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'Red flags' as evidence of corruption in arbitration proceedings?

The recent award in Penwell Business Limited v Kyrgyz Republic confirmed that arbitral tribunals will, in appropriate cases, rely on the existence of indicia or 'red flags' of corrupt conduct, rather than direct evidence, when determining whether an investment has been obtained through corruption.

This approach recognises that corruption can be very difficult to prove conclusively, even with the benefit of the coercive investigatory powers of a state enforcement agency.  It permits tribunals to rely on compelling circumstantial evidence of corruption, which in effect shifts the burden of proof onto the allegedly corrupt party to explain its conduct and disprove the corruption allegations.

Whilst the 'red flags' approach is not new, it is not universally observed.  The Penwell decision is an important reminder for investors that respondent parties are becoming more confident in raising and evidencing corruption allegations; and tribunals may be willing to dismiss claims where there are strong indicators of corruption, even when there is no direct evidence of bribes having been paid. 

The claims in Penwell

BiMoCom Ltd was a Kyrgyz company established in 1999 to provide telecommunication services in the Kyrgyz market.  In 2005, the Claimant in the arbitration, Penwell, acquired 100% of the shares in BiMoCom.  It subsequently sold 49% of its shares to Forntek Enterprises Limited, a Hong Kong registered company that was owned and managed by two local Kyrgyz businessmen.  One of these men was Alexei Eliseev, who was allegedly closely connected to the son of the Kyrgyz President.

Penwell alleged that it was deprived of its investment in BiMoCom by the Kyrgyz Republic, in breach of both Kyrgyz and international law. Specifically, Penwell claimed that its joint venture partner, Mr Eliseev, organised a corporate raid resulting in the fraudulent transfer of Penwell’s 51% shareholding in BiMoCom to Forntek. Penwell also alleged that BiMoCom was fraudulently declared bankrupt and its assets sold and confiscated. 

The Kyrgyz Republic denied these allegations, arguing that the corporate raid was not attributable to the State, and the Kyrgyz courts did not act improperly in recognising Forntek's title over Penwell's shares in BiMoCom. It also contended that Penwell's claims were in any event inadmissible because Penwell had obtained and maintained its investment through corruption. In particular, the Kyrgyz Republic argued that:

  1. Penwell was associated with Mr Eliseev, who had allegedly secured a restoration of BiMoCom’s licenses in 2005 through corruption; and
  2. Following a change in the Kyrgyz regime, Penwell had attempted to "restore" its investment by bribing members of the Kyrgyz judiciary and prosecutor’s office.

The Kyrgyz Republic was not able to adduce direct evidence to support either corruption allegation. 

Penwell argued that the standard of proof for making out corruption allegations required clear and convincing evidence, which had not been provided.  However, the Kyrgyz Republic argued in favour of a less stringent standard based on red flags, which it defined as “potential forms of circumstantial evidence that once established can lead to a shifting of the burden of proof, requiring the rebuttal of allegations by evidence to the contrary, failing which certain inferences and conclusions might be drawn.” 

The Kyrgyz Republic pointed to a growing number of investment treaty awards in recent years which have relied on red flags to dispose of cases, including Metal-Tech v Uzbekistan, Libananco v Turkey and Union Fenosa v Egypt.  The Tribunal agreed with the red flags approach taken in these awards, concluding that the majority view in recent practice accepts circumstantial evidence as sufficient to discharge a party's burden of proof in respect of corruption allegations.  Whilst the Tribunal emphasised both that (i) the red flags must be “sufficiently clear and convincing” and (ii) the facts underpinning these red flags must be convincingly proven, in the Tribunal's view the absence of direct evidence should not necessarily preclude a finding of corruption where the red flags are compelling and unexplained.

Comment

The award in Penwell marks a further step in the increasing trend of Tribunals to accept red flags as satisfying the standard of proof for corruption allegations, where those red flags are linked to the event in dispute. 

Still, the red flags approach is not universally adopted, including by some national courts in the context of set aside and enforcement proceedings for commercial arbitration awards. For example, in 2016, Alexander Brothers Limited (ABL) obtained a €1.56 million award against two Alstom subsidiaries. In the arbitration, the tribunal had considered corruption allegations raised by Alstom, but concluded that Alstom had not proved corruption as a defence to non-payment.  

Alstom then attempted to have the award annulled in Switzerland, the seat of the arbitration, on the basis that the award was contrary to Swiss public policy.  The Swiss Federal Supreme Court refused to look behind the tribunal's analysis of the facts with respect to corruption, and Alstom's annulment application failed. 

However, in 2019, the Paris Court of Appeal quashed an order for enforcement of the award in France, finding that there were “serious, precise and consistent indicia” that the sums Alstom paid to ABL were used to bribe Chinese government officials, adopting a more expansive red flags approach than that adopted by the tribunal.  In October 2021, France’s Court de Cassation overturned the 2019 Paris Court of Appeal’s ruling, indicating that the lower court had distorted certain portions of the hearing transcripts.  

In the meantime, in June 2020, the Commercial Court in London also considered Alstom's bribery allegations in the context of a parallel enforcement application in the English courts.  The Commercial Court did not accept the red flags approach, commenting that the substance of the allegations was “entirely unspecific and based on suspicions and inferences” and that Alstom had not met the required standard of proof (as matter of Swiss applicable law). 

That notwithstanding, investors in riskier jurisdictions where corruption issues may be more prevalent should be alert to the possibility that any potential claims will be challenged on the grounds there are indicia of corruption.  Investors should therefore consider putting in place appropriate anti-corruption policies and procedures, and implementing them diligently.

Tags

international arbitration, alastair livesey, garreth wong
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