This article originally appeared in Mining Journal.
Ensuring the enforceability of natural resources contracts in emerging markets, particularly those concluded with state entities, can be challenging. On occasion, investors can be protected by the provisions of an applicable bilateral investment treaty. However, in the absence of such protection, international arbitration is often an attractive dispute resolution mechanism. It avoids potentially partial local court judgments, and provides for relatively simple enforcement in over 150 New York Convention states.
If arbitration is chosen, it is of crucial importance that arbitration agreements are valid and enforceable. The validity of an arbitration agreement is generally determined by the law applicable to that arbitration agreement. It is important to be aware that the governing law of a contract will not necessarily be the law applicable to an arbitration agreement, in particular where the seat of the arbitration is not the country whose laws apply to the substantive contract.
In Habas Sinai v. VSC Steel Company Ltd, the English Commercial Court was asked to determine whether an arbitration agreement was governed by Turkish or English law. The law applicable to the contract itself was Turkish law, but the seat of the arbitration was London.
In Habas, the Court reaffirmed that the applicable law of an arbitration agreement is to be determined by a three-stage enquiry into: (i) express choice; (ii) implied choice; and (iii) the system of law with which the arbitration agreement has the “closest and most real connection”.
Where there is no express choice of law in the arbitration agreement itself, the starting point for establishing the implied choice of law of the parties would be either the law applicable to the substantive contract, or the law of the seat of the arbitration.
An express choice of law clause in the underlying substantive contract would generally be a "strong indication" that the contracting parties also wished that law to govern the arbitration agreement. However, that indication may be displaced by sufficient factors pointing the other way. The parties' choice of a different country for the seat of the arbitration may not in itself be "sufficient" for these purposes. Where sufficient factors exist, the law of the arbitration agreement will be the law of the place with which the arbitration agreement has its “closest and most real connection”. In many cases, this will be the law of the country of the seat.
Conversely, where there is no express choice of law clause whatsoever in the underlying substantive contract, the choice of seat is likely to be "overwhelming" for the purposes of determining the closest and most real connection.
The Court held that, as a question of fact, the London arbitration agreement had its closest and most real connection with England, and that as a result English law applied to it. The arbitration agreement was therefore valid and binding.
Although the judgment in this case is a helpful reaffirmation of the three-stage test previously set out, this test may produce unpredictable results. Where the law of the underlying substantive contract and the arbitral seat are different, it will often be difficult to foresee whether the choice of arbitral seat alone will be enough to displace the indication of choice implicit in an express choice of law clause in the underlying substantive contract. Even if that indication can be displaced, there is no guarantee that an arbitration agreement will have its closest and most real connection with the place of the seat; this will be a question of fact depending on any relevant circumstances.
The judgment highlights the importance of stating the law governing an arbitration agreement expressly. Not to do so creates a risk that an unexpected system of law could apply, under which the arbitration would be invalid: certain types of contract, for example, are not capable of being submitted to arbitration under the laws of some countries. Even where - such as in Habas - the arbitration clause was eventually found to be valid, the need for English court involvement created significant, and no doubt costly, delays.
Consideration should thus be given to amending existing arbitration agreements that do not have an express choice of applicable law, where possible. The certainty this would give would generally be in the interests of both parties to a contract.
For new contracts, the simplest means of making this express choice is generally to include wording in the governing law clause a provision that the governing law is applicable to the contract and the arbitration clause itself. If it is the intention that the governing law of the arbitration clause be different to that of the underlying contract, this should be stated expressly. As always, where arbitration agreements are concerned, paying attention to apparently small details at the time of drafting can have an enormous impact at the time of a dispute.