The law governing the arbitration agreement: Why we need it and how to deal with it

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Amanda Nunes Sampaio
Demarest Advogados, Sao Paulo, Brazil
ansampaio@demarest.com.br

The problem

International arbitration constantly relies on choice-of-law rules to determine which law should apply to which aspect of the dispute. There are usually more than one national system of law bearing upon an arbitration proceeding and sometimes tribunals invest too much time determining which one is to apply to a precise matter.

Article II of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the ‘Convention’) allows the courts to decline a request to refer parties to arbitration if the agreement to arbitrate is ‘null and void, inoperative or incapable of being performed’. However, the provision does not indicate which law determines so, nor does it appoint a choice of law rule to be followed.

The theory and practice of arbitration created the fiction of separability (or ‘severability’) to preserve¹ and insulate² the arbitration agreement from its underlying contract. Coupled with party autonomy and consent, it is one of the cornerstones of international arbitration.³ Although not absolute,⁴ such presumption leads to the autonomy of the arbitration agreement⁵ and the idea that the law applicable to the underlying contract does not automatically apply to the arbitration clause – although parties may agree upon a choice-of-law clause that expressly applies to both. All jurisdictions favourable to arbitration accept the separability presumption to some extent, whether from common or civil law.⁶

But what is the law that governs the arbitration agreement? Is this inquiry important at all?

Since parties frequently fail to agree upon the law governing their agreements to arbitrate, courts and tribunals apply different choice of law rules to find the applicable law to the agreement, and multiple options might be considered – that is, the law governing the underlying contract, the law of the seat, the law with the closest connection with the arbitration, principles and rules internationally accepted and a validation principle that gives effect to the agreement to arbitrate. This exercise is time consuming and costly, and hence directly impacts on the efficiency of the arbitral proceeding.

This article focuses on the importance of agreeing upon an applicable law to the arbitration agreement at the outset and finding the most suited approach to determining which law applies in the absence of parties’ choice.

Why is it important? Practical matters controlled by the law governing the arbitration agreement

The law governing the arbitration agreement will decide matters of formal and substantive validity, formation, termination, interpretation, assignment and waiver of the arbitration agreement. If it is not specified, a choice-of law rule will be applied to find it.

Besides being costly and time consuming, such process may ensue the application of a law that parties attempted to avoid in the first place, because discussions about the validity of the arbitration agreement regularly wind up in national courts when one of the parties moves to prevent the other to commence arbitration – for example, one party argues that it has not given its consent to arbitrate or holds that the issue under dispute is not arbitrable considering the scope of the clause, among other examples. When national courts, instead of arbitral tribunals, must decide on the validity of an arbitration agreement, they are likely to apply their lex fori – which usually relates only to the moving party – especially when the court is not arbitration-friendly.

Laws potentially applicable to the arbitration agreement

Since international arbitral tribunals are not bound by any sort of lex fori, when arbitrators face a challenge to the arbitration agreement they tend to apply a body of law that connects somehow with the arbitration because it was chosen by the parties to govern some other aspect of their arrangements.

The first solution that comes into mind is to extend the law applicable to the underlying contract where the arbitration clause rests.⁷ It is an interpretation of parties’ choice, assuming they have impliedly chosen the law to govern their arbitration agreement. This approach is seen in the Sulamerica case.⁸ Here, the main agreement – an insurance policy – was governed exclusively by Brazilian law. London was chosen as the seat of arbitration. The insurers commenced arbitration without respecting a multi-tiered dispute resolution clause and consequently the insured companies filed court proceedings in Brazil. Thereafter, the insurer obtained an anti-suit injunction by the English High Court to suspend proceedings in Brazil. The insured companies appealed the injunction, arguing that under Brazilian law the arbitration clause could not be invoked against them without their consent. This issue of whether the arbitration clause could be invoked was to be determined by the law governing the arbitration agreement. The English High Court firstly understood that, in the absence of an express choice of law for the arbitration agreement, parties are assumed to have intended the whole of their relationship to be governed by the same system of law, that is, the choice of law for the underlying agreement. However, because the Court concluded that Brazilian law – which governed the main agreement – would invalidate the arbitration agreement, it concluded that parties could not have impliedly chosen Brazilian law since they had indeed agreed to arbitrate. Thus, the Court ended up applying the law with the closest connection with the arbitration agreement, which was the law of the seat. In other words, the English High Court decided that there is a rebuttable presumption that, in absence of an express choice of law for the arbitration agreement, the choice made for the underlying agreement applies.

