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Copyright © International Chamber of Commerce (ICC). All rights reserved.
( Source of the document: ICC Digital Library )
Arbitrator and founding partner of Abogados Ortega & Gómez Ruano
In a noted decision rendered in February 2017, the Paris Court of Appeal considered the extent to which arbitrators may draw adverse inferences according to the IBA Rules on the Taking of Evidence in full respect and observance of due process, and the rights of defense.
The recent Dresser Rand case1 provides an example of an award that was put to the test because of its mention of the use of adverse inferences by the arbitral tribunal for the resolution of the dispute.
The arbitration derived from a stock purchase agreement signed in 2011 (the ‘SPA’) whereby twelve Spanish companies (the ‘Sellers’) transferred their shares in the Spanish company, Grupo Guascor S.L. (‘Grupo Guascor’), to the US entity Dresser Rand Group Inc. who then assigned its rights under the SPA to a Spanish related company, Dresser Rand Holdings Spain S.L.U. (‘Dresser Rand’).
Under the SPA, the Sellers provided a warranty in case Grupo Guascor’s financial information delivered during the due diligence proved afterwards to be inexact. In the arbitration, Dresser Rand invoked this provision with respect to a certain debt by Grupo Guascor with a Brazilian subsidiary. In response, the Sellers argued before the arbitral tribunal that Dresser Rand should not benefit from such warranty since it had effective knowledge of facts or circumstances constituting a breach by the Sellers prior to the purchase of the shares, a situation that resulted in an exception to the warranty obligation.
At the document production stage of the arbitration, each party requested documents from the other. Among those requested by the Sellers, were the preliminary and final versions of all due diligence reports or presentations prepared (i) internally by Dresser Rand, and (ii) by all service providers that participated in the due diligence for Dresser Rand ‘including Baker & McKenzie, KPMG and UBS’, with respect to the acquisition of Grupo Guascor, during a certain period of time.
In its answer to this request to produce, Dresser Rand objected to the production of the due diligence reports prepared by Baker & McKenzie on the basis that the information included therein was protected by attorney-client privilege. It objected to the production of the due diligence reports prepared internally for the same reasons. Dresser Rand complemented this response by stating that, without waiving these objections, it would provide the documents in reply to this request that were in its possession, custody or control.
Notwithstanding this statement, Dresser Rand did not subsequently produce the reports prepared by KPMG and UBS, nor did the Sellers insist on this request or ask the arbitral tribunal to draw inferences from the non-production.
In its award, among other rulings, the arbitral tribunal decided that the Sellers had breached their obligation to deliver complete and accurate accounting documents of Grupo Guascor, but concluded, by majority, that Dresser Rand could not benefit from the warranty in the SPA because it was aware of such violation before the purchase.
Dresser Rand sought the setting aside of the arbitral award before the French courts on the grounds that the arbitral tribunal had ignored its mission (Article 1520, 3° of the French Civil Procedure Code), and had violated the adversarial and right of defense principles (Article 1520, 4° and 5° of the French Civil Procedure Code).
Dresser Rand argued before the Paris Court of Appeal that by drawing an adverse inference against the non-producing party, as included in the IBA Rules on the Taking of Evidence in International Arbitration (the ‘IBA Rules’), without previously consulting the parties as to the application of such rules, the arbitrators had ignored their mission. According to Dresser Rand, the arbitral tribunal had the obligation to make such inquiry with the parties for any procedural matter other than those included in the ICC Arbitration Rules and the Terms of Reference.
Dresser Rand also invoked the violation of the adversarial principle and right of defense by claiming that the arbitral tribunal had based its ruling on adverse inferences, without having ordered the production of the UBS and KPMG audit reports at any time. Further, the arbitral tribunal did not invite the parties to explain the lack of production of such documents nor warn them on the application of adverse inferences.
