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On 12 July 2022, the Paris Court of Appeal stayed the enforcement of the final award in the Heirs of the Sultan of Sulu v Malaysia. The Court held that an award of damages, based on the restitution value of disputed territory, presented a risk of serious prejudice to territorial sovereignty that warranted a stay.

The decision reiterated that serious prejudice in stay applications is not limited to the economic consequences of enforcement and should be based on concrete grounds without considering the merits of the annulment application. The magnitude of an award or hypothetical claims of financial difficulty would not justify a stay.

The dispute arose out of two agreements between the Sultan of Sulu and Messrs Alfred Dent and Baron Gustavus de Overbeck, Malaysia's predecessors-in-interest, in 1878 and 1903 over Northern Borneo, now Sabah. The heirs, the Sultan's successors-in-interest, claimed that the agreements created a lease under which control and possession over Sabah was transferred to Overbeck and Dent in return for annual payments of $5,000 in perpetuity.(1) Malaysia took over the payments in 1963 but stopped paying in 2013.

The agreements contained a clause which provided that any dispute between the parties "will be brought for consideration or judgment of Their Majesties' Consul-General in Brunei".(2) The heirs treated this as an arbitration clause and asked for assistance from the British Foreign Secretary to initiate arbitration. When the latter refused, they turned to the Superior Court of Justice in Madrid which appointed Mr Gonzalo Stampa as arbitrator.(3) The heirs claimed that Malaysia had breached the lease and asked Stampa either to increase the annual rents in view of changed economic circumstances in Sabah, or to terminate the lease and award the value of the leased territory in lieu of restitution.(4) Malaysia argued that the agreements had ceded sovereignty over Northern Borneo to the Malaysian state.(5)

The arbitration was initially seated in Madrid but later transferred to Paris.(6) Stampa issued a preliminary award on 25 May 2020,(7) confirming jurisdiction over the dispute. He released the final award on 28 February 2022 favouring the heirs.

In his final award, Stampa concluded that the agreements had created an international private lease and that Malaysia had breached its terms by stopping payments. He declared the agreements to be terminated and ordered Malaysia to pay the value of Sabah state, amounting to a monumental $14.92 billion.(8)

Malaysia asked the Paris Court of Appeal to annul the final award and to stay enforcement pending the annulment proceedings. Malaysia argued for a stay on three grounds:

The Court held that a stay application must be assessed beyond the economic consequences of enforcement. Echoing the judgment of the Court of Appeal in Oschadbank v Russia,(12) the Court held that the stay application must also be analysed "strictly" and "in concreto".(13) In typical style, the Court did not expound on what these terms meant. In Oschadbank v Russia,(14) however, the Court previously explained that stay applications must be assessed restrictively, keeping in mind that annulment applications have no suspensive effect. The risk of prejudice must be demonstrated such that general, abstract or hypothetical grounds are insufficient to obtain a stay.(15) The grant of a stay will not depend on the merit of the annulment petition.(16) Following this standard, the Court rejected the first two arguments.(17)

By contrast, the Court found merit in Malaysia's third argument. The Court stayed enforcement, concluding that execution of the final award would seriously prejudice Malaysia's rights. First, the final award related to a sensitive geopolitical dispute between the Philippines and Malaysia. Both countries had been claiming ownership of the island for decades and it was undisputed that forcing Malaysia to cede Sabah could lead to civil unrest.(18) Furthermore, the final award described Malaysia as a lessee and the heirs as the owners of Sabah, impinging directly on the state's territorial integrity. Finally, the measure of compensation (the restitution value of the territory) was a function of revenues from the exploitation of natural resources, an activity closely associated with Malaysia's sovereignty.

The Sultan of Sulu decision further clarifies the definition of "serious prejudice" that will justify a stay of enforcement pending annulment of an arbitral award in France.

Under article 1526 of the Code of Civil Procedure (which governs international arbitration), neither an application for annulment, nor an appeal against exequatur of an award, has suspensive effect. The opposite rule applies in relation to French domestic arbitration awards. However, the courts can stay execution if it will seriously prejudice the rights of one of the parties.(19) Here, the Court held that serious prejudice is not limited to the economic consequences that would result from immediate enforcement. Prejudice should be assessed restrictively based on concrete and demonstrable grounds without relying on the merits of the annulment application. As noted above, the Court adopted this from the judgment of the Court of Appeal in Oschadbank v Russia,(20) which appears to be the prevailing standard for stay applications.

