In this industry, it is generally presumed that arbitration is preferable to litigation. However three recent high-profile arbitral awards highlight the risks of arbitration and demonstrate that, contrary to widespread belief, arbitration is often not cheaper, faster or more predictable than litigation. These three awards, though not strictly maritime in nature, call into question the common practice among corporations of including contractual provisions mandating arbitration in the event of any and every dispute. This is because despite the fact that these decisions are not strictly maritime, the emerging trend in arbitral proceedings also leads to questioning this common practice. As coined by a local judge that will remain nameless, the word "arbitrary" is the root word for the word "arbitration".
In the first case, there were arbitration proceedings that were pending for nearly eight years involving a patent license agreement between the technology companies Amkor Technology and Tessera Technologies. Tessera was awarded $145 million, on top of $64 million Amkor had already paid to Tessera in connection with a prior, related ruling. These adverse awards far exceeded Amkor’s publicly disclosed worst-case estimates of its possible exposure. An article in Corporate Counsel dated July 29, 2014 suggests that the Amkor proceedings present a recent example of the delays, costs and unpredictability often associated with arbitration.
The second case involved coffee giant Starbucks Corporation. Starbucks lost an arbitral award totaling $2.76 billion (including $527 million in interest and legal fees) to Kraft Foods Group Inc. in connection with a dispute related to the termination of an agreement that allowed Kraft to distribute Starbucks coffee in grocery stores. Even for a "giant" like Starbucks, the size of the arbitral award was of enormous significance. Starbucks’ net profits for the years 2011 and 2012 were $1.2 billion and $1.4 billion, respectively. Thus standing alone, the award wiped out two years’ worth of Starbucks’ profits. Starbucks was forced to issue $750 million of additional debt to help raise money to satisfy the adverse award.
The third case involves luxury jeweler Tiffany & Co. Tiffany lost $449.5 million, plus interest, costs and attorney's fees, in an arbitral proceeding to Swatch SA concerning a failed partnership in which Swatch was to develop watches for Tiffany’s brand. Tiffany’s loss surpassed the profits it had earned during all of 2012.
As is commonly the case in arbitrations, neither "loser" has the ability to effectively appeal the decisions. It has been suggested that it is incredible that that risk-averse, well-represented corporations would willingly put such large sums of money in the hands of ultimately unaccountable arbitrators, whose decisions are almost always non-appealable. As a result, it is advised that the instinctive decision to automatically include arbitration language in agreements may need revisiting.
Arbitration Is Problematic for Risk-Averse Corporations
Corporate defendants are often concerned about “runaway juries” in the context of cases in which there is a sympathetic victim and thus, the use of arbitration clauses in agreements is understandable. However, there is nothing that prevents the parties from excluding jury trials from an agreement which does not call for arbitration. Nevertheless, in contractual and other business-related disputes juries may, in fact, be less likely than an arbitrator to award unreasonable damages or issue an unexpected, highly lopsided verdict.
In other words, in connection with business-related disputes, an experienced arbitrator in the industry may be more inclined than a jury to view the parties’ conduct in black-and-white terms and thus rule in a way that overwhelmingly favors one side over the other. For example, it has been suggested that the arbitrator in the Kraft v. Starbucks dispute apparently did precisely that. In that dispute, Kraft asserted that it was owed $2.9 billion, plus attorney's fees. The arbitrator ultimately awarded Kraft a total of $2.76 billion, thus giving Kraft just about everything it wanted. In other words, after considering the underlying agreements and the parties’ positions, the arbitrator read the contract and calculated damages in a way that essentially mirrored Kraft’s demands.
One-sided awards in arbitration underscore what are ultimately larger concerns for risk-averse corporations: The absence of meaningful checks and balances in arbitration proceedings and the extraordinarily wide latitude that arbitrators have in rendering decisions. For instance, arbitrators have broad discretion to decide disputes and may disregard the factual evidence presented by the disputing parties. Furthermore, unlike judges and juries, arbitrators are typically unconstrained by statutes, case law or the rules of evidence. The consequence is that an arbitrator’s subjective notion of fairness in a given case can easily translate into a lopsided award against the losing party, even when the facts and the law are on the losing party’s side. For risk-averse companies seeking some semblance of predictability concerning their legal affairs, the very nature of arbitration arguably renders arbitration a highly precarious prospect.
Arbitration Is Often More Expensive Than Litigation
It is routinely argued—often without empirical support—that arbitration is cheaper than litigation. Although litigation can be costly, many of the costs incurred in litigation are also incurred in arbitration, and additional costs are incurred during the course of a typical arbitration to pay for what is essentially a private judicial system.
