The law applicable to an arbitration agreement: Part 1 of our analysis of Enka v OOO Insurance

Articles
02 Dec 2020

In the eagerly awaited judgment in Enka Insaat Ve Sanayi AS v OOO Insurance Company Chubb [2020] UKSC 38, the Supreme Court finally settled an important issue in the law of arbitration that has long divided the authorities and commentary: in the absence of a choice by the parties, where the law applicable to the main contract differs from that of the seat, it is the law of the seat that governs the validity and scope of the arbitration agreement.  Our Overview on the decision sets out the key holdings; Part I (below) of our commentary on the decision examines the reasoning of the Majority in greater depth. 

Background

The appeal concerned the determination of the law applicable to an arbitration agreement in the following terms:

    1. If [the matter cannot be resolved by negotiations], the Dispute shall be referred to international arbitration as follows:
    • the Dispute shall be finally settled under the Rules 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.

No express choice of law had been made to govern the arbitration agreement, and the main contract contained no express governing law clause. For the background facts and procedural history of the case, see our commentary on the decision of the Court of Appeal.

Whilst the majority in the Supreme Court upheld the decision of the Court of Appeal that English law governed the arbitration agreement, it differed on the reasoning.  Part I of our detailed analysis on the decision of the Supreme Court therefore focuses on the reasoning of the majority, drawing particular attention to the points of principle upon which the Supreme Court itself was divided, as well as where they differed from the Court of Appeal.

The Majority Decision: Lord Hamblen and Lord Leggatt, with whom Lord Kerr agreed

The Majority held that the parties had not chosen, either expressly or impliedly, a choice of law governing the main contract; and considered that this was unlikely to  have been accidental but, rather, that the parties had not been able to agree on a choice of the governing law.  The law governing the arbitration agreement was, therefore, to be construed by reference to the place with which it had the ‘closest and most real connection’ under the English common law rules.  Although the Majority, like the Court of Appeal, concluded that the law applicable to the arbitration agreement was English law, it differed significantly in its approach to the determination of the issue.

Important points in the reasoning are as follows:

  1. The Putative Applicable Law of the Contract: Determined by the Law of the Forum

The majority began with the proposition that, where an English court has to determine which law governs an arbitration agreement incorporated in a contract, it is the common law rules alone which the court must apply, because of the exclusion of arbitration agreements from the scope of the Rome I Regulation by article 1(2)(e).

Under the common law rules of conflict of laws, where the court must determine whether a contract said to be governed by a foreign system of law is valid, the court applies the “putative applicable law”, i.e., the law which would govern the contract if it were validly concluded. At the prior stage, however, of determining what the applicable law or putative applicable law of the contract is, the leading authorities proceed on the basis that it is English rules of law which apply.

The majority therefore considered it both consistent with authority and sound in principle to apply English law, as the law of the forum, to ascertain whether the parties have agreed on the law which is to govern their contract and, if not, what law governs it in the absence of agreement.

This is of particular note, as the approach differs from that taken by the Court of Appeal, which held that in construing the contract to determine whether a choice of governing law applies to an arbitration agreement within it, the court should apply the principles of construction of the main contract law if different from English law (cited at [34]).  The majority did not consider this to be correct, and clarified at [34] that the proper approach is:

…”to apply English law as the law of the forum. Where the question is whether there has been a choice of the law applicable to an arbitration clause, the relevant English law rules are the common law rules which require the court to interpret the contract as a whole applying the ordinary English rules of contractual interpretation. The main contract law, if different, has no part to play in the analysis.”

The English common law rules of whether the parties had agreed a choice of law to govern the contract were not in dispute: a contract (or relevant part of it) is governed by: (i) the law expressly or impliedly chosen by the parties; or (ii) in the absence of such choice, the law with which it is most closely connected.  The majority confirmed at [28] that this broadly aligns with the position under the Rome I Regulation (albeit that the Rome I Regulation ought not to be interpreted through the prism of the common law), and that cases in which the two regimes would yield different results are likely to be rare.

2.  Dépeçage and the Doctrine of Separability

Although English law recognises the conflicts of law principle of dépeçage, i.e. that different obligations under the same contract may be governed by different laws, the Majority noted that the common law will not “split a contract in this sense readily or without good reason”  (Kahler v Midland Bank Ltd [1950] AC 24, 42 per Lord MacDermott; cited at [39]).  That the obligation in question is an arbitration agreement is, in itself, immaterial: the principle that, unless there is good reason to conclude otherwise, all the terms of a contract are governed by the same law applies to an arbitration clause, as it does to any other clause of a contract. Where, therefore, there is a clear choice of law governing the main contract, this generally is to be construed as applying to an arbitration agreement set out or otherwise incorporated in the contract.

Dépeçage and the doctrine of separability in the law of arbitration, though prima facie similar, should not be conflated.  As the Majority accepted, the principle of separability does not mean that an arbitration agreement is to be treated as a distinct agreement for all purposes.  Rather, the doctrine of separability requires that an arbitration agreement is to be treated as distinct from the main contract only for the purpose of determining its validity or enforceability.  This was held to be clear from  the wording of section 7 of the Arbitration Act 1996.