The magnitude of the award appears to be of little consequence in this regard, even where billions of dollars are at stake (as in this case). Similarly, the judgment debtor's financial difficulties are not a sufficient basis for a stay where the applicant has failed to demonstrate the negative consequences that enforcement would cause. Here, Malaysia does not appear to have developed its argument on the economic consequences of a stay, asserting only that the damages were triple its health budget. Malaysia's bare reliance on the size of the award was insufficient to meet the threshold test of serious prejudice. It is therefore unsurprising that the Court turned quickly to Malaysia's other grounds for stay without substantial reasoning.

It is equally unsurprising that the Court summarily denied Malaysia's arguments relating to the merits of its annulment application. The Court's decision reinforces the rule that stay applications are to be assessed without regard to the likelihood of success on annulment or appeal against an exequatur.

The decision also establishes that potential harm to a state's territorial sovereignty is a ground to stay enforcement. While sound in principle, the factual basis for this conclusion is disputable where enforcement could not have had any actual impact on Malaysia's control or possession of Sabah. The Court concluded that payment of compensation would have the same prejudicial effects on Malaysia's sovereignty as restitution in kind. While payment of damages is often a substitute for restitution where the latter is impractical or impossible, the Court's decision takes the legal fiction of their equivalence quite far. The final award did not decide that Malaysia should return Sabah to the heirs, and nor did the heirs ask for that remedy.(21) Instead, the arbitrator had ordered Malaysia to pay damages based on Sabah's restitution value. The Court found that this payment was inseparable from restitution in kind since the value was based on the exploitation of Sabah's resources. It concluded that payment would seriously prejudice Malaysia's sovereignty in a way akin to restitution in kind.

The Court's conclusion is interesting for several reasons. While the final award did not determine who should exercise sovereignty over Sabah (a point which the Court recognised),(22) it did indicate that Malaysia's ownership and possession could be challenged based on a final executory award under both the New York Convention and French law. The Court, however, treated Malaysia's claim of ownership as if there were no doubts over its title. Despite the ongoing territorial dispute over the island (of which the Court was well aware),(23) the Court found that Malaysia had a right over Sabah and that this should not be prejudiced. This indicates that maintenance of the status quo may be a factor in analysing stay applications.

Moreover, while the amount awarded included projected profits from Sabah's oil, gas and palm oil production, the final award did not determine that compensation should be drawn from these profits or resources. Indeed, the arbitrator made no order in relation to any assets or economic activity in Sabah. Enforcement of the final award therefore would have had no impact on Malaysia's territory or Sabah's cash flow. The effect would have been similar to enforcement of any award of monetary damages, which the Court opined would be an insufficient basis for a stay.(24)

The Court's conclusion equating the enforcement of a monetary award with restitution in kind opens the door to analogous arguments in other cases where damages are awarded in lieu of returning property.(25) For example, a state found liable for unlawful expropriation may be able to stay an award pending annulment even if the relief granted is purely monetary. Following the Court's reasoning, a state may be able to establish serious prejudice merely by showing that the damages awarded against it are based on the value of the expropriated property. Enforcement would therefore by extension injure its existing ownership and possessory rights. The same reasoning may be extended to commercial contracts. A lessee may be able to argue for a stay even where an award does not eject it from the disputed property for as long as the damages are based on the value of the premises. If so, the decision dilutes the meaning of "serious prejudice" and weakens the pro-enforcement policy that article 1526 was meant to advance.

Even if it was accepted that a monetary award could seriously prejudice a state's territorial sovereignty, the Court could have imposed conditions on enforcement instead of a stay.(26) Instead, the Court reasoned that a stay was the only way to avert the risk of serious prejudice.(27) This is unconvincing. Any risk to Malaysia's control over Sabah would have remained purely hypothetical, even if the final award had been enforced.(28)

For further information on this topic please contact April Lacson at Freshfields Bruckhaus Deringer LLP by telephone (+31 20 485 7000) or email ([email protected] ). The Freshfields Bruckhaus Deringer LLP website can be accessed at www.freshfields.com.

