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Chapter 3

3.1 The Importance of Dispute Resolution

Business people often wonder why lawyers attach great importance to the issue of dispute resolution. If parties, dealing in good faith, establish the rules that are to govern their relationship, why should they bother about future disputes? Is this not, on the contrary, a sign of distrust which may actually endanger the good relationship between them?

Any experienced lawyer knows that this preoccupation is unfounded: dealing from the very beginning with dispute resolution problems does not disrupt the trust between the parties; on the contrary, the setting up of a fair and balanced mechanism for dispute resolution is the best guarantee that none of the parties will be induced to breach the contract, taking advantage of the other party’s weaker position in case of dispute.

In fact, when a lawyer is asked by his client to assess the effectiveness of an existing contract (particularly where the other party appears unwilling to fulfil its obligations), he will first ask himself what legal remedies his client would have in case of breach by the other party. And if he comes to the conclusion that these remedies are weak, he will advise his client to look for a compromise solution instead of trying to enforce his rights.

Consequently, if it appears impossible (or unreasonably expensive) to obtain a favourable court judgment (or an arbitral award, if arbitration has been agreed upon in the contract) and/or to enforce it in the country of the other party, and the other party is unwilling to spontaneously perform its obligations, the interested party will be forced to give up its claims even if they are well-founded.

Example 3-1 – Sale to a customer in a far-away country

A manufacturer has sold goods for US$30,000 to a customer of a far-away country with payment on open account (60 days from invoice). After a certain time, it appears that the customer, invoking pretended defects of the goods, does not intend to pay. The contract of sale does not say anything with respect to dispute resolution.

A quick inquiry as to the legal situation in the country of the customer shows that a possible judgment obtained in the supplier’s country would not be recognized in the buyer’s country and that bringing a claim in the buyer’s country would be expensive and without certainty as to the results.

In the situation described above, it is clear that whatever right the supplier may have, he will not be able to obtain payment through judicial means. In cases of this kind, no appropriate dispute resolution clause can solve the problem, and the solution must be found elsewhere, i.e. by putting the seller in a situation where he does not need to obtain payment after delivery of the goods (such as, payment in advance, documentary credit, bank guarantee), or by insuring his credit. Alternatively, the seller may decide to take the risk and to accept that there may be a number of cases where he will not be paid.

However, there are also many cases where the choice made by the parties in the contract with respect to the resolution of future disputes may be decisive for the outcome of a possible controversy. [Page58:]

Example 3-2 – Turnkey contract

A German supplier of equipment sells a production line to a company in a developing country on a turnkey basis, warranting certain performance results. At the moment of testing, it appears that the agreed parameters are not met, and the purchaser claims a huge price reduction (40%) apparently due under the contract. The supplier knows that the non-attainment of the performance is, for the most part, due to incorrect performance of the tests (use of non-conforming materials, lack of skill of the local personnel). However, his representatives on the site apparently accepted the results of the test (wrongly assuming that the buyer knew and would admit that they were not relevant due to the particular conditions of the performance test). The purchaser does not accept to carry out further tests; he insists that he is entitled to the price reduction.

The seller is certain that the plant is actually capable of reaching the agreed parameters, but he knows that this is rather difficult to prove. The supplier’s technical personnel can vouch that the tests were not correct and that they accepted the results on the assumption that such acceptance was not binding. Further tests could show that the plant substantially meets the parameters, provided the purchaser fully cooperates or authorizes the supplier to perform the tests with its own technicians.

The supplier must decide if he should settle by granting the requested price reduction or bring the dispute before the competent courts (or arbitrators).

This is a typical case in which the chances of the supplier to successfully prove his reasons in case of a dispute substantially depend upon the composition of the arbitral tribunal (or court). While experienced arbitrators (or judges with practical experience in this type of business) may be easier to convince of the seller’s good reasons, judges with a more formal attitude are more likely to be impressed by the argument that the seller’s technicians actually signed the test report.

Therefore, where a negotiator knows that these kinds of problems are likely to arise, he will try to agree upon an arbitration clause, possibly referring to an arbitral institution, which leaves leeway for the choice of arbitrators (see, infra, § 4.3.3.1) and maximum neutrality as to the choice of the chairman of the arbitral tribunal.

