Third, USDA’s Animal and Plant Health Inspection Service (APHIS) has promulgated regulations that ban the importation of ruminants and ruminant products from countries where BSE was known to exist. 9 C.F.R. §§ 93.401, 94.18 (2003). This import ban, dating back to 1989, was an early regulatory step following discovery of the disease in the U.K.

BSE was first discovered in a Canadian cow in May of 2003. See “Change in Disease Status of Canada Because of BSE,” 68 Fed. Reg. 31,939 (May 29, 2003). Under USDA regulations then in effect, all imports of live ruminants or ruminant meat products from Canada were therefore prohibited. See 9 C.F.R. §§ 93.401, 94.18 (2003). (An import ban of Japanese beef was similarly begun in 2001 when BSE was discovered in Japan).
On November 4, 2003, the Secretary published notice of a proposed rule seeking to amend the regulations governing the importation of ruminants from countries where BSE is known to exist. On January 4, 2005, USDA published its Final Rule lifting the ban on importing Canadian beef as follows:

Bovine Spongiform Encephalopathy: Minimal-Risk Regions and Importation of Commodities; Final Rule and Notice, 70 Fed. Reg. 460 (Jan. 4, 2005).

The Ranchers Cattlemen Action Legal Fund United Stockgrowers of America (R-CALF) challenged USDA’s final rule in the U.S. District Court for the District of Montana. On March 2, 2005, the district court issued a preliminary injunction, barring USDA from implementing its Final Rule. Ranchers Cattlemen Action Legal Fund United Stockgrowers of Am. v. United States Dep’t of Agric., 359 F. Supp. 2d 1058, 1074 (D. Mont. 2005).
In an opinion filed July 25, 2005, a three-judge panel of the Ninth Circuit Court of Appeals overturned the preliminary injunction issued by Judge Cebull, thereby allowing Canadian cattle and beef products to enter the US in accordance with USDA’s Final Rule. Ranchers Cattlemen Action Legal Fund United Stockgrowers of Am. v. United States Dep’t of Agric., 415 F.3d 1078 (9th Cir. 2005).

Implementing, Then Partially Lifting Japan’s Ban on U.S. Beef Imports

In October 2001, after the first case of BSE was discovered in Japan, Japan initiated a comprehensive BSE prevention and food safety scheme that included:

See <http://www.us.emb-japan.go.jp/english/html/fafacts/bse/bse.htm>. This regulatory regime, once implemented, was arguably more stringent than in the U.S. However, Japan’s feed ban was imposed later than in the U.S. creating the potential for a higher rate of BSE cases in Japan.

The first BSE case in the U.S. was announced on December 23, 2003. On December 24, 2003, Japan suspended importation of U.S. beef and beef products under Japan’s pre-existing ban on beef imports from countries where BSE is present. Prior to Japan’s suspension of beef imports from the U.S., Japan was the largest export market for U.S. beef—about $1.5 billion annually. Because of the presence of BSE, other nations also imposed bans on U.S. beef imports, resulting in a precipitous drop in U.S. Beef Exports, as illustrated below.

Source: <http://www.agmanager.info/livestock/marketing/graphs/Trade/Annual%20Beef%20Exports/AnnualBeefExp.htm>.

After the import ban was imposed, the United States and Japan began a series of discussions intended to harmonize their approaches to BSE prevention and ultimately allow the resumption of beef imports by both countries.
On October 23, 2004, Japan and the United States agreed in principle to resume U.S. beef imports of cattle aged 20 months or younger, after Japan officially revised its blanket testing policy to exempt domestic cattle of similar age. Under subsequent amendments to Japan’s anti-BSE law, cattle slaughtered at 20 months of age or younger could be excluded from blanket BSE testing. Japan in fact eased its domestic blanket BSE testing requirements, exempting cattle 20 months or younger effective August 1, 2005.

On August 9, USDA-APHIS announced plans to expand its mad cow surveillance program to include 20,000 healthy cattle (USDA had been focusing its testing on sick, injured or dead cattle, the animals seen at high risk for possibly having contracted the disease). Japan, on the other hand, had been testing more extensively. Many U.S. animal health experts believed that little will be gained from testing “clinically normal” animals in the U.S. Others noted that it makes political, if not scientific, sense to expand the surveillance program.

The intensive efforts to harmonize Japanese, Canadian, and U.S. health and safety regulations related to BSE finally bore fruit. On December 13, 2005, the Embassy of Japan in Washington, D.C. issued a press release noting:

The press release also noted that “[t]he U.S. has reopened its border to Japanese beef on December 12th, and Canada has done the same on December 9th.” See <http://www.us.emb-japan.go.jp/english/html/pressreleases/2005/121305a.htm>.

Also, on December 12, 2005 while attending WTO trade talks in Hong Kong, U.S. Agriculture Secretary Mike Johanns announced that “the Japanese market is now open to U.S. beef products. Resuming beef trade with Japan is … an important step toward normalized trade based on scientifically sound, internationally recognized standards.” See USDA Press Release No. 0544.05.

USDA’s Audit, Review, and Compliance Branch has been assigned responsibility for reviewing and approving companies as eligible suppliers of meat and meat products under the USDA Export Verification Program for Japan. Product requirements for the program are available online (http://www.ams.usda.gov/lsg/arc/ARC1030J.pdf).

U.S. beef producers hope that other countries, including South Korea, Taiwan, China, Singapore, etc., will soon lift their import bans on U.S. beef. On December 29, Hong Kong announced it will lift its import ban. Others are expected to follow the lead of Japan and Hong Kong in early 2006.

BSE, the WTO-SPS (Sanitary and Phytosanitary Measures) Agreement, and International Politics
WTO members must base their import requirements on an assessment of risk, taking into account the guidelines, recommendations, and risk assessment techniques developed by relevant international organizations. The Office International des Epizooties (OIE, also now referred to as the World Organization for Animal Health) is the key international organization for BSE.

The OIE guidelines on BSE are contained in Chapter 2.3.13 of the Terrestrial Animal Health Code, and supplemented by Appendix 3.8.4 of the Code (available from the OIE Web site, http://www.oie.int/eng/en_index.htm). Under OIE guidelines, BSE risk in a particular region should be assessed using a combination of factors within a region including import requirements, the actual incidence of BSE, the intensity of BSE surveillance, feed restrictions, etc.

The U.S., Canada, and Japan would each argue that it based its newly revised rules regarding beef imports on the OIE guidelines and standards, even if the new rules do not match exactly the OIE guidelines. See, for example, the extensive discussion on this topic by APHIS when it published the final rule lifting the ban on Canadian beef imports. “Bovine Spongiform Encephalopathy: Minimal-Risk Regions and Importation of Commodities; Final Rule and Notice,” 70 Fed. Reg. 460, 463-464 (Jan. 4, 2005). See also the references to OIE guidelines in the final rule allowing the importation of whole cuts of boneless beef from Japan. “Importation of Whole Cuts of Boneless Beef From Japan; Final Rule.” 70 Fed. Reg. 73905 (Dec. 14, 2005).

Undoubtedly, science played an important role in these beef import decisions. However, USDA Secretary Johanns gave special credit to President Bush “for being personally and directly engaged in the effort.” Johanns also thanked Secretaries Rice (State), Snow (Treasury), and Gutierrez (Commerce), U.S. Trade Representative Rob Portman, and Ambassador Howard Baker (Japan) for making the beef import ban a centerpiece of their discussions. Where’s the imported beef? The answer, it seems, is determined by a combination of modern science and old-fashion politics.
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Donald L. Uchtmann is Professor of Agricultural Law, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign and President, American Agricultural Law Association. Brian Garwood, a student in the College of Law, University of Illinois, assisted in the preparation of this article. Uchtmann is Vice Chair of the ISBA Agricultural Law Section Council and may be reached at uchtmann@uiuc.edu.

