Harbour Assurance Co. Ltd. V. Kansa General International Insurance Co. Ltd., [1992] 1 Lloyd's L.Rep. 81

Harbour Assurance Co. Ltd. v. Kansa General International Insurance Co. Ltd.

Queen's Bench Division (Commercial Court)

July 31, 1991

Before Mr. Justice Steyn





Mr. Justice STEYN: Introduction: On this application for a stay under s: 1 of the Arbitration Act, 1975 important questions regarding the jurisdiction of arbitrators arise for decision. At the outset it is important to emphasize that this case has nothing to do with the question whether arbitrators are competent to decide on questions relating to their own jurisdiction. The approach in English law is simple, straightforward and practical. As a matter of convenience arbitrators may consider, and decide, whether , they have jurisdiction or not: they may decide to assume or decline jurisdiction. But it is well settled in English law that the. result of such a preliminary decision has no effect whatsoever on the legal rights of the parties. Only the Court can definitively rule on issues relating to the jurisdiction of arbitrators. And it is possible to -obtain a speedy declaratory judgement from the Commercial Court as to the validity of an arbitration agreement before or during the arbitration proceedings.

This case is concerned with a different matter, namely the scope of the principle of the separability of the arbitration clause in, an integrated written contract. That principle is legal shorthand for a group of rules which govern the circumstances in which the arbitration clause remains binding despite the invalidity, discharge, termination or rescission of the contract. Mustill and Boyd, Commercial Arbitration, 2nd ed., at p. 7, note 6, state: The doctrine of the separability of the arbitration clause has not been espoused in the wider form in which it is known in other jurisdictions. But the narrower English form leads . in many cases to the same result.

Given the fact that it is established that in a number of circumstances the arbitration agreement does not fall to the ground with the principal contract, there is no doubt about the existence in English law of the principle of the separability of the arbitration agreement. But this case raises in acute form the question where precisely the line should be drawn between


circumstances which do, and circumstances which do not, render. the arbitration. clause ineffective, This question cannot be answered by concluding on narrow grounds that the case falls on a particular side of a notional line. It is an important and complicated question, which must be considered in some detail.

The dispute:

For reasons which will emerge later in this judgement, the nature of the commercial dispute can be sketched quite briefly. The six defendants are Finnish insurance and reinsurance companies. I am only concerned with the first to the fifth defendants. The plaintiffs are an English insurance and reinsurance company. Four of the five defendants were members of a pool formed in Finland for securing reinsurance business. The other defendant subsequently joined .the pool. The pool wished to extend its portfolio to reinsurance business originating from the London market. Such business was duly written. None of the defendants were ever authorized by the Department of Trade and Industry to carry on the business of insurance or reinsurance in Great Britain. It is the plaintiffs .case that the defendants did, in fact; carry on the business of insurance and reinsurance in Great Britain in the years 1980, 1981 and 1982. Consequently, the plaintiffs allege that the defendants were acting in breath of s. 2(1) and s. 83 of the Insurance Companies Act; 1974 and the equivalent provisions of the Insurance Companies Act, 1981. By a quota share obligatory retrocession agreement the plaintiffs as retrocessionaires agreed to reinsure the defendants in respect of risks retroceded for the years 1980,1981 and 1982.

The plaintiffs allege that the underlying insurance arid reinsurance contracts are illegal contracts. The plaintiffs say that the retrocession agreements were irrevocably affected by the illegality of the underlying contracts. The plaintiffs -therefore contend that the retrocession agreements are themselves illegal, null and void. It is the plaintiffs. case .that the Court of Appeal decision in Phoenix General Insurance Co.- of Greece S.A. v. Administratia Asiqurarjor de Stat, [1986] 2 Lloyd's Rep. 552; [1988.B. 242 settled this controversial question in their favour. In passing I note .that in giving the judgement of the Court of Appeal Lord Justice Kerr said (at p. 572, col. 2; p. 276H):

... any reputable reinsurers, solicitous of their good,, name and reputation, will no doubt hesitate long before relying on this defence.

This hope has not been fulfilled. The plaintiffs, Harbour Assurance Co. (U.K.) Ltd., English reinsurers; have raised this very defence. Possibly, it will be wise in future to work on the basis that, provided the sum is large enough, insurers and reinsurers will be guided solely by their own commercial interests.

The defendants contest the plaintiffs allegations. They have raised a number of substantial defences. First, the defendants deny that the Insurance Companies Acts apply to the underlying reinsurance contracts. Secondly, the defendants dispute that they carried on business in Great Britain by virtue of the manner in which the relevant contracts were effected, or by virtue of, the manner in which those contracts were carried out. Thirdly, the defendants assert that s. 132 of the Financial. Services Act, 1986, provides them with a complete answer. There are other issues which I need not set out here.

The arbitration agreement

The quota share obligatory retrocession agreement contains in art. 12 an arbitration clause. For present purposes the relevant part of art. 12 reads as follows:

All disputes or differences arising out of this Agreement shall be submitted to the decision of two Arbitrators one to be chosen by each party and in the event of the Arbitrators failing to agree, to the decision of an umpire to be chosen by the Arbitrators before entering upon the reference. The Arbitrators and Umpire shall be executive officials of . insurance. or reinsurance corn. parties, or Lloyd's Underwriters. If either of the parties fails to appoint an Arbitrator within one month after being required by the . other party in writing to do so or if the Arbitrators fail to appoint an umpire within one month of their nomination, such Arbitrators or Umpire as the case may be shall at the request of either party be: appointed by the Chairman of the Reinsurance Offices Association. The Arbitration proceedings shall take place in London.

Then there follows an equity clause in the form familiar in reinsurance contracts. It has not been suggested that this provision is relevant to the issues in the present case.




