Choice of Law in JVs: Or, Why an English Court Applied Russian Law

2003

A recent English court decision has provided an interesting object lesson regarding the need for express choice of law clauses in contracts, as well as a relatively rare instance of a foreign court applying Russian law. In Base Metal Trading Limited v. Shamurin (2003) (note 1), decided in the London Commercial Court, Justice Tomlinson held that Russian law governed certain claims brought by Base Metal Trading Limited ("BMTL") against a former director who had lost US$6 million through allegedly unauthorised futures trading on the London Metals Exchange. BMTL argued that English law should apply, in part because the metals trading was conducted through London brokers and BMTL was a Guernsey company. However, the court decided to apply Russian law principles, and found that Mr. Shamurin was not liable of any breaches of duty. Among other things, this decision illustrates that where parties in a joint venture do not establish proper agreements to specify the country whose laws will govern their relationship, unintended consequences may follow. Accordingly, it is strongly advisable to use suitably detailed written contracts in joint venture situations, including express "choice of law" clauses.

The background to the case was as follows. Two brothers, Yuri and Mikhail Zhivilo, entered into a "joint venture or partnership based in Russia" (which the court treated as a partnership under English law) with the defendant, Mr. Shamurin, for the purpose of trading aluminium. The metal to be traded was produced at the Novokuznetsk Aluminium Plan in the Eastern Kemerovo region of Russia. To facilitate the marketing and sale of the metal to Western buyers, the parties incorporated BMTL as a company in the island of Guernsey, which is a tax-friendly island jurisdiction affiliated with, but not part of, the United Kingdom. Yuri Zhivilo owned 50% of the shares of BMTL, and Mr. Shamurin owned the other 50%. Both were appointed directors of the company.

At no time did BMTL ever establish a fixed place of business in either England or Guernsey. The company’s business was conducted almost entirely from Russia. Trading was carried out in London through various metal brokers, with whom Mr. Shamurin opened accounts. After a period of time, a dispute arose. In particular, it was alleged that Mr. Shamurin was conducting "unauthorised futures trading", and he was relieved of control of metal sales. Several years later, Mr. Shamurin commenced legal proceedings in the Guernsey courts, claiming that he had been deprived of his rights to 50% of the shares of BMTL by duress.

The Zhivilo brothers, who now effectively controlled BMTL, responded by causing BMTL to bring a claim against Mr. Shamurin in the London Commercial Court. The claim included three separate grounds: (1) that Mr. Shamurin had breached his employment contract, (2) that Mr. Shamurin was liable to the company for damages from the unauthorized metals trading, based on the English law concept that he had failed to act in the company’s best interests (breach of "assumed responsibility"), and (3) that Mr. Shamurin had breached his duties as a director of BMTL.

Given the several jurisdictions involved, the court carefully considered which country’s law should be applied to each part of the claim, noting that different laws could apply to different duties of the defendant. Under English law, the applicable law of a contract is determined according to the Contracts (Applicable Law) Act 1990, which incorporates the 1980 Rome Convention on the Law Applicable to Contractual Obligations. Generally, under these rules English courts should respect the private choice of the parties to a contract regarding the applicable law, with certain limited exceptions. Where no governing law is chosen in the contract (either expressly, or through an "implied" choice of law), the contract will be governed by the law of the country with which "it is most closely connected." Separate rules apply to employment contracts, and the general rule is to apply the law of the country in which the employee habitually performs his work (or if he does not habitually perform his work in any one country, the law of the country in which he was first hired).

The court went on to apply these rules to the facts of the case. First, since the joint venture’s business was conducted from Russia, through a representative office of BMTL in Moscow, the court held that Russian law applied to the employment contract.

Second, BMTL claimed that Mr. Shamurin had caused wrongful damage or loss due to a breach of his assumed responsibility. The plaintiff argued that because BMTL’s bank account was located in London, the loss was incurred in England and therefore English law should apply. Moreover, the hedging contracts which caused the loss were entered into in London with London-based brokers. The court fully rejected this analysis, holding that in reality the loss was suffered by BMTL in Russia, as evidenced by a lack of funds which prevented BMTL from entering into an aluminum tolling contract. The result would have been the same even if Mr. Shamurin had entered into the contracts somewhere else, such as in New York. It was therefore artificial to claim that English law should apply to the claimed tort.