The Paris Court of Appeal rejected the challenge. Among its considerations, it noted that the arbitral tribunal had described in its award several elements that proved, to the satisfaction of the majority, that Dresser Rand had known about the debt before the share purchase. Moreover, in Procedural Order No. 1, the arbitral tribunal had announced -and the parties had accepted- that it could refer to the IBA Rules for guidance, and that, according to Article 9.5 of such Rules, if a party failed without satisfactory explanation to produce a document to which it had not objected in due time, the arbitral tribunal could infer that such document would be adverse to that party’s interest. In the case at hand, the Sellers had requested the financial and accounting due diligence reports prepared by UBS and KPMG, and Dresser Rand had neither objected to their production nor produced them. By majority, the arbitral tribunal inferred that such documents were adverse to the interests of Dresser Rand.
Importantly, the Court of Appeal considered that, contrary to Dresser Rand’s arguments, the arbitral tribunal had not relied on adverse inferences for an issue that was determinative to its ruling, but that the majority of the arbitrators had rather based their decision on the evidence on record, and only referred in passing to the lack of production of the UBS and KPMG reports.
The Paris Court of Appeal also noted that (i) the arbitration clause provided for an arbitration proceeding under the ICC Arbitration Rules, (ii) the Terms of Reference mentioned that for all questions not contemplated in such rules the arbitral tribunal, after consulting the parties, would adopt and apply the rules that it considered appropriate, and (iii) the arbitral tribunal had provided the parties with a draft of Procedural Order No. 1 which stated that for all procedural matters not contained in such order the arbitral tribunal could make references to the IBA Rules without being bound by such rules. As this wording was part of the final text of Procedural Order No. 1 and drafts of Procedural Order No. 1 were subject to several exchanges between the parties, it could be concluded that the parties had agreed to the use of provisions contained in the IBA Rules, and that there was no further need to consult them. According to the Court, there was no need for the Sellers to specifically request the use of such inferences, or for the arbitral tribunal to invite parties’ comments.
The Court of Appeal also stated that, contrary to Dresser Rand’s arguments, the request for the production of the UBS and KPMG audit reports was perfectly clear and precise. Dresser Rand had the opportunity to comment on it, and had made no objection. Consequently, there was no need for the arbitral tribunal to order the production of such documents in order to fulfill the conditions for the arbitrators to draw adverse inferences. In the words of the court ‘the arbitral tribunal may not be reproached for any ignorance of the adversarial principle or rights of defense’.
Paris Court of Appeal, 28 February 2017, RG No.15/06036, Dresser-Rand Group Inc and Dresser-Rand Holdings Spain, S.L.U. v. Diana Capital I, F.C.R., Fond-Icopyme, F.C.R. de Régimen Simplificado, E-Novating Venture, S.L., Opción Fotovoltaica 24, S.L., Caixa Fondos, Centauro Capital, S.L.U., Villamendi, S.L., Sei Ta Lau, S.L., Sugar Magnolia 2003, S.L., Ibainarko, S.L., Aldaia BI, S.L. and El Portillo 2005, S.L.
Legal commentators in arbitration have drawn a distinction between improper adverse inferences and proper adverse inferences. The first are drawn in cases where the affirming party has provided sufficient evidence to support its claim or defense even without the other party’s production of the required document. In these cases, the adverse inference is used by the arbitral tribunal to strengthen its decision, and attach more weight to the requesting party’s evidence in the file. The second refer to cases where the document requested is essential for the party that makes the claim or defense to prove its case. Without that document, or the adverse inference drawn by the arbitrators in case of unjustified refusal to produce it, the affirming party will lose its case. The use of this second category of inferences must necessarily be preceded by notice to the parties on the possibility of its application, and an opportunity to produce the requested document, or any other that may contradict the possible inference in order to preserve the requested party’s rights of due process. See Simon Greenberg and Felix Lautenschlager, ‘Adverse Inferences in International Arbitral Practice’, ICC International Court of Arbitration Bulletin, Vol. 22: 2, 2011, pp. 43-56.