Thus, at [62]:

“Descriptions of an arbitration clause as, for example, “collateral to the main contract in which it is incorporated” (Paal Wilson & Co A/S v Partenreederei Hannah Blumenthal (The Hannah Blumenthal) [1983] 1 AC 854, 917, per Lord Diplock) or “a separate contract, ancillary to the main contract” (Bremer Vulkan Schiffbau und Maschinenfabrik v South India Shipping Corpn Ltd [1981] AC 909, 998, per Lord Scarman) need to be seen in their context as ways of expressing the doctrine that the discharge by frustration (or for other reasons) of the substantive obligations created by the contract will not discharge the parties’ agreement to arbitrate.”

Nor, therefore, does the separability principle require that an arbitration agreement should be treated as a separate agreement for the purpose of determining its governing law.  As Moore-Bick LJ said in Sulamérica Cia Nacional de Seguros SA v Enesa Engenharia SA [2012] EWCA Civ 638 at [26] (cited at [63]):

“The concept of separability itself, however, simply reflects the parties’ presumed intention that their agreed procedure for resolving disputes should remain effective in circumstances that would render the substantive contract ineffective. Its purpose is to give legal effect to that intention, not to insulate the arbitration agreement from the substantive contract for all purposes.”

This too marks a significant difference from the approach taken by the Court of Appeal, which the Majority considered put the principle of separability too high.

3.  Is choice of an English seat an implied choice for English law to govern the arbitration agreement?

As the Majority noted, although it is rare that an express choice of law is identified in respect of an arbitration clause, it is common for such express choice to be made in respect of the contract as a whole.  A typical clause to the effect of the latter is: “This Agreement shall be governed by and construed in accordance with the laws of [name of jurisdiction].” The difficulty of the present case was, however, that no such express choice had been made for the contract as a whole in those terms.

The Court of Appeal had been willing to accept that an express choice of the law applicable to the whole contract may amount to an express choice of the law applicable to the arbitration agreement contained within it, but that this conclusion would follow only in a minority of cases; as a general rule, there is a strong presumption that the parties have impliedly chosen the law of the seat of the arbitration to govern the arbitration agreement (cited at [59]).

The essential reasoning of the Court of Appeal turned on ‘the overlap argument’,’ i.e. that the substance and process of arbitration are so closely intertwined, both generally and under the Arbitration Act 1996, that separating them would be an “artificial division.”  Thus, the Court of Appeal concluded that “the overlap between the scope of the curial law and that of the [arbitration agreement] law strongly suggests that they should be the same” (cited at [66]).

The Majority did not agree with this proposed general rule.  Although recognising that the nature and scope of the jurisdiction exercised by the courts of a country over an arbitration is a highly material consideration in choosing a seat, such choice went to the curial law alone.  This was held to be clearly distinct from the law to determine the validity and scope of the arbitration agreement. Whether, therefore, a choice of the curial law carries any implication that the parties intended the same system of law to govern the arbitration agreement – and, if so, the strength of any such implication – must depend on the content of the relevant curial law.

4.  Implied Choice of Law Under The Arbitration Act 1996 and the Common Law of Contract

The Majority noted that the arbitration laws of several other jurisdictions, notably Scotland and Sweden, provide that a choice of seat amounts to an implied choice of law to govern the arbitration agreement.  In contrast, however, the Arbitration Act 1996 contains no such provision, and section 4(5) and its legislative history (discussed at [76]-[80]) specifically provides for a situation in which the arbitration agreement will be governed by a foreign law, notwithstanding that English law governs the arbitration process [73].  No inference could, therefore, be drawn by reference to the Arbitration Act 1996 that the parties impliedly chose English law to govern the arbitration agreement by choosing an English seat for the arbitration.

By contrast, under the ‘validation principle’ of English contractual interpretation, the courts may find an implied choice of English law to govern an arbitration agreement if such construction would uphold its validity, rather than defeat its purpose and/or render it null and void.  There is a very powerful inference that the parties could not rationally have intended another law to govern the arbitration agreement if the arbitration agreement would be void or of no legal effect under that law.  The Majority at [109] endorsed the formulation of Moore-Bick LJ in Sulamérica at [31], that commercial parties are generally unlikely to have intended a choice of governing law for the contract to apply to an arbitration agreement if there is “at least a serious risk” that a choice of that law would “significantly undermine” that agreement.

5.  The Default Rule Under the “Closest Connection” Test

As the parties had not made any choice of the law governing the arbitration agreement, either expressly or impliedly, the Majority therefore applied the third limb of the common law rules, i.e. the “closest and most real connection” test.   The Majority noted that this operates as a positive principle of law: if the court cannot ascertain an intention – express or implied – of the parties as to the law which is to govern their agreement:

…”it becomes necessary for the court to proceed to the second stage, of determining itself what is the proper law applicable… this is applied as a positive rule of English law. It is applied not because it is the choice of the parties themselves but because they never intended to exercise their liberty to make a choice or, if they did, they have failed to make their choice clear.  (Cie Tunisienne de Navigation SA v Cie d’Armement Maritime SA [1971] AC 572, 603-604, per Lord Diplock, cited at [36]).”