(1) It is unclear whether US dollars were meant. In any event, Malaysia paid the heirs 5,300 ringgit until 2013.

(3) Paris Court of Appeal, No. 22/04007, 12 July 2022, paras 8-11.

(6) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 18; Malaysia had obtained a decision from the Madrid Superior Court annulling the proceedings leading to Stampa's appointment. Later, the clerk of the Madrid Superior Court ordered Stampa to stop the proceedings. Stampa held that the Madrid courts had no right to interfere with the arbitration and transferred the seat to Paris after the heirs obtained an exequatur of the preliminary award from the Paris Court of Appeal. Final award, Section IV.4.C.

(7) The Paris Court of Appeal granted an exequatur of the preliminary award on 29 September 2021. The exequatur was later stayed. Paris Court of Appeal, No. 22/04007, 12 July 2022, paras 16-17.

(9) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 25.

(10) On this point, Malaysia argued that the Madrid Superior Court had annulled Stampa's appointment. This in turn nullified the preliminary award. While the heirs were able to obtain an exequatur of the preliminary award, this was stayed by the Paris Court of Appeal. Thus, on Malaysia's case, Stampa had no jurisdiction to continue adjudicating the dispute and to render the final award. Paris Court of Appeal, No. 22/04007, 12 July 2022, para 28.

(11) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 27.

(12) Oschadbank v Russia, Paris Court of Appeal, No. 19/04161, 22 October 2019.

(13) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 36.

(14) Oschadbank v Russia, Paris Court of Appeal, No. 19/04161, 22 October 2019, para 38.

(15) Oschadbank v Russia, Paris Court of Appeal, No. 19/04161, 22 October 2019, paras 38-39.

(16) Paris Court of Appeal, No. 22/04007, 12 July 2022, paras 36-39.

(17) Malaysia did not challenge the heirs' ability to reimburse funds collected should the award be annulled, a point which the French courts have considered may constitute serious prejudice in other cases. These cases usually involve an award creditor in a poor or uncertain financial situation, giving rise to a risk that the assets seized will not be returned should annulment be successful. The financial condition of the award debtor carries less weight. In SAS Chanter Naval Couach v Sedes Holding, the Paris Court of Appeal suspended execution of a part of the award because the applicant had shown that there was a risk of non-restitution in case the award was annulled. Paris Court of Appeal, No. 20/09273, decision of 4 November 2020. In CSPI v Flashbird, the Court of Appeal denied CSPI's request for a stay since it had not proven that enforcement of the award would halt its operations. However, the Court of Appeal modified the execution of the award and ordered CSPI to consign the monies with the Caisse des Depots et Consignation since there was a risk of non-restitution. Paris Court of Appeal, No. 20/04017, decision of 30 June 2020. See also Paris Court of Appeal, No. 13/02612, decision of 23 April 2013.

(18) Paris Court of Appeal, No. 22/04007, 12 July 2022, paras 54-60.

(19) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 35.

(20) Oschadbank v Russia, Paris Court of Appeal, No. 19/04161, 22 October 2019. While the decision does not expressly mention Oschadbank, it adopts the phrasing of the standard for assessing stay applications used in that case.

(21) Final award, paras 181, 255; Paris Court of Appeal, No 22/04007, 12 July 2022, para 60.

(22) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 43.

(23) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 54.

(24) See for instance Oschadbank v Russia, Paris Court of Appeal, No. 19/04161, 22 October 2019; Bolivarian Republic of Venezuela v Gold Reserve Inc, Paris Court of Appeal, No. 14/21103, 29 January 2015.

(25) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 53.

(26) See for instance CSPI v Flashbird, Paris Court of Appeal, No. 20/04017, decision of 30 June 2020. See also Paris Court of Appeal, No. 13/02612, decision of 23 April 2013.

(27) Paris Court of Appeal, No. 22/04007, 12 July 2022, para 61.

(28) In fact, the heirs have continued trying to enforce the final award outside France and had obtained an attachment of Malaysia's assets in Luxembourg. See C Sanderson, "Malaysia gets stay of mega-award as assets frozen in Luxembourg", GAR, 12 July 2022.

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