Enforcement in the asset management context: what is the relevant asset and who does it belong to?
The Commercial Court in London has recently given judgment in the latest instalment of a long-running dispute concerning the Republic of Kazakhstan, the National Bank of Kazakhstan and Moldovan investors.
(1) National Bank of Kazakhstan (2) the Republic of Kazakhstan v (1) The Bank of New York Mellon SA/NV, London Branch (2) Anatolie Stati (3) Gabriel Stati (4) Ascom Group SA (5) Terra Raf Trans Traiding Limited  EWHC 916 (Comm)
The Commercial Court in London has recently given judgment in the latest instalment of a long-running dispute concerning the Republic of Kazakhstan, the National Bank of Kazakhstan and certain Moldovan investors. The dispute has focused on attempts by the investors Anatolie and Gabriel Stati (and their companies Ascom Group SA and Terra Raf Trans Traiding Limited, the “Stati Parties”) to enforce a USD 500M Arbitration Award granted against the Republic of Kazahkstan (“RoK”).
Despite the difficulties in conducting court hearings during the COVID-19 pandemic, the most recent English trial was heard remotely, with witnesses giving evidence from a number of different jurisdictions. It is to the considerable credit of the English Courts that such a complex hearing could be accommodated and that judgment followed so swiftly.
The underlying dispute between the Stati Parties and RoK was originally determined in an Energy Charter Treaty arbitration in 2013, and there have been multiple enforcement proceedings to date. These wider enforcement proceedings have given rise to judgments across several jurisdictions. These decisions will be the focus of our second article, which will also highlight some of the practical issues that arise in such disputes.
However, this article focuses on the latest English judgment, and the practical and commercial issues that arise from the decision on the custody aspects of this dispute. In March 2020, the English court was required to consider whether it should grant certain declarations about the status of funds held by a custodian bank, pursuant to an English law agreement. In giving its judgment, the English court was required to consider not only who was entitled to the funds but, also, the particular nature of the rights that arose in connection with the relevant custody and asset management agreements. This decision will therefore have particular significance for custodian banks, the wider asset management industry and international investors.
In simple terms, the court decided that the funds in the account were not owed to RoK (the enforcement defendant) under the custody arrangements but, instead, the specific asset in question was a contractual debt, which was owed to and could only be enforced by the National Bank of Kazakhstan (“NBK”). This in an important decision for both the banking and asset management industries. The judge’s reasoning provides a helpful guide for those considering the potential for their own, or their client’s, assets to be the subject of enforcement measures in future.
A brief history of the underlying dispute
In 1999, the Stati Parties acquired companies that held petroleum licences in Kazakhstan. Over the course of the next decade they invested over USD 1 billion creating highly successful trading businesses, yielding significant revenues for RoK.
Prior to the Stati Parties receiving significant dividends, RoK seized the petroleum operations and nationalised them. The Stati Parties commenced arbitration against RoK in Sweden pursuant to the Energy Charter Treaty and, in 2013, were awarded approximately USD 500M (the "Award"), with the tribunal finding that RoK had failed to treat the Stati Parties fairly and equitably. The Award was challenged by RoK in Sweden but ultimately upheld by the Swedish Supreme Court.
The Stati Parties sought to enforce the Award by attaching an obligation allegedly owed to RoK by the Bank of New York Mellon (“BNYM”). BNYM provide banking and custody services to NBK, which, in turn, manages assets for RoK through the National Fund of Kazakhstan (a sovereign wealth fund). The Stati Parties therefore argued that the accounts held by BNYM represented assets of RoK against which enforcement could take place.
The Stati Parties fought to secure garnishment orders against the BNYM accounts, a process which commenced in Belgium and Holland in 2014. Eventually, the Stati Parties successfully secured garnishment orders against BNYM in both countries, although the process was complicated, and there were contested proceedings across multiple jurisdictions before the garnishment orders were granted in 2017.
Upon being served with a garnishment order, under both Dutch and Belgian procedural law, the garnishee is obliged to issue a declaration as to the assets owing or held on behalf of the debtor. BNYM took the view that it was arguable that the garnishment orders effectively attached the whole of the National Fund of Kazakhstan. Certain assets of the National Fund of Kazakhstan were managed by NBK, and held by BNYM's London branch. This agreement was documented under a 2001 Global Custody Agreement ("GCA") executed between BNYM and NBK on 24 December 2001, which was subject to English law.
Accordingly, BNYM froze the GCA Accounts of NBK, including approximately USD 22.6 billion in cash, bonds and equity shareholdings, comprising around 40% of the National Fund of Kazakhstan. BNYM contended that they were required to freeze the entirety of the assets, even though their value was more than 40 times that of the Award.
