Brazil Swimming Against The Tide

Mauricio Gomm-Santos¹

I. Introduction

Ignoring 12 years of case law in favor of arbitration, on January 30, 2008, the Tribunal of Justice of the Brazilian State of Paraná, in Inepar S.A Indústria e Construções (“Inepar”) v. Itiquira Energética S.A²(“Itiquira”) has denied enforcement to a domestic award because the parties had not signed the submission agreement (“compromisso”). Although the decision has no precedential force in Brazil, it may raise some concerns of foreign, as well as domestic, investors because the State of Paraná is one of the best states in the country to invest in Paraná is located in the southern region of Brazil, close to Argentina and Uruguay, and is the headquarters for many multinational corporations, such as car manufacturers Renault, Nissan, Audi-Volkswagen and Volvo.

II. The Facts

In 2000, Itiquira, a Brazilian subsidiary of U.S. NRG Energy, entered into a contract with Inepar in 2000 for construction of a hydroelectric power plant in Brazilian State of Mato Grosso. The contract called for arbitration in Curitiba, Paraná, Brazil³. A dispute arose due to alleged construction delays, and the subsequent termination of the agreement by Itiquira. In June 2002, Inepar initiated arbitration claiming damages of approximately US$ 20,000,000 for allegedly wrongful termination. Inepar gave notice to Itiquira and appointed one arbitrator. Itiquira counterclaimed for approximately US$ 70,000,000, and promptly appointed an arbitrator. The presiding arbitrator was then appointed. In March 2003, the parties, their legal counsel and arbitrators signed the terms of reference, based on ICC Rules. Although the contract calls for an arbitration to be conducted under ICC Rules, the parties opted for an ad hoc procedure, importing ICC Rules.

The judicial records show that both parties actively participated in the arbitral proceedings, including in multiple expert examinations and hearings. During the arbitration, neither party ever raised any plea as to any irregularity in the terms of reference, nor there was a dispute concerning the arbitral tribunal's jurisdiction to rule on procedural or substantive issues. In September 2005, after an extensive evidentiary proceeding, the arbitral panel awarded⁴ Itiquira (the respondent) US$ 20 million sought in the counterclaim⁵. The award also granted Inepar (the claimant) approximately US$ 2,500.000. In 2006, Itiquira started enforcement proceedings before the courts of Curitiba, Paraná, Brazil. Inepar⁶ filed an action⁷ to vacate the award, and concurrently filed a pre-enforcement challenge⁸ seeking to dismiss the enforcement action. The district court judge denied Inepar’s challenge. In 2007, Inepar filed an appeal⁹ before a panel of the Tribunal of Justice, the State of Paraná’s highest court, alleging that the arbitral award was null because the parties had not signed a “compromisso”. On January 30, 2008, the court ruled¹⁰ two to one in favor of Inepar’s claim that the award violates mandatory provisions of Brazilian Arbitration Law. (“BAL”).

III. Comments

A. The issue

The issue before the Tribunal of Justice is whether BAL, enacted in 1996,¹¹ still requires the signing of a compromisso as a condition to a valid arbitration and an enforceable award, even when the arbitration agreement itself contains all elements to start and to process the arbitration. The State of Paraná Tribunal of Justice's current ruling seems to push the arbitration back to the pre-BAL old fashioned concept that a full arbitration clause was insufficient to compel the parties to arbitration. It is true that a compromisso remains in the BAL, but its use has been confined to a very specific situation, which apparently was misunderstood by the majority in Inepar, who believed that a compromisso is mandatory under Brazilian law in all circumstances. However, there is a substantial difference as to the role of the compromisso under the previous regime as opposed to its role after the enactment of the BAL.

B. The compromisso and the lack of efficacy of the arbitration clause under the previous legal regime

Before the enactment of the BAL, the Brazilian Code of Civil Procedure characterized an arbitration clause only as a “pactum de contrahendo”; a mere promise to contract. According to the previous legislation¹², in order to exclude state courts jurisdiction, the agreement should include a clear indication of all details of the dispute including the names of the arbitrators and the description of the subject matter, which would be the object of the arbitration. Needless to say, such requirements were (are) almost impossible to fulfill during the drafting stage of an arbitration clause. Therefore, only after the conflict had arisen were the parties in a position to reaffirm the intention to arbitrate, through a compromisso, which would be the basis for preventing adjudication by the courts, and for granting the authority to the arbitrator to issue a valid award¹³.

According to the previous regime, to grant a motion to dismiss a lawsuit brought in contravention of the arbitration agreement, a court required proof that the parties had agreed to resolve the dispute based on a valid compromisso¹⁴.

C. The compromisso and the efficacy of the arbitration clause under the current arbitral regime

The BAL introduced many progressive changes in the legal text, but unfortunately left the compromisso requirement. The ill-advised decision in Inepar highlights the need to understand the distinction between an arbitral clause and compromisso, and between the so-called “full arbitration clause” and “empty arbitration clause.”

