Use of arbitration in finance disputes
14 May 2021
14 May 2021
Litigation has traditionally been the forum of choice for dispute resolution in international finance. However, globalisation and the increased involvement of parties from emerging markets has resulted in international arbitration being used more frequently as a means of resolving finance disputes.
This guide provides an introduction to commercial international arbitration, explaining what it is and the factors to consider when deciding if it is appropriate. It also looks at developments which have led to an increase in its use by the finance sector and then goes on to address the issues to consider when drafting an arbitration clause.
At its simplest, international arbitration is an alternative to national court litigation as a means of resolving disputes; in choosing arbitration parties are opting to have their dispute resolved privately instead of going to a national court.
Key characteristics of international arbitration include:
The finance sector has not embraced arbitration in the same way as other sectors, such as energy, insurance and shipping. Until recently, the general approach in many major financial centres had been to use either the English or New York courts – jurisdictions with which financial institutions are familiar and can rely on to produce sound judgments. However, the sector has seen an increase generally in the use of international arbitration in finance disputes2 and that is expected to increase further.3 The main drivers behind this increase are:
Globalisation is one of the drivers behind the increase in the use of arbitration in derivatives transactions. This prompted ISDA to publish a guide in September 2013 on the use of arbitration in the ISDA Master Agreement. The 2013 Guide included sample clauses for use in both the 1992 and 2002 Master Agreements.
The Guide was updated in 2018 and included an expanded range of “ISDAfied” model arbitration clauses for a larger number of arbitral institutions and seats around the globe. This reflects the increasing use of arbitration in finance transactions.
The concern over the ability of the courts to deal with complex disputes resulted in the establishment of an international finance disputes centre: P.R.I.M.E. Finance.4 This is based in The Hague and launched on 16 January 2012. The centre offers mediation, arbitration and other dispute resolution services to the finance sector and has its own arbitration rules which have been adapted to meet the needs of the financial markets. It also has its own panel of experts and arbitrators – which includes representatives from both mature and developing markets, dealers and end-users, legal experts and market experts. The experts are available to either arbitrate disputes or offer their expertise for the benefit of arbitrators and judges in other fora.
The P.R.I.M.E. Finance Arbitration Rules are inspired by, and very closely follow, the UNCITRAL Arbitration Rules.5 P.R.I.M.E. kept deviations from the original UNCITRAL text to a minimum, both with a view to the role of the Permanent Court of Arbitration and in order to ensure that, in the case of any ambiguities, reference could easily be made to the commentaries on the UNCITRAL Rules. That said, the P.R.I.M.E. Finance Arbitration Rules have been tailored to the needs of arbitration in financial markets and tailored to reflect the fact that they provide for an arbitral institution that will administer the arbitral proceedings (P.R.I.M.E. Finance), whereas the UNCITRAL Rules have been written for ad hoc arbitration. The main adjustments made to the UNCITRAL Rules reflect the market need of speedy resolution of disputes, with the inclusion of several provisions and annexes allowing parties to arbitral proceedings to shorten time frames in several ways.
The P.R.I.M.E. Finance Arbitration Rules also provide that awards may be made public with the consent of all parties. P.R.I.M.E. Finance may also publish an award or an order in its entirety, in anonymised form, so long as no party objects to the publication within one month after receipt of the award. These provisions are aimed at supporting the overall goal of P.R.I.M.E. Finance; namely to increase legal certainty through creating a significant body of case law in the area of complex financial products.
One of the reasons commonly given for preferring national courts (and the English courts in particular) is the ability to secure a relatively speedy resolution via the summary judgment procedure. Historically, a similar procedure was not available in arbitration, because of the duty that is commonly imposed on arbitrators to give a "full opportunity" to parties to set out their respective cases.
That is no longer the case. Several arbitral institutions now include a procedure for summary disposal or early determination of disputes, including the Singapore International Arbitration Centre (SIAC), the Arbitration Institute of the Stockholm Chamber of Commerce (SCC) and the Hong Kong International Arbitration Centre (HKIAC). The International Court of Arbitration of the International Chamber of Commerce (ICC) has also clarified the procedures already available under the general case management provisions of its Rules for summary dismissal applications.
