Parties entering into a cross-border contract often wonder whether they should agree to litigate or to arbitrate potential disputes. More specifically, they ask which method is more effective, faster, and less expensive. There is no one-size-fits-all answer, and several factors should be taken into account. Some considerations, including practical tips, are set forth below.

Time

Given their procedural characteristics, the time line of a typical international arbitration is not the same as an average litigation in the United States. Some key differences:

  • There is not much “discovery” in international arbitration. There may be document production, but rarely depositions. The scope of the document disclosures largely depends on the agreement of the parties and the legal background of the arbitrator. If the arbitrator comes from a common law jurisdiction, the scope may be broader than if the arbitrator is from a civil law jurisdiction. But either way, the exchange of documents in most international arbitrations is very limited, with the requesting party having the initial burden to show that the documents sought are “relevant and material.” In U.S. federal court litigation, the information sought in discovery “need not be admissible at the trial if the discovery appears reasonably calculated to lead to the discovery of admissible evidence.” Fed. R. Civ. P. 26(b)(1). Broad-ranging requests for “any and all” documents are common-place in litigation, while generally not acceptable in international arbitration. Additionally, because depositions are rare in international arbitrations, the usual practice is for testifying witnesses to prepare written declarations which usually serve as direct testimony at the arbitration hearing.
  • In U.S. litigation, motion practice is common place, while in international arbitration it is still the exception. However, some motions, especially those which dispose of substantive claims, are becoming more popular in arbitration. The rules of some arbitral institutions specifically provide for dispositive motions, and courts have found that arbitrators have implicit authority to rule on summary adjudication type motions.  
  • The pleading requirements of U.S. courts and international arbitral tribunals differ. The U.S. Supreme Court has heightened the pleading standards in federal court litigation in its Iqbal and Twombly decisions. Under the Federal Rules of Civil Procedure, a complaint must contain a “short and plain statement of the claim showing that the pleader is entitled to relief.” Applying a two-pronged approach, the U.S. Supreme Court interprets this to mean that the party is required to make factual allegations that, if accepted as true, “state a claim to relief that is plausible on its face.” A claim has facial plausibility if the pleaded facts allow the court to draw the reasonable inference that the defendant is liable for the alleged misconduct. Conversely, pleadings that are no more than conclusions are not entitled to the assumption of truth. Legal conclusions may provide the framework of a complaint, but they must be supported by factual allegations. In other words, if there are well-pleaded factual allegations, a court will assume their veracity and determine whether they plausibly entitle the plaintiff to the relief sought. If the plaintiff does not meet this heightened standard, its complaint will be dismissed. In international arbitration, such strict pleading standards do not apply, making it easier for claimants to bring meritless claims and force respondents to spend time (and resources) in defense.
  • With the stated goal of providing quick and final resolution to disputes, one of the hallmarks of arbitration is the absence of appeals and a stark limitation of judicial review of arbitration awards. While the parties are, in theory, free to agree on appellate review in arbitrations, it is very rarely done. As such, the only judicial review of an arbitral award is at the enforcement stage. But an international arbitration award can only be set aside if there are fundamental violations such as if it was procured by “corruption,” “fraud” or “undue means” and where the arbitrators were “guilty of misconduct” or “exceeded their powers.” 9 U.S.C. § 10(a)(1)-(4). The U.S. Supreme Court has held that the parties cannot expand this limited scope of review by agreement. A proceeding to vacate an arbitration award is not a de novo review, and a court will not overturn an award if arbitrators “got it wrong” on the merits. A court may vacate an arbitration award if the arbitrators “manifestly disregarded” the applicable law, but the manifest disregard standard is, by design, exceedingly difficult to satisfy. The complaining party must basically prove that the arbitrators knew the applicable law, but purposefully decided not to apply it. U.S. courts increasingly sanction parties (and counsel) for filing frivolous challenges against arbitral awards.

It follows from the foregoing that arbitration tends to be faster than court litigation. An average arbitration takes somewhere between 18 and 24 months, whereas a comparable court litigation may continue for several years, especially if appeals are filed. If, on the other hand, a party is most likely to win on a motion for summary judgment since the other side does not have any real defenses (and is simply unable to perform), court litigation may be the quicker way to obtain a final judgment.

Costs

Arbitration and litigation also differ in terms of costs. Since the average arbitration moves quicker (as set forth above), it typically requires less attorney’s fees.

Having said that, not only do the arbitrators have to be identified, vetted, and appointed (all of which takes expensive attorney time), arbitrators, unlike judges, are paid by the parties. In administered arbitrations, the arbitral institution also charges fees. While such costs may be recoverable by the winning party (depending on the rules of the arbitral institution and the arbitration clause), the parties will have to pay advance payments on these costs from the outset of the arbitration. Different institutions have different models. Under some arbitration rules, the arbitrators charge by the hour, whereas in others, the panel gets compensated based on the amount at stake.

To put things in perspective, let’s assume a party wants to bring a claim for $50 million. Under the rules of the International Chamber of Commerce (the “ICC”), the party has to pay a non-refundable filing fee of $3,000 when it submits its request for arbitration. The ICC will also request an advance to cover the costs of the arbitration. For a $50 million dispute, the advance on costs exceeds $600,000. This amount is split between the parties, which means the claimant has to pay more than $300,000 to commence the case. (In addition, if the respondent refuses to pay, the claimant has to bear the entire advance if it wants the arbitration to move forward.) To bring the same $50 million complaint in a U.S. federal court only requires a $350 filing fee.

If the amount at stake is relatively low, it may make little sense to pay expensive arbitrators. At the very least, parties may want to provide in their arbitration clause that if all disclosed claims and counterclaims do not reach a certain threshold, the case will be heard by a sole arbitrator instead of a panel of three.

