REPORT OF CHAPTER 3 Applicable Laws

A
nna Normanton

Many disputes that are referred to arbitration are determined by

arbitral tribunals with no more than a passing reference to the law.
They turn on matters of fact.
In such cases the arbitral tribunal first needs to resolve the issues of
fact, as best it can, before moving on to interpret the contract and, if
need be, to refer to any underlying system of law.
An arbitral tribunal may well pay little or no attention to the law that
governs its own existence and proceedings as an arbitral tribunal.
Indeed, it may not even give more than fleeting recognition to the
fact that such a law exists.
It would be wrong to deduce from this, however, that international
commercial arbitration exists in a legal vacuum. That would be like
suggesting that there is no need for a law of contract, since parties to
a contract make their own law.
The parties to a contract make their own law, and it is, of course, true
that, subject to the rules of public policy and ordre public, the parties
are free to agree upon such terms as they may choose. Nevertheless,
agreements that are intended to have a legal operation (as opposed
to a merely social operation) create legal rights and duties, and legal
rights and duties cannot exist in a vacuum but must have a place
within a legal system which is available for dealing with such
questions as the validity, application and interpretation of contracts,
and, generally, for supplementing their express provisions.
Like a contract, an arbitration does not exist in a legal vacuum. It is
regulated first by the rules of procedure that have been agreed or
adopted by the parties and the arbitral tribunal. Secondly, it is
regulated by the law of the place of arbitration. It is important to
recognise at the outsetas even distinguished judges and
commentators sometimes fail to dothat this dualism exists.
For the most part, modern laws of arbitration are content to leave
parties and arbitrators free to decide upon their own particular,
detailed rules of procedure, so long as the parties are treated equally.
Under these modern laws, it is accepted that the courts of law should
be slow to intervene in an arbitration, if they intervene at all.
Nevertheless, rules need the sanction of law if they are to be
effective; and in this context the relevant law is the law of the place
or seat of the arbitration. This is occasionally referred to as the curial
law, generally by English lawyers, but is much more commonly
known as the lex arbitri.
International commercial arbitration, unlike its domestic counterpart,
usually involves more than one system of law or of legal rules.

It might be assumed that this is the same law as that which the
parties had chosen to govern the substantive issues in dispute. But
this is not necessarily a safe assumption.
The applicable law clause set out above refers expressly to the
substantive issues in dispute. It does not refer in terms to disputes
that might arise in relation to the submission agreement itself; and it
would be sensible, in drafting a submission agreement, to make clear
what law is to apply to that agreement.
If no such express designation has been made, and it becomes
necessary to determine the law applicable to the agreement to
arbitrate, what are the choices? There are other possibilities, but the
principal choicein the absence of any express or implied choice by
the partiesappears to be between the law of the seat of the
arbitration and the law which governs the contract as a whole.
Since the arbitration clause is only one of many clauses in a contract,
it might seem reasonable to assume that the law chosen by the
parties to govern the contract will also govern the arbitration clause.
There is a very strong presumption in favour of the law governing the
substantive agreement which contains the arbitration clause also
governing the arbitration agreement. This principle has been followed
in many cases. This could even be implied as an agreement of the
parties as to the law applicable to the arbitration clause.
However, the reference to the autonomy of the arbitration clause, in
this citation, points to the problem that may arise. An arbitration
clause is taken to be autonomous and to be separable from other
clauses in the agreement. If necessary, it may stand alone. In this
respect, it is comparable to a submission agreement. It is this
separability of an arbitration clause that opens the way to the
possibility that it may be governed by a different law from that which
governs the main agreement.
The New York Convention points towards this conclusion. In the
provisions relating to enforcement, the Convention stipulates that the
agreement under which the award is made must be 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
(which will be the law of the seat of the arbitration).
Taking as their point of departure the separability of the arbitration
clause, there are a number of cases, in different jurisdictions, in which
a court or arbitral tribunal has taken the law of the seat of the
arbitration as the appropriate law to govern the parties' arbitration
agreement.
The arbitration agreement should be presumed to be governed by the
law of the seat, which usually coincides with the place with which the
agreement to arbitrate (as opposed to the underlying contract as a
whole) has the closest and most real connection. The Court went on
to proffer that an agreement as to the seat of an arbitration is
analogous to an exclusive jurisdiction clause.

