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The power of arbitration: key benefits and potential pitfalls for contracts

This post is also available in: Deutsch

Arbitration plays an essential role in the modern business world. Arbitration can be used to resolve disputes between parties outside the state court system. Arbitration is often found in business purchase agreements, investor contracts, and service contracts. In this extended article, we will discuss the advantages and disadvantages of arbitration in such contracts, highlight the aspect of international partners in contracts, and consider the possibility of free choice of law for companies.

What is arbitration and how does it work?

Arbitration is a procedure for resolving disputes between parties by an independent body known as an arbitral tribunal. The arbitral tribunal shall render a decision which shall be binding on the parties. The jurisdiction of arbitral tribunals and the applicable law must be bindingly agreed by the parties in advance. This is often done by including an arbitration clause in the contract. Arbitration proceedings can be conducted in Germany or abroad, depending on the agreement of the parties.

Advantages and disadvantages of arbitration clauses in contracts

Arbitration offers a number of advantages and disadvantages over traditional court proceedings. One of the main advantages of arbitration is its confidentiality. Because the procedures usually take place behind closed doors, companies can protect their trade secrets, which is particularly important in sensitive business areas. Another advantage is the flexibility that arbitration offers. The parties involved have the ability to determine various aspects of the process, such as the location, language, and applicable law, which gives them greater control over the process and allows the process to be customized to their specific needs. In addition, arbitration proceedings are often characterized by their speed, which can be an advantage for companies seeking a timely resolution. Finally, arbitrators may have expertise in certain business areas, which can help ensure that more informed and knowledgeable decisions are made.

However, there are also some disadvantages that should be considered when deciding to use arbitration. Cost can be a significant factor, especially in complex cases, as arbitration can be expensive. This is due, among other things, to the fact that the parties must pay for the costs of the arbitrator and possibly for other procedural costs. Another disadvantage is the limited reviewability of arbitration decisions. Once a decision is made, there are usually fewer opportunities to challenge it compared to decisions made by a court. This can be problematic if one party believes the decision is unfair or flawed. Finally, the unpredictability of arbitration proceedings can pose a risk. Without established case law, outcomes can be more unpredictable than litigation, which can lead to uncertainty about the potential outcome.

It is therefore important to carefully weigh the specific circumstances of the case and the advantages and disadvantages of arbitration before making a decision. In certain cases, such as when confidentiality is of paramount importance or when the parties operate across international borders and prefer flexibility to determine venue and applicable law, arbitration may be the more appropriate option. In other cases, particularly where cost is an important consideration or where the parties value the opportunity to review the decision, a regular court proceeding might be more advantageous.

International Aspects and Free Choice of Law in Contracts

When companies do business with international partners, there are additional factors to consider. To be effective, an arbitration clause must be voluntary by both parties and meet certain criteria. The subject matter of the dispute must be specified and the scope of the arbitral tribunal’s decision-making competence must be defined. The arbitration agreement should exclude recourse to state courts, although it is possible that arbitration courts will only have jurisdiction over a certain amount in dispute. The arbitration clause should specify the language, place of arbitration and choice of law.

An important aspect in international contracts is the choice of law. In principle, the parties are free to decide which law will be applied to the contract. In international transactions, the Rome I Regulation is often applicable if the contractual obligation is in civil and commercial matters and the facts have an international connection. This gives the parties the flexibility to choose a right that seems most favorable to them.

However, it is important that the parties understand the implications of their choice of law and how it may affect the contract. It is also critical to consider whether there is a functioning court system in the countries where the parties are located, as this can affect the enforcement of arbitration decisions.

Conclusion: Careful consideration is crucial

Arbitration can be an effective method of resolving disputes in business contracts, especially in international transactions. The flexibility in terms of choice of law and procedure is a significant advantage. However, it is important for companies to consider the costs, the limited reviewability of arbitration decisions, and the potential unpredictability of decisions.

When drafting contracts, especially with international partners, it is critical that companies think carefully about the inclusion of arbitration clauses and the choice of applicable law. Bringing in legal experts to review and advise can help companies make informed decisions and effectively protect their interests.

In an increasingly global economy, the ability to negotiate and resolve disputes effectively and efficiently across borders is critical to success. Arbitration, if used carefully and strategically, can be a valuable tool for companies seeking to succeed in the modern business world.

Please note that this article provides a general overview and does not constitute specific legal advice. For specific questions or concerns, it is strongly recommended that you consult with an attorney or subject matter expert.

Marian Härtel

Marian Härtel

Marian Härtel is a lawyer and entrepreneur specializing in copyright law, competition law and IT/IP law, with a focus on games, esports, media and blockchain.


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