Out-Law Guide | 12 Aug 2011 | 10:56 am | 8 min. read
Arbitration is a form of alternative dispute resolution (ADR) which allows disagreements between two parties to be resolved outside of the traditional court system. In an arbitration case the parties to a dispute will refer it to one or more persons - known as the 'arbitrators' or an 'arbitral tribunal' - by whose decision or award they agree to be bound. Arbitration is often used to resolve commercial disputes, particularly in the context of international commercial transactions.
This guide considers the differences between institutional and 'ad hoc' arbitration methods, and the advantages and disadvantages of each.
An institutional arbitration is one in which a specialised institution intervenes and takes on the role of administering the arbitration process. Each institution has its own set of rules which provide a framework for the arbitration, and its own form of administration to assist in the process.
Some common institutions are the London Court of International Arbitration (LCIA), the International Chamber of Commerce (ICC), the Dubai International Finance Centre (DIFC) and the Dubai International Arbitration Centre (DIAC). There are approximately 1200 institutions worldwide which offer arbitration services, and some will deal with a particular trade or industry. Care should be taken in the selection process as some institutions may act under rules which are not adequately drafted.
Often the contract between two parties will contain an arbitration clause which will designate a particular institution as the arbitration administrator. If institutional administrative charges are not a concern for the parties, this approach is usually preferred to less formal 'ad hoc' methods of arbitration.
Advantages of institutional arbitration
For those who can afford institutional arbitration, the most important advantages are:
Institutional arbitration saves parties and their lawyers the effort of determining the arbitration procedure and of drafting an arbitration clause, which is provided by the institution. Once the parties have selected an institution, they can incorporate that institution's draft clause into their contract. They may wish to add other elements to the clause in some circumstances – for more information, please see our separate OUT-LAW Guide to Drafting an Arbitration Clause. These clauses can be amended from time to time by the institution, drawing on experience in conducting arbitrations regularly, and ensures there is no ambiguity in relation to the arbitration process.
An institution's panel of arbitrators will usually be made up of experts from various regions of the world and include many different vocations. This allows parties to select an arbitrator possessing the necessary skill, experience and expertise to provide a quick and effective dispute resolution process. It should be noted, however, that the parties merely nominate an arbitrator - it is up to the institution to make an appointment and the institution is free to refuse an appointment if it considers that the nominated arbitrator lacks the necessary competence or impartiality.
A further benefit of institutional arbitration is that the parties and arbitrators can seek assistance and advice from institutional staff. In a less formal ad hoc arrangement, parties to the arbitration would have to approach the court in order to take the arbitration forward and this would inevitably incur further expenditure.
One of the perceived advantages of arbitration generally is that it provides a final and binding award which cannot be appealed. However, there is an inherent risk that a mistake made by a tribunal could not be rectified at a later stage. To counterbalance this risk, some institutional rules provide for scrutiny of the draft award before the final award is issued. A dissatisfied party could then appeal to an arbitral tribunal of second instance which would be able to confirm, vary, amend or set aside the draft award. Less formal processes provide no such option.
Disadvantages of institutional arbitration
The primary disadvantages of institutional arbitration are:
Ad hoc arbitration
An ad hoc arbitration is one which is not administered by an institution such as the ICC, LCIA, DIAC or DIFC. The parties will therefore have to determine all aspects of the arbitration themselves - for example, the number of arbitrators, appointing those arbitrators, the applicable law and the procedure for conducting the arbitration.
Provided the parties approach the arbitration with cooperation, ad hoc proceedings have the potential to be more flexible, faster and cheaper than institutional proceedings. The absence of administrative fees alone provides an excellent incentive to use the ad hoc procedure.
The arbitration agreement, whether reached before or after a dispute has arisen, may simply state that 'disputes between parties will be arbitrated'. It is infinitely preferable at least to specify the place or 'seat' of the arbitration as well since this will have a significant impact on several vital issues such as the procedural laws governing the arbitration and the enforceability of the award. If the parties cannot agree on the detail all unresolved problems and questions relating to the implementation of the arbitration - for example, how the tribunal will be appointed or how the proceedings will be conducted – will be determined by the 'seat' or location of the arbitration. However, this approach will only work if the seat of the arbitration has an established arbitration law.
Ac hoc proceedings need not be kept entirely separate from institutional arbitration. Often, appointing a qualified arbitrator can lead to the parties agreeing to designate an institutional provider as the appointing authority. Additionally, the parties may decide to engage an institutional provider to administer the arbitration at any time.
