“An arbitration clause is a commonly used clause in a contract that requires the parties to resolve their disputes through an arbitration process” Discuss.

Introduction:

An arbitration clause[2] is a commonly used clause in a contract that requires the parties to resolve their disputes through an arbitration process. Although such a clause may or may not specify that arbitration occur within a specific jurisdiction, it always binds the parties to a type of resolution outside of the courts, and is therefore considered a kind of forum selection clause.

Unlike litigation, arbitration must be specifically chosen by parties as a dispute resolution mechanism. This choice can be set out in a separate arbitration agreement or, more commonly, incorporated into the underlying commercial agreement by an arbitration clause. This guide addresses the issues to bear in mind when drafting international arbitration[3] clauses.

 Why choose arbitration?

Parties to international commercial disputes often choose arbitration because they can have the dispute heard in a forum which they perceive to be more neutral than a national court and  they can often enforce an arbitral award abroad more easily than they can a court judgment because the New York Convention[4]:

• They can select arbitrators with expertise in the relevant industry or subject-matter of the underlying commercial contract.

• They can choose the language that the proceedings will be conducted in.

• Arbitration offers greater procedural flexibility compared with court proceedings.

• The proceedings are generally private and confidential.

• Disputes can be resolved faster because the possibility of appeals is minimized and sometimes costs can be lower.

 However, sometimes parties prefer to go to litigation[5] in a national court. This is because the range of remedies in litigation is usually wider than in arbitration. It is possible to obtain orders affecting third parties which are not party to the agreement to arbitrate, for example, a freezing order which can be served on a third party bank.

 Litigation in some jurisdictions is quicker and cheaper than international arbitration or they wish to seek publicity for a claim or set a precedent.

 How to draft an arbitration clause: overview:

The first step is to consider what the parties want to achieve. Is speed the aim or a possible cost saving? Is confidentiality the key factor? Or is arbitration the only viable means of dispute resolution, given that there are two or more international parties involved?

As with all contract clauses, to introduce a “standard” arbitration clause into all contracts can be unhelpful, since there is no such thing as a “standard” contract or a “standard” dispute. Rather, the parties should consider whether there are any matters that the clause ought to address in the particular circumstances.

The parties should consider:

• The nature and value of potential claims (monetary and otherwise).

• The complexity of potential claims, including whether these are likely to involve technical matters.

• The speed with which a decision is required (e.g. is there an ongoing contract to be performed?).

• The location of the relevant parties, and (for the purposes of enforcement) their assets.

• The language to be used in the arbitration.

• Whether the resolution of the dispute is likely to require written or oral evidence.

• Multi-party issues: are there more than two parties to the contract or involved in the same project, or are there likely to be several related disputes taking place at once?

• Whether pre-arbitration ADR such as mediation is desirable.

• Whether there are any particular types of dispute (such as completion account disputes) which would be more suited to expert determination rather than arbitration.

 Major Features of Arbitration:

Arbitration is a private, informal process by which all parties agree, in writing, to submit their disputes to one or more impartial persons authorized to resolve the controversy by rendering a final and binding award. It is used for a wide variety of disputes – from commercial disagreements involving construction, securities transactions, computers or real estate, to insurance claims and labor-union grievances. When an agreement to arbitrate is included in a contract, it might expedite peaceful settlement without the necessity of going to arbitration at all. Thus, an arbitration clause is a form of insurance against loss of good will.

The major features of arbitration are:

1. A Written Agreement to Resolve Disputes by the Use of Impartial Arbitration. Such a provision may be inserted in a contract for resolution of future disputes or may be an agreement to submit to arbitration an existing dispute.

1. Informal Procedures. The procedure is relatively simple: courtroom rules of evidence are not strictly applicable; there usually is no motion practice or formal discovery; and there is no requirement for transcripts of the proceedings or for written opinions of the arbitrators. Though there may be no formal discovery.

1. Impartial and Knowledgeable Neutrals to Serve as Arbitrators. Arbitrators are selected for specific cases because of their knowledge of the subject matter. Based on that experience, arbitrators can render an award grounded on thoughtful and informed analysis.

1. Final and Binding Awards that are Enforceable in a Court. Court intervention and review is limited by applicable state or federal arbitration laws and award enforcement is facilitated by those same laws.

 Drafting an arbitration clause:

 Seat of arbitration:

The clause should specify the seat, or place, of the arbitration. The seat of the arbitration will determine the procedural rules which govern the arbitration. For example, if the seat is Paris then aspects such as without prejudice and disclosure will be governed by civil law principles and may be different from the position in a common law jurisdiction such as England.

When thinking about what location to choose, consider how supportive of the process the national courts at the seat may be. You will need to consider enforcement, and whether the seat is in a country that is party to an international convention such as the New York Convention.

If the seat is abroad, you will need to seek advice from a local lawyer. The seat of arbitration does not dictate the physical location of the arbitration hearings. Hearings often take place at the seat of the arbitration but this is not always the case.

