When you first enter into a commercial contract, you may not foresee a business dispute on the horizon whatsoever. But one thing’s for sure when scaling a business, and that’s nothing is certain. Futureproofing your contracts with an arbitration clause or agreement will stand you in good stead if a dispute arises and will also help you choose the right form of dispute resolution to suit your requirements and to get you the best possible outcome for your business. Read our guide below and get to know the ins and outs of arbitration so that you know the importance of including an arbitration clause in your contracts and how arbitration could benefit you, as opposed to costly litigation.
Here we will discuss:
- What is arbitration?
- Arbitration: The basics
- What are the advantages and disadvantages of arbitration?
- How is arbitration regulated?
- Is arbitration a final and binding process?
- Is arbitration suitable for complex disputes?
- Are arbitration proceedings private?
- At what point do the parties agree to arbitration?
- Types of arbitration
- What is the arbitration process?
- Can an arbitration award be challenged?
- Arbitration vs litigation
- How are arbitration rules applied?
- Drafting the arbitration clause
- What should a typical arbitration agreement establish?
- What is the cost of arbitration?
What is arbitration?
Arbitration is a form of dispute resolution. Instead of going to court if you find yourself in dispute with another business, you can submit your dispute to an arbitrator, whose decision is binding. The location and procedure for arbitration are usually contractually agreed between the parties.
Arbitration: The basics
For more information on the basics of arbitration, watch this video on the topic – featuring our Dispute Resolution Partner, Michael Key.
What are the advantages and disadvantages of arbitration?
Advantages of arbitration
Below are some of the key advantages of the arbitration process:
- Speed: generally, the arbitration process is a lot faster than the court process.
- Flexibility: the arbitration tribunal tailors the process to the dispute in question.
- No need for separate expert evidence (as is the case in litigation proceedings): this is because the arbitrator is an expert in the subject matter in question.
- Confidentiality: arbitration proceedings are usually held in private, and the parties are subject to duties of confidentiality.
- An element of control: the parties themselves can select the number and identity of the arbitrators they wish to appoint.
- Binding awards: an award made by an arbitration tribunal is binding on the parties.
- Enforcement: generally speaking, enforcement of an arbitration award is relatively straightforward both domestically and internationally.
- Certainty: having an arbitration clause in the contractual documentation provides for a degree of certainty as to how a dispute will be addressed.
- Cost: on the whole, arbitration tends to be more cost-effective than court litigation.
Disadvantages of arbitration
The following are some of the main disadvantages of arbitration:
- Cost: whilst cost-effectiveness is listed as an advantage above, it is important to be aware that it is not always the case that arbitration is guaranteed to cost less than litigation.
- Narrow scope for challenge: the opportunities for challenging or appealing an arbitration award are extremely limited, which could be perceived as a negative.
- Multi-party disputes: arbitration may be less effective in these circumstances.
- Bias: sometimes, an arbitrator’s bias can be reflected in their decisions.
How is arbitration regulated?
The Arbitration Act 1996 (the AA) regulates arbitrations that take place in or ‘have their seat’ (to use the legal term) in England and Wales. When introduced, the Arbitration Act was perceived as ushering in a dramatic change to the existing laws on arbitration. It gave parties to arbitration much greater control and restricted the powers of the courts to influence arbitration proceedings.
Is arbitration a final and binding process?
Unlike forms of alternative dispute resolution (ADR) such as commercial mediation, early neutral evaluation or expert determination, you should be aware that the outcome of arbitration is binding on the parties. Decisions are final, with a limited possibility of appeal. Arbitration decisions are also widely enforceable both nationally and internationally.
Is arbitration suitable for complex disputes?
The arbitration procedure is particularly attractive to businesses involved in complex commercial disputes. This is because the process is overseen by an arbitrator, who usually possesses a degree of expertise in the subject matter at hand that a judge may lack. This helps to reduce the time and expense involved in instructing independent experts to clarify technical matters to a court presided over by a judge.
Are arbitration proceedings private?
Arbitration proceedings are normally held in private, so you can rest assured that the possibility of sensitive information becoming public is minimised.
At what point do the parties agree to arbitration?
Parties must agree to arbitration, and the decision to arbitrate is often taken when the original contract is entered into. Great care should be taken, therefore, when you or your lawyer is drafting the arbitration clause in your commercial contract.
We deal with arbitration agreements in more detail below, but key considerations include:
- Specifying where the arbitration will take place
- What arbitration procedure will be used
- How the arbitrator will be chosen
- Whether any limits should be placed on the arbitrator’s power to take decisions
Types of arbitration
As touched upon above, it’s particularly important to take care when crafting an appropriate arbitration clause in your contract. In practice, the arbitration clause is often left until other contract terms are negotiated, which can result in terms that aren’t always as rigorously negotiated as they could be.