Noble Ventures Inc. v. Romania—Bilateral
investment treaty claim against Romania dismissed

By Violeta I. Balan *

Romania won an important arbitration in front of the International Center for Settlement of Investment Disputes (ICSID) on October 12, 2005. See ICSID Case No. ARB/01/11.1 The ICSID Tribunal unanimously dismissed all claims that Romania’s actions violated certain provisions of the 1992 United States—Romania Bilateral Investment Treaty (BIT) and held that Romania was not responsible for a foreign company’s failed investment in a privatized steelwork.

The dispute was initiated by an American company, Noble Ventures Inc., that offers business consulting services for steel companies in Eastern Europe. The U.S. company invested in a privatized steel mill, Combinatul Siderurgic Resita (CSR), located in Resita, Romania. In August 2000, the American company entered into privatization agreements with a Romanian agency in charge of privatization of state-owned enterprises called the State Ownership Fund (SOF). The privatization agreement provided for the acquisition, management, operation and disposition of the CSR steel mill. At the time, CSR had a significant amount of debt to other government entities and Noble Ventures alleged that the government promised to initiate the rescheduling of the mill’s debts. Six months after the acquisition took place, however, political control changed to the opposition party. The change of government was reflected in the replacement of the SOF by a different entity, the Authority for the Privatization and Management of the State Ownership (APAPS). After the acquisition of CSR by Noble Ventures, a number of problems arose. Mainly, the rescheduling of the mill’s substantial debt never occurred and that allegedly caused the mill to became inoperable and eventually led to the new government retaking control. Noble Ventures initiated arbitration proceedings in August 2001.

Noble Ventures claimed that Romania violated Article II(2) of the BIT by failing to provide international law standards of treatment such as good faith and fair and equitable treatment. Romania’s actions and inactions were allegedly arbitrary and discriminatory and prevented the American company from exercising its rights to manage and control its investment. It was also claimed that Romania engaged in misrepresentation about key assets in the tender book prepared for the privatization and it failed to honor the terms of several agreements related to the control of CSR. Further, Romania allegedly failed to provide full protection and security during a period of extreme labor unrest in the spring and summer of 2001. Noble Ventures also claimed that Romania failed to carry out its good faith obligations regarding negotiation of debt rescheduling with state budgetary creditors. Lastly, it was claimed that Romania’s initiation of judicial bankruptcy proceedings violated article III(1) of the BIT which prohibited direct or indirect expropriation. Noble Ventures sought $3.1 million in damages.

All of the allegations were contested by Romania. In sum, Romania contended that Noble Ventures simply failed to respect and accept the limits of the agreement it entered into with SOF. It was argued that Noble Ventures knew or should have known that when CSR was privatized, it was burdened with substantial debt and, under Romanian law, the SOF did not have the authority to forgive this debt. Romania contended that the parties’ share purchase agreement did not guarantee that CSR’s debts would be restructured. Further, Romania asserted that after failing to obtain the debt restructuring it sought, Noble Ventures simply stopped paying CSR employees’ wages and refused to invest capital in CSR, resulting in a labor strike. In May 2001, the government authorized substantial debt restructuring for CSR, but Noble Ventures rejected the restructuring package. In July 2001, CSR’s budgetary creditors filed a judicial reorganization petition in Romanian courts. Romania contended that Noble Ventures’ claim that the judicial reorganization was arbitrary, discriminatory, unfair and expropriatary was groundless as a matter of fact and law. Further, it argued that Romanian authorities reacted reasonably and exercised appropriate due diligence in response to alleged isolated acts of violence against Noble Ventures’ agents. Romania asked to be reimbursed for legal fees, costs and expenses totaling $8.9 million.

Preliminary, the Tribunal dealt with the issues of the umbrella clause and attribution. The first related to a provision in the BIT that provided that “[e]ach Party shall observe any obligation it may have entered into with regard to investments.” Noble Ventures claimed that this is the type of umbrella clause present in other similar treaties which brings contractual obligations under the treaty umbrella. Thus, it was argued that a breach of an investment contract can be construed as a breach of a treaty and, consequently, international law. After noting that the wording is different that similar provisions in other treaties and a fresh interpretation was required, the Tribunal agreed with Noble Ventures’ reading of the clause and found that found that “Article II(2)(c) would be very much an empty base unless understood as referring to contracts.” The Tribunal supported its conclusion by an examination of the wording itself and by reliance on an object-purpose analysis.

The second preliminary question was whether the acts of the SOF and APAPS (the Romanian governmental agencies in charge of privatization) were attributable to Romania. Relying heavily on the ILC Articles on State Responsibility, the Tribunal held that the acts of the Romanian institutions were attributable to Romania “for purposes of assessment under the BIT.” Further, because the BIT contained a valid umbrella clause, Romania was deemed to be a party to the privatization agreement.

Turning to the merits of the dispute, the Tribunal found that all the claims were meritless. It noted that the duty to provide full protection and security guaranteed in Article II(2)(a) of the BIT “is not to be understood as an absolute standard providing for strict liability but as a due diligence standard.” The Tribunal found that Romania had not failed to exercise due diligence in protecting Noble Ventures’ investment and, in any case, Noble Ventures did not prove that its alleged injuries would have been prevented had Romania exercised due diligence. Another issue was whether judicial proceedings initiated by Romania due to Noble Ventures’ insolvency could be regarded as arbitrary, discriminatory, unfair, and inequitable treatment and whether they amounted to expropriation at all. In this regard, the Tribunal rejected all these claims and observed that the purpose of the judicial reorganization was to preserve, rather than to destroy, the ability of Noble Ventures to revive CSR as an economic steel producer. Further, it questioned whether Noble Ventures was capable of meeting the promises made, including to the workforce of the CSR, and suggested that the restructuring proceedings were the “short term solution of the ‘social crisis” that had engulfed Resita as the result of [Noble Ventures’] inability to pay CSR’s workforce.” Finally, the tribunal held that each party would bear the expenses incurred in connection with the arbitration.

While this award is a resonant victory for Romania, there are other ICSID cases against Romania brought by disappointed foreign investors. They include a case filed by EDF in August 2005, an Israeli-American investor, over duty-free retail operations at Romanian international airports and allegations that a government official demanded a $2.5 million bribe. In July 2005, Rompetrol Group NV (TRG) notified the Romanian government that it intends to bring an ICSID arbitration based on the investment treaty between Netherlands and Romania. An Italian group of investors, Gavazzi Steel, has also made known its intentions to bring an ICSID claim over similar facts as in the Noble Ventures proceedings regarding another steel mill, Combinatul Siderurgic Otelu Rosu. The company Cross Lander USA declared in September 2005 that it intends to bring an ICSID claim against Romania over the privatization of ARO—a car manufacturer and the only producer of Support Utility Vehicle in Romania. The Romanian government, through its Ministry of Public Finance, is currently in the process of selecting the law firms which would represent Romania in front of ICSID. These cases, as well as the perception of corruption, tarnish the image of Romania and have a negative effect on the foreign investment in Romania. These consequences are particularly important in light of Romania’s accession to the European Union, scheduled to be consummated in early 2007.
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* Violeta I. Balan is an associate with the law firm of Mayer, Brown, Rowe & Maw LLP. Her practice focuses on international arbitration, particularly ICSID-related arbitration. She can be contacted at vbalan@mayerbrownrowe.com or (312) 701-8387.

1. A copy of the arbitral award is available online at: <http://www.investmentclaims.com/decisions/Noble-Ventures-Final-Award.pdf>.