 Number of arbitrators:

An arbitral tribunal[6] can have one or three arbitrators. Parties should consider whether the value of the contract and of any potential disputes justifies the selection of three arbitrators, which will be more expensive. Coordinating space in three arbitrators’ diaries will also take more time, which will be bad news if you want a speedy resolution to your dispute.

The parties may agree not to specify the number in advance and to decide in accordance with the size and complexity of the dispute if one arises. The disadvantage of this is that proceedings may be delayed if the parties disagree on the number of arbitrators once relations have broken down. If institutional arbitration is used, the institution will decide the number of arbitrators if this is not specified in the arbitration agreement.

 Language of arbitration:

Specifying the language that will be used up front may save a considerable amount in translators’ fees. If the language is not specified, the arbitrators get to choose.

 Institutional or ad hoc:

Parties should consider whether they want their arbitration to be administered and supervised by a recognized arbitral institution or whether they want an ad hoc procedure.

An arbitral institution can help with the selecting and replacing of arbitrators, organizing hearings and handling communications between the parties and the arbitrators – although of course this will come with a fee. Under an ad hoc arbitration the parties are able to create their own rules, but this requires a spirit of cooperation. Cost savings can disappear if this is lacking.

 Governing law of arbitration agreement:

Usually, but not necessarily, this will be the same as the law of the substantive contract. Often the arbitration agreement will consist of a clause or clauses within the substantive contract, and will be governed by the law specified within that contract. However, it may be that a different law is specified as the law governing the arbitration agreement.

This is the law governing the subject of the dispute, sometimes termed the substantive law or the law of the main contract. The parties should decide on the law they wish to apply to any disputes that arise and the tribunal will apply that law to the merits of the dispute.

If this is not specified, it may be a source of substantial dispute in itself further down the line if relations between the parties sour.

Scope of disputes covered:

The arbitration clause should be wide enough to encompass all possible disputes and claims – this includes damages claims as well as breach of contract. The words ‘disputes relating to’ or ‘arising in connection with’ the contract are wider than disputes ‘arising under’ the contract, which a court may interpret as covering only contractual claims.

There must be clear, unambiguous and mandatory submission of disputes to arbitration.

 Selecting and replacing arbitrators:

If the parties agree to have a tribunal of three arbitrators, the usual process is for each side to nominate an arbitrator and for those two arbitrators then to nominate a presiding arbitrator. In the case of an institutional arbitration, the chosen institution may nominate the presiding arbitrator. If there are more than two parties to the arbitration agreement, the drafting may need to be adjusted. It is useful to include the default mechanism which will apply if the parties fail to agree.

 Multiple parties:

Some thought needs to be given when there are more than two parties to the contract – for example, in relation to the mechanism for nominating arbitrators. In this case the clause may provide that if a dispute arises and more than two of the parties are in dispute, then one arbitrator may be chosen by the party or parties making the claim and one arbitrator by the party or parties on the other side. The presiding arbitrator can then be chosen by these two arbitrators in the usual way.

 Mandatory rules:

Mandatory rules are rules that cannot be contracted out of. Any applicable institutional rules can only amend or override non-mandatory rules.

 Sovereign immunity:

Sovereign, or state, immunity is the immunity of a state from being sued in the courts of another state. If you are contracting with a state or state body you may need to consider including a waiver of any immunity, both as to jurisdiction and execution, in the arbitration agreement.

The choice of seat is again very important here. Where the defense of sovereign immunity is raised, the tribunal’s ability to consider that defense will be determined in accordance with the law of the seat of the arbitration.

 Confidentiality:

Under English law there is an implied duty of confidentiality in arbitration, but this is not the case in some other jurisdictions. If confidentiality is important, you should consider including an express obligation to keep the arbitration and all materials generated for the purpose of the arbitration confidential in the arbitration clause. You may not need to do this in all cases, as some of the institutional rules already provide for confidentiality.

 Opting out of the non-mandatory provisions of the Arbitration Act:

The Arbitration Act is the main law governing arbitration procedure in England. Some of the institutional rules exclude the non-mandatory provisions under the Act: by agreeing to this exclusion the parties waive the right to seek a determination from the English courts on a preliminary point of law or to appeal an award on a point of law. If you are using institutional rules which contain these exclusions but you wish to retain these rights then your arbitration clause will need to make this clear.

 Enforcement:

This is not a drafting issue as such, but it is an extremely important issue to consider at the outset and is an important factor when considering the seat of the arbitration. If the seat is in a country which has signed the New York Convention[7], then the award will be recognized in all the other signatory countries.

Authority to sign arbitration agreements:

Check that the person signing the arbitration agreement – which, in many cases, will be the main contract containing the arbitration clause within it – has authority to enter into arbitration agreements. Bear in mind that in some jurisdictions a special power of attorney will be needed.