According to article three of the BAL, “parties can submit their disputes to arbitration by virtue of the arbitration agreement, consisting of the arbitration clause and the compromisso.”¹⁵ Article four says that “an arbitration clause is an agreement by which the parties to a contract undertake to submit to arbitration the disputes which may arise with respect to that contract”¹⁶ while article nine defines compromisso as “an agreement by which parties submit an existing dispute to arbitration.”¹⁷

The question that arises is whether a valid arbitration clause must always be completed by a compromisso in order to grant the arbitrators the authority to issue a valid and enforceable award. The answer comes from articles five, six and seven of the BAL, as well as the case law and doctrine.

Article five of the BAL describes the scenario when the parties clearly agree on the mechanisms to commence the arbitration proceeding. It also states that “[w]hen the arbitration clause makes reference to the rules of a particular arbitral institution or specialized entity, the arbitration shall be instituted and conducted in accordance with such rules….”¹⁸ On the other hand, article six of the BAL deals with cases where the parties fail to make reference to the rules of a particular arbitral institution or the method to initiate the arbitration. In other words, article-six situations are those where the parties only agree to arbitrate, without saying much more. For these “empty” arbitral clauses, Brazilian law requires the interested party to call the other party for a meeting to conclude the compromisso by any means of communication, which leaves proof of receipt, already fixing a date, time, and place for this occasion.

The next question is what if the other party, in this very specific situation, fails to appear at the requested meeting, or, if he does appear, refuses to sign the compromisso.

Article seven states that “[w]here there is an arbitration clause but one of the parties shows resistance to the commencement of arbitration, the interested party may request the court to summon the other party to appear in court to sign the compromisso, and the judge shall designate a special hearing for such purpose.¹⁹ Article-seven specific performance lawsuit for the drafting and signing of a compromisso clearly deals only with article-six scenario.

If the arbitration clause contains a provision concerning the procedures for appointing the arbitrator(s), as for instance, where the parties make reference to the rules of a particular arbitral institution,²⁰ and one of the parties brings an action in court, the other party may file a motion to dismiss. On the other hand, if there is an arbitration clause with no provision concerning the appointment of the arbitrator,²¹ and should one of the parties show resistance as to the initiation of the arbitration, the interested party has no option but to file the specific performance articleseven lawsuit.²²

Article-five agreements came to be defined by Brazilian courts as “full arbitral clauses” with no need to require the drafting and signature of a compromisso.

On the other hand, article-six agreements have been defined as “empty (blank) arbitral clauses”. This is the scenario where the clause does not indicate a method of initiating the arbitration. Under Brazilian law, an empty arbitral clause still requires the parties to comply with the agreement to arbitrate. However, if there is a resistance to start arbitral proceedings, the interested party has to go to court for assistance. Such assistance takes the form of a compromisso signed before the judge, which occurred in Compushopping et al. v. Americel.²³ In this case, an agency contract contained an empty arbitration clause, with no mention of any method for appointing an arbitrator. A conflict arose, and Compushopping firstly gave Americel the article-six notification to appear at a certain place, date and time to sign a compromisso. Americel failed to show up, which forced Compushopping to file article-seven judicial action to have a compromisso signed before the judge. Taking into account that the parties did not agree as to the number, method of appointment of arbitrator and the contents of the compromisso, the judge appointed²⁴ a sole arbitrator and issued a compromisso. Americel appealed on the grounds, inter alia, that the judge erred in appointing an arbitrator, who apparently had some ties to the opposing party. The Tribunal of Justice, and later on, the Superior Court of Justice, upheld the first instance decision. It should be noted that state court decision ruling on a compromisso is a judicial decision, therefore subject to appeal, which some times can take more than five years to be fully decided. The arbitration, however, may proceed²⁵.

The Compushopping case was the first one involving resistance of arbitration under an empty clause to reach the Superior Court of Justice. Some lessons can be drawn from this case: a) The preservation of the compromisso inside Brazilian arbitral legal system in situations where the conflict arises out of a contract which contains an empty arbitration clause; b) Where the arbitration clause is empty and the parties fail to reach an agreement as to the method of initiating the arbitration, only a judge can complete it through the compromisso. c) The decision by the judge appointing the arbitrator – where the parties fail to do so – is subject to appeal, which does not stay arbitral proceedings.

Inepar is clearly an article-five scenario. The clause contains in details the method of initiating the arbitration, which was voluntarily and ostensibly followed by both parties. Although a compromisso was not required, in Inepar the parties drafted and signed the terms of reference, which fulfills the same requirements for a compromisso,²⁶ under the BAL.