Involvement of the English court
RoK and NBK initially commenced Part 8 proceedings in the courts of England and Wales against BNYM. RoK sought confirmation that, under the terms of the GCA, BNYM was not obliged or entitled to freeze the NBK funds as a result of the garnishment orders. The Part 8 proceedings focused on contractual interpretation of the GCA, and BNYM's powers thereunder, under English law. Both the High Court and the Court of Appeal confirmed that BNYM was entitled to freeze the assets. The correct interpretation of the relevant provisions of the GCA, given both: (i) the language of the clause and (ii) the context in which the GCA was entered into, led the Court to the clear conclusion that BNYM was obliged and entitled to freeze the NBK funds upon receipt of a garnishment order. The first instance judgment, given by Poppelwell J, also stated that BNYM owed "loyalty" to the courts of the Netherlands and Belgium and "must obey" the orders, "if it is not to face civil liability and criminal sanction".
RoK also challenged the Belgian garnishment order on the ground that BNYM had no “attachable obligation” to RoK. The Stati Parties argued that there was an “attachable obligation” as RoK was entitled to demand repayment of the sums held by NBK from BNYM. The Belgian court referred the question to the English Courts for consideration (the “Belgian Referral”). NBK and RoK commenced an action in the English Court on 28 May 2018, seeking five declarations under both the GCA, and a Trust Management Agreement (“TMA”) executed between NBK and RoK:
(i) That the contracting parties to the GCA are BNYM London and NBK (and not RoK);
(ii) That the obligations owed by BNYM London under the GCA are owed solely to NBK (and not RoK);
(iii) BNYM London has no obligation to pay any debt due under the GCA to RoK;
(iv) BNYM London has no obligation to transfer any security, or any interest in any security, held under the GCA to RoK; and
(v) That the Belgian garnishment order, and subsequent declaration of assets made by BNYM (Belgium):
(a) was materially inaccurate as to its description of the relationship between RoK and BNYM London; and
(b) ought to have stated in terms that BNYM London was not indebted towards and held no assets of RoK capable of forming a valid subject matter under the Belgian garnishment order.
Following a jurisdiction challenge by the Stati Parties, the English court confirmed that it had jurisdiction to hear the issues arising from the Belgian Referral, and a trial was set for March 2020. Despite the COVID-19 outbreak, the trial took place as planned, albeit on a virtual basis.
The principle substantive issue for the English court at the hearing was whether only NBK (and by exclusion not RoK) was able to demand repayment of a debt from BNYM. Under English law, the relationship between a bank and its customer is that of debtor and creditor; the customer has a ‘chose in action’, which entitles them to draw upon the credit balance on demand from the bank. Consequently, the National Fund of Kazakhstan sums held in the BNYM accounts represented the liability of BNYM to pay the sums, on demand, to the entity holding the right to demand payment. The English court was asked to determine whether it was NBK (as argued by NBK and RoK), or RoK (as argued by the Stati Parties) who had the right to demand payment.
The Stati Parties argued that RoK had the right to demand payment under principles of (i) agency and (ii) trust law. The court also addressed the role of the ultimate ownership of the National Fund of Kazakhstan by RoK.
Agency: the question examined by the court was whether NBK had entered the GCA as agent for RoK.
In examining the position on agency, the court focused on clauses in the TMA that gave NBK authority to deal with the National Fund of Kazakhstan. The court found that several clauses empowered RoK to direct NBK’s activities (including giving instructions concerning the fund). However, it found that nothing in the TMA gave NBK actual authority to act as agent for RoK.
In order for NBK to have entered into the GCA as agent for RoK, NBK must have had actual authority to do so, and must have intended the contract to be entered into on behalf of RoK, binding BNYM. The general position was that NBK is constituted as a legal person separate and distinct from RoK, and acts in its own name when entering into commercial relations with other parties as an independent central bank. The court held that the terms of the TMA did not establish that NBK entered into the GCA as agent for RoK and were equally consistent with NBK acting on its own behalf (albeit owing duties to RoK).
In considering all the matters which may establish an agency relationship under English law (the applicable law governing the GCA), the court found that a reasonable person, in the position of NBK would not have understood that it was authorised to enter into the GCA as agent for RoK. As such, RoK would not have understood that NBK was doing so. NBK was stated to be the independent central bank of RoK, and, absent any express grant of actual authority in the TMA, it was not possible to infer actual authority or an agency relationship (notwithstanding judicial commentary that “some aspects of their relationship were consistent with an agency relationship”). The court held that the Stati Parties had not established the necessary and actual authority.
