The costs of international arbitration can be significant. Parties to international arbitration proceedings are increasingly concerned about the costs of the proceedings as they may ultimately have to bear not only their own costs, but also a part of their opponent’s legal and other costs. This can be an overwhelming burden.
This article considers costs awards in international arbitration, the effect of certain institutional arbitration rules on the tribunal’s discretion in awarding costs, the apparent tendency to award costs to the prevailing party, and one way in which parties to an international arbitration can seek to control their potential costs liability in those proceedings.
The proposed method of control is the “sealed offer,” a mechanism which is widely used in a number of common law jurisdictions to encourage the parties to settle their disputes by imposing cost penalties on those who choose to continue with the proceedings in the face of a reasonable offer to settle. This article discusses the concept of the sealed offer, the policy behind it, the potential for using it in international arbitration, how it should be made and its expected effect on the award of costs.
Costs awards in international arbitration
Parties to an international arbitration can generally expect to incur the following categories of costs:
1. The administrative charges of any arbitral institution which is involved
2. The fees and expenses of the arbitral tribunal
3. The fees and expenses of the lawyers
4. The fees and expenses of any experts
5. The fees and expenses of any other professionals whose services may be required (e.g., transcribers and interpreters)
6. The cost of hire of the hearing room and facilities
7. Witness expenses
8. Any internal costs These costs can be substantial, both per se and when compared with the amounts in dispute.
Unlike parties to litigation or domestic arbitration proceedings in jurisdictions such as those in the United States where, in the absence of a specific contractual provision to the contrary, the parties are generally expected to bear their own legal and other costs (i.e., the fees and expenses of the lawyers and experts, witness expenses and any internal costs) with only minimum court costs being awarded, parties to international arbitration proceedings may be liable not only for their own costs, but also for those of their opponents.1 This is because a tribunal in an international arbitration usually has the power (and is often obliged) to make an award on costs as well as the substantive claims referred to arbitration and the award of costs may well allocate costs in such a way as to require one party to pay all or part of the other party’s legal and other costs. As noted by Derains and Schwartz, increasingly claims for the reimbursement of costs constitute a substantial part of the relief sought in ICC arbitrations; in large arbitrations, it is not uncommon for cost claims to total several million US dollars.2
This gives rise to the question: “How are costs awarded in international arbitration?” The answer is that any award on costs will be in the discretion of the arbitral tribunal, regulated only by the specific language of the arbitration clause and any applicable institutional rules for international arbitration.
The most commonly used institutional rules require a tribunal in an international arbitration conducted under the auspices of those rules to make an award on costs.3 The majority also contain some suggestion as to how costs are to be apportioned. While the ICC Rules of Arbitration and the ICSID Arbitration Rules are silent in this regard,4 it is clear that under the AAA International Arbitration Rules, the LCIA Arbitration Rules, the UNCITRAL Arbitration Rules and the Rules of the Arbitration Institute of the SCC, there is a general expectation that the legal costs of the “successful party”5 will form part of the award on costs, with the “losing party”6 being ordered to compensate the successful party for its reasonable legal and other costs. The LCIA Arbitration Rules go so far as to suggest that there is a
“ general principle that costs should reflect the parties’ relative success and failure in the award or arbitration, except where it appears to the arbitral tribunal that in the particular circumstances this general approach is inappropriate”7 (emphasis added).
Costs awards in international arbitration and the use of “sealed offers” to limit liability for costs With respect to ICC arbitration, Derains and Schwartz comment that the attitudes and practices of both arbitrators and parties vary considerably when it comes to claiming and awarding costs, given the great diversity in approach to the question of costs in different jurisdictions. For example, while some parties do not even consider making a claim for costs, others make detailed submissions accompanied by supporting documentation. Similarly, while many awards contain no more than a few lines on the question of costs, in some cases costs will be the subject of a separate final award, the merits having been dealt with in an earlier partial award.8
Derains and Schwartz observe that the treatment of costs by arbitrators is often influenced by their national backgrounds, and that in this regard, there are three approaches to awarding costs that appear to be most commonly followed.9 One approach is to order the losing party to bear all costs; this is noted to be the usual rule in England.10 Another, said to be prevalent in Germany, Switzerland and Austria in particular, is to allocate costs in proportion to the outcome of the case, taking into account the relative success of each claim. The third approach is to require the costs to be shared equally by the parties or borne by the party which incurred them.
