Feature: Which law governs an International Arbitration Agreement?

International Feature

Abdullah Akpinar
PCM Project Controls and Services (Turkey)

Which law governs an International Arbitration Agreement?

The Agreement to arbitrate and the categories of an Arbitration Agreement

The foundation of an international arbitration remains an agreement by the parties to submit any disputes or differences between them to arbitration. Once there is a valid agreement to arbitrate, the scope of the resulting arbitration can be enlarged in order to cover non-signatories, whose consent to arbitrate is a “deemed” or “implied” consent, rather than a formal agreement.

In order to have a valid arbitration, there must first be a valid agreement to arbitrate. This is recognized by international conventions and treaties. Both the New York Convention (Art. V.) and the Mode Law (Art. 35) states that the recognition and enforcement of an arbitral award may be refused if the parties to the arbitration agreement were under some in capacity or if the agreement was not valid under its own governing law.[1] 

An agreement to arbitrate is usually contained in a separate clause – arbitration clause – in contract between parties. The significance of an arbitration clause is to make it clear that the parties have concluded as part of their contract that any dispute that arise out of, in connection with, the contract will be referred to arbitration not to the courts.

The second but less common type of agreement to arbitrate which is made once a dispute has arisen, such an agreement is called as a “Submission Agreement”. It is generally more complex than an arbitration clause.

There is also a third “agreement to arbitrate” which is deemed to arise under international instruments, such as a bilateral investment treaty (BIT) entered into by one state with one another. BIT’s state that each state party to the treaty agrees to submit to international arbitration any dispute that might arise in the future between itself and an “investor”. Of course, this investor is not a party to the treaty. The Investor’s identity will be unknown at the time when the treaty is made. This agreement to arbitrate constitutes a “standing offer” by the state concerned to resolve any “investment” disputes by arbitration.

The New York Convention, which provides the international recognition and enforcement of arbitration agreements as well as of arbitration awards, insists that arbitration agreements should be in writing. Under the New York Convention [Art. II (1)] each contracting state undertakes to recognise and give effect to an arbitration agreement when the followings are fulfilled;

  • The agreement is in writing
  • The agreement deal with existing or future disputes
  • The disputes arise in respect of a defined legal relationship, whether contractual or not; and
  • The dispute(s) concern a subject matter capable of settlement by arbitration.

International Arbitration involves more than one system of law or of legal rules;

Arbitration is a system of formal dispute resolution by one or more impartial people (arbitral tribunal) for a final and binding decision.

Different laws probably will govern different aspects of an international arbitration. For example, different systems of law may apply to [2]:

  • The law governing the arbitration agreement and the performance of that agreement;
  • The law governing the existence and proceedings of the arbitral tribunal (the lex arbitri);
  • The law, or the relevant legal rules, governing the substantive issues in dispute (the applicable law, the governing law, the proper law of the contract, or the substantive law)
  • Other applicable rules and non-binding guidelines and recommendations.[3]
  • The law governing recognition and enforcement of award.

The doctrine of Separability

Separability is a legal doctrine which allows an arbitration agreement to be considered entirely a separate agreement from the underlying contract in which it is contained. This is important where there are questions about the enforceability of the underlying agreement.

The rule originate from the case of Harbour Assurance [4]and was subsequently set out in section 7 of the Arbitration Act 1996. The practical effect of the rule is that unenforceability of the underlying agreement does not automatically render an arbitration agreement contained within it unenforceable. Without the rule, an arbitral tribunal would always be precluded from hearing any dispute which raised a question about the validity or existence of the contract containing the arbitration agreement.

It follows that, in order to render an agreement to arbitrate unenforceable, the arbitration agreement itself must be directly challenged. In other words, there must be independent factors that specifically invalidate or render void the arbitration clause [5].

Under English law, an arbitration agreement may be directly challenged on public policy grounds [6]. The question which arises is whether or not the arbitration agreement can stand independently of the void contract. The general principle expressly set out in S.7 of the Arbitration Act 1996 is that an arbitration agreement which forms part of another agreement shall not be regarded as invalid because that other agreement is invalid.

The New York Convention in its article V (2) (b), where the "public policy" exception on the enforcement of awards finds its place. The article states the following:

Recognition and enforcement of an arbitral award may also be refused if the competent authority in the country where recognition and enforcement is sought finds that:

(b) The recognition or enforcement of the award would be contrary to the public policy of that country.

