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Aspects of Applicable Laws in the International Commercial Arbitration

International commercial arbitration (ICA) is an approach, chosen privately by the parties who have entered into an international commercial transaction in which the disputes have occurred or may occur, to resolve the disputes. Compared with the litigation, the arbitration as a private option, looks like a more amiable, negotiable and flexible method. In international commercial transactions, parties come from different territories with different traditions, cultures and legal or political backgrounds. They settle issues through negotiation and put the results into a contract ultimately. The contract is regarded as their own law created not only for setting down each party’s obligations but also for designing a means of dispute solution. From the party’s perspective, they prefer trusting their contract to trusting other laws. Is this meant the ICA should preclude any law? The answer is ‘no’. It is usually the case, one party’s behavior was alleged breaking the contract, but this party said that he had to do so because he believed his opponent broke the contract first. Dispute occurred and the arbitrator(s) was invited. Then, who was a competent arbitrator? He should be a person who is authorized by a law. What the arbitrator(s) should do? He should follow a procedure permitted by a law. How could an arbitrator interpret the term of contract legitimately? He may invoke a law as standard. How may an award be valid and enforceable? The answer again should come from a law. Obviously, the ICA cannot be operated without any law. Conversely, the application of law in arbitration is more complicated than litigation.

This essay attempts to give a general introduction to five different law systems involved in the whole process of ICA by means of dividing the arbitral process into five sections in order to consent with the analysis of the five different laws. I will concentrate on the following topics: What law governs the parties’ capacity to enter into the arbitration agreement, the arbitration agreement and the performance of that agreement, the existence and proceedings of the arbitration tribunal, the substantive issues in dispute and the recognition and enforcement of the award. In this essay, I would like to invoke Chinese arbitration law, which is familiar to me to illustrate the discussion.

1. The law governing the capacity

The capacity means the ability of a person to effect a legal transaction. Person in this respective can be defined as a natural or legal person. In the context of the ICA, the latter would usually be a corporation. The Model Law illustrates a list of ‘international commercial transactions’, in which activities involved in ICA was introduced, even if they are not limited to the list. Many jurisdictions admit the term ‘commercial’ should be given a wider interpretation than it has been given in Model Law. The arbitration is a method used to resolve disputes that have arisen or may arise in a legal transaction, and the ICA deals with the international commercial transactions, thus we can determine the parties’ arbitral capacity by means of determine whether a party has the ability to effect an international commercial transaction or whether a party has capacity to sign an agreement of this kind. Here, questions would like to be asked. Who are competent to enter into an international commercial agreement? The answer may be referred to the national contract law. This would cause complex problems because the contract law, as a national law, is so different among countries. It is hardly possible to reach a universal rule to determine the applicable law dealing with capacity. Different contract has different issues to be solved; we should take the individual matters involved in the contract into account.

For instance, when Contract Law of People’s Republic of China deals with the circumstances of void contract, it says that a contract shall be void if it is ‘violating the compulsory provisions of the laws and administrative regulations.’ Some Chinese law or administrative regulation prohibit Chinese nature person to enter into international trade contracts or joint venture contracts, even if Chinese firms are prohibited from international trade without being authorized by the State administrator, but these prohibitions do not apply to foreign parties. The rigorous international trade-restraints may sometimes confuse the foreign parties. It is really a tough job to find out those provisions that could invalidate a contract without a Chinese lawyer’s help. However, in practice, this issue seems rarely happened. A Chinese firm having no authorization for international trade may often ask for an authorized firm to be its agent to sign the contract. It is quite an interesting phenomenon that during the arbitration proceeding in CIETAC, the opponent that the foreign parties usually see was not the actual business partner that has contract with the foreign party.

Concerning the circumstance in which an international arbitral award may refused, Article V.1. (a) Of the New York Convention provides:

“The parties to the agreement referred to in article II, 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 country where the award was made.”

This provision of New York Convention leaves a room for the national courts to decide the capacity of the arbitral party, so the issue of applicable law relating to the capacity is very important in legal practice rather than just have some theoretical influence. The law-choice clause is a part of contract or a part of an independent arbitration agreement. The reasonable choice of law which governing the capacity should be a starting point of an arbitration agreement. It seems to be impossible to the parties to choose their preferable law to avoid incapacity. Once a party is incapable under the applicable law, usually the law of a state where the party’s nationality belongs to or he resides in, or where a corporate is registered, that means this party is incompetent to affect the said contract or arbitration agreement. In an agreement, it can not be permitted to validate a clause by an invalid agreement, for it is not justified for the parties. In other words, provided that a party was incompetent to conclude an agreement, of course, he is incompetent to pick a law-choice clause. Thus, the principle of ‘party autonomy’ should not apply to avoid the matter of incapacity or should only apply to capable parties.

