The Principle of Separability

Ever since Heyman v Darwins Ltd the English common law has been evolving towards a recognition that an arbitration clause is a separate contract which survives the destruction (or other termination) of the main contract. Heyman v Darwins Ltd itself was a case of termination by accepted repudiation. A major evolutionary step was taken in Harbour v Kansa in which it was decided that the arbitration clause applied to a dispute whether the agreement in which it was embedded was void for initial illegality. Section 7 of the 1996 Act now codifies the principle that an allegation of invalidity of a contract does not prevent the invalidity question being determined by an arbitration tribunal pursuant to the (separate) arbitration agreement”. As per Longmore LJ in Fiona Trust v Yuri Privalov  & Others  [2007] 2 Lloyd’s  Rep 267.

Critically discuss with reference to emerging case law under the Arbitration Act 1996.

CHALLENGES INVOLVED IN THIS QUESTION:

Is it possible to challenge as to illegality, bribery or fraud of the underlying contract affect the arbitration clause as well hence the jurisdiction of the arbitrators?

Can arbitrators decide such matters?

These two questions were considered to be the key aspect in this question and further we have to concentrate on the previous approaches to this issue by the Common law (English courts) and the separability doctrine and discussing on Harbour V Kansa, Heyman V Darwins clearly gives us picture.

From the time when Heyman v Darwins Ltd [1942] AC 356, the English common law has been budding towards enforcement of an arbitration clause even in termination of the main contract. In the beginning everything is related with the main contract, people often used to say if the main contract itself void, there is no need for further enquiry in dealing with arbitration clause. But this position is gradually changed; now the legislation gives importance to the arbitration clause. Whatever happens to main contract doesn’t stop the arbitration clause; it still goes on like a river. The parties to the dispute have absolute right to carry down their arbitration proceedings. It was clearly mentioned in a key evolutionary case Harbor v kansa (1993), whatever may be the main agreement whether void for initial illegality or lapses on the ground, it is sure the parties to the dispute got the arbitration clause. This statement is governed by principle of separability, which is given in Section 7 of the 1996 Arbitration Act.

Again this query of the separability was considered in the recent Court of Appeal case of Fiona Trust & Holding Corporation & Others v Yuri Privalov & Others

Imposing questions on invalidity of a contract does not stop the issue from being decided by arbitrators under the arbitration agreement. It is distinct from main contract, and this is enshrined in section seven of the UK act which codifies the Common law principles. It is only if the arbitration agreement itself is directly impeached for a specific reason that the arbitral tribunal will be prevented from deciding the dispute relating to the main contract. In this connection, it is insufficient to say that the contract as a whole is impeachable on the grounds of illegality, bribery or misrepresentation, etc. more must be shown to impeach the arbitration agreement, e.g. a special basis by which invalidating event impeaches the arbitration clause in particular.

The principle of separability

This doctrine gives us the arbitration agreement is to be treated separate from the main contractual responsibility. It clearly indicates that there exist a clear distinction between the two clauses i.e., main contract is totally have no nexus with the arbitration clause. The principle of separability has been accepted by the English courts, and the landmark decision in Harbour assurance confirms us separability of the arbitration agreement was part of English common law.

As Lord Hoffman rightly points out Businessmen often try to escape from the liability of arbitration clause to prevent such things, which is considered the most obstacles for rendering judgment. Because after making several debates on the arbitration clause parties to the dispute raising questions to the validity of the contract doesn’t make any sense. . In confirming the things of the standard, and instructing its limits, the House of Lords acknowledged that English law must to be in line with international practice.

Separability is applied by international arbitral tribunals, both in cases where the underlying agreement is alleged to have been terminated and in cases where it is alleged to have been invalid or nonexistent ab initio. For example in elf Acqitaine iran v National Iraninan oil company. separability was referred to as ‘a generally recognized principle of the law of international arbitration’. Nonetheless, section 7 of the act is not mandatory and may be excluded by the parties contrary agreement is less likely to come in the form of an express ouster provision.

CASE ANALYSIS

In Harbour v Kansa at first instance [1992] approved by the Court of Appeal said

“Once it became accepted that the arbitration clause is a separate agreement, ancillary to the contract, the logical impediment to referring an issue of the invalidity of the contract to arbitration disappears. Provided that the arbitration clause itself is not directly impeached (e.g. by a non est factum plea), the arbitration agreement is as a matter of principled legal theory capable of surviving the invalidity of the contract.”

In the Fiona Trust v Yuri Privalov case, the Court of Appeal considered that if arbitrators can decide whether a contract is void for initial illegality, there is no reason why they should not decide whether a contract has been procured by bribery, just as much as they can decide whether a contract has been procured by misrepresentation or non-disclosure. It is not enough to say that the bribery impeaches the whole contract unless there is some special reason for saying that the bribery impeaches the arbitration clause in particular.

