Annulment of a brazilian aequo et bono arbitral award

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ANNULMENT OF A BRAZILIAN AEQUO ET BONO ARBITRAL AWARD:

The VYTTRA case

Igor Cunha Arantes Castro[1]

 

 

  1. INTRODUCTION

On May 10, 2021, the 1st Chamber of Business Disputes of the Court of Appeals of the State of São Paulo (“Appellate Panel”), one of the most relevant venues for commercial disputes in Brazil, vacated an ex aequo bono arbitral award (“Award”).[2] The Appellate Panel concluded that the arbitrators had not complied with their duty to justify their decisions (“Decision”). Under Brazilian Law, Brazilian courts will not review the merits of arbitral awards and may only set them aside in minimal circumstances. The purpose of this article is to review if the Appellate Panel’s grounds for vacating the award are within the limits set forth under Law 9,307/96 (Brazilian Arbitration Act – “BAA”). We conclude that the Decision reviewed the merits of the Award in breach of the BAA, potentially weaking the institute of arbitration in Brazil in the long run.

 

  1. SUMMARY OF THE FACTS
  • The Business Transaction and the Arbitration

In 2015, LRM Serviços de Manutenção em Equipamentos em Máquinas Ltda. and others (“Sellers”) sold to Vyttra Diagnóstico Importação e Exportação Ltda. 100% of the quotas of Alka Tecnologia em Diagnósticos Comércio Importação e Exportação de Produtos Ltda. (“Company”) by means of a quota purchase agreement (“QPA”).[3] The QPA had an estimated price of BRL24,550,000.00, to be paid in four installments.[4] The final and fourth installment would be calculated based on the Company’s EBITDA[5] after the closing, affecting the QPA’s final revised price. Buyer alleges that, contrary to what Sellers represented in the QPA, Buyer found out after the closing that one of the Company’s most important clients had ended a contract with it, affecting the Company’s revenue. As a result, Buyer requested damages connected to the Sellers’ breaches of the QPA’s representations and warranties.[6]

 

The arbitration was seated in the City of São Paulo, Brazil. It was governed by Brazilian law. The Parties agreed in the Terms of Reference that the arbitral tribunal could issue decisions ex aequo et bono.

 

In its Award, the tribunal concluded that Sellers breached the representations and warranties by not informing that the Company ended a contract with a client before closing. As a result, the tribunal ordered Sellers to pay damages for Buyer connected to this breach. The tribunal awarded damages in the amount of BRL4,296,750.00, which corresponded to 25% of the final revised contract price (“Award”).[7][8]

 

  • The setting aside proceedings

Sellers filed a lawsuit to vacate the Award with the 1st Business Court of the City of Sao Paulo (first instance level). Sellers argued, among other things, that the Award lacked sufficient justification on why the damages should be 25% of the contract price.[9] The lower court found that Sellers were  in fact seeking a revision of the merits of the Award and, therefore, rejected the claim.[10] The Buyer appealed to the Appellate Panel. The Appellate Court found that, even though the arbitrators were authorized to judge ex aequo et bono, they were not dismissed from justifying their conclusions. The Appellate Panel vacated the Award and ordered the Buyer to pay attorney’s fees.[11]

 

The Buyer then appealed to the Brazilian Superior Court of Justice (“STJ”).[12] The Buyer’s appeal is pending judgment.

 

  • ARBITRATION FRAMEWORK IN BRAZIL

Brazil is considered a pro-arbitration country.[13] In 1996, Brazil enacted the BAA, which mirrored many of the provisions of the UNCITRAL Model Law.[14] In 2002, Brazil ratified the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“NY Convention”). Brazilian courts have jurisdiction on arbitration-related disputes in four primary scenarios: (a) recognition of foreign arbitral awards (Section 38 of the BAA), (b) pre-arbitral injunctions (Sections 22-A and 22-B of the BAA), (c) claims to set aside domestic arbitral awards (Section 32 of the BAA), and (d) enforcement of foreign and domestic arbitral awards (Section 555 of the Brazilian Civil Code of Procedure – Law 13,105).[15]

 

A domestic award will be a final and binding decision and not be subject to appeal (Section 18 of the BAA). As a result, Brazilian courts must not review the merits of an arbitral award. Under Section 26 of the BAA, arbitrators also must give the reasons and rationale for their decisions.

 

Arbitrators may only rule ex aequo et bono if the parties have expressly authorized them to do so (Section 2 of the BAA). By deciding ex aequo et bono, arbitrators should decide based on notions of justice (not specifically on the law), reaching the decision that best creates justice in the case at hand. This means that arbitrators are free to disregard a specific law or contractual provision if they believe that their application will not result in justice.[16] Courts may vacate ex aequo et bono arbitral awards that violate Brazilian public policy.

