Standard Clauses in International Contracts. The Arbitration Clause

Standard Clauses in International Contracts - Principles & Interpretation, Drafting & Pitfalls

The Arbitration Clause

Introduction of the Arbitration Clause - Definition and Purpose of the Arbitration Clause

An arbitration clause is a clause of a Contract that deals with the parties’ options and rights in case of a lawful disagreement over the contract. In most of these clauses, the parties decide mutually not to sue each other, and rather will settle their disputes through arbitration. Arbitration is a procedure that enables a third party (outsider) arbitrator to be the head of the discussions between the parties.

The parties will need to work out their disparities during these arbitration sessions and try to reach a mutual accord about how the issue is to be settled. This might bring about remedies close to what a court might issue, such as settlement payment. But the difference is that arbitration is significantly more flexible and enables the parties to talk about the remedies on their own terms.

The arbitration clause is one type of the arbitration agreements. The other type is the “submission agreement” which deals with existing disputes (when a dispute has already begun, the parties agree then to submit the dispute to arbitration). On the contrary, the arbitration clause deals with future disputes. The dispute does not have to be of great importance.^[1]

In international arbitration, the most common problem related to the legal capacity of the parties that act on behalf of legal entities (e.g. government) by the persons who execute the arbitration agreement.

The parties’ consent to arbitration is of paramount importance. This consent is incorporated in the arbitration agreement, generally concluded in writing and then signed by the parties. However, the requirement of a signed agreement does not preclude the possibility of an arbitration agreement concluded by two or more parties that can bind third parties. So, is it possible for the third parties to arbitration to be bound by the agreement to which they are not signatories?^[2]

According to the group company theory based on case law: 1) the conclusion, performance, termination of the contract containing arbitration clause and the mutual intention of all the parties to the proceedings, the nonsignatories can be de facto parties to the contract and therefore, can be bound by the arbitration clauses contained within them.

The dispute that is to be settled through arbitration has to be arbitrable. While state judges will make their determination in accordance with the national laws and interests, arbitrators will strive for a balance between the interests of the legal systems concerned in the dispute and the reasonable expectations of the parties of the proceeding.

As for the principle of the autonomy of the arbitration clause from the main contract, the consequence of this principle is that arguments as to the nullity of the main contract containing the arbitration clause shall not affect the validity of the arbitration clause or the competence of the arbitral tribunal to rule on these arguments. For example, the French principle of autonomy of the arbitration clause goes beyond the classic principle of seperability. It recognizes that an arbitration clause can be subject to a different applicable law than the law governing the main contract.

The arbitration clause is also independent from the law governing the contract. Consequently, an arbitration clause could survive despite provisions of the law governing the main contract that would arguably invalid that contract.

But which are in brief the advantages and disadvantages of arbitration that one has to take into consideration when including an arbitration clause?

Advantages: 1) speed: Arbitration tends to be quicker than national courts (several institutions provide with emergency arbitration and short time limits so as to shorten arbitral proceedings) 2) Arbitrators have an appropriate experience, they have technical knowledge, they apply different national laws and deal with comparative law issues. 3) Enforceability: Arbitration awards are more widely enforceable than court judgments as a result of NY convention (157 states) 4) confidentiality: the proceedings and the award are confidential. Also, there is a duty of confidentiality for solicitors and arbitrators. 5) Neutral forum: It is not necessarily the jurisdiction of one of the party’s national courts. International arbitration can provide a neutral forum, also. 5) Party autonomy: the parties to arbitration can shape their dispute resolution process by for example, selecting the governing law, the place of arbitration, many aspects of the arbitral procedure and the arbitrators, who are selected to be impartial.

Disadvantages: 1) Once the award has been made, the decision becomes final and binding (except the limited grounds for challenging for challenging an award such as biased arbitrator and unfair acting when making the decision). It cannot be appealed. 2) Large arbitration fees 3) Rules of evidence: the rules of submitting evidence in arbitration are much lenient than the courts.^[3]

So it is not always to your advantage having less stringent rules for the admissibility of evidence. If you present, instead, your case to a judge, there are strict rules regarding evidence.

Two Types of Contracts where the Arbitration Clause is typically found

First of all, arbitration disputes can be either international or national. Respectively, the contract containing this clause can be international or domestic. When it comes to the international ones, the contract can be either investment or commercial. The latest are the most typical ones.

But what can be considered as international? The ICC established the International Court of Arbitration in Paris in 1923 to provide for settlement “of business disputes of an international character”. According to ICC, the rules cover disputes that contain a foreign element even if the parties are nationals of the same country. So, the contract can extend beyond national borders, when e.g. it is concluded between two nationals of the same State for performance in another country, or when it is concluded between a state and a subsidiary of a foreign company doing business in that State. According to French regime, the civil code provides that arbitration is international when it involves interest of international trade. But according to UNCITRAL model law, the 1) internationality of the dispute and the 2) internationality of the parties arising from the place of business in different countries make the arbitration international.

The most commonly used type of contract is “commercial or business contract”. This shows the distinction made in civil law countries between contracts that are commercial and contracts that are not. There are countries in which disputes arising out of a commercial contract can be submitted to arbitration whereas disputes arising out of a contract which is not commercial (e.g. for the allocation of property on the marriage of their children) cannot be submitted to arbitration. UNCITRAL model laws, as well as the 1923 Geneva Protocol refer to the commercial nature of disputes.

In certain countries such as the US, arbitration is also frequently met in consumer and employment matters, where arbitration may be mandated by the terms of employment or commercial contracts and may include a waiver of the right to bring a class action claim.

