Section 33(2) of the Swedish Arbitration Act (SAA) provides that an arbitral award is invalid if it is contrary to the basic principles of the Swedish legal system.

The National Joint-Stock Company "Naftogaz of Ukrain" (Naftogaz) is a large state-owned Ukrainian oil and gas company. Italia Ukraina Gas SPA (IUGAS) is an Italian energy company, owned by the Italian FISI group.

In December 2003, Naftogaz and IUGAS entered into a "Natural Gas Supply Agreement from 2003 to 2013" covering sales of up to a maximum of 13 billion cubic metres of gas over the entire contract period (2003 to 2013) at US$110 per thousand cubic metres (subject to possible price adjustments). The initial intention was for Naftogaz to own a majority of the shares in IUGAS but that intention never materialised. After entering into the contract, material changes occurred in the gas markets and in 2006 there was a gas crisis which resulted in export restrictions being enacted throughout the Ukraine (today by the 2010 law on the Fundamentals of Natural Gas Market Operation).

As of 1 June 2007, IUGAS requested deliveries of gas under the contract. Naftogaz did not deliver the gas, rejecting any obligations under the contract, on the basis that performance was (and is) impossible due to the export restrictions enacted in the Ukraine after the 2006 crisis.

In January 2008, IUGAS requested arbitration under the contract. It sought, among other things, declarations that the contract was valid, that Naftogaz was obliged to deliver the gas to IUGAS under that contract and penalties for the non-delivered quantities.

Naftogaz rejected the claims and sought declarations that the contract was invalid and that no obligations existed under that contract. Subsequently, the parties agreed to bifurcate the proceedings and the tribunal issued an interim award on 19 October 2010, confirming its own jurisdiction and finding, in brief, that the contract was valid and binding and that Naftogaz was obliged to deliver gas to IUGAS according to the terms of the contract. Further, it ruled that penalties for non-delivered quantities were to be paid (in amounts to be decided by the final award), but not damages for breach of contract.

Naftogaz appealed the award at the Svea Court of Appeal, alleging, among other things, that the award was invalid as it obliged Naftogaz to undertake deliveries of gas even though such deliveries are and would have been illegal under the laws of Ukraine (under legislation aimed at protecting the public interests of Ukrainian society by safeguarding supplies of gas necessary for the Ukrainian population). Accordingly, the award was, in the opinion of Naftogaz, contrary to the public policy of Sweden as well as of the Ukraine (ordre public) and should be declared invalid pursuant to section 33(2) of the SAA.

IOGAS considered that the Ukrainian regulations did not amount to a prohibition of gas export but rather that they were a licensing system giving priority to internal needs. IOGAS argued that the award did not oblige Naftogaz to act in contravention of Ukrainian laws and, therefore, was not invalid or contrary to public policy.

The Svea Court of Appeal dismissed the appeal.

The court did not accept Naftogaz's argument that export of Ukrainian gas had been prohibited in the Ukraine since 2006. It found that such exports were possible, provided that the required licences were obtained. The court noted that the parties had also disagreed on the likelihood of obtaining such licences but it found it did not need to take a position on that issue. The court only noted that where a licence could not be obtained, that would have been due to a shortage in the gas market and not to an export prohibition.

The court then considered Naftogaz's ordre public argument under section 33(2) of the SAA. This rule only covers truly offensive situations and in Sweden, public order (ordre public) claims have been given a narrow interpretation. It is, as the court put it, extremely rare for there to be an ordre public situation. The court also considered international public order to avoid the risk of rejecting international arbitration awards for purely national reasons. In doing so, the court referred to the International Law Association's (ILA's) Recommendations on the application of public policy as a ground for refusing recognition or enforcement of international arbitral awards (see the ILA website).

In order to determine whether or not the award was contrary to public policy, the court analysed the legal effect of the award. The court noted that Naftogaz argued that the award obliged Naftogaz to deliver gas in breach of legal prohibitions in Ukraine, while IUGAS argued that the award only confirmed Naftogaz contractual obligations.

Assessing the implications of the award, the court considered the effect of the decision to bifurcate the proceedings, concluding that the award confirmed the validity of the contract and the contractual obligations contained in it. The award does not oblige Naftogaz to make physical deliveries of gas and no deliveries of gas can be enforced under the award. To the extent that Naftogaz cannot carry out its obligations under the contract, it will have to pay penalties. The amount of such penalties is to be decided in the final award. The court did not accept that the penalty provisions, and the award of penalty, would be against public policy as such.

The court did not find that the declaration in the award that Naftogaz is obliged to deliver gas to IUGAS, and pay penalties, would breach ordre public in its traditional interpretation, nor indeed the doctrine of international ordre public. The court also added that the penalties did not constitute the type of "punitive damages" found in the US which have been found to be contrary to public order by other courts.

It is interesting to note that the Svea Court of Appeal found cause to refer to international ordre public to avoid the risk of rejecting international awards for purely national reasons, and that the court in this context referred to the ILA's recommendations. Unfortunately, the Court of Appeal did not give leave to appeal. It would have been interesting to hear the opinion of the Supreme Court on the issues of public policy. It is too early to assess the practical implications of the award, as it is difficult to define exactly the parameters of what the tribunal will hear in the next stage of the proceedings.