IA Fundamentals | 4. International Arbitration Agreement (I)

Editor's Note: As enterprises are increasingly engaged in international trade and investment, international arbitration is recognized as the preferred option in the face of cross-border disputes. However, international arbitration, which differs from domestic arbitration with complex procedures, often put parties unfamiliar with its rules in an inherent disadvantage. King & Wood Mallesons' international arbitration teams are located in Beijing, Shanghai, Shenzhen, Hong Kong Special Administrative Region of China, Sydney, Melbourne, Perth, London, Madrid, Brussels, Dubai, Tokyo, New York and Silicon Valley. KWM International Arbitration Fundamentals is co-hosted by King & Wood Mallesons' China and Australia international arbitration teams. The purpose of the program is to share knowledge and experience on international arbitration, including international commercial arbitration and investment arbitration, from the perspective of experienced lawyers. Hopefully it will benefit parties engaged in international arbitration. Please comment with any suggestions or ideas.

Arbitration agreement is the cornerstone of international commercial arbitration which records the parties' consent to submit the dispute for arbitration. Such consent is the prerequisite for the smooth progress of arbitration proceeding and the recognition and enforcement of arbitral awards.

However, in business negotiations, the arbitration clause in the contract is often the last matter to be agreed upon. The parties often fail to consider it carefully for various reasons, and sometimes even "copy" the arbitration clause from other previous contracts as it is. As it may involve multiple legal systems to determine the validity of an arbitration agreement, the parties who fail to carefully consider the content and wording of the arbitration agreement due to the lack of systematic knowledge of international commercial arbitration, or their confinement to their own understanding of, and experience in the domestic arbitration legal system, may face a series of risks, including but not limited to the arbitration proceeding being conducted in a way unfamiliar or unfavorable to them, disputes over jurisdiction, and the annulment or unenforceability of the awards.

This article will start with a general introduction to the international commercial arbitration agreements, including the definition and elements of arbitration agreements. Referring to New York Convention and UNCITRAL Model Law on International Commercial Arbitration ("UNCITRAL Model Law"), and taking into account the judicial practice of various countries, this article will introduce the principles for determining the validity of international arbitration agreements. Hopefully, it could provide reference for participants in international arbitration in drafting, negotiating, and determining arbitration agreements.

1

Overview of Arbitration Agreement

(I) Definition of arbitration agreement

In an arbitration agreement, the parties agree to submit disputes to arbitration. From the perspective of precise legal definition, "arbitration agreement" is defined as "an agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not. An arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate agreement" under Article 7(1) of the UNCITRAL Model Law.

This definition includes four elements: (1) an arbitration agreement may govern the disputes that have arisen or may arise in the future; (2) an arbitration agreement may provide that any dispute to be submitted to arbitration may be contractual or non-contractual; (3) an arbitration agreement may be either an arbitration clause in a contract or a separate arbitration agreement between the parties concerned; and (4) any dispute subject to an arbitration agreement shall arise from a defined legal relationship.

Countries and regions, including the United States, the United Kingdom, Germany, Canada, Singapore, and Hong Kong SAR which have taken the UNCITRAL Model Law as their model legislation have adopted this definition in their arbitration laws. However, there are also some domestic arbitration laws have adopted a narrower definition. For example, China's arbitration law has imposed restriction on the content of the arbitration agreement, providing that the arbitration agreement shall specify the arbitration commission selected by the parties. 

In order to ensure the validity of their arbitration agreement, the parties must first consider the basic definitions of arbitration agreements in the arbitration laws of countries and regions that are likely to examine the validity of the arbitration agreement.

It is worth noting that the arbitration agreement does not require the parties to reach an agreement before the disputes arise. For disputes that have already occurred, the parties can also reach an arbitration agreement. In this case, as the facts in dispute have already occurred, the arbitration agreement between the parties can even make more specific and flexible arrangements based on the current situation than the one reached in advance of the dispute.

(II) Contents of arbitration agreement

The contents of an arbitration agreement can be detailed or brief. In accordance with some relatively lenient arbitration laws (such as the Arbitration Ordinance of Hong Kong SAR), the contents of an arbitration agreement may only include the intention of the parties to submit the dispute (i.e. matters for arbitration) to arbitration. However, in general, in order to make such issues as the location, institution and procedure of arbitration more foreseeable, the following elements are mostly covered in a common arbitration agreement:

A. Applicable laws: procedural law (lex arbitri, crucial law), governing law of the arbitration agreement, substantive law;

B. Location: seat of arbitration, venue/place of arbitration;

C. Institutions and rules: arbitration institution, arbitration rules, constitution of arbitration tribunal, arbitrator, language of arbitration.

