While working toward the closing of a transaction that will reward both parties for their mutual performance, there is often a tendency for the parties to believe that future disputes are unlikely to arise between them or, if they do occur, to believe that they can simply work them out through the course of good business. That would be ideal, but sometimes we find that we do not live in an ideal world. As a result, the parties often give the dispute resolution clauses in many transaction documents little or no consideration. Yet disputes can and do arise following signing or closing and a significant one could wipe out many of the transaction’s intended benefits.
That is not to say that dispute resolution issues should become the focus of contractual negotiations. However, parties who decide, on the front end, how best to resolve potential disputes in the context of the overall deal they strike, either as an extra benefit or an additional risk, may be able to gain a leg up on achieving a favorable result in the face of a dispute and may be able to save substantial time and expense in the process.
Drafting Considerations–Dispute Resolution
Foreign or domestic, a key first step to crafting an appropriate dispute resolution mechanism is for the parties to analyze and understand the core components of their relationship that might impact the successful resolution of a dispute. The following list of questions should be asked before deciding on the best type of dispute resolution for a particular deal. Because the answers to these questions will differ with each transaction, so will the dispute resolution mechanism:
- Which party is more likely to be the plaintiff and which will be the defendant?
- What types of disputes are likely to arise and are they likely to be about non-payment, performance or something more complicated?
- Who will be holding the money or assets and in what jurisdiction?
- Is there any key intellectual property involved in the transaction and, if so, who owns it?
- How difficult will it be to locate/serve the opposing party after the transaction has closed?
- How difficult will it be to get jurisdiction in the preferred forum?
- Will discovery be necessary to prove claims that are more likely to arise?
- Is there a likelihood that a dispute may involve more than two parties?
- Are there quality, fairness or other concerns with the local courts in the country where the counterparty is located?
- Is it likely or desirable that the parties’ relationship will continue after resolution of the dispute?
- Which party will be most concerned about the publicity associated with any disputes?
- How difficult will it be to have a foreign country judgment enforced in the countries where enforcement is most likely to occur?
- Whether a party is better off utilizing a particular form of dispute resolution or resolving the disputes in a particular country will depend largely on the answers to questions like these.
Dispute Resolution Clauses
In general, dispute resolution clauses take on a few forms but practical experience teaches us that no single approach to dispute resolution and no single approach to forum selection will be appropriate for every deal. If the resolution provision is written to address only one party’s concerns, it will be adverse to the other party—and therefore a bone of contention in the negotiations.
The first option is essentially “the Ostrich Option”, which is to not provide for any dispute resolution clause in the transaction agreement. This approach results in the most uncertainty, leaving either party free to file a lawsuit in any court it believes will exercise jurisdiction. However, this approach can be a strategic fallback when the other party refuses to include any dispute resolution clause except for one you simply cannot live with.
For those parties opting to include a dispute resolution clause in the transaction agreement, the choice generally comes down to litigation or arbitration, with various levels of negotiation or mediation often agreed upon as a preliminary step. The forum for the arbitration or litigation usually will be the home country (or state) of either party or a third, neutral country (i.e., home, away or neutral). Litigation in a neutral court is a relatively new concept and is only available in a few jurisdictions, including the United States and England. It is also a concept that I do not recommend.
In the United States, several states, including New York and Illinois, have passed statutes expressly permitting the selection of their courts for cross-border disputes even if there is no other contact with the forum. Typically, that state’s law must be the governing law for the underlying agreement and a minimum dollar threshold must be met. To date, there are very few jurisdictions outside the United States and England that will accept jurisdiction over disputes on this so-called “neutral basis” as most courts require some level of contact with the forum. However, in the overall context of Ace transactions, there will be sufficient contact with Illinois as the “home state”.
Litigation remains the most common dispute resolution mechanism, in part because unless the parties agree to another approach, they will be forced to litigate their disputes by default. When the parties in fact prefer litigation, the thoughtful drafting of a forum selection clause can provide significant benefits, including the avoidance of expensive and protracted fights over service of process, personal jurisdiction, enforcement and other critical issues. Courts in the United States and in most other industrialized countries typically will enforce forum selection and arbitration clauses in accordance with the parties’ agreement, although most countries also require some level of contact with the selected forum. As mentioned above, jurisdiction for Illinois will be supported by the fact that Ace has its main headquarters in Illinois and is one of the contracting parties.