Moreover, if the negotiator cannot obtain a neutral solution (e.g. because the buyer requests that the courts of his country have jurisdiction, he will take other precautions at a contractual level (e.g. he will try to increase the amount of a possible advance payment and/or reduce the amount of performance guarantees, etc.) in order to limit his risk and to counterbalance his weakness in case of a dispute.

Example 3-3 – Know-how agreement

Parties are negotiating a know-how agreement whereby the licensor is to grant the licensee all the technical information needed for the manufacture of certain products (not protected by patents). The licensor knows that, once he has transferred the information, the licensee will be able to manufacture the licensed products without his assistance. With respect to the payment conditions, the licensor would like to obtain a lump-sum payment at the beginning of the contract, while the licensee insists on paying royalties on the goods manufactured under licence during a period of eight years.

In a case of this kind, a prudent licensor will try to insist on the lump-sum payment, knowing how difficult it could be to receive payment for several years from a licensee who has already obtained all of the know-how. However, if the licensor is forced to accept the licensee’s request (e.g. because he knows that the licensee is unable to pay a lump sum in advance and he wants nevertheless to conclude the deal), the dispute resolution issue will become crucial. In fact, should it appear that the only means of obtaining payment from an unwilling licensee is to bring a claim before the courts, the licensor must make sure that such action is possible and likely to be effective. [Page59:]In addition, if it appears impossible to set up an appropriate and effective dispute resolution system, the licensor will have the choice between refusing the payment conditions requested by the licensee, or seeking alternative means to ensure that the licensee will actually fulfil his payment obligations (such as, for example, retaining an essential part of the know-how¹ until the end of the payment period).

The two examples show how important it is to consider the dispute resolution system from the very beginning of contract negotiation. Although this is not always possible in practice (due to the bad habit of postponing the dispute resolution issue to the end of the negotiation), negotiators should consider in advance what solutions they envisage for dispute resolution and consequently adapt their choices (concerning the various substantial contract issues) to the actual dispute resolution scenario.

Of course, this does not imply an in-depth knowledge of how the various dispute resolution systems are to be applied in practice. A negotiator does not need to know how to manage the procedure for recognizing a court judgment abroad or how to conduct an arbitration proceeding, this being the task of lawyers specialized in litigation who will intervene at a later stage if litigation cannot be avoided. What is important for the negotiator is to know which solutions are more or less appropriate in a given context so that he can make a pertinent choice with the aim of ensuring the strongest possible position in case of dispute.

In this book I will deal with the problems of dispute resolution mainly from the above perspective, i.e. I will concentrate upon the effectiveness of the various dispute resolution options in the context of contract negotiation.

3.2 The Main Options

Before examining the various issues in detail, it is necessary to consider two basic options:

1. Should possible disputes be resolved by ordinary (domestic) courts or by arbitrators?
2. Should a mediation procedure (ADR) be introduced before bringing the dispute to court (or to arbitration)?

3.2.1 The choice between arbitration or ordinary jurisdiction

The first issue to be decided is the choice between arbitration and the jurisdiction of national courts.

If arbitration is chosen, the dispute will be decided by arbitrators appointed by the parties or by an arbitral institution chosen by the parties. If the ordinary jurisdiction is preferred, possible disputes will be decided by state courts having jurisdiction on the matter or chosen by the parties.

If no choice has been made, the dispute can be brought before any state court having jurisdiction over the dispute.² As we will see later, in this context an agreement is needed only for the choice of a particular court.

When choosing between arbitration and ordinary jurisdiction, a number of issues that will be discussed in the following paragraphs should be taken into consideration.

3.2.1.1 Reasons for preferring arbitration

Many people believe that the normal way of resolving disputes in cross-border contracts is arbitration, and that this is always the preferable solution.

However, such a general assumption is not true. Actually, no type of dispute resolution can be considered as being the most appropriate in general terms. There are situations in which arbitration is to be preferred and others where the recourse to state courts is [Page60:]more appropriate. An experienced lawyer will try to establish the likely scenario of future disputes and then try to identify the dispute resolution system that may answer, in the best possible way, the needs of his party.

