Litigation or Arbitration?
The Wealth Finance Brief - 1 October 2014
- Lending to law firms
- A Lender's Right to Take Possession of Residential Property
- Litigation or Arbitration?
- Lending to Limited Partnerships against Capital Calls
The jurisdiction or arbitration clause is often seen as a boilerplate provision – no more than a "footnote" to the agreement, and far less important than the commercial terms of a deal. However, in the event of a dispute, this short clause tagged on to the end of an agreement can have a significant effect on the strategy, timing and legal costs in any dispute.
This note sets out a brief summary of the different types of jurisdiction clauses that may be included in an agreement and the considerations to bear in mind when choosing litigation or arbitration in a dispute resolution clause.
There are various forms of jurisdiction clauses, but in every case, the jurisdiction clause in an agreement is separable from the agreement as a whole. This means that if the parties to the contract can show that the jurisdiction clause was agreed between them, all disputes about the validity of the underlying contract should be resolved in accordance with the jurisdiction clause.
The English courts have recognised that there is a “hierarchy” of jurisdiction clauses and these can be described as follows:
1. Exclusive jurisdiction
An exclusive jurisdiction clause is generally the preferred form of jurisdiction clause because it specifies one jurisdiction in which the parties must then litigate. The clause can even set out the acceptable methods of service and choose specific courts within the jurisdiction. If a party to the agreement issues proceedings against the other in any other jurisdiction than the agreed exclusive jurisdiction, the Claimant will be in breach of contract.
It is possible to further strengthen an exclusive jurisdiction clause by adding what is known as a waiver of forum non conveniens ("FNC"). FNC is a legal argument that a dispute should not be heard in a particular jurisdiction because that jurisdiction is not the appropriate forum for the litigation, for example, that it would be inconvenient, unsuitable or expensive for the dispute to be heard in the country in question. By waiving FNC, the parties agree that they will not try to use the FNC argument in respect of the jurisdiction named in the agreement.
2. Non-exclusive jurisdiction with waiver of FNC
This clause usually provides for one (or possibly more than one) jurisdiction in which a party may be sued by the other party. The specified jurisdiction is therefore elevated above others, but the parties may still choose to litigate elsewhere. This clause is somewhat strengthened by the addition of the FNC waiver because the parties agree not to use the FNC argument in relation to the jurisdiction named in the clause.
This is the weakest form of jurisdiction clause. It allows either party to bring proceedings against the other, either in the court of the chosen country, or in the courts of any other country which has jurisdiction over the dispute under domestic jurisdictional rules. The issuing party is not required to bring proceedings first in the country designated as having non-exclusive jurisdiction.
On the face of it, an exclusive jurisdiction clause would appear to be desirable in every case. However, whilst such a clause would provide the parties with certainty as to forum, they would be sacrificing the flexibility to take action in a forum appropriate to each dispute. For example, the witnesses in a particular dispute may be overseas, or a Defendant's assets may be in a different jurisdiction resulting in issues with enforcement. Of course, with a non-exclusive jurisdiction clause, there will always be a risk that a party could end up defending proceedings in an unfavourable (or just inconvenient) jurisdiction.
Many commercial parties, such as banks, now use a hybrid of exclusive and non-exclusive jurisdiction clauses to deal with some of the above issues. For example, it is possible to include an exclusive jurisdiction clause that specifies more than one jurisdiction, the applicability of each jurisdiction to be dependent upon specified circumstances.
Alternatively, a clause could be drafted to especially benefit one party. Such a clause could permit A to sue B in any competent jurisdiction but restricts B to bring proceedings in only one jurisdiction. So the clause is exclusive in respect of B but non-exclusive in respect of A (for whose benefit the agreement is made). This type of clause is popular with commercial lenders – it allows the lender to pursue a debtor in any jurisdiction where the debtor has assets, but the lender may only be sued in its home jurisdiction.
Litigation or arbitration?
When negotiating a dispute resolution clause in a contract, the parties should also consider whether litigation or arbitration would be more appropriate. An arbitration clause will not only decide on jurisdiction (by designating the "seat" or designated city / country of the arbitration) but also the applicable rules. These may be the rules of an institution (e.g. the LCIA Arbitration Rules) or the legislation of the applicable seat (e.g. for England, this would be the Arbitration Act 1996).