2. The law governing the agreement and performance of the agreement

In order to give rise to arbitration, an agreement considers the choice of legal proceeding is necessary. A valid arbitral process in the ICA could not be invoked without arbitration agreement. The agreement could be a clause (or clauses) in the main contract or an independent one. Practically speaking, the later often be used to deal with an existing dispute, for confronted with the matters that have already come into sight, parties would prefer to take more considerations to choose a preferable law to govern their exist dispute, therefore, the law governing the agreement often together with the law governing the substantive issues.

If the agreement is consist as a part of a main contract, more attention should be paid when determine the governing law of the agreement. There are three approaches to determine the applicable law for the arbitral agreement as we can perceive. First, parties could choose a proper law by reaching a sole clause to govern the agreement. Secondly, in order to govern the main contract, the provisions that include a choice of proper law should be referred to when the sole clause that is absent. It can be perceived that the same law governs both the main contract and arbitration agreement. Because the arbitration clause is a part of main contract, it would be illogical if one separates the proper law of agreement from those provisions in the principal contract. In this circumstance, the arbitration clause is theoretically subjected to the provisions of its principal contract. There are some cases that can be found out to support this assumption. For example, in the case of Union of India v. McDonnell Douglas Corp, the judge stated: "An arbitration clause in a commercial contract like the present one is an agreement inside an agreement… The parties may make an express choice of law to govern their commercial bargain and that choice may also be made of the law to govern the agreement to arbitrate." Thirdly, if none of choice of law is made, the law of the seat where the arbitration takes place should be applied to govern the agreement, according to the seat theory. The provisions of Swiss law offer the approach that is much similar to these three steps. The law provides:

“As regards its substance, an arbitration agreement shall be valid if it conforms either (i) to the law chosen by the parties or (ii) to the law governing the subject matter of the dispute, in particular the law governing the main contract or (iii) if it conforms to Swiss law.”

The validity of arbitration agreements generally covers two areas of essential validity: the parties’ capacity and the formal validity. In respect of the formality validity of an arbitration agreement, ‘in writing’, as an important factor, has been set down in treaties as well as in national laws. Article II 2 of New York Convention defined the term “in writing” as: “the term ‘agreement in writing’ shall include an arbitral clause in a contract or an arbitration agreement, signed by the parties or contained in an exchange of letters or telegrams.” Due to the rapid developed of Internet and other new communication technology, this definition has been proved to be outdated. The Model Law gives a modern definition of ‘in writing’; some new situations have been justified such as an exchange of statement might form a valid agreement, although the parties did not sign it. Oral agreement has been accepted by many jurisdictions; provided that there is reference to written form which itself contains an agreement to arbitration. Even though there are still many jurisdictions have not adopted the definition of Model Law, they do have realized the limitation of the New York Convention’s definition. For example, although the Law of Arbitration of People’s Republic China was enacted as early as in the year 1995 but the provision considered the form of arbitration agreement was quite simple. It provided that an arbitration agreement, including arbitration clauses written in a contract or other forms of agreement, should be, in writing, agreed before or after the emergence of disputes. After that, in 1999, the new Chinese Contract Law sets out a clear definition of ‘written forms’ that include a written contractual agreement, letters, and data-telex (such as telegram, telex, fax, EDI and e-mails), but whether an oral agreement or implied agreement is acceptable still remains in debates.

The content of arbitration agreement also has great influence on the validity of the contract. A clause written in a contract providing as ‘any dispute is to be settled by arbitration in London’ may constitutes a valid arbitration agreement under English law. As to Chinese law, under Article 16 of Law of Arbitration of P. R. China states that a written arbitration agreement shall, inter alia, designate an arbitration commission. Without a certain designation, the courts would consider the agreement invalid. The reason is that ad hoc does not been accepted by Chinese law, and all arbitrations are taken place in different standing arbitration commissions. An arbitration tribunal should be composed of arbitrators or arbitrator who had been listed in a given commission. There are several arbitration commissions in some cities of

China

, so an absence of designation would cause arguments between parties. Compared with English law, a clause as ‘any dispute is to be settled by arbitration in Beijing’ cannot be treated as a valid agreement under Chinese law.

Because of the limitation of the definition in the Convention as well as the different interpretations existing in national laws, the requirements of a valid arbitration agreement are likely different from state to state. Some modern arbitration laws have improved the formative validity of arbitration agreements. The parties have more opportunities to choose the good law, as applicable law, which is suitable for their arbitration agreement.

