Applicable Law in International Commercial Arbitration

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International Trade and Commerce:

In International trade and commerce, every commercial activity is generally preceded by a contract fixing the obligations of the parties to avoid legal disputes. But in this ever-changing world of trade and commerce, disputes between parties are inevitable. As was mentioned in Alex lando’s article,

No matter how carefully a contract is drafted, one party to the contract may understand his right and obligations in a different way. Often international trade involves traders belonging to different countries whose legal systems may differ in many ways to that of the other, presenting complicated and even conflicting features. The law courts of each country have jurisdiction only within the territorial limits of the concerned country. Therefore, arbitration came to be preferred as an effective means of resolving disputes between the parties belonging to different nations”.[i]

The parties are often reluctant to “seek settlement for disputes in the court of law because judicial process is complicated, time consuming and expensive”.[ii] Moreover, arbitration permits a degree of flexibility, which is denied in traditional judicial settlement.

When the determination of disputes which is of “a commercial nature involving an international element falls within the scope of private law, it gets termed as International Commercial Arbitration. International Commercial Arbitration is styled as international, not because sovereign nations participate, but because the parties, the facts, or the legal effects of the dispute extend beyond a single jurisdiction”.[iii] As Baxter observes, “The expenses, delay and complexity of a court action are normally avoided in the case of arbitration procedure. In addition, arbitration provides a degree of privacy, informality and convenience that cannot be matched by the more traditional court room atmosphere. International conventions, and in particular the latest New York Convention, together with legislations based on the convention, have provided facilities for the enforcement of foreign awards, having greater range and flexibility than that exist in regard to court judgments”.[iv] Of course, this is an important consideration in cases where the assets of parties may be situated in different countries. Thus, advantages of arbitration attract parties towards it and while entering into economic agreements, they often include arbitration clauses in their contracts to ensure that any dispute can be solved without recourse to litigation.

However, in the case of international commercial arbitration, when parties belong to different legal systems, conflict of laws arises by itself, and a choice of the substantive law to be applied in a given dispute has to be made. Often, the substantive law to be applied in arbitration may be stated by the parties in their original agreement. But complications arise in deciding the applicable law in situations when the parties fail to approve a choice of law for settling their disputes.

Applicable Law in International Commercial Arbitration

Determining the applicable law in international commercial arbitration is often a dicey issue. Most of the arbitral awards are usually kept confidential and the published awards are generally either severely modified or summarised. Arbitration awards are often confidential, and the published awards are often summarized or heavily edited. This adds to the difficulties which exist in international arbitration. The question of choice of procedural law could be resolved to a certain extent by the Model Act or any other procedural law but when it comes to the substantive law, complications often arise.”Generally speaking, international arbitral rules “allow parties to as agreement containing an arbitration clause to choose the substantive law of any particular jurisdiction to govern disputes”.[v] Even though the parties have such power they often specify “the general principles of law”. Such a course is adopted because many circumstances reduce the benefits of choosing a neutral forum on account of uncertainty of the substantial law of that forum.

One benefit of international arbitration is the option to avoid choice-of-law complexities that unavoidably arise in an international dispute, although choice of law in international commercial arbitration can pose a question.

There are four different choice-of-law issues in international arbitration that arise:

  • “Determination of the substantive law applicable to the merits of the case
  • Determination of the substantive law applicable to the arbitration agreement
  • Determination of the procedural law applicable to the arbitral proceedings
  • The conflict of law rules applicable to determine each of the above-mentioned laws.

Difficulties arise when one or more of the four laws is different”.[vi]

The stages of determination are mentioned below, as was enumerated in the works of Professor Redfern and Professor Hunter –

“First, regarding the law applicable to the merits of the case, arbitrators will determine it according to the parties’ agreements, unless a mandatory national law, or public policy, trumps such an agreement. In the alternative, where parties have failed to agree, the arbitral tribunal will choose the law applicable depending on the facts of the case at hand, using criteria such as selecting the law with the closest connection to the dispute.

Second, regarding the law applicable to the arbitration agreement itself, parties may also agree on such law, which can be different from the others on the basis of the presumption of separability. If the parties have not agreed on an applicable law, then the law applicable to the arbitration agreement is often found to be the law of the arbitral seat but may also be found to be the law governing the parties’ contract or international principles.