On 31 January 2020, 11pm GMT, the United Kingdom left the European Union (Brexit). Although Brexit will not impact on international arbitration, it may result in an increase in the use of international arbitration due to the impact it could have on court jurisdiction clauses and enforcement of English court judgments within the EU.
The Brussels Regulation (recast) determines the rules applied by EU courts when giving effect to court jurisdiction clauses and the enforcement of court judgments within the EU.6 Those rules ceased to apply to UK court judgments from 1 January 2021, once the Brexit transitional period ended.
As no replacement for those rules has yet been agreed (this area was not included within the Trade and Cooperation Agreement reached on 24 December 2020), there remains some uncertainty about the enforceability of court jurisdiction clauses and English court judgments within the EU. As a result, where enforcement within the EU is a concern, contracting parties may prefer to incorporate an arbitration provision.
This is the latest initiative aimed at raising awareness of the benefits of international commercial and investment arbitration and ADR in the finance sector. The research project is conducted jointly by the Institute for Banking Law and the Center for Transnational Law (CENTRAL) at the University of Cologne, Germany. The project builds on and references the work carried out by others (including ISDA and the ICC). In addition to raising awareness, it also aims to assist financial institutions in making informed choices on dispute resolution strategy. More information is available on its website.
Whether arbitration is appropriate for a particular transaction will depend on the particular circumstances. It is therefore important that anyone responsible for drafting financial documents understands:
As noted above the use of international arbitration in finance disputes has risen largely due to the increased involvement of parties from emerging markets. The key issue for banks to date has been the country in which the contractual counterparty is based, or the country in which the assets (and therefore where enforcement will be sought) are based. While these will remain important considerations, international arbitration offers other advantages that may be relevant to its use.
Increasingly banks are dealing with counterparties in emerging markets and with state entities. These parties may not be happy for disputes to be referred to the English or New York courts but may demand that dispute resolution take place in locations that are more conveniently located for them – and the banks may not want disputes to be referred to the counterpart's local courts. International arbitration offers neutrality, in that it allows the parties to choose a neutral "seat" or place of the arbitration (see below for a discussion of that legal concept) and the parties can also ensure that the composition of the tribunal is neutral.
As regards the concern that many national courts do not have the expertise to deal with complex financial products, again arbitration has the advantage in that parties are able to choose the arbitrators and can, if they want, choose an arbitrator with experience and knowledge of the particular industry or financial product.
Another advantage, particularly for commercially sensitive areas such as advisory and M&A work, is the privacy and confidentiality that arbitration offers. Unlike court litigation, an arbitration hearing is not open to the public, and the parties can agree that the arbitration award and the documents produced in arbitration are to be confidential (if the applicable procedural rules or law are silent on the question).
Other perceived advantages include the procedural flexibility offered by arbitration; the ability to tailor procedures to meet parties' needs is attractive. In addition the finality offered by the limited rights of appeal can, in certain circumstances, be regarded as advantageous.
However, in the context of dealing with parties from emerging markets, the biggest advantage that international arbitration has over national court litigation is in relation to enforcement.
Generally speaking, arbitration awards are easier to enforce than court judgments, because the New York Convention provides an extensive enforcement regime. So, provided that the seat of the arbitration is a country which is a signatory to the Convention, the award should (in theory) be easily enforced in any of the other signatory states (although some states have a better compliance reputation than others). Currently, there are over 160 signatories, and all the major jurisdictions are covered.7
In contrast, there is as yet no real equivalent for enforcement of court judgments.8 The enforcement problem could be avoided by referring disputes to the national courts where the assets are based but, unless it is familiar with those courts, that will not usually be attractive to a bank. In addition, there is the risk that assets may be moved to another jurisdiction. The starting-point is therefore to look at whether a reciprocal arrangement is in force between the country where the dispute will be resolved and the countries in which any court judgment is likely to be enforced. However, if no reciprocal arrangement is in place, international arbitration may be preferable.
There are disadvantages in choosing arbitration and an awareness of these is required to make a fully informed choice.
Arbitration used to be perceived as providing a quick and cost-effective alternative to litigation. However, this is no longer the case in all countries and speed and cost are often two of the criticisms made of it.