The Tiffany v. Swatch arbitration provides concrete evidence of the often-significant costs associated with arbitration. Not only was Tiffany required to pay the $449.5 million award, plus interest, to Swatch, but Tiffany was also required to pay two-thirds of the cost of the arbitration and two-thirds of the reasonable attorney's fees and expenses incurred by Swatch. As a publicly listed U.S. company, Tiffany publicly disclosed these amounts, lifting the veil on how both attorney's fees and forum costs (including arbitrator fees) can be surprisingly high in arbitration proceedings.
Swatch alone incurred approximately $13.3 million in attorney fees (which were found to be reasonable), costs and other expenses (of which the arbitral panel required $8.8 million to be paid by Tiffany). For an arbitration that lasted less than three years, $13.3 million in attorney's fees and related expenses is striking, particularly in comparison to reported legal fees in complex litigation in federal court. It has been stated that the amount of legal fees that Swatch incurred in arbitration was more than twice that of the average total fees for patent litigation in federal court.
Indeed, features of arbitration that once may have made it a less-costly alternative to litigation are increasingly a thing of the past. In many arbitrations today, for instance, discovery is as common as it is in litigation, increasing both the cost of arbitration and the time required to complete it. And recalcitrant parties to an arbitration can often employ dilatory and other tactics that result in significant attorney's fees to both sides as the parties spar over procedural and other issues. In contrast, many courts and judges have established routinely enforced rules that parties must follow and which are not subject to challenge. But in arbitrations, more flexible rules often apply, which give litigious parties and their attorneys more things to argue about, thus further increasing the cost of arbitral proceedings. Furthermore, litigation can often be dismissed at a preliminary stage, such as decisions on motions to dismiss or motions for summary judgment, but such preliminary determinations are less-frequently used in arbitration.
In addition to the attorney's fees each side are required to pay, the parties to an arbitration must pay fees to the arbitral tribunal and to the arbitrators themselves. In the Tiffany v. Swatch arbitration, the costs of the arbitration, which was heard by a panel of three arbitrators pursuant to the rules of the Netherlands Arbitration Institute, totaled $1.2 million ($800,000 of which was paid by Tiffany). In comparison, had the parties used a court in the United States, these costs would have essentially been nonexistent (in Florida State Court, the filing fee is $401.00), given that courts and judges are paid for by the public. Indeed, a 2013 study described in the Global Arbitration Review found that costs for the arbitrators themselves and the arbitral tribunal with respect to one type of arbitral proceeding have risen by 56 percent in just the past eight years. Contributing to the growing cost of arbitration is the fact that unlike in litigation, for which judges are appointed to preside over a case, in an arbitral proceeding the parties will first have to decide on mutually acceptable arbitrators, which often takes time and runs up the attorney's fees of the parties. Once an arbitrator is agreed upon, the parties then have to pay for their services. Since arbitrators are often top lawyers or retired judges with steep hourly rates, this is almost always a significant expense.
The Bottom Line
Despite the disadvantages of arbitration, there always will be circumstances under which arbitration is preferable and perhaps even required. For example, an arbitral proceeding may be the only venue in which a party can secure an enforceable judgment against the assets held by a counterparty in a given country. However, these cases are the exception rather than the rule. The fact remains that even as arbitration can, in theory, offer some advantages over litigation, in practice it is often an inefficient method of dispute resolution. Arbitration, despite its promise of efficiency, often drags on for years and results in substantial fees and costs—which can add up to more than the parties would have spent in traditional litigation.
The one area where it would appear that arbitration is the preferred choice of corporations as opposed to litigation is in cruise line disputes. In the last several years, the major cruise lines have been inserting arbitration provisions in their crew member's employment agreements and now more recently, passenger tickets. In these arrangements, the cruise lines are generally responsible for the filing fee and the fees of the arbitrators, and as discussed above, these costs and fees can be expensive. Nevertheless, the motive of the cruise lines is simple--to deprive their crewmembers and passengers the right to bring their lawsuit in court, before a jury. Regardless of the deprivation of jury trial rights, some have commented that arbitration in these matters is a fair compromise, as while the cruise lines pay for the costs of arbitration (something which crew and passengers cannot generally afford) it allows cases to be heard in a much timelier fashion. Of course, the other side of this coin is that the cruise lines paying the costs may lead to biased results from arbitrators wanting to keep the cruise lines happy and continually utilizing their services.
Nevertheless, for risk-averse companies seeking to effectively manage their legal risks that are not cruise lines, arbitration may place their financial fortunes in the uncertain hands of arbitrators bound by only their own sense of the proper outcome and which may have only a tenuous connection to the law. The lesson for corporate parties is that, instead of agreeing to arbitrate disputes as a matter of course, they should carefully consider whether arbitration will actually be beneficial in a particular instance. As companies like Amkor, Starbucks and Tiffany have discovered, the downsides of choosing arbitration can be significant indeed.
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