Response to a Recent Criticism of Arbitration Clauses

I read earlier today an interesting commentary on a recent decision of the Ontario Court of Appeal in the Novatrax case.  Let’s start with the basic facts.  Novatrax had an exclusive sales agreement with a German company to sell industrial fans in Canada and the U.S.  Either side could terminate on the giving of 12 months’ notice or without notice in certain circumstances.  The German company terminated giving no notice and saying that it had just cause to terminate.  The plaintiff sued the German company in Ontario and also added as defendants the individual owners of the company along with a new Canadian company that had been set up to take over the sales in Canada and the U.S.  The agreement had a provision that said that the parties agreed that German law governed the relationship and that they would “settle any disputes by a binding arbitration … in Frankfurt.”  Because of this, the German company argued that the Ontario lawsuit should be stayed and that the matter should go back to Germany for determination there.  The motions judge agreed and then the majority of the Court of Appeal agreed.

The commentary that I read took issue with this decision and used it as an attack on arbitrations generally and cautioned readers to consider whether it just might be better off to not have arbitration clauses in the first place.  In doing so, several old chestnuts were thrown out to attack arbitrations.

The first attack was to say that this case showed that, even though there was a belief that there would be only arbitration (and, presumably, that this would reduce legal costs overall), the fact that it gave rise to a fight in the courts, in fact, greatly increased the ultimate costs because there would have to be the arbitration AND the costs of the court fight.  I do not doubt that that was (or will be), in fact, the situation at the end of the day.  But let’s consider two factors.  First, suppose that there was no arbitration requirement and that the clause only said “settle any disputes … in Frankfurt”.  Now we’re only talking about a choice between litigation in the Canadian courts and litigation in the German courts.  You can be guaranteed that the plaintiff would have done the exact same thing – sued in Ontario.  This doesn’t surprise me.  Why?  Because it’s a heck of a lot cheaper for someone in Ontario to sue in Ontario than to sue in Germany.  So the plaintiff would have sued in Ontario and the exact same motion would have been brought and the exact same result would have occurred – the court would have said that they agreed to settle their disputes in Germany, so off to the German courts they go.  And in that situation, whatever the cost of litigation would have been in Germany, it would be increased by the cost of the motion and the appeal in Ontario.  Therefore, whether it is litigation or arbitration, the result (and the increased costs) would have been the same.  So that complaint with respect to arbitration goes by the wayside.

The second factor, already alluded to, is that the plaintiff had the choice of dealing with the matter either in Canada or in Germany.  If the plaintiff had sued in Germany, then the plaintiff would have saved the costs of the fight over where to have the dispute resolved.  Beyond this, if the lawsuit had continued in Ontario, then each side would have had to hire German lawyers to give expert evidence as to what was the law of Germany that governed the dispute.  If the dispute was fought out in Germany, they wouldn’t have to pay for that cost because the German lawyers / judges / arbitrators would have known the law.  In addition, suppose that the plaintiff sued in Canada and won a judgment.  The plaintiff would then have a judgment against a Canadian company (which, presumably, could be wound up pretty quickly with little in terms of assets) and the result is that the plaintiff would have to go to Germany to enforce its judgment against the German parent company and the two German citizens.  I don’t know what the law in Germany is like for recognition of foreign judgments.  If it is like Canada, then an application has to be brought and the application could be fought and there can be an appeal.  Sounds like the same costs of the motion and appeal in this case.  If it is like the U.S., then the plaintiff could end up having to re-litigate the whole case again before the German courts.  In these circumstances (at least based on what has been set out in the case), I would have been inclined to tell the client to just sue everybody in Germany because it would be easier to enforce the judgment.  So, the position that arbitration isn’t cheaper and, in fact, could be more expensive isn’t supported by other factors that would have existed even if it were simply litigation and not arbitration.

The authors also question the result of the decision because the result was that the plaintiff was not able to proceed with its claim in Ontario against the Canadian subsidiary and the two German owners because any arbitration in Germany would have only been between the plaintiff and the German parent company.  As noted by the majority of the Court of Appeal, there was nothing to stop the German owners and the Canadian subsidiary from agreeing to be parties to the German arbitration.  (This is possible, but the only reasons I can quickly think of why they would want to do so would be to ensure that there were not inconsistent findings by different triers of fact – be it judges or arbitrators – and to keep the dispute confidential.)  Moreover, once the arbitration was done, the plaintiff could start again its lawsuit in Canada against the subsidiary and the German owners – if they didn’t settle based on the arbitral decision.  The authors suggest that somehow this taints arbitration because it could force either non-parties into the arbitration or else it creates a multiplicity of proceedings (separate arbitrations and lawsuits).  There are three responses.  The first response is that of the majority when they found that it was “very doubtful” that there was merit to the claims against the two German owners.  If that is the case, then the Court of Appeal did the plaintiff a favour by saving it from having to fight what was likely a losing case against the individual owners.  The second response is that the non-parties were not forced to join the arbitration, but if they did not, then they had to wait around (with interest on damages potentially increasing at a significant amount per year) to see what happens in the arbitration – but nobody was being forced to join the arbitration.  The third response is that all of this presumes that a different result would have been reached if there had been no arbitration.  Again, suppose that the clause only said “settle disputes … in Frankfurt”.  You can pretty much be guaranteed that if the court was sending the main lawsuit between the plaintiff and the German parent company back to Germany, it would have sent the claims against the two owners and the Canadian subsidiary over there as well.  Why?  Because of the concept of “forum non conveniens” – which means that the courts will send cases to where it is the most convenient for the parties.  It would make little sense to have one lawsuit in Germany and the second lawsuit – involving German nationals on basically the same facts – being tried in Canada.  That would be a bigger cost and waste to the parties (and to at least one court system) than to deal with everything in one country or the other.  So if this matter was dealt with as litigation instead of arbitration, the result would not necessarily have been any different – and thus it is not a valid reason to challenge the arbitration system.

