Overview

The doctrine of competence-competence is one of the most fundamental pillars sustaining international arbitration. From a practical standpoint, it is hard to imagine that international arbitration could have developed as much as it has if this principle were not considered a true doctrine.

According to Gary Born, the principle of competence-competence – which is universally recognised in all developed national legal systems, international arbitration conventions, legal scholars' writings and judicial decisions – "is used to describe an international arbitral tribunal's power to consider and decide disputes regarding its own jurisdiction".(1) Therefore, state courts are generally not permitted to decide jurisdictional conflicts, but must await the arbitrator's jurisdictional decision regarding its own competence.

Nevertheless, despite being almost universally accepted, there are certain exceptional situations and grey areas regarding the application and interpretation of this principle, especially with regard to the allocation of jurisdictional competence between arbitral tribunals and state courts. This is particularly true in relation to the timing and binding nature of state court decisions on issues relating to jurisdictional matters in cases where an arbitration agreement exists. For example, Article 8(1) of the United Nations Commission on International Trade Law (UNCITRAL) Model Law provides that state courts must refer to arbitration a claim that is allegedly subject to arbitration "unless it finds that the said agreement is null and void, inoperative or incapable of being performed."

Thus, the basic structure of the UNICTRAL Model Law allows for the interlocutory judicial decision of jurisdictional issues to occur before an arbitral decision. In other words, Article 8(1) grants state courts the power to decide on jurisdictional matters arising from an arbitration clause (eg, its existence, validity, legality and scope) before the arbitral tribunal renders its decision.

This update analyses the legal background of the competence-competence doctrine under Brazilian law, as well as the Sao Paulo State Court's recent decision, which declared an arbitration clause null before any decision was rendered by the arbitral tribunal.

Competence-competence under Brazilian law

As previously stated, despite a near consensus on the basic doctrine of competence-competence, different legal systems have varying approaches to the implementation of this principle. In particular, several legal systems have significant differences in the allocation of competence to rule on jurisdictional conflicts between state courts and arbitral tribunals and the appropriate role of state courts when deciding on such conflicts.

Article 8 of the Arbitration Law (9,307/96) regulates the principle of competence-competence:

"The arbitration clause is autonomous in relation to the agreement in which it is inserted, whereupon the nullity of the agreement does not necessarily implicate the nullity of the arbitration clause.

Sole paragraph. It is the arbitrator's duty to decide, on his own motion, or at the request of the parties, issues regarding the existence, validity and effectiveness of the arbitration agreement and of the contract that contains the arbitration clause."

In reading Article 8, it is clear that there is no express provision in the law regarding state courts' right to rule on jurisdictional matters (eg, the existence, validity, effectiveness and scope of an arbitration clause) before the constitution of the arbitral tribunal when an arbitration clause is manifestly null – for instance, as stipulated by the UNCITRAL Model Law.

While there have been Superior Court of Justice and state court cases demonstrating that the legislature has an arbitration friendly and pro-arbitration stance,(2) the Sao Paulo State Court recently rendered a decision in a case concerning a franchise agreement, declaring the nullity of the arbitration clause inserted into the agreement before any decision was given by an arbitral tribunal.(3)

It is important to consider the reasons why the Sao Paulo State Court refrained from applying the principle of competence-competence and instead declared the arbitration clause null.

Decision

In the case at hand, the Sao Paulo State Court was faced with a dispute between the contracting parties to a franchise agreement. The franchisee had requested the cancellation of the agreement and the annulment of the arbitration clause.

First, the judge rapporteur recognised that the Brazilian legal system provides for competence-competence as a general rule. However, given the circumstances of this case, he declared the arbitration clause in the relevant franchise agreement to be null.

The main argument for nullity was that the franchisor was allegedly participating in a fraudulent scheme, with the supposed goal of misleading dozens of inexperienced entrepreneurs who used the company's business.

Below is a relevant portion of the judge rapporteur's decision:

"In situations such as this one, where there are repeated complaints against the abnormality of the generalized contract, the Judiciary must act in favor of legal certainty and hereby declare the nullity of the clause included contra legem. The system of combating the fraudulent scam that puts dozens of inexperienced people at risk… cannot suffer formal obstacles, such as admitting the absolute competence of the arbitrators previously deciding the validity or ineffectiveness of the arbitration clause (art. 8, Law 9,307/96)."

According to the Sao Paulo State Court's understanding, the franchisor allegedly used the arbitration clause in the franchise contracts to hinder the franchisees' access to justice (in the case at hand, most were individual entrepreneurs with little business experience and background).

The franchisor, which operated in the automotive sector and sold sealing products for tyres, executed several franchise contracts to expand its business. All of the agreements contained an arbitration clause. Nevertheless, the Sao Paulo State Court found that the formation of the franchisee network had the spurious goal of deceiving the franchisees, offering fake and illusory expectations of profit.

At least 11 franchisees of the same company had gone to court seeking termination of their franchise contract based on the same argument and requesting that the respective arbitration clauses be declared null.

The decision analysed herein does not violate the principle of competence-competence; instead, it adapts its application in accordance with the context of the case. In addition, there are other precedents where state courts have ruled in favour of the evident and manifest nullity of an arbitration clause before the constitution of the arbitral tribunal.(4) Brazilian legal scholars also admit that this possibility exists in exceptional cases, affirming that the principle of competence-competence cannot and must not be absolute.

Comment

This decision applies the principle of competence-competence based on the particular facts of the case, removing the need for the arbitral tribunal's ruling on the validity of an arbitration clause that was clearly null, and can thus be considered an efficient decision from an economics standpoint.

Therefore, this decision can be considered an exception to Brazilian case law, due to the circumstances of this particular case, since the Superior Court of Justice and the main state courts have rendered several decisions submitting claims to arbitral tribunals when an arbitration clause exists – decisions which have privileged arbitration and contributed to the positive development of arbitration in Brazil.

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For further information please contact Luciano Timm, Marcelo Richter or Isabela Popolizio Morales at Carvalho, Machado & Timm Advogados (+55 11 2872 4760) or email (ltimm@cmtlaw.com.br, mrichter@cmtlaw.com.br or ipopolizio@cmtlaw.com.br). The Carvalho, Machado & Timm Advogados website can be accessed at www.cmtlaw.com.br.

Endnotes

(1) This update is not an exhaustive overview of the principle of competence-competence – in particular given the existence of several different approaches, at times divergent, to this principle in different legal systems. Notably, Gary Born points out that:

"there is almost equally broad disagreement and uncertainty concerning the doctrine's precise scope and consequences. With remarkable and unusual diversity, leading legal systems take substantially differing approaches to the arbitral tribunal's competence-competence and to the related allocation of jurisdictional competence between arbitrators and national courts". (BORN, Gary B International Commercial Arbitration, Kluwer Law International, p 853).

(2) For further details please see "Superior Court of Justice suspends execution lawsuit and declares arbitral tribunal competent".

(3) Civil Appeal 1121895-77.2015.8.26.0100, 1st Commercial Chamber, Judge Rapporteur Enio Zuliani.

(4) Civil Appeal 0010032-70.2011.8.26.0037, Sao Paulo State Court:

"Particularities of the concrete case to indicate the manifest abuse of the contractual provision of the arbitration clause. Clause executed without the minimum remnants of equality and freedom to contract, since there is no power, and even less freedom that enabled the co-plaintiffs to object to the arbitration clause, even addressed to a clearly partial "Court". Inexistence, therefore, binding effect."