An arbitration clause embedded in a written contract

At the outset it must be emphasized that the principle of the separability of an arbitration agreement only arises if the arbitration agreement forms part of a written agreement. The perceived logical difficulty is summed up in the proposition Ex nihilo nil fit: see Heyman v. Darwins Ltd., (1942) 72 Ll.L.Rep. 65 at p. 85, col. 2; [1942) A. C. 356 at p. 392. That difficulty does not arise in cases where the arbitration agreement is not embedded in a written contract. The point is of some importance, notably in regard to the plaintiffs alternative sub-86mission that issues as to illegality are never arbitrable.

First, there is the case of an ad hoc arbitration agreement which is concluded after a dispute as to the initial validity of the contract has arisen. In Heyman v. Darwins, sup., Lord Porter commented on this point. He said (at p'. 85, col. 1; p. 392):

If two parties purport to enter into a contract and a dispute. arises whether they have done so or not, or whether the alleged contract is binding on them, I see no reason why they should not submit that dispute to arbitration.

Lord Wright (at p. 80, col. 1; p. 385) expressed a similar view. The other members of the House did not comment on the point but it seems to me that the proposition is self evidently correct. The only conceivable qualification is the exceptional case where the ad hoc arbitration a greement is itself contrary to public policy and illegal, e.g. an arbitration agreement vesting authority in a citizen of a foreign enemy country to decide a contractual dispute relating to trading with the enemy. This qualification has, however, no relevance to the type of illegality asserted in the present case. Leaving such exceptional cases aside, there is, no principle of English statute or common law, and no recognized head of English public policy, which could preclude arbitrators to determine such disputes under an ad hoc arbitration agreement. Certain disputes fall outside the domain of arbitrability (e.g. matters of responsibility under the criminal law or the status of natural persons) but issues as to the, illegality of contracts do not. It therefore comes as no surprise that illegality issues, involving contracts governed by English law,. and assertions that the contracts are illegal as a matter of English law, are frequently heard and determined in London arbitration proceedings.

Secondly, it seems, to me that the same reasoning is applicable in the case of an ad hoc arbitration agreement made after the contract was concluded but before a dispute has arisen. It is difficult to conceive of any logical or common sense basis for a distinction between the first two cases.

Thirdly, there is the case where a written contract and a separate written arbitration agreement, contained in the separate documents, are executed at the same time. That is something which happens not infrequently in business a practice. The logical problem raised by the proposition Ex nihilo nil fit does not arise. Rhetorically, one is entitled to enquire why this case should be any different from the first two cases which I have discussed. There is no material distinction. In other words, in all three cases an arbitrator so appointed is entitled to decide issues relating to the initial invalidity or illegality of the contract provided that the arbitration agreement is widely enough drawn.

Circumstances directly impeaching the arbitration agreement

The foundation of an arbitrator's authority is the arbitration agreement. If the arbitration agreement does not in truth exist; the arbitrator has no authority to decide anything. Similarly, if there is an issue as to whether the arbitration agreement exists, that issue can only be resolved by the Court. For example, if the issue is whether a party ever assented to a contract containing an arbitration. clause, the issue of lack of consensus impeaches the arbitration agreement itself. Similarly, the arbitration agreement itself can be directly impeached on the ground that the arbitration agreement itself is void for vagueness, void for mistake, avoided on the ground of misrepresentation, duress, and so forth. All such disputes fall outside the scope .of the arbitration agreement, no matter how widely drawn, and are obviously outside the arbitrator's jurisdiction. The scope of the principle of the separability of the arbitration agreement only arises for consideration where the challenge is directed at the contract, which contains an arbitration clause. This fundamental distinction requires the Court to pay close attention to the precise nature of each dispute.

The case law: The extent to which the separability principle has been recognized in English law.

Mr. Longmore submits that a study of the English decisions reveals that it is established law that the initial invalidity of the contract, which contains an arbitration clause, can never be an arbitrable issue under the arbitration clause. Acknowledging the anomalies which would flow from such a state of the law, he reminded me that it is not part of the duties of a first instance Judge to reason why or to attempt to rationalize the, law of England. He said that any development of the law, even incrementally by extending the ambit of established rule to materially similar cases, ought to take place at an appellate level. Subject to stare decisis, I am not sure that by adopting quite such a stark self denying ordinance a Judge of first instance would be doing justice according to law. But the real difficulty seems to me to ascertain what legal rules are laid down by binding precedent.


The starting. point of any examination must be Heyman v. Darwins, which is the great land mark decision in this area of the law. Before 1942 our arbitration law was in a rather unsatisfactory state. This can be illustrated by the "trilogy of difficult decisions" (Heyman v. Darwins, per Viscount Simon, LC, at p. 70, col. 2; p. 365) which led the House of Lords to give leave to appeal (Heyman v. Darwins, per Lord Porter, at p. 84, col. 1; p. 389). Those earlier decisions appeared to decide, or were understood by some to decide, that an accepted repudiation or frustration of a contract cannot be within the arbitration clause contained in the contract. By and large that meant that the arbitration clause only applied to pretermination disputes. Obviously, this seriously detracted from the usefulness of arbitration as a method of dispute resolution When the process of arbitration was most needed, it was unavailable. This was radically altered by the decision in Heyman v. Darwins. The case concerned a widely drawn arbitration clause, and the question was whether the arbitrator had jurisdiction to decide whether the contract was brought to an end by an accepted repudiation. Distinguishing earlier authorities with some care, all their Lordships answered this question in the affirmative. This important ruling provided the springboard for further developments to which I will turn in due course.

It was, however, submitted by Mr. Longmore that Heyman v. Darwins laid down as a matter of binding precedent that a dispute as to whether the contract was void ab initio was not arbitrable. For this submission he relied on the combined effect, of the speeches of Viscount Simon, the Lord Chancellor, and Lord Macmillan, who stated that Lord Russell of Killowen agreed with his speech on all points. The passage from Viscount Simon's speech, which is relied on, reads as follows (at p. 71, col. 2; p. 366):

. . . if one party to the alleged contract is contending that it is void ab initio (because, for example, the making of such a contract is illegal), the arbitration clause cannot operate, for on this view the clause itself also is void.