The Majority considered that, as a positive rule of law applied objectively and irrespective of the parties’ intentions in the absence of a choice, there were many reasons why, as a default rule, the law of the seat should govern the arbitration agreement.

First, the seat of arbitration is – legally, if not necessarily physically – the place where the arbitration agreement will be performed.  The place of performance has long been the connecting factor to which the common law places the greatest weight when determining the system of law with which a contract, or part of it, has its closest or most real connection.  By contrast, the Majority found no reason to regard the place of performance of the substantive obligations created by the main contract as a significant connecting factor, because the subject matter and purpose of an arbitration agreement are different from those of the contract in which it is incorporated.

Furthermore, a second and “compelling” reason for treating an arbitration agreement as governed by the law of the seat of arbitration in the absence of choice was that such construction accords with international law as embodied in the 1958 New York Convention and other international instruments.

Under Article V(1)(a), Convention States may refuse recognition or enforcement of an award upon proof that the arbitration agreement “is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made.”  Thus, Article V provides a clear conflicts of law scheme for an arbitration agreement: the court is to apply (i) the law chosen by the parties; or, failing any indication thereon, (ii) the law of the country where the award was made.

Article II(3) is also framed by reference to the arbitration agreement: Convention States must order a stay on proceedings brought in breach of an arbitration agreement, unless satisfied that the arbitration agreement is null, void, or incapable of being performed.  Although, unlike Article V, Article II does not expressly provide a conflicts of law scheme, the Majority was persuaded by the “strong and widely accepted argument” that the Convention is to be interpreted as requiring the conflicts rule set out in Article V(1)(a) to be applied to Article II(3).

Ultimately, the Majority’s reasoning (at [135]-[136]) turned on logic and coherence:

….”where the parties have not chosen the law of the arbitration agreement but have chosen the seat of arbitration, it would be illogical if the English courts were to treat the validity of the arbitration agreement as governed by the law of the seat if the parties have chosen a foreign seat [i.e. when the English courts are considering enforcement of an arbitration award made in another Convention State], but by the law of the main contract if they have been chosen [sic] an English seat of arbitration.  Such approach would be all the more incoherent given that, if proceedings were brought in another Convention state to enforce an award made in England, the foreign court would apply the law of the seat (and not the law of the main contract, if different) to determine the validity of the award as required by article V(1)(a) of the Convention.

…It would be equally illogical if the law governing the validity of the arbitration agreement were to differ depending on whether the question of validity is raised before or after an award has been made.”

Accordingly, the Majority considered it would wrong for the English common law to adopt a rule which treated the law of the main contract as applicable to the arbitration agreement in the absence of choice, as this would be out of step with both the legislative policy of the Arbitration Act 1996 and the underlying uniform rule established by the New York Convention.

The Majority also considered that such a default rule would: thirdly, give effect to commercial purpose; and fourthly, provide legal certainty.  However, the Majority recognised a case for making an exception to the default rule where the arbitration agreement would be invalid under the law of the seat but not under the law governing the rest of the contract.

Commentary

Key to the reasoning of the Majority was that the parties had not, expressly or impliedly, chosen a governing law for the main contract.  Accordingly, the Majority applied the third limb of the English common law rules for determining the law applicable to a contract or to part of it: the law with which the agreement has its closest and most real connection.  The Majority noted that this rule operates as a positive principle of law and is not concerned with the parties’ intentions; the rule applies precisely because the parties have not made their intentions clear.

In formulating a default rule for the third limb of the test, the Majority found the most “compelling” reason for treating an arbitration agreement as governed by the law of the seat of arbitration, rather than the law applicable to the main contract, to be that such construction accords with international law as embodied in the 1958 New York Convention, as implemented into domestic law through the Arbitration Act 1996.  In doing so, the Majority identified a number of problematic scenarios which could arise if the default rule were different, and instead applied the law governing the whole of the contract.

Interestingly, the Majority did not address the question of whether courts in other jurisdictions might regard an ‘implied choice’ of law for an arbitration agreement as constituting “the law to which the parties have subjected it” for the purposes of Article V(1)(a) of the 1958 New York Convention or whether foreign courts might regard that wording in Article V(1)(a) as requiring an express choice.  If the latter, the reasoning of the Majority in relation to implied choice might give rise to just the sort of difficulties contemplated in this passage of the leading judgment.  That said, this risk ought not to be overstated: ‘implied choice’ is a long-established part of English conflicts of law rules (without obviously apparent ill effect), and has a footing in international law in Article 3.3 of the Rome I Regulation (albeit that the wording of that provision differs significantly from that of Article V(1)(a) of the New York Convention).

Ryan Hocking
November 2020

 

Author

Ryan Hocking

Call: 2014

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