Andrew Tweeddale
The cases of Kabab-Ji SAL (Lebanon) v. Kout Food Group (Kuwait) [2021]UKSC 48 (26 October 2021) and Enka Insaat Ve Sanayi AS v. OOO Insurance Company Chubb (Rev1) [2020] UKSC 38 both consideredthe validation principle but from different stages in the arbitration. The validation principle is an established principle of contractual interpretation. Where there is ambiguity in a contract, the law presumes that the interpretation that upholds the validity of the contract will prevail. Therefore, if the parties have chosen two laws to apply to an arbitration agreement, the law will presume that the one which upholds the arbitration agreement will apply. However, at the enforcement stage of an award the validation principle no longer applies. The result is that the law may require parties to settle their disputes by arbitration only to find that the award is not enforceable because there is no valid arbitration agreement.
The validation principle is ‘a well-established principle of contractual interpretation in English law, which dates back at least to the time of Sir Edward Coke (see Coke upon Littleton (1628) 42a), that an interpretation which upholds the validity of a transaction is to be preferred to one which would render it invalid or ineffective’. The principle applies not only in England but in many civil law countries. In Interim Award of 1984 in case no. 4145, an ICC tribunal, applying Swiss law, held that ‘It is also a general and widely recognized principle that from two legal solutions, the judge will choose the one which favours the validity of an agreement (favor negotii)’. The validation principle also forms part of the lex mercatoria as Principle XIV.3: 241
If a contract has contacts to more than one jurisdiction and the parties have not agreed on the applicable law, it is in the presumed interest of the parties to apply the law, both as to form and to substance, that validates the contract (“favor negotii”; “lex validitatis”; “rule of validation”).
The validation principle, as it applies to arbitration, can be illustrated in Hamlyn & Co v. Talisker Distillery. In this case the performance of the contract was in Scotland and an arbitration agreement referred to arbitration by the London Corn Exchange. It was held by the Court of Session that Scottish law applied to the contract. However, on appeal to the House of Lords it was found that the arbitration agreement would be subject to English law, as it was common ground that this arbitration clause would be valid according to English law but invalid according to the law of Scotland because the arbitrators were not named. The House of Lords held that it was the intention of the parties to resolve their disputes by arbitration and therefore it could not be right to make the arbitration agreement subject to Scottish Law, which would fail to give effect to this intention. If it had been suggested to the House of Lords that after the arbitration had taken place, and an award issued, it should not be enforced because at enforcement the arbitration agreement would be subject to Scottish law, they would no doubt have looked with incredulity at the person making the submission. However, that is precisely the position that the Supreme Court has got itself into in the recent case of Kabab-Ji SAL (Lebanon) v. Kout Food Group (Kuwait).
The recent Supreme Court case of
Enka v. Chubb found that in determining which law applied to the arbitration agreement, the validation principle was one of the principles that needed to be considered.
The facts of
Enka v. Chubb were that Chubb Russia paid out on an insurance claim and took over the rights and obligations to bring proceedings against the party that had caused the damage (Enka). Chubb Russia started proceedings in Russia and Enka argued before the English courts that their contract with the head-contractor contained a London arbitration clause and therefore Chubb Russia was bound by that arbitration clause. The Supreme Court agreed, finding that there was no choice of law clause to govern the contract or the arbitration agreement and that therefore the scope of the arbitration agreement was governed by the law of the seat of the arbitration, which in this case was London, so English
242law applied. As the arbitration agreement was therefore valid it was just and convenient to grant the injunction against Enka Russia.
The Supreme Court at [170] set out nine principles that should be used to determine the law applicable to the arbitration agreement. These nine principles may be summarized in the following five guidelines. (1) The arbitration agreement will be governed by any law chosen by the parties to govern the arbitration agreement; or (2) if there is no law chosen by the parties, the law with the closest connection to the arbitration agreement will govern. If there is no law chosen to govern the arbitration agreement, then (3) the law with the closest connection will usually be the law governing the contract. If there is no law chosen to govern the contract, then (4) the law of the seat of the arbitration may apply. If, however, the law chosen to govern the contract would result in the arbitration agreement being invalid, then (5) it will be presumed that the law of the seat of the arbitration applies to the arbitration agreement (the validation principle).