Proposed amendments to the Investment Canada Act

By Cliff Sosnow

Overview

This past summer, the Minister of Industry announced intended amendments to Canada’s foreign investment review legislation, the Investment Canada Act (ICA), that if permitted to become law would allow the government to modify or disallow foreign investments when the government believes they may compromise Canada’s national security. The ICA currently allows for review of foreign investment but this review is expressly limited and the factors to be considered are set out in the ICA. These limits and factors reflect those set out the North American Free Trade Agreement (NAFTA) Investment Chapter under Annex I, certain provisions of the World Trade Organization (WTO) General Agreement in Services (GATS), and the Trade Investment Measures (TRIMs) Agreement. This combined transparency provides certainty and predictability in decision making and affords a clear level of protection to investors. In our view, the proposed national security amendments, contained in “Bill C-59”, would remove this certainty and protection. The amendments do not define national security, do not set out the criteria to be used to make a decision, and inevitably reduce the justiciability of decisions to reject foreign direct investments.

The Investment Canada Act Amendments

Recognizing that increased capital and technology would benefit Canada, the ICA was originally established to encourage investment in Canada that contributed to economic growth and employment opportunities, ensuring a “net benefit” to all Canadians.

When the Minister is making a decision as to whether the investment will be of net benefit to Canada, certain listed economic factors, known as the net benefit test, must be considered. These factors are reflected in Annex I to Chapter 11 of the NAFTA, the Schedule of Canadian Commitments appended to the GATS, and the TRIMs Agreement. They include the effect of investment on domestic competition; on Canada’s ability to compete in world markets; and on the compatibility of the investment with national and provincial economic and industrial policies.
Currently, the ICA differentiates between investments in cultural businesses and other investments. Investments in cultural businesses are subject to the net benefit test regardless of their asset value. Other investments are reviewable by the Minister of Industry (the “Minister”), but only when the asset value exceeds an established threshold: $250 million in direct acquisitions for WTO members. A lower threshold applies for investments in the uranium industry, certain financial services and transportation services or where both the buyer and the seller are not from countries or entities that are members of the WTO.

Under the proposed amendments, national security reviews will be required for investments by a “non-Canadian” that (i) establish a new “Canadian” business; (ii) acquire control over a Canadian business; or (iii) establish or acquire control over a business that has operations in Canada, or employees or assets in Canada where the Minister has “reasonable grounds to believe that an investment by a non-Canadian could be injurious to national security.” If the Minister so decides, then the proposed investment is referred to the “Governor-in Council” (i.e., the Cabinet) together with a report detailing the Minister’s findings and recommendations. Cabinet can then make any order it considers advisable to protect national security including prohibiting the acquisition or requiring the foreign company to divest itself of the target Canadian company.

The new powers provided by the amendment do not come with any limit on the exercise of national security review (a decision by the Minister or Cabinet is not appealable to any Canadian court, although a decision would be subject to judicial review by the Federal Court); do note define national security or the activities to which it would apply (for example, the traffic in arms or respecting the non-proliferation of nuclear weapons); and do not list criteria to be applied when either the Minister or the Cabinet make the determination.

Comparable U.S. Provisions

While the government claims that the proposed amendments bring the Act in line with other G8 countries, there are important differences with, for example, the equivalent United States legislation.

The United States federal government reviews foreign direct investment for national security concerns under Section 721 of Title VII of the Defence Production Act of 1950, known as the Exon-Florio Amendment. Under the legislation and regulations implementing the Amendment, the President has the authority to suspend or prohibit any foreign acquisition, merger or take-over of a U.S. corporation that is determined to threaten the national security of the United States; if, but only if, the President finds there is credible evidence that the foreign entity exercising control might take action that threatens national security, and the law does not provide adequate authority to protect against the threat to national security.

The U.S. legislation states that credible evidence is required, while no such requirement is included in the Canadian legislation. And unlike the proposed Canadian amendments, the U.S. legislation lists the factors that the President or a designee may consider in determining the effects of a foreign acquisition on national security, including the potential effects of the transaction on the sales of military goods, equipment, or technology to a country that supports terrorism.

In our view, recognizing the General Accounting Office report that between 1988 and 1994 one-third of cases notified to the Committee on Foreign Investment in the United States involved transactions that were unlikely to raise national security concerns, still, the Amendment provides more protection to potential investors from arbitrarily being denied the opportunity to invest than the proposed Canadian amendments.

Limited Judicial or Administrative Protections

Under current ICA law, listed net-benefit test criteria and financial thresholds to review, are intended to minimize hindrance to investments flowing into Canada. Foreign investors are afforded protection from arbitrary and capricious decisions and can appeal decisions using the NAFTA or the WTO through the proxy of their government or seek judicial review to the Federal Court to the government’s application of the test criteria and threshold to the transaction in issue.

In our view, the new provisions reduce this protection. First, although the proposed amendments provide a right to make representations to the Minister, currently there is no such right when Minister refers the investment to the Cabinet, the ultimate decision-making body. Second, although Cabinet decisions are subject to judicial review, the absence of a definition of what constitutes national security or criteria to be applied in making the determination will most certainly be understood by the Federal Court as Parliament’s signal to the Court to exercise maximum judicial deference in the assessment and review of Cabinet authority. Finally, the NAFTA and the WTO will offer limited proxy challenge authority by their representative governments under either of these trade agreements.
Under Article XIV bis of the GATS, Article XXI of the GATT (General Agreement on Tariffs and Trade) and Article 2102 of the NAFTA, there are expansive exceptions for national security measures. Historically, these have been understood to allow countries maximum deference in invoking these exceptions in deciding to limit trade and investment when there is a perceived threat to national security. In practice, little or no recourse is left to governments whose nationals have been denied access to markets for reasons of national security.
Given the current threat environment and heightened geopolitical tensions associated with China’s rise as a regional economic power, this is unlikely to change in the future. Investors are likely to get little protection from the Federal Court or either of these agreements if they feel they have been unfairly denied access to Canada’s investment market as a result of national security concerns invoked under the proposed amended ICA.

Listing Criteria is a Reasonable Alternative

The proposed Canadian amendments to the ICA lack explicit direction in considering what constitutes a threat to Canadian security. By providing a definition of national security or at a minimum, the activities against which national security review may be invoked; criteria to be considered when making a decision; and right of representation to the ultimate decision-makers, the Canadian Government can provide limits to the unbridled application of national security review without unduly constraining the government’s ability to review transactions on national security grounds. In so doing, amendments can provide protection, certainty and greater regulatory clarity to foreign investors, yet also protect Canadians against threats to Canadian security.
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Cliff Sosnow is a partner at Blake, Cassels & Graydon LLP, a Canadian law firm with offices throughout Canada, as well as offices in London, Beijing, New York and Chicago. Cliff is located at the firm’s Ottawa office where he is group leader of the firms trade law practice. Cliff has been recognized in the Canadian Legal Lexpert Directory as a leading practitioner in international trade regulation, and is recommended in Chambers Global: The World’s Leading Lawyers for Business as a leading practitioner in WTO/international trade. Previously, Cliff was counsel to the trade law division of the Canadian Department of International Trade and in-house counsel to the Canadian International Trade Tribunal. E-mail: cliff.sosnow@blakes.com.

International commercial arbitration: An introduction

By Jason B. McGary

The landscape in which international disputes are resolved is changing rapidly. The once generally held belief that the adversarial judicial process was vastly superior to the superficial and unpragmatic “inquisitorial” process that is alternative dispute resolution is being abandoned on a large scale.¹ It is being replaced by the growing ideal that Nation-States are balancing both their procedural and substantive law with one another. A prime example of this is the European Union’s adoption of a set of uniform arbitral laws in hopes of harmonizing the law of contractual relationships.²

The modern world is an extremely competitive market in which time is very expensive and where progress waits for no one. Globalization and corporate efficiency are a powerful incentive for the creation of a proficient and homogenous environment for international dispute resolution.³ Widespread use of international commercial arbitration in the settlement of disputes is the outgrowth of this stimulus.

What is International Commercial Arbitration?