Before getting into the fine points of this milestone case, the beginning line for any conversation on the applicability of arbitration clauses is the Arbitration Act 1996 (the “Act”). Section 7 of the Act states as follows:

“Unless otherwise agreed by the parties, an arbitration agreement which forms or was intended to form part of another agreement (whether or not in writing) shall not be regarded as invalid, non-existent or ineffective because that other agreement is invalid, or did not come into existence or has become ineffective, and it shall for that purpose be treated as a distinct agreement.”

Prior to the Act, this concept had been recognized by the courts by the doctrine of separability that developed in order to make arbitration a more practical and efficient method of dispute resolution. The doctrine of separability is the principle that an arbitration agreement is a separate contract, not necessarily affected by the invalidity, ineffectiveness or non-existence of the main contract. The doctrine is recognized in most jurisdictions and is enshrined in the leading arbitral rules e.g. LCIA, ICC and UNCITRAL.

The question that arises from this background is how far can this notion of separability be extended? The case of Fiona Trust sheds some light on this often complex and uncertain area of law.

Background of Fiona Trust case

“Any dispute arising under this charter shall be decided by the English Courts to whose jurisdiction the parties hereby agree…Notwithstanding the foregoing…either party may, by giving written notice of election to the other, elect to have any such dispute referred…to arbitration in London in accordance with the London Maritime association of arbitrators…”

The charterers initiated arbitration measures and the owners filed an application for an injunction to the court under s 72 looking for restraining arbitration proceedings on the basis that they had rescinded both the charter parties and the arbitration agreements contained therein on the center that they had been obtained by bribery.

Key issues in this case

(A) Scope of the arbitration clause

“The Court of Appeal set out to consolidate earlier common law on the jurisdiction of arbitral tribunals. The Court stated that for their part they, “…consider that the time has now come for a line of some sort to be drawn and a fresh start made…” The case law that Fiona Trust purported to consolidate related to the use of expressions: “under the contract” and “arising out of the contract”. There had previously been much judicial discussion as to whether these expressions covered disputes as to the validity of the agreement itself”.

The Court of Appeal, applying a purposive approach to interpretation of the terms, stated as follows:

“As it seems to us any jurisdiction or arbitration clause in an international commercial context should be liberally construed. The words “arising out of” should cover “every dispute except a dispute as to whether there was ever a contract at all”…Although in the past “arising under the contract” have sometimes been given a narrower meaning, that should no longer continue to be so…”

The Court took the common sense view that if business men go to the trouble of agreeing that their disputes be heard in a particular country or by a particular tribunal, they do not expect time and money to be spent on arguing about whether a cause of action comes within the meaning of a particular phrase that they have used. As the Court of Appeal stated, “If any business man did want to exclude disputes about the validity of a contract, it would be comparatively simple to say so.”

(B) The doctrine of separability

The Court of Appeal recognised that the common law had evolved to a point where an arbitration clause is a separate contract which survives the destruction or termination of the main contract. Harbour Assurance [2] was – as recognised by the Court of Appeal in Fiona Trust – a major evolutionary step. In Harbour Assurance it was decided that the arbitration clause applied to a dispute regardless of whether the agreement in which it was embedded was void for initial illegality.

As Longmore LJ stated in Fiona Trust:

“This statutory principle codifies the principle that an allegation of invalidity of a contract does not prevent the invalidity question being determined by an arbitration tribunal pursuant to the (separate) arbitration agreement. It is only if the arbitration agreement is itself directly impeached for some specific reason that the tribunal will be prevented from deciding the disputes that relate to the contract.”

The Court of Appeal therefore held that if the arbitrators could decide (as they did in Harbour Assurance) whether a contract was void for initial illegality, there was no reason why they could not decide whether a contract had been procured by bribery.

Interaction between sections 9 and 72

The Court of Appeal held that it would be for the arbitrators first to consider whether they have jurisdiction to determine the dispute and not the courts. If the court was faced with conflicting applications to stay court proceedings under section 9 of the Act in favour of arbitration and an application for a declaration that there is no arbitration agreement under section 72, the application under section 9 is the first matter that there arbitrators should decide. The Court came to this decision on the basis that this was more in line with the UK’s obligations under the New York Convention to consider section 9 applications first.

An exception

In Fiona Trust, the Court of Appeal demonstrated the support of English courts for international commercial arbitration. Fiona Trust confirms the doctrine of separability of the arbitration clause from the main contract, even in situations where that contract was procured by bribery. Coupled with the Court’s liberal (and commercial) approach to the interpretation of arbitration clauses, it highlights that where parties have agreed to arbitration, the arbitrators should be the first to consider whether there are any jurisdictional issues that need to be resolved.

