ARBITRAT ION BATTLE

Characters

Stolichnaya Manufaktura – a highly perspective and successful textile company

Ivan Trofimovich Tarasov – major shareholder of Stolichnaya Manufaktura, who owns 76% of

its shares

Lev Knop2 – one of the richest businessmen in the Russian Empire, “cotton king”

Saint Petersburg, 1880

1 Some facts were invented by the authors.2 http://strategyjournal.ru/articles/lvinaya-dolya-nemetskaya-volya-i-russkij-razmah/

The dispute to be resolved at the Saint-Petersburg Interna-tional Legal Forum had occurred in hard times, which certainly affected its reasons and development.

Meanwhile we hope the honourable arbitrators will resolve it in the most impartial, diligent and fair way.

Any coincidences, parallels and analogies are purely acci-dental.1

BY THE ARB ITRAT ION CENTER AT THE I NST I TUTE OF M ODERN ARB I TRAT ION

BACKGROUND OF DISPUTE: F INANCIAL CRISIS AND

INTERNATIONAL TENSIONAfter the global crisis of 1873 resulting from Stock Market Crash3 the Russian

Empire’s economy was in a desperately poor condition.

Black Friday at Vienna Stock Exchange (9 May 1873)

Panic of 1875 provoked a financial crisis in Russia aggravated by the bankruptcy of

Moscow Commercial Loan Bank. Here is what A. Pisemskiy, Russian writer, tells his son:

Moscow is experiencing a deep anxiety. Moscow Commercial Loan Bank has crashed. Though

I have never deposited any piece there (neither in any other bank), even I am being chaotic with

this social grief. The shares of this bank possess no value anymore. What will depositors receive?

No one has any idea. One thing is though clear - deficit is enormous… The Government is truly

concerned about the possibility of a bank crisis. The citizens rippled by a wave of panic are likely to

retrieve their deposits from other banks. The newspapers report that the Government is ready to assist

the banks, if so happens. The president of Moscow Commercial Loan Bank was Mr. Polyanskiy,

very young gentleman, who once lived in our neighbourhood in Ostankino. He has already been

arrested together with the vice-president, whose name is unfamiliar to me. Public prosecutor has

3 https://en.wikipedia.org/wiki/Panic_of_1873

initiated an investigation. The Bank witnesses terrible scenes: people cry, shout, pass out, - it’s a total

nightmare!...4

Thus, Russia is faced with a grave bank crisis. Within the few days (starting from

12 October 1875) shareholders attacked the banks to retrieve their savings. Most of

the major banks suffered considerable losses: Russian Bank of External Trade lost

200,000 Rubles while Volzhsko-Kamskiy - 100,000 Rubles.

K.E. Makovskiy Crash of a Bank (1881)

Meanwhile the tension intensified on the international scale, specifically in the

Balkans, where the protests against the Osman Empire were held. The war was imminent.5

The summer of 1875 experienced the mass protests in Herzegovina, which latter

on spread to Bosnia. The protests were supported in Serbia and Montenegro. Turkish

governors replied the protestors with a cruel and sanguinary massacre. The army of

executioners entered into Bosnia and Herzegovina.

Trying to diminish the social breakdown, the government of the Osman Empire

began cultivating violent Islam extremism and provoking the massacre of Christians.

Counsels of France and Germany were assassinated during the attacks of Islamises

on Christians in Thessaloniki.

4 http://www.kommersant.ru/doc/14735395 http://studopedia.ru/1_18726_balkanskiy-krizis--gg.html; https://ru.wikipedia.org/wiki/Русско-турецкая_война_(1877—1878)

In April 1876, Bulgaria was faced with various manifestations, which were violently

oppressed resulting in more than 30,000 victims. This provoked a global crisis, which,

inter alia, paralysed Europe. Notwithstanding the pro-Turkish policy implemented by

Benjamin Disraeli, prime-minister of the Great Britain, Charles Darwin, Osсar Wilde,

Victor Hugo and Giuseppe Garibaldi supported Bulgarians.

In August 1876, Victor Hugo expressed the following opinion in a French

parliamentary newspaper:

It is indispensable to attract the attention of European governments to the fact, “minor” fact,

on which they turn a blind eye… The whole nation is being massacred… Where? In Europe… Will

the sufferings of the small heroic nation ever come to an end?

K.E. Makovskiy Bulgarian Grief (1881)

Meanwhile in 1875 Russia experienced a mass movement supporting Slavic

military campaign, which engaged all social strata. The whole society was involved in an

acute discussion: progressivists justified the war by its liberating character; conservatists

considered its political dividends, such as creation of a Slavic federation headed by the

Russian Empire.