The term "split" or "hybrid" clause covers a variety of hybrid dispute resolution clauses, the most common being a clause which provides for both court jurisdiction and arbitration coupled with a mechanism allowing one or both parties the right to determine the procedure once a dispute arises. These clauses tend to be used when one party – usually the bank – has a stronger bargaining position; they give the bank the right to choose between national court litigation or international arbitration when a dispute arises. So, for example, the clause could provide that disputes are to be resolved in the English High Court but with the bank also being permitted to elect that the dispute in question be referred to international arbitration.
These clauses are increasingly appearing in finance agreements. They have the obvious advantage of letting the bank decide which forum it prefers until the dispute arises. So, if it is a matter which can be dealt with quickly and easily, the bank may prefer to go to the English courts where the matter can be determined by way of summary judgment. Alternatively, if assets have been moved and enforcement becomes an issue, the bank can choose to go to international arbitration.
Caution should be used whenever such a clause is considered. Although valid in several jurisdictions, some jurisdictions take a different approach. Split clauses may be deemed invalid on the basis that they do not provide a proper reference to arbitration (where only one party has the right to refer the matter to arbitration) or that they are unfair and against public policy (given that they strongly favour one party). In either case, a bank could find itself facing litigation in the particular jurisdiction it had hoped to avoid, or could face difficulties when seeking to enforce an award made pursuant to a hybrid clause in such jurisdiction.
The risks can be minimised by both checking the governing law of the contract to make sure that it recognises their use and validity, and taking local advice in the particular jurisdiction where enforcement is likely to be sought.
Clarity is also essential and it should be clear how the clause is to operate. It is important to set out precisely the circumstances in which the option may be exercised and the extent of control of the stronger party. For example, is the stronger party to have an effective right of veto so that if the other party commences proceedings in the specified forum, the stronger party can then step in, have those proceedings stayed and proceedings commenced in their choice of forum?
One of the benefits of arbitration is the ability to tailor the arbitration clause to suit the particular circumstances. However, the downside is that if the agreement is unclear or does not satisfy certain requirements, it could be unenforceable and the dispute ends up before a national court. We discuss below the basic drafting principles so that those problems can be avoided.
When drafting an arbitration clause, there are certain key questions that parties must first address:
All arbitrations are conducted under arbitral rules which govern the procedure of the arbitration. These can be chosen by the arbitrators themselves but it is better for the parties to specify which rules should be used. A basic choice is between arbitration under "ad hoc" rules and arbitration under "institutional" rules.
This is conducted under rules adopted for the purpose of the specific arbitration, without the involvement of any arbitral institution. The parties can draft the arbitral rules themselves. However, since this can be time-consuming and expensive, they usually either leave the rules to the discretion of the arbitrators or they adopt rules specially written for ad hoc arbitration, for example, the UNCITRAL Rules.9
This is arbitration administered by a specialist institution. Parties should incorporate the rules of the selected institution into their arbitration clause by reference. Such rules are expressly formulated for arbitrations conducted under the administration of the relevant institution.
Institutional arbitration can lend political or moral weight to awards. More practically, because institutional rules are designed to regulate the proceedings comprehensively from beginning to end, the institutions are better suited to cater for contingencies that might arise even if, as sometimes happens, the respondent fails or refuses to co-operate.
There are other advantages: by choosing institutional arbitration the parties can avoid the time and expense of drafting a suitable ad hoc clause; the fees and expenses of the arbitration are, with varying degrees of certainty, regulated, and time and costs can be avoided because arbitrators' fees are settled at the outset, without the need for this to be discussed by the parties and the arbitrators. Having said that, the additional layer of bureaucracy imposed by institutional arbitration may cause delay and, inevitably, additional fees are payable.
There are many institutions to choose from (see examples in the following section). There is no magic formula for choosing between them. Increasingly, institutions and institutional rules are offering similar processes with little to distinguish them. Such similarity leads parties to look to more subjective factors in deciding which institution to use: familiarity with the institution, their opinion of the international acceptability or reputation of a given institution, the pro-activeness and responsiveness of the institution's staff, and the institution's neutrality or "internationalism".
Another key consideration for parties is the chosen seat of arbitration. A reputable institution based in the parties' chosen seat will often be viewed favourably because of its perceived association with and knowledge of how things work in that seat, as well as its geographic proximity. As a general rule, newly formed institutions or institutions without a proven track record should be avoided.
