Dispute resolution clauses are not the most glamorous of clauses in commercial agreements and therefore it is unsurprising that they are often referred to as “midnight clauses” which, as the phrase implies, are the last clauses in agreements to which parties turn their attention.

Dispute resolution clauses are often multi-tiered i.e. they include provisions for negotiation, mediation and then either litigation or arbitration. Careful thought should be given to drafting these provisions. Each of these steps needs to be clearly defined and time limits set for each stage. Where arbitration is chosen as the ultimate means of resolving a dispute, careful thought needs to be given to the laws that apply to the constituent parts of the arbitral procedure and process. This alert focuses on the law or laws which may apply to agreements where the parties have chosen arbitration as the ultimate means of resolving their disputes.

Experience shows that although parties to an agreement will stipulate the governing law of the contract they, more often or not, fail to consider the law governing the arbitration agreement, which as a matter of law is severable from the underlying contract.

The growing internationalisation of arbitration and the divergent approaches taken by different jurisdictions as to which law governs the arbitration agreement can result in the governing law of the arbitration agreement becoming the subject of lengthy and costly proceedings at the expense of resolving the substantive dispute between the parties.

In recognition of this problem, the Hong Kong International Arbitration Centre (HKIAC) has added as an option to its model arbitration clause wording which allows parties to expressly select the law governing the arbitration agreement, that wording quite simply states:

The law of this arbitration clause shall be ... (Hong Kong law).

The HKIAC recommends that “This provision should be included particularly where the law of the substantive contract and the law of the seat are different. ... It does not replace the law governing the substantive contract.

Applicable laws

In the course of an arbitration, consideration may need to be given to other applicable laws as follows in order to avoid satellite arguments:

  1. the law governing the substantive contract;
  2. the law governing the arbitration agreement;
  3. the law of the seat (place) of the arbitration;
  4. the procedural rules of arbitration; and
  5. the law of the place where the award will be enforced.

The HKIAC optional clause is clearly relevant to (b) above, i.e. the law governing the arbitration agreement. In addition, this law is also potentially relevant to “matters including the formation, existence, scope, validity, legality, interpretation, termination, effects and enforceability of the arbitration clause and identities of the parties to the arbitration clause”.

Clearly, in an ideal world, parties will make express provision for all laws applicable to their agreement, however as previously mentioned, parties often select only the law governing the substantive contract, and possibly, the procedural rules, leaving open to dispute other applicable laws such as those relevant to the arbitral tribunal and the seat (or place) of arbitration.

In circumstances where a dispute arises as to which law is applicable, recourse to the courts is likely to be required. How the court decides the applicable law very much depends upon which jurisdiction that court resides in. To make matters worse, disputes can arise as to which jurisdiction the relevant court should decide that question!

Jurisdictional divergent positions

The position in England, Hong Kong and Singapore as to how the courts approach the issue of applicable laws in the context of arbitration agreements is considered below.

1. England

Under English law, the approach generally adopted by the courts is that the law of the substantive contract will also govern the arbitration agreement. In Sulamérica CIA Nacional de Suguros SA and others v Enesa Engenharia SA and others [2012] EWHC 42 (Comm), the Court of Appeal stated:

If the court were concerned with a free-standing agreement to arbitrate in London containing no express choice of proper law, it is unlikely that there would be a sufficient basis for finding an implied choice of proper law and it would simply be necessary to seek to identify the system of law with which the agreement had the closest and most real connection. In those circumstances the significance of the choice of London as the seat of the arbitration would be overwhelming. However, where the arbitration agreement forms part of a substantive contract an express choice of proper law to govern that contract is an important factor to be taken into account. [Emphasis added]

In the absence of any indication to the contrary, an express choice of law governing the substantive contract is a strong indication of the parties' intention in relation to the agreement to arbitrate. A search for an implied choice of proper law to govern the arbitration agreement is therefore likely … to lead to the conclusion that the parties intended the arbitration agreement to be governed by the same system of law as the substantive contract, unless there are other factors present which point to a different conclusion.

The test laid out in Sulamérica for deciding the law applicable to an arbitration agreement (in order of priority) is as follows:

  1. Is there an express choice, if not;
  2. Is there an implied choice, if not;
  3. What is the law under which the [arbitration] agreement has the closest and most real connection.

