Finland: The Governing Law Of The Arbitration Agreement – Finnish And International Perspectives On The Prevailing Ambiguity

Introduction

The renewal process of the 1992 Finnish Arbitration Act has been pending for a while now, and with the recent reformation of the Finnish Government, it seems to be taking steps ahead. According to the new government programme from June 2023, the Finnish Government plans to investigate the needs for the renewal of the Finnish Arbitration Act and to prepare the necessary legislative changes to promote the competitiveness of Finnish arbitration.

The discussion on the renewal of the Finnish Arbitration Act has revolved around making the Arbitration Act align with contemporary needs of international arbitration. Namely, many contributors to the discussion have called for the Arbitration Act to be more compatible with the standards of the UNCITRAL Model Law.

In addition to ensuring the general compatibility of the Finnish Arbitration Act with the UNCITRAL Model Law, the possible redrafting of the Finnish Arbitration Act would also provide an opportunity for the Finnish legislature to address various legal issues which have arisen in international arbitration practice. One such issue is the question of the applicable law to the arbitration agreement. So far, this issue has not been considered in the Finnish discussion concerning the potential redrafting of the Arbitration Act.

In this article, I put forward the basic principles and problems which have arisen in international arbitration practice regarding the determination of the proper law of the arbitration agreement. Further, I reflect on the opportunities to address these issues in the prospective redrafting of the Finnish Arbitration Act.

In England, the issue of the applicable law to the arbitration agreement has been quite extensively addressed in recent case law as well as in the proposed amendments to the 1996 English Arbitration Act. Therefore, in my reflections on the Finnish legal situation, I especially focus on recent developments in England as a point of comparison.

Starting points and main issues in the choice of law consideration

The jurisdiction of any arbitral tribunal rests on the arbitration agreement, and therefore it is the foundation of the arbitral proceedings. As such, the law governing the arbitration agreement is not an irrelevant consideration, as it determines, e.g., the relevant rules of substantive contract law under which the validity of the arbitration agreement is decided.

As a general starting point, the New York Convention contains a choice of law rule applicable to arbitration agreements, Article V(1)(a). According to the Article, the enforcement of an arbitral award can be refused if the arbitration 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 (i.e., the law of the seat). The choice of law rule is virtually universally recognized and has been adopted in, e.g., Articles 34 and 36 of the UNCITRAL Model Law.

The generally accepted principles established in the Convention as well as the UNCITRAL Model Law call for the mutual intention of the parties to take precedence in the choice of law consideration regarding the arbitration agreement. However, in practice, the determination of the parties' intention is in many cases open to serious interpretative difficulties.

The problems can be seen to ultimately stem from the so-called separability doctrine. Following this almost universally recognised legal doctrine, the arbitration agreement is viewed as a separate (or at least, separable) agreement from the so-called main contract. The main contract is the commercial contract between the parties, which includes material provisions concerning, for example, the price and delivery of the goods. In contrast to the main contract, the arbitration agreement provides the process by which disputes arising from the main contract are to be resolved. The separability doctrine is generally seen to apply regardless of how the arbitration agreement is included in the main contract, thus applying even in cases where the arbitration agreement and the main contract are contained in the same document.

Further, the arbitration agreement is typically included in the main contract along with a choice of law clause, specifying the law to be applied to the contract. However, the law applicable to the arbitration agreement itself is in practice very rarely considered or specifically mentioned in the arbitration agreement or in the main contract.

Because of the separability doctrine, the lack of an explicit specification of the law governing the arbitration agreement in a contract containing a choice of law clause raises the question whether the choice of law clause sufficiently extends to the arbitration agreement. If there are no other considerations to take into account, the answer would in many cases be positive.

However, the choice of law difficulties are emphasised when the arbitration agreement specifies a certain seat of arbitration, and the seat is in a different country than the law of which has been chosen to apply in the choice of law clause. The problem that arises in this case is whether the choice of seat or the law specified in the choice of law clause determines the law applicable to the arbitration agreement.

Indeed, even though it would seem to call for an internationally uniform choice of law approach for arbitration agreements, the choice of law rule in the Convention does not decide the question of whether the law of the main contract or the law of the seat takes precedence in determining the proper law of the arbitration agreement in situations where the contract is silent on the matter. As such, the issue is ultimately in the hands of courts and tribunals to solve.

Courts in different jurisdictions as well as arbitral tribunals and academics have approached the question in a multitude of ways, which cannot be thoroughly outlined in this article. As an example, however, in the courts of common law countries, the law chosen to apply to the main contract has usually been considered decisive when evaluating the question of the law governing the arbitration agreement. In contrast, in certain civil law countries, such as France and Sweden, the question has been approached differently, with decisions ruling that the law applicable to the arbitration agreement is the law of the chosen seat.