The Supreme Court therefore saw the validation principle as an essential element in determining the law applicable to the arbitration agreement. Lord Burrows, in his dissenting judgment, considered how the validation principle applied. His Lordship concluded that there was no dispute about the validity of the arbitration agreement in
Enka v. Chubb and therefore the court did not need to apply the principle in that case. He stated that the validation principle applied only to issues relating to the scope or interpretation of the arbitration agreement and is not about the validity of the agreement.
The recent case of
Kabab-Ji SAL (Lebanon) v. Kout Food Group (Kuwait) had to deal specifically with the enforcement of an award under section 103(2)(a) and (b) of the Arbitration Act 1996. This gives statutory effect to Article V(1)(a) of the New York Convention, which states that recognition and enforcement of the award may be refused if:
The parties to the agreement referred to in article II [i.e., the arbitration agreement] were, under the law applicable to them, under some incapacity, or the said agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made.
The facts of the
Kabab-Ji case were that Kabab-Ji, a Lebanese company, entered into a Franchise Development Agreement (‘FDA’) with Al Homaizi Foodstuff
243Company (‘Al Homaizi’) in 2001. Al Homaizi operated fast-food franchises in Kuwait including Burger King, Taco Bell and Pizza Hut. The FDA was subject to English law and granted Al Homaizi a licence to run restaurant franchises in the name of Kabab-Ji in Kuwait for ten years. For each creation of a franchise outlet, Al Homaizi and Kabab-Ji were to sign a specific agreement relating to the franchised outlet (the ‘FOAs’). The FOAs were also subject to English law. Subsequently, in 2004 Al Homaizi became a subsidiary of the respondent, Kout Food Group (‘KFG’), following a corporate reorganization. In 2011 the FDA expired without agreement to renew it. A dispute arose under the FDA and other FOAs. In 2015 Kabab-Ji referred the dispute to arbitration against KFG, and not Al Homaizi. The dispute resolution clause specifically referred to the ICC Rules of Arbitration with the seat of the arbitration in Paris.
The ICC arbitral tribunal had to consider two issues in relation to their jurisdiction. First, if there was a valid arbitration agreement and second, whether KFG was a party to the contract and the arbitration agreement. The arbitral tribunal unanimously considered that it must apply French law, as the law of the seat of the arbitration, to determine whether KFG was bound by the arbitration agreements. It then decided that it had to apply English law to decide whether KFG had acquired substantive rights and obligations under the Franchise Agreements. A majority of the tribunal held that, applying French law, KFG was party to the arbitration agreements and, applying English law, regarding the FDA, there was novation by addition, rather than substitution, whereby KFG had become an additional party to the FDA alongside Al Homaizi.
The one dissenting opinion of the arbitral tribunal was a barrister of Middle Temple in London, Mr Reichert. He confirmed that the arbitral tribunal’s ruling on the application of French law to the question of the validity of the arbitration agreement was unanimous. However, in his opinion, KFG did not become a co-contractor of Kabab-Ji under English law and so Kabab-Ji’s claims should have been rejected by the arbitral tribunal. Mr Reichert was the sole English-qualified arbitrator on the tribunal.
The majority award made against KFG was for over USD 6 million. Kabab-Ji then sought to enforce the award in England and Wales, and KFG, who had participated in the arbitration under protest, sought to appeal the decision before the French courts.
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On 23 June 2020, the Paris Cour d’appel upheld the majority decision of the arbitral tribunal. The Cour d’appel found that English law governed the FDA but that the arbitration agreement was separate and distinct. The court stated as follows :
Pursuant to a substantive rule of international arbitration law, the arbitration clause is legally independent from the underlying contract in which it is included either directly or by reference, and its existence and validity are interpreted, subject to the mandatory rules of French law and international public policy, according to the common will of the parties, without the need to refer to any national law.
