International Arbitration: A Tool To Manage Risk When Dealing In High Growth/High Risk Markets

Thursday, May 1, 2008 - 01:00

As many businesses experience declining growth in their domestic and traditional markets, they are looking increasingly towards the "BRIC" countries (Brazil, Russia, India and China) and other high-growth economies outside their traditional trading areas. The report of the International Monetary Fund entitled the " World Economic Outlook" which was released on April 9, 2008 downgraded projections for growth in 2008 and 2009 across the major Advanced Economies including those of the U.S., Canada and Western Europe whilst continuing to project relatively higher rates of growth across certain Emerging and Developing Economies including China and India. It seems likely that the move by many U.S. businesses to target Emerging and Developing Economies will gather pace.

This article will assess the extent to which international arbitration can play a role in assisting U.S. businesses in managing commercial risk when seeking to invest and/or trade in higher-risk overseas markets, and it will provide a number of suggestions on ways to limit risk.1

"Home Courts" Are Not An Option

When dealing in many high growth overseas markets, court-based dispute resolution is simply not a viable option.Seen from the perspective of the U.S. business, the "home court" of the other party may appear to have a poor reputation for neutrality and impartiality. This may be all the more the case in circumstances where the other party is a state-controlled or politically connected entity and there is perceived to be a risk of state interference in the operation of the local judiciary.

It is also increasingly the case that many non-U.S. parties are unwilling to agree to subject prospective disputes to determination by U.S. courts. The rationale behind this may differ in individual cases but may include: an adverse perception of the jury trial concept, an aversion to penal damages or simply an unwillingness to agree to the U.S. business home court as a result of a less coherently reasoned reciprocal reaction to the rejection of its own home court.

Factors Favoring Prescribing International Arbitration As The Dispute Resolution Mechanism In Cross-Border Contracts

A cynic might suggest that in many cross-border transactions the primary reason why international arbitration is selected by parties is that it is " the least worst option." This may be true, but the relative attractiveness of international arbitration can in fact be assessed more analytically by reference to the following factors.

Neutral and Independent Decision Makers

One of the key reasons for prescribing international arbitration is the ability to select a neutral and independent tribunal that will determine any disputes that may arise under the relevant contract. This addresses precisely the kind of "home court" deficiencies noted above in connection with traditional litigation.

It is a basic tenet of arbitration that the tribunal is neutral and most domestic arbitration laws and most sets of arbitral rules promoted by the leading arbitral institutions expressly provide for neutrality and/or independence, though the precise definition of what constitutes a conflict of interest which impairs neutrality differs across the world.

The Availability of a Range of Viable "Seats" Across the World

The clause in the contract prescribing the parties' agreement to arbitrate (or a subsequent submission agreement executed after a dispute has crystallised) should expressly prescribe the "seat" or legal place of the arbitration.

The key criteria to consider when selecting a seat are to ensure that the country in which the city is situated has both a supportive arbitration law and a supportive but non-interventionist judiciary and that the country has ratified the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 (the "New York Convention").

The Arbitration Law

Key requirements are that the law:

• establishes the requirement that all arbitrators are neutral;

• provides a court-administered mechanism for appointment of arbitrators in the absence of agreement between the parties; and

• provides a court-administered mechanism for challenge to and removal of arbitrators in circumstances in which there are justifiable doubts as to their impartiality or their capability to perform their role.

The Judiciary

It is also essential to ensure that the courts of the country in which the seat is located are supportive yet non-interventionist. An important element of this (especially in countries that are new adopters of the concept of international arbitration) is that the judiciary is experienced in interpreting arbitration law and so can be relied upon to facilitate (without undue court interference) an efficient arbitral process.

In recent years the number of arbitrataion centres has grown rapidly as the popularity of international arbitration has grown. There are now arbitration centres in many cities in the U.S. (with New York chief amongst them) together with London, Paris, Stockholm, Geneva, Zurich, Vienna, Singapore and Hong Kong.

It should also be borne in mind that the choice of seat can influence the style and approach to the practice and procedure applied in the arbitration. Whilst there could be said to be a developing set of "procedural norms," an arbitration conducted in a civil law seat such as Berlin before a civil law-schooled tribunal may differ somewhat from one conducted in a common law city such as London or New York.

