“Cost shifting” is now a familiar concept in international arbitration but there is no internationally recognised guidance or practice in relation to a party wanting to protect itself against an award of costs following the event, on the “loser pays” principle, where there has been an offer to settle by one party during the dispute and yet the proceedings go the distance to (an expensive) full hearing with the result that the award is less than the offer to settle. Why should the losing party meet the majority of the opponent’s costs incurred after the offer?
2. Allocation of costs provisions
The allocation of costs in international arbitration, and in particular “the legal or other costs of the parties” is generally a matter for arbitrators to deal with in their award. This is provided for in many legislative regimes and most institutional rules: see for example section 59(1)c of the English Arbitration Act 1996 (the Act). There are differing provisions which permit arbitrators to take into account the success, failure or conduct of each party, or the circumstances of the case, in making an award of costs.
The Act refl ects the position which generally applies in English Court proceedings, namely a presumption that an award of costs follows the event except in appropriate circumstances, or subject to any agreement between the parties. Section 61 of the Act provides:
"(1) The Tribunal may make an award allocating the costs of the arbitration as between the parties, subject to any agreement of the parties.
(2) Unless the parties otherwise agree, the Tribunal shall award costs on the general principle that costs should follow the event except where it appears to the Tribunal that in the circumstances this is not appropriate in relation to the whole or part of the costs.”
The LCIA Rules do not go so far as to raise a presumption that costs should follow the event. Instead they set out a general principle that an award of costs should refl ect the parties’ relative success or failure in the award or arbitration (again subject to agreement between the parties). Article 28 provides:
“(3) The Arbitral Tribunal shall also have the power to order in its award that all or part of the legal or other costs incurred by a party be paid by another party, unless the parties agree otherwise in writing. The Arbitral Tribunal shall determine and fi x the amount of each item comprising such costs on such reasonable basis as it thinks fi t.
(4) Unless the parties otherwise agree in writing, the Arbitral Tribunal shall make its orders on both arbitration and legal costs on the general principle that costs should refl ect the parties’ relative success and failure in the award or arbitration, except where it appears to the Arbitral Tribunal that in the particular circumstances this general approach is inappropriate. Any Order for costs shall be made with reasons in the award containing such Order.”
The new UNCITRAL Rules (as adopted in 2010) provide for the allocation of costs under the new Article 42 as follows:
“1. The costs of the arbitration shall in principle be borne by the unsuccessful party or parties. However, the Arbitral Tribunal may apportion each of such costs between the parties if it determines that apportionment is reasonable, taking into account the circumstances of the case.”
The AAA Rules for International Arbitration also permit apportionment, taking into account the circumstances of the case if such apportionment is reasonable, without express reference to success or failure of the parties, in Article 31:
“The tribunal shall fi x the costs of arbitration in its award. The tribunal may apportion such costs among the parties if it determines that such apportionment is reasonable, taking into account the circumstances of the case.
Such costs may include: …
(d) the reasonable costs for legal representation of a successful party.”
The ICC Rules provide for apportionment without any reference to the outcome or conduct of the parties or consideration of the circumstances of the case, in Article 31 as follows:
“(1) The costs of the arbitration shall include … the reasonable legal and other costs incurred by the parties for the arbitration …
(3) The fi nal Award shall fi x the costs of the arbitration and decide which of the parties shall bear them or in what proportion they shall be borne by the parties.”
3. The attitude of arbitrators
The attitude and practice of both arbitrators and parties can be very different, often refl ecting the varying approaches to allocation of costs in various jurisdictions.
As Yves Derains and Eric A Schwarz observed:
“The approach of ICC arbitrators are just as diverse … Not surprisingly, however, the treatment of costs by arbitrators is often infl uenced by their national background. In this regard, there are three different approaches that appear to be most commonly followed. One is to order that all of the costs be borne by one of the parties (ie the losing party). It is, thus, for example, the usual rule in England that the successful litigant is entitled to an Award of Costs (ie the costs follow the event). Another approach, prevalent in Germany, Switzerland and Austria, in particular, is the allocation of the costs in proportion to the outcome of the case (eg 75/25 or 60/40, taking into account the relative success of the claims and defences). Yet a further possibility is to require that the costs be shared equally by the parties or that they bear their own costs. Arbitral tribunals may also consider that administrative costs and arbitrators’ fees and expenses, on the one hand, should be treated differently than legal and other possible expenses, on the other.”
So here we can see how different the approaches can be to the award of costs by arbitrators taking into account the different rules, and other factors, not the least of which is their own domestic practice.