Arbitrators’ duty to justify decisions remains in ex aequo et bono awards.[17] In other words, arbitrators would still have to explain why they believe the ex aequo bono decision is fit and creates justice in the case. If the award goes against a specific contractual or statutory provision, the arbitrators should justify why they are not following such contractual/statutory provision.[18]

 

  1. ANALYSIS

The Appellate Panel vacated the Award because it lacked proper reasoning regarding the damage’s estimation. According to the Appellate Panel, the Award should have given reasons why the damages should correspond to 25% of the contract price.[19] As a result, the Award violated Section 944 of the Brazilian Civil Code (“BCC”), which determines that the condemnation must be equivalent to the aggrieved party’s actual damages.[20][21] Moreover, the Appellate Panel reasoned that other methods would be more fit to calculate the damages, such as comparing the Company’s EBITDA after and before the alleged breach and the impact on the contract price.[22]

 

The Award, however, specifically stated that it awarded damages on an et aequeo et bono basis.[23] Based on the evidence produced by Buyer demonstrating that Sellers’ breach corresponded to around 25% of the Company’s revenues, the arbitrators found that the 25% rate over the contract price constituted adequate damages to the Buyer.[24]

 

In this author’s opinion, the arbitrators met their duty to justify the estimation of damages. Paragraphs 160-170 of the Award expressly address the damages’ estimation. It seems that the Appellate Panel in fact disagreed with the arbitrators’ rationale and believed that the arbitrators should have used a different method or given a different interpretation to the evidence. Nonetheless, a court’s disagreement with the arbitrators’ decision is not grounds for vacating an arbitral award under the BAA. Moreover, even if one proved that the awarded damages somehow violated Section 944 of the BCC, the tribunal was allowed to disregard it, because it was entitled to rule ex aequo et bono. The Appellate Panel reviewed the merits of the Award, disrespecting the parties’ intention by choosing ex aequo et bono arbitration and violating the BAA.

 

  1. CONCLUSION

By reviewing the merits of the Award and vacating it, the Appellate Panel penalized the winning party for resorting to arbitration and encouraged losing parties to frivolously file vacating lawsuits aiming at reviewing the merits of the award. Even though this decision may be isolated, it weakens the arbitration institution in Brazil in the long run. It may also discourage parties from choosing São Paulo as the seat of arbitration since São Paulo courts in principle will have jurisdiction to rule any future setting aside proceedings under Brazilian procedural provisions.

[1] Igor Cunha Arantes Castro is an associate at Veirano Advogados’s Dispute Resolution practice.  He holds an LL.B from the Universidade de São Paulo and an LL.M degree from the New York University, New York

[2] Lawsuit registered under No. 1048961-82.2019.8.26.0100.

[3] See: Decision, ¶5, page 4.

[4] Idem.

[5] EBITDA stands for earnings before interest, taxes, depreciation, and amortization.

[6] See: Decision, ¶5, page 4.

[7] See: Award, ¶¶162-166, pages 56-57.

[8] Sellers filed two subsequent motions for interpretations. The tribunal renounced after denying the first motion for interpretation. A second tribunal was then constituted to rule and ultimately rejected Buyer’s second motion. These circumstances are not relevant for this article and are not addressed herein.

[9] See: Decision, ¶2, page 3.

[10] See: Lower Court Decision on merits dated August 11, 2020.

[11] See: Decision, ¶14, page 22.

[12] The STJ is the highest court responsible for uniformizing and interpreting federal law and is considered a pro-arbitration court.

[13] See: Carlos Nehring Netto. National Report for Brazil. ICCA International Handbook on Commercial Arbitration. ICCA & Kluwer Law International. Supplement 114. 2020, pages 4-5.

[14] See: idem, page 43. Please see the main differences between BAA and UNCITRAL Model law: idem, pages 1-2.

[15] Official text available at: http://www.planalto.gov.br/ccivil_03/_ato2015-2018/2015/lei/l13105.htm. Accessed on March 3, 2022.

[16] See: Selma Lemes. A arbitragem e a decisão por equidade no direito brasileiro e comparado. Arbitragem: estudos em homenagem ao Prof. Guido Fernando da Silva Soares (in memoriam). Atlas. 2007, page 197.

[17] See: Carlos Alberto Carmona. Arbitragem e processo: um comentário à lei 9.307/96. 3rd Edition. 2008, pages 66-7.

[18] See: idem.

[19] See: Decision, ¶11, pages 18-19.

[20] See: Decision, ¶10, pages 11.

[21] See: Decision, ¶10, pages 11.

[22] See: Decision, ¶11, page 18.

[23] See: Award, ¶¶162-166, pages 56-57.

[24] See: idem.

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