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Drafting arbitration clauses – the international considerations

As readers are no doubt aware, there are many methods available for companies to resolve disputes with their contractual counterparties. These range from a variety of non-binding mediation techniques to the more established and most common way of resolving disputes: litigation. Within this spectrum, arbitration is by far the most developed form of alternative dispute resolution, carrying international recognition in a way that litigation in national courts may not. In this article we aim to provide some practical guidance on how parties that have chosen to resolve disputes by arbitration can ensure that disputes are resolved in the way chosen by them without uncertainty, delay and expense.

Increase in arbitration

Benefits of arbitration

Before looking at the practical issues of drafting a suitable arbitration clause, we would like to provide a preliminary introduction on why arbitration may be more appropriate for certain disputes than other methods such as mediation or litigation.

In recent years arbitration has become a popular method of dispute resolution, mostly used in international business and trade. The number of cases resolved by way of arbitration has significantly increased according to the main arbitration institutions. For example, according to the London Court of International Arbitration (LCIA) Director General’s review of 2004, the number of cases filed with this institution increased by 23% in 2003 and 2004, compared to the previous two-year period. According to the statistics of the International Chamber of Commerce (ICC) there was a significant increase in the number of cases registered by this well-established institution from the 1950s to the 1990s, from four cases in 1950 to 291 cases in 1983.1 During the 1990s the number of cases increased further.2 More recent figures are available on the ICC website and demonstrate significant growth in the years around the millennium. Finally, during the period from 1994 to 2005 the number of treaty-based investment arbitrations before the World Bank International Centre for Settlement of Investment Disputes (ICSID) increased from 4 to 135.3 Obviously these are just a small selection of available statistics, but they all clearly demonstrate the significant increase in the popularity of arbitration over the years. The question to be asked is why has there been such a significant increase in arbitration? One of the obvious answers is that over the past few decades there has been a dramatic increase in international trade and, in most cases, arbitration has proved to be the dispute resolution method of choice.

Reasons for increased popularity

In general, the increase is likely to be dependent on a number of advantages of arbitration over litigation. For example, litigation has been criticised as having a tendency to reflect the interests of the state within which the courts are based, rather than the interests and values of all the parties involved.4 This can be seen particularly in cases where one of the parties is the state itself. Also, the courts rarely take into account the convenience of the parties in terms of costs. In litigation proceedings, parties have to comply with the relevant national procedural laws, whereas parties to an arbitration may agree on simpler procedures for the resolution of their disputes.

Furthermore, having a dispute between two international parties resolved in local courts may provide significant disadvantages to the foreign party as opposed to the local party. Parties from different countries may have different expectations as to the relevant principles of law applicable to the resolution of their dispute, both from a procedural and substantive point.

Another issue worth mentioning is that in some countries – due to a lack of a sufficient number of available courts and judges – trials may face delays, in some places of up to six years or more.5 Furthermore, in some countries the judicial system lacks independence due to the corruption, or perceived corruption, of judges and other officials. An eye-catching statistic that can be given as an example of this is Mexico, where, according to the UN special report on judicial independence in 2001, between 50% and 70% of federal judges were affected by corruption, although no judge had ever been formally charged (see the Legal Business Arbitration Report 2006, p3).

In our view, however, the main reasons for choosing arbitration over litigation are fourfold. First, the arbitration process is confidential and, unlike litigation, has better potential for maintaining a commercial relationship between parties, even though there may be certain issues between them that require resolution.

The second reason is the expertise of arbitrators. Parties are free to choose who has the relevant expertise, whatever it may be, to resolve their dispute, unlike the situation in the courts where judges may be appointed with little regard to the suitability of their qualifications.

Thirdly, the lack of an appeal process is advantageous. Most arbitrations are final and legally binding, subject to very limited grounds available for appeal, which may be limited even further by agreement of the parties.

Finally, the widespread adoption of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, to which more than 120 countries have subscribed, ensures that enforcement of arbitration awards internationally can be significantly easier than enforcing court judgments.

