The Court of Appeal has, on 16 May 2012, rendered its keenly awaited decision in the case of Sulamerica v Enesa Engenharia.[1] It clarifies what has, for some time, been an uncertain area of law as to which law should apply to the arbitration agreement where none is expressly stated. Whilst it upheld the High Court’s decision that the law of the seat should apply in this case, it explains that this need not necessarily be the case and sets out a helpful test by which to ascertain the relevant law.

Until now, cases have been divided as to whether the arbitration agreement follows the law of the underlying contract or the law of the seat/supervisory jurisdiction selected by the parties. The law of the arbitration clause is legally distinct from the contract of which it forms a part (following the principle laid down by the House of Lords in Fiona Trust v Privalov).[2] This is significant because its law governs issues of its validity and effectiveness. Different laws may, as in this case, apply restrictions on the right to arbitrate which would need to be considered when selecting the appropriate applicable law.

However, although the case provides useful guidance, to avoid surprises it is always worthwhile for parties to stipulate the law they wish to apply to the arbitration agreement within their contract.

Background

The case involved two all-risk insurance policies (the “Policy“) for the construction of one of the world’s largest hydro-electric facilities known as Jirau in Brazil. When Enesa claimed under the Policy for physical damage and consequential losses resulting from incidents which occurred in March 2011, Sulamerica promptly denied liability under the Policy. Pursuant to an arbitration clause in the Policy, (providing for arbitration in London under the ARIAS Rules), they commenced arbitration proceedings seeking a declaration of non-liability and a declaration that a material alteration had occurred.

In response, Enesa commenced proceedings in the Brazilian courts pursuant to the exclusive jurisdiction clause also contained in the Policy. Sulamerica sought an interim anti-suit injunction in the English courts to restrain Enesa from pursuing the Brazilian proceedings in view of the arbitration afoot. Whilst anti-suit relief (under section 44 of the Arbitration Act 1996) is not available against European Member State courts (following the ECJ’s ruling in the West Tankers case) it can still be used effectively in relation to jurisdictions outside Europe.

To defend these anti-suit proceedings in the High Court, Enesa made the following contention as to the proper law of the arbitration agreement. Since the policy was expressed to be under Brazilian law and exclusive jurisdiction of Brazilian courts, the parties, location of risk and events in question were all Brazilian and only the law of the seat of arbitration was English, it should follow that the law of the arbitration agreement is also Brazilian. Furthermore, under Brazilian law, only Enesa was permitted to commence arbitration under the particular type of contract of which the arbitration agreement formed part (an ‘adhesion contract’).

In support of the injunction, Sulamerica submitted that “the law with which the arbitration agreement has its closest and most real connection is that of England because the arbitration clause provides that the seat of the arbitration is to be London, England”. Furthermore, the arbitration clause formed part of a larger escalation clause containing a mediation provision. Since that provision referred to ‘without prejudice’ negotiations and there is no such concept in Brazil, this was additional evidence that the parties meant the arbitration agreement to be governed by English law.

Decision – what test applies?

At first instance, Cooke J determined that England, the law of the seat should apply to the arbitration agreement despite the fact that all other factors pointed to the law of Brazil. In so doing, he adopted a ‘closest connection’ test, namely “if there is no express or implied choice of law, the arbitration agreement will be governed by the law with which the agreement has its closest and most real connection”. He determined that the choice of supervisory jurisdiction was the deciding factor.

The Lord Justices of Appeal (Moore-Bick LJ giving the leading judgment) have now upheld this decision and continued the anti-suit injunction. However, in so doing, they have provided a more sophisticated analysis and recognised that the closest connection will not always be to the law of the seat. Indeed, they acknowledged that previous case law is more mixed on this point than the first instance judgment suggested.

In order, then, to determine which law should apply to the arbitration agreement, they laid down a two pronged approach:

  1. First, one cannot assume that the proper law of the arbitration agreement will follow the law of the contract;
  2. Rather, there should be a “three-stage enquiry” into (i) express choice; (ii) implied choice and (iii) closest and most real connection.

They recognised that stages (ii) and (iii) of the enquiry will often merge into one another. Contrary to the rationale at first instance, they accepted that, in the absence of other factors, the implied law of the arbitration agreement will often be the same as the law of the substantive contract. However, they chose not to be more prescriptive as this will always be a matter of contractual interpretation, taking into account “the wider commercial and legal context in which the arbitration agreement is set”.

When ascertaining that the implied choice was English law, the Lord Justices were persuaded by the fact that, under Brazilian law, the agreement to arbitrate was only enforceable with Enesa’s consent. This would seriously undermine the parties’ agreement. In addition, the choice of London as seat imported acceptance that the arbitration agreement would be conducted under the Arbitration Act 1996. The supervisory jurisdiction was held to have a closer connection to the arbitration agreement in this case than the law of the insurance policy “whose purpose is unrelated to that of dispute resolution.”

Mediation provisions

As regards the mediation agreement, the Lord Justices of Appeal concurred with Cooke J who, at first instance, had held that it did not give rise to a legal obligation. As such, it was not a bar to the jurisdiction of the arbitral tribunal. They did not go so far as to prescribe the essential ingredients for a mediation provision to be effective as they considered that each case must be considered on its own terms. However they accepted that certain factors were required that did not exist in this situation, namely:

  • a definite undertaking to enter into a mediation;
  • clear provisions to appoint a mediator; and
  • a clearly defined mediation process.

Going forward – how does this affect our approach to drafting dispute resolution agreements?

This case is of enormous practical significance and leaves us with various points to bear in mind.

First, escalation clauses should be drafted clearly to ensure that any agreement to mediate is construed as a condition precedent to arbitration.

Second, although we now have clearer guidance as to the law which will apply to the arbitration agreement where it is not stipulated, there is still room for uncertainty and much will depend on the circumstances of the case. To avoid surprises, it is always worthwhile for parties to state the law they wish to apply. This will ensure that the agreed procedure for resolving disputes remains effective, including in circumstances that would render the substantive contract ineffective.

Finally, it is worth noting that the Court in this case upheld the arbitration clause despite the existence of an exclusive jurisdiction clause alongside it in the Policy. The exclusive jurisdiction clause did not encroach on the validity of the parties’ choice to arbitrate but rather would be limited to peripheral matters such as declaring a dispute arbitrable, compelling arbitration, declaring the validity of the award, or deciding on the merits if the parties dispense with arbitration. It is, however, advisable to steer clear of incorporating conflicting dispute resolution clauses when entering into new agreements.

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1. Sulamerica CIA Nacional De Seguros SA and others v Enesa Engenharia SA and others [2012] EWHC 42 (Comm); [2012] EWCA Civ 638

2. Fiona Trust and Holding Corporation and Others v Yuri Privalov and Others [2007] UKHL 40