Of course, this inevitably leaves space for uncertainty, because one can try to imagine what is likely to happen in the future, but no one can foresee the future. However, this does not mean that one should not try to figure out a likely scenario and look for solutions that are appropriate with reference to it.

As regards the choice between arbitration and ordinary (domestic) jurisdiction, we will examine in this paragraph a number of aspects which may justify the choice of arbitration, and thereafter, in § 3.2.1.2, situations in which arbitration is less appropriate.

Neutrality

One of the main advantages of arbitration is that it is possible to set up a “neutral” tribunal (normally two arbitrators from the respective countries and a chairman from a third country, or a sole arbitrator from a third country), while in the case of ordinary jurisdiction, the choice is between the courts of one or another country, which leaves less space for a solution that will be acceptable to both parties.

Qualification of the arbitrators

Another important advantage of arbitration is that, in selecting arbitrators, parties can choose between persons with a specific qualification and expertise in dealing with the matters in dispute, and in particular identify people who know the commercial practice and thus can better understand the substance of the dispute.

So, for instance, in the case dealt with in Example 3-2, the supplier would clearly be better off if the case were submitted to qualified arbitrators instead of a domestic court.

Less formalistic procedure

The procedure before arbitrators is normally simpler and less formalistic than that before ordinary courts. Moreover, in international arbitration there is a trend towards a more common approach to conducting proceedings³ that reduces the risk of a party being “surprised” by unfamiliar procedural rules. Moreover, this less formal approach often, although not always, contributes to creating an atmosphere in which it is easier for the parties to settle the dispute.

Confidentiality

Arbitral proceedings are confidential. Also, the arbitral award will remain confidential unless a party challenges the award and requests its enforcement before a state court.

Possibility of excluding the jurisdiction of state courts

In those countries that have ratified the New York Convention of 1958, the local courts are bound to respect arbitration clauses, and consequently they will refuse jurisdiction if the parties have submitted the matter to arbitration. While in several countries a clause giving exclusive jurisdiction to the courts of the country of one of the parties will not necessarily bind the courts of the state of the other country,⁴ an arbitration clause will have far more chance of being effective due to the large number of countries having ratified the New York Convention. For example, a European party wishing to exclude the jurisdiction of the courts of its US counterpart, will be more successful with an arbitration clause⁵ than with a clause submitting possible disputes to the exclusive jurisdiction of the courts of its own country.⁶[Page61:]

Easier recognition in countries having ratified the New York Convention

A further advantage of arbitration is that in several countries where a foreign court’s judgment would not be recognized, it is easier to obtain recognition of an arbitral award on the basis of the New York Convention, provided the conditions of the Convention are met.

3.2.1.2 Situations where arbitration is less advisable

(a) Parties placed in a merely “defensive” position

A party which expects that, in case of dispute, it will only have to defend itself against a possible claim from the other party, without needing to bring a claim against that party,⁷ will normally prefer a choice of forum clause in favour of the courts of its own country. In fact, such party will be better placed for a defence in its home country where it is more difficult for the other party to conduct a proceeding, while a more neutral solution, like arbitration, will make it easier for the other party to engage in litigation. This is particularly the case when a party fears being subjected to exorbitant and unfounded actions, as shown in the example described hereunder.

Example 3-4 – Sale of an industrial plant in Egypt

An Italian manufacturer sold to an Egyptian purchaser the equipment for the construction of a manufacturing plant to be erected in Egypt. The contract contained a clause for arbitration in Cairo under the ICC rules. The contract entered into force when signed, but difficulties arose with respect to the payment conditions, which provided an advance payment and successive payments against delivery of the equipment. Since the purchaser was unable to meet the agreed payment conditions, it proposed alternative means of payment, which, however, were refused by the supplier, and the contract was finally not carried out. The purchaser began arbitration, claiming damages for the expenses borne and for loss of profit for an amount equal to 70% of the purchase price of the equipment.

Comment: When the purchaser began arbitration, the Italian seller had no other choice than to defend itself before the arbitral tribunal — since a possible award would have been easily enforceable in Italy under the New York Convention — and to bear the quite high costs the procedure implied, i.e. fees of the arbitrators, administrative expenses, fees for his counsel, etc.

