John is an in house counsel for a large Chinese company working on a cross border transaction with a Qatari company. It is 11:30 pm on a Thursday night and John has to prepare the final draft of the contract for the Managing Director who is due to sign it with the counter party in Doha the following day.
John gets to the dispute resolution clause at the end of the contract which provides for disputes to be referred to the Qatari Courts. John is not quite comfortable with this and decides arbitration would be better. Short on time, John uses a "boiler plate" arbitration clause the company has used in previous contracts in Qatar which simply provides for disputes to be referred to "arbitration in Doha".
While it is tempting to use a boiler plate arbitration clause, when it comes to arbitration, that can be a dangerous practice. In the example cited above, if a dispute arose between the parties, the boiler plate clause would mean the dispute would have to be referred to ad hoc arbitration in Doha administered by the Qatari Courts. This will potentially give rise to all sorts of issues over the enforceability of the clause, the procedural rules to be adopted for the arbitration and the enforceability of the award itself. Issues might also arise in arranging visas for counsel, witnesses and the tribunal members, not to mention the cost flying all of these people to Doha.
In this article, we look at the elements of an arbitration clause, what factors should be considered when drafting an arbitration clause and give five "top tips" on how to draft an effective clause.
Components of an arbitration clause
In order to draft an effective arbitration clause, it is important to have an understanding of the following concepts:
1. Institutional and ad hoc arbitration
There are two types of arbitration the parties can choose from to resolve any disputes under their contract – institutional or ad hoc. Institutional arbitration is simply an arbitration that is administered by a recognized arbitral institution such as International Commercial Court (ICC), the Singapore International Arbitration Centre (SIAC) and the China International Economic and Trade Arbitration Commission (CIETAC). These institutions have their own rules and are responsible for arranging the appointment of the arbitral tribunal and the administration of the arbitration.
Ad hoc arbitration refers to arbitration that is not administered by an institution and requires the parties to make their own arrangements for the selection of the arbitral tribunal.
2. Arbitral tribunal
In most arbitrations, the arbitral tribunal will comprise of either one or three arbitrators. Where the parties have agreed on institutional arbitration, the rules of the institution will usually contain default provisions governing the number of arbitrators in the event the parties have not covered this in the contract and cannot agree.
3. Procedural rules
Most arbitral institutions issue rules governing the appointment of the tribunal and the procedure for the arbitration. In many cases the procedural rules will give the tribunal a wide discretion to determine the manner and timing of the various procedural steps in the arbitration such as the filing of pleadings, the exchange of documents and witness evidence and the scheduling of hearings.
In an ad hoc arbitration, it is up to the parties to agree on the procedural rules that will apply. In such cases, the parties can agree to make their own rules, or adopt internationally recognized rules such as the UNCITRAL Rules.
The venue of the arbitration is the physical location where the arbitration hearing will take place.
Out of all the components of an arbitration clause, the seat is the one that always causes the most confusion. Put simply, the seat of an arbitration is the "legal place" of the arbitration. The seat is important because it will determine:
- The procedural law governing the arbitration. In some jurisdictions, there are arbitration laws that contain mandatory provisions dealing with such matters as the removal of arbitrators, the general duties of the tribunal and the parties, enforcement of an award or a challenge to an award on the basis of lack of substantive jurisdiction or serious irregularity. In other jurisidictions, there may be no such laws or the laws will be very basic;
- Which court has supervision over the arbitration. If a procedural issue arises during the course of the arbitration that cannot be determined by the tribunal - for example if an arbitrator has to be replaced because of death, injury or a conflict of interest or if the Tribunal has committed a gross procedural error - the seat determines which Court will resolve that issue;
- The "nationality" of the award.
To give an example, if the seat of an arbitration is Shanghai, then Chinese law will be the procedural law of the arbitration, the Shanghai Courts will have supervision over the arbitration and the award will be a Chinese award for the purposes of enforcement.
While the seat and the venue of an arbitration will often be in the same country, this is not always the case and is not a mandatory requirement. For example, it is perfectly acceptable to have, say Hong Kong as the venue of the arbitration and Singapore as the seat. This means that hearings will be held in Hong Kong, Singaporean law will be the procedural law of the arbitration, the Singapore Courts will have supervision over the arbitration and the award will be a Singaporean award for the purposes of enforcement.
The language of the arbitration covers all aspects of the proceeding including the parties' pleadings, the presentation of documentary and oral evidence and the award itself. This is important, particularly where the parties do not share a common language. If, for example, a Chinese company enters into a contract with a UK company and the language of the arbitration is English, all pleadings will need to be in English, any documents that are in Chinese will need to be translated into English and any Chinese witnesses who do not speak English will need to have a translator at the hearing.
Drafting an effective clause
In drafting an arbitration clause, it can be difficult to decide where to be begin. How do all the elements described above fit together? In our experience, the crucial issues to consider are:
The first question to ask when drafting an arbitration clause is: – do I want certainty that the arbitration award will be enforced? If the answer to that question is yes, then you need a clause that will give you the most direct route to enforcement. That in turn will depend on where the other party's assets are located. If the other party has assets in several jurisdictions, then it is a good idea to have the seat of the arbitration in a neutral jurisdiction that is a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the "New York Convention"). As there are 156 signatories to the New Yok Convention, having the seat in a neutral jurisdiction which is itself a signatory will ensure maximum flexibility when it comes to enforcement. For example, a Chinese company entering into a contract with a UK company that has assets in the UK, Malaysia and Australia might want to choose Hong Kong or Singapore as the seat of the arbitration as this will mean the award will be able to be enforced in each of those three jurisdictions as a foreign award under the New York Convention.