We found that many parties who are not familiar with international arbitration agreements are often confused about the above elements and do not know the legal significance of them. As a result, contradictions and vagueness are often found in the badly-drafted arbitration agreement, causing procedural delay and deadlock. In this regard, we should clarify some of the most important yet confusing concepts below:

Firstly, it's necessary to clearly distinguish between three different applicable laws

First, procedural law applicable to arbitral proceedings, which refers to the law that the arbitral proceedings themselves shall be subject to, governing both internal procedural matters and external regulatory matters of domestic courts in arbitration. Specifically, the most important content is the boundary of judicial review of arbitration, including formal elements, jurisdiction, and enforcement of awards. In principle, the arbitration procedural law shall be the arbitration law of the seat of arbitration. However, under very limited circumstances, if it is otherwise expressly agreed in the arbitration agreement, there are judicial precedents recognizing that the arbitration procedural law may differ from the arbitration law of the place of arbitration. However, such inconsistency will cause great trouble to the arbitration proceeding itself and the possible judicial review.

Second, the governing law for the validity of an arbitration agreement or the "law applicable to arbitration agreement", which refers to the substantive law that determines the validity of the arbitration agreement itself. This concept is not equivalent to the arbitration procedural law, and it also differs from the governing law for substantive disputes (such as the governing law for the underlying contract) because of the independence of the arbitration agreement. If the parties fail to expressly agree on the governing law for determining the validity of arbitration agreement, courts in most countries and regions may determine the validity of arbitration agreement in accordance with the law of the seat of arbitration determined in the arbitration agreement.

Particularly, as the requirements of PRC laws for the validity of an arbitration agreement are more stringent than that of the laws and regulations of popular international arbitration venues, the parties to an international arbitration involving Chinese mainland may make a clear agreement thereto, for the purpose of ensuring the stability of the validity of the arbitration agreement.

Third, law applicable to substance of parties' dispute. Where a dispute is contractual, it refers to the law applicable to the settlement of substantive disputes, including disputes surrounding such issues as the formal requirements, validity, interpretation of terms, rights and obligations of the parties and liability for breach of contract with respect to the underlying contract. The law applicable to substance of parties' dispute does not determine how the parties resolve a dispute, but rather is used to judge their respective rights and obligations under the underlying contract. Furthermore, it is not a requisite element of an arbitration agreement. However, in practice, we noticed that the parties tend to incorporate the law applicable to substance of parties’ dispute into the Dispute Resolution and Governing Law clause, and this often does give rise to confusion. Therefore, the parties should pay special attention to the differences between the law applicable to substance of parties’ dispute, the procedural law applicable to arbitral proceedings and the governing law for the validity of arbitration agreements, and it is better to clearly provide them in the contract respectively.

Secondly, it's necessary to distinguish between the seat of arbitration and venue/place of arbitration and pay special attention to the choice of the seat of arbitration

• Seat/forum of arbitration refers to the legal situs of the arbitration proceedings. It determines the court in the corresponding jurisdiction which shall conduct the supervision and judicial review of the arbitration and the procedural law applicable to the arbitration may also be known from the seat of arbitration. These issues are some of the most important factors in determining the influence of courts on arbitration and the enforcement of arbitral awards. The parties concerned shall pay special attention

  thereto and make express agreement thereon.

  In principle, in the absence of an express agreement, the seat of arbitration shall be the place where the arbitration institution is located. Therefore, if the arbitration agreement provides an ad hoc arbitration without a determined arbitration institution and doesn’t determine the seat of arbitration neither, the country where the arbitration will take place is very likely to be unknown, resulting in uncertainty in the later actions.

• Venue of arbitration refers only to the place where the parties concerned can choose at their own discretion to conduct their actual arbitration activities considering convenience, cost and other factors, and is not a necessary part of the arbitration agreement. The parties may agree on the venue freely according to the actual conditions. The venue of arbitration does not affect the legal effect of arbitration itself, nor does it constitute the basis for local courts to exercise jurisdiction. However, as the venue of arbitration is easily confused with the seat of arbitration, it is necessary for the parties to make clear and definite statement in the agreement.

  Among the leading international arbitration institutions, we believe that the model clauses published by the Hong Kong International Arbitration Centre (HKIAC) stand out in terms of completeness, standardization and guidance. The model clauses are set out as follows:

Arbitration under the HKIAC Administered Arbitration Rules

"Any dispute, controversy, difference or claim arising out of or relating to this contract, including the existence, validity, interpretation, performance, breach or termination thereof or any dispute regarding non-contractual obligations arising out of or relating to it shall be referred to and finally resolved by arbitration administered by the Hong Kong International Arbitration Centre (HKIAC) under the HKIAC Administered Arbitration Rules in force when the Notice of Arbitration is submitted.