The Contracting States' freedom to define their own national public policy standard inevitably impedes the predictability and consistency of the enforcement decisions. Therefore, while discussing the article V (2) (b) of the New York Convention, one should explore on the respective public policy standard of the contracting state where the award's recognition and enforcement is sought.

The Governing Law of the Arbitration

The governing law of an arbitration agreement is the law that will be applied to determine any dispute that may arise as to the validity, scope or interpretation of the agreement to arbitrate. It matters because if, for example, there is a dispute as to whether a claim falls within the scope of an arbitration clause, that dispute will be resolved by applying the law governing the arbitration agreement.

While the parties are negotiating the terms of a contract the arbitration clauses are usually drafted at the very last minute, when the parties are in a rush to close the transaction. Hence, such clauses are usually referred as the “Midnight Clauses”. It’s probably the last thing in parties mind is dispute resolution and whether the arbitration clause properly drafted or not.

This is just one of the reasons why there are many examples of poorly drafted arbitration clauses. These clauses can result in confusion as to the actual intention of the parties, causing delay and additional expense if a dispute arises.

The parties may think of why does the governing law of an arbitration clause matter? – They may consider that it will be the same as the governing law of the underlying contract?

As mentioned earlier, the governing law of an arbitration agreement is the law that will be applied to determine any dispute that may arise as to the validity, scope or interpretation of the agreement to arbitrate. The governing law of arbitration matters because if, for instance, there is a dispute as to whether a claim falls within the scope of an arbitration clause, that dispute will be resolved by applying the law governing the arbitration agreement.

Does the governing law of the arbitration clause should be the same as the governing law of the underlying contract?

The response to above question; “sometimes it is the same, but it is not always the case!"

As mentioned above, the parties to an international transaction have agreed to arbitrate, the legal framework for resolving disputes may result in the application of a number of different laws. Those laws will include the law governing the substantive rights and obligations of the parties – usually expressly chosen and set out in a governing law clause – and the curial law of the arbitration proceedings themselves – which is determined by the choice of a seat or legal place of arbitration.

In an international contract, it is not unusual for the governing law of the underlying contract to differ from the law of the place which is chosen as the seat of arbitration. A common example of this is where parties to an international contract governed by English law have chosen to resolve disputes by ICC arbitration seated in Paris.

What parties may not appreciate is that, in this scenario, a failure to specify the governing law of the arbitration clause could give rise to a dispute as to which law (English law or French law) should apply to any issues relating to the validity, scope or interpretation of the arbitration clause.

In other words, where the governing law of the underlying contract and the system of law at the seat of the arbitration are different it’s best to specify what law governs the arbitration clause.

What happens if the parties do not specify the governing law?

There is no internationally accepted approach to determining what the governing law should be in cases where the governing law of the underlying contract differs from the system of law at the seat of arbitration.

The Convention on the Law Applicable to Contractual Obligations 1980, or the "Rome Convention", is a measure in private international law or conflict of laws which creates a common choice of law system in contracts within the European Union. The convention was signed in Rome, Italy on 19 June 1980 and entered into force in 1991.[7]

If the contracting parties have not chosen the law(s) to govern their dealings, The Rome I Regulation contains a code by which the governing law of a contract can be determined, but this expressly does not apply to arbitration agreements.

The courts in some jurisdictions have held that, in the absence of an agreement to the contrary, the law of the seat of the arbitration will also apply as the governing law of the arbitration clause. Courts in other jurisdictions have held that the governing law of the arbitration clause should be the same as the governing law of the underlying contract.

This can end up in costly litigation, which would have been unnecessary had the parties specified a governing law in the arbitration clause. This will not only delay the resolution of the substantive issues in dispute but may also result in an unintended (and perhaps unwelcome) choice of law being imposed on the parties by the courts. It also introduces a huge element of uncertainty into the dispute resolution procedures that the parties negotiated and agreed at the outset of the transaction.

Has the governing law addressed in Model Arbitration Clauses?

Very few model arbitration clauses include a governing law provision.

One exception is the HKIAC model arbitration clause which includes optional choice of law provisions reminding parties to specify the governing law of the arbitration agreement, as well as specifying the seat and the number of arbitrators. There is also a note specifically reminding parties of the importance of specifying a governing law for the arbitration agreement in circumstances where the law of the underlying contract and the law of the seat are different.

