When disputes do arise, most go into arbitration at the end of the project. Very few arbitration proceedings are initiated during the project execution phase. Unfortunately, this leaves disputes unresolved, leading to delays and cost overruns on both sides that need to be settled by arbitration at the end of the project. So it is a “catch 22” situation.
Despite the fact that the tribunal has no power to enforce an award, and can be time consuming and costly, arbitration provides a legally binding award that can and will be enforced by the relevant courts.
Are there alternatives to arbitration?
Every now and then large project contracts provide a dispute resolution board (DRB) for escalating disputes to management level, but such contracts are not the norm. Despite their obvious benefits, dispute resolution methods such as mediation, expert determination, or mini-trials are unusual.
So what are these alternative methods and how do they work?
Mediation is a process that involves an external mediator who tries to achieve an amicable agreement between the parties. The mediator is not an arbitrator; he or she should not get involved in the facts of the case. The mediator's sole task is to be a messenger between the parties in trying to find an acceptable solution. In practice they commute between the parties sitting in separate rooms, conveying their settlement offers. One reason mediation is not often used is because it is non-binding. With no real pressure to achieve an outcome, either party can leave the mediation at any time and the mediator has no power to enforce whatever agreement was achieved.
Expert determination - In oil and gas projects technical issues very often lead to disputes best solved by technical experts. However, the involvement of one or more experts to evaluate the case is rare. In theory, each party appoints an agreed number of experts who individually prepare their reports. The experts then meet to resolve any differences of opinion and write a final report about the subject under dispute. If the parties would commit themselves to the outcome of the report, expert determination could be a very effective dispute resolution method. However, it seems that both legal departments and management are wary of being bound by a purely technical viewpoint on the particular issue under dispute. This may be because limitations in their technical understanding affect their ability to judge their lose/win position.
Mini-trials: A mini-trial is much like a court trial but with senior management presiding instead of judges. Project teams and their solicitors (attorneys) prepare their case and present it to the top management of both parties. After presenting the issues, the parties can negotiate a settlement that can then be formalized in a legally enforceable written agreement. The management must be senior enough to make binding decisions and they should not have been involved in the dispute before the trial.
Include the right provisions in your contract
To make sure disputes are handled properly it is important to include provisions in your contract. The most common dispute resolution feature is the arbitration agreement. Standard form contracts3 such as JCT, NEC, and FIDIC include relevant clauses. However, such contracts are of very limited use in international oil and gas contracts. Some contracts might borrow parts of standard forms but most contracts are specifically drafted for a particular project.
Arbitration agreements require two key obligations. First, the parties must agree that any dispute falling within the contract will be resolved by arbitration and second, the parties must agree that they are bound in an arbitral award. Arbitration agreements must therefore either be part of a substantive contract or they may be entered into as the result of an existing dispute (called ad-hoc agreement). When such agreement exists, the parties waive their right to take a dispute to the court. It should also be mentioned that in certain scenarios an arbitration agreement could also be oral or assumed.
A very interesting scenario results when a dispute arises over the existence of a contract, meaning one party claims that no contract was in place and the other party refers this dispute to arbitration (e.g. terminating a letter of intent or LOI). If the arbitration tribunal finds that no contract is in place, how can a tribunal, appointed under the non-existent contract, have any power to issue an award? The answer is severability.
Arbitration clauses are severable from the main contract - they can be enforced even though the contract never came into existence. This fact plays a major role when drafting the arbitration clause, because if a party decides to refer a dispute straight to the courts, it may find that the courts will, upon application of the other party, stay the proceedings, leaving the claiming party with the choice of abandoning the claim or arbitrating it.
International arbitration basics
No international law governs commercial arbitration. The underlying laws will always depend on the applicable law agreed on in the contract. The only common denominator is the UNCITRAL Model Law 1985 (MAL)4 that provides guidelines to countries on how to implement international arbitration into their national legislation.
Currently 69 countries have adopted the MAL and implemented it, with or without modifications, into their national legislation. This allows parties from different jurisdictions to resolve their disputes based on a similar set of laws in an efficient and fair manner. It is, however, recommended that all parties scrutinize applicable laws to be certain how the MAL specifically applies.
In addition to the UNCITRAL Model Law, the UNCITRAL Arbitration Rules5 were published and revised in 2010. In contrast to the MAL, the Arbitration Rules do not include recommendations for national lawmakers but provide a set of comprehensive procedural rules guiding arbitration proceedings.
The Arbitration Rules include a model arbitration clause and cover all relevant issues such as appointment of the tribunal, the arbitration conduct, and the effect and interpretation of the award. Including the model arbitration clause in the contract is usually sufficient to base arbitration on these rules. However, most of the time the UNCITRAL Arbitration Rules are used in ad-hoc arbitrations only.