Third, the procedural law applicable will in most cases be the domestic arbitration law of the seat of arbitration. This law will govern all issues relating to the arbitration proceeding, such as the appointment of arbitrators, the issue of provisional relief, the procedural timetable and provisions related to the award. In most jurisdictions, this law provides significant freedom to arbitrators in relation to the conduct of the proceedings, as long as due process is respected.

Finally, the arbitral tribunal may decide the conflict-of-law rules that will apply for each applicable law. The tribunal may resort, for instance, to applying the arbitral seat’s conflict of law rules, or international conflict of law rules”.[vii]

The Position where no Applicable Law is selected 

A major problem arises when the parties fail to select an applicable law by agreement. Under such circumstances, the Model law provides, “Failing any designation by the parties, the arbitral tribunal shall apply the law determined by the conflict of law rules which it considers applicable”. But this provision and the policy embodied in it have been disputed – “The application of rules of lex fori is conventional in litigation, but international commercial arbitration is confronted with the question whether the tribunal has a lex fori and if so where it is located? Presuming, the legal system of the place where the arbitration is held to be the lox fori, there is still a strong body of opinion that an arbitration tribunal is not bound to apply, the conflict rules of the seat of arbitration”.[viii] The next question that arises in this context is how the arbitral tribunal should select the rules of law.

It was stated in the Saphire Arbitration that a tribunal “must look for common Intention of the parties and use the connecting factors generally used in doctrine and in case law and must disregard national peculiarities. Thus, in rare situations where the parties have not provided for an agreed choice of applicable law, it would be seen that an arbitrator may have substantial freedom in the choice of rules of law. One would assume that in these situations a system familiar to the arbitral tribunal will be used. If the parties made a choice of the law of a country which included an international business law approach, the tribunal would give effect to that choice, and would apply the rules of the sub area. If the parties do not agree, it would still be opened to an arbitration tribunal to apply the law of a country which includes an international business law approach”.[ix]

Determination of Proper Law

The proper law of contract may be determined in three ways. (1) by express selection by the parties (2) by inferred selection from the circumstances (3) or by judicial determination of the system of law with which the transaction has the closest and most real connection. Where direct selection and closest connection are to a certain extent, free from misunderstanding, the supposed selection is a typical problem posed before arbitrators.

Inferred Choice of Law

The convolution in an arbitration agreement increases when there is no explicit choice of the proper law. Then the court will consider whether it can ascertain that there was an implied or inferred choice of law by the parties. If the parties agree that the arbitration shall take place in a particular country, “an English court will usually, conclude that the parties have by implication chosen the law of the country of arbitration as the proper law. Similarly, if the parties agree that the courts of a particular country shall have jurisdiction over the contract, there is a strong inference that the law of that country is to be the proper law”.[x]

Other factors from which the courts have preferred to infer the intention of the parties as to the proper law are the legal terminology in which the contract is drafted, the form of documents involved in the transaction, the currency in which the payment (if any) is to be made, the use of a particular language, a connection with a preceding transaction, the nature and location of the subject matter of the contract, the residence of the parties or the fact that one of the parties is a government. Thus, when express provision is missing, the arbitrator can go through all these factors to find the intention of the parties.

Applicable Law is the Common Law Rule

Two issues arise whenever a contract has an international element – “which country’s law shall be the contract’s applicable law, and if there is an arbitration clause, in which country, should the arbitration be held”. An international element could exist because parties are domiciled, or companies incorporated in different countries; or because the subject matter of the contract is located in a country which is different from that of any of the parties. The common law rule is that, “in an action for damages for breach of contract, the applicable law determines questions of remoteness of damage, whereas the quantification of damages which according to the applicable law is not too remote is governed by the law of the country in which the proceedings are brought”.[xi] 

The general rule is that legislation only discharges or modifies obligation under a contract if passed under the contract applicable law. And the common law is that parties are free to select the applicable law, provided that their choice is bonafide and legal and there is no reason for setting aside the choice on the ground of public policy. The view strengthens when they say that the parties’ choice will be conclusive. However, it has been doubted whether at common law parties have absolute freedom of choice. In particular, “there has not been any clear authority that a choice of English Law would be valid where a contract has no connection whatsoever with England, although the assumption underlying a wide range of commercial and financial agreements have been that such a choice would be upheld”.[xii]

 Internationally accepted Principles of Law Governing Contractual Relations

The decision of the court of Appeal in Deutsche Schachtbau – Und Tiefbohrgesellschaftu v. R Al-Khaimah National Oil Co., indicates that, “where parties do not permit their contract to be governed by the law of any particular country, a provision that the contract shall be governed by – Internationally accepted principles of law governing Contractual relations” – will not be rejected by the English Court on the common law ground of uncertainty or public policy”. An oil exploration agreement contained an international chamber of commerce arbitration clause. The ICC arbitration rules provided that “the parties were free to determine the governing law and that in the absence of any indication by the parties, the arbitrator shall apply the law designated as proper law by the rule of conflict which he deemed appropriate”. In pursuance of that clause, the arbitrators determined that the proper law was internationally accepted principles of law governing contractual relation.