However, in light of the severability principle, it seems like moving backwards to assume that parties have impliedly decided that their agreement to arbitrate was not exactly severable, since it is governed by the same law that governs the main contract. This proposition undermines two cornerstones of international arbitration: party autonomy and separability.

The second most common option is to apply the law of the arbitral seat. One may argue, however, that implied choice might not work properly for this proposition. Since the seat is frequently chosen, among other reasons, because of its arbitration laws – laws of procedure – it is difficult to defend that when parties elect the seat they impliedly define that the substantive law of the seat would govern matters related to their arbitration agreement, such as validity, formation, etc. Likewise, the law of the seat is not always chosen by the parties – for example, agreements in which parties fail to appoint a seat and the arbitral institution or even arbitrators must do so. Hence, it may be unreasonable to consider that the validity of the agreement depends upon a choice made ex post by a third party – institution or tribunal – who would be basically picking a law to govern the agreement to arbitrate without considering parties’ intention. On the other hand, the ex post choice only takes place because parties had impliedly delegated such choice to the third party, therefore, one could argue that, by force of law, the third party’s decision reflects the contractual parties’ own will.

The application of the law of the seat is reflected in the Firstlink case.⁹ In this case, one party moved to compel arbitration based on an arbitration clause providing for the proceeding before the Arbitration Institute of the Stockholm Chamber of Commerce seated in Sweden. The choice of law clause for the underlying agreement provided that it was ‘governed by and interpreted under the laws of Arbitration Institute of the Stockholm Chamber of Commerce’. Hence, the other party resisted to the action to compel arbitration by arguing the invalidity of the arbitration agreement. The Singapore High Court expressly disagreed to the rebuttable presumption created in SulAmérica, stating that ‘it cannot always be assumed that commercial parties want the same system of law to govern their relationship of performing the substantive obligations under the contract, and the quite separate (and often unhappy) relationship of resolving disputes when problems arise’. The Court decided that in absence of an express choice of law, the assumption should be that parties have impliedly chosen the law of the seat of arbitration to govern their arbitration agreement.

To assume that parties in arbitration implied anything is not ideal, but this proposition trumps the previous one simply because it does not undermine separability. Either way, and putting the ‘implied choice’ aside, the law of the seat seems to be the one that generally has the closest connection with the arbitration. A persuasive argument in favour of the law of the seat can be found in the Convention, by application of the choice of law rule contained in article V(1)(a): if the law of the seat is to be considered for the arbitration agreement after the award was rendered, why should such law not be considered for the same agreement before the award is made, in an article II(3) context? The approach is convincing since ‘[t]he fact that no reference to these conflict rules was made in Article II is not to be interpreted e contrario, but may rather be considered another omission due to the last-minute insertion of provisions relating to arbitration agreements in the Convention’.¹⁰

Following this analogous application, one might say that when facing a challenge to the arbitration agreement, an adjudicator should advance and apply the public policy and arbitrability laws of the judicial forum where the resulting award may be enforced, considering article V(2) of the Convention. This argument might seem reasonable from the perspective that the arbitrators have the duty to render an award that is enforceable, but rules of arbitrability and public policy rarely give answers to all possible challenges to arbitration agreements. Generally, this formula cannot be transposed to the primary stage of enforcement of agreements and has been rejected by courts that considered it.¹¹

However, an analogous application of article V(2) of the Convention has been considered from a different perspective: applying the public policy and arbitrability rules of the place where enforcement of the arbitration agreement is sought. Since the arbitration agreement will constantly be enforced in the place of the seat, there is no reason to overthink this proposition.

Another approach is the traditional locus regit actum, leading us to the law of the place where the agreement was made. However, because in the context of international arbitration the relevance of the situs shifts from the place where the arbitration agreement is concluded to the place where the arbitration will be held or the award will be rendered, this rule is not relevant for our purposes – the law of the seat will eventually be applied.¹²

Notions and principles of law internationally applied are also an influential approach. A good example is the interpretation of the article II(3) of the Convention performed by the US Third Circuit in the Rhone v Lauro case.¹³ Two Italian parties executed an agreement which contained an arbitration clause providing for arbitration in Naples, Italy. Rhone claimed the award was null and void since Italian laws required the tribunal to be formed by an odd number of arbitrators. The Third Circuit concluded that the most consistent meaning of article II(3) is that an agreement to arbitrate is ‘null and void’ only: (1) when it is subject to an internationally recognised defence such as duress, mistake, fraud, or waiver; or (2) when it contravenes fundamental policies of the forum state. Thus, the ‘null and void’ language must be read narrowly given a presumption of enforceability of agreements to arbitrate. The conclusion is reasonable since it recognises the true international character of the Convention and foster jurisdictions to get rid of their parochial practice.

