Parties should avoid uncertainties by stipulating the applicable law to the arbitration agreement.

The decision in J (Lebanon) v. K (Kuwait)[i] provides a useful analysis of which law (i.e., the law of the arbitration agreement or the law of the seat) governs the issue of whether a non-party has become party to the arbitration agreement and, more broadly, how to determine which law governs the arbitration agreement if there is no express choice. While in this case there was an express choice, the judgment highlights the uncertainties that arise if the parties have made no express provision regarding the law of the arbitration agreement. Moreover, the case demonstrates the jurisdictional difficulties that arise when arbitration proceedings are brought against a non-party to an arbitration agreement.

The English High Court adjourned the claimant’s (J’s) application to enforce an arbitral award against a non-party to an arbitration agreement (K), pending the outcome of set aside proceedings at the seat of the arbitration in Paris. The Court overturned the tribunal’s decision that the law of the seat (French law) should determine whether K was bound by the arbitration agreement contained in a franchise development agreement (FDA). Rather, the court held that the question was one of English law, as the law governing the arbitration agreement. Applying English law, the Court held that K had not become party to the arbitration agreement in the FDA by novation or joinder, and accordingly adjourned the enforcement of the award pending the decision of the Paris Court of Appeal.

Background

J and Z entered the FDA by which J granted Z the exclusive license to market, prepare, and sell certain food products. A dispute arose between J and Z, which was referred to ICC arbitration. The FDA was governed by English law and the seat of the arbitration was Paris. Z notified J of a restructuring by which K was to become the holding company of Z. J consented to the change in shareholding. The jurisdictional issue for the tribunal was whether K had itself become a party to the FDA and its arbitration agreement.

The majority of the tribunal concluded that the issue of whether K was bound by the arbitration agreement was a matter of French law (since the validity of the award depended on the law of the seat) and the issue of whether during the restructuring a transfer of rights and obligations had taken place as between Z and K was governed by English law. The majority of the tribunal held that as a matter of English law, the parties had conducted themselves so as to give rise to a novation by which K became the second and main franchisee under the FDA.[ii] The majority also held that the capacity of K to become a party to the arbitration agreement was governed by French law. The award was ordered to be enforced as a judgment in February 2019.

J, the award creditor, applied under section 103(5) of the Arbitration Act 1996 to adjourn the enforcement of the award pending the decision of the Paris Court of Appeal on the set aside application. J also applied for security for its award/judgment debt.

The Applicable Law Issues

The Court had to determine:

  1. Issue 1: Whether the law governing the validity of the arbitration agreement also governed the question of whether K had become a party to the arbitration agreement
  2. Issue 2: Which law governed the validity of the arbitration agreement (and therefore whether K had become a party to the arbitration agreement)
  3. Issue 3: Whether under English law, K had become a party to the FDA and the arbitration agreement
  4. Issue 4: Which law governed the capacity of K to become a party to the arbitration agreement

Issue 1

The fundamental question was whether the alleged arbitration agreement between J and K was valid. The Court held that section 103(2)(b) clearly indicated that the law governing the validity of the arbitration agreement governed whether K had become a party to the arbitration agreement. Section 103(2)(b) provides that the recognition or enforcement of an award may be refused if “…the arbitration agreement was not valid under the law to which the parties subjected it or, failing any indication thereon, under the law of the country where the award was made.”

Issue 2

Applying the three-stage test set out in Sulamerica v. Enesa Engenharia[iii], the Court held that in order to determine the law governing the arbitration agreement, it must consider whether the parties had made an express or implied choice of law. In the absence of such a choice, the Court was required to identify the system of law with which the arbitration agreement has the closest and most real connection.

In J (Lebanon) v K (Kuwait), the Court was satisfied that an express choice of law had been made in the FDA. The FDA provided that English law was the governing law of the FDA and the dispute settlement clause also stated that “the arbitrators shall apply the provisions contained in the agreement”. Accordingly, the Court held that English law, the law governing the arbitration agreement, applied to the issue of whether K had become a party to the FDA and the arbitration agreement. Unlike the tribunal, the Court held that whether K was bound by the arbitration agreement, and whether a transfer of rights and obligations to K had occurred, were part of the same question governed by the same system of law.

Issue 3

Having determined that the applicable law was English law, the Court considered whether K had become party to the FDA and to the arbitration agreement. While noting that in theory, due to the doctrine of separability, K could have become party to the FDA and not the arbitration agreement, the parties did not pursue this argument.

The Court considered the majority of the tribunal’s decision that K had become a party to the FDA by way of “addition”. Noting that there is no concept of “novation by addition” in English law, the Court considered whether K had become a party to the FDA by joinder. The Court noted that a joinder would amount to a variation under the FDA and proceeded to consider whether there had been a joinder with express or implied consent of J and Z. The Court cited a number of contractual provisions that prohibited assignment without prior written consent of J, which required any waiver to be in writing and that only allowed amendments or modifications to the contract in writing executed by both parties. The Court held that the express contractual provisions made it “extremely difficult” for J to rely on any action/statement by itself or Z as constituting implied consent to the joinder of K to the FDA.

J relied on an exchange of letters in which Z had given notice of the restructuring by which K was to become the holding company of Z, and subsequent communications post termination of the FDA in which K was involved in negotiations for a renewal or replacement agreement with Z. Other evidence included that Z paid the relevant taxes, the licences and leases were in the name of Z, and Z employed the employees.

The Court did not find the evidence sufficient to demonstrate consent. Much of the conduct was consistent with K acting as agent for its subsidiary, rather than demonstrating a novation by substitution. Even if K had been “added” to the FDA, compliance with the terms of the FDA, which required consent in writing, was still necessary. This requirement was arguably to be interpreted in good faith in accordance with an express provision of the FDA that required the parties to “act in accordance with good faith and fair dealing”. While leaving open the possibility that J may locate documents that could support a case that there was something resembling consent in writing, the Court, leaving the issue “slightly unanswered”, held that as a matter of English law, K had not become a party to the FDA or to the arbitration agreement.

Issue 4

In the event that K lost on Issue 3, the Court held that Kuwaiti law (the law of K’s incorporation) would govern the question of whether K had capacity to become a party to the arbitration agreement. Pursuant to section 103(2)(a) of the Act, the court may refuse recognition and enforcement of an award if a party to the arbitration agreement was under some incapacity.

Security and Adjournment

As part of the application, J sought security for the award debt. Applying section 103(5) of the Act, the Court refused to grant security to J. There was no evidence that as a result of, or during, an adjournment any of K’s assets would be dissipated. Accordingly, the Court left open the question of whether it had power to grant security on application of the award creditor seeking an adjournment. (Usually an application for adjournment is sought by the award debtor who wants to avoid enforcement). However, the Court adjourned the enforcement of the award pending the judgment of the Paris Court of Appeal.

Comment

The case highlights the uncertainties that can arise as to the law governing the arbitration agreement, in the absence of an express choice. In order to avoid potentially lengthy and costly proceedings, parties might be advised to include a clause in their contract that stipulates the applicable law to the arbitration agreement.

The case also highlights the importance of parties making careful and strategic decisions regarding who/which entity to bring proceedings against at the outset. In this case, no explanation was given as to why J had not brought proceedings against Z as the actual counterparty to the arbitration agreement. The Court observed that had proceedings been brought against Z, many of the issues in the case would not have arisen.