This position is therefore fairly well-settled in English law and so

parties arbitrating in England, who intend the arbitration agreement
to be governed by the same law as the law governing the underlying
contract rather than the law of the seat, would be well advised to
include an express provision to that effect.
No particular provision concerning the applicable law for the
arbitration agreement itself was indicated [by the parties]. In such
circumstances the issue of the validity of the arbitration clause should
be determined in accordance with the law of the state in which the
arbitration proceedings have taken place.
The Supreme Court thus ignored the parties' choice of Austrian law to
govern the underlying contract, considering that the arbitration
clause ought to be treated as a separate agreement subject to a
separate law.
The arbitrable nature of the dispute be determined, under the said
Articles II and V, under the same law, that is, the lex fori.
In all of these cases, it is plain that the effect of the decision (and
perhaps one of the driving forces behind it) was to validate the
arbitration agreement. The parties had agreed to arbitrate disputes,
but when the time came to do so, one party sought to renege on that
agreement.
The solutions considered so far have focused on establishing the law
governing the arbitration agreement by reference to a national law:
be it the law of the contract or the law of the seat of arbitration.
The French courts, however, have adopted a different method
whereby the existence and scope of the arbitration agreement is
determined exclusively by reference to the parties' discernible
common intentions. In this way, the arbitration agreement remains
independent of the various national laws which might, in other
jurisdictions, be deemed to apply to it. This approach avoids the
difficulties of categorising the arbitration agreement for conflict of
laws purposes, as well as the particularities of private international
law regimes.
By virtue of a substantive rule of international arbitration, the
arbitration agreement is legally independent of the main contract
containing or referring to it, and the existence and effectiveness of
the arbitration agreement are to be assessed, subject to the
mandatory rules of French law and international public policy, on the
basis of the parties' common intention, there being no need to refer
to any national law. References in this context to the independence of
the arbitration agreement are to its autonomy from the national laws
which otherwise might apply to it as opposed to autonomy from the
main contract in terms of its existence.
The final approach in determining the law or rules applicable to an
arbitration agreement is to combine several approaches.
As regards its substance, the arbitration agreement shall be valid if it
conforms either to the law chosen by the parties, or to the law

governing the subject-matter of the dispute, in particular the law

governing the main contract, or if it conforms to Swiss law.
This formulation allows Swiss courts maximum opportunity to uphold
the validity of the arbitration agreement.
An international commercial arbitration usually takes place in a
country that is neutral,in the sense that none of the parties to the
arbitration has a place of business or residence there. This means
that in practice the law of the country in whose territory the
arbitration takes place, the lex arbitri, will generally be different from
the law that governs the substantive matters in dispute.
This difference between the lex arbitri (the law of the place or seat
of the arbitration) and the law governing the substance of the
dispute, was part of the juridical tradition of continental Europe, but is
now firmly established in international commercial arbitration.
It is right that there should be a distinction between the lex arbitri and
the substantive law of the contract. Where parties to an international
arbitration agreement choose for themselves a seat of arbitration,
they usually choose a place that has no connection with either
themselves or their commercial relationship. They choose a neutral
place. By doing so, they do not necessarily intend to choose the law
of that place to govern their relationship. Indeed, as well as choosing
a place of arbitration, they may well choose a substantive law that
has no connection with that place.
If the parties do not make an express choice of the place of
arbitration, the choice will have to be made for them, either by the
arbitral tribunal itself or by a designated arbitral institution.
Unless the parties have agreed upon the place where the arbitration
is to be held, such place shall be determined by the arbitral tribunal,
having regard to the circumstances of the arbitration.
If the ICC is called upon to choose a place of arbitration under this
provision of the Rules, it generally selects the country of the sole or
presiding arbitrator
In cases of this kind, which are not uncommon both in institutional
and in ad hoc arbitration, the choice of the place of arbitration has
little or nothing to do with the parties or with the contract under
which the dispute arises. It is, so to speak, an unconnected choice. In
these circumstances, it would be illogical to hold that the lex arbitri,
the law of the place of arbitration, was necessarily the law applicable
to the issues in dispute. (Occasionally, it may be otherwise if the
parties have chosen a place of arbitration but not chosen a law to
govern their contractual relationship.)
Is the law governing the arbitration? It is, as the present authors
trenchantly explain, a body of rules which sets a standard external to
the arbitration agreement, and the wishes of the parties, for the
conduct of the arbitration.
Each State will decide for itself what laws it wishes to lay down to
govern the conduct of arbitrations within its own territory.

