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The Contract or the Seat? Final word from the Supreme Court on the Proper Law of Arbitration Agreements14 December 2020

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In Enka Insaat Ve Sanayi AS v OOO “Insurance Company Chubb” & Ors¹, the UK Supreme Court has handed down a significant decision on the proper law governing arbitration agreements, an “intriguing” question which, as Lord Burrows noted, courts and commentators have been grappling with for many years. Although the majority ultimately upheld the Court of Appeal’s decision that in this case the law governing the arbitration agreement was the same as the law of the seat, the Supreme Court held that where the parties have specified which law should govern the underlying contract, the inference is that such a choice is also intended to apply to the arbitration agreement. Will this decision finally settle the debate and lead to greater clarity and predictability for commercial parties?

"The Supreme Court held that where the parties have specified which law should govern the underlying contract, the inference is that such a choice is also intended to apply to the arbitration agreement."

BACKGROUND

The proceedings concerned a contract between a Turkish construction and engineering company, and a Russian employer (whose rights were eventually subrogated to Chubb Russia). Somewhat unusually, the contract was silent as to which country’s laws it was to be governed by, although both the Court of Appeal and the Supreme Court considered it was governed by Russian law. The contract also contained a dispute resolution clause that provided that all disputes were to be finally settled by ICC arbitration in London (the “Arbitration Agreement”). This clause was similarly silent as to the proper law governing the Arbitration Agreement (the “AA Law”).

Neither the Court of Appeal nor the Supreme Court had much difficulty in deciding that the choice of London as the seat of arbitration conferred curial jurisdiction on the English courts; that is, supervisory or procedural jurisdiction to ensure that the Arbitration Agreement was honoured (including the power to grant an anti-suit injunction preventing the parties from initiating court proceedings in separate jurisdictions, in breach of the Arbitration Agreement).

A far more nuanced question, however, was what the AA Law itself was in circumstances where (1) there had been no express choice of law between the parties; and (2) the main contract was held to be governed by Russian law, while the seat of the arbitration was in England (and therefore subject to the English courts’ curial jurisdiction). Put simply, should the AA Law be the law of the main contract, or that of the seat?

Determining the AA Law can be a point of some practical significance, as it governs an arbitration agreement’s interpretation, scope and validity. It can determine, in other words, what matters can and cannot be referred to arbitration, including whether tortious claims are covered by the arbitration agreement, or whether non-signatories can be a party to the arbitration.

THE SUPREME COURT JUDGMENT

The majority judgment of the Supreme Court, delivered by Lord Hamblen and Lord Leggatt, agreed with the Court of Appeal that the AA Law was English law. They reached this conclusion, however, by very different reasoning.

"The Supreme Court noted that the curial law is conceptually distinct from the AA Law, and that an English court exercising its supervisory/curial jurisdiction was perfectly capable of deciding questions under foreign law if necessary."

Has there been an express or implied choice of AA Law?

The justices observed that an English court will apply English common law rules in determining the AA Law. This means that the applicable law will be the law chosen by the parties or, in the absence of such a choice, the system of law with which the Arbitration Agreement is most closely connected.  In order to assess whether the parties have agreed on a choice of AA Law, they considered that it was necessary to construe both the Arbitration Agreement, and the contract containing it, applying usual rules of contractual interpretation, and emphasised that the parties may have made an “implied” choice, even if their contract does not contain an express governing law clause.

The justices held that, as a general rule, a choice of law clause governing the main contract should also be construed as applying to an arbitration agreement set out, or otherwise incorporated, in the contract. In their view this approach provides a degree of certainty, assuring parties that an agreement as to governing law will usually be an effective choice in relation to all of their contractual rights and obligations, and all of the disputes, as well as achieving consistency and avoiding complexity, ensuring that the same system of law governs all the parties’ rights and obligations.

