Always specify the law governing the arbitration agreement

SindhuSivakumar_DraftingForArbitrationI had referred to the Sulamerica decision a couple of weeks ago in the context of inconsistency in drafting arbitration agreements. There, the contract in question contained both an exclusive jurisdiction clause (to the courts in Brazil) as well as arbitration clauses referring disputes to arbitration in London. While the inconsistency issue was resolved (in favour of the arbitration agreement) in the High Court itself, the Court of Appeal had to be brought in to decide another critical question — what was the proper law of the arbitration agreement in the absence of an express choice by the parties?

Most of us know that as a consequence of the doctrine of separability, the law governing the arbitration agreement need not be the same as either the governing law of the contract or the law of the seat of arbitration. Most of us also know the importance of the law governing the arbitration agreement – it decides issues concerning the scope, validity, and interpretation of the arbitration agreement.

Drafting-and-Reviewing-Comm-Contracts-Ad-2In spite of its importance however, arbitration clauses rarely specify the law governing the arbitration agreement. Even though they should. This is especially so because courts in different jurisdictions have not been consistent at all on how to decide, in the absence of an express choice made by the parties, which law governs the arbitration agreement.

The governing law (of the contract) approach

Older English decisions had held that in the absence of an express choice made by the parties, the law governing the arbitration clause would follow the governing law of the underlying contract. It was implied, they felt, that the parties intended for their express choice of governing law to also govern the arbitration clause.

Indian decisions also followed this approach (see the Supreme Court’s decision in N.T.P.C. v Singer (1994). Only where the parties did not specify either the governing law of the contract or the law governing the arbitration agreement would a presumption arise that the latter follows the law of the seat of arbitration.

The law of the seat approach

Recent English decisions (such as C v. D, [2007] EWCA Civ 1282) however, seem to favour the objective “closest and most real connection” test in deciding the proper law of the arbitration agreement, which invariably leads to the law of the seat of arbitration.

In Sulamerica, the governing law of the insurance policy was Brazilian law while the arbitration was English-seated. The law governing the arbitration agreement was not specified. The High Court, following other recent English decisions, held that the proper law of the arbitration agreement was English law because it had its closest and most real connection with the law of the seat.

This decision was appealed on the ground that the High Court judge should have held that the parties had made an implied choice of Brazilian law as the proper law of the arbitration agreement (following their express choice of Brazilian law as the governing law of the contract).

The Court of Appeal dismissed the appeal.  Lord Justice Moore-Bick stated that the proper law was to be determined by undertaking a three-stage enquiry.

The test

ProperLaw_ArbitrationAgreement_LordJusticeMoore-Brick_SulamericaFirst, look into the express choice of the parties, if any. If this did not exist, then the courts should turn to the implied choice of the parties, and if this could not be determined, the courts should determine the system of law with which the arbitration agreement had its “closest and most real connection”.

No implied choice

There was no express party choice in Sulamerica, so Lord Justice Moore-Bick went on to consider the implied choice of the parties. He said that “in the absence of any indication to the contrary”, an express choice of law governing the substantive contract was a strong indication that implied the choice of the same law in relation to the agreement to arbitrate; unless of course “there are other factors present which point to a different conclusion.”

Two important factors in this case indicated that the parties had not impliedly chosen Brazilian law to govern the arbitration agreement. The first was the choice of London as the seat, and second was the fact that a choice of Brazilian law meant that the arbitration agreement was enforceable only with the insured’s consent (which, according to the court, the parties could not have intended!).

Law of the seat has the closest and most real connection to the arbitration agreement

Because there was no express or implied choice of the law governing the arbitration agreement, he then went on to consider which system of law the arbitration agreement had the closest and most real connection. The court determined that the arbitration clause had its closest and most real connection with the law of the seat, that is, English law.

It is interesting to note Lord Justice Moore-Bick’s words in this regard. You may disagree with this assessment, but to me, it almost seems as if once the enquiry proceeds to the third stage, it will be the law of the seat that will almost always have the closest connection to the arbitration agreement.

… No doubt the arbitration agreement has a close and real connection with the contract of which it forms part, but its nature and purpose are very different. In my view an agreement to resolve disputes by arbitration in London, and therefore in accordance with English arbitral law, does not have a close juridical connection with the system of law governing the policy of insurance, whose purpose is unrelated to that of dispute resolution; rather, it has its closest and most real connection with the law of the place where the arbitration is to be held and which will exercise the supporting and supervisory jurisdiction necessary to ensure that the procedure is effective. Its closest and most real connection is with English law. I therefore agree with the judge that the arbitration agreement is governed by English law.”

Lord Neuberger’s observations – back to the High Court’s approach?