However, because the arbitration process is extremely flexible (you and your opponent can decide how it will operate), it’s always worth considering how an arbitration might run if you were to encounter one further down the line. You may choose either for a recognised institution to assist you (‘institutional arbitration’), or you may opt for what is known as ‘ad hoc arbitration’. The latter will follow rules designed by you and the other side, backed up by any default rules that operate in the seat of the arbitration itself.
What is institutional arbitration?
National and international institutions have broadly similar approaches to arbitration. However, in some areas, big differences exist in relation to issues such as confidentiality and costs. This means that when you’re drafting an institution-specific arbitration clause, it’s crucial to ensure that the correct choice of arbitrator is made. An experienced dispute resolution solicitor will be able to recommend an appropriate arbitral institution for your business dispute.
Some of the major arbitral institutions include the following:
- International Chamber of Commerce (‘ICC’)
- London Court of International Arbitration (‘LCIA’)
- International Centre for Dispute Resolution (‘ICDR’)
- The Hong Kong International Arbitration Centre (‘HKIAC’)
- The International Centre for Settlement of Investment Disputes (‘ICSID’)
What is ad hoc arbitration?
If you choose to engage in ad hoc arbitration, you and the other side will decide upon the procedural rules yourselves. This means that an arbitral institution won’t be involved, and you won’t receive any institutional support. Rather than design an entire procedure from scratch, parties will often use an existing framework – such as those developed by the United Nations Commission on International Trade Law (‘UNCITRAL’) – to run an ad hoc arbitration.
The chief advantage of ad hoc arbitration is its bespoke nature: you can tailor the rules to suit the specific dispute in question. However, the lack of institutional support and restricted access to experts available through this type of arbitration means it’s often a less attractive option for businesses in need of arbitration.
It’s worth highlighting here that even ad hoc arbitration must comply with relevant laws of the country in which the arbitration takes place. For example, under the Arbitration Act (as applicable to England and Wales), the rules of natural justice must be observed, and parties must have a right to challenge the award.
There are also sector-specific types of arbitration, including rules developed for the construction and shipping industries, as well as rules for arbitration in commodity disputes.
What is the arbitration process?
The main steps in the arbitration process are as follows:
- When a dispute arises under a contract and there is reason for that dispute to be referred to arbitration – whether ad hoc or through a recognised institution – a party wishing to commence arbitration sends a ‘notice to arbitrate’ to the other side.
- If an institutional arbitration is being carried out, the body in question will specify what the notice should contain. Typically, it will include a description of the claim and, if appropriate, they will nominate an arbitrator.
- The responding party will be required to reply within a specified time and nominate its preferred arbitrator.
- The arbitration panel or tribunal must then be constituted in accordance with the rules of the appropriate institution. Usually, a single arbitrator or a panel of three will oversee the process.
- With input from the arbitrator(s), the parties will narrow down the issues to be resolved and prepare a timetable for the process.
- The arbitration then proceeds in accordance with the rules of the institution or the ad hoc rules developed by the parties. Generally, there will be provision for producing written submissions, witness statements and exchange or disclosure of documents between the parties.
- A hearing or hearings will take place where lawyers will appear before the tribunal to present arguments and challenge the other side’s position.
- The tribunal announces its decision or ‘award’.
Can an arbitration award be challenged?
The arbitration award may, in some circumstances, be challenged. These circumstances depend largely on the terms of the contract, the rules of the relevant arbitral institution and the rules of the seat in which the arbitration was held. Under English law, for example, there are strict time limits if one side wishes to challenge an arbitration award. Notably, the grounds for challenge are also limited in scope. They include:
- The award failing to address all the issues
- Ambiguity or a mistake in the award
- Serious irregularity in the conduct of the arbitration
- The tribunal lacking the correct jurisdiction
- A mistake of law contained within the award
Arbitration vs litigation
As a means of resolving commercial disputes, arbitration is an increasingly attractive option – but the process isn’t suitable for every business or every type of problem. The table below highlights some of the advantages and disadvantages of arbitration when compared to litigation through the courts.