Either approach could be credibly argued for. The application of the law of the main contract could be seen in many cases to be in line with the parties' mutual intentions and reasonable expectations. However, the law of the seat has been considered to apply, e.g., as it provides the lex arbitri, which by default governs the arbitration proceeding and, in the usual case, certain aspects of the arbitration agreement itself.

In short, the relevant forums in which the issue arises are free to apply any choice of law rules that they deem applicable to the arbitration agreement. Due to the lack of truly uniform choice of law rules or principles, the rules applied can vary greatly between courts in different jurisdictions and between courts and tribunals.

Ultimately, these discrepancies can lead to serious problems, especially when instances in different jurisdictions rule on the choice of law question within the course of a single dispute. This is precisely what happened in the Kabab-Ji saga, which is discussed below.

The Kabab-Ji saga – a choice of law tragedy

The issues regarding the law applicable to the arbitration agreement are highlighted in the quite recent series of decisions in English and French courts in the matter Kabab-JI SAL v. Kout Food Group (KFG). The latest and final judgements in the matter are the decision by the UK Supreme Court from October 2021 and the decision by the highest instance in France, the Cour de cassation, from September 2022.

The case concerned a dispute regarding franchise agreements. The franchise agreements all had an arbitration clause, designating disputes to be solved in an ICC arbitration seated in Paris and a choice of law clause in favour of English law. The relevant legal question was whether KFG was bound to the arbitration clauses in the franchise agreements even though the party to the franchise agreements was originally a company that became a subsidiary of KFG through a corporate restructuring.

The ICC tribunal found that the question of the validity of the arbitration agreement was a matter of French law and as a matter of French Law, KFG was bound to the arbitration agreement. The tribunal awarded nearly USD 7 million in damages and other costs to the claimant, Kabab-Ji SAL.

In France, KFG had filed for the setting aside of the arbitral award. The matter ended up in the Cour de cassation, which held (as did the previous instance in the Paris Cour d'appel and the arbitral tribunal) that the law applicable to the arbitration agreement was French law and as a matter of French law, the arbitration agreement bound KFG. Thus, the award was not set aside.

In England, the matter was also brought before the courts, which had to decide on the enforceability of the arbitral award against KFG. The instances from the Commercial Court to the UK Supreme Court found that English law as the law of the main contract applied to the arbitration agreement. According to English law, the arbitration agreement was not binding on KFG and thus the award could not be enforced.

The Kabab-Ji saga is an example case of a key uncertainty arising from the multitude of different approaches to the law applicable to the arbitration agreement, described above. As the jurisdiction of the arbitral tribunal to render enforceable awards relies on the arbitration agreement, situations can arise in which an arbitral award, valid in one instance, is then set aside or denied enforceability in another instance due to the arbitration agreement being found invalid under a "new" applicable law, determined by distinct choice of law rules. These potential approaches in different forums can be very difficult to predict by the parties.

In the Kabab-Ji saga, the arbitral award was denied enforceability in the English courts due to the arbitration agreement being found invalid under English law, which was not applied by the arbitral tribunal. Thus, the arbitration, along with all the costs already incurred, became essentially futile.

Difficult problems – simple or more difficult solutions?

As stated, the mutual intention of the parties is primary in determining the applicable law to the arbitration agreement. Despite the above-established confusion, it is virtually universally recognized that a sufficient declaration of such intention would be an explicit stipulation on the law governing the arbitration agreement made by the parties.

Thus, the choice of law issue would, in principle, be quite easily solved if commercial parties would simply start adopting a provision explicitly stipulating the applicable law to arbitration agreements in their contracts. The provision could be included in the arbitration agreement itself, and stipulated, e.g., in the form: "This arbitration agreement shall be governed by the law of [State X]". Indeed, arbitral institutions like the HKIAC and AIAC have provided such optional additions to be included in their model arbitration clauses. Time will tell whether such a practice would become the norm. So far however, it has not.

Further, as the law applicable to the arbitration agreement can have wide-ranging legal effects, any choice of law should always be carefully considered. As there is no generally established commercial practice which the parties could rely on in choosing such a law, this could decrease the willingness of the parties to adopt such provisions. Thus, other solutions should be considered.

The current situation in which courts in different jurisdictions apply varying choice of law rules to arbitration agreements is not adequate. As seen above, this can lead, and has led, to problems which are unnecessary and unwanted considering the ideal of international arbitration as an efficient dispute resolution mechanism by which enforceable awards should be rendered. Thus, it should be considered whether a universal solution to the choice of law issue could be made. This would mean, e.g., making relevant amendments to the New York Convention and/or the UNCITRAL Model Law, specifying how the law applicable to the arbitration agreement should be addressed by courts in light of the issues established above.