3. The law governing the existence and proceeding of the arbitration tribunal

Procedure laws in some countries are regarded as the law governing the existence and proceeding of the arbitration tribunal. Take Chinese law system as example, the provisions to regulate arbitration were written in the Civil Procedure Law of the P. R. China (1991), and the Law of Arbitration of the P. R. China (1994) is cited in the procedure law category of the authoritative law collections. Generally speaking, the arbitration law should be separate from the substantive law in an arbitration proceeding, because arbitration law shares many characteristics with procedure law in many aspects, such as the composition of tribunal, time-limits, conduct of procedure, interim measures of protection and so on. In practice, parties usually chose a neutral state as the place of arbitration. A neutral state means that this place has no connection with the place of each party’s business or residence as well as their substantive contractual disputes, so the arbitration law or lex arbitration should be distinct from the proper law of the contract. Confronted with such distinctions, parties have to make a choice of law to govern the procedure of the arbitration. The parties have rights to stipulate that arbitration shall be held in a country but apply to the procedure law of another country, while this option would be less worthy to be recommended and would be impractical because the parties would face the difficulty to acquire the assistance of a foreign court to exercise trans-national jurisdiction.

Although the parties have the right to devise their own rules, it is much safer for the parties to choose the existing arbitration law or lex arbitri as applicable law in order to avoid the conflict between own rules and New York Convention. For example, during the proceedings of International commercial arbitration, a party may request a summon of witness or a writ of property preservation from a national court. In this case, if the parties’ own rules conflicted with the arbitration law followed by that court, it would lead the court to being in a dilemma: suppose the parties’ own rules were followed and the award would not be considered as domestic award, this award might be challenged in the course of seeking enforcement in this country because of ‘contrary to the public policy of that country’ under Article V 2 (b) of New York Convention; if the existing arbitration law was followed, the award might be challenged because of that ‘the composition of the arbitral procedure was not in accordance with the agreement of the parties’ under Article V 1 (d) of the Convention. In this respect the arguments named as ‘de-localization’, favored ‘party autonomy’, which means neither the lex arbitri nor the national courts should intervene the procedure of arbitration and advocate that the parties could devise the rules by themselves, probably caused danger to reach fair awards, therefore the recognition and enforcement of those awards.

“Seat theory” is so important under the modern arbitration laws, to decide a seat is regarded as to decide the lex arbitri. The acceptance of “seat theory” in the ICA would lessen much more inconvenience or impracticality. “Seat theory” means that the law of the place in which it is held governs the arbitration and that place is the seat of arbitration. The Geneva Protocol 1923 states: “The arbitral procedure, including the constitution of the arbitral tribunal, shall be governed by the will of the parties and by the law of the country in whose territory the arbitration takes place.” The English law and the Swiss law provide the similar provisions to build links between the seat of arbitration and the lex arbitri. Swedish Arbitration Act 1999 makes a clear point of this theory by means of denying any other laws to govern the proceeding of arbitration held in

Sweden

. Section 46 of this Act states: ‘this Act shall apply to arbitration proceedings which take place in

Sweden

notwithstanding the fact that the dispute has an international connection.’ This theory has been well established both in international treaties and national laws. Many arbitration rules also emphasize a seat should be fixed, for instance, the ICC Rules says as “The place of arbitration shall be fixed by the Court unless agreed upon the parties.” Although international law and national law all provide so much about fixing a seat, the right of fix a seat still remain in the hands of the parties, only if the parties’ choice is absent, the arbitral institution or arbitrators may designate it.

4. The law governing the substantive issues in dispute

“Party autonomy” is such an important principle which is widely respected by the arbitration tribunal. Parties operate their right of the choice of governing law to choose a “neutral” law system to resolve their disputes. The tribunal and the participants of the ICA need to discern what law is applicable. According to the autonomy of parties, in order to cope with different issues, choices of governing law are changed along with time and circumstances. National law, public international law, concurrent laws, combined laws, the Shari’ah, trans-national law, equity and good conscience, etc. are all can be adopted as applicable law in the international commercial practice.

Under some circumstances, if the party has not expressed its choice, the arbitration tribunal may then have a task to establish the applicable law by means of inferring such a tacit choice that is “demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case”. If neither express nor tacit choice exists, the traditional approach is that the arbitrators should determine the applicable conflict rules first and then follow the rules to reach the proper law. This approach was established in some early international conventions. While it was realized that the traditional way might cause the proper law unforeseeable because the conflict rules in one state might refer the proper law to another state and the choice of law might be time consuming. The new trend has moved to conferring the arbitrators the right to determine the proper law directly rather than follow conflict rules. Many west European states have accepted the new approach.

There are some compulsory restrictions to ‘party autonomy’ that catered to national public policy in relation to the choice of proper law. For instance, Article 126 of Chinese Contract Law provides: ‘the contracts for Chinese-foreign equity joint ventures, for Chinese-foreign contractual joint ventures and for Chinese-foreign cooperative exploration and development of natural resources to be performed within the territory of the P. R. China shall apply the laws of the P. R. China.’

