08 October 2020 ….Uncertain and unstable trade conditions created by the COVID-19 pandemic are providing fertile ground for cross-border disputes. In turn, the global increase in disputes has precipitated a rise in challenges to the jurisdiction of arbitral tribunals. Consequent on such challenges are significant delays to proceedings and even more seriously, attacks on the enforceability of arbitral awards.
Critical to resisting challenges to the jurisdiction of arbitral tribunals and the enforceability of awards, and indeed to ensuring the effective conduct of arbitrations, is the law governing the arbitration agreement itself. Often, however, this essential ingredient is overlooked when drafting an arbitration agreement. It can be a fatal mistake.
The arbitration agreement’s governing law determines questions of formation, validity, effect and discharge of the arbitration agreement. Failing to include an express governing law provision that is considered carefully and drafted precisely within an arbitration agreement may cause significant delay in an arbitration and may ultimately render any subsequent award unenforceable.
In this article, we consider how courts determine the proper law of an arbitration, by reference to recent Singapore and UK Court of Appeal decisions, and ahead of a much anticipated a UK Supreme Court decision. We also consider the implications for Australian courts, which have not yet considered this issue, and provide drafting tips to avoid common pitfalls.
Approach of the Singapore Court of Appeal
BNA v BNB and another (BNA v BNV) concerned an agreement for the sale of industrial gases by the Korean company BNB (which later transferred its rights to BNC) to the Chinese company BNA.
The agreement contained a governing law clause and arbitration clause providing for Singapore International Arbitration Centre (SIAC) administered arbitration in Shanghai:
‘ARTICLE 14: DISPUTES
14.1 This Agreement shall be governed by the laws of the People’s Republic of China.
14.2 With respect to any and all disputes arising out of or relating to this Agreement, the [p]arties shall initially attempt in good faith to resolve all disputes amicably between themselves.
If such negotiations fail, it is agreed by both parties that such disputes shall be finally submitted to the Singapore International Arbitration Centre (SIAC) for arbitration in Shanghai, which will be conducted in accordance with its Arbitration Rules. The arbitration award shall be final and binding on both [p]arties.’ (Emphasis added.)
BNA failed to make the necessary payments under the agreement, and BNC applied for arbitration. BNA challenged the Tribunal’s jurisdiction, contending that the arbitration agreement was invalid, on the basis that its governing law was the law of the People’s Republic of China (PRC), which prohibited a foreign arbitral institution like the SIAC from administering the arbitration. BNB and BNC contended the proper law was Singapore law, which gave effect to the arbitration agreement.
The parties, the High Court at first instance, and the Court of Appeal followed previous Singaporean High Court decisions in agreeing that the three-stage test set out in the England and Wales Court of Appeal decision of Sulamérica v Enesa Engelharia SA was the correct test to determine the law governing the arbitration agreement. That test is as follows:
- Did the parties expressly choose a law to govern the arbitration agreement?
- If an express choice is not evident, did the parties implicitly choose a law to govern the arbitration agreement?
- If an implied choice cannot be identified, what system of law has the closest and most real connection to the arbitration agreement?
The High Court at first instance and the Court of Appeal both found the parties had not expressly chosen the proper law of the arbitration agreement, despite Article 14.1 providing, in the same article, that the governing law of the agreement was PRC law.
The parties accepted the starting point of the second stage is presuming the governing law of the main agreement, not the law of the seat (i.e. curial law or lex arbitri), is the governing law of the arbitration agreement. However, the Court of Appeal found this starting presumption was unnecessary in this case because the law of the seat and substantive agreement were the same. The words ‘arbitration in Shanghai’ indicated the seat was Shanghai, despite the reference to the SIAC and its Arbitration Rules, so the law of the seat was the law of the PRC. Article 14.1 provided that law of the PRC was the law of the substantive agreement.
Unlike the decision of the Tribunal and the High Court, the Court of Appeal did not consider it relevant that the law of the PRC potentially invalidated the arbitration agreement. Although the Court of Appeal considered the status of the law of the PRC to be unclear, it also stated that BNA had to show the parties were ‘aware’ of this fact.
Interestingly, this position appears to be different to the English Court of Appeal’s position in Sulamérica (and that of the Singaporean High Court in the earlier decision in BCY v BCZ), where such proof of ‘awareness’ did not seem to be required. Moore-Bick LJ in Sulamérica considered the law of the substantive agreement (Brazilian law) potentially rendering the arbitration clause unenforceable ‘[i]f correct…a powerful factor and one which the court musttake into account when considering an implied choice of Brazilian law’. His Honour concluded that the law of the seat, English law, governed the arbitration agreement, because the serious risk that Brazilian law would undermine the arbitration agreement suggested the parties did not intend for it to be governed by Brazilian law.