The above example shows that there are situations in which an arbitration clause puts the other party in a better situation than it would have had without it. If there had been no arbitration clause, the purchaser would have been forced to claim before the Italian courts or before the Egyptian courts. In the first case, he would have been placed in a less favourable situation and, in the second case, a judgment would have been difficult to enforce in Italy.

Consequently, when a party is placed in a purely defensive position, it should bear in mind that the choice of a neutral dispute resolution system, like arbitration, is not always the most appropriate solution.

It should, however, be noted that the above reasoning only applies when the interested party is in a purely defensive position, i.e. when it does not fear a claim before the courts of the other country.⁸ When, on the contrary, a claim in the country of the other party would be dangerous (e.g. because the party in question has property or credits in the country that might be attached by the other party, or because it needs to defend its image in such country), the recourse to arbitration may nevertheless be preferred, particularly when the main preoccupation is to preclude the other party from bringing a claim before its own courts.

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(b) Countries that have not ratified the New York Convention

If the other party is from a country that has not ratified the New York Convention — or to a country that, although adhering to the Convention, does not actually respect it — the choice of arbitration would be effective in one country and not in the other, thus creating a disadvantage for the party of the country that observes the Convention. Therefore, Party A (from the country bound to respect the New York Convention) would be prevented from bringing the case before its own courts and would be unable to enforce a possible arbitral award in the country of Party B, while the latter would be free to claim before its courts and — in case of arbitration — it would be able to enforce the award in the country of Party B.

Of course, the above does not mean that arbitration should always be avoided in similar contexts, but only that the various issues described above should be carefully checked on the basis of all circumstances of the case.⁹

(c) Non-arbitrability of the subject matter

Even if the other party is from a country that has ratified the New York Convention, arbitration is not advisable with respect to disputes concerning matters that are non-arbitrable under the law of the interested countries. This will be the case whenever the national legislator has decided to reserve the jurisdiction on certain matters exclusively to its courts.

Example 3-5 – Employment contract

A German manufacturer appoints a marketing consultant in Italy under an employment contract submitted to German law and providing a clause whereby all future disputes must be settled by a sole arbitrator appointed under the ICC rules of arbitration.Comment: Since under Italian law employment contracts fall under the exclusive jurisdiction of labour courts (which implies non-arbitrability of the issue), the Italian employee will be able to bring a claim before the competent labour courts notwithstanding the arbitration clause.

In situations of this kind, arbitration is, in principle, not recommended because:

1. the courts of the country where the issue cannot be subject to arbitration are entitled to disregard the arbitration clause (and thus affirm their jurisdiction, notwithstanding the arbitration clause), and
2. they can refuse recognition of foreign awards dealing with such non-arbitrable subject matters.

(d) Small claims

Another situation in which arbitration may not be advisable occurs when there are claims of limited economic value where the costs of the arbitration may be out of proportion to the amount in dispute.

Such a situation arises, for instance, when a producer concludes a great number of sales contracts, each involving rather limited amounts. In cases of this kind, it is normally preferable to opt for the ordinary jurisdiction, by putting a choice of forum clause in the general conditions of sale.

In any case, before deciding that arbitration is not the appropriate solution, one should also consider that the costs of arbitration may induce the other party to settle the dispute amicably. Moreover, there may be good reasons to prefer arbitration, even for a small dispute, in case there are issues of principle, which may give rise to a number of successive claims.

3.2.1.3 Arbitration and ordinary jurisdiction as alternative solutions

An important issue, which frequently gives rise to confusion, concerns the relations between arbitration and ordinary (domestic) jurisdiction.

It is important to have in mind that arbitration and ordinary jurisdiction are alternative solutions.

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Except for very special cases, arbitration is a dispute resolution means to be used instead of litigation before the state courts.

Nevertheless, it is not unusual to see contracts in which the parties have provided for arbitration and for the jurisdiction of ordinary (domestic) courts at the same time.

