On January 28, 2015, the High Court of Justice of Madrid (“HCJ of Madrid”) rendered a decision[1] setting aside an award dated January 14, 2014 that dealt with an interest rate swap agreement signed between a retail company and a bank. The HCJ of Madrid concluded, after reviewing the law applicable to the merits of the dispute, that the award was contrary to economic public policy and, therefore, according to article 41(1)(f) of the Spanish Arbitration Act, it should be annulled.
Remarkably, the decision has not been an exception. In the past months, more judgments with a similar factual background (the purchase of an interest rate swap by a retail company) and analogous reasoning and outcome have been lodged by the HCJ of Madrid—Judgments of April 6, 2015, April 14, de 2015, and June 1, 2015—, pleasing those who blame the financial entities for the country’s economic crisis, but alarming Spain’s arbitral community.
Until recently, Spanish courts had respected that arbitral awards cannot be reviewed on their merits, and had interpreted the concept of public policy restrictively, applying it only when there had been a clear violation of a fundamental constitutional right. Do these decisions represent a change in trend?
- The Award of January 14, 2014
In 2008, the sole administrator of a retail company negotiated and agreed with BBVA (Spain’s second largest bank) the novation of a mortgage loan. During the negotiations, the company expressed its concern regarding the possible increase of interest rates and asked the bank if there was any product that covered such risk. The bank then offered the company to subscribe an interest rate swap.
Before contracting the financial product, the bank applied the convenience test[2] to the sole administrator, from which it resulted that he had passed 4 out of 5 years of the degree in business administration. Moreover, a BBVA worker explained to him the terms of the interest rate swap[3]. After the explanation, the sole administrator subscribed the mortgage novation as well as the interest rate swap agreement.
Six years later, the company initiated arbitration proceedings (under the administration of the Court of Arbitration of the Official Chamber of Commerce and Industry of Madrid) against BBVA requesting the arbitral tribunal to annul the interest rate swap agreement due to an error in consent. In this regard, the company alleged that, at the time of the agreement, the sole administrator thought he was contracting an insurance agreement that could be cancelled at any time; that BBVA had not applied the suitability test[4], as it should have due to the complex nature of swaps, and that the bank had advised him to contract the product before having him take the convenience test.
The arbitral tribunal rejected all of these arguments. In summary, the tribunal concluded that the product had characteristics that clearly distinguished it from an insurance (the company had never paid a premium); that a swap could not be qualified as a specially complex product for a person with a minimum formation and experience in commercial and financial activities; that the information provided by the bank was clear, true, impartial and non-fraudulent, allowing the client to be conscious of the essential terms of the agreement; and that the anticipated cancelation of the product had a cost that had to be paid. Hence, the award determined that the company had to comply with the terms of the interest rate swap in order to cancel it.
Disappointed with the award, the company sought its annulment under two grounds: (1) the partiality of the Court of Arbitration[5] and the absence of independence and impartiality in the co-arbitrator; and (2) the infringement of public policy due to the misinterpretation and misapplication of the standard of conduct rules imposed by the Spanish Securities Act and the national and European Union case law that applies those rules[6].
- The decision of the HCJ of Madrid of January 28, 2015
In the application to set aside the award, the company alleged that the award infringed public policy for four reasons: (1) it disregarded article 79(8) of the Spanish Securities Market Act when considering the swap a non-complex product; (2) it did not apply the statute of protection of retailers; (3) in view of the evidence, it could not be concluded that BBVA informed the company of the high risks and costs associated to the swap nor its probability of occurrence and possible range; and (4) it did not sanction the fact that the suitability test was not applied to the sole administrator.
BBVA rejected both grounds for the annulment of the award and, in relation to the second one, it held that the action to set aside awards does not open a second instance and could not allow the courts to review the merits of the case.
Although the decision seemed to agree with BBVA when quoting the Preamble of the Spanish Arbitration Act —“the grounds for setting aside an award must be appraised and must not allow, as a general rule, a review of the arbitrators’ decision on the merits”—, the fact that it underlined the words “as a general rule” gave a hint of what it would later dispose. The HCJ of Madrid stated that article 41(1)(f) of the Spanish Arbitration Act comprised not only the protection of fundamental rights (contained in the Spanish Constitution) but also, due to the imperative mandate of European Union Law, the protection of economic public policy.