The critical passage from Lord Macmillan's 'speech is to the following effect (at p. 73, col.. 2; p. 371):

. . . a claim to set aside a contract on such grounds as fraud, duress or essential error cannot be the subject-matter of a reference under an arbitration clause in the contract sought to be set aside.

While this observation is less explicit than Viscount Simon's statement it seems clear that the reference to "essential error" is a reference to mistake in Scots law, which involves voidness ab initio. In any event, if there can be no reference to arbitration if the contract is rescinded for fraud and duress being cases of voidability of the contract it follows a fortiori that the same applies in cases of initial validity of the contract. Since Counsel's submission finds no support in the speeches of Lord Wright and Lord Porter, I need not quote from those speeches despite the valuable analysis contained in them. Mr. Longmore's point is that he has demonstrated three votes for his proposition.

While the dicta, which I have quoted, support Mr. Longmore's submission, I am unable to accept that those observations form part of the ratio decidendi of Heyman v. Darwins in the sense that they are binding on lower Courts as a matter of precedent. After all, those observations were in no sense necessary for a decision on the question in issue, viz whether an ,accepted repudiation was within the arbitration.. In both speeches the dicta form part of introductory material before - the real issue is. addressed. Moreover, it is clear from the argument irk Heyman v. Darwins, and the speeches in that case (see in particular Lord Porter, at pp. 84-90, pp. 389-399) that the effect of voidness ab initio was not regarded as an issue to be addressed. The point was not argued. In any event, if it had been raised neither Counsel would have had any incentive in the circumstances of the case to delve into the issue. In the circumstances it is wrong to regard those dicta as creating a binding precedent on this particular point., See Cross and Harris, Precedent in English law; 4th ed., pp: 158-161.

Nevertheless, if matters rested there, I would have regarded those dicta as guidance which a first instance Judge ought to follow without further enquiry. But the law has developed since Heyman v. Darwins in ways which compel a more critical examination of the dicta relied on.

While the principle of the separability of the arbitration clause is inherent in the ratio decidendi of Heyman v. Darwins Ltd., the nature and scope of that principle came to be appreciated more clearly as, a result of subsequent developments. Indeed Mr. Longmore emphasized that; although the speeches of Viscount Simon and Lord Macmillan mention the distinctive characteristics of an arbitration clause, they never described it as a severable agreement. Only Lord Wright (at p. 77; p. 378) and


Lord Porter (at, p. 85; p. 400) did so. Forty years after Heyman v. Darwins the House of Lords again had the opportunity to consider the nature of an arbitration clause. In Bremer Vulkan Schiffbau Und Machinenfabrik v. South India Shipping, [1981] 1 Lloyd's Rep. 253 at p. 259, Col. 2; [1981] A.C: 909, at p. 980, Lord Diplock stated in a speech, which had the approval of at least two other members of the House of. Lords: . .

The arbitration clause constitutes a self contained contract collateral or ancillary to the shipbuilding contract itself: Heyman v. Darwins (1942) 72 L1.L.Rep. 65; [1942] A.C. 356.

In the same case Lord Scarman said at p. 270, Col. 2; p. 998F that an arbitration clause is:

... in strict analysis, a separate contract, ancillary to the main contract.

See also Wilson (Paal) & Co. A/S v. Partenreederei Hannah Blumenthal, .(The Hannah Blumenthal), [1983] 1 Lloyd's Rep. 103 at p. 117, Col. 1; [1983] A.C. 854, at p. 917F; Deutsche Schachtbau-Und-Tiefbohr-Gesellschaft m. b. H. v. Shell International Petroleum Co., [1987] 2 Lloyd's Rep. 246 at p. 249; [1990] A.C. 295, at p. 309, the latter being an observation by the Master of the Rolls which was not affected by the appeal in this case to the House of Lords.

Section 24(2) of the Arbitration Act, 1950 (which re-enacted s. 13 of the Arbitration Act, 1934) casts some light on the matters under consideration. It reads as follows:

Where an agreement between any parties provides that disputes which may arise in the future between them shall be referred to arbitration, and a dispute which so arises involves the question whether any such party has been guilty of fraud, the High Court shall, so far as may be necessary to enable that question to be determined by the High Court, have power to order that the agreement shall cease to have effect and power to give leave to revoke the authority of any arbitrator or umpire appointed by or by virtue of the agreement.

Obviously, under s. 24(2) the contract survives an order of the Court depriving the arbitration clause of effect. The legislature therefore treated the arbitration clause as severable for the purposes of s. 24(2). Moreover, the reference to dispute involving "the question whether any such party has been guilty of fraud" is sweeping in its generality. It is no doubt apt to. cover post-contractual fraud but it will more commonly apply to claims asserting fraud committed in the inducement of the contract and resultant claims rescission, restitution and damages or; in cases where the contract has been affirmed, a claim for damages. All such cases appear to be within the scope of the section. The legislation supposition is that all such disputes are arbitrable, subject to the Court's power under s. 24(2): It is therefore no surprise that over the years, and to this day, it is commonplace in England for arbitrators to deal with issues of fraud, including claims for rescission and ancillary relief. Section 24(2) is hardly ever invoked in practice.

