A game of Russian roulette

Even before the break-up of the Soviet Union in the early 1990s, London was a well established arbitration centre for shipping disputes involving the former communist state. Many of the shipping contracts drawn up by the Soviet Union also included UK contract law or jurisdiction clauses.

The reason for this was straightforward enough. Because of the UK's history as a shipping nation, it had developed one of the most sophisticated maritime case law systems in the world. As a result, when the Soviet Union collapsed, the newly privatised companies in what were now independent states also turned to UK lawyers – whether in the courts or through arbitration – to resolve an increasing number of disputes about the ownership of the assets of the former Soviet bloc. The result was a boom in shipping litigation in this country, sometimes involving multimillion dollar cases, that is only just starting to level out.

Prior to the break-up of the Soviet Union, the different shipping companies and their properties were state-owned and run centrally from Moscow by the Soviet Ministry of Mercantile Marine (Morflot). If a company had a dispute involving a claim above a certain amount, it was the legal team in Moscow that issued the instructions to solicitors in the UK, assuming that a UK law clause applied.

But according to Lawrence Graham partner Imogen Rumbold, many potential disputes “would not have seen the light of day here because the Comecon [Council for Mutual Economic Assistance] countries would have sorted out their differences behind the Iron Curtain.”

When Morflot ceased to exist, the different shipping companies tried to take ownership of the various assets previously held centrally. Needless to say, the question of ascertaining who owned what spawned endless disputes, complicated by the fact that some of the companies were now run by countries that were independent of Russia.

Tom Moisley, an assistant solicitor at niche shipping practice Shaw and Croft, explains that the break-up had different effects depending on whether the shipping companies were domiciled in Russia or one of the newly independent states. “For example, because Latvia asserted its independence of Russia, the Latvian Shipping Company – based in Riga – became a state-owned company in Latvia. The same applied to the companies based in the Ukraine, Estonia, Lithuania, Georgia etc,” he says.

“The Russians were left with, among others, the Baltic Shipping Company, Northern Shipping and Fesco [Far Eastern Shipping Company]. The problem for all of them was making the transition from being part of a state-owned centrally planned operation to one where the rules of a cold, hard, commercial world applied. Some have adapted better than others.”

Not surprisingly, some complicated disputes have arisen. For instance, before the break-up of the Soviet Union, Morflot was in control of all container hire and any interchange of containers between the shipping companies. It purchased the containers and then allocated them to the companies as necessary. After the break-up, the interchange of containers did not stop, but new arrangements were needed so that each company would know who owed what to whom.

Take for example, the case of the Latvian Shipping Company and the Baltic Shipping Company. In 1995, Latvian claimed that Baltic owed it money for the hire of containers under a new agreement reached in 1992 (called GUCA) for the mutual use of former Morflot containers. It won an arbitration hearing in September 1996, which Baltic subsequently challenged unsuccessfully in the High Court.

In 1997, modelling its claim on the precedent set in the Latvian case, Baltic started a claim against Azov (see box) in which it asserted that Azov was also a signatory to GUCA and owed it money. Moisley says: “Baltic overlooked the factual differences in the two cases. It argued that Azov had not only agreed to participate in GUCA, but had also agreed to arbitration. We contested the arbitrator's jurisdiction successfully, as we were able to satisfy the court that there was insufficient evidence that Azov had agreed to participate in GUCA.”

The judgment in this case has far-reaching implications, extending beyond the shipping industry. It is the first time that an arbitration award has been overturned on appeal in the High Court and has led one arbitrator to say that it has created a satellite industry for lawyers challenging the jurisdiction of arbitrators. Vernon Flynn, a tenant at Essex Court Chambers who acted for Azov in the case, says: “The key importance of the Azov decision is that arbitrators are not free to pull themselves up by their own bootstraps. The Arbitration Act 1996 introduced the doctrine of kompetenz kompetenz, which allows arbitrators to determine their own jurisdiction. The decision in Azov held that that decision could be subject to review on fact and law by the courts.”

Other cases have arisen through sheer mismanagement of fleets. Michael Collett, a barrister at 20 Essex Street, explains: “A number of companies were not run well after the break-up of the Soviet Union. When it collapsed, it had huge, relatively modern fleets, none of which were subject to a mortgage. Within a few years, something had gone badly wrong. The companies went from a position of being in a good state to a state of insolvency, which led to a huge amount of litigation as vessels were arrested and creditors brought proceedings to get their money back.”

Shaw and Croft partner Bob McCunn says that some of the mismanagement can be attributed to the fact that the systems used by the new companies were not as tight as they needed to be in the commercial world. Charles Buss, a partner at Watson Farley & Williams, agrees. “It is not unusual for Russian businessmen to conclude high value deals and draft their contracts there and then on a one-page document. This almost invariably leads to arguments about contractual interpretation, especially when the relationship goes sour,” says Buss.

Corruption is also a problem in some of the new companies. Richards Butler partner Alex Andrews says: “If you are going from a system where everything is done for you to a situation where assets worth many millions of dollars are transferred to you, and you have no idea what is going to happen to your country, it is a recipe for disaster. And the problem was not just limited to internal corruption. Foreigners took advantage of individuals, some of whom were very naive.”

McCunn recently acted in a case arising from a joint venture between a Russian and a Greek company. He says: “Basically, the Russians were hoodwinked by the Greeks. Our client put its ships into the joint venture and the Greeks were then supposed to bring them up to scratch and manage them, but the Greeks went off with all the money. No one knows how much has been lost, but it is upwards of $10m (£6.6m) or maybe even $20m (£13.3m).”

