An arbitration mystery tour? Determining the governing arbitral law where the arbitration clause is silent

Legal — By on December 13, 2012 at 6:27 PM

Tara Johnson

The English Court of Appeal recently provided some much needed clarity on what law is to be applied to an arbitration agreement where there is no choice of governing law in the arbitration clause itself (Sulamerica Cia Nacional De Seguros S.A. and others v Enesa Engenharia S.A. and others [2012] EWCA Civ 638).

There had previously been some uncertainty as to which law applies to an arbitration where there is no express governing law stipulated in the arbitration clause itself and the seat of the arbitration is in a different country from the governing law stipulated in the general law and jurisdiction clause. In English law, an arbitration agreement is separate and distinct from the underlying contract. This means that it is possible for an arbitration agreement to be governed by a different law to the underlying contract. However, despite this, English courts have in the past been divided as to whether to apply (i) the law governing the underlying contract; or (ii) the law of the seat of the arbitration. The Court of Appeal has now set out some helpful guidelines for ascertaining the relevant law in these circumstances.

Background

The dispute arose in connection with two insurance policies (the Policies), relating to the construction of a hydroelectric generating plant in Brazil. The Insured (Enesa Engenharia S.A) made claims under the Policies. However, the insurers (Sulamerica Cia Nacional De Seguros S.A) refused to pay out under the insurance policy, denying all liability.

The wording of the Policies included the following:

Clause 7: Law and jurisdiction

“…this Policy will be governed exclusively by the laws of Brazil. And disputes arising under, out of or in connection with this Policy shall be subject to the exclusive jurisdiction of the courts of Brazil”.

Clause 11: Mediation

“If any dispute or difference of whatsoever nature arises out of or in connection with this Policy… the parties undertake that, prior to a reference to arbitration, they will seek to have the Dispute resolved amicably by mediation … If the Dispute has not been resolved to the satisfaction of either party within 90 days … or if either party fails or refuses to participate in the mediation, or if either party serves written notice terminating the mediation under this clause, then either party may refer the Dispute to arbitration …”

Clause 12: Arbitration

“In case the Insured and the Insurer(s) shall fail to agree as to the amount to be paid under this Policy through mediation as above, such dispute shall then be referred to arbitration under ARIAS Arbitration Rules … The seat of the arbitration shall be London, England”.

Relying on Clause 12, the insurers commenced arbitration in England seeking, amongst other things, a declaration of non-liability. In response, the insured commenced proceedings in the Brazilian courts pursuant to the exclusive jurisdiction clause (Clause 7). The insurers in turn, initiated an anti-suit injunction in the English High Court in order to halt the Brazilian proceedings.

In the English anti-suit proceedings, the insured argued that the arbitration clause was governed by Brazilian law and was invalid because (1) under Brazilian law, it could only be invoked with their consent; and (2) the requirements of Clause 11 had not been satisfied and this was a condition precedent to any arbitration. The insured also argued that the Policies were more closely connected with Brazil: the Policies were governed by Brazilian law, both parties were Brazilian, the subject of the Policies was situated in Brazil and the incidents leading to the claim occurred in Brazil.

The arbitration law test

The Court of Appeal recognised that the proper law of an arbitration clause within a commercial contract may not be the same as the governing law of the substantive contract itself. The Court held that the proper law of an arbitration agreement must be determined by making a three stage enquiry into:

  1. Any express choice of governing law.
  2. Any implied choice of governing law.
  3. Which system of law has the closest and most real connection with the agreement to arbitrate.

Each of these stages must be considered separately and in the stated order, since any choice made by the parties ought to be recognised. However, the Court emphasised that (1) and (2) would often merge together and the implied law of the arbitration agreement will often be the same as the law of the substantive contract. However, there may be factors that point a different way and so in some cases the law of the arbitration agreement will not be the law of the substantive contract.