Many parties opt to require various levels of negotiation or mediation prior to resorting to binding arbitration or litigation. These steps can save time and money if both parties are motivated to fully participate and thus tend to be more common in long-term relationships like joint ventures or outsourcing transactions, which are presumed at the outset to be more cooperative in nature.
Litigation vs. Arbitration
Litigation and arbitration each offer definable benefits and risks.
Characteristics of litigation generally include:
- the right to an appeal;
- potentially lengthy delays;
- relatively low costs to initiate the process, but often significant long-term costs to see it through to conclusion;
- the language of the proceedings (and pleadings) is generally the language of the local jurisdiction;
- various procedural formalities are required to initiate the process including service of process and jurisdiction;
- established procedures for adding third parties;
- the fairness and quality of courts can vary significantly depending on the country or even within a particular country;
- the process is typically a matter of public record and thus is not generally confidential;
- discovery is largely unique to the United States and is generally unavailable in other countries;
- court rulings in the United States generally create binding precedent, but this is generally not the case in other countries; and
- potential difficulties with enforcing judgments abroad.
Characteristics of a typical international arbitration include:
- the lack of the right to an appeal;
- a flexible process that may be tailored by the parties to best suit their needs (including as to the language of the arbitration);
- a process that can be significantly faster than litigation;
- greater costs to initiate the process compared to litigation, but often lower costs to see it through to conclusion;
- fewer technical procedural requirements are needed to initiate the process (e.g., no service of process or jurisdiction requirements);
- the ability to select arbitrators with specific qualifications, which may result in a more appropriate or practical resolution;
- the same counsel may be used in almost every forum;
- the process is generally confidential;
- discovery is generally not available unless the parties specifically agree to it;
- awards are often easier to enforce abroad than court judgments; and
- potential difficulties in obtaining emergency relief on an urgent basis.
Some of the drawbacks of litigation can be addressed in the dispute resolution clause itself. For example, the parties can consent expressly to jurisdiction in a particular court and an agent for purposes of accepting service of process. The parties can also empower the court to award attorney’s fees. Language and customs, however, are more difficult to negotiate, as courts and third parties will not feel constrained by provisions of a contract. Also, no matter how carefully the parties draft the clause, nothing in the agreement can force a court to act more quickly or enable a judgment to be more enforceable in another country.
Arbitration, on the other hand, is extremely flexible in that the parties are generally free to craft almost any process they want, including one that balances the parties’ competing concerns as to how disputes should be resolved based on experience in their home countries. As such, a cross-border transaction involving parties from different countries presents a compelling argument for arbitration over litigation because the parties likely come to the table with different rules and expectations for litigation.
Enforcement of Judgments and Awards
One of the most unique issues in cross-border disputes relates to the uncertainty surrounding the enforcement of foreign country judgments or arbitration awards. While parties may more easily appeal a court judgment in the jurisdiction in which it was rendered, some countries will not enforce the judgments of foreign courts, including those of the United States. Several European conventions exist, including the Brussels and Lugano Conventions, regarding the recognition of court judgments within and among various signatory countries; however, the United States is not a party to any convention or any other treaty providing for the enforcement of judgments rendered by foreign courts. Nevertheless, the courts of the United States are generally more receptive to the enforcement of foreign court judgments than are the courts of most other countries. Accordingly, a US judgment is less likely to be enforced abroad, while US courts are often more inclined to enforce a judgment rendered by a foreign court.
On the other hand, the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (commonly referred to as the “New York Convention”), which more than 130 countries have signed, including the United States, has made arbitral awards significantly easier to enforce across international borders. Thus, unless enforcement will occur in the same jurisdiction in which the dispute is decided, a US plaintiff is typically better off choosing arbitration in a cross-border transaction in order to increase the likelihood that it will be able to enforce a decision should the need arise.
Practical Tip: Once a party determines that it is more likely to be the plaintiff in significant disputes, it might be compelled to require arbitration as the mechanism for resolving disputes under the transaction agreements in order to increase the chance that an award will be enforceable in a foreign jurisdiction. A party who is more likely to be a defendant might press for litigation in order to make it more difficult for the plaintiff to enforce a judgment.
