How Separate is Separate? Court of Appeal clarifies the scope of the Separability Principle with respect to arbitration agreements

Summary

The Court of Appeal has clarified the application and scope of the fundamental principle that an arbitration agreement is treated as a separate agreement to the agreement in which it is incorporated (the “Separability Principle”). The court emphasised the difference between contract formation and contract validity and found that for the Separability Principle to apply, there needs to be a binding arbitration agreement in place at the first place, which has been concluded by reference to the general principles of contract formation. Where no arbitration agreement has been validly concluded, an Arbitral Tribunal (which depends for its jurisdiction upon the arbitration agreement) would not have jurisdiction. Where however the issue is whether the agreement is rendered void or voidable, that may or may not invalidate the arbitration agreement, but that will be legitimately a matter for a Tribunal.

Background

In DHL Project & Chartering Ltd v Gemini Ocean Shipping Co., Ltd [2022] EWCA Civ 1555 (24 November 2022), the underlying dispute arose out of a negotiation of a voyage charterparty. DHL (potential charterer) and Gemini (owner of the vessel ‘Newcastle Express’) negotiated a charterparty via brokers. The brokers circulated a “recap” of the negotiations which was expressed to be ‘subject shipper/receiver approval’ and provided for London arbitration. Since approval from the shipper nor receiver was received, the charterer rejected the charter.

Gemini, as owner, then initiated arbitration proceedings, in which DHL did not participate, claiming damages for repudiatory breach of the charterparty on the basis that clause 20 of the proforma charterparty provided that the approval for the vessel by the charterer should not be unreasonably withheld. The Arbitral Tribunal held that the rejection of the vessel by the charterer was not reasonable and that a binding charterparty had therefore been concluded, in which DHL was in breach. He therefore awarded damages of just over US$280,000, together with interests and costs, to Gemini.

DHL challenged the award under section 67 of the Arbitration Act, 1996 (‘the Act’) on the basis that the arbitrator lacked substantive jurisdiction. Alternatively, it submitted if the arbitrator did have jurisdiction, under section 69 of the Act, the arbitrator had erred in law by finding that a charterparty was concluded. The application under section 67 of the Act was granted by the High Court which held that neither a charterparty contract nor an arbitration agreement has been concluded as the “subject” (subject to shipper/receiver’s approval) was never “lifted” in the present case. Since the case was decided under section 67 of the Act, the court did not consider the application under section 69 of the Act, but the judge made it clear, that, if necessary, it would have allowed the appeal and set aside the award. Since the interrelationship between the “subject” clause and terms incorporated in the proforma charterparty raised the question of public importance, leave to appeal was granted.

In the appeal against the High Court's decision on the section 67 application, Gemini argued that the High Court had not given proper effect to the Separability Principle. It argued that in circumstances where parties had entered into an agreement containing an arbitration clause, the court should presume that all disputes arising out of the defined relationship should be resolved by resorting to arbitration. The non-existence or invalidity of the main agreement does not necessarily impeach the arbitration agreement. In the present case, the lifting or non-lifting of the “subject” did not affect the validity of the arbitration agreement.

Decision

The Separability Principle, recognised internationally, and statutorily by Section 7 of the Act, provides for the arbitration agreement to be treated as an independent contract to the main contract. This protects the validity of the arbitration agreement where the validity of the main contract is disputed.

In the present case, the Court of Appeal held that for the application of the Separability Principle, there needs to be a binding arbitration agreement in place, concluded by reference to the general principles of contract formation. The court emphasised the difference between contract formation and contract validity. The former involves disputes where no contract was ever agreed, which necessarily affects the arbitration clause, which is also treated as not having been agreed upon. In the latter, however, the parties have assented to an agreement containing an arbitration agreement, but the issue is whether the main agreement is rendered void or voidable on some legal grounds. These grounds may or may not invalidate the arbitration agreement, but the presumption is that it will not do so unless the ground of invalidity directly attaches to the arbitration agreement. The court clarified that Section 7 of the Act applies to issues of contract validity and not contract formation.

On analysing the effect of the “subject” clause in charterparty negotiation the Court found that a binding contract had not been concluded. The court elucidated,

“.. “subject” which is intended to negative contractual intention. Commercial parties would reasonably expect such a “subject” to apply to the whole of the contract and not to everything apart from the proposed arbitration clause.”

In this case, the non-lifting of the “subject” precluded both the main agreement and the arbitration agreement from coming into existence.

To Gemini’s submission on the ‘one-stop’ dispute resolution presumption, the Court of Appeal noted that, for one-stop shopping to be applicable, the shop needs to be “open for business”. Essentially, the parties need to have entered into an arbitration agreement first in order to take advantage of the presumption.

The Court of Appeal therefore upheld the High Court’s decision in setting aside the arbitral award as the arbitrator had no substantive jurisdiction.

Comment

This case provides useful guidance on the application of the Separability Principle under English law. The impact of the judgment might not be restricted to the ship chartering business but may also apply to any commercial transaction which has a condition precedent to the validity of the contract, which needs to be fulfilled before the contract becomes effective. Businesses entering such commercial contracts with arbitration clauses should consider whether to expressly state in terms, if their intention is that, even if a condition precedent is not satisfied, the arbitration agreement is still valid and potentially also whether disputes arising out of the condition precedent itself are within the scope of the arbitration agreement.

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The article was co-authored by Vijaya Singh Gautam, intern at CMS.