To summarise, arbitration has numerous advantages over litigation, which has resulted in its increased popularity over recent decades as a dispute resolution mechanism. Its advantages over litigation are that it is confidential, it is independent from the state, and parties are free to choose exactly how they want their disputes to be resolved. Should parties desire this, arbitration may be quicker and cheaper than litigation. Finally, arbitration awards are generally easier to enforce in foreign countries than court judgments. If any of the above reasons are particularly important to parties entering into a contractual relationship, they should include an arbitration provision into their agreement instead of a clause providing for the jurisdiction of the court of one or another country.

Practical Advice on Drafting Arbitration Clauses

We now move on to the practical advice of how to draft an arbitration clause. It is important to point out that – subject to very complex dispute resolution provisions that allow for both the use of arbitration and litigation, depending on the circumstances of the dispute – in most cases an agreement should contain either an agreement for parties to resolve disputes by arbitration or a submission to the jurisdiction of particular courts, and not both of those provisions. If parties have chosen to go down the arbitration route, then the arbitration clause needs to contain a number of key elements to ensure that it works and to avoid unnecessary future disputes about the intention of the parties.

Key points of the clause

First, the clause needs to state clearly that the parties agree to arbitrate. It is not possible to force a party to arbitrate without its agreement.

Secondly, the parties need to choose whether they will agree to resolve disputes by way of an ad hoc arbitration or by way of an ‘institutional’ arbitration in accordance with the procedural rules of a particular institution. In ad hoc arbitrations, parties must agree to decide the procedure for the resolution of the dispute on a point-by-point basis as matters arise, or the tribunal would be left to craft the procedure without the prescriptions of an established set of rules. The alternative to ‘ad hoc’ arbitration is ‘institutional’ arbitration, which means that parties elect to resolve disputes between them by way of arbitration in accordance with procedural rules provided by a certain institution, which usually also administers the dispute resolution process. The best known institutions include the LCIA, the ICC and the Arbitration Institute of the Stockholm Chamber of Commerce (the SCC). A list of these and other well-known institutions is set out in the table below.

The third element that has to be included in an arbitration clause is the relevant applicable law. The contract or agreement between the parties should, as a general rule, contain an applicable law provision, which would determine the relevant substantive law in accordance with which the contractual relationship is to be governed. In respect of the substantive law of an arbitration clause, the parties may decide that the general applicable law clause, which applies to the rest of the agreement, will also apply to the arbitration clause, or they may opt to have a different substantive law govern the arbitration clause. It is important to point out that the second option is less common. In the event that the applicable law is not stated specifically in the arbitration clause, or in the agreement as a whole, and there is a dispute between the parties in connection to the particular agreement, this matter will have to be decided by the arbitration tribunal as one of its first actions.

The fourth element is the place of arbitration. This is an important element of any arbitration clause, as the place of arbitration effects the relevant applicable procedural law. For example, if the place of arbitration is said to be London, England then this automatically implies that the Arbitration Act 1996 will apply to the resolution of the dispute. It is important for parties to be aware of this consequence of electing a place of arbitration so as not to inadvertently breach any of the procedural laws applicable to the resolution of their disputes, as breaches of applicable procedural laws during the resolution process may lead to a challenge of the subsequent arbitral award. When choosing a place of arbitration it is also important to think about the logistics and practicalities of any dispute that may arise between the parties.

The fifth key element of an arbitration clause is the number of arbitrators. Usually, parties have a choice between one arbitrator or three arbitrators. Should parties choose to have only one, then they may agree either that all parties have to agree to the identity of the arbitrator or elect an independent third party, for example the president of the Law Society, to determine a suitable arbitrator. Should parties elect to have three arbitrators then usually each party would choose one arbitrator and those two arbitrators would elect a tribunal chairman. The difference between having one and three arbitrators is obviously reflected in the costs of the arbitration, but, on the flip side, three arbitrators may provide a wider set of relevant skills and abilities.

