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Focus: Choosing the law for your international arbitration agreement

18 June 2012

In brief: With potentially important consequences for parties entering into contracts that have international arbitration clauses, the English Court of Appeal recently held that English law governed an agreement in a contract to arbitrate disputes, even though the parties had agreed that the laws of Brazil governed the underlying contract. Partner Brian Millar and Lawyer Tom Levi consider the effect of this on the drafting of commercial contracts.

How does it affect you?

  • While commercial contracts usually include a clause specifying which law governs the parties' rights and obligations under it, arbitration agreements contained within commercial contracts usually do not expressly state which law the parties intend will govern the arbitration agreement. Provisions providing for arbitration involving international elements do usually specify the 'seat' of the arbitration, which determines the procedural laws applying to the conduct of the proceedings.
  • Uncertainty can therefore arise as to whether the parties intended the laws governing the underlying contract also to govern the arbitration agreement, or whether some other law, such as that of the state nominated as the seat for the arbitration, should apply. Different consequences can flow from this and such uncertainty can result in a separate dispute about which law applies.
  • Previous authorities had suggested that, in most cases, the proper law of the contract expressly chosen by the parties would also govern the validity of their agreement to arbitrate disputes arising under it.
  • However, in this case, the court considered the law governing the arbitration agreement to be independent of the proper law of the contract, and found that the parties had not expressly or by implication chosen the law governing the arbitration agreement. It decided that the arbitration agreement was governed by English law, to which it had its 'closest and most real connection'; in particular, due to the choice of London as the seat of the arbitration.
  • In short, parties entering into contracts with international arbitration clauses should consider expressly nominating the law governing the arbitration agreement, as well as the law governing the arbitration procedure and the proper law of the contract.

The facts

A Brazilian insured brought a claim against its Brazilian insurer regarding an incident that occurred during construction of a hydroelectric generating plant in Brazil.

The insurers declined liability and a dispute subsequently arose. Although the policy contained a provision providing that the laws of Brazil were to govern the contract and that the parties submitted to the exclusive jurisdiction of the courts of Brazil, it also contained an arbitration clause providing for arbitration in London.

The insurers issued a notice of arbitration. The insured then commenced court proceedings in Brazil and obtained an injunction restraining the insurers from proceeding with the arbitration, on the basis that, under Brazilian law, the insurer could only bring an arbitration with the insured's consent (under a law that protects parties adhering to standard terms from being compelled to have disputes resolved by arbitration). The insurers then applied for, and succeeded in obtaining, an injunction from the Commercial Court in England restraining the insured from pursuing the court proceedings in Brazil.

The issues

When entering into a commercial agreement with an international arbitration clause, which is, in effect, a self-contained agreement to arbitrate disputes arising under the commercial agreement, there are (at least) three different laws that the parties should consider.

  • First, the 'proper law' of the contract. This is the law under which the rights and obligations of the parties under the contract will be determined.
  • Second, the 'curial law', or the law governing the conduct of the arbitration proceedings, which is determined by reference to the seat or location of the arbitration. This governs such things as confidentiality, the arbitral tribunal's power to grant interim measures and the role of the courts in the jurisdiction of the 'seat' to supervise the arbitral proceeding.
  • Third, the 'proper law' of the arbitration agreement. This is the law that governs the validity and enforceability of the arbitration agreement. The dispute arose in this case because if the proper law of the arbitration agreement was Brazilian law, the arbitration agreement was only enforceable if the insured consented to arbitration.

The decision

Lord Justice Moore-Bick gave the court's leading judgment. His Honour noted that an arbitration agreement is separable in the sense that it exists separately to the substantive contract in which it is found.

His Honour applied a three-step process for determining what the proper law of an arbitration agreement is. The court must consider:

  • the express choice of the parties;
  • the implied choice of the parties; and,
  • failing that, the system of law with which the arbitration agreement has the 'closest and most real connection'.

His Honour believed that, as a starting point, it was 'probably fair' to assume the parties intended the whole of their relationship to be governed by the same system of law, and considered the case law supporting this.2 He thought it was generally agreed that where the parties had not included an express choice of law, the arbitration agreement would be most closely connected with the law of the seat of the arbitration.3 His Honour also considered recent decisions that, irrespective of a choice of law clause for the contract, the arbitration agreement would be 'most closely connected' with the law of the place where the arbitration has its seat.4 Attention should also be paid to whether the states whose jurisdictions are at issue are party to the New York Convention, which facilitates enforcement of the arbitral award,5 and the jurisdiction of which will give greater effect to the arbitration agreement.

On the basis of the earlier authorities, his Honour held that 'an express choice of law governing the substantive contract is a strong indication of the parties' intention in relation to the agreement to arbitrate'. However, in this case, he held that the parties had not impliedly chosen the laws of Brazil, for two reasons:

  • First, the choice of England as the seat for the arbitration indicated the parties' intention to be bound by the law of England regarding the conduct and supervision of arbitrations. The parties must have intended that England's Arbitration Act 1996 would apply, including its provisions regarding the validity of an arbitration agreement.
  • Second, the choice of the law of Brazil as the law governing the arbitration agreement would, it was argued, limit the effectiveness of the arbitration agreement. If the parties had intended that the insured's consent would be required for any arbitration that would take place, they would have agreed this in the arbitration agreement.

His Honour decided the arbitration agreement had its closest and most real connection with the laws of England, which was the place where the arbitration was to be held and whose laws would provide the supporting and supervisory jurisdiction. The court held that the laws of England applied to determine the validity and enforcement of the arbitration agreement, and, after considering other issues, dismissed the appeal.

Comment

This case has potentially significant consequences for parties entering into contracts involving international elements, and that provide for disputes to be resolved by arbitration but do not specify the law governing the arbitration agreement.

It is common for a contract to provide for different laws for the proper law of the contract and the law of the arbitration. Often, the proper law of the contract is chosen by reference to the contract's subject matter. In contrast, parties often choose a neutral jurisdiction for the law of the arbitration, so that neither party has the 'home advantage'. Parties often do not specify which law governs their agreement to arbitrate. If no choice is made, there will be uncertainty about whether the law governing the underlying contract or the law of the seat will apply. There will often be circumstances, as in this case, where a decision about which law applies will have a major impact on the parties' ability to enforce their commercial arrangements.

Parties should consider including a specific choice of law for their arbitration agreement, to avoid such uncertainty and the cost of potential litigation regarding the question of which law should apply.

Footnotes
  1. Sulamerica Cia Nacional de Seguros SA & Ors v Enesa Engenharia SA & Ors [2012] EWCA Civ 638.
  2. Channel Tunnel Group Ltd v Balfour Beatty Construction Ltd [1993] AC 334; Black Clawson International Ltd v Papierwerke Waldhof-Aschaffenburg AG [1982] 2 Lloyd's Rep 446; Sonatrach Petroleum Corp v Ferrell International Ltd [2002] 1 All ER (Comm) 627; Sumitomo Heavy Industries Ltd v Oil & Natural Gas Commission [1994] 1 Lloyd's Rep 45; Leibinger v Stryker Trauma GmbH [2005] EWHC 690 (Comm).
  3. Dicey, Morris & Collins, The Conflict of Laws, 14th ed, [16-016].
  4. C v D [2007] EWCA Civ 1282; XL Insurance Ltd v Owens Corning [2001] All ER (Comm) 530.
  5. Mustill & Boyd, Commercial Arbitration, 2nd ed.

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