Drafting an arbitration clause into a contract? Read this first

Article 15 July 2021 Experience

This guidance note will be useful for commercial lawyers and professionals involved in corporate transactions.

What should happen in the event of a dispute is often the last thing on everyone’s mind when agreeing a commercial contract. But, without due consideration, potential perils lie in wait for both lawyers and their clients. It is, therefore, imperative that you understand why it’s important to choose arbitration and to draft arbitration clauses carefully in contracts, seeking appropriate advice and consultation, in order to manage risks.

How to approach the governing law of an arbitration agreement

The dispute resolution clause is referred to as the ‘midnight clause’ because parties typically draft this at the last minute before a contract is finalised. However, the recent case of Enka v Chubb has demonstrated the dangers lurking in this unprioritised clause and provided long awaited clarification over which law should govern an arbitration agreement where this is not specified. This is important in order to be able to determine the scope of arbitration and will have an impact on parties’ choices over how to resolve disputes in their commercial contracts.

What are the takeaway points?

Although parties usually specify which governing law applies to their contract, they do not usually specify what law applies to the arbitration agreement contained within the contract. The English Supreme Court in Enka v Chubb has settled the debate as to what law applies to the arbitration agreement in these situations and found that the governing law of the main contract would also apply to the arbitration agreement unless that law would invalidate or significantly undermine the arbitration agreement. An arbitration clause has long been considered to be a separate agreement to the main body of the contract. The Supreme Court accepted this principle but found that the clause can be separated from the wider contract only in situations where the wider contract is invalid or has been terminated.

What happened in Enka v Chubb?

The case involved Chubb, a Russian insurance company, and Enka, a Turkish engineering and construction company. Enka had been subcontracted to do work on a power plant in Berezovskaya, which was subsequently damaged by a fire in 2016. Chubb paid the insurance claim filed by the owner of the power plant, and proceeded to issue a claim in the Moscow Court against Enka, claiming that Enka (and others) were liable for the damage caused to the power plant by the fire.

The contract specified that a dispute would be settled by ICC arbitration in London but did not contain a governing law clause. Enka filed to have the claim in the Moscow Court dismissed on the basis that the dispute should be resolved by arbitration in London rather than by Russian litigation. The Moscow Court denied this application, and so Enka applied in the English High Court for an anti-suit injunction to stop the Russian proceedings. This was also denied, however the English Court held a trial to consider the issue. Unfortunately for Enka, the English Court held that the Moscow Court was the proper place to decide the issue. Enka appealed, and proceeded to file a request for arbitration with the ICC in London.

The English Court of Appeal considered the issues, and found that the contract was governed by the law of the arbitral seat, being London. This meant that English law applied. Chubb appealed the decision, but the English Supreme Court dismissed the appeal. The majority (in a 3-2 split decision) held that, where a governing law is not clearly chosen in a contract and there is also no implied choice of governing law, the law ‘most closely connected’ to the contract would be the law of the seat of the arbitration which in this case was English law.

What does this mean for arbitration clauses?

As simple and logical as the finding of the Supreme Court sounds, there can be many complications. In order to avoid such complications, arbitration clauses should always specify the law that governs those clauses in addition to the law that governs the main contract. A number of arbitration institutions, for example the ICC and the LCIA, recommend the arbitration clause includes the law governing the contract and the LCIA has updated its model clause to reflect this.

It is important for parties to be aware that the choice of a seat does not mean that the law of that seat will apply to the arbitration agreement. The best way to have certainty as to which law will govern the arbitration agreement is to expressly provide for it.

For more information on this issue or assistance in drafting jurisdiction clauses in commercial contracts, please contact us.