However, the universal approach would be a long haul. It is difficult to see delegates from different countries arriving at a consensus on the matter, at least in the foreseeable future. Thus, one option that could be considered would be making express stipulations in the national arbitration legislations, addressing how the applicable law to the arbitration agreement is to be determined. Preferably, such rules should be formulated to leave as little room for interpretation as possible. They should also be drafted keeping in mind the compatibility of the legislation with the principles established in international arbitration practice as well as those applied in other relevant countries. This would benefit legal certainty, as parties would have hard and fast rules which they could rely on being applied to their arbitration agreement in the relevant forums.

The legislative approach is considered below from the English and Finnish perspectives and put in context by the relevant legal background in both countries.

Possible legislative developments in England

The difficulties in establishing a fixed choice of law rule for arbitration agreements is highlighted in English legal practice even before the above-described Kabab-Ji saga. In the past, English courts have switched between rules favouring the application of the law of the main contract and rules favouring the application of the law of the seat.

However, with its landmark judgement from 2020 in the so-called ENKA v. Chubb case, the UK Supreme Court established a set of seemingly concrete principles regarding the determination of the proper law of the arbitration agreement. The Supreme Court held that where the law applicable to the arbitration agreement is not specified by the parties, a choice of governing law for the main contract will generally apply to an arbitration agreement which forms part of the contract. The ENKA v. Chubb decision was subsequently referred to in the above-described Kabab-Ji v. KFG decision by the Supreme Court.

However, far from being completely settled, the principles established by the Supreme Court have been subject to some criticism in the international arbitration sphere. Indeed, in March 2023, in its second consultation paper on the review of the English Arbitration Act, the English Law Commission proposed an approach in opposition to the one taken by the Supreme Court in ENKA v. Chubb.

In the consultation paper, the English Law Commission proposed a provision for the proper law of the arbitration agreement to be adopted in the Arbitration Act. According to the Law Commission's proposal, the arbitration agreement should be by default governed by the law of the seat in absence of the parties' explicit choice of law governing the arbitration agreement itself.

The proposal by the Law Commission in the second consultation paper sparked criticism of its own. The critique was based on the requirements of party autonomy and party expectations, among other things. However, in the final report by the Law Commission published 6 September 2023, the Law Commission maintained their position, stating that "a clear rule, like our proposal, would help establish expectations. Parties could reliably expect our proposal to apply the law of the seat by default."

Reflections on the issue from the Finnish perspective

The issue of the proper law applicable to the arbitration agreement can be considered unresolved in Finland. The Finnish 1992 Arbitration Act contains a choice of law provision in Section 53, similar to the one in the New York Convention, Article V(1)(a). However, like the article in the Convention, the provision in the Finnish Arbitration Act does not specify whether the law of the main contract or the law of the seat would take precedence in determining the law applicable to the arbitration agreement in absence of the parties' explicit choice of law.

There have so far been two Finnish Supreme Court decisions where the choice of law problem has been addressed, namely the decisions KKO 2007:39 and KKO 2020:89. In these decisions, the Supreme Court confirmed the effect of the separability doctrine in the determination of the applicable law to the arbitration agreement – the law chosen by the parties to govern the main contract does not necessarily extend to the arbitration agreement even when it is contained in the main contract.

However, in both cases the parties' choice of seat as well as the choice of law clause pointed at the law of the same country. Thus, the hierarchy between the seat of arbitration and the choice of law clause remained unsettled.

The potential future redrafting of the Finnish Arbitration Act would provide an opportunity for the Finnish legislature to address the issue by adopting an express provision on the proper law of the arbitration agreement in the Arbitration Act. As established above, after past confusion, such an approach has already been suggested to be taken in the revision of the English Arbitration Act.

Further, such a provision has long been legislated in Sweden. According to the Swedish Arbitration Act, Section 48(1), if the parties have not reached an agreement on the law applicable to the arbitration agreement, the arbitration agreement is governed by the law of the country where, in accordance with the parties' agreement, the arbitration had or will have its seat.

A choice of law provision for arbitration agreements in the Finnish Arbitration Act would pre-emptively address some of the unnecessary issues which have arisen in international legal practice. In drafting such a provision, it should be assessed and settled whether applying the law of the main contract or the law of the seat constitutes the default rule in absence of the parties' explicit choice of law governing the arbitration agreement. Solid arguments can be made for either approach under pre-existing Finnish legislation, case law and literature. In addition, the methods of comparative law should be used, and relevant international sources should be considered. In the interest of legal certainty and the effectiveness of arbitration, the end result should be a reasonably definite and well-justified choice of law provision for arbitration agreements.

Time will tell whether these considerations will play a role in the possible redrafting of the Finnish Arbitration Act or in future Supreme Court practice. HPP is following any developments in the arbitration sphere with a keen interest.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.