What is Commercial Arbitration?

Summary

This article explains what arbitration is and acts as a short glossary for the main concepts in international commercial arbitration.

Сommercial arbitration is a private and consensual dispute resolution tool between two or more parties to a commercial contract, which results in a binding decision or award. The award is then enforceable in most countries in the world via the New York Convention on Recognition and Enforcement of Arbitral Awards.

Concepts discussed in this article include the arbitration agreement, the seat of the arbitration, interim measures in support of arbitration proceedings, ad-hoc vs institutional arbitration, applicable law, tribunal, jurisdiction of the tribunal, award, appeals and enforcement.

What is commercial arbitration

At its core, commercial arbitration is a private and consensual dispute resolution tool between two or more parties to a commercial contract, which results in binding decisions.

Private means that, in most cases, arbitration proceedings are conducted outside of the national court system. The parties to arbitration select their arbitrators and decide on the procedure, including how and where hearings are to be held. As a result, parties bear costs for the entire procedure, including the arbitrators’ fees, the fees of any arbitral institution, the costs of the hearing facilities and all other related expenses.

Consensual means that arbitration requires consent by the parties. Parties consent to arbitration by agreeing to arbitration clauses which are included in their commercial contracts or by arbitration agreements which are concluded separately.

One of the greatest benefits of arbitration is that it results in binding decisions,i.e.awards, which are enforceable almost anywhere in the world. Most countries have arbitration laws allowing the arbitral awards rendered in the country to be recognised and enforced as a state court judgment. Enforcement of awards is governed by the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards (“the NY Convention”). At the time of writing, 169 counties are parties to this Convention. Under the NY Convention, an award made as a result of arbitration seated in one member state can be recognised and enforced in all other member states (subject to exceptions).

Arbitration agreement

Arbitration clauses and arbitration agreements can take many different forms, from standard dispute resolution clauses in commercial contracts to standalone agreements concluded both prior and after a dispute has arisen. Regardless of their form, their core purpose is to evidence the parties’ clear intention to resolve disputes through arbitration rather than through court litigation.

An arbitration clause may be very short, simply stating: “Arbitration in London under English law“. Equally, it may be very detailed, dealing with a wide range of matters, including:

• a clear definition of the scope of disputes covered, including whether the clause extends beyond contractual claims to tort, statutory, or other non-contractual disputes;
• the arbitral seat;
• the arbitral rules and, where relevant, the administering institution;
• the governing law;
• the number of arbitrators;
• the mechanism for appointing the tribunal, including default procedures if a party fails to cooperate;
• the language of the arbitration.

The more complex the underlying commercial relationship, the more carefully these issues should be addressed at the drafting stage, as poorly drafted clauses often give rise to costly jurisdictional disputes.

Seat of arbitration

The seat of arbitration is one of the most important choices in any arbitration clause because it determines:

• the legal framework governing the arbitral procedure (the lex arbitri);
• the courts with supervisory jurisdiction over the arbitration, including applications for interim relief, jurisdictional challenges, and any challenge to the award; and
• whether, and on what basis, the resulting award will be recognised and enforced as a foreign arbitral award under instruments such as the NY Convention.

For example, where the arbitration is seated in London:

• the arbitration will be governed procedurally by the Arbitration Act 1996 and the relevant English case law;
• the English courts will act as the supervisory courts of the arbitration and may grant support measures, such as injunctions, evidence orders, or assistance with tribunal appointments; and
• any application to challenge the award, including on jurisdictional or serious irregularity grounds, must be brought before the English courts. If enforcement is later sought abroad, the award will ordinarily be enforceable as a NY Convention award in any other contracting state.

Interim measures in support of arbitration

When selecting the seat of arbitration, an important practical consideration is which interim measures are available in the jurisdiction of the seat, how quickly they can be obtained and what the consequences of a party’s failure to comply are.

Consider, for example, a sale of a cargo of oil. Party A, a shell company with few recoverable assets, sells the cargo to Party B. Party B pays the purchase price, and Party A ships the cargo. Party A then bribes the carrier to divert the cargo to a different destination and a different buyer. In such circumstances, Party B’s prospects of recovering against Party A itself may be minimal. Its only realistic protection may be to secure the cargo before it is delivered elsewhere or to freeze the bank account into which the purchase price was paid.

Where the cargo is in transit, there is not enough time to commence arbitration, to appoint the tribunal, to make submissions to the tribunal and to seek its award concerning the disposition of the cargo. By the time Party B gets the award, the cargo may disappear, and Party A may have withdrawn the purchase price from its account. Therefore, Party B must turn to the courts to seek an immediate interim injunction freezing the money and ordering Party A to refrain from taking any steps in relation to the cargo. As discussed above, the court most naturally approached for such relief will usually be the court of the seat.