*The law of this arbitration clause shall be ... (Hong Kong law).

The seat of arbitration shall be ... (Hong Kong).

**The number of arbitrators shall be ... (one or three). The arbitration proceedings shall be conducted in ... (insert language)."

Note:

*   Optional. This provision should be included particularly where the law of the substantive contract and the law of the seat are different. The law of the arbitration clause potentially governs matters including the formation, existence, scope, validity, legality, interpretation, termination, effects and enforceability of the arbitration clause and identities of the parties to the arbitration clause. It does not replace the law governing the substantive contract.

**  Optional

The above clause covers all elements of an arbitration agreement, including matters for arbitration, intention of arbitration, seat of arbitration, arbitration institution, arbitration rules, governing law for the validity of the arbitration agreement, constitution of the arbitration tribunal and language of arbitration, and clearly explains the concepts that are easy to be confused. Even if the parties wish to arbitrate in other arbitration institutions, they can also make use of this model arbitration clause for reference.

The parties that adopt the above recommended model arbitration clause may still make supplementary agreements on certain specific matters, such as the venue of the arbitration, the nationality of the arbitrators, the qualification requirements of the arbitrators, the rules for the replacement of arbitrators, the rules for default judgment, and the language used in the arbitration proceeding, etc. If there is no prior agreement on these matters, once the parties fail to reach an agreement on such matters in the institutional arbitration procedure, the relevant disputes must be settled by the relevant arbitration institution or arbitration tribunal in accordance with the arbitration rules of the arbitration institution.

(III) Can arbitration agreements bind third parties?

The parties' voluntary consent to arbitration is the prerequisite for arbitration, and such consent is embodied in an agreement to arbitrate, which will generally be concluded in writing and signed by the parties. Arbitration agreements are generally included in contracts signed by the parties to the transaction, and are therefore naturally binding upon the parties.

However, in some cases, third parties that have not signed arbitration agreements are also directly involved in the dispute. In practice, an effective arbitration agreement may be binding on a "non-signatory" party for a number of reasons:

Firstly, the "Group of Companies Doctrine" may, under certain circumstances, serve as a basis for binding third parties which are not the signatories of the arbitration agreement. In the Dow Chemical[1] case, the International Chamber of Commerce International Court of Arbitration ("ICC") accepted a claim brought jointly by the companies that had signed the arbitration agreement, their US parent company and another French subsidiary within the same group. As those companies within the same group had important connections to the contractual disputes and had the common intention to participate in the arbitration proceedings, the court acknowledged in its review that the effect of the arbitration agreement could be extended to the third-party companies within the group.

Secondly, the general provisions of private law, mainly the rules on assignment, agency and succession, may also subject the "non-signatory" party to be bound by the arbitration agreement.

It is worth noting that unlike litigation in the courts, in which third parties can often be joined to proceedings, the jurisdiction of an arbitral tribunal to allow for the joinder or intervention of third parties to an arbitration is limited. The tribunal's jurisdiction derives from the consent of the parties to the arbitration agreement and therefore joinder or intervention is generally only possible with the consent of all parties concerned (including the original parties and the third parties to the arbitration proceedings). 

2

Arbitration Agreement Requirement under the New York Convention

The third article of the "IA Fundamentals" series has discussed the legal framework for international commercial arbitration based on the New York Convention. Such framework has established a “pro-arbitration” regime for the recognition and enforcement of international commercial arbitration agreements.

The New York Convention, however, is applicable only to the arbitration agreements with the following attributes:

1. "International" connection

The New York Convention and the laws of many Contracting States governing international arbitration are only applicable to the arbitration agreement with "international" or "foreign" connection.

However, the New York Convention does not set a standard for the requirement on "international" connection. The domestic arbitration laws of the Contracting States provide diversified definitions on "international" connection, depending on the sole factor of the nationality of the parties, the legal relationship between the nationality of the parties and the entity in dispute, and other comprehensive standards. An example for determination based on comprehensive standards is the UNCITRAL Model Law, which provides in Article 1(3) that:

"(3) An arbitration is international if:

    (a) the parties to an arbitration agreement have, at the time of the conclusion of that agreement, their places of business in different States; or

    (b) one of the following places is situated outside the State in which the parties have their places of business:

(i)

the place of arbitration if determined in, or pursuant to, the arbitration agreement;

(ii)

any place where a substantial part of the obligations of the commercial relationship is to be performed or the place with which the subject-matter of the dispute is most closely connected; or

   (c) the parties have expressly agreed that the subject matter of the arbitration agreement relates to more than one country."

