CV1-I2-11-LEGAL CONCERN : Contract’s Midnight Clauses

Contract’s Midnight Clauses:

Governing law; Applicable jurisdiction and Arbitration Clause

Uttam Hathi

Uttam Hathi, B.Sc., P.G.D.M.M.T., LL.M., is practising lawyer since 1992. Currently he is associated with BRUS Chambers-Advocates & Solicitors as Managing Partner handling the Corporate Commercial & Contracts matters. He is enrolled with Bar Council of Maharashtra and Goa,

A commercial contract is a legal relationship, the first legal hurdles to be met are: Governing law; Applicable jurisdiction; and Arbitration Clause as applicable to a contract. In negotiations, these clauses largely are renegaded to a last option and thus as referred to as midnight clause, these are glossed over in the finalization of the agreement and unless a full thought is given, if parties are from different geographies it results in lawyers’ paradise.

Whilst interpreting these midnight clauses unless clear within the ambit of legal interpretation creates a nightmare, incurs substantial costs in its interpretation. These clauses and has resulted in much heartburn: for miscalculating the applicable forum; time arbitrage for the disposal of the core dispute issues, thus cost in resolution of a dispute.

Prefacing the concept and premising that either or both parties (natural/legal) are from India the first landing points are The Code of Civil Procedure, 1908 (“CPC”), the Indian Contract Act, 1872 (“ICA”) and the Indian Evidence Act, 1872 (“IEA”), which have bearing on the Enforceability of forum selection clauses. CPC provides for the jurisdiction of the courts to try an action arising out of a breach of contract.  ICA declares any contract in restraint of legal proceedings void, if it absolutely restrains usual legal proceedings in the ordinary tribunals. IEA provides that every fact, of which the court does not take judicial notice, should be proved. Accordingly, in India, foreign laws are to be proved like any other fact by leading evidence. Now, let us discuss the implications of these statues on the validity and enforceability of forum selection clauses.

Under CPC, every suit arising out of a breach of contract is instituted in a court within the local limits of whose jurisdiction the cause of action arises. The Supreme Court has laid down the following propositions regarding the venue for the suits on contract:

• In a court within whose jurisdiction the acceptance was communicated; The place where the contract should have been performed or its performance completed;
• In the suits for agency actions, the cause of action arises at the place where the contract of agency was made or the place where the actions are to be rendered and the payment is to be made by the agent;
• Part of the cause of action arises where the money is expressly or impliedly payable under a contract;
• In a case of repudiation of a contract, the place where the repudiation is received; and
• If a contract is pleaded as part of cause of action giving jurisdiction to the court where the suit is filed and that contract is found to be invalid, such part of the cause of action disappears.

It was held that an Indian court does not have jurisdiction to try a suit on a cause of action, which arose wholly outside the Indian territory. Further, where two or more courts have jurisdiction to try a suit or proceeding, an agreement between the parties that the dispute between them shall be tried in one of such courts is valid and not contrary to public policy.

Thus, the analyses are on two scenarios: when it is “contracted to refer disputes to arbitration”, the other being a silence on arbitration thus disputes are to be referred to “usual legal proceedings in the ordinary tribunals”

As with governing law, there is otherwise a risk of costly, time-consuming and wasteful preliminary battles about whether disputes should be handled in the courts of country A or country B, or in city A or City B if applicable in India and a risk of multiple claims proceeding in parallel in several different jurisdictions simultaneously.

GOVERNING LAW

Here is a typical governing law clause: "This Agreement is governed by and shall be construed in accordance with the laws of [India/England/ Singapore/etc]."

While this wording is straightforward, there are several important factors to note:

The choice of governing law is not a "my law or your law" battle of strength. It may be the case that "my law" is not in fact the best choice, which is why some international contracts are governed by laws that have nothing to do with either party (e.g., international parties all over the world regularly choose English, New York or Singapore law to govern their contracts). Nor is it wise to choose a neutral third-country law as a kind of compromise, unless one is sure that the chosen law is reliable. The key point to understand is that the choice of legal system can have fundamental, sometimes unintended consequences, even affecting the basic validity of the contract. Therefore, it is vital to get informed advice and to ensure that the chosen law is reliable and effective.

