When you’re in the midst of drafting a complex international construction contract, probably the last thing on your mind is specifying the governing law of your arbitration agreement. You may not think this is particularly important, or that it will be the same as the governing law of the underlying contract. This could prove a costly mistake.
Governing law is important
The governing law of an arbitration agreement is important as it will determine any dispute that may arise as to the validity, scope or interpretation of the arbitration agreement itself.
If your arbitration agreement does not specify a governing law, there is no internationally accepted approach to determining what the governing law should be. Courts in some jurisdictions have held that, in the absence of an agreement to the contrary, the law of the seat of the arbitration will also apply as the governing law of the arbitration agreement. Courts in other jurisdictions have held that the governing law of the arbitration agreement should be the same as the governing law of the underlying contract.
In England, the Court of Appeal in Sulamérica Cia Nacional de Seguros SA and others v Enesa Engeharia SA and others established a three stage test:
- Have the parties made an express choice of the governing law of an arbitration agreement?
- In the absence of an express choice, have the parties made an implied choice?
- In the absence of an express or implied choice, which system of law has the closest and most real connection with the arbitration agreement?
The application of this test can result in different outcomes, depending on the circumstances of the case.
Why is it important?
In international construction contracts, the law governing the underlying contract is often different from the law of the seat. As a result, the failure to specify the governing law of an arbitration agreement can give rise to disputes as to which law should apply to any issues relating to the validity, scope or interpretation of the arbitration agreement. This can result in costly litigation, which would have been unnecessary had the parties specified a governing law in the arbitration agreement. This will not only delay the resolution of the substantive issues in dispute but may also result in an unintended (and perhaps unwelcome) choice of law being imposed on the parties by the courts. It also introduces a huge element of uncertainty into the dispute resolution procedures that the parties negotiated and agreed at the outset of the project. Unwelcome indeed.
This problem has been exacerbated by the fact that standard arbitration clauses rarely include a governing law provision and, until recently, none of the major arbitral institutions specifically addressed this issue in their model clauses.
How has this changed?
The Hong Kong International Arbitration Centre (HKIAC) has recently amended its model arbitration clauses to include optional choice of law provisions reminding parties to specify the governing law of the arbitration agreement, as well as specifying the seat and the number of arbitrators. There is also a note specifically reminding parties of the importance of specifying a governing law for the arbitration agreement in circumstances where the law of the underlying contract and the law of the seat are different and that the law of the arbitration agreement does not replace the law governing the underlying contract.
The London Court of International Arbitration (LCIA) has recently adopted new arbitration rules, which will be effective from 1 October 2014. Article 16.4 of the new rules provides that, unless the parties have agreed otherwise, the governing law of the arbitration agreement will be the same as the law of the seat.
Parties all too often fail to appreciate the importance of specifying the governing law of an arbitration agreement until it is too late. The changes adopted by the HKIAC and the LCIA should help parties to focus on this issue and it will be interesting to see if other arbitral institutions follow suit. That said, it is notable that the International Chamber of Commerce (ICC) did not take the opportunity to do so when it revised its rules in 2012.
Parties can and should deal with the governing law issue at the drafting stage. However, the problem continues to persist because the dispute resolution provisions are usually considered right at the end of a long negotiation period which, understandably, has focused on the more “commercial” terms of the construction contract. Parties therefore tend to resort to provisions they have used before or are otherwise familiar with, rather than looking at this issue with a fresh pair of eyes.