Effective incorporation of arbitration clauses: are you making it clear?
The question of whether an arbitration agreement is incorporated into a contract is fundamental, determining whether the parties are required to resolve their disputes by arbitration. However, whilst section 6 of the Arbitration Act 1996 clearly defines what is meant by an “arbitration agreement”, the provision leaves open the question of what is required for the effective incorporation of an arbitration clause by reference.
The incorporation of terms by reference is not uncommon in certain commercial contexts, including charterparties and bills of lading, reinsurance contracts and construction contracts. The case of Barrier Limited v Redhall Marine Limited is a useful reminder of the specific rules that apply when parties seek to incorporate into an agreement other terms (which may include an arbitration clause) from an external source.
The courts continue to distinguish between incorporation of the terms of a contract made between (a) the same and (b) different parties. In the former, known as “single-contract” cases, no special rules apply and general words of incorporation are sufficient to incorporate an arbitration clause which may be contained in another document such as standard terms and conditions or a previous contract between the same parties. In the second type of case, known as “two-contract” cases, an express reference to the arbitration clause is necessary in order for it to be effectively incorporated, since the arbitration clause originates from a separate contract between two other parties or one of the parties and a third party.
In complex commercial arrangements, particularly of the type which involve negotiable instruments, it is important for the parties’ intentions to be clearly expressed, especially where that intention is to oust the jurisdiction of the courts in favour of arbitration.
The types of cases in which the incorporation of terms tend to arise
The four most common situations in which the incorporation of terms from an external source arise are where:
- A and B make a contract in which they incorporate standard terms (a single contract case).
- A and B make a contract incorporating terms previously agreed between A and B in another contract or contracts to which they were both parties (a single contract case).
- A and B make a contract incorporating terms agreed between A (or B) and C (a two-contract case).
- A and B make a contract incorporating terms agreed between C and D (a two-contract case).
In Barrier Limited v Redhall Marine Limited, the first and third scenarios from the above list were under consideration:
- The respondent (Redhall) contended (in response to an application for pre-action disclosure by Barrier) that a purchase order sent by Redhall to Barrier, which stated that “the terms overleaf must be read and strictly adhered to”, had the effect of incorporating the arbitration clause contained in Redhall’s standard conditions, notwithstanding that the particular purchase order that was sent to Barrier was a carbon copy with no set of standard conditions printed on the back. Further, the subcontract entered into by Barrier and Redhall (the subcontract) contained a clause (clause 10) incorporating Redhall’s standard terms and conditions.
- Redhall further contended that the subcontract incorporated the terms of a main contract entered into between Redhall and a third party, BAE (the main contract), which itself contained an arbitration clause. The incorporating clause in the subcontract stated that “the terms of the [Main] Contract shall be incorporated into this Agreement so as to bind Barrier to perform its terms save only where inconsistent with the express terms of this Agreement”.
As regards the first scenario, the judge identified that this was a “single contract” based argument in which there were only two parties involved. Since no special rules applied to the construction of the contract, the judge found that a reasonable person reading the relevant clause of the subcontract (clause 10) would have no doubt that Redhall’s standard terms (including the arbitration clause) were incorporated, and the fact that the standard terms did not appear on the back of the purchase order would not affect this conclusion.
This contrasts directly with the treatment of cases falling within the third and fourth categories above. These categories concern “two-contract” cases; therefore clear words are needed to incorporate the arbitration clause. The rationale for this is that arbitration clauses are not directly relevant to the main subject matter of the contract but are ancillary provisions which oust the jurisdiction of the courts. In the case there were considerable difficulties in incorporating the arbitration clause from the main contract into the subcontract because “significant modifications” would be required to the wording in order to do so.
Incorporation by reference vs the doctrine of reparability
One of the issues considered by the court in previous cases is whether arbitration clauses should be treated differently to other clauses which the parties seek to incorporate (and which may or may not be more directly relevant to the subject matter of the contract), by reason of the arbitration clause being a self-contained contract that is collateral or ancillary to the main contract.
On one level, it might be argued that it is not possible to incorporate an arbitration clause (whether in a single contract or two-contract case) by mere reference to the terms and conditions of a contract, since the arbitration clause constitutes a collateral contract to those very same terms and conditions. This was the reasoning expressed by Sir John Megaw in the earlier case of Aughton Ltd v M.F. Kent Services Ltd, and an argument raised by counsel in Habas Sinai Ve Tibbi Gazlar Isthisal Endustri A.S. v Sometal S.A.L. The effect of applying this reasoning would be to remove the distinction between “single contract” and “two-contract” cases, so that clear words of incorporation (identifying the arbitration clause itself rather than the contract of which it forms part) would be needed in all categories of cases. So far, however, the courts have taken a more commercial approach. Christopher Clarke J in Habas Sinai v Sometal thought that a businessman would have no difficulty in regarding the arbitration clause as part of a contract and as capable of incorporation, by appropriate wording, as any other term of such a contract.
Although a practical and commercially workable compromise has been found, the more academic issue of separability has not perhaps found a complete answer. In the meantime, the safest course for parties wishing to incorporate an arbitration clause from an external source into their contract is to use clear words of incorporation. Where the arbitration clause is contained in a contract that has been made between different parties, clear words expressly identifying the arbitration clause itself should be used.