We explore the differences in more detail in our Quickguide: Which Institution?
Popular arbitral institutions include:10
Copies of the rules and recommended wording for arbitration clauses are published by the above institutions on their websites. These may need supplementing.
The legal place of the arbitration is one of the most important matters to specify. This is called the "seat" of the arbitration and it is a legal concept that ties the arbitration into a legal jurisdiction. Usually expressed as a city, the key aspect is the jurisdiction in which the seat is located as it is the procedural law of that jurisdiction that will govern the arbitration. Getting the seat (and therefore choice of procedural law) right is crucial as it can affect:
In making this choice the parties must consider both the legislation enacted in the particular jurisdiction relating to arbitration, and the attitude of the national courts towards arbitration generally in that jurisdiction.
Most countries have legislation governing arbitrations that take place in their territory. This does not replace the procedural rules chosen by the parties to govern the arbitration but provides a framework in which those rules operate. Many countries' national laws are based on the UNCITRAL11 Model Law on International Commercial Arbitration. The Model Law is intended to even out disparities between national laws and suggest a common standard for arbitral practice.
Most arbitration laws give the parties flexibility on matters such as the appointment of the tribunal and the procedures to adopt, while providing a safety net where agreement is lacking. They also generally prescribe elements from which the parties cannot depart by agreement, including the more fundamental aspects of the process such as fairness of the proceedings and the duties of the tribunal.
The national law will also give powers to the courts of the seat in relation to certain aspects of the arbitration. Broadly speaking, these include issues such as the ability of the parties to apply to the national courts for support (for example an order to freeze assets or obtain evidence), the ability to challenge decisions of the tribunal and the award, and provisions on enforcement.
The national law, and the general attitude of the judiciary in a country, will determine how supportive or interventionist those courts will be. Interventionist jurisdictions, where courts interfere in the arbitral process to the detriment of its autonomy, are to be avoided.
Finally, it is important that the country chosen has ratified the New York Convention. This is because some countries which are signatories to the Convention will only allow enforcement of awards which have been made in countries which are also signatories to the Convention. Over 150 countries have ratified the Convention, including most of the world's leading trading nations. A full list of countries is available on the UNCITRAL website.12
It is also worth noting that a country may aim to be seen as a modern, favourable forum for international arbitration, but in practice when the courts become involved, an arbitration may be delayed for many months, if not years.
A recent survey found the most popular seats to be as follows: London, Singapore, Hong Kong, Paris and Geneva(in order of preference).13
The parties can specify the number of arbitrators in the arbitration clause or leave this to be determined under the relevant rules once a dispute has arisen. Usually an arbitration is heard by either one or three arbitrators. An arbitration will be less expensive and involve less delay if the parties provide for a sole arbitrator. Appointments for meetings and hearings can be more easily arranged, a sole arbitrator does not need to spend time deliberating with fellow arbitrators in order to reach a decision and, in general, the arbitrator fees for an arbitration conducted by a sole arbitrator is likely to cost, overall, about half as much as the arbitrator fees for an arbitration conducted by three arbitrators. The disadvantage of having a sole arbitrator is there is a higher chance of errors in the decision as only one person makes the award.
In an international dispute, the more usual procedure is to provide for the appointment of an arbitral tribunal of three arbitrators. Where the tribunal is to consist of three arbitrators, the procedure usually adopted is for each party to nominate an arbitrator and for a "neutral" third arbitrator (usually the presiding arbitrator or chairman) to be appointed either by agreement between the two party-nominated arbitrators or by agreement between the parties. This has the advantage that each party has a greater sense of investment in the arbitration in that each party has been able to nominate one arbitrator of its choice to listen to its case. It also ensures that at least one arbitrator is familiar with the national or legal culture of the country where the relevant party is based.
If you are choosing arbitration because you want your disputes to be decided by someone from the same industry or who has particular expertise, it is sensible to set this out in the arbitration agreement. It is common to see arbitration clauses where the parties agree that an arbitrator should be a member of a particular organisation or should have particular qualifications. However, be careful not to define the qualifications too narrowly as there may then be an insufficient pool of arbitrators who are able or willing to accept appointment. One way round this may be by just specifying that the arbitrators have to be selected from the panel of experts and arbitrators on PRIME Finance. In addition, you should never specify a named individual as that person may be unable or unwilling to act when the dispute arises and then the arbitration clause would be unenforceable.
