Contractual engagements inevitably beget legal disputes. Even the best agreement is no guarantee the engagement will succeed. Accordingly, one of the most important provisions in any commercial agreement is the provision that governs how to resolve disputes.

This is all the more important when one of the parties to the contract is a foreign company or a foreign citizen. If the agreement does not contain a clause on how to resolve disputes, a “race to the courthouse” might start, with the Israeli party hurrying to file a proceeding in Israel and the foreign party hurrying to launch a proceeding in its domicile. This naturally results in further uncertainty and legal disputes that beget legal costs and loss of precious time.

Thus, the parties to an agreement may stipulate a jurisdiction clause to determine which court will have jurisdiction over a future proceeding. Alternatively, the parties may stipulate to resolve disputes in arbitration. Arbitration proceedings have an advantage over resolving disputes before the court, because they are more efficient and streamlined. Accordingly, the parties can decide on the identity of the arbitrator or the arbitration institute, the mechanism of arbitrating the dispute, and the procedural rules.

Hence, an arbitration agreement must include a clause stipulating that if the parties have a dispute, it must be resolved by arbitration according to the laws of the agreed upon country, at an agreed upon forum, and before an agreed upon and professional institution that can administrate the proceeding. (One well-known example is the International Court of Arbitration of the International Chamber of Commerce.)

The Judicial Interpretation

Arbitration, around the world and particularly in Israel, is a legitimate and well-established mechanism. Israeli courts normally honor arbitration clauses and consider them a standalone arbitration agreement. For example, the Supreme Court held that:

“Our legal system considers arbitration an alternative system to judicial decisions in disagreements between opposing sides in legal disputes. Arbitration has many upsides, both individually and socially. Arbitration furthers the best interest of the public, benefits the opposing sides’ personal interest, and reflects their will. It reduces the load on the courts and facilitates dispute resolution in the framework chosen by the sides, according to fundamental principles set forth in the law, and it is subject to judicial review. Established legal policy seeks to promote consensual arbitration within the law, and only revokes the option under unusual circumstances.”

The trend of encouraging arbitration is also reflected in judicial rulings under which the text of an arbitration clause, as appearing in any agreement, must be interpreted “as broadly as possible” and cover “anything else related to the contract.” In fact, not honoring the arbitration clause means undermining the autonomy of free will and freedom of contract, and is a quasi-contractual breach.

Nevertheless, an arbitration clause is not enough. One must pay attention to the clause’s wording and the wording of the agreement in which it appears. Israeli courts do not honor arbitration clauses in certain situations (e.g., in a standard form contract or when there are other defendants in the dispute that are not parties to the agreement and who are joined to the lawsuit for substantial and non-artificial reasons. In this context, such additional defendants can be other companies that have something to do with the engagement, officers, shareholders, subcontractors, and more).

Arbitration Essentials

To avoid the possible thwarting of the arbitration process, make sure the clause contains these components:

  • Apply the arbitration clause primarily to commercial agreements between commercial entities or businesspersons, not necessarily to agreements between major companies and end customers. In this context, if the contract can be construed as a standard form contract (as it involves a major power imbalance between the parties, in favor of the foreign party), it should stipulate an as fair and neutral arbitration mechanism as possible. This will help eliminate the possibility the court will void the arbitration clause because it is depriving.
  • A clause must appear in the agreement in which the other party’s lawyer explains the agreement’s meaning and consequences, including with respect to the arbitration clause.
  • The arbitration clause must stipulate that a party that wishes to file a lawsuit against other parties in addition to the contractual parties (who are also a party to the arbitration clause) will have to split the proceedings, and cannot sue the foreign entity with the other defendants in the same proceeding. The clause should also stipulate the amount of liquidated damages upon violation of this undertaking.

Foreign entities might worry about the possibility Israel may not honor the foreign arbitration award. However, they need not lose sleep over it, as the Arbitration Law and different covenants Israel is party to govern this issue.

Furthermore, ratification of the issued arbitration award followed by submission of a motion to recognize it as a judgment in Israel is possible under the Foreign Judgment Enforcement Law. Such a process is subject to these conditions:

  1. Execution of the judgment is possible in its state of issuance.
  2. The judgment is final (cannot be reversed).
  3. The parties received an adequate opportunity to make their case and present their evidence.
  4. The judgment and its enforcement are not against the law or public policy and do not undermine the State of Israel’s security interests or sovereignty.

In conclusion, the optimism between them when signing an agreement notwithstanding, the parties must make sure the agreement contains a dispute resolution clause. We recommend formulating this clause according to the above instructions.