In form, international commercial arbitration is a mechanism through which multiple transnational parties may seek to resolve a dispute using one or more arbitrators in lieu of litigating the matter before a court. Arbitration is similar to, yet yields different results, from other forms of alternative dispute resolution such as conciliation or mediation. In arbitration, there will be a clear winner and a clear loser. An arbitral award will be given the winner, and the loser will be expected to comply with the terms of the award. Whereas, conciliation and mediation involve compromise by the parties and involve all parties winning in some things and losing in other things.⁴ Conciliators and mediators encourage settlement among the parties without weighing in on the underlying facts of the dispute.⁵ Typically, the parties will have previously agreed to arbitrate the dispute by inclusion of an arbitration agreement or clause in their business agreement or contract.⁶ However, frequently, the parties may also make the decision to proceed to arbitration after the dispute arises by mutual agreement.⁷

There are a number of factors to be considered when the parties decide to arbitrate versus proceeding to a court. The primary factors that the parties should take into account are the legal systems involved in the litigation of the dispute.⁸ It is essential that the parties consider where the litigation would take place either domestically or internationally, as well as in what legal system(s) would the party seek enforcement of the judgment.⁹ Other factors that should be considered by the parties are: the type of agreement or contract that is the subject of the dispute, the type of remedy sought, and the relationship and nature of the parties.¹⁰

How International Commercial Arbitration Proceeds after Agreement by Parties

When the parties have made the decision to arbitrate their dispute, they can proceed in one of two ways. The parties may choose to proceed with either “ad hoc” or “institutional” arbitration.¹¹ Whichever method the parties choose, the jurisdictional requirements differ greatly from those of traditional court proceedings. There is no legal requirement that the proceedings be conducted at the place where a party is legally established.¹² Further, the parties typically choose a “neutral” place or an institution or place whose rules or national arbitration law they are familiar with.¹³

Ad hoc means quite simply that there have been no arrangements made by the parties to the arbitration beyond those basic provisions in the arbitration agreement that are legally required to be included in any such agreement.¹⁴ Arbitration proceeding in this manner is very flexible and can be tailored to the particularized dispute between the parties and is informally referred to as “do it yourself arbitration.”¹⁵ The procedures of ad hoc arbitration will depend to a great extent upon the legal background of the parties and the “lex arbitri,” or the applicable arbitration law of the place of arbitration.¹⁶ The parties will stipulate many of their own rules and procedures, but will look to the national law of the place of arbitration for any rules or procedures that the parties did not expressly agree to or specify. Therefore, the parties would be well advised to look at the choice of law rules of the place of arbitration or to include carefully drafted choice of law provisions in their arbitration agreement.

In addition, the arbitration tribunal is restricted in its decision making ability in an ad hoc proceeding to the extent that the parties have provided it with authority in their arbitration agreement. Unlike institutional arbitration, there is no supervising body, and the only support available to the parties will be the local court’s arbitration rules, which may require filing litigation with the local court.¹⁷ This can be of great importance when it comes to the terms of discovery and presentment of each of the parties’ supportive evidence.¹⁸ In an extreme example, a decision may be issued by the tribunal predicated entirely upon only the documents submitted to the tribunal if no party has requested otherwise or objects, or if the arbitration agreement and the lex arbitri are silent on the issue.

Institutional arbitration on the other hand, is in general the more widely accepted and utilized method for settling international commercial disputes. In an institutional arbitration proceeding, the parties stipulate that the rules of a recognized arbitration institution will control.¹⁹ Several of the leading international commercial arbitration institutions are the International Chamber of Commerce (ICC), the American Arbitration Association (AAA), the International Center for Dispute Resolution (ICDR), and the International Center for Settlement of Investment Disputes (ICSID). Each of these named institutions has its own set of rules or has adopted the United Nations Commission on International Trade Law (UNCITRAL) Model Law.²⁰ The ICC is often the default arbitration institution for transnational parties arbitrating a dispute. Their strength lies in the fact that the ICC does not reflect a particular national law and that they administer arbitrations throughout the world.²¹

The institutions’ purposes are to provide the parties with a cost effective and time efficient set of neutral rules for the resolution of their dispute. As a result, many if not all of the procedural complexities that accompany ad hoc arbitration are alleviated by institutional arbitration.²² The lex arbitri choice of law rules are displaced in an institutional proceeding in favor of the institution’s procedural rules.²³

Similar to ad hoc proceedings, institutional arbitration rules are deliberately vague and silent on some points. The focus is still to allot the parties great flexibility in how to proceed so that any hearing is customized to the specific dispute between the parties.²⁴ Typically, in institutional proceedings, a pre-hearing conference will be held in which the parties will decide: the governing arbitration rules, the language the arbitration will be held in, the place of the arbitration, the costs, confidentiality, the issue(s) to be decided, and the arbitration schedule.²⁵

Discovery in both ad hoc and institutional proceedings is quite different than the broad discovery generally allowed in courts in the United States (US). In fact, US “style” discovery is frequently not allowed and is in fact disfavored in international arbitration proceedings.²⁶ For example, there are no depositions, no interrogatories, and no requests to admit. Besides the exchange of documents, the only real discovery is the testimony of witnesses. Document exchange between the parties is kept to a minimum as well. Only documents that each side will use to prove their case are generally allowed.²⁷ Requests for additional documents must contain a statement sufficient to identify the documents requested and state their relevance to the case.²⁸ The power of an arbitration tribunal to order discovery is limited by the domestic law of the place of arbitration in ad hoc proceedings, by the applicable institutional rules when proceeding through an institution, by the International Bar Association Rules of Evidence, and finally, can be limited to a great extent by agreement between the parties.²⁹ Often, the parties will agree to the scope of discovery in the arbitration clause, and to a certain extent outline the discovery process. Otherwise, default discovery rules of the adopted institution or the domestic rules of the place of arbitration will serve as “gap-fillers.”

To Arb or Not to Arb…That is the Question

The decision to proceed to arbitration requires the parties to carefully weigh many distinct factors that set arbitration apart from traditional litigation in resolving their dispute. As with litigation, international commercial arbitration is not without its benefits and drawbacks. The parties must be aware of these factors and consider them in depth in order to decide which procedure will best allow them to reach their goals for resolving the disagreement and provide the remedy they seek.

One of the major advantages, and typically of primary concern to the parties, is that of enforcement of international arbitration awards. Officially, an arbitration tribunal, whether ad hoc or institutional, has no means of enforcing compliance with its decision or award. Informally, the stigma that is raised by the losing party’s non-compliance creates severe concerns in the eyes of future trading partners and the resulting damage to its public image supplies a great deal of pressure to comply. Some would view this as a significant disadvantage of utilizing arbitration as a source of resolution. However, the New York Convention is an international enforcement mechanism that was agreed to and signed by one hundred and thirty countries.³⁰ It provides for recognition and enforcement of foreign arbitral awards in the courts of any of the member countries. It has given international arbitral awards teeth in the area of enforcement and parties are not left without only the informal recourse mentioned above. The winning party, however, must register the award for enforcement with the courts of the place where enforcement is sought.

There is no similar international convention for enforcement in a foreign court of a domestic judgment. In fact, in many instances a foreign court’s judgment will only have evidentiary value in a separate claim for damages in the country where enforcement is sought.³¹ There is a substantial lack of reciprocity across nations with regard to recognizing and enforcing foreign judgments. In a great many instances, the dispute must be retried in the court where enforcement is sought.

Countries who are members of the Convention are greatly limited in the grounds on which their domestic courts may refuse to enforce or recognize an award. A court may only refuse to enforce the award on the grounds of procedural defect, such as an award that goes beyond the scope of the original arbitration agreement.³² Also, the Convention does not allow for any judicial review of any award unless the subject matter is one that cannot be arbitrated under the laws of the country where execution or enforcement is sought.³³ Therefore, the standardization of the conditions of enforcement of foreign arbitral awards is a major advantage of proceeding to arbitrate an international dispute.