Note: Since no one knows for sure which side of a dispute one will find itself, it is far better practice to seek the arbitration clause.
This choice should be balanced, however, by a careful consideration of the actual rules in the particular jurisdiction where enforcement will likely need to occur. The most obvious location for enforcement is the place of business of the other party; however, enforcement can be sought anywhere that the judgment debtor has assets.
Delays in Justice
As a rule, plaintiffs, not defendants, are generally more interested in avoiding delays in resolving disputes. Delays can affect the dispute resolution process, including the length of time required for a court or arbitrator to render a judgment or award, hear and decide appeals and rule on matters of enforcement. Litigation typically takes longer than arbitration in all three phases, and these delays are generally thought to be a disadvantage for a plaintiff and an advantage for a defendant. There are, however, ways to reduce the delays associated with litigation and arbitration.
In litigation under most judicial systems throughout the world, proper service of process and personal jurisdiction over the parties are unavoidable prerequisites to a court’s ability to hear a dispute. Without an express clause in the agreement concerning these issues, a party is likely to spend six months or more obtaining service of process on a foreign party and perhaps another six months fighting over whether the chosen court has jurisdiction or is an appropriate forum for the dispute in question. The delays and risks associated with these very provincial litigation issues can be mitigated in a clause where the parties expressly consent to a specific jurisdiction and expressly appoint a local agent to accept service of process on a party’s behalf.
Practical Tip: Parties can and should expressly consent to a specific jurisdiction and appoint a specific local agent to accept process within their contractual agreements.
With arbitration the parties have the ability to potentially create a more efficient resolution process by tailoring the procedures to best fit the transaction and the anticipated disputes. For example, the parties can choose the language to be used in the arbitration proceedings, whether the arbitration should proceed under the purview of an administrative body, whether to appoint arbitrators with specific industry experience, what procedural rules will apply to the conduct of the arbitration, how much discovery is permissible, how quickly an award must be rendered and what damages are available, all within the arbitration clause contained in the transaction agreement. Whether opting for arbitration or litigation, the more the parties are able to agree on the procedural aspects during the relatively cooperative period while they are negotiating the transaction agreements, the more time and money they could save in the future should a dispute arise and the relationship turns contentious. At that point, with the haggling over procedural aspects behind them, the parties will be able to focus their efforts on resolving the underlying dispute.
Discovery Issues
Discovery is a concept that is largely unique to the US legal system. Pretrial depositions and very expansive document productions, while common in the United States, are unavailable in almost every other legal system in the world. US discovery is typically one of the most intrusive, prolonged and expensive phases of a lawsuit, but it becomes critically important if proving or defending against the potential claims requires information that is uniquely in the possession of another party (e.g., proving knowledge of a particular factual circumstance as it may be relevant to a “knowledge” qualifier in a representation contained in the principal transaction agreement).
While US courts provide an obvious forum in the event pre-trial discovery is necessary, the parties are generally free to agree on a procedure for discovery in the context of arbitration. If the arbitration clause is silent as to discovery, the availability of discovery will largely depend on the arbitrators’ willingness to allow it, which will be greatly influenced by the arbitrators’ personal experience. Generally, US arbitrators tend to permit discovery and non-US arbitrators do not.
Practical Tip: Parties should specifically provide for discovery in the applicable dispute resolution clause, and if so provided, the arbitrators must allow it.
Dispute Costs
Litigation is often thought to be more expensive than arbitration, but outside the United States where legal systems do not permit discovery or jury trials, the cost to litigate can be much more in line with the cost to arbitrate. Even if the overall legal expenses are less, no one selecting arbitration should be confused into thinking that arbitration will be cheap.
International arbitration has become a highly advanced and sophisticated dispute resolution mechanism and the arbitrators, or one side’s counsel, can independently cause fees to increase significantly if, for example, discovery is permitted as part of the arbitration. Moreover, certain arbitration organizations charge significant up-front fees and many arbitrators require significant advance payments, which can make it very costly just to begin the dispute resolution process. While these up-front costs can be a drawback, they can also provide a strategic benefit to the would-be defendant by deterring the other party from filing some or all of their potential claims.