 Capacity to enter into arbitration agreement:

Check that all parties have the capacity to enter into the agreement. For example, French public bodies are not normally entitled to arbitrate in domestic arbitrations unless authorized by decree. Under Dubai law if the Government of Dubai or its departments and corporations are party to a contract, the arbitration must take place in Dubai and must be governed by Dubai procedures and laws unless an exception has been granted by the Ruler of Dubai.

 Advantages and Disadvantages of Arbitration:

For simple contract disputes in which the matter can be heard in one day, arbitration is usually a good choice. However, if in doubt, consider the advantages and disadvantages, below.

Advantages: Arbitration is usually faster, simpler, more efficient, and more flexible for scheduling than litigation. Also, it avoids some of the hostility of courtroom disputes, perhaps because it’s a private proceeding versus the public drama of the courtroom. And if the subject of the dispute is technical–for example, about a patent–the parties can select an arbitrator who has technical knowledge in that field, rather than a judge who may not be familiar with the issues. The number-one benefit of arbitration is that it serves as a forum to resolve disputes outside of the judicial system. Arbitration can be fast, quick and easy, whereas lawsuits can drag on for years and years. Since the rules of evidence and procedure are usually relaxed in arbitration proceedings, the parties are also in a better position to represent themselves without having to get lawyers involved.

It naturally follows that arbitration also tends to be less expensive than pursuing a lawsuit. While the parties will usually end up having to pay the arbitrator, his or her fees will inevitably be less than the attorneys’ fees that they may have to pay to take the same case to trial.

Even in non-binding arbitration, a benefit can be that it serves to bridge the gap in an adversarial proceeding so that the parties can get a better glimpse of where things are headed if they are unable to resolve their differences. Most cases settle, but many times it is not until the parties are “on the courthouse steps.” Non-binding arbitration may help to facilitate a settlement sooner rather than later.

Another good thing about arbitration is that an arbitrator is typically not bound by the strict rules of procedure in reaching a decision. He or she can consider a lot more facts and circumstances than a judge or jury. Arbitrators typically try to be practical and oftentimes look at compromise as being inherently fair. Thus, the likelihood is that an arbitrator’s decision will award something to at least one of the parties. However, you would not expect that damages would be awarded that were anywhere near what a jury might have awarded if (and that is a big if) the matter were to have been tried before a jury.

Arbitration can also bring finality. Sometimes for the better, a decision on a binding arbitration cannot be appealed or overturned in the absence of a showing of extraordinary circumstances (for example, fraud, bias or other inappropriate actions on the part of the arbitrator). Thus, once a decision is rendered, the case is over. The losing party will typically not be able to appeal (which can make the matter drag on for years and years).

Disadvantages: Unlike a court ruling, a binding arbitration ruling can’t be appealed. It can be set aside only if a party can prove that the arbitrator was biased or that the arbitrator’s decision violated public policy. Unlike a court case, there is no automatic right to discovery (the process by which the parties have to disclose information about their cases to the other party). (However, you can include a requirement for discovery in your arbitration clause or agree to it under arbitration rules.) The costs of arbitration can be significant; in some cases, they may even exceed the costs of litigation. There are no guarantees that arbitration will be a fair process. As noted, once a decision is rendered in a binding arbitration, the parties are generally stuck with that decision. Without the right to appeal, there is always the risk of being subject to the whims and prejudices of the arbitrator. Overall, this is probably the biggest drawback to the arbitration process. Identifying other drawbacks will typically depend upon which side of the fence you are on. For example, if a party were concerned about a large jury verdict in the event a dispute ever arose, that party would negotiate for an arbitration clause so as to keep things out of court if a dispute happens to arise. For example, in view of the potential for a large jury verdict on a wrongful termination case, this might explain why an employer would want an arbitration clause in an employment contract. Given the potential for a large jury award on a malpractice action, this would also help to explain why a medical provider would want a patient to sign an arbitration clause.

Ironically enough, the rationale for having an arbitration clause in the first place may actually encourage parties to fight about something where a dispute otherwise could have been avoided. In the absence of an arbitration clause, the parties may be more inclined to compromise rather than pursue an expensive lawsuit. If arbitration is an option, though, there may not be the same deterrents and the parties may simply elect to fight about something rather than try to work out their differences more informally.

 Conclusion:

So we can conclude that a contract bearing “arbitration clause” binds the parties to arbitrate with each other in case of any dispute out of the contract and no party can seek remedy without exhausting the arbitration procedure.

 References:

Drafting Dispute Resolution Clauses – A Practical Guide, American Arbitration Association.

Web Address:

http://www.scmediator.com/Forms/Arbitration_Clauses/arbitration_clauses.html

http://www.out-law.com/en/topics/projects–construction/international-arbitration/drafting-an-arbitration-clause/

http://www.nolo.com/legal-encyclopedia/arbitration-clauses-contracts-32644.html

http://www.iama.org.au/clauses.htm