Another distinct advantage to arbitrating a dispute versus litigating lies in the flexibility and autonomy afforded to the parties to the arbitration. If proceeding with an institutional arbitration, parties are free to choose the language in which to arbitrate, and it need not necessarily be the same language as the place in which the arbitration will take place.³⁴ Whereas the language to be used in litigating the dispute, will normally be the same language used by the country where the court is located. Also, the parties are free to choose any institution they wish.

Along these same lines, the parties are able to choose the members of the tribunal that will hear their dispute. Generally, a tribunal is comprised of a three person panel. The parties will each choose a member individually, and the third member will usually be one whom both parties agree to.³⁵ The members of the tribunal will typically be experts in the field giving rise to the dispute. Therefore, an arbitration tribunal may be in a much better position to decide a dispute on a very technical or specialized subject matter than a court that hears a wide range of issues and specializes in none. Further, this will limit significantly the expenses associated with expert witness testimony, and in some disputes may be able to eliminate them all together.³⁶

The financial costs of arbitration are seen by many parties as an advantage over traditional litigation as well. The costs and fees of arbitrating a dispute will be known by the parties prior to the initiation of the proceedings. The cost is based to a great extent on the amount in dispute. The parties will be given a high and low figure by the institution indicating the amount above which and below which the cost of the arbitration will not rise or fall. This fee will be an all inclusive figure, including the cost of administering the proceeding, the arbitrator’s fees, and the institution’s fees. The parties are expected to pay the fees in advance, and the fees are ideally to be borne by the parties in equal shares. However, if one party fails to pre-pay the proceedings are suspended or sometimes even terminated.³⁷ If this occurs, the other party may elect to pay the whole amount of the advance fees if they wish to proceed.

Typically, courts are reluctant to get involved where the parties have agreed to arbitrate their dispute, or to interfere with the arbitration process. Therefore, many arbitration clauses, as well as the rules of many institutions, have been modified to allow the parties to plan for interim and preliminary remedies. The parties no longer need to file a separate action in a local court injunctive type relief.

The neutrality of foreign courts is also another concern, which tends to support arbitration as a preferable means of resolving an international dispute. In an international commercial arbitration hearing, no party will have a procedural or substantive advantage over the other because the dispute is resolved in a “home” jurisdiction for both parties.³⁸ The procedures and rules will be familiar or at least acceptable to both parties.

Some argue, however, that the neutrality of foreign arbitration institutions is questionable at best. These commentators suggest that the arbitrators’ cultural differences and unfamiliarity with the laws of the place where enforcement will be sought lead to a natural bias.³⁹ While this is certainly a legitimate concern, the parties can take precautions to safeguard against these types of issues, and with arbitration, they always have the freedom to choose the institution and the members of the tribunal. Some parties have included “two-institution” clauses into their arbitration agreement clauses. This empowers two arbitration institutions to adjudicate the dispute.⁴⁰ However, this may not solve the problem in its entirety, as empowering more than one institution to render a decision could lead to two different decisions thereby creating an impasse.

Arbitration proceedings are inherently less adversarial than litigation. Therefore, arbitration is more likely than not to facilitate the continuance of the parties’ business relationship after the dispute is resolved.⁴¹ Arbitration proceedings tend to be of a more cooperative nature and therefore much less confrontational.

If the parties to a dispute decide to adjudicate the dispute before a court, then they compromise their confidentiality. Litigation is conducted in a public forum (i.e. a court), and as a result there is little to no privacy for the parties, the subject matter of the dispute, and the ultimate decision or outcome. Arbitration can offer the parties a level of privacy and confidentiality that is unavailable in traditional litigation. This can be of great benefit to parties to a dispute involving trade secrets or other highly sensitive business information.⁴² Arbitration proceedings are not conducted in a public forum, and the parties have the power to decide who can or cannot attend and what the scope of discovery will be.

There are several drawbacks to proceeding with arbitration. One of the larger concerns parties have lies in the appellate process. With arbitration, there are essentially no appeals of an arbitral award. Currently, only a very limited number of international arbitration institutions have rules in place allowing for the review of awards.⁴³ There is a powerful presumption that the tribunal has acted within its scope in rendering a decision. Therefore, the burden of proof for overturning a tribunal’s decision is very high, and typically can only be done by a court. More time and money must be invested then, there is still no guarantee that the court will overturn the award. Great deference is given to the arbitration tribunal.

Similarly, modification of an arbitral award can be equally challenging. Some institutional rules allow for correction of simple errors and interpretive errors (i.e., mistakes of law and fact).⁴⁴ However, other institutions, such as the ICC, have no such rules, and even when modification rules do exist, the period in which to request the modification is very short, being as short as 30 days.⁴⁵ The ICC, as well as other institutions, has taken measures to insure the integrity of their arbitral awards though. For example, the ICC’s awards are subject to an administrative review process before they are considered to be final. The review process can be looked at as a sort of “checks and balances” system by which the institution makes certain that an arbitral decision has been rendered on the facts of the dispute, that the tribunal’s decision was rational and limited to the issues in the arbitration agreement, that a detailed explanation for the decision was given, and that the dispute was resolved according to the arbitration clause and institutional rules.

Parties accustomed to litigating disputes will quickly notice another quite distinct difference in arbitration proceedings. There is very limited pre-hearing motion practice. Nearly all disputes will only be disposed of after a full evidentiary hearing on all of the issues.⁴⁶ This can lead to a longer process for the parties. The mechanisms for pre-hearing disposal of the issues, such as summary judgment or motion to dismiss, are not generally available. However, there are some arbitration institutions that have attempted to remedy this fact by the introduction of rules that allow the parties to present evidence in an initial hearing or conference, at the express order of the tribunal, which is dispositive of the dispute.⁴⁷

The discovery procedure of arbitration hearings is another area in which litigators may be uncomfortable. Tribunals have no effective power to enforce a discovery order.⁴⁸ There are no discovery sanctions available to the party seeking the discoverable evidence. Thus, there are no real consequences for a failure to comply with a discovery order or request. The only “penalty” a non-complying party is likely to face is that the tribunal may draw a negative inference from the party’s failure to comply. However, a company policy of destruction of documents or a similar excuse may explain away the non-compliance and defeat the negative inference. That is really of no help to the other party, who may need the discovery materials for making their case to the tribunal.

The time, or speed, of arbitration proceedings versus litigation is a factor that is not easily classified as an advantage or drawback. In many disputes, arbitration will produce a quicker resolution because there is less formality and increased simplicity to the process. Disputes involving complex contracts with multiple parties have typically not been good candidates for arbitration. Facts have shown that arbitration hearings are inefficient when dealing with disputes with multiple general contractors and sub-contractors, and that these hearings often last much longer than anticipated, and fees and costs are in many cases comparable with those of litigation.⁴⁹ To exacerbate the situation, there are few, if any, institutions that have procedural rules similar to US civil procedure allowing joinder and consolidation of claims.

Into the Future

As the global market increases in size and scope, international commercial arbitration is growing nearly as fast. New international disputes constantly call for inventive ways to resolve them that are cost and time efficient, and which give the parties a degree of certainty. The number of disputes which are filed for arbitration each year persistently risen. Parties are becoming more educated and sophisticated as well. Rudimentary arbitration clauses have been systematically replaced by clauses that are much more skillfully drafted and which afford the parties much greater autonomy in settling their dispute.

As a result of this pressure, new institutions are always being formed in an effort to meet this demand head-on. Institutional arbitration rules and procedures are regularly rewritten, revised, and modified in an effect to stay on the cutting edge of international dispute resolution. Arbitration organizations, such as the ICC, continue to be pioneers in this area through upholding and improving upon the principle ideals on which international arbitration is founded: preserving the finality of awards, and maintaining a just system for resolving disputes.
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Jason B. McGary is a Juris Doctor student at The John Marshall Law School in Chicago, graduating this month. He is a committee member of the American Bar Association Section of International Commercial Dispute Resolution and the committee of International Arbitration. He is a student member of the Chicago International Dispute Resolution Association.

