A tale of three cities: Why parties should specify the governing law of their arbitration agreement

The importance of specifying the governing law of arbitration agreements

The arbitration agreement within a contract is a contract in its own right, collateral to the main contract. The law governing the arbitration agreement covers substantive matters relating to the agreement to arbitrate, for example, the interpretation, scope and validity of the agreement to arbitrate. When drafting an arbitration agreement, parties should specify the governing law of the arbitration agreement, and not just the governing law of the main contract.  A failure to do so creates risk for the parties:

1. It exposes the parties to the risk of protracted and costly litigation over the question of which law applies to the arbitration agreement in cases where the seat of the arbitration and the governing law of the main contract are different.
2. It creates uncertainty - even if the courts in one jurisdiction apply a particular law to the arbitration agreement and uphold the validity of the arbitral award, in another, the courts may take a different approach to the applicable law and as a result refuse to enforce the award.

The uncertainty of the approach that will be taken to an award at international level is illustrated by the case of Kabab-Ji SAL v Kout Food Group which was discussed in our earlier article here and is summarised below. The parties had not specifed the governing law of the arbitration agreement. The UK Supreme Court held that the governing law of the main contract (English law) applied to the arbitration agreement and, on that basis, refused to recognise and enforce the award. The same case was considered by the French Court of Cassation which held that the law of the seat (French law), not the law of the main contract, should be deemed to govern the arbitration agreement and as a result, the Court refused to set aside the award.

This issue continues to generate caselaw. In Unicredit Bank GmbH v RusChemAlliance LLC all three levels of the English courts considered the question of which law applied to the arbitration agreement in a series of English law governed performance bonds where the parties had specified Paris as the seat. In its judgment in October 2024, the UK Supreme Court emphasised and applied its reasoning from earlier cases that where an arbitration agreement is silent and the law governing the main contract and seat are different, the contract’s governing law should generally be construed as applying to the arbitration agreement (see our article on this decision here.) 

Similarly, in a recent decision, discussed below, the Turkish Court of Cassation considered the question of what law will apply to the arbitration agreement in cases where the parties have chosen the seat of the arbitration and the law governing the main contract but have omitted to choose the law applicable to the arbitration agreement. The court followed a similar approach to that adopted by the English courts and applied the law governing the main contract.

However, the approach of the English courts will change in future once the English Arbitration Bill completes the legislative process and passes into law. As explained further below, the Arbitration Bill will change the current common law approach to the question of which law applies to the arbitration agreement.

All of these divergent approaches to the law governing the arbitration agreement (and therefore the issues that turn on that question) highlight the importance of expressly identifying the governing law of both the main contract and the arbitration agreement so as to avoid any uncertainty and protracted legal proceedings.

Recap of Kabab-Ji SAL v Kout Food Group – an example of different answers to the same question

In 2001, Kabab-Ji SAL (Kabab-Ji) entered into a franchise development agreement (FDA) with Al Homaizi Foodstuff Company (AHFC). Under the FDA, Kabab-Ji granted a licence to AHFC to operate one of Kabab-Ji’s restaurant franchises in Kuwait. The parties agreed that any dispute was to be referred to ICC arbitration seated in Paris. The FDA itself was governed by English law, however, there were no express provisions regarding the governing law of the arbitration agreement.

After a dispute arose under the FDA, Kabab-Ji commenced ICC arbitration proceedings against AHFC’s parent company, Kout Food Group (Kout Food), on the basis that a novation of the FDA to Kout Food was to be inferred from the conduct of the parties. By majority decision, the ICC tribunal concluded that Kout Food was indeed bound by and in breach of the FDA, despite the FDA containing a number of no oral modification clauses.

Kout Food applied to the Paris Court of Appeal (being the courts of the seat) to have the arbitral award set aside on the basis that, amongst other things, it was not a party to the arbitration agreement. Kabab-Ji then issued its own proceedings in England for the enforcement of the award.

