Advantages of Arbitration and Associated Risks

Arbitration (also known as “arbitral proceedings” or “arbitrations”) is considered an evolving branch of law that is still developing and not beyond the influence of legislators or the general public

There is a rule that any dispute between parties is referred to an independent person or authority for resolution, to which they will succumb. The parties wish their dispute to be resolved in an expedient, just and cost-effective manner. However, traditional legal proceedings (court litigations) cannot fully meet those requirements. Therefore, notably in the 20th century, this resulted in a boom in arbitrations as an alternative method of dispute resolution.

Two world wars led to the destruction of governmental and economic systems. The post-war situation faced new challenges in global economy and trade. It was already apparent after World War I that national regulations on dispute resolution were insufficient (different countries had different regulations, legal traditions, languages). A completely different approach was required in the face of steadily-developing international economic relations. Accordingly, the first Geneva conventions on international commercial arbitration date back to 1923 and 1927 (Czechoslovakia was a signatory to those conventions) and the first modern international arbitral institution was founded in Paris in 1923. In comparison with traditional legal proceedings, arbitration entails a number of advantages which are described below. However, the advantages have recently come up against a number of risks, which we regard as an unfortunate trend.

Informality and Speed

If the parties refer their dispute to an arbitrator or arbitrators (arbitral tribunal) for resolution, they can agree on a number of aspects for the arbitration proceedings. If no such agreement is made, the arbitrators shall proceed (conduct the proceedings) in a manner which they consider appropriate so that the facts of the case are ascertained as necessary to resolve the dispute without needless formalities, while maintaining equal treatment of the parties and while providing all the parties with the same opportunity to exercise their rights. This philosophy is inherent not only in Czech law, but also in most modern international legal regulations.

In principle, arbitration is conceived as one (single)-instance proceedings (less onerous, without being encumbered with legal barriers, such as excessive legal remedies). Therefore, only in exceptional cases can legal remedies be applied or an arbitral award be annulled in court. As a standard rule an arbitral award becomes final and enforceable once it is delivered to the parties (known as a “writ of execution” or “execution title”).

In the ’90s of the last century, Anglo-Saxon lawyers “discovered” the advantages of international arbitrations, and from then on Anglo-Saxon law began influencing the rules of arbitration. As a result, numerous rules have been established relatively often, allowing to call upon parties to give evidence, even against themselves. However, this is in direct contradiction to traditional civil-law (continental) principles, under which parties are only required to give evidence of what they claimed, nothing else. This trend has directly subverted the three key advantages of arbitration: informality, speed and cost-effectiveness. In the past, court files consisted of from several dozens up to, at most, hundreds of pages (including attachments) in complicated cases, where entire proceedings were conducted over a span of months and were less costly than legal proceedings. Nowadays, the situation is quite different – court files consisting of thousands (even tens of thousands) of pages are common; proceedings extend over several years and the costs of proceedings are astronomically high.

Parties to proceedings often make use of services provided by major law firms, which submit to the arbitrators not only everything that is factually necessary to clarify the substance of a dispute and prove the claimed allegations, but practically everything provided by their client or obtained from legal sources. As a consequence, major law firms charge high fees, which were simply unimaginable until a few years ago, and require that reimbursement of the costs of proceedings be awarded in an arbitral award. If the parties follow the approach described above, proceedings become overly formal and lengthy, unless the parties are prevented from doing so by arbitrators (this situation occurs only rarely, in order to avoid accusations that the arbitrators are not allowing the parties to thoroughly discuss the issue at hand).

Discussions on second-instance proceedings also represent a complication for the principles of arbitration. This concept partially devalues one of the key advantages of arbitration proceedings – speed. Nevertheless, the parties may agree that second-instance proceedings are to be initiated. As far as the “second-instance” issue is concerned, in international practice it is still generally accepted as an insurmountable barrier that the factual correctness (accuracy) of arbitral awards cannot be reviewed without the parties’ mutual agreement. Therefore, in proceedings to annul an arbitral award the courts are entitled to review only procedural errors of law. The application of these extraordinary legal remedies is subject to very precise and restrictive rules. However, where investment arbitrations are concerned, there is increasing pressure to also require a mandatory review of arbitral awards from a material point of view. This is because the state is often ordered to pay massive damages to investors from public funds on the basis of arbitral awards, and this has an impact on the state budget.

Choice of the Place of Arbitration

If disputes are resolved by state courts, the parties’ choice of the place of arbitration (also known as the “seat of arbitration”) is either fully excluded or substantially limited. In arbitrations the parties may choose the place arbitration. The parties usually choose the place of arbitration before the arbitration begins, in order to know where their potential disputes will be resolved; in addition, they can obtain information about the decision-making practice, rules and costs of proceedings, as well as about other relevant issues.

Whilst the classical courts follow applicable laws and regulations of their respective jurisdictions (i.e. the Code of Civil Procedure in the Czech Republic), parties to an arbitration may agree on the procedure in which arbitrators are to conduct the proceedings. The number of judges in classical courts is set by procedural legislation. In arbitration proceedings the parties may choose whether disputes will be resolved by an arbitral tribunal composed of several arbitrators (“multi-member tribunal”) or by a sole arbitrator.