In view of the court, “the distinguished paradigm of economic public policy is the principle of contracting in good faith (…), the observance of which is specially unavoidable when, in a particular transaction, a situation of unbalance, disproportion or asymmetry takes place between the parties due to the complexity of the product that is being bought and the disparate knowledge that parties have of such product”.
In order to determine if the award had breached economic public policy, the HCJ of Madrid reviewed the circumstances of the case in the light of the Judgment of the Supreme Court of January 20, 2014[7] —which contained essential doctrine that delimited the scope of the principle of contracting in good faith in relation to financial products—, and then concluded that the award erred in the following three aspects:
- The award disregarded the facts of the case that proved that the tasks carried out by the bank “implied advice and not only commercialization”, which should have led BBVA to apply both the test of convenience and the test of suitability to the sole administrator.
- The award ignored article 79 bis (8) of the Spanish Securities Market Act, which forbids to consider swaps as non-complex financial products.
- The award failed to analyze whether the bank informed the company of the possibility of early terminating the interest rate swap agreement and its related costs.
In view of the aforementioned errors, the court concluded that the award’s motivation, based on legal grounds that are contrary to imperative applicable law, was arbitrary and that it, therefore, contravened public policy.
III. The decision of the HCJ of Madrid violates article 41(1)(f) of the Spanish Arbitration Act
While an appeal allows a court to re-examine the decision rendered in first instance, the action of annulment of an award is limited to the numerus clausus grounds listed on article 41 of the Spanish Arbitration Act. This grounds allow a three level control: (1) the existence and validity of the arbitral agreement; (2) the regularity of the proceedings; and (3) respect of public policy.
But, what is public policy and in what particular cases does it allow tribunals to review the merits?
Spanish courts have always interpreted and applied the concept of public policy in a very restrictive manner, respecting the fact that an arbitral award cannot be, as a general rule, reviewed on its merits. This limitation implies that the proven facts, the assessment of the evidence and the interpretation given to the applicable law should, in general, remain out of the scope of the action of annulment.
In other words, courts cannot replace the criterion of the award by their own. The court may disagree with the final decision of the award but that does not allow it to dispense justice when the parties have attributed jurisdiction to an arbitral tribunal. The courts role is reduced to verify if the award is reasoned and if it is not flagrantly incompatible with the practiced evidence, and not to verify if another conclusion could have been reached out of the evidence.
As the Provincial Court of Pontevedra clearly stated in its decision of January 21, 2010[8], through the action of annulment the courts may only challenge awards that absolutely ignore the rights and principles that form public policy (i.e. fundamental constitutional rights), but not the particular interpretation and application that of those rights and principles the arbitrator does.
In view of the above, it is not a surprise that the decision of the HCJ of Madrid, which bypassed the arbitral tribunal’s reasoning, has been harshly criticized in every arbitral forum. This decision has unlawfully taken advantage of a broad concept of public policy to expand the scope of the action of annulment and reverse an award that is perfectly reasoned, just because the court disagrees with the outcome.
This new tendency has led to subsequent judgments like the decision of 14 April, 2015 of the HCJ of Madrid[9] in which the court even affirms that law grants judges an “extraordinary control” that has the goal of “revoking any excess of the arbitral award”. Indeed, this view is mistaken. As it is alleged in the dissent of Judge Francisco Javier Vieira Morante, the powers of the annulment tribunal are not the ones of an appellate one; thus, the annulment tribunal may not replace the conclusions of the award for others it considers to be more just[10].
In order to respect the principle of party autonomy and avoid any abuse of discretion in the future, it would be advisable to determine and narrow a definition of economic public policy, bearing in mind that public policy should only be considered where there is a clear and serious violation of a fundamental right. Otherwise, the ability to set aside an award would be boundless.
The absence of certainty and precision of such an important concept menaces the exceptional scope of the action of annulment, which could become a forbidden second instance. However, even if a definition is not found, courts cannot ignore that an award cannot be set aside when it is reasoned and the assessment of the evidence does not result irrational.