In the 50 years since Heyman v. Darwins was decided there has been a remarkable shift in the decisions of. English Courts from a policy. of extensive judicial scrutiny of arbitration to 'a recognition of the need for respect of party autonomy. Today, a more balanced approach prevails. The watershed may have been the Arbitration Act, 1979 but the change in policy is also to be found in the decisions of the Court of Appeal and House of Lords. For example, in the context of the principle of the separability of the arbitration clause, there is the decision in Ashville Investments Ltd. v. Elmer Contractors Ltd., [1988] 2 Lloyd's Rep. 73; [1989] 1 Q.B. .488. In Ashville the misconception that there was a "rule" that arbitrators may not rectify a contract (as opposed to rectifying the arbitration agreement) was swept away. Recognizing the importance of party autonomy, Lord Justice Balcombe accepted the proposition that (at p. 81, col. 1; p. 503E-F):

It may be presumed that the parties intended to refer all the disputes arising out of this particular transaction to arbitration.

This change in approach is one of the reasons why one must approach old cases, which deal with the interpretation of particular arbitration clauses and the principle of, separability of the arbitration clause, with some circumspection.

Against this background I now turn to the vicissitudes of the principle of the separability of the arbitration clause in the decisions after Heyman v. Darwins. It has been clearly established in the case law that the initial invalidity of the arbitration clause, or its subsequent termination by repudiation or frustration does not affect that validity of the contract. That is so because an arbitration clause is a separate and severable agreement: E.J.R. Lovelock Ltd. v. Exportles, [1968] 1 Lloyd's Rep. 163. In the converse case, namely where supervening events brought the contract to an end, the subsequent case law added to the circumstances in which the arbitration clause survives the demise of the contract. In Heyman v. Darwins Lord Macmillan (with whom Lord Russell of Kil-89lowen agreed) was not prepared to express a hew about the question whether an arbitration clause can survive supervening frustration. Subsequently, it was held that the arbitration clause can indeed survive such a termination of the contract: Kruse v. Questier & Co. Ltd., [1953) 1 Lloyd's Rep. 310; [1953) 1 Q.B. 669; Government of Gibraltar v. Kenny, [1956] 2 Q.B. 410. Similarly, it was held that supervening illegality of the contract does not destroy the arbitration clause: Prodexport State Company for Foreign Trade v: E. D. & F Man Ltd.; [1972] 2 Lloyd's Rep. 375; [1973] 1 Q.B. 389

A case which appeared to point the other way is David Taylor & Son Ltd. v. Barnett Trading Co. Ltd., [1952] 1 Lloyd's Rep. 181; [1953] 1 W.L.R. 562. It was a case involving the illegality of a contract which contained an arbitration clause. The issue was whether the Court of Appeal should set aside an award. The award was set aside, and dicta arguably held that the arbitration clause itself was illegal and of no force and effect. In their submissions in the present case both Counsel distinguished between invalidity and illegality of the contract. The point requires separate and detailed examination and I will discuss the decision in Taylor under the heading of illegality.

An important question is whether an issue as r to the avoidance of a contract, as opposed to an issue as to the initial invalidity of a contract, is capable of being referred to arbitration under an arbitration clause contained in such a contract. In Mackender Hill and White v. Feldia A. G., [1966] 2 Lloyd's Rep. 449;.[1967] 2.Q.B. 590 this issue was considered in the context of an exclusive jurisdiction clause in a contract of insurance- which was alleged to have been lawfully avoided on the ground of material nondisclosure. The question was whether rescission for nondisclosure of the insurance contract struck down the exclusive jurisdiction clause. The Master of the Rolls, Lord Denning said (at p. 455, Col. 2; p. 598E):

. . . The contract is not avoided from the beginning but only from the moment of avoidance. In particular, the foreign jurisdiction clause is not abrogated. A dispute as to non-disclosure is a "dispute arising under" the policy and remains within the clause: just as does a dispute as to whether one side or other was entitled to repudiate the contract: see Heyman v. Darwins Ltd.

Lord Justice Diplock (later, Lord Diplock) agreed that rescission for non-disclosure of the insurance contract leaves intact the arbitration clause. He stated (at p. 458, Col. 2; pp. 603G 604A):


. . . It is sometimes sought to. assimilate the concept of avoidance of a voidable contract to the concept of non est factum which prevents a contract ever coming into existence at all. It is argued that innocent misrepresentation or, in the case of contracts of insurance, non-disclosure of material facts vitiates consent and makes the apparent consent of the party misled, no consent at all. But this is specious. What is really meant is that the party did in fact consent but would not have , done so if he had known then what he knows now. Fraud may raise other considerations into which it is not necessary to go.

Lord Justice Russell agreed but emphasized that his expression of view covered only the case before the Court. In other words it was unanimously held that the rescission of a contract of insurance for nondisclosure does not bring to, an end an exclusive jurisdiction clause contained `within the contract. It is clear, and, conceded, that the same reasoning must apply to an arbitration clause contained in a contract. And in Craig v. National Indemnity Company, (July 25, 1980), unreported, but noted in vol. VIII of the Yearbook of Commercial Arbitration, 1983, at p. 410, Mr. Justice Lloyd held that the same reasoning applies to an arbitration clause.

For the plaintiffs strong reliance was placed on observations in Dalmia Dairy Industries Ltd. v. National Bank of Pakistan, [1978] 2 Lloyd's Rep. 223. The case was concerned with the enforcement of a Swiss arbitration award, which was made pursuant to an arbitration clause in a bank guarantee. Both the guarantee i and the arbitration clause were governed by Indian law. One issue was whether the guarantee and the arbitration clause had been brought to art end by supervening illegality. Lord Justice Megaw, giving the judgement of the Court of Appeal, stated (at p. 286):

First, it is common ground that in Indian law, as indeed in English law, no arbitrator can have jurisdiction, however wide the wording of the arbitration clause which the parties or alleged parties insert into their contract, to decide a dispute as to the initial existence or validity of the alleged contract in which that arbitration clause appears, or concerning the initial existence, or validity of the arbitration clause itself. In English law this is a matter of binding authority, namely Heyman v. Darwins, (1942) A.C. 356. The same principle is now clearly part of the law of India see Khardah's case, A.I.R. 1962 S.C. 1810, a decision of the Supreme Court


which directly followed the principles laid down in Heyman v Darwins in a case, not whether the existence of the contract was in issue, but where the issue as the alleged initial illegality of a contract admittedly concluded. Clearly, therefore, it is the law of India as of England that just as a dispute whether a contract existed is not within the arbitration clause in the alleged contract sought to be established; so a dispute whether a contract admitted to exist was illegal at the time of its conclusion and therefore void ab initio does not fall within such a clause.