4. The effect of a settlement offer on the award of costs
The risk of an adverse award of costs provides a great incentive to settle a dispute. To be truly effective the incentive must be for all parties to the dispute to settle to avoid unnecessary legal costs. The “loser pays” principle is ingrained into the psyche of the English litigator and that of those who practice in the many common law countries which follow this principle, eg Australia. The most notable exception is in the United States. The prospect of a double whammy in terms of costs, ie a party’s own costs as well as some or all of those of an opponent, should have a signifi cant impact on any decision on how and when to resolve a dispute. This, together with the support of public policy considerations, has led to the development of devices designed to encourage realistic settlement offers coupled with some protection against the frightening expense of litigation or arbitration. Indeed one of the most important skills of a lawyer in these jurisdictions is the continuous and careful evaluation of the prospects of a client’s case leading to a well judged offer, in terms of amount and timing to put maximum pressure on the other side based on increasing exposure to costs if the offer is not beaten at the hearing, and to minimise the costs’ risk to one’s own client, using the appropriate procedural device. These procedural devices take a number of forms. In pre-Woolf times, English Court procedure had the practice of a “payment into court”: money was paid into an account administered by the Court upon which interest accrued. There was a time limit within which the “payment in” had to be accepted; if not accepted and the winning party did not recover more than the “payment in”, then the winning party faced paying the losing party’s costs incurred from the date of payment in. This worked well enough for a simple claim for money or monetary compensation and relied on a system where the Court could hold money with which to satisfy a claim.
The Calderbank letter, based on an offer expressed to be “without prejudice save as to costs”, was fi rst developed in relation to claims for fi nancial relief in matrimonial cases where settlements are more complex, involving a sale of matrimonial assets and their division among the parties. It found favour soon enough in other types of case where something more than a claim for money, e.g. injunctive relief, was involved. The Calderbank offer is now in codifi ed form in Part 36 of the English Civil Procedure Rules. A key point is that the offer is inadmissible and therefore not to be seen by the tribunal until issues of liability and quantum have been decided. The party making the offer is claiming privilege in respect of the offer, subject to the express reservation of the right to bring the offer to the notice of the tribunal on the issue of costs should the offer prove to be unacceptable to the other party. The Calderbank offer has been used in English domestic arbitration almost as much as in litigation. It is noteworthy that in relation to the Construction Industry Model Arbitration Rules (CIMAR) r.13.9 makes specifi c provision, so that the arbitrator should have:
“[R]egard to any offer of settlement or compromise from either party, whatever its description or form. The general principle which the arbitrator should follow is that a party who recovers less overall than was offered to him in settlement or compromise should recover the costs which he would otherwise have been entitled to recover only up to the date on which it was reasonable for him to have accepted the offer, and the offeror should recover his costs thereof thereafter.”
In English arbitration there has a lso grown up the practice of the “sealed offer”. This was described by Donaldson J. in Tramountana Armadora SA v Atlantic Shipping Co SA:
“A “sealed offer” is the arbitral equivalent of making a payment into Court in settlement of the litigation or of particular causes of action in that litigation. Neither the fact, nor the amount, of such a payment into Court can be revealed to the judge trying the case until he has given judgment on all matters other than costs. As it is customary for an award to deal at one and the same time both with the parties’ claims and the question of costs, the existence of a sealed offer has to be brought to the attention of the arbitrator before he has reached a decision. However, it should remain sealed at that stage and it would be wholly improper for the arbitrator to look at it before he has reached a fi nal decision on the matters in dispute other than as to costs, or to revise that decision in the light of the terms of the sealed offer when he sees them.”
5. Comment and conclusion
So, whilst these devices have been developed in relation to English domestic arbitration, in the author’s experience the issue has been dealt with inconsistently in the context of international arbitration.
In one LCIA arbitration where the substantive law was that of New York, the seat, or, curial law was that of England, the English defendant made an offer “without prejudice save as to costs” to the US plaintiff. The US plaintiff’s lawyer professed a lack of knowledge of the effects of the offer on costs. The English arbitrator curiously sympathised and held the offer inadmissible on the issue of costs, thus leaving the defendant to meet all the costs, despite offering to settle for more than the award.
There is no doubt that there is a gap in international arbitration practice with regard to devices to protect one’s client against an adverse award of costs including making offers “without prejudice save as to costs”. Although the international arbitration community is being plagued by the proliferation of “soft law”, the healing hand of the arbitral institutions may provide a cure.
[This is an abbreviated version of an article which fi rst appeared at (2008) 74 Arbitration 2].