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Legal Opinion – Arbitration clauses

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Shourav Lahiri considers, in a two part article, some of the key areas where issues can arise when drafting an arbitration clause. (Part one)

When drafting a contract, the arbitration clause frequently ends up being drafted at the last minute when all parties are desperate to complete the deal. Often jokingly referred to as the ‘Midnight Clause’ for this reason, the lack of care and attention to the arbitration clause can turn it into a ‘Nightmare Clause’. Now more than ever, parties need to be aware of the pitfalls in this approach.

Let us consider some of the key areas where issues can arise when drafting an arbitration clause.

When you first pick up your construction contract, which clauses do you first turn to? The payment clause? The EOT clause? The scope of work clause, maybe? It’s rarely the dispute resolution clause, is it? Don’t worry – you are not alone. Even those drafting the contract are likely to have paid the least attention to the dispute resolution clause. When all is well in the project, this approach is fine but the risks of this approach become clear when things start getting a bit less rosy. Without an adequate and effective dispute resolution clause, relief may be illusory. In this article and the one following, we look at some of the main pitfalls to avoid when drafting or reviewing an arbitration clause.

Do you have an effective arbitration clause?

It is important to make sure that your arbitration clause is effective and workable. Without this, your dispute may end up in the local court of the state or country where the agreement was signed or the project is being undertaken. The dispute will then be significantly more time consuming and expensive. More importantly, it will become very public.

An arbitration clause needs to be unambiguous in demonstrating the parties’ intention to have their disputes resolved in arbitration and not in the local courts. Each party needs to have the unilateral right to take the other side to arbitration. That needs to be made clear.

Following is an example of a clause of what not to do:
“If any disputes arise between Contractor and Subcontractor ….it shall be referred to arbitration and final decision of a person agreed between the parties or failing such agreement the dispute shall be submitted to the jurisdiction of the Courts or Laws of India…”

What did the parties intend to achieve here? Arbitration only? A choice between arbitration and court? Arbitration followed by referral to the court? What does failing such agreement mean? Is it an agreement to the arbitrator or the decision of the arbitrator? A clause like this is ripe material for an obstructive party as it could allow it to raise jurisdictional challenges to the commencement of arbitration and force the dispute to be dealt with by the court. That was presumably not the parties’ intention.

It is also important to have a clear arbitration clause in the contract. It is quite common for subcontracts to ‘incorporate by reference’ terms from the main contract or other standard forms.

Whilst on the face of it, this approach may seem like a very practical and quick way to draft a subcontract, incorporation by reference is a risky business. Depending on how it is done, you may have sufficiently incorporated some parts of the ‘outside terms’ and not the others – and there is a risk that the arbitration clause from those terms has not found its way into the subcontract. Don’t take the risk – write an arbitration clause separately in the subcontract.

Is there a condition precedent to the commencement of arbitration?

Many contracts provide that arbitration can only be commenced once certain steps have been satisfied. These ‘conditions precedent’ could be, for example, obtaining an Engineer’s Decision before a party has the right to commence arbitration, or referral to a Dispute Advisory Board, or meeting between executives or a ‘cooling-off’ period where the parties can try to resolve or settle the dispute. Sometimes, a party may be allowed to refer a matter to arbitration but the arbitrators are not allowed to ‘enter into the reference’ until completion of works.

Where you have such a clause, think practically: you need to be able (and willing) to operate and satisfy the condition precedents before you can commence arbitration. Can you obtain an Engineer’s Decision? Has an engineer even been appointed under the contract – for example, in circumstances where a subcontract has been formed by incorporating by reference the terms of a main contract, there will be an engineer under the main contract but not one under the subcontract. If not, how are you going to satisfy the condition precedent to the commencement of arbitration? Do you want to wait until the works are complete before being able to have your dispute resolved? The risk of jurisdictional objections increases significantly if these condition precedents are not met and hence, if you are not willing or able to comply, remove such conditions from the clause itself at the time of negotiating the clause.

The Rules – Institutional Vs Ad hoc

Parties should also consider which rules to adopt when drafting the arbitration clause. Choice of rule may have a considerable impact on the procedural operation of the arbitration clause. There are many different rules to choose from and therefore it is important that parties are aware of the different mechanisms and regimes that exist. Each set of rules has its own advantages and disadvantages.

When choosing a set of rules, parties need to consider what key factors are motivating them in the arbitration:
1. Is time of the essence? If so you might want to use the International Chamber of Commerce Rules of Arbitration (the “ICC Rules”) which provides, as a default, an award to be issued within six months. Practically, though, this timescale is often extended, but it at least provides a starting point.
2. Is the dispute in question particularly complex? Complex arbitrations will require a certain level of expertise from the arbitral tribunal. Consider the scope of expertise on the panel of arbitrators of an institution appointing the arbitrators (such as ICC or LCIA). For example, does the Indian Council of Arbitration have a number of suitable arbitrators to deal with your complex dispute when compared with the choice from other institutions?
3. How much is your dispute worth? If your dispute is small, don’t choose an institution that charges expensive administration and arbitrators’ fees. You will not obtain value for money. You may choose to go for ad-hoc rules (such as UNCITRAL rules) instead, as the only fees payable there are to the arbitrator; there is no ‘institution’ to whom administrative fees are payable.

Final tip

Paying attention to the drafting of an arbitration clause at the outset of contractual negotiations is vital. At this stage all parties are on good terms and it is the right time to address the issues discussed above. Leaving the clause to the end of the negotiations, or “cutting and pasting” a clause from another contract, can give rise to difficulties later on and potentially weaken your position should a dispute arise.

Part 2 of this article will continue to examine other pitfalls that parties should be aware of when drafting arbitration clauses, including examination of the seat of arbitration, appointing the arbitrator and preparation for arbitration.

Shourav Lahiri is a Partner in the international law firm Pinsent Masons LLP. He wishes to thank his colleague Ms Helen Turner for her assistance with this article. The author can be reached at shourav.lahiri@pinsentmasons.com.

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