Arbitration Clauses in Commercial Contracts: What Companies Should Know Before Signing

During the negotiation of a commercial contract, the attention of companies is usually focused on the price, terms, method of payment, liability of the contracting parties and security instrument. The provision on dispute resolution is often left to the end and is accepted without detailed analysis.

The problem is that just a few sentences of the arbitration clause can determine where the future dispute will be conducted, according to which rules, in which language, before how many arbitrators and at what cost.

Once the dispute has already arisen, it is usually too late to negotiate how it will be resolved.

That is why the arbitration clause should not be seen as a standard final contract provision. As with other key provisions of a commercial contract, its consequences should be assessed before signing, especially in the case of large-value contracts, complex business relationships and contracts with foreign partners.

What is an arbitration clause?

An arbitration clause is a contractual provision that the parties agree to entrust a specific dispute or disputes that may arise from their legal relationship to arbitration instead of a state court.

According to the Law on Arbitration of the Republic of Serbia, a dispute can be resolved through arbitration only based on the agreement of the parties. Arbitration can be agreed for property disputes about rights freely available to the parties, except when the exclusive jurisdiction of the court is prescribed for a specific dispute.

An arbitration agreement can be contained in the commercial contract itself as an arbitration clause or concluded as a separate agreement.

It is also important that the arbitration clause is not simply legally identified with the rest of the contract. The issue of the existence, validity and effect of an arbitration agreement can have its own legal significance and that is why the wording of the clause should be approached carefully.

The practical consequence of a valid arbitration agreement is particularly significant. If, despite the arbitration clause, one party brings a dispute covered by the arbitration clause in a state court, the court, upon timely objection by the other party, declares itself without jurisdiction and dismisses the suit, unless it finds that the arbitration agreement is clearly void, without effect, or unenforceable.

What is a company actually accepting when it contracts to arbitrate?

A company does not just choose another forum to resolve the dispute, but accepts a different process mechanism.

Depending on the content of the clause, the parties can decide on the arbitration institution, the number of arbitrators, the method of their selection, the seat of the arbitration, the language of the procedure and the rules according to which the procedure will be conducted.

In institutional arbitration the procedure is organized by a specific arbitration institution according to its rules. In ad hoc arbitration, there is no such permanent institution, so the organization of the procedure is based to a greater extent on the agreement of the parties and the chosen procedural rules.

The Arbitration Law of Serbia allows both institutional and ad hoc arbitration.

One ​​of the most important consequences concerns legal remedies against the decision.

The arbitration decision is not reviewed in the same way as the first-instance court verdict in the regular appeal procedure. The law provides for a lawsuit to annul a domestic arbitration award only for certain reasons. The deadline for its submission is, as a rule, three months from the receipt of the arbitration decision. A domestic arbitration decision has the force of a domestic court decision.

Therefore, the arbitration decision should not be made with the assumption that the dissatisfied party will later simply be able to request a completely new decision before the state court.

When can arbitration have advantages?

Arbitration can be a very good solution, but not in every business relationship.

One of its important advantages is the possibility for the parties to choose arbitrators with experience in the field from which the dispute may arise. In complex construction, energy, financial, technological or international business relations, the arbitrator’s expertise can be of considerable practical importance.

Arbitration also provides greater flexibility in the organization of the procedure. The parties can agree on the language, seat of arbitration, number of arbitrators and, to some extent, procedural rules.

Neutrality is especially important in international agreements. A company from Serbia and a company from another country may not want to resolve a future dispute before the courts of the country of their contractual partner. Arbitration allows them to choose a neutral seat and an international arbitral institution.

A significant advantage may also exist in the international enforcement of the award.

The 1958 New York Convention establishes an international framework for recognition and enforcement. foreign arbitration decisions, and Serbia is one of the contracting states of the Convention. The broad international application of the Convention is one of the reasons why arbitration is particularly important in cross-border business relations.

However, this does not mean that the recognition and enforcement of every arbitration decision is automatic. There are reasons why recognition or enforcement may be refused.

What are the risks of an arbitration clause?

One of the most common mistakes is to assume that arbitration is always faster and cheaper than court proceedings.

It is not.

In high-value disputes, the arbitrator’s fee, the administrative costs of the arbitration institutions, legal fees, expertise, translations and the costs of maintaining proceedings can be significant. The costs will depend on the chosen institution, the value and complexity of the dispute, the number of arbitrators and other circumstances.

The speed of the procedure is not guaranteed either. Complex international arbitration can take a long time.

Additional risk arises precisely from the finality of the arbitration decision. The limited possibilities of its judicial review can be an advantage when the company wants a final and efficient settlement of the dispute, but they become a serious disadvantage if the arbitral tribunal makes a decision with which the party fundamentally disagrees.

Problems can also arise if, without sufficient thought, arbitration is agreed in a foreign country, in a foreign language or before an institution whose rules and costs have not been previously analyzed.

That is why the same arbitration clause should not be automatically transferred. from one contract to another.

What should a good arbitration clause regulate?

A well-written arbitration clause should first of all clearly define which disputes are covered by it.

Formulation that leaves room for a dilemma as to whether a particular claim should be resolved before arbitration or a state court can produce exactly what the parties wanted to avoid: an additional dispute about who is responsible in the first place. competent to settle the main dispute.

If institutional arbitration is chosen, it is necessary to mark the institution correctly. Improper or imprecise naming of an institution can cause serious procedural problems.

The number of arbitrators should also be considered. A single arbitrator can reduce costs and simplify the process. A three-member arbitration panel may be more suitable for complex disputes of high value, but as a rule it also means higher costs.

The method of selecting arbitrators is also important.