D. The Renault case

In 1999, in Renault do Brasil S.A. and others (“Renault”) v. Carlos Alberto de Oliveira Andrade²⁷ (“CAOA”), the São Paulo Tribunal of Justice recognized the principle of party autonomy and the validity of an ICC arbitration clause²⁸ in a contract concluded between the French car manufacturer and its former dealer in Brazil. In Renault, the contract provided for arbitration in New York under ICC Arbitration Rules. A dispute arose between the parties, and CAOA challenged the jurisdiction of the arbitral tribunal, which had already been appointed pursuant to ICC rules. CAOA brought a lawsuit before Brazilian courts, arguing that the arbitration should be initiated by virtue of a compromisso based on article seven of the BAL. The district court, in a preliminary decision, granted the order. The court recognized the existence of the arbitral clause but held that it did not have a binding effect because the parties had not signed the compromisso. The Tribunal of Justice reversed on the ground that the arbitration clause contained all necessary elements to initiate arbitration without the need for judicial support or intervention. The court held that the Brazilian judiciary lacked jurisdiction to examine preliminary questions about the effects of arbitration clauses. Such matters could only be heard by the arbitral tribunal pursuant to article eight²⁹ of the BAL, which recognizes the principle of Kompetenz/Kompetenz.

This decision had a significant importance in the development of arbitration in Brazil because it ruled on some then controversial issues. First it recognized that article-seven scenario does not apply to cases covered by article-five institutional clauses. Second, it holds that arbitration can begin without the need for the execution of a compromisso, where the contract provides for the method to appoint the arbitrator. Thirdly, the courts have a responsibility to make sure that the principle of autonomy of the parties prevails in arbitral matters.

IV. The issue before the Supreme Court

The interpretation of articles five, six and seven of the BAL however, did not pass without a debate before the Brazilian Supreme Court. In M.B.V. Commercial and Export Management Establishment v. Resil Industria e Comercio Ltda,³⁰ the foreign winning claimant filed a request for recognition of a Spanish arbitral award before the Brazilian Federal Supreme Court (STF)³¹. The case was filed right after the enactment of the BAL, and due to its novelty, Justice Sepulveda Pertence³² raised, sponte sua, doubts as to the constitutionality of the BAL. The Justice’s opinion was anchored in the old-fashioned assumption that the parties are not free to agree to arbitrate any future disputes without violating the Constitution³³. The essence of his argument was that, while the parties are free to settle an existing dispute by virtue of arbitration, they are not so free to dispose their rights prior to a dispute has arisen. Apart from its technical misunderstandings, Justice Pertence did not mention the Panama Convention³⁴ – which Brazil had already ratified, nor, for that matter, did he consider the Geneva Protocol³⁵.

The doubts and concerns about the outcome of the Supreme Court ruling lasted until December 2001, when the Court by majority recognized the constitutionality of all provisions of the BAL. Justice Nelson Jobim, who delivered the opinion for the Court, stated that "the article-seven procedure does not apply to arbitration clauses which refer to institutional rules or which foresee the appointment of the arbitral tribunal. This kind of arbitration clause exempts the conclusion of a new agreement [compromisso]."³⁶ In a concurring opinion, Justice Ellen Gracie, who is now Chief Justice of the STF, held that “[d]enying the possibility of recognizing the full validity of the arbitration clause or denying the possibility that it can be enforced before State Courts gives a benefit to the reluctant party to evade the method of settlement of disputes that the party had already accepted when the contract was formed. Denying it offers to the reluctant party power to destroy the condition that – given the nature of the interests involved – may well be the basic reason for the existence of the contract.”³⁷

In fact the debate revealed the real underlying issue, the ideological approach by the minority members of the Supreme Court that feared the “unknown” consequences of the so-called “privatization of Justice”, and – as a consequence – the loss of prestige of the Judiciary. The parochial and outdated understanding of the minority did not prevail.

The M.B.V. case, apart from having offered the Supreme Court opportunity for recognition of the full constitutionality of the BAL, put an end in the period in which all pre-dispute arbitral clauses were unenforceable. Five years later, Brazilian courts have been enforcing full arbitration clauses, without the need of the compromisso.³⁸

V. Conclusion

In Inepar the parties did sign the terms of reference, which contain all elements equivalent to the Brazilian compromisso, and, equally importantly, the parties actively participated during the entire arbitral process without raising any procedural defect, which came out only during judicial proceedings. As the first instance judge recognized: “[i]n addition to the fact that the parties have previously agreed on the rules to be followed in the arbitration, based on a “full arbitration clause”, [Inepar] entirely participated in the proceedings without raising, oportuno tempore, any objection regarding the absence of the compromisso. To bring this point only before the state court, [after the award is rendered], undoubtedly violates the principle of good faith and party autonomy.”³⁹

It is true that the court of appeals’ decision overturning the first instance ruling, and insisting on a compromisso does not reflect the prevailing opinion in Brazil. Normally, a two-to-one decision would give to Itaquira, the possibility of requesting a rehearing of the appeal en banc, based on the minority opinion, but this is not very clear when the ruling comes from an interlocutory appeal. In any event, there is always the option of filing an appeal to the Superior Court of Justice, which has already shown a more enlightened approach as to the interpretation and the scope of articles five, six and seven of the BAL. Although, the author anticipates that the Inepar’s decision will be overturned, appeals, within any judicial system, take time. For the time being, Inepar may regrettably bring an unnecessary uncertainty and an equivocal understanding as to the position of Brazilian courts regarding a well-settled concept of law, in the case law and among scholars, which may negatively impact in contracts with Brazilian parties. This article aims at demystifying this possible approach.

________________