A common mistake is to refer to a country which has more than one legal system, e.g., "USA" or "China". Sometimes the ambiguity can be resolved by considering the wider context, but it is better to be clear by referring to, say, "New York" or "Hong Kong".

Simple is best. One should avoid phrases such as "publicly available laws of [ ]" or the like. Similarly, one should avoid splitting the governing law (e.g., "issue X shall be governed by the law of [place A] and issue Y shall be governed by the law of [place B]"). Such wording is a recipe for parallel litigation and the associated costs and delays.

For similar reasons, one should generally avoid over-clever formulae "excluding the conflicts of laws rules of that country", or similar. Occasionally it can be appropriate to include such a formula, but this is a highly technical issue on which professional advice should be obtained.

JURISDICTION

An example of a jurisdiction clause: "The parties submit all their disputes arising out of or in connection with this Agreement to the exclusive jurisdiction of the Courts of [ ]".  Again, there are many factors to consider in drafting a clause of this type:

A jurisdiction clause represents the parties' decision to resolve their disputes in court. It is therefore an alternative to arbitration. If in doubt, one should choose a jurisdiction clause or an arbitration clause, not both. Sometimes it can be appropriate to provide for arbitration and to include a clause conferring jurisdiction on certain courts to support the arbitration and to enforce awards.

If one wants to provide for particular courts only the clause should clearly state that the jurisdiction is "exclusive". Conversely, if one wants to include a non-exclusive jurisdiction clause (e.g., because one wants to preserve their ability to sue the counterparty in many possible venues), one should spell out exactly what their intention is. That is because courts in different places have taken different approaches as to what is meant by the shorthand phrase "non-exclusive jurisdiction".

As with governing law clauses, simple is usually best. Trying to assign different types of disputes to different jurisdictions frequently gives rise to problems, although there can be workable solutions in particular cases. One should also avoid words that create uncertainty and ambiguity (e.g., it is better to say that courts "shall" have jurisdiction, not that they "may" have).

Consider carefully whether the clause will be effective in legal and commercial terms. Will a court take jurisdiction just because the parties have chosen it in their contract? Will a judgment from that court be enforceable in the place where the defendant's assets are located? Depending upon the answers to these questions, incorporation of an arbitration clause may be a better option on some occasions.

We have looked at the purpose of governing law and jurisdiction clauses to explain why they are important and should be included in commercial contracts. Usually a jurisdiction clause will provide for either "exclusive" or "non-exclusive" jurisdiction.

TWO CENTRAL STRANDS OF ANALYSIS

This principle was revisited in Orchard Capital I Ltd v Ravindra Kumar Jhunjhunwala [2012] SGCA 16 – Court of Appeals, Singapore to interpret the following Governing Law clause: "This Agreement is governed by and construed in accordance with the laws of Hong Kong, SAR. The Parties submit to the non-exclusive jurisdiction of the courts of Hong Kong, SAR. The parties hereby knowingly, voluntarily and intentionally waive fully permitted by law any rights they may have to trial by jury in respect of any litigation based here on, or arising out of, under or regarding this Agreement." for a stay of proceedings initiated in Singapore against the Respondent who normally resided in Singapore and defaulted in payments.

The issue tested was -"The resultant issue is, as set out at the outset of this judgment, a simple one: ought the action started by the Appellant to be stayed on the ground of forum non-convenience? The real question, however, hinges on the legal effect of the Clause (bearing in mind that it is a non-exclusive jurisdiction clause) – for much will flow from our finding in this regard.

Court of Appeal, Singapore returned its finding least in so far as non-exclusive jurisdiction clauses are concerned reflecting that are two central strands of analysis.

