What is arbitration?

Take a court. Specifically, a court that deals with non-criminal matters, i.e., a civil court. Two or more parties are in a dispute which they cannot resolve between them. The judge, or judges, are a neutral third party who then decide the dispute (partially) in one party’s favour. Arbitration is similar. Two parties are in a dispute, but rather than resolving their dispute in a court, they appoint a neutral third party or third parties to decide the dispute. As during a court case, each party will present evidence and often also plead their case orally. As with court judgments, decisions are binding.

In commercial arbitration, the two parties are generally companies (or natural persons acting in a commercial context) who are resolving a commercial dispute. In investor-state arbitration, the dispute is between a country and a party that invested in that country but where the investment went awry. There is also state-to-state arbitration, which, as the name, suggests, is between two countries.

Generally, everyone has a guaranteed right to protection by the courts, i.e., the right to litigate their dispute. In Europe, this is protected by Article 6 of the European Convention on Human Rights. By choosing to arbitrate a dispute, parties essentially forgo this right. It is for this reason that consent is so important in arbitration. In fact, it is often said to be the ‘cornerstone’ of arbitration.

In practice, parties rarely agree to arbitrate once a dispute arises. Rather, they include an arbitration clause (known as an ‘arbitration agreement’) in their commercial contract and are thus bound to arbitrate (if the arbitration clause is deemed valid) once a dispute arises. This does not breach the principle of consent, as the parties consented to the clause’s inclusion.

Arbitration can be national or international. National arbitration occurs where both parties are from the same jurisdiction. In practice, international arbitration is more common because where two parties are from the same jurisdiction, they are more likely to refer the matter to courts (more on why below). However, some arbitral institutions, notably in Germany and the US, do mainly deal with national arbitration.

Why is arbitration used?  

Quite a few reasons!

• Confidentiality

  Court decisions are made public, and some court cases are also open to the public. In common law countries, party names are usually revealed in their entirety (in non-criminal cases, that is). Very often, commercial parties do not want the fact that they are in a dispute to be known, especially if there is a risk that their loss is subsequently publicised. Most commercial arbitration awards are confidential, allowing parties to avoid this issue.

• Neutrality

  In the world of cross-border trade we live in, many commercial agreements have some kind of international aspect. The parties may be from, or domiciled in, different countries. When these parties enter into an agreement for the provision of goods or services, they will want to include a dispute resolution clause in case issues arise. However, both parties may object to having the courts in the other party’s country preside over the dispute, fearing that the other party will have an unfair advantage when litigating in its home jurisdiction. The solution is either appointing a court in a third country or using arbitration. The downside of choosing a third country’s court is that both parties will need to familiarise themselves with the laws and ascertain the level of commercial expertise the courts possess . The upside of arbitration is that it can be tailored to parties’ needs: they can select rules and arbitrators specific to their industry, e.g., shipping. Because of these and other benefits, arbitration may be the best ‘neutral’ choice.

• Enforceability

  a. Background on enforceability

  Court decisions or arbitral awards are essentially useless in themselves (there are some exceptions, but these go beyond the scope of this explanation). All you really end up with is a piece of paper saying who won the dispute. It still has to be ‘translated into the real world’, so to speak, and this can only be done by a court. Enforcement of judgments also exists in litigation, where it is similarly a separate exercise. However, this fact often gets lost because it fits so seamlessly into the process: it is usually enforced by the same body who rendered it, so is generally not subject to review.

  In arbitration, this process is divided. The tribunal does the first part, but the Court then executes the award. Awards will usually be enforced where a party has assets, often their place of domicile. If parties don’t comply voluntarily, a tribunal doesn’t have the power to seize assets, but a court does.

  b. How is enforceability a benefit of arbitration?

  The enforceability benefit specifically applies to international arbitration, i.e., arbitration between two or more parties from different jurisdictions. If they had chosen to use the courts, this may have resulted in issues at the enforceability stage. This is because (with some exceptions, e.g., in the EU) a court decision of one country is not automatically recognised in another – it’ll be individually assessed, which takes time, and may not result in a positive outcome.

  For arbitration, however, there is an international treaty in place (the New York Convention of 1958) which allows for the automatic enforcement of arbitral awards in countries which form part of it (i.e., most countries), subject only to certain exceptions. This essentially forces the courts at the place of enforcement to recognise the arbitral award. Recognition may be refused on only a few grounds. The first of these is for formalistic reasons: some countries may require that the place where the award was issued (which the award bears the nationality of) is also party to the New York Convention or meets some other criteria. More importantly, however, are the substantive reasons for refusal, including, e.g., refusal of an award that contravenes the public policy of the enforcing country. Whilst the details are too complicated to delve into right now, it suffices to say that such refusal is infrequent, and that awards are often voluntarily complied with (due to the knowledge of what may happen otherwise).

• Expertise

  Court judges are often commercial generalists. This has slowly been changing, with commercial courts or other specialised courts being set up in London or further abroad. Arbitration, however, allows parties to select arbitrators, institutions and rules relevant to, or acquainted with, their industry, e.g., shipping or art.

• Flexibility

  Arbitration is more flexible than litigation. This stems from the fact that parties are essentially opting out of the state’s system (which is understandably and necessarily rigid) and designing their own system. They select which laws and rules apply to them and are able to vary the non-mandatory provisions of these laws and rules. In practice, however, parties will not stray too far from the general procedure set out in the rules. There is often no need to, and there is a risk of complicating matters and causing issues down the line.