When to provide for litigation, arbitration, mediation or a combination of each
October 2017 | SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION
Financier Worldwide Magazine
October 2017 Issue
Each method of dispute resolution has its own features that may be benefits or downsides, depending upon your perspective and circumstances. In many cases, parties select either court litigation or arbitration, depending upon what suits them best. However, parties sometimes provide for combinations of litigation or arbitration and alternative dispute resolution (ADR) procedures, such as mediation, in ‘multi-tier’ clauses. In other cases, parties seek to delay the choice of arbitration or litigation until they know what would best suit the particular dispute that arises, by using ‘option’ clauses. Whatever choices are being made, it is important to understand the consequences that follow and the potentially significant traps that parties often fall into in this regard.
Court litigation is the default system for dispute resolution. Even where litigation is not provided for expressly, it will be the method that applies if no other method is selected. England benefits from a first class court system, with specialist courts and judges of very high quality. Where a defendant does not participate or present a defence, the claimant can quickly and cheaply obtain a default judgment. Where a defence is very weak, the claimant may be able to obtain a summary judgment without expending the time and cost of proceeding to a full evidential hearing. The English courts also have powers to impose severe sanctions where, for example, persons (whether parties or not) breach injunctions or are otherwise in contempt of court. Of course, not all court systems are the same, and in many other countries the court systems are a far less attractive option. However, these features of English court litigation make it very attractive to the banking and financial community where, for example, simple loan defaults may be among the most likely disputes to arise.
While nearly every feature can be positive or negative, depending upon a party’s perspective, this is particularly true of the public nature of most court proceedings. For some parties, publicity can be a valuable tool in applying pressure to an opponent or to set a precedent. For others, the confidentiality available in arbitration proceedings is a significant advantage. However, what makes arbitration the clear choice for many international contracts is the relative enforceability of arbitration awards worldwide. There may be little point in obtaining a court judgment if that cannot be enforced where the defendant’s assets are located, whereas the New York Convention provides for the enforcement of arbitration awards in over 150 countries worldwide. Other key reasons for the selection of arbitration over court litigation include that it can provide a neutral and convenient forum which is easily accessible to those from different countries, and that parties can participate in the selection of the arbitrators and help shape the procedure to be followed to resolve their disputes.
Mediation differs from both litigation and arbitration in that it does not necessarily result in a final and binding resolution of disputes. Mediation is essentially a negotiation between the parties, facilitated by the third-party mediator, and a binding result is only reached if the parties make a contract to that effect. As mediation operates outside of the litigation or arbitration process, and is about reaching a settlement rather than determining the legal rights of the parties, it can be very flexible. Mediation can encompass matters that could not properly be taken into account in formal dispute resolution, such as the potential for further business dealings between the parties. If the parties truly wish to settle their dispute, mediation can be very effective. However, because it does not guarantee a binding result, mediation should be used against the backdrop of actual or potential litigation or arbitration. For this reason, where parties provide for mediation they generally do so as part of a ‘multi-tier’ clause.
A ‘multi-tier’ clause typically requires the parties to attempt alternative forms of dispute resolution, such as discussions between senior executives or mediation, before commencing arbitration or litigation. The intention is, of course, to try to settle any dispute at an early stage, so as to avoid the time and costs of formal dispute resolution. Parties can always agree to seek to settle through direct discussions or mediation, whether or not this is provided for in their contract. However, providing for this in advance may avoid any concern about looking weak by suggesting settlement discussions or mediation, and allows some of the details to be agreed in advance of a dispute, when cooperation may not be forthcoming. Provision for discussions or mediation can be made without making these steps mandatory. A party cannot be forced to settle a dispute amicably and such steps are most likely to be successful where both sides wish to resolve their dispute. Nonetheless, sometimes multi-tier clauses are drafted so that the discussions or mediation are preconditions to any arbitration taking place. This ensures that the parties must try to settle their disputes but can be dangerous because, unless the preconditions are clearly drafted, they can become a source of dispute over whether they have been met such that the jurisdictional basis for the arbitration is established. For example, a common error is for parties to stipulate that a dispute shall be referred to arbitration if it cannot be settled amicably, without specifying exactly what ‘cannot be settled’ means. A clearer stipulation may simply provide for a time period during which parties are to seek to settle their dispute, failing which it is to be referred to arbitration.
Where parties are not sure, at the time of contracting, whether arbitration or litigation would suit them better, they sometimes try to keep their options open by providing for the choice to be made later. These ‘option’ clauses are often seen in finance documents where, for example, the bank wants to reserve for itself the right to elect for arbitration or litigation after the dispute has arisen. In a simple loan default situation, the bank may want the possibility of obtaining a default or summary judgment in the English courts, whereas in other types of dispute the features of arbitration may make it the preferred solution. Where the option to choose between litigation and arbitration is only given to one party or side to a dispute, it is known as a ‘unilateral option clause’.
Unfortunately, despite their popularity, option clauses, and particularly unilateral option clauses, can cause significant problems. Although the English courts have confirmed the validity and enforceability of unilateral option clauses under English law, there have been different findings in some other countries under other laws, and in many further jurisdictions the position is unclear. If an option clause is invalid, the provision for arbitration can fall away completely, with potentially disastrous consequences, for example where the enforceability of an arbitration award is a key factor. It is therefore very important that, before agreeing to option clauses, parties understand whether such clauses are acceptable under the laws and in the countries that may be relevant should a dispute arise.
In summary, litigation, arbitration, mediation and combinations of each can provide parties with the most appropriate means to resolve their disputes. However, it is important to consider at the outset which features of each method are most important for any given party and situation. Combinations of these methods of dispute resolution are possible and, where properly drafted, can lead to effective and efficient procedures. However, there are potentially severe pitfalls to be aware of when using these more complex arrangements.
Philip Clifford is a partner and Daniel Harrison is an associate at Latham & Watkins. Mr Clifford can be contacted on +44 (0)20 7710 1861 or by email:firstname.lastname@example.org. Mr Harrison can be contacted on +44 (0)20 7710 4692 or by email: email@example.com.
© Financier Worldwide
Philip Clifford and Daniel Harrison
Latham & Watkins