When deciding upon the seat of the arbitration, it is important to bear in mind the following factors:

• Do the courts of the jurisdiction have the power to grant interim injunctions in respect of foreign assets?
• How long does it take to obtain an interim injunction in the jurisdiction?
• Do the courts of the jurisdiction have duty judges who can issue injunctions on holidays and out of hours?
• What sanctions are available for breach of court orders, including contempt sanctions?
• Who may be sanctioned for failure to comply with court orders, e.g. only the company or also its directors and officers personally?
• Lately, whether a party’s business may be subject to sanctions in the forum which is being selected is also an important consideration.

Ad-hocand institutional arbitration

In their arbitration clause, the parties may simply agree to “arbitration“, or they may provide for arbitration under the rules of a particular institution, such astheLondon Court of International Arbitration (LCIA), the International Chamber of Commerce (ICC) or the Stockholm Chamber of Commerce (SCC). Where the parties incorporate a set of arbitration rules by reference, or agree to arbitration administered by an institution, the arbitration will proceed in accordance with those rules.

In institutional arbitration, the applicable rules govern the procedure in the first instance. Depending on the institution, those rules will typically regulate matters such as:

• commencement of the proceedings;
• selection or appointment of the arbitral tribunal;
• challenges;
• procedural decisions in relation to the arbitration prior to the appointment of the tribunal;
• managing the financial side of the arbitration, by requesting advance payments from the parties and distributing them to the tribunal;
• reviewing and approving final awards.

In ad-hoc arbitration, all of these matters will either be contained in the law of the seat of the arbitration or will have to be decided by the court of the seat of the arbitration or the tribunal once appointed. For example, arbitration rules will typically provide that the first step after the appointment of the tribunal is the exchange of written submissions by the parties. The rules will also set deadlines for each written submission. In ad-hoc arbitrations, the parties will either have to agree when written submissions are due or will have to invite the tribunal to make an order on the issue. In institutional arbitration, where the parties have agreed that there should be one arbitrator but cannot agree on the candidate, the institution will typically appoint the arbitrator itself. In ad-hoc arbitration, if the parties cannot agree on the candidate, they will have to go to the court of the seat, and the court will make the appointment.

Institutional arbitration is generally more expensive at the outset. That said, those fees often represent good value. It is frequently faster and ultimately less costly to have procedural issues resolved by an institution under established rules than to involve the courts. Equally importantly, a pre-existing procedural framework reduces the scope for early tactical disputes over the mechanics of the arbitration, which in practice can save both time and cost.

Applicable (substantive) law

The arbitration agreement or the underlying contract will usually specify the law governing the parties’ substantive rights and obligations. For example, the contract may provide that “all disputes arising out of this contract shall be governed by English law”. This is commonly referred to as the governing law of the contract, or the substantive law applicable to the merits of the dispute.

The distinction between the substantive law and the law of the seat can be illustrated as follows. Assume the arbitration is seated in England, but the underlying contract is governed by Swiss law. English law will govern the procedural framework of the arbitration, including matters such as the constitution of the tribunal, the tribunal’s procedural powers, and any supervisory role of the English courts. Swiss law, however, will determine the parties’ substantive rights and obligations and will therefore decide whether the claims ultimately succeed or fail.

Tribunal

The tribunal, usually consisting of one or three arbitrators, is the arbitration equivalent of a judge. Normally, in their arbitration clause, the parties agree on how many arbitrators there will be and how they will be appointed. If there is one arbitrator, then they are normally appointed either:

• by agreement of the parties;
• by the arbitral institution; or
• by the court of the seat.

If there are three arbitrators, each party usually appoints one, and the two so chosen appoint the third. If the two arbitrators cannot agree on the third, then, again, they will either be appointed by the arbitral institution or the court of the seat. The parties sometimes agree that all three arbitrators are appointed by an arbitral institution.

Jurisdiction of the tribunal

Arbitral tribunals usually have very extensive powers, although not as broad as the powers of judges in state courts. Tribunals derive their powers from the parties’ arbitration agreement. Accordingly, if the arbitration agreement authorises the tribunal to determine disputes arising out of a specific contract, that will ordinarily define the outer limits of its jurisdiction. The tribunal will have no authority to determine disputes arising under a separate contract unless that contract is also covered by the clause. Equally, where the arbitration agreement applies only to disputes between two contracting companies, the tribunal will generally lack jurisdiction over claims against directors, shareholders, affiliates, or other third parties who are not parties to the arbitration agreement. The law of the seat and institutional rules often provide for default powers of the tribunal in absence of the parties’ agreement.

