Many contracts have an arbitration clause. The provision concerning arbitration is often placed at the end of the contract, and you often get the impression that the clause has not been the object of much attention. The parties have run out of energy when they come to the last provisions of the contract, and standard provisions are therefore often chosen which have not been assessed in relation to the specific transaction or any potential disputes.
But you need to be careful not to give such scant attention to arbitration clauses. If an arbitration clause is worded incorrectly, it may be very difficult and expensive to have a dispute settled - to obtain an award in favour of a legitimate claim.
Disputes and arbitration
An agreement concerning arbitration prevents the ordinary courts from having authority, and it is therefore not possible for a party to a dispute to opt out arbitration once the dispute arises and to bring action before the ordinary courts instead. The parties may jointly agree on this. This means that the parties may agree not to have an arbitration clause so that a dispute may instead be settled before the ordinary courts. However, it may be difficult to agree on this once the dispute has arisen as one party may at that time have an interest in the dispute being difficult and expensive to pursue for the other party.
In the last months, Horten has been involved in several disputes where the arbitration clause has caused challenges in relation to an appropriate solution of the dispute. Below, we will review two cases in which we have been involved. They each illustrate the problem - that it is important to carefully consider the wording of an arbitration clause.
The expensive arbitration clause
The first case concerns an employee purchasing a small block of shares in a company. The purchase price of the shares is a few thousand Danish kroner to be paid as instalments over the next three years. A few months after the purchase, the company goes bankrupt. The employee feels that she has been misinformed about the company’s situation and has made her investment on a wrong basis. She wants to cancel the purchase so that she does not have to pay the instalments over the next three years for shares which are now of no value. The seller maintains the purchase.
In the transfer agreement, it is stated that a dispute concerning the share transaction must be settled by an arbitration tribunal consisting of three members to be appointed by the Association of Danish Law Firms, the Danish Association of State-Authorised Public Accountants and the president of the Danish Eastern High Court. The transfer agreement also lays down rules on the exchange of documents and an oral negotiation of the dispute before the arbitration tribunal. Finally, the transfer agreement states that the arbitration tribunal lays down the rules and procedures of the proceedings.
Consequently, the parties have agreed that in case of a dispute, they must contact three different institutions which are each to appoint an arbitrator (in some cases against payment of a fee). The three arbitrators will then prepare the specific rules to apply to the dispute in question. Documents are then to be exchanged, in which each party will account for its views, and then there will be an oral negotiation (premises must be rented), at which the parties, the arbitrators, witnesses, etc. are to attend.
The remaining debt prior to the bankruptcy is not commensurate with such expensive procedure.
This case is exactly an example of how an inappropriate arbitration clause may make it very difficult and expensive to have a dispute settled. The parties have agreed on comprehensive and complex arbitration proceedings compared to the relatively simple and small claim, and the expenses relating to a settlement of the dispute will quickly amount to the disputed claim. Obviously, this is inappropriate and may end up preventing a solution of the dispute.
In practice, the arbitration clause will not have the intended effect. The clause prevents a solution instead of facilitating it.
The too simple arbitration clause
In many ways, the second case is the opposite of the first case. The second case concerned a medium-sized transfer of a business between a Danish seller and a Swedish purchaser. The company in question quickly had financial problems, and a dispute arose between the purchaser and the seller. The parties disagreed on the construction of a number of warranties provided in connection with the transfer.
According to the transfer agreement, disputes were to be settled based on a simplified procedure before an international arbitration tribunal. The simplified procedure implied that each party was generally to submit one written document to the arbitration tribunal which was then to deliver an award on the basis of the written documentation. There was also a number of limitations as to witnesses (only limited witness statements were allowed) as the matter was not to be negotiated orally.
Also in this case, the arbitration clause was inappropriate. It did not take into account the circumstances of the specific transaction and the potential disputes that could arise. The agreed arbitration clause was suited for a quick and cheap settlement of uncomplicated disputes. This lacks coherence with the actual transfer of a business where it is to be expected that disputes may be complex with comprehensive documentation and the need to examine witnesses in detail.
The arbitration clause - Perhaps the most important clause in the contract
In the above two cases, the parties had been better off if the arbitration clauses had been switched. In the second case, the parties succeeded in agreeing on other and more appropriate rules to govern the arbitration proceedings. However, this is far from always possible. Consequently, it is greatly to be preferred that an appropriate arbitration clause is agreed upon from the beginning, which is adapted to the specific transaction and any potential disputes which may arise.
In summary, it is therefore essential that the arbitration clause is not given low priority, simply because it traditionally appears at the end of the contract. When a dispute occurs, and the contract has to stand its test, the arbitration clause is perhaps the most important clause in the contract.