Why a choice of law should never be arbitrary

Why a choice of law should never be arbitrary

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Author: Helen Watson

We take a look at the different laws governing the various aspects of international arbitration including a recent commercial court decision on determining the law of the arbitration agreement.

The legal framework governing international arbitration is complex, and different laws may apply to its various elements, so that the law of the substantive dispute, the procedural law of the arbitration and the law of the arbitration agreement may not necessarily be the same.

Law of substantive dispute

Assuming that the underlying dispute is contractual, the applicable law of the dispute will be the law of the contract. Most contracts contain an express choice of law clause, but where the contract is silent as to its governing law, the arbitral tribunal will generally determine the most appropriate law to apply to the substantive dispute.

Procedural law

The seat of the arbitration (i.e. the country in which the arbitration is "rooted") determines the procedural law of the arbitration. The procedural law will then be supplemented by procedural rules as determined by the parties and/or the tribunal and/or the designated arbitral institution. In their choice of seat, the parties are submitting the arbitration to the national arbitral laws of that state, some of which may be mandatory and would override any provisions to the contrary in the arbitration agreement.

The procedural law of the arbitration will determine the role of the local courts in intervening in, or merely supporting, the arbitration, including their powers to grant interim measures. For example, the Arbitration Act 1996, which provides a particularly effective procedural framework where London is the chosen seat, allows the English courts to grant injunctive relief and to make orders for the preservation of evidence.

The seat is also important as it gives the arbitral award its nationality, which has implications for its recognition and enforceability, and the extent to which it can be challenged or set aside.

If the parties have not chosen a seat, then the tribunal or arbitral institution will determine it.

Law of arbitration agreement

Issues relating to the validity, scope, effect and meaning of the arbitration agreement, including issues as to the scope of the tribunal's jurisdiction, are governed by the law of the arbitration agreement. The arbitration agreement (or clause) is severable from the contract in which it is contained. In other words, the arbitration agreement is a contract in its own right, collateral to the main contract. It is therefore possible for the proper law of the arbitration agreement to be different from that of the underlying (or matrix) contract.

Parties often do not include a governing law clause in the arbitration agreement, assuming that the law of the matrix contract will automatically apply to the arbitration clause. However, the doctrine of severability means that this is not necessarily the case, and the rules for determining the governing law of the arbitration agreement in the absence of express choice are complex.

In the recent decision of Habas Sinai Ve Tibbi Gazlar Istihsal Andustrisi AS v VSC Steel Company Ltd [2013] EWHC 4071 (Comm), the Commercial Court confirmed and summarised the principles for ascertaining the applicable law of an arbitration agreement, as previously laid down in Sulamerica Cia Nacional De Seguros SA and others v Enesa Engenharia SA [2012] EWCA Civ 638 and Arsanovia Ltd v Cruz City 1 Mauritius Holdings [2013] 2 All ER 1.

These principles can be summarised as follows:

  • The proper law of the arbitration agreement is determined by using a 3-stage test: (i) express choice; (ii) implied choice; and (iii) the system of law with which the arbitration agreement has the closest and most real connection.
  • Where the matrix contract does not contain an express governing law clause, the significance of the choice of the seat is likely to be "overwhelming" in determining the applicable law of the arbitration agreement, on the basis that the law of the country where the arbitration has its seat is likely to be the law with which the arbitration agreement has the closest connection.
  • Where the matrix contract does contain an express governing law clause, then in the absence of anything to the contrary, this is a strong indication of the parties' intention as to the law governing the arbitration agreement.
  • The choice of a different country for the seat of the arbitration is an indication to the contrary, although it may not be sufficient to displace the choice implicit in the express choice of law governing the matrix contract.
  • Where there are other sufficient factors to displace the implied choice derived from the express choice of law of the matrix contract, then the arbitration agreement will be governed by the law with which it has the closest and most real connection - this is most likely to be the law of the seat.

The court in Habas also added that the terms of the arbitration agreement themselves may indicate an implied choice of law of the arbitration agreement. It referred to the cases of Cie. Tunisienne v Cie d'Armement [1971] AC 572 and Egon Oldendorff v Liberia Corp [1996] 1 Lloyd's Rep 380, which recognised that the terms of an arbitration agreement might operate as an implied choice of law for the matrix contract. The court reasoned that, where this is the case, the terms of the arbitration agreement must also operate as an implied choice of law of the arbitration agreement itself.

It is clear following Habas that the outcome of the 3-stage test remains uncertain. Parties should therefore always consider expressly including a governing law clause in the arbitration agreement in international contracts, particularly if they wish the arbitration agreement to be governed by a different law from that of the seat or of the matrix contract. Failure to do so could lead to jurisdictional challenges and of the arbitral award ultimately being set aside.

Comment

Parties should spend time at the drafting stage carefully considering the legal framework which will apply to any dispute under the contract to be submitted to arbitration. Absence of express choice as to the law of the matrix contract or of the arbitration agreement could lead to significant uncertainty, and to the delay and expense of satellite litigation. Choosing the wrong seat could bind the parties to a procedural regime that hinders rather than supports the arbitration and could jeopardise the enforceability of the arbitral award.

About the Author

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Helen Watson

Senior Associate

03700 86 6751

Helen has extensive experience of commercial disputes, including a wide range of contractual disputes, breach of warranty claims, director and shareholder disputes and professional neligence claims. Helen is experienced in High Court and County Court litigation, all forms of ADR including mediation and arbitration. Helen has managed disputes for a wide range of clients, but has particular experience in the energy, defence and financial services sectors.

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