DEAL: GOVERNMENT PROCUREMENT

AND OBSESSION BY ARTThe war was imminent, so were the government procurement. The most profitable

public contracts related to production of equipment and uniform for soldiers. Only big

manufactures could afford such contracts.

N.D. Dmitriev-Orenburgskiy General M.D. Skobelev Riding a Horse (1883)

Lev Knop was an experienced and extremely smart businessman closely related

to governing authorities. At that time, he was considering how to invest his assets to get

the most profitable public contracts, if the war between the Osman and Russian Empire

broke out.

Meanwhile Ivan Trofimovich Tarasov, shareholder of Stolichnaya Manufaktura, one

of the biggest producer of textile, wanted to withdraw from his business. He could not

help contributing all his time and effort to Peredvizhniki.6 He was deeply touched by their

social idea and followed the group of artists everywhere. He organized their exhibitions

in the remotest towns of Russia, always for free.

Stolichnaya Manufaktura abandoned by Ivan Tarasov as a result of his obsession

needed modernization and contribution of significant resources. Ivan Tarasov could

no more obtain financing from the Russian banks, which refused to loan money

under the existing financial crisis. Contributing his own money to the development of

the Manufaktura was unacceptable for Ivan Tarasov. He preferred buying the paintings

of A. K. Savrasov, V. G. Perov and N.N. Ge.

А.K. Savrasov Rooks Have Come Back (1871)7

Lev Knop met Ivan Tarasov on an art exhibition in Saint Petersburg, where he

discovered the art lover’s intention to sell Stolichnaya Manufaktura. Lev Knop desiring

to conclude public contracts on production of uniform for soldiers decided to buy

the Manufaktura and contribute considerable resources to its development without any

hesitation.

Thus, in 1876 Lev Knop and Ivan Tarasov negotiated the purchase of the controlling

interest in Stolichnaya Manufaktura. 6 Group of Russian realist artists, who formed an artists’ cooperative in protest of academic restrictions.7 Ivan Tarasov bought the painting for his personal collection. He put the painting on the wall of his library as it reminded him of his home in Kostromskaya guberniya.

As a result of the negotiations, on 7 November 1876 Lev Knop and Ivan Tarasov

concluded an agreement (hereinafter Share Purchase Agreement). Ivan Tarasov was to

transfer to Lev Knop 75% shares of Stolichnaya Manufaktura plus one share, while Lev

Knop was to pay 150,000 Rubles.

When the Share Purchase Agreement was signed, the war between Serbia,

Montenegro and Turkey reached its peak. The Russian Empire was getting more and

more involved in the conflict. The dreams of Lev Knop to obtain public contracts could

at any time come true. Thus, he wanted to get the controlling interest in the Manufaktura

as soon as possible in order to start the modernisation.

The transfer of shares was to be effectuated step by step. Firstly, Lev Knop was to

make an advance payment in the amount of 100,200 Rubles before 1 December 1876

for 50% of the shares plus one share. Secondly, he had to deposit 50,000 Rubles for

the remaining 25% of the shares before 15 February 1877. Ivan Tarasov was obliged to

transfer 50% of the shares plus one share and 25% of the shares within fourteen (14)

days after the dates of the respective payments by Lev Knop.

Lev Knop wanted to avoid dealing with the Chamber of State Control8 headed by

his long-standing enemy. As Ivan Tarasov never had any controversies with the Chamber,

in the Share Purchase Agreement he warrantied the absence of any tax liabilities with

respect to the Manufaktura for the period prior to its purchase by Lev Knop. If the

Chamber was ever to file a tax claim against the Manufaktura for the period prior to the

purchase,9 Ivan Tarasov agreed to pay the amount of the contested tax liabilities, but

not exceeding 20,000 Rubles.

The Share Purchase Agreement contained an arbitration clause referring all

disputes arising out of the Agreement to the arbitration administered by the Arbitration

Center at the Institute of Modern Arbitration (hereinafter the Arbitration Center).

8 Authority responsible for tax control at that time9 In Ivan’s Tarasov view, it was “highly unlikely” and “absolutely impossible”

TRANSFER OF SHARES, SUITCASE AND WOODEN CHEST

On 30 November 1876, Lev Knop brought Ivan Tarasov an impressively big wooden

chest with 100,200 Rubles. The title on 50% of the shares plus one share was transferred

to Lev Knop on 12 December 1876.

On 27 December 1876, the Chamber of State Control filed a tax claim against the

Manufaktura in the amount of 40,000 Rubles for the period prior to the conclusion of

the Share Purchase Agreement. Lev Knop was shocked. So was Ivan Tarasov, who at that

moment was actively negotiating with the Moscow authorities with respect to the Fifth

Exhibition of Peredvishniki in Moscow School of Painting, Sculpture and Architecture.

