Which Law Governs an Arbitration Agreement? A Question that Divides the Highest Courts of England and France

Which Law Governs an Arbitration Agreement? A Question that Divides the Highest Courts of England and France

October 5, 2022, Covington Alert

When a court has to assess the scope and validity of an agreement to arbitrate, the first step is to identify which system of law the court must apply to answer this question. This enquiry continues to evade a uniform response from two of the most popular legal systems for users of international arbitration, England and France.

In October 2021, the UK Supreme Court (“UKSC”) unanimously refused to recognize and enforce an international arbitral award under the rules of the International Chamber of Commerce (“ICC”) in Kabab-Ji v Kout Food Group on the grounds that, applying English law, Kout Food Group (“KFG”) had not become a party to a series of arbitration agreements.

On 28 September 2022, the French Court of Cassation delivered its highly anticipated decision in parallel proceedings relating to the same arbitral award. The French Court of Cassation reached the opposite conclusion to the UKSC and refused to annul the award on the basis that, applying French law, KFG was indeed bound by the arbitration agreements.

The French Court of Cassation’s judgment concludes a five-year enforcement battle that has entrenched the divergent positions of the English and French courts on the fundamental issue of which law governs an arbitration agreement in circumstances where the law governing the arbitration agreement is not expressly stated, and the law of the main contract differs from the law of the seat of arbitration. The conflicting approaches taken by the highest courts in England and France underscore the importance of careful drafting of arbitration agreements.

The Kabab-Ji arbitration arose from a series of franchise agreements concluded between the Lebanese company Kabab-Ji Sal (“Kabab-Ji”), as franchisor, and the Kuwaiti company Al Homaizi Foodstuff Company (“AHFC”), as franchisee. KFG became AHFC’s parent company following a corporate restructuring, but never signed the franchise agreements. The franchise agreements were governed by English law, and each contained a separate arbitration clause providing for ICC arbitration seated in Paris. Crucially, the arbitration clauses did not contain an express choice of law to govern the parties’ agreements to arbitrate.

In 2015, a dispute arose under the franchise agreements, which Kabab-Ji referred to ICC arbitration. Kabab-Ji commenced the arbitration proceedings against KFG alone, and not against AHFC. KFG objected to the arbitral tribunal’s jurisdiction on the grounds that it was a third-party non-signatory that was not bound by the arbitration agreements. In response, Kabab-Ji alleged that KFG should be subject to the arbitration agreements because KFG was involved in the performance of various obligations under the franchise agreements over a sustained period of time.

In a 2017 award, the arbitral tribunal held that French law, as the law of the seat of arbitration, applied to the question of whether KFG was bound by the arbitration agreements. The majority of the tribunal held that, applying French law, non-signatory KFG was a party to the arbitration agreements. The majority of the tribunal also determined that, on the merits, KFG was in breach of the franchise agreements.

In December 2017, KFG initiated annulment proceedings before the Paris Court of Appeal. That same month, Kabab-Ji issued proceedings in the English Commercial Court in London to enforce the arbitral award as a judgment. KFG resisted the recognition and enforcement of the award in England on the basis that it was not bound by the arbitration agreements.

In the first judgment to be issued in these parallel proceedings, the English Commercial Court ruled that English law, the law of the contracts, governed the validity of the arbitration agreements. The Court, however, adjourned a final decision on whether KFG was bound by the arbitration agreements. Kabab-Ji appealed this decision to the English Court of Appeal, which delivered its judgment in January 2020. The English Court of Appeal summarily refused recognition and enforcement of the arbitral award and Kabab-Ji appealed this decision to the UKSC.

Shortly thereafter, in June 2020, the Paris Court of Appeal issued its judgment in the French annulment proceedings. Amongst other arguments, KFG asserted that the tribunal had wrongly retained jurisdiction over KFG as a non-party to the franchise agreements. KFG claimed that the tribunal should have applied English law, as the law which the parties had expressly chosen to govern the entirety of the contracts, including the arbitration agreements contained therein. Consequently, KFG argued that the tribunal, applying English law, should have determined that it could not exercise jurisdiction over KFG.