…
These courts consider as a substantive rule of international arbitration that the existence and the validity of an arbitration clause must be assessed, without any reference to any national law, but only as regards the will of the parties in the light of all circumstances of the case.
The Paris Cour d’appel concluded that the arbitral tribunal was correct and that the arbitration agreement had not been subject to an express choice of law by the parties. The Cour d’appel found that in accordance with the common will of the parties there was a valid arbitration agreement. It further found that it was not bound to follow the decision of the English High Court which had, by that time, ruled that the arbitration agreement was subject to English law.
In regard to the question of whether KFG was bound by the arbitration agreement, the Cour d’appel held that an arbitration clause inserted in an international contract has a validity and effectiveness of its own:
such that the clause must be extended to the parties directly involved in the performance of the contract and in any disputes arising out of the contract, provided that it is established that their contractual situation and their activities give rise to a presumption that they accepted the arbitration clause, the existence and scope of which they were aware of, irrespective of the fact that they were not signatories to the contract containing the arbitration agreement.
participated in the performance of the franchise agreements, and this was sufficient to find that it was a party to the arbitration agreement. The Cour d’appel also noted that KFG had paid royalties under the FOAs to Kabab-Ji.
The case has now been appealed to the Cour de Cassation and a decision is pending.
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The judgments of the High Court and Court of Appeal were given on 29 March 2019 and 20 January 2020, respectively. Both courts found that under English law KFG had not become a party to the FDA or to the arbitration agreement within the FDA. The Court of Appeal therefore refused to allow Kabab-Ji’s application for recognition and enforcement of the arbitral award in the United Kingdom. Kabab-Ji appealed to the Supreme Court.
The Supreme Court held that the arbitration agreement was governed by English law and that under English law there was no real prospect of a court finding that KFG became a party to the arbitration agreement. The Supreme Court refused to enforce the arbitral tribunal’s award. However, to arrive at this decision the Supreme Court had to ignore the validation principle when considering enforcement.
When
Kabab-Ji came before the High Court, Sir Michael Burton found that there had been an express choice of law for the arbitration agreement because (1) the contract contained at Article 15 a governing law clause for the FDA; and (2) in Article 14 there was an express requirement for the arbitrators to apply the provisions contained in the Agreement. The Court of Appeal similarly found that the construction of Articles 1 and 15 of the Agreement created an express choice of law for the arbitration agreement. Flaux LJ stated:
Article 1 makesit clear that “This Agreement” (capitalised) includes all the terms of agreement then set out, which include Article 14. Because Article 15 providesthat: “This Agreement [again capitalised] shall be governed by and construed in accordance with the laws of England” it is making clear that all the terms of the Agreement, including Article 14, are governed by English law.
The Supreme Court’s decision in
Enka v. Chubb had not been issued when the Court of Appeal made its decision. The Supreme Court in
Kabab-Ji therefore had to consider the question, having recently made a decision on the law to apply to an arbitration agreement. The Supreme Court in
Kabab-Ji departed from the approach of the High Court and the Court of Appeal, when it found that the wording of the Agreement did not create an expresschoice of law for the arbitration agreement.
If the Supreme Court in
Kabab-Ji had followed the principleslaid down in
Enka v. Chubb (including applying the validation principle) they would have arrived at a decision that the arbitration agreement was valid and KFG was a
246party to it, asit wassubject to French law. The Court would then have to enforce the award. This would have meant that they would have to enforce an award which wasclearly wrong as a matter of English law.
The Supreme Court was therefore faced with a problem:enforce an award which is wrong in law, or distinguish the principles laid down in
Enka v. Chubb because this was a case of enforcement rather than assessing the validity of the arbitration agreement.
The Supreme Court chose the latter route and held that it should follow the common law test laid down in
Enka v. Chubb, except that it was not bound to apply the validation principle. This meant that it could apply English law to the question of whether KFG was a party to the arbitration agreement rather than French law.
