© Mayer, Brown, Rowe and Maw LLP The Midnight Clause: 10 Traps to Avoid in Drafting Arbitration...

© Mayer, Brown, Rowe and Maw LLP

The Midnight Clause: 10 Traps to Avoid in Drafting

Arbitration Agreements

A Webinar

June 19, 2007

Presented by William H. Knull, III and Philippa M. Casey

Mayer, Brown, Rowe & Maw LLP

Today’s Presenters

William H. Knull, III is Co-Chair of Mayer, Brown, Rowe & Maw LLP’s International Arbitration Group. He has extensive experience in transnational and domestic disputes involving oil and gas related matters and has frequently served as counsel and lead counsel in arbitrations under the auspices of the AAA/ICDR, ICC and NASD, and in ad hoc proceedings pursuant to UNCITRAL rules.

William H. Knull III, Partner, Houston

[email protected]

Philippa Casey is a partner at Mayer, Brown, Rowe & Maw LLP. Her practice is focused on acting for clients in international litigation matters, including disputes arising out of cross-border contracts. She regularly advises on all aspects of litigation and arbitration practice and procedure, including in relation to the use of evidence in overseas proceedings, confidentiality issues, and the validity of dispute resolution agreements.

Philippa Casey, Partner, London

[email protected]

Today’s Discussion

• Ten traps to avoid when drafting international arbitration clauses

• Q&A at the end of the presentation

• Operator Assisted

• Press *1 on your touch-tone dial when you are ready to ask a question

• Brief survey

• After complex negotiations, a deal is finally taking shape

• With the deadline fast approaching, the junior deal lawyer is told to “add in the usual terms,” including an arbitration clause

• Rationale:

• Not really necessary: we all agree this is a great deal

• If there is a problem down the road, we’ll fix it then

The ContextThe Context

The Context (cont.)The Context (cont.)

• Four years later, a serious dispute breaks out, and everyone looks at the arbitration clause for the first time

• But with the dispute in full swing, both sides calculate their procedural advantages, and an agreement to correct problems in the dispute resolution terms is impossible

Some Potential ResultsSome Potential Results

• Arbitration clause is unenforceable, and you are stuck in your counter-party’s home court

• Arbitration is held in a jurisdiction whose courts

• Favor the other side, or

• Are prone to interfere in arbitration, or

• Decline to enforce arbitral awards

• Key parties are not bound to arbitrate

• The reasonable, cost-effective process you intended can be achieved only through an expensive, time-consuming, patience-thinning, adversarial process

One Size Does Not Fit All NeedsOne Size Does Not Fit All Needs

• Arbitration clause should fit the needs of the parties AND the deal

• Clause used last time may not work on new deal

• Other side’s clause may be dangerous

• Clause promulgated by arbitration institutions may not fit needs

• However, the bespoke clause is full of traps for the unwary

• Without arbitration expertise, traps may not be apparent

Trap 1: The Missing PartyTrap 1: The Missing Party

• Clause fails to name all the parties with rights/obligations under the agreement

• Parent – the one with the money

• Guarantor – not bound to arbitrate based on separate guarantee alone

• Host government – only if all formalities observed

• Subcontractors

Trap 1: The Missing Party (cont.)Trap 1: The Missing Party (cont.)

• Arbitration is a creature of contract

• Waiver of right to judicial due process not lightly presumed

• Written agreement is a prerequisite under the N.Y. Convention

• Requirement of individual agreement applies to each juridical entity, including other members of a “group of companies” or government entities

• Be sure everyone necessary is committed

Trap 2: Capacity to ArbitrateTrap 2: Capacity to Arbitrate

• Once dispute arises, respondents will use any available argument as defense

• Ability of state-owned entities to commit to arbitrate may be limited by constitution or statute

• Local legal advice is essential

• Whether entity is permitted to commit to arbitrate

• What approvals are necessary to make commitment enforceable

• What evidence is required to establish the existence of enforceable authorization to arbitrate

• Even if law of place of arbitration would disregard law of home jurisdiction on capacity, ensure compliance to avoid cost of dispute

Trap 3: The Seat of the ArbitrationTrap 3: The Seat of the Arbitration

• Problem:

• You propose neutral governing law (England, N.Y.), neutral seat (Paris, Singapore)

• They propose own law as governing, seat in their capital

• Midnight compromise: neutral governing law, seat in their capital

• Result: Potential disaster

Trap 3: The Seat of the Arbitration (cont.)Trap 3: The Seat of the Arbitration (cont.)