The authors of the commentary then abandon discussion of the case and go on to complain that another problem with arbitration is that you can be stuck with 3 arbitrators.  While this may seem like a good idea at the beginning when there is a lot of money at stake, if the contract ends up being not worth a lot of money by the time that a dispute arises, then the parties are “stuck” having to pay for 3 arbitrators and the amount at stake doesn’t justify the cost.  That’s a fair comment.  It doesn’t mean, however, that it’s something that justifies doing away with arbitration clauses completely.  However the arbitration is commenced, there will eventually be some document that sets out what amount the plaintiff is seeking.  Some rules call it a Statement of Claim, some are called Terms of Reference, etc.  There is nothing to stop the parties from saying that any claims under $X shall be determined by one arbitrator and any claims over $X shall be determined by three arbitrators.  This alleviates the concern of the authors of the commentary.  Arbitration clauses shouldn’t be avoided.  However, companies (and their lawyers) should ensure that they give more thought to arbitration clauses than to simply stick in clauses like the following:  ”All disputes arising hereunder shall be resolved by arbitration pursuant to the Arbitrations Act, 1991.”  Being surprised that this doesn’t do the trick for you is like being surprised when somebody says “oh, you’re bleeding from both nostrils, both ears and both tear-ducts in your eyes, go see Billy Smith, the first year medical student, he ought to be able to patch you up” and that doesn’t do the trick for you.  If someone gets lazy with arbitration clauses and treats them as an after-thought in commercial agreements, don’t blame the entire system of arbitration that it cannot make a solution that works, just like the fact that Billy Smith not being able to fix your brain haemorrhage means that the entire medical system is faulty.

The ultimate suggestion of the authors of the commentary, as I have alluded, is therefore to simply scrap arbitration clauses.  Their view is that good litigation counsel can agree to an arbitration later on when the dispute arises.  That’s a lovely thought and I completely endorse it.  Now, back to reality.  Whether it is litigation or arbitration the result is the same: someone is going to win and someone is going to lose OR each side is going to win some issues and lose other issues.  If you have a party with a good lawyer who can tell it what are its chances of success – and if the lawyer says that the chances of success are not great – then no client will ever agree to an arbitration.  I had a case that was going to go to trial settle shortly before trial.  This was a case I never thought in a million years would have settled because the plaintiff and the other defendants (my client was a very minor player) were completely entrenched in their positions and the plaintiff wanted a ton of money and the other defendants were willing to put up something but nowhere near what the plaintiff wanted.  Suddenly, the plaintiff decided to settle.  Why?  We all learned out later on that it was because the main witness for the plaintiff had died.

While not guaranteed, as a general rule, litigation takes longer than arbitration to get the dispute determined.  If you are the defendant and you are likely to have to pay something to the plaintiff, do you want to pay that this year – and take the hit on this year’s profit and loss – or put it off to another year?  Moreover, there’s always the chance that a key witness might die / move / become ill / etc. and that affects the plaintiff’s case.  Litigation gives more than enough time for this to occur – certainly far more time than arbitration does.  In the U.S., the parties generally absorb their own costs regardless of the result of the dispute.  In Canada, the loser pays a portion of the winner’s legal costs.  In arbitration, the general rule is that the loser pays all or almost all of the winner’s costs.  So there’s a costs incentive towards litigation.  If you have parties in different countries, arbitral awards are relatively easy to enforce – while court judgments, as mentioned above, can be very problematic to enforce.

With these realities, how many defendants are going to want to go with arbitration over litigation?  Some, certainly, who might want confidentiality over their dispute.  But even that is not a guarantee.  I was at a conference a year or two ago and the head of the dispute department in the U.S. for either IBM or Kodak was speaking and she said that their view is that they absolutely never agree to arbitration and they only ever want to be before the courts.  That was just their policy.  If that’s the case, then it doesn’t matter how good, bad or otherwise counsel are, there will be no arbitration occurring once the dispute has arisen.

The authors suggest that arbitration clauses be scrapped.  I disagree.  They do go on, in a final sentence, to suggest that, at a minimum, one should consider more closely arbitration clauses.  With that I fully agree.  The more that an arbitration clause is not considered an “add-on” or a “throw away” clause and real consideration is given to what is to happen, the better the chances that the arbitration experience will not only be productive, but, in fact, more productive than litigation.

Something to think about.




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