Arbitration agreements: governing law clarified and NOM clauses show their bite
The recent Supreme Court decision in Kabab-Ji SAL (Lebanon) v Kout Food Group (Kuwait) provides welcome clarity on how the English courts will determine the governing law of arbitration agreements, and the extent to which a third party may become party to an agreement in the face of no-oral modification (NOM) clauses ( UKSC 48). The decision also clarifies the appropriateness of using the summary procedure in order to determine these questions and enforce an award.
Kabab-Ji SAL is a Lebanese company which developed and owns a Middle Eastern restaurant franchise concept. In 2001, it entered a franchise development agreement (FDA) with a Kuwaiti company, Al Homaizi Foodstuff Company. The two parties subsequently entered into a number of separate franchise outlet agreements (FOAs) in respect of individual outlets.
The FOAs and FDA (together, the franchise agreements) were expressly governed by English law and contained provisions stating that, with limited exceptions, any dispute between the licensor and licensee would be settled by arbitration, to be conducted in Paris. However, although an arbitration agreement is separable from the underlying contract in which it is contained, here the franchise agreements did not separately specify the law of the arbitration agreement. The FDA contained a number of NOM clauses which required variations to be agreed in writing signed by both parties to the FDA.
In 2005, Al Homaizi was restructured, and became a subsidiary of a new holding company, Kout Food Group (KFG). When a dispute subsequently arose, Kabab-Ji referred the matter to arbitration in Paris, under the rules of the International Chamber of Commerce. However, Kabab-Ji only commenced the arbitration against KFG, not Al Homaizi. KFG participated under protest and argued that it was not a party to the franchise agreements or the arbitration agreements contained in them.
In considering this point, the arbitral tribunal decided that French law, as the law of the seat of the arbitration, governed the question of whether KFG was bound by the arbitration agreements, but that English law governed the question of whether KFG had acquired substantive rights and obligations under the franchise agreements. Finding in Kabab-Ji’s favour on both points, the tribunal made a principle award of $6.7 million against KFG.
Challenging the award
KFG appealed the award in the French courts on the ground that the arbitrators had no jurisdiction against KFG. Shortly afterwards, Kabab-Ji commenced enforcement proceedings in the High Court in England. KFG made a cross-application in the English proceedings for an order refusing recognition and enforcement.
The High Court gave directions for a trial of preliminary issues. It formulated three key issues by reference to the FDA, as it was agreed that this would be determinative of similar issues arising under the FOAs:
Whether the law governing the validity of the arbitration agreement governed the question of whether KFG became a party to the arbitration agreement.
What that law was.
In English law, whether KFG had become a party to the FDA and, if different, the arbitration agreement.
The High Court held that the validity of the arbitration agreement was a matter of English law and that, when this was applied, KFG was not a party to either the FDA or the arbitration agreement, although the court did not finally decide this point ( EWHC 899). Both parties appealed the decision to the Court of Appeal.
In upholding the High Court’s judgment in respect of the applicable law, the Court of Appeal went further and also held that, as there was no real prospect of it being shown that KFG had become party to the arbitration agreement, summary judgment should be given refusing recognition and enforcement of the award. Kabab-Ji appealed to the Supreme Court ( EWCA Civ 6). In the meantime, the Paris Court of Appeal upheld the validity of the award.
Supreme Court’s decision
The Supreme Court distilled the grounds of appeal into three issues:
- Which law governed the validity of the arbitration agreement.
- If it was governed by English law, whether there was any real prospect that a court might find at a further hearing that KFG became a party to the arbitration agreement, despite the existence of the NOM clauses in the FDA.
- As a matter of procedure, whether the Court of Appeal was justified in giving summary judgment refusing recognition and enforcement of the award.
Choice of law
In considering the first issue, the court noted that the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) establishes that the validity of an arbitration agreement is governed by the law chosen by the parties, but also that, where no choice has been indicated, the default rule is that the applicable law is that of the country where the award was made, which is typically the seat of the arbitration. In English law, this is expressly provided for by section 100(2)(b) of the Arbitration Act 1996 (1996 Act).
The court referred to its recent decision in Enka Insaat Ve Sanayi AS v OOO Insurance Company Chubb, where it found that a general choice of law in an agreement that contains an arbitration clause will normally be a sufficient indication of the law to which the parties intended to subject the arbitration agreement for the purposes of Article V(1)(a) of the New York Convention (Article V(1)(a)) ( USKC 38; see News brief “Governing law of arbitration agreements: cutting the Gordian knot”). The court confirmed that the same principle applies whether the issue has arisen before or after an award has been made. Therefore, the arbitration agreement in the FDA was governed by English law.