Lev Knop started to doubt whether the purchase of the Manufaktura was a clever

idea. He decided to conduct an independent appraisal concerning the value of the

shares of Stolichnaya Manufaktura. The independent appraisal revealed that the value

of all shares amounted to 146,738 Rubles, while 75% of the shares plus one share cost

only 110,200 Rubles. The appraisal was over on 11 February 1877. It made clear that

misrepresentation made by Ivan Tarasov reduced the value of 75% of the shares plus

one share by 40,000 Rubles.

Lev Knop, outraged by Ivan’s Tarasov bad faith, arrived in Moscow on 13 February

1877.10 He gave Ivan Tarasov a small suitcase with 10,000 Rubles. In the suitcase, there

was a Notice of Set-off. Lev Knop purported to set-off an unpaid 40,000 Rubles against

indemnified losses in the amount of 20,000 rubles and damages caused by Ivan’s Tarasov

breach of the representation regarding the absence of tax liabilities in the amount of

20,000 rubles.

Moreover, a couple of days before his visit to Moscow (on 3 February 1877) Lev

Knop read an article on arbitration agreements in “Zakon” review. He became worried

that his arbitration agreement with Ivan Tarasov could be deemed unenforceable,

whereas he wanted arbitrators included in the list of the Arbitration Center to resolve

his disputes. Lev Knop made his messenger pigeon with a personalised ring deliver a 10 The month before the opening of the Fifth Exhibition of Peredvizhniki

letter to Ivan Tarasov.11 On 10 February 1877 a carrier knocked at Lev’s Knop door and

handed him an envelope.12 The carrier carried the cockade with oak leaves, exactly the

same as ones on the envelope.

As of 1 March 1877, Ivan Tarasov, who got carried away by the trip to Elabuga with

Ivan Shishkin looking for picturesque landscapes, had not transferred to Lev Knop the

remaining 25% of the shares.

On 12 April 1877, the war between Russia and Turkey burst out. A long-standing

friend of Lev Knop, who was general-major at the time, invited him to serve as assistant

to the Chief of Staff of the Russian Empire’s Army. Lev Knop was extremely honoured

to receive such invitation. He departed for the river of Danube to develop military

strategies, forgetting Stolichnaya Manufaktura for a while. After the end of the war Lev

Knop was proposed to remain assistant to the Chief until 1 January 1880. Thus, between

1878 and 1880 Lev Knop had been pursuing various secret missions upon the Emperor’s

request, which is why his location is impossible to define.

After his service came to an end, Lev Knop returned to Saint Petersburg. Revising

his previous business arrangements, he came across the note from Ivan Tarasov. He

remembered his affairs with Stolichnaya Manufaktura and decided to take action.

DISPUTEOn 1 March 1880, Lev Knop arrived in Moscow and handed the Executive

Administrator of the Arbitration Center a Request for Arbitration. He appointed

Ruslan S. Ibragimov as arbitrator.

When Ivan Tarasov received the Request, he was taken aback.

On 11 March 1880, the Arbitration Center received an Answer to Request, where

Ivan Tarasov objected to the jurisdiction of the Arbitral Tribunal. He appointed Prof.

Irina S. Shitkina as arbitrator.

On 28 March 1880, the Arbitral Tribunal was constituted. The Board of the

Arbitration Center appointed Prof. Anton V. Asoskov as presiding arbitrator.

11 The letter had the following content: “I am slightly worried by what I have just read in “Zakon” review about the arbitration reform in Russia. I would like to make sure that our arbitration clause is valid. L. Knop”12 There was a note in the envelope: “By all means! There is no need to worry. By the way, there will be a magnificent exhibition in Moscow. You are cordially invited to attend it. I.T.”

On 1 April 1880, the Arbitral Tribunal dismissed Ivan’s Tarasov Request for

Bifurcation. Without prejudice to his jurisdictional objections set out in the Answer to

Request, the Arbitral Tribunal asked Ivan Tarasov to express his position with respect

to the merits of the dispute.

On 10 April 1880, the Arbitration Center received a Claim, where, inter alia, Lev

Knop refuted the jurisdictional objections made by Ivan Tarasov.

On 20 April 1880, the Arbitration Center received a Response to the Claim, where

Ivan Tarasov, still denying the jurisdiction of the Arbitral Tribunal, expressed his legal

position with respect to the merits of the dispute.

On 1 May 1880, the Parties and the Arbitral Tribunal agreed upon the Timetable

of the Arbitration Proceedings.

