Traditionally, the financial sector has favoured litigation rather than arbitration as a means of resolving disputes.  However, in recent years there has been a marked increase in the use of arbitration by the financial sector.  A recent survey by the School of International Arbitration, Queen Mary, University of London and PricewaterhouseCoopers asked those in financial services about their preference for arbitration as a dispute resolution mechanism.  Although 69% of those respondents considered that arbitration is ‘well suited’ to their industry, when expressing a preference respondents in financial services significantly preferred litigation over arbitration.

The International Swaps and Derivatives Association, Inc (ISDA) began a consultation process last year on the potential incorporation of arbitration clauses within its Master Agreements.  That consultation has resulted in a Guide to Arbitration being published by ISDA on 9 September 2013 with various options for arbitration clauses to insert in ISDA Master Agreements.

In addition, the increase in the use of arbitration by the financial sector is also reflected by the establishment of the Panel of Recognised International Market Experts in Finance (P.R.I.M.E. Finance), a specialist institution for resolving financial disputes.

We explore in this article the traditional advantages of litigation for the financial sector, the current trend towards arbitration and the status of optional litigation/arbitration clauses.

Traditional Advantages of Litigation

Traditionally litigation has been favoured by the financial sector due to the following perceived advantages over arbitration:

  • Availability of summary and default judgments – Court procedures in common law jurisdictions allow for summary and default judgments, which are unavailable in arbitral proceedings.  These procedures make it quicker to obtain judgment debts when the respondent raises only a very weak defence to a claim.  Such procedures are especially suited to financial disputes, in particular when disputes relate to overdue payments.
  • Potentially shorter length of proceedings – Arbitral proceedings can be delayed by disputes over the tribunal’s jurisdiction.  Arbitration can similarly permit extensive document production in comparison to civil law jurisdictions.  As a result, arbitration has been viewed in the past as comparatively inefficient and uneconomic in the financial sector.
  • Existence of ‘bank-friendly’ jurisdictions – The traditionally favoured courts of New York and London have also been perceived as ‘bank-friendly’.  Both jurisdictions have a reputation for upholding the sanctity of contract and permitting only limited defences for the non-performance of contractual obligations.  In addition, the presence of commercially-minded judges bound by previous cases has given parties the comfort that outcomes will be, to a certain extent, predictable.

The current trend towards arbitration

The driving force behind the current shift towards arbitration seems to be globalisation.  As investment in emerging markets increases, issues have arisen as to the enforceability of foreign court judgments in local courts due to the lack of comprehensive reciprocal arrangements for the enforcement of such judgments.  In contrast, arbitration offers a valuable solution to such issues through the New York Convention, which requires signatory countries to enforce arbitral awards without, for example, reviewing their merits.  The New York Convention has been signed by 149 countries, and includes almost every major trading nation.

A number of the perceived disadvantages of arbitration in relation to the settlement of financial disputes have also been addressed, for example through the P.R.I.M.E. Finance Rules, as the arbitration community reacts to increased demand from the financial sector:

  • Expedited proceedings – Several arbitral institutions have introduced measures to increase the speed and efficiency of arbitral proceedings.  For example, under Article 2a of the P.R.I.M.E. Finance Rules, parties may agree shortened timelines subject to the agreement of the tribunal.  Article 9 of the LCIA Rules provides for the expedited formation of an arbitral tribunal in exceptional circumstances.  CIETAC has developed its own Financial Disputes Arbitration Rules to provide for the prompt resolution of financial disputes.  These measures help to provide a viable alternative to summary and default judgments.
  • Availability of urgent provisions – Article 26a of the P.R.I.M.E. Finance Rules and Article 29 of the ICC Rules both provide for emergency arbitral proceedings, allowing parties to apply for urgent provisional measures which cannot await the constitution of a tribunal.
  • Transparency – Article 34(5) of the P.R.I.M.E. Finance Rules also allows for awards to be published in anonymised form provided neither party objects within one month of receipt of the award.  Such provisions allow the institution to develop a consistent body of decisions, encouraging outcomes to be more predictable.
  • Specialist arbitrators – In arbitration parties have the ability to choose arbitrators with an in-depth knowledge of a particular sector, which can help speed up the proceedings.

Optional clauses

A potential solution is the incorporation of an optional arbitration clause.  Such a clause provides one or both parties with the option of pursuing either litigation or arbitration, therefore offering flexibility and allowing a party to make an informed decision as to the most suitable process once a dispute has arisen.  These clauses have been consistently upheld in England. (See, by way of example, Mauritius Commercial Bank Ltd v Hestia Holdings Ltd and Another [2013] EWHC 1328 - our report on this case can be found here.)  Recent international decisions have cast doubt upon the enforceability of optional arbitration clauses elsewhere.

In 2012 in Russian Telephone Company OJSC v Sony Ericsson Mobile Communications Rus LLC (Case No. A40-49223/2011), Russia’s highest commercial court found an optional arbitration clause which gave one party the right apply to any competent court to be invalid, stating that the clause created an unfair advantage for one of the parties.  This was followed later that year by Ms. X v Banque Privée Edmond de Rothschild (No. 11-26.022), in which the French Cour de Cassation also stated that a clause giving one party similar rights is one-sided and therefore ineffective under French law.  Indeed, there is little guidance on optional arbitration clauses in many other jurisdictions, with uncertainty persisting as to their enforceability in numerous key jurisdictions.

Conclusion

There are a number of factors to consider when choosing litigation, arbitration or an optional arbitration clause in a financial contract, with no single option being universally suitable.  However, with developments in arbitration and increased activities in emerging markets, arbitration can provide an effective and efficient means of dispute resolution.

The recent publication by ISDA of arbitration clauses for Master Agreements will lead to more awareness of arbitration in the financial sector and there is a real opportunity for arbitration to prove itself as a viable process for derivatives contracts.