The Paris Court of Appeal refused to adopt KFG’s reasoning. It held that the parties’ designation of English law as generally governing the contracts did not amount to establishing the requisite “common will of the parties” to also submit the arbitration agreements to English law. The Court also noted that generally recognized principles of law established that the substantive law of the place of the seat of arbitration should apply to determinations involving the arbitration clause.

Accordingly, applying French law, the Paris Court of Appeals found that the arbitration agreements could be extended to a non-signatory directly involved in the performance of the contract and in any disputes arising out of the contract. It therefore dismissed KFG’s annulment action.

Shortly thereafter, in October 2021, the UKSC reached the opposite conclusion from the Paris Court of Appeals. The UKSC concluded that English law governed the question of whether KFG became a party to the arbitration agreements, because: (i) the parties chose English law to govern the franchise agreements; and (ii) the parties expressly stated that English law would govern all provisions of the ­­­­franchise agreements (i.e., including the arbitration agreements). Applying English law, the UKSC confirmed that KFG was not bound by the arbitration agreement between AHFC and Kabab-Ji and unanimously dismissed Kabab-Ji’s appeal.

Our previous alerts on the UKSC’s decisions in Kabab-Ji, as well as Enka Insaat Ve Sanayi AS v OOO Insurance Company Chubb, address the general approach under English law in further detail.

The final episode in the saga has just culminated with the French Court of Cassation confirming its disagreement with the UKSC.

The Court of Cassation upheld the decision of the Paris Court of Appeal. It held that, under French law, the law of the seat will govern an arbitration agreement, including its validity and effectiveness, except where the parties expressly submit the validity and effects of the arbitration agreement to a different choice of law.

In reaching this conclusion, the Court of Cassation rejected KFG’s argument that the contract’s choice of law clause should apply to the entire agreement, including the arbitration clause, because (i) the contract stipulated that it should be interpreted as a single agreement and (ii) the arbitration agreement itself explicitly instructed the arbitrators to apply the provisions of the contract and prohibited the arbitrators from applying rules that would contradict the contract. The Court of Cassation held that, pursuant to a “substantive rule of international arbitration”, an arbitration agreement is legally independent from the underlying contract wherein it is contained. By virtue of French law, the existence and effectiveness of the arbitration agreement is determined by the “common will of the parties”. The parties’ choice of English law as the substantive law of the contracts did not evidence common will to designate English law as the law governing the arbitration agreement. Because the arbitration agreements referred to a Paris seat of arbitration, the substantive rules of the seat (i.e. the material rules of French law in the field of international arbitration) applied to the determination as to whether a non-signatory was bound by an arbitration agreement. Under French law, KFG was bound by the agreement to arbitrate.

The diverging decisions of the French Court of Cassation and the UKSC demonstrate that there is no answer of universal application to the question of which law should govern an arbitration agreement, where the substantive law of the contract and the law of the seat differ. What the Kabab-Ji dispute does provide, though, is a practical take-away for users of international arbitration going forwards:

• If the parties do not specify the law governing an arbitration agreement, they run the risk of conflicting outcomes across jurisdictions – and potentially protracted legal proceedings – regarding the validity and enforceability of an arbitration agreement. This risk is particularly acute where the substantive law of the contract and the law of the seat differ.
• To minimize uncertainty, parties should consider specifying in their contracts the law they wish to govern their arbitration agreement in particular.
• The standard arbitration clauses provided by some arbitral institutions currently do not address the issue of the law of the arbitration agreement. To the extent that parties use such clauses, they should consider whether it serves their interests to state the law governing the arbitration agreement explicitly.

If you have any questions concerning the material discussed in this client alert, please contact the members of our International Arbitration practice.