According to party autonomy, in respect of international transactions, choice of national law might cause some disadvantages such as restriction of public interests, unfair treatment, and changing of the law. It could be possible that the same dispute might get different results attribute to different choices of law. However, these disadvantages could be avoided. For example, the parties have opportunities to choose trans-national laws, or even they have the right to refuse choosing any law at all. These opportunities are practical and could be implemented. First, parties could choose the well-developed uniform commercial customs which were made by the international trade community, such as Uniform Custom and Practice for Documentary Credits. These custom or codified terms are welcomed throughout the world, and designed for certain activities. Secondly, the ‘rules of law’ has been accepted by the Model Law, the Conventions, the national laws and even the arbitral rules in case of the parties agreed. Thirdly, the national courts are reluctant to use the public interests to refuse the recognition of ‘rules of law’ unless the compulsory applicable law involved. It seems that the reason why the choice of trans-national law is not so popular is due to the limitation of those laws themselves. The reason may be that trans-national laws are fragments of particular rules rather than a uniform legal system, and it may be just competent to deal with particular activities rather than competent to deal with the whole matters consisting in the course of international trade. Anyway, the modern national arbitration laws should be encouraged to set down provisions to leave a room open for accepting the trans-national laws. Providing the parties appointed trade experts or technical experts as arbitrators, so they appeared to trust their own rules and the expertise more than trust any other laws or rules. In this event, the parties would prefer referring to ‘equity and conscience’ to law or rules of law. The national laws should by no means erect any barriers to reject such a choice any more.

5. The law governing the recognition and enforcement of the award

Parties may consider the issues of recognition and enforcement before they conclude the arbitration contract in order to guarantee the award which is made by a legitimate arbitration could be enforced even though it is in case of absence of voluntary carrying out. Both of the potential claimants may think of these questions: If I win, where are the opposing party’s assets located? Will the award of arbitration be enforced in that place?

The process of recognition and enforcement will be easier to realize if the intended recognition and enforcement is sought in the country in which the arbitration award was made. The court will regard this award as a domestic arbitration award because it is not a foreign or international award. However, according to the party’s choice, the arbitration process often takes place in a neutral place, and the losing party’s assets probably are located in more than one state. The awards of international commercial arbitration which is submitted to the national courts are often regarded as foreign awards, in other words, seeking the recognition and enforcement should be more difficult and be regarded as has a worldwide dimension. In order to cope with these confusions, treaties like Geneva Protocol of 1923, the Geneva Convention of 1927, the New York Convention have been acting an important role respectively to call for the recognition and enforcement of foreign or international arbitral awards. Once a country has signed on a treaty, the only thing should be done by its domestic courts is to examine whether the award meets the requirements of the provisions for recognition and enforcement. As a result, the ICA awards have been recognized and enforced by the national courts in most important trading countries of the world.

Although parties have the “party autonomy” to choose referable lex arbitri, appoint arbitrators whoever they like, decide the proper law referred to arbitral tribunal and select the appropriate place for enforcement of the award, but they are not allowed to choose other law to avoid that countrys public interest. Public policies are a very complex and political issues, there is no universal standard have been reached. As far as I concern, the most practical way is left these disputes to conventions, bilateral treaties or multi-treaties by way of national treatment or reciprocity principles.

6. Conclusion

Arbitration is so different from litigation which is based on single national law system, even if the international factors involved, the court would still follow the national conflict rules to determine applicable law. Due to many uncertain factors, ICA has many complex legal issues to be resolved and many jurisdictions confer the arbitral tribunals more freedom to determine the applicable law than the national courts when parties do not choose their applicable law.

Concerning the parties of ICA, they should always be aware of the fact that they have the freedom to choose different laws to govern the arbitral agreement, the arbitral procedure, or the subject matters of disputes, and they also have the freedom to choose any suitable place for arbitration when they have decided to submit their disputes to arbitration. Because ICA is expensive to some extent and the process of choice of law is time consuming, the parties should be cautious when use their rights to choose the proper law, for not every choice is acceptable or practicable in all legal systems involved. Wasting money and the award could not be enforced would be the last thing that both parties want to see. To avoid this dilemma, parties should make a scrutiny to the applicable laws before they make their choices.

Concerning the arbitration tribunals, the seat theory has resolved the question what procedure should be followed but when the parties gave up the choice of proper law expressly. But the question about how to determine the proper law is remained unsolved. Some systems may still insist that the arbitration tribunal should follow the conflict rules of the seat of arbitration. Some system may have abandoned these two-steps approach and confer the arbitration tribunal to determine the proper law.

Concerning the national laws and the trans-national laws, parties are in the best place to make their own choice to pick out a good law that is suitable to their interest. In my opinion, the applicable law should be certain, competent to resolve dispute, accessible, and practicable. The choice should not invoke any barriers to the recognition and enforcement of arbitral award. Any uncertain rules of law seem like causing risk of refusal of enforcement of awards should been avoid.

(Edited by: China West Lawyer)

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