On behalf of the plaintiffs emphasis was placed on a subsequent passage in Lord Justice Megaw's judgement where he stated (at pp. 292-293) that it was a logical conclusion that

. . there is no difference in principle between a contract containing an arbitration clause admittedly concluded but void for initial illegality and a contract containing such a clause admittedly concluded but where it is alleged that either the contract or the arbitration clause or both have become void because of subsequent illegality. It seems to us to follow that even where the arbitration clause is framed as widely as in the present claim and bears. the construction which we have upheld in our answer to issue 1(A), Indian law will not allow effect to be given to it so as to allow an arbitrator appointed thereunder finally to determine his own jurisdiction.

It is, of course, axiomatic in English law that an arbitrator cannot finally determine his own Jurisdiction. On the other hand, insofar as the quoted passages state that the initial invalidity or illegality of the contract or supervening illegality, render the arbitration clause ineffective; Dalmia creates no binding precedent.First, the case was decided in the light of conflicting expert. evidence on Indian law. Secondly, in the light of a formal concession "It is common ground . . . . . . ") these points were not argued. Lord Justice Megaw recorded not a ruling of law but an assumption as to what the law is. Nevertheless I shall, of course, give careful consideration to what was said in Dalmia.

Finally, I draw attention to an obiter dictum in Blue Circle Industries v. Holland Dredging Co. (U.K.) Ltd., (1987) 37 B.L.R. 40. The case was concerned with an arbitration clause in a building contract. Lord Justice Purchas (with the agreement of Mrs. Justice Butler-Sloss, now Lord Justice Butler-Sloss) stated (at pp. 53-54) that to refer an issue of misrepresentation to an arbitrator:

. . . would in effect . . . be inviting him to adjudicate upon his own jurisdiction and this is not in accordance. with the authorities -j see Munro v. Bognor Urban Council [19151 3 KB 167 and Willcock v. Pickfords Removals Ltd, [1979] Lloyd's Rep. 244.

Surprisingly, Counsel did not refer the Court of Appeal to the contrary decision in Mackender v. Feldia: Munro v. Bognor Urban Council does not lay down any principle of law which a Court is bound to follow today: Ashville, sup., per Lord Justice Bingham, at p. 86, col. 2; p. 512 C-D. In Willcock, v. Pickfords Ltd., [1979] 1 Lloyd's Rep. 244 the question Was whether the contract contained an arbitration clause. Obviously that issue went directly to the arbitrator's jurisdiction, which he could not decide. The obiter dictum in Blue Circle cannot therefore be regarded as correctly stating the law: Ashville, sup., per Lord Justice May (at p. 78, col. 2; p. 499F-G); Lord Justice Balcombe (at p 82, col. 2; p. 505H); Lord Justice Bingham (at p. 89, col. 1; p. 515G-H).

How far has the separability principle been recognized?

It is clearly established that if a contract is terminated for breach, by an acceptance of repudiation, and by frustration, the arbitrator is still: entitled to deal with disputes flowing from the ending of the contract. No similar concession is made in respect of subsequent illegality but I will consider that aspect separately. In the meantime it is right to remember that the logical purity of the Ex nihilo nil fit proposition is already compromised by the conceded cases. After all, the arbitrator may in one interim award declare the contract, which contains, an arbitration clause, terminated with effect from a date before the commencement of the arbitration, and then he may proceed in a second award to deal with monetary claims and cross claims. The arbitration clause necessarily survives a declaration that the contract was terminated.

Now I turn to cases where the contract was voidable and was avoided. It is conceded on the authority of Mackender v. Feldia that in the case of avoidance for non-disclosure the arbitration clause survives. In an attractively presented argument Counsel for the plaintiffs adopted an extreme position. He submits that a except in the case of non-disclosure, disputes a to the recission of voidable contracts cannot be referred to arbitration. He claims no logical of practical merit for such a strange result but he 91says that is all that has been decided. Leaving aside the case of fraud, which requires separate consideration, this submission files in the face of the reasoning in Mackender v. Feldia. Indeed Lord Justice Russell equated the cases of nondisclosure and innocent misrepresentation: Mackender v. Feldia, sup., at p. 459, col. 2; pp. 505-606. What support there may have , been to be found in Munro v. Bognor Urban Council for saying that an avoidance for innocent or negligent misrepresentation cannot be referred to arbitration, has fallen away in the light of Mackender v. Feldia and the criticism of .Munro v. Bognor Urban Council in the judgements in Ashville which I have mentioned. It .is also important to bear in mind that disputes as to the avoidance of contracts are common place in London, arbitration. An acceptance of the narrow view, urged on me would. seriously imperil London's position as a major centre of international commercial arbitration. Fortunately, since Mackender v. Feldia, the law is clear. Disputes as to the avoidance of contracts for innocent or negligent misrepresentation,, undue influence, or duress may be referred to arbitration. In all such cases a widely drawn arbitration clause will ~ survive avoidance of the contract. When the arbitrator declares that the contract is avoided it operates retroactively, i.e. it operates ab initio. Again, the argument based cm logical purity is compromised. Having declared the contract avoided, .the arbitrator may proceed in the same or a subsequent award to unscramble the monetary consequences in the light of claims and cross claims. These propositions regard as beyond argument.