The above standards are designed to expand the scope of "international" connection as much as possible by incorporating all relevant factors in relation to entities and procedures.

In terms of the domestic law, Article 202, Chapter 2 of the Federal Arbitration Act of the United States provides that "An agreement or award arising out of such a relationship (which refers to commercial legal relationship) which is entirely between citizens of the United States shall be deemed not to fall under the Convention unless that relationship involves property located abroad, envisages performance or enforcement abroad, or has some other reasonable relation with one or more foreign states". It can be seen from the above provision that the United States has no obligations under the New York Convention with respect to arbitration agreements without "international" connection.

Although China did not specify "international" connection as the prerequisite for undertaking the obligations under the New York Convention in its legislation, whether there is "international" or "foreign-related" connection is an important criterion for a Chinese court to determine the validity of an arbitration agreement on which a foreign arbitral award is based. [2] As for the specific standard for the "international" connection in judicial practice, China basically adopts the nationality of the parties as the main standard with due consideration given to the type of substantive legal relations. Compared with countries and regions adopting the rules under the UNCITRAL Model Law, such standard is relatively stringent.

2. "Commercial" relationship

In some cases, the New York Convention and the domestic laws of the Contracting States governing international arbitration are only applicable to arbitration agreements arising out of a "commercial" relationship. The New York Convention provides Contracting States with the option of making commercial reservations in Article 1(3), whereby the Contracting States may declare that the application of the New York Convention is limited to contractual or non-contractual disputes which, in accordance with their domestic laws, are to be regarded as commercial legal relationship. As of the drafting date of this article, a total of 51 Contacting States have made commercial reservations, most of which are developing countries except the United States. [3]

Most Contracting States that have made commercial reservations to the New York Convention do not have a clear definition of the concept of commerce in their legislation. This means that in the application of the New York Convention, whether it is a commercial legal relationship largely relies on the judicial discretion of domestic courts, bringing relatively large uncertainty.

China also made commercial reservations when entering into the New York Convention. The Supreme People’s Court of China provides the following definition on "commercial legal relationship" in its judicial interpretations:[4]

"The so called ‘legal relationships, whether contractual or not, which are considered commercial’ refers to the economic rights and obligations arising from contracts, torts or relevant legal provisions, such as sales of goods, lease of property, project contracting, processing, technology transfer, equity or contractual joint adventure, exploration and development of natural resources, insurance, credit, labor services, agency, consultation services, marine, civil aviation, railway or road passenger and cargo transportation, product liability, environment pollution, marine accidents, and ownership disputes, except disputes between foreign investors and the host government."

There are no such cases so far where Chinese courts refuse to apply the New York Convention on the ground of commercial reservation.

3. Reciprocity requirement

In addition to commercial reservation, Article 1(3) of the New York Convention also provides for reservation based on reciprocity, which means "any State may declare that it will apply the Convention to the recognition and enforcement of awards made only in the territory of another Contracting State". Article 14 of the New York Convention also provides for a more general provision on reciprocity stating that "a Contracting State shall not be entitled to avail itself of the present Convention against other Contracting States except to the extent that it is itself bound to apply the Convention".

As of the drafting date of this article, a total of 76 Contracting States have made reservation on the basis of reciprocity.[5] In practice, as the application of the New York Convention has been ratified by major important trading countries in the world, reciprocal reservation rarely becomes an obstacle to the recognition of the validity of an international commercial arbitration agreement.

To sum up, an arbitration agreement that does not apply to the New York Convention due to its failure to satisfy the above three requirements may not enjoy the "pro-arbitration" regime under the New York Convention.

3

Principles for Determination of the Validity of an International Arbitration Agreement

As discussed above, the validity of an international arbitration agreement is governed by the governing law for the validity of such agreement in the place of arbitration. Determination on the validity of the arbitration agreement may vary in different places. However, thanks to the New York Convention and the UNCITRAL Model Law which aim to set a unified standard, in practice, consensus has been reached to a certain degree in the laws of various countries and regions on the separability and presumptive validity of arbitration agreements.

1. Separability of arbitration agreements

The separability presumption of an arbitration agreement is a principle prerequisite for determining the validity of an international commercial arbitration agreement. Specifically, arbitration clauses are presumptively "separable" or "severable" from the contract within which they are found (sometimes termed the "main" or "underlying"contract) when the arbitration agreement takes the form of an arbitration clause in the main contract. Article 16(1) of the UNCITRAL Model Law explicitly provides that "an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract".