In most cases, this is because parties not familiar with legal issues do not clearly understand the difference between arbitration and the jurisdiction of state courts, and consequently do not see the contradiction of having both kinds of dispute resolution in the same contract, as in the “pathological” clause of the following example.

Clause 3-1 – “Pathological” arbitration clause

In the event of disputes concerning any aspect of the Agreement, including Claim of breach, remedy shall first be sought by communication between parties. lf such communication fails to resolve the dispute then the parties agree in advance to have the dispute submitted to binding arbitration through The American Arbitration Association or to any other US court. The prevailing party shall be entitled to attorney’s fees and costs. The arbitration may be entered as a judgment in any court of competent jurisdiction. The arbitration shall be conducted based upon the Rules and Regulations of the International Chamber of Commerce (ICC 500).

This clause provides at the same time arbitration under the AAA rules and the jurisdiction of any other US court: when a dispute was brought before a Swiss court by one of the parties, the objection of the other party that the court had no jurisdiction because of the choice of arbitration by the parties, was rejected considering that the clause could not be qualified as a valid arbitration clause.¹⁰Solutions of this kind are dangerous and should be avoided.

When clauses such as the above have been included in the contract, the lawyer who needs to make a claim is placed in a very difficult position. If he brings a claim under the arbitration clause, the defendant may answer that he should go to the ordinary courts and vice versa.

In some cases, the arbitration clause can nevertheless be saved by interpreting the contract so as to exclude a conflict between the two clauses: e.g. by claiming that the parties intended to provide two alternative solutions between which they will have to choose before initiating the dispute; or by reducing the scope of application of the choice of forum clause so that it does not conflict with the arbitration clause. For instance, it was considered in one case that the actual purpose of a clause submitting the contract to English law and to the jurisdiction of English courts was to determine the substantial law applicable to the dispute^.11In another case, it was decided that the parties only intended to determine which court would be competent for a possible enforcement of the arbitral award.¹²In any case, it is advisable to avoid situations of this kind and to make a clear choice between the two solutions.

Should the need arise, in very special circumstances, to combine the two solutions in the same contract,¹³ parties should not draft the respective clause without having consulted a lawyer having expertise in international arbitration.

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3.2.2 Mediation and ADR

A possible recourse to mediation or ADR¹⁴ is another important option that may be considered.

ADR (Alternative Dispute Resolution) covers a rather wide range of procedures aimed at providing an amicable settlement of a dispute. The most important of these procedures is mediation.

In fact, mediation has existed since the beginning of the civilized world, particularly under the name of “conciliation”. However, in recent years, new techniques have been developed that have significantly increased its effectiveness. Nowadays, an experienced mediator can succeed in getting parties to settle a large share of the disputes in which he is asked to intervene.

The role of the mediator is to help the parties find an amicable solution to their dispute. By meeting with the parties jointly and separately, he will obtain information about the underlying reasons for their differences and will attempt to guide the parties towards solutions of mutual interest.

Mediation is substantially different from arbitration. The mediator assists the parties in settling their disputes, but has no power to decide the dispute; his proposals, if any,¹⁵are not binding and the parties always remain free not to reach an agreement. On the contrary, an arbitrator (as well as a domestic court, of course) has the precise task of settling the case by a decision that binds the parties.

Many lawyers distrust mediation because they think that it is a “weak” instrument, since the mediator does not have the power to impose a solution. However, this is incorrect: a mediator can be effective precisely because the parties know they are dealing with someone who cannot decide the dispute — he can obtain the trust of the parties and consequently obtain information about matters that the parties would not disclose to a judge or an arbitrator.

If the mediation succeeds, it can be considered as an alternative to other means of dispute resolution. In fact, once a settlement is reached, the recourse to arbitration or to the courts becomes unnecessary.

However, if the mediation does not succeed, parties must be able to initiate the “normal” dispute resolution procedures. This is why clauses providing for mediation should be drafted with great attention, in order to avoid their being used as a means to hinder the recourse to dispute resolution (infra, § 4.5.3.4).

3.2.3 The ICC Mediation rules

The ICC Mediation Rules, effective as of 1 January 2014, are part of the ICC Publication 865, Arbitration Rules and Mediation Rules.