• Reason: to the extent it is not governed by the parties’ agreement or their choice of arbitration rules, arbitral procedure and other important issues will be governed by the law of the official seat of the arbitration

• Not necessarily the place where hearings are held

• The seat must be designated by the agreement

• The arbitration is within the jurisdiction of the courts at the seat

• Important: lex arbitri is the law of the seat, not the governing law of the contract


• Selection of neutral seat is critical

• Procedural and other issues not governed by rules or agreement are governed by law of the seat

• Must be in a N.Y. Convention country (140+)

• Hostile courts can interfere with and frustrate arbitration

• Hearings can be held elsewhere by agreement or ruling of arbitrators for convenience, cost

• Stick to established arbitration centers

• Compromise on the official seat can lead to outcome-determinative problems


• Problems with the involvement of local courts:

• Many do not respect arbitration agreements and awards

• Many interfere in or delay the process

• Some will actively interfere on behalf of local parties

• Avoiding the other side’s home courts is one of the principal advantages of arbitration in the international context

Trap 4: Failure to Optimize BIT ProtectionTrap 4: Failure to Optimize BIT Protection

• Investment treaties protect foreign investors from host-government abuse

• BIT’s bind governments to arbitrate even in the absence of a specific agreement with the investor

• Protection is available only if

• An owner in the chain is a national of a state with a treaty with the host country, and

• Claimant has a qualified “investment”

Trap 4: Failure to Optimize BIT Protection (cont.)Trap 4: Failure to Optimize BIT Protection (cont.)

• There are more than 2400 BIT’s, but not every pair of states is covered

• E.g., U.S. and Venezuela have no treaty

• But Venezuela and the Netherlands do

• Intermediate subsidiary in chain of ownership can usually bring BIT claim

• Unless BIT denies benefits to mere “mail drop” entities

• Can “stack” treaties, with more than one treaty applicable to an investment

• Lesson: have to know host country’s treaties to optimize your protection

Trap 4: Failure to Optimize BIT Protection (cont.)Trap 4: Failure to Optimize BIT Protection (cont.)

• Activities in host country must constitute an “investment”

• Very broadly defined

• Includes stock ownership, contract rights, mineral concessions, etc.

• Does not include mere commercial transactions (sales of goods or services)

• BIT’s provides remedy against host government for breach of treaty provisions

• Addition to, not a substitute for, claims against contract counter-party for breach of contract

Trap 5: Ambiguity in Naming Institution and RulesTrap 5: Ambiguity in Naming Institution and Rules

• Examples:

• International Chamber of Commerce of Hong Kong

• Court of International Arbitration, London

• Chamber of Commerce, Paris

• Association of American Arbitrators

Trap 5: Ambiguity in Naming Institution and Rules (cont.)Trap 5: Ambiguity in Naming Institution and Rules (cont.)

• Arbitration institutions

• Administer proceedings

• Appoint arbitrators if parties can’t agree or one party refuses to cooperate

• Provide rules for arbitration

• Negotiate arbitrators’ fees


• Results of ambiguity in designation:

• Arbitration clause may fail altogether

• Authority to appoint arbitrators may be determined by local courts

• Confusion as to arbitral rules may default to local statute

• Extensive, expensive litigation in arbitration and potentially the courts on what was agreed to


• Defective designation may negate meeting of the minds on arbitration altogether or change the agreement from what you thought it was

• Best practice: use the clause suggested by the institution to avoid any possibility of confusion, and always check the description of the institution to ensure accuracy

Trap 6: Ambiguity in Choice of Forum or Scope of AgreementTrap 6: Ambiguity in Choice of Forum or Scope of Agreement

• Choice of Forum:

• Litigation or arbitration

• Litigation and arbitration

• Scope of Agreement: Arbitration of some, but not all, claims

Trap 6: Ambiguity in Choice of Forum or Scope of Agreement (cont.)Trap 6: Ambiguity in Choice of Forum or Scope of Agreement (cont.)

• Permissive clause: Contract provides that in the event of a dispute, parties “may” submit the matter to arbitration

• Unless arbitration is unambiguously identified as the exclusive forum, clause leaves open to either party the option of seeking relief in the courts

• Risk of parallel proceedings, race to judgment


• Agreement to arbitration and broad submission to jurisdiction of particular court results in race to judgment

• Expensive litigation over forum

• Potentially parallel proceedings in arbitration and in court

• Leverage for financially stronger party with weaker position to force settlement on the other


• Ambiguity on scope of agreement to arbitrate ensures protracted, expensive fight on what is arbitrable

• May include fight on whether scope is to be determined by arbitrators or courts

• In most cases, broad clause to submit all disputes to arbitration is preferable to avoid any possible ambiguity

• Special case: general arbitration clause, purchase price adjustment before expert


• Broad form agreement

“All disputes, controversies and claims arising out of, relating to or in connection with this contract, including, without limitation, any question regarding its existence, validity, interpretation, performance, termination or breach, shall be referred to and finally resolved by arbitration in accordance with ….”


