The Law Governing Arbitration Agreement In International Contracts: Lex Arbitri or Substantive?

July 7, 2020

Analysing Kabab-Ji SAL (Lebanon) v Kout Food Group (Kuwait)

An agreement to arbitrate typically takes in the form of a clause within a contract. An arbitration clause (commonly referred to as an arbitration agreement) is an agreement within an agreement and distinguishable from the broader contract in which it sits in. This reflects the parties presumed intention that their agreed dispute resolution mechanism (by way of arbitration) should remain effective even if the underlying contract is found to be invalid. Consequently, the law governing an arbitration clause is not necessarily the same as the law governing the contract.

The significance of the law governing an arbitration agreement is demonstrated in the Kabab-Ji Sal v Kout Food Group saga, facts of which will be discussed below.

Brief Facts

Kabab-Ji Sal (Kabab), a Lebanese company, entered into a franchise development agreement with Al Homaizi Foodstuff Company (Al Homaizi), a Kuwaiti company. Following a corporate restructuring exercise, Al Homaizi became a subsidiary of Kout Food Group (Kout). During the performance of the agreement, a dispute arose between Kabab and Al Homaizi. Instead of commencing an arbitration against Al Homaizi, Kabab commenced arbitration directly against Kout.

An arbitration tribunal seated in Paris applied French law to the question of whether Kout had become party to the arbitration agreement, and held that it had, based on the parties’ conduct. The tribunal then found Kout liable for breaching the agreement. Upon the delivery of the arbitration award, Kabab sought to enforce the arbitration award at the English Court, which was resisted by Kout. Concurrently, Kout sought to set aside the arbitration award at the French Court on jurisdictional grounds (i.e. that the law governing the arbitration agreement is English law as opposed to French law, and upon applying English law, Kout is not a party to the arbitration agreement resulting in the arbitral tribunal acting in excess of its jurisdiction).

The English Position

In January 2020, the English Court of Appeal held in favour of Kout and refused to enforce and recognise the arbitration award, on amongst others, the following grounds:

1. The fact that the arbitration clause itself did not expressly refer to English law did not matter as the wording used in the contract demonstrated a clear intention that the entire agreement would be governed by English law.

2. Accordingly, and pursuant to English law, Kout is not a party to the arbitration agreement nor the underlying contract.

The position taken by the Court of Appeal coincides with the conventional Sulamerica1 approach: where the arbitration agreement is silent on the law governing the arbitration agreement, there is a rebuttable presumption that the law governing the arbitration agreement is the same as the law governing the contract.

The French Position

However, on 23 June 2020, the Court of Appeal of Paris (Cour d’appel de Paris) held in favour of Kabab and refused to set aside the arbitration award, on the following grounds:

1. The starting point was the substantive rule of international arbitration law, meaning that the arbitration agreement is legally independent from the underlying contract in which it is included and its existence and validity are interpreted subject to the law of the seat, unless there is an intention of the parties to have a different approach.

2. Having regard to the organisational chart of Kout and its participation in the performance of the contract, it was more than sufficient under French law to make it a party to the arbitration clause.

The French position deviates from the conventional Sulamerica approach, in that unless otherwise stated, the law governing the arbitration agreement should be the law of the seat. The contradicting positions taken by London and Paris resulted in the arbitration award being enforceable in France, but not in England – leaving the question on enforceability of the arbitration award in other jurisdictions being uncertain.

Although it principally aligns with the doctrine of separability, the French position deviates from generally accepted principle in Sulamerica that “the concept of separability itself… simply reflects the parties’ presumed intention that their agreed procedure for resolving disputes should remain effective in circumstances that would render the substantive contract ineffective. Its purpose is to give legal effect to that intention, not to insulate the arbitration agreement from the substantive contract for all purposes”.

Practical Considerations

The position in Malaysia is similar to the French position. In the Thai-Lao Ignite Co Ltd case, the Federal Court held that where the law of the seat differs from the substantive law of the contract, and if parties fail to specify the law applicable to the arbitration agreement, there is a rebuttable presumption that law governing the arbitration agreement is the law of the seat (i.e. lex arbitri). On the contrary, the Singaporean Courts accept the English position in Sulamerica, as was decided in the recent BNA case.

The Kabab-Ji Sal v Kout Food Group saga, as well as the contradicting positions highlighted in the preceding paragraph, illustrates the inherent danger of ambiguity in international contracts – one that is capable of being interpreted differently between different jurisdictions, with unanticipated consequences. Whilst the failure to specify the law governing the arbitration agreement appears insignificant on the surface, disputes surrounding the interpretation of an arbitration clause is common and resolving them can be an expensive and lengthy process. Parties are therefore reminded to be mindful when drafting arbitration clauses in an international contract so as to avoid ultimately having an unenforceable arbitration award.