Despite such variances, several international arbitration practitioners have observed an emerging trend in favour of the first approach.11 According to Fouchard, Gaillard and Goldman:
“ It is increasingly common for the arbitral tribunal to order the party which is defeated on the merits of a dispute to pay all or a substantial part of the costs of the arbitration. That is traditionally the practice in some common law countries and now frequently occurs when the arbitral tribunal has its seat in continental jurisdictions such as France or Switzerland.”12
In light of this evident inclination to award substantial costs to the successful party, parties to international arbitration who consider themselves at risk of receiving an unfavourable award, albeit for substantially smaller sums than those claimed, must look for a means by which they can cap their potential costs liability.
One potential solution is the “sealed offer.”
What is a “sealed offer”?
A “sealed offer” (often referred to as a “Calderbank letter” or “Calderbank offer”)13 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. 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, hence the words “save as to costs.”
A sealed offer will be used by a party to arbitration proceedings which is concerned about the high costs of the proceedings in which it has become embroiled, for the purposes of capping its potential costs liability (for both its own costs and the other side’s costs, where the tribunal has the power to order one party to pay the other side’s costs) in those proceedings.
Can a sealed offer be effective in an international arbitration?
The sealed offer derives from English law and the practice of the English courts and arbitral tribunals in allocating costs. In litigation or domestic arbitration in England, 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. It is generally followed, even where the loser may have 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 mechanism has been devised specifically to counteract this seemingly harsh approach to allocating costs.14 The sealed offer alleviates the general rule on costs in England by displacing the “loser pays all” principle when the winner has failed to accept an offer which it does not subsequently beat (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.15 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 for such amounts as the offeror sensibly believes the tribunal would award in respect of those claims, if the proceedings were not settled.
It is unsurprising that common law jurisdictions which follow the English approach towards allocating costs, most notably Hong Kong, Australia and Canada, also give cognisance to the use of sealed offers to counterbalance the potentially unfair effect of that approach.16 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 an international arbitration which has its seat in England, Hong Kong, Australia or Canada, which has the law of one of those jurisdictions as its procedural law, or which is made up wholly or partly of arbitrators who practise in one of those jurisdictions, should certainly use the sealed offer procedure where possible to contend with the potential application of the general rule on costs that is normally followed in those jurisdictions. In light of the growing tendency in international arbitration to allocate costs to the successful party, it is submitted that those conducting international arbitrations which have no connection with these jurisdictions should also be considering the use of this procedure in their arbitrations where the tribunal has a discretion over the award of costs; the sealed offer provides invaluable ammunition to those who have no choice but to defend exaggerated or unduly inflated claims brought against them.
The author recently represented respondents in an arbitration conducted under the ICC Rules of Arbitration who were keen to cap their potential costs liability in the arbitration; they believed that the tribunal would issue an award against them for a fraction of the sum claimed, but were concerned that they would nevertheless be held liable for the bulk of the costs of the arbitration, including the claimant’s legal and other costs, because the award would be for more than a nominal amount. The respondents were an unincorporated joint venture made up of Continental European and Asian companies. The claimant was an Asian company. The applicable law of the contract was Taiwanese law, but the seat of the arbitration was London. The chairman was a civil law lawyer but the two party-appointed arbitrators were English and the other side was represented by an English claims consultant practising in Hong Kong. It was felt that in all the circumstances, there was a good chance that a sealed offer would be taken into account by the arbitral tribunal when allocating costs. A sealed offer was drafted and sent to the claimant. The case settled within three and a half weeks of the offer being made. It was subsequently confirmed that the claimant shared the author’s view as to the potential impact of the sealed offer on costs, and that this had a significant bearing on its decision to compromise its claims for a sum significantly less than that claimed.
Making the sealed offer
The sealed offer must be in writing and very clearly marked with the words “Confidential and Without Prejudice Save as to Costs.” The significance of these words, which should be explained in the offer letter, is that the letter should not be revealed to the tribunal, save with respect to the question of the costs of the arbitration following a decision on the merits of the substantive claims.
Ideally, neither the fact nor the amount of the sealed offer should be revealed to the tribunal before it has made a decision on the merits of the substantive claims, the rationale being that such knowledge might influence its decision with regard to the merits of the substantive case. However, this is not so straightforward, as it is customary for an arbitral award to deal at one and the same time both with the parties’ substantive claims and the question of costs.
Following the issue of the final award, the arbitral tribunal is rendered functus officio (i.e., it is deemed to have fulfilled its functions and lacks the power to reconsider or amend its decision) and cannot alter the award on costs. Accordingly, the existence of any sealed offer has to be brought to the attention of the arbitral tribunal before it issues its final award.