For example, there are consumer arbitration agreements in almost every contract to purchase a car which are placed by automobile dealerships. There is a pending legislation at the Federal level to prohibit the agreements in consumer contracts. It is ironic that the automobile dealers have lobbied Congress to prohibit arbitration agreements in the relationships with the manufacturers such as Ford, Chrysler. So, they are very commonplace in consumer contracts. Both the New Jersey Supreme Court and the US Supreme Court have ruled over and over again that these clauses are proper in written agreements between parties. They have also decided that the limitations provided arbitration clause reason so long as they or reasonable.

When it comes to investment contracts having the arbitration clause, it refers to investment disputes between foreign investors and the host state. The International Centre for the settlement of Investment Disputes (ICSIS) is an ad hoc tribunal established pursuant to UNCITRAL rules to arbitrate International Investment Agreements and provide foreign investors with a means for redness against states for breaches of the contract. The ICSID was designed so that it cannot be reviewed by domestic courts which in theory makes it more enforceable.

So what if the arbitration clause is violated? The way that an arbitration clause is violated is obviously in the event that one of the parties seeks to file a lawsuit despite the fact that they consented to settle disputes through arbitration. Fundamentally, the parties relinquish their right to file a lawsuit with this clause.

The nonsuing party may have the capacity to show the arbitration clause to the judge in response to any papers served against them. On the off chance that the arbitration clause is found to be valid, the judge may order the parties to pursue arbitration as per the guidelines contained in the clause.

In many countries, the parties consent that their contract rights and advantages will be void on the off chance that they violate the arbitration clause by attempting to sue the other party.

Legal Basis & Regime - Are there any applicable international or national codes or conventions governing or limiting the use of the Contract Clause and are there any requirements for legal validity

Although it is common for parties to neglect it, that is to say not to mention it in the contract, the law applicable to the arbitration agreement (in this situation, the arbitration clause) is an important topic that could alone generate disputes if not chosen by the parties.

The reason can be found in the fact that the phase of the “drafting of the arbitration clause” usually comes at the end of the series of commercial agreements, and, thus, get less attention than the previous agreements. If the law of the contract is decided, the law governing the arbitration clause will usually be forgotten.

In that respect, arbitration clauses are often qualified as “midnight clauses”.^[4]

However, the importance of this law is illustrated in all the issues it determines, namely^[5]: the scope and interpretation of the agreement (whether the dispute will fall within the terms of the clause), the conditions of validity and the termination of the arbitration agreement, or even the identification of the parties.

Usually, the law of the contract will be the one governing the arbitration clause it contains as well. This presumption has been affirmed by many scholars, such as Professor J. Lew: “there is a very strong presumption in favour of the law governing the substantive agreement »^[6].

However, this situation is not mandatory and may differ. Indeed, the seperability of the clause has to be taken into account. The arbitration clause is considered to be a contract “within the contract”.

Art 16 of the UNCITRAL model law upholds the principles of seperability and kompetenzkompetenz. Under the doctrine of seperability, the contract has some kind of autonomy, its own rules, and therefore, not only that the invalidity of the contract doesn’t imply an invalidity if the agreement, but it can also be governed by a different law than the one of the main contract. The principle of kompetenzkompetenz will give the power to arbitrators to decide whether they have jurisdiction on the agreement first.

These two doctrines allow the arbitrators to have jurisdiction and then decide if the arbitration clause, regardless of the main contract, is valid or void.

The arbitration involves a number of “layers of law”. When addressing the issue of this legal framework, a few criteria have to be taken into account in order to determine the law of the arbitration clause: the law governing the contract, the procedural laws, the law of the seat of the arbitration, the procedural rules of the arbitration.

It is usually required that the law chosen has some connection with the elements of the arbitration, which limits the freedom of the parties.^[7]

i. The law of the substantive contract: used to solve all issues related to the contract and, usually, to the arbitration agreement as well.

ii. The law of the arbitration agreement: used to determine the validity of the clause.

iii. The procedural rules of the arbitration: institutional or ad hoc.

iv. The law of the seat or place of the arbitration: this law will define the procedural law. The seat is usually in a country neutral to all parties and will govern all questions concerning the arbitral tribunal (from its appointment to its powers and duties). By choosing the seat in a certain country, its procedural rules will apply, for instance, if the seat is located in England, the Arbitration Act of 1996 will apply.

v. The law where the award will be enforced: the law of the place of enforcement of the award, and practice of the Courts in respect of a foreign award is also considered.

Although the parties to arbitration have the freedom to choose the law governing the arbitration clause, they do not always do so. As it was previously explained, this aspect of the contracts is usually neglected. In the situation where no choice is made, arbitrators are mostly relying on the law of the seat of the arbitration. In that respect, under the New York Convention, the place of arbitration will determine the law applicable to the validity of the arbitration agreement

Its article V.1 states : “Recognition and enforcement of the award (...) may be refused (...) if proof that (...) the agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made.”

This makes of the law of the seat, the law applicable to the arbitration clause, when it was not determined by the parties, in respect to the validity of the agreement.

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^[1] (Drafting an Arbitration Clause, 2011)

^[2] (Williams , Lal, & Hornshaw , 2018)

^[3] (Williams , Lal, & Hornshaw , 2018)

^[4] Dispute Resolution, Tokyo, International Arbitration N°3, Baker & McKenzie, January 2016

^[5] (Welsh, 2018)

^[6] (Lew, 1998)

^[7] Regarding the legal transaction or controversy : United Nations Conference on Trade & development, Dispute settlement, International Commercial Arbitration, 5.2 Arbitration Agreement, p.13