Background
Kabab-Ji SAL (“Claimant”), a Lebanese company operating restaurant specialising in Lebanese and other Middle Eastern cuisines. It owns the trademark of the restaurant. The Claimant granted a licence to Al Homaizi Foodstuff Company, a Kuwaiti company by way of a Franchise Development Agreement (“FDA”) dated 16 July 2001. As per FDA, Al Homaizi could develop and operate Claimant’s restaurant concept in Kuwait for ten years. Further, the Claimant and Al Homaizi entered into ten Franchise Outlet Agreements (“FOAs”) for individual outlets in Kuwait. The Franchise Agreements (FDA and FOAs) expressly mentioned English law as law governing the contract.
Al Homaizi underwent a corporate restructuring in 2005. A new holding company called Kout Food Group (“Respondent”) was established, of which Al Homaizi became a subsidiary. Disputes arose under the Franchise Agreements, which was referred by the Claimant under the rules of International Chamber of Commerce (“ICC”) in Paris. Respondent alone and not Al Homaizi was the party to arbitration. Respondent took part in arbitration under protest contending that it was not a party to the arbitration agreements contained within the Franchise Agreements.
Arbitral Award
The Arbitral Tribunal in Paris unanimously held that French law (law of the seat of arbitration) must apply to determine whether Respondent was bound by the arbitration agreements or not. In contrast, English law must apply to determine if the Respondent had acquired substantive rights and obligations under the Franchise Agreements.
The majority of the tribunal, in accordance with the French law, found Respondent to be a party to the arbitration agreements and as per English law, Respondent was found to have become an additional party to the Franchise Agreements alongside Al Homaizi by virtue of its conduct which led to “novation by addition”. The majority found that Respondent breached the Franchise Agreements and awarded unpaid license fees, damages and legal costs to the Claimant.
In his dissenting opinion, the third arbitrator found that in accordance with English law, Respondent never became a party to the Franchise Agreements as the strict wordings of the agreement prohibited any novation by conduct. Therefore, in the opinion of the third arbitrator, Respondent owed no substantive obligations to the Claimant.
Challenge to the award
Respondent brought an action in the French courts to annul the award on the ground that the arbitrators had no jurisdiction over Respondent as it was not a party to the agreement. Simultaneously, the Claimant brought proceedings in England before the English Commercial Court to enforce the award. The annulment proceedings in France ran parallel to enforcement proceedings in England.
On 29 March 2019, the English Commercial Court, decided the preliminary issues by holding that law governing the validity of arbitration agreement also governed the question of whether the Respondent had become a party to the arbitration agreement or not, which the English Commercial Court held to be English Law. The Commercial Court further observed that the Respondent did not become party to the franchise agreement, however, did not decide this issue finally, observing that further evidence might establish some form of written consent. While deciding the preliminary issues, the English Commercial Court also granted the Claimant’s request to adjourn further hearing until Paris Court of Appeal gave a decision on Respondent’s annulment application, although the same was objected by the Respondent. An appeal before the English Court of Appeal was preferred against this decision, by both parties.
The English Court of Appeal gave its judgment on 20 January 2020, wherein it held that English law governed the arbitration agreement and Respondent could not have become a party to the arbitration agreement in the absence of written consent as required under the Franchise Agreement or estoppel. The Court of Appeal further held that English Commercial Court should not have granted adjournment and should made the final determination that Respondent was not a party to the arbitration agreement. The English Court of Appeal made a summary determination in favour of Respondent and refused the recognition and enforcement of the award.
Subsequently, the Paris Court of Appeal dismissed Respondent’s application to set aside the award. Respondent preferred an appeal against this decision before the Court of Cassation, and the Claimant preferred an appeal against the English Court of Appeal’s decision to the UK Supreme Court.
Issues and Decision
What law governs the validity of the arbitration agreement?
The Claimant argued that although English law is specified as the law governing the FDA, however, Clause 14.3 of the FDA states that the arbitrators must also apply “principles of law generally recognised in international transactions”, which is admittedly a reference to UNIDROIT Principles. As per the Claimant, the term “law” in Article V(1)(a) and Section 103(2)(b) of the English Arbitration Act, 1996, refers exclusively to a law of a country and do not include principles such as UNIDROIT Principles. Thus, the law governing the arbitration agreement is a composite of national law and UNIDROIT principle, which does not qualify as “law”; hence, in the absence of a sufficient indication or no indication of “law” by the parties, the default rule requires the validity of arbitration agreement to be governed by law of the country where the award was made, i.e. law of the seat.
The Claimant further invoked “validation principle” to contend that contractual provisions must be given such an interpretation that upholds, rather than defeat, the parties’ intention to arbitrate. It submitted that if the application of English would lead to a conclusion that there is no valid arbitration agreement between the Claimant and the Respondent, then the English law should not be treated as the law governing arbitration agreement.
The Court rejected these submissions. It held that the Claimant’s approach would produce an illogical and inconsistent result with the principle of party autonomy, wherein parties would be deprived of both their chosen national law and their chosen principles, only to subject them to them to a different system of law, which they did not choose at all. The Court further observed that the reference to UNIDROIT principles was directed to the Arbitral Tribunal as part of the rules applicable to the merits of the dispute and had no bearing on the determination of the law governing the validity of arbitration agreement. Moreover, even if the arbitration agreement is said to be governed both by English Law and the UNIDROIT Principles, that would not lead to a conclusion that arbitration agreement is governed by French law. Even assuming that “law” refers to only national law and does not include the UNIDROIT principles, there is no basis to disregard the clear choice of a national law as the governing “law”.