In England, there are two common methods of bringing the sealed offer to the attention of the arbitral tribunal before it makes its final award.17 The first is to request a “bifurcation” of the award, so that the substantive claims are dealt with in an interim award and the costs are addressed in a final award, on the grounds that the parties would like an opportunity to address the tribunal separately on costs once they know the outcome on the substantive claims. A bifurcation is often requested on this basis, even where there is no sealed offer. Therefore, a request that the award be bifurcated will not suggest to the tribunal that there has necessarily been a sealed offer.
Where there is a bifurcation, the sealed offer will be revealed to the tribunal following receipt of the interim award on liability and damages, during the course of the submissions on costs. The sealed offer can thus be taken into account in the award on costs which will form part of the final award.
The second method of bringing a sealed offer to the attention of the tribunal before the final award is issued is actually to inform the tribunal that there has been an offer of compromise from one of the parties to the other,18 and to provide the tribunal with a sealed envelope containing a copy of that offer on the understanding that the envelope will not be opened before the tribunal has reached a final decision on the merits of the parties’ substantive claims.
This method is not prevalent in England due to concerns that where the tribunal can guess the identity of the offeror, the offer may be deemed an admission of liability by that party and may influence the tribunal’s decision on the substantive claims.
However, since bifurcation will lead to further costs and delays in reaching a final award, the offeree may object to the bifurcation of an award on such grounds. In the case of an objection, the tribunal would probably agree that bifurcation would be overly burdensome, unless the indications were that the amount of costs at stake would be sufficiently high so as to justify a separate award on costs. In the event that the tribunal declined to bifurcate the award, there would be no choice but to follow the second approach.
In truth, any fear that an arbitral tribunal’s decision on the substantive claims may be influenced by the knowledge that one party has made an offer of compromise to the other party in relation to the dispute before it is unwarranted in most cases. Any sophisticated arbitral tribunal should appreciate that an offer of compromise may have been made simply because the offeror is keen to remove any uncertainty from its accounts, for commercial or other reasons, and despite the lack of any belief in the merits of the compromised claims. Equally, the tribunal cannot dismiss the possibility of the offer being one to settle the offeree’s claims for a nominal sum, aimed solely at obtaining some costs protection.
Accordingly, while a party to an arbitration who seeks to make a sealed offer should be warned of the potential difficulty in concealing the existence of the offer from the tribunal, and the possible risk in certain cases of the tribunal drawing adverse inferences from the existence of the offer if made aware of it, the failure to secure a bifurcation of the award subsequently should not necessarily be seen as an obstacle to utilising the sealed offer procedure. This is not least because the offer places the offeree on risk (in respect of costs) from the date immediately following that on which the offer could have been accepted, which may be relatively early in the proceedings, thereby resulting in a settlement long before the failure to secure a bifurcation could become an issue.
Of course, this is largely a matter of judgment in each case and may require some knowledge of the arbitral tribunal, as well as careful consideration of the circumstances of the case. In the recent ICC arbitration in which the author made a sealed offer on behalf of the respondents, the claimant would not agree to a bifurcation of the award, therefore the respondents would have had to have brought the offer to the attention of the arbitral tribunal by way of a sealed envelope, had the case proceeded to a hearing.
However, it was considered unlikely in that particular case that the arbitral tribunal would draw any adverse inferences from the existence of an offer. There were several counterclaims in that case which meant that the tribunal could not guess the identity of the offeror before it looked at the offer; the offer may have been an offer by the claimant to settle the counterclaims and the tribunal could not assume an admission of liability on the part of the respondents with regard to the claimant’s claims. Furthermore, it was fairly clear on the facts of that case that the respondents were liable to pay something to the other side, albeit significantly less than the sums claimed, therefore it would not have been surprising to the tribunal to learn that the respondents had admitted some liability.
What are the general costs consequences of a sealed offer in England?
Previously, an English arbitral tribunal was bound to apply the same principles as are applied in the High Court of England, when deciding its award on costs.19 This changed with the enactment of the English Arbitration Act 1996, ss. 59 to 65 of which contain an elaborate code relating to costs in an arbitration that has its seat in England or Wales or Northern Ireland.20 Accordingly, the English Civil Procedure Rules (the CPR), which set out the rules and procedures that apply to the conduct of litigation in the High Court of England and Wales,21 including provisions as to the effect of a “Part 36 offer” (which is the court equivalent of the sealed offer), do not govern arbitrations in England and Wales. The rule as to the allocation of costs in an arbitration that has its seat in England, Wales or Northern Ireland, is set out in s. 61 of the English Arbitration Act 1996:
“(1) The tribunal may make an award allocating the costs of the arbitration as between the parties, subject to any agreement of the parties.
