UK: When Is An Arbitration Clause Unenforceable In An International Transaction

Last Updated: 15 July 1997
(First published in In House Lawyer, May 1997)

When civil action is commenced on a contract which contains an arbitration clause, the court may be asked to rule that it has no jurisdiction because the parties' reference of all disputes to arbitration acts to bar recourse to the courts. Provided that there is a dispute which comes within the scope of the arbitration clause and that reference to arbitration has not been treated as a mere option by the parties, a court in a member state of the 1958 New York Convention on the Recognition and Enforcement of Arbitration Awards, which also governs the enforcement of arbitration agreements, will in such circumstances normally be under an obligation to grant an order to stay court proceedings in favour of arbitration.

However, Article 11(3) of the Convention sets out three exceptions to the enforcement of an agreement to arbitrate disputes. If a court finds an arbitration clause to be 'null and void, inoperative or incapable of being performed', it may decide to accept jurisdiction and proceed to hear the matter on the merits. It has been pointed out that the legislative history of Article 11(3) of the Convention does not provide any guidelines to the scope or meaning of these words. Article 11(3) of the Convention, or its equivalent in municipal enacting legislation (see figure 1), has been considered in legal writings and has come before courts around the world for interpretation. Because of what has been termed a 'pro-arbitration bias' on the part of the courts, there has been a growing tendency to limit exceptions to enforcement.

An American court, for example, has referred to the New York Convention as 'a joint policy that presumes the enforceability of agreements to arbitrate'. What is increasingly viewed as determinative and sufficient is the presence of a clear intent to arbitrate. More often than not, defects in arbitration clauses will be repaired by the court in order to give effect to the parties' underlying intent to arbitrate.

'Null and void'
It has been suggested that these words cover situations where an arbitration clause is invalid from the beginning: fraud, misrepresentation, lack of capacity or consent. A number of American decisions have considered the words 'null and void' and confirmed this interpretation.

Interestingly, the fact that an arbitration agreement may be 'null and void' in one country will not necessarily mean that it is unenforceable in another. In an American decision (Rhone Mediterranee Francese di Assicurazioni e Riassicurazioni v Achille Lauro et al (Dist Court: 555 F Supp 481, 1982; Court of Appeals: 712 F 2nd 50, 1983)), the court ordered a stay of proceedings and referred the parties to arbitration in Italy even though the arbitration clause, under Italian law, was null and void (for having provided for the appointment of an even number of arbitrators). The court reasoned that the agreement was not incapable of performance under Article 11(3) because it may yet produce an award with which all parties could agree and that would, therefore, not require enforcement in Italy, or because it was capable of producing an award enforceable outside of Italy.

'Inoperative'

Legal opinion considers this term to refer to an arbitration clause that ceases to have effect for the future because of the expiry of a time limit, the setting aside of an award, or a settlement of a dispute between the parties.

In one English decision decided prior to the New York Convention (Radio Publicity (Universal) Ltd v Compagnie Luxembougeoise de Radiodiffusion [19361 2 All ER 721), the court considered the meaning of the similar phrase 'inoperative or cannot proceed' in s8 of the Arbitration (Foreign Awards) Act 1930 which implemented the Arbitration Clauses (Protocol) Act 1924 and held that: 'until all matters in dispute under the agreement have been duly settled, the agreement is still perfectly operative, although it may be that an end has been put to the relations which the agreement originally brought into being between the two parties.'

The Court of First Instance of the Netherlands Antilles has held that evidence of a mutual intent to terminate a contract will include termination of the arbitration clause it contains which, thereby, becomes inoperative. However, a Canadian court considering the application of Article 11(3) of the New York Convention rejected arguments that the termination of obligations under a contract will result in the termination of the arbitration agreement it contains.

A number of cases have held that Article 11(3) encompasses situations where one party has abandoned or waived its right to a stay of court proceedings under 11(3) by participating in litigation before the courts.

'Incapable of being performed'
This category would appear to include instances where an arbitration clause is too vaguely worded, or where some defect in the wording prevents an arbitration agreement from producing effect, or renders the constitution of an arbitral tribunal, in accordance with the agreement, unworkable. Such clauses are sometimes known as 'pathological' clauses.

This category sometimes also includes instances where there is no dispute. Recently in Hong Kong, it has been held that the court should grant a stay unless the claim had been admitted (Guangdong Agriculture Co Ltd v Conagra International (Far East) Ltd [1993] HKLR 113). In Zhan Jiang E&T Dev Area Service Head Co v An Hau Co Ltd (unreported), A 10781/1993, 21 January 1994, digested at [1994] HKLD the court required an unequivocal admission, both as to liability and as to quantum, before it could be said that there was no dispute which could be referred to arbitration.

In Praczy v Haendler ([1981] 1 Lloyds Report 302), a plaintiff, prevented from litigating a dispute because of an arbitration clause, pleaded that the prior arbitration agreement ,as incapable of being performed because, impecunious, he ,as unable to pay the costs of commencing arbitral proceedings before the ICC. The plaintiff was a legally aided person and legal aid was not available for ICC arbitration proceedings. The court had to consider whether the situation constituted proper grounds to lift a stay of proceedings and discussed the meaning of 'incapable of being performed'. The court reasoned that this exception related only to the arbitration agreement, not to one of the parties, and that a plaintiff could not rely on his own inability to carry out his part of the arbitration agreement as a means of securing release from the arbitration agreement. The agreement itself was otherwise perfectly capable of being performed and the court granted a stay.

Another more recent legal aid case highlights the differences there may be between international and domestic arbitration agreements. Under the old law in England, the grounds for refusing to grant a stay in a domestic arbitration were broader than those for international disputes. Stay could be refused for 'sufficient' reason. Under this more flexible test, a plaintiff was allowed to rely on financial difficulties to resist an application for stay where his bankruptcy was caused by the defendant's breach of contract (Trustee of the Property of Andrews v Brock Builders (Kessingland) Ltd, The Times 9 December 1996 (CA). It is questionable whether the same result could be obtained under the new law.

A variety of arguments relating to the inconvenience of litigating in foreign countries because of practical or legal obstacles have been attempted by parties and rejected by courts. A court in Hong Kong, for instance, refused to accept that the adverse legal consequences which may flow from the parties' choice of a foreign venue could allow it to disregard the parties' arbitration clause.

There is an increasing tendency to refuse to consider that an error as to the identity or location of the arbitral institution renders an arbitration clause incapable of being performed. A Hong Kong court has recently had to consider the case of a choice of a non-existent arbitral institution. The decision in this case provides a measure of the strength of the court's pro-enforcement bias in such circumstances. In deciding to enforce the parties' arbitration agreement, the court viewed the parties' choice to arbitrate disputes as more important than their choice of instrumentality for arbitration. The court considered the parties' mistake to be evidence that the means selected for arbitration was only of secondary importance (Lucky-Goldstar International v Ng Moo Kee Engineering [1993] HKLR 73). A recent American decision has held, however, that the choice of a non-existent forum is a mistake which renders arbitration agreement incapable of performance.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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