1. De Zylva and Harrison, “Developing Rules for the New Millennium,” International Commercial Arbitration, Jordan Publishing, Bristol, Great Britain (2000), pp 4, & 6.
2. Id at p 6.
3. Id at p 7.
4. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 3.
5. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 17.
6. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 1.
7. Id at p 1.
8. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 11.
9. Id at p 11.
10. Id at p 11.
11. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 6.
12. Id at p 2.
13. Id at p 2.
14. Id at p 6.
15. International Trade Centre, Arbitration and Alternative Dispute Resolution; How to Settle International Business Disputes, UNCTAD/STO, Geneva, (2001), p 65.
16. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 7.
17. International Trade Centre, Arbitration and Alternative Dispute Resolution; How to Settle International Business Disputes, UNCTAD/STO, Geneva, (2001), pp 66-67.
18. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), pp 8-9.
19. International Trade Centre, Arbitration and Alternative Dispute Resolution; How to Settle International Business Disputes, UNCTAD/STO, Geneva, (2001), p 57.
20. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), pp 1-2.
21. Id at pp 1-2.
22. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 21.
23. Id at p 21.
24. Rhoades, Kolkey, and Chernick, Practitioner’s Handbook on International Arbitration and Mediation, Juris Publishing, Inc., Huntington, New York (2004), p. 1.5-5
25. Id at p 1.5-9.
26. Id at p 1.5-14.
27. Id at p 1.5-14.
28. Id at p 1.5-14.
29. Id at p 1.5-14.
30. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 5.
31. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 12.
32. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 5.
33. Id at p 5.
34. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 13.
35. Id at p 13.
36. De Zylva and Harrison, “Institutional Rules: Straitjacket or Scaffold?,” International Commercial Arbitration, Jordan Publishing, Bristol, Great Britain (2000), p 58.
37. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 134.
38. De Zylva and Harrison, “Institutional Rules: Straitjacket or Scaffold?,” International Commercial Arbitration, Jordan Publishing, Bristol, Great Britain (2000), p 57.
39. Schafer, Verbist, and Imhoos, ICC Arbitration in Practice, Kluwer Law International, The Hague, The Netherlands, (2005), p 1.
40. Id at p 1.
41. De Zylva and Harrison, “Institutional Rules: Straitjacket or Scaffold?,” International Commercial Arbitration, Jordan Publishing, Bristol, Great Britain (2000), p 58.
42. Id at pp 57-58.
43. Gelander, Jessica L., “Judicial Review of International Awards: Preserving Independence in International Commercial Arbitration”, 80 Marq. LRev (1997), p 625.
44. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 119.
45. Id at p 121.
46. Rhoades, Kolkey, and Chernick, Practitioner’s Handbook on International Arbitration and Mediation, Juris Publishing, Inc., Huntington, New York (2004), p 1.5-15.
47. Id at p 1.5-16.
48. Id at p 1.6-12.
49. Garnett, Gabriel, Waincymer, and Epstein, A Practical Guide to International Commercial Arbitration, Oceana Publications, Inc., Dobbs Ferry, New York (2000), p 15.

The pledge in French secured transaction law: Creditors’ most favored security

By Sac’i Nakano

The history of secured transactions in France goes back to Roman law. The Romans had developed various ways to guarantee against insolvent debtors. Some securities were based on an in personam basis, others on an in rem basis.¹ Among the former is the guaranty. Solidarity was important in Roman society; therefore, a guarantor would often agree to fulfill another’s obligation in the event of that person’s default.² Among the latter are the fiducie, the hypothec, and the pledge. With the fiducie, the debtor transferred the good with its property right to the creditor. The creditor agreed to return the good once the debtor fulfilled his obligation.³ With the hypothec, the debtor gave a security interest in a real estate property without giving possession of it.⁴ With the pledge (gage), the most commonly used security interest in Roman society, the debtor transferred possession of one of his goods to the creditor.⁵ Possessory security interests were predominant in Roman law.

In 1804, the French civil code adopted most of these securities. As a result, possessory security interests were still favored. Additionally, at that time, wealth was mainly in goods and real property.⁶ Therefore, the civil code dealt with tangibles. Only a few provisions dealt with intangibles. With the evolution of French society in the twentieth century, an important share of the wealth is nowadays contained in intangibles. Thus, today, the civil code provisions are ill fitted to deal with security interests in intangibles.⁷ Although the code recognizes security interest in intangibles,⁸ the legislature has yet to create a specific regulation for them. Thus, such security interests are largely treated under the general provisions of the code, which were originally drafted for tangible possessory security interests.⁹ Needless to say they are inappropriate. It is out of this background, that the pledge, a tangible possessory security interest, still offers the best security interest to creditors in modern French society. However, such an interest is not without inconvenience as it rests on a requirement of dispossession. Part I summarizes the conditions and effects of the pledge. Part II illustrates this cherished security interest in actual cases and concludes on the archaism of the dispossession requirement.

I. The pledge in the civil code

French law distinguishes between a civil pledge and a commercial pledge. Articles 2071 to 2084 of the civil code¹⁰ deal with the civil pledge; Article L521-1 to L522-40 of the commercial code¹¹ deal with the commercial pledge. The commercial code provisions of the pledge apply to merchants and individual non-merchants for commercial agreement (acte de commerce).¹² Unlike a civil pledge, a commercial pledge need not be in writing.¹³ Additionally, in a commercial pledge, upon default of the debtor, the creditor does not have to request a court to sell the collateral. The creditor only has to notify the debtor of his intention to sell, wait eight days, and then ask an auctioneer to sell the collateral.¹⁴ Only the civil code regime is presented in detail; however, the commercial regime is very similar.

A. Conditions for the pledge to be valid

Articles 2071 and 2072 combined define the pledge.¹⁵ In order to guarantee a specific debt, the debtor gives possession of one of his personal properties, the collateral, to the creditor. Therefore, the property must already exist. After acquired property cannot be the object of a pledge. The requirement of transfer of possession prevents such a pledge. However, article 1130 allows agreement involving after acquired property.¹⁶ Thus, the pledge on future goods is treated as a promise of a pledge.¹⁷ The pledge only occurs when the property is acquired and transferred to the creditor. Under article 2073, the pledge gives the creditor priority over other creditors on the pledged collateral.¹⁸ However, the creditor could only prevail over third parties if the pledge was in writing and registered properly.¹⁹ Additionally, the writing must mention the amount due and identify the collateral.²⁰ If the collateral is fungible, then the quality and weight of the collateral must be given.²¹

Under Article 2076, possession of the collateral must be given to the creditor for the priority to apply, but it must also remain with the creditor, or with a third party if agreed upon by the parties.²² Some companies have developed and specialized in the business of such third party activities;²³ the role of these companies is similar to the role of trustees in the United States. The requirement of the possession of the collateral is a prerequisite for the validity of the pledge.²⁴ In the absence of possession, the agreement between the parties is only a promise of a pledge.25 The reason behind the requirement of possession is notification to third parties.²⁶ It also prevents fraud: the debtor cannot pledge the same collateral several times.²⁷ Finally, it limits general pledges, which are pledges over a group of collateral.²⁸

B. The effects of the pledge

The creditor in possession of the collateral is presumed to possess in good faith.²⁹ Therefore, if the creditor believes the debtor is the owner of the collateral, the true owner has no action against the creditor.³⁰ Possessing the collateral gives rights to the creditor, but also obligations. Under Article 2080, the creditor is liable for loss or deterioration of the collateral if it is due to his negligence.³¹ However, if the creditor incurs useful and necessary expenses for repair of the collateral, he can ask the debtor for reimbursement.³²

