Exclusive Jurisdiction Clauses in Loan Agreements can they always be relied on

15 April 2005

Jeremy Sharman

In any loan documentation where the lender(s) and the borrower are located in different jurisdictions, one of the key issues to be addressed is which country’s courts are to have jurisdiction in the event of a dispute arising. Typically this is addressed by including a clause in the loan agreement under which both parties agree to submit to the exclusive jurisdiction of a chosen country’s courts (the jurisdiction is stated to be "exclusive" rather than "non-exclusive" to ensure that only the designated courts have jurisdiction). In normal circumstances the lender will want this jurisdiction to be that of its lending branch or, if different, that of the governing law of the document. There are obvious benefits in a dispute being determined by courts of the jurisdiction which provides the governing law. There are also practical advantages to a lender in proceedings taking place in its local courts. Lenders may also be concerned that courts which are local to the borrower may look more favourably on defences raised by the borrower than will the lender’s own chosen courts.

Lenders need to be aware, however, that exclusive jurisdiction clauses may not always work effectively where the borrower is resident in an EC country. The problem stems from an EC regulation on jurisdiction and the recognition and enforcement of judgments (No.44/2001) (the “Regulation”). Article 27 of the Regulation provides that, where court proceedings involving the same cause of action are brought in the courts of different Member States, it is the courts of the country in which the proceedings are first brought which must decide whether they have jurisdiction. Until those courts have decided whether they have jurisdiction, the courts of any otherMemberStatein which proceedings are also brought must stay their proceedings.

Importantly, in the decision of the European Court of Justice in Case C/116/02 Erich Gasser GmbH v MISAT Srl [2005] 1QB 1, the European Court of Justice held that Article 27 of the Regulation could not be overridden by an exclusive choice of jurisdiction made by the parties[1]. So even if the parties had expressly agreed that the courts of Country A would have exclusive jurisdiction to determine a particular dispute, if proceedings were first brought before the courts of (EC) Country B, then the courts of Country A could not hear proceedings brought before them involving the same cause of action until the Country B courts had determined whether they had jurisdiction. Moreover, the European Court determined that this principle still applied even though the courts of Country B might take an excessively long time to determine whether they had jurisdiction.

The difficulties caused by the Gasser case are graphically illustrated by a recent decision of the Commercial Courti n London. In JP Morgan Europe Ltd v Primacom AG and others [2005] EWHC 508, JP Morgan acted as agent for a number of banks which had provided a loan facility to Primacom, a German company. The facility agreement expressly provided that the English courts were to have exclusive jurisdiction to determine disputes. Following default by Primacom, and, critically, before proceedings in respect of that default were commenced by JP Morgan in England, Primacom issued proceedings in Germany challenging, among other things, the Bank's right to claim interest under the facility agreement. JP Morgan issued separate proceedings in the English courts seeking (among other things) a declaration that the interest provisions in the facility agreement were valid (the “declaratory proceedings”). JP Morgan relied on the exclusive jurisdiction wording of the loan agreement, but Primacom applied for those proceedings to be stayed on the basis of Article 27 of the Regulation.

It was clear that Primacom had commenced proceedings in Germany in breach of the exclusive jurisdiction clause. There was also evidence that it had done so primarily to prevent the Banks from bringing the dispute before the English courts. However, the judge in the English proceedings nonetheless stayed the declaratory proceedings. He held that, where the German proceedings and the English proceedings were in respect of the same cause of action, he had no option but to apply Article 27; the effect of the stay was that the English proceedings could not go ahead until the German courts had determined whether they had jurisdiction. It should be noted that the English court did allow JP Morgan to proceed with claims which related to different causes of action to those being pursued by Primacom before the German courts.

The problems which the Gasser decision causes for lenders are clear. For example, an English-based lender may enter into an English law loan agreement with a borrower in another EC state, believing that any disputes under the agreement must be determined by the English courts by virtue of the exclusive jurisdiction clause. However, when a dispute arises, the lender may find that the borrower can use Article 27 to frustrate the intended effect of the exclusive jurisdiction clause by commencing proceedings before its home courts (or possibly even the courts of another EC state where it perceives some advantage).

One might expect that this problem would be only a temporary one. In particular, one might expect that proceedings started in the Courts of Country A, in clear breach of an agreement conferring jurisdiction on the Courts of Country B, would be rapidly dismissed by Country A’s courts. This is particularly so bearing in mind that Article 23 of the Regulation states that, where the parties have agreed that the courts of a particular Member State are to have jurisdiction, then “those courts shall have jurisdiction”. However, the reality is that, at the very least, there may well be a significant delay while the courts of Country A decide whether they have jurisdiction. There may also be a further period while any such decision is appealed. In one recent case in which this firm was involved before the Spanish courts, it took nearly three years before the Spanish courts decided that they did not have jurisdiction. One of the principal reasons for the delay was that in Spain, as in certain other EC countries, a party can appeal as of right, irrespective of the merits of its case.

A lender seeking to challenge the borrower’s decision to proceed in another jurisdiction may also incur considerable costs. Even where the challenge is successful the borrower may have no, or only a limited, liability to pay those costs, although in any well drafted loan agreement the costs of the lender should be covered by a costs indemnity provision. Whilst there is always the possibility that a court will decline to give effect to an exclusive jurisdiction clause, this should be a remote possibility bearing in mind Article 23 of the Regulation. That said, the possibility of this happening is something which lenders will want to research when taking decisions for cross-border lending.

There is no easy solution to the problem which the Gasser case presents. It is not, for example, possible to draft the exclusive choice of jurisdiction provisions in a way that avoids the effect of Article 27. Lenders may, however, be able to avoid being caught by the problem by quick action in a default situation. In particular, if the lender issues proceedings in the agreed jurisdiction before the borrower has time to issue its own domestic proceedings, this will then mean that the problem is avoided. Of course, there are limits to applying a policy of rapidly commencing litigation at the earliest point in any dispute. In reality, and for sensible commercial and other reasons, the parties will usually prefer to resolve disputes on a negotiated basis without issuing proceedings. However, it is clear that whenever a dispute arises, the lender should, at the very least, consider issuing proceedings earlier than it would normally do, and should be prepared to issue proceedings at short notice if it gets any indication that the borrower is about to issue its own domestic proceedings.

For a lender who has been caught by the problem, it can either fight on the jurisdiction issue (and accept the delay which this is likely to produce) or it can resign itself to losing the benefit of the exclusive jurisdiction clause and pursue the proceedings instead in the courts of the borrower’s home jurisdiction. For the reasons mentioned above, this may not always be an attractive option.

In the Gasser case, the European Court of Justice justified its decision that a choice of exclusive jurisdiction did not override Article 27 on the basis that there should be certainty as to the EC courts with jurisdiction. Without such certainty there was the risk of parallel proceedings taking place in different countries which could give rise to conflicting decisions. The Court considered that the need for certainty should be based purely on the chronological sequence of the issue of proceedings. In doing so, however, the Court established a principle that Article 27 can frustrate the intention of a contractual bargain as to jurisdiction made by business parties concluding a freely negotiated contract.

It is, of course, desirable to have certainty as to which courts have jurisdiction. However, banks which are lending on a cross-border basis are also entitled to be certain, when they lend, where loan agreement disputes will be resolved. If the loophole created by the Gasser case becomes widely exploited, there must be strong arguments for changing the law.

[1] The decision of the ECJ in the Gasser case was infact based on Article 21 of the 1968 Brussels convention the forerunner to Article 27 of the Regulation.