Choice of law clauses are separate from arbitration clauses, since these set out the applicable law regulating the parties' rights and obligations, by which substantive questions are to be judged.14 In contrast, an arbitration clause sets out the mechanism by which a dispute is to be resolved. However, choice of law clauses are often combined with arbitration clauses, so parties may have to consider this when drafting the arbitration clause. It is important to appreciate the distinction between the governing law of the contract, the procedural law of the arbitration, and the law applicable to the arbitration clause.
Parties should select an appropriate governing law carefully. The governing law of a contract can be pivotal not only to its formation and validity but also to the question of whether disputes arising under or in connection with the contract can be submitted to arbitration, and what remedies can be awarded by the arbitrators. It is always advisable, therefore, to specify the governing law when drafting the contract. Where the parties do not select a governing law, the choice will be made for them by the arbitrators.
The procedural law in an arbitration is different from the governing law of the contract: this is the law by which the arbitration will operate (such as the UNCITRAL Model Law). The procedural law is normally the law relating to arbitration in the seat of the arbitration. It is not advisable to specify in the arbitration clause a different procedural law from the procedural law in the seat of the arbitration and, if possible, align the governing law and the procedural law/seat.
Under the widely-accepted principle of "separability", an arbitration clause is considered to be separate from the contract in which it resides. This means that the arbitration clause survives termination of the contract and allows any claims arising out of that termination to be referred to arbitration. It is generally assumed that where no separate choice of law for the arbitration clause is made, the governing law of the contract is also the governing law of the arbitration clause. It is therefore unusual in such a situation to specify the governing law of the arbitration clause.
However, where the law of the underlying contract differs from the seat, e.g. English governing law but Paris seat, there may be uncertainty over whether the governing law of the arbitration clause is the same as the governing law of the main contract, or whether it should be the law of the seat. In this situation, it is sensible to specify a governing law of the arbitration agreement.
Generally, arbitration clauses will cover all disputes arising out of the relevant contract and national courts and arbitral tribunals will not favour arguments that say that certain disputes do not fall within the wording of the clause as a matter of construction.15 Also, another result of the principle of separability discussed above is that an arbitration clause will remain valid even if the contract in which it is found is alleged to be invalid. There are limited grounds to challenge the validity of an arbitration clause itself. The New York Convention provides that the courts of a signatory country must uphold an arbitration clause unless the clause is "null and void, inoperative or incapable of being performed".
It is advisable to provide for the language of the arbitration as this will determine the language of the written and oral submissions in any hearing. If not specifically provided for, the tribunal will decide the language.
As mentioned above, one of the disadvantages of arbitration is that arbitrators, unlike judges, do not have the authority to join additional parties to the arbitration or consolidate related arbitrations without the additional parties' consent. Where there are inter-related contracts, and the parties want any related disputes to be heard together or want the ability to join into the arbitration the various parties to the different contracts, it is possible to cater for that. However, advice on the drafting should always be sought.
If confidentiality is a concern, it is sensible to insert a confidentiality clause as the approach to confidentiality can vary as between different arbitral institutions and different jurisdictions. A clause which specifically addresses the arbitration is advisable, as opposed to relying on more general confidentiality provisions that apply to the underlying contract. Several of the institutions provide standard wording for such clauses.16 Alternatively, choose arbitration rules (such as the SIAC Rules) which have express confidentiality provisions.
Parties can agree to waive the right to appeal on a point of law in order to ensure that an award is final and binding, to the extent the waiver is permitted by the laws of the relevant state. Certain institutional rules (such as the ICC and LCIA rules) also include this waiver. However, parties to finance transactions may prefer to retain the right to appeal on points of law and so they should always check the position under the chosen institutional rules and, if necessary, exclude the waiver of the right to appeal.
Most institutions recommend sample clauses for use when their institutional rules are being adopted. These are revised from time to time and so it is best to check the websites. We list the key institutions and provide links to their sample clauses below.
Note that the clauses are only sample clauses. They may need to be modified to take into account requirements of national law and the specific requirements of the contracting parties. However, they provide useful examples of a basic arbitration clause and can easily be adapted.
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.