What happens, however, where the parties dispute that there was ever a contract at all as quoted above in relation to the scope of an arbitration clause? If there was no contract, how can there be an arbitration clause? Academic writers, including Mustill & Boyd, consider that the words “arising out of” should cover “every dispute except a dispute as to whether there was ever a contract at all.”

At first glance, this position (supported by the decision in Fiona Trust) appears difficult to square with the wording of section 7 of the Act (see above) which appears to cover contracts which “…did not come into existence…”. However, the crucial distinction with this situation and the facts in Fiona Trust is that there was an intention to create legal relations. The contract “did not come into existence” (for the purposes of section 7) because of bribery but there was still an intention, at the outset, to create legal relations between the parties. In contrast, it seems that a party cannot rely on an arbitration clause in a proposed contract where the offer is revoked before it has been accepted by the other party. However, Harbour Assurance even clouds this concept:

“It seems to me impossible to accept so sweeping a proposition. There will obviously be cases in which a claim that no contract came into existence necessarily entails a denial that there was any agreement to arbitrate. Cases of non est factum or denial that there was a concluded agreement, or mistake as to the identity of the other contracting party suggest themselves as examples. But there is no reason why every case of initial invalidity should have this consequence…In every case it seems to me that the logical question is not whether the issue goes to the validity of the contract but whether it goes to the validity of the arbitration clause. The one may entail the other but…it may not.”

Whilst the original Mustill & Boyd position may be a starting point – and the doctrine of separability may not apply to a situation where there is a denial that a contract came into existence – Harbour Assurance appears to confirm that every case must be decided on its own special facts. Whilst it may seem unlikely that a contract that never came into existence according to basic contractual principles could nevertheless still produce a binding agreement to arbitrate, this is an anomaly that has still not been tested by the courts as such.

Recent developments

Another key point to note is that on 29 March 2007 the House of Lords granted permission to appeal against the judgment in Fiona Trust. The Court of Appeal has, separately, refused to extend an injunction restraining the Appellants from pursuing the arbitration pending judgment in the House of Lords. The Court of Appeal held that the courts should adopt a cautious approach to injunctive relief in the arbitration context.

The Respondents would have to show a strong case of potential prejudice before the Court would intervene and the Respondents had not shown a strong enough case. The Appellants were, however, required to give three undertakings, namely:

The Respondents could participate in the arbitration without prejudice to their rights under section 72 of the Act; the Respondents would be permitted to appoint their own arbitrator; and any additional costs incurred as a result of the arbitration would be borne by the Appellants if the House of Lords held the arbitral tribunal did not have jurisdiction.

Whilst the Court of Appeal decision in Fiona Trust appears to shed light on the doctrine of separability and demonstrate support for international arbitration, the Law Lords may yet decide to reverse the decision. Arbitrators everywhere should, therefore, watch this space.

Conclusion

The judgment in the Fiona Trust v Yuri Privalov case is a further important affirmation that an arbitration clause is a separate contract which survives the termination of the main contract. The Court of Appeal ruled that if a contract is said to be invalid for reasons such as bribery, unless that bribery relates specifically to the arbitration clause, the arbitration clause survives and the validity of the contract as a whole is to be determined by an arbitrator and not by the court.

In Fiona Trust [1], the Court of Appeal drew a clear line under a voluminous body of case law that considered how far to push the envelope in relation to the applicability of arbitration clauses.

There are a number of cases that should be discussed:

Vee Networks Limited v Econet Wireless International Ltd

It is also a land mark case in providing the importance of Arbitration clause importance. The summary issues involved in the case were the following

“Section 7 of the Arbitration Act 1996 clearly gives us the separability doctrine. It gives us the importance of arbitration clause. It is “for that purpose” to be regarded as a distinct agreement. S.30 of the Act introduced, for the first time in statute, the power of the arbitral tribunal to decide upon its own jurisdiction, subject to challenge in Court under s.67. This decision looks at the interaction of those two provisions and holds that a ruling on the validity of the host contract does not – in and of itself – affect the validity of its arbitration clause and does not amount to a ruling on the “substantive jurisdiction” of the tribunal, open to challenge under s.67”

O’Callaghan v Coral Racing

The summary issues in this case were discussed below:

“Lord Justice Hirst gave the case is about wagering contract between the appellant and Coral was affirmed null and void by section 18 of the Gaming Act 1845. It was evident therefore that the arbitrator would be gratified to hold that the transaction was null and void. He would also be gratified to recognize that he was expelled from awarding any sum of money alleged to have been won on the bet. Therefore, rule 21 had to be taken as part and parcel of the void agreement and could not continue to exist independently”.

Soleimany v Soleimany

This case law speaks about the enforcement of foreign arbitral awards in illegal contract. This case is also serves an important key aspect in determining the validity of the contract with the arbitration clause.