[M]istakes will occur even in the practices of the best of arbitrators

England and Wales

In a rare example of a successful challenge under section 68 of the Arbitration Act 1996, in Doglemor Trade Limited and Others v Caledor Consulting Limited and Others [2020] EWHC 3342 (Comm) the English High Court found that a tribunal’s error constituted a serious irregularity that had caused substantial injustice to Doglemor. The court remitted the award back to the tribunal for reconsideration after a computational error resulted in US$58 million in damages being awarded, instead of allegedly US$4 million.

International arbitration has seen a growth in popularity for models used to calculate damages, particularly when there is competing evidence on quantum and where there are multiple variables for determining quantum. This case demonstrates the perils of using such models, whilst also providing guidance on the English court’s approach to a challenge to an arbitral award that contains computational errors.

Background

Alexander Bogatikov, who co-founded the Business Lines Group in 2001, took on Mikhail Khabarov in 2014 to perform senior managerial functions in the Business Lines Group. Part of the arrangement was that Mr Khabarov had an option to acquire an ownership stake in the business. The option was exercisable in respect of 30 percent of the shares of DL Management Limited (DLM), the holding company of Business Lines Group, at a price of US$60million. The option was exercisable in a two-year period commencing at the end of February 2018, was governed by English law and had an LCIA arbitration clause with a London seat.

Following a disagreement, between Mr Bogatikov and Mr Khabarov, in 2017, Mr Khabarov was excluded from the Business Lines Group. As a result, Mr Khabarov alleged that the option had been repudiated and that he accepted the repudiation in February 2018.

Mr Khabarov and his connected companies, the Caledor parties, commenced arbitral proceedings seeking a declaration that the option had been terminated and for damages. Mr Bogatikov and the Doglemor parties admitted the termination of the option and the only substantive issue for determination in the arbitration was the amount of the damages payable to Mr Khabarov and the Caledor parties.

The valuation of the damages claimed by Mr Khabarov and the Caledor parties was US$180m, whereas the position of Mr Bogatikov and the Doglemor parties was that Business Lines Group was worthless due to its potential tax liabilities.

The tribunal determined that the correct approach to calculating the amount of the damages was to:

  1. calculate the value of the 30% shares in Business Lines Group that Mr Khabarov and the Caledor parties would be entitled to acquire under the option; and

  2. deduct from the above the purchase price under the option.

At the conclusion of the hearing, the tribunal had directed the parties to produce an agreed valuation model, which would set out the substance of the parties’ respective positions and enable the tribunal to select and apply the variables as it deemed appropriate. This is in keeping with the growing trend in international arbitration, particularly, where issues of quantum turn on multiple variables and there is scope for the tribunal to make a determination on each variable.

The crux of the issue in this case arose out of the use of the above model. In using the model to determine the value of the Business Lines Group, the tribunal added an adjustment for historic tax liabilities of US$90 million, rather than subtracting the adjustment for the tax liabilities. Had the tribunal deducted the tax liabilities, the quantum of the damages produced solely by use of the model would have reduced from US$58m to US$4 million. In the event, the Tribunal awarded damages of U$58m to the Claimants.

Article 27 of the LCIA Arbitration Rules

Under Article 27(1) of the LCIA Rules, a party may request an arbitral tribunal to correct in the award “any error in computation, any clerical or typographical error, any ambiguity or any mistake of a similar nature”. If the tribunal considers such a request to be justified, it “shall make the correction by recording it in an addendum to the award within 28 days of receipt of the request”.

Mr Bogatikov and the Doglemor parties made an application under Article 27(1) to request the tribunal to correct the error relating to the treatment of the historic tax liabilities in the model, which would result in the reduction of the damages awarded from US$58m to US$4m.

The tribunal’s response to the Article 27 application was that:

  1. the tribunal had, unfortunately, overlooked the instruction in the model to enter a negative value for the historic tax liabilities;

  2. focussing purely on the model, it was clear the tribunal had made an error of computation;

  3. however, the Article 27 application was not justified because it was, in effect, seeking to change the amount of damages awarded;

  4. to change the damages awarded would not give effect to the tribunal’s true intention of awarding substantial damages to Mr Khabarov and the Caledor parties;

  5. the damages awarded were not purely by reference to a mechanistic application of the model. The damages assessment was an iterative, holistic, subjective and evaluative process and the output of the model was part of the consideration taken into account;

  6. the damages awarded provided reasonable compensation which neither over-compensated nor under-compensated Mr Khabarov and the Caledor Parties; and

  7. it could not be assumed that the other inputs into the model would not be different if the correction for the tax liabilities was made.