Judgment: English governing law applied

The Court of Appeal held that the proper law of the arbitration agreement in this case was English law, despite the fact that the Policies were expressly governed by Brazilian law. This was because, although there were “powerful factors in favour of an implied choice of Brazilian law as the governing law of the arbitration agreement”, the Court was persuaded by two important factors that pointed the other way. Firstly, the choice of London as the arbitral seat imported acceptance that the arbitration would be conducted and supervised according to the Arbitration Act 1996. Secondly, the possible existence of a rule of Brazilian law which would undermine the arbitration agreement indicated that the parties did not intend the arbitration agreement to be governed by Brazilian law.

The mediation clause (Clause 11) was too uncertain to give rise to a legal obligation of any kind. In order for a mediation agreement to be regarded as binding:

  1. There should be an unequivocal undertaking to enter into mediation.
  2. There should be clear provision for the appointment of a mediator.
  3. The process of the mediation should be clearly defined.

Clause 11 did not meet these requirements and accordingly, there was no binding agreement to mediate and Clause 11 was not an effective precondition to arbitration. The anti-suit injunction was therefore upheld.

Certainty of arbitration law

The Court of Appeal’s decision will generally be welcomed, as it brings greater clarity to the determination of the proper law of an arbitration agreement where there is doubt. Where there is no clear choice of law in the arbitration clause itself, the three stage test must be applied to determine the governing law.

However, while the Court of Appeal has set out a clear test, each case will in practice continue to depend on its own circumstances and how each particular judge interprets the test. A substantial uncertainty, and therefore litigation risk, will always remain where there is no express choice of law in the arbitration clause.

Consequences for enforcement

Enforcement difficulties are also more likely where there is no express choice of governing law in the arbitration clause itself. In particular, one common ground for refusing to recognise or enforce an award under the New York Convention is where the arbitration agreement was not valid “under the law to which the parties subjected it or, failing any indication thereon, under the law of the country where the award was made”.

Where there is no express choice of arbitral law, and consequently uncertainty about the law governing the arbitration agreement, the respondent is more likely to challenge jurisdiction not only in the substantive proceedings themselves, but also in any enforcement proceedings. This Court of Appeal decision is unlikely to prevent such challenges, which will remain an issue.

A different seat?

In the majority of arbitration clauses, the seat will be in the country of the chosen governing legal system. For most contracts, this is the best choice and it reduces cost and removes one potential cause of inconsistency.

However, for some contracts and/or contracting parties, the selection of the law of one country and a different seat may be commercially advantageous. For example, some contracts for projects in the Middle East stipulate English law (to take advantage of well developed English construction law, for example) but provide for DIFC-LCIA arbitration in Dubai. This allows local companies to arbitrate close to home if they are in a dispute.

This Court of Appeal decision will not interfere with such arrangements, which remain valid. However, clauses stating a different seat should be carefully drafted and appropriate local law advice taken to ensure that they are valid under the law of the seat and the governing law.

Conclusion

Contractual negotiations between parties naturally concentrate on the key commercial terms, which means that the wording of the dispute resolution clauses can often be an afterthought. This Court of Appeal decision has highlighted the importance of including an express choice of governing law in arbitration clauses. The decision also demonstrates the importance of careful drafting of multi-tiered or escalating dispute resolution clauses, to ensure that each stage is effective and enforceable. In this case the insured were unable to enforce the mediation clause as a binding obligation to mediate and were left unable to enforce a Brazilian exclusive jurisdiction clause.

Clauses which do not expressly state the governing law, or which fail to achieve the desired ‘multi-tiered’ process are more likely to lead to uncertainty, inconvenience, additional costs and delays in both progressing and enforcing the proceedings.

For more information,  viewers can contact Tara Johnson, Associate, on +44 (0)20 7264 8422 or tara.johnson@hfw.com, or your usual HFW contact.

A version of this article was published on the Steamship Mutual website and will appear in their Sea Venture newsletter in due course.

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