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The Governing Law of Arbitration Agreement: Settling the Unsettled

Editor_4

Introductory note

The law and practice of international commercial arbitration suggests that there are at least five systems of law that are  relevant and have a bearing on the process and the outcome of  arbitration, which are as follows: (a) law governing the contract; (b) law governing the arbitration agreement; (c) law governing the arbitral proceedings; (d) law governing the capacity of parties to sign and get into an arbitration agreement; and (e) the law governing the land of enforcement of arbitral award.[1] Out of these, as a matter of best practice, at least the first three laws are expressly mentioned in a contract itself, which then makes it easier to move on to the next two. Problems arise when any of the first three are not expressly provided for in the text of the contract, because then the tribunals generally rely upon a number of doctrines, tests and theories to pinpoint the same. The current paper briefly discusses about one such mistakes that the draftsmen commit most often. This paper deals with the scenario, when the law governing the arbitration agreement is not specifically mentioned or expressly given for. The paper tries to analyse the law in relation to this problem from international practice [since most of the countries have adopted the model text provided by United Nations Commission on International Trade Law (UNCITRAL)[2]] and attempts to come up with a coherent test that could be applied in India for this purpose. While doing so, the paper also analyses the conflicts in positions in International Practice, England and then India. Then, the paper attempts to harmonise these positions to read them together in light of a recent English Court decision, which arguably could be an end to this jurisprudential confusion. Therefore, the objective of the paper is to define the principles laid down to determine the proper law of the arbitration agreement and the issue that the paper seeks to address is whether the various positions of law with respect to determination of law governing the arbitration agreement be read harmoniously in order to give out an objective test or a standard formula?

The confused jurisprudence

This section attempts to provide a brief of the jurisprudential debate that is ongoing between countries, courts and tribunals about which law to choose if the parties do not state any law to govern the arbitration agreement. The two positions broadly taken are: (a) the law governing the main contract governs the arbitration agreement; and (b) the law of the seat of the Arbitral Tribunal governs the arbitration agreement.[3]

The position earlier was more in favour of seat of the Tribunal, which is now however slowly changing with time. The UN Working Group which also drafted the UNCITRAL Model Law on International Commercial Arbitration started with the assertion that[4] when the parties have not expressly provided for any law to determine the substantive validity of the arbitration agreement itself, then the law of the seat of the Arbitral Tribunal must apply for the same. The same rule can also be inferred from Article 31(3) and Article V(1) of the New York Convention. The primary rationale behind adopting such a position is because the law of the seat of the Tribunal has the “real and close” connection with arbitration.[5] The argument of severability of the arbitration agreement from the contract also added to their favour to argue for two different laws for contract and the arbitration agreement. Notwithstanding, there have been cases where it has been held by courts from most of the countries that regardless of where the seat of arbitration is, the law governing the underlying contract will extend to the arbitration agreement in the absence of an express choice, since it acts as a tacit choice.[6] This line of argument is to see the contract as a whole and not in bits and parts.[7]

The tension was prevalent in English Law as well. The initial understanding was in favour of adopting the law of the seat of the Tribunal as the law of the arbitration agreement as well based on the understanding of “real and close connection” test.[8] This was, however, changed in Sulamérica Cia Nacional de Seguros SA v. Enesa Engelharia SA[9] that gave primacy to the law of the contract and held that to be the proper law of the arbitration agreement as well. The same was upheld later by subsequent cases because the same was taken as an “implied” choice of law.[10]

In India as well, there has been confusion with regard to the same, however in a different order. India initially recognised the principle of extending the law of the underlying contract to the law of the arbitration agreement.[11] The line of reasoning adopted by the courts in these cases were similar that argued that the contract must be seen as a whole; choice of law of contract creates a “strong indication of parties’ intention of implied choice; it is rare and exceptional to have it any other way, etc. However, just along with this model of argument developed its counter that the law of the seat determines the law applicable to arbitration agreement.[12] They adopted the arguments of severability of the main contract from the arbitration agreement and the real and close connection to the arbitration test in essence. In this context, Bhatia International v. Bulk Trading SA[13] created more confusion by making Part 1 applicable to almost all international commercial contracts with some connection to India unless specifically excluded. While Bharat Aluminium Co. v. Kaiser Aluminium Technical Services Inc.[14] came in to rectify Bhatia[15], it referred to the New York Convention and turned down the position to a “seat-centric” from “contract-centric” approach, which has remained somewhat constant since then.[16] So, even though India roughly follows a seat-centric approach as of now, the position regarding the same is still undecided and uncertain.

