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Arbitration and illegality: still an exacting test

17 May 2013
Under English law, a contract made with the object of breaking the laws of a foreign country is likely to be unenforceable. So, for example, in Foster v Driscoll [1929] 1 K.B. 470, the English court refused to give effect to an agreement to ship 7,500 cases of whisky to the United States during prohibition.

What happens if the unenforceable contract provides for disputes to be resolved by arbitration in London – will such an arbitration agreement (governed by English law) also be unenforceable?

Answer: no – according to a recent decision of the English court, the arbitration agreement will be given effect despite the unenforceability of the contract in which it is contained.

In Beijing Jianlong Heavy Industry Group v Golden Ocean Group Ltd & Ors [2013] EWHC 1063 (Comm) (1 May 2013), a Chinese company had guaranteed performance under a charterparty pursuant to a letter of guarantee made in favour of Bermudan and Liberian parties. The guarantee was governed by English law. Contrary to mandatory provisions of Chinese law, the Chinese company had failed to obtain necessary governmental authorisations before entering into the guarantee.

For the purposes of the proceedings before the English court, it was assumed that the failure to do so had been deliberate and that the parties' common purpose had been to contravene Chinese law. It was also assumed that the parties' sole purpose in concluding the London arbitration agreement had been to prevent the question of the validity of the guarantee coming before the Chinese courts.

Under the internationally-recognised doctrine of separability, an arbitration agreement is distinct and separable from the contract of which it forms part. The unenforceability of the contract will, therefore, not of itself result in the unenforceability of the arbitration agreement. However, an arbitration agreement may be rendered unenforceable if it is directly impeached on grounds which relate to the arbitration agreement itself and are not merely a consequence of the invalidity of the underlying contract. In Fiona Trust v Privalov [2007] UKHL 50, the House of Lords described this test of direct impeachment as "exacting".

In the present case, the claimant's attempt to establish that the arbitration agreement was directly impeached was unsuccessful. The relevant question was whether the policy and purpose of the rule which invalidated the guarantee would be liable to be defeated by giving effect to the arbitration agreement. The court held that this would not be the case. A London arbitration pursuant to the arbitration agreement would not involve any act in China that would contravene any provision of Chinese law, and it could not be contrary to the policy underlying the Foster v Driscoll principle for the arbitrators to be allowed to apply that very principle to the facts of the present case.

Accordingly, the court upheld the arbitration agreement and dismissed the claimant's application to set aside (pursuant to section 67 of the English Arbitration Act 1996, which relates to an arbitral tribunal's substantive jurisdiction) an award made pursuant to it.

The case serves to reiterate the high hurdle facing any party seeking to establish that an arbitration agreement governed by English law is unenforceable.

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