(2) Unless the parties otherwise agree, the tribunal shall award costs on the general principle that costs should follow the event except where it appears to the tribunal that in the circumstances this is not appropriate in relation to the whole or part of the costs.”22
Unfortunately, the Arbitration Act provides no guidance as to the effect of a sealed offer or how it should be dealt with by an arbitral tribunal. Consequently, and in the absence of any other guidelines, it is generally accepted that while not bound to follow the practice of the courts, an English arbitral tribunal should be guided by the CPR when exercising its discretion in relation to costs in an arbitration which has been the subject of a sealed offer.23 For that reason, we must look at the relevant provisions of the CPR when considering the likely cost consequences of a sealed offer in an arbitration in England.
Part 36 of the CPR
The cost consequences of a “Part 36 offer,” which is the court equivalent of a sealed offer, are set out in Part 36 of the CPR.
Under Part 36 of the CPR, if a defendant’s Part 36 offer or a claimant’s Part 36 offer (this will be a reverse offer from the claimant to settle its own claims for a sum less than that claimed in the proceedings) is accepted within the permitted time period,24 the claimant will be entitled to his reasonable costs of the proceedings (including his legal costs) up to the date of acceptance. If a defendant’s Part 36 offer is not accepted and subsequently it is found that the claimant would have recovered the same or more by accepting the offer, the court will, unless it considers it unjust to do so, hold the claimant liable for the defendant’s costs incurred after the permitted time period within which the offer could have been accepted.25 If a claimant’s Part 36 offer (to settle its own claims for a lesser sum) is not accepted and subsequently the claimant beats that offer, the court may, unless it considers it unjust to do so, order the defendant to pay the claimant’s costs on an indemnity basis. The court retains a general discretion in relation to costs where a Part 36 offer is not accepted and may take account of a number of things, including the conduct of the parties, to award costs on a different basis than that suggested by Part 36 of the CPR.
Nothing prevents a party from making an offer to settle a dispute in any way he chooses, but if the offer is not made in accordance with Part 36 of the CPR, the costs consequences set out in that Part will only follow from the offer to settle if the court so orders.
As with court proceedings, it is entirely up to each party in what form it wishes to make its offer to settle the proceedings. However, the more removed the contents of an offer are from that envisaged in Part 36 of the CPR, the less likely it may be that the costs consequences set out in Part 36 of the CPR will be applied to that offer by the arbitral tribunal. Accordingly, if a party to an English arbitration wants its sealed offer to have the same cost consequences as a Part 36 offer, it must follow the rules as to the form and content of a Part 36 offer, as contained in Part 36 of the CPR, as closely as possible.
The offer does not have to include an offer to pay the costs of the offeree, if accepted. However, the intended cost consequences of the offer, if accepted, should be clearly stated so that the offeree can make an informed choice and the tribunal can ultimately determine whether the offeree would have been better off accepting the offer. An ambiguous or uncertain offer may not be void, but it will be given little weight by the arbitral tribunal in exercising its discretion on costs.26
An offer should be clear not only in relation to the question of costs, but also as to whether it purports to take account of interest and any counterclaims. If an offer is made by the respondent to settle the claimant’s claims only, a separate reverse offer can be made by the respondent in respect of any counterclaim that he has.
A sealed offer may be revised at any time as the case proceeds. The usual consequence of revising a sealed offer, however, is that the previous offer will be ignored for the purposes of assessing costs (i.e., costs will be assessed by reference to the date of the revised offer).
In international arbitration, the award of costs is left largely to the discretion of the arbitral tribunal and it is difficult to state with confidence exactly how the tribunal will allocate costs between the parties. What is certain, however, is that 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. To deal with this additional burden on parties to international arbitration, there is no reason why the sealed offer procedure used by parties to legal proceedings in certain common law jurisdictions, to cap their potential costs liability in those proceedings, cannot be effectively used by parties to an international arbitration to the same effect.
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. As observed by Derains and Schwartz, the award of costs in ICC arbitrations often depends on the behaviour of the parties.27 Therefore, it is to be hoped that a tribunal in an international arbitration might give effect to a sealed offer (made in that arbitration) in line with the practice of the English courts and tribunals. Certainly, logic and common sense must be followed in the absence of any set rule or procedure.
Parties who are at the contract negotiating 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.