Approach of the UK Court of Appeal
Kabab v KFG
Kabab-Jl S.A.L (Lebanon) v Kourt Food Group (Kuwait)(Kabab v KFG) concerned a franchise development agreement between a Lebanese company Kabab-Jl S.A.L and a Kuwaiti company, AHFC (and its parent company KFG).
The agreement contained the following governing law clause and arbitration clause providing for an ICC arbitration in Paris.
‘Article 14: Settlement of Disputes
14.2. Except for those matters which specifically involve the Mark, any dispute, controversy or claim between LICENSOR and LICENSEE with respect to any issue arising out of or relating to this Agreement or the breach thereof, …shall, failing amicable settlement, on request of LICENSOR or LICENSEE, be finally settled under the Rules of Conciliation and Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the said Rules.
14.5. The arbitration shall be conducted in the English language, in Paris, France.
Article 15: Governing Law
This Agreement shall be governed by and construed in accordance with the laws of England.’(Emphasis added.)
The word ‘Agreement’, used in the governing law clause, was defined to include the arbitration agreement.
A dispute arose, and Kabab commenced arbitration against KFG before the ICC International Court of Arbitration (ICC) in Paris. The Tribunal rendered its award in Kabab’s favour.
KFG challenged the enforcement of the award in England, contending it was not a party to the arbitration agreement. In order to determine whether KFG was a party, the England and Wales High Court, and in turn the Court of Appeal, were required to decide the proper law of the arbitration agreement. To that end, both courts applied the three-stage Sulamérica test, similar to that applied in BNA v BNB.
Significantly, however, when applying the test’s first stage, the Court of Appeal (but not the High Court) found the parties had made an express choice of law under Article 15, because:
- Article 15 used the word ‘Agreement’, which was defined to include the arbitration agreement in Article 14;
- a governing law clause, which on its terms applies to the arbitration agreement, is an express choice by the parties that the law of the contract also governs the arbitration agreement; and
- that conclusion is not undermined by the doctrine of separability. In the leading judgment, Flaux LJ noted: ‘The rationale of separability is that it ensures that the dispute resolution procedure chosen by the parties survives the main agreement becoming unenforceable for example because of fraud or misrepresentation’. Separability does not provide that the arbitration agreement is a separate agreement from the underlying contract.
This conclusion is at odds with first stage inquiry in BNA v BNB. In that case, the Singapore Court of Appeal concluded that a governing law clause of almost identical terms was not an express choice of law, even when contained in the same clause as the arbitration agreement.
Having found that the parties made an express choice of law, the Court was not required to consider the second stage. Flaux LJ did indicate, however, that the second stage involved the implication of a term of fact, not law, and so a term may only be implied if it is necessary for ‘business efficacy’.
Enka v Chubb
Enka Insaat Ve Sanayi A.S. v OOO “Insurance Company Chubb”concerned a massive fire at a Russian power plant project on which Enka was the boiler and auxiliary equipment subcontractor. Enka’s counterparty commenced proceedings before the Moscow Arbitration Court against Enka, through its subrogated insurer Chubb, seeking damages regarding the fire.
The subcontract between Enka and its counterparty contained the following agreement for ICC arbitration in London:
If the matter is not resolved within twenty (20) calendar days after the date of the notice referring the matter to appropriate higher management or such later date as may be unanimously agreed upon, the Dispute shall be referred to international arbitration as follows:
- the Dispute shall be finally settled under theRules of Arbitration of the International Chamber of Commerce,
- the Dispute shall be settled by three arbitrators appointed in accordance with these Rules,
- the arbitration shall be conducted in the English language, and
- the place of arbitration shall be London, England.’(emphasis added)
Enka applied for an anti-suit injunction against Chubb before the England and Wales High Court, on the basis that the arbitration agreement applied to the parties’ dispute. The parties agreed that the subcontract was governed by Russian law, but disagreed on the governing law of the arbitration agreement. Following Fiona Trust v Privalov, if the arbitration agreement was governed by the laws of England and Wales, the dispute would be within the scope of the arbitration agreement.
The High Court declined to reach a decision on the proper law of the arbitration agreement, and ruled it was not the appropriate forum to determine finally whether the dispute was within the scope of the arbitration agreement.
On appeal, the Court of Appeal awarded the injunction. The Court found:
- it was the appropriate forum, because the arbitration was seated in London;
- the arbitration agreement was governed by English law, and the dispute between Enka and Chubb was within the scope of the arbitration agreement; and
- the Russian proceedings thus were brought in breach of the arbitration agreement.
To determine the proper law of the arbitration agreement, the Court applied the three-stage Sulamérica test.