The court rejected two arguments that Kabab-Ji had advanced to resist this conclusion. Clause 14.3 of the FDA stated that the arbitrator should also apply principles of law generally recognised in international transactions, which was generally agreed to be a reference to the UNIDROIT Principles of International Commercial Contracts (UNIDROIT Principles). Kabab-Ji had argued that this meant that the regime chosen to govern the arbitration agreement was not the law of a country but a composite of national law and the UNIDROIT Principles, so that it did not qualify as “law” for the purposes of Article V(1)(a). It followed that the default rule applied and so the arbitration agreement was governed by the law of the country where the award was made. However, the court held that this would effectively deny parties their choice both of that country’s law and of the UNIDROIT Principles, which was an illogical result and was also focused on the law to be applied by the arbitrators to the merits of the dispute, not the law governing the validity of the arbitration agreement.
Kabab-Ji’s second argument invoked the so-called “validation principle” on the basis that, if applying English law would lead to the conclusion that there was no valid arbitration agreement entered into between Kabab-Ji and KFG, then it was to be inferred that the parties did not intend for the arbitration agreement to be governed by English law (see box “The validation principle”). The court held that this agreement extended the validation principle beyond its proper scope, which is not a principle relating to the formation of contracts but applies where the parties have agreed to resolve disputes by arbitration and seek to uphold their presumed intention that the agreement should be legally effective.
On the second issue, Kabab-Ji contended that KFG had become a party to the FDA by its conduct over a sustained period of time so that there had been a novation of the FDA. However, as the court observed, the Supreme Court held that NOM clauses are legally effective in MWB Business Exchange Centres Ltd v Rock Advertising Ltd ( UKSC 24; see News brief “Contract variation: does it need to be in writing?”). Here, the NOM clauses applied not just to amendments or modifications to the FDA, but also to its termination, which would be necessary for a novation. The NOM clauses had not been followed and so the court held that there was no prospect of it being found that KFG had become a party to the arbitration agreement in the FDA.
On the third issue, Kabab-Ji submitted that a full evidential hearing and trial of the issue was necessary. Article V(1) provides that the recognition and enforcement of an award may only be refused if the party against whom it is invoked provides proof of one or more of the grounds set out in Article V(1)(a) to (e). Similarly, section 103 of the 1996 Act provides that recognition or enforcement will not be refused except if the person against whom the award is invoked proves one or more of the grounds set out in section 103(2)(a) to (f), which mirror those set out in Article V(1)(a) to (e).
The court rejected Kabab-Ji’s arguments and held that the approach of the Court of Appeal had been appropriate and proportionate. There is nothing in the New York Convention or the 1996 Act that prescribed how the relevant proof is to be established and it is for the English court to determine in accordance with its own procedural rules, including the overriding objective under the Civil Procedure Rules. It has long been recognised as a matter of English procedural law that summary determination may be in the interests of justice and achieve significant savings in time and costs, and that, ultimately this will depend on the facts and circumstances of the case. Here, Kabab-Ji had been unable to show that an opportunity to submit further evidence would have made any realistic difference to the outcome. The court therefore dismissed Kabab-Ji’s appeal.
The court’s reasoning on governing law is consistent with its decision in Enka, which considered a similar issue at a pre-award stage. It confirms that the principles in Enka also apply in the context of enforcement under the New York Convention. Taken together, Enka and Kabab-Ji provide certainty for those with existing arbitration agreements that, unless the agreement explicitly states otherwise, the English courts will interpret a choice of law clause as also applying to the arbitration agreement.
The decision is also relevant to the preparation of arbitration agreements. Clients should be advised on, and understand, the implication of choice of law clauses. If their intention is to submit an arbitration to the laws of a jurisdiction other than that governing the contract as a whole, an express provision should be included.
Finally, the decision highlights the importance of NOM clauses. These clauses will be enforced by the courts and any party that wishes to depart from agreed contractual terms should be aware of their presence and the need to comply with the relevant provisions. The existence of NOM clauses in this case, and the failure to comply with them, ultimately proved fatal to Kabab-Ji’s attempt to enforce its award through the English courts.
The validation principle
Where the law applicable to an arbitration agreement is not specified, there is a presumption that a choice of governing law for the main contract is intended to apply to the arbitration agreement. The presumption applies except where the law of the seat expressly states otherwise or where there is a serious risk that, if governed by the same law as the main contract, the arbitration agreement would be ineffective (the so-called “validation principle”).
This article was first published in the December issue of PLC Magazine.