In Sulamerica, Lord Neuberger agreed with Lord Justice Moore-Bick’s three-stage enquiry. However, while referring to C v. D, he added the following observations:

….there are a number of cases which support the contention that it is rare for the law of the arbitration to be that of the seat of the arbitration rather than that of the chosen contractual law, as the arbitration clause is part of the contract, but …the most recent authority is a decision of this court which contains clear dicta (albeit obiter) to the opposite effect, on the basis that the arbitration clause is severable from the rest of the contract and plainly has a very close connection with the law of the seat of the arbitration.

Again, you may disagree with this analysis, but it seems to me that he gives precedence to the ‘close connection’ test (over the parties’ implied choice) on the basis of the doctrine of separability (unlike Lord Justice Moore-Bick who resorted to the third step only because there was no implied choice).

Subsequent application of the three-step test

However, it is Lord Justice Moore-Bick’s three-step test that has been applied since Sulamerica. In Arsanovia Ltd v. Cruz City 1 Mauritius Holdings, [2012] EWHC 3702 (Comm), which involved Indian governing law and an English seat, Justice Andrew Smith (in the High Court) applied the three-step test and concluded that as a matter of contractual interpretation, the parties had demonstrated their mutual Arsanoviacase_arbitrationagreement_Indianlaw.jpgintention that the arbitration agreement be governed by the law of India. Because the judge was able to determine the implied choice of the parties in this case, there was no need to resort to the closest and most real connection test (which, according to him, would have been the law of the seat).

It will be interesting to see how Indian courts apply these decisions. The recent English decisions do not give a whole lot of certainty as to the principles that should be followed in determining the proper law of the arbitration agreement, and it will be interesting to see if Indian courts adopt the C v. D — Lord Neuberger reasoning and give precedence to the law of the seat, Lord Justice Moore-Bick’s three step test, or come up with a completely different line of reasoning.

In any case, the drafting lesson here is clear – specify the law governing the arbitration agreement. With the uncertainty on the law in this area, it seems safest to think about and solve the problem at the drafting stage itself.

(Sindhu Sivakumar is part of the faculty on


Use unilateral option clauses sparingly… And check if they can be enforced

SindhuSivakumar_DraftingForArbitrationIn our previous post, we looked at optional arbitration clauses — where the parties may arbitrate their disputes. Such clauses, we found, may be rejected for being uncertain. There is no certainty about the parties’ intention to arbitrate or to oust the jurisdiction of the competent national court.

In this post, we look at a specific type of optional clause — a unilateral option clause. Common in finance contracts, a unilateral option clause provides one of the contracting parties (typically the party with the stronger bargaining position, like the bank in a financing contract) with the flexibility of selecting between arbitration and litigation for the resolution of contractual disputes.

A unilateral option clause can be an arbitration clause with the option to litigate or a jurisdiction clause with the option to arbitrate. See the two examples below.

OptiontoLitigate_Unilateraloptionclause_DraftingforArbitration OptiontoArbitrate_UnilateralOptionClause_DraftingforArbitration

English courts have held both to be enforceable. Other jurisdictions however, may refuse to recognise such clauses for the following reasons.

– Uncertainty: The unilateral option could be construed as undermining the requirement to clearly agree to submit disputes to arbitration.

– Lack of mutuality: The unilateral option may be held to be unenforceable because it does not have the consent of all parties to submit to arbitration. Indian courts have used this argument in the past to invalidate such clauses.

– Unconscionability: The unilateral option may be considered unconscionable (and therefore, invalid), for example in consumer and employment contracts where the contractual parties are not commercial counterparties.

Recent French and Russian decisions for example, have invalidated unilateral clauses — leading to concerns in the international arbitration community that more and more jurisdictions will follow this trend. In the French Rothschild case, on September 26, 2012, the court invalidated a unilateral jurisdictional clause (offering one party the choice between two national courts) because of its potestative nature — it made the fulfilment of the agreement depend upon an event, which only one of the contracting parties had the power to make happen.

Similarly, a Russian decision, on June 19, 2012, held that a unilateral dispute resolution clause was unenforceable on the ground of unconscionability – as it was “contrary to the basic principle of procedural equality of the parties, adverse to the nature of the dispute resolution process, and breach the balance between the interests of the parties.

The drafting lesson here is to firstly, avoid using optionality clauses just for the sake of it — only have them in the contract if your client (assuming your client has the stronger bargaining position and can ask for it) really sees a need for the flexibility it provides. Secondly, check the validity of the clause that you have drafted under the law governing your arbitration clause, the law at your seat, the law at the chosen court (for the litigation option), and the law at your likely place of enforcement.