It was held that “the arbitration clause was governed by Swiss Law and uncontradicted expert evidence was that the arbitration clause was valid under Swiss Laws. The arbitration was held in Geneva, and the arbitral tribunal held that the defendant should pay 4.6 million dollars to the plaintiff. The letter applied to the English Courts for leave to enforce the award as a Judgment. The court of Appeal rejected the defendant’s submission that it would be contrary to English public policy to enforce an arbitration award which held that the rights and obligation of the parties were to be determined, not on the basis of any particular national law but upon some unspecified, and possibly ill defined, internationally accepted principles of law. Sir John Donaldson described the internationally accepted principles of law governing contractual relation which the arbitrator applied as a common denominator of principles underlying the laws of the various nations governing contractual relation”.[xiii]

The position was reiterated in DST v. Raknoc. The same position was confirmed by the late Professor Clive Schmitthoff who noted that “the Supreme Courts of France and Italy had ruled to the same effect”. But these decisions have to be treated with caution as there is no specific law prescribed. If a court were to decide that a clause providing for a contract to be governed by internationally accepted principles of law governing contractual relation is not a valid choice of proper law, the common law position is that it would apply as the proper law the system of law with which it determines that the transaction has its closest and most real connection. 

General Principles of Choosing the Substantive Law

When the parties agree upon a substantive law of a particular jurisdiction, there is no scope for the application of general principles of law. This is determined by the choice of law clause. This does not however confirm that national law is the best choice of substantive law available, for national law too may have its own shortcomings. Hence parties may allow arbitral tribunals to apply a substantial law not tied to any particular jurisdiction. Still, the fact that “Calvo Doctrine traditionally argued for equal treatment only to foreigners, could not be made applicable because international arbitration often gives foreigners, but not citizens a right to arbitrate disputes. Thus, Calvo Doctrine opposes arbitration on the ground that it gives preferential treatment to foreign investors.”[xiv]

 Circumstances when Parties prefer a Non-National Standard

 When parties prefer a national law, the arbitral tribunal has to follow that and “when they substitute it with some non-national standard such as general principles of law, lex mercatoria, or the law of international trade, or with specification only to a non- national standard without reference to any national law, then the arbitral tribunal gets a wider discretion with respect to the applicable law”.[xv] In such a case the arbitrator does not get the benefit of any direct guidance.

Hence, the arbitrator is forced to make a broad inquiry into the nature of the general principles invoked by the parties. He has to discover the principles from vacuum. So, during the departure from a national conflict-of-laws system to the General Principles, the arbitrator tries many other choices. He may apply a variety of other conflict-of-laws standards that have only an indirect foundation in national law – “The least significant departure from a national conflict-of- laws system is the cumulative application of the conflict-of-laws system connected with the dispute. This Knocking at the door’ of each choice is warranted because the concept of general principles of law is very vague and not a clarified aspect. A more substantive departure is the application of the conflict of laws system which the arbitrator views as most appropriate and most responsive to international commerce. A third still greater departure is the application of a basic conflict-of-laws rule derived from a comparison of competing systems. And before reaching out to the last stage of fully non-national standard such as lex mercatoria, or standard usages or general principles of law, they may go for a substantive national law without reference to any conflict-of-laws system”.[xvi] And when finally, it happens to be “general principles, the vagueness and uncertainty of it calls for a listing of the same in an exhaustive manner which becomes highly necessary, to initiate a sustained effort to achieve a consensus as to the content of the general principles of law in the international arbitration context”.[xvii] 

