Determining The Proper Law Of An Arbitration Agreement

Client Update
June 2012
Dispute Resolution
Determining The Proper Law Of An
Arbitration Agreement
Introduction
An arbitration agreement is a unique clause in a contract because it exists separately from the contract in which it is found. Therefore, it may be governed by a different law than the substantive contract. While this may appear to be a somewhat academic issue, the distinction may have practical consequences. In the English case of Sulamerica CIA Nacional De Seguros SA v Enesa Engenharia SA [2012] EWCA Civ 638, the proper law of the arbitration clause was potentially determinative of whether arbitration could be invoked at all. The case involved a contract which specified the law of Brazil as the choice of law, and was also closely connected with Brazil in terms of parties and subject matter. However, the English High Court found that the proper law of the arbitration agreement within the contract was English law. This was based on the choice of London as the seat of arbitration, as well as the fact that Brazilian law could possibly render the arbitration agreement enforceable only upon further consent of the parties, which could not be the intention of the parties. Parties do not often specify the proper law of an arbitration clause, seeing as it is usually identical to the governing law of the substantive contract. However, this is not always the case, and contracting parties should be aware of the factors which may lead to a divergence of governing law within a contract. Contract drafters should also take note of the potential implications of any variation in governing law, such as in the present case, where the proper law of the arbitration agreement would mean the difference between unilateral and two‐sided invocation of arbitration. Brief Facts
(1) The Appellant insured and the Respondent insurer entered into a contract of insurance. The policy contained the following terms: 1
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a.
The policy was to be governed exclusively by the laws of Brazil, and the Brazilian courts would have exclusive jurisdiction of any disputes arising under, out of or in connection with the policy. (“The choice of law clause”) b. The parties would attempt to resolve any disputes amicably by mediation before any reference to arbitration. c.
If mediation failed to result in any resolution, the dispute would be referred to arbitration under the ARIAS arbitration rules. The seat of the arbitration would be London. (“The arbitration agreement”) (2) The parties encountered a dispute, whereupon the Respondent gave notice of arbitration. The Appellant then started proceedings in Brazil, obtaining an injunction restraining the Respondent from proceeding with arbitration. (3) In response, the Respondent obtained an injunction from the English courts restraining the Appellant from pursuing the proceedings in Brazil. The Appellant sought to appeal this injunction. Issue
The main issue at hand was the proper law of the arbitration agreement. The Appellant argued that the arbitration agreement was governed by Brazilian law, under which arbitration could only be invoked with the Appellant’s consent. The Respondent submitted that the arbitration agreement was governed by English law, under which the Appellant was bound to arbitrate once the clause was invoked by the Respondent. The Court of Appeal thus had to determine the governing law of the arbitration agreement to decide whether to continue the injunction. Holding of the Court of Appeal
It was held that the arbitration agreement was governed by English law. Therefore, the appeal was rejected, and the injunction against the proceedings in Brazil would continue. 2
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General law Even if an arbitration agreement forms part of a substantive contract, it has a separate existence. This means that its proper law may not be the same as that of the substantive contract. The proper law of an arbitration agreement is to be determined by enquiring: (i)
Whether there is an express choice of law; (ii)
If there is no express choice, whether there is an implied choice of law; and (iii)
If there is no express or implied choice, which law has the closest and most real connection with the arbitration agreement. Where the arbitration agreement is part of a substantive contract, an express choice of proper law to govern the substantive contract remains an important factor. In the absence of any contrary indication, such choice of law is likely to indicate that the arbitration agreement is intended to be governed by the same law. This may of course be countered by opposing factors. Such factors may be found in the terms of the arbitration agreement itself, or in the consequences on the arbitration agreement’s effectiveness were it to be construed based on the proper law of the substantive contract. Application Here, the arbitration agreement contained no express choice of law. The court thus proceeded to seek an implied choice of law. The parties, through the choice of law clause, had agreed that the governing law of the substantive contract would be the law of Brazil. This was seen to be a strong indicator that the law of Brazil was the implied choice to govern the arbitration agreement, as parties usually intend for the entire contract to be governed by the same law. Further, there was a close commercial connection between the policy and Brazil, including the parties, the subject matter of the insurance and the currency and language of the policy. However, despite the factors in favour of an implied choice of Brazilian law, the court found two important countervailing factors. 3
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(i)
The parties chose London as the seat of the arbitration, which suggests that they may have intended for English law to govern all aspects of the arbitration agreement. (ii)
The Appellants claimed that Brazilian law rendered the arbitration agreement enforceable only under their consent. However, most arbitration agreements permit either party to refer disputes to arbitration. Here, there is nothing to indicate that the parties intended for arbitration to be available only at the option of one party, suggesting that the parties did not intend for the arbitration agreement to be governed by Brazilian law. In light of the above, the court was unable to find that the parties had made an implied choice of Brazilian law for the arbitration agreement. Moving on to the third stage of assessment, it found instead that English law had the closest and most real connection with the arbitration agreement. This was because London was the chosen seat of arbitration, meaning that English law would exercise the supporting and supervisory jurisdiction necessary. Therefore, it was held that the proper law of the arbitration agreement was English law, and not Brazilian law. Concluding Words
The court observed that while it is common for parties to make an express choice of law to govern their contract, it is unusual to make an express choice of law to govern an arbitration agreement contained within that contract. The assumption is that the law governing the substantive contract will also apply to the arbitration clause. However, as demonstrated here, that is not always true. Contract drafters may thus consider specifying the proper law of arbitration agreements in order to avoid uncertainty. Alternatively, they should also be aware of other laws which the arbitration agreement may have a close connection with, as well as the potential consequences of these different laws. For example, in this case, the law of Brazil could change the arbitration agreement from one which could be invoked by either party to one which could only be activated upon the agreement of the Appellant. This is a serious practical consequence, and drafters would do well not to be caught unawares. 4
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[email protected]
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