(Sindhu Sivakumar is a member of the faculty on


Non-mandatory arbitration clauses are also pathological

SindhuSivakumar_DraftingForArbitrationA major reason pathological clauses are so common is that contractual parties and their lawyers, against better judgement, tend to treat arbitration clauses as mere ‘boiler plate’ or ‘midnight’ clauses. Little attention is paid to these clauses when closing the deal and signing the contract.

This leads to all kinds of drafting disasters such as the inconsistent clause we saw in the previous post, which contained an agreement to arbitrate and the designation of a national court to resolve contractual disputes.

Optional or non-mandatory arbitration clauses are another type of pathological clauses. See the following examples.

Drafting-and-Reviewing-Comm-Contracts-Ad-2 “In the case of dispute (contestation), the parties undertake to submit to arbitration but in the case of litigation the Tribunal de la Seine shall have exclusive jurisdiction”

“English law – arbitration, if any, London according ICC Rules” 

“[t]he parties may refer any dispute to arbitration”

The language in all these clauses leads to uncertainty about the parties’ intention and agreement. Did they or did they not intend to submit their disputes to arbitration?

The agreement to arbitrate is the cornerstone of arbitration. An arbitration clause has to — clearly and unequivocally — record the consent of the parties to submit to arbitration. This is essential to conduct any process of dispute resolution outside the national court systems.

Not all the clauses listed above survived when challenged in the courts (which includes the English, Canadian, and Hong Kong courts). Even a pro-arbitration jurisdiction cannot always give effect to arbitration clauses that contain no clear agreement to arbitrate.

Moral of the story? Don’t draft a non-mandatory arbitration clause if your clients have indicated their preference to arbitrate. Make it very clear when drafting your arbitration clause that disputes arising out of or in connection with the underlying contract will be resolved by arbitration. Clearly oust the jurisdiction of the courts.

(Sindhu Sivakumar is a member of the faculty on


Avoid pathological arbitration clauses. Be consistent.

Arbitration clauses have four essential purposes. They have to:

  1. produce mandatory consequences for the parties;
  2. exclude the intervention of state courts in the settlement of disputes likely to arise between the parties,
  3. give the arbitrators the powers necessary to resolve the disputes; and
  4. permit a procedure which leads, under the best conditions of efficiency and rapidity, to the rendering of an enforceable award.

SindhuSivakumar_DraftingForArbitrationA former Secretary General of the ICC International Court of Arbitration, Frederic Eisemann, had coined the term clauses pathologiques in 1974. A “pathological arbitration clause” fails to achieve any of the purposes above.

So what’s wrong with these clauses? Apart from being incoherent, confusing to interpret, and often plain baffling, these clauses are likely to end up in court, very much contrary to the original intention of the parties to avoid a long and drawn out public battle in the courts and have a speedy, efficient, and private resolution of their disputes.

Remember, being “pathological” does not always mean the clause is unenforceable. Where they can, courts try and make sense of, and give meaning to these clauses and enforce them. All these clauses however, have caused much confusion and delay, and often defeated the purposes of efficiency, speed, and privacy.

So how do we ensure we don’t have a pathological clause on our hands?

Rule Number 1 – Don’t be inconsistent. Look at these two clauses. Both are found in the same contract – an insurance policy).

“7. Law and Jurisdiction

It is agreed that this Policy will be governed exclusively by the laws of Brazil. Any disputes arising under, out of or in connection with this Policy shall be subject to the exclusive jurisdiction of the courts of Brazil.

12. Arbitration

In case the Insured and the Insurer(s) shall fail to agree as to the amount to be paid under this Policy through mediation as above, such dispute shall then be referred to arbitration under ARIAS Arbitration Rules….

The seat of the arbitration shall be London, England.”

How do you read these two clauses together? One clause makes disputes arising under the contract subject to court litigation in Brazil. Another wants disputes to be referred to arbitration under the ARIAS Arbitration Rules. No other clause in the contract gave any indication as to which should take precedence.

You can’t read them together. They are blatantly contradictory. Justice Cooke agreed.

Drafting-and-Reviewing-Comm-Contracts-Ad-2When faced with these two clauses in the High Court, the only reason he ultimately upheld the arbitration clause (overriding the exclusive jurisdiction language in clause 7) is because of the strong English policy in favour of arbitration. He adopted a very liberal approach to the words chosen by the parties in their arbitration clause and held that the parties, as rational businessmen, must have intended to have arbitration as the sole dispute resolution mechanism for all disputes arising under their policies.

However, it is unlikely that any policy in favour of arbitration is likely to save such pathological clauses in other jurisdictions. It would in all likelihood be held to be void for uncertainty.

So don’t draft inconsistent, pathological arbitration clauses and hope for the courts to save you. If your clients want arbitration, draft watertight and consistent arbitration and governing law clauses and ensure they never have to go to court on account of your bad drafting.

(Sindhu Sivakumar is a member of the faculty on