Now, I turn to the question whether fraud is in a special category. It is conceded that a claim for damages for fraudulent misrepresentation can be referred to arbitration. But it is submitted that avoidance for fraudulent misrepresentation of the contract is; in any event, not a dispute which can be referred to arbitration. Both in Mackender v. Feldia and in Ashville the position in regard to fraud was reserved. That is perfectly understandable. After all, the idea that "fraud unravels all" or "fraud changes everything" runs deep in our system of law. It seems to me that Mustill and Boyd, op. cit., at p. 7 and. p. 117, note 8, are right in saying that an issue of fraud is capable of falling within the scope of an arbitration agreement. That was the view of Lords Wright and Potter in Heyman v. Darwins, sup., at p.81, p.378 and p.85; p. 392. Lord Macmillan's contrary view (at p 73; p. 371) can no longer be regarded as correctly stating the law. It will be recalled that 24(2) assumes that such issues can go to arbitration.

The inexorable logic of Mackender v. Feldia requires me to hold that a question of voidability for fraudulent misrepresentation is just as much capable of being referred to arbitration as an issue of avoidance for innocent misrepresentation. Given that claims for damages for fraud are arbitrable, there can be no reason for a different rule in the case of avoidance for fraud. After all, if the arbitration agreement is contained. in a separate agreement, executed at the same time, an issue as to avoidance of the contract is clearly arbitrable; if the agreement is wide enough. This conclusion is consistent with modern practice. Claims for ,damages for fraud, and avoidance for fraudulent misrepresentation, together with other relief, are commonplace in London arbitrations. I hold therefore that in the light of the developments since Heyman v. Darwins Ltd Lord Macmillan's statement in that case that a claim to set aside the contract on the ground of fraud or duress is not arbitrable, is no longer the law.

So far I do not believe that my conclusions ought to be seriously controversial. But now I turn to a more difficult category of cases namely instances where the contract is invalid (as opposed to voidable) ab initio.

Voidness ab initio

In no English case has it ever been held, and in no English textbook has it ever been suggested, that an arbitration clause can survive the initial invalidity of the contract. There are the obiter dicta of Viscount Simon and Lord Macmillan in Heyman v. Darwins, and the obiter dicta in Dalmia, to the contrary. Leaving aside for a moment initial illegality, it was contended on behalf of the plaintiffs by way of alternative submission that the critical line to be drawn is between cases of initial validity of the contract, and cases of subsequent avoidance and subsequent termination. For the defendants it was submitted that the question is an open one and I was invited to rule that the development of the principle of separability now makes it right on an incremental basis to say that cases of initial invalidity of the contract are arbitrable under a widely drawn arbitration clause.

The argument for excluding such cases is based on the Ex nihilo nil fit proposition. Earlier in this judgement I have suggested that the logical purity of that proposition has already been compromised in cases of post-contractual termination, and in cases of avoidance operating retroactively. I will examine the soundness of the argument in logic. But I record that I


invited Counsel for the plaintiffs to suggest whether there is any other argument, referable to the interests of users of the arbitral process or the public interest, which requires the exclusion of such cases from the domain of arbitration. None was suggested. The fact is that there are none. The exclusion of such cases is underpinned solely by the argument in logic.

There is no binding authority on the point. The question must therefore be resolved by taking into account the traditional shaping forces of the common law respect for received views, the application of first principles to new situations, the dictates of logic, common sense and policy considerations.

The argument in logic

At a time when the principle of separability of the arbitration was not recognized, the logic of saying that the arbitration clause necessarily follows the misfortunes of the contract was inescapable. While the arbitration clause was treated as an integral part of one contract, the invalidity of the contract necessarily spelt the invalidity of the arbitration clause. And this argument seemed particularly forceful if one focused on the single written document rather than on the diversity of contractual rights and obligations evidenced by it. Once it became accepted that the arbitration clause is a separate agreement; ancillary to the contract; the logical impediment to referring an issue of the invalidity of the contract to arbitration disappears. Provided that the arbitration clause itself is not directly impeached (e.g. by a non est factum plea), the arbitration agreement is as a matter of principled legal theory capable of surviving the invalidity of the contract. After all, such an arbitration clause is, by reason of its categorization as a separate agreement, in the same position as an arbitration agreement contained in, a separate document but executed at the same tune as the contract. Logically, there is no obstacle in either case to the arbitration agreement surviving the invalidity of the contract. The argument in logic is heavily compromised by acknowledged developments of the separability principle which I have outlined. Moreover, on examination, the plaintiffs assertions as to the inexorable march of logic disappear altogether once it is accepted that the arbitration clause is in law a separate agreement.

The practical consequences of the suggested dividing line:

It also seems worthwhile to consider from the point of view of a businessman and user of the arbitral process the intrinsic merits of a distinction between invalidity and avoidance ab initio. I venture to suggest that this distinction, in the context of arbitration clauses, runs counter to 'the reasonable expectations of businessmen:If this distinction is accepted a dispute as to mistake at common law (as in Bell v. Lever Bros Ltd., [1932] A.C. 161) is not arbitrable under an arbitration clause. On the other hand, an issue of mistake as to the correctness of the written contract, i.e. a question whether the contract should be rectified, can be referred to arbitration. A mistake in equity (as in Solle v. Butcher, [1950] 1 K.B. 671), which does not render the contract void but may allow it to be set aside on terms, is also so arbitrable: While I accept, that many general principles can be subjected to criticism by citing penumbral cases, nevertheless it seems to me that, in the context of arbitration clauses, the distinction is artificial and devoid of merit.

The reasons for the development of the separability principle

In a seminal paper Stephen M. Schwebel, a Judge of the International Court of Justice, has illuminated the reasons for the development of the principle of the separability of the arbitration clause: The Severability of the Arbitration Agreement, published in International Arbitration: Three Salient Problems, 1987, pp: 1.-60: I acknowledge my indebtedness to Judge Schwebel's paper but I will attempt to state the reasons for the development in my own less felicitous language.