The subcontract did not contain a governing law clause, and it was not contended that there had been an express choice of the law governing the arbitration agreement. However, the Court of Appeal explained that:
- an express choice may be found either in the terms of a governing law clause in the main contract, as in Kabab v KFG, or within the terms of the arbitration agreement;
- it is a matter of construction of the whole contract, and an express choice will only be found in ‘the minority of cases’ where the language of the contract and circumstances of the case demonstrate that the substantive contract law is also the law governing the arbitration agreement.
Unlike in BNA v BNB, the Court of Appeal found that the starting point was presuming the law of the seat, not the law of the substantive contract, governed the arbitration agreement. That presumption would only be rebutted by ‘powerful reasons to the contrary’, and was supported by three principal considerations.
First, the law of the main contract applies to the terms of the main contract and the validity, interpretation, and performance of those terms other than the terms of the separate arbitration agreement and the validity, interpretation, and performance of those separate arbitration terms. The arbitration agreement being separate for that purpose is a powerful indication that it is also separate for the purpose of determining the arbitration agreement law more generally
Second, the scope of the curial law is not limited to procedural powers, but involves the court of the seat determining the rights of the parties under the arbitration agreement. The law of the seat is more closely connected to the law governing the arbitration agreement than the law governing the main contract. Further, if the law of the seat and the law governing the arbitration agreement are different, the court of the seat will be bound to apply the foreign law governing the arbitration agreement when exercising its jurisdiction. Lord Justice Popplewell noted that: “[I]t is inherently unlikely that businessmen would have made that choice because… as a matter of commercial common sense, one would not expect businessmen to choose two different systems of law to apply to their arbitration package.”
Third, determining the law governing the arbitration agreement is a matter of implied choice under the second stage of the Sulamérica test rather than an application of the closest and most real connection test under the third stage.
The Court ultimately found that the presumption that the law of the seat (English law) applied was not rebutted.
The UK Supreme Court has heard an appeal of Enka v Chubb, and is expected to hand down its decision soon.
Implications in Australia
The decisions in BNA v BNB, Kabab v KFG, and Enka v Chubb continue an expanding body of jurisprudence supporting the use of the Sulamérica test to determine the law governing arbitration agreements. Australian courts have yet to consider the applicable test to determine the law governing an arbitration agreement, but are likely to be guided by this jurisprudence.
Despite the growing support for the test enunciated in Sulamérica, the decided cases show there is divergence in how that test is applied. The uncertainty involved in determining the proper law of arbitration agreements, where there is no express choice of law, has been recognised by some arbitral institutions. For example, the ACICA Rules and LCIA Rules both provide that unless the parties have expressly agreed otherwise, the law of the seat governs the arbitration agreement.
It will be interesting to see whether Australia courts, and indeed the UK Supreme Court, do follow the Sulamérica test, and if so whether they consider:
- a governing law clause in a contract which, by its terms, applies to the arbitration agreement, constitutes an express choice of the law governing the arbitration agreement;
- the starting point of the second stage is presuming the law of the substantive agreement or law of the seat governs the arbitration agreement; and
- under the second stage, the requirements of implying terms of fact apply.
No doubt, the Supreme Court decision may provide clarity on how these issues are resolved before UK courts, and may influence how Australian and international courts determine the governing law of arbitration agreements.
Drafting tips to avoid common pitfalls
BNA v BNB, Kabab v KFG, and Enka v Chubb also are timely reminders of the consequences of imprecise drafting of arbitration agreements. The parties suffered considerable delay and costs as a result of uncertainty as to the law governing the arbitration agreement.
Parties choosing arbitration should ensure that their arbitration agreements (whether contained within transaction agreements or as standalone submission agreements) adequately address all relevant issues, which ought to include:
- the law governing the arbitration agreement;
- legal seat of the arbitration;
- any applicable arbitral institution administering the arbitration;
- the rules governing the conduct of the arbitration;
- the number of arbitrators; and
- the language of the arbitration proceedings.
Additionally, it is good practice to consider any mandatory requirements of the seat of the arbitration and likely place(s) of enforcement that ought to be addressed expressly in the arbitration agreement.
Arbitration agreements that fail to address adequately, or indeed at all, each of the above issues run the real risk of significantly delayed proceedings and/or unenforceable arbitral awards.
We will provide an update once the UK Supreme Court delivers its decision in the Enka v Chubb appeal.
 SGCA 84.
Sulamérica Cia Nacional de Seguros SA and others v Enesa Engelharia SA and others  1 WLR 102, 114 .
BNA v BNB and another  SGCA 84 ; BCY v BCZ 3 SLR 357, 368 ; BMO v BMP  SGHC 127 .
  EWCA Civ 6.
  EWCA Civ 574.
  1 Lloyd’s Rep 254.
 See ACICA Rules r 23.5; LCIA Rules r 16.4.