This consensus would lead to “a greater consistency of results in international commercial arbitration and to a corresponding increase in certainty for contracting parties. Ultimately, it may also encourage greater reference to the general principles of law. This would serve the interest of contracting parties by enabling them to establish a neutral forum in which they control the language and proceedure and avoid the various difficulties that arise for handling such disputes in a national court system. At the same time, a list of general principles will help maintain the stability and certainty that exist in a system currently dominated by national laws”.[xviii] The frequent invocation by arbitral tribunals and its recognition by scholars makes the proposition take the shape of general principle. But as most of the principles are interrelated, delineating a set of general principles of law becomes an uphill task. A proposition that “a sovereign government may make and be bounded by contractual agreement with foreign private parties is generally recognized, thereby, giving it the colour of a general principle, which is frequently used in international commercial arbitration with the total satisfaction of parties”.[xix]

The main principles in the 1969 Vienna Convention on the law of Treaties, requires that a sovereign government honours any international commercial agreement into which it enters. The “conflict proposition of the government’s domestic legislative power, which otherwise would permit it to alter the law governing agreements with foreign investors would not come in the way of its contractual commitments to foreign nationals”.[xx] This helps the foreign investors to invest without the fear of internal political changes.

Act of God could not be controlled, and it justified non-performance of a contract. Force majeure constitutes non-performance and not breach of contract. When no such force plays, and if beneficial owner tries to escape from contractual liability, the “piercing of corporate veil becomes a general principle. When damage is caused to anything and it could not be restored to its original state, equitable compensation constitutes the primary remedy. This has become a general principle of universal application. The proposition that parties in the international commercial context can bring suit against unjust enrichment when a defendant has acquired money or value from a plaintiff need not be a text book law”.[xxi] But as long as these principles are not adequately articulated and documented, this could only produce uncertainty and unpredictability. Therefore, it is highly necessary that these principles have to be adequately and precisely mentioned. 

Standardizing the Choice of Law

Virtually all legal systems and arbitration rules permit the parties to choose the law governing their contractual relationship. It is important that “the parties do so in the arbitration agreement or in a separate contractual provision for a number of reasons – first, the parties get a clear picture as to the governing law from the moment the contract is concluded, and this clarifies the whole position.  Thus, the loophole in contracts can be effectively plugged. Interpretation becomes easy when the law is clear: Secondly, where the parties do not designate the governing law, its determination can be difficult or uncertain. If it is with Model law, then Art. 28 (2) vests power with the arbitral tribunal, to determine the law by the conflict of law rules which it considers applicable”.[xxii] When law becomes clear, “final offer of arbitration clears the mist in spite of the conventional arbitration where usually players take extreme positions in the anticipation that by doing so, they will skew the midpoint to their favour”.[xxiii] 

Clarity constricts an arbitrator’s choices of choosing either one side or the other. It never allows scope of compromise in this regard. If one side embraces an arbitrary position, that side stands the risk that its offer will be questioned, and the other side’s proposal preferred. Thus purportedly, it causes disputing parties’ offers to congregate and thereby augment the chances of settlements. To uncover the truth, “an illuminating process is needed, one that would evoke elucidating responses from the disputants”.[xxiv] Present day arbitration needs a resolution which should come in the shape of a specific law, because then only impartiality could be preserved.

 Conclusion 

The nature of the debate about the possibility of delocalizing arbitration procedure and awards often conceals the real concerns that underlie the debate. The cardinal issue is not whether or not arbitrations are jurisdictional or contractual in nature, but to what extent and according to what standards international arbitrations should be regulated and administered. Most legal systems accord parties considerable freedom in determining arbitral procedure, while reserving the right to ensure the fairness and integrity of the process. The controversy regarding the independence of arbitration from national law actually addresses concerns regarding the standards by which the fairness and integrity of the process should be governed, domestic or international standards. 

To be sure, there is much to be said for setting an international standard by which international arbitrations should be superintended, as opposed to leaving each State to enact its own individual standard, which may run contrary to the aspirations of foreign arbitrating parties. International conventions on arbitration are designed to provide an effective international regime for the conduct of arbitrations. These conventions are aimed at “conflating and modernizing national arbitration practices relating to international arbitration, thus obviating the need for States to establish their own domestically influenced regimes”.[xxv] 

Hence, while choosing the applicable law in international commercial arbitration is usually less complicated than choice-of-aw issues in domestic courts, it is still not as straightforward as expected. The simplest way to avoid any confusion is to explicitly specify that “all laws relating to the merits, arbitration agreement and arbitration procedure are identical in the parties’ contract, and that no conflict of law rules are applicable”.[xxvi]

Edited by Anubhuti Rastogi
Approved & Published – Sakshi Raje

Reference

[i] Alex Lando, The Law Applicable to the Merits of The Dispute, in Contemporary problems in International Arbitration, 15 Arb. Int’l 22. 86 (1998).