The legal consequences of separability presumption are as follows:

(1) Invalidity or non-existence of underlying contract does not necessarily entail invalidity or non-existence of arbitration agreement;

(2) Invalidity of arbitration agreement does not necessarily entail invalidity of main or underlying contract;

(3) Law governing main or underlying contract is not necessarily the same as law governing arbitration agreement;

(4) Different form requirements for main or underlying contract and arbitration agreement.

2. Presumptive validity of arbitration agreements

The New York Convention is mainly designed to enhance the trust of Contracting States towards international arbitration so as to create a relaxed environment for the recognition and enforcement of international arbitration agreements. Therefore, Article 2 of the New York Convention provides that each Contracting State shall recognize an agreement under which the parties undertake to submit relevant disputes for arbitration unless the above agreement is null and void under certain exclusive and limited circumstances.

Similarly, Article 8(1) of the UNCITRAL Model Law provides that "A court before which an action is brought in a matter which is the subject of an arbitration agreement shall, if a party so requests …, refer the parties to arbitration unless it finds that the agreement is real and void, inoperative or incapable of being performed."

Most courts of Contracting States interpret Article 2 of the New York Convention as a mandatory obligation to enforce an arbitration agreement save for a few explicit exceptions.

4

Conclusion

The smooth progress of the international commercial arbitration proceeding and the final enforcement of the arbitration award shall be on the premise of an effective international commercial arbitration agreement that conforms to the parties' legal and commercial interests. Although the New York Convention intends to safeguard the enforceability of the international commercial arbitration agreement to the maximum, the domestic legal systems of various Contracting States still have the final jurisdiction on the validity of the arbitration agreement. For complicated transactions across different jurisdictions, if the parties lack an accurate understanding of the differences in the legal provisions and judicial practice of different countries when drafting international commercial arbitration agreements, the arbitration agreements reached thereby may not be recognized as valid.

In subsequent articles in this series, we will elaborate on the key points that should be paid special attention to when drafting international commercial arbitration agreement in light of the situations that often arise in practice among the parties to the transaction. Please stay tuned.

Footnotes:

[1] Dow Chemical v. Isover Saint Gobain, ICC Case No. 4131 of September 23, 1982, 9Y.B. Commercial Arbitration (1984), p131-137.

[2] See Reply Letter of the Supreme People's Court to the Request for Instructions concerning the Confirmation of the Validity of the Arbitration Agreement Dispute in the Case between Nantong CASC Wanyuan Acciona Wind Turbine Manufacture Co., Ltd. and LM Wind Power (Tianjin) Co., Ltd., Min Si Ta Zi [2012] No.2; also see Reply Letter of the Supreme People's Court to the Request for Instructions concerning the Application Made by Beijing Chaolai Xinsheng Sports Leisure Co., Ltd. to Recognize the No. 12113-0011 and the No. 12112-0012 Arbitration Awards of the Korean Commercial Arbitration Board, Min Si Ta Zi [2013] No.64.

[3] The Status of Convention on the Recognition and Enforcement of Foreign Arbitral Awards, UNCITRAL Homepage, https://uncitral.un.org/en/texts/arbitration/conventions/foreign_arbitral_awards/status2, last access: June 30, 2020.

[4] Notice of the Supreme People's Court on Implementing the Convention on the Recognition and Enforcement of Foreign Arbitral Awards Acceded to by China, 10 April 1987, Fa (Jing) Fa [1987] No.5.

[5] Ibid.

References:

1. Gary B. Born, International Commercial Arbitration, Second Edition, Kluwer Law International, 2014.

2. Nigel Blackaby and Constantine Partasides QC with Alan Redfern and Martin Hunter, Redfern and Hunter on International Arbitration, Sixth Edition, Oxford University Press, 2015.

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Authors

Shining Guo

过仕宁

Partner

Dispute Resolution

[e-mail]

Ms. Shining Guo specializes in dispute resolution, especially in cross-border commercial dispute resolution.Ms. Guo is proficient at assisting Chinese and foreign clients with complex commercial disputes, and she has handled many influential arbitration cases before major international arbitral institutions, which includes the HKIAC, ICC, SIAC, FOSFA, CIETAC, as well as ad hoc arbitrations in Hong Kong and London, in respect of joint venture shareholders’ disputes, financial derivative disputes, product liability disputes, sale of goods disputes, bill of lading, charterparty and shipbuilding contract disputes. She also represents clients in recognition and enforcement of foreign arbitral awards in China. Additionally, Ms. Guo has participated in several litigation cases before the UK and the US courts.

Mengtao Mao 

毛孟涛

Associate 

Dispute Resolution

Thanks to intern Jin Xiaojia for her contribution to this article.