The parties can also influence the costs of arbitration proceedings. If the parties agree on their own rules, the regulation of the costs of arbitration proceedings is left to the parties’ sole discretion (as regards institutionalized arbitration courts, regulations governing the costs of proceedings form part of the rules of the court). In proceedings before regular courts the parties cannot, in practice, influence the selection of a judge appointed to resolve their dispute (arbitrator). In arbitration proceedings the parties are given the opportunity to appoint “their” arbitrators themselves. This is one of the most important rights delegated to the parties. Arbitrators must at all times be impartial and independent. In arbitration proceedings the parties may choose the place of arbitration. In their decision-making, arbitrators follow substantive law, by which the dispute is governed. If so authorized by the parties, the arbitrators may decide the dispute according to the principles of equity, which is a very practical method of dispute resolution in certain cases.

However, Czech courts tend to intervene in arbitration proceedings more than they should. The courts’ intervention may sometimes result in a violation of the rights of the parties to such proceedings. The origin of this approach taken by Czech courts should really only be sought in relatively special situations; however, over the last decade, mostly due to the insufficient and ineffective functioning of Czech courts, ad hoc arbitrations were used excessively in consumer disputes. As a response to this situation and due to related political pressure, the courts subsequently began taking a protective approach towards consumers and imposing unreasonable requirements on arbitrations in order to protect consumers as a party to the proceedings.

It must be noted that the parties cannot be forced to withdraw their dispute from the jurisdiction of regular courts by means of an arbitration agreement. However, if the parties do so, they must accept that their dispute will not be subject to the principles, procedures and regulations that would otherwise apply in civil court proceedings. Arbitration proceedings are primarily at the disposition of the parties and are therefore based on the principle that the arbitrators will only consider what the parties submit to them and may not assist one party over another. Attempts by Czech courts (the Constitutional Court, the Supreme Court) to impose classical rules of contentious legal proceedings on an arbitration in the end turn into a poisoned apple for the parties. Not only is it problematic to apply certain rules, but some of them directly conflict with the principles of arbitration proceedings (e.g. under the duty to instruct (in Czech: “poučovací povinnost”), arbitrators are compelled not to be impartial and to assist one party over the other; in spite of this, the Constitutional Court insists on the fulfilment of this duty).

A judicial review of an arbitral award also impacts the enforcement of the judgment (known as “execution proceedings”). As an example, in 2013 the Supreme Court ruled that if an arbitral award is rendered by an arbitrator who was not appointed under transparent rules, the arbitral award will not be enforceable because the arbitrator did not have jurisdiction to issue the award (this was in line with the case law of the Constitutional Court). And if the execution has already been ordered, or if the court (subsequently) ascertains that the arbitrator lacked jurisdiction to issue an arbitration award, the execution proceedings must be discontinued at any stage for inadmissibility. This conclusion applies regardless whether the liable party in the arbitration proceedings raised objections claiming non-existence of an arbitration agreement and whether it originally submitted itself to the arbitration proceedings of its own accord.

These court decisions have serious consequences, as they represent a major breakthrough in practice – i.e. objections that the arbitrator lacks jurisdiction are reserved only to arbitration proceedings, and courts should limit their judicial review only to a formal verification that the arbitral award was issued. In essence, the courts are saying to the parties: don’t try to resolve the issues at such time when they can be easily resolved (i.e. in arbitration proceedings), because you’ll have sufficient opportunity to address them at a time not intended for their resolution (e.g. in execution proceedings). We find this judicial approach to be quite problematic, as it goes against the principles of arbitration proceedings and protects irresponsible persons who, though they could have, never raise their objections in due time and harm the interests of the counterparty, who came to the stage of enforcement in good faith. A small consolation could be that the above court rulings – which were primarily rendered in consumer disputes – will not transfer to commercial disputes.

Another example of violating the principles of arbitration proceedings involves the attempt by courts to extend the grounds for a material judicial review of arbitral awards. We consider this judicial approach to be misguided. The concept of the court annulling an arbitral award is not a legal remedy under which evidence should be produced with respect to the subject of the dispute, or any new dispute; it is a completely special procedure that may result in the annulment of a final and conclusive arbitral award. Its uniqueness means, inter alia, that the grounds for annulling an arbitral award have been strictly established and that the petitioner cannot subsequently change the ground(s) for which one party seeks the annulment of the arbitral award. Therefore, strict rules should apply not only to the observance of the deadline to file an application for the annulment of an arbitral award, but also to the situation where a party is required to responsibly select the grounds for the annulment of the arbitral award and to include them in its application without possibility of any additional changes.

General note: Whilst most European countries and their courts are “arbitration friendly” (i.e. they always try to keep the contested award in force and rule to annul it only if they find material procedural errors in the performance of the arbitrators’ duties), Czech courts often tend to cancel an arbitral award for absolutely marginal and trivial failures and, moreover, they subsequently take decisions in multiple instances; this situation results in lengthy proceedings over the annulment of an arbitral award lasting many years.

Controversial tendencies

Arbitrations have long been under substantial development. However, not all arbitration trends were appreciated, and this area of law has had to overcome many controversial tendencies during this development. Relatively recently, at the end of 2016, a fundamental step occurred when a long-term burning issue concerning the regulation of arbitration proceedings in consumer disputes was most-likely resolved (by operation of law, the use of arbitration proceedings in consumer disputes is prohibited). This recent amendment is proof that arbitrations represent a living legal sector still under development – and one that is not beyond the influence of legislators and the general public (whether expert or not).

Robert Němec
Partner at PRK Partners and Head of the Dispute Resolution Department