When evaluating the relative costs of the dispute resolution mechanisms, a party to a cross-border transaction should also consider whether the default rule of the applicable forum is that the loser pays the winner’s legal fees or whether each side pays its own fees.
In the arbitration context, the default rules of most international arbitration associations specifically empower the arbitrators to award arbitration expenses, including attorney’s fees, as part of the final award. By contrast, the general default rule for arbitrations conducted in accordance with US rules is for each side to be responsible for their own legal fees regardless of who prevails. Similarly, in the litigation context, the general default rule in the United States is that the parties pay their own legal fees, whereas in Europe the general default rule is that the loser pays. Accordingly, the default rules can be a significant deterrent to a party’s ability to bring a claim.
Practical Tip: When a party to a contract has good controls in place for implementing and abiding by contractual terms, it is by far the better practice to include a provision in the contract requiring the losing side to be responsible for all legal fees. It acts as a deterrent to parties who may be inclined to take hard-line, risky positions.
Confidentiality Concerns
As in the domestic context, another significant concern for many parties to cross-border transactions is preserving confidentiality, both with respect to the dispute itself and with respect to the components of the underlying transaction. Often the parties will have entered into a confidentiality agreement or will include a confidentiality clause within the main transaction agreement that prevents the parties from disclosing the transaction and any proprietary information shared in connection with it.
Litigation in the United States, Europe and Asia is a public process, however, so these clauses can lose much if not all of their intended effect during the course of litigation. While the parties might be able to preserve the confidentiality of some documents produced during the discovery process, most of the documents will become publicly available information. The trial itself and the judgment will also typically become a matter of public record.
Arbitration, on the other hand, is generally a private process and the parties are typically free to agree among themselves to keep documents, the proceedings and the award confidential. In addition, the laws governing the arbitration process in many countries, including England, as well as the rules of many arbitration organizations, actually require arbitration hearings to be kept private unless the parties agree otherwise. While several laws and arbitration rules require the institution and the individual arbitrators to maintain confidentiality, very few of these rules provide for similar restrictions on disclosure by the parties to the arbitration.
Practical Tip: If desired, parties may expressly tailor their arbitration clause to provide for the confidentiality of the arbitration proceeding and everything disclosed in connection with it. However, in evaluating whether to expressly provide for this type of confidentiality, the parties should also consider the powerful effect of negative publicity (including the threat of it) as that can sometimes weigh in favor of avoiding confidentiality.
TROs and Other Interim Relief
As in domestic transactions, cross-border transactions often present situations in which one party may require immediate relief at the outset of a dispute in order to prevent irreparable harm. This interim relief may take the form of a temporary restraining order or a preliminary injunction and it may be necessary to protect a party’s intellectual property or to preserve assets, evidence or other rights that are essential to a party’s business. The courts of most jurisdictions have well-established procedures to both facilitate the adjudication of requests for interim relief and to impose the necessary relief immediately. Even so, the parties should consider expressly providing for the right to bypass any preliminary requirement to negotiate or seek mediation in the event emergency relief is necessary.
In arbitration, on the other hand, the matter is significantly more complicated. While many arbitration organizations are starting to adopt rules for granting interim relief, the parties must agree to special procedures and those procedures are not very tested yet. Further, there is a delay associated with the selection of the arbitrators. If there is no arbitral tribunal in place at the time a party requires interim relief, that party may have little other recourse than to head to the courts to seek interim relief, particularly if arbitration on the merits will be practically meaningless absent interim protection.
Certain national arbitration laws as well as the arbitration rules of certain organizations, including the International Centre for Dispute Resolution and the International Chamber of Commerce, expressly provide that a party may go to the local courts to seek interim relief without waiving or otherwise affecting the ongoing obligation to arbitrate. If the applicable arbitration rules do not provide this right, the parties could expressly provide for it in their arbitration clause. This is yet another example of why it is important to understand the rules selected and the arbitration law of the chosen forum when opting for arbitration in a cross-border transaction. This consideration is even more critical in the arbitration setting given that the orders of an arbitral tribunal granting interim relief may be difficult to enforce abroad.
