Contract formation v contract validity – separate applications of the separability principle?

The Newcastle Express concerned the application of the separability principle under s7 of the Act and its resulting effect on the jurisdiction of the arbitrator for the purposes of s30 and s67 of the Act.  The separability principle is the fundamental principle that where a binding agreement between two parties contains an arbitration clause, this clause creates a further, separate agreement to arbitrate, legally distinct from the parties' main agreement.  The arbitration clause shall not be regarded as invalid or ineffective because that other agreement is invalid, did not come into existence, or has become ineffective, and shall, for that purpose, be treated as a distinct agreement. 

For the Charterer it was submitted that the agreement was "subject to" approval, no such approval had been obtained, and therefore no agreement had been concluded by the parties. Because no contract had been formed, it was submitted that the arbitrator did not have jurisdiction to determine the dispute, and that the award should be struck down under s67.  

The Owner's argument had two parts. First, the language of s7 of the Act contemplated the wide application of the separability principle, such that it was unnecessary to consider the "subjects" provision at all in the context of a s67 challenge. The parties had clearly and expressly agreed to arbitration, and therefore, the arbitration clause survived the non-formation of the main agreement, and the s67 challenge should not be upheld.  Second, so far as s69 was concerned, it was argued that this statutory provision was only engaged where the arbitrator's decision was "obviously wrong". It was possible to construe the "subjects" provision in the Owner's favour so that it amounted to a "performance condition", not a precondition to a contract; there was thus no reason to interfere with the conclusion that the charterparty and arbitration agreement bound the parties.

Jacobs J found for the Charterer on the basis that the effect of the "subject" provision was to impeach the formation of both the charterparty and the arbitration agreement.  He held that where a subject has not been lifted, it "negates the Charterers' intention to enter into any contract at all", including an agreement to arbitrate. This was a case where the contract and arbitration agreement "stand or fall together".

The Owner appealed on the primary ground that Jacobs J had erred in allowing the s67 challenge, developing its argument at first instance into five propositions of law:

The Charterer restated its original argument, suggesting that the question of whether an arbitration agreement has been entered has to be answered by applying ordinary principles of contract formation, and while parties who conclude an arbitration agreement are generally presumed to favour one-stop adjudication, this presumption says nothing about whether an arbitration agreement has been entered into in the first place.  In this case, the "subjects" clause rendered both the main agreement and the arbitration clause non-binding, and thus the arbitrator did not have any jurisdiction to determine the dispute.

Males LJ upheld the first instance decision. In doing so, however, he took Jacob J's reasoning in two competing directions.  The first direction, explored most pertinently in paragraphs (47), (62), (72), and (80)(5), appears to draw a line in the sand between two situations in which the separability principle is sometimes invoked.

The first situation is where the question in issue is the arbitral tribunal's jurisdiction to determine a question of contract validity, i.e., where an otherwise binding contract is rendered void or voidable. The second situation is where the question is one of contract formation, i.e., where no main contract containing an arbitration clause has been concluded at all.

Males LJ noted that it was with only the first of these two situations that the House of Lords dealt in the Fiona Trust case (the leading judgment on separability), where it held that an arbitration agreement survived the invalidation of the main contract by reason of the agent of one of the parties having been induced to enter the contract by bribery.  Males LJ suggested that "where the issue is one of contract formation, it will generally impeach the arbitration clause ... but where the issue is one of contract validity, that is not necessarily so" (47).

His reasoning, here, points towards a general rule: where the main agreement is not formed, the arbitration clause generally sinks with it; conversely, if the main agreement is invalid, the arbitration agreement may survive the main agreement's invalidation.

The judgment also points in a second direction, more in keeping with the Fiona Trust decision, which suggests that the non-existence of the main contract does not necessarily mean that an arbitration agreement is also non-existent.  Rather, the separability principle means that the question of contract formation must be asked twice, once in relation to the main contract and again in relation to the arbitration agreement.  In most cases the same answer will be given to both questions, but it is theoretically possible for parties to conclude a binding agreement to arbitrate even if they have not yet agreed on the main contract.   

Parties negotiating terms of an agreement that are "subject to contract" should be advised that their arbitration clause may not be binding unless both parties specifically agree to be bound by it prior to entering the main contract. 

Where it is argued that an arbitration clause is not binding because there is no contract, it may fall to the courts to determine the issue, unless, as the Court of Appeal referred to at (86), and as is suggested above, the parties can make an ad hoc agreement to submit the issue whether a binding contract has been concluded to arbitration, without prejudice to any issue whether such an ad hoc agreement is necessary.  As Males LJ noted, "there could be no serious objection to that course.  One party wants to arbitrate its claim, while the other party was prepared to arbitrate any dispute if a contract had been concluded and can therefore have no sensible objection to arbitration as a process to resolve a dispute of this nature".