30 Aug 2012

Does your choice of law for the contract extend to the international arbitration agreement?

by Sid Wang, Danielle Briers

Just because your contract specifies a governing law doesn't mean that law will apply to the parties' agreement to arbitrate disputes under that contract.

The English Court of Appeal has clarified the principles for determining which jurisdiction's laws govern an arbitration clause where the contract doesn't specify this.

In Sulamérica CIA Nacional De Seguros SA v Enesa Engenharia SA [2012] EWCA Civ 638, the Court held that English law governed the arbitration clause, despite the parties' express choice of Brazilian law to govern the contract. As a result, Enesa was prevented from avoiding arbitration by arguing that the laws of Brazil meant arbitration could only occur with both parties' consent.

The case highlights the importance of choice-of-law questions in contracts with international elements and the uncertainties that arise if parties don't specify the law to govern their arbitration agreement.

Facts of the case

The case involved disputes under insurance policies for the construction of a hydro-electric plant in Brazil (the Policy). The Policy specified that it was governed by Brazilian law and subject to the exclusive jurisdiction of Brazil's courts. The arbitration clause in the Policy named London as the seat of arbitration.

The insured construction consortium, Enesa, brought a claim against its insurer Sulamérica for physical damage and consequential loss arising from a workers' protest during construction. Sulamérica denied liability and commenced arbitration in London seeking declarations to that effect. Enesa brought proceedings in Brazil to prevent the arbitration (arguing that, under Brazilian law, the arbitration could only occur with both parties' consent).

Sulamérica then obtained an anti-suit injunction from the Commercial Court in England, restraining Enesa from pursuing the Brazilian court proceedings. Enesa appealed to the English Court of Appeal.

Principles for determining what law governs an agreement to arbitrate

In deciding that the Policy was governed by English law, Lord Justice Moore-Bick set out the following principles for determining what law governs an agreement to arbitrate.

The proper law of an arbitration agreement may differ from that of the contract in which it appears, and is to be determined by a three-stage inquiry into:

  • the parties' express choice of law;
  • the parties' implied choice of law; and
  • the law which has the closest and most real connection with the arbitration agreement.

An express choice of the law governing the contract is a strong indication that the parties intended for that law to also govern the arbitration clause within that contract, unless there are other factors which point to a different conclusion. These other factors may include:

  • the terms of the arbitration agreement itself; or
  • the consequences for the arbitration agreement's effectiveness of choosing the proper law of the substantive contract. As discussed below, this factor turned out to be highly influential in the Court of Appeal's decision.

Law of England held to apply

In this case, the fact that the parties expressly agreed that the Policy was to be governed by the law of Brazil was a strong pointer towards an implied choice of Brazilian law to govern the arbitration agreement. However, two important factors pointed the other way:

  • Firstly, the parties expressly chose England as the seat of arbitration, which implied an acceptance that English law regarding the conduct and supervision of arbitrations would apply. The parties must therefore have foreseen that the English Arbitration Act 1996 would apply to any arbitration, including provisions of that Act which were more substantive than procedural.
  • Secondly, if the arbitration agreement were governed by Brazilian law, this would arguably have made it enforceable only with both parties' consent. There was nothing in the Policy to indicate the parties intended that. To the contrary, the Policy expressly permitted either party to refer a dispute to arbitration if it had not been resolved by mediation.

The Court concluded that:

  • the parties' express choice of Brazilian law to govern the contract was not sufficient evidence of an implied choice of Brazilian law to govern the arbitration agreement; and
  • it was therefore necessary to consider which system of law the arbitration agreement had the closest and most real connection with. This was the law of England, the place where the arbitration was to be held and which would exercise the supporting and supervisory jurisdiction for it.

Significance and take-home points

This case highlights the uncertainty that can arise when parties do not specify the law governing their agreement to arbitrate. This is particularly so where the contract specifies the law of one jurisdiction to govern the contract, and names a different jurisdiction as the seat of the arbitration (for example, where the parties desire a "neutral" arbitration location).

The case highlights some important points, particularly for parties involved in international contracts:

  • Be aware of the potential consequences when specifying the seat of arbitration: Just because your contract has a close connection with a jurisdiction and is expressly governed by the law of that jurisdiction, don't assume that law will automatically govern disputes over the arbitration clause. If you specify a different seat of arbitration, a court could infer that the parties intended for the law of the seat to govern the arbitration clause.
  • Don't assume the law of the seat will automatically apply: Conversely, the law of the arbitration seat will not necessarily be the law that governs the arbitration clause. Whilst the seat of arbitration generally determines the curial law which governs the conduct of the arbitration, it may not determine the proper law which governs the agreement to arbitrate, particularly where the parties have nominated a different proper law to govern the contract.
  • Specify the choice of law for the arbitration clause/agreement: To avoid uncertainty and costly disputes over which law applies, parties should consider expressly stating the law they wish to govern their arbitration clause and agreement.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.