It is clear, as Judge Schwebel points out, that in the national laws of countries with developed arbitration systems the trend in practice is predominantly m one direction, viz the full recognition of the principle of the reparability of the arbitration clause, subject to that clause not itself being impeached. This trend is also discussed in slime detail in the majority judgement of the Court of Appeal of Bermuda in Sojuznefteexport v. Joe Oil Ltd, which was given on July 7, 1989. A detailed summary of this judgement is to be found in (1990) XV Yearbook Commercial Arbitration, pp. 384-431. See also the decision of the Federal Supreme Court of the Federal Republic of Germany, as noted by Professor Schlosser in Arbitration International, vol. 6, pp. 79-80.

For my part I regard it as important to state briefly the reasons for this trend. First, there is the imperative of giving effect to the wishes of the parties unless there are compelling reasons of principle why it is not possible to do so. As Lord Justice Balcombe put the matter in a pas-93sage in his judgement in Ashville, which I have already quoted, it must be presumed that the parties intended to refer all the disputes arising out of the particular transaction to arbitration. Party autonomy therefore, militates in favour of the full recognition of the separability principle. Secondly, if. the arbitration clause is not held to survive the invalidity of the contract, a party is afforded the opportunity to evade his obligation to arbitrate by the simple expedient of alleging; that the contract is void. In such cases Courts of law then inevitably become involved in deciding; the substance of a dispute. Moreover, in international transactions where the neutrality of the arbitral process is highly prized, the collapse of this consensual method of dispute resolution compels a party to resort to national Courts where in the real world the badge of neutrality is sometimes perceived to be absent. For parties the perceived effectiveness of the neutral arbitral process is often a vital condition in the process of negotiation of the contract. If that perception is absent, it will often present a formidable hurdle to the conclusion of the transaction. A full recognition of the separability principle tends to facilitate international trade. These considerations are of concern in England since England is a major trading nation and London is a major centre of international arbitrations.

Conclusion on initial invalidity

My conclusion is therefore that the separability principle, as applicable also to cases of the initial invalidity of the contract, is sound in legal theory. It is also in the public interest that the arbitral process, which is founded on party autonomy, should be effective. There are strong policy reason's in favour of holding that an arbitration clause is capable of surviving the initial invalidity of the contract. While I have, of course, given weight to the obiter dicta in Heyman v. Darwins Ltd. and in Dalmia, there is no binding authority. As a matter of precedent it is therefore open to make a ruling such as I have indicated. In my judgement, the developments which have taken place, and the reasons for it; required me to make such a ruling. I do so.

Illegality ab initio

It will be recalled that it is the plaintiffs' pleaded case that the retrocessions were illegal and void ab initio. If the approach, which I have adopted is correct, it would be consistent to say that an issue as to the initial illegality of the contract is capable of being referred to arbitration. There is, of course, the qualification that such initial illegality must not directly impeach the

arbitration clause. That qualification would not, however, as a matter of legal principle appear to apply in a case such as the present.

It is also important to bear in mind that an issue as to supervening illegality can be referred to arbitration under an arbitration clause: Prodexport State Company for Foreign Trade v. E.D.F. Man Ltd., sup. Morever, there is no reason why arbitrators appointed under an arbitration agreement contained in a separate document, executed contemporaneously with the ancillary contract or thereafter; cannot decide an issue regarding the initial illegality of the contract. It is therefore not easy to see why such an issue is not capable of being referred to arbitration under an arbitration clause embedded in a contract.

There is, however, a weight of precedent to the contrary effect. In Joe Lee Ltd. v: Lord Dalmeny, [1927] Ch: D. 300 a contract between bookmakers and their customers was contained ! in a book of rules which contained an arbitration agreement. Mr. Justice Eve held that the contract was one by way of gaming and ,wagering and was therefore null and void. Mr. Justice Eve had to consider an issue whether the arbitration agreement was valid and enforceable. He stated (at pp. 306-307):

I cannot separate that part of the document from the rules and treat the agreement to refer as one distinct and apart from the other contents of this book. There is only one contract and that a contract or-agreement by way of gaming or wagering, a contract therefore which is void and cannot be made the foundation of any successful application in these Courts.

In Smith, Coney & Barrett v. Becker Gray & Co.,. (1916] 2 Ch. 86, Lord Cozens-Hardy, M. R. stated (at p. 91):

The plaintiffs in this action sought a declaration that the contract which I have just read was illegal by reason of the war. Of, course, if it was illegal, then any question of arbitration under the contract would fall with it.

On the facts of the case, however, it was held that the contract was not illegal. These two decisions might be explained away on the basis that they represent views expressed at a time when the principle of separability was in its infancy. But now I turn to the critical decision It is the decision in 1953 of the Court of Appeal in David Taylor & Sons Ltd. v. Barnett Trading i Co., sup. The defendants (the buyers) sold a consignment of steak to the plaintiffs (the sellers) at a price which was in excess of the maximum price permitted by emergency legis-94lation. The buyers claimed damages for nondelivery. The contract was referred .to arbitration. The arbitrators disagreed, and the umpire accordingly became seized of the matter. It was pointed out to him that the .contract was illegal. It plainly was. Nevertheless; he published an award awarding damages to the buyers. The buyers sought to enforce the award. The sellers issued a motion to set aside the award on the following grounds (at p. 182, col. 1; p. 564)

(1) that it was bad on the fact of it, in that it incorporated by reference and purported to enforce a contract that was illegal, and (2) that the umpire had. misconducted himself to law in failing to take into account that the contract was llegal.