“24. The first central strand is contractual in nature. Put simply, depending on the intention of the parties concerned, a non-exclusive jurisdiction clause could (taken at its highest) be given the effect of an exclusive jurisdiction clause – in which case strong cause would be required to be demonstrated by the party seeking to sue in a jurisdiction other than that stated in the relevant clause itself (in this case, the Appellant). Such effect may, for instance, be given where it would be a breach of the non-exclusive jurisdiction clause to object to the exercise of jurisdiction by the selected forum, given the wording of the clause and the circumstances. However, a possible critique of such an approach is that, on occasion at least, the distinction between non-exclusive jurisdiction clauses and exclusive jurisdiction clauses will be blurred, if not effaced. Prof Yeo frankly admits this (see Yeo at 359, where Prof Yeo explains that the consequence of this contractual analysis is that there is no theoretical distinction between these two types of clauses). Such a result runs, of course, counter to the Appellant’s view (as briefly noted above at [13]) and, perhaps, is also not entirely consistent with the approach taken by the courts in OCBC Capital and Noble. On the other hand, as Prof Yeo argues, such an approach is a Principled one. One can appreciate the persuasiveness of such an argument, especially if one has regard to the substance – as opposed to the mere form – of the contractual arrangement entered by the parties. Further, as just noted, the result is by no means a forgone one if strong cause can in fact be demonstrated by the party seeking to act in breach of the clause itself.

25. The second central strand is general in nature. Put simply, a non-exclusive jurisdiction clause is a factor – in all cases – in ascertaining, whether or not the action concerned ought to be stayed (pursuant to the principles first laid down in the seminal House of Lords decision of Spiliada (see [12] above)), although (according to Prof Yeo) its qualitative strength as a factor will differ, depending on the precise circumstances before the court. We will, in fact, return to these principles later (see below, especially at [31]). As Prof Yeo correctly emphasises, this second central strand is separate and distinct from the first inasmuch as it is not premised on the contractual intention of the parties as such (see Yeo at 350 and 351).”

ARBITRATION CLAUSE

Sulamérica CIA. Nacional De Seguros S.A. and Anors v Enesa Engenharia S.A. – ENESA and Anors [2012] EWHC 42 (Comm) and Abuja International Hotels Limited v Meridien SAS [2012] EWHC 87 (Comm), the court heard argument in two very different contexts on the law governing the parties’ agreement to arbitrate, but delivered judgments affirming the same principle.

The governing law (of the contract) approach: Supreme Court’s decision in N.T.P.C. v Singer SC 1993 AIR 998. Only where the parties did not specify either the governing law of the contract or the law governing the arbitration agreement would a presumption arise that the latter follows the law of the seat of arbitration.

The law of the seat approach: Recent English decisions (such as C v. D, [2007] EWCA Civ 1282) however, seem to favour the objective “closest and most real connection” test in deciding the proper law of the arbitration agreement, which invariably leads to the law of the seat of arbitration.

THE TEXT

First, consider the express choice of the parties, if any. If this did not exist, then the courts should turn to the implied choice of the parties, and if this could not be determined, the courts should determine the system of law with which the arbitration agreement had its “closest and most real connection”.

Subsequent application of the three-step test

In any case, the drafting lesson here is clear – specify the law governing the arbitration agreement. With the uncertainty on the law in this area, it seems safest to think about and solve the problem at the drafting stage itself.

SEAT AND VENUE OF ARBITRATION

Enercon (India) Ltd and Ors v Enercon Gmbh - the relevant provision was “The governing law of the IPLA was Indian law; the venue of the arbitration was London; and the provisions of the Indian Arbitration and Conciliation Act, 1996 were to apply”

to which Hon’ble Supreme Court held that

“the express mention in the arbitration clause that London was the venue of the arbitration could not lead to the inference that London was to be the Seat because although London was termed as the venue, the law governing the substantive contract, the law governing the arbitration agreement and the law governing the conduct of the arbitration were chosen to be Indian law and the closest and most real connection was with India. Once the Seat was in India, Indian Courts would have exclusive supervisory jurisdiction and English Courts cannot have concurrent jurisdiction”

CONCLUSION:

Thus, a seasoned practitioner will mentally jog the midnight clauses before pencilling it down reverts and update his research where required. But treating it as midnight clause with mindless drafting is a road full of potholes, whose depth are unknown.