If an arbitral award in an international dispute has been issued, the question of enforceability inevitably arises. Imagine an arbitral award issued in England against an unwilling employer located in France who executes a project in Oman, while the claimant is located in Singapore. It's a very common scenario in oil and gas projects and one of the reasons why the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 exists.6
About 150 countries that ratified this convention committed to enforce international arbitration awards against incompliant parties not only located in their countries, but also having assets there. So let us assume our unwilling employer has assets in Germany, the Singaporean claimant could call the German courts to get their award enforced.
Which arbitration institute to choose?
Apart from ad-hoc arbitration pursuant to UNCITRAL Arbitration Rules, the parties are free to decide on an arbitration institute to administrate their proceedings. This is called administered arbitration and the favored institute is usually predetermined in the arbitration clause of the contract (but can also be agreed on at a later point in time).
Many arbitration institutes exist worldwide. Almost every country's chamber of commerce includes one. Some of the more popular are the London International Court of Arbitration (LICA), the International Chamber of Commerce (ICC), Singapore International Arbitration Centre (SIAC), Vienna International Arbitration Centre (VIAC), the American Arbitration Association (AAA), International Centre for Dispute Resolution (ICDR), and the Chartered Institute of Arbitrators (CIArb). They all provide administrative supports and a set of rules for the conduct of the proceedings (usually not permissible in ad-hoc arbitrations).
The fees for involving an arbitration institute are twofold, apart from a party's legal attorney fees: the administrative fee (usually calculated on the amount in dispute) and fees for the arbitrators. While the appointment of such institute will definitely add to the budget, the main advantage seems to be a faster finalization of the proceedings based on the power of the institute to resolve procedural disputes, such as arbitrator's appointment and jurisdictional issues.
Involvement of courts, highly complex
Involvement of the courts during international arbitration proceedings is highly complex. Sometimes more than one court from different jurisdictions claim supervisory jurisdiction. In general, there are two types of courts: those having primary (supervisory) jurisdiction and those with secondary jurisdiction. While both courts can stay litigation in favor of arbitration proceedings, courts with primary jurisdiction have the power to assure that the arbitration proceedings comply with the applicable laws and they can set aside an award.
Courts with secondary jurisdiction do not have that power. They can only enforce, or refuse to enforce, an arbitral award and they can be called for conservatory matters within their jurisdiction.
The UNCITRAL Model Law is clearly in favor of keeping the courts out of arbitration proceedings. Depending on national adoptions, areas where courts might get involved are limited to:
- appointment, challenge and termination of the arbitration tribunal;
- jurisdiction of the arbitration tribunal;
- setting aside and enforcement of arbitral awards; and
- the taking of evidence.
Note: The courts are not appointing - they only assist in the appointment. Courts are not challenging the arbitrator - they assist during a challenge.
When 'less expensive' may cost more
As stated, two different arbitration styles exist: ad-hoc arbitration and administered arbitration. Theoretically, ad-hoc arbitration is less expensive simply because no institute is involved and therefore no administration fees are applicable other than fees for the tribunal and the attorneys. But this is only a theoretical value, because ad-hoc arbitration usually takes longer and therefore accumulates more legal fees than an administered arbitration. In general, it takes between 12 to 36 months until the award is published depending on the complexity of the dispute and the delaying tactics deployed by the parties.
In administered arbitration, fees for the institute are usually calculated based on the amount in dispute and the applicable arbitrator fees. To get an overview about these costs, consider using the International Chamber of Commerce (ICC) cost calculator available on their website.7
These examples put the typical costs into perspective:
- An average ICC administered arbitration for a $1 million USD dispute and three arbitrators will cost roughly $140,000 consisting of $22,000 administration fees and £118,000 arbitrator fees. The cost of legal representation and expert reports for both parties can add up to $400,000 or 40% of the value in dispute depending on the complexity of the case.
- In contrast, a $10 million dispute of the same complexity might be settled with roughly double that cost or 8% of the value in dispute ($60,000 administration fees, $340,000 arbitrator fees plus experts and attorneys). If the contemplated costs are too high the parties can always agree to a tribunal consisting of a sole arbitrator to lower the cost considerably.
- Housing Grants, Construction and Regeneration Act (HGCRA) of 1996
- The Scheme for Construction Contracts (England and Wales) Regulations 1998 (Amendment) (England) Regulations 2011
- Standard form contracts – definitions:
- UNCITRAL Model Law on International Commercial Arbitration (1985), with amendments as adopted in 2006
- UNCITRAL Arbitration Rules See also International Arbitration definition and commentary
- New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958
- International Chamber of Commerce cost calculator. See also ICC website
Known for his entrepreneurial spirit and wide experience in the oil and gas industry, Thomas Pfeller is a seasoned contract and project management expert. His past expertise spans industries of automation, IT, software, and satellite communication. Thomas is also a member of the Chartered Institute of Arbitrators.