Where the counter party only has assets in one jurisdiction, then one has to look more closely at the jurisdiction. Some jurisdictions such as Vietnam, Saudi Arabia and, to a certain extent China, have an uneven track record in enforcing foreign awards. In these jurisdictions, the chances of enforcement may be improved by having a local seat and referring the dispute to arbitration before a domestic arbitration center which will be more familiar to the enforcing Court. In some cases, it may even be better to dispense with arbitration entirely and simply refer disputes to the local Courts if that is the most direct route to enforcement. In many middle eastern jurisdictions for example, arbitral awards have to be ratified by the Courts before they can be enforced. This ratification process can take many months, sometimes years, before the award will be finally recognized and enforced, if at all. If the counter party only has assets in that jurisdiction, the better course may be to go straight to court rather than go to the expense of arbitration and face the risk of a lengthy ratification battle.
Cost is an important factor when drafting an arbitration clause. Arbitration is an expensive form of dispute resolution (often more expensive than litigation) and if an arbitration clause is not drafted correctly, costs can increase significantly. In our experience, costs can be minimized in the following ways:
- Opting for institutional rather than ad hoc arbitration;
- Choosing an arbitral institution with a good track record of for efficient management of claims and the appointment of competent tribunals;
- Choosing an arbitration friendly seat – This will ensure your arbitration will be supervised by a competent court supported by a body of tried and tested arbitration law;
- Opting for one arbitrator instead of three – It is often the case that the parties to a contract will want to have a tribunal of three arbitrators to minimize the risk of a "rogue" or biased arbitrator. However, if the contract is relatively straightforward and/or low value, then one arbitrator is probably sufficient. If the arbitration clause provides for institutional arbitration before a reputable arbitration center, then the risk of an unsuitable arbitrator being appointed should be low;
- Choosing a convenient venue – The cost of flying counsel, witnesses and the tribunal members to the arbitration venue for the hearing and their accommodation costs can add up to a significant sum. When selecting the venue for the arbitration therefore, it is good practice to choose a city which will not be too difficult or expensive to get to and will not have any unusual visa restrictions;
- Choosing a common language for the arbitration – When selecting the language of the arbitration, it is good practice to choose a language that will keep translation costs to a minimum.
3. Procedural fairness
One of the key benefits of arbitration is that it provides for an alternative form of dispute resolution where there are concerns over the expertise and neutrality of the local Courts. However, referring disputes to arbitration is not an absolute guarantee that the tribunal will be either competent or neutral. When in doubt, the safest course is to choose institutional arbitration over ad hoc arbitration and select an institution with a good reputation for appointing experienced and impartial tribunals.
Other points to consider
Some arbitral institutions will have default provisions in their rules which will give the tribunal the power to award legal costs to the successful party. Others do not. If you want the right to claim legal costs in an arbitration, check whether the rules cover this. If they don't, it is best to include the right to claim costs in the arbitration clause itself. Don't rely on the tribunal assuming it has this power.
- Stepped arbitration clauses
Stepped arbitration clauses, which provide for "amicable negotiations" and/or mediation before a dispute is referred to arbitration, are quite popular these days. However, they can cause problems if they are loosely drafted with no clear deadlines or procedures for the settlement discussions. A respondent party intent on dragging the dispute resolution process out can often exploit a poorly drafted clause to buy more time. If you want to refer a dispute to arbitration as quickly as possible, these types of clauses are best avoided. If you want to commence settlement discussions with the other party, you can do that at any time. You don't need a clause in your contract to negotiate.
- Governing law
When drafting an arbitration clause, it is important to distinguish between the rules of the arbitration and the governing law . The rules of the arbitration relate to the procedural aspects of the arbitration such as the appointment of the tribunal, the exchange of pleadings and evidence and the issuing of the award. The governing law is the substantive law that is to be applied to determine the underlying legal issues in dispute. Many general counsel consider the governing law clause to be of primary importance in a contract. While the governing law is certainly important, in our view, it is more important to ensure that you have an arbitration clause that is enforceable and provides for an efficient and fairly administered arbitration. If you have to compromise with your counter party over the terms of a dispute resolution clause, in many cases it will be better to compromise on the governing law than, say, the forum and seat of the arbitration.
Drafting an arbitration clause can be tricky and getting it wrong can cost your company time and money. We have seen many cases where a badly drafted clause has resulted in arbitrations being carried out in hostile jurisdictions or has led to the clause being declared unenforceable or the award invalid. Against that background, here are our 5 top tips for drafting an effective arbitration clause:
- When in doubt, go for institutional rather than ad hoc arbitration and choose an institution with a good track record for efficient administration and the appointment of competent tribunals;
- Don't reinvent the wheel. If you elect institutional arbitration, use the arbitration clause recommended by the institution. Most of the more well known arbitration centers will have recommended clauses you can insert in your contract which can be modified easily to change the seat, venue, language or number of arbitrators;
- Keep it simple. Don't try and use hybrid clauses where you have arbitration for some disputes, but reserve the right to revert to litigation for others. Complex clauses lead to uncertainty which lead to disputes which result in delay and additional costs to the parties;
- Choose a convenient venue. This doesn't have to be the same place as the seat although it does help to have the seat and venue in the same place;
- Remember – an arbitral award is worth nothing if it can't be enforced. When choosing a seat, select one that will give you the maximum chance of enforcement against the other parties assets wherever they may be.
If you are not sure whether the arbitration clause is appropriate, ask an experienced arbitration counsel for a second opinion. Given the potentially costly consequences of a badly drafted clause, it is far better to be safe than sorry.