The same principle applies to procedural powers. Where the parties have made specific procedural choices, the tribunal is generally bound to give effect to them. For example, if the arbitration agreement excludes any power to award legal costs, the tribunal must respect that limitation. Where there is no agreement on the tribunal’s procedural powers, they will be governed by the law of the seat and the rules of the relevant arbitral institution.

A fundamental principle of modern arbitration is that the tribunal is entitled, in the first instance, to rule on its own jurisdiction. This is commonly referred to as the principle of competence-competence (or Kompetenz-Kompetenz). Thus, where one party contends that no valid arbitration agreement exists, or that a particular claim falls outside its scope, the tribunal may decide that objection as a preliminary issue or together with the merits.

That said, the tribunal’s ruling on jurisdiction is ordinarily subject to review by the courts of the seat. If the tribunal exceeds the jurisdiction conferred by the parties’ agreement, the resulting award may be set aside or local courts may refuse to enforce it.

Awards

An award is the tribunal’s determination of substantive rights or liabilities in the arbitration. It may grant, dismiss, or otherwise dispose of one or more claims or issues in dispute. Awards should be distinguished from procedural orders, which concern the conduct of the arbitration itself, for example, extensions of time, document production, hearing logistics, or directions for written submissions. The distinction matters because awards are generally capable of recognition, enforcement, or challenge before the courts of the seat, whereas procedural orders are usually not.

There are three categories of awards: interim awards, partial awards and final awards. Interim awards are awards made while the arbitration is ongoing. They are the tribunal’s provisional decisions on certain matters, which means that at the conclusion of the arbitration, the tribunal may change its mind and make a different ruling. Partial awards are awards on part of the issues in dispute between the parties. These awards may be made, for example, where there is no defence to one of the claims. Partial awards are final in that they are final decisions on the matters they cover and generally cannot be changed or overturned by other subsequent awards. Final awards are rendered at the conclusion of the arbitration. They resolve all issues between the parties and terminate the proceedings. Unless the tribunal reserves for itself the right to rule on some other matters, the tribunal will normally be released from office once it issues its final award and will lose jurisdiction to make any further decisions.

Appeals

In international arbitration, what is often called an “appeal” is in fact a challenge to the tribunal’s award before the courts of the seat of arbitration. In simple terms, this means asking the courts of the country where the arbitration is legally based to review whether something went seriously wrong.

Those courts do not normally reconsider the whole dispute from the beginning. Their role is much narrower. Depending on the law of the seat, they may set the award aside in full or in part, send it back to the tribunal to look at again, or, in limited cases, vary the outcome.

Under English law, there are three main grounds on which an award may be challenged:

• the tribunal did not actually have the power to decide the dispute;
• something went seriously wrong in the procedure, for example, one party was not given a fair opportunity to present its case; or
• the tribunal made an error of law.

The third ground is different from the first two. The parties are free to agree that there should be no right to challenge the award for an error of law. This is common in international contracts, either because the arbitration clause says so expressly or because the parties choose institutional rules that exclude that right, such as the LCIA Rules.

This limited court review is one of the reasons businesses choose arbitration. The idea is that the tribunal’s decision should be final, while still allowing the courts to step in if there is a real problem with jurisdiction, fairness, or the application of the law.

Enforcement

Enforcement is a process whereby the tribunal’s awards are implemented, usually by collecting the respondent’s assets to satisfy the amounts due to the claimant under the award.

Enforcement in the country where the arbitration is seated will usually be governed by local law. In England, for example, an award may, by leave of the court, be enforced in the same manner as a court judgment, and a court judgment may be entered in terms of the award pursuant to Section 66 of the Arbitration Act 1996.

Enforcement in countries other than the country where the arbitration is seated is usually governed by the NY Convention and the local law of the country where enforcement is sought. Most countries have laws consistent with the NY Convention.

Recognition and enforcement of foreign arbitral awards is usually a quick and easy process provided that certain conditions are satisfied (e.g. there is a final award and the party seeking enforcement has an original or a certified copy of the award and the arbitration agreement).

It is possible to oppose enforcement only on the limited grounds set out in the NY Convention or the local law. Those grounds are similar to the grounds upon which awards may be appealed.

It is also possible to oppose enforcement on the basis that the award is contrary to the public policy of the country where enforcement is sought. In Western European jurisdictions, it is difficult to oppose enforcement on this basis, but each country has its own interpretation of what public policy may entail.