The costs of international arbitration can be considerable.1 The "sealed offer" provides a potential mechanism for capping those costs. This article briefly outlines some tips to consider in making a "sealed offer".

The Award of Costs in International Arbitration

An award of costs in international arbitration will be in the discretion of the arbitral tribunal, regulated only by the specific language of the arbitration clause and any applicable institutional arbitration rules. However, the most commonly used institutional arbitration rules impose a positive obligation on the tribunal to make an award on costs.2 Further, there is a general expectation that the legal and other costs3 of the successful party will form part of the award on costs, with the unsuccessful party being ordered to compensate the successful party for its reasonable legal and other costs.4

Three approaches to awarding costs have been observed in ICC arbitration: first, to order the losing party to bear all of the costs; second, to allocate costs in proportion to the outcome of the case, taking into account the relative success of each claim; and third, to require that the costs be shared equally by the parties or that each party bears its own costs.5 Nevertheless, several international arbitration practitioners have observed an emerging trend in favor of the first approach.6

In light of this, parties to international arbitration who are at risk of receiving an unfavorable award must look for a means by which they can cap their potential costs liability. One potential solution is the "sealed offer."

The "Sealed Offer"

A "sealed offer" (often referred to as a "Calderbank letter" or "Calderbank offer")7 is a written offer to settle a dispute which has been referred to arbitration, made "without prejudice save as to costs". What distinguishes the sealed offer from an ordinary offer to settle a dispute, is the cost penalty (in respect of which see below) which the arbitral tribunal is expected to attach to it, against the offeree who does not accept the offer and fails subsequently to achieve a more favourable award by continuing the proceedings (i.e., "to beat the offer").

The offer is "sealed" and "without prejudice" because it is not to be brought to the attention of the arbitral tribunal before the determination of the substantive dispute, in case it influences the decision of the tribunal with regard to the merits of the substantive case. However, in order that the offer can be taken into account in assessing liability for costs, it must be brought to the attention of the arbitral tribunal before the tribunal makes a determination on costs,8 hence the words "save as to costs."

The Use of a Sealed Offer in International Arbitration

The sealed offer derives from English law and the practice of the English courts and arbitral tribunals in allocating costs whereby, as a general rule, the party considered to be the overall loser is ordered to pay the costs of the proceedings and the reasonable legal and other costs of the overall winner, as well as any sum awarded on the merits. This has been described as the "loser pays all" or "costs follow the event" principle, and is generally followed even where the loser has defeated the winner on a number of points and the recovery of the latter is significantly less than the amount originally claimed, so long as the recovery is for more than a nominal amount.

The sealed offer alleviates the general rule on costs in England by displacing the "loser pays all" principle when the winner has failed to beat the offer (in other words, where it would have recovered the same or more by accepting the offer). In such an eventuality, the winner will generally be held liable for the loser's costs incurred after the time when the offer could have been accepted. Accordingly, the offeror can seek to place a ceiling on its potential costs liability in respect of the period following the offer, by offering to settle the offeree’s claims (or certain of them) for such amounts as it sensibly believes the tribunal would award in respect of those claims, if the proceedings were not settled.

Common law jurisdictions which follow the English approach towards allocating costs, most notably Hong Kong, Australia and Canada, also give cognizance to the use of sealed offers to counterbalance the potentially unfair effect of their approach towards awarding costs.9 It is submitted that such a mechanism is crucial in any forum where costs are awarded in accordance with the English principle that "costs follow the event"; international arbitration, where this principle is increasingly followed, is one such forum. Anyone conducting international arbitration which has some connection with England, Hong Kong, Australia or Canada, should certainly use the sealed offer procedure where appropriate to contend with the potential application of the general rule on costs normally followed in those jurisdictions.

Tips for Making the Sealed Offer

Tip 1: Make the sealed offer as early in the proceedings as possible

The winner will generally be entitled to its costs up to the date when the offer can be accepted; any costs protection which the loser derives from the offer will apply only to those costs that are incurred after that date. Accordingly, the sealed offer should be made as early in the proceedings as possible to derive maximum protection on costs.

Tip 2: Set out the sealed offer in writing

The sealed offer should be set out in writing in a letter which should be clearly marked "Confidential and Without Prejudice Save as to Costs". The effect of these words (which should be explained in the letter) is that the letter should not be revealed to the tribunal, save with respect to the question of the costs of arbitration after the merits of the substantive claims have been decided.

Tip 3: State the intended cost consequences of the offer

Any ambiguity in the offer may prevent the tribunal from determining the terms of the offer and thus, whether or not the loser has "beaten the offer"; this could render the sealed offer ineffective. The sealed offer letter should therefore contain an express statement as to the intended costs consequences of the offer, so that there can be no argument subsequently as to whether the sum offered was inclusive or exclusive of costs.

Tip 4: State whether interest and counterclaims are taken into account

For the same reason, to avoid any ambiguity in the terms of the offer which would risk the tribunal disregarding the offer, the sealed offer should state whether or not it takes interest and any counterclaims into account.

Tip 5: State the period during which the offer remains open for acceptance

The offeree must be given a reasonable period to consider the offer before it is hit by the costs penalty generally attached to a sealed offer. On the other hand, in order to place pressure on the offeree to accept the offer and cease incurring further costs, the offer should not be left open for acceptance indefinitely. Accordingly, the sealed offer should state a reasonable period during which it remains open for acceptance. This will also permit the tribunal to determine the date from which to impose the said costs penalty.

Additional Tips

In addition, the sealed offer should include the date of the offer, the method of acceptance, and the deemed date of acceptance, to avoid subsequent argument as to whether it was accepted within the permitted period for acceptance.

Conclusion

In international arbitration, the award of costs is left largely to the discretion of the tribunal and it is difficult to state with confidence exactly how the tribunal will allocate costs between the parties. However, the costs of international arbitration can be significant, with losing parties often having to bear not only their own costs, but also a considerable proportion of the other side's costs. In this context, the sealed offer can provide powerful ammunition for parties to international arbitration who are forced to defend inflated or exaggerated claims.

The cost consequences of sealed offers in England are largely a matter of logic and common sense; they go to the reasonableness of the conduct of the offeree in declining to accept the offer. The reasonableness of the conduct of the parties is also an important consideration for an international arbitral tribunal when exercising its discretion on costs, therefore it is to be hoped that a tribunal in an international arbitration will similarly give effect to a sealed offer made.

Parties who are at the contract negotiation stage may wish to consider drafting their arbitration clauses in such a way as to anticipate the use of the sealed offer mechanism. For those who are already at the dispute stage, there is no harm in making any "without prejudice" offer of compromise in the form of a sealed offer, so that it can be brought to the attention of the tribunal at the appropriate time and used in argument as to who should be responsible for the costs of the arbitration, where it was reasonable for the offeree to accept the offer.