|Compared to litigation, arbitration is a flexible process. Parties can choose to follow the rules of a recognised institution, or design their own procedural framework that is tailored to the dispute in hand. Arbitration gives parties a degree of control that litigation doesn’t offer.||The cost of an arbitrator is carried by the parties. A judge presiding over a commercial dispute is not paid by the parties.|
|Arbitration awards are recognised internationally. The 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards introduced a regime for enforcement of awards internationally. It requires signatory countries to give effect to international arbitration awards in a way that surpasses any current agreements for the international recognition of court judgments.||When several parties are involved in a dispute, litigation is often more appropriate. Although arbitration can be multi-partied, the procedural mechanisms to join parties into arbitration can be complex and depend on the consent of third parties.|
|Because parties can choose the seat of arbitration, the process is perceived as being neutral. When the parties in dispute are from different legal jurisdictions, one party won’t be forced to submit to the courts in the country of his or her opponent. This sense of neutrality is strengthened by the fact that the parties themselves decide on the composition of the arbitration panel in a consensual manner.||In general, courts have greater sanctions at their disposal to force uncooperative parties to comply with court orders and directions. A party that wishes to delay matters can more effectively achieve this during arbitration than during litigation.|
|Expertise – the parties have a wide discretion when choosing the arbitrator(s). They can establish the credentials of a potential arbitrator before appointment to ensure that he or she has sufficient expertise in relation to the specific dispute. This can avoid delays and the cost associated with the extensive technical briefing of a less experienced arbitrator or judge.|
|Private hearings – the privacy of arbitration proceedings is particularly attractive to businesses that may fear the disclosure of commercially sensitive information in a court case heard in public. Additionally, under English law, disclosure to third parties of most documents in arbitration proceedings is prohibited.|
|With limited opportunity to appeal an arbitral award, arbitration is sometimes viewed as offering a more clear-cut and final outcome when compared to litigation.|
How are arbitration rules applied?
The rules governing arbitration will depend on what the arbitration agreement says. Often, the agreement will state that the rules of a particular arbitration institution will apply to the process. These will usually cover issues such as when the arbitration procedure can begin, how the tribunal is to be set up and what procedures are to be followed. If the arbitration is ad hoc, you must agree with the other side upon the rules that will apply – subject, of course, to any mandatory rules that apply in the jurisdiction concerned.
As mentioned above, the rules vary between institutions, so you should always seek legal advice before committing to the authority of a particular institution.
Drafting the arbitration clause
Once you decide that arbitration is a sensible way to deal with any conflicts that arise during the life of your commercial contract, it’s worth giving some thought to the type of arbitration clause you want to include. Unsuitable or inadequate provisions will only cause uncertainty (and possible legal challenges) if the clause is ever invoked. One of the first decisions to make is whether you want to use ad hoc arbitration or make use of the template clauses of an arbitral institution. We discuss the differences in these two types of arbitration in the ‘types of arbitration’ section above.
As with any legal agreement, it’s crucial to ensure that the terms of your arbitration clause are transparent. Above all, you should absolutely make it clear that there is a requirement to arbitrate ahead of litigation or any other form of ADR.
If you want to exclude certain types of dispute from arbitration, you should clearly define what type of issues will be subject to arbitration and which will not.
What should a typical arbitration agreement establish?
Aside from the initial considerations set out in the topic above, a typical arbitration agreement should establish the following:
- Which country’s law governs the agreement
- Where arbitration under the contract will take place (the seat)
- How many arbitrators will be appointed and what their expertise should be
- Whether proceedings are confidential
- Which institution’s procedures apply (if it’s an institutional arbitration)
- What specific rights will exist to appeal or challenge the arbitrator’s award
For more insight on putting together arbitration clauses, read our guide: Drafting An Arbitration Agreement: What To Look Out For.
What is the cost of arbitration?
As we have mentioned, arbitration is generally cheaper than litigation – but it can still result in significant costs for you and the other side. At its core, arbitration is carried out by consensus. So, whilst there are statutory rules about how costs may be incurred following arbitration, these aren’t binding.
This status quo is reflected in the Arbitration Act. It states that:
- The tribunal may make an award allocating the costs of the arbitration as between the parties, subject to any agreement they have made.
- Unless the parties agree otherwise, the tribunal shall award costs on the general principle that costs should follow the event (meaning that the successful party is entitled to an order to recover costs from the unsuccessful side) – except where it appears to the tribunal that in the circumstances, it’s not appropriate in relation to the whole or part of the costs.
In terms of costs, it’s also important to note that:
- Arbitrators have a wide discretion when it comes to the issue of costs
- Parties can decide amongst themselves how to divide costs
- If arbitration is being carried out with the support of an institution, that body may have its own rules about costs. These must be taken into account.
Find more information on the costs associated with the arbitration process in our guide to Funding Litigation and Arbitration.