This is a quite different approach to that recommended by the Court of Appeal, which proposed a general rule – that the AA Law (absent an express choice) should be the same as the curial law (i.e. the law of the seat). The Supreme Court disagreed that the choice of the seat of arbitration was capable of being construed as an implied choice as to the AA Law, noting that the curial law is conceptually distinct from the AA Law, and that an English court exercising its supervisory/curial jurisdiction was perfectly capable of deciding questions under foreign law if necessary.

It was only if there were additional factors which would negate the inference that the AA Law was the same as the express governing law of the main contract that the choice of a different country as the seat of the arbitration would be relevant. One such factor would be a serious risk that the arbitration agreement would be ineffective or invalid if governed by the same law as the underlying contract (as may be the case if the wording of the arbitration agreement is incompatible with the relevant law and/or would not be enforceable under that law).

With which system of law is the Arbitration Agreement most closely connected?

"It was only if there were additional factors which would negate the inference that the AA Law was the same as the express governing law of the main contract that the choice of a different country as the seat of the arbitration would be relevant."

However, the Supreme Court held that the law of the seat will be of significance if there is no express or implied choice of AA Law, since in such a circumstance it is necessary to determine with which law an arbitration agreement is most closely connected. In the majority’s view, this will generally be the law of the seat, even if it is different from the law applicable to the parties’ substantive contractual obligations.

Given that the majority considered that the law of the main contract in this case was Russian law only by application of the “closest connection” test (and not by virtue of even an implied choice), the justices considered that the Arbitration Agreement naturally had a closer connection with the law of the seat, in part because the Arbitration Agreement was being performed in London, even though the main contract (i.e. the construction contract) was being performed in Russia. The AA Law was thus found to be English law.

THE DISSENTING JUDGMENTS

Dissenting judgments were given by Lords Burrows and Sales who were both of the view that the AA Law ought to be the same as the law of the main contract.

Even if, the minority added, it was only by the application of the “closest connection” test that Russian law had been found to govern the underlying agreement, the presumption that the same law should govern the AA Law still applied. This was in part because the minority disagreed that the Arbitration Agreement was as separable from the main contract as the majority had treated it, Lord Burrows noting that separation was the exception, not the rule, and that dividing the Arbitration Agreement from the main contract could cause confusion and a number of a practical difficulties.

CONCLUSION

"If the law of the main contract presents unusual consequences in terms of the scope of disputes that are referable to arbitration, an express choice of AA Law within the arbitration agreement itself will achieve the greatest degree of certainty."

In practice, of course, it is rare for commercial contracts of this scale to be silent as to the applicable governing law. Where there has been an express choice of law (or where an implied choice of law can be discerned), the clear rule that emerges from the Supreme Court’s decision is that the law of the underlying contract will usually be the law of the arbitration agreement as well.

In many respects, the Supreme Court’s decision makes sense from a business perspective. Most commercial parties are unlikely to appreciate that arbitration agreements are a separate species of clause to which a different law might apply, and a degree of clarity and consistency is therefore achieved by adopting this new general rule. But commercial parties may not all think alike. The Court took the view that considerations of neutrality applied to the quality and integrity of the decision maker and rarely had anything to do with the proper law to be applied. However, a commercial party who selects arbitration seated in London for neutrality reasons may be surprised to find that the neutrality does not extend to the interpretation of the arbitration agreement itself.

With that said, there may be instances where the law of the underlying contract places limitations on the scope of disputes that may be adjudicated, whereas such limitations would not apply under the law of the chosen seat. Parties may not necessarily be aware of these limitations when the contract is formed, and while it is unusual for commercial parties to negotiate over the AA Law specifically, in light of the Supreme Court’s decision parties should adopt an increased consciousness of these issues in the future. Procedurally, if the Supreme Court decision increases the likelihood of English courts having to decide questions of foreign law when exercising its supervisory/curial jurisdiction, this would be an unwelcome development in terms of efficiency and cost effectiveness. In any event, if the law of the main contract presents unusual consequences in terms of the scope of disputes that are referable to arbitration, it is important that parties are aware of such consequences from the outset. In such circumstances especially, an express choice of AA Law within the arbitration agreement itself will achieve the greatest degree of certainty.

[1] [2020] UKSC 38

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