The Problem of the Arbitrability of the Rescission of a Public Works Contract in Mexican Law.

After the execution of NAFTA the government Mexico began to accept arbitration as an alternative method for resolving contractual disputes arising between national and foreign companies with wholly owned governmental entities such as PEMEX or CFE(1).  In this regard, although there was no specific legal provision in the Law of Public Works which regulates this type of public contracts, there were some provisions in the Organic Acts of both PEMEX and CFE which allowed them to enter into agreements with arbitration clauses.

For the last fifteen years the system has operated based on said specific legal provisions and allowed the Mexican government to attract important investments in the energetic sector.  In addition, many important arbitration procedures arose with mixed results for PEMEX and CFE.  Most of those arbitrations dealt with disputes concerning the execution of the public Works and some of them also dealt with the rescission of the contracts by the public entities.  In this regard, it is important to point out that the Law of Public Works authorized the public entities to unilaterally rescind the public Works contracts whenever there was a breach by the private contractor.  The procedure for this rescission was established in the law, and basically was a mini-trial in which the private contractor was given the opportunity to justify and cure its contractual breach within a specific period.  If the breach was not cured or justified, then the public entity was entitles to rescind the agreement.  This was called in Mexican law as “administrative rescission”. 

It is important to note, however, that the Law of Public Works was silent in connection with the legal means to challenge the administrative rescission.  This silence gives rise to two different and contradictory interpretations by Mexican Courts.  The first approach was that the administrative rescission of a contract by a public entity should be deemed as a governmental act (act of authority) which may be challenged before a Federal Court through an amparo action.   In this line of argumentation, Mexican Courts deemed that the power to unilaterally rescind an agreement placed the public entity in a position of superiority before the contractor, which implied that the public entity would be enforcing the public policy of the Mexican government.  Therefore, the public entity would be acting as an“governmental authority”.

The relevance of this first interpretation toward the administrative rescission was that by definition a governmental decision or resolution is not arbitrable under Mexican Law and could only be challenged before Mexican Courts.  Consequently, pursuant to this approach, an administrative rescission of a public work contract could not be subject to arbitration and would leave the arbitration clause agreed by the parties ineffective, at least concerning to any dispute regarding the administrative rescission.  The potential ramifications of this position were not much studied at the time, but in theory may extend beyond the mere rescission, considering that any rescission implies the existence of a contractual breach by the private contractor and the rescission itself produces several effects on the contractual relationship.

The second approach to the problem was exactly the opposite and it considered that the administrative rescission was just a contractual decision by the public company.  In this regard, it deemed that the administrative rescission was alike to the unilateral contractual rescission that sometimes is agreed by private companies, in which the party who is not in default may rescind the agreement by given a simple notice to the other.  Therefore, there were no substantial differences between both cases and in the event of an administrative rescission it should be considered as a contractual conduct.  The necessary consequence of this position was that if a contract subject to arbitration was administratively rescinded, then the private contractor was able to challenge the decision in arbitration.  Some cases were ruled in this scenario by Arbitral Tribunals and the resulting awards were note ever challenged based on the inarbitrability of the dispute using the arguments of the first position explained.

Now, the Congress decided to clarify the conflicting judicial interpretations and with the alleged intention to incorporate arbitration as an alternative method of resolution not only for PEMEX or CFE but to all public entities which are subjected to the Law of Public Works and Related Services in force, it included a provision establishing that arbitration clauses may be included in public contracts but that the administrative rescission, notwithstanding, could not be subjected to arbitration.

Unfortunately, this reform will have a negative impact in all the public works contracts subject to arbitration, since it will have the practical effect of rendering the arbitration clause(2) ineffective or at least to provoke parallel litigation.  Indeed, now if a private contractor enters into a dispute with a public company, and the latter opts to attribute the former a contractual breach and rescinds the contract, the private contractor would be forced to challenge the legality of the rescission, through an amparo (or through an administrative trial, pursuant to a recent precedent).  At the same time, the additional contractual claims that the private contractor may have should be brought in arbitration.  In this regard, it is not clear the manner in which the challenge of the administrative rescission before Mexican Courts would interact with a parallel arbitration, since it is clear that the decision on the legality of the rescission would certainly have impact in the arbitration.  This would obviously impose the dilemma on the private contractor to bring the arbitration immediately or wait until the judicial challenge of the rescission is ruled by Mexican Courts with the consequent delays, uncertainty and increase of costs.

In light of the above, several specialists in arbitration are lobbying for a modification to the Law of Public Works and Related services in order to eliminate the restriction on the arbitrability of the administrative rescission. We hope that in the following months this legal anomaly would be corrected and the arbitration with public entities in Mexico for infrastructure projects will again run smoothly.

Mr. Venegas is partner of the litigation and arbitration areas, he is in charge of the International Commercial Arbitration and Investment Arbitration cases, as well as of the Administrative and Intellectual Property Litigation, Civil and Commercial Litigation; Constitutional (Amparo) Litigation.  His experience includes the participation in two of the largest commercial arbitrations in Mexican history (for more than 1.7 billion dollars), as well as in several construction and infrastructure disputes.

Mr. Venegas is a professor on the Arbitration Seminar at the Escuela Libre de Derecho and has written several articles in arbitration and litigation.  He can be contacted on +5255 5258 1034 or by email at Mtvenegas@Vwys.Com.Mx

Marco has also authored an article on Reforms To The Commercial Code: Special Proceeding in Arbitration Matters