- Conclusion
Some authors[11] believe that the commented decision (as well as the ones that have followed it) “undermine the basis of arbitration and put in danger arbitrations with a seat in Madrid, which from now on are subject to appeal before the HCJ.” Others[12] believe “these judgments to be exceptional decisions on a very specific matter based on the specific circumstances of these cases [that] cannot be extrapolated to other types of controversies or disputes of a different nature.”
In this author’s opinion, the nature of the case should not justify the fact that courts go beyond their authority and, unless we want to detriment arbitration proceedings with a seat in Madrid, the concept of public policy should remain interpreted in a restrictive manner.
A broad interpretation of public policy, even if tied to arbitrations related to swap agreements, may (rectius, will) influence negatively in investors who will become reluctant to include arbitration clauses with a seat in Madrid in their agreements, because when deciding upon a dispute settlement clause, parties want to ensure an absolute legal certainty.
If the HCJ of Madrid misinterpreting article 41(1) of the Spanish Arbitration Act puts an end to the main virtues of arbitration —finality of the decisions, lower cost, enforceability of the award and speed—, by creating the possibility of reviewing awards on the merits, arbitrations with a seat in Madrid may be in danger. For now, these decisions have only affected a certain type of cases (arbitrations related to financial products acquired by retails companies), but what counsel can guarantee its clients that this reasoning will not be applied to other type of cases in the future?
As it was stated by a well-known dissertation, “the binding nature of the award, or indeed any legal instrument, cannot exist in isolation, but must stem from a legal system which recognizes that binding quality.”[13] In this regard, efficiency of arbitration proceedings does not only rely on the arbitrators but also on the support given to it by the courts. Only an intervention that shows a true support of the arbitral proceedings will allow arbitration to be a successful method of dispute resolution.
Lara Rodríguez Mulet
Class of 2016 graduate in the International Business Regulation, Litigation, and Arbitration (IBRLA) LL.M. program at New York University School of Law. Foreign Associate of the International Arbitration Practice Area at Freshfields Bruckhaus Deringer in New York.
[1] Civil and Criminal Chamber of the High Court of Justice of Madrid, decision number 13/2015, dated January 28, 2015 (Westlaw JUR\2015\79489).
[2] Test used to evaluate the knowledge and experience of the client in relation to the product being offered or requested.
[3] In summary: the bank would pay the company a 12 month EURIBOR rate and the company would pay the bank a fixed rate of 4.64% during a period of 13 years, being the amount equal to the one of the loan. Or, in other words, that he would have a fixed rate for the loan equal to 5.29%.
[4] Test used to evaluate the knowledge of the client in relation to the concrete product, his experience with such product, his financial situation and the objectives of his investment.
[5] The company alleged that the Court’s neutrality was jeopardized by the fact that at least one third of the arbitrators listed by the Court had had a direct relationship with BBVA or other banks who offer swaps.
[6] The HCJ of Madrid rejected the former ground, so we shall focus on the analysis of the latter.
[7] Note that this judgment was passed 6 days after the award was rendered.
[8] Provincial Court of Pontevedra, decision number 41/2010, dated January 21, 2010 (La Ley 8466/2010).
[9] Civil and Criminal Chamber of the High Court of Justice of Madrid, decision number 30/2015, dated April 14, 2015 (Westlaw JUR\2015\136198).
[10] In words of Judge Vieria, “it is true that when legal issues have been debated we may not agree with the judgment of the award, especially when it contradicts the Supreme Court’s decisions. But that does not allow us to impart justice in the particular case, since it is impeded by the decision of the parties to exclude tribunals of the dispute settlement.”
[11] Conthe, M., Swaps de intereses: la sentencia del Tribunal Superior de Justicia de Madrid de 28 de enero de 2015, Diario La Ley, n. 8515 (April 9, 2015).
[12] Ardila, G. and Fernandez-Miranda, B., No rain forecast for arbitration in Spain, LexisNexis (July 14, 2015).
[13] Fouchard, P., Gaillard, M., and Savage, J., Fouchard Gaillard Goldman on International Commercial Arbitration, Savage and Gaillard (1999).