The reasoning of the Supreme Court was that the validation principle was a principle of contractual interpretation which presupposes that an agreement has been made. This principle does not extend to the question of whether or not there is a valid contract, as the principle would otherwise presume an agreement exists where none does. It therefore 'does not apply to questions of validity in the expanded sense in which that concept is used in article V(1)(a) of the Convention and section 103(2)(b) of the 1996 Act to include an issue about whether any contract was ever made between the parties to the dispute’.
The problem with only using the validation principle at the outset of the arbitration and not at the enforcement stage is that an English court could, at the outset of a dispute, confirm that there is a valid arbitration agreement. However, when considering enforcement, the same court may then conclude that there is no valid contract. This is an absurd position that the English courts have arrived at, and it islittle wonder that there are concerns about this decision in the international arbitration community. It is expected that the Cour de Cassation in France will reach a decision that is opposite to the English Supreme Court and will uphold the award.
The Supreme Court’s decision in Kabab-Ji turned on an analysis of the wordsin section 103(2)(b) of the Arbitration Act 1996:
that the arbitration agreement was not valid under the law to which the parties subjected it or, failing any indication thereon, under the law of the country where the award was made.
247The Supreme Court stated that in order to answer the question of whether KFG was a party to the arbitration agreement, it would need to apply the law that would govern the agreement if it existed or was valid (the conflict of law issue). The Supreme Court considered whether there was a consensus of opinion as to the law which it should apply, looking at the laws ofcountries which had adopted the New York Convention. It answered that question in the negative. It then stated that the only way to answer the question was by looking at it from first principles. By applying first principles the Supreme Court concluded that:
Once it is accepted that an express agreement asto the law which isto govern the arbitration agreement is not required and that any form of agreement will suffice, it seems difficult to resist the conclusion that a general choice of law clause in a written contract containing an arbitration clause will normally be a sufficient ‘indication’ of the law to which the parties subjected the arbitration agreement.
As stated above, the Supreme Court applied the principlesset out in
Enka v. Chubb at [170] except for the validation principle, which it held was a rule of interpretation and therefore not applicable when considering enforcement. It came to this conclusion because it found that the validation principle was‘not a principle relating to the formation of contracts which can be invoked to create an agreement which would not otherwise exist’. However, the validation principle does not do this. It simply determines which law should be applied to the arbitration agreement. The arbitration agreement must then be proven to exist under that law. It is this author’s opinion that on this point the Supreme Court erred.
Is the validation principle simply a rule of interpretation or does it reflect the implied agreement of the parties? Gary Born in his article on the choice of law applicable to international arbitration agreements states, ‘This principle (the validation principle) rests on the premise that parties generally intend application of the law which will give effect to their agreement to arbitrate’. Born suggests that the validation principle is mandated by the New York Convention and applies equally to enforcement as it applies to the formation of the arbitration agreement.
The validation principle has existed for hundreds of years, so that where the parties have expressly agreed on arbitration, with a designated seat, the choice of
248law for that arbitration agreement should be a law that upholds the validity of the arbitration agreement. This is not just a rule of interpretation but, in this author’s opinion, an expression of the common intention of the parties. It does not create a contract where none would exist, as the issue of the validity of the arbitration agreement still hasto be determined by the arbitral tribunal. On this point the approach of the French courts is to be preferred over that of the English courts.
It may be that the Supreme Court was swayed by the fact that under English law KFG never became a party to the FDA or the arbitration agreement. However, the fact that the arbitral tribunal may have got this issue wrong as a matter of law should not have been considered. By agreeing to the ICC Rules the parties were ‘deemed to have waived their right to any form of recourse insofar as such waiver can validly be made’. The role of the courts is not to prevent enforcement of an award by a review of the merits. The grounds for refusing enforcement are limited under the Arbitration Act 1996, and some commentators may think that the Supreme Court has stepped over a line. The adage remains true: ‘difficult cases make bad law’.