Has the arbitration rules addressed the governing law?

Some arbitration rules include a default provision specifying a governing law for the arbitration agreement. For example, the Article 16.4 of the LCIA (2020) Rules provides that, unless the parties have agreed otherwise, the governing law of the arbitration agreement will be the same as the law of the seat.

However, the fact that Article 16.4 gives precedence to the law of the seat, as opposed to law governing the underlying contract, could come as unwelcome surprise to parties who have not actively considered this issue at the drafting stage.

According precedence to the law of the seat is also the approach that has been adopted by the English courts when they are called upon to determine this question.

The English Law Approach

The English courts apply three stage test for determining the law governing an arbitration clause, which was formulated by the Court of Appeal in Sulamerica CIA Nacional de Seguros SA and others v Enesa Engenharia SA and others [2012] EWCA Civ 638.

Stage 1; Is there any clause stating express choice of law? If not;

Stage 2; Is there any implied choice of law? If not;

Stage 3; What system of law does the arbitration agreement have its closest and most real connection?

 

There is a fine distinction between each of three stages of enquiry and the relative significance that should be attached to the choice of law of the underlying contract on the one hand and the choice of the seat of arbitration on the other.

There is an important recent decision of Court of Appeal in Enka Insaat VE Sanayi A.S v Chubb [2020] EWCA Civ 574 which is worth-while to mention here.

A dispute arose as to which law governed the arbitration agreement, as English and Russian law were likely to come to different conclusions as to whether or not the Russian proceedings were within its scope, and therefore in breach of the arbitration agreement.

The High Court refused the injunction, forming the view that the Russian courts were the appropriate forum for the dispute, and therefore declining to decide which law governed the arbitration agreement.

On appeal, the Court of Appeal overturned that decision. It adopted a presumption that, in the absence of party choice, an arbitration agreement should be governed by the law of the seat of arbitration (in this case English law); that the Russian proceedings were in breach of the arbitration agreement; and that the insurers (Chubb) should be restrained from pursuing the Russian proceedings. The Court of Appeal therefore issued an anti-suit injunction.

The insurers (Chubb) appealed to the Supreme Court, an appeal that was heard on an expedited basis to reflect the urgency of the matter.

The Supreme Court departed from the reasoning of the Court of Appeal and ruled that where parties have not specified what law governs the arbitration agreement, but have specified the law governing the contract containing the arbitration agreement, that choice will generally apply to the arbitration agreement even if a different country or national system of laws has been nominated as the “seat” of the arbitration. Where, as in the Enka case, the parties have not expressly or impliedly chosen any law to govern the contract, the arbitration agreement will be governed by the law with which it is most closely connected, and typically this would be the law of the seat.

Whatever your industry, the choice of law to govern not just the contract but also the arbitration agreement is worthy of consideration. Same is valid for the express choice of the seat of the arbitration. As the Enka case has shown, the choice of England as the seat, even without English law as the law governing the contract, meant that English law governed the arbitration agreement. The English court was thus able to intervene by exercising its supervisory powers to restrain Russian legal proceedings by means of an anti-suit injunction.

Recommendation to avoid Uncertainty

There are two simple steps that parties can take to avoid costly uncertainty and over the law governing an arbitration agreement;

1) Check whether the governing law of the underlying contract the same as the law of the seat of the arbitration. If not, then there is a potential for a potential conflict of laws. To overcome this;

2) The arbitration clause shall be revisited and added an express choice of governing law by including the following expression;

“The governing law of this arbitration clause (agreement) is [insert law of choice]” 

References;

1 [New York Convention Art. V (1)(a) and Model Law Art. 36 (1)(a)(i)]

2 Redfern and Hunter on International Arbitration Six Edition para. 3.07 pg.157 

3 Procedural soft laws such as IBA Guidelines on Evidence, IBA Guidelines on Conflict of Interest

4 Harbour Assurance v Kansa General International Insurance [1993] 1 Lloyd's Rep 455

5 Fiona Shipping v Privalov [2007] EWCA Civ 20

6 Section 103 (3) of the English Arbitration Act 1996

7 Wikipedia Convention on the Law Applicable to Contractual Obligations 1980. 

These are the views of the author and not of Barton Legal.