In recognition of the distinction between domestic arbitration and

international arbitrationwhere the sums at issue are likely to be
larger and the parties are judged better able to look after themselves
some States have (sensibly, it may be thought) introduced a code
of law specifically designed for international arbitrations. Such a code
of law is usually fairly shortthe Swiss Code, for example, contains
only 23 articles, some of which consist of a single sentence, and the
French Code, containing only 16 articles, is even more concise.
Indeed, some States (such as Colombia) have enacted short laws
which simply define the concept of international arbitration and clarify
that such arbitrations are to be governed by the international treaties
signed by that State rather than by codes applicable to domestic
arbitration. Reference has already been made to the Model Law,
which the authors have described as the baseline for any State
wishing to modernise its law of arbitration.
In most international commercial contracts, including those where a
State or State entity is one of the parties, it is usual for a given
system of law to be chosen as the law applicable to the contract itself.
There is much sense in such a choice. Parties who choose a law to
govern their contract, or any subsequent dispute between them, will
generally choose an autonomous system of law. Such a system is not
merely a set of general principles or of isolated legal rules. It is an
interconnecting, interdependent collection of laws, regulations, and
ordinances, enacted by or on behalf of the State, and interpreted and
applied by the courts. It is a complete legal system, designed to
provide an answer to any legal question that might be posed.
Furthermore, a national system of law will in principle be a known and
existing system, capable of reasonably accurate interpretation by
experienced practitioners.
The standard arbitration clauses recommended by arbitral
institutions, such as the ICC,
are usually followed by a note pointing out that in addition to
incorporating the arbitration clause in their agreement, the parties
should also add a choice of law clause. In-house lawyers and others
who are concerned with the drafting of contracts will invariably do
this, so that in most commercial contracts it is usual to find an
arbitration clause, followed by a choice of law clause.
In an ideal world, almost any national system of law should be
suitable, so long as that law has been drawn up, or has developed, in
a manner which suits the requirements of modern commerce. In the
real world, some national systems of law will be found to contain
outdated laws and regulations which make them unsuitable for use in
international contracts.
Parties to an international commercial contract will need to bear
these kinds of considerations in mind in choosing a given system of
law to govern their page "200"contractual relationships. Even in
countries which favour international trade and development,