As a result, the tribunal refused to make any corrections in response to the Article 27 application.

Section 68 Challenge

A party to arbitral proceedings seated in England can apply to court to challenge an award in the arbitral proceedings if there has been a serious irregularity affecting the tribunal, the arbitral proceedings or the award. This right is enshrined in section 68 of the Arbitration Act 1996, which also sets out a list of circumstances that amount to a serious irregularity. One of those circumstances is:

any irregularity in the conduct of the proceedings or in the award which is admitted by the tribunal or by any arbitral or other institution or person vested by the parties with powers in relation to the proceedings or the award”.

If there is shown to be a serious irregularity, the court can, remit the award back to the tribunal for reconsideration, set aside the award or declare the award to be of no effect (in each case the whole or part of the award).

Having not obtained the redress being sought via the Article 27 application, Mr Bogatikov and the Doglemor parties made an application to the English court to challenge the award pursuant to section 68. This was on the basis that the tribunal had in its response to the Article 27 application admitted a serious irregularity by accepting its computational error but refusing to correct it. This, it was said by Mr Bogatikov and the Doglemor parties, caused them substantial injustice because the error resulted in the award against them being higher by US$54m. On the other hand, Mr Khabarov and the Caledor parties’ position was that no injustice was caused because the tribunal had explained in its response to the Article 27 application that the error did not materially affect the damages calculation.

In deciding on the challenge, the court held the following:

  1. The tribunal’s response to the Article 27 application has no legal status under the Arbitration Act 1996 or the LCIA Rules. It cannot be read as part of the tribunal’s award and cannot be used to interpret or supplement the reasons for the award. However, it can be relied on to establish the tribunal’s admission of an error for the purposes of section 68. In addition, the response contains admissible evidence from the tribunal about the consequences of its mistake on the award.

  2. In order to be successful on a section 68 challenge a party must show not only a serious irregularity within the meaning of the section but also that this has caused or will cause it substantial injustice. If this need for substantial injustice that can be much harder to establish than the serious irregularity itself.

  3. The tribunal’s admission of the computational error in its response to the Article 27 application is precisely the type of scenario listed in section 68 as a serious irregularity.

  4. There was also substantial injustice because:

    1. There is an award enforceable in other jurisdictions, which contains a computation mistake that, on its fact, leads to significantly different damages payable. It appears the error did, in fact, affect the enforcement of the award in Russia.

    2. The tribunal did not in its response to the Article 27 application assert that notwithstanding the error the damages awarded would be US$58million – it simply stated that its intention was to award substantial damages.

  5. Parts of the award would be remitted back to the tribunal for reconsideration. In determining which parts were to be remitted, the court was mindful of previous cases on this issue, which establish that the arbitral award is prima facie conclusive and the court has only limited powers of intervention. As a result, the court rejected the submission by Mr Khabarov and the Caledor parties that the court should allow the tribunal to reconsider the award’s quantum analysis as whole.

  6. Parts of the award would be remitted for the tribunal to:

    1. Correct the computational mistake in the treatment of the tax liabilities adjustment.

    2. Reach a concluded view on the EBITDA margin.

    3. Calculate the loss incurred by Mr Khabarov and the Caledor parties once the above is coupled with other (unchanged) findings in the award.

Conclusion

Although Article 27.1 of the LCIA Rules restricts a party’s ability to request the tribunal to correct any error in computation, any clerical or typographical error, any ambiguity or any mistake of a similar nature, article 27.2 of the LCIA Rules does allow the tribunal to correct any error (including any error in computation) upon its own initiative in the form of an addendum to the award within 28 days of the date of the award, after consulting the parties.

It is a rare occurrence for a tribunal to admit an error in its award and perhaps rarer for such an error to not be corrected. This case demonstrates the consequences of errors in an award that are then not addressed as part of the mechanism for correcting errors in arbitration rules like Article 27 of the LCIA Rules. It also demonstrates the perils of using complex valuation models for determining damages.

It is important that complex models which are provided to the tribunal for calculating the quantum are set up in a way that avoid incorrect entries or to minimise the scope for error in inputting data. For example, if a value is to be subtracted, it should not be capable of being inputted into the model as a positive value. It may also help if nominated individuals from the party appointed experts can be made available to the tribunal to assist with using the model.

Co-authored by Misbah Qamar.