The sixth key element to be included in an arbitration clause is the language of arbitration. This is particularly important in international contracts where parties from different countries with different languages are involved. Usually, the parties have to consider the language of the documentation of the relationship between them and whether there is an agreed neutral working language. Inclusion of a language of arbitration avoids any subsequent disputes about parties being more comfortable with one language, or preferring one over another.

Standard clauses

Obviously, the above six points are essential should you decide to draft an arbitration clause from scratch for insertion into your agreement. However, it is important to know that arbitration institutions usually recommend using a standard clause. These clauses are available on the websites of the relevant institutions. They are often short and simple, and incorporate a reference to their institution’s arbitration rules.

It is important to bear in mind that the language of these recommended clauses has been bullet-proofed through numerous prior disputes where the clause was relied on. Introducing even small changes to the clauses may create reasons for additional, unnecessary arguments between the parties later on.

When relying on a standard arbitration clause, it is important to ensure that particular elements are included. First, as before, it is important that the clause states that the parties agree to refer disputes to arbitration. Secondly, if there is a reference to the rules of a particular institution, it is important that the correct and full title of the institution is used, so as to avoid any uncertainty as to exactly what is meant by the particular reference. Finally it is important that disputes are referred to ‘binding arbitration’. This is usually achieved by inserting the words ‘shall be referred to and finally resolved by arbitration’.

It is also important to address the use of so-called ‘escalating dispute resolution clauses’, otherwise known as ‘multi-tiered clauses’. An ‘escalating’ or ‘tiered’ clause provides an armoury of dispute resolution techniques to the parties. These range from informal to formal in the hope that early settlement will be achieved using a simple dispute resolution process, thereby keeping money and time to a minimum. Usually, these clauses will begin with a paragraph that provides that the parties agree to submit disputes for resolution by way of mediation. If the mediation fails, the dispute may be referred to arbitration. It is important that any ‘escalating’ dispute resolution clause provides for clear time frames within which the resolution of a dispute can be escalated to the next level.

These clauses should make it clear that the clause does not preclude parties from seeking interim or provisional relief, if necessary. In general, contract drafters should anticipate that one party may try to use the reference to the first tier in a multi-tiered clause as a delaying tactic to avoid or postpone any resolution altogether. For more information on different types of dispute resolution clauses, incorporating various alternative dispute resolution methods, including ‘escalating’ provisions, readers may wish to refer to an article by David Shapiro entitled ‘Another way’ in Solicitors’ Journal (published 10 June 2005).

Finally, it is important to talk about arbitration clauses when there are parties involved in the contractual relationship who are not necessarily signatories to the contract containing the arbitration clause. This may happen, for example, where different companies within a group will perform different elements of a contract.

Obviously, arbitration is a consensual dispute resolution mechanism, which means that a party cannot be forced to arbitrate a dispute unless it has agreed to do so. Therefore all parties to a contract need to consent to arbitration. There are different mechanisms that can be used to minimise any risks associated with this issue.

The best-case scenario is if all parties involved in a particular contractual arrangement sign up to the arbitration clause. This may be achieved by having a standalone arbitration agreement that relates to the contractual relations as a whole and all parties to the contractual relationship sign this document. If it is impractical for all the companies within a group to sign, then the top company should sign on behalf of its subsidiaries and affiliated companies.

This non-signatory problem may also arise if an agreement is assigned to a third party that was not present at the beginning of the agreement. In this event, it is important to ensure that the new party submits to arbitration. This can be achieved by the insertion of an arbitration clause within the assignment agreement. However, it is also important to ensure that the original agreement contains a provision within its assignment clause whereby should one party assign its rights and obligations to a third party, the second party to the agreement consents to arbitrate any potential dispute against any such third party.

The above has been a quick overview and outline of various practical steps that should be taken by drafters of arbitration agreements to maximise the chances that, should a dispute arise, it will be resolved exactly in the way that the parties anticipate.

