regulations to prevent corruption, but such conduct may not provide grounds to terminate the contract. In the US, the “books and records” offense in the FCPA does not require proof of bribery, but rather the statute requires listed entities in the US to keep books and records that fairly and accurately reflect the corporation’s transactions. Individuals have been charged for failing to adequately supervise employees to make and keep accurate books and records and implement an adequate set of internal controls, despite not necessarily having direct knowledge or involvement in a bribery scheme. For example, Con-way Inc. was charged with violations of the FCPA after a subsidiary in the Philippines in its freight forwarding business allegedly paid hundreds of thousands of dollars in small sums to customs and other government officials. Con-way Inc. was not prosecuted for bribery. Instead, the complaint was based on the allegation that (i) none of the improper payments made by its subsidiary to government officials were accurately reflected in Con-way’s books and records and (ii) that Con-way knowingly failed to implement a system of internal accounting controls concerning its subsidiary complying with the FCPA and require that the payments it made to foreign officials were accurately reflected on its books and records. In the case of agents, prosecutors may point to abnormally large commissions as a sign that employees of the principal knew or were willfully blind to such funds being used to pay bribes.

Accordingly, to avoid the risk of criminal prosecution, companies often need to take proactive steps to end the relationship with parties who cannot provide assurance that their activities are legal, even where there may not yet be sufficient evidence to convict the agent. Under the terms of a contract, the threshold for termination may be higher or lower (or simply different) to when termination is required in the criminal or regulatory context. Where a contract is terminated for a regulatory offense that does not require direct evidence of bribery, such as improper record keeping, this may be necessary from the perspective of avoiding prosecution but (depending on the law and terms of the contract) may not, on its own, justify termination of the contract.

Ultimately, in such circumstances, while the evidence uncovered in an internal anti-corruption investigation will be helpful in subsequent disputes relating to contractual termination, the core focus of such investigations will likely be different from the issues in dispute in an arbitration. Arbitration counsel should therefore consider whether the grounds and evidence required to meet the contractual threshold for termination are different from those triggering termination in a criminal or regulatory context.

Privilege considerations

An internal anti-corruption investigation typically results in a report by legal counsel setting out legal advice in response to the evidence uncovered during an investigation. This may include an assessment of whether the client faces any liability for the acts of their agent, future steps for the client to prevent any further criminal or regulatory liability from accruing, and an assessment by investigation counsel of whether the agent is likely to have committed the bribery or another suspected corruption offense. The latter point may be relevant to a claim by an agent for wrongful termination.

However, there will often be good reasons why arbitration counsel will not wish to waive privilege over such a report in a subsequent arbitration with the agent. For one, for the purposes of the report, investigation counsel may have found it unnecessary to reach firm conclusions on whether the agent committed bribery. As discussed above, if there is no explanation from the agent for suspicious conduct, a client may have to terminate the agent’s contract to avoid potential liability under criminal or regulatory law. In some cases, this may satisfy the contractual threshold for termination. However, where there is an absence of clear language in the contract supporting termination in such circumstances, some jurisdictions may require that bribery be proven on the civil standard for it to succeed as grounds for termination.

Furthermore, in an anti-corruption investigation, facts may be learned which are irrelevant to a subsequent arbitration, but which are nonetheless critical to the client as part of the client’s compliance efforts. For example, an investigation may reveal that a client’s due diligence practices in the terminated agent’s jurisdiction were satisfactory, but that due diligence on agents in another jurisdiction fall short. A client may reasonably object to such irrelevant but sensitive information being disclosed in an arbitration, even where confidentiality protections are in place.

Considerations in the investment arbitration context

In investor-state arbitrations where a state has made an allegation of bribery, there are two competing needs from an investigation: first, the need to gather evidence to refute the allegations of bribery in the arbitration, and second, the more general need to investigate the allegations and determine if remedial action needs to be taken.

In the context of investor-state disputes, different challenges arise. For an investor who is accused by a state of having achieved an investment through bribery, there is the potential difficulty that the original investment was made many years prior and that witnesses who could refute allegations that it had been obtained through bribery are no longer available, either to testify or to participate in an internal investigation.

If the investor was not aware of any allegations of bribery prior to commencing a claim against the state, allegations by the state that the investment was obtained through bribes may come as an unpleasant surprise. For the investor who commenced the arbitration believing that the dispute was about the interpretation and application of a treaty, their focus will now have to shift to a different area of the law— refuting evidence that the investment at issue was obtained through bribery.