Damages
Another important reason why parties select arbitration over litigation, especially non-US parties, is to avoid the possibility of excessive damages. That said, punitive damages, as well as other undesirable or speculative damages can be specifically excluded in most dispute resolution clauses, whether litigation or arbitration is the chosen mechanism. While punitive damages are against the public policy of most non-US jurisdictions, some US jurisdictions, including the state of New York, and some arbitral rules, including those of the International Centre for Dispute Resolution, prohibit arbitrators from awarding these types of damages as well.
In order to ensure that the arbitrators adhere to any contractual limitations on damages, the parties may expressly state in the arbitration clause that the arbitrators have no authority to render an award in excess of the limitations provided for in the agreement. This type of express link to the scope of the arbitrator’s authority should give the parties stronger grounds for vacating any award that is inconsistent with the limitations on liability provisions.
Choice of Law
Different than jurisdiction, choice of law allows arbitrators and judges to use one set of laws (eg. Illinois), though the case is being heard in a different jurisdiction (eg. Alabama) altogether. While choice of law provisions are not always housed in the dispute resolution clause, in practice they are frequently negotiated in connection with the forum selection provision of the dispute resolution clause. Often, the parties will trade these two terms, with one party settling for the forum of its choice and the other settling for its desired choice of law. In the context of arbitration, however, the forum of the arbitration is often much more valuable than the choice of law. This is so because most disputes in the transaction setting tend to relate to breach of contract claims and contract law is relatively consistent from one country to the next. True, procedural laws and the quality of the courts can vary significantly from country to country. However, the selected forum for arbitration will have significant impact on the arbitrator pool, procedures to be applied to the arbitration itself, how much the local courts can interfere, and the grounds for vacating or appealing an award.
Practical Tip: If negotiating choice of law issues, choose to win the forum rather than the choice of law battle. It is favorable in both arbitration and litigation aspects.
Multiple Parties Issues in Cross Border Disputes
Disputes involving multiple parties are common. A supplier, a contractor and the owner might have related disputes, or the parent and local entities could be involved in a dispute with a third party. Most jurisdictions have procedural rules that govern the involvement of multiple parties in the litigation context. However, since arbitration is governed by contract, it is not as easy to bring in a third party, especially when that third party is not a signatory to the arbitration agreement. The most troubling aspect of the multiple party arbitration dilemmas occur when one party has an arbitration agreement in its contract with party A and a different arbitration provision in its contract with party B. While some courts may order consolidation when the disputes are related, more often than not, the party will have to arbitrate against A and B separately. Not only could this lead to additional expenses, but it also raises the risk of inconsistent awards. The solution to this dilemma is to ensure consistency among disputes provisions and to expressly provide for consolidation of arbitrations.
When a cross-border transaction involves multiple parties or multiple agreements, care should be taken to include the same disputes clause in each of the agreements. The following is an example of the type of language that is sometimes included to effectuate consolidation when necessary:
“Arbitration proceedings under this agreement may be consolidated with arbitration proceedings pending between other parties if the arbitration proceedings arise from the same transaction or relate to the same subject matter. Consolidation will be by an order of the arbitrator in any of the pending cases or, if the arbitrator fails to make such an order, the parties may apply to any court of competent jurisdiction for such an order.”
Where consolidated arbitration proceedings are a possibility, the parties should also ensure that the applicable rules address the methodology for the selection of arbitrators or include an express provision to that effect within the agreement. This precaution will prevent the inevitable conflict created when one or more parties feels left out of the arbitrator selection process.
Again, dispute resolution clauses very rarely need to become a central focus in cross-border negotiations, and they seldom need to become complicated or long. However, careful attention to the dispute resolution clause at the drafting and negotiation stage, particularly with respect to the issues of cost, delay and the potential impact on the intended allocation of risk between the parties, could prove strategically advantageous if and when a dispute does arise.
This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
Kurt M. Carlson | Creditors’ Rights, Insolvency & Bankruptcy Litigation & Resolution
Kurt’s practice concentrates on representing creditors, assignees and businesses of all sizes in a variety of ways, including complex business litigation, workouts, insolvency proceedings, bankruptcy reorganization cases and complex settlement negotiations. Kurt has extensive experience in a broad range of quasi-business and legal issues companies must address. If you need assistance with a related matter, contact Kurt.