Another largely seen and highly convincing approach is to apply the law of the place with the closest connection with the arbitration. This goes on a case-by-case basis and can be seen in judgments without being expressly considered, as in the Firstlink case.

The final approach is the validation principle under which all potentially applicable laws will be tested to apply the one that gives effect to the parties’ agreement to arbitrate. We can also see a tendency to this approach in judgments that do not expressly say so, such as the SulAmérica and Lauro cases. It is already adopted by Swiss national arbitration law¹⁴ and establishes ‘a pro-arbitration enforcement regime, consistent with the objectives of the New York Convention, that overcomes the complexities and uncertainties of traditional choice-of-law analysis’.¹⁵

Conclusion: adjudicators should favor the arbitration agreement

Among all approaches, none is individually perfect for determining what is the law applicable to the arbitration agreement in case parties fail to previously do so. However, there is a good recipe behind most of the propositions altogether.

All cases considered, two easy conclusions are: (1) the law of the seat tends to be applied; and (2) tribunals attempt to uphold the agreement.

Thus, since the lex arbitri – generally reflected in the arbitration laws of the seat – tends to have the closest connection with the arbitral proceeding, the substantive law of the seat tends to be the best suited to govern the arbitration agreement when parties fail to choose one. This conclusion matches the rationale behind the Convention when article V(1)(a) was drafted. However, this interpretation should depend on such law being favourable to arbitration to the extent that if parties undoubtedly agreed to arbitrate, such law will not be applied to invalidate it and submit the dispute to national courts. In other words, in the absence of parties’ choice, when the law of the seat governs the arbitral proceeding (lex arbitri), there is a rebuttable presumption that such law is the one to govern the arbitration agreement, but such presumption is rebuttable by consideration of the validation principle to always give deference to the parties’ expressed intention to submit their dispute to arbitration.

Therefore, the validation principle should be a modus operandi that guides the analysis despite the presumption. Such consideration is in line with the civil law approach of venire contra factum proprium and the common law approach of collateral estoppel.

In other words, if parties had chosen to arbitrate a given dispute, adjudicators should exercise their best to uphold such a choice – and parties should comply with it.

Notes

1. Preservation entails that the jurisdiction of the arbitral tribunal is generally preserved to adjudicate a challenge to the main contract.

2. Insulation entails that if one seeks to challenge the agreement to arbitrate, one has to address that challenge directly to such agreement. See, generally, Emmanuel Gaillard & John Savage (Eds), Fouchard Gaillard Goldman On International Commercial Arbitration 197-240 (Kluwer Law International, 1999).

3. Gary B Born, International Commercial Arbitration (Kluwer Law International, 2nd Edn, 2014), Section 3.02.

4. Preliminary Award in ICC Case No 6401, 7(1) Mealey’s International Arbitration Report, B-13-B-14, 19-20 (1992).

5. See, generally, Nigel Blackaby & Constantine Partasides QC, Redfern and Hunter on International Arbitration 103-107 (Oxford University Press, 6th Edn, 2015).

6. See, generally, Born, n 3 above.

7. Yves Derains, ‘The ICC Arbitral Process, Choice of Law Applicable to the Contract and International Arbitration’, 6, 16-17 ICC Court of Arbitration Bulletin (1995, No 1).

8. Sulamérica Cia Nacional De Seguros SA and Others v Enesa Engenharia SA[2012] EWCA Civ 638.

9. FirstLink Investments Corp Ltd v GT Payment Pte Ltd and Others[2014] SGHCR 12.

10. Reinmar Wolf, New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 163 (CH Beck – Hart – Nomos 2012).

11. Born, n 3 above, at 598.

12. Julian D M Lew, ‘The Law Applicable to the Form and Substance of the Arbitration Clause’ in Improving the Efficiency of Arbitration Agreements and Awards: 40 Years of Application Of The New York Convention, ICCA Congress Series No 9, Paris 1998, 114, 141 (Albert Jan van den Berg with the assistance of the Permanent Court of Arbitration The Hague; Kluwer Law International 1999).

13. US Court of Appeals, Third Circuit, 712 F2d 50, 6 July 1983.

14. ‘Article. 178(2): As regards its substance, an arbitration agreement is valid if it conforms either to the law chosen by the parties, or to the law governing the subject-matter of the dispute, in particular the main contract, or to Swiss law.’

15. Born, n 3 above, at 541.

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