It is critical that claimant counsel be aware of indicia of corruption and seek appropriate advice if they have reason to believe an investment may have been achieved through a bribe. In one of the best-known arbitration awards where the arbitral tribunal rejected a claim because an investment had been obtained through bribery, the evidence of bribery came from the claimant’s very own witness statement and prompted the arbitral tribunal to make its own inquiries about whether bribery had occurred.

In World Duty Free Co. Ltd. v. Republic of Kenya, ICSID Case No. ARB/00/7, the claimant, a company incorporated in the United Kingdom, commenced an arbitration against Kenya. Unlike most investment arbitrations pursued under investment treaties, this arbitration was commenced pursuant to an arbitration agreement contained in a contract between the claimant and Kenya entered by the parties in 1989 (the “1989 Contract”). Under the 1989 Contract, the claimant was to construct, maintain and operate duty-free complexes at two airports in Kenya. The claimant alleged Kenya had breached this agreement. The arbitral tribunal ultimately held that the claimant had obtained the 1989 Contract through a bribe to the former President of Kenya. As a result, the claimant had no right to pursue or recover under any of its pleaded claims under the 1989 Contract, because it had obtained the contract through bribery.

What is unusual about the case is that the evidence of bribery came, apparently unprompted, in the form of a witness statement from the claimant’s CEO, where he described making a “personal donation” to the former president of Kenya to obtain the 1989 Contract.

While there may have been strategic reasons why the claimant’s counsel chose to risk the introduction of this evidence, this case highlights the importance of arbitration practitioners being aware of indicia of bribery by their own client when preparing their case.

In the context of bribery of state officials, some commentators have suggested that the existence of bribery should not be grounds for inadmissibility of an investment claim, since (the argument goes) the state shares complicity for the bribery of the official. The problem with this argument is that it fundamentally ignores the nature of bribery: the state – or rather the citizens it represents – are the victims of the state official who committed the bribery. A similar argument was advanced in World Duty Free Co. Ltd. v. Republic of Kenya but rejected by the tribunal. Arbitration counsel should accordingly be aware that such arguments are unlikely to gain much sympathy from arbitrators.

Recommendations

Many steps can be taken to proactively address the dynamics described above.

During an investigation

If an arbitration has not been commenced but is anticipated in the future, one option is to seek separate opinions following an internal anti-corruption investigation: (i) one giving the client advice on what it should do to protect itself from criminal or regulatory liability and (ii) a separate opinion from different counsel assessing whether the evidence supports terminating the agent’s contract. The risk in this approach is the potential for conflicting opinions, and waiving privilege over the latter report could give rise in some jurisdictions to arguments that privilege has also been waived over the first report.

When there is more than one legal system involved, it may be necessary to have reports or opinions under the laws of different jurisdictions. For example, for an internal anti-bribery investigation, a Canadian company will typically need legal advice on what constitutes bribery under Canadian law and often US law (as those are the states most likely to claim jurisdiction). However, if the contract with the agent or other party accused of bribery is governed by the law of a different jurisdiction altogether, then legal advice will be needed from that jurisdiction to determine whether the law of the contract permits termination based on the facts uncovered by the investigation.

In cases where there are signs of bribery by the agent or partner, but no conviction or other direct evidence of bribery, the advisable course from an anti-corruption perspective may nonetheless be to terminate the contract. At the same time, depending on the law governing the contract and the terms of the contract, indirect evidence of bribery may be insufficient to justify contractual termination. In such cases, a client will have to weigh the respective risks, and may determine that the heavy penalties imposed in bribery prosecutions outweigh the risk of an adverse award in a subsequent arbitration claim for wrongful termination.

When an arbitration is underway

Where an arbitration is already underway, it is often appropriate to obtain an expert report from an anti-corruption expert to address whether the conduct described by the evidence meets the threshold for termination in the contract. Expert evidence on anti-corruption obligations is also vital where a contract contains anti-corruption obligations of a very general nature, to explain what conduct is prohibited. Because there are often local nuances to how bribery occurs – the form of the bribe and how, where and when it is made – expert evidence explaining why particular conduct is suspicious and indicia of bribery are often critical.

Expert evidence may also be vital when the underlying reason for the termination is the potential for a regulatory offense that does not require direct evidence of bribery, such as a books and records offense. Expert evidence will also be important when the law of the contract or the arbitration is different from the law of the jurisdiction where the respondent faces potential criminal or regulatory liability.

The trend in some jurisdictions, particularly the US, to resolve anti-bribery charges through negotiated settlements (such a deferred prosecution agreements) can mean that there is little or no case law resolving difficult legal issues, such as the adequacy of the state’s jurisdiction to prosecute. This makes expert evidence particularly important in establishing that what has occurred satisfies the provisions in the contract permitting termination.