Notes

1) See the ‘ICC Court of Arbitration: the institution and its procedures’ by Tila Maria de Hancock, Journal of International Arbitration, Vol 1 No 1 (1984), pp21-38.

2) See ‘The internationalization of international arbitration: looking ahead to the next ten years’ by Dr J Gillis Wetter, Arbitration International, Vol 11 No 2 (1995), pp117-136.

3) See ‘UNCTAD reviews investor-state dispute settlement cases and draws implications for developing countries’.

4) See ‘Commercial alternative dispute resolution’ by M Fulton (LBC, 1989), p42.

5) See ‘Inside Asia’s Courts’ by D Samuels and N Smith, International Commercial Litigation (April 1997), at 23

Main International Arbitration Centres, Courts and Organisations

Country/Location
Centre
Rules
AUSTRIA (Vienna) UNCITRAL http://www.uncitral.org/pdf/english/texts/arbitration/arb-rules/arb-rules.pdf
AUSTRIA (Vienna) International Arbitral Centre of the Austrian Federal Economic Chamber http://portal.wko.at/wk/format_detail.wk?angid=1&stid=323813&dstid=8459&opennavid=0
BELGIUM (Brussels) Belgian Centre for Mediation and Arbitration http://www.cepani.be/EN/default.aspx?Pid=388
http://www.cepani.be/EN/default.aspx?Pid=369
BRAZIL Market Arbitration Panel http://www.camaradomercado.com.br/InstDownload/Regulation.pdf
CHINA (Hong Kong) Hong Kong International Arbitration Centre (HKIAC) http://www.hkiac.org/HKIAC/pdf/Rules/HKIAC%20Procedures%20for%20International%20Arbitration.pdf
CHINA (Beijing) China International Economic & Trade Arbitration Commission http://www.sccietac.org/cietac/en/content/index.jsp?board_id=4
FRANCE (Paris) International Chamber of Commerce (ICC) International Court of Arbitration http://www.iccwbo.org/court/english/arbitration/rules.asp
INDIA (Chennai) Council for National and International Commercial Arbitration (CNICA) http://www.cnica.org/cnica.pdf
INDIA (New Delhi) Indian Council of Arbitration (ICA) http://www.ficci.com/icanet/rules/commercialarbitration/rules.htm
RUSSIAN FEDERATION (Moscow) International Commercial Arbitration Court (ICAC) http://www.tpprf-mkac.ru/en/
SWEDEN (Stockholm) Stockholm Chamber of Commerce (SCC): Arbitration Institute http://www.swissarbitration.ch/rules.php
SWITZERLAND (Basel) Swiss Arbitration Association (ASA) http://www.swissarbitration.ch/rules.php
SWITZERLAND (Geneva) World Intellectual Property Organisation (WIPO): Arbitration and Mediation Centre  
SWITZERLAND (Geneva) World Trade Organisation (WTO): Dispute Settlement Body  
SWITZERLAND (Zurich) Zurich Chamber of Commerce (ZCC)  
UAE (Dubai) Dubai International Arbitration Centre (DIAC)  
UK (London) Chartered Institute of Arbitrators (CIArb)  
UK (London) London Court of International Arbitration (LCIA)  
UKRAINE (Kiev) International Commercial Arbitration Court (ICAC) http://www.ucci.org.ua/arb/icac/en/rules.html
USA (Los Angeles) Independent Film and Television Alliance http://www.ifta-online.org/IndustryServices/rulesinternational.aspx
USA (New York) American Arbitration Association http://www.jus.uio.no/lm/american.arbitration. association.international.arbitration.rules.2000/portrait
USA (Washington DC) International Centre for Settlement of Investment Disputes (ICSID) http://www.worldbank.org/icsid/basicdoc/basicdoc.htm
Additional Facility Rules: http://www.worldbank.org/facility/iii.htm

 

By David Goldberg, partner, and Artem Doudko, associate, SJ Berwin LLP.

E-mail: david.goldberg@sjberwin.com;

artem.doudko@sjberwin.com.

For more information please visit www.sjberwin.com.