This test was applied in the case of Arsanovia Ltd & Ors v Cruz City 1 Mauritius Holdings [2012] EWHC 3702 (Comm) in circumstances where the parties had expressly chosen Indian law to govern the underlying contract and London as the seat of arbitration provision. In this case, debate centred upon the relative significance of the (Indian) governing law clause compared to the (London) seat of arbitration when determining the law of an arbitration agreement. The court found that on the facts the parties had intended that Indian law should apply.

Arsanovia (the Claimant) contended that the choice of governing law of the underlying contract provided a strong indication of the parties’ intention in respect of the agreement to arbitrate. On that basis Indian law should apply. However, Cruz City argued that as the seat of arbitration was London, the law governing the arbitration agreement should be English law. Cruz City’s argument was rejected by the judge (following Sulamérica) stating that although the seat of arbitration was a factor that should be considered, it was insufficient to override the express choice of Indian law to govern the underlying contract which, again following Sulamérica, was a “strong pointer” that the parties intended the same law to apply to the agreement to arbitrate.

Reflecting these decisions, the LCIA’s new arbitration rules set to come into effect on 1 October 2014 include the following clause:

“The law applicable to the Arbitration Agreement and the arbitration shall be the law applicable at the seat of the arbitration, unless and to the extent that the parties have agreed in writing on the application of other laws or rules of law and such agreement is not prohibited by the law applicable at the arbitral seat.”

2. Hong Kong

In Hong Kong, the Court has not laid down a strict rule as to which law applies to the arbitration agreement in the absence of an express provision. The Court of First Instance in Klöckner Pentaplast Gmbh & Co Kg v Advance Technology (H.K.) Company Limited, 14/07/2011, HCA1526/2010, stated:

There is no doubt that the proper law of the contract and the lex arbitri of the arbitration may be different. There is no doubt too, that practical difficulties may arise when the lex arbitri is different to that of the seat of the arbitration”, but that “there is no rule that the lex arbitri must be the law of the seat of the arbitration. That is especially so where the law is chosen by the parties.”.

In Klöckner Pentaplast Gmbh the court examined a number of decisions from different jurisdictions where it was concluded that “the law of the seat of the arbitration is the appropriate law to govern the parties’ arbitration agreement” but stated that “the starting point must be the terms of the particular clause and the contract in question.”

Therefore, only in circumstances where there is no express choice as to the proper law of the contract, which is regarded as a ‘surrounding circumstance’ of the arbitration or of the law governing the arbitration agreement, will the court consider the implication that the law of the seat applies.

3. Singapore

In Singapore, the approach taken by the courts is that the law of the seat of arbitration governs the arbitration agreement. In FirstLink Investments Corp Ltd v GT Payment Pte Ltd and others [2014] SGHCR 12, the Court stated 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 went on to hold that:

In fact, the more commercially sensible viewpoint would be that the latter relationship often only comes into play when the former relationship has already broken down irretrievably. There can therefore be no natural inference that commercial parties would want the same system of law to govern these two distinct relationships. The natural inference would instead be to the contrary. When commercial relationships break down and parties descend into the realm of dispute resolution, parties’ desire for neutrality comes to the fore; the law governing the performance of substantive contractual obligations prior to the breakdown of the relationship takes a backseat at this moment (it would take the main role subsequently when the time comes to determine the merits of the dispute), and primacy is accorded to the neutral law selected by parties to govern the proceedings of dispute resolution.

The Singapore court therefore took a different view when deciding the law of the arbitration agreement compared with the decision of the Court of Appeal in Sulamérica which, absent express provisions, leant more towards adopting the law of the underlying contract as the law of the arbitration agreement. The Singapore Court also and importantly cautioned that the determination of the implied proper law ultimately remains a question of construction and each case turns upon its own particular facts, which results in uncertainty.

What should parties do?

A review of the cases in various jurisdictions demonstrates that, in the absence of parties specifying the law of the arbitration, there is likely to be a degree of uncertainty as to the applicable law to be applied. Although there is guidance from decisions such as Sulamérica, the choice of law to be applied to agreements to arbitrate is also dependent upon the facts of the particular case, leading to uncertainty.

Careful thought should be given to drafting dispute resolution clauses as mentioned at the outset of this alert and in particular when the parties wish any dispute to be resolved by arbitration in order to avoid the possibility of uncertainty and the potential for unwanted satellite disputes.

Therefore, as the HKIAC has provided, simply inserting, “The law of this arbitration clause shall be ... (Hong Kong law).” can remove any uncertainty concerning the law of the agreement to arbitrate.

This publication is only a general outline.  It is not legal advice.  You should seek professional advice before taking any action based on its contents.