On 3 June 2020, the Cairo Court of Appeal (the “Court”) ordered the annulment of the arbitral award in the case of Mohamed Abdulmohsen Al-Kharafi & Sons Co. v. Libya and others (“Al-Kharafi v. Libya”),[1] where the tribunal (the “Tribunal”) had granted Al-Kharafi nearly US$ 1 Billion in damages for Libya’s breach of its obligations to protect Al-Kharafi’s investments. The Court’s judgment left many arbitration practitioners wondering about the actual grounds of annulment and questioning whether such grounds are valid under Egypt’s Arbitration Law (the “Arbitration Law”).

The Facts:

In 2006, Al-Kharafi leased land (the “Land”) from the Libyan government to develop a tourism project in Libya to be executed within 7.5 years (the “Project”). Al-Kharafi would also benefit from usufructuary rights on the Project for 90 years starting from the day it receives the Land. Al-Kharafi was responsible for financing and operating the Project, which included a 5 Star Hotel, a shopping mall, apartment hotels, and restaurants.

The contract signed with Libya (the “Contract”) stipulated that the Libyan Government would give the Land to Al-Kharafi free of any liens, incumbrances, or any physical or legal obstacles that could preclude Al-Kharafi from benefiting from its 90-year investment.

The Court notes that, upon signing the Contract, Al-Kharafi was surprised to find that the Land was subject to legal and physical incumbrances that the Libyan authorities were unable to remove, which precluded Al-Kharafi from enjoying its quiet possession of the Land.

In January 2009, Libya offered Al-Kharafi alternative locations for the execution of the Project. Al-Kharafi refused the offer, insisted on implementing the Project according to the terms of the Contract (i.e., on the Land), and requested the Libyan authorities to remove the physical and legal impediments that prevented Al-Kharafi from enjoying its peaceful possession of the Land. The parties failed to reach an agreement.

In May 2010, and without any warning, the Libyan Minister of Economy cancelled the Project and revoked the investment license granted to Al-Kharafi. Al-Kharafi objected stating that Libya’s actions were abusive. It further emphasized that it was willing to perform its obligations under the Contract provided Libya remove the physical and legal obstacles so that Al-Kharafi may enjoy quiet possession of the Land.

Al-Kharafi argued that it incurred economic and moral damages as a result of Libya’s actions, which allegedly breach the Contract as well as domestic and international investment laws applicable in Libya (notably the Unified Agreement for the Investment of Arab Capital in the Arab States (1980)) (the “Arab Investment Treaty”)).

Following the constitution of Tribunal, the Parties reportedly agreed to subject their dispute to Libyan law.

On 22 March 2013, the Tribunal ruled that:

a.The Contract was not an administrative contract. Rather, it was a BOT contract subject to the rules applicable to civil contracts, including the Arab Investment Treaty;

b.Al-Kharafi exhausted all amicable means to resolve the dispute before initiating the arbitration;

c.Al-Kharafi’s inability to proceed with the Project was caused by Libya’s failure to deliver the Land free of any physical or legal incumbrances, and as a result;

d.Libya should not have rescinded the Contract or revoked the investment license.

e.The Tribunal found that Al-Kharafi’s investment was terminated in an abusive manner, triggering Libya’s responsibility for the pecuniary (including lost profit) and moral damages sustained by Al-Kharafi.

In the dispositive of the award, the Tribunal ordered that Al-Kharafi be awarded:

                        i.        US$ 30 Million in moral damages;

                       ii.        US$ 5 Million for losses and expenses actually incurred;

                      iii.        US$ 900 Million for lost profit; and

                     iv.        US$ 1,940,000 in arbitration fees and expenses.

(i.e., a total of US$ 936,940,000) in addition to 4% interest annual interest on the awarded amount. 

The Court’s analysis:

The Court did not summarize the parties’ arguments[2] but began its analysis by explaining that while an arbitral tribunal’s error in calculating damages is not subject to review by the Court of Appeal, arbitration may not operate in isolation from general legal principles. Therefore, in the Court’s opinion, if an arbitral tribunal exceeds or breaches fundamental principles of justice or “distances itself from the behavioral duties that [a tribunal] must uphold”, the award it renders must be annulled.

Guided by the foregoing, the Court found that proportionality between the awarded damages and the harm sustained by a claimant is a principle of public policy, whose breach empowers the Court to annul the award if the disproportionality between the harm and damages is found to be egregious, highly unjust, and unjustifiable.

The Court criticized the Tribunal’s reasoning by noting that it based its calculation of damages on theoretical assumptions and abstract principles that were not supported by the facts of the case. Furthermore, it found Al-Kharafi’s behavior vexatious, as it noted that at Al-Kharafi was initially willing to settle the dispute for approximately US$ 5 Million, yet kept increasing the amount it claimed throughout the proceedings until it exceeded US$ 2.05 Billion.

The Court was also concerned by the Tribunal’s suggestion that the “lost profit” portion of the damages sustained by Al-Kharafi exceeded US$ 2 Billion (even if Al-Kharafi claimed less than this amount as lost profit) before reducing the damages for lost profit to US$ 900 Million (plus interest). The Court explained that a distinction needed to be made between (i) damages for lost profit, which are a form of direct damages that will inevitably occur in the future; and (ii) compensation for lost opportunity (whose existence is uncertain in the future, thus requiring a conservative examination of the facts to determine if it warrants compensation for “lost hope”). The Court found that the Tribunal conflated both types of restitution and failed to approach the evidence with caution, leading the Tribunal to award Al-Kharafi “excessive” damages.

