International Commercial Arbitration

Ignoring Arbitration Clauses: Rarely the Right Choice

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Scrutinize the Forum Carefully When Reviewing Contracts with Arbitration Clauses

by Anthony Guerino II . Email Anthony here.

There are parts of the world where cultural differences, xenophobia, political considerations and simple differences in legal systems can result in a lack of fairness in the resolution of disputes. Even domestically, the arbitration law of one state can produce drastically different results from that of another.

Therefore, choice of the applicable arbitration law is an important, and often misunderstood, preliminary issue for business people to consider when entering a contract providing for arbitration of disputes. This is quite different from the substantive law governing the contract.  The former, absent a stipulation by the parties, is governed by the venue or seat of the arbitration.

Unfortunately choice of law, type of dispute resolution and applicable procedural law in arbitration are the stepchildren of contractual agreement, often resulting in unpleasant surprises when a dispute develops. In fact, the arbitration clauses recommended by the major arbitral bodies do not even mention applicable procedural laws, leaving the issue to pass by default to the skimpy rules of the arbitral body or the laws of the seat. 

The same attention should be given to the dispute resolution provisions of the contract as are given to the commercial terms. Selecting the seat for an arbitration should be more than looking for an enchanting location.  A major factor in venue and governing law selection is whether the country has user-friendly and judicially fair arbitration laws. If it does, specific mention of the inclusion of the arbitration provision in the choice of law clause should be made in the contract choice of law clause.

If it does not, a specific reference to the law applicable to the arbitration should be included in the arbitration clause, unless the parties are agreeable to having this issue determined by default.  These decisions also may impact the finality and enforcement of the arbitration award, which is why it is vitally important for business people to think ahead when negotiating arbitration clauses in their contracts.  Unfortunately, forum selection drafting clauses tend to be treated in a casual way - until they are invoked. At that time, the client or management may wonder who had the incredibly bad idea or unfortunate oversight to have/leave in such an unfavorable arbitration law to govern their disputes.

Enforcement.  Prior to the 1970’s contractual choice of forum and applicable law provisions were not favored by American courts.   However, times have changed and such provisions are now routinely enforced, as a result of the 1972 Supreme Court decision in M/S Bremen v. Zapata Off - Shore Company. 

The underlying contract was for the German company Breman to tow an ocean-going drilling rig owned by Zapata from the Gulf of Mexico to the Adriatic Sea, near Italy.   Completing the contract required the rig to pass through international waters and the territorial waters of several nations.  The contract included a judicial forum selection clause - not an arbitration provision - specifying that any disputes were to be heard in London.  The rig was damaged during a storm and taken into a Florida port, per Zapata’s instructions.  Zapata brought suit in a Florida federal court seeking damages of $3.5 million. Although the Zapata contract did not involve an arbitration provision, the Court’s holding has been applied to arbitration clauses.

The Supreme Court  held the forum selection/choice of law provision agreed to by the parties is enforceable, as doing so promoted the intention of the parties to the contract by preventing either one from obtaining a “home court” advantage.  The Court also recognized that wider policy issues were implicated.

The expansion of American business and industry will hardly be encouraged if, notwithstanding solemn contracts, we insist on a parochial concept that all disputes must be resolved under our laws and in our courts. This approach would severely retard the future development of international commercial dealings by Americans.  We cannot have trade and commerce in world markets and international waters exclusively on our terms, governed by our laws and resolved in our courts.

Zapata’s desire for an American forum was result oriented, as opposed to mere convenience.  The contract included a limitation of remedies provision that made the owner responsible for any damage to the rig during transportation – even if caused by the negligence of the towing company.  This term would be enforced under English law, while it probably would not have been enforced under American law. 

Since the 1970’s American courts construing choice of law, designation of venue and arbitration provisions have tended to give greater credence to party autonomy in contracting.

Thinking Ahead.    When business people fail to adequately plan for dispute resolution they can find themselves in a forum they would not have not chosen, without much recourse.  It is well known that forum selection terms are form terms that are usually not negotiated — and that is true of commercial as well as consumer contracts. 

In the 1990’s, the Supreme Court, in Carnival Cruise Lines, Inc. v. Shute, noted that forum selection clauses are subject to “judicial scrutiny for fundamental fairness.”  Forum selection terms are therefore enforced unless they are fundamentally unfair.  Thus, the burden of proof is on the party that claims unfairness, and that burden is a heavy one.  Between businesses of relatively equal bargaining power, this burden is practically insurmountable. As such, it is important for the parties think ahead during contract negotiations. This forethought should include a review of the applicable arbitration law of the seat of the arbitration and any mandatory laws of that forum that the parties cannot waive. This will help to avoid unpleasant surprises in the event of a dispute.  

Planning Badly. Failure to plan properly may provide several trips to Geneva, Paris or other pleasant venues but the ambiance will be lost on explanation to the client why strange procedural rulings are hampering the case. Remember that the primary obligation of the arbitrators is to treat the parties equally and fairly, and, unless the parties have stipulated otherwise, they need not  apply any particular procedural regime. Given the recent trend for parties from developing countries to want arbitration in either their own country, such as China, or locals close by such as Singapore, Malaysia or Indonesia, there may not even be the offsetting charm of the venue to somewhat balance the atmosphere of hostility to foreign businesses, or the interference of a  judiciary that seems to lack independence or is widely thought to be corrupt.  Today, energy companies, in particular, find themselves doing business in foreign jurisdictions in which all of the aforementioned factors are prevalent.  