problems may arise, particularly where the contract is made with the
State itself or with a State agency. The problem, shortly stated, is that
the State (as legislator) may change the law and so change the terms
of the contract, lawfully but without the agreement of the other party
to the contract. The State may, for instance, impose labour or import
restrictions, which render performance of the contract more
expensive. Unless the contract has been drafted with such possible
contingencies in mindand they may be difficult to foreseeit is the
private party who will suffer from this change in the equilibrium of the
contract.
One method of introducing a freezing solution, particularly in oil
concession agreements, has been the inclusion of stabilisation
clauses. These are undertakings page "201"on the part of the
contracting State that it will not annul or change the terms of the
contract by legislative or administrative action, without the consent of
the other party to the contract. In one of the arbitrations which arose
out of the Libyan oil ationalisations, the arbitrator held that the Libyan
Government's act of nationalisation was in breach of certain
stabilisation clauses and was accordingly an illegal act under
international law entitling the companies to restitution of their
concessions. This decision is generally criticised as going too far, not
only in its rejection of Libyan law as a basic ingredient of the
governing law clause, and in its so-called internationalisation of the
oil concession agreement, but also in its decision in favour of
restitutio in integrum. In any event, restitution was obviously
impracticable. The only purpose it could serve was to indicate the
basis on which damages should be paid for the allegedly illegal
expropriation.
As their name implies, economic equilibrium (or renegotiation)
clauses attempt to maintain the original economic equilibrium of the
parties at the time of contracting, where subsequent measures might
otherwise alter the expected economic benefits to which the parties
have subscribed. These clauses do not aim to freeze the law. Thus,
newly enacted laws will apply to the investment. However, they will
provide the investor with a contractual entitlement to be
compensated for the cost of complying with new laws or,
alternatively, require the parties to negotiate in good faith to restore
the original economic equilibrium of the contract. Avoiding any
purported restriction on the development of local law, such clauses
thereby steer clear of the principal ground of criticism of freezing
clauses.
In most of the international commercial disputes that are referred to
arbitration, there is a choice of law clause, in addition to the
arbitration clause. As already indicated, the law chose will generally
be that of a given countrythe law of England, or of Switzerland, or
whatever the case may be. The same is true of arbitrations that are
commenced under the terms of a submission agreement.

In the same way, a party to a contract with a State or State entity

may well insist, or try to insist, upon one of these options. The State
concerned would almost certainly not agree to subject its contracts to
the law of another State; and the private party might well be unwilling
to accept the national law of the State with which it was contracting,
for fear of adverse changes in that law.
Although it is generally recognised that parties to an international
commercial agreement are free to choose for themselves the law (or
legal rules) applicable to that agreement, there are limits to this
freedom. Mandatory rules have been defined as those that cannot be
derogated from by way of Contract, (144)and may feature in the
determination of a contractual dispute in addition to the governing
law selected by the parties.
Thus, by way of example, Russian law may feature in the
determination of corporate governance issues relating to a Russian
company even if the arbitration arises from a shareholders agreement
governed by Swedish law. In the same way, to take another example,
US-quoted companies cannot exclude the application of the Foreign
Corrupt Practices Act from the operations simply by concluding an
investment agreement in Kazakhstan that is subject to Kazakh law.
Moreover, in yet another example that the authors have seen in
practice in an ICC case in Paris, the commercial export of defence
technology from the United States to the Gulf region will be subject to
the US International Trade in Arms Regulations, even if the supply
contract in question is governed by the law of the United Arab
Emirates. However, perhaps the most frequently encountered
instance of the application of mandatory law is competition or antitrust law, and the authors now proceed to use that as an illustration.
Taking together the Court's decision and the Advocate General's
opinion, and even if no express duty to raise European competition
law issues ex officio was recognised, the ECJ was at the very least
signalling the existence of a powerful incentive to arbitral tribunals
themselves to raise and apply issues of European competition law if
they are concerned about potential challenges to, and ultimate
enforceability of, their awards in Europe.
Public international law is concerned primarily with States, but not
exclusively so. As Dame Rosalyn Higgins, a former President of the
ICJ, has contended, international law is a dynamic (not static)
decision-making process, in which there are a variety of participants:
Now, in this model, there are no subjects and objects, but only
participants. Individuals are participants, along with states,
international organizations (such as the United Nations, or the
International Monetary Fund (IMF) or the ILO), multinational
corporations, and indeed private non-governmental groups.
There are many sources of public international law, including
international conventions and international custom, but probably the
most relevant, so far as non-State Parties are concerned, are the