The Court also rejected the Claimant’s reliance on the validation principle, observing that the principle concerns the interpretation of an arbitration agreement whose existence has already been established. Its purpose is to give effect to the parties’ presumed intention that their agreement to arbitrate should be legally valid and effective, particularly where competing interpretations of the applicable law may affect the agreement’s enforceability. However, the Court emphasized that the principle presupposes the existence of an agreement and does not operate as a rule governing contract formation. It therefore cannot be invoked to infer that parties entered into an arbitration agreement where the very dispute is whether any such agreement was ever concluded between them. To apply the validation principle in such circumstances would wrongly assume the existence of an agreement and thereby predetermine the question before the court. Accordingly, the Court held that the principle has no application to issues of contract formation or to challenges concerning whether an arbitration agreement was ever made between the parties.
The Court ultimately concluded that English Law governed the arbitration agreement in the present case. In reaching that conclusion, it relied on Clause 15 of the FDA, which provided that the agreement was governed by English law, and Clause 1, which defined the agreement as including all of the FDA’s terms, including the arbitration clause contained in Clause 14. Reading these provisions together, the Court found it unequivocally clear that the parties had chosen English law to govern the arbitration agreement. Referring to its decision in Enka v Chubb, the Court reaffirmed that a general choice of law clause governing a contract containing an arbitration agreement is ordinarily sufficient to constitute an express or implied choice of law governing the arbitration agreement. The mere selection of a different seat of arbitration does not displace that inference absent a contrary indication.
If English law governs the arbitration agreement, is there any real prospect that a court might find at a further hearing that KGF became a party to the arbitration agreement in the FDA?
The Claimant contended that the Respondent became a party to the arbitration agreement by becoming a party to the FDA, due to “novation by addition”. According to the Claimant, conduct of the parties, particularly Respondent’s continuing with the performance of obligations under the FDAs and FOAs over a sustained period, establishes “novation by addition”.
To overcome the “No Oral Modification clauses”, the Claimant relied on UNIDROIT Principles. It invoked Article 2.1.18 of the Principles, which provides that a party can be precluded from insisting on modification in a particular form by its conduct, if the other party has reasonably relied on that conduct and on Article 1.8 of UNIDROIT Principles, which provides that a party cannot act inconsistent to the understanding it has caused to other party to have and upon which that other has acted to its detriment. The Claimant contended that the Respondent is arguing inconsistently with the understanding it created in the mind of the Claimant that the Respondent had become a party to FDA, upon which the Claimant had acted and therefore, it should be precluded from contending otherwise. The Claimant also relied on the obligation of good faith and fair dealing in Clause 2 of the FDA to support the claim that the Respondent became a party to the arbitration agreement.
On the contrary, the Respondent contended that as per the English law, the Respondent never became a party to the FDA and therefore, to the arbitration agreement. The Respondent placed reliance on “No Oral Modification clauses” and argued that such clauses are legally effective under the English law. Therefore, the “novation by addition” cannot be invoked as per the strict requirements of English law.
The Court agreed with the Respondent. It observed that novation under English law involves substitution of one party by another with the consent of all concerned and is affected after Termination of the original contract and its replacement with a new one. No document evidencing such Termination of old contract and its replacement with a new one is produced.
The Court also laid emphasis on several provisions of the FDA containing “No Oral Modification” clauses. Particularly, Clause 24 of FDA required a written consent for a change, Termination or waiver of any provision of the agreement. The Court described Section 24 as a “double lock” provision: not only did any novation require written agreement, but even a waiver of the no-oral-modification requirements itself had to be effected in writing. The Court relied on MWB Business Exchange Centres Ltd v Rock Advertising Ltd[1], where it was laid down that the “no oral modification” clauses are legally effective under English law, and the English law does not normally obstruct the parties’ intention when they agree to such clauses, unless concern of public policy is shown.
Accordingly, any purported addition of KFG as a contracting party required the written consent of the Claimant and Al Homaizi. The Court further noted that the FDA involved grant of personal licence. Clauses 3.1 and 19 of the FDA stated that the grant of rights under the FDA was strictly personal in nature to the licensee and could not be assigned or transferred without a written approval of the parties. These provisions reinforced the strict compliance of “No oral modification” clauses.
The Court also rejected the Claimant’s estoppel argument. It observed that estoppel requires a high threshold and clear evidence of a representation capable of justifying departure from the contractual formalities. No such representation by Al Homaizi or Respondent had been identified. Nor could Article 2.1.18 of the UNIDROIT Principles assist the Claimant. Clause 14.3 merely authorised arbitrators to apply the UNIDROIT Principles when determining the merits of a dispute; it did not empower courts to rely upon those principles when deciding questions concerning the existence or validity of an arbitration agreement. In any event, the UNIDROIT Principles could supplement English law but could not contradict English contract law.
Finally, the Court dismissed the Claimant’s reliance on the FDA’s good faith obligation. The Court held that such an obligation could only bind Respondent if Respondent had already become a party to the FDA, which was precisely the issue in dispute. Accordingly, the Court concluded that there was no realistic prospect of establishing that Respondent had become a party to either the FDA or the arbitration agreement contained within it.
Case Details
Citation code: [2021] UKSC 48
Date of Judgment: 27 October 2021
Court: Supreme Court, United Kingdom
Judges: Lord Hodge, Lord Lloyd-Jones, Lord Sales, Lord Hamblen, Lord Leggatt
[1] MWB Business Exchange Centres Ltd v Rock Advertising Ltd [2018] UKSC 24; [2019] AC 119
Author(s)
Sakshi Upadhyay
LLM candidate at NLSIU, Bengaluru