Advantages of ad hoc arbitration
A properly structured ad hoc arbitration should be more cost effective, and therefore better suited to smaller claims and less wealthy parties. The ad hoc process places a heavier burden on the arbitrator to organise and administer the arbitration. A distinct disadvantage of the ad hoc process is that its effectiveness is dependent on how willing the parties are to agree on the arbitration procedures at a time when there may already be a dispute. The failure of one or both parties to fully cooperate can result in time spent resolving issues or an ultimate recourse to court.
A primary advantage of the ad hoc process is its flexibility, enabling the parties to decide the dispute resolution procedure themselves. However, this will of course require a greater degree of effort, cooperation and expertise from the parties to determine the arbitration rules. Often the parties may misunderstand each other if they are different nationalities and come from different jurisdictions, and this can cause delays. Again, once a dispute has arisen this may frustrate the parties' intention to resolve the dispute on an ad hoc basis.
Such situations can be avoided if the parties agree that their arbitration should be conducted under certain arbitration rules. This will result in reduced deliberation and legal fees, and parties will be able to begin proceedings early as they will not have to engage in negotiating specific rules. The United Nations Commission on International Trade Law (UNICITRAL) Arbitration Rules, revised in 2010, are among the most suitable rules for this purpose.
Another reason why ad hoc arbitration is less expensive than institutional arbitration is that the parties will only have to pay fees for the arbitrators, lawyers or representatives and the costs incurred in conducting the proceedings rather than paying fees to an arbitration institution. If the amount in dispute is considerable, these fees can be prohibitively expensive. In order to reduce costs, parties and the arbitrators may agree to conduct the arbitration at the arbitrator's office.
The arbitrators' fees will be negotiated directly between the parties and the arbitrators, allowing them the option to negotiate, whereas in institutional arbitration the arbitrators' fees will be set by the institution. The disadvantage here is that this can involve an uncomfortable discussion and, in certain cases, the parties may not be able to negotiate a fee reduction. The arbitrators are the 'judges' in the case and no party would wish to upset the judge, particularly before the proceedings have even commenced.
Disadvantages of ad hoc proceedings
Parties wishing to include an ad hoc arbitration clause in the underlying contract between them, or seeking to agree the terms of arbitration after a dispute has arisen, have the option of negotiating a complete set of rules which meet their needs. However, this approach can require considerable time, attention and expense with no guarantee that the terms eventually agreed will address all eventualities. Furthermore, if parties have not agreed on arbitration terms before any dispute arises they are unlikely to fully cooperate in doing so once a dispute has arisen.
As we have seen, bodies such as UNICITRAL have rules available which are designed specifically for ad hoc proceedings. Other options available to parties wishing to proceed in this way, who are not in need of rules drawn specifically for them, include:
These options all carry certain risks. For example, where rules drawn up by an institutional provider are incorporated into ad hoc proceedings existing provisions which require administration by the provider - such as making appointments - will need to be amended or excluded. This runs the risk of creating ambiguities, or of the parties unintentionally creating an institutional process.
Ad hoc – less expensive than institutional?
In reality, an ad hoc arbitration may not prove to be less expensive than the institutional process. Firstly, the parties are required to make arrangements to conduct the arbitration but they may lack the necessary knowledge and expertise. Arbitrations are generally conducted by people who are not lawyers - however, this may result in misinformed decisions especially in international commercial arbitration.
Secondly, where there is lack of cooperation between the parties or delay on the part of the tribunal conducting the arbitration or writing the award, a party may need to seek court intervention. Litigation costs would not only negate the cost advantages of ad hoc arbitration, but also the parties' intention to avoid the courts through alternative dispute resolution methods.
Thirdly, in complex cases the tribunal may seek to appoint a secretary to deal with the considerable administrative work involved. The additional costs of the secretary's fees will add to the cost burden of the arbitration.
Although ad hoc arbitration is more flexible and often best suited to the parties' individual needs, it will only be cost effective where:
It is said that parties are the masters of arbitration. However this is questionable in institutional arbitration, where the institution effectively acquires the parties' powers to make decisions - such as the appointment of arbitrators – and can impose their will upon the parties. This seems against the spirit of arbitration. Although ad hoc arbitration may seem preferable in today's modern and commercially complex world, it is really only suitable for smaller claims involving less affluent parties in domestic arbitrations.
In the context of international commercial disputes, institutional arbitrations may be more suitable - despite being more expensive, time consuming and rigid. The institutional process provides established and up to date arbitration rules, support, supervision and monitoring of the arbitration, review of the awards and strengthens the awards' credibility.
The particular circumstances of the parties and the nature of the dispute will ultimately determine whether institutional or ad hoc arbitration should prevail.