Internal corruption is also a problem. Buss is involved in a case in which six vessels – all mortgaged to the Bank of Scotland – have been illegally detained in St Petersburg for over a year by the Russian border guard. Although the ships were re-flagged and transferred to Cypriot owners, some as long ago as 1992, the detentions have been based on claims against their previous Russian owners. Buss says that the ships are likely to be sold in Russia for a fraction of their 1999 market value, in which case the bank will lose its security. As the ships will probably be purchased by Russian interests, the net effect of the detentions will have been to return the ships to Russian ownership.

Buss accuses Governor Nazdratenko of Vladivostok, a port in South East Russia, who has repeatedly called for the confiscation of the ships, of being behind the detentions. He says that the message to western banks is clear. “Although Russia has ratified [various] conventions, this will not prevent the legal rights of registered owners and mortgagees from being flagrantly ignored by the authorities there.”

Apart from the volume of litigation, the number of solicitors now involved in shipping litigation arising from the former Soviet Union has significantly increased in recent years. Lawrence Graham once had a virtual monopoly on bringing cases into this country for the former USSR, going back to the revolution in 1917. There are now about six to eight firms that get the work. These include Clyde & Co, Ince & Co, Lawrence Graham, Richards Butler, Shaw and Croft and Watson Farley & Williams.

Lawrence Graham's Rumbold says that there are two main reasons for the change. “With the break-up, work is spread around more generously because there are more companies involved and there is more litigation,” she says.

“Also, Lawrence Graham is often conflicted out. For instance, because both parties approached us in the Azov case, we felt that we could not act for either of them.” As a result, the firm has found that its client base has changed, not least because some of the companies it used to act for no longer exist.

Likewise, there is only a select band of barristers involved in Russian shipping litigation. Apart from Flynn, Essex Court Chambers boasts Gordon Pollock QC and Richard Siberry QC. Other specialist chambers include 20 Essex Street (where Nicholas Hamblin QC and Mike Coburn are worth a mention) and 7 King's Bench Walk (leading lights include Julian Flaux QC and Charles Priday).

Although the boom has now flattened out, there is still plenty to keep UK lawyers busy. And no doubt there will be plenty more in the future.

The Latvian Shipping case

Stocznia Gdanska v Latvian Shipping Company & ors

Court: Queen's Bench Division (Commercial Court)

Judge: The trial of the main action was heard recently by Judge Thomas. During the course of interlocutory proceedings, judgments were given by Judge Tuckey, Judge Clarke, Judge Waller, Judge Longmore, Judge Colman and Judge Toulson. The case went to the House of Lords on the summary judgment application.

Key Points: The case concerned six ship building contracts signed in September 1992 to build refrigerated vessels for a subsidiary of the Latvian Shipping Company by the Polish shipyard, Stocznia Gdanska. Work started on the first two vessels, but the defendants, Latvian Shipping & ors, failed to pay the keel laying installments as required under the contract. The shipyard applied for summary judgment and obtained it from Judge Clarke. This judgment was overturned by the Court of Appeal, but restored by the House of Lords.

A large number of issues have arisen in the course of proceedings. Judge Colman held that the shipyard could not revert to a right to accept an anticipatory breach, having elected to keep the contracts alive. His judgment has been the subject of much academic debate. The trial of the main action recently took place before Judge Thomas. The main trial concerns both the remaining contractual claims and also tort claims against other defendants including Latvian Shipping Company.

The contractual value of the six ship building contracts was in excess of $170m (£113m). The shipyard is claiming more than $40m (£26.6m) plus interest and costs for breaches of the contracts.

Counsel and solicitors: Roderick Cordara QC and Vernon Flynn of Essex Court Chambers (instructed by Ince & Co) for the shipyard. Angus Glennie QC and Karen Maxwell of 20 Essex Street (instructed by Lawrence Graham) for the majority of the defendants.

The Baltic shipping case

Azov Shipping Company v Baltic Shipping Company

Court: Queen's Bench Division (Commercial Court)

Judge: Mr Justice Colman

Key points: This case concerned a container exchange agreement (GUCA) made in December 1992 between at least nine shipping companies, all of which had been state-owned and state-operated regional entities under the Soviet Union. The purpose of the agreement was to provide for a system of compensation for the exchange of containers. The agreement included a London arbitration provision subject to UK law.

Baltic alleged that Azov was a party to the GUCA agreement and owed it a considerable amount of money for the hire of containers. For its part, Azov denied that it was a signatory to the agreement and the dispute was referred to arbitration. The arbitrator decided that he had jurisdiction in the dispute and found against Azov, which then applied to set aside the award by challenging the substantive jurisdiction of the arbitrator under section 67 of the Arbitration Act 1996.

A retrial took place before Mr Justice Colman, and Azov succeeded in having the award set aside on the basis that it was not a party to the GUCA agreement. This was the first case in which there has been a full rehearing of an arbitration award and as such is the first representative decision on how the Arbitration Act will be interpreted by the courts.

Counsel and solicitors: Vernon Flynn of Essex Court Chambers (instructed by Shaw and Croft) for Azov. Christopher Smith of Essex Court Chambers (instructed by Sinclair Roche & Temperley) for Baltic.

Trial: Judgment delivered on 11 May 1999.