With international contracts, special attention should be paid to the language of the procedure. If this issue is not resolved in advance, additional costs may arise for the translation of contracts, business documents, expert findings and other evidence.

Finally, it is necessary to correctly determine the seat of arbitration.

The seat of arbitration is not only the city specified in the contract

The concept of the seat of arbitration has a legal meaning that goes beyond the physical place where the arbitrators and the parties hold a meeting or hearing.

The seat of arbitration connects the arbitration with a specific national legal system and may be relevant for the procedural legal framework of arbitration, court support for arbitration proceedings and the procedure for annulment of an arbitration award.

In practice, this means that the choice of seat may also affect the courts of which country any proceedings for the annulment of an arbitration award are conducted.

According to the Serbian Law on arbitration, its provisions are applied to arbitration and arbitration proceedings when the place of arbitration is on the territory of the Republic of Serbia, with special rules for international arbitration.

That is why a clause which, for example, stipulates that the seat of arbitration is in Belgrade is not just an agreement on where the eventual hearing will be held.

It is a legally important decision.

An arbitration clause is not the same as a choice of governing law

This is one of the most important differences when drafting international commercial contracts.

Companies should consider at least three issues separately.

The first is who resolves the dispute: state court or arbitration.

The second is the seat or the legal framework in which the arbitration takes place.

The third is which substantive law regulates the contract and the rights and obligations of the contracting parties.

These issues can lead to different countries.

For example, the parties can contract for arbitration based in one country, choose a specific international arbitration institution, and at the same time provide that the law of another country applies to their basic contract.

That is why the wording “disputes shall be settled by arbitration” is not a substitute for the applicable law clause.

Unclear regulation of these issues can significantly increase legal uncertainty once a dispute has already arisen.

Special caution in international contracts

In a domestic contract, the wrong arbitration clause can be costly. In the case of an international contract, the consequences can be much more complex.

Before signing, one should consider where the other contracting party has property and where the eventual arbitration award would have to be enforced.

If the company wins the dispute, but the opposing party does not have property in the country where the decision was made, the issue of international recognition and enforcement becomes crucial.

The New York Convention plays a central role in this area. Its purpose is to establish a common framework for the recognition of arbitration agreements and the recognition and enforcement of foreign and non-domestic arbitral awards in contracting states.

However, the fact that a particular state is a contracting party to the New York Convention is not the only issue to be verified. In practice, it is important to analyze the local rules on recognition and enforcement, as well as the possible reasons for which the enforcement of a specific decision could be challenged.

The company should evaluate much more than just the issue of enforcement.

The language of the procedure, distance and costs, availability of appropriate arbitrators, rules of the chosen institution, seat of arbitration, applicable law and nature of the potential dispute are important.

The neutrality of the forum can be a great advantage, but only if the clause is carefully designed.

The most common mistakes in contracting arbitration

One of the most common mistakes is copying the arbitration clause from a previous contract.

A clause that was appropriate for an international contract worth ten million euros may not make sense in a much smaller domestic one. business.

Another problem is the imprecise naming of the arbitration institution. If the parties want institutional arbitration, the correct name of the institution should be used and its valid rules should be checked.

A common mistake is to simultaneously enter several mutually incompatible provisions on jurisdiction. In one part of the contract it may be written that disputes will be settled by arbitration, and in the other that a certain state court is competent for them.

Such a contradiction does not represent additional security. On the contrary, it may open a dispute about what the parties actually agreed to.

The overly narrow or unclear formulation of the range of disputes covered by the clause can also be problematic.

Finally, companies sometimes negotiate the entire commercial part of the contract, and accept the arbitration clause without first assessing the costs of the chosen institution and the consequences of the chosen seat.

That’s the wrong order of priority.

What to check before signing a commercial contract?

Before accepting an arbitration clause, a company should be able to answer several practical questions.

Who will decide the future dispute? Is institutional or ad hoc arbitration chosen? If there is an institution, which institution is it exactly and what rules does it apply?

It is necessary to check where the seat of arbitration is and what legal consequences that choice produces.

The company should also know whether a single arbitrator or a panel will decide, how the arbitrators will be appointed and in what language the proceedings will be conducted.

It is also necessary to analyze the costs. In the case of institutional arbitration, one should look at the valid tariff of the specific institution, and not start from the general assumption that arbitration is cheaper than the court.

The applicable law should be checked in particular. Choosing to arbitrate does not automatically resolve that issue.

For international contracts, it is necessary to think several steps in advance: if the dispute is won, where does the opposing party have property, what will claim collection look like and where will the decision probably have to be recognized and enforced?

Only when there are clear answers to these questions can one assess whether a particular arbitration clause really protects the company’s business interests.

An arbitration clause is negotiated before a dispute, not after it

The greatest value of a well-drafted arbitration clause is seen precisely when the business relationship no longer works as planned.

Then a few sentences of the contract determine who resolves the dispute, where the proceedings will be conducted, how many arbitrators will decide, what procedural framework will be applied and how much room there is for reviewing the final decision.

Arbitration can be a very effective way of resolving commercial disputes, especially in international business relations. But it is not universally the best solution. The appropriate choice depends on the nature and value of the contract, the relationship of the contracting parties, the potential dispute, the countries in which they do business and the place where the future decision should have effect.

Before accepting an arbitration clause in a domestic or international commercial contract, it is necessary to assess its procedural, financial and executive consequences. The best moment for that assessment is before signing the contract, while the dispute does not yet exist.

JPLAW advises companies in the negotiation, drafting and legal analysis of commercial contracts, including the evaluation of arbitration clauses and the selection of an appropriate mechanism for resolving potential disputes.