The law governing the validity of an arbitration agreement under English law

Background

Kabab-Ji, a Lebanese company, entered into a Franchise Development Agreement ("FDA") whereby it granted a licence to Al Homaizi Foodstuff Company ("Al Homaizi"), a Kuwaiti company, to operate a franchise using its restaurant concept in Kuwait for 10 years. The FDA was governed by English law and the dispute resolution clause provided for ICC arbitration seated in Paris.

Following a restructuring of the Al Homaizi group, Al Homaizi became a subsidiary of a new holding company called KFG.

ICC arbitration

A dispute arose and Kabab-Ji commenced an ICC arbitration against KFG, but not against Al Homaizi (who had signed the FDA).

What has been at the heart of the dispute is whether KFG was a party to the FDA or to the arbitration agreement that it contained.

A majority of the Tribunal held that: (i) by applying French law, as the law of the seat of the arbitration, KFG was a party to the arbitration agreement; and (ii) by applying English law, there had been a "novation by addition" whereby KFG became an additional party to the FDA, alongside Al Homaizi, by reason of the parties’ conduct.

The Tribunal held, on the merits, that KFG had breached the FDA and made an award in favour of Kabib-Ji in the principal amount US$6.7 million.

French and English proceedings

KFG applied to the French courts seeking an annulment of the award on the basis that the Tribunal had no jurisdiction over KFG as it was not a party and so not bound by the arbitration agreement.

At the same time, Kabab-Ji applied to enforce the award in England. The High Court held that English law governed the arbitration agreement and so made the preliminary finding that KFG was not a party to the FDA or arbitration agreement. The parties appealed to the Court of Appeal whose judgment dated 20 January 2020 held that as English law was the governing law of the main contract, this was also the law that governed the arbitration agreement and it refused to recognise and enforce the award against KFG. Kabab-Ji obtained permission to appeal to the Supreme Court.

In the French proceedings, the Paris Court of Appeal dismissed KFG's annulment action in its decision of 23 June 2020 and so upheld the validity of the award. KFG has filed an appeal with the Court of Cassation and that decision is awaited.

Decision of the English Supreme Court

The Supreme Court dealt with three issues that are discussed below, the first being the most relevant for arbitration users.

1. The law governing the arbitration agreement

English law approach

In summary, the Supreme Court held that the arbitration agreement was governed by English law and, as a result, KFG had not become party to the FDA or the arbitration agreement and so the Supreme Court refused recognition and enforcement of the award.

The court's reasoning is referred to in more detail below.

Under section 103(2)(b) of the English Arbitration Act 1996 (the "1996 Act"), which transposes the text of Article V(1)(a) of the New York Convention, recognition and enforcement of an award can be refused if “the arbitration agreement was not valid under the law to which the parties subjected it² or, failing any indication thereon, under the law of the country where the award was made³.”

The court referred to its reasoning in Enka v Chubb,⁴ where it held that in the absence of an express choice of law, the law governing the arbitration agreement is the law of the underlying contract. Only when there is no identifiable law governing the contract can the choice of law be the law of the seat, but only after the closest connection test has been established. Enka was a case that considered the validity and scope of an arbitration agreement before an arbitration had taken place and applied English common law rules whereas, in the present case, the question arose after the arbitration took place in the context of English enforcement proceedings and applied section 103(2)(b) of the 1996 Act. However, the Supreme Court emphasised that it would be "illogical if the law governing the validity of the arbitration agreement were to differ depending on whether the question is raised before or after an award has been made."⁵

The FDA was governed by English law and the Supreme Court held that there was "no good reason" to infer that the parties intended to except clause 14 (containing the arbitration agreement) from their choice of English law to govern all the terms of the contract. As such, the Supreme Court concluded that the "law to which the parties subjected" the arbitration agreement is English law.

Kabab-Ji put forward two arguments to resist the application of English law, which were rejected by the Supreme Court:

1. UNIDROIT principles: Kabab-Ji argued that reference to these principles in the FDA meant there was no choice of law governing the arbitration agreement for the purposes of Article V(1)(a) of the New York Convention and section 103(2)(b) of the 1996 Act.
2. Validation principle: Kabab-Ji argued that if applying English law would lead to the conclusion that there was no valid arbitration agreement between Kabab-Ji and KFG, then it is to be inferred that the choice of English law to govern the FDA does not extend to the arbitration agreement.

French law approach

The English law approach differs to that under French law.

As above, the Paris Court of Appeal dismissed KFG's annulment action and so upheld the validity of the award. This was on the basis that the arbitration agreement is legally independent from the main contract that contains it directly or by reference.

This solution is in conformity with latest developments in French international arbitration law. Indeed, the French Court of Cassation ruled in the Dalico case that: "given that under a substantive rule of international arbitration law, the arbitration clause is legally independent of the main contract which contains it directly or by reference and that its existence and its effectiveness are assessed, subject to the French law mandatory rules and international public order, according to the common will of the parties, without it being necessary to refer to a state law."⁶

Therefore, the existence and effectiveness of the arbitration agreement are assessed apart from the main contract, according to the common will of the parties (subject to the aforementioned reservations).

In the case at hand, despite KFG's objections, the Paris Court of Appeal asserted that the fact that English law was the law governing the FDA was not sufficient to conclude that the common will of Kabab-Ji and KFG was to submit the arbitration agreement to English law. Therefore, the Court ruled that there was no agreement between the parties which would designate English law as the law governing the arbitration agreement. KFG has filed an appeal with the Court of Cassation. That decision is awaited.

2. Real prospect at a further hearing from KFG had become party to the arbitration agreement

The second issue that the Supreme Court considered was whether there was any real prospect that a court might find at a further hearing that KFG had become a party to the arbitration agreement.

Kabab-Ji argued that KFG had become a party by way of novation through the parties' conduct. The Supreme Court rejected this on the basis of No Oral Modification Clauses in the FDA (i.e. clauses which provided that it could not be amended save in writing signed by the parties).

3. Summary judgment refusing recognition and enforcement of the award

The third issue that the Supreme Court considered was whether, as a matter of procedure, the Court of Appeal was justified in giving summary judgment refusing recognition and enforcement of the award.

Kabab-Ji argued that a full evidential hearing and trial was required. After analysing the relevant principles of English procedural law, the Supreme Court rejected this and upheld that the Court of Appeal's decision.

Points to take away

At present, Kabab-Ji is in an uncertain position as the award has been upheld in France, albeit subject to appeal to the Court of Cassation, but is unenforceable in England.

This case is an interesting one in respect of the approach taken by courts in different jurisdictions to choice-of-law rules. Whilst it may be interesting, there is a risk of lack of uniformity in the application of the rules. Whilst the Supreme Court decision found that English law governed the validity of the arbitration agreement because the agreement in question contained an express choice of English law for the underlying contract, French law emphasises the separability and autonomy of the arbitral agreement to determine the law governing its validity.

As a practical point, to avoid potential ambiguity, and the risk of long and costly enforcement proceedings, parties may wish to consider providing expressly for which law is applicable to the arbitration agreement, in addition to specifying the governing law of the main underlying contract.