The Commercial Court, Court of Appeal and Supreme Court in England all held that the governing law of the arbitration agreement was English law and that under English law, Kout Food was not a party to the FDA. The ICC tribunal therefore had no jurisdiction to issue an award against Kout Food and the English courts would not recognise nor enforce the arbitral award. The Supreme Court held that in the absence of an express provision regarding the governing law of the arbitration agreement, the parties’ choice of the governing law of the main contract (English law) applied (applying the principles set out in its seminal judgment in Enka v Chubb, which is relevant at all stages of the arbitral process).

In contrast, the French Court of Cassation upheld the Paris Court of Appeal’s refusal to set aside the award. The French courts considered that the law of the seat (French law), and not the law of the main contract, governed the arbitration agreement. Under French law, the arbitration agreement extended to the non-signatory, Kout Food.

Turkish Court of Cassation decision

In a recent case¹ where the law of the seat of arbitration and the law applicable to the main contract were different, the Turkish Court of Cassation took a stance similar to the English courts and decided that the law governing the main contract will also apply to the arbitration agreement.

In this case, the validity of the arbitration agreement was one of the points in dispute. During the arbitration, the sole arbitrator decided that the issue of consent to submit the disputes to arbitration should be governed by the law applicable to the main contract. Accordingly, the sole arbitrator upheld their jurisdiction to determine the dispute and ordered for the outstanding amount to be paid. That approach was bolstered during the set-aside proceedings where the Istanbul Regional Court of Appeal upheld the sole arbitrator’s jurisdiction by stating that the substantive validity of the arbitration agreement was to be determined in accordance with the governing law of the underlying contract.² Finally, upon the appeal of the Regional Court of Appeal’s decision, the Turkish Court of Cassation upheld the decision.

Following the contrasting approaches taken by the English and French Courts in the Kabab-Ji v. Kout Food cases, the Turkish Court of Cassation clearly preferred the approach seen in the English courts and decided that the law governing the main contract will also apply to the arbitration agreement in cases where the parties have chosen different laws for the seat of the arbitration and to govern the main contract, but have not specified the law applicable to the arbitration agreement.

The English Arbitration Bill – change to the English law position

Following the Law Commission’s review of the English Arbitration Act 1996, the British Government accepted the Law Commission’s recommendations and the Bill to amend the English Arbitration Act 1996 was introduced to Parliament in November 2023. This Bill did not complete the legislative process before the general election held in July 2024. However, the Arbitration Bill 2024 was reintroduced to Parliament by the new Government on 18 July 2024 and it passed its third reading in the House of Lords on 6 November 2024.

One of the most interesting changes proposed in the Arbitration Bill 2024 relates to the law applicable to the arbitration agreement. Clause 1 introduces a new section 6A to the Arbitration Act 1996 as follows:

“6A Law applicable to arbitration agreement

(1) The law applicable to an arbitration agreement is—

(a) the law that the parties expressly agree applies to the arbitration agreement, or

(b) where no such agreement is made, the law of the seat of the arbitration in question.

(2) For the purposes of subsection (1), agreement between the parties that a particular law applies to an agreement of which the arbitration agreement forms a part does not constitute express agreement that that law also applies to the arbitration agreement.”

Accordingly, the approach of the Arbitration Bill differs to the approach of the English courts developed in Enka v. Chubb and Unicredit. Where the parties have not expressly agreed the law applicable to the arbitration agreement, the law of the seat of the arbitration will apply to the arbitration agreement, rather than the law of the main contract.

It should be noted that the 2024 version of the Bill now includes a carve out for investment treaty arbitration provisions from Clause 1. A new section 6A(3) provides that the provision determining the law applicable to the parties' arbitration agreement does not apply to an arbitration agreement derived from a standing offer to submit disputes to arbitration contained in a treaty (including any Annex or protocol thereto) or the legislation of a country or territory other than the UK (for example, a national investment law).

Conclusion

This discussion illustrates that if parties wish to avoid uncertain, and potentially unwelcome, outcomes in relation to a future arbitration and the enforcement of any award, they should specify the governing law of the arbitration agreement, in addition to the governing law of the main contract.

This article was written in conjunction with Ergin Mizrahi (Senior Partner) and Mustafa Mert Dicle (Senior Associate) from the Turkish law firm, Pekin Bayar Mizrahi.