Disputes happen in any commercial relationship, and when they happen to companies based in different countries, they get complicated. Traditionally, the first choice for disputing parties in national relationships has been litigation before domestic courts. But that system is rather rigid and not intended for dealing with international issues, the proceedings can be long and expensive, and decisions are subject to appeal and can be challenging to enforce.

That's why automotive manufacturers and distributors are including arbitration clauses in their international contracts. Arbitration is international by design, provides flexible and tailor-made solutions, is often faster and less expensive, and awards are difficult to reverse and easier to enforce. Arbitration thus has become the preferred method of dispute resolution for the automotive industry, worldwide.

In this hoganlovells.com interview, Hogan Lovells partners Daniel E. González (Miami) and Karl Pörnbacher (Munich) discuss automotive industry trends in international arbitration, best practices, and the elements of a well-crafted dispute clause.

What are the trends in arbitration in the automotive industry in the United States and Europe? Are more matters going to arbitration now compared to several years ago? 

Karl Pörnbacher: First, let me take a step back: Until six or seven years ago, the automotive industry was not prone to major disputes in its core business. Even in large international automotive supply contracts, the participants didn’t pay much attention to dispute resolution clauses because they were pretty sure that they would adequately solve any conflict commercially, without having to resort to a formal dispute resolution mechanism. That's what they were used to, after all. But we’ve seen this change slowly, with an increasing number of automotive-related disputes — not only national disputes before state courts, but also, and particularly, in international arbitration.  The reason for this development is that the automotive industry is undergoing dramatic changes:

  • New players have entered the automotive industry, sometimes diversifying from other industries. They are often more inclined to break out of conventional mindsets and patterns. They themselves may view their approach as innovative, others as disruptive. Be that as it may: It certainly is a challenge to the traditional, expected behavior in the industry. For example, we had a widely discussed case before German state courts where a supplier – in order to enforce its alleged rights – ceased to supply an original equipment manufacturer (OEM). This could have caused a production stop with far-reaching consequences and potentially enormous damages. Such a course of action would have been unthinkable some years ago. Even when a supplier had a serious dispute with an OEM, it would never have stopped supplying, thereby jeopardizing the entire production.
  • Then you have dramatic changes to the political environment with potentially new and unexpected barriers for international trade which can cause substantial strain on commercial relationships. 
  • And we see increasingly strict regulators causing, for example, OEMs to conduct more frequent very expensive recalls. This raises the question of who should ultimately bear the responsibility for the recall and pay for the costs. Is it the OEM, or can the OEM turn to its supplier and try to get reimbursed? And may the supplier push the dispute down the supply chain if the root cause lies further down?
  • And finally, the automotive industry is facing a downturn. There is less money available for generous business solutions. Business units feel the pressure to save costs and to enforce their rights more than they did before. Insurers are not as quick to settle as they used to be. They often insist that their insured, which could be a supplier, have the dispute adjudicated.

These would be the key concerns that I see from the European perspective. 

What about the U.S. perspective, Dan? Why are we seeing a trend toward more disputes, and why is there a greater tendency towards arbitration?

Daniel González: Because the automotive market was for a long time a very closed market, it had consistent distributors and when it came time to supply, regardless of other passed disputes, you moved on and went forward, as Karl said. Now that is changing and has opened up the environment to potentially more disputes. That’s Step One.These would be the key concerns that I see from the European perspective.

Step Two is that you still have the urgency that always existed, which is, these distributors and manufacturers do not want and cannot afford to be in disputes endlessly, because they’re all still in a market where they need to continue to work together.

And that brings us to arbitration. When you did have a major automotive dispute, typically it would have been a purely domestic matter and you would have gone to court. But arbitration offers significant advantages for the various parties in the automotive sector.

First, comparatively speaking to a court action in the United States, arbitration can be quicker. And I’m very careful about how I say that, because it is relatively speaking; arbitration by definition typically has no appeal rights, so whatever is decided by that arbitral tribunal has finality. By removing from the process the possibility of appeals you will make the dispute resolution process shorter and faster, which again is very desirable in the automotive sector. 

Second, it has the advantage that arbitration is private and structured to maintain confidentiality. Therefore, the parties in this very small sector could benefit from that ability to resolve this private dispute and potentially not have it impact other distributors, relationships, or contracts. 

There are various elements of arbitration, such as time, the nature of the dispute, and the sophistication of the decision makers that lend themselves well to the automotive industry. For example, rather than turning technical defect cases in the supply chain to a generalist judge in the United States – or even more dangerous to a jury – you can have an arbitration where you select arbitrators who have dealt with these issues worldwide, and/or who have technical, scientific, or automotive sector experience. You can hand pick your decision makers much better than you could if you were to take potluck in a court system. 

The last factor – and this circles back to what Karl was saying from the European perspective – is that you have globalization now and suppliers spread out all over the world. The idea that all your suppliers were in Detroit, or all of your products come from one domestic location and you don’t need the international arbitration component, has changed. If you have suppliers coming from different parts of the world, that’s another factor as to why you may want to have an arbitration clause, because you have an ability to confirm and enforce those awards around the world much better than if you were in a court in the United States.

How should companies plan for arbitration or dispute resolution? What best practices do you recommend?

González: We regularly advise our clients in drafting appropriate dispute resolution clauses. One of the advantages of arbitration is that you have the flexibility to agree on a solution both sides can live with. One option is also to require that the parties need to attempt to settle amicably, e.g. by a C-level meeting, before formal proceedings may be commenced. Existing contracts should also be reviewed from time to time to see if the dispute resolution mechanism still fit the needs.

Sometimes, of course, clients come to us when the dispute has arisen, they have already decided how its resolution is going to be handled, and are prepared to move forward. 

What we would say in terms of best practices is, number one, clarity, especially on how the parties agree as to how they’ll handle a potential dispute. It’s not unique to the automotive sector that, when they’re contracting, no one is thinking that we’re going to have a dispute. There are many very large sectors and important contracts where the parties go into them thinking everything is going to be fine. But you still have to have some sort of dispute resolution clause. 

We would tell you, from having to deal with these clauses on the back end, the more clarity there is, the better – clarity on how you intend your dispute to be handled and the key elements of a well drafted arbitration clause.  

This includes specifying the venue where the arbitration will be held.  And when we talk about the “venue of the arbitration,” we mean the “juridical seat” because in international arbitration, it matters where the seat of the arbitration is. That is the place where you will have to rely on the local courts to enforce the arbitration clause, and that is where an award has to be challenged. Also need to consider what is the substantive law of the arbitration going to be? Will the arbitration be administered or ad hoc? How will the arbitrators be selected? What is the language of the arbitration? Can documents be submitted in a certain language, or does everything have to be translated into English? In many disputes, much time is wasted just arguing about that, because even though the contract may have been in English or another language, if the parties don’t specify a language, it will be at issue in the dispute.   

You also want to have the finality that we mentioned. Many times, in our industry, we talk about “pathological clauses,” which goes back to not having clarity; that is, where the parties say they want arbitration but then say, we’re still going to go to court, or we’re still going to handle these other types of disputes in these different ways. The parties are not left with a clear understanding as to what happens once they have a dispute. 

And is there finality as to the arbitration so there will not be later appeals? Again, another pathological element is when they say they’re going to go to arbitration, but if one party is not happy with the results of the arbitration, they can still go to court, and that’s a horrible thought – it’s very expensive, lacks finality, lacks clarity, and you don’t want it.

We would also advise that the more you customize the clause to fit the kind of contract that you’re dealing with, the better.

Karl, what would you add, from an automotive-specific perspective?

Pörnbacher: Dan described the core issues very well. 

A couple of additional points: you have increasingly global sourcing agreements or global supply chains. For instance, you might have a German car supplier supplying an OEM in the United States. The parties will probably conclude a general framework agreement under which the supplier would supply the OEM in different factories in different countries all over world. This may change over time: while the supplier may have delivered a couple of years ago from a German factory to Detroit, it now runs its production lines in Romania, Mexico, or China, and supplies Romanian, Mexican, or Chinese factories of the U.S. OEM. All this would be covered by the general framework agreement, despite the various and potentially changing international entities and factories involved on both sides of the supply agreement.

The parties thus need to carefully draft conflict clauses that reflect the complexity of the actual supply relationship and allow for the flexibility required when this relationship is adjusted and production is relocated to different countries or continents. Nobody wants to renegotiate an arbitration clause or think about the contractual implications every time production is relocated. Therefore, we need to provide our clients with clauses that are flexible enough to capture such situations or which can be easily adapted. 

We need to make sure that wherever and by whatever affiliate supplies are made to the OEM or any of its affiliates around the globe, the dispute resolution mechanism follows and provides for a practical solution.

This is something that only arbitration can achieve, because otherwise you would end up in jurisdictions where you don't want to be before state courts, because you don't understand the local language, you are not familiar with the substantive law they apply, and they may not have the required experience for such disputes. For example: Neither the supplier nor the OEM might want to have their disputes adjudicated by Chinese state courts litigating in Chinese, by Hungarian courts in Hungarian, or by German courts in German – depending on the question which affiliates have been involved in the specific supply relationship. Instead, they will prefer to have a general framework agreement, under U.S., English, or German law, which would apply everywhere with proceedings being conducted in English. You want to have dispute resolutions in a language that you can follow, not in different languages and different court systems that you are not familiar with. 

The second point is that in many situations the parties will need a quick resolution. For example, if a supplier threatens to cease supplying the OEM if no agreement on new delivery conditions is reached, you need a fast, final, and binding decision. While some national courts systems can help in such situations, they are rarely equipped to address these situations adequately on an international level. In arbitration, by contrast, the parties can provide the tribunal with specific authority to take such decisions. 

A last point: arbitration gives the parties more flexibility as to the choice of the substantive law. Arbitration allows them to pick the applicable law for the entire global relationship, and avoid the problem of adapting the agreement to each and every legal system of the countries in which the supply might take place and avoid the application of overly broad restrictions resulting from national law, such as the German law on standard terms and conditions.