There are a number of advantages that arbitration can have over litigation. However, it is important to examine each supposed advantage carefully in the context of every individual transaction. Factors to consider include the following:
1. Enforcement – ease of enforcement is often an important deciding factor in favour of arbitration. The New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards provides an established enforcement regime for international arbitration awards. The vast majority of states have signed up to the New York Convention, and there are very few grounds for a signatory state to refuse to recognise an arbitration award. There is no real equivalent for the enforcement of court judgments. There is piecemeal legislation in each state which may allow for similar enforcement, but this is very dependent on each state's own rules.
It is essential to check the position for cross-border enforcement of judgments and arbitral awards before finalising the dispute resolution clause. For example, there is currently no agreement between Russia and the UK for the reciprocal enforcement of court judgments. This means that a Russian court will generally refuse to recognise an English court judgment, but it will recognise an arbitral award made in England under the New York Convention.
2. Certainty – as with an exclusive jurisdiction clause, an effective arbitration clause will also give the parties a degree of certainty in relation to the forum for any disputes. It is particularly useful where there is a cross-border element to the dispute as an effective clause could sidestep entirely the complex rules of private international law governing jurisdiction.
3. Procedural flexibility – arbitration can allow the parties to tailor procedures to the needs of a particular dispute and is generally thought to allow the parties more freedom to agree a suitable procedure, and have a greater influence over procedure than is possible in court proceedings. However, in reality many commercial parties tend to opt for institutional arbitration and simply adopt the standard rules and procedures of their chosen institution (e.g. the London Court of International Arbitration, which recently adopted new rules – see commentary).
Generally in arbitration, procedural deadlines can be more flexible and informal. This can be an advantage for the parties in terms of reducing arguments and applications over time extensions and deadlines, but it can be frustrating if one party continually fails to comply with the procedural timetable. In litigation, procedural deadlines are more rigid and the courts have greater powers (and the appetite to use those powers) to penalise parties in respect of breaches of procedural deadlines.
4. Expertise – parties can choose their arbitral tribunal. This allows them to choose arbitrators with the relevant technical or other expertise for the dispute.
5. Privacy – arbitration hearings are usually held in private and the fact that a party is involved in arbitration proceedings is confidential. In contrast, the fact that a party is involved in English litigation is a matter of public record.
English law also recognises an implied duty of confidentiality which prevents the disclosure to third parties of most documents produced or disclosed in an arbitration. This includes statements of case and the award. Different jurisdictions will have different rules regarding the duties of confidentiality in respect of arbitrations so it is advisable to check the relevant position before completing any arbitration agreement.
6. Neutrality – in arbitration, the parties are able to refer their disputes to a neutral forum. This is often attractive to commercial parties especially if they are wary of referring disputes to the home courts of the other party. Arbitration will also enable the parties to ensure that the composition of the tribunal, as well as the seat of the arbitration, and the location of hearings are neutral.
7. Cost – arbitration is sometimes cheaper than litigation particularly where the parties achieve procedural efficiencies by agreement. However, this is not always the case. In a court claim, there are some court fees, but essentially the parties obtain the services of the court and the judge for free. In arbitration, the parties need to pay the fees the tribunal plus administrative costs (e.g. room hire) and these can be substantial. They will also need to deal with the practical arrangements and organisation for any hearing.
8. Delays – sometimes arbitration is a quicker way of resolving disputes than litigation. In truth, significant delays can occur in arbitration, particularly in cases where one party deliberately breaches procedural deadlines and seeks to delay proceedings.
9. Finality – the opportunities for appealing or challenging an arbitration award are more limited than those relating to court judgments. Therefore, the parties are less likely to become caught up in lengthy appeals. Of course, this is not such an advantage if the arbitral tribunal does not decide in your favour.
10. Multiparty disputes – the right to arbitrate comes from the arbitration agreement. This means that there is no power to join third parties unless all the parties, and the third party, agree. Joining a party could save costs, however most parties will refuse agreement for tactical reasons. This can result in a cumbersome and inconvenient procedure with a risk of inconsistent findings and could prejudice settlement. Arbitration cannot easily accommodate class action litigation.
11. Summary determination – although an arbitral tribunal has the ability to determine claims and defences summarily, in practice, they are often less willing than a court to do so. English courts on the other hand can be quite forceful in disposing of meritless claims or defences at an early stage in proceedings.
12. No precedent – arbitration awards are generally confidential to the parties. They do not give rise to any binding precedent on other parties. In cases where a final and binding ruling on a point of law and/or construction is required, litigation will always be the better option.