The oral hearings were agreed to be held on 19 May 1880 in Saint Petersburg in the

General Staff Building located on Dvortsovaya Square, 6-8.

SHAREHOLDERS’ AGREEMENTwith respect to stock company

Stolichnaya Manufaktura

This Agreement was concluded in Saint Petersburg on 7 October 1876 between

all shareholders of stock company Stolichnaya Manufaktura (hereinafter Stolichnaya

Manufaktura), in particular:

Tarasov Ivan Trofimovich, owing 76 % of shares in Stolichnaya Manufaktura;

Muromtsev Sergey Andreevich, , owing 14 % of shares in Stolichnaya

Manufaktura;

Kavelin Konstantin Dmitrievich, owing 10 % of shares in Stolichnaya

Manufaktura,

Hereinafter referred to jointly as the Shareholders, and separately as the Shareholder.

The Shareholders hereby agree to hold their shares in Stolichnaya Manufaktura

(hereinafter – the Shares) and exercise their rights arising out of holding the Shares subject

to the terms hereof.

...

Article 4. Terms of Disposal of the Shares

1. The Shareholders may sell the Shares to the third persons subject to the terms provided

by this article.

2. The Shareholders undertake not to sell the Shares to the third persons if, as a result of such

sell, the cumulative shareholding owned by all the Shareholders will not exceed 25 % of

the Shares plus one Share.

3. If the Shareholder or the Shareholders are in breach of the provision set forth in paragraph

2 of this article, the other Shareholders or the Shareholder may claim full compensation

for damages caused by such breach.

4. The provisions set forth by this article are confidential.

Article 6. Confidentiality

The Shareholders hereby undertake not to disclose any information that is subject to

confidentiality provisions hereof.

…

Article 9. Dispute Resolution

Any and all disputes, controversies or claims related to the incorporation of Stolichnaya

Manufaktura, management thereof or participation therein, between its Shareholders,

Stolichnaya Manufaktura itself, as well as other persons who consented to be bound by this

arbitration agreement, shall be resolved by arbitration administered by the Arbitration Center

at the Autonomous Non-profit Organization “Institute of Modern Arbitration” in accordance

with the Arbitration Rules.

Persons who are not party hereto, but who enter into legal relations with Stolichnaya

Manufaktura (Stolichnaya Manufaktura’s counterparties) may consent to be bound by this

arbitration agreement by way of entering into the respective arbitration agreement with

Stolichnaya Manufaktura.

The Parties undertake to voluntarily perform the arbitral award.

…

SHARE PURCHASE AGREEMENT

Saint Petersburg 7 November 1876

Tarasov Ivan Trofimovich, a subject of the Russian Empire (hereinafter the Seller), on the

one hand, and Mr. Lev Knop, a subject of the Russian Empire (hereinafter the Purchaser), on

the other hand, hereinafter referred to as “the Parties”, have concluded this Share Purchase

Agreement (hereinafter the Agreement) as follows:

1. Subject Matter of the Agreement

1.1. The Seller shall sell and transfer to the Purchaser the ownership of seven hundred

fifty one (751) ordinary voting shares (hereinafter the Shares) of stock company Stolichnaya

Manufaktura (hereinafter the Company), that constitutes seventy five (75) percent plus one

share of the Company, and the Purchaser shall take and pay the Shares subject to the terms

hereunder.

2. Representations

2.1. The Seller warrants that the Seller is the owner of the Shares and the Shares

are fully paid, free of any encumbrances, arrests, and neither subject to any court or other

disputes nor to any restrictions as to their sell to the Purchaser. The Seller undertakes not to

sell or encumber the Shares before the transfer of the ownership of them to the Purchaser.

2.2. The Seller warrants that the Company does not have any tax liabilities for the

period preceding the conclusion of the Agreement.

2.3. Should the statements in paragraph 2.2 above of the Agreement be untrue and

the tax authorities file a claim to the Company for the period stated in paragraph 2.2, the

Seller shall indemnify the Purchaser against the losses amounting to the monetary claims of

the tax authorities, but in any event not exceeding twenty thousand (20,000) Rubles.

3. Purchase Price of the Agreement

3.1. The Purchase Price of the Shares shall be two hundred (200) Rubles per a share.

3.2. The Purchase Price of the Agreement shall be the total price of all the sold shares

and amount to 150,200 Rubles.

4. Procedure for the Payment and Transfer of the Shares and Rights to Them

4.1. The Purchaser shall pay five hundred and one (501) shares before 1 December

1876.

4.2. The Seller shall transfer five hundred and one (501) shares within fourteen (14)

calendar days form the date of the receipt of the payment mentioned in paragraph 4.1 hereof.