The Opportunity to Select the Applicable Law of the Contract

Whilst it is possible to prescribe that the law of country A will regulate a contract and yet prescribe that disputes under that contract will be resolved by the courts of country B, that is often felt to be a more dangerous course to adopt. This is because domestic courts whilst adept at applying the domestic law of the relevant country are less used to applying "foreign" laws. In the area of international arbitration it is commonplace to prescribe that the substantive law of the contract is that of country C with the parties selecting a seat in country D and being themselves based in or primarily headquartered in countries E and F.

The interaction between the choice of seat and the choice of substantive law does however bring with it various hazards especially when the parties additionally prescribe that the arbitration will be governed by specific institutional rules. Many such rules mandate that any sole arbitrator or chair of a three-person tribunal must be of a neutral nationality to the parties. It can create significant difficulties in arbitrator selection if the chosen law of the contract is also the law of the country of nationality of one of the parties, especially when that law is one that is practiced by a smaller pool of experienced international arbitrators.

Flexibility of Procedure

As originally developed, arbitration was intended to offer a straightforward means by which business people could secure the resolution of commercial disputes more speedily and cost effectively than by reference to domestic courts. It first gained popularity in business sectors in which disputes tended to develop over highly technical issues or ones for which there was perceived to be a requirement for the decision maker to possess a high level of industry knowledge.

Today, whilst it is often said that many high stakes international commercial arbitrations increasingly resemble court disputes, scope continues to exist to finesse the actual procedure to fit the dynamics of the particular dispute.

Limits on the Scope to Appeal

One of the greatest criticisms of traditional Litigation (in both the Developed and Emerging countries of the world) is that the availability of rights of appeal means disputes can last for many years. In arbitration the right to appeal on the merits is precluded, and even when the seat of the arbitration is in a country that allows for appeals on a point of law to the courts at the seat, that can be expressly excluded by the parties in their agreement to arbitrate.

Enforceability

Perhaps the greatest advantage of international arbitration over traditional litigation is the far greater scope that exists to enforce an arbitral award than any court judgement.

Court judgements can only be enforced against assets located in countries in which the domestic courts will recognise the judgement of the "foreign court." The international network of reciprocal enforcement treaties is far from universal, and there are many countries across the world that are unlikely to enforce a U.S., English or French court judgement.

By contrast the New York Convention establishes a network of over 140 countries across the world that have by ratifying the convention agreed to enforce arbitral awards made by a tribunal seated at a country that is also a party to the convention. Whilst there are a number of examples of countries that have ratified the convention, but whose judiciary remain prone to misapply the convention and so refuse to enforce arbitral awards made in favour of nationals of the country in which enforcement is sought, the picture is far better than in respect of the enforcement of court judgements.

Playing The "Nationality Game"

The primary route to manage risks when dealing cross border is of course through a combination of the terms of the contract with the counterparty and overarching commercial structures (including payment protection mechanisms), but when dealing cross border in dynamic markets U.S. businesses should be aware of the scope which may exist to bring treaty claims as a last line of protection.

Whilst this is a complex area, treaty claims are claims that a party can make against a host state in which a qualifying investment has been made, if the investor's rights have been infringed in a manner that constitutes a breach of the terms of either a bilateral investment treaty (a "BIT") or a multilateral investment treaty ("MIT") like NAFTA. There are now over 2,500 BIT's world-wide (46 involving the U.S., of which 39 are in force).

The most common form of infringement of rights giving rise to a treaty claim is "expropriation," and current examples include the alleged expropriation by Ecuador of the oil exploration and extraction rights of the U.S. oil major Occidental and the recent actions of Venezuela in relation to the cement industry.

At the contracting stage U.S. businesses should consider whether their transaction has the potential to qualify as an investment and if so to consider how the transaction is structured so as to trigger an ability to claim nationality in a country that has a BIT with the host state.

For a version of this article that includes a complete set of footnotes, as well as a checklist of "Do's and Don'ts" for international arbitration, please see: http://www.klgates.com/newsstand/Detail.aspx?publication=4461.

1 See further my chapter on drafting effective arbitration clauses in the PLC Cross-Border Handbook on Arbitration, publication expected May 2008, also available on-line at www.practicallaw.com.

Ian Meredith is a Partner in the London office of Kirkpatrick & Lockhart Preston Gates Ellis LLP. His practice focuses on international commercial disputes encompassing alternative dispute resolution, international arbitration and both domestic and multijurisdictional litigation.

Please email the author at ian.meredith@klgates.com with questions about this article.