Applicable Law to the Contract, Arbitration Agreement and Arbitration Procedure

As could be expected, international arbitration’s usually arise out of cross-border commercial transactions involving a complex interaction of laws. There are many issues—from the capacity of the parties to sign a contract to the recognition and enforcement of an award—that require the application of different laws and rules in order to resolve the dispute properly. In this context, questions often arise surrounding which laws or sets of rules should govern the underlying contract, the arbitration agreement and the arbitration procedure. This article is designed to provide a brief overview of these issues as they could play out in an international arbitration.

Substantive Law Applicable to the Contract
Substantive contractual issues most often refer to the interpretation, validity, rights of parties, performance, breaches and remedies derived from a contract. Given that in a cross-border transaction, laws from several jurisdictions may potentially apply, the question is what criteria should be used to determine the law governing these substantive contractual issues.

Party Autonomy
A generally accepted principle is that parties entering an international commercial transaction are free to choose the law applicable to such agreement and that arbitral tribunals will respect the parties’ autonomy to do so. This principle of party autonomy is recognized not only by most systems of national law and arbitral tribunals, but also by international conventions and institutional arbitration rules such as those from UNCITRAL, ICC, LCIA and ICDR.

Even though parties usually choose a national or a state law to govern the contract, they are not limited to these common choices. Parties also may choose other sets of rules such as public international law, transnational law (e.g., the United Nations Convention on Contracts for the International Sale of Goods), general principles of law or equitable principles, or even agree that different parts of the contract will be governed by different laws. This choice can be made either when the contract is made or by a later agreement.

Mandatory Law
There are some limits to the principle of party autonomy. These limits ordinarily involve laws that regulate matters of public policy within a given country. By way of example only, parties cannot opt out of United States securities laws when the object of the contract is raising capital in the United States, or exclude Venezuelan currency controls when the object of the contract is investing in Venezuela, or contract away Colombian environmental regulations when the object of the contract is constructing a power plant in Colombia. Parties should carefully consider the applicability of mandatory local laws before entering into a contract.

Lack of Express Provisions
While parties usually provide for their choice of law applicable to the contract in express terms, what happens when the parties to a contract fail to do so?

Generally, courts and arbitral tribunals resolve this issue by assessing party intent and selecting the law that the parties are presumed to have intended to choose. For example, in the absence of an express contractual provision, a Mexican arbitral tribunal resolving a dispute between a Mexican company and a U.S. contractor for a construction project in Mexico under a contract executed in Mexico may infer that the parties intended for the contract to be governed by Mexican law, despite the fact that one of the parties is not Mexican.

In cases where no inference as to intent of the parties can be drawn, however, the governing law of the contract shall be the one resulting from the application of conflicts of laws rules from the seat of arbitration. Many jurisdictions include in their conflicts of laws rules specific criteria, such as the state or the country to which the contract is most closely connected or where the contract was executed, to determine the applicable law of the contract. In countries that are signatories to the European Convention on International Commercial Arbitration of 1961, however, arbitrators are not bound by the conflicts of laws rules from the seat of arbitration; rather they are free to “apply the proper law under the rule of conflict that the arbitrators deem applicable.”

Law Applicable to the Arbitration Agreement
Notably, an arbitration clause and the underlying contract are generally considered separable contracts under a widely accepted legal theory known as the separability doctrine. Therefore, different laws may apply to the contract and the agreement to arbitrate.

Similar to the substantive law applicable to the contract, the parties can choose the substantive law governing the arbitration agreement. The question is, again, what law should apply absent such agreement. Courts and arbitral tribunals differ about which approach to take.

For example, the English Court of Appeals formulated a three-stage inquiry to establish the law of an arbitration agreement: (1) whether the parties expressly chose the law of the arbitration agreement; (2) whether the parties made an implied choice of law for the arbitration agreement; and (3) in the absence of express or implied choice, the system of law with which the arbitration agreement has “the closest and most real connection.”

In contrast, courts in Singapore and Hong Kong have ruled that the law of the seat of arbitration is the appropriate one to govern the parties’ arbitration agreement in the absence of an express provision.9 Similarly, the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (also known as the New York Convention) specifies that, absent express agreement between the parties, the applicable law to the agreement should be the one where the award is made, i.e., the seat of the arbitration.

Parties may, therefore, find it surprising that a court or a tribunal deciding their case may end up applying different laws to the underlying dispute and the arbitration agreement, even when the parties have expressly chosen the law applicable to the underlying dispute. In order to reduce uncertainty, the parties should use clauses stating in express and unequivocal terms the substantive law governing the arbitration agreement.

Law Applicable to the Arbitration Procedure
Since arbitration is by nature contractual, parties also can agree to different procedural laws that will govern the arbitration proceedings. Usually, the rules of arbitral institutions such as the ICC, ICDR, LCIA or HKIAC,12 or the UNCITRAL Arbitration Rules (in the case of ad hoc arbitration), as well as supplemental rules such as the International Bar Association Rules on the Taking of Evidence in International Commercial Arbitration, provide the procedural framework for the parties to conduct the arbitration. Parties may also choose national or state laws either to govern the arbitral procedure or to supplement the rules of the selected arbitral institution.

Lex Arbitri
In addition to the procedural law chosen by the parties, the law of the seat of the arbitration, known as the lex arbitri, which the parties are also free to choose by virtue of their choice of arbitral seat, is a source of procedural laws affecting the rights and remedies available to parties.

The lex arbitri refers to mandatory provisions imposed by each country on arbitrators in their own territory on issues such as arbitrability, interim measures, entitlement of the tribunal to rule on its own jurisdiction (otherwise known as the doctrine of competence-competence), judicial assistance, rules of ethics and many others. Because the lex arbitri often relates to matters of public policy, parties and tribunals are usually not allowed to circumvent these laws.

Therefore, because the lex arbitri may take precedence over other freely chosen rules of procedure, and may subject the arbitral award to annulment if some aspect of the arbitral proceeding or award is found to violate the lex arbitri, parties should be careful in choosing the seat of the arbitration.

Parties have ample autonomy to choose the law or rules that apply to an arbitration. If chosen hastily, however, this freedom comes with inherent risks, as described above. Therefore, parties should make it a practice to recognize potential conflicts and issues at the outset; limit to the extent possible the number of potentially conflicting laws and rules governing the contract, the arbitration agreement and the arbitration proceedings; and aim to be consistent with national or state laws, including the lex arbitri.

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