Should you have an Arbitration Clause in your Contract?
In today's current economic climate, parties are increasingly turning away from the courts to resolve contractual disputes, in favour of alternative dispute resolution procedures such as arbitration.
To achieve this end it is becoming commonplace to see agreements with clauses which state that the parties must conduct arbitration, in place of litigation.
While in theory these arbitration clauses may appear to relieve parties of the sometimes costly and lengthy litigation process; the reality is often very different, leaving parties confused. This leads to the question, what does your arbitration dispute resolution clause really achieve for you?
What is arbitration?
Arbitration is a process whereby a neutral third party is assigned the role to make binding decisions in relation to a dispute between two parties in relation to performance or lack thereof of parties' contractual obligations.
Arbitration has often been seen as a preferable course over litigation for the alleged lower costs and greater efficiency in resolving disputes. Where the arbitration clause is specifically drafted for disputes it may also require that the arbitrator has special expertise and require either a single arbitrator or a panel format for the arbitration. However in recent times these advantages have been questioned in light of the increased costs of arbitration.
What is an arbitration clause?
An arbitration clause is in the simplest terms, a contractual provision that prevents parties from suing on the contract until the dispute is submitted to arbitration and an award is obtained1. A typical arbitration clause is often referred to as a Scott v Avery clause2.
However due to the uniform Commercial Arbitration Acts3 an arbitration clause which purports to make arbitration a condition precedent before the commencement of litigation will not be upheld by the Court.
The uniform Commercial Arbitration Acts will apply to all contracts, except when a party to a contract is not domiciled or ordinarily resides in Australia.
So what is the net effect of an arbitration clause?
By virtue of the uniform Commercial Arbitration legislation, a typical arbitration clause in the Scott v Avery form will be read down so the parties cannot force arbitration before litigation.4
The net result is that the best an arbitration clause can do is allow a party to apply to the Court for a stay of proceedings and to refer the matter to arbitration, if one of the parties to the dispute does not consent to the arbitration process. By its very nature, a party can only make this application to the Court once litigation has already began.
Therefore a Scott v Avery clause cannot prevent a party from taking a matter to litigation. The reason for this is because courts have made it clear that any clause that purports to oust the Court of its own jurisdiction, and purports to regulate litigation so as to make it the last resort, will not be valid.
It can however be effective to permit the party against whom the litigation is commenced to have the matter referred to arbitration, in lieu of a court determination at first instance.
Litigation can only be definitively regulated so as to be made a last resort, when the uniform Commercial Arbitration legislation does not apply. As mentioned, this is the case when a party to a contract is not domiciled or ordinarily resident in Australia or the parties give their consent. In this instance a Scott v Avery arbitration clause remains effective to its full extent. That is, the contract can force parties to enter into arbitration as a condition precedent to litigation.
It is also important to note that not all disputes between parties are capable of being referred to arbitration. It is only private disputes that can arbitrated. Examples of disputes that are not referrable to arbitration include tax matters and marriage and intellectual property matters that relate to registration and recognition.
Although at first instance an arbitration clause may appear to be advantageous to parties to a contract, and prevent the delay and cost of court proceedings, in reality this may not ultimately be the case, and one must consider the practical effect of such clauses. Parties should seek legal advice to clearly understand the effect and implications of arbitration clauses contained within their contractual agreements before they sign.
1 Butterworths Australian Legal Dictionary (Sydney Butterworths 1997).
2 The name for the clause is taken from the House of Lords decision of Scott and Avery (1856) 5HL CAS811, where their Lordships held that a provision in a contract referring to arbitration a difference between the parties was lawful and accordingly no action was maintainable until an award was made.
3 In South Australia see 55 of the Commercial Arbitrations Act 1986 (SA).
4 See Commercial Arbitrations Act 1986 (SA).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.