In the leading judgement Lord Justice Singleton held (at p. 186, cal. Z; p: 569)

In the circumstances of this case, I think that it is the duty of the Court to say that the award should be set aside, not upon the ground that the award is bad upon the face of it upon that ground I find myself in full agreement with that which the Lord Chief Justice said but upon the second ground . . .

In other words, Lord Justice Singleton considered that the award should be set aside not on jurisdictional grounds but on the ground of misconduct, i.e. because the arbitrator deliberately ignored the legal rights and obligations of the parties. It is, however, right to point out that .Lord Justice Singleton quoted the dictum of Lord Crozens-Hardy M.R. in the Smith Coney case to the effect that if the contract was illegal "then any question of arbitration under it would fall with it". Lord Justice Denning approached the matter differently. He said (at p. 18'7, cols. 1 and 2; pp. 570-571)

In my opinion, the court has jurisdiction to set aside an award based on an illegal contract. It may be that the umpire, not being a lawyer, did not realize that the contract was illegal; it may be that the claimants themselves did not know it; and in, that sense there was no misconduct or improper procedurement, but, nevertheless, the. award cannot stand. An arbitrator has no jurisdiction or authority to award damages on an illegal contract. It is obvious that the court would not itself enforce such an award. Equally it should not allow it to stand.

Mr. Beyfus suggested that if we were in doubt about misconduct or improper procurement under section 23, we might remit the award under section 22 for reconsideration. I agree that we might do so, but I see no point in remitting the award to the umpire when there is only one. conclusion to which he could come, namely, that the contract was illegal.

Lord Justice Denning , squarely based his reasoning on a jurisdictional ground. But he then contemplated a possible remission which presupposed a valid arbitration agreement. Lord Justice Hodson said that the first ground of the motion to set aside was not made out. He stated (at p:188, col.2; p.189, col.1; pp. 572-573):

It is, I think, clear from Smith, Coney and Barrett v. Becker, Gray & Co. that the Court will interfere by injunction in a proper case to prevent an arbitration being held on an illegal contract The application failed in that case because it was held that there was not an illegal contract.

Mr. Levy argued further that illegality is not necessarily fatal even to an action on an award, and for that proposition he referred to Delver v. Barnes and Wholenburg v. Lageman. To my mind, the judgements in those cases do not really support the proposition contended for. I will not refer in detail to those judgements, but it does seem to me that the headnote in the first seems to go rather further than the judgement of Sir James Mans field warranted. I think that it is clear that, once the illegality is made plain, the award can, and should be, set aside . . .

The principle which I think is applicable is that often quoted, the language of Lord Ellenborough C:J. in Langton v. Hughes: "What is done in contravention of the provisions of an Act of Parliament, cannot be made the subject-matter of an action." In the circumstances of this case, I think that principle is applicable and ought to be acted on by this court.

On the face of it Lord Justice Hodson appeared to adopt as the ground of his decision, or one of the grounds, that the arbitrator had no jurisdiction.

It may well be arguable that Taylor was simply decided on the basis that the arbitrator committed misconduct warranting the setting aside the award. It is certainly clear that all the members of the Court took the view that error of law on the face of the award was not made out. That left the attack on the ground of misconduct, namely on the basis of manifest and deliberate disregard of the applicable law. There are frequent references in the judgements to misconduct. The headnote suggests that the case was 95decided on this basis. If that is the case, Taylor is not binding authority that an issue of illegality of the contract cannot be determined under an arbitration clause in a contract. And, it is a fact that there was no pending action or originating ,notion for a declaration that the arbitrator had no jurisdiction: there were only counter motions to enforce and set aside the award. On balance though it seems to me that Taylor can not be so distinguished at first instance, and that it must be regarded, at first instance at least as binding authority that an issue of initial illegality of the contract is always beyond an arbitrator's jurisdiction. That is how Mr. Justice Mocatta interpreted this decision in: Prodexport, .sup., at p. 381, cols. 1 and 2; p. 382, cols. 1 and 2; pp. 395H 398C. I feel compelled to do the same In coming to this conclusion it is right to acknowledge also that some cases of illegality of the contract, as opposed to other forms of invalidity of the contract, have in the United States apparently been treated as directly impeaching the arbitration agreement. See Domke on Commercial Arbitration, Revised Edition, 1988, pp. 100-102. This affords a possible basis .for treating cases of illegality differently. In any event, while the distinction between initial invalidity and illegality is not one which in my view should nowadays prevail; I am constrained by high authority to hold that it does prevail. Having come to this conclusion, it follows that the. application for a stay must be dismissed.

The interpretation of the arbitration clause:

In view of my conclusion that the stay application cannot succeed, it is strictly unnecessary to discuss the question whether the arbitration clause is, in any event, Wide enough as a matter of language to cover a dispute as to the initial illegality of the contract. Counsel made only the briefest reference to authorities on the width of the words "any differences or disputes arising from the Agreement". My comments will be equally economical. Older cases about the width of arbitration clauses must, for substantially the same reasons as I have discussed in this judgement, be, approached with some care. In any event, ever since Heyman v. Darwins the words "arising from the contract" have almost invariably been treated as words of very wide import. Many examples are to be found in the law reports. Only one example need be cited. Even a tort connected with the transaction falls with the scope of such or similar words: The Playa Larga, [1983] 2 Lloyd's Rep. 171. The modern approach is as set out in Ashville, sup. If I had concluded that the separability principle

extends to cases of ab initio illegality of the contract, I would have concluded that the arbitration clause in the present case is wide enough to cover such a dispute.


By way of summary, I conclude that the decision in Taylor compels me to hold that the separability principle does, not extend to ab initio illegality of a contract in which the arbitration clause is embedded. It follows that the application for a stay of the illegality issue must be dismissed.

Referring Principles
Trans-Lex Principle: XIII.2.4 - Principle of separability of the arbitration clause
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