4.3. The Purchaser shall pay the remaining two hundred fifty (250) shares before 15

February 1877.

4.4. The Seller shall transfer the remaining two hundred fifty (250) shares within

fourteen (14) calendar days form the date of the receipt of the payment mentioned in

paragraph 4.3 hereof.

4.5. The Purchaser bears all the costs related to the transfer of the Shares.

…

9. Dispute Resolution

9.1. Any and all disputes, controversies or claims arising out of or in connection with

this Agreement, or a breach, termination or invalidity hereof, shall be resolved by arbitration

administered by the Arbitration Center at the Autonomous Non-profit Organization “Institute

of Modern Arbitration” in accordance with the Arbitration Rules. The Parties undertake to

voluntarily perform the arbitral award.

9.2. The arbitral tribunal shall be composed of 3 arbitrators.

NOTICE OF SET-OFFSaint Petersburg 13 February 1877

According to paragraph 2.2 of the Share Purchase Agreement dated 7 November 1876

(hereinafter the Share Purchase Agreement), concluded between Mr. Tarasov Ivan Trofimovich

and Mr. Lev Knop, Mr. Tarasov warrantied that stock company Stolichnaya Manufaktura

(hereinafter the Company) did not have any tax liabilities. In case of the claims by the tax

authorities to the Company, Mr. Tarasov undertook to indemnify Mr. Knop against the losses

amounting to the monetary claims of the tax authorities, but not exceeding 20,000 Rubles

(paragraph 2.3. of the Share Purchase Agreement).

Mr. Tarasov breached its warranty regarding the absence of tax liabilities of the Company.

On 27 December 1876 State Control Chamber filed a claim against the Company amounting

to 40,000 Rubles for the period preceding the conclusion of the Share Purchase Agreement.

This resulted in the decrease of the value of the Company’s sold shares (751 shares) by 40,000

Rubles. The results of independent appraisal confirm these calculations.

According to paragraph 4.3 of the Share Purchase Agreement Mr. Knop undertook to pay

the remaining 250 shares before 15 February 1877. The Purchase Price for 250 shares provided

in the Share Purchase Agreement is 50,000 Rubles. Mr. Knop has not performed its obligation

to pay 50,000 Rubles to date.

In light of the above, Mr. Knop notifies of the set-off the unpaid purchase price of the

shares in the amount of 40,000 Rubles against indemnified losses in the amount of 20 000

Rubles and damages caused by the Respondent’s breach of the representation regarding the

absence of tax liabilities in the amount of 20,000 Rubles.

CONTESTED ISSUES

Jurisdiction of Arbitral Tribunal

Respondent Claimant

The Arbitration Agreement is unenforceable. The Parties did not duly confirm it after 1 February 1877, with the entry into force of the legislative provisions expressly allowing submission of corporate disputes to arbitration administered by a Permanent Arbitration Institution (PAI). In any event, the Arbitration Center at the Institute of Modern Arbitration obtained an authorization to administer disputes as PAI only on 20 April 1877, and the Arbitration Rules of the Arbitration Center were deposited with the Ministry of Justice after the conclusion of the Share Purchase Agreement.

The Arbitration Agreement is enforceable. The authorization of the Arbitration Center to administer disputes as PAI on 20 April 1877 does not influence the enforceability of arbitration agreement.

This dispute is “conditionally arbitrable” corporate dispute as it arises out of the Shareholders’ Agreement

This dispute is “unconditionally arbitrable” corporate dispute as it arises out of the Share Purchase Agreement and relates to the ownership of the shares

The Claimant did not comply with the limitation period for the claim. According to Article 71 of the

The Claimant complied with the limitation period. The Claimant filed the Request for Arbitration according

Merits of the Dispute

The Shareholders’ Agreement does not have any bearing for this dispute.

The Share Purchase Agreement is invalid as it contradicts the terms of the Shareholders’ Agreement.

Claimant Respondent

The Claimant duly performed its obligations under the Share Purchase Agreement and may claim consideration from the Respondent (transfer of the shares).

The Claimant failed to duly perform its obligations and did not pay in full for the shares, thus he may not claim any consideration from the Respondent.

The Claimant was entitled to set-off.

The Claimant was not entitled to set-off.

Arbitration Rules of the Arbitration Center, arbitration of a corporate dispute is commenced upon filing a claim. In case of a “conditionally arbitrable” corporate dispute, the Request for Arbitration that the Claimant filed cannot be considered as a due “recourse”.

to Article 10 of the Arbitration Rules of the Arbitration Center, resulting in the cessation of the limitation period.