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How Do Arbitration Clauses Work?

Heads of Agreement

Arbitration is a popular form of alternative dispute resolution. Parties can choose arbitration as the means of resolving dispute by expressly agreeing for arbitration in their contract or at a later time. Arbitration clauses are the means by which parties can agree to arbitration.

Process of Arbitration

Similar to a court trial, arbitration involves a neutral third party making a decision on the dispute. The third party (the arbitrator) is selected by the parties and can be chosen from arbitration organisations. Both parties present evidence to the arbitrator and the arbitrator can make a binding decision. You can refer to our guide ‘Arbitration: An Alternative Form of Dispute Resolution‘ for more information on arbitration.

But, in comparison to going to court, arbitration is cheaper and leads to a timely outcome. This is because the process is less informal and parties do not need a lawyer to represent them. A more comprehensive guide on the benefits of arbitration is available here.

Content of Arbitration Clauses

Arbitration Clauses

In an arbitration clause, the parties agree to resolve disputes arising from their contract through arbitration. Arbitration clauses are common in commercial contracts. However, the contents of an arbitration clause may differ if it is a domestic commercial arbitration or an international commercial transaction. In NSW, the Commercial Arbitration Act 2010 (NSW) governs domestic commercial arbitration. However, the International Arbitration Act 1974 (Cth) governs international commercial arbitrations in Australia.

The arbitration clause begins with a statement that provides that parties will refer their disputes arising from the contract to arbitration. Such a statement may be phrased in several ways. The Australian Centre for International Commercial Arbitration (ACICA) provides a model clause: “Any dispute, controversy or claim arising out of, relating to or in connection with this contract, including any questions regarding its existence, validity or termination, shall be resolved by arbitration…“. Parties are free to adopt this clause as it exists within their contract.

Arbitration Rules

An arbitration clause must then agree out the rules of arbitration. Usually, this can involve adopting arbitration rules already established by an organisation. For example, in international commercial disputes, parties can refer to the UNCITRAL Arbitration Rules or rules established by the ACICA in 2016 These rules govern the process of arbitration.

Seat of Arbitration

The parties then agree to a seat of arbitration. This is the place where the arbitration will take place. In domestic arbitration, it is common for parties to accept the state where the business is taking place. For international commercial transactions, it is also common to find that parties refer to an external place as the seat of arbitration. For example, two businesses in different Asian countries may choose London, UK as the seat of arbitration. This provides a neutrality to the dispute resolution process.

Governing Law

The arbitration clause must also set out the governing law. The governing law is the law that the arbitrator will apply to resolve the dispute. Commonly, the governing law will the law in the seat of arbitration. For example, an arbitration taking place in Sydney, NSW will apply the law of NSW. This is also common in international commercial transactions so that an arbitration in the UK will apply UK common law. However, some clauses may require that the arbitrators apply the law of the purchaser or the seller. For example, two parties in different Asian countries may require the arbitration to be held in London, UK but the governing law will be the law of the purchaser’s country in Asia.

Additional Rules

The arbitration clause may also set out some additional rules. For example, the parties may agree on the number of arbitrators. Notably, many arbitration rules contain a default of 3 arbitrators so parties do not need to always agree on this point. Further, the parties may set out the language of arbitration as well.

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