The Bulgarian Supreme Court of Cassation has issued an important ruling[i] on the issue whether a general arbitration clause in a contract covers rights and obligations of the parties which stem directly from the law.

At first sight, the matter seems quite clear – the arbitration clause applies only to disputes arising out of the agreement and does not cover disputes regarding any other legal relations between the parties.

However, in some situations there is a thin line between legal relations stemming from the contract itself and legal relations stemming directly from the law. Sometimes entering into a particular type of contract could be a precondition for arising of entirely different legal relations between the parties based on the applicable substantive law. This is the case referred to the Bulgarian Supreme Court of Cassation.

Background of the dispute and the relations between the parties

According to a repealed provision of the Electricity Market Rules[ii], the Renewable Energy Source (RES) producers who have concluded a long-term power purchase agreement with NEK (the Bulgarian electricity public supplier) and have not chosen another coordinator of a balancing group, were automatically included in NEK’s special balancing group. As members of the balancing group, the producers have statutory obligations to pay balancing costs to NEK determined in accordance with NEK’s methodology for allocation of imbalances.

Based on that, NEK filed a claim before the state court against a RES producer (member of NEK’s balancing group) for payment of balancing costs. The respondent objected that the state courts had no jurisdiction to hear the dispute, because there was an arbitration clause in the power purchase agreement between the parties. According to the arbitration agreement, all disputes arising out of or connected to the power purchase agreement were to be referred to ad hoc arbitration in accordance with the ICC Rules.

The court of first instance sustained the objection of the respondent and discontinued the proceedings. This ruling was upheld by Sofia Court of Appeal (court of second instance). The ruling of Sofia Court of Appeal was appealed by NEK before the Supreme Court of Cassation.

The ruling of the Supreme Court of Cassation

The Supreme Court of Cassation found that the general arbitration clause in the power purchase agreement does not apply to disputes concerning balancing costs.

The main argument of the supreme judges is that the obligations of the RES producers who are members of NEK’s balancing group to pay balancing costs stemmed directly from the legislative provisions of the Electricity Market Rules issued by the Energy and Water Regulatory Commission. The conclusion of a power purchase agreement with NEK was just a precondition for the respective RES producer to be included in NEK’s balancing group. However, the power purchase agreement itself did not contain any rights and obligations of the parties with regard to the balancing costs and therefore the arbitration clause in the power purchase agreement did not cover these rights and obligations.

As a result, the supreme judges found that the general arbitration clause in the power purchase agreement should not apply to the claim of NEK for payment of balancing costs. Hence, the state courts had jurisdiction to hear the case on the merits.

Why is this important?

The ruling of the Bulgarian Supreme Court of Cassation brings clarity to the scope of the arbitration clause and whether it covers rights and obligations of the parties which stem directly from the law which are not explicitly regulated in the underlying contract.

When entering into a contract the parties should carefully examine whether there are any rights and obligations which stem directly from the law and if the underlying contract between the parties is only a precondition for creation of an entirely new legal relation based on the applicable law. If that is the case and the parties wish to subject those relations to an arbitration – this should be explicitly stated in the arbitration clause.

[i] Ruling No. 388 of 14 August 2019 under commercial case No. 1157/2019 of the Supreme Court of Cassation

[ii] Article 56, Para 5 of the Electricity Market Rules

Authors: Pencho Stanchev, Alexander Georgiev