[ii] Deutsche Schachtbau – Und Tiefbohrgesellschaftu v. R Al-Khaimah National Oil Co., 1 AC 295 (1990).

[iii] B. Brown, General Principles of Law in International Commercial Arbitration, 101 Harv. L. Rev. 1824 (1988).

[iv] F.G. Baxter, International Business Disputes, 39 I.C.L.Q. 288 (1990).

[v] Ibid.

[vi] Choice of law in International Arbitration, https://www.international-arbitration-attorney.com/choice-of-law-international-arbitration/ (last visited Feb. 10, 2019, 5 pm).

[vii] A Redfern and M. Hunter, Law and Practice of International Commercial Arbitration, 66 (4th Edition, 2004).

[viii] Ibid.

[ix] Saphire Award, ILR 1963, at 136 et seq., https://www.trans-lex.org/261600 (last visited Feb. 10, 2019, 5 pm).

[x] Compagnie d’ Armement Maritime SA v. Compagnie Tunnisienne de Navigation SA., 3 All E.R. 71 (1970).

[xi] A Redfern and M. Hunter, Law and Practice of International Commercial Arbitration, 24 (4th Edition, 2004).

[xii] M. C. Clelland, Toward a More Natural System of International Commercial Arbitration. The Establishment of Uniform Rules of Procedure and the Elimination of the Conflict of Laws Question, 5 J. Int’l L. 169, 11 (1980).

[xiii] Deutsche Schachtbau – Und Tiefbohrgesellschaftu v. R Al-Khaimah National Oil Co., 1 AC 295 (1990).

[xiv] Giovanni B. Longo, Towards a Common Core of Legal Rules on Commercial Arbitration, 59 A. L. J. 407(1985).

[xv] Arthur Taylor Vou Mehren, Special Substantive Rules for Multistate Problems : Their Role and Significance in Contemporary Choice of Law Methodology, 88 Harv. L. Rev. 182 (1975).

[xvi] M. C. Clelland, Toward a More Natural System of International Commercial Arbitration. The Establishment of Uniform Rules of Procedure and the Elimination of the Conflict of Laws Question, 5 J. Int’l L. 169, 11 (1980).

[xvii] Ole Lando, The Lex Mercatoria in International Commercial Arbitration, 34 J.Int’l. Art. 28, 110 (1985).

[xviii] B. Jones, Three Centuries of Commercial Arbitration in New York – A Brief summary, 72 ICLQ 18, 169-72 (1988).

[xix] Ibid.

[xx] Compagnie d’ Armement Maritime SA v. Compagnie Tunnisienne de Navigation SA., 3 All E.R. 71 (1970).

[xxi] M. C. Clelland, Toward a More Natural System of International Commercial Arbitration. The Establishment of Uniform Rules of Procedure and the Elimination of the Conflict of Laws Question, 5 J. Int’l L. 169, 11 (1980).

[xxii] S.K. Chawla, Law of Arbitration and Conciliation: Practice and Procedure, 7 (2nd Edition, 2004), Eastern Law House.

[xxiii] Clive Schmitthoff, Choice of Law in International Commercial Law, 6 J.B.L. 169 (1987).

[xxiv] A Redfern and M. Hunter, Law and Practice of International Commercial Arbitration, 66 (4th Edition, 2004).

[xxv] Alex Lando, The Law Applicable to the Merits of The Dispute in Contemporary Problems in International Arbitration, 15 Arb. Int’l 22, 86 (1998).

[xxvi] A Redfern and M. Hunter, Law and Practice of International Commercial Arbitration, 45 (4th Edition, 2004).

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Rituparna Padhy
I am Rituparna Padhy from National Law University Odisha and I am pursuing B.A. LL.B.. Since the very beginning of law school, I have been interested in the field of arbitration and alternative dispute resolution in general. This has been a wonderful opportunity to improve my writing skills. Life beyond law school for me is dominated by reading books, discovering new music to obsess over, and just generally interacting with people. Mooting and debating have also consumed a significant part of my law school, and I have no regrets! As an ambivert, I am able to derive energy from people as well as by myself. While I like to believe that I’m a natural leader, I also understand that every person’s views need to be validated. On a rather unrelated note, I am really proud of my poetry blog.

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