According to the Mediation Guidance Notes published by ICC,

… for the purpose of the ICC Mediation Rules, mediation is a flexible settlement technique, conducted privately and confidentially, in which a mediator acts as a neutral facilitator to help the parties try to arrive at a negotiated settlement of their dispute. The parties have control over both the decision to settle and the terms of any settlement agreement.”

The Mediation Rules are administered by the ICC International Centre for ADR which is a separate administrative body within ICC.

The Rules provide that the prospective mediator must sign a statement of acceptance, availability, impartiality and independence.

The mediation shall be conducted as agreed between the parties and the mediator. The proceedings shall be confidential.

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Before the ICC mediation proceedings can take place, the parties must agree to submit their dispute to the Rules.

Where there is an agreement between the parties to refer their dispute to the Rules, any party or parties wishing to commence mediation pursuant to the Rules shall file a written Request for Mediation (the “Request”) with the Centre.

In the absence of an agreement to refer their disputes to the ICC mediation, any party may propose the mediation by sending a request to the Centre, and the mediation proceedings will commence if the other party agrees.

This last option is important, because it gives a party the opportunity to attempt to convince the other party to participate in mediation proceedings, even in the absence of a previous agreement.

ICC suggests four types of mediation clauses that may be included by the parties in their contracts.

The first clause simply provides that the parties may try to settle any dispute that may arise from their contract by having recourse to the ADR rules.

Clause A – Option to use the ICC Mediation Rules

The parties may at any time, without prejudice to any other proceedings, seek to settle any dispute arising out of or in connection with the present contract in accordance with the ICC Mediation Rules.

This clause leaves the parties free to agree if they wish to engage in the Mediation Procedure according to the ICC Mediation Rules. From a strictly legal point of view, the clause has little meaning, since it imposes no obligation upon the parties. However, it may have a psychological impact upon the parties in the sense that if one of them proposes to refer the dispute to ADR, it will be more difficult for the other party to refuse a procedure that has been mentioned in the contract.

Under the second clause, parties are obliged to consider submitting the dispute to the ADR Rules.

Clause B – Obligation to consider the ICC Mediation Rules

In the event of any dispute arising out of or in connection with the present contract, the parties agree in the first instance to discuss and consider referring the dispute to the ICC Mediation Rules.

This clause still leaves the parties free not to proceed to Mediation under the ICC Rules, but requires them to discuss the possibility of referring the dispute to Mediation before taking such decision. Considering that in many cases parties refuse Mediation because they are not sufficiently informed about its advantages, this clause may be a useful tool for increasing the likelihood of an amicable settlement without imposing an obligation to this effect.

The third clause provides for a real obligation to submit possible disputes to the ICC Mediation procedure. It is designed to ensure that when a dispute arises, the parties will attempt to settle the dispute using proceedings under the Rules.

The clause also makes it clear that the parties do not need to conclude the proceedings under the ICC Mediation Rules, or wait for an agreed period of time, before commencing arbitration proceedings.

Clause C - Obligation to refer dispute to ICC Mediation Rules while permitting parallel arbitration proceedings if required

(x) In the event of any dispute arising out of or in connection with the present contract, the parties shall first refer the dispute to proceedings under the ICC Mediation Rules. The commencement of proceedings under the ICC Mediation Rules shall not prevent any party from commencing arbitration in accordance with sub-clause y below.

(y) All disputes arising out of or in connection with the present contract shall be finally settled under the Rules of Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the said [Page66:]Finally, the fourth clause is identical to the third, except that it provides for ICC arbitration in case the dispute has not been resolved within 45 days after the filing of the request for ADR.

Clause D - Obligation to refer dispute to the ICC Mediation Rules, followed by arbitration if required

In the event of any dispute arising out of or in connection with the present contract, the parties shall first refer the dispute to proceedings under the ICC Mediation Rules. If the dispute has not been settled pursuant to the said Rules within [45] days following the filing of a Request for Mediation or within such other period as the parties may agree in writing, such dispute shall thereafter be finally settled under the Rules of Arbitration of the International Chamber of Commerce by one or more arbitrators appointed in accordance with the said Rules of Arbitration.

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