What is to be noted is that these kinds of disputes become important to Indian courts at least in the following contexts—

The three-step formula

The above survey of cases in all contexts (international, English jurisprudence and Indian jurisprudence) reflect two broad positions that the courts have taken from time to time. Regardless of the confusion caused thereto, what remained constant is the rationale that the courts gave every time for reaching the decision. One of the strongest rationales for extending the law of contract to the arbitration agreement was broadly that, it could be counted in as a tacit/implicit choice by the party which creates a rebuttable presumption in its favour. Similarly, one of the strongest reasons applied to choose the law of the seat to govern the arbitration agreement is that because it has a “real and close connection” to the arbitration itself. Even though the decision changes, the rationale for the decision has always remained constant nevertheless. This could perhaps be useful to attain a coherent and harmonious perspective when approached with a question to determine the proper law of arbitration agreement when the same is not already chosen by the parties.

Sulamérica case[19] while moving away from the seat-centric approach, formulated a three-step test to determine the law of arbitration agreement in case the same as not been determined and the law of seat is different from law of the underlying contract while referring to Dicey’s Conflict of Laws.[20] The case laid down that while looking into any of such cases, one must follow the common law rules for the determination of the proper law of arbitration agreement.[21] The common law rules says that one must look into either express or implied choice of the parties while determining the proper law of the arbitration agreement.

Therefore, the Court came up with a three-tiered step-wise inquiry to be followed for the determination of the proper law of arbitration agreement setting hierarchy between the three tests:

What is to be noted here is that some courts have jumped directly to “real and close connection test” or even substituted “implied choice” to “real and close connection test” which, I argue, is a wrongful reading of the rules of determination even if they were from common law jurisdictions.[22] As gleaned from the above discussion, “implied choice” is not as same as the “real and close connection” unless the law governing the underlying contract and the seat of the Arbitral Tribunal is the same. Therefore, this caution must also be maintained at all times while determining the proper law of the arbitration agreement.

Quite recently, this issue came up for consideration again in the Court of Appeals in the matter of Kabab-Ji SAL v. Kout Food Group.[23] The Court in this case held that choosing a law governing the contract will extend to the arbitration agreement as “express choice of law” itself. It further held that the argument of separability will not apply in cases of determination of proper law of arbitration agreement, since the concept, at least in the context of arbitration agreement developed in a different context altogether which was to save the arbitration agreement from being invalidated even if the entire contract gets invalidated. While the Court relied upon Sulamérica[24] and borrowed its provisions it still moved further away from it.

I argue that this is an extreme manner of reading Sulamérica case[25].  Sulamérica[26] only used the word “express choice” to mean the express choice by parties stating that they choose to apply a particular law to arbitration agreement. However, the intention and essence of the argument made in Kabab-Ji case[27] cannot be sidelined due to its extremeness in interpreting the law laid down by Sulamérica[28].  I submit that the approach taken by Sulamérica[29] is here a middle-ground approach to deal with such situations.

Secondly, it is pertinent to note that these laws must be seen in a way of a hierarchical inquiry which needs to be followed in a step-wise manner. The inquiry must be to look into the express choice of the parties first. Only if it is not found, the argument of implied choice kicks in and which if not found then the argument of the law with real and close connection to arbitration comes into picture. As discussed earlier, we can fix the last two steps as the contractual law (Step 2) and the curial law/seat of the Arbitral Tribunal (Step 3) since they were the rationale in choosing the either of them. So, effectively, it would mean that if there is no express choice made by the parties, it is the law of the contract that extends by necessary implication and in case, both are missing, it is the curial law or the law of the seat of the Arbitral Tribunal.

Concluding remarks

From the above discussion what emerges is that even though there was a confused jurisprudence where two set of laws were applied to arbitration agreements in the absence of an express choice, they were at least consistent in themselves, like the inner morality of law discussed by Fuller. This consistency within the two sets of decisions has now led us looking at the issue from a holistic and coherent manner rather than sticking to just side of the discussion. Of course, one could criticise Sulamérica[30] or Kabab-ji[31] as showcasing their value judgments of applying contractual law over the curial law. However, this criticism may not stand true for common law countries at least, from where the rules were inferred. This way of harmonious reading of course looks too simplistic to see the issue as of course there will be a lot of other factors that goes into consideration while determining the proper law of arbitration agreement. Notwithstanding, it is very essential to make this at least as an academic argument to bring out certainty and consistency in relation to law governing arbitration agreement and reduce subjectivity or forum shopping by the parties. The formula that emerges out of the discussion is that: (a) express choice of parties; (b) law of the underlying contract; and (c) the curial law/ law of the seat.[32] Again, none of these problems will emerge if the parties just choose a law to govern the arbitration agreement at the time of drafting, which is also the best practice to do.

†  Fourth year student, BA LLB (Hons.), NALSAR University of Law, Hyderabad.

[1] Redfern and Hunter, Law and Practice of International Commercial Arbitration, 4th  Edn., 2004 at [2-04].