 If a party fails to plan properly and finds itself in a forum where they believe that they are unlikely to receive a fair hearing of their claims or their defenses, there is little they can do other than make a record that will enable them to challenge an unfavorable award by showing that they were not given a fair opportunity to present their case and, as a consequence, justice was not served. 

While a challenge to the mandatory forum selection clause can be made, it is extremely difficult to prevail for two reasons.  First, the trial court presumes a forum selection clause is valid and enforceable, and second, the burden is on the party seeking to avoid a forum selection clause to show that the clause is unreasonable under the circumstances, which includes “clearly showing that enforcement would be unreasonable and unjust; that the clause is invalid for such reasons as fraud or overreaching; that enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision; or that the contractual forum will be so gravely difficult and inconvenient that the opponent will for all practical purposes be deprived of his day in court.," according to M/S Bremen. However, with proper planning, it will not be necessary to ask, or answer, the question: Whose awful idea was this?  

Ignoring Arbitration Clauses: Rarely the Right Choice
by Peter Scaff. Email Peter here.

An arbitration clause allows parties to resolve their disputes in a private forum without the necessity of a courthouse tour. Because state and federal courts universally embrace arbitration as a matter of public policy — and to deter trial lawyers’ propensities to choose a forum that is perceived to be more favorable — courts and legislatures have designed relatively ministerial proceedings allowing compulsion of arbitration when a lawsuit is filed in contravention to the dispute resolution procedure set forth in the contract.

The Federal Arbitration Act, for example, provides for a summary procedure that merely requires a trial court to be satisfied that 1) there is a written agreement containing an arbitration clause, and 2) the issue involved in the suit is within the scope of the arbitration clause.

Notably, however, the FAA requires that the issue of the existence of an arbitration clause be brought to the court’s attention through the application of one of the parties. For a variety of reasons, it is not uncommon for parties to ignore a perfectly good arbitration clause and, instead, institute and proceed with litigation.

In some cases, an evaluation may determine litigation is the preferred forum for a particular dispute. In others, a litigant may have a preference for a particular forum or judge. Additionally, a party may believe that the dispute involves legal issues that are suitable for a summary judgment motion in a trial court. While usually allowed, prevailing thought is that one is much more likely to see a unicorn than be granted request for summary disposition in an arbitration. Because one of the few valid grounds for vacatur of an arbitration award is a showing that the arbitrator refused to hear evidence pertinent and material to the controversy, arbitrators have an incentive to sort it out after the presentation of evidence at the arbitration hearing.

So, at what point in litigation may a party still insist upon enforcement of an arbitration clause? As arbitration is a creature of contract, enforcement of an arbitration clause is subject to contractual defenses, including waiver. However, because public policy favors arbitration, a strong presumption exists against finding that a party has waived its right to arbitration, and a court will resolve any doubts concerning waiver in favor of arbitration.

Although a factor, delay alone is insufficient, and a party urging waiver must establish that any delay resulted in prejudice. The two-part test developed to determine waiver asks: (1) did the party seeking arbitration substantially invoke the judicial process? and (2) did the opposing party prove that it suffered prejudice as a result?

In Northwest Construction Co. Inc. v. Oak Partners LP, the Fort Worth Court of Appeals recently had an opportunity to discuss at what point in the litigation process a party waives his contractual right to arbitration. Northwest entered into a construction contract containing a mandatory arbitration clause with Oak Partners. After Northwest constructed the facility, Oak Partners sued Northwest alleging breach of contract. Northwest filed its answer without invoking the arbitration clause and asserted counterclaims. A number of subcontractors then filed separate suits against Northwest and Oak Partners alleging they were owed money. Northwest successfully moved to consolidate their claims into the suit it was defending against Oak Partners. Nineteen months later, and three months before trial, Northwest moved to compel arbitration, which was denied upon a finding that it had waived its right to arbitration.

The Fort Worth Court of Appeals agreed. Taking part in litigation does not constitute substantial invocation of the judicial process. However, Northwest’s deliberate acts in filing an answer, setting up a counterclaim, engaging in extensive discovery, and filing a summary judgment motion, showed a substantial invocation of the judicial process.

The court also found that Oak Partners presented sufficient evidence that had been prejudiced by Northwest’s failure to timely invoke the arbitration clause. Noting that judicial opinions focus on factor’s such as (1) access in litigation to information that is not discoverable in arbitration; and (2) incurring costs due to the delay, the court found it significant that the applicable arbitration rules did not provide for requests for admissions or for interrogatories, which constituted the bulk of the discovery Northwest sought from Oak Partners, and that Oak Partners incurred legal fees to review and respond to this discovery.

While Northwest Construction Co. Inc. v. Oak Partners LP presented a relatively easy decision for the appellate court, fact patterns are not usually so clear cut. This is especially the case when it is argued that a defendant has waived its right to arbitrate. Waiver is a quintessential 'question of fact' and there are dozens of waiver cases falling on both sides of the equation. A party that decides to ignore an arbitration clause in a case without opposing counterclaims or an active opposition (or a wily one that restricts discovery to matters that are also allowed in arbitration) to the litigation must consider the risk of being compelled to arbitrate at the whim of the other party, even though significant time has elapsed and expenses incurred. While unusual circumstances may justify this strategy, it is usually more certain, and almost always less expensive, to invoke the arbitration clause in the first instance .