Trust law: the Stati Parties argued that RoK was the beneficiary of a trust, where NBK was trustee, such that RoK could enforce payment of BNYM’s debt to NBK through either: (i) RoK instructing NBK to commence proceedings to enforce payment of the debt owed to NBK, in an action whereby NBK is the nominal claimant, or (ii) through a derivative action in RoK’s own name.
The court started its analysis from the position that “money paid into a bank account belongs legally and beneficially to the bank and not to the account holder”. Therefore, BNYM was the owner of the sums over which the garnishment order applied. BNYM had “contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that put into his hands”. The court held that the person entitled to enforce that demand for repayment was NBK. BNYM did not therefore owe any debt to RoK, and “the right to claim the [frozen sums] is a contractual right, and it lies with the NBK”. It did not, on the court’s analysis, matter that RoK could cause NBK to bring a claim, as the claim would still be to enforce a debt owed to NBK.
The court accepted that this conclusion would be “disappointing” for the Stati Parties in circumstances where “the Republic is ultimately beneficially entitled to the proceeds of the debt, and has the right to require the NBK to make payment from the National Fund to enable demands on the Republic’s budget to be met, which could of course include payment of the award in favour of the Stati Parties if the Republic so wished”.
However, interestingly, Justice Teare did suggest that “subject to matters of jurisdiction and state immunity, the debt due from the NBK to the [RoK] could be garnished from NBK”, despite the Stati Parties’ election to “garnish the sums due from BNYM”. It is not clear whether the Stati Parties are pursuing this route.
Ultimate ownership: the Court also considered whether the fact that, under Kazakh law, title to the assets managed by NBK may remain with RoK, affected its overall conclusions. The court found that whatever ownership rights exist under Kazakh law, the correct consideration is whether English law allows RoK a right to claim the sums frozen (i.e. the debt owed by BNYM). It was held that ‘ownership’ of the National Fund of Kazakhstan did not give RoK a right to demand payment from BNYM, or to say that the sums were held by BNYM for RoK. The right to demand payment of sums was a contractual right lying with NBK.
Justice Teare made four declarations, slightly modifying those proposed by NBK and RoK:
(i) The contracting parties to the GCA are BNYM London and NBK;
(ii) The obligations under the GCA are owed solely to NBK;
(iii) BNYM London does not have an obligation to pay any debt due under the GCA to RoK;
(iv) Kazakhstan does not have any claims against BNYM in relation to the cash deposits by BNYM pursuant to the GCA.
Whilst the enforcement of arbitral awards (and judgments) might be considered a topic for contentious lawyers, this decision (and other decisions in this dispute which will be covered in our second article) demonstrate that such cases can be just as important for transactional and advisory lawyers, particularly those in the asset management industry or institutions providing banking and custody services to international investors (including sovereign parties).
Any business involved in holding or managing assets could potentially be subject to freezing, attachment or garnishment orders, imposed domestically and internationally. Whilst there may be defences or exceptions that apply, for example on grounds of contractual nexus, ownership/control or sovereign immunity, it is often the case that these issues are not resolved until after the initial measures have been obtained on an interim basis.
As this decision demonstrates, there can be many reasons why assets cannot, ultimately, be enforced against. However, that does not necessarily mean that those assets will not be subject to interim measures. Those holding or managing such assets must therefore be prepared to deal with such issues.
The common example of a domestic freezing order affecting a relevant bank account presents relatively fewer problems for the institution, which can usually simply stop all dealing on the account. However, even in such cases, there can be complications; for example, where there is a separate asset management mandate, and the potentially affected party is not served with an order directly, it can be much harder to form a clear view on the obligations that arise. The position can become much more complicated when other jurisdictions, sovereign immunity or other factors are also involved.
In practice, it may also be difficult to obtain information about the underlying proceedings from the customer, who may be reluctant to share sensitive information, or may not be fully involved in the underlying dispute (for example, because it is a party alleged to hold or manage assets on behalf of a defendant to enforcement but is not itself a party). There may also be a lack of understanding of the potential jurisdictional reach of the relevant orders, or the regulatory and risk constraints on custodians and managers who are asked by their customers to continue dealing with assets in the face of such orders.
On the facts of this particular case, the relevant asset was the right to demand repayment of sums held in a bank account. The court held that the right to demand repayment was a contractual right, held by the account holder, and not a right held by an entity who, ultimately, may be beneficially entitled to the proceeds of the account.
The detailed analysis that was required in this case demonstrates that it is not always possible to anticipate, in advance, whether an asset or a counterparty may be at risk of enforcement. It is essential therefore to have an understanding of the legal and procedural issues involved when these issues arise.