Costs: The American rule in English arbitation?
COSTS:THE AMERICAN RULE IN ENGLISH ARBITRATION?
In the last issue of Arbitration Watch mention was made of the incorporation in the GAFTA Rules of Arbitration of an Article 16 which provided that legal costs would not be recoverable unless the parties had agreed in writing. While no time-limit is set for the conclusion of an agreement in writing allowing for the recovery of costs, practically speaking, any such agreement will have to have been executed and brought to the attention of the arbitral tribunal prior to the issuance of the award.
The author of the article obviously thought that this development was worthy of note without, however, explaining why.
While Art.16 has been part of the GAFTA Rules since at least 1st July 2007 and is thus not a new development, its introduction into a system of procedural arbitral rules based on English law is by no means anodyne.
Arbitrations under GAFTA Contracts and Rules of Arbitration are, like all other arbitrations, based on contracts in writing subject to the Arbitration Act 1996.
The Arbitration Act 1996 at s.61(2) makes specific provision for the treatment of costs and reads as follows:
“(2) Unless the parties agree otherwise, the tribunal shall award costs on the general principle that costs follow the event except where it appears to the tribunal that in the circumstances this is not appropriate in relation to the whole or part of the costs.”
It is clear from the formulation of s.61(2) that the rule is (as it always has been under English law) that “costs shall follow the event”. Thus, it is only where the arbitrators “find that in the circumstances this is not appropriate in relation to the whole or part of the costs” that a deviation from the rule is permissible. But even here, the determination is left to the arbitrators as to whether the specific circumstances of any given case justify a refusal to award the winning party all or part of his costs.
What the GAFTA Rule 16 does is:
1. To reverse the principle that costs follow the event by establishing a basic rule that unless otherwise agreed, no costs at all can be awarded.
2. To remove from the arbitrators the power to grant costs at all or, in special circumstances, to use their discretionary power to reduce or to deny costs that would normally be granted to the successful party.
In short, GAFTA Rule 16 turns s. 61(2) on its head.
But apart from these objections of principle, there are objections of a far more pragmatic nature which will, no doubt, be of greater interest to practitioners and parties than those described above.
Put brutally, Art.16 gives the rogue a stick with which to beat the honest man and gives every claim, no matter how specious, a “settlement value”.
To illustrate the point, let us take a hypothetical but entirely realistic case deriving from the recent mad gyrations of the price of wheat.
A seller (S) of wheat sells, on 1st March 2011, to a buyer (B) 10,000 MT of milling wheat for delivery FOB one Black Sea/Turkish port in the month of May 2011 at a price of USD 350/MT. When the time for delivery comes, the market price has risen to USD 450/MT. S. cynically calculates that if he defaults on his contract with B., he can make an immediate extra USD 1,000,000 profit by selling to C. at USD 450/MT. He defaults. What does he risk? His reputation? Too bad: he has none to lose. Being taken to arbitration? Almost certainly. His own legal costs? Maybe, but maybe not. After all, he was quite conscious when he refused to deliver that he had no right to do so, so why should he throw away money in employing lawyers on a case he knows he is going to lose?.Costs of the arbitration? The other side pays up-front the deposit and he counts on either settling the case before the issuance of a final award on “a costs lie where they fall basis” or, as no interest is granted on costs to the successful party, to effectively pay up, a great deal later, only the principal. The other side’s legal costs? No, because he is not a fool, he will never agree that any costs will be paid to the winner because he knows in advance who that winner is: the other side!
Knowing this, he can factor in a possible amicable settlement, a discount on the other party’s principal damages at least equivalent to the irrecoverable legal costs that party will necessarily incur by reason of having to proceed to an award.
This cannot be right and it is not, but this is the entirely predictable result of importing into our English law system a particularly perverse feature of the U.S. legal system.
I rest my case: Art.16 as currently phrased should be excised from the GAFTA Rules as an alien and ugly excrescence on what is otherwise a perfectly sensible system for resolving international soft commodity disputes.
In criticizing the formulation of s.16 it is not our intention to deny that parties and lawyers do on occasion spend far more time and money than the case demands and that it was with the perfectly worthy objective of discouraging such practices that led to the relatively recent introduction of Art.16 in its present form. Unfortunately, the cure is worse than the malady in that it introduces enormous unfairness into the system by depriving the honest man from ever obtaining full indemnification of losses caused by his contract partner’s fault or default.
The truth of the matter is that the drafters of the 1996 Act got it entirely right by reaffirming the old Common Law rule that “costs should follow the event” while giving the arbitrators discretion to deny or cut down on costs which appeared to be excessive or excessively incurred and it was with the perfectly worthy objective of discouraging such cost inflation that Gafta introduced the present wording of Art. 16 into the Rules a few years ago.
For all these reasons and in view of the wave of claims for default which, it is expected, will shortly sweep across the GAFTA arbitration platform as a result of the recent turbulence in the market, a rapid return to the English law rule on costs as specifically reaffirmed in s.61(2) of the Arbitration Act is not only desirable but essential if justice is to be done between the parties to GAFTA arbitrations.
J.S. (Stephen) Smid
Vernate, February 2011