Unravelling the Obstacle Course of Arbitration of Corporate Disputes

Keywords: arbitrability, articles of association, bylaws, corporate disputes, shareholders

Introduction

Corporate disputes can be broadly defined as disputes affecting the rights of shareholders to a company. Given the success of international commercial arbitration and its popularity in industries such as construction or oil and gas, it might come as a surprise that arbitration has not been as widely accepted to resolve corporate disputes. Thus, although several countries, such as most recently Switzerland and Poland, have enacted laws in an attempt to facilitate arbitration in this area, arbitration remains controversial and facing many obstacles. In particular, an analysis of the legal issues and the related policy questions involved reveals that arbitration faces particular problems when applied to corporate disputes, often requiring well-developed case law or, preferably, a robust legislative framework addressing them.

Consent

It is commonly asserted that consent is the cornerstone of arbitration. However, consent does not necessarily play the same role in corporate disputes as in typical contractual relations. Thus, while a shareholders’ agreement would fit the traditional contractual framework, with each shareholder specifically agreeing to be bound by the terms of the contract (including any arbitration agreement), it is also possible to have an arbitration provision included in the company’s articles of association or bylaws. Consequently, if the arbitration provision were to be adopted through a decision by a majority of the shareholders amending the articles of association or bylaws, shareholders in the minority would be bound by an arbitration clause to which they specifically did not agree.

While this is certainly different from the situations frequently encountered in contractual disputes, it is simply an application of the corporate rules on how companies operate. In that regard, minority shareholders will often find themselves bound by resolutions supported by the majority of the shareholders, even if they vote against them, so excluding arbitration agreements from this normal process without any additional reason does not seem justified. Nonetheless, it might still be useful to clarify at a legislative level, like the in the recent reforms in Switzerland, that such type of agreement is non-contractual in nature, which could affect, among other things, how the agreement is interpreted (e.g., the typical rules for contract interpretation might not apply). [1]

Effect on stakeholders

Another source of uncertainty refers to the effect of arbitration on other stakeholders potentially affected by any decision from an arbitrator. As it is well known, because arbitration is often a contractual creation, the effects of an award are only binding on the parties to the arbitration, who must be parties to the arbitration agreement. However, in a dispute between, for example, two minority shareholders in a large company, can the claimant request the invalidation of a resolution adopted by a majority of the shareholders, when many of them are not parties to the arbitration? Another example typical of corporate settings would be derivative actions. These actions are claims brought by the shareholders on behalf of the company against a third party, normally a member of the board. This last hypothetical generates additional questions because, although a director could hold no shares and therefore would not have participated in any vote to include an arbitration provision in the bylaws, the bylaws will probably describe some of his/her duties.

The general understanding is that in situations like those previously described, in which the relief requested would affect third parties’ rights, the arbitrator would not have the authority to grant such relief. This can affect not only the effectiveness of arbitration by reducing the range of available remedies but even the arbitrability of the dispute itself, making it difficult to determine whether any remedy is available that would not affect third parties. [2] Probably the best solution to these problems, as established by the German Federal Supreme Court, is to impose some requirements to keep the other stakeholders informed about the dispute and allow them to participate, making the award enforceable against them as long as these requirements are met. [3]

Conflict of laws

The determination of the applicable law can be another point of contention. Although it is almost universally accepted that parties to an arbitration agreement can in most cases freely choose the law applicable to their case, this may not be the case in many corporate disputes. This is because in cases related to the internal functioning of the company it would seem inconsistent to have the dispute resolved under a law different from the law applicable to the corporate procedure in question, to the point of possibly justifying a limitation of party autonomy. This is further complicated by the fact that countries might follow diverging theories as to which law should apply to a corporation, with the two most common proposals being the law of incorporation and the law of the company’s real seat (i.e., where control and management are effectively exercised). [4] In light of this complexity, the laws regulating corporate arbitration should more clearly regulate this aspect, although the discrepancies between countries on which law should apply are likely to persist in the near future.

