February, 2023 - Hard to fix: Court of Appeal decision on the separability of an arbitration agreement when subjects have not been lifted

The separability principle, as set out at section 7 of the Arbitration Act 1996, essentially provides that an arbitration agreement is, or must be treated as, a contract which is separate from the main contract of which it forms part. In DHL Project & Chartering Ltd v Gemini Ocean Shipping Ltd (the “Newcastle Express”) [2022] EWCA Civ 1555 the Court of Appeal considered the application of the separability principle in determining whether there was a binding arbitration agreement where the proposed charterparty recap expressly contained a subject and that subject had not been ‘lifted’. 

The facts and the Commercial Court judgment

A detailed summary of the facts can be found in the Club’s publication following the Commercial Court decision.  However, by way of brief summary, the owner (Gemini Ocean Shipping Ltd) and the charterer (DHL Project & Chartering Ltd) agreed a fixture recap which was “SUBJECT SHIPPER/RECEIVERS APPROVAL”.  The recap terms also provided for English law and arbitration. Following purported issues with the ship’s RightShip inspection and the shipper’s refusal to approve the ship, the charterer did not proceed with the fixture.

The owner subsequently brought a claim against the charterer in arbitration for repudiatory breach of the charterparty and was awarded US$283,416.21 in damages by the arbitrator. The charterer challenged the arbitration award under section 67 of the Arbitration Act 1996 on the basis that the arbitrator lacked substantive jurisdiction because there was no binding fixture and, therefore, no binding arbitration agreement between the parties.  The fixture was subject to shipper/receiver’s approval and this was a precondition to any binding contract.  Therefore, as the shipper had not approved the ship, the charterer claimed that this subject was not lifted and there was no binding contract in place, including no arbitration agreement.

The Commercial Court found in the charterer’s favour and held that the fixture was not binding unless and until the charterer communicated that the subject (in this case the shipper’s approval) had been lifted.  The arbitrator did not have jurisdiction as there was not a binding contract in place between the parties and therefore no concluded arbitration agreement.  However, the owner was granted leave to appeal to the Court of Appeal and appealed the Commercial Court’s decision on the section 67 application.

The Court of Appeal decision

Before the Court of Appeal, the owner submitted that the Commercial Court had failed to give proper effect to the separability principle and that, in circumstances where the parties had “expressly” and “undoubtedly” concluded an arbitration agreement, the court ought to have applied the separability principle and held that the arbitrator had jurisdiction.

The charterer submitted that the starting point should be to consider the meaning and effect of the ‘subject’ in question. In this case, it was clear that the effect of the ‘subject’ was to create a condition to the conclusion of a binding charterparty until the subject was ‘lifted’.  The arbitration clause in the contract in the recap was nothing more than a clause which the parties would have included in their contract if the relevant ‘subject’ condition had been fulfilled, which it had not.

Upholding the decision of the Commercial Court and dismissing the owner’s appeal, the Court of Appeal held:

1. The use of ‘subjects’ in charterparty negotiations is a conventional and well-recognised means of ensuring that no binding contract is concluded and (at least in many cases) is equivalent to the expression ‘subject to contract’;
2. The ‘subject’ in the present case was a pre-condition the effect of which was to negative any intention to conclude a binding contract until such time as the subject was lifted;
3. As a result, either party was free to walk away from the proposed fixture at any time until the subject was lifted, which it never was;
4. The negativing of an intention to conclude a binding contract applied as much to the arbitration clause as to any of the other clauses set out in the recap. Commercial parties would reasonably expect a ‘subject’ to apply to the whole proposed contract and not to everything apart from the proposed arbitration clause;
5. These conclusions are unaffected by the separability principle. The principle applies where the parties have reached an agreement to refer a dispute between them to arbitration which they intend to be legally binding. It means that a dispute as the validity of the contract in which the arbitration agreement is contained does not affect the arbitration agreement unless the ground of invalidity “impeaches” the arbitration agreement as well as the main agreement.  It has no application, however, when the issue is whether agreement to a legally binding arbitration agreement has been reached in the first place; and
6. What the parties agreed in their negotiations in this case was that, if a binding contract was concluded as a result of the subject being ‘lifted’, that contract would contain an arbitration clause. However, it is misleading to say that they entered into an arbitration agreement merely by acknowledging that any contract concluded between them would include that clause.

The Court of Appeal referred to the decision of Foxton J. in The Leonidas [2021] 2 Lloyd’s Rep. 165 (a case where the UK Defence Club was involved for its owner Member) in concluding that the ‘subject’ was a pre-condition the purpose of which was to prevent a binding contract coming into existence.  This was for the charterer to ‘lift’ and it did not matter whether the shipper had, in fact, given its approval, but rather whether the charterer had communicated to the owner that the subject was lifted. Therefore the arbitrator had no jurisdiction because the requisite subject had not been ‘lifted’ which was a pre-condition to the formation of a binding contract, including the arbitration clause. 

This decision further reinforces that, generally, subjects in fixture negotiations are seen by the court as pre-conditions to the conclusion of a binding contract.  Furthermore, it is the leading judgment on the separability principle and confirms that in cases where it can be said that a party has not entered into the contract containing the arbitration clause, the principle of separability does not apply.

As always, if Members have any questions in relation to the above issues they are invited to contact the Club for further information.