• Best practice:

• Use express, exclusive agreement to arbitrate all disputes;

• Remove unnecessary references to court jurisdiction;

• Ensure there are no mutually incompatible clauses or clauses which lead to uncertainty in the performance of the Agreement;

• Avoid complexity where possible.

Trap 7: Inconsistent or ambiguous Governing Law ClausesTrap 7: Inconsistent or ambiguous Governing Law Clauses

• "Floating law" clauses

• Sonatrach v. Ferrell – the parties to two agreements which were inter-related had provided that Japanese or English law would govern the resolution of the dispute depending on the identity of the parties involved

• Held: such a provision could not be enforced: parties had to be able to know under which law they were performing the contract at the relevant time

• Contrast "floating jurisdiction" clauses – perfectly acceptable under English law

Trap 7: Inconsistent or Ambiguous Governing Law Clauses (cont.)Trap 7: Inconsistent or Ambiguous Governing Law Clauses (cont.)

• In federal systems (e.g., U.S., Canada, Switzerland), both federal and state/provincial/cantonal law may apply at a particular seat

• Distinction can make an important difference

• Scope of law may be different

• Content of law may be different

• Choice will be honored, so choice should be informed and unambiguously expressed

Trap 8: Indeterminate Time PeriodsTrap 8: Indeterminate Time Periods

• Problem:

• Contract provides that, “in the spirit of cooperation,” parties must attempt to negotiate a resolution in good faith before resorting to arbitration

• If no agreement can be reached through negotiation, parties must submit to good faith mediation

• Only if agreement is still not reached may a party initiate arbitration

• Question: when can arbitration begin?

Trap 8: Indeterminate Time Periods (cont.)Trap 8: Indeterminate Time Periods (cont.)

• Solution: provide for crisp beginning and ending dates for each stage

• Notice in writing of claim

• X days after notice to negotiate

• If no agreement after X days from delivery of notice, mediate during subsequent Y days

• If no agreement within Y days, either party may initiate arbitration

Trap 9: Over-specificationTrap 9: Over-specification

• Problem: Anticipating technical disputes, parties designate specific engineers specializing in the product’s technology

• Actual dispute relates to questions involving contract formation and interpretation, turning on legal implications of conflicting testimony of percipient witnesses

• By the time the dispute arises, designated engineers have moved, retired or passed away

Trap 9: Over-specification (cont.)Trap 9: Over-specification (cont.)

• Except for essential terms (scope, seat, appointing authority, language, governing law), leave flexibility to structure proceedings to fit the need when the claim arises

• In addition to arbitrators’ qualifications, best to wait on, e.g., procedures (discovery, witness statements and testimony, etc.) until nature of dispute is known

Trap 10: Assuming ConfidentialityTrap 10: Assuming Confidentiality

• Problem: Since confidentiality is one of the main advantages attributed to arbitration, contract makes no separate provision, relying on reputation and tradition

• But: most arbitration rules and national arbitration statutes provide for only limited confidentiality, leaving room for disclosure

• Solution: If confidentiality is important, provide for it specifically in the agreement

• And recognize that it may be ephemeral if either party files for or against enforcement in court (though note that the courts in England will protect confidentiality by anonymising judgments/holding private hearings)

Conclusions Conclusions

• In international deals, arbitration offers

• Neutral forum, freedom from other side’s “home court”

• Enforcement across borders under N.Y. and other international conventions

• Advantages can be lost through

• Drafting that creates pathological ambiguity

• Use of terms whose implications for subsequent proceedings are not fully understood

Conclusions (cont.) Conclusions (cont.)

• To secure the benefits and avoid the traps:

• Always get expert advice at the drafting stage

• Use tested language

• Know the local law of the counter-party as to how it affects capacity to contract and to arbitrate

• Avoid inconsistent terms on forum, jurisdiction, governing law, etc.

• Ensure accurate designation of administering institution, rules

© Mayer, Brown, Rowe and Maw LLP

The Midnight Clause: 10 Traps to Avoid in Drafting

Arbitration Agreements

A Webinar

This presentation is provided for general informational purposes only and may not reflect the complete legal analysis on the subject. Any information contained herein should not be construed as legal advice and is not intended to be a substitute for legal counsel on this subject. You should not act or refrain from acting on the basis of this presentation without seeking appropriate legal advice based on your particular facts and circumstances. Your participation in this presentation does not create an attorney-client relationship.

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