Under the traditional rule in English law, where wrongful damage is caused in a foreign country and the claim is brought in England, the plaintiff must show that his claim would succeed both in the foreign country and in England (note 2). This rule does not apply in certain circumstances (for example, where one Englishman injures another Englishman in a foreign country, the court should only apply English law). Here, because the plaintiff apparently believed that its claim would have been unsuccessful under Russian law, it argued that only English law should apply. The court rejected this argument, since the facts of the case showed a total lack of any connections with England, and each of the parties had a close relationship with Russia. Accordingly, it was not appropriate to apply English law.

Finally, the court addressed the law governing directors’ duties. BMTL argued that since it was a Guernsey company, the court should interpret the relationships of the parties in accordance with Guernsey law, where the internal management of the company was conducted. The court also rejected this argument. In its view, acts or contracts creating obligations between interested members of a company do not have to be governed by the laws of the country of its incorporation. Here, the actions of the parties failed to demonstrate any intention that their relationship should be governed by Guernsey law. Indeed, the parties appear to have been indifferent regarding the jurisdiction in which the company should be formed.

In summary, the court found that the entire claim should be governed by Russian law. This clearly meant that the claim failed in all respects. According to the court, on the basis of evidence agreed by the parties, Russian law (unlike English law) does not recognise "a duty to exercise reasonable skill and care" during business transactions, nor does it impose any obligations to perform specific duties in the absence of a written agreement. Moreover, Russian law does not impose duties on directors in the same way as English law.

In fact, we suppose that certain of these conclusions regarding Russian law could have been challenged. For example, various provisions of Russian civil and company law do impose duties on directors of a company and provide for liability in the event of breach. An example is Article 53.3 of the Russian Civil Code, which provides that one who acts in the name of a legal entity "must act in the interests of the legal entity . . in good faith and reasonably", and must compensate damages caused by his conduct. Russian labor law also provides that employees are liable to their employers for certain damages caused by misconduct. It is not clear from the decision whether these matters were brought to the attention of the English court.

Interestingly, the court commented that even if it were to apply English law to the facts of this case, the claimants would still lose. In the opinion of the court, Mr. Shamurin did not breach his employment agreement under principles of English law, since the contract did not expressly (or impliedly) prohibit him from entering into futures contracts. Thus it could not be found that Mr. Shamurin "failed to exercise reasonable skill and care" in the performance of his employment duties, nor that he had breached other "assumed" duties to the company. Similarly, as far as English law was concerned, Mr. Shamurin had not breached any duties as a director. In short, the court would not impose liability on Mr. Shamurin under English law in the absence of clearer standards in the employment contract regarding his authorisation to engage in futures trading. (Guernsey law would lead to similar results, since it is largely based on English law.)

Another ironic aspect of the decision is that although the court found in favor of Mr. Shamurin, it also stated that his evidence was "inherently incredible" and "far-fetched". The court acknowledged that it was extremely unlikely that the Zhivilos had ever agreed (through BMTL or otherwise) to Mr. Shamurin’s futures trading. Nevertheless, this did not change the court’s conclusion under the applicable principles of Russian law.

The decision serves as a useful reminder that if parties have not properly documented their rights and duties in a written contract, they cannot expect the English courts to do so after a dispute arises. In this case, the fact that the parties conducted metals trading through a Guernsey company was not sufficient to guarantee the application of English or Guernsey law. Instead, the court was perfectly satisfied to apply Russian law, in essence because Russia appeared to have the closest connection to the parties and their business. Ironically, even if BMTL had succeeded in persuading the court to apply English law, the court’s comments indicate that it would have lost anyway. However, under other circumstances the difference between Russian and English law could make a major difference in the outcome of litigation. The results would also have been different if the parties had set down their rights and obligations in a formal contract before entering into business together. Accordingly, the decision provides a useful example of some legal pitfalls to avoid in foreign-based joint ventures with – or between – Russian partners.

Endnotes:

1 - 2003 EW HC2419 Comm.

2 - A different rule would apply under the Private International Law (Miscellaneous Provisions) Act 1995, but this would not have changed the court’s decision.

 

Authors: Brian Zimbler, Peter Gray.

This article appeared in the August 2004 edition of European Forum News.