general principles of law recognised by civilised nations. These have

been defined as the general principles of municipal jurisprudence, in
particular of private law, in so far as they are applicable to relations of
States.
However, the problem of adopting public international law as the
system of law which is to govern a commercial relationship is not a
problem of principle, but of practice. Public international law, being
concerned primarily with the relationship between States, is not
particularly well equipped to deal with detailed contractual issues
such as mistake, misrepresentation, time of performance, the effect
of bankruptcy or liquidation, force majeure or the measure of
damages, and so forth. The same criticism may be directed at the
choice of general principles of law as the governing law of a
commercial contract. The problem with the general principles is they
are just that. They deal with such topics as the principle of good faith
in treaty relations, abuse of rights, the concept of State and individual
responsibility. They are excellent as generalisations, but lack sufficient
detail. That is why the authors suggest that if they are to be used in a
contract, they should be used as a concurrent law, rather than on
their own.
One established safeguard against unfair or arbitrary action by the
State party to the contract is to stipulate that the State's own law will
apply only insofar as it accords with either public international law,
the general principles of law, or some other system with accepted
minimum standards.
The Washington Convention, which established ICSID, makes use of
this system of concurrent laws. The Convention (159)provides for the
resolution of disputes between a State (or a State entity) and a
private party; (160) it stipulates that if a dispute arises and there has
been no express choice of law by the parties, the arbitral tribunal will
apply the law of the contracting State party to the arbitration
andsuch rules of international law as may be applicable. Thus,
honour is satisfied. The State's own law is given proper recognition.
Yet some fetter is imposed upon possibly unfair or arbitrary action, by
the reference to public international law.
This is a system of concurrent laws. For example, a State that
terminated a long-term investment contract by an act of
nationalisation would presumably do so in a way that was valid under
its own law. However, such an act of nationalisation would not be
valid under international law unless it was shown to be nondiscriminatory and to serve a public purpose, with proper
compensation being offered. In this way, international law would be
brought into play to set a minimum standard, which the arbitral
tribunal would be empowered to uphold in its award.
The coupling of national law with international law is seen in the three
arbitrations that arose out of the Libyan oil nationalisations, the

Texaco, BP, and Liamco arbitrations, although it only worked

effectively in one of them.
The choice of law clause was identical in the different concession
agreements that came before three different arbitrators. It read as
follows:
This concession shall be governed by and interpreted in accordance
with the principles of law of Libya common to the principles of
international law and, in the absence of such common principles, then
by and in accordance with the general principles of law, including
such of those principles as may have been applied by international
tribunals. In the event, this clause was interpreted in three different
ways by the three different arbitrators. In the Texaco arbitration, the
sole arbitrator held that the clause was primarily a choice of public
international law. In the BP arbitration, the sole arbitrator appears to
have regarded it as a choice of the general principles of law.
The use of a system of concurrent laws, such as that envisaged by
the Washington Convention in the absence of an express choice of
law by the parties to the dispute, seems to be the way forward for
international contracts to which a State or State entity is a party. The
reference to the law of the State concerned gives proper importance
to the sovereign position of the State party; yet the reference to
international law, or possibly to the general principles of law, provides
a measure of protection to the private party to the contract. There is
a balance to be struck between State law and international law. It is
important that arbitral tribunals should be prepared to give due
weight to both.
One of the recognised advantages of international arbitration is the
flexibility that results from the paucity of rules (and the corresponding
preponderance of discretion) that enables arbitrators to tailor
proceedings precisely to the characters, cultures, and claims that
feature in any particular arbitration. Thus, every international
arbitrationat least in theoryis a microcosm of potential procedural
reform. That potentiality is undoubtedly a quality of the arbitral
process; but that quality has a priceprocedural unpredictability. And
it is a price that many in the expanding constituency of arbitration
users are increasingly unwilling to pay.