How to Draft an Arbitration Clause: 4 Key Considerations

KEY TAKEAWAYS:

• Instead of drafting your own arbitration agreement, consider relying on an institution’s model arbitration clause because there is no doubt the language will be enforceable.
• Any reputable arbitral institution provides its model arbitration clause on its website, which can simply be copied and then adopted into the contract.
• Instead of making mediation (and/or negotiation) a mandatory step, it is much better to simply decide on a case-by-case basis whether it is appropriate for your dispute.

Arbitration is by far the most preferred method to resolve international disputes, according to a study from Queen Mary University of London and White & Case,[1] whether as a standalone method (31%) or in combination with ADR (59%). Whether you love or hate arbitration, there is a great chance that you will face an arbitration clause in a contract one way or another.

You’d then be well-advised to not merely accept the arbitration clause, but first assess whether it meets your needs. This article breaks down the process of drafting an arbitration clause into four main considerations.

1. Rely on an arbitral institution to administer the arbitration.

Broadly speaking, there are two forms of arbitration: institutional and ad hoc. An arbitral institution is a permanent organization with a set of its own arbitration rules regulating the services provided by the organization. In institutional arbitration, the parties decide to incorporate these rules. Ad hoc arbitration can be defined as arbitration proceedings with no institution involved.

The arbitration services provided by institutions are often not cheap. And the fees for the administration of a dispute increase as the amount in dispute increases. For example, it costs USD $5,000 to file a Request for Arbitration with the International Chamber of Commerce (ICC), the best-known arbitral institution globally. Further fees will be due for the administration of the proceedings. For example, the Singapore International Arbitration Centre (SIAC), Asia’s best-known arbitral institution, will ask for around $25,000 to manage a matter with an amount in dispute of $5 million.

However, administration by an institution provides stability. If the institution does not take care of matters (such as advance payments of costs, the appointment of arbitrators, etc.), the arbitration proceedings will almost certainly not run as smoothly as they would in an administered arbitration. The fees paid to the arbitral institution usually represent just a small portion of the total amount spent on the arbitration. Legal fees usually exceed 80% and arbitrators also take a large chunk. The fees are still a very good trade-off for stability.

2. Implement an institution’s model arbitration clause and don’t change its core aspects.

You can either draft your own arbitration agreement or rely on an institution’s model arbitration clause. The latter is usually the better choice because there is no doubt whether that clause will be enforceable.

Any reputable arbitral institution provides its model arbitration clause on its website, which can simply be copied and then adopted into the contract.[2]  The American Arbitration Association – International Center for Dispute Resolution (AAA-ICDR) even offers a free and anonymous clause builder.[3] If you provide basic information such as the industry you are in, it will come up with the most suitable clause for your dispute.

A model clause typically consists of a core portion and optional parts. The core portion covers the scope of disputes covered by arbitration. Here is an example core provision from the London Court of International Arbitration:[4] “any dispute arising out of or in connection with this contract, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration under the LCIA Rules, which Rules are deemed to be incorporated by reference into this clause.”

Do not change this portion! In practice, many jurisdictional issues only arise because commercial parties or their lawyers (inexperienced with international arbitration) change the core aspects of a clause. But model clauses are described as such because you should model your contract after them–not use them as some form of guidance only.  Hence, it is typically best to simply adopt the model clause of your preferred institution. Your future self will thank you if you end up having to rely on it!

3. Carefully consider the optional portion of an arbitration clause.

There are seldom jurisdictional issues arising from the optional portions of an arbitration clause. However, this does not make the optional part any less important.

Typically, the optional part is about:

• the seat of the arbitration (e.g., Tokyo, Paris, New York, etc.);
• the language of the arbitration; and
• the number of arbitrators.

Seat of Arbitration

The seat of arbitration is the legal place of arbitration, which consequently determines the procedural framework of the arbitration (the so-called lex arbitri). This may coincide with the physical place where the hearing takes place–the venue–but, in principle, the two are unconnected. This is by far the most important part of the optional portion of an arbitration clause because the courts at the seat have the power to act in aid of an arbitration. The courts of the seat also have jurisdiction when it comes to the sole remedy against an arbitral award before courts, a setting-aside action.

First and foremost, you don’t want to end up in a country where courts are corrupt, biased against foreign companies, or not supportive of arbitration. If that’s the case, you may suddenly find yourself having to litigate in that country because the courts found the arbitration agreement to be invalid, a neutral arbitrator to be biased, or perfectly proper proceedings to have been conducted against natural justice (oh yes, we’ve seen it all!).

Language of Arbitration

But there are also additional factors you should consider, such as the language spoken in the courts of the seat. Can the lawyers there communicate in English or your preferred language? If not, how expensive are translations? Another factor to consider is the general legal framework. Is a party from a common law country like the US fine with the courts of a civil law country?  Also, keep in mind the number of court tiers in case of setting-aside proceedings. For example, in Austria and Switzerland, the Supreme Court is the sole instance where a setting aside application may be heard – there can be no further appeals from these courts.

Number of Arbitrators

It is best to not determine the number of arbitrators in advance because you never know what type of dispute will arise. If you set the number to three, there may be unnecessary and additional costs in a small dispute. If you set the number to one, you may regret it when the stakes are very high because having more arbitrators (perhaps with differing specialties or backgrounds) would have been advantageous.

Arbitral institutions have a very good sense of when three arbitrators are better than one and they will take a determination only when an arbitration has been commenced. That’s the best time to make such a determination, so you should leave that number open.

4. Use multi-tiered arbitration or dispute resolution clauses with prudence.

Multi-tiered clauses usually provide for a negotiation stage, a mediation stage, and an arbitration stage. Multi-tiered clauses used to be popular, but they have since lost their appeal to some extent.

When a dispute arises, the parties always attempt to negotiate to resolve it, one way or another. It is best not to provide for a 30-, 60- or 90-day time limit during which negotiations must take place. If one party truly doesn’t want to negotiate or even communicate, you will be wasting precious time because you will likely have to wait for the lapse of the agreed time-limit before you can file for arbitration.

Combining mediation with arbitration is a good idea, but conducting mediation at the outset of a dispute often does not lead to a settlement. This is because the parties do not want to put their cards on the table yet having the arbitration in mind. It is usually much more useful to enter into mediation at a later stage of the dispute, such as when each side has filed at least one written brief.

Furthermore, the problem with a non-participating party described above in the context of a mandatory negotiation also exists in the scope of mandatory mediation. Consequently, it may be necessary to “waste” a few months on mediation proceedings, that have no chance of resulting in a mediated settlement agreement.

Instead of making mediation (and/or negotiation) a mandatory step, it is much better to simply decide on a case-by-case basis whether it is appropriate for your dispute.

Drafting arbitration agreements is easy if one sticks to the basics set out above. However, getting the arbitration clause wrong may lead to months of pre-merit disputes on matters of jurisdiction. Or, even worse, ending up in a place where the courts are hostile to foreign parties and to the arbitration process.

[1]               Queen Mary University of London and White & Case, 2021 International Arbitration Survey: Adapting Arbitration to a Changing World, available at https://arbitration.qmul.ac.uk/research/2021-international-arbitration-survey.

[2]               For instance, see www.icdr.org/clauses for the International Center for Dispute Resolution’s model clauses. The ICDR is the American Arbitration Association’s international arm.

[3]                For details, see www.clausebuilder.org.

[4]                See www.lcia.org/dispute_resolution_services/lcia_recommended_clauses.aspx for details.