Under French law, the bundle of rights contains three elements: 1) the usus or the right to use, 2) the abusus or the right to abuse, i.e. sell or dispose of the property, and 3) the fructus or the right to collect the fruits of the property.³³ In a pledge, the debtor only relinquishes possession of the collateral. The creditor does not acquire property in the collateral; the creditor neither acquires the fructus nor the abusus. As for the usus, although, the debtor is deprived of the use of the property, he does not transfer that right to the creditor.³⁴ The creditor cannot use the collateral.³⁵ The purpose of the pledge is not to give the use of the collateral to the creditor, but to secure the debtor’s obligation.³⁶ Once the debtor fulfils his principal obligation, i.e. complete payment of the debt, the creditor must return the collateral. The crux of the pledge is not so much what it confers to the creditor but what it deprives the debtor of.³⁷ Dispossession should not be necessary, only the deprivation of some of the debtor’s rights should be.³⁸

Upon default of the debtor, the creditor can request the court for an authorization to sell the collateral³⁹ or a judicial attribution of that collateral.⁴⁰ The creditor can also remain passive.⁴¹ In the case of a court authorization to sell, the collateral is sold at an auction. The creditor reimburses himself out of the auction’s proceeds. However, the creditor might face the concurrence of other super-privilege creditors: the debtor’s employees, the French fiscal services (Trésor) and other creditors in a bankruptcy proceeding.⁴²

In the case of a judicial attribution, the creditor can request the court to declare that the collateral is his.⁴³ After an expert appraisal, the court will give propriety in the collateral to the creditor up to the amount due to him.⁴⁴ In that case, the creditor avoids any concurrent creditor.⁴⁵ The reason behind the judge’s intervention is to protect the debtor’s interest.⁴⁶ To insure that such interest is protected, the code prohibits any agreement by which the parties agree that the creditor will become the owner of the collateral upon default of the debtor.⁴⁷ Additionally, any agreement by which the parties agree to sell the collateral without a court approval is also prohibited.⁴⁸ Finally, a creditor cannot request such a judicial attribution when bankruptcy proceedings are under way.⁴⁹

Upon default of the debtor, the creditor can also remain passive. The creditor has an absolute right of retention.⁵⁰ In this right lies the reason behind the strength of the pledge. Because a pledge is indivisible, the creditor can retain the collateral until complete payment of the debt.⁵¹ Therefore, even if the debt is partially repaid, the creditor retains the collateral in its entirety. Furthermore, this right is enforceable against the whole world.⁵² As a result, the creditor does not have to consider any consequences of his inaction.⁵³ Even under bankruptcy proceedings, the creditor can remain inactive and retain the collateral.⁵⁴ However, the creditor’s action might be solicited by third party creditors. It is very likely that the creditor will be reimbursed in such a case, particularly if the value of the collateral is higher than the amount due to the creditor.⁵⁵ In such a situation, third party creditors have an interest in the sale of the collateral. They want to be reimbursed from the proceeds in their order of priority.⁵⁶ The only limit a creditor might have is that he cannot abuse his right of retention (abus de droit). Such an abuse could arise where the value of the collateral would be highly disproportionate compared to the amount due to him.⁵⁷ Mere prejudice to the debtor is irrelevant.⁵⁸ Two cases below illustrate the power of the right of retention, one the possession requirement.

II. Jurisprudence on the pledge: an absolute right of retention, with archaic dispossession requirement

A. The right of retention: an absolute right recognized by the court

The first case involved drugs as collateral.⁵⁹ The second case dealt with stocks.⁶⁰ In SA Sté Marseillaise de Crédit, the creditor Sté Marseillaise de Crédit (SMC) agreed with the debtor Pharmacom to a pledge agreement to secure Pharmacom’s debt.⁶¹ The agreement provided that the debtor could not withdraw any pledged goods (drugs) unless it gave the equivalent value of the goods withdrawn or substituted them with goods of equivalent value.⁶² The drugs had an expiration date. Pharmacom went into bankruptcy proceedings. It asked the creditor for an authorization to take back some of the goods pledged arguing that the value of the goods pledged was higher than the loan it was securing.⁶³ The creditor refused and did not take any action.⁶⁴ The drugs did expire. A suit followed. The court of appeal found for the debtor, holding that the creditor could not knowingly prejudice the debtor.⁶⁵ The creditor knew the drugs would expire; it did not ask for a court’s authorization to sell the drugs or to attribute them to the creditor. Therefore, it deliberately let the goods expire, against the debtor’s interest. Although this solution might appear equitable, it disregards the purpose of a pledge. Therefore, unsurprisingly, the cour de casssation⁶⁶ reversed on the basis of Article 2073 of the civil code: the creditor can refuse to give the collateral back if he does not receive full payment of the debt.⁶⁷ The refusal is at the creditor’s discretion. The debtor did not reimburse his debt; the creditor kept the drugs, although valueless drugs. The notion of mitigating damages does not seem to have much force in France, if known at all! The second case is another illustration of the absolute discretionary right of the creditor.

In SA Société Générale, the debtor gave stocks to the bank to secure a loan.⁶⁸ The debtor had to reimburse the loan by December 31, 1990 but failed to do so. The bank agreed to a new loan to consolidate the previous one, to be reimbursed by July 7, 1993.⁶⁹ The price of the stocks went down. Upon default of the debtor, the bank filed a suit for payment of the loan. The court of appeal held that the bank was negligent when it did not sell the stocks in December 31, 1990, upon the first default of the debtor.⁷⁰ As a consequence, the bank caused the debtor a loss equal to the difference between the value of the stocks in December 31, 1990 and value of the stocks at the date of the lawsuit. Therefore, the bank must bear the loss. Like in the SA Sté Marseillaise de Crédit case, the cour de cassation reversed the court of appeal decision based on Article 2073. The creditor is never obliged to act upon the default of the debtor. The creditor has several choices as already mentioned: the creditor can request the court for an authorization to sell the collateral or a judicial attribution of that collateral, or he can simply remain passive. Logically, one would expect that the creditor would choose the action that would most benefit him; however, such an action is not required, and apparently it is sometimes foregone.⁷¹ Therefore, economic efficiency is not always achieved, especially when one considers that the absolute right of retention also requires dispossession of the collateral.

B. The dispossession requirement

The inconvenience of dispossession is obvious. The pledge agreement has been accused of being a security for the wealthy because the debtor cannot need the collateral pledged.⁷² He cannot need it because he has to transfer its possession to the creditor. Therefore, he is deprived of its use. There is a saying in France: “one lends only to the wealthy” (on ne prête qu’aux riches).⁷³ However, if the dispossession is not realized or cannot be realized, the debtor or third party creditors do not face the absolute obstacle of the retention right. SA Baron Philippe de Rothschild illustrates such a situation in a commercial setting.⁷⁴

In the Rothschild case, between March and June 1990, a wine distributor purchased 6,108 bottles of wine, vintage1989, from the Rothschild Company.⁷⁵ However, the distributor could not take the wine as it needed to age until October 1991.⁷⁶ In December 1991, the distributor filed for bankruptcy. The administrator for bankruptcy asked Rothschild to deliver the bottles, already paid for, to honor a subsequent sale of the bottles to a US company.⁷⁷ Rothschild refused, arguing that some orders made by the distributor had not been paid. Therefore, Rothschild argued it could keep the bottles as collateral.⁷⁸