Policy issues

Finally, policy concerns can make it complicated to advance in facilitating arbitration of corporate disputes. For instance, in the United States enforcement of shareholders’ rights has traditionally been regarded as the exclusive domain of courts, and attempts to include arbitration clauses in public companies’ bylaws have been met with fierce opposition not just from the shareholders, but also from civil society groups. [5] This is at least partially caused by the fear that arbitration could be used together with class action waivers in order to avoid class litigation, a common forum for this type of dispute in the United States. A detailed study of the potential benefits and drawbacks of class actions is beyond the scope of this short piece, but it should be noted that class arbitration is in principle a possible alternative. In fact, it has been suggested as a solution to facilitate the enforcement of shareholders’ rights in countries, such as India, in which courts are overburdened. [6]

A number of other policy arguments could be raised against arbitration of corporate disputes, although most of them could be overcome with a properly drafted arbitration clause. For instance, although arbitration is usually considered as cheaper than litigation due to its finality, it could be argued that the additional initial costs could prevent shareholders from initiating claims that they would otherwise file in court. Nonetheless, a possible solution is to provide in the clause that the company will cover a majority of the arbitration costs. [7] The lack of an appeal mechanism in arbitration is sometimes also presented as a negative aspect, [8] but the arbitration provision could simply incorporate an appeal mechanism, such as the AAA Optional Appellate Arbitration Rules.

Conclusion

Despite these obstacles, arbitration of corporate disputes can offer several benefits. Arbitration is better suited to offer confidentiality, which might prevent loss of value to the company arising out of negative publicity, at least as long as any requirements to notify stakeholders do not necessitate a full public announcement. Furthermore, having a specialized arbitrator decide this type of dispute could promote a more specialized application of concepts and rules normally applied in corporate law. Besides, arbitration is normally faster and less expensive than court proceedings when including potential appeals. However, for these advantages to outweigh the potential problems previously highlighted, in many countries, it would be advisable to have a more developed legal framework addressing these disadvantages. Although this can be done through the progressive accumulation of case law, that would require parties willing to assume the legal risks of a negative court decision in an underdeveloped area of the law. Consequently, the implementation of more detailed laws seems the preferable approach. In that sense, the fact that more and more countries are enacting laws in this area is an encouraging sign and it might point to a brighter future for arbitration of corporate disputes.

ENDNOTES

[1] Richard G. Allemann, ‘Setting the Ground for Corporate Arbitration in Switzerland: Swiss Parliament Approves New Rules for Arbitration of Corporate Law Disputes’ (Kluwer Arbitration Blog, 17 August 2020) http://arbitrationblog.kluwerarbitration.com/2020/08/17/setting-the-ground-for-corporate-arbitration-in-switzerland-swiss-parliament-approves-new-rules-for-arbitration-of-corporate-law-disputes/ accessed 15 September 2020.

[2] Timothy Cooke, ‘Arbitrability of Shareholder Disputes’ (Lexology, 2 April 2015)

https://www.lexology.com/library/detail.aspx?g=1bf0df32-c826-40c4-a9e5-9f681088325b accessed 15 September 2020.

[3] Tilmann Hertel & Alessandro Covi, ‘Arbitrability of Shareholder Disputes in Germany’ (Kluwer Arbitration Blog, 7 February 2018) http://arbitrationblog.kluwerarbitration.com/2018/02/07/arbitrability-shareholder-disputes-germany/ accessed 15 September 2020.

[4] Joseph Lee, ‘Intra-Corporate Dispute Arbitration and Minority Shareholder Protection: A Corporate Governance Perspective’ (2017) 83 Arbitration: The Intl J Arbitration, Mediation & Dispute Management 85, 95.

[5] Alison Frankel, ‘New Battleground in the Fight Over Mandatory Shareholder Arbitration: Intuit’s Annual Meeting’ (Reuters, 16 January 2020) https://www.reuters.com/article/us-otc-arbitration/new-battleground-in-the-fight-over-mandatory-shareholder-arbitration-intuits-annual-meeting-idUSKBN1ZF2VQ accessed 15 September 2020.

[6] Brian T. Fitzpatrick & Randall S. Thomas, ‘The Indian Securities Fraud Class Action: Is Class Arbitration the Answer?’ (2020) Northwestern J Intl L & B 203.

[7] Hal S Scott & Leslie N Silverman, ‘Stockholder Adoption of Mandatory Individual Arbitration for Stockholder Disputes’ (2013) 36 Harvard J L & Public Policy 1187, 1224.

[8] Claudia H Allen, ‘Bylaws Mandating Arbitration of Stockholder Disputes’ (2015) 39 Delaware J Corp L 751, 801.

Rafael Carlos del Rosal Carmona is a Director at the International Centre for Dispute Resolution (ICDR), a division of the American Arbitration Association, Inc. (AAA).

The views and opinions expressed in the article are those of the author(s) solely and do not reflect the official position of the institution(s) with which the author(s) is /are affiliated. Further, the statements of the author(s) produced herein should not be construed as legal advice.