To reach this conclusion, the Court examined the expert evidence submitted by Al-Kharafi before holding that it was based on flawed assumptions, exaggerated the losses, and ignored the fact that the Project was never implemented. It was, what the Court coined, a “Project on paper”. The Court added that the foregoing, coupled with the political situation in Libya following the Contract’s execution (implicitly referring to the instability that led to the removal of Colonel Ghaddafi), proves that it was unrealistic for Al-Kharafi to expect to make any profit. In other words, the Court found that the revocation of the license protected Al-Kharafi’s investment from an ill-fated future in Libya!

Against this background, the Court concluded that the Tribunal erred in its reasoning and acted in an abusive and discriminatory manner that breached fundamental principles of law and justice which mandates that its award be annulled on public policy grounds.

Initial Thoughts:

This case raises several questions that should be addressed by the Egyptian Court of Cassation, ranging from potential errors of law, to defining the scope of public policy. For example, the Court appears to have applied principles of Egyptian law in matters of damages and compensation to a dispute subject to Libyan law when it examined the difference between inevitable lost profit and possible lost opportunity. Notwithstanding the substantial similarity between the Egyptian and Libyan legal systems, the Court effectively stated how it would approach the case on the merits if it were in the Tribunal’s shoes. Unless this approach can be linked to a ground of annulment, the Court would have exceeded its powers under Egypt’s Arbitration Law, even if its substantive analysis were correct. Moreover, the Court made certain statements that suggest that its analysis on damages may have been incorrect under Egyptian law as well. For instance, its affirmation that the deteriorating situation in Libya following Libya’s revocation of the Contract saved Al-Kharafi additional losses (since the Project would have stalled) is irrelevant to the calculation of lost profit under Egyptian law. What matters for the purpose of this exercise is what Al-Kharafi objectively expected to gain at the time it executed the Contract but for Libya’s subsequent breach.[3] The facts taking place following Libya’s reported breach should have no bearing on the damages owed to Al-Kharafi.

Notwithstanding the Court’s apparent ultra vires actions, its analysis appears to have been affected by two factors, namely (i) Al-Kharafi’s refusal to accept Libya’s offer to construct the Project on another land (i.e. its failure to mitigate its losses); and its (ii) alleged failure to take serious steps to implement the Project before the rescission of the Contract and revocation of the investment license. Put differently, it did not sit well with the Court that the Tribunal could award damages nearing US$ 1 Billion when Al-Kharafi’s actual damages were in the neighborhood of US$ 5 Million, and knowing that Al-Kharafi (i) failed to take serious steps to implement the Project; and (ii) refused offers to construct the Project on another land to mitigate its damages.

The Court held that the award of damages that are disproportionately higher than the harm incurred (or one that would certainly take place in the future) breaches public policy, which would justify annulment under Article 53(2) of the Arbitration Law and VI(2)(b) of the New York Convention. No precedent was relied on by the Court, leaving practitioners wondering whether this is an uncontested principle of Egyptian law. Assuming it is, reaching this conclusion would necessarily require a reassessment of the case on the merits to decide whether the Tribunal applied the test to determine damages correctly. The limits of this analysis have yet to be defined by precedent.

Equally unclear is the reason for the Court’s abstention from explaining what constitutes proportionate compensation that complies with Egyptian public policy, since doing so would have allowed the Court to enforce the part of the award that meets acceptable public policy limits. Partial annulment is exercised by Egyptian courts, as several awards were annulled “in part” on public policy grounds when tribunals awarded delay interest rates that exceeded the statutory cap. The Court missed the opportunity to set a precedent by seeking guidance from jurisprudence on what Egyptian law deems to amount to usura vorax.[4] However, unlike the reduction of awarded delay interest rates that are clearly stated in Egyptian legislation,[5] the determination of what represents proportionate compensation inevitably involves an analysis of the merits that may force the Court of Appeal to exceed its statutory powers. The Court of Cassation will need to answer this question by determining the limits of this examination; or even more, to confirm whether such an examination is permissible in the first place.

Conclusion:

The Cairo Court of Appeal was offered a golden opportunity to set a ground-breaking precedent that could have put an end to the longstanding Al-Kharafi v. Libya saga.  Instead, it raised important yet unarticulated legal questions to the dismay of arbitration practitioners. One hopes that the Egyptian Court of Cassation will clarify these questions by determining the scope of Egyptian public policy and the limits, if any, of a court’s involvement in the determination of damages, which is an issue that traditionally falls within the discretionary purview of an arbitral tribunal.

§ Partner, Shahid Law Firm, Cairo.

[1] Mohamed Abdulmohsen Al-Kharafi & Sons Co. v. Libya and others, award available athttps://www.italaw.com/cases/2185.

[2] The parties had exchanged swords before the Court of Appeal and Cassation on other grounds before the case made its way back to the Court for determination of the award’s compliance with Egyptian public policy.

[3] Court of Cassation, Case No. 45/36 JY, judgment dated 31 March 1970.

[4] Court of Cassation, Case No. 282/89 JY, judgment dated 9 January 2020.

[5] Egyptian Civil Code, Art. 227.