The court of appeal found in favor of the distributor. First, the bottles could not be used as collateral for debts that had no relation to the bottles retained. Second, and most importantly, there was no transfer of possession from the distributor to Rothschild. Rothschild had remained in possession of the bottles the entire time. From the time of the purchase in 1990 to the end of the aging process in October 1991, the distributor could not, technically, be put in possession. Because the distributor could not have possession of the bottles, he could not transfer any possession. After October 1991, when the distributor could have technically been put in possession, he never agreed to “give” possession to Rothschild. There was no board attached to the bottles that would have materialized the dispossession.⁷⁹ Therefore, there could not have been any pledge agreement. The court ordered Rothschild to deliver the bottles. This case fell under the commercial code provision; as already mentioned no writing is necessary to evidence a commercial pledge. The cour de cassation affirmed the court of appeal findings. Although Rothschild was in possession of the bottles, it had no right of retention. The distributor never transferred possession. Absent dispossession, the bottles could not be treated as collateral. The Rothschild case emphasizes the importance of the dispossession requirement. The cour de casssation will not move away from the tradition of that requirement.⁸⁰

Conclusion

The purpose of a security interest is to guarantee the creditor’s interest. However, even if this transfer of possession gives its creditor an absolute right, the creditor does not possess the usus, fructus or abusus in the collateral. Therefore, the dispossession only reduces the debtor’s rights in the collateral without the correlative transfer of that right to the benefit of the creditor. Additionally, the collateral secures the creditor’s interest only to the extent that the collateral keeps its value. As illustrated by the drug case, the collateral can become valueless. As a result, the debtor can lose his business and the creditor his security. In such a case, economic efficiency is severely diminished.

In French modern society, the dispossession requirement seems archaic. Registration requirements could replace dispossession without affecting the creditor’s rights. If the pledge is highly favored among creditors, it is because the retention right gives creditors an absolute priority right over any third party creditors such as the debtor’s employees, the French fiscal services (Trésor) and other creditors in a bankruptcy proceeding. Such priority could remain even without the debtor’s dispossession of the collateral. However, consequences similar to the drug case should be avoided as they benefit neither the creditor nor the debtor. For the 200-year anniversary of the French civil code, the French legislature could have moved away from the dispossession requirement for tangibles. Unfortunately, it failed to do so.
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Sac’i Nakano, received her JD from The John Marshall Law School in Chicago, and her Licence in Law from Universite’ d’Orleans in Orleans, France. Admitted to the Bar in Illinois, she speaks English, French, Hungarian, Spanish and Japanese. She has previously contributed to The Globe. She may be reached at sacinakano@yahoo.com.

1. Dominique Legeais, Sûretés et Garanties du Crédit, § 7 at 5 (3d ed., 2002).
2. Id.
3. Id. The risks were important: the creditor could sell the good without considering the debtor’s rights. Id.
4. Id.
5. Id.
6. Id. § 368 at 295.
7. Legeais, supra note 1, § 428 at 322.
8. C. civ. art. 2075 (2004). French codes are available at <www.legifrance.gouv.fr>.
9. Legeais, supra note 1, § 428 at 322. The legislature did intervene to favor corporations and enacted specific regimes for stocks and account receivables (parts sociales, compte d’instruments financiers, créances professionnelles) . Id. § 443 at 332.
10. C. civ. art.2071-2084.
11. C. com. art L521.1-522.40.
12. C. com. art. 521.1.
13. Id. (cross-referring to C. com art. L110.3 which states that commercial agreements can be evidenced by any means, unless the law provides otherwise).
14. C. com. art L.521.3.
15. C. civ. art. 2071-2072.
16. C. civ. art. 1130.
17. Legeais, supra note 1, § 378 at 299.
18. C. civ. art. 2073.
19. C. civ. art 2074.
20. Id.
21. Id.
22. C. civ. art. 2076.
23. Legeais, supra note 1, § 383 at 302.
24. Cass. Com., July 7, 1998, J.C.P. 1998, II 10206, note Odile Salvat. This case will be presented in Part II.
25. Legeais, supra note 1, § 382 at 301.
26. Id.
27. Id.
28. Id.
29. Philippe Simler & Philippe Delebecque, Droits des suretés, June 19, 1996, J.C.P. 1996, I 3942 (citing CA Paris, 15e ch. B, Oct. 27, 1994, Juris-Data no. 025091).
30. Id.
31. C. civ. art. 2080.
32. Id.
33. Etienne Verges, Le banquier réceptionnaire n’est pas tenu personnellement de restituer les fonds provenant d’une créance cédée par son client à une autre banque et n’en n’est pas tenu responsable, Jan. 16, 2002, J.C.P. 2002, II 10013.
34. Marc Billiau, Reflexions sur le gage, Jan. 10, 1996, J.C.P. 1996, I 3897 § 13.
35. Id. and note 47.
36. Id.
37. Id.
38. Id. However, the French legislature has yet to make that step in its analysis of the pledge.
39. C. civ. art. 2073. In a commercial pledge, the court authorization is not necessary. C. com. art L521.3.
40. C. civ. art. 2078.
41. C. civ. art. 2082.
42. Legeais, supra note 1, § 389 at 305.
43. C. civ. art. 2078.
44. Id.
45. Legeais, supra note 1, § 391 at 306.
46. Id. § 393 at 307.
47. C. civ. art. 2078. The courts have recognized the validity of such agreements if entered upon after the pledge agreement. Legeais, supra note 1, § 393 at 307 (citing Cass. 1e civ., Nov. 17, 1959 Bull. Civ. I 480).
48. C. civ. art. 2078. However, as already mentioned, this prohibition does not apply in a commercial pledge. C. com. art L521.3.
49. Legeais, supra note 1, § 394 at 308.
50. C. civ. art. 2082. Cass. com July 4, 2000, J.C.P. 2001, I 315, obs. Simler & P. Delebecque.
51. C. civ. art. 2083.
52. Legeais, supra note 1, § 390 at 305.
53. Cass. com., Nov. 19, 2002, J.C.P. 2003, I 124, obs. P. Simler & P. Delebecque. This case is presented in Part II.
54. Cass. com July 4, 2000, J.C.P. 2001, I 315, obs. Simler & P. Delebecque. In that case, the parties had agreed that upon the creditor’s approval, the debtor could withdraw pledged goods if he substituted the goods at the time of withdrawal with goods of equivalent value. The debtor went into bankruptcy proceedings. The administrator of the bankruptcy wanted to withdraw and substitute the goods. The creditor refused. The court held that the creditor had an absolute right to retention until complete payment of the debt, regardless of the substitution agreement and regardless of the bankruptcy proceedings. Id.
55. Legeais, supra note 1, § 640 at 441.
56. Id.
57. Id. § 641 at 443. However, the cour de cassation has not recognized it. Id. 443 n.66.
58. Cass. com., Nov. 19, 2002, SA Sté Marseillaise de Crédit c/ Beauquis, J.C.P. 2003, I 124, obs. P. Simler & P. Delebecque.
59. Id.
60. Cass. com Oct. 10, SA Société générale c/ Epx J., 2000, J.C.P. 2001, II 10575, note S. Piedelievre. Although stocks are not tangibles, for the interest of the analysis, it is not pertinent. The pledge was governed by the general provisions of the pledge in the civil code. Id.
61. SA Sté Marseillaise de Crédit, J.C.P. 2003, I 124.
62. Id.
63. Id.
64. Id.
65. Id.
66. The Cour de Casssation is the highest court in France. However, it does not hear constitutional issue or administrative law issue. Separate courts exist for these issues.
67. SA Sté Marseillaise de Crédit, J.C.P. 2003, I 124.
68. SA Société générale, 2000, J.C.P. 2001, II 10575.
69. Id.
70. Id.
71. See SA Sté Marseillaise de Crédit, J.C.P. 2003, I 124.
72. Billiau, supra note 34.
73. Id.
74. Cass. com. July 7, 1998, SA Baron Philippe de Rothschild c/ Silvestri, J.C.P. 1998, II 10206, obs. Odile Salvat.
75. Id.
76. Id.
77. Id.
78. Id.
79. Id. obs. § 13.
80. SA Baron Philippe de Rothschild, J.C.P. 1998, II 10206, at § 11.