THE THREE-STEP TEST OF THE SULAMÉRICA CASE

This article has been authored by Winnie Mathew, a third year student at Symbiosis Law School, Hyderabad.

The background of the Sulamérica case

This famous case revolved around the construction of one of the largest hydro-electric facilities in the world known as the ‘Jirau’, situated in Brazil. Due to certain incidents that occurred in March 2011, Enesa claimed for physical damages and consequential losses, the liability of which Sulamérica outrightly denied. Sulamérica then initiated the arbitration proceedings to take place in London under the ARIAS Rules, pursuant to the arbitration agreement in their insurance policy.

Enesa subsequently initiated proceedings in the courts of Brazil as per an exclusive jurisdiction clause which was present in the policy. Sulamérica then sought an interim anti-suit injunction in the courts of England in an attempt to prevent Enesa from pursuing the proceedings in Brazil with regards to the arbitration happening. In response, Enesa contended that the policy was expressed to be under the laws of Brazil and within the exclusive jurisdiction of the courts of Brazil. Additionally, they contended that since the parties’ locations of risk as well as the events in question were all situated in Brazil, and only the seat of arbitration was in London, the governing law of the arbitration agreement must be that of Brazil. Further, since the contract to which the arbitration agreement was part of was an adhesion contract, only Enesa was allowed to initiate arbitration proceedings, as per the laws of Brazil.

Sulamérica’s submissions were that, since the seat of arbitration was expressly stated to be London, the law with which the arbitration agreement had the closest and most real connection was that of English laws. This led to the buildup of one of the most significant cases in the history of arbitration which lay down the famous three step test to determine the seat of arbitration and governing law of an arbitration agreement.

The significance of the Sulamérica case

The case of Sulamerica Cia Nacional de Seguros SA and others v. Enesa Engenharia SA is a case of utmost importance in arbitration as it clarifies an aspect which has been quite unclear for a long time, i.e., the governing or applicable law to the arbitration agreement in the absence of an express jurisdictional clause.

Initially, Justice Cooke determined that the law of England, i.e., the law of the seat of arbitration should be the applicable law to the arbitration agreement despite all other factors and instances occurring or pertaining to Brazil. He therefore, adopted the ‘closest and most real connection’ test, in cases where there is a lack of an express or implied choice of law. In continuation to this, Justice Moore-Bick upheld this decision and provided a detailed analysis of why the closest connection will not always be to the law of the seat of arbitration.

As a result, a two-pronged approach was established to determine the governing law of the arbitration agreement-

● Firstly, it cannot be assumed that the law of the contract will be applied to the arbitration agreement.

● Secondly, to determine the applicable law, there should be a ‘three stage enquiry’ which enquires into (i) express choice, (ii) implied choice and (iii) the closest and most real connection.

This case paved the way for what was to be henceforth known as the ‘three-step test’ which would be applied in all cases where an express choice of law or jurisdiction was absent and the governing law of an arbitration agreement had to be determined.

The three-step test

This test is structured in such a manner that it explores the obvious intent of the parties involved and delves into the non-obvious intent as well by investigating the facts and circumstances surrounding the case, thereby leaving no avenue unexplored.

The first stage of the test looks into whether an express choice of law is in place and what it states. In cases where an express choice of law is mentioned with respect to the contract as a whole and not specifically the arbitration agreement, one cannot simply assume that the law of the contract extends to the arbitration proceedings as well. The relevance of the doctrine of separability comes into play here which lays down a clear distinction in purpose, functions and therefore the governing laws of the main contract and the arbitration agreement. This separability ensures the validity and enforceability of the arbitration agreement even in cases where the validity of the main contract is being challenged.

The second stage of the test enquires into the implied choice of law. This is achieved by studying the facts and circumstances surrounding the case. In determining the implied choice of law, factors such as place of business of the parties, nationality of parties, etc. are considered, thereby making this stage of the test quite similar to the third stage. In the absence of an express choice of law, the implied choice is given equal importance and is considered to be a true or real choice of law. Most legal systems around the world recognize and acknowledge tacit or implied choice of law. However, the determination of an implied choice of law may not always work in the parties’ favour considering its determination is based on assumptions and operates in a space of immense ambiguity thereby establishing that tacit choice of law is always apparent with uncertainty.

The third stage of the test enquires into the closest and most real connection when determining the governing law of the arbitration agreement. What usually happens in this stage is that the law of the seat of arbitration is considered to be the governing law of the arbitration agreement. In the Sulamérica case, the court held that the identification of the seat is a far more impressive factor in determining the governing law. The test of the closest and most real connection was confirmed in the case of Habas Sinai v. VSC, the following year by the English courts where it was concluded that the law of the seat would be the applicable law when neither the governing nor the substantive law (proper law of the contract) was specified.

The essence of the test

Even though the test is the most reliable mechanism is determining the governing law of an arbitration agreement, it is still not the most accurate method. The reliance of assumptions based on what the parties may have wanted but have not expressed doesn’t assure complete accuracy and varies from case to case. Through this test, emphasis is also laid on the distinction between venue of arbitration (lex arbitri) and seat of arbitration, which are key elements in the determination of the governing law. When comparing the two, the seat of arbitration is considered to be the most accurate assertion of the governing law of the arbitration agreement. This means that the place where the arbitration takes place does not always imply the closest and most real connection. However, different nations have differing views on this subject matter when it comes to the determination of the governing law.

Conclusion

The verdict of the Sulamérica case established the significance of seat of arbitration over any other factors. Here, even though Brazil had the closest and most real connection with various aspects of the case and parties involved, the governing law was decided to be that of the law of the seat of arbitration, i.e., English laws. This also emphasizes the importance of a neutral, third party country in the governance of the arbitral proceedings.

The case also brings to light the adverse position, parties are placed in should a dispute arise and there is no express choice of law for the arbitration agreement. Deciding and expressly stating the governing law of the arbitration agreement is of immense importance for the protection of the best interests of parties. Even though this test gives one a clear idea of what law will be made applicable to the arbitration agreement in the absence of an express choice, there is still room for uncertainty and ambiguity, and a lot of deciding factors will stem from the circumstances surrounding the case. Therefore, to avoid surprises and the imposition of an undesirable law, it is always worthwhile for parties to state the applicable law of their choice. This will ensure effectiveness and clarity in the process of dispute resolution and enhance the purpose of arbitration.