  See also, Shaun Lee, The Laws Governing an Arbitration

[2] United Nations Commission on International Trade Law, Texts and Statutes

[3] Berger, Klaus Peter: Re-examining the Arbitration Agreement, Applicable Law Consensus or Confusion? in: van den Berg (ed.) ICCA Congress Ser No.13; International Arbitration 2006: Back to Basics?

[4] “(…) to use the place of arbitration as a secondary criterion was beneficial in that it provided the parties with a degree of certainty which was lacking under (other suggested approaches, like the application of the law of the main contract). There were also doubts as to whether in fact a trend could be discerned in favour of determining the question of the validity of the arbitration agreement according to the law of the main contract”, –UN Doc. A/40/17, para 284.

[5]Alan Redfern and Martin Hunter, Law and Practice of International Commercial Arbitration, op. cit., fn. 9, Nos. 2-90.

[6] ICC Award No. 2626, Clunet 1978, p. 981; No. 6379, Yearbook XVII (1992) p. 215; BGH, RIW (1976) p. 449; Union of India v. McDonnell Douglas Corpn., (1993) 2 Lloyd’s  Rep. 48, 50; Sonatrach Petroleum Corpn. (BVI) v. Ferrell International Ltd., (2002) 1 All ER (Comm) 627; Julian D.M. Lew/Loukas A. Mistelis/Stefan M. Kröll, Comparative International Commercial Arbitration, op. cit., fn. 2, No. 6-59; Alan Redfern and Martin Hunter, Law and Practice of International Commercial Arbitration, op. cit., fn. 9, Nos. 2-87.

[7] Paul Smith Ltd. v. H & S International Holding Inc., (1991) 2 Lloyd’s Rep 127. See also, Shell International Petroleum Co. Ltd. v. Coral Oil Co. Ltd., (1992) 1 Lloyd’s Rep 72.

[8] Black Clawson International Ltd. v. Papierwerke Waldhof-Aschaffenburg AG, (1981) 2 Lloyd’s Rep 446; Naviera Amazonica Peruanna SA v. Compania Internacional De Seguros Del Peru, (1988) 1 Lloyd’s Rep 116 (CA).

[9](2013) 1 WLR 102 : 2012 EWCA (Civ) 638  (Sulamérica).

[10] C v. D, (2008) 1 Lloyd’s Rep 239 : 2007 EWCA (Civ) 1282

[11] NTPC v. Singer Co., (1992) 3 SCC 551 ; Shin-Etsu Chemical Co. Ltd. v. Aksh Optifiber Ltd., (2005) 7 SCC 234  (recognised that the closest and real connection would make the seat of the tribunal to be made applicable); Videocon Industries Ltd. v. Union of India, (2011) 6 SCC 161 and Yograj Infrastructure Ltd. v. Ssang Yong Engg. & Construction Co Ltd., (2011) 9 SCC 735.

[12] Sumitomo Heavy Industries Ltd. v. ONGC, (1998) 1 SCC 305; Union of  India v. Reliance Industries Ltd., (2015) 10 SCC 213; Eitzen Bulk A/S v. Ashapura Minechem Ltd., (2016) 11 SCC 508 ; Roger Shashoua v. Mukesh Sharma, (2017) 14 SCC 722 .

[13] (2002) 4 SCC 105 .

[14]  (2012) 9 SCC 552 .

[15] Supra Note 13.

[16] Supra Note 12.

[17] Arbitration and Conciliation Act, 1996

[18] BGS SGS Soma JV v. NHPC Ltd., (2020) 4 SCC 234 the court had to determine the proper law of the arbitration agreement in the stage of appeal (i.e. S. 34), where New Delhi and Faridabad were the place of arbitration.

[19] Supra Note 9.

[20] Dicey, Morris & Collins, op. cit. Para 32-006. Sulamérica, supra Note 9 at para 25.

[21]Sulamérica, supra Note 9 at para 9 while referring to Dicey, Morris & Collins, The Conflict of Laws, 14th Edn., Para 16R-001.

[22]The cases that substituted the two tests were – Enercon (India) Ltd. v. Enercon GmbH, (2014) 5 SCC 1; James Miller & Partners Ltd. v. Whitworth Street Estates (Manchester) Ltd., 1970 AC 583: (1970) 2 WLR 728:  (1970) 1 Lloyd’s Rep 269 (HL)  and Naviera Amazonica Peruana SA v. Compania Internacional De Seguros Del Peru, (1988) 1 Lloyd’s Rep 116 (CA) (English courts).

[23] 2020 EWCA (Civ) 6 (Kabab-Ji case).

[24] Supra Note 9.

[25] Ibid.

[26] Ibid.

[27] Supra Note 23.

[28] Supra Note 9.

[29] Ibid.

[30] Supra Note 9.

[31] Supra Note 23.

[32] Even though I am well aware that there are exceptionally rare situations where curial law may not be the same as law of the seat at times, but that again seems very impractical in real life terms.

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