Enforceability of the Final Decision

A decision is useful to the winning party only if it is enforceable. Court judgments and arbitral awards rendered in a U.S. state are generally enforceable in all sister states. If enforcement will have to be sought abroad, however, things are different. Currently, the United States has no treaty regarding the mutual recognition and enforcement of court judgments with any country in the world. International enforcement of court judgments is thus mostly dependant on comity, which makes it sometimes extremely difficult, if not impossible, to enforce a U.S. judgment abroad.

An international arbitration award, by contrast, will be enforceable almost anywhere in the world. The United States has joined the most important international treaties in that area, namely the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) and the Inter-American Convention on International Commercial Arbitration (the Panama Convention). Under these treaties, an arbitral award issued anywhere can generally be enforced in a contracting state (some contracting states have elected to enforce only awards from other contracting states), subject only to certain, limited defenses and without a de novo review.

Confidentiality

U.S. courts publish their dockets, and their records can even be accessed online. Court hearings are usually public as well, which means that anyone can attend, not just the litigants. To exclude the public from a hearing or to file submissions under seal requires a protective order from the court. The requesting party must show “good cause” to justify sealing, and case law interpreting this standard has generally mandated a demonstration of “compelling circumstances.”

Arbitral proceedings make it much easier to keep things confidential. Most arbitration rules provide for privacy, i.e., the arbitral institution. The arbitrators are not allowed to disseminate any documents or information relating to the arbitration, and the hearings are private as they are usually held at a conference room at a hotel, a law firm, or an arbitral organization. Complete confidentiality (also prohibiting the parties from passing on any information) is easy to achieve by complementing the arbitration clause with a confidentiality provision. Unless there is a court proceeding to enforce and/or challenge an arbitral award, or one of the parties has to disclose certain aspects of the award in order to comply with reporting obligations, the general public would not be aware of the existence, let alone the outcome of the arbitration. As such, where confidentiality is of great concern to a party, arbitration has certain advantages.

Expertise

In court litigation, the parties have to present their respective cases to a judge or jury randomly assigned to them. While the judges of the federal bench in the U.S. and of specialized commercial courts of some States (such as the Commercial Division of the Supreme Court of New York State) enjoy an excellent reputation, they may lack the expertise to easily evaluate highly technical issues. And juries almost always lack relevant expertise. International arbitration, on the other hand, permits parties to select arbitrators with expertise in the subject matter in dispute. Usually each party nominates one arbitrator (who is supposed to be impartial and independent), and the two co-arbitrators select the third, who acts as the chair. Usually, the party-nominated arbitrators allow the party who nominated them to provide them with a list of acceptable candidates, or at least identify some key qualifications that the chair should fulfill. This ensures the dispute is heard by someone who fully understands the issues.

Decision Making Process

A court will strictly follow the applicable rules of civil procedure, including evidentiary rules. By contrast, arbitrators have much more flexibility. Unless the parties state so in the arbitration clause, the arbitrators are not constrained by any specific rules of evidence. Arbitrators may consider and weigh whatever evidence they want, even if such evidence would be typically excluded in a court trial. In addition, arbitration minimizes or excludes exposure to punitive damages, which are generally not allowed under most arbitration rules.

Relationship Considerations

Many people feel arbitration is less confrontational and more “genteel” than court litigation. If the parties have a long-standing business relationship that they would like to maintain, arbitration may be less damaging than litigation. The parties may also agree on so-called “step-up” clauses which require them to first negotiate any disputes in good faith (often in a mediation), and only if such negotiations fail, to arbitrate. The faster speed of an arbitral process may provide an additional benefit to the parties, since a quick and final resolution helps put the dispute behind them and move on with their commercial relationship.

Drafting Tips

As seen above, in certain constellations, arbitration lends itself as the dispute resolution method of choice. Classic examples include when the award has to be enforced internationally; the disputed matter is strictly confidential; or the matter at stake requires highly specialized expertise on the part of the trier of fact. Conversely, there are situations such as straightforward domestic loan payment claims, or when discovery is necessary to establish claims, or when the parties want to preserve their right to appellate review, that make court litigation preferable.

For all other situations, a careful analysis is necessary. The drafter of the dispute resolution clause should consider the most likely dispute and the most likely roles of the parties (i.e., which party is expected to be the claimant and which the respondent). Some further tips:  

  • One should also keep in mind that an agreement on the dispute resolution mechanism is much easier to achieve during the contracting stage, when there is no dispute and the parties are in a cooperative mode.  
  • The parties and their counsel should determine whether litigation or arbitration is the better dispute resolution mechanism for their specific transaction. One option is also to carve out certain claims. For instance, one could generally agree on arbitration, but provide for court litigation in case of straightforward payment claims (if enforcement is sought locally). Conversely, the parties may provide for litigation as the default dispute resolution mechanism, but agree to arbitrate disputes relating to post-closing purchase price adjustments. Instead of having such a dispute decided by an “independent expert” from one of the big accounting firms (who are often conflicted), parties may want to choose arbitration before a panel of qualified arbitrators.  
  • The dispute resolution clause needs to be drafted in a clear and concise way. Otherwise, additional disputes may ensue, and instead of providing guidance for solving a dispute, the clause will do the exact opposite.  
  • The dispute resolution clause should be tailored to the specific needs of the parties and the transaction. Not all deals require the same clause. Copying and pasting clauses from other contracts should be avoided. Instead, international arbitration counsel should